Investment Adviser

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.

SEC Warns Broker Dealers and Investment Advisers About Conflicts of Interest Related to Compensation Incentives

August 30, 2022 | Katherine Oberlies

On August 3, 2022, the U.S. Securities and Exchange Commission (“SEC”) published a Staff Bulletin related to compensation incentives that may cause a conflict of interest in violation of Regulation Best Interest (“Reg BI”) rules and the SEC’s fiduciary standards for investment advisers (“IA fiduciary standard”). Reg BI and the IA fiduciary standard provide that a conflict of interest is an interest that may consciously or unconsciously incline a broker dealer or investment adviser to make recommendations or render advise that is not disinterested. According to Reg BI and the IA fiduciary standard, broker dealers and investment advisers must identify and either disclose or eliminate all conflicts of interest.

The IA fiduciary standard encompasses both the duty of loyalty and the duty of care. According to the Commission Interpretation Regarding Standard of Conduct for Investment Advisers published in 2019, the duty of loyalty requires investments advisers to at a minimum disclose a conflict of interest so that a client may provide informed consent to said conflict or eliminate the conflict entirely. The 2019 Commission Interpretation also explains that the duty of care requires investment advisers to provide advice based on a reasonable understanding of the client’s goals and objectives that is in the client’s best interest.
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Colorado Releases Guidance for Financial Planners

August 18, 2022 | Charlie Jarrett

For the past several years, regulators at both the federal and state levels have placed a greater emphasis on the advisory fees charged to retail clients and how those fees are calculated and disclosed. We have previously written about these efforts publicized through Risk Alerts, Exam Priorities and Observations, and Staff Bulletins. Recently, the Colorado Division of Securities published an Ongoing Financial Planning Guide that articulated its concerns regarding investment adviser firms that provide continuous financial planning services.

The Colorado Division of Securities stated that it has encountered a growing trend in which investment advisers provide on-going financial planning rather than the traditional hourly or one-time fixed fee models. Under the on-going financial planning arrangement, investment advisers theoretically take a greater role in implementing financial plans, assisting clients with day-to-day financial decisions, updating financial plans, and making themselves available to the client as needed.

Compliance concerns regarding financial planning have traditionally focused on the disclosure of services and fees, including how and when the fees are charged, whether collecting fees in advance triggers custody concerns, and whether collecting fees in advance create a refund obligation. Colorado’s Guidance continues highlighting these areas of focus and expands what it considers to be best practices.
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SEC Releases Staff Bulletin for Account Recommendations

July 7, 2022 | Charlie Jarrett

The Securities and Exchange Commission (SEC) recently released a Staff Bulletin regarding the Standards of Conduct for Broker-Dealers and Investment Advisers Account Recommendations for Retail Investors. Since the adoption of Regulation Best Interest, or Reg BI, in 2019, the SEC has issued guidance and best practices for adoption of the policies and procedures expected for compliance with the regulation. We have previously written about the best interest standard applied to retirement rollover recommendations and the SEC’s announcement of the first enforcement case being filed under Reg BI.

The Staff Bulletin, presented in a Q&A format, provides the SEC’s views on how financial professionals can fulfill their obligations to retail investors when making account recommendations. The obligations discussed include the applicable standard for making account recommendations, factors to consider when making account recommendations, how and when cost is a factor, retirement rollover considerations, client account preferences, and developing and implementing a compliance plan reasonably designed to address Reg BI.

While Reg BI and the investment adviser fiduciary standard differ, the SEC points out that both standards require an account recommendation to be in the client’s best interest and prohibits an investment adviser from placing its interest ahead of a client’s interest. Additionally, the SEC states that a firm that does not evaluate sufficient information about a retail investor, it will not have the ability to form a reasonable basis to believe its account recommendations are in the retail investor’s best interest.

SEC Releases 2022 Examination Priorities

April 21, 2022 | Charlie Jarrett

The Securities and Exchange Commission (SEC) recently released the 2022 Examination Priorities from the Division of Examinations, formerly known as the Office of Compliance Inspections and Examinations. This annual release provides insight into the areas that the SEC plans to highlight when examining investment advisers during the coming year.

While the SEC notes the continued impact of COVID-19 on investment advisers and the investment industry, the SEC reported an increase in examinations conducted during FY21, with the total number of completed examinations close to the pre-pandemic levels of FY19.

For FY22 examinations, the SEC will place a significant focus on (1) private funds; (2) environmental, social, and governance (ESG) investing; (3) standards of conduct: Regulation Best Interest (Regulation BI), fiduciary duty, and Form CRS; (4) information security and operational resiliency; and (5) emerging technologies and crypto-assets. Many of these focus areas, such as ESG and Regulation BI, are carried over from previous years and mark a multi-year emphasis for the SEC.

SEC Releases Observations from Examinations Relating to Advisory Fees

November 30, 2021 | Charlie Jarrett

The Division of Examinations of the Securities and Exchange Commission (SEC) recently released a Risk Alert relating to the Advisory Fee Initiative titled “Division of Examinations Observations: Investment Advisers’ Fee Calculations.” Under this Initiative, the SEC conducted approximately 130 examinations of SEC-registered investment advisers focusing on how advisory fees are disclosed and charged, particularly to retail clients.

Since 2018, the SEC has included the disclosure of the costs of investing in its list of yearly exam priorities. The Division of Examinations has focused on whether advisers have adopted policies and procedures reasonably designed to produce fair and accurate fee assessments, and whether those fees are disclosed to clients in a manner such that clients understand the costs of the advisory services provided.

During the Initiative, the Division’s review included: (1) the accuracy of the fees charged by the examined advisers; (2) the accuracy and adequacy of the examined advisers’ disclosures; and (3) the effectiveness of the examined advisers’ compliance programs.

FINRA Withdraws Expungement Rule Proposals

June 8, 2021 | Steve Parker

In late May, FINRA issued a press release announcing the temporary withdrawal of proposed rule changes regarding the process for obtaining expungement of customer dispute information maintained for registered representatives on WebCRD, or “BrokerCheck.”

The proposed rule changes were issued in 2017 for possible SEC approval and have previously been discussed on our blog. Since 2017, FINRA has responded to various SEC requests for additional information, and the deadline for adoption of the rule proposals has been extended. The withdrawal release cites “consultations with the SEC staff” as the basis for withdrawal of the rule proposal and concludes by restating FINRA’s commitment that it will continue to consult with, and solicit input from, the SEC and other interested parties “who share a common interest in revising” the expungement process.

Among other things the proposed rule changes included:

Establishing a new category of arbitrators trained and qualified to decide expungement cases, and maintaining a roster of those arbitrators who will decides such cases;
Eliminating the process for ranking arbitrators that are appliable to other industry and customer arbitrations;
Prohibiting stipulations or agreements to allow the case to be decided by fewer than three arbitrators chosen from the special panel;
Requiring a broker who is named in the underlying arbitration to seek expungement in that arbitration;
Imposing stricter time limits within which brokers may request expungement; and
Limiting situations in which a party to a customer dispute – such as a broker-dealer – can request expungement relief for an unnamed party, such as a registered representative of that broker-dealer.