Mother, May I? The SEC Declares War on the Use of “May”

Ethan CoreyLegal Insights

The SEC Declares War on the Use of “May”

Lloyd Christmas:
What are the chances of a guy like me and a girl like you… ending up together?

Mary Swanson:
Not good.

Lloyd Christmas:
Not good like one in a hundred?

Mary Swanson:
I’d say more like one in a million.

Lloyd Christmas:
So you’re telling me there’s a chance?

If Lloyd Christmas had been an investment adviser and had disclosed on his ADV “Mary and me may end up together” (or, more likely, “me and Mary might end up together”), the chances of the Securities and Exchange Commission (SEC) seeking to sanction him would be significantly higher than the chances of Lloyd and Mary ending up together.  The SEC has recently made it known in a variety of contexts that it believes investment advisers should not use say that they “may” do something when an adviser: (1) always will do something; or (2) can articulate the circumstances under which it will do something.

1. Commission Interpretation Regarding Standard of Conduct for Investment Advisers

On June 5, 2019, the SEC issued the Commission Interpretation Regarding Standard of Conduct for Investment Advisers (Interpretation) 1 as part of its fiduciary rulemaking package.  The SEC discussed the use of the word in “may” in the context of its discussion of an adviser’s duty of loyalty to its clients.  The SEC stated that “[i]n order for disclosure to be full and fair, it should be sufficiently specific so that a client is able to understand the material fact or conflict of interest and make an informed decision whether to provide consent.” 2 With respect to the use of the word “may”, the SEC stated:

[D]isclosure that an adviser “may” have a particular conflict, without more, is not adequate when the conflict actually exists.  For example, we would consider the use of “may” inappropriate when the conflict exists with respect to some (but not all) types or classes of clients, advice, or transactions without additional disclosure specifying the types or classes of clients, advice, or transactions with respect to which the conflict exists. In addition, the use of “may” would be inappropriate if it simply precedes a list of all possible or potential conflicts regardless of likelihood and obfuscates actual conflicts to the point that a client
cannot provide informed consent. On the other hand, the word “may” could be appropriately used to disclose to a client a potential conflict that does not currently exist but might reasonably present itself in the future.3

Interestingly, the SEC failed to acknowledge that “may” could be appropriately used to disclose a conflict that currently exists but the circumstances under which it would arise are not wholly within the control of the investment adviser.  For example, an adviser may advise two client accounts – one which is prohibited from transacting with an affiliated broker, and another which does not have any restrictions on brokers. An adviser’s best execution obligation may cause it to execute a transaction with the client-affiliated broker from time to time.  In those instances, the adviser’s obligations to each account will conflict. However, an adviser will not know in advance how often it will want to execute a transaction with the client-affiliated broker. In those circumstances, any language less generic than “may” is likely to be misleading.

2. MVP Manager LLC

On August 13, 2019, the SEC announced settled charges against MVP Manager LLC (“MVP”), an exempt reporting adviser to private funds, for failing to adequately disclose conflicts of interest.4 The SEC order5 stated that MVP failed to adequately disclose to its client private funds actual or potential conflicts of interest.  The conflicts of interest consisted of MVP personnel’s receipt of brokerage commissions from counterparties to certain transactions with MVP’s advisory-client funds.

a. What Did MVP Personnel Do?

Certain principals of MVP and other MVP personnel also operated an office of supervisory jurisdiction of a registered broker-dealer (the “Broker”).  These MVP personnel was registered representatives of the Broker, and a principal of MVP was the supervisor of the office of supervisory jurisdiction. 

