Intro (00:00):
This is Advisor Intelligence, the podcast for investment advisors and financial institutions. In each episode, attorneys from your investment management and securities team break down compliance, regulation, and risk into practical insights that help you stay exam ready and ahead of what’s next. This podcast is brought to you by Stark & Stark.
Joseph Antonakakis, Esq. (00:28):
Hello and welcome back to Advisor Intelligence. My name’s Joseph Antonakakis. I’m here today with Steve Goleto and Mital Patel. And today we’re having a conversation about the SEC’s recent June 2026 risk alert related to disclosure of economic incentives and related affiliations and things of that nature. And we’re going to give you an idea of what you need to do to ensure that your economic incentives are appropriately disclosed, where they need to be disclosed, what the SEC noted in their risk alert, and to the extent you have any affiliated entities, whether it’s an affiliated RIA or a CPA firm or whatever the case may be, how we need to ensure that they are appropriately disclosed. And we all reviewed and read the SEC’s risk alert on disclosure of economic incentives. Mittal, you actually helped us write an alert that we sent out to our clients and that blog I think is available on our website as well for folks to read.
(01:39):
The SEC, obviously we see a ton of exams on an annual basis. We have 500 or more clients across the country, most of whom are SEC registered. So we see a bunch of exams every year and we’ve noticed that this is coming up during exams and it’s notable that the SEC wrote a risk alert about it because it just goes to show it’s an important aspect of a firm’s compliance program.
Stephen Galletto, Esq. (02:07):
And a frequently mishandled issue as well.
Joseph Antonakakis, Esq. (02:12):
Absolutely.
Stephen Galletto, Esq. (02:15):
I mean, the takeaway from today’s podcast is there’s no harm in disclosing. Over disclosure is much better than not disclosing or under disclosing. And we’ll talk a little bit about situations that we’ve run into where a little three line paragraph would have saved people a lot of hassle going through an SEC exam. The ADV deals with conflicts of interest, relationships and affiliations and additional compensation type situations that create conflicts of interest. If there’s any additional money coming to you as a result of any of your relationship, guess what? That’s a conflict of interest and you have to disclose it. Whether you have to explicitly disclose it as we receive $10,000 from ABC custodian because ABC custodian gives us money to facilitate our growth so long as we continue to direct clients their way or whether it’s XYZ mutual fund gives us money so that we can host client events and even if they pay the vendors directly, this still creates a conflict of interest for us.
Joseph Antonakakis, Esq. (03:31):
And these are things, Steve, that are generally people call them soft dollar arrangements or hard dollar arrangements.
Stephen Galletto, Esq. (03:39):
Technically, I don’t know if they actually amount to soft dollar relationships or not. Either way, we disclose them.
Joseph Antonakakis, Esq. (03:45):
Well, let me ask you a question. Oh sorry, I meant to interrupt. No,
Mittal Patel, Esq. (03:48):
Go
Joseph Antonakakis, Esq. (03:48):
Ahead. The question I was going to ask is, would you be able to define for the audience the difference between a soft dollar arrangement and a hard dollar arrangement and perhaps the distinction between those and what you were just describing?
Stephen Galletto, Esq. (04:01):
So we’ll start with the most obvious. A hard dollar relationship is you will custody with ABC custodian, here’s $100,000 to spend it as you see fit on whatever you want, whether it’s competition for your folks internally, whether it’s building out your own marketing crew, whether it’s applied towards technology, it’s $100,000 you can spend it any which way you want.
Joseph Antonakakis, Esq. (04:27):
And that can take the form of as well transition assistance.
Stephen Galletto, Esq. (04:31):
That’s different. So hard dollars is do whatever you want, right? I haven’t seen a hard dollar relationship in over a decade. It’s incredibly rare because it’s incredibly scrutinized. A soft dollar relationship, and I think this is where you were going Joe. A soft dollar relationship is typically another relationship with a custodian in all likelihood. And you’re transitioning, let’s say, I don’t want to use names of actual custodians. Let’s say you’re moving from ABC to XYZ custodian. ABC is going to charge you or charge your clients an ACAT fee or something along those lines in order to move over to XYZ custodian.
