Compliance

NSCP Proposes Regulatory Guidance Regarding CCO Liability

January 31, 2022 | Steve Parker

Earlier this month the National Society of Compliance Professionals, a nonprofit membership organization that supports compliance personnel and programs in the financial services industry, published a report entitled “Firm and CCO Liability Framework.” The report is designed as an aid to compliance professionals and as a proposal to regulators, including the Securities and Exchange Commission, to determine situations in which liability of Chief Compliance Officers should be mitigated.

The SEC has provided its own guidance regarding when CCOs may be held liable, some of which we have highlighted in a previous post. Additionally, the New York City Bar Association’s Compliance Committee released a comprehensive report last year that contains a description of the history of regulatory comments and guidance provided on the issue of CCO liability and proposes its own framework of liability.

The NSCP report was motivated in part by a widespread belief among compliance professionals that financial services regulators have expanded the situations in which CCOs will face liability for firm compliance failures. According to a survey contained in the report, 72% of compliance professionals share that belief. Additional survey results contained in the report include: that 35% of compliance professionals claim to have insufficient resources to adequately carry out the obligation to provide firm training on compliance issues; that 20% claim to have insufficient authority either to enforce or to develop compliance policies and procedures; and that 25% claim to be unable to meaningfully raise compliance concerns to the firm’s senior management.

SEC Fines Investment Adviser Over Variable Representative Compensation Disclosures

July 27, 2021 | Bryan Gort

On July 13, 2021, the Securities and Exchange Commission (“SEC”) published an order instituting administrative cease-and-desist proceedings against TIAA-CREF Individual & Institutional Services, LLC (“TIAA”). TIAA consented to this order without admitting or denying the findings except as to jurisdiction and subjection matter. The SEC’s order alleges TIAA failed to properly disclose conflicts of interest and made materially misleading statements concerning rollover recommendations they made to clients over a five-year period from 2013 to 2018.

TIAA’s policies and procedures required their investment adviser representatives, who were also dually registered as registered representatives, to present clients with four options regarding rollover recommendations when providing financial planning services. The options were:

Leave client assets in their employer-sponsored retirement plans;
Rolling the assets into a self-directed individual retirement account;
Rolling over the assets to a new employer’s plan; or
Cashing out the account value/taking a lump-sum distribution.

New Investment Adviser Marketing Rule Relaxes Restrictions on Use of Testimonials

April 29, 2021 | Steve Parker

Rule 206(4)-1 under the Investment Advisers Act, known as the “Marketing Rule,” becomes effective on May 4, 2021. Full details of the new rule and the related amendments to the Books and Records Rule and for ADV can be reviewed in the SEC’s adopting release. The new rule changes many aspects of the current guidance applicable to advertising by SEC-registered investment advisers, some of which is drawn from no-action letters and other informal releases. Advisers must come into compliance with the new rule within eighteen months of the effective date or by November 4, 2022. Firms may choose to come into compliance at any time between the effective date and the compliance date, but the SEC has warned that RIAs may not choose to implement parts of the new rules at different times. Rather, a firm must implement and be prepared to comply with the entirety of the new rule on a single date within the eighteen-month compliance period. The rule does not, on its face, apply to state-registered RIAs, who should continue to follow the rules applicable to the states in which they conduct business. Some state rules mirror or adopt the SEC advertising rules in some respects.

One of the most important changes relates to using what has historically been referred to as “testimonials,” or statements by clients regarding their experience with an adviser. The current rule 206(4)-1, titled “Advertisements by Investment Advisers,” states that any advertisement by an adviser that uses a “testimonial of any kind” is deemed fraudulent, deceptive or manipulative. Although “testimonial” is not defined in the current rule, the SEC consistently interpreted the term as a statement of a client’s experience with, or endorsement of, an investment adviser. Under the new rule, however, testimonials as traditionally understood are permitted as long as firms comply with a number of requirements. Continue reading ›

SEC Announces 2021 Examination Priorities

March 25, 2021 | Steve Parker

Earlier this month, the Securities and Exchange Commission announced the examination priorities for registered investment adviser and broker-dealer examinations to be conducted in 2021 by the SEC’s Division of Examinations (formerly the Office of Compliance Inspections and Examinations).

The list included a continued focus on conflicts of interest, including examining for compliance with Reg BI (for broker-dealers) and with an investment adviser’s fiduciary duty. Among the matters examined will be whether RIAs comply with care and loyalty duties that arise from the fiduciary duty. Whether firms have taken appropriate steps to mitigate, disclose or eliminate conflicts of interest will continue to be a focus, with an emphasis on whether customers received enough information to be the basis of informed consent. The Division will also continue to prioritize examining information regarding investment products that carry elevated risks, such as certain ETFs, municipal securities, private placements, variable annuities, and microcap securities.

