SEC Share Class Selection Disclosure Initiative

Introduction

In 2018, the United States Securities and Exchange Commission (“SEC”) announced a program (the Share Class Selection Disclosure Initiative or “SCSDI”) whereby investment advisory firms could work with the SEC to self-report instances in which their customers were invested in high-fee share classes when lower-fee options were available in the same fund (“affected investors”). ProEquities and numerous other investment advisory firms voluntarily elected to participate in the SEC’s SCSDI. The purpose of this letter is to provide information on: (a) the circumstances leading to ProEquities’ determination to participate in the SCSDI; and (b) the corrective actions being undertaken. 

ProEquities’ Determination to Participate in the SCSDI

The intent of the SCSDI is to identify instances where advisors did not make required disclosures in connection with the recommendation and sale of mutual fund share classes that paid the advisor fees pursuant to Rule 12b-1 of the Investment Company Act (“12b-1 fees.”)  12b-1 fees, which can range from .25% to 1.00%, are built into a fund’s operating expenses and are used to pay for shareholder servicing costs. The fund company collects 12b-1 fees and pays them to the investment advisory professional (“advisor”) who recommended the fund. The advisor’s receipt of 12b-1 fees is in addition to the separate fee charged by the advisor for managing the customer’s account. 

Advisors can often offer multiple share classes of mutual funds for the same fund, including share classes that do and do not impose 12b-1 fees. An advisor’s recommendation of a higher-fee share class that paid the advisor a 12b-1 fee created a conflict of interest that was not clearly disclosed. This was a conflict because, by investing in higher-fee share classes, investors either paid more in expenses or received a lower rate of return than they would have received if they had invested in lower-fee share classes. 

Corrective Actions Undertaken

ProEquities voluntarily elected to participate in the SEC’s SCSDI to address past conflicts of interest issues related to the payment 12b-1 fees. The SCSDI review period was from January 2014 through June 25, 2018, however, ProEquities stopped paying advisors 12b-1fees for advisory accounts in October 2016, with the exception of a small number of accounts. Although ProEquities stopped paying advisors the 12b-1 fees, many customers continued to pay the 12b-1 fees until moved to a lower-fee share class, as discussed below.  

ProEquities also agreed to distribute approximately $1.852 million to affected investors (“Distribution Fund”). The Distribution Fund consists of the 12b-1 fees attributable to the affected investors ($1,638,191.06) plus prejudgment interest ($214,192.04). ProEquities will deposit the Distribution Funds into an escrow account and make distributions to affected investors over the next several months in accordance with SEC requirements.  
As part of the agreement with the SEC, ProEquities agreed to complete the following activities within 30 days:

1. Review and correct as necessary all relevant disclosure documents concerning mutual fund share class selection and Rule 12b-1 fees.  
2. Evaluate whether to move existing clients to a lower-cost share class and move clients as necessary.  
3. Evaluate, update (if necessary), and review the effectiveness of internal policies and procedures so that they are reasonably designed to prevent subsequent violations regarding mutual fund share class selection. 
4. Notify affected investors of the settlement terms.  

If you are a current ProEquities client, you will receive a refund via check in the next several months. A separate communication will detail the amount of the refund.  If you are no longer a current ProEquities client and the amount of the refund exceeds $10, you also will receive a refund via check in the next several months. If you are no longer a current ProEquities client and the amount of the refund is less than $10, you will NOT receive a refund.  

If you have any questions regarding the SCSDI, please contact your ProEquities advisor or ProEquities Client Services at 1-800-288-3035. You may review the Order at this link: 

https://www.sec.gov/litigation/admin/2019/ia-5125.pdf

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