Petition for Rulemaking to End the Commission’s Backdoor Regulation of 12b-1 Fees


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This petition is about the Securities and Exchange Commission’s thirty-year effort to effectively outlaw Rule 12b-1 fees, and the concerted campaign of subregulatory sabotage upon which it embarked when it could not get its way through the proper channels.

It is no secret that the Commission has long opposed Rule 12b-1 fees—the fees that mutual funds use to compensate financial advisers for ongoing sales and marketing assistance.  The agency has tried to repeal or otherwise undo the Rule for the better part of a decade.  See infra pp. 7–10.  But the Rule remains important to the broader investment community, accounting for nearly $10 billion a year in economic activity.  E.g., Mutual Fund Distribution Fees, Securities Act Release No. 9128, Exchange Act Release No. 62,544, Investment Company Act Release No. 29,367, 75 Fed. Reg. 47,064, 47,070 (Aug. 4, 2010).  And the Commission has never been able to garner the political will needed to repeal it.  So Rule 12b-1 is, and remains, the law.  See 15 U.S.C. § 80a-12(b); 17 C.F.R. § 270.12b-1 (Rule 12b-1).

On paper, that is.

Although federal law requires agencies to conduct rulemaking in a transparent manner and to seek public input, agencies often overlook these mandates and impose their rulemaking through the backdoor.  The Commission’s actions here are a prime example of these practices.  Having failed to repeal or seriously refashion Rule 12b-1 through conventional means, the Commission has turned to “guidance,” coupled with “voluntary” self-reporting programs for those in violation of the “guidance,” and punitive enforcement actions for those who refuse to turn themselves in.  So with a few speeches, “initiatives,” “frequently asked questions,” and the like, the Commission has achieved what, through rulemaking, it could not—the effective repeal of Rule 12b-1.  The law, however, does not countenance such guerilla governance.  

Why does this matter?  Yes, there are policy concerns.  Rule 12b-1 helps funds to grow their asset base, lowering investors’ average costs; it offers investors flexible payment options, and it helps to compensate intermediaries for valuable services.  There is, in fact, abundant literature on the benefits of Rule 12b-1 that the Commission has ignored.  See infra pp. 5–6.  But more is at stake than policy.

This is about the rule of law.  In this country, there is law that governs the government.  For good reason.  Agencies like the Commission wield massive power.  They promulgate binding regulations.  And they bring enforcement actions against private citizens.  But their leaders are not elected, nor are they fully accountable to anyone who is.  So we at least demand that these agencies act in the open and in accordance with the law.  People who will have to comply with a new rule can bring their knowledge and experience to the table in shaping and improving a proposed rule.  Congress can monitor the agency’s actions.  And, most important, the people can see the rules for themselves—and try to comply—before the agency initiates an enforcement action.  This is fundamental, and it is the policy of the current Administration:  “Regulated parties must know in advance the rules by which the Federal Government will judge their actions.”  Executive Order No. 13,892, 84 Fed. Reg. 55,239, 55,239 (Oct. 15, 2019).

None of that has happened here.  In its latest guidance documents, the Commission announced a brand-new, detailed disclosure regime that the agency had previously failed to discern in existing law, was never mentioned in any rule, and which, presumably, the entire investment adviser industry has been violating for decades.  Worse still, the Commission has used its newly minted standards, not only to impose obligations going forward (without notice-and-comment), but also to retroactively punish scores of firms for conduct that no one knew, or even could have known, was supposedly unlawful.  That is not how the rule of law works.

The Commission’s actions here go well beyond permissible “guidance.”  Its pronouncements do not merely “clarify or remind” investment advisers of their “preexisting duties.”  Mendoza v. Perez, 754 F.3d 1002, 1022 (D.C. Cir. 2014).  Far from it.  Here, the Commission’s edicts “supplement” the existing regulatory regime “by imposing specific,” newly minted “duties” on an entire industry, id.—duties that cannot fairly be traced to any “existing document,” id. at 1021, and that are backed by the threat “of significant . . . civil penalties,” Army Corps of Eng’rs v. Hawkes Co., 136 S. Ct. 1807, 1815 (2016).  Accordingly, these pronouncements should have been promulgated through notice and comment, should have been transmitted to Congress for review, and should have been discussed with the Office of Information and Regulatory Affairs.  And in no event should the Commission have attempted to apply the guidance retroactively.

To correct these myriad errors, the Financial Services Institute, American Securities Association, Competitive Enterprise Institute, and New Civil Liberties Alliance petition the Commission to initiate a rulemaking to promulgate regulations to bring the Commission’s guidance into compliance with applicable law.  See 5 U.S.C. § 553(e); 17 C.F.R. § 201.192(a).  Corrective rulemaking is imperative, as the Commission—in the words of its Co-Director of Enforcement—is “not resting on the success of” its misguided effort to regulate Rule 12b-1 fees out of existence; far from it, the Commission has just as improperly turned its attention to the longstanding, widespread, and previously uncontroversial practice of revenue sharing.  Stephanie Avakian, Co-Director, Div. of Enforcement, U.S. SEC, What You Don’t Know Can Hurt You: Keynote Remarks at the 2019 SEC Regulation Outside the United States Conference (Nov. 5, 2019),‌/news‌/speech‌/speech-avakian-2019-11-05.  This expanding effort to regulate without rulemaking must stop.  The Commission should comply with its legal obligations and with the policy of this Administration—not open a new frontier.  Indeed, if there were ever a time for the Commission to recommit itself to promoting regulatory certainty, this is it—a time when the financial services industry is fighting to regain its footing as the nation pulls itself out of the current crisis and gears up for the impending recovery. 


    1. Mutual Funds And 12b-1 Fees.

Investment advisers have long recommended mutual funds to their clients.  Mutual funds give regular investors access to diversified, professionally managed portfolios of equities, bonds, and other securities.  And they do so at low cost.  E.g., Comment Letter from Financial Services Institute 2, File No. S7-15-10 (Nov. 5, 2010) (“FSI Comment”).

The key is economies of scale.  Many expenses associated with running a mutual fund are constant.  The same legal opinion, for instance, can guide a $50 million fund or a $500 million fund.  The total cost is the same.  But in the larger fund, the expense is spread over a greater asset base, meaning that each investor pays a smaller share per invested dollar.  And with lower per-investor costs, come higher per-investor earnings.

Enter Rule 12b-1.  Because growing fund size generates economies of scale, there are circumstances in which it may be appropriate for a mutual fund to use fund assets to fuel the sale of its own shares.  E.g., Comment Letter from American Bar Association Business Law Section 3, File No. S7-15-10 (Nov. 5, 2010); Comment Letter from Charles Schwab & Co. 5, File No. S7-15-10 (Nov. 5, 2010).  And that is exactly what Rule 12b-1 allows, just as Congress intended when it first enacted Section 12(b) of the Investment Company Act of 1940.  See Pub. L. No. 768, § 12(b), 54 Stat. 789, 809 (codified as amended at 15 U.S.C. § 80a-12(b)) (permitting mutual funds to participate in the distribution of their own shares in accordance with the “rules and regulations [of] the Commission”).  Promulgated in 1980, Rule 12b-1 permits mutual funds to use fund assets to pay investment advisers and other intermediaries for providing services that are “primarily intended to result in the sale of [the fund’s] shares.”  Bearing of Distribution Expenses by Mutual Funds, Securities Act Release No. 6254, Investment Company Act Release No. 11,414, 45 Fed. Reg. 73,898, 73,905 (Nov. 7, 1980) (codified at 17 C.F.R. § 270.12b-1(a)(2)).  It remains the law.

And it remains “an integral part of the structure and strength of the mutual fund industry.”  Comment Letter from Prudential Investments, LLC 1, File No. S7-15-10 (Nov. 8, 2010).  The Rule:

  • Expands investor choice.  By offering multiple classes of shares (some with 12b-1 fees, some without) mutual funds enable investors “to select the pricing option that best suits their needs.”  Comment Letter from Investment Company Institute 11, File No. 4-538 (July 19, 2007) (“2007 ICI Comment”).  Some investors, for example, prefer class “A” shares.  Those shares generally are sold with a “front-end” load, see 75 Fed. Reg. at 47,066 n.22—that is, a fee that pays the intermediary’s “entire remuneration up front,” at the time of the purchase, Comment Letter from Financial Planning Association 2, File No. S7-15-10 (Nov. 5, 2010) (“FPA Comment”).  Other investors, however, prefer class “C” shares.  See id. (“Class C shares are often the preferred vehicle for investing . . . .”).  Those shares typically “avoid [the] high front-end loads” of class “A” shares, 75 Fed. Reg. at 47,068, and allow investors to pay “distribution costs over time,” 2007 ICI Comment 1—usually in the form of an annual, “100 basis point 12b-1 fee,” 75 Fed. Reg. at 47,070.  

  • Benefits regular investors.  “For many investors, particularly those with relatively smaller amounts to invest, [12b-1 fee-paying] C shares have proven to be the best available option to obtain . . . the ongoing services of a financial professional.”  Comment Letter from Investment Company Institute 11, File No. S7-15-10 (Nov. 5, 2010) (“2010 ICI Comment”).  The 12b-1 fees are “used to pay . . . for bundled financial planning advice[ and] active account management” services, Comment Letter from Center for Capital Markets Competitiveness of the U.S. Chamber of Commerce 3, File No. S7-15-10 (Nov. 5, 2010)—services that “investors with more modest amounts to invest” would not otherwise qualify for, 2010 ICI Comment 11 n.23.  And “[e]ven if they [did] qualify,” they would (without the option to pay in 12b-1 fees) “stand to pay substantially more by virtue of a minimum [account management] fee.”  Id. at 11; see, e.g., Comment Letter from David A. Madsen, Financial Advisor, Bank of America-Merrill Lynch, File No. S7-15-10 (Sept. 17, 2010) (explaining that without “‘C’ shares,” advisers would have to “abandon . . . smaller accounts” or transition them “into a much higher fee-based wrap account with base annual fees of $500.00 per year,” which “would be prohib[i]tive to the small investor”); see also Comment Letter from Securities Industry and Financial Markets Association 5, File No. S7-15-10 (Nov. 5, 2010) (“SIFMA Comment”) (“[S]mall investors[] may be forced to select investment advisory account alternatives . . . at significantly higher cost.”).

