Articles Posted in Investment Adviser

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The Securities and Exchange Commission (SEC) recently issued new guidance regarding the Custody Rule and inadvertent custody of client assets in the form of a No-Action Letter on standing letters of authorization (SLOAs) and a Guidance Update on custodial contract authority. This guidance comes in the wake of the recent SEC Risk Alert identifying most frequent compliance issues found in examinations of registered investment advisers and listing custody as one of these most frequent compliance issues.

The Custody Rule, or Rule 206(4)-2, provides that it is a fraudulent, deceptive, or manipulative act within the meaning of section 206(4) of the Investment Advisers Act of 1940 for a registered investment adviser to have custody of client assets unless certain requirements are met. One of these requirements is an annual surprise examination requirement, although this requirement does not apply if the investment adviser solely has custody as a result of its authority to make advisory fee deductions. Continue reading ›

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On January 17, 2017, the Securities and Exchange Commission (“SEC”) issued ten Orders Instituting Administrative and Cease-and-Desist Proceedings (“Orders”) against ten investment advisory firms.  In each of its Orders, the SEC alleges that each investment advisory firm gave money to campaigns for politicians who, if elected, would have the power to determine the choice of investment advisers to oversee government assets, and subsequently gave investment advisory services to public pension funds.  According to the SEC, these actions constituted violations of the Investment Advisers Act of 1940 (“Advisers Act”).

Rule 206(4)-5(a)(1), commonly known as the Pay-to-Play Rule, provides that investment advisers who are registered with the SEC, foreign private advisers, and exempt reporting advisers are not permitted to provide “investment advisory services for compensation to a government entity within two years after a contribution to an official of a government entity made by the investment adviser or any covered associate of the investment adviser.”  This rule applies regardless of whether the investment adviser or covered person intended to sway the official.  According to the SEC’s Orders, five of the investment advisory firms were SEC-registered investment advisers, while the remaining five were exempt reporting advisers.  Thus, all ten of the investment advisory firms were subject to the provisions of Rule 206(4)-5(a)(1). Continue reading ›

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The Department of Labor (DOL) recently issued two new sets of FAQ guidance regarding the revised definition of fiduciary investment advice under the Employee Retirement Income Security Act of 1974 (ERISA) and the Internal Revenue Code of 1986 (Code), as well as the new prohibited transaction exemptions (PTEs). The first set of guidance is directed to retirement investors, not advisers, and answers basic questions investors may have regarding the new rule and how it will work. The second set of guidance is aimed at financial service providers and focuses mainly on the revised definition of fiduciary investment advice and the situations in which fiduciary duties will or will not attach under the new rule.

While the first set of FAQ guidance is not necessarily aimed at financial service providers, it did provide a few useful insights that I will briefly discuss here. The DOL stated that the new rule does not require advisers to indiscriminately move clients from commission-based accounts to fee-based accounts, and instead requires advisers to act in the client’s best interest when deciding what type of account to recommend. Regarding the best interest requirement, the DOL clarified that providing investment advice in a client’s best interest does not mean that advisers have a duty to find the best possible investment product for clients out of all the investments available in the marketplace. Continue reading ›

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Most deficiencies identified in the course of investment adviser examinations can be remedied by the adviser simply taking corrective measures. This can be true even with regard to deficiencies that are somewhat serious violations, but only if corrective action is taken and sustained.

In 2016, the Securities and Exchange Commission (“SEC”) starkly demonstrated the importance of following through with promises advisers make to the SEC Examinations Staff. Because they did not make promised corrections, Moloney Securities Co., Inc. and Joseph R. Medley, Jr. were forced to consent to the entry of an Order Instituting Proceedings that required them, among other things, to pay civil penalties and to hire an independent compliance consultant to monitor and report certain aspects of the firm’s compliance program. Continue reading ›

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On December 1, 2016, the Securities and Exchange Commission (“SEC”) announced that it had filed a complaint for injunctive and other relief in the United States District Court for the Southern District of Florida against Onix Capital LLC (“Onix Capital”), an asset management company, and its owner, a Chilean national by the name of Alberto Chang-Rajii (“Chang”).  The complaint alleges that Onix Capital and Chang “violated the federal securities laws by fraudulently raising approximately $7.4 million from investors based on material misrepresentations regarding the investments offered, the use of the funds raised, and the background and financial success of Chang himself.”

Onix Capital was not an SEC-registered adviser, nor was Chang registered as an investment adviser or broker-dealer.  However, the SEC alleged that Onix Capital and Chang violated the Investment Advisers Act of 1940 (“Advisers Act”).  Specifically, the SEC alleged that Chang, “for compensation, engaged in the business of advising… investors… as to the value of securities or as to the advisability of investing in, purchasing, or selling securities,” and therefore met the definition of an “investment adviser” subject to the anti-fraud provisions of the Advisers Act. Continue reading ›

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The U.S. Circuit Court of Appeals for the District of Columbia recently denied a motion brought by the National Association for Fixed Annuities (NAFA) to enjoin the implementation of the new Department of Labor (DOL) fiduciary rule. This is the first court decision on a legal challenge to the rule. There are currently several other lawsuits against the DOL seeking to overrule the new DOL fiduciary rule that await decision.

