Compliance

SEC Settles Charges Against RIA for Failure to Review Wrap Fee Programs

February 16, 2023 | Katherine Oberlies

On August 26, 2022, the U.S. Securities and Exchange Commission (“SEC”) issued an order settling charges against Kovak Advisors, Inc. (“Kovak”), for compliance failures related to its wrap fee program. The case highlights how important it is for an investment adviser to adopt and follow policies and procedures relating to any wrap fee program, to ensure that the adviser’s services are in the client’s best interest.

From 2015 through August 2018, Kovak offered advisory services to clients through a wrap fee program. Clients that participated in the wrap fee program paid a fee that included asset management, trade execution, and other costs. The SEC made three findings during the time Kovak offered the wrap fee program.
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SEC Announces Enforcement Action Against Investment Adviser for Custody Violations

February 8, 2023 | Charlie Jarrett

The Securities and Exchange Commission announced a settled enforcement action against a registered investment adviser for violating the Custody Rule and for compliance violations associated with custody. The enforcement action, coupled with the SEC’s announcement, shows the significance that the SEC places on the safeguarding of client assets.

An investment adviser has custody when it holds client funds or securities or has the ability to obtain possession of such assets, directly or indirectly. In general, the custody rules and regulations are intended to protect client assets from misappropriation or misuse by their investment adviser. As a result, it is considered a prohibited act for an investment adviser to have custody of client funds or securities without implementing policies and procedures specifically designed to comply with the rules and regulations and prevent misuse of the assets. These policies and procedures include notice to client in certain situations, identification of the qualified custodian, and obtaining an audit or verification by an independent CPA of the client assets subject to custody. Custody can be further imparted to an investment adviser through a related party of the investment adviser.

SEC Enforcement Case Highlights Importance of Conflict of Interest Disclosure

January 30, 2023 | Steve Parker

In this first quarter of the year, most investment advisers are working diligently to complete and file their annual updating amendment to Form ADV, including Part 2A, commonly called the “Brochure.” One of the most important requirements in drafting a Brochure is to make sure that all conflicts of interests, together with a description of how the conflict is mitigated or addressed, are fully and fairly disclosed. An administrative action brought by the SEC and settled last week illustrates, and should serve to underscore, the importance of identifying and disclosing such conflicts.

The SEC charged registered investment adviser Moors & Cabot (“M&C”) with breaching its fiduciary duty to investment advisory clients by failing to disclose conflicts of interest relating to revenue sharing payments and other financial incentives that the adviser received from two clearing brokers. The financial benefits included discounts, incentive credits and shared revenue that were contingent upon M&C meeting certain thresholds in total assets maintained in FDIC-insure bank deposit cash sweeps. M&C also received a share of margin interest the clearing firms charged to M&C’s clients who maintained margin loans. M&C also received a portion of postage and handling fees that one of the clearing brokers charged to its clients.

Investment Advisers and the Annual Updating Amendment Process

January 6, 2023 | Charlie Jarrett

For the majority of investment advisers registered with either the SEC or state regulators, annual updating amendment season is once again upon us. Advisers whose fiscal year ends on December 31 are required to file their Form ADV annual amendment within 90 days or by March 31, 2023.

While investment advisers are under a continuing obligation to update their disclosure documents when certain or material information becomes inaccurate, the annual update is a universal requirement designed to ensure that the filing information for investment advisers is up to date. This serves an important function in that it allows clients and potential clients to review the publicly filed ADVs for investment advisers on FINRA’s BrokerCheck and the SEC’s IADP. Additionally, regulators review the filings and the underlying analytics to track industry trends, plan examination targets, and conduct regulatory sweeps.

SEC Announces Enforcement Action for Compliance Policies and Procedures Failures

December 15, 2022 | Charlie Jarrett

The Securities and Exchange Commission recently announced the filing of an administrative proceeding against a registered investment adviser and the investment advisers owner/CCO for failing to adopt compliance policies and procedures, a Code of Ethics, and for failing to conduct annual reviews of the same. The advisory firm is Two Point Investment Management, Inc., based in Pittsford, New York. The SEC found that the violations occurred over a 10-year period starting when the adviser first registered with the SEC in 2012.

