Failure to Disclose Fees Received From Third-Party Broker-Dealers May Result in Significant Penalties for Investment Advisers

A recent SEC settlement order illustrates that undisclosed conflicts of interest remain in the agency’s crosshairs. A registered investment adviser had a relationship with a third-party broker-dealer pursuant to which it received a portion of the revenues earned by the clearing broker on certain mutual funds purchased by the adviser’s clients. The SEC asserted that, while the adviser disclosed to its clients some features of the relationship, the adviser’s failure to disclose the revenue-sharing arrangements or the resulting conflict of interest violated the anti-fraud and compliance rule provisions of the Investment Advisers Act of 1940. This settlement should be of particular interest to advisers that receive compensation outside of traditional management fee and incentive compensation arrangements. As a best practice, advisers should periodically identify all compensation received by the adviser and its affiliates, ensure that compensation is accurately disclosed and consider whether the receipt of that compensation raises conflicts of interest that need to be communicated to clients. This article summarizes the SEC’s allegations and the terms of the order. For additional insight on the SEC’s scrutiny of compensation received by advisers, see “Former SEC Asset Management Unit Co-Chief Describes the Agency’s Focus on Conflicts of Interests and Increased Efforts to Crack Down on Private Fund Managers” (Sep. 15, 2016); and “Absent Proper Disclosure, Allocation of Manager Expenses to Funds May Bring Significant SEC Penalties” (Sep. 29, 2016).

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