  • Aligns incentives.  “12b-1 fees support and encourage . . . ongoing relationships” between investment advisers and investors.  FSI Comment 5.  If, for example, “a small client purchases a front-end load share class,” the adviser may have less of an “incentive to provide ongoing service.”  Comment Letter from Commonwealth Financial Network 3, File No. S7-15-10 (Nov. 5, 2010) (“Commonwealth Comment”).  Not so with 12b-1 fees.  See, e.g., Investment Company Institute Cost-Benefit Analysis of SEC Rule 12b-1 Reform Proposal 13, File No. S7-15-10 (Dec. 1, 2010) (“ICI Cost-Benefit Analysis”) (explaining that 12b-1 fees “act as an incentive for financial professionals to continue to provide [ongoing] services”); Commonwealth Comment 3 (“The main advantage for C-shares to small investors is that it gives their advisor an incentive to continue to service their account.”); FPA Comment 2 (stating that 12b-1 fees are “highly effective at providing agents with the compensation necessary for them to service smaller accounts”).  

  • Unlocks freedom of movement.  Investors “may not want to buy class A shares” if they “have a short or uncertain time horizon.”  2010 ICI Comment 11; see also ICI Cost-Benefit Analysis 24–25 (explaining that total cost “depends on [investors’] holding periods”).  Because investors are “free to liquidate a C-share in one fund family and purchase a C-share in another,” without the upfront costs of purchasing an A-share, many investors “may be willing to pay [the 12b-1 fees associated with a C-share] for the freedom to move along fund families.”  Commonwealth Comment 3.

  • Diversifies distribution channels.  Rule 12b-1 has “resulted in an increase of available distribution channels for mutual funds,” FSI Comment 5, with funds fashioning “share classes that incur fees that reflect the different services investors receive through [different] distribution channel[s],” ICI Cost-Benefit Analysis 5.  Investors “seeking advice and assistance” can purchase share classes designed for that experience through “securities firms, banks, insurance agencies, and financial planning firms,” id., while investors seeking a more “self-directed model” can access other share classes through “fund supermarkets,” SIFMA Comment 2.

  • And fosters competition.  “The ability of funds to assess [12b-1 fees] has allowed many small fund groups to remain competitive by allowing them to gain access to a wider array of distribution channels, such as fund supermarkets, than they otherwise would have through traditional front-end sales load structures.”  ICI Cost-Benefit Analysis 5; accord, e.g., Review of Current Investigations and Regulatory Actions Regarding the Mutual Fund Industry: Hearing Before the S. Comm. on Banking, Hous. & Urban Affairs, 108th Cong., 2004 WL 715513 (Mar. 31, 2004) (statement of Thomas O. Putnam, Founder & Chairman, Fenimore Asset Mgmt.).  Small funds simply “could not exist without the existence of the 12b-1 fee to grow the funds.”  Div. of Inv. Mgmt.: Rule 12b-1 Roundtable Tr. 67:16–17 (June 19, 2007) (statement of Mellody Hobson, President, Ariel Capital Mgmt.),‌/news‌/openmeetings‌/2007‌/12b1transcript-061907.pdf; see id. at 68:12–15 (“[I]t’s the only reason, having that 12b-1 fee plan, that we can be in the plans at Wal-Mart and General Motors, alongside other gigantic mutual fund companies, like Fidelity and others.”).  

“Investing is not a ‘one-size-fits-all’ proposition . . . .”  Commonwealth Comment 3.  And Rule 12b-1 recognizes that reality, fostering an environment in which investors can take account of “many factors, such as account size, time horizon, . . . impact of paying front-end vs. level . . . charges, and the flexibility to move from one fund family to another, when determining the share class or account type that is more suitable” to their needs.  Id.  

    1. The Commission’s Failed Two-Decade-Long Effort To Modify Or Repeal Rule 12b-1.

Despite the benefits of Rule 12b-1, the SEC has long been skeptical of its own Rule.  From day one, the Commission announced that it would “monitor the operation of” Rule 12b-1 and its companion rules “closely and [would] be prepared to adjust the rule[] in light of experience.”  45 Fed. Reg. at 73,901.

Within eight years, the Commission was complaining about “the innovative use of rule 12b-1,” and the “wide variety of increasingly complex . . . arrangements” that “were not or could not have been anticipated when the rule was drafted.”  Payment of Asset-Based Sales Loads By Registered Open-End Management Investment Companies, Investment Company Act Release No. 16,431, 53 Fed. Reg. 23,258, 23,274 (June 21, 1988).  For example, in 1988, many funds had begun offering shares with “contingent deferred sales loads,” or CDSLs.  Id. at 23,266 & n.69.  Unlike a traditional “front-end” load, where an investor pays a sales commission at the time of the purchase, a CDSL is paid when an investor redeems his or her shares.  Id.  The Commission worried that these plans were increasing 12b-1 fees.  So it proposed to eliminate certain arrangements that facilitated the CDSLs’ operations.  But “[m]any commenters opposed the proposed amendments, arguing that spread load plans benefited investors by permitting them to defer their distribution costs and avoid high frontend loads.”  75 Fed. Reg. at 47,068.  And the Commission backed down, “never adopt[ing] [its proposed] amendments.”  Id.

The story is familiar.  Over the years, the Commission has repeatedly complained that the market has evolved since 1980 and that Rule 12b-1 should therefore be “reexamine[d]” (2002), “refashion[ed]” (2004), or “replace[d]” (2010).  See Mutual Fund Distribution Fees, Securities Act Release No. 9128, Exchange Act Release No. 62,544, Investment Company Act Release No. 29,367, 75 Fed. Reg. 47,064, 47,064 (proposed Aug. 4, 2010); Prohibition on the Use of Brokerage Commissions to Finance Distribution, Investment Company Act Release No. 26,356, 69 Fed. Reg. 9726, 9731 (proposed Mar. 1, 2004); Harvey L. Pitt, Chairman, U.S. SEC, Remarks Before the Investment Company Institute (May 24, 2002),‌/news‌/speech‌/spch562.htm.  But, time and again, the Commission’s efforts fell short.  Consider:

  • By 2000, the Commission’s staff was pushing its own reforms, advocating for “modifications” to the Rule “to reflect . . . the experience” that they had “gained from observing how [the Rule had] operated since it was adopted in 1980.”  Div. of Inv. Mgmt., U.S. SEC, Report on Mutual Fund Fees and Expenses pt. IV.B.2. (2000),‌/news‌/studies‌/feestudy.htm.

  • Within two years (2002), the Chairman had taken up the staff’s cause.  Market practices had “changed,” the Chairman declared, so it was time for a thorough “reexamin[ation]” of Rule 12b-1.  Pitt, Remarks Before the Investment Company Institute, supra.

  • In 2004, the Commission proposed “refashion[ing]”—or even repealing—Rule 12b-1 to address “issues that [had supposedly] arisen under the rule.”  69 Fed. Reg. at 9731–32.  But the Commission soon retreated.  See Prohibition on the Use of Brokerage Commissions to Finance Distribution, Investment Company Act Release No. 26,591, 69 Fed. Reg. 54,728, 54,731 (Sept. 9, 2004) (“We are not adopting any further changes to rule 12b-1 today.”).

  • In 2007, the Commission was still “further explor[ing]” its options.  75 Fed. Reg. at 47,071.  Chairman Cox proclaimed that “today’s uses of 12b-1 fees ha[d] strayed from the original purposes underlying the rule, and [that] it [was] time for a thorough re-evaluation.”  Commission Announces Roundtable Discussion Regarding Rule 12b-1, Press Release No. 2007-106 (May 29, 2007),‌/news‌/press‌/2007‌/2007-106.htm.  And the agency convened a roundtable to discuss whether Rule 12b-1 had “outlived its purpose.”  Agenda for Rule 12b-1 Roundtable (June 19, 2007),‌/spotlight‌/rule12b-1‌/rule12bagenda-061907.htm. 

  • The next year (2008), the Chairman stressed that “repeal or reform of rule 12b-1” was still “on the Commission’s front burner.”  “[I]n the coming days,” he said, “you can look for the SEC to open up the hood of this old jalopy and start cleaning out the gunk.  When the overhaul is done, I predict there won’t be a 12b-1 anymore. . . .  [W]e can throw [it] out . . . in favor of modern regulation that is more consistent with economic realities.”  Christopher Cox, Chairman, U.S. SEC, Keynote Address to the Investment Company Institute 4th Annual Mutual Fund Leadership Dinner (Apr. 30, 2008),‌/news‌/speech‌/2008‌/spch043008cc.htm.

  • In 2009, the Commission expressly addressed 12b-1-style payments—the payments a fund makes to a “broker-dealer or other financial intermediary . . . for the sale of Fund shares.”  Enhanced Disclosure and New Prospectus Delivery Option for Registered Open-End Management Investment Companies, Securities Act Release No. 8998, Investment Company Act Release No. 28,584, 74 Fed. Reg. 4546, 4557 (Jan. 26, 2009).  But the Commission admitted that it would be “more appropriate” to set standards for “describ[ing] . . . rule 12b-1 fees . . . in the context of [the supposedly forthcoming] full reconsideration of . . . rule 12b-1.”  Id. at 4555–56.

  • By 2010, the Commission had “carefully considered” the views that “emerged from the [2007] roundtable discussion.”  75 Fed. Reg. at 47,073.  And the agency advocated scrapping the allegedly “outdated” Rule 12b-1 in its entirety and starting over.  Id. at 47,064.  Seemingly every Commissioner agreed:

  • Chairman Schapiro asserted the need to “modernize” Rule 12b-1, which she said was “borne of a period in the late 1970s . . . as a short-term solution.”  Mary L. Schapiro, Chairman, U.S. SEC, Opening Statement at the SEC Open Meeting—12b-1 Fees (July 21, 2010),‌/news‌/speech‌/2010‌/spch072110mls-12b1.htm.

  • Commissioner Casey opined that “Rule 12b-1 has evolved from its original, more limited purpose” and that new rules were needed to “reflect the realities of . . . the market.”  Kathleen L. Casey, Comm’r, U.S. SEC, Statement at SEC Open Meeting—Mutual Fund Distribution Fees (July 21, 2010),‌/news‌/speech‌/2010‌/spch072110klc-12b1.htm.

