The SEC recently commenced an enforcement action against an investment advisory firm and its principal in connection with the failure to disclose material conflicts of interest in connection with new mutual funds that the firm recently created and managed. The SEC is seeking disgorgement and an injunction against the firm and its principal. 

Clients of the firm paid a fee for investment advice. Initially, the clients were invested in an ETF program. The firm subsequently created its own mutual funds that it managed for a fee. Without disclosing that it would be paid both an investment advisory fee and fees for managing the mutual funds, the firm moved its clients into the mutual funds, which mirrored the investments in the ETF program. So why did the SEC take issue with this?

For one, the firm did not disclose the conflict of interest associated with this new strategy. The conflict of interest is that the firm is going to be paid two fees for an investment program that was the same as the prior program for which clients were only charged one fee.

Interestingly, the SEC in its complaint does not contend that the charging of two fees is per se improper. Instead, the issue is the fact that the firm did not disclose the conflict to its client before shifting the investment program. So what does this mean?

It all comes down to disclosure. If you disclose all conflicts of interest in sufficient detail, you may be able to avoid these types of enforcement issues.