Compliance

What Firms Can Expect Now That the SEC is Back at Work

January 31, 2019 | Elizabeth Dalziel

On December 20, 2018, two days before the recent partial federal government shutdown began, the Securities and Exchange Commission’s Office of Compliance Inspections and Examinations announced its 2019 Examination Priorities. As discussed previously, the shutdown resulted in the SEC operating at a quite minimal level. Now that the shutdown is over, registered investment advisers and broker-dealers can likely expect OCIE to fully implement the following examination priorities.

OCIE listed six examination priorities for 2019: (1) matters of importance to retail investors, especially seniors and investors saving for retirement; (2) compliance and risk in registrants who are tasked with overseeing critical market infrastructure; (3) focus on FINRA and MSRB; (4) digital assets; (5) cybersecurity; and (6) anti-money laundering. According to OCIE, this is not an exhaustive list, and one can expect OCIE to cover other issues in its examinations. However, OCIE has concluded that these issues “present potentially heightened risk to investors or the integrity of U.S. capital markets.” Continue reading ›

SEC Investigating Investment Advisers That Did Not Self Report Under 12b-1 Initiative

January 9, 2019 | Steve Parker

Following several enforcement actions brought against registered investment advisers that received 12b-1 fees when institutional shares were available to be purchased in clients’ advisory accounts, in February of this year the Securities and Exchange Commission announced an initiative under which firms could self-report the receipt of “avoidable” 12b-1 fees since 2014. Under the so-called Share Class Selection Disclosure Initiative (SCSDI), advisers who self-reported receiving 12b-1 fees under those circumstances would be subject to an SEC enforcement action but would receive favorable treatment in such a case. Such favorable treatment included no recommended civil penalties as long as the firm agreed to disgorge all avoidable 12b-1 fees received.

In order to participate in the SCSDI, however, firms were required to report to the SEC by June 12, 2018. In announcing the SCSDI, the SEC indicated that firms that did not self-report may be subjected to harsher sanctions if their practice was later discovered.

In recent weeks through information available through clearing firm data and public sources the SEC has identified RIAs that may have received 12b-1 fee but chose not to self-report. Some of these firms are receiving subpoenas or requests for information and testimony. Whether the failure to report was justified and/or the original receipt of the 12b-1 fees were not improper are questions that the SEC Enforcement Staff will be evaluating during its investigations. In some limited circumstance a firm might be able to justify receipt of the questioned fess, and also might be excused from or ineligible for the self-reporting initiative. Continue reading ›

Recent OCIE Risk Alert Warns Advisers to Ensure Compliance with Cash Solicitation Rule

December 17, 2018 | Parker MacIntyre

The SEC’s Office of Compliance Inspections and Examinations (“OCIE”) periodically issues “Risk Alerts” highlighting common deficiencies encountered by its staff during routine investment adviser compliance exams. These Risk Alerts serve the dual purpose of providing advisers with both useful insight into the results of recent OCIE examination activity as well as advance warning of areas that OCIE may be paying closer attention to in the future. Accordingly, a recent Risk Alert issued by OCIE details the most common deficiencies the staff has cited relating to Rule 206(4)-3 (the “Cash Solicitation Rule” or “Rule”) under the Investment Advisers Act of 1940. See National Exam Program Risk Alert, Investment Adviser Compliance Issues Related to the Cash Solicitation Rule (Oct. 31, 2018).

By way of background, the Cash Solicitation Rule prohibits SEC-registered investment advisers from paying a cash fee, directly or indirectly, to any person who solicits clients for the adviser unless the arrangement complies with a number of conditions specified in the Rule, including that the fee must be paid pursuant to a written agreement to which the adviser is a party. Notably, the Rule discerns between solicitors that are affiliated with the registered adviser versus those that are not, setting-up more comprehensive requirements for the latter third-party solicitors. For example, third-party solicitors must provide potential clients with both a copy of the adviser’s Form ADV Part II (or other applicable brochure) and a separate written solicitor’s disclosure document containing specific data about the solicitation arrangement—including the terms of the solicitor’s compensation. Moreover, with respect to third-party arrangements, the Rule obliges advisers to: (i) collect a signed and dated acknowledgment from every potential solicited client that such client has in fact received the adviser’s brochure and the solicitor’s disclosure document; and (ii) make a “bona fide effort” to ascertain whether the solicitor has complied with its duties under the Rule.

