BEST PRACTICES

The SEC often alleges “conflicts of interest” in various enforcement actions and also derides “conflicts” in letters, speeches, testimony, and other public statements.

In order to help clarify what the SEC means by “conflict of interest,” today’s list describes 10 prohibited practices that the regulators have identified as conflicts of interest in enforcement cases.

1

Recommending the Wrong Share Class

The SEC has brought several cases in which 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.

2

Recommending Proprietary Products

The regulators highly scrutinize advisers and broker-dealers that recommend proprietary funds or managed account programs that include built-in fees.

3

Favoring Certain Clients

The SEC has criticized firms for allowing redemptions to favored clients after telling other clients a fund was closed to redemptions or by selling out liquid investments for insiders and leaving outside clients holding illiquid investments.

4

Manipulating Valuations to Increase Fees

Firms have tried all manner of schemes including using “friendly” broker quotes, lying about inputs, and using non-economic options trades.

5

Making Sweetheart Deals with Affiliates

The SEC will not like firms that feign “independence” and then recommend affiliates for ancillary services to jack up revenue.

6

Cherry-Picking Allocations

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.

7

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.

8

Overbilling Clients

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.

9

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.

10

Lying About Qualifications

In addition to performance, the SEC has also faulted firms that lie about their academic or business qualifications, the firm’s AUM, or the firm’s financial or disciplinary record.