Not surprisingly, the Division will also focus on two areas that were emphasized over the last two years to varying degrees: ESG-related risks and disclosures and proxy voting practices. RIAs who offer asset management based on ESG principles will be questioned regarding their representations regarding products or services provided, including representations regarding third-party managers or products. The Division will also examine to ensure that proxies have been voted consistent with customer’s desires to invest in ESG focused investments.

Business continuity and disaster recovery plans will be a focus this year, including whether lessons learned during the pandemic have appropriately informed changes to such plans. A greater emphasis will also be placed on climate-related risks, due to greater instances of climate hazards experienced in recent years attributable to climate change. These types of issues will be of heightened concern for examinations of critical market participants such as clearing firms and market makers.

Exchange-Traded Product Probe Results in Fines for Investment Advisory Firms

January 21, 2021 | Steve Parker

Late last year, the SEC announced the settlement of five enforcement cases against RIA firms relating to their recommendations and purchases of complex exchange-traded products (ETPs) in clients’ accounts. The settlements – against Benjamin F. Edwards & Co., Royal Alliance Associates, Inc., Securities America Advisors, Inc, Summit Financial Group, Inc., and American Portfolios Financial Services. The actions were announced in connection with the SEC’s ETP initiative.

These cases may be the first of many, and they followed a joint statement from SEC Chairman and division heads in October of last year indicating that firms would be examined relating to their use of complex ETPs. However, the SEC has not formally announced a new initiative on the subject. Earlier in 2020, the SEC had resolved a similar charge against Wells Fargo resulting in a $35 million fine.

Generally, the products in question were those that track market volatility and are designed as short-term investments. Typically, these products are tied to the CBOE volatility index or VIX. Examples of such products are the VelocityShares Daily Inverse VIX Short Term Exchange-Traded Notes and the ProShares VIX Short-Term Futures ETF, both of which are tied to the performance of the S&P 500 VIX Short-Term Futures Index. The product offering materials describe the objectives of these products as to manage trading risks on a daily basis, and warn that their use over periods longer than a single day is not suitable, as the risk control objective will not be met by using them over such longer period. The issuers’ materials clearly describe that the products could lead to substantial losses when held in portfolios over periods longer than a single day.

SEC Multi-Branch Initiative Results in Branch Office Risk Alert

January 5, 2021 | Steve Parker

Late last year, the SEC’s Office of Compliance Inspections and Examinations (OCIE), now known as the Division of Examinations, issued a compliance risk alert warning investment advisers to ensure that their compliance programs are uniform and are uniformly applied across all branch office locations.

The alert summarized the findings from OCIE’s two-year Multi-Branch Initiative, in which it examined nearly 40 advisers’ main offices and their respective branches. Most of the advisers included in the initiative had 10 or more branches that were widely dispersed from the main office. Primarily, the report emphasized that compliance risks relating to supervising personnel and processes are heightened when the branch office has policies or procedures that differ from those of the main office.

In the report, OCIE further explains that more than half of the examined firms had policies and procedures that were either inaccurate or not consistently applied among branches, or both. Almost all firms had at least one compliance defect. Many of the deficiencies related to unrecognized custody of client funds, inadequate or inconsistent fee billing practices, failure to recognize and disclose conflicts of interests, or differences in portfolio management practices or other ways in which the firm’s advisers formulate or deliver investment advice.

SEC Modernizes Marketing and Solicitation Rules

December 23, 2020 | Steve Parker

The U.S. Securities and Exchange Commission yesterday issued long-anticipated changes to the rules governing marketing for RIAs, including managers of private funds. The changes are designed to modernize the rules to account for the era of digital communication and other marketplace “evolutions.” The rule changes also impact firms’ uses of testimonials and paid solicitors.

By a 5-0 vote, the amendments will replace prior separate rules into a single comprehensive rule that deals with advertising and solicitation. The replaced rules date back to the 1970s and earlier.

By and large, the rules allow for more flexibility. For instance, instead of a blanket prohibition of testimonials, the new rule permits testimonials if certain disclosures are made. These disclosure requirements dovetail with the emphasis on preventing conflicts of interests that was the focus of last year’s IA Release 5248, relating to advisers’ fiduciary duty. The rules also create additional questions related to marketing on Form ADV Part 1.