  • Commissioner Paredes supported the “far-reaching” new proposal.  Troy A. Paredes, Comm’r, U.S. SEC, Statement at Open Meeting to Propose Amendments Regarding Mutual Fund Distribution Fees (July 21, 2010),‌/news‌/speech‌/2010‌/spch072110tap-12b1.htm.

  • Commissioner Walter stated that “[i]n my view, and I know that the staff shares it as well, reforming our regulatory approach to 12b-1 fees is an initiative whose time has come.”  Elisse B. Walter, Comm’r, U.S. SEC, Opening Statement at SEC Open Meeting—Mutual Fund Distribution Fees (July 21, 2010),‌/news‌/speech‌/2010‌/spch072110ebw-12b1.htm. 

  • And Commissioner Aguilar endorsed the proposed “paradigm shift in the regulatory framework.”  Luis A. Aguilar, Comm’r, U.S. SEC, Working Toward Fairness and Transparency in Distribution Costs (July 21, 2010),‌/news‌/speech‌/2010‌/spch072110laa-12b1.htm. 

  • Yet in 2015, “12b-1 fees were [still] in [the Commission’s] sightline,” the 2010 rulemaking having been inexplicably abandoned.  M. Waddell, 12b-1 Fees in Crosshairs at SEC—and DOL, ThinkAdvisor (Feb. 1, 2016),‌/2016‌/02‌/01‌/12b-1-fees-in-crosshairs-at-sec-and-dol/ (discussing Chairman White’s statements).

Throughout this time, the Commission recognized the vital importance of following proper procedures given the significant economic interests at stake in this area.  For example, Commissioner Casey noted that “[g]iven the significance of the 12b-1 fees to the mutual fund market, it is vital that the Commission fully understand the potential impact of changes in this area”; “[w]e need to hear from investors and others as to the consequences—either positive or negative—of [changing Rule 12b-1].”  Casey, Statement at SEC Open Meeting, supra.  But nothing happened.  Having begun the required process of notice-and-comment rulemaking, and received over 1500 public comments along the way (see 75 Fed. Reg. at 47,071), the Commission chose not to proceed down that path.  Rule 12b-1 survived, more or less unscathed.  And it is still the law today.

    1. The Commission’s Alternate Plan: Eliminate 12b-1 Fees Through The Backdoor.

      1. “We promise that if we find [you] later we will punish [you] more severely.”

In 2018, having failed through notice-and-comment procedures to reshape Rule 12b-1, the “SEC Launche[d],” in its words, a so-called “Initiative.”  SEC Launches Share Class Selection Disclosure Initiative to Encourage Self-Reporting and the Prompt Return of Funds to Investors, Press Release No. 2018-15 (Feb. 12, 2018),‌/news‌/press-release‌/2018-15 (Exhibit 1) (“Share Class Selection Initiative”).  This “Share Class Selection Disclosure Initiative” had not gone through notice-and-comment rulemaking, had not been reviewed by Congress, and had not been discussed with the Office of Management and Budget’s Office of Information and Regulatory Affairs.  Nevertheless, the Initiative targeted “widespread” industry practice—and tried to change it virtually overnight.

For decades, investment advisers had disclosed 12b-1 fees.  The disclosures were simple and straightforward: because the investment adviser received 12b-1 fees in connection with a client’s investment, the adviser faced a conflict of interest: to recommend mutual funds that paid a higher fee.  Armed with this information, investors could decide how best to proceed.  No statute, regulation, or litigated case questioned these straightforward disclosures.  And they became the standard method of discussing 12b-1 fees—all $10 billion a year worth, 75 Fed. Reg. at 47,070.

Until the Initiative.  The Initiative proclaimed that virtually every investment adviser had been violating federal law, presumably for decades, based on the Enforcement Division’s opinion of what the disclosures should contain.  Even though advisers disclosed that they placed their clients in a 12b-1 fee paying share class, and that the receipt of 12b-1 fees created a potential conflict of interest, the Initiative declared that advisers had more to do.  Advisers were “required” to state explicitly, in very particular language, that “a lower-cost share class was available.”  Share Class Selection Initiative pts. Introduction, III.A (Feb. 12, 2018),‌/enforce‌/announcement‌/scsd-initiative; see id. pt. II (quibbling over the use of the word “may” versus the word “will”).  But the Commission could find no statute, regulation, or litigated case that had ever mentioned such an additional disclosure.

Even so, the Initiative “encourage[d]” advisers—presumably, all of them—to “self-report” their violations of the “clear,” yet heretofore unknown, “legal and regulatory requirements” announced in the Initiative.  Press Release No. 2018-15, supra (emphasis added).  Behind the “encouragement” was an explicit threat: “For advisers that would have been eligible for the terms of [the Initiative] but did not participate, the Division [of Enforcement] expects . . . to recommend additional charges . . . and the imposition of penalties. . . .  A [case] against an eligible adviser that fails to self-report under the . . . Initiative may include greater penalties than those imposed in past cases . . . .”  Share Class Selection Initiative pt. III.E (emphasis added).  Or as the Co-Director of Enforcement put it: “we promise that if we find [an adviser] later we will punish [it] more severely.”  S. Garmhausen, SEC to Advisors: Don’t Test Us, Barron’s (Mar. 2, 2018),‌/articles‌/sec-to-advisors-dont-test-us-1520021433 (emphasis added).  The directive to the industry was clear:  (A) you are all violating the law; (B) the smart ones among you will take our “offer” and settle with us; and (C) we will sue the rest of you and you will be penalized not just for the alleged legal violation but also for not “cooperating” with us.  

Industry got the message.  Within a year, 79 investment advisers responded to the Initiative’s “incentive[s],” self-reporting their “violations” and coughing up “more than $125 million” in refunded 12b-1 fees.  SEC Share Class Initiative Returning More Than $125 Million to Investors, Press Release No. 2019-28 (Mar. 11, 2019),‌/news‌/press-release‌/2019-28.  More settlements have been announced since.  See SEC Orders Three Self-Reporting Advisory Firms to Reimburse Investors, Press Release No. 2020-90 (Apr. 17, 2020),‌/news‌/press-release‌/2020-90 (declaring that the Commission has ordered a return of “more than $139 million”); Div. of Enforcement, U.S. SEC, 2019 Annual Report 2 (2019),‌/files‌/enforcement-annual-report-2019.pdf (announcing that 95 investment advisers had “voluntarily self-reported” to the Commission); see also RBC Capital Mkts. LLC, Securities Act Release No. 10,777, Exchange Act Release No. 88,745, Advisers Act Release No. 5487 (Apr. 24, 2020),‌/litigation‌/admin‌/2020‌/33-10777.pdf (announcing settlement).  Plainly, because the Initiative uses mandatory language, it “speaks” with the force and effect of law.  There is nothing in it that suggests it is not mandatory.

Underscoring the need for this petition, more investigations are underway, built on the settlements wrenched out of the “voluntary” self-reporters.  See SEC Press Release 2020-90, supra (promising to “continue to actively pursue” these cases); see also D. Michaels, Focus on Sale of Higher-Fee Mutual Funds Fuels 30-Year High for SEC Enforcement Actions, Wall St. J. (Nov. 6, 2019),‌/articles‌/focus-on-sale-of-higher-fee-mutual-funds-fuels-30-year-high-for-sec-enforcement-actions-11573043400 (discussing the Commission’s “‘sweep[],’ or industrywide enforcement campaign[]”).  Staff now claim that these nonbinding settlements put industry on notice of the Commission’s newly minted standards—even for conduct that occurred before the Initiative-derived settlements were announced.  See Peter Driscoll, Dir., Office of Compliance Inspections & Examinations, How We Protect Retail Investors (Apr. 29, 2019),‌/news‌/speech‌/speech-driscoll-042919 (stating that inspectors “frequently” seek “deficiencies that were consistent with recent settled actions the Commission has instituted”).  See generally Harvey L. Pitt & Karen L. Shapiro, Securities Regulation by Enforcement, 7 Yale J. on Reg. 149, 270 (1990) (explaining how the Commission tries to “‘bootstrap[]’ a negotiated” settlement “into a substantive rule of law”).   

Moreover, as part of the Initiative, investment advisers “voluntarily” “[e]valuate[d]” whether their existing clients “should be moved to a lower cost share class and move[d] clients as necessary.”  Share Class Selection Initiative pt. III.C.4.  Again, the Commission cited no statute, regulation, or litigated case that required investment advisers to move their clients out of higher-12b-1-fee-class shares.  For seemingly obvious reason: as the Commission itself has stated, “there is no legal requirement for [share-class] conversion.”  75 Fed. Reg. at 47,070 n.86.

In sum, even though Rule 12b-1 is still the law, the Commission has pressured more than 100 investment advisers to refund over $100 million in 12b-1 fees and to move their clients into mutual fund share classes that pay lower 12b-1 fees. 

      1. “No rational firm . . . welcomes a government audit.”

But the Commission was not finished.  Next up as part of the pressure campaign against 12b-1 fees were the “Frequently Asked Questions,” or FAQs.  The Commission doubled down on its claim that investment advisers are required to—they “must”—disclose that “more than one mutual fund share class is available.”  Frequently Asked Questions Regarding Disclosure of Certain Financial Conflicts Related to Investment Adviser Compensation (Oct. 18, 2019),‌/investment‌/faq-disclosure-conflicts-investment-adviser-compensation (Exhibit 2) (“Frequently Asked Questions”).  But, once again, the Commission cited no statute, regulation, or litigated case that mentioned such a disclosure.  Nor did the Commission seek input from the public or industry.

Undeterred, the Commission went further.  The FAQs add nearly 4,000 clarifying (but “not . . . comprehensive”) words to the regulatory arena.  And they warn that more inspections and examinations are forthcoming.  See Frequently Asked Questions 4 (discussing “compliance examinations”); see also Share Class Selection Initiative pt. III.E (“Eligible advisers are cautioned that staff from the Commission’s Office of Compliance Inspections and Examinations and the Division of Enforcement plan to continue to make mutual fund share class selection practices a priority, and plan to proactively seek to identify investment advisers that may have failed to make the necessary disclosures related to mutual fund share class selection.”); Jay Clayton, Chairman, U.S. SEC, Remarks at the PLI 49th Annual Institute on Securities Regulation (Nov. 8, 2017),‌/news‌/speech‌/speech-clayton-2017-11-08 (“I expect that our Enforcement Division will continue to be active in pursuing cases . . . .”).

