SEC Issues FAQ on 12b-1 Fee Disclosure Obligations

Advisors are also encouraged to disclose "[w]hether the adviser has a practice of offsetting or rebating some or all of the additional costs to which a client is subject (such as 12b-1 fees and/or sales charges), the impact of such offsets or rebates, and whether that practice differs depending on the class of client, advice, or transaction" such as ERISA accounts.

The FAQ also points to how advisors must report certain forms of compensation and conflicts of interest on Form ADV.

When "an advisor receives, directly or indirectly, 12b-1 fees in connection with mutual fund recommendations, it has a financial incentive to recommend that a client invest in a share class that pays 12b-1 fees," IM states.

"The resulting conflict of interest is especially pronounced when share classes of the same funds that do not bear these fees are available to the client."

An advisor's disclosure on Form ADV must include "sufficiently specific facts" to allow clients to understand the advisor's conflicts and business practices and give informed consent or reject them.

"This may require an advisor to disclose 'information not specifically required by' the Form or more detail than the Form otherwise requires," the FAQ notes.

For instance, an advisor "disclosing that it 'may' have a conflict is not adequate disclosure when the conflict actually exists."

IM states that in the in the course of administering Form ADV, as well as conducting compliance exams and enforcement investigations, IM staff "has observed a range of practices with respect to this type of disclosure."

Examples of material facts that, in IM's view, an advisor should disclose about its practices and conflicts "in plain English," include:

• The existence and effect of different incentives and resulting conflicts.
• The fact that different share classes are available and that different share classes of the same fund represent the same underlying investments.
• How differences in sales charges, transaction fees and ongoing fees would affect a client's investment returns over time.
• The fact that the advisor has financial interests in the choice of share classes that conflict with the interests of its clients.

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