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FYI: Is the SEC Wearing Its “Reasonableness Pants”?

FYI: In a recent speech, SEC Commissioner Hester Peirce questioned whether the SEC was wearing its “reasonableness pants”* when it undertook the recent Share Class Selection Disclosure Initiative, which earlier this year resulted in 79 settled enforcement actions against advisers that voluntarily self-reported having selected for clients mutual fund share classes that carried a 12b-1 fee when a lower-cost share class for the same fund was available to the clients, ostensibly without adequate disclosure of the attendant conflicts of interest.

While acknowledging that the aggregation of all those cases together helped to preserve precious SEC staff resources, Commissioner Peirce does not view the initiative as a “high point” in the Commission’s history, pointing out the following:

  • All of the 79 settling advisers appeared to have been treated largely the same. Advisers that purportedly “lied” about not taking 12b-1 fees when they actually did, were lumped together with advisers that had disclosed they were taking 12b-1 fees and had disclosed the conflict at hand, at least in broad strokes, but using wording the SEC ultimately deemed to be subpar. While the Enforcement Division made it clear that each firm that responded to the initiative would be assessed on its own merits, lumping firms together in this way, in Commissioner Peirce’s view, placed “great tension” on the due process owed to individual firms.
  • Commissioner Peirce also pointed out the fact that numerous firms in the securities industry participated in the initiative — including some very large firms — suggests that the SEC has fallen down on its job as a regulator. Acknowledging that it is ultimately the firm’s duty to make proper disclosure, she emphasized that the SEC has a duty as regulator as well, to make clear to firms what their obligations are and take appropriate steps to end a problem before it hurts investors on a widespread basis.
    • In the Commissioner’s view, once the SEC had seen wide-scale departure from what it believed were required disclosures occurring over many years, the SEC owed it to regulated firms — and to investors — to be very clear that there is a problem.
    • In her view, this meant going beyond bringing a few enforcement actions and expecting firms to find them on the SEC website and revise their disclosures in light of what they could glean from those orders.
    • To her, this also meant going beyond issuing an OCIE risk alert (as useful as they can be), but rather, should have entailed the SEC issuing its own guidance or promulgating a rule to put an end to the problem before more investors were harmed.
    • In Commissioner Peirce’s view, however, this is not what happened. Rather, “[the SEC] spotted a problem and let it fester without a definitive reaction from the Commission for five plus years. The delay meant that investors went years without the necessary disclosure to appreciate that they were not being put in the cheapest share classes available.”

In her speech, Commissioner Peirce addressed various other examples of SEC regulatory action aside from the initiative and concluded her remarks by inviting those who scrutinize the SEC’s work to identify and inform the Commission about instances in which the SEC is wearing something other than “reasonableness pants.”

Commissioner Peirce’s full speech can be accessed here: https://www.sec.gov/news/speech/speech-peirce-050819.

*The “reasonableness pants” reference appears to be derived from remarks of a District Court judge made earlier this year in the unrelated case brought by the SEC against Elon Musk, where the judge called for the SEC and Musk to put on their “reasonableness pants” and work out their differences on how Musk’s tweets should be monitored.

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