On notice: What SEC examiners expect from advisors despite pandemic

Register now

WASHINGTON — Even with the SEC halting in-person exams due to the coronavirus pandemic, examiners are still monitoring firms remotely, and advisors can help their cause by demonstrating that they have thought seriously about how they are handling conflicts of interest, according to current and former regulators.

SEC examiners and enforcement staff are likely to take a kinder view of firms that can show that they have taken meaningful steps to identify conflicts and make detailed disclosures to clients in cases where the conflict can't be eliminated.

That means that the SEC won’t be satisfied if advisors try to rely on gauzy formulations describing how a certain product or service "may" create a conflict of interest, according to David Bartels, associate director at the chief counsel's office at the SEC's Division of Investment Management. Firms have included that kind of language in documents as a vague catchall to point to as evidence that they envisioned conflicts arising and made an effort to disclose them if challenged by an examiner, Bartels said during a panel discussion at the Investment Adviser Association's annual compliance conference.

The word "may" can be fairly applied when contemplating a potential future conflict, the commission has said. But regulators want to see enough detail to show advisors have made a good faith effort to game out such potential scenarios.

"If you find yourself really wrestling with a 'may' versus 'will,' it's worth stepping back and asking if you're trying to use or get a single word to do too much work," Bartels said. "If you're wrestling with it that might be an indication that you need to step back and really think about providing more detail about when the conflict would exist and when it wouldn't."

The SEC is also looking closely at how advisors are handling compensation amid pressure throughout the industry to lower the most visible fees charged to clients. In that context, Bartels said, examiners are on the lookout for emerging novel alternative compensation models, and whether those could create new conflicts of interest.

That was at the heart of the commission's share class initiative, through which advisors were offered favorable settlement terms if they came forward and acknowledged charging clients high-cost shares when less expensive classes of a mutual fund were available.

With the SEC on the hunt for new compensation structures, advisors need to take a thorough inventory of all their revenue streams and ensure that their disclosures accurately reflect the evolving nature of the business, according to James Lundy, a partner at the Chicago office of the law firm Faegre Drinker Biddle & Reath and a former senior official at the SEC.

Lundy tells clients to look closely at the cases the SEC is bringing against firms in this area, explaining that when the commission publicizes an enforcement case, in addition to publishing a single firm, it's also signaling to the rest of the industry that certain types of conduct are unacceptable.

SEC halts in-person exams and weighs delay for Reg BI, says OCIE head
Only a firm “actively swindling funds” would trigger an onsite visit, according to Peter Driscoll.

"The messaging is very, very real: Don't just wait for an FAQ from Investment Management. Don't just wait for the OCIE risk alert," Lundy said at the conference. "Have some folks on your team who can follow enforcement cases and interpret what they may mean for the business, what they may mean for the disclosures that you're making, and be prepared to put a plan in place to proactively take that information to remediate any gaps that may be there," he said.

"I think enforcement still appreciate those efforts, and if you're doing that before examiners arrive or before enforcement arrives, that's a really, really powerful story to tell the staff that you're being proactive, that you're doing things the right way to head off an enforcement action before it gets going further down the line," Lundy added.

For reprint and licensing requests for this article, click here.
Regulatory guidance SEC enforcement SEC Regulatory actions and programs