SEC staff recently published their FAQs regarding financial conflicts and adviser compensation. While not carrying the full weight of formal rulemaking, the guidance provides useful insight into staff thinking around certain compensation arrangements and the related disclosure obligations.
The frightening topics include:
- Considerations for disclosure of conflicts where the adviser or its related and associated persons receive compensation from the investments it recommends.
- Facts advisers should disclose related to offerings with different compensation characteristics.
- Form ADV disclosure requirements when an adviser earns additional compensation such as 12b-1 fees or shares in revenue earned by the issuer
- Examples of material facts that an adviser should disclose.
- Considerations for materiality in amending conflict disclosures in an annual update.
Staff reiterate a fiduciary’s obligation to eliminate or provide full and fair disclosure of all conflicts of interest that might incline the fiduciary – consciously or unconsciously – to render advice that is not disinterested.
While general Instructions 2 & 3 of Form ADV Part 2 are helpful touchstones, advisers need to understand when their fiduciary duty requires broader disclosures that are not specifically required in the instructions. Such disclosure must include “sufficiently specific facts” covering not just the existence of the conflict but 1–the nature of the conflict (compensation differences, incentives, shelf space fees), 2–its potential effect including incentives to the adviser as a firm and to individual employees, 3–the resulting impact on the client and 4–measures taken by the adviser to mitigate that conflict. Disclosures should be specific to affected security or client types. In the end, disclosure must allow clients to understand the adviser’s conflicts and business practices and provide the opportunity for the client consent or decline services.
Advisers must be reviewing and, if applicable, disclosing any and all incentives provided by or shared with brokers, custodians, and platform or other service providers.
We covered the SEC’s expectations around Share Class Disclosure and the SEC’s most recent string of cases. The question becomes what happens to the firms that improve their disclosure as a result of this most recent FAQ? Will they find themselves under fire with SEC enforcement for not meeting their fiduciary disclosure obligations sooner? Boo. Does the SEC expect that they should self- report if conflicts were material and not previously disclosed? So scary.