In this context, OCIE cited the following as the most noteworthy deficiency areas encountered by its front-line examiners:

Recent SEC Order Clarifies CCO and Other Firm Manager Liability

December 10, 2018 | Parker MacIntyre

The SEC routinely hears appeals arising from FINRA disciplinary proceedings, and in turn issues “Adjudicatory Orders” announcing its decisions. To the extent that these Orders are issued by vote of the full Commission, they stand as highly useful guidance to industry players on the thoughts of the SEC’s ultimate leadership. In a recent Adjudicatory Order, the SEC articulated its current position on Chief Compliance Officer (“CCO”) liability for securities regulatory violations, as well as the liabilities of other members of a securities firm’s senior management for failure to supervise the CCO. See Application of Thaddeus J. North for Review of Disciplinary Action Taken by FINRA, Order of the Commission, Rel. No. 34-84500 (Oct. 29, 2018).

The facts of the case involve findings by FINRA that the CCO (Mr. North) of a multi-office 50+ representative brokerage firm violated FINRA rules by failing to establish a reasonable supervisory system for the review of electronic correspondence, failing to reasonably review electronic correspondence, and failing to report a relationship with a statutorily disqualified person. Specifically, despite being the person responsible for reviewing the firm’s electronic communications, the record showed that for a roughly two-year period North completely failed to review any Bloomberg messages/chats (such messages making up 85% of the firm’s electronic communications). North testified that he “did not understand” his firm’s Smarsh e-mail retention/retrieval system, and further attributed his failure to review electronic communications to that activity being “boring.” Separately, North failed to either independently investigate or report to FINRA his knowledge of a material relationship between one of his firm’s registered representatives and a statutorily-disqualified person. This particular failure came despite North’s knowledge that the representative had paid the disqualified person over $150,000, had executed a services agreement with that person, and that FINRA was actively investigating the matter.

On these facts, the SEC upheld FINRA’s disciplinary action as “clearly appropriate” in light of North’s “egregious” conduct in “fail[ing] to make reasonable efforts to fulfill the responsibilities of his position.” Notably, “North ignored red flags and repeatedly failed to perform compliance functions for which he was directly responsible.”

Overview of State-Registered Investment Advisers and Current Regulatory Issues, Part 2

December 6, 2018 | Elizabeth Dalziel

In our previous post regarding state-registered investment advisers, we examined the landscape and discussed common deficiencies found in state adviser examinations. In this post, we will discuss enforcement actions typically aimed at state-registered investment advisers, as well as current enforcement trends such as fraud pertaining to emerging markets and protection of senior investors.

Earlier in 2018, the North American Securities Administrators Association (NASAA) published its 2018 Enforcement Report. This report contains information and statistics regarding NASAA members’ enforcement actions in 2017 and highlights current trends in enforcement actions aimed at state-registered investment advisers.

According to the Report, NASAA members received 7,998 complaints that resulted in 4,790 investigations. Once the investigations were completed, NASAA members initiated 2,105 enforcement actions, over half of which were administrative actions. Criminal actions made up the second largest number of enforcement actions, followed by civil and other types of enforcement actions. Continue reading ›

SEC Proposes Rule Changes Regarding Disclosures About Variable Annuities and Variable Life Insurance Contracts

November 15, 2018 | Elizabeth Dalziel

On October 30, 2018 the Securities and Exchange Commission announced amendments to rules and forms designed to improve disclosures made to clients regarding variable annuities and variable life insurance contracts. According to the SEC, the purpose of the proposed amendments is to assist investors in comprehending the characteristics of variable annuities and variable life insurance contracts and the risks associated with those investment products. The proposed amendments would allow financial institutions who offer variable annuities and variable life insurance contracts to give a summary prospectus to investors, which would satisfy the financial institutions’ disclosure obligations. The SEC has invited the public to comment on both the proposed amendments and the hypothetical summary prospectus samples created and included in the proposed rule. The comment period will run through February 15, 2019. Continue reading ›

