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The Division of Investment Management recently issued guidance on the obligation of investment advisers to disclose financial conflicts of interest in the form of Frequently Asked Questions Regarding Disclosure of Certain Financial Conflicts Related to Investment Adviser Compensation (the “Guidance”).  The Guidance substantiates (and to some degree legitimizes) the positions previously articulated in the course of SEC examinations and enforcement actions, and indicates that the SEC staff will continue to expand its focus beyond 12b-1 fees and revenue sharing to evaluate how investment advisers manage conflicts of interest associated with the receipt of compensation from investments the advisers recommend to their clients.

Although the Guidance does not alter or amend applicable law, nor does it have legal force or effect, this is the first time the staff of the Division of Investment Management is affirmatively addressing disclosure obligations that have been at the heart of SEC examinations and enforcement actions preceding and resulting from the SEC Mutual Fund Share Class Selection Disclosure Initiative (“SCSD”).  Accordingly, advisers should use this as an opportunity to review and enhance their disclosure about financial conflicts of interest.  In addition to the specific disclosure components discussed below, advisers should consider the following broad concepts from the Guidance:

  • Consider all direct and indirect compensation.  Although the Guidance focuses on disclosure of conflicts of interest associated with the receipt of 12b-1 fees and revenue sharing, advisers should not stop there.  The Guidance makes clear that “many of the same principles and disclosure obligations apply to other forms of compensation,” including service fees from clearing brokers, marketing support payments, compensation designed to defray the cost of educating and training sales personnel, and transaction fees.  Importantly, the staff refers to “compensation” broadly to include the reduction or avoidance of expenses that the investment adviser incurs or would otherwise incur.
  • Be thoughtful about all types of investments.  Much of the compensation referenced in the Guidance is related to the offering of mutual funds, but the staff does not limit the discussion to mutual funds, rather it refers to “investments” broadly.
  • More disclosure is just more disclosure.  Consistent with the principles set forth in the recent adoption of Form CRS and the SEC Standards of Conduct more generally, the staff makes clear that it expects Form ADV disclosure to be “concise, direct, appropriate to the level of financial sophistication of the adviser’s clients and written in plain English.  As a result, longer disclosures may not be better disclosures.”  This is a pretty clear warning that simply adding more disclosure will not address the staff’s concerns.  Rather, the focus should be on developing disclosure that is specific enough to explain whether and how the conflict could affect the advice a client receives.
  • Be proactive.  One of the criticisms of the SEC staff’s positions in the SCSD cases was that the SEC was evaluating disclosure with the benefit of hindsight, but that the staff of the Division of Investment Management had never precisely articulated principles that investment advisers should follow when seeking to satisfy their fiduciary obligation to disclose financial conflicts of interest under Section 206.  The staff is now providing affirmative guidance and it will be difficult to defend in examinations or enforcement investigations future disclosure that does not conform to the disclosure points referenced in the Guidance to the extent relevant to the adviser’s business practices.
  • Don’t Delay.  There will be a desire to wait until the next annual update of Form ADV (in March 2020 for most firms) to make any changes, but depending on the nature of the adviser’s existing disclosure, it may be worthwhile to file an interim update that incorporates the disclosure points set forth in the Guidance, as well as the recently adopted Interpretation of Standards of Conduct for Investment Advisers (the “Interpretation”).

Material Facts to be Disclosed

The Guidance provides examples of material facts that the Staff believes should be disclosed in connection with the receipt of 12b-1 fees and revenue sharing payments.  This list is not intended to be comprehensive, so advisers should consider whether they need to disclose different or additional facts depending on the firm’s particular circumstances.

  • Disclose the existence and effect of different incentives and resulting conflicts. 
    • The fact that different share classes are available and that different share classes of the same fund represent the same underlying investments.
    • How differences in sales charges, transaction fees and ongoing fees would affect a client’s investment returns over time.
    • The fact that the adviser has financial interests in the choice of share classes that conflict with the interests of its clients.
    • Any agreements to receive payments from a clearing broker for recommending particular share classes (e.g., NTF mutual fund share classes or 12b-1-fee-paying share classes).
  • Disclose the nature of the conflict. 
    • Whether the conflict arises from differences in the compensation the adviser and its affiliates receive, or results from financial incentives shared between the adviser and others (e.g., clearing brokers, custodians, fund investment advisers, or other service providers).  These financial incentives might include offsets, credits, waivers of fees and expenses.  In the case of revenue sharing arrangements, these incentives could also include the receipt of payments and expense offsets from a custodian for recommending that the adviser’s clients maintain assets at the custodian.
    • Whether there are any limitations on the availability of share classes to clients that result from decisions or relationships at the adviser or its service providers (e.g., where the clearing firm only makes certain share classes available, the fund or clearing firm has minimum investment requirements, or the adviser limits investment by type or class of clients, advice, or transactions).
    • Whether an adviser’s share class selection practices differ when making an initial recommendation to invest in a fund as compared to recommendations to convert to another share class, or buy additional shares of the fund. For example, the adviser could consider disclosing its practices for reviewing, in conjunction with its periodic account monitoring, whether to convert mutual fund investments in existing or acquired accounts to another share class.
  • Disclose how the adviser addresses the conflict. 
    • 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 (e.g., considerations associated with selecting between share classes that charge 12b-1 fees or transaction fees).
    • 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 (e.g., retirement accounts).

The Guidance also noted that in making disclosure determinations, an adviser needs to look both to “the specific disclosure requirements in Form ADV” as well as broader, general, disclosure obligations as a fiduciary.  The Guidance did not expound on this latter point, but it serves as a reminder to advisers that during any examination or enforcement investigation, the staff will review Form ADV disclosures in a non-formulaic fashion and disclosures should be drafted and reviewed accordingly.

“May”- Based Disclosure

The Guidance reiterates that disclosure that an adviser “may” have a conflict of interest resulting from the receipt of compensation is not sufficient if the conflict actually exists.  This was a central point of contention in evaluating the adequacy of disclosure in the SDSC Initiative and related mutual fund share class cases.  In this regard, the Guidance is consistent with the Interpretation, which warned that “may”-based disclosure could be appropriately used only in cases where the disclosure identifies a potential conflict that does not currently exist but might “reasonably present itself in the future.” According to the Interpretation, investment advisers should not use “may” to explain that a conflict exists only with respect to a subset of clients or services it provides, unless the “may”-based disclosure specifies the subset of clients or services where the conflict applies. In the SEC’s view, “may”-based disclosure that precedes a list of all possible or potential conflicts regardless of likelihood has the effect of “obfuscating” actual conflicts to a point that clients cannot provide informed consent.

Available Share Classes and Account Monitoring

When evaluating the presence of a conflict of interest advisers are required to consider the “available” share classes.  The Guidance clarifies that references to “available” share classes means all share classes offered by the fund for which the client is eligible (based on, for example, minimum investment amounts) at the time of a recommendation, “except to the extent the adviser or the adviser’s service provider imposes limitations on the availability of a share class to certain types of clients and the adviser provides full and fair disclosure and receives informed consent from the client with respect to those limitations.”  In doing so, the staff clarifies that advisers can limit the universe of funds they consider in making investment recommendations to those funds available on the clearing firm’s platform or to particular classes of shares that the adviser decides to offer to its clients – so long as those limitations are clearly disclosed in a manner that is specific enough to meet the standard for informed consent under the Interpretation.

In clarifying this position, however, the staff also notes that eligibility for a particular share class is evaluated at the time of a recommendation – “including a recommendation to continue holding current investments.”  Accordingly, the Guidance suggests that advisers that have an ongoing relationship with their clients should reevaluate whether a particular share class continues to be appropriate for a client over time consistent with the adviser’s periodic account monitoring responsibility, and should consider whether to convert existing or new positions to a lower cost share class.  This would be the case regardless of whether the adviser made the initial recommendation with respect to the investments in the account.

We are Here to Help

We expect the SEC examination and enforcement staff will evaluate the adequacy of disclosure relating to financial conflicts of interest against this Guidance and the principles set forth the Interpretation.  Accordingly, advisers should revisit existing Form ADVs, as well as other client facing materials, to update the disclosure or consider whether to document why the incorporation of particular disclosure points may not be relevant in relation to the adviser’s business practices.  In addition, advisers may wish to update their policies and procedures around the selection of particular investments where there is a conflict of interest and to confirm that their disclosure matches actual business practices.


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Jennifer L. Klass serves as the co-chair of Baker McKenzie's North America Financial Regulation and Enforcement Practice, which provides clients with a full range of regulatory advice and enforcement counseling. Jen is an experienced financial services regulatory lawyer with particular focus on investment adviser regulation and the convergence of investment advisory and brokerage services. She regularly represents clients before the US Securities and Exchange Commission (SEC), both in seeking interpretative guidance and in managing examination and enforcement matters.


Amy serves as the Co-chair of Baker McKenzie's North American Financial Regulation and Enforcement Practice, which provides our clients with a full range of regulatory advice and enforcement counseling. Amy also serves on the steering committees of the Firm's Global Financial Services Regulatory and Global Financial Institutions Groups. Previously, Amy has served as chief litigation counsel at the US Securities and Exchange Commission's (SEC) Philadelphia regional office and managed a team of lawyers overseeing a wide variety of enforcement matters.


Peter K.M. Chan is a member of Baker McKenzie’s North American Financial Regulation and Enforcement Practice, which provides our clients with a full range of regulatory advice and enforcement counseling. Peter brings two decades of experience at the US Securities and Exchange Commission (SEC) to his litigation and counseling work. His tenure at the SEC, as well as a stint as Special Assistant US Attorney in the Northern District of Illinois, have given Peter experience with civil and criminal matters. At the SEC, Peter served as assistant regional director in the Chicago regional office, where he led investigations and litigations of high-profile enforcement cases. In the course of his SEC career, he handled corporate issuer disclosure and reporting violations, financial fraud, auditor independence violations, insider trading, broker-dealer misconduct and failure to supervise cases, hedge fund and investment company fraud, and Dodd-Frank and Sarbanes-Oxley violations. As the head of the Municipal Securities and Public Pensions Unit at the SEC's Chicago office, he oversaw cases involving municipalities and public pensions throughout the Midwest, including disclosure failures by states, cities, and underwriters in municipal bond offerings; pay-to-play and public corruption; and securities fraud victimizing municipalities and public pensions. Peter also served in national leadership roles within the SEC's Enforcement Division. Peter acted as national leader of the Municipalities Continuing Disclosure Cooperation (MCDC) Initiative. He also served as co-chair of the Priorities and Resources Subcommittee of the Division of Enforcement Advisory Committee and was one of the original architects of the SEC Financial Reporting and Audit Task Force. Peter's experience in criminal securities fraud cases includes serving as Special Assistant US Attorney in the Northern District of Illinois in a criminal investigation into market abuse by a Chicago broker-dealer, resulting in guilty pleas by several senior executives at the firm. In 2014, Peter received the SEC's prestigious Paul R. Carey Award for his [e]xceptional personal commitment and effectiveness as a member of the Division of Enforcement.