RIA Compliance Blog

DOL Reinstates Investment Adviser Fiduciary Definition and Proposes New Rules

July 17, 2020 | Steve Parker

In late June, the U.S. Department of Labor reinstated the previous definition of “fiduciary investment advice” that was contained in its prohibited transactions rules prior to 2017. That definition was amended by the “Fiduciary Rule” that went into effect in 2017, but the new rule was ultimately struck down by the Fifth Circuit Court of Appeals. Because the DOL interprets the Fifth Circuit’s decision to have reinstated the original rule, it dispensed with the normal comment period and made the new rule effective immediately.

The original (now reinstated) definition was passed in 1975 and was applied consistently by the DOL and IRS until the 2017 Fiduciary Rule became effective, albeit temporarily. The reinstated definition, being much narrower than the definition under the Fiduciary Rule, means that many fewer situations between plans and investment advisers will constitute “fiduciary investment advice” compared to the 2017 Fiduciary Rule and, consequently, the risk of engaging in a prohibited transaction is smaller.

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.

Investment Advisers to Private Funds Urged to Review SEC Risk Alert

June 25, 2020 | Steve Parker

Earlier this week, the SEC’s Office of Compliance Inspections and Examinations (OCIE) issued a risk alert in which it discussed ongoing deficiencies identified during compliance examinations of investment advisers that advise private funds. This risk alert follows on the heels of other SEC activity relating to private fund advisers, including enforcement referrals, deficiency letters, and informal guidance.

The deficiencies discussed in the risk alert fall into three broad categories: disclosures relating to fees; disclosures relating to conflicts of interests; and sufficiency of a firm’s policies relating to nonpublic material information and its internal enforcement of such policies. The purpose of this risk alert was to provide guidance to private fund advisers regarding steps they should take to improve their compliance policies and program, while simultaneously advising investors in private funds of the types of issues to be aware of when dealing with private fund advisers. Many investors in private funds are pensions or other qualified retirement plans, charities and endowments, and families who have family offices.

This blog post focuses on the portion of the risk alert relating to fees and expenses. Continue reading ›

Recent Merrill Lynch Scenario Underscores Need to Avoid Unnecessary Mutual Fund Fees

June 16, 2020 | Steve Parker

Last week, the Financial Industry Regulatory Authority (FINRA) issued a Letter of Acceptance Waiver and Consent (AWC) censuring Merrill Lynch and ordering $7.2 million in restitution to investor clients. Merrill had already reimbursed the clients as a result of an internal review and had self-reported the underlying violations to FINRA, a move that earned praise from FINRA in the AWC.

At issue was the failure to honor rights of reinstatement in connection with mutual fund purchases. Mutual fund companies usually offer various rights to their shareholders, as set forth in a fund’s prospectus or the fund’s statement of additional information. Some funds grant shareholders a right of reinstatement, which allows investors to buy fund shares without incurring a front-end charge if the investor previously sold shares of any fund within the same family. Usually, this involves A-shares, but it could apply to different classes of shares, depending on the fund company. Similarly, a right of reinstatement usually allows the investor to recoup any previously charged contingent deferred sales charge relating to the sale of a fund within the family. Rights of reinstatement typically specify that the new purchases must occur within 30 to 90 days of the prior sale, but the period could be as up to one year later, depending on the fund and the particular situation. Continue reading ›

Investment Adviser Touting COVID-19 Investments Sued By SEC

June 8, 2020 | Steve Parker

On June 3, 2020, the U.S. Securities and Exchange Commission filed suit against a company claiming to be an internet-only investment adviser, based on the firm’s failure to respond to a request for documents and information, in violation of the Investment Advisers Act and rules. The company, E*Hedge Securities, Inc., is registered as an investment adviser with the SEC. The complaint also alleges, however, that E*Hedge is not properly registered, as it is ineligible to claim the basis for registration of an “internet only” adviser under Rule 203A-2(e), and does not meet any other qualification for federal registration. E*Hedge’s President, Devon W. Parks, is also named as a defendant in the complaint.

The complaint alleges that in March 2020, E*Hedge began marketing investment opportunities relating to COVID-19 related products and services, particularly tests and treatments. The firm began operating a website at www.Covid19invest.com. It also used social media websites for the same purposes. Together the websites touted investments in companies involved in manufacturing vaccines, diagnostic tests, and treatments for COVID-19. E*Hedge’s website identifies the company’s primary business is to provide a platform for initial public offerings, offerings under Regulation A+, and private offerings under Rule 506 (c). Continue reading ›

SEC Provides Form CRS Guidance and Issues RIA Examination Risk Alert

May 27, 2020 | Steve Parker

As we mentioned in an earlier post, in April of this year the SEC’s Office of Compliance Inspections and Examinations (OCIE) issued separate risk alerts on the subjects of Form CRS and Regulation Best Interest (Reg BI). The risk alerts were designed to provide investment advisers and broker-dealers information regarding the anticipated scope and content of the examinations OCIE will conduct following the filing deadline for Form ADV, Part 3 and following the compliance date for Regulation Best Interest. In this post we examine the new requirements regarding Form ADV, Part 3, which we will refer to as “Form CRS,” and then review the SEC’s Risk Alert relating to Form CRS. Firms seeking to comply with the new requirements should carefully review the 17-page instructions to Form CRS. The SEC has also published a helpful Small Entity Compliance Guide.

