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US SEC building in Washington, D.C., 2008 Chip Somodevilla/Getty Images
US SEC building in Washington, D.C., 2008

FSI Hits SEC for 'Regulation by Enforcement'

FSI argued in a petition that the SEC's Share Class Selection Disclosure Initiative unfairly subjects brokers to de facto rules and regulations.

The Securities and Exchange Commission should end its policies of “regulation by enforcement,” according to a new petition from the Financial Services Institute and several other advocacy organizations. In the petition, they argue the SEC's Share Class Selection Disclosure Initiative regarding fees for high-cost mutual fund share classes unfairly subjects brokers to de facto rules and regulations the agency never passed.

“Americans should never be at the mercy of independent agencies’ extralegal ‘guidance,’ particularly when that guidance seeks to retroactively coerce compliance outside the rule-making process prescribed by Congress and impose massive penalties on them for failure to conform to such extralegal standards,” the petition read. “The Commission should initiate a rulemaking to promulgate the proposed rules and end these unlawful ‘regulation by enforcement’ practices.”

However, consumer advocates dispute this framing, including Barbara Roper, the director of investor protection at the Consumer Federation of America. She called the FSI’s illustration of the SEC’s actions as an attack on 12b-1 fees as an “absurd” characterization.

“They say the SEC is trying to ban 12b-1 fees; they’re not,” Roper said. “They don’t prohibit fiduciary advisors from steering investors into higher class share funds...all they’ve said is ‘if you do that, you have to disclose it.’ Does that sound like banning fees?”

FSI’s petition arrived several weeks after the SEC announced it was settling charges against three advisors who self-reported during the disclosure initiative. According to the SEC, these orders would be the final cases the commission’s Division of Enforcement would intend to recommend under the terms of the initiative.

The SEC originally announced the initiative in February 2018, offering advisors a chance to self-report failures to disclose conflicts of interests with clients about recommendations on more expensive mutual fund share classes when cheaper options were available. By doing so, the SEC said, advisors and firms could avoid stronger civil penalties. The commission eventually issued orders against nearly 100 advisors who self-reported between March and September of last year.

But the FSI, along with the American Securities Association, the Competitive Enterprise Institute and the New Civil Liberties Alliance, argued in the petition the SEC had long endeavored to outlaw Rule 12b-1 fees, which advisors can receive for selling and marketing certain funds, and resorted to creating self-reporting programs like the disclosure initiative in lieu of an official rule banning the fees. The critiques in the petition mirror a broader push from the FSI to halt the SEC Enforcement Division’s reliance on guidance to self-report.

FSI CEO Dale Brown said firms and advisors deserved to be aware of “the rules of the regulatory road” and to have time to make necessary changes.

“It is for this reason that Congress established the requirements of the rulemaking process, and we urge the SEC to address our concerns with regulation by enforcement as called for in the petition,” he said.

However, Roper said FSI seemed to be opposed to the fact that advisors or firms would need to disclose certain information about their share class options to clients, including that there may be more affordable options available for clients. She said that while there were many advisors who did take their fiduciary responsibilities seriously, the advocacy organizations' petition and broader argument suggested such advisors might not be found at FSI or ASA.

“Their objection isn’t regulation through enforcement,” she said. “Their objection is enforcement of regulation. It’s a very cynical campaign.”

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