(05:11):
XYZ custodian gives you $75,000 to offset that expense for your clients. So you’re able to reimburse your clients for the ACAT fees and transition fees that they have to eat in order to move over to the new custodian. Also, soft dollar relationships could be technology assistance. It could be marketing assistance. It could be something like that, but it needs to be earmarked for approved services. There are very specific types of expenses that you can use soft dollars for, otherwise it doesn’t qualify for the soft dollar safe harbor and then you’re dealing with a hard dollar type relationship which you don’t want. Methel, did you have anything to add on that?
Mittal Patel, Esq. (05:53):
No, just make sure it’s properly disclosed. You mentioned that it’s better to have over disclosures,
Stephen Galletto, Esq. (05:57):
But
Mittal Patel, Esq. (05:57):
We need to make sure that they’re correct disclosures.
Stephen Galletto, Esq. (05:59):
Right. If money’s involved, there should be a disclosure, bottom line.
Mittal Patel, Esq. (06:03):
Yeah,
Stephen Galletto, Esq. (06:04):
That is true. Do you have to say, and again, typically with a soft dollar relationship or money being handed to you or offered to you for these types of transition assistance issues, there’s a confidentiality clause in that agreement where you’re not supposed to say how much you’re getting or why you’re getting it in your ADV per se. Alluding to the fact that you get compensation or that there is some sort of assistance or some benefit that you’re receiving is usually enough. We don’t have to go all out and say we’re getting $150,000 in transition assistance in the ADV. Depending upon the climate though, I’ve seen an SEC examiner or a dozen look at these types of disclosures in an ADV and a general sort of disclosure that we do get transition assistance, but we don’t state that we’re getting $150,000 in transition or up to $150,000 in transition assistance.
(06:59):
And we can get to that in a minute. The SEC has flagged that saying it’s not sufficient.You didn’t disclose enough information in the ADV because there was additional detail that we think is material. And again, the SEC can pick and choose whatever they think is material depending upon how they actually want to conduct their reviews of their audits. Again, we’re just doing our best here, but again, we need to have some disclosure there. If you have no disclosure about this transition assistance or soft dollar type relationship in your ADV, you’re not looking good during an examination or an audit.
Joseph Antonakakis, Esq. (07:33):
Yeah. And sort of in a similar vein is affiliated entities, which we alluded to just a moment ago.
Stephen Galletto, Esq. (07:42):
Why?
Joseph Antonakakis, Esq. (07:43):
Why did we allude to
Stephen Galletto, Esq. (07:44):
It? No. Why is affiliated entities also in the same sort of vein?
Joseph Antonakakis, Esq. (07:47):
Well, because there is certain economic incentives potentially for referring a client to let’s say an affiliated CPA firm. An absent disclosure of that affiliation, an absent disclosure of the economic incentives associated with the referral to the CPA firm, it may pose an issue from a regulatory perspective.
Stephen Galletto, Esq. (08:13):
Let’s walk through this a little bit more direct.
Joseph Antonakakis, Esq. (08:15):
Absolutely.
Stephen Galletto, Esq. (08:15):
So let’s say we have a principal owner of an investment advisory firm, that principal owner also happens to be a CPA and they have an outside CPA business. Everyone within the RIA refers their clients to the outside CPA firm for tax or accounting services. The principal obviously has a direct incentive there because as the owner of the outside CPA firm, they’re going to get more money. More or less, they’re advising their clients to engage an affiliate and the principal who owns both entities gets paid. That’s very, very clear. We need to make sure that that’s abundantly clear in the ADV, fully disclosed, otherwise we’re looking at trouble.
Joseph Antonakakis, Esq. (08:57):
And that was going to be my next question is how does a firm, an RIA firm disclose that affiliation and that conflict of interest to their clients? So method number one, like you said, is via ADV disclosure.
Stephen Galletto, Esq. (09:08):
Yep. Item 10C. Yep.
Joseph Antonakakis, Esq. (09:09):
And that’s part 2A?
Stephen Galletto, Esq. (09:11):
Correct.
Joseph Antonakakis, Esq. (09:12):
Is there anywhere on part one where an RIA would also disclose their affiliated entities?
Stephen Galletto, Esq. (09:17):
Item
Mittal Patel, Esq. (09:17):
Seven. We need to disclose it on item seven for other industry affiliations.