SEC Examination Director Discusses Importance of Empowering the CCO

December 2, 2020 | Steve Parker

In a speech last month, Peter Driscoll, the director of the Securities and Exchange Commission’s Office of Compliance Inspections and Examinations (OCIE), stressed that registered investment advisers must take steps to grant authority to their Chief Compliance Officers, pointing out that the failure to do so is often cited as a deficiency following RIA audits. Driscoll explained that CCOs must be supported and empowered by an RIA’s upper management and that OCIE examiners are looking closely to determine whether that is or is not happening at a particular firm.

Driscoll’s speech comes on the heels of the SEC’s upholding a FINRA enforcement action against the CCO of a broker-dealer who was fined $45,000 and given a 90-day suspension for failing to follow up on “red flags” that the broker-dealer was making payments to a firm owned by a barred broker. A federal appellate court recently affirmed that decision. The speech seemed designed, in part, to allay concerns by CCOs that they are at risk of becoming frequent enforcement targets. Consistent with prior SEC guidance, Driscoll’s speech highlighted that compliance failures are more often the result of other senior firm officers not sufficiently fulfilling their roles to assure that the compliance function is adequately staffed and complied with. Compliance should not fall entirely “on the shoulders of the CCO,” he said.

Too often, says Driscoll, OCIE sees firms take a “check-the-box” approach to their CCO position, meaning they are given just enough authority to complete the bare minimum compliance tasks but aren’t fully integrated into the ongoing operations, direction, or major decisions of the company. He notes that in many examination meetings, the CCO stays quiet as the company’s other senior executives dominate answers to core compliance questions. In other instances, he says, firms try to use the CCO as a “scapegoat” to cover failings by other firm personnel to follow clear policies or guidance. When OCIE notices that the CCO is turned into a target for every compliance problem identified, while CEOs take no responsibility, it is an indication that the firm has not set the proper tone and the top that is critical to all good compliance programs.

Possible Cognitive Decline of Investment Advisers Underscores Need for Succession Plan, Training

November 18, 2020 | Steve Parker

Earlier this year, the North American Securities Administrators Association (NASAA), through a working group within the Senior Issues/Diminished Capacity Committee, issued a report of findings and recommendations relating to issues of cognitive impairment or diminished capacity that may affect investment advisers and other financial professionals. The report summarized information received by the working group from registered investment advisers, broker-dealers, and compliance consultants in the industry. The findings focused on communication, education, and succession planning as key elements of an effective plan to address impairment issues.

Of course, an adviser suffering from diminished capacity could face serious difficulties relating to his or her work, including not being able to provide effective service to the client or to comply with responsibilities under the securities laws, including meeting the standards of conduct and maintaining adequate books and records. Those interviewed in connection with the study indicated that the industry welcomes continued regulatory engagement and continued input on this subject. Many of them also identified existing guidance from NASAA, the Securities Industry and Financial Markets Association, and the Financial Services Institute as being resources they currently consult when issues arise.

Among the key areas considered are how firms can recognize signs of diminished capacity and how they should consider dealing with issues that arise. The report encouraged firms to consider implementing an appropriate training program to enable staff to detect “red flags” of impairment by an adviser and a mechanism to communicate concerns freely within an organization. While dementia associated with aging is still the most common reason for impairment, other underlying causes include accidents and traumatic injury, side effects from medications, a non-dementia medical diagnosis, and drug or alcohol addiction. When a situation is detected, how a firm should confront the adviser is a key issue, and one that may be fraught with both practical and legal considerations. The report summarized a few instances where firms had successfully dealt with such issues and stressed that sensitivity and respect should be paramount in every such encounter.

SEC Issues Risk Alert to Private Fund Advisers, Part 2

July 9, 2020 | Steve Parker

SEC Issues Risk Alert to Private Fund Advisers, Part 2

This supplements our previous post relating to a Risk Alert issued by the SEC’s Office of Compliance Inspections and Examinations on June 23. The Risk Alert was directed at investment advisers to private investment funds. While the prior post discussed the portion of the Risk Alert dealing with fees and expenses, this post discusses the SEC’s findings relating to failure to disclose conflicts of interest.

By way of background, the Risk Alert reminds private fund advisers that they owe duties of care and loyalty to the investors in private funds. In order to fulfill the duty of loyalty, the adviser may not prefer his own interests to those of the investors and must disclose to its clients, in a full and fair manner, all material facts relating to the advisory relationship. The scope of the investment adviser’s duties is discussed at length in IA-5248, issued in June 2019, which we have discussed in a previous post.