The SEC, in its latest share class disclosure settlement with an advisory firm, makes a point of noting, fairly prominently in the settlement order, that the firm chose not to self-report its alleged violations to the Division of Enforcement. The result appears to be that the adviser got hit with more than $900,000 in disgorgement and civil money penalties – part of which could have been avoided by voluntarily coming forward.
If at first you don’t succeed, try again. That appears to be what the SEC has done with the Commission’s unanimous November 25 vote to propose a new Derivatives Rule, designed to “modernize” or “standardize” the use of these financial instruments by mutual funds, exchange-traded funds and other registered funds, as well as business development companies. Now the ball is with the asset management community to decide whether they like this proposed Rule better than the last one.
SECs settlements with advisory firms involving share class violations have gotten a lot of attention recently, particularly when the advisers self-reported under an agency initiative and avoided civil money penalties. Not every advisory firm qualified for that initiative, however, as a recent settlement shows where an adviser had to pay more than $1.5 million, including a $140,000 fine.
Its a limited time offer. The SECs Division of Enforcement will not impose financial penalties against advisory firms that voluntarily report placing clients in certain share classes when less expensive share classes for the same investment are available. Advisers taking advantage of this offer will still have to pay disgorgement and prejudgment interest, be censured and face the possibility of individual liability.
There are two kinds of solicitation that advisory firms might pursue: seeking new advisory clients, and finding new investors for private funds. In terms of compliance, while the two solicitation types share some requirements, they dont share them all - and, in fact, there are some compliance requirements that are unique to each. It is essential that advisory firms design compliance procedures that address the type of solicitation they perform.
Advisers managing funds that pay for marketing and distribution services would be wise to make sure those payments fall within each funds 12b-1 plan. The SECs distribution-in-guise crackdown, which resulted in several settlements in recent months, has already netted two in May - and the month isnt over yet.
Sometimes simple errors can lead to dire consequences. An advisory firm that inadvertently misclassifies distribution and marketing service agreements outside its Rule 12b-1 Plan and then causes its funds to pay for those services, for instance, may well find itself facing an SEC enforcement action.
Sometimes even the big players need to learn a lesson about disclosure. Morgan Stanley Smith Barney and Citigroup Global Markets found this out the hard way when they each settled charges from the SEC that they made false and misleading statements about a foreign exchange trading program they sold to investors.
Theres nothing wrong with putting clients into funds that charge fees for distribution - as long as you first let your clients know of any other funds you manage that do not charge such fees. Its also probably best to if your firm didnt receive those distribution fees.