Stephen Galletto, Esq. (09:26):
And
Mittal Patel, Esq. (09:26):
Then also in their part 2Bs if they’re registered investment advisors. And that usually that disclosure happens if it’s material or it’s 10% or more of their time or income.
Stephen Galletto, Esq. (09:39):
Right. What do you guys think about form CRS? Is there some reference in the form CRS that we need to make directly about these affiliates?
Joseph Antonakakis, Esq. (09:47):
I think if there’s economic incentives, absolutely. I think form CRS requires disclosure.
Stephen Galletto, Esq. (09:51):
The reason why I’m bringing it up is because there’s so much limited space on that form CRS. If the form CRS could be a thousand pages long all day of the week –
Joseph Antonakakis, Esq. (10:01):
Like the ADV.
Stephen Galletto, Esq. (10:02):
Honestly, my CRS, if there was not a two page disclosure maximum for the form CRS, my CRS would be, here’s the full part 2A again. That’s exactly what it should be. I hate having to reduce the quality of the disclosures in order to fit within that two page limit for the form CRS. So if you don’t have the room to specifically disclose the affiliated relationship with the CRS, direct or redirect the reader back to the part 2A.
Joseph Antonakakis, Esq. (10:35):
Yeah. Well, I mean, this is sort of an aside about the form CRS, but – I hate the form. I hate it. Everyone knows I like the form. If you ever watched episode one or two, I forget which one it was, you know that I like form CRS for obvious reasons.
Stephen Galletto, Esq. (10:48):
There are no obvious reasons to like form CRS other than it’s an easy stupid document.
Joseph Antonakakis, Esq. (10:52):
Well, I see the form CRS as the TikTok or the Instagram reel of disclosure documents because it’s not the full form – I think
Stephen Galletto, Esq. (11:02):
You’re calling me old.
Joseph Antonakakis, Esq. (11:04):
I
Stephen Galletto, Esq. (11:04):
Think so too. I think you’re calling me old in an indirect way.
Joseph Antonakakis, Esq. (11:06):
Well, I think it’s for people who –
Stephen Galletto, Esq. (11:09):
Not for me.
Joseph Antonakakis, Esq. (11:09):
Don’t have a lot of time on their hands and perhaps want an abridged disclosure that’s available to them that they can read in 10 minutes as opposed to the form ADV part 2A, which can be 15 or 20 pages.
Stephen Galletto, Esq. (11:22):
How do you like this argument during an SEC exam, right? Your Part 2A didn’t disclose X, Y, and Z. You can just say, sorry, this is the TikTok version of my Part 2A. It’s the abridged version of my Part 2A. No, the disclosure’s got to be there in full. It just does.
Joseph Antonakakis, Esq. (11:35):
Well, the Part 2A is the Odyssey, the feature film of the disclosure documents. The Form CRS is like the clip of the Odyssey that you see as you’re scrolling through, depending on –
Stephen Galletto, Esq. (11:46):
Don’t say TikTok again.
Joseph Antonakakis, Esq. (11:48):
Listen, some people use TikTok, some people use Instagram, others use Facebook. There’s a lot. I mean, short form videos becoming.
Stephen Galletto, Esq. (11:55):
What I absolutely love is that someone listening to this podcast five years from now is going to think you’re old for referencing this.
Joseph Antonakakis, Esq. (12:00):
For referencing TikTok. Yeah,
Stephen Galletto, Esq. (12:02):
Exactly.
Joseph Antonakakis, Esq. (12:02):
They’re going to say, “Oh, you’re not on whatnot. Are you guys familiar with Whit?” I can’t
Stephen Galletto, Esq. (12:06):
Wait.
Joseph Antonakakis, Esq. (12:07):
Mittel’s familiar with Whatnot. Anyway, that’s neither here nor there. So you’re both exactly right. There’s these disclosures of affiliated entities, like we said, disclosures of the economic incentives as it relates to soft dollar or hard dollar arrangements or compensation received in some way from third parties. Another place that, and I don’t know if this was expressly mentioned in the SEC’s recent alert, but promoters. There are economic incentives associated with the use of promoters. Mittal, I don’t know if you want to talk a little bit about that.
Mittal Patel, Esq. (12:41):
Yeah. So if we are engaging with promoters or solicitors, we want to disclose that in the part ADB as well, because usually there’s some sort of referral arrangement and compensation arrangement between them. So I usually recommend indicating to the client with a two part analysis to indicate that we do have a referral arrangement between this firm and this firm and also let the client know that, hey, we are part of this referral arrangement as well.
