SEC releases FAQ for RIAs amid heightened fee disclosure scrutiny

Last week, the Securities and Exchange Commission released a document on frequently asked questions regarding fiduciary advisors’ disclosure requirements on their compensation.

The latest guidance comes on the heels of the SEC’s Share Class Selection Disclosure Initiative, run by the Commission’s Division of Enforcement, which allowed fiduciary advisors to self-report failures to disclose 12b-1 compensation on investment recommendations.

The Initiative resulted in settled charges against 79 firms, and the disgorgement of $125 million in compensation, most of which will be returned to investors, according to the SEC.

The FAQ notes that firms’ Form ADV filings instruct advisers to disclose “sufficiently specific facts” to inform clients of conflicts of interest, and “may require an adviser to disclose ‘information not specifically required by’ the Form,” according to the FAQ.

That means disclosure may require “more detail” than Form ADV requires, the SEC said.

Importantly, simply disclosing that an adviser “may” have a conflict of interest is not sufficient disclosure when a conflict actually exists.

Fully disclosing the practice of recommending share classes with 12b-1 fees is necessary, even if that practice only represents a minority of the adviser’s assets under management.

“An adviser must disclose if it or its supervised persons accepts sales compensation, including asset-based sales charges or service fees,” according to the FAQ, “including information about the conflict, how the adviser addresses the conflict and whether the adviser offsets the compensation against its advisory fees.”

While the FAQ reminds of the need to fully disclose all conflicts, it also underscores the need to be concise on Form ADV filings. “Longer disclosures may not be better disclosures,” the SEC says.

Examples of material facts that need to be disclosed

The necessary disclosure obligations when multiple share classes of the same mutual fund are available are “well established,” the FAQ says.

The FAQ provides several examples of the kind of material facts that need to be disclosed.

Those facts include the existence and the effect of different adviser incentives and the resulting conflicts, the nature of the conflicts, and how the adviser addresses the conflicts.

Advisers also have to disclose compensation from third-party custodians of clients’ assets, the FAQ says.

Compensation from clearing brokers for recommendations on no-transaction-fee mutual fund share classes should also be disclosed, “in the staff’s view,” the SEC says.

As with 12b-1 fees, simply disclosing that an adviser “may” have a conflict with its relationships with custodians and clearing brokers is not sufficient when the conflicts actually exist.

When advisers amend previous Form ADVs to account for share class recommendations or revenue sharing agreements, advisers are required to highlight the changes in the Forms summary of material changes, the FAQ says.