On October 18, 2019, the SEC’s Division of Investment Management issued guidance in the form of Frequently Asked Questions that address certain matters regarding the disclosure of conflicts of interest involving the receipt by investment advisers of certain types of compensation, including 12b-1 fees, service fees, marketing support payments and other forms of revenue sharing by advisers and their affiliates and/or associated persons. The FAQs should be read in the context of the SEC’s continued focus on conflicts of interest, particularly through the adoption of Form CRS and the SEC’s recent focus on advisers’ share class selection practices and receipt of 12b-1 fees through the Share Class Selection Disclosure Initiative. The FAQs address the conflicts of interest presented by these compensation arrangements and related disclosure obligations required under an adviser’s fiduciary duties and Form ADV.
Key takeaways from the FAQs are as follows:
- Fiduciary duty principles and SEC guidance require an adviser to disclose in its Form ADV any compensation the adviser receives, directly or indirectly, in connection with its advisory activities.
- Compensation received by an adviser includes the receipt of payments as well as “the reduction or avoidance of expenses that an adviser incurs or otherwise would incur.”
- If a conflict of interest exists, an adviser’s fiduciary duties require the adviser to disclose the existence of the conflict, the nature of the conflict and how the adviser addresses the conflict.
- The SEC staff continues to caution against the use of the word “may” in situations in which a conflict actually exists or a business practice is actually followed. For example, in situations in which a conflict or practice applies only to a subset of clients, the adviser must specifically explain that a conflict exists and the circumstances that make the conflict applicable and identify the types of clients impacted. In this case, it would not be sufficient to note that the adviser “may” have a conflict of interest.
- Because market practices are constantly evolving, advisers are encouraged to proactively review their practices periodically to identify new or changing conflicts of interest.
- If an adviser materially amends or supplements its disclosures concerning share class recommendations or revenue-sharing arrangements, the adviser is required to highlight the amendments in Item 2 (“Material Changes”) in its Form ADV Part 2.
The FAQs are available here.