Unless, of course, the adviser “eliminat[es]” the conflict.  Frequently Asked Questions 1, 2.  After all, if the adviser does not place clients in funds with 12b-1 fees then there is no conflict.  And for that reason, there is no 4,000-word regulatory gauntlet to run, and no risk that the impending inspections, under the Commission’s ever-evolving standards, will find shortcomings in need of the Commission’s swift remediation.  See id. at 2 (informing advisers that they “must . . . expose through full and fair disclosure” “or” “eliminate . . . all conflicts of interest” (emphasis added)); Avakian, Keynote Remarks at the 2019 SEC Regulation Outside the United States Conference, supra (praising firms that “chose not to take 12b-1 fees and did things like rebate the fees”); see also Frequently Asked Questions 2 (“encourag[ing]” investment advisers to “be proactive” in anticipating changes in the staff’s views as “[m]arket practices evolve”).

Thus, having tried to make rules, but having failed for decades, the Commission, through a combination of the Initiative, enforcement actions, and the FAQs, has coerced regulated entities to surrender to its view that the Rule 12b-1 fees it approved through notice-and-comment rulemaking should not exist at all.  The hydraulic pressure to give up 12b-1 fees is undeniable.  Cf. Lutheran Church-Missouri Synod v. FCC, 141 F.3d 344, 353 (D.C. Cir. 1998) (recognizing that because “[n]o rational firm . . . welcomes a government audit,” purportedly nonbinding guidance often becomes the “de facto” law).  

    1. The Commission Is A Full Participant In This Backdoor Effort To Undo Rule 12b-1.    

The Commission is well aware of the backdoor effort to undo Rule 12b-1.  Both the Director of Enforcement (who announced the Initiative) and the Director of Investment Management (the FAQs) are “responsible to the Commission” for the fulfillment of the duties in their respective areas.  See 17 C.F.R. §§ 200.19b, 200.20b.  The Commission knows full well what is happening.

When the Commission failed to “adopt[] any further changes to rule 12b-1” through proper channels in 2004, 69 Fed. Reg. at 54,731, the agency openly “asked the staff to explore” possible “alternatives,” id. at 54,730.  And after a decade of these alternatives failed to repeal or seriously undo Rule 12b-1, as detailed above, see supra pp. 8–9, the staff turned to the Initiative—a strategy approved at the highest levels of the Commission.  See, e.g., CFTC/SEC Budgets: Hearing Before the S. Subcomm. on Fin. Servs. & Gen. Gov’t of the S. Appropriations Comm., 116th Cong., 2019 WL 6493245 (May 8, 2019) (statement of Jay Clayton, Chairman, SEC) (calling the Initiative “out for commendation”); see also SEC Announces Enforcement Initiatives to Combat Cyber-Based Threats and Protect Retail Investors, Press Release No. 2017-176 (Sept. 25, 2017),‌/news‌/press-release‌/2017-176 (“When Stephanie and Steve approached me with the[ir] initiatives, I endorsed them wholeheartedly.” (quoting Jay Clayton)); Steven Peikin, Co-Director, Div. of Enforcement, Keynote Speech at Southeastern Securities Conference 2019 (Sept. 6, 2019),‌/news‌/speech‌/peikin-keynote-speech-southeastern-securities-conference-2019 (describing the projects “undertaken under Chairman Clayton”).

Indeed, far from being an aloof observer of the Commission’s activities, the Chairman has displayed an intimate familiarity with the staff’s plans.  A few months before the Initiative even launched, the Chairman announced that he “expect[ed]” the Division of Enforcement to pursue share class cases (i.e., the Initiative); and he added that the Commission was “also exploring whether more can be done to clarify fee disclosures” (i.e., the FAQs).  Clayton, Remarks at the PLI 49th Annual Institute on Securities Regulation, supra.  

Chairman Clayton is not alone; other members of the Commission are also well aware of the staff’s backdoor effort to undo Rule 12b-1.  The Commissioners have voted—more than 100 times—to settle cases involving alleged violations of the standards announced in the Initiative and the FAQs.  2019 Annual Report, supra, at 2; see also Press Release 2019-28, supra.  And these settlements could not have come at a better time.  2017 was a low point for the Commission’s enforcement stats.  See D. Michaels, SEC Says Don’t Judge Its Enforcement Strength Solely on Volume of Cases, Fines, Wall St. J. (Sept. 20, 2018),‌/articles‌/sec-says-dont-judge-enforcement-strength-solely-on-volume-fines-1537451398.  And 2018 was not looking much better; the Supreme Court had just reminded the Commission that it was bound by the statute of limitation, see Kokesh v. SEC, 137 S. Ct. 1635 (2017), a real drag on Commission’s plans, see, e.g., Steven Peikin, Co-Director, Div. of Enforcement, U.S. SEC, Remedies and Relief in SEC Enforcement Actions (Oct. 3, 2018),‌/news‌/speech‌/speech-peikin-100318 (noting that Kokesh “will continue to be” “felt across [the] enforcement program”).  But with the Initiative’s “efficient approach” to “maximize” disgorgement penalties “in light of . . . the Supreme Court’s decision,” Peikin, Keynote Speech at Southeastern Securities Conference, supra, the Commission soon found itself raking in penalties at thirty-year highs, see Michaels, Focus on Sale of Higher-Fee Mutual Funds Fuels 30-Year High for SEC Enforcement Actions, supra; R. Sinay, SEC Initiative Spurs Record Enforcement Against Public Cos., Law360 (Nov. 20, 2019),‌/compliance‌/articles‌/1221898‌, a performance the Commission has touted to Congress as the very definition of success, see Jay Clayton, Chairman, Robert J. Jackson Jr., Hester M. Pierce, Elad L. Roisman & Allison Herren Lee, Commissioners, U.S. SEC, Oversight of the Securities and Exchange Commission: Wall Street’s Cop on the Beat, Before the U.S. H.R. Comm. on Fin. Servs. (Sept. 24, 2019),‌/news‌/testimony‌/testimony09-24-2019 (jointly touting the $125 million that the Commission wrenched out of the Initiative’s “cooperat[ors]”).


    1. Financial Services Institute

The Financial Services Institute (“FSI”) was founded in 2004 with a clear mission: to ensure that all individuals have access to competent and affordable financial advice, products, and services delivered by a growing network of independent financial advisers and independent financial services firms.  FSI’s members are independent broker-dealers and their registered representatives who operate as independent contractors.  FSI has over 90 broker-dealer member firms with more than 138,000 affiliated registered representatives who serve more than 19 million American households.  FSI also has more than 33,000 independent “financial advisor” members, who are independent contractors of a broker-dealer.  Independent financial advisers are entrepreneurial business owners who typically have strong ties, visibility, and individual name recognition within their communities and client base.  Thus, these financial advisers have a strong incentive to make the long-term achievement of their clients’ investment objectives their primary goal.  FSI members participated in the Share Class Selection Disclosure Initiative and have been subject to follow-on SEC Enforcement inquiries.

    1. American Securities Association

The American Securities Association (“ASA”) is a trade association that represents the retail and institutional capital markets interests of regional financial services firms who provide Main Street businesses with access to capital and advise hardworking Americans on how to create and preserve wealth.  The ASA’s mission is to promote trust and confidence among investors, facilitate capital formation, and support efficient and competitively balanced capital markets.  This mission advances financial independence, stimulates job creation, and increases prosperity.  The ASA has a geographically diverse membership base that spans the Heartland, Southwest, Southeast, Atlantic, and Pacific Northwest regions of the United States.

    1. Competitive Enterprise Institute

Founded in 1984, the Competitive Enterprise Institute (“CEI”) is a nonprofit research and advocacy organization that focuses on regulatory policy from a pro-market perspective.  CEI has promoted its views through regulatory comments, congressional testimony and litigation, and over the years many of its policy solutions have been incorporated into bipartisan legislation.

CEI has long been concerned with regulatory barriers that affect investor choice and access to capital, especially when it comes to small investors.  CEI has also been heavily involved in analyzing administrative transparency and the need to assure that agency actions are taken with public notice and input, rather than through backdoor mechanisms that produce regulatory “dark matter.”  This petition addresses both of these concerns.

    1. New Civil Liberties Alliance

The New Civil Liberties Alliance (“NCLA”) is a nonpartisan, nonprofit civil rights organization founded to defend constitutional rights from violations by the Administrative State through original litigation, amicus curiae briefs, and other means, including participating in the rulemaking process at federal agencies.  The “civil liberties” of the organization’s name include rights at least as old as the United States Constitution itself, such as trial by jury, due process of law, the right to live under laws made by the nation’s elected lawmakers rather than by prosecutors or bureaucrats, and the right to be tried in front of an impartial and independent judge.

Although Americans still enjoy the shell of their Republic, there has developed within it a very different sort of government—a type, in fact, that the Constitution was framed to prevent.  This unconstitutional Administrative State that has developed within the United States violates more rights of more Americans than any other aspect of American law, and it is therefore the focus of NCLA’s efforts.

Even where NCLA has not yet brought a suit to challenge an agency’s unconstitutional exercise of administrative power, it encourages agencies themselves to stop the unlawful use of guidance.  Independent agencies and commissioners have a duty to follow the law, not least by avoiding unlawful modes of governance and coercion of regulated parties.  NCLA therefore advises SEC to examine whether its modes of rulemaking, guidance, adjudication, and enforcement comply with the APA and with the Constitution.


No statute, rule, or litigated case has ever required the type of disclosure mandated by the Initiative or the FAQs.  Instead, the Commission is improperly using the Initiative and the FAQs—and the threat of enforcement actions for violating them—to pressure investment advisers into eschewing 12b-1 fees altogether, all without engaging in notice-and-comment rulemaking.  The Commission’s actions are unwise and unlawful.  The SEC’s coordinated pressure campaign—including the Initiative and the FAQs—created a “rule.”  A “rule” is defined “very broadly,” Sugar Cane Growers Coop. of Fla. v. Veneman, 289 F.3d 89, 95 (D.C. Cir. 2002), to mean “the whole or a part of an agency statement of general or particular applicability and future effect designed to implement, interpret, or prescribe law or policy,” 5 U.S.C. § 551(4).  That, of course, is exactly what the Commission tried to do here.  And for that reason (given that the Commission’s actions qualify for no relevant exceptions), the Commission’s pronouncements should have been issued through notice-and-comment rulemaking, should have been submitted to Congress, and should have been discussed with the Office of Information and Regulatory Affairs.  Moreover, the Commission should never have attempted to apply these pronouncements retroactively, violating bedrock constitutional and administrative law principles of due process and fair notice.  See also Executive Order No. 13,892, 84 Fed. Reg. at 55,239, 55,241.

  1. Federal Agencies, Including The Commission, Increasingly Use Guidance Documents To Circumvent Rulemaking Requirements, Impeding Public Participation In The Lawmaking Process.

The rulemaking process is “fundamental to an agency’s effectiveness.”  Hester Peirce, Backdoor and Backroom Regulation, The Hill (Nov. 10, 2014),‌/blogs‌/pundits-blog‌/finance‌/223472-backdoor-and-backroom-regulation.  The rulemaking procedures “enable[] the agency promulgating the rule to educate itself before establishing rules and procedures which have a substantial impact on those who are regulated.”  Batterton v. Marshall, 648 F.2d 694, 704 (D.C. Cir. 1980).  Indeed, public input is “critical to identifying the benefits and costs of regulatory actions, including situations where a [proposed] rule’s effects may not be consistent with expectations.”  Jay Clayton, Chairman, SEC, Remarks at the Economic Club of New York (July 12, 2017),‌/news‌/speech‌/remarks-economic-club-new-york; see also Attorney General’s Manual on the Administrative Procedure Act 9 (1947) (explaining that one of the “basic purposes” of the Administrative Procedure Act was to “provide for public participation in the rulemaking process”).

The rulemaking process is also fundamental to an agency’s legality.  The Constitution vests “[a]ll legislative powers” in the Congress.  U.S. Const. art. I, § 1.  So even if Congress could authorize an agency to exercise some type of quasi-legislative power, but see, e.g., Dep’t of Transp. v. Ass’n of Am. R.Rs., 135 S. Ct. 1225, 1246 (2015) (Thomas, J., concurring in the judgment), the “agency literally has no power to act . . . unless and until Congress confers power upon it,” La. Pub. Serv. Comm’n v. FCC, 476 U.S. 355, 374 (1986).  And when that happens, the Administrative Procedure Act, or APA, establishes how the agency must act.  See 5 U.S.C. § 553.  Generally, the APA requires the agency, before imposing binding rules on society, to solicit and consider public input.  Besides the effectiveness benefits mentioned above, the APA’s procedures “protect[]” (at least somewhat, for independent agencies) “a free people from the danger of coercive state power undergirding pronouncements that lack the essential attributes of deliberativeness present in statutes.”  Cmty. Nutrition Inst. v. Young, 818 F.2d 943, 951 (D.C. Cir. 1987) (Starr, J., concurring in part and dissenting in part).

Unfortunately, agencies often evade the APA’s requirements by imposing new, substantive rules in the form of “guidance” documents—the letters, memos, blog posts, and the like, that stream out of the administrative state each and every day.  Although guidance documents are supposed to be nonbinding clarifications of existing law, it has long been recognized by the courts, Congress, and scholars that agencies frequently use guidance documents to engage in “backdoor” lawmaking—that is, agency lawmaking “without transparency and broad public input.”  Hester Peirce, Regulating Through the Back Door at the Commodity Futures Trading Commission 4 n.5 (Mercatus Working Paper, 2014).  From its perch overseeing the wide range of agency action, the D.C. Circuit has witnessed the problem over and over:

The phenomenon we see in this case is familiar.  Congress passes a broadly worded statute.  The agency follows with regulations containing broad language, open-ended phrases, ambiguous standards and the like.  Then as years pass, the agency issues circulars or guidance or memoranda, explaining, interpreting, defining and often expanding the commands in the regulations. . . .  Law is made, without notice and comment, without public participation, and without publication in the Federal Register or the Code of Federal Regulations.


Appalachian Power Co. v. EPA, 208 F.3d 1015, 1020 (D.C. Cir. 2000). 

Congress has similarly been troubled by agency attempts to “circumvent[]” public notice and comment requirements “by issuing unofficial rules as ‘guidance documents.’”  159 Cong. Rec. S8189-01 (daily ed. Nov. 19, 2013) (statement of Sen. Collins).  A report by the House Committee on Government Reform, for example, “found that some guidance documents were intended to bypass the rulemaking process and expanded an agency’s power beyond the point at which Congress said it should stop.”  Non-Binding Legal Effect of Agency Guidance Documents, Committee on Government Oversight and Reform, H.R. Rep. No. 106-1009, at 1 (2000).  And a Senate subcommittee has held hearings to ensure that agency guidance “is not used as a shortcut to reinvent or to restate current regulation in a way that is inconsistent with . . . the law.”  Examining the Use of Agency Regulatory Guidance, Part II Before the Subcomm. on Regulatory Affairs and Federal Mgmt. of the S. Comm. on Homeland Security and Gov. Affairs, 114th Cong. 2 (2016) (statement of Sen. Heitkamp).

Scholars have also observed this alarming trend:  “[G]uidance documents have long since ceased to be mere information.  They have become process-free vehicles for agency declarations of explicit standards and principles that have a real, direct, and potentially devastating impact.”  Gwendolyn McKee, Judicial Review of Agency Guidance Documents, 60 Admin. L. Rev. 371, 377 (2008); see also Philip Hamburger, Is Administrative Law Unlawful? 260 (2014) (“When agencies want to impose restrictions they cannot openly adopt as legislative rules . . . they typically place the restrictions in guidance, advice, or other informal directives.”).  Of course, the use of “guidance” also avoids the hard work that should be attendant to adopting any regulation—the work that some of the agency’s senior-most representatives have publicly admitted the Commission strives to avoid.  See, e.g., Barry P. Barbash & Jai Massari, The Investment Advisers Act of 1940: Regulation By Accretion, 39 Rutgers L.J. 627, 653 (2008) (former Director of the Division of Investment Management explaining that the SEC uses “enforcement actions as a means of establishing rules of conduct for investment advisers” because “[e]nforcement-action rulemaking can . . . be undertaken quickly and almost certainly is a faster form of proceeding that traditional rulemaking, which contemplates the Commission’s publishing a rule proposal, receiving and responding to public comment, and adopting a final rule”); Pitt & Shapiro, 7 Yale J. on Reg. at 270 (former Chairman describing how the Commission has “bootstrapp[ed]” settled enforcement actions “into a substantive rule of law” as a means of “bypass[ing] the notice and hearing requirements of the Administrative Procedure Act”); see also Roberta Karmel, Regulation By Prosecution (1981) (former Commissioner criticizing the Commission’s regulation by enforcement).

The Securities and Exchange Commission is no exception to this phenomenon, as the Initiative and the FAQs lay bare; the Commission intentionally structured these in an attempt to deny regulated parties the opportunity to participate in the rulemaking process.  See also Examining the Use of Agency Regulatory Guidance, 114th Cong. at 59–62 (statement of Clyde Wayne Crews, Jr.) (listing significant guidance documents issued by the SEC and others).  Petitioner NCLA raised similar concerns with the Commission a year and a half ago and proposed to the Commission a straightforward rule that would have eliminated this unlawful practice.  See Petition for Rulemaking to Promulgate Regulations Prohibiting the Issuance, Reliance on, or Defense of Improper Agency Guidance 26, No. 4-726 (July 30, 2018) (urging the Commission to “commit to prohibiting the issuance . . . of improper agency guidance”).  Nevertheless, the Commission ignored NCLA’s petition and instead doubled down on its practice of unlawful rulemaking through guidance and enforcement.

  1. The Initiative And Its Associated Pressure Campaign Improperly Circumvent Virtually Every Check On The Commission’s Authority.

As shown above, the APA provides an important check on the Commission’s otherwise broad rulemaking authority.  Various parts of the Congressional Review Act, along with policies adopted by the current Administration, impose additional checks as well.  The Commission has flouted them all.

    1. The Initiative And The FAQs Are Legislative Rules That Should Have Gone Through Notice And Comment.

      1. The Initiative And The FAQs Are Legislative Rules Because They Add New Duties To The Prior Regulatory Framework And Are Binding As A Practical Matter.

The Initiative and the FAQs—key parts of the SEC’s larger effort here—are legislative rules.  These pronouncements do not simply “clarify or remind” investment advisers of their “preexisting duties.”  Mendoza, 754 F.3d at 1022.  Nor do they “‘merely track[]’ preexisting requirements and explain something the statute or the regulation already required.”  Id. at 1021 (alteration in original) (quoting Nat’l Family Planning & Reprod. Health Ass’n, Inc. v. Sullivan, 979 F.2d 227, 236–37 (D.C. Cir. 1992)).  To the contrary.  The Initiative and the FAQs “supplement” the existing regulatory regime “by imposing specific,” newly minted “duties” on an entire industry, id. at 1022—duties that cannot fairly be traced to any “existing document,” id. at 1021.  In these circumstances, the Commission “may not escape the notice and comment requirements” simply “by labeling a major substantive legal addition to a rule a mere interpretation.”  Appalachian Power, 208 F.3d at 1024; accord, e.g., U.S. Telecom Ass’n v. FCC, 400 F.3d 29, 34–35 (D.C. Cir. 2005) (“[F]idelity to the rulemaking requirements of the APA bars courts from permitting agencies to avoid [notice-and-comment] requirements by calling a substantive regulatory change an interpretive rule.”); C.F. Commc’ns Corp. v. FCC, 128 F.3d 735, 739 (D.C. Cir. 1997) (holding that the FCC “may not bypass [the APA’s notice-and-comment] procedure by rewriting its rules under the rubric of ‘interpretation’”).  The law sees through the labels; the Initiative and the FAQs are substantive rules.

The Initiative and the FAQs alter the legal obligations of hundreds of investment advisers.  Before the Initiative and the FAQs, precedent and the Commission’s rules required simple conflict disclosure about “the transaction” into which an adviser’s client was entering, not other possible transactions into which he might enter.  Belmont v. MB Inv. Partners, Inc., 708 F.3d 470, 503 (3d Cir. 2013).  The instructions to Form ADV, for example, required advisers to disclose the fact that they received 12b-1 fees for a transaction, and that the receipt of 12b-1 fees “present[ed] a conflict of interest” (pt. 2A, item 5(E)(1)), see 75 Fed. Reg. at 49,293, which gave the adviser “an incentive to recommend investment products based on” the receipt of such a fee (pt. 2B, item 4(A)(2)), see 75 Fed. Reg. at 49,311.  See also Form ADV (Paper Version), Part 2,‌/about‌/forms‌/formadv-part2.pdf.  Neither the cases, nor the rules, said anything about a detailed discussion of other possible transactions, much less about transactions involving different classes of mutual fund shares.

The Initiative and the FAQs, by contrast, set forth an entirely different regulatory regime.  Out went the straightforward disclosure that 12b-1 fees “present[ed] a conflict of interest”; in came a detailed regime requiring disclosure of, among other things:

  • “The fact that different share classes are available”;

  • “The fact that the adviser has financial interests in the choice of share classes that conflict with the interests of his clients”;

  • “Whether there are any limitations on the availability of share classes to clients that result from the business of the adviser or the service providers that the adviser uses”;

  • “Whether an adviser’s practices with regard to recommending share classes differs when it makes an initial recommendation to invest in a fund as compared to: (a) when it makes recommendations regarding whether to convert to another share class; or (b) when it makes recommendations to buy additional shares of the fund”;

  • “The circumstances under which the adviser recommends share classes with different fee structures and the factors that the adviser considers in making recommendations to clients”; and

  • “Whether the adviser has a practice of offsetting or rebating some or all of the additional costs to which a client is subject (such as 12b-1 fees and/or sales charges), the impact of such offsets or rebates, and whether that practice differs depending on the class of client, advice, or transaction.”

Not one of these requirements appears in any rule, statute, or litigated case.  The Initiative and the FAQs made substantive legal additions to the regulatory framework, and are thus legislative rules.  

The Commission disagrees.  It maintains that its FAQs “create[d] no new or additional obligations,” Frequently Asked Questions 1, and that its Initiative addressed only conduct that was previously “required,” Share Class Selection Initiative at Introduction.  But, tellingly, the Commission cannot cite any statute, regulation, or litigated case that requires such detailed disclosures.  Not one.  The Commission does cite a few settled cases.  But settlements cannot “impose[] obligations on a party that did not consent to the decree.”  Local No. 93, Int’l Ass’n of Firefighters v. City of Cleveland, 478 U.S. 501, 529 (1986).  And the fact that the Initiative relied on such non-binding authority confirms that there was no “require[ment]” at all.

Indeed, the sheer number of advisers whose disclosures allegedly fell short of the Commission’s standards is itself strong evidence that the Commission’s newly minted interpretation seeks to substantively change the law.  The Commission has found that nearly 100 advisers violated its share class disclosure standards.  2019 Annual Report, supra, at 2.  But courts “will not lightly presume an entire industry negligent.”  In re City of New York, 522 F.3d 279, 285 (2d Cir. 2008) (emphasis added).  And while it “may be ‘possible’” that an “entire industry” was “in violation of the [Investment Advisers Act] for a long time without the [Commission] noticing,” the “more plausible hypothesis is that the [Commission] did not,” until recently, “think the industry’s practice was unlawful.”  Christopher v. SmithKline Beecham Corp., 567 U.S. 142, 158 (2012) (quoting Dong Yi v. Sterling Collision Ctrs., Inc., 480 F.3d 505, 510–11 (7th Cir. 2007)); see also Util. Air Reg. Grp. v. EPA, 573 U.S. 302, 324 (2014) (“When an agency claims to discover in a long-extant statute an unheralded power to regulate a significant portion of the American economy, we typically greet its announcement with a measure of skepticism.” (citation and quotation marks omitted)); Chamber of Commerce v. Dep’t of Labor, 885 F.3d 360, 380 (5th Cir. 2018) (“[T]hat it took DOL forty years to ‘discover’ its novel interpretation further highlights the Rule’s unreasonableness.”).

The Commission also may claim that the Initiative and the FAQs are exempt from notice-and-comment rulemaking because they are supposedly nonbinding.  But courts routinely look beyond “boilerplate” disclaimers that guidance is nonbinding, recognizing that agencies often use such disclaimers as a “charade[] intended to keep . . . courts at bay.”  Appalachian Power, 208 F.3d at 1023 (internal quotation marks omitted); see also Gen. Motors Corp. v. EPA, 363 F.3d 442, 448 (D.C. Cir. 2004) (“eschewing the notion that labels are definitive”).  The question is whether the agency pronouncement is “binding as a practical matter.”  Elec. Privacy Info. Ctr. v. Dep’t of Homeland Sec., 653 F.3d 1, 7 (D.C. Cir. 2011) (quoting Gen. Elec. Co. v. EPA, 290 F.3d 377, 383 (D.C. Cir. 2002)).  And for two independent reasons, the Initiative and the FAQs both are.

First, the Initiative and the FAQs are binding as a practical matter because regulated “private parties are reasonably led to believe that failure to conform” to the Initiative’s and the FAQs’ mandates “will bring adverse consequences.”  Gen. Elec., 290 F.3d at 383 (quoting Robert A. Anthony, Interpretive Rules, Policy Statements, Guidances, Manuals, and the Like, 41 Duke L.J. 1311, 1328 (1992)).  Here, the Initiative’s and the FAQs’ mandatory terms are all but dispositive:  “It commands, it requires, it orders, it dictates.”  Appalachian Power, 208 F.3d at 1023; accord Gen. Elec., 290 F.3d at 383 (“If the document is couched in mandatory language, or in terms indicating that it will be regularly applied, a binding intent is strongly evidenced.”); see, e.g., Frequently Asked Questions 2 (“An adviser must eliminate” (emphasis added)); id. at 4 (“An adviser has a conflict of interest that it must disclose” (emphasis added)); id. (“an adviser must also disclose” (emphasis added)); Share Class Selection Initiative pt. III.A (“the disclosures must have clearly described” (emphasis added)); id. pt. III.B (“an investment adviser must self-report” (emphasis added)).  Regulated parties will reasonably—indeed, necessarily—interpret the Initiative and the FAQs as “marching orders.”  Appalachian Power, 208 F.3d at 1023; see also Lutheran Church, 141 F.3d at 353 (recognizing that because “[n]o rational firm . . . welcomes a government audit,” purportedly non-binding guidance often becomes the “de facto” law).  And failure to comply with these newly minted marching orders may lead to civil penalties.  Indeed, the agency here explicitly threatened—“promise[d]”—that failure to accede to the Initiative’s mandates would result in greater punishment.  Garmhausen, supra (quoting the Co-Director of Enforcement); see also Share Class Selection Initiative pt. III.E (“[T]he Division expects in any proposed enforcement action to recommend additional charges . . . and the imposition of penalties.”).  Under these circumstances, any reasonable regulated party would understand that refusing to comply with the Initiative or the FAQs would run “the risk of significant . . . civil penalties.”  Hawkes, 136 S. Ct. at 1815.  

Second, regardless of the documents’ language, the Initiative and the FAQs are binding as a practical matter because the Commission “bases enforcement actions on the policies or interpretations formulated in the document[s].”  Appalachian Power, 208 F.3d at 1021; see also Chamber of Commerce v. U.S. Dep’t of Labor, 174 F.3d 206, 213 (D.C. Cir. 1999) (requiring notice-and-comment rulemaking where the “effect of the rule is . . . not to ‘announce[] the agency’s intentions for the future,’ . . . but to inform employers of a decision already made” (quoting Am. Bus. Ass’n v. United States, 627 F.2d 525, 531 (D.C. Cir. 1980))).  As the Commission put it in a press release touting 79 separate enforcement actions, the “actions stem from the SEC’s Share Class Selection Disclosure Initiative.”  Press Release 2019-28, supra; see also 2019 Annual Report 2 (touting 95 enforcement actions).  Indeed, no other document could plausibly have sustained those actions, because no other document addresses share class disclosure. 

In short, the Initiative and the FAQs create new legal obligations that are binding on regulated parties in every practical sense.  They are thus legislative rules that should have been promulgated through notice-and-comment rulemaking, not snuck through the backdoor of guidance.  Memorandum from Dominic J. Mancini, Acting Adm’r, Office of Info. & Regulatory Affairs, to Regulatory Policy Officers at Executive Departments and Agencies 2, 3 (Oct. 31, 2019) (explaining that “regardless of name or format,” guidance documents “should never be used to establish new positions,” because “any such requirements must be issued pursuant to applicable notice-and-comment requirements”).

      1. The Initiative And The FAQs Are Attributable To The Commission Itself.

The Initiative and the FAQs are attributable to the Commission itself.  See Bennett v. Spear, 520 U.S. 154, 177–78 (1997).  As just discussed, the Initiative and the FAQs are binding as a practical matter on regulated parties.  See also Peirce, Backdoor and Backroom Regulation, supra (“Regardless of the language and the format, the effect is the same for regulated entities.  The agency suggests that you do something—even if it says that it might suggest something different later—and you do it.”).  And they represent the Commission’s—not just the staff’s—settled determination.  Yes, the Initiative and the FAQs purport to have issued solely from the staff.  But no reasonable observer could believe for a second that these actions are not being undertaken with at least the implicit sanction of the Commission.  The Commissioners have predicted and openly praised both the Initiative and the FAQs.  See supra pp. 15–17; see also Jay Clayton, Chairman, U.S. SEC, Management’s Discussion and Analysis of the SEC (Apr. 8, 2019),‌/news‌/speech‌/speech-clayton-040819 (calling out the Initiative “for commendation”).  And they have voted—more than 100 times—to settle cases involving alleged violations of the standards announced in the Initiative and the FAQs.  2019 Annual Report, supra, at 2; see also Press Release 2019-28, supra.  Since no other binding document discusses the broad disclosure requirements applied in those more than 100 settlements, the Commission must have been applying the Initiative and the FAQs.  In these circumstances, no court would believe that the “Commission has neither approved nor disapproved” the announced standards.  Frequently Asked Questions 1.

The Initiative and the FAQs are attributable to the Commission.

    1. The Commission Violated The Congressional Review Act. 

      1. The Initiative And The FAQs Should Have Been Sent To Congress For Review.

Even if the Commission’s Initiative and FAQs were exempt from notice-and-comment rulemaking—and they are not—those pronouncements still flouted the strictures of the Congressional Review Act (“CRA”), and on that basis alone are void.  The CRA is intended to give the people’s representatives in Congress a say over the activities of the administrative state.  The Act’s requirements are clear:  No rule can “take effect” unless the issuing agency has submitted “a copy of the rule” to “each House of the Congress” for review.  5 U.S.C. § 801(a)(1)(A).

The CRA takes a “very broad” view of the term “rule,” reaching virtually all agency pronouncements, not only those “that must be promulgated according to the notice and comment requirements” of the APA.  Hon. Orrin Hatch, B-323772, 2012 WL 3801373, at *2 (Comp. Gen. Sept. 4, 2012); accord, e.g., Hon. Doug Ose, B-287557, 2001 WL 522025, at *4 (Comp. Gen. May 14, 2001) (“[W]e must be mindful that Congress intended that the CRA should be broadly interpreted both as to the type and scope of rules covered.”).  The Act reaches binding and “non-binding” documents alike.  Hatch, 2012 WL 3801373, at *4; see also Hon. David M. McIntosh, B-281575, at 4 (Comp. Gen. Jan. 20, 1999).  And the Comptroller General of the United States has, in fact, applied the CRA to a vast array of agency documents—from booklets, to letters, to interim, nonbinding guidance.  See, e.g., Hon. John D. Rockefeller, IV, B-316048, 2008 WL 1795346 (Comp. Gen. Apr. 17, 2008) (letter); Hon. James A. Leach, B-286338, 2000 WL 1568268 (Comp. Gen. Oct. 17, 2000) (booklet); McIntosh, B-281575 (interim, nonbinding guidance).  The Initiative and the FAQs are not somehow exempt.

Recently, for example, the Comptroller General ruled that multiple supervisory guidance letters from the Board of Governors of the Federal Reserve were, in fact, rules under the CRA.  See Hon. Thom Tillis, B-331324, 2019 WL 5448290 (Comp. Gen. Oct. 22, 2019); Congressional Requestors, B-330843, 2019 WL 5448291 (Comp. Gen. Oct. 22, 2019).  Just like the Initiative and the FAQs, the purportedly non-binding guidance letters were: (1) “agency statement[s]” that were (2) “of future effect,” as they “provided new guidance,” and (3) “designed to implement, interpret, or prescribe law.”  Id. at *4; see also Tillis, 2019 WL 5448290, at *3.  Just like the guidance letters, therefore, the Initiative and the FAQs were required to be submitted to Congress under the CRA.  And because they were not, the Commission is “not compliant with the Congressional Review Act.”  Majority Staff Report of H.R. Comm. on Oversight & Government Reform, 115th Cong., Shining Light on Regulatory Dark Matter 4 (2018) (explaining that the Commission is apparently “confused with respect to the definition of guidance” and the Commission’s legal obligations).     

      1. The Initiative And The FAQs Should Have Been Sent To The Office Of Information And Regulatory Affairs For Review.

The Commission should also have sent the Initiative and the FAQs to the Office of Information and Regulatory Affairs, or OIRA.  The CRA creates a special category of “major rule[s],”  which may not go into effect until 60 days after the rule is sent to Congress or published in the Federal Register.  5 U.S.C. § 801(a)(3)(A).  Whether a rule is “major,” however, is not a question for the agency; OIRA makes the call.  See id. § 804(2).  And so “Federal agencies, including the historically independent agencies” such as the Commission, “must coordinate with OIRA regarding a major determination” for all of their rules.  Memorandum from Russell T. Vought, Acting Director, Off. of Mgmt. & Budget, to Heads of Executive Departments and Agencies 3, 4 (Apr. 11, 2019) (emphasis added).  That is so even though the Commission does not “otherwise” submit its rules for OIRA “regulatory review,” and even though the Commission believes that the rules may be “guidance documents, general statements of policy, . . . interpretive rules,” and the like.  Id. at 3.  The CRA “encompasses a wide range of . . . regulatory actions,” id., including the Initiative and the FAQs.

  1. The Commission’s Retroactive Application Of The Initiative And The FAQs Violates The Investment Advisers Act, Bedrock Principles Of Fair Notice And Due Process, And The Policy Of This Administration.

Although investment advisers have long disclosed that they receive 12b-1 fees and that receipt of those fees presents a conflict of interest, as per the Commission’s actual regulations, the Commission has recently claimed that investment advisers are (and were) also required to state specifically that some clients were placed in more expensive share classes where less expensive share classes were available.  But, as discussed above, this type of broad disclosure has never been required by any of the Commission’s rules, or any litigated cases.  

Indeed, it goes well beyond a conflict disclosure requirement.  To disclose a conflict is to disclose a divergence of interest and the fact that it could tempt an adviser to act differently than if the divergence were absent.  Conflict disclosure does not require identifying specific alternative investments or investment terms that might be offered in the absence of a conflict.  On the contrary, the disclosure serves to notify the customer that, because of the conflict, such alternatives may never be identified or offered.  

The Commission’s newly minted standards thus stretch the concept of “conflict disclosure” beyond all recognition, and attempt even to outlaw 12b-1 fees entirely.  Any enforcement action brought against an investment adviser on this basis would violate the Investment Advisers Act along with bedrock principles of fair notice and due process, not to mention an Executive Order.  

That would be intolerable in the best of times—and we are far from that.  The nation is “facing an unprecedented national challenge—a health and safety crisis that requires all Americans . . . to significantly change their daily behavior and, for many, to make difficult personal sacrifices.”  Jay Clayton, Chairman, SEC, The Deep and Essential Connections Among Markets, Businesses, and Workers and the Importance of Maintaining Those Connections in Our Fight Against COVID-19 (Mar. 24, 2020),‌/news‌/public-statement‌/statement-clayton-covid-19-2020-03-24.  In this time of crisis, individuals and businesses need ready and efficient access to our financial markets.  Id.  That is an “essential component of our national response to, and recovery from, COVID-19.”  Id.  The Commission should thus free those markets from the unnecessary uncertainty that its “regulation by enforcement” has inflicted—not continue to weigh them down.

    1. The Investment Advisers Act Expressly Protects Those Who Act In Good Faith Reliance On The Commission’s Rules. 

In the Investment Advisers Act, Congress expressly created a safe harbor for any person who acted in good faith reliance on the Commission’s rules.

No provision . . . imposing any liability shall apply to any act done or omitted in good faith in conformity with any rule, regulation, or order of the Commission, notwithstanding that such rule, regulation, or order may, after such act or omission, be amended or rescinded . . . .

15 U.S.C. § 80b-11(d).  Here, there is no question that advisers acted in conformity with the Commission’s Form ADV.  As detailed above, that form required advisers to disclose the fact that they received 12b-1 fees for a transaction, and that the receipt of 12b-1 fees “present[ed] a conflict of interest,” which gave the adviser “an incentive to recommend investment products based on” the receipt of such a fee.  For decades, advisers disclosed just that.

The Commission cannot turn around now and claim—with the threat of retroactive punishment—that more needed to be done.  In Basham v. Finance American Corp., 583 F.2d 918 (7th Cir. 1978), for example, the court assumed that a lender had in fact violated the Truth in Lending Act by “fail[ing] to disclose the actual proceeds” of its loan.  Id. at 923.  But the court nevertheless held that “no civil liability [could] be imposed.”  Id.  Why?  Because, like the Advisers Act, the Truth in Lending Act offered a safe harbor to any person who acted “in good faith in conformity with any [applicable] rule, regulation, or interpretation.”  Id. (quoting 15 U.S.C. § 1640(f)).  And, like the advisers here, the defendants in that case had issued “disclosures [that] followed the requirements” of the applicable regulation.  Id.  So, even if the regulation-conforming disclosures were otherwise “found violative of [federal law],” as here, “no claims [could] exist[] on [that] basis.”  Id.; accord Warren v. Credithrift of Am., Inc., 599 F.2d 829, 831–32 (7th Cir. 1979) (“[N]o civil liability may be imposed upon defendant for failing to make the disclosure required by section 1639(a)(1) because the disclosure made meets the requirements of Regulation Z.”); see also, e.g., 74 Fed. Reg. at 4573 (explaining that “a person that provides investors with a mutual fund Summary Prospectus in good faith compliance with rule 498 will be able to rely on section 19(a) of the Securities Act,” an analogous good-faith provision).

    1. The Commission Is Bound By An Executive Order And Principles Of Constitutional And Administrative Law Requiring Fair Notice.

The Commission is bound by an Executive Order and principles of constitutional and administrative law requiring fair notice.  “Traditional concepts of due process incorporated into administrative law preclude an agency from penalizing a private party for violating a rule without first providing adequate notice of the substance of the rule.”  Satellite Broad. Co. v. FCC, 824 F.2d 1, 3 (D.C. Cir. 1987); accord Gen. Elec. Co. v. EPA, 53 F.3d 1324, 1329 (D.C. Cir. 1995).  In fact, the President of the United States has forbidden such unfair surprise.  See Exec. Order No. 13,892, 84 Fed. Reg. 55,239 (Oct. 15, 2019).  “An agency must avoid unfair surprise not only when it imposes penalties but also whenever it adjudges past conduct to have violated the law.”  Id. at 55,241 (emphasis added).  The President’s Order is binding on the Commission.  See U.S. Const. art. II, § 1, cl. 1; id. art II, § 3; see also Meyer v. Bush, 981 F.2d 1288, 1297 (D.C. Cir. 1993) (“[T]he President has a constitutional duty to see that the laws are faithfully executed, and, therefore, a duty to oversee the regulatory policies produced by the departments and agencies.”); Pub. Citizen v. Burke, 843 F.2d 1473, 1477 (D.C. Cir. 1988) (“[The] President, by virtue of Article II’s command that he take care that the laws be faithfully executed, quite legitimately guides his subordinates’ interpretations of statutes . . . .”).

The President has instructed that an agency’s understanding of “unfair surprise” “should be informed” by the Supreme Court’s decision in Christopher v. SmithKline Beecham Corp., 567 U.S. 142 (2012).  84 Fed. Reg. at 55,240.  That case is right on point.  There, as here, an agency’s “interpretation” was “preceded by a very lengthy period of conspicuous inaction” in the face of an “industry’s decades-long practice.”  567 U.S. at 157–58.  And there, as here, an agency’s novel interpretation created an “acute” “potential for unfair surprise.”  Id. at 158.

Indeed, the Commission’s actions here are even broader and more troubling than the agency action at issue in Christopher.  In that case, the Supreme Court castigated the agency for inflicting “unfair surprise” and “potentially massive liability” by announcing a new interpretation of a rule affecting 90,000 sales workers in the pharmaceutical industry.  567 U.S. at 155, 158.  Here, by contrast, the Commission’s 12b-1 “guidance” threatens to upend decades-old practices in the investments of mutual funds, which together hold over $20 trillion in combined assets from nearly 60 million house-holds in the United States.  See Inv. Co. Inst., Trends in Mutual Fund Investing, September 2019,‌/research‌/stats‌/trends‌/trends‌_09‌_19; Inv. Co. Inst., Characteristics of Mutual Fund Investors, 2019,‌/pdf‌/per25-09.pdf.  The unfair surprise from the Commission’s actions is thus several orders of magnitude greater than the already “massive” agency unfairness previously condemned by the Supreme Court and the President.

The Commission should avoid unfair surprise, not weaponize it.

Tellingly, the Commission has had multiple opportunities over the last two decades to require the type of share class-specific disclosure that it now demands.  In 2004, for example, the Commission adopted new requirements on the disclosure of mutual fund expenses, see Shareholder Reports and Quarterly Portfolio Disclosure of Registered Management Investment Companies, 69 Fed. Reg. 11,244, 11,246 (Mar. 9, 2004), and barred certain broker-dealer practices that it thought “pose[d] conflicts of interest,” see 69 Fed. Reg. at 54,728.  But the Commission declined to “adopt[] any further changes to rule 12b-1.”  Id. at 54,731.  Likewise, in 2009, the Commission tried “to increase awareness of potential conflicts of interest” by requiring express notification to investors “that a conflict of interest may exist with respect to [a] broker-dealer’s recommendation.”  74 Fed. Reg. at 4558.  But, again, the Commission refused to consider additional disclosures, even though “commenters [had] suggested . . . alternative terms to describe . . . rule 12b-1 fees.”  Id. at 4555.  The Commission admitted that it would be “more appropriate to consider [such] changes in the context of a full reconsideration of . . . rule 12b-1,” id. at 4555–56—a reconsideration that never came.

In short, the Commission has repeatedly promulgated rules that address mutual fund fee disclosure requirements and related conflicts of interest.  But it has never adopted, or even proposed, a rule requiring the specific share class disclosures that the Commission—through the Initiative and the FAQs—has said were always really required.  Such detailed disclosures have never been the law.  And the Commission cannot pretend otherwise, retroactively punishing firms for violating rules that the Commission never adopted.  The new “guidance isn’t law—it’s just paper.”  Claire McCusker Murray, Principal Deputy Assoc. Att’y Gen., Remarks at the Compliance Week Annual Conference (May 20, 2019),‌/opa‌/speech‌/remarks-principal-deputy-associate-attorney-general-claire-mccusker-murray-compliance. 

  1. The Commission Should Adopt Rules To Bring Its Actions Into Compliance With Applicable Law, Not Open New Frontiers.

The Commission is at a fork in the road.  Emboldened by “the success of the Share Class Initiative” in achieving through guidance what the agency could not—for decades—achieve through rulemaking, Avakian, What You Don’t Know, supra, the Commission has doubled down on the 12b-1 investigations and litigation, see, e.g., SEC Press Release 2020-90, supra (promising to “continue to actively pursue” these cases); RBC Capital Mkts., supra (announcing settlement); J. Nancarrow, More Cases Over High Investor Fees Expected, SEC Official Says, Bloomberg Law (June 26, 2019),‌/banking-law‌/more-cases-over-high-investor-fees-expected-sec-official-says; see also Complaint, SEC v. Commonwealth Equity Servs., LLC, No. 1:19-cv-11655-ADB (D. Mass. Aug. 1, 2019).  And it has gone further still, turning its attention to longstanding, widespread, and previously uncontroversial industry practices—like revenue sharing—that could even “be construed” as a form of 12b-1 fee.  75 Fed. Reg. at 47,608 n.65; see Avakian, What You Don’t Know, supra (“Let me assure you, we are looking for other . . . conflicts—and we are finding them. . . .  One is revenue sharing.”); Frequently Asked Questions 6 (citing “the staff’s views” while adding novel disclosure requirements for “[s]imilar” practices like “revenue-sharing”).  And not settling there, the Commission has announced the counterintuitive proposition that the “avoidance of expenses” has (apparently) always been a form of “compensation,” which also needed to be disclosed.  All of this, of course, has been done “without notice and comment, without public participation, and without publication in the Federal Register or the Code of Federal Regulations.”  Appalachian Power, 208 F.3d at 1020. 

This subregulatory sabotage must end.  The Commission should not turn its flawed 12b-1 playbook into standard operating procedure, much less bootstrap its coerced settlements into a never-ending parade of similar misadventures.  As part of its assault on revenue-sharing, the Commission is actually suggesting that the same companies it strong-armed into settling the 12b-1 Initiative should now pay an additional fine for supposed violations of the same statute, during the same period, for alleged conflicts in the selection of the same product class—if not, the same product—for, in many cases, the same clients.  That is blatantly unfair and inappropriate.  The Commission should get out of this “business of gotcha,” guidance-based enforcement.  T. Longo, SEC’s Battle with Brokers Over ‘Regulation By Enforcement’ Flares at Senate Hearing, Financial Advisor (Dec. 11, 2019),‌/news‌/battle-between-sec-and-industry-over–regulation-by-enforcement–breaks-into-open-at-senate-hearing-53183.html (quoting Chairman Clayton).  “[I]f the commission feels some way about” the state of the law, it “should articulate it”—in an actual rule.  Id. (quoting Chairman Clayton).  And in no event should the Commission “be relying on staff guidance.”  Id. (quoting Chairman Clayton).    

To correct the myriad errors described throughout this Petition, and to prevent future abuses the Commission is on course to commit, the agency should initiate a rulemaking to promulgate regulations to bring its guidance into compliance with applicable law.  See 5 U.S.C. § 553(e); 17 C.F.R. § 201.192(a).  Other agencies have already taken similar action.  See DOT Administrative Rulemaking, Guidance, and Enforcement Procedures, 84 Fed. Reg. 71,714, 71,731–32 (Dec. 27, 2019) (barring the Department from using “its enforcement authority to convert agency guidance documents into binding rules” (to be codified at 49 C.F.R. § 5.85)).  This provides an easy and clear path to follow.  To keep pace with its peers, the Commission must make clear that investment advisers, like all Americans, are bound only “through duly enacted statutes or through regulations lawfully promulgated under them,” not through the backdoor of regulatory “guidance.”  Exec. Order No. 13,891, 84 Fed. Reg. 55,235, 55,235 (Oct. 15, 2019).  Thus, in the context of Rule 12b-1, the Commission must affirmatively “distin[guish]” between “rules and regulations, on the one hand, and staff views on the other.”  Jay Clayton, Chairman, U.S. SEC, Statement Regarding SEC Staff Views (Sept. 13, 2018),‌/news‌/public-statement‌/statement-clayton-091318.  Specifically:   

  • The Commission should adopt a clear statement:  “Apart from issues concerning the compensation of individual employees, if a financial services firm discloses a conflict of interest, then that firm is not required to take affirmative steps to eliminate the disclosed conflict.”

  • The Commission should adopt a clear statement:  “Customers have a duty to inform themselves about the features of particular mutual funds and share classes within those funds, as long as the information is readily available and clearly disclosed (e.g., in a prospectus).” 

  • The Commission should propose amendments to Form ADV Part 2, and Form N-1A, to make clear exactly what forms of compensation are or are not disclosable.

  • The Commission should acknowledge that compensation disclosures in a prospectus are the equivalent of compensation disclosures in Form ADV Part 2.

  • The Commission should adopt a statement that compliance with the disclosure requirements set forth above triggers the safe harbor of section 211(d) of the Investment Advisers Act.

  • The Commission should clarify that “best execution” principles do not apply to actions under section 206 of the Investment Advisers Act.


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 Commission should initiate a rulemaking to promulgate the proposed rules and end these unlawful “regulation by enforcement” practices.  The Commission must resolve this petition “within a reasonable time,” 5 U.S.C. § 555(b), which is “typically counted in weeks or months, not years,” In re Am. Rivers & Idaho Rivers United, 372 F.3d 413, 419 (D.C. Cir. 2004).  Petitioners look forward to the Commission’s prompt action on this important petition.


Dated: April 29, 2020 Respectfully submitted,

/s/ Sam Kazman   /s/ Helgi C. Walker


Sam Kazman

Competitive Enterprise Institute

1310 L St. NW, 7th Floor

Washington, DC 20005

(202) 331-1010

[email protected]


Attorney for Competitive Enterprise Institute


Helgi C. Walker

Jacob T. Spencer

Brian A. Richman‡

Max E. Schulman

Gibson, Dunn & Crutcher LLP

1050 Connecticut Avenue, N.W.

Washington, DC 20036-5306

(202) 955-8500

[email protected]


Attorneys for Financial Services Institute and 

American Securities Association



/s/ Mark Chenoweth


/s/ David T. Bellaire


Mark Chenoweth

Michael P. DeGrandis†

New Civil Liberties Alliance

1225 19th Street, NW, Suite 450

Washington, DC 20036

(202) 869-5210

[email protected]


Attorneys for New Civil Liberties Alliance


David T. Bellaire

Financial Services Institute

1201 Pennsylvania Ave., NW, STE 700

Washington, DC 20004

(202) 803-6061

[email protected]


Attorney for Financial Services Institute