Under the new requirements, federally registered RIAs must electronically file Form CRS via the IARD system and must deliver a Form CRS to all retail investors, regardless of net worth or sophistication. Currently registered RIAs or entities who currently have pending applications to become RIAs may file their form CRS at any time, but they must file the initial CRS on or before June 30, 2020. The Form CRS may be filed as part of an initial application to register under Rule 203-1, or as an other-than-annual amendment to the Form ADV under Rule 204-1. Beginning June 30, 3020, any new application will be considered incomplete and will be rejected if it does not contain a Form CRS. Every RIA’s firm must post its Form CRS on its public website, but there is no requirement that a firm without a public-facing website must create one. Continue reading ›

SBA Extends Safe Harbor for Return of PPP Loans and Signals Further Guidance

May 8, 2020 | Steve Parker

Through updates to the Frequently Asked Questions maintained on its website, the Small Business Administration announced that it has extended the safe harbor date previously announced in Question 31 from May 7, 2020 to May 14, 2020, and that it intends to issue updated guidance relating to the safe harbor before May 14.

By way of background, on April 23, 2020 the SBA issued guidance relating to the certification that must be made by any applicant for a loan under the Paycheck Protection Program (PPP). Specifically, the SBA advised all applicants to consider the truthfulness of the certification in the application regarding the need for the loan to support business operations. The answer to question 31 clarified that all borrowers must carefully consider whether, in light of their current business and access to capital, the loan is necessary, provided the capital is available in a way that would not substantially impair the business. The SBA granted a “safe harbor” by which anyone who had received funds through a PPP loan will be deemed to have made the loan certification in good faith if they return the funds on or before May 7, 2020. A few days later the SBA made it clear that the answer to Question 31 applied to private as well as public companies, through the addition of Question and Answer 37.

The entire process has been sloppy and uncertain. Even the original certification required is vague. What exactly does it mean that a loan is necessary “to support the ongoing operations of the Applicant.” This question could have been avoided through the development of more thorough, objectively measurable eligibility standards, rather than through such a scatter gun approach.

SBA and SEC Add Guidance on Paycheck Protection Program Loans

May 7, 2020 | Steve Parker

Due to recent guidance from the Small Business Association (SBA) and the Securities and Exchange Commission (SEC), registered investment advisers (RIAs) should carefully consider their eligibility for a loan under the Paycheck Protection Program, and whether they must disclose the circumstances that led to the loan, or the fact of receiving the loan itself, on form ADV.

The PPP Loan Certification
In order to qualify for a PPP loan, an applicant must certify that “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.” Our view of this language was that it was very broad, so as to apply to any business that reasonably anticipated a reduction in revenue that could result in curtailment of its current operations. If an RIA believed in good faith that its revenue will decrease or has decreased as a result of the pandemic, and also anticipated that it will have to terminate any employees without the loan, then it is eligible for the loan. Since the primary purpose of the loan program was to minimize unemployment, in our view such an RIA should have easily been able to make the certification in good faith. However, later SBA guidance effectively altered the standard, and any RIA who applied for a loan should reevaluate the certification under the new standard.

April 23, 2020 — SBA Guidance
There was political backlash in mid-April when it was revealed that certain large companies, including publicly-traded companies that had access to capital markets, were receiving PPP loans. This led the Small Business Administration to issue formal Q&A guidance last Thursday, April 23, 2020. As a result of the guidance, the SBA stated that, before submitting a PPP application, all borrowers should review carefully the required certification that “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.” Borrowers must make this certification in good faith, taking into account their current business activity and their ability to access other sources of liquidity sufficient to support their ongoing operations in a manner that is not significantly detrimental to the business. While it is tempting to read the SBA guidance as applicable only to large businesses with access to capital, the Q&A made it clear that the “significantly detrimental” standard applies to “all borrowers.”Furthermore, while the guidance could be interpreted to apply only to public companies, the SBA clarified that it applied to private companies by updated guidance issued on April 28, 2020.

SEC Publishes Risk Alerts Relating to Reg BI and Form CRS

April 22, 2020 | Steve Parker

Earlier this month the SEC’s Office of Compliance Inspections and Examinations (OCIE) issued two related risk alerts on the subjects of Form CRS and Regulation Best Interest (Reg BI). The purpose of the risk alerts was to provide investment advisers and broker-dealers information regarding the anticipated scope and content of the examinations OCIE will conduct following the compliance date for Regulation Best Interest, and the filing deadline for Form ADV, Part 3. In this post, we summarize the risk alert relating to Reg BI.

The initial broker-dealer examinations will focus on whether firms have established policies and procedures reasonably designed to comply with Regulation Best Interest’s for distinct obligations: the duty to disclose; the duty of care; the duty to avoid or disclose conflict of interest; and the duty to adopt compliance procedures. In addition to assessing whether a registrant has adopted policies and procedures reasonably designed to comply with Regulation BI, the examinations will also assess the operational effectiveness of those procedures.

Wells Fargo Settles Enforcement Case Over Unsuitable ETF Recommendations

March 30, 2020 | Steve Parker

Last month Wells Fargo Advisors Financial Network LLC agreed to settle administrative charges brought by the SEC, and will pay a $35 million civil penalty in order to resolve the matter. According to the allegations, Wells Fargo failed to supervise investment adviser representatives who recommended inverse exchange-traded funds to their customers, leading to investor losses.

Inverse ETFs allow investors to short the entire market or a sub-market, depending on the ETF involved. However, because they usually “re-set” every day, inverse ETFs are not designed to be held for longer than a single trading day. Instead, they are designed to be used by traders to implement risk hedges on an intra-day basis. If they are held on a long-term basis, they will not necessarily perform consistently with the long-term direction of the market being shorted. This is especially true in volatile markets.

These risks are often described in detail in the product prospectuses but are not often explained sufficiently by financial advisers. In fact, advisers who are not specifically trained on the products often do not understand their unique characteristics. For example, a single-inverse ETF based on a particular index will usually lose money even if the index performance remains flat. In fact, even if the index falls the ETF can lose money.