NAFA is an insurance trade association that represents insurance companies, independent marketing organizations, and individual insurance agents. NAFA has been very vocal in its opposition to the new DOL fiduciary rule, stating that the new rule will have “catastrophic consequences for the fixed indexed annuities industry” and that meeting the April 2017 deadline is “almost an impossibility for the industry.” Along with other opponents to the rule, NAFA believes the rule will lead to higher compliance costs and will greatly increase litigation risk.

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Nebraska has proposed multiple changes to its securities laws, including changes to investment adviser registration requirements, changes related to broker dealers and agents, and changes relating to securities registration procedures.

As the proposed changes relate to investment advisers, Nebraska proposes to eliminate the Form IAR and to substitute registration through the CRD/IARD system.  An original application for registration would be required to contain Form ADV, Part 2 for the firm and a brochure supplement for each investment adviser representative.  An original application would also be required to contain copies of all other promotional or disclosure literature expected to be provided to clients and perspective clients in Nebraska.  The proposed rule would eliminate from the registration renewal requirements, the current requirements of submission of Form IAR and the promotional and disclosure literature.  The rules would align Nebraska with the annual updating amendment requirements of other states, by requiring submission of annual updating amendments to Form ADV within 90 days of the end of the fiscal year.  Additionally, the rule would require firms to submit other-than-annual amendments to Form ADV as required by the Form ADV instructions.

The proposed rule would also require brochure delivery to clients in a manner consistent with the requirements of most other states.  For example, delivery of Part 2 and a brochure supplement for each individual that provides investment advice and has direct contact with the client, or exercises discretion over the client’s assets in Nebraska either at the time of entering into an advisory contract or within 48 hours before entering into the contract.  If the delivery is made at the time the contract is entered into, the client must be given the right to terminate the contract without penalty within 5 days of entering into the contract.  Either an annual update or summary of material changes must be delivered to each client within 120 days after the end of the firm’s fiscal year.

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The Department of Labor (DOL) recently released its first set of rolling FAQ guidance regarding its new rules expanding the definition of fiduciary investment advice under the Employee Retirement Income Security Act of 1974 (ERISA) and the Internal Revenue Code of 1986 (Code), adopting new prohibited transaction exemptions (PTEs), and amending certain previously existing PTEs. The DOL answered questions regarding the new PTEs and the amendments to existing PTEs under ERISA and the Code. The DOL also reaffirmed the applicability date of April 10, 2017, stating that this date provided adequate time for financial service providers to adjust to the rule changes.

One common area of confusion regarding the new rules was the extent to which the new Best Interest Contract (BIC) exemption would be available for use by discretionary investment managers. One of the conditions to use of the BIC exemption is that the fiduciary not have any discretionary authority or control with respect to the recommended transaction. This excludes a large portion of investment advisers that serve as discretionary investment managers. However, there are limited circumstances in which they can receive protection under the BIC exemption.

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On July 29, 2016, the Appellate Court of Illinois entered a decision reversing a circuit court decision that affirmed an administrative order of the Illinois Secretary of State (“Secretary”) finding that Richard Lee Van Dyke, a registered investment adviser with the Illinois Department of Securities (“Department”), had defrauded clients by recommending the sale of indexed annuities in violation of Illinois law.

Section 2.1 of the Illinois Securities Law of 1953 (“Act”) provides that the term “security” is defined to include a “face amount certificate.”  Section 2.14 of the Act further defines a “face amount certificate” to include “any form of annuity contract (other than an annuity contract issued by a life insurance company authorized to transact business in this State)”.  However, Section 12(J) of the Act prohibits fraudulent or manipulative conduct as an investment adviser regardless of whether the investment adviser sells securities.  The Van Dyke case is perhaps most notable for its rejection of the circuit court’s conclusion that Van Dyke’s practices were fraudulent. Continue reading ›

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Earlier this year, the North American Securities Administrators Association (“NASAA”) adopted a proposed model legislation or regulation (“Model Act”) aimed at protecting vulnerable adults from financial exploitation.  A 2010 survey by the Investor Protection Trust Elder Fund Society found that one out of every five United States citizens age sixty-five and over has been a victim of financial fraud.  As a result, the protection of vulnerable adults, such as senior investors, from financial exploitation has been one of NASAA’s priorities.

The Model Act is entitled “NASAA Model Legislation or Regulation to Protect Vulnerable Adults From Financial Exploitation.”  It is designed to protect “eligible adults.”  An “eligible adult” is defined as a person age sixty-five years or older, or a person subject to a state’s Adult Protective Services statute, such as disabled or impaired persons. Continue reading ›

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