The SEC has commenced enforcement proceedings against a fund-of-funds manager and its principals for failing to adequately disclose revenue sharing payments received from underlying fund investments.  The firm’s ADV and the funds’ PPMs included disclosure stating that the adviser “may” receive revenue sharing from underlying fund investments.  However, the SEC asserts that the disclosure was misleading because (i) the firm was already receiving revenue sharing payments, (ii) the disclosure was not specific enough about the sources, recipients, amounts, and duration of the fees, (iii) the firm did not inform investors that the revenue sharing payments would be distributed directly to the firm’s principals, and (iv) the PPM disclosure was “buried” on page 60 of the PPM.  The SEC also alleges that the firm fired a compliance consultant that recommended enhanced disclosure and terminated an administrator that asked for substantiating documents.  The SEC charges violations of various antifraud statutes and rules.

OUR TAKE: The SEC has indicated that it will heavily scrutinize any revenue sharing payments received from investments recommended by an investment adviser.  Although revenue sharing is not per se illegal, it may not be possible to include enough disclosure to satisfy the staff that a firm has cured the inherent conflict of interest.  Also, firing a compliance consultant is a red flag that something may be amiss.