As the manager of and investment adviser to private funds, MVP’s practice was to form a new series of interests in a private fund, conduct an offering of that series, and invest the proceeds in shares of a specified pre-IPO company—typically by advising, negotiating, and arranging for the fund to enter into a stock purchase agreement with a secondary market seller.   MVP provided prospective investors with a private placement memorandum (“Fund PPM”) and a PPM series supplement (“Series Supplement”) specific to the series of the Fund that was then being offered to the investor. The Fund PPM described the series structure of the private fund, its management, general conflicts and risks, and that a Series Supplement would describe the terms applicable to that series. Each Series Supplement disclosed the specific pre-IPO company in which that series would invest and the fees and expenses that would be payable in connection with the series. The Series Supplement disclosed the amounts of two types of up-front, one-time fees that would be paid out of the series offering proceeds: a two percent “management fee” to MVP and a six percent “placement fee” to the Broker, which ultimately would be paid out to MVP personnel in their capacities as registered representatives of the Broker. It also disclosed payments that would be made at the conclusion of the investment of the actual expenses attributable to the series and an eight percent carried interest distribution to MVP.

However, in three separate instances, MVP personnel also represented the selling pre-IPO companies in their capacities as registered representatives of the Broker, and they received a brokerage commission from the seller out of the gross sales proceeds that the private fund series paid to the seller. In each instance, the seller agreed to receive a net purchase price that was 3-4% lower than the gross purchase price MVP caused to be paid by the buyer Fund. This arrangement created a conflict of interest for MVP in advising the Funds to purchase the securities from the seller. 

The private funds did not have an investment committee or other independent entity that was authorized to approve any conflicts of interest on their behalf.  Although MVP personnel was also simultaneously soliciting investors who might be interested in investing in the Fund series offering and advising the relevant Fund on investing the proceeds of such an offering, none of the disclosure documents provided to investors revealed the existence of the relevant Counterparty Commission Agreement or MVP’s attendant conflicts of interest. 

b. What Did MVP Disclose to the Funds and to Fund Investors?

The Fund PPM – but not any particular Series Supplement – disclosed as a “potential” conflict of interest that the Broker “may receive a placement agency fee or brokerage commission in connection with the purchase of securities of Portfolio Companies … [,] provided, however, that such placement agency fee or brokerage commission will be paid only by the seller of such securities and not by the Fund”.

c. Why was “May” Insufficient?

Because the conflict of interest actually existed as a result of the seller’s commission payment to MVP personnel, yet the particulars of the arrangement were omitted from all of the disclosure documents.  The SEC stated that “[a]lthough the more general Fund PPM disclosed as a ‘potential’ conflict of interest that the Broker ‘may receive a placement agency fee or brokerage commission in connection with the purchase of securities of [pre-IPO companies] …this was not adequate given the actual arrangements“ for the sellers to pay the Broker a commission from the proceeds of the payment made by the Fund series.  The SEC particularly noted that each “Series Supplement—which provided the definitive details on fees and expenses for the series—made no mention of the arrangement.” Essentially, MVP could have disclosed more particulars about the brokerage commission payments than it did. It is also noteworthy that the SEC acted against an exempt reporting adviser, rather than a registered investment adviser. 

3. Commonwealth Equity Services, LLC d/b/a Commonwealth Financial Network

On August 1, 2019, the SEC announced that it had charged Commonwealth Equity Services, LLC d/b/a Commonwealth Financial Network (Commonwealth), a registered investment adviser and broker-dealer, with failing to disclose material conflicts of interest related to revenue sharing Commonwealth received for certain client investments.6 The SEC complaint7 stated that “Commonwealth was paid to select and manage investments for its clients, but failed to tell its clients that some investment choices generated additional multi-million dollar revenues while other similar investment choices would have generated much less, or no, additional revenue.”  The complaint further stated that “[t]he undisclosed conflicts of interest . . . created incentives for Commonwealth to select and hold investments for advisory clients that financially benefited Commonwealth over the interests of its clients, including the incentive to select and hold investments that were more expensive for clients.”  It is important to note that as of now, Commonwealth intends to contest the SEC’s allegation, and the summary below is based on the allegations set forth in the SEC complaint.

a. What Did Commonwealth Do?

Commonwealth offered its investment advisory services through three in-house Preferred Portfolio Services (PPS) programs.  Commonwealth contracted with National Financial Services, LLC (“NFS”), a registered broker-dealer and investment adviser, to maintain custody of Commonwealth’s clients’ assets and to provide clearing services for its advisory clients. NFS is an affiliate of Fidelity Investments, which is a sponsor of “Fidelity” mutual funds offered by NFS.   PPS advisory clients must use NFS as the clearing broker for PPS investment accounts. 