The Invest Georgia Exemption and Intrastate Capital Formation (Part 2)

December 7, 2022 | Charlie Jarrett

While designed as a capital formation alternative to going public or conducting a private placement offering under Section 4(a)(2), use of the intrastate offering exemption has not been widely used since the SEC revised the regulation in 2016. Sometimes referred as “crowdfunding” due to the ability to raise smaller amounts from more investors, the intrastate offering exemption differs greatly from Regulation Crowdfunding, also known as Regulation CF.

North American Securities Administrators Association (NASAA), the group of state securities administrators tracks the state jurisdictions that have implemented an intrastate offering exemption. In total, 35 jurisdictions have adopted some form of an intrastate exemptions with the regulatory requirements differing from state-to-state. While not widely used by Issuers in the majority of jurisdictions, other states such as Texas, Michigan, and Georgia have seen numerous filers take advantage of the exemption.

The Invest Georgia Exemption and Intrastate Capital Formation (Part 1)

December 1, 2022 | Charlie Jarrett

Organizations seeking to raise capital have multiple options at their disposal – each with their own benefits, limitations, and regulatory obligations. As part of the JOBS Act, the SEC was tasked with reviewing an almost century old regulatory structure with the goal of easing and modernizing aspects of the federal securities regulations concerning capital formation. One of these such areas that the SEC reviewed and modernized was the traditional intrastate offering exemption.

The intrastate offering exemption, codified as Section 3(a)(11) of the Securities Act of 1933, customarily has been used in conjunction with the safe harbor contained in Rule 147. Under this framework, offerings conducted by an Issuer, that are only offered or sold within the same state jurisdiction as the Issuer, solely to residents within the same state jurisdiction as the Issuer, are exempt from registration with the SEC, and instead only have to comply with the respective state’s securities laws.

SEC Proposes Rule on Third Party Service Providers

November 10, 2022 | Katherine Oberlies

On October 26, 2022, the Securities and Exchange Commission (“SEC”) proposed a rule that would prohibit investment advisers from using certain third party service providers without additional due diligence and monitoring.

The proposed rule provides an oversight framework for investment advisers designed to ensure that any “covered functions” outsourced to third parties are consistent with the adviser’s obligations to their clients. A “covered function” is a function or service that is necessary to provide investment advisory services in compliance with Federal securities laws, and if the service is not performed or is performed negligently, would be reasonably likely to cause a material negative impact on the adviser’s clients or advisory services.

SEC Announces Enforcement Actions Concerning Electronic Records

October 27, 2022 | Charlie Jarrett

The Securities and Exchange Commission (SEC) recently announced a series of enforcement actions centered on several of the largest broker-dealers in the financial sector. The enforcement actions addressed longstanding failures of the firms and their employees to preserve certain electronic communications. The 15 broker-dealers, and one affiliated investment adviser, admitted to the facts as stated, acknowledged their actions violated the securities laws, and agreed to pay a combined $1.1 billion in penalties.

Under the various securities rules, including recordkeeping provisions, broker-dealers and investment advisers are required to maintain and preserve electronic communications of business-related matters. Regulators expect that the written policies and procedures address this requirement and set forth a framework for the firm and firm employee’s compliance with the policies and procedures. To meet the regulatory expectations, firms traditionally have set out parameters for both internal and external communications and prohibited communications outside of those parameters. The goal of this method is to limit the forms of communications to those that the firm can monitor and preserve.

SEC Announces Examinations Under New Marketing Rule

September 22, 2022 | Charlie Jarrett

While it comes with little surprise, on Monday the SEC’s Division of Examinations officially announced the areas of focus regarding compliance with the New Marketing Rule. The recently released Risk Alert was expected as the compliance date for the New Marketing Rule is quickly approaching.

Initially introduced in December 22, 2020 the modernized Marketing Rule allowed for an 18-month transition period ending with a compliance date of November 4, 2022. Since adoption, we have previously written about the passage of the New Marketing Rule and some of the significant areas impacted by the new rule. The newest announcement shows that the SEC is going to initially focus on some of the top-level issues under the New Marketing Rule: policies and procedures, substantiation, and performance advertising.

When reviewing policies and procedures, the SEC will look that the investment adviser has adopted and implemented a compliance program that is reasonably designed to prevent violations of the New Marketing Rule by the firm and its supervised persons. The Risk Alert mirrors sections of the Adopting Release and states that the SEC expects a thorough New Marketing Rule compliance program should include objective and testable means to prevent violations. Testing includes some documentable review process for advertisements for compliance with the policies and procedures.