The SEC’s Office of Compliance Inspections and Examinations (“OCIE”) has released its latest National Exam Program Risk Alert – “Share Class Initiative.”
The OCIE publishes risk alerts to highlight the risks identified during the course of the examination program. The latest focus of advisory activities relates to conflicted recommendations to clients, fees charged, and disclosure practices. Specifically, “OCIE is seeking to identify conflicts of interest tied to advisers’ compensation or financial incentives for recommending mutual fund and 529 Plan share classes that have substantial loads or distribution fees.” This risk alert reminds registered advisers that “you have violated your fiduciary duty when you cause a client to purchase a more expensive share class of a fund when a less expensive class of that fund is available.”
The OCIE staff will review the adviser’s practices in connection with share class recommendation and compliance oversight, including but not limited to, the following primary areas:
Fiduciary Duty and Best Execution: Examiners will review an adviser’s investment practices to confirm they are acting in their clients’ best interest and seeking best execution in connection with recommending or selecting mutual funds and 529 Plan investments to clients. Accordingly, Examiners will identify share classes held and purchased in clients’ accounts and any compensation received by the adviser or any of its associated person related to such investment.
Disclosures: Examiners will review an adviser’s disclosures to clients (including an adviser’s Form ADV Part 2) to ensure adequate disclosure of compensation for the sale of investment products, including asset based sales charges or services fees from the sale of mutual funds. The disclosure should adequately address conflicts of interest inherent in the receipt of such compensation and the practice of handling that conflict.
Compliance Programs: Examiners will review an adviser’s compliance program to determine if it adequately addresses the selection of mutual fund and 529 Plan share classes.
Takeaway: Advisers should assess their supervisory, compliance and/or other risk management systems related to the aforementioned risks; review their compliance policies and procedures; and ensure they have established and implemented sound advisory practices related to share class recommendations and associated fees.