Conflict Disclosures: SEC Warns of Top Issues

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ARLINGTON, VA. -- When SEC examiners come to inspect an advisory practice, the exercise seldom results in an enforcement action. But in nearly all their reviews, examiners cite the advisor for insufficient disclosures about conflicts of interest, according to a senior commission official.

"One of the takeaways is almost every exam report has a deficiency in disclosure and conflicts of interest," said Daniel Kahl, assistant director of the Investment Adviser Regulation Office within the SEC's Division of Investment Management. "I recognize that it's a difficult task. And it can be hard to resolve and address all the conflicts."

In remarks at the Investment Adviser Association's compliance summit, Kahl outlined several of the most common conflicts that advisors fail to disclose adequately to their clients.


Advisors' relationships with affiliated brokerage practices, is one of those areas, Kahl said. For example, SEC examiners commonly cite advisors who simply alert their clients that they might use an affiliated broker, he said, particularly in practices where the advisor exclusively uses that broker. Moreover, advisors will help their cause when they go out of the way to flesh out the nature of their relationship with their brokers for clients.

"A common theme is it wasn't effective disclosure. There were numerous citations for identifying the conflict of affiliated brokers, but not telling your clients what that meant, allowing them to assess the conflict," Kahl said. "It's not just the disclosure of the conflict, but provide enough information to the client so in essence they're effectively consenting to the conflict."


Similarly, Kahl said that examiners had dinged advisors for multiple failures to disclose conflicts about their dealings with other service providers.

In some cases, conflicts arose from advisory staff holding an ownership stake in the provider. In others, the firm failed to disclose gifts or services provided to advisory staff, such as "lavish dinners" or travel on a private jet, according to Kahl.

"If it's going to color the choice of the service provider, think about how you address that in your compliance program," he said. "If you're going to allow your personnel to engage in those types of practices, think about telling your clients that that's going to happen and the potential impacts of that conflict of interest."


He also warned about "disguised referral fees" that come from "quid pro quo" arrangements with lawyers, accountants or other service providers. Often, he said, examiners uncovered instances when advisors would recommend to clients the same professionals who had previously sent business their way -- an off-the-books agreement that still warrants disclosures.


SEC examiners also logged numerous disclosure citations associated with advisors' trade-error policies. In many such cases, advisors simply failed to abide by what Kahl called "disclosure 101," that they had a policy in place to deal with trade errors, but when such situations arose, they deviated from it.

"It comes down to disclose what your trade error policy is, and make sure you follow it," he said. "That is a common exam deficiency: you said to your clients you were going to do X, and you did Y."


Kahl and other compliance experts speaking at the conference acknowledged that disclosure is not a panacea, and that indeed some conflicts are so glaring that they simply cannot be disclosed away. But he also acknowledged that conflicts are inherent in the typical advisor practice, and are not in and of themselves a problem. Where many advisors fall down, however, is that they turn a blind eye to practices that the SEC's Office of Compliance Inspections and Examinations sees as a conflict, or, even if they do offer a disclosure, it still isn't clear enough for the clients to understand what's going on.

"There are conflicts continually. How do you address them? OCIE is going to come and kick the tires and then make sure that you ... have a strong compliance program, and if there are conflicts, you're disclosing them, and you're disclosing them in a fulsome manner," Kahl said.

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