NFS offered to Commonwealth a “no transaction fee” program, through which investors can purchase and sell from a menu of mutual funds without a transaction fee as well as a “transaction fee” program, through which investors can purchase and sell from a different menu of mutual funds, with a transaction fee.  NFS generally charges a mutual fund a higher fee for no transaction fee mutual fund share classes than for transaction fee mutual fund share classes. 

The clearing agreement between Commonwealth and NFS provided that NFS would share this recurring fee, or mutual fund revenue, with Commonwealth based on Commonwealth’s client assets invested in no transaction fee mutual fund share classes, except with respect to Commonwealth client assets invested in Fidelity mutual funds, for which there was no revenue sharing. 

As a result of its agreement with NFS, the SEC has alleged that Commonwealth had an incentive to select and hold more expensive mutual funds for clients, and to select and hold more expensive mutual fund share classes when lower-cost mutual funds were available for the same fund, because, in each instance, the more expensive fund or the more expensive class would generate more revenue for Commonwealth.

b. What Did Commonwealth Disclose to PPS Clients?

Commonwealth at one point amended its Form ADV to disclose that:

Additionally, NFS offers an NTF [no transaction fee] program composed of no-load mutual funds. Participating mutual fund sponsors pay a fee to NFS to participate in this program, and a portion of this fee is shared with Commonwealth. None of these additional payments is paid to any advisors who sell these funds. NTF mutual funds may be purchased within an investment advisory account at no charge to the client. Clients, however, should be aware that funds available through the NTF program may contain higher internal expenses than mutual funds that do not participate in the NTF program and could present a potential conflict of interest because Commonwealth may have an incentive to recommend those products or make investment decisions regarding investments that provide such compensation to Commonwealth. (emphasis added)

c. Why was “May” Insufficient?

Because in reality, Commonwealth had an actual conflict that did create those incentives.  It did not have only a potential conflict that may create incentives to select more expensive investments based on its compensation.  In particular, the SEC objected to Commonwealth’s failure to disclose that its revenue-sharing arrangement with NTF created varying financial incentives for Commonwealth depending on which products it selected for its customers:

i. in some instances mutual fund shares offered through this program had at least one lower-cost share class available to Commonwealth clients for which Commonwealth received less or no revenue sharing; 

ii. Commonwealth also received revenue sharing on certain mutual fund investments for which the broker charged a transaction fee; and 

iii. there were certain mutual funds for which Commonwealth did not receive any revenue sharing payments, which created an incentive for Commonwealth not to select those funds.

4. Conclusion

Lloyd and Mary did not end up together.  If Lloyd had failed to update his ADV to reflect that there was no longer a chance, the SEC could have sanctioned him for misleading clients.  Other investment advisers should not use “may” as a means to avoid disclosing: (a) that they always/never will do something; or (b) the circumstances under which they will do (or refrain from doing) something.


 1Investment Advisers Act Rel. No. 5248, 84 FR 33669 (July 12, 2019). 
2 Id., 84 FR at 33676.
3 Id., 84 FR at 33676-77 (citations omitted).
4 SEC Charges Investment Adviser with Failing to Disclose Financial Conflict of Interest, https://www.sec.gov/enforce/ia-5319-s (visited Aug. 16, 2019).
5 MVP Manager LLC, Investment Advisers Act Rel. No. 5319 (Aug. 16, 2019).
6 SEC Charges Investment Adviser for Failing to Disclose Conflicts Arising from Receiving Revenue Sharing On Client Investments, Litigation Rel. No. 24550 (Aug. 1, 2019), https://www.sec.gov/litigation/litreleases/2019/lr24550.htm (visited Aug. 19, 2019).
7 https://www.sec.gov/litigation/complaints/2019/comp24550.pdf (filed Aug. 1, 2019).