RIA Compliance Blog

SEC Adds RIAs to Definition of “Accredited Investor,” Adopts Other Changes

September 3, 2020 | Steve Parker

In a closