Four industry groups are filing a petition today to end what they say is "backdoor regulation" by the SEC of alleged disclosure violations related to mutual fund 12b-1 fees.

"Over the last year, the SEC has used its enforcement authority, rather than its rulemaking authority, to change longstanding, widespread, and previously uncontroversial business practices in the mutual fund space," according to the petition the groups are filing to the SEC today. "This is not how the rule of law is supposed to work."

The petition is set to be filed by the Financial Services Institute, which says its nearly 90 independent financial services firm members comprise more than 60% of all producing registered representatives; the American Securities Association, which represents the retail and institutional capital markets interests of regional financial services firms; the Competitive Enterprise Institute, a pro-market non-profit research and advocacy organization; and the New Civil Liberties Alliance, founded "to protect constitutional freedoms from violations by the Administrative State."

The groups accuse the SEC of trying to ban Rule 12b-1 fees for three decades. But they claim that these fees for the marketing and distribution of mutual funds account for close to $10 billion in economic activity annually. They represent "an integral part of the structure and strength of the mutual fund industry" and foster competition, diversify distribution channels and allow for expanded investor choice, according to the petition.

After failing to adopt rules that would repeal or revamp Rule 12-b1 in 2010, the SEC has resorted to guidance, followed by an offer of amnesty for voluntary self-reporting of alleged violations set out in that guidance, the groups say.

Launched in February 2018, the Share Class Selection Disclosure Initiative promised lenience to companies that would self-report any failures to disclose conflicts of interest in the selection of mutual fund share classes through which the firms received 12b1-fees. C. Dabney O'Riordan, co-chief of the SEC's asset management unit, has said that the initiative resulted in close to $140 million getting returned to harmed investors.

The SEC also pursued punitive enforcement actions against firms that didn't participate in the amnesty, which was "undertaken without the notice or public participation that Congress requires for regulatory changes of this type," the groups say.

"Investment advisors, like all Americans, have a right to be bound only by duly enacted statutes and the regulations lawfully promulgated under them — and, most importantly, to know what the law is before the SEC brings its enormous enforcement arsenal to bear," Helgi Walker, a partner at Gibson Dunn and lead counsel on the petition, says in a statement.

The petition also claims the SEC violated the Congressional Review Act because it did not submit its FAQs on 12b-1 fees and the disclosure initiative to Congress for review.

"It is time for the SEC to stop its troubling, ongoing trend of backdoor regulation, or regulation by enforcement. Financial services firms and financial advisors deserve to know the rules of the regulatory road on which they operate and be allowed sufficient time to comply with any changes," Dale Brown, FSI president and CEO, says in a statement. "It is for this reason that Congress established the requirements of the rulemaking process, and we urge the SEC to address our concerns with regulation by enforcement as called for in the petition."

ASA CEO Christopher Iacovella says in a statement: "The SEC's foray into regulation by enforcement has established a dangerous precedent, which allows the agency to adopt vague disclosure requirements and then decide on the fly what is and is not acceptable. We will comply with clear rules of the road adopted using the formal rulemaking process, anything else flies in the face of how the rule of law in America is supposed to work."

The petition comes days after the SEC reached a $325,000 settlement with Merrill Lynch as one of the final cases in the Share Class Selection Disclosure Initiative.

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