Joseph Antonakakis, Esq. (13:09):
Yeah, exactly right. So it’s like disclosure in the referred RIAs ADV part 2A at item 14, if I remember correctly, I think. 14B. Item 14B, that’s one part of the disclosure. Exactly right. And the other part –
Stephen Galletto, Esq. (13:24):
8H2 of the part one.
Joseph Antonakakis, Esq. (13:25):
8H2 of the ADV part one. And also if you’re
Stephen Galletto, Esq. (13:28):
The – 5B6.
Joseph Antonakakis, Esq. (13:30):
I’m sorry?
Stephen Galletto, Esq. (13:30):
Isn’t it 5B6, the ADV part one? We’re referencing the number of solicitors.
Joseph Antonakakis, Esq. (13:37):
Yep. 5L, which discusses promoters as well. There are myriad places where you disclose these types of incentives as the RIA receiving the referral. And then if you’re the individual or if you’re a registered entity, depending on the state, who is referring clients to the firm, there’s also requirements of disclosure for you as well where you tell the prospect, “I have this economic incentive to refer clients to this RIA because I’m receiving compensation.” And that’s another important area of disclosure as well. And something we were talking about before the podcast is disclosure of fees in myriad ways. And this is something that was expressly mentioned in the SEC’s risk alert, which is that some firms aren’t adequately and appropriately disclosing their fees to clients. And to the extent that, let’s say you’re billing perhaps a family member at a different fee rate, or you’re billing friends at a different fee rate, or you have different service levels.
Stephen Galletto, Esq. (14:48):
Making
Joseph Antonakakis, Esq. (14:49):
Sure that that is abundantly clear, number one, in the ADV, and number two, in the client’s investment advisory agreement.
Stephen Galletto, Esq. (14:57):
So how clear do we have to be in the ADV?
Mittal Patel, Esq. (14:59):
We should have the fee schedule that is being used
Stephen Galletto, Esq. (15:03):
For the baseline fee schedule for all clients. The baseline fee schedule. We can always discount that baseline fee schedule. And in limited instances, we could actually charge more, but we have to be very, very clear in that client relationship and that agreement that we’re charging a separate fee schedule for a number of reasons. We have to be very, very deliberate with that communication to the client.
Mittal Patel, Esq. (15:24):
Usually what I recommend for clients is that this, or in the ADV, this is our baseline fee schedule, but due to limited circumstances or different scenarios, we might have a different fee schedule
Stephen Galletto, Esq. (15:36):
In
Mittal Patel, Esq. (15:36):
Place.
Stephen Galletto, Esq. (15:37):
Right. But we don’t need to say, “I charge my mom half of the fee. I charge my brother two times the fee.”
Mittal Patel, Esq. (15:46):
That’s nice of
Stephen Galletto, Esq. (15:47):
You. Well, I don’t have a brother, but- But if
Joseph Antonakakis, Esq. (15:49):
You did, you would charge him
Stephen Galletto, Esq. (15:50):
Two times the fee. I totally would. I totally would. He’d have it coming. So we don’t need to necessarily hold that all the way out there. And again, having grandfathered fees, right? If you do grandfather in older fees under a previous fee schedule, do you need to explicitly state that in your ADV? Probably not explicitly. Does it hurt to disclose it? No, because obviously the SEC is going to see that, but do your existing clients need to know that you have grandfathered fees? I think at the very least, a general disclosure in the part 2A indicating that you may charge less than the stated fee schedule. If you are going to charge more and it’s going to be more than a handful of times, maybe you consider not having a standard fee schedule in your ADV. Maybe you get more into a range sort of definition, but anytime you are not going to have a fee schedule in your ADV, you’re going to deviate from the fee schedule in your ADV.
(16:45):
The investment advisory agreement, which really controls the relationship and communicates the individual client’s fees must be very, very clear as to what that client is subject to by way of
Mittal Patel, Esq. (16:54):
Fees.
