Since the fiduciary rule was passed, regulators have been clamping down on advisory firms for failing to protect the rights of clients. Advisers must make sure they are putting their clients’ interest ahead of their own, says Todd Cipperman, founding principal of Cipperman Compliance Services.
To help planners spot the red flags of noncompliance, Cipperman identified 10 potential conflicts that may bring on an enforcement action.
The SEC has brought several cases where wrap or managed account sponsors recommended share classes that were not the lowest-cost available. In many cases, the SEC alleged a conflict because the respondent received some sort of financial benefit such as loads or revenue sharing.
Favoring certain clients
The SEC has criticized firms for allowing redemptions to favored clients after telling other clients a fund was closed to withdrawals or by selling out liquid investments for insiders and leaving outside clients holding illiquid investments.
Recommending proprietary products
Regulators highly scrutinize advisers and broker-dealers that recommend proprietary funds or managed account programs that include built-in fees.
Making sweetheart deals with affiliates
The SEC doesn't like firms who feign independence and then recommend affiliates for ancillary services to jack up revenue.
Manipulating valuations to increase fees
Firms have tried all manners of schemes, including the use of friendly broker quotes, lying about inputs, and using non-economic options trades.
Lying about performance or strategy
The SEC views misleading marketing materials as a form of conflict of interest. There have been many criticized practices including using backtested data, failing to describe a strategy’s true risks, omitting poor recommendations from performance calculations, and cherry-picking time periods.
Taking undisclosed fees
The fee may appear legitimate — and maybe the client should have known — but, without specific written disclosure, a firm looks like it has engaged in a classic conflict of interest when it surreptitiously takes undisclosed compensation. Examples include payment of overhead expenses, consulting fees, and investment banking fees.
Firms have found regulatory trouble by overbilling clients by using an opaque billing formula such as changing measurement dates for valuing client assets or failing to deduct unrealized losses.
Several firms have been prosecuted for using omnibus accounts and then retroactively cherry-picking good trades for proprietary accounts and not-as-good trades to client accounts.
Lying about qualifications
In addition to performance, the SEC has also faulted firms who lie about their academic or business qualifications, the firm’s AUM, or the firm’s financial or disciplinary record.