On Oct. 18, 2019, the Securities and Exchange Commission (SEC) Division of Investment Management staff published Frequently Asked Questions Regarding Disclosure of Certain Financial Conflicts Related to Investment Adviser Compensation (FAQs). Many in the industry view the FAQs as overdue SEC guidance in an area that has been a focus of the SEC Division of Enforcement. Registered investment advisers (RIAs) should review the FAQs in light of continuing enforcement actions in this area, including the recent action announced against Bolton Securities Corporation d/b/a Bolton Global Asset Management.
Highlights of the FAQs
- Sources of disclosure obligations. The Division of Investment Management staff emphasized an RIA’s duty to disclose conflicts of interest relating to its compensation from both its general fiduciary duty to make full and fair disclosure and the specific disclosure obligations imposed by Form ADV. The FAQs detailed the various sections of Form ADV that require disclosure of conflicts of interest relating to an RIA’s compensation, including incentives relating to compensation that could influence the RIA’s advice.
- Mutual fund share class disclosure. The SEC has particularly focused on disclosure surrounding selection by RIAs of one share class of a mutual fund when a lower-cost share class is available. The Division of Investment Management staff continued this focus in the FAQs, providing examples of material facts related to share class conflicts that RIAs should disclose.
- Incentives. The Division of Investment Management staff provided a few examples of material facts an RIA should disclose about its practices related to revenue-sharing arrangements, emphasizing that the list was not comprehensive. These examples included the existence of any incentives provided to the adviser or shared between the adviser and others (for example, an affiliate of the adviser).
- Continued dislike of “may.” The Division of Investment Management reiterated its position that a disclosure that an RIA “may” have a conflict is insufficient disclosure when a conflict actually exists. See, e.g., Robare Group, LTD. v. SEC, No. 16-1453 (D.C. Cir., Apr. 30, 2019) and SEC Share Class Selection Disclosure Initiative.
- Share class disclosure is material for Form ADV Update. The Division of Investment Management staff stated that an adviser must identify changes in disclosure concerning share class recommendations or revenue sharing arrangements as material changes for purposes of Item 2 of Form ADV Part 2A.
In its Litigation Release issued Nov. 6, 2019, the SEC alleged violations of Sections 206(2), 206(3) and 206(4) of the Investment Advisers Act of 1940 and Rule 206(4)-7 thereunder in connection with, among other things, Bolton’s alleged failure to disclose to clients that it purchased or held share classes for its clients that generated Rule 12b-1 fees for an affiliate of Bolton when different share classes of the same mutual fund were available that did not include Rule 12b-1 fees.
Expect SEC and other regulatory scrutiny in this area to continue. RIAs should re-examine disclosure practices regarding all types of conflicts of interest, including receipt of compensation from various sources.