District Court Agrees with SEC in Finding Adviser Liable for "Hypothetical" Disclosure Regarding Conflicts
Commentary by Nick Allen
The U.S. District Court for the District of Massachusetts found an investment adviser liable for failing to disclose to its advisory clients material conflicts of interest with respect to a revenue sharing.
In a Memorandum and Order, the Court granted the SEC’s Motion for Summary Judgment finding that the investment adviser violated (i) Advisers Act Section 206(2) ("Prohibited transactions by investment advisers") for failing to disclose material conflicts of interest to clients and (ii) Advisers Act Section 206(4) and Rule 206(4)-7 ("Compliance procedures and practices") thereunder for failing to adopt related required policy and procedures.
The investment adviser entered into various revenue-related agreements in connection with a variety of fund offerings, in which the adviser received a percentage of fees associated with such funds. Among other things, the Court said that the investment adviser argued that its disclosure - which stated it "may receive transaction-based commissions [and other fees]" - sufficiently apprised its clients of the conflict of interests. However, the SEC contended, and the Court agreed, that such hypothetical disclosure was inadequate given that it "presents the payments it receives from the revenue sharing arrangement as a hypothetical rather than disclosing it as a matter of fact."
Commentary
Where a conflict or risk is known, specific disclosure about such conflict or risk is what’s required. This case (along with several large fines in recent years) make clear that mere boilerplate or generic discussions about conflicts and risks will not suffice; disclosures must align with the specific facts of each particular situation and, importantly, must be updated as those facts change.