SEC Division of Investment Management Releases FAQs Regarding Disclosure of Financial Conflicts Related to Investment Adviser Compensation


The staff of the Securities and Exchange Commission’s (SEC) Division of Investment Management released frequently asked questions (FAQs) on October 18, 2019, which discuss certain compensation arrangements and related disclosure obligations arising from an investment adviser’s fiduciary duties and from Form ADV requirements. The FAQs provide guidance on disclosure requirements related to (i) conflicts of interest regarding compensation that an adviser receives in connection with recommended investments; (ii) adviser conflicts related to mutual fund share class recommendations; (iii) advisers’ receipt of revenue sharing payments; and (iv) material amendments to Form ADV. The guidance specifically notes that it does not alter or amend applicable law and has no legal force or effect, nor does it create any new or additional obligations for advisers. Interestingly, the Division of Investment Management issued this guidance almost twenty months after the Division of Enforcement announced its Share Class Selection Disclosure Initiative to self-report and almost eleven months after the Division of Enforcement initiated a “sweep” regarding revenue sharing.

Key takeaways from the FAQs are outlined below.

Recommended Investments

The FAQs emphasize that an investment adviser is subject to general disclosure obligations as a fiduciary in addition to the specific disclosure requirements of Form ADV. As part of an adviser’s duty of loyalty as a fiduciary, an adviser must make full and fair disclosure to its clients of material facts relating to the advisory relationship. Thus, an adviser must eliminate or disclose all conflicts that might incentivize the adviser to render advice that is not disinterested or not in the best interest of its client.

In addition to discussing an adviser’s fiduciary obligations, the FAQs highlight key parts of Form ADV and related instructions that relate to disclosure requirements of adviser conflicts with respect to recommended investments, including the following:

Where a conflict exists, an adviser must also disclose how it addresses the conflict, and, as noted previously, an adviser’s fiduciary duties may require it to provide disclosure beyond what is specifically required by Form ADV. These disclosure obligations should be considered by advisers when making a recommendation to purchase an investment or to continue holding an investment. The FAQs also emphasize the importance of utilizing concise and direct language that is written in plain English.

Mutual Fund Share Class Recommendations

The FAQs state that an adviser has a conflict of interest that must be disclosed when multiple mutual fund share classes are available to a client and the adviser receives, directly or indirectly, compensation based on the recommended share class. Advisers must disclose material facts related to (i) the existence and effect of different incentives and resulting conflicts, (ii) the nature of the conflict; and (iii) how the adviser addresses the conflict. The FAQs highlight the following material facts that should be disclosed to investors, if applicable:

Revenue Sharing

According to the FAQs, if a nonclient provides an economic benefit to an adviser for providing investment advice or other advisory services to its clients, the adviser must disclose the arrangement, explain the associated conflicts and describe how the adviser addresses the conflicts. The FAQs note that advisers must disclose the existence of any incentives provided to advisers or shared between the adviser and others, including clearing brokers, custodians, fund advisers or service providers. As with receipt of 12b-1 fees, an adviser disclosing that it “may” have a conflict of interest is not sufficient disclosure where a conflict actually exists.

Material Amendments to Form ADV

The FAQs remind advisers that if an adviser materially amends its brochure for its annual update, the adviser must identify and discuss those changes on the cover page of the brochure, the page immediately following the cover page or as a separate document accompanying the brochure, including with respect to disclosures regarding share class recommendations and revenue sharing.

Practice Points and Tips

A key takeaway from the FAQs is that the SEC is focused on transparency with respect to conflicts related to share class recommendations and revenue sharing. The FAQs are in line with the SEC’s Commission Interpretation Regarding Standard of Conduct for Investment Advisers (the “RIA Interpretive Guidance”) that it issued in June, and advisers should analyze the FAQs in conjunction with the RIA Interpretive Guidance. Further and more generally, this guidance is consistent with the SEC’s heightened focus on all financial conflicts related to compensation, such as other types of fees and undisclosed mark-ups. Based on the Division of Enforcement’s efforts as discussed at the start regarding these issues, many in the industry have been aware of the heightened focus on these particular conflicts and disclosures. Nevertheless, this guidance provides helpful specificity that advisers should strongly consider to evaluate their practices and disclosures accordingly.


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National Law Review, Volume IX, Number 303