Stephen Galletto, Esq. (16:54):
One of the
Mittal Patel, Esq. (16:54):
Questions I get asked by advisors all the time is what if we decide to amend our fee schedule? If you decide to amend your fee schedule, you need to amend your ADV to indicate that change, but you also need to notify your clients
Stephen Galletto, Esq. (17:07):
Of that. If the new fee schedule’s going to apply to the existing clients. If it’s only going to apply going forward, you don’t need to notify your existing clients that there’s been a change in the fee schedule because it doesn’t impact them or affect them.
Joseph Antonakakis, Esq. (17:18):
Here’s a question. In pop quiz, Mittel, if you’re an RIA who is amending your fee, like you said, what are the two methods through which you can amend your fee?
Mittal Patel, Esq. (17:31):
Yes. So it comes back to we need to read what your investment advisory agreement says. So we can either have affirmative consent or negative consent. If we are relying on negative consent, the amendment provision within the investment advisory agreement needs to allow for negative consent. So if it doesn’t allow for it, that means we need the client’s signatures to let them know of the amended fee schedule. If we’re relying on negative consent, what we need to do is usually provide the clients with 30 days written notice that they’re being subject to a new fee schedule. If they don’t object otherwise, that means we have their consent.
Joseph Antonakakis, Esq. (18:07):
So in both situations where both of those situations begin – You need to notify the
Mittal Patel, Esq. (18:11):
Clients.
Joseph Antonakakis, Esq. (18:11):
Right. Begins with notification. And where they diverge is. Is the
Mittal Patel, Esq. (18:14):
Signature part.
Joseph Antonakakis, Esq. (18:16):
What
Stephen Galletto, Esq. (18:16):
If we’re reducing fees?
Mittal Patel, Esq. (18:18):
I still recommend notifying clients.
Joseph Antonakakis, Esq. (18:21):
I think notification at the very least.
Mittal Patel, Esq. (18:25):
You never know what the SEC’s going
Stephen Galletto, Esq. (18:26):
To say. True. But again, the SEC loves it when investment advisors don’t get paid. So if an investment advisor is going to get paid less, I think they would probably say, “Yay, this is awesome.”
Mittal Patel, Esq. (18:37):
So you’re saying that the SEC only cares about investors, not the RIAs?
Stephen Galletto, Esq. (18:41):
Yes.
Joseph Antonakakis, Esq. (18:42):
Well, let me ask you a question. It’s interesting that you mentioned this because this goes back to another part of the SEC’s risk alert about disclosure of economic incentives. Am
Stephen Galletto, Esq. (18:50):
I helping you answer a client question? Do I get a billing number?
Joseph Antonakakis, Esq. (18:54):
I don’t know how to respond to that.
Stephen Galletto, Esq. (18:56):
Not on tape.
Joseph Antonakakis, Esq. (18:57):
I can’t. Yeah. And what it comes down to, to your point, is testing for fees to ensure that the fee that you billed is accurate because we have all seen situations during, whether it’s an SEC exam or a state level exam, where the regulators come in and they perform a fee test. The same fee test, by the way, that we perform for a lot of our clients. They perform a fee test to ensure that the fee billed to the client aligns appropriately with what’s in the form ADV part
(19:32):
2A and with the client’s investment advisory agreement. And the issues that come up is either A, you have overbilled this client, which is an obvious problem, and B, you have underbilled this client. I’ve seen certain state regulators, not going to name names, Texas, but certain state regulators will come in and say, “Why are you underbilling these clients? And you should remedy that situation and bill them for the amount that you should have prior.” They’ll go down to the penny in some cases and identify that as a deficiency. I think it’s incredibly important, even if it’s lower, like to Mittal’s point, even if it’s a lower fee that you are number one, notifying the client, disclosing it like we said to the client, and number two, performing that regular fee testing exercise to ensure that the fee billed to the client aligns with the fee that’s in their investment advisory agreement.
Stephen Galletto, Esq. (20:31):
Mittal, what have you seen as being primary causes for the fee not equaling what’s actually debited from the account? The calculation being inaccurate, I should say.
Mittal Patel, Esq. (20:40):
I think it’s just a misstatement of the percentages is usually the issue that I’ve run into.
Stephen Galletto, Esq. (20:48):
Have you seen instances where people are changing from one software to another and across the stream, so to speak, on whether or not they’re billing on a 252 day calendar year or 365 day calendar year? I
Mittal Patel, Esq. (21:05):
Have seen that because the math does not usually check out once you change from those deviations. So I would say to really also understand how the software and how the custodians are calculating your
Stephen Galletto, Esq. (21:16):
Fees,
Mittal Patel, Esq. (21:16):
Please just don’t take their words as the gold standards because sometimes they are wrong and when they’re wrong, it’s hard to explain to the regulators why they’re wrong.
Stephen Galletto, Esq. (21:25):
The proration aspects of fee calculation have gotten incredibly difficult. Not incredibly difficult. They’ve become more complex and I’m not exactly sure why people try to make their billing practices so very special. They’re just math
Mittal Patel, Esq. (21:42):
Geniuses,
Stephen Galletto, Esq. (21:42):
Steve. Yeah, maybe. Maybe. I think the simpler you can keep your fee calculation, the better. The more variances or nuances to how a fee will be calculated in a specific situation, the more likely you are to be off by a dollar here, $5 there, completely screw up this fee calculation over there. You don’t really want to go back to your client and say, “I overbilled you by $17 and the SEC’s making me give you $17 here.” You’re handling someone’s money and apparently you can’t calculate their fee correctly, right?
Mittal Patel, Esq. (22:19):
I usually recommend a simple formula. If your
Stephen Galletto, Esq. (22:21):
Formula
Mittal Patel, Esq. (22:21):
Is not simple, that means it’s complex.
Stephen Galletto, Esq. (22:24):
Right. Yeah. If it takes a specialist to be able to calculate your fee –
Joseph Antonakakis, Esq. (22:28):
You’re probably doing it wrong.
Stephen Galletto, Esq. (22:30):
Maybe we need to dumb it down a little bit.
Joseph Antonakakis, Esq. (22:31):
Yeah. And the one last thing I do want to talk about as part of this episode and disclosure of these economic incentives and fees and such is disclosure of fees that are not the advisory fee. So Mital, would you mind giving us an idea of what types of fees could be billed to clients outside of the advisory fee? Something that doesn’t necessarily appear at item 5A that discloses the fee schedule.
Mittal Patel, Esq. (22:57):
So are you talking about transaction costs related to mutual funds and ETFs? So this relates to whether you have a wrap program or a non-wrap program. Usually for a wrap program, sometimes these fees are included within it. That is the purpose of a wrap program. If you are a non-wrap advisor and these additional costs are being sent to the clients, so we need to indicate in the form ADV that certain securities will incur transaction costs that the clients are being subject to. The form ADV should include this, but also the client’s investment advisory agreement.
Joseph Antonakakis, Esq. (23:33):
Yeah. Yeah, and that’s exactly right. And to your point about wrap fee programs, I have dealt with a couple advisors over the past year or so during SEC exams, firms who do have wrap fee programs. And another issue that has come up with rap fee programs is an evaluation and determination of whether that wrap fee program is suitable. Or is in
Mittal Patel, Esq. (23:59):
The client’s best
Joseph Antonakakis, Esq. (23:59):
Interest. Correct. Is in the client’s best interest. And so that’s another thing that’s come up and obviously –
Stephen Galletto, Esq. (24:06):
It’s another conflict of interest, isn’t it, right?
Joseph Antonakakis, Esq. (24:07):
It’s another conflict of interest
Stephen Galletto, Esq. (24:08):
That needs to be
Joseph Antonakakis, Esq. (24:09):
Disclosed.
Stephen Galletto, Esq. (24:09):
Right. So we should do a whole other podcast on wrap fees and the horror stories of firms offering a rap fee program without fully understanding or appreciating it. But yeah, it’s just another example where there’s a conflict whether you see it or not as the investment advisor, and the SEC really hones in and targets that.
Joseph Antonakakis, Esq. (24:34):
Yep. So the lesson from this episode is any economic incentive that you have that poses a potential conflict of interest, make sure it’s disclosed. And if you need a team to help you with identifying those conflicts and drafting disclosures for those conflicts in an appropriate manner, that’s what our team is here to help for. Steve and Mittal, thanks so much for your time today. I am incredibly grateful that we had this conversation about economic incentives and appropriate disclosures, and we look forward to seeing everyone on the next one. Thanks.
Intro (25:14):
The Advisor Intelligence Podcast provides general information and commentary only. The content is not legal advice, nor does it create an attorney-client relationship. For more information about Stark & Stark services, please visit our website at stark-stark.com.
