Three Firms’ Failure to Disclose Conflicts of Interest Lead to Almost $1 Million in Disgorgement, Interest

The U.S. Securities and Exchange Commission (“SEC”) recently announced settled charges against two advisers that self-reported conflicts of interest as a part of the Share Class Selection Disclosure Initiative.

The Initiative resulted in more than $139 million returned to investors. The firms involved self-reported. The goal of the initiative was to allow advisers to self-report if they believed they had failed to fully and fairly disclose their conflicts of interests in selecting more expensive mutual fund share classes that paid fees when lower-cost share classes were available for their advisory clients, violating their fiduciary obligation to recommend shares with lower overall costs, particularly when they are available. This lack of due diligence will not be tolerated by the SEC going forward as the Initiative has ended.

Read the entirety of the SEC press release here.

Ensure Surveillance Systems Are Sound and that All Employees Are Acting in the Best Interest of Your Clients

Although no firm can avoid conflicts of interest entirely, the simplest way to attempt to mitigate conflicts of interest to a reasonable degree is to ensure close supervision of transactions through a robust surveillance system.

Compliance and senior management must constantly assess whether internal controls are robust enough to detect conflicts of interest (such as looking at share class selection prior to a mutual fund transaction) so that they can be eliminated or mitigated. Advisory firms (and by extension, their employees and associated persons) are obligated to act in the best interest of their clients. Oversight of sales transactions, and compensation to be received by the firm’s representatives, are obviously critical, but attention to detail and careful documentation of situations where it may appear that a transaction was not in a client’s best interest is extremely important and will likely be requested during regulatory examinations. Inability to produce this could lead to a referral to enforcement.

Evaluate Your Firm’s Unique Business Model to Mitigate Risks

Every business in this industry is unique in some way, and conflicts of interest can rarely be avoided entirely. Firms must be diligent in evaluating all possible conflicts of interest, first taking a close look at products and services offered – for example, by ensuring that lower class funds are always being offered when appropriate and in the client’s best interest.

Common areas where conflicts of interest exist include advisers that offer a proprietary fund and fail to conduct due diligence on the adequacy of the product for the adviser’s clients or incentivize employees to push this product; revenue share or solicitor arrangements that could influence the recommendation of a product; and remuneration in the form of incidental or actual benefits offered by sponsors of certain mutual funds. Carefully implemented surveillance systems can help to identify these conflicts and assist Compliance in responding to these risks. 

Contact Us Today to Help Evaluate and Mitigate Conflicts of Interest

JLG’s attorneys are able to help advisory firms identify their conflicts and implement internal controls, including surveillance and other systems, to identify business and compliance risks. For more information, or to speak with one of our attorneys, please contact us at or 619.298.2880.

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