The SEC has had a healthy obsession with conflicts of interest as of late, and this week’s Guidance Update from the Division of Investment Management is no exception. The update, entitled “Acceptance of Gifts or Entertainment by Fund Advisory Personnel – Section 17(e)(1) of the Investment Company Act,” may at first blush appear to be a bit of a puzzler.
Restrictions are relevant only to broker-dealer reps subject to the FINRA $100 annual gift limit, right? In a word – no. Funds and their advisers are subject to a gift and entertainment regulatory regime all their own.
Following the SEC’s logic takes a few steps:
- Someone doing business with a fund (or hoping to do business with a fund) confers gifts or entertainment upon that fund’s advisory personnel
- The receipt of gifts or entertainment = compensation
- Section 17(e)(1) of the Investment Company Act prohibits fund advisory personnel from receiving compensation for the purchase or sale of any property to or for a fund
In short form, the SEC is warning against undisclosed conflicts of interest and, more specifically, violations of section 17(e)(1) (which cannot be solved by disclosure). Both concerns are deeply rooted in the policy goals of the Investment Company Act: that the investment decisions of a fund should be based on the shareholders’ best interest, not those of the fund’s adviser or its personnel.
The receipt of gifts and entertainment has the potential to jeopardize that sanctity.
Even if the person conferring the gift or entertainment did not intend to influence the advisory personnel, and even if the advisory personnel receiving the gift or entertainment did not influence the actions of the fund, the conflict still exists and 17(e)(1) is still violated. The fund also need not suffer economic injury. Intent, influence and harm are all foregone conclusions…or at least are completely irrelevant.
Though there must be “some nexus” between the compensation received and the fund business transacted, the SEC’s burden of proof appears but a minor speed bump on the road to a successful 17(e)(1) or conflicts case.
Two caveats: fund advisory personnel can still receive a regular salary or wages from the fund, and compensation received in the course of acting as the underwriter or broker to the fund is permissible. Any “compensation” received outside of those two carveouts, however, is subject to scrutiny.
In the end, the guidance calls for firms to review their policies and procedures to specifically address the receipt of gifts and entertainment. Though the SEC only calls out funds’ compliance policies and procedures under rule 38a-1, any corresponding investment advisor policies and procedures under rule 206(4)-7 should also be reviewed for consistency and accuracy.
If your firm has an affiliated broker-dealer, don’t forget gifts/gratuities and non-cash compensation policies and procedures adopted pursuant to FINRA and NASD rules.
As to be expected, the guidance does not prescribe the specific contents of each firm’s policies and procedures, but instead suggests that a blanket prohibition on G&E may be appropriate for some firms and a pre-clearance regime may be appropriate for other firms. Where your firm falls on the spectrum depends on the nature of your business.
Any gifts received in violation of section 17(e)(1) must be forwarded to the Division of Investment Management at the SEC’s headquarters in Washington D.C. within 30 days using a postal carrier reasonably designed to ensure safe delivery.
Just kidding about that last part.
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This article originally appeared on February 26, 2015 in ThinkAdvisor.