Oregon Implements Temporary Rules Regarding Proof of E&O Insurance for Advisers

August 17, 2018 | Elizabeth Dalziel

Oregon requires all investment advisers and broker-dealers to maintain errors and omissions insurance for at least $1 million. Under Section 59.175 “every applicant for a license or renewal of a license as a broker-dealer or state investment adviser shall file with the director proof that the applicant maintains an errors and omissions insurance policy.” This law provides investors with recourse if they suffer losses because of an uninsured investment adviser. Presently, investment advisers in Oregon may obtain errors and omissions insurance through either the Oregon surplus lines, the Oregon risk retention markets, or both. However, according to the Oregon Secretary of State’s Department of Consumer and Business Services, which oversees the Division of Finance and Securities Regulation, neither of those groups is “admitted” or authorized to conduct insurance business in Oregon. As a result, the Department has decided that a temporary rule is necessary to help both Oregon investment advisers and insurance producers understand the steps they need to take to provide proof of insurance. Continue reading ›

SEC Settles Charges with Three Investment Advisers Over Violations of Pay-to-Play Rule

August 7, 2018 | Elizabeth Dalziel

Last month three registered investment advisers settled with the Securities and Exchange Commission over charges they violated the pay-to-play rule, Investment Advisers Act Rule 206(4)-5. The Orders Instituting Proceedings were entered against EnCap Investments, L.P., Oaktree Capital Management, L.P., and Sofinnova Ventures, Inc. All three advisers submitted offers of settlement in connection with the Orders.

The Pay-to-Play Rule prohibits registered investment advisers and exempt reporting advisers from offering investment advisory services for compensation to a government entity for a period of at least two years after the investment adviser or a covered associate of the investment adviser makes a political contribution to an official of the government entity. An investment adviser violates the Pay-to-Play Rule regardless of whether the investment adviser intended to influence the government entity official. Continue reading ›

SEC Directors Stress Importance of Budget Request to Expand and Improve Investment Adviser Examinations

June 14, 2018 | Elizabeth Dalziel

On May 16, 2018, SEC Co-Directors Stephanie Avakian and Stephen Piekin appeared before the Subcommittee on Capital Markets, Securities, and Investment, a subcommittee of the House of Representatives’ Committee on Financial Services. At this meeting, Avakian and Peikin emphasized the importance of the budget increases requested by the SEC in February of this year. The Commission’s Fiscal Year 2019 Congressional Budget Justification; Annual Performance Plan and Fiscal Year 2017 Annual Performance Report includes budget requests for each SEC division, including the Office of Compliance Inspections and Examinations. As part of OCIE’s budget request, the SEC requested funding for “13 restored positions to focus on examinations of investment advisers and investment companies.”

According to the SEC, the number of registered investment advisers, as well as the amount of assets that they manage, has significantly increased in the last few years. The SEC also anticipates that the number of registered investment advisers and the complexity of these investment advisers will continue to grow throughout 2018 and 2019. Moreover, a hiring freeze, which began at the beginning of 2017, has caused the number of compliance staff to decrease. The SEC anticipates that it will need funding to restore 100 positions that were lost because of the hiring freeze. Therefore, the SEC believes that without the requested funding, SEC staff will be unable to address its growing responsibilities adequately. Continue reading ›

SEC Continues to Pursue Municipal Advisor Examinations

April 11, 2018 | Elizabeth Dalziel

Following its publication of a Risk Alert in late 2017 detailing findings from examinations of municipal advisers, the SEC’s Office of Compliance Inspections and Examinations (OCIE) continues to examine municipal advisers in 2018. In 2014, OCIE established the Municipal Advisor Examination Initiative to perform an examination on municipal advisers who recently registered for the first time. OCIE performed over 110 examinations in the course of the Initiative and found that many municipal advisers did not have adequate knowledge of regulatory requirements for municipal advisers. As a result, many municipal advisers were found not to be in adequate compliance with regulatory requirements pertaining to registration, recordkeeping, and supervision. OCIE hoped that in publishing the 2017 Risk Alert, municipal advisers will be compelled to evaluate their policies and procedures to find possible areas for improvement.

Municipal advisers are obligated to register with the SEC pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”). The SEC established its municipal adviser registration rules in September 2013, and the rules became effective in July 2014. The Dodd-Frank Act also established the Municipal Securities Rulemaking Board (“MSRB”), which exercises regulatory authority over municipal advisers. OCIE’s examinations of municipal advisers covered “compliance with regulatory obligations including registration, statutory fiduciary standard of care, fair dealing, recordkeeping, and supervision, among other things.” OCIE discovered that the most common deficiencies among municipal advisers related to registration, books and records, and supervision requirements. Continue reading ›