SEC Remains Vigilant on Share Class Selection as Deficiencies Rise

 

SEC Remains Vigilant on Share Class Selection as Deficiencies Rise 

                                                   

For over six years, mutual fund share classes have been a major risk consideration for Registered Investment Advisors (RIAs), and priority for the U.S Securities and Exchange Commission (SEC). Throughout this period, AdvisorAssist has consistently updated RIAs on the SECs’s share class selection risk priority, and subsequent disclosure Initiative. Given the SEC’s continued focus on mutual fund share class selection, we wanted to bring your attention to the increased number of RIAs receiving deficiencies for continuing to operate with lack of disclosure and/or inadequate policies and procedures regarding share class selection. As a fiduciary, an RIA can not place the Advisor’s financial interests ahead of their clients. Violations of an Advisor’s Duty of Loyalty is where regulators continue to maintain that, if the Advisor reaps financial benefit from clients, there will be regulatory action. In addition, even if the Advisor does not stand to financially benefit, under the Duty of Loyalty obligation, rendered advice needs to be in the client’s best interest. Failure to adhere to the Duty of Care and Duty of Loyalty standards, Advisors can be subject to the following disciplinary action items:

• Cease-and-Desist Order and Censure 
• Disgorgement and Prejudgment Interest 
• Civil Penalties
• Individual Liabilities 

Regardless of disciplinary actions, Advisors may be pressured by the SEC to refund clients based on perceived harm to clients, due to the Advisor not adhering to their fiduciary obligations. This can be a material financial impact on an Advisor depending on the severity of potential harm to clients, and you can review results of this financial impact from our prior Blog Posts or through the various releases of the SEC Share Class Initiative. At AdvisorAssist, we remind clients that as part of your fiduciary duty to clients, Advisors should endeavor to purchase the lowest-cost share class available when recommending a particular mutual fund. Further, Advisors must maintain policies and procedures that align with the Advisor’s actual business practice. AdvisorAssist encourages Advisors to perform forensic reviews of their share class selection policies and procedures, while periodically reviewing their mutual fund holdings. Regardless of whether a higher cost share class was purchased or transferred in, if a client is invested in a share class that is potentially not the lowest cost, there is a very important need to ensure the firm has proper documentation substantiating why the client is holding the position. If the Advisor determines and/or discovers that there is no substantive reasoning to support the holding of a higher cost share class, the Advisor should promptly begin to convert the mutual fund to its lowest cost share class. In certain instances, substantive reasoning regarding why a holding isn't converted to the lowest share class may include, but is not limited to:

• Tax implications
• Dollar-cost averaging
• It does not meet the minimum investment/the fund is closed to new investors
• Investment time horizon
• The availability of lower share classes at the custodian

By clicking here, you will find an example of a common deficiency letter related to Share Class Selection. Should you have any current questions or concerns regarding Share Class Selection, please reach out to your Consultant.

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