Conflict-of-Interest Disclosure for Referral Platforms

Launching a new service line or technology requires more than innovation; it demands rigorous attention to disclosure obligations. The SEC's enforcement action against Zoe Financial Inc. underscores the rapid emergence of disclosure gaps when business models evolve, particularly for investment advisers operating referral platforms with algorithmic matching and human intervention.

Scope of This Guide

This guide outlines conflict-of-interest disclosure requirements under Section 206(2) of the Investment Advisers Act of 1940 for investment advisers who:

• Operate referral or matching services connecting clients with third-party advisers
• Use algorithms or automated tools in the adviser selection process
• Maintain financial relationships with referred advisers
• Introduce new service offerings that create additional revenue streams
• Employ sales personnel who supplement or override algorithmic recommendations

The focus is on Form ADV Brochure disclosure obligations, applicable whether you're a registered investment adviser or an exempt reporting adviser.

Key Concepts and Definitions

Material Conflict of Interest: Any interest or relationship that could reasonably compromise your ability to provide unbiased advice or create an incentive to favor one recommendation over another. Materiality exists when a reasonable investor would consider the information important in making an investment decision.

Fiduciary Obligation: Your duty to act in your client's best interest and provide full and fair disclosure of all material facts relating to the advisory relationship, especially those that might incline you to render advice not disinterested.

Form ADV Brochure: The plain-English disclosure document required under Part 2A of Form ADV, detailing your advisory business, fees, conflicts of interest, disciplinary information, and other material facts. You must deliver this to clients before or at the time you enter into an advisory contract.

Algorithmic Recommendation System: Any automated process that generates adviser matches or investment recommendations based on client inputs, scoring criteria, or predictive models. The algorithm's design, limitations, and potential override mechanisms are material facts requiring disclosure.

Requirements Breakdown

Section 206(2) Core Obligation

Section 206(2) of the Investment Advisers Act prohibits any transaction, practice, or course of business that operates as a fraud or deceit upon any client or prospective client. This imposes an affirmative duty of utmost good faith and full and fair disclosure of all material facts.

Your disclosure must be specific enough for a client to understand:

• The nature of the conflict
• How it might affect the advice you provide
• What steps, if any, you've taken to mitigate the conflict

Form ADV Part 2A Item 4 (Advisory Business)

Describe your advisory services, including referral or matching services. If you use technology to generate recommendations, explain:

• What factors the algorithm considers
• What factors it doesn't consider
• Whether human personnel can supplement or override algorithmic recommendations
• How frequently you update the algorithm's criteria

Form ADV Part 2A Item 10 (Other Financial Industry Activities)

Disclose material relationships with other financial industry participants, including:

• Ownership interests you hold in referred advisers
• Ownership interests referred advisers hold in your firm
• Revenue-sharing arrangements
• Referral fee structures

Form ADV Part 2A Item 11 (Code of Ethics, Participation in Client Transactions)

If you recommend advisers in which you have a financial interest, or if you have an incentive to recommend certain advisers over others, describe:

• The specific nature of your financial interest
• How this interest might influence your recommendations
• Your process for managing this conflict

Implementation Guidance

Timing Requirements

Update your Form ADV Brochure promptly when you introduce new services. In the Zoe Financial matter, the company launched Zoe Wealth in January 2023 but didn't adequately disclose the resulting conflict until December 2024. This gap violated Section 206(2).

While the SEC doesn't define "promptly" with a specific day count, you should update your Brochure within 90 days of a material change and deliver the updated Brochure to existing clients. For new conflicts that fundamentally alter your business model, consider updating immediately.

Human Override Disclosure

If sales personnel or relationship managers can suggest advisers beyond those generated by your algorithm, disclose this explicitly. Clients who believe they're receiving purely algorithmic recommendations need to know when human judgment enters the process, particularly if those humans have incentives to favor certain advisers.

Your disclosure should address:

• Under what circumstances personnel supplement algorithmic recommendations
• What training or guidelines govern these supplemental recommendations
• Whether personnel receive different compensation based on which advisers they recommend

Revenue Stream Transparency

When you launch a service that generates revenue from referred advisers (such as sub-advisory services, technology platforms, or back-office support), disclose:

• The nature of the service
• How you're compensated
• Whether this compensation creates an incentive to favor advisers who use the service
• How, if at all, use of the service affects adviser recommendations

Avoid general statements like "we may have financial incentives." Specify the incentive and quantify it when possible.

Mitigation Measures

Disclosure alone doesn't satisfy your fiduciary duty if the conflict is severe enough. Consider implementing and documenting:

• Policies prohibiting personnel from considering revenue-generating service adoption in recommendations
• Independent review of referrals to advisers with whom you have financial relationships
• Periodic audits comparing algorithmic recommendations to actual referrals
• Compensation structures that don't reward personnel for steering clients to particular advisers

In the Zoe Financial order, the SEC noted that while the company disclosed certain advisory firms held minority interests, it didn't accurately describe how it mitigated that conflict. Your mitigation description must match your actual practices.

Common Pitfalls

Pitfall 1: Describing the algorithm without describing human involvement. If your process combines algorithmic matching with human follow-up, both elements require disclosure. Clients need to understand the complete recommendation process.

Pitfall 2: Disclosing conflicts in principle without specifics. Statements like "we may have conflicts of interest with some advisers" don't satisfy your disclosure obligation. Name the specific conflict, explain its source, and describe its potential impact.

Pitfall 3: Treating technology as neutral. Algorithms embody design choices. If your algorithm doesn't consider whether an adviser uses your revenue-generating services, that's material information, particularly if human personnel later enter the process.

Pitfall 4: Updating compliance manuals without updating client-facing documents. Internal policy changes don't constitute disclosure. You must update your Form ADV Brochure and deliver it to clients.

Pitfall 5: Assuming minority ownership interests are immaterial. Even small ownership stakes create conflicts requiring disclosure, particularly when those stakeholders are also service recipients or referral sources.

Quick Reference Table

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The Zoe Financial matter resulted in a cease-and-desist order and a $450,000 penalty. The company has since revised its compliance manual and hired an in-house chief compliance officer. These remedial steps, while noted by the SEC, didn't prevent the enforcement action. Your disclosure obligation runs continuously as your business evolves. When you introduce a new technology or service, treat Form ADV updates as a core deliverable of the launch process, not an administrative afterthought.