FAQ on SEC’s New Share Class Exams

In July, the SEC’s National Exam Program issued a Risk Alert regarding its new 2016 Share Class Initiative, which has already begun. The following is an FAQ that addresses what you need to know now in order to prepare for a Share Class exam:

  1. What types of firms will the SEC visit?

A. SEC registered investment advisers that offer mutual funds with multiple share classes and/or 529 Plans to clients. Most likely targets will be advisers with an affiliated broker-dealer or those that are dually registered.

  1. What is the primary goal of the SEC initiative?

A. The SEC is conducting exams to determine how investment advisers are monitoring for the actual and potential conflicts that exist when multiple fund share classes are available to clients. Examiners will review not only the firm itself, but also investment adviser representatives, especially those reps that are dually registered.

  1. Are there specific areas of concern for the SEC?

A. Yes. The Exam Staff is concerned that investment advisers and their adviser representatives are not properly disclosing conflicts such as additional compensation for certain share classes offered or other financial incentives for a specific share class recommendation.

  1. What areas of operations will the SEC examiners focus on during these exams?

A. Examiners will be looking for how conflicts are disclosed in client documentation (Form ADV), how best execution is monitored, and how written policies and procedures address the selection process of fund share classes for clients. Supervision of advisory representatives in relation to fund share selection will also be a focus.

  1. Does the SEC define “best execution” in relation to this initiative?

A. Yes. In this case, the SEC has defined “best execution” as “to seek the most favorable terms reasonably available under the circumstances.” Examiners will be looking to see if the adviser and its reps are acting in clients’ best interest as is required under their fiduciary duty.

  1. Are there specific disclosures that the examiners will look for?

A. Yes. Form ADV Parts 2A and 2B will be closely scrutinized by examiners to determine if all material conflicts or potential conflicts have been properly disclosed to clients. An adviser has a fiduciary obligation to make full and fair disclosure of all material facts, which includes all material conflicts that could affect an advisory relationship.

  1. What do examiners want to see in firm written policies?

A. The SEC is looking for firm policies and procedures to address the actual and potential conflicts that exist in relation to the selection of fund share classes for clients. Most importantly, they will compare the firm’s actual monitoring and supervision practices to its written policies in order to identify gaps and inconsistencies.

  1. Will the reviews be limited to the stated areas within the Risk Alert?

A. No. The Staff made a point to mention that the areas discussed within the Risk Alert were a starting point for examiners. These are the areas that they will definitely review, but examiners will routinely ask for additional information. As the exam unfolds they may delve more deeply into other areas.

 View the National Exam Program Risk Alert, “OCIE’s 2016 Share Class Initiative,” July 13, 2016.