On November 5, 2019, Stephanie Avakian, Co-Director of the SEC’s Enforcement Division (“Division”), delivered prepared remarks regarding the Division’s enforcement philosophy and current areas of focus.1 Ms. Avakian also discussed recent actions regarding undisclosed conflicts of registered investment advisers (“advisers”) in recommending mutual fund share class investments to clients—referred to as the share class selection disclosure initiative (“SCSDI”).2
Ms. Avakian reported that the SEC’s “top enforcement priority… is to protect retail investors” and that an aspect of that objective is identifying material financial conflicts of interest, particularly those that may be harmful to investors. She emphasized that the Division is actively looking for circumstances where an adviser is financially conflicted by incentives that could affect investment decisions and recommendations for clients, citing the SCSDI as an example. She then highlighted the below conflict areas on which the Division is focusing its efforts.
- Revenue Sharing: Arrangements pursuant to which a dually-registered adviser or an introducing broker affiliated with the adviser receives revenue sharing payments from a clearing broker for investing in certain funds or classes of funds invested in or recommended by the adviser.
- Cash Sweep Arrangements: Arrangements pursuant to which a dually-registered adviser or a broker-dealer affiliated with the adviser receives Rule 12b-1 fees or revenue sharing payments for investing in or recommending a money market fund or bank deposit account in connection with a cash sweep program.
- Unit Investment Trust (“UIT”) Investments: Arrangements pursuant to which an adviser’s affiliated broker-dealer receives fees from a UIT in offerings that have different fee structures for investors in brokerage and fee-based advisory accounts.
- Administration of Teacher Retirement Plans: Ms. Avakian also noted that the Division is scrutinizing compensation arrangements and related conflicts disclosures relating to how investment options are chosen for teacher retirement plans and how advisers and their affiliates are compensated.
The enforcement priorities outlined in Ms. Avakian’s speech are very consistent with recent SEC actions and clearly indicate that the Division intends to apply its investigation and enforcement approach followed in SCSDI to other areas of undisclosed conflicts and compensation arrangements. Advisers should continue to be proactive in understanding and reviewing their direct and indirect compensation arrangements with third parties for conflicts of interest (particularly those that can affect the investment return of their clients). Advisers should also review their current Form ADV disclosures of these arrangements to ensure that they are disclosed, and disclosed with sufficient specificity, in a way that is consistent with applicable requirements, as well as any client agreements that include corresponding conflicts disclosure.
1 See “What You Don’t Know Can Hurt You: Keynote Remarks at the 2019 SEC Regulation Outside the United States Conference,” Stephanie Avakian, Co-Director, Division of Enforcement, SEC, available at: https://www.sec.gov/news/speech/speech-avakian-2019-11-05.
2 We previously discussed these actions at https://40actblog.sewkis.com/sec-continues-to-pursue-share-class-selection-cases/ and https://40actblog.sewkis.com/sec-orders-an-additional-16-self-reporting-advisory-firms-to-pay-nearly-10-million-to-investors/. On October 18, 2019, the Division of Investment Management provided additional guidance in an FAQ on the sources of the requirements to disclose conflicts of interest and the staff’s views on how these requirements apply to certain types of compensation arrangements. See “Frequently Asked Questions Regarding Disclosure of Certain Financial Conflicts Related to Investment Adviser Compensation,” Division of Investment Management, SEC, available at https://www.sec.gov/investment/faq-disclosure-conflicts-investment-adviser-compensation. We previously discussed the FAQ here: https://www.sewkis.com/publications/sec-releases-faq-on-investment-adviser-conflicts-of-interest-disclosure-for-certain-compensation-arrangements/.