With Securities and Exchange Commission examiners still finding advisors—specifically dually-registered advisors—are not fully disclosing or eliminating compensation conflicts of interest, now is a critical time for firms to evaluate and fix their practices, the Best Interest Compliance Team at Drinker Biddle told clients in a new blog this week.

It’s no secret that SEC examiners continue to uncover dually-registered advisors and firms that are not disclosing or eliminating conflicts of interest with regard to their compensation practices. Problems include mutual fund share class recommendations and revenue sharing arrangements, but also financial conflicts related to compensation, types of fees and undisclosed mark-ups, Drinker Biddle partner David L. Williams said.

The SEC FAQs come a year after the Division of Enforcement announced its Share Class Selection Disclosure Initiative asking firms to self-report conflicts and almost 11 months after the Division of Enforcement initiated a surprise regulatory “sweep” looking for revenue sharing violations.

In total, these SEC enforcement actions have cost broker-dealer RIAs hundreds of millions of dollars in fines and customer reimbursements.

“The key takeaway is that advisors must eliminate or disclose all conflicts that might incentivize the adviser to render advice that is not disinterested or not in the best interest of its client,” Williams said.

Firms should pay particular attention to the following areas, Drinker Biddle said:

• An advisor disclosing that it “may” have a conflict is not adequate disclosure where a conflict actually exists.
• Disclosures must include sufficiently specific facts to allow clients to understand an advisor’s conflicts and give informed consent to accept or reject them, which may require an advisor to disclose “information not specifically required by the Form.
• An advisor must disclose if it or its supervised persons accept sales compensation, including asset-based sales charges or service fees, including how the adviser addresses the conflict and whether the compensation is offset against the advisor’s advisory fees.
• An advisor must disclose in its brochure supplement whether a supervised person of the advisor receives commissions, bonuses or other compensation based on the sale of securities or other investment products, including as a broker-dealer or registered representative, and including distribution or service fees from the sale of mutual funds.

“Where a conflict exists, an adviser must also disclose how it addresses the conflict, and, as noted previously, an adviser’s fiduciary duties may require it to provide disclosure beyond what is specifically required by Form ADV,” Williams said.

On the mutual fund share class front, the SEC expects firms and dually-registered reps still brave enough to sell more expensive C-shares to make the following disclosures:

• The fact that different share classes are available that represent the same underlying investments; (ii) how differences in sales charges, transaction fees and other fees may affect a client’s returns over time; and (iii) the fact that an adviser has a conflict of interest with respect to the selection of share classes.
• The nature of the conflict, including (i) whether the conflict arises as a result of differences in compensation that the adviser or its affiliates would receive or from the existence of incentives shared between the adviser and a clearing broker or custodian.
• Whether an adviser’s practices with regard to share class recommendations differ when it makes an initial recommendation to invest in a fund compared to (i) recommendations regarding share class conversions and (ii) recommendations to buy additional fund shares.
• The circumstances under which the adviser recommends share classes with different fees and the factors considered by the adviser in making such recommendations.
• 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 or sales charges), the impact of such offsets or rebates, and whether the practice varies depending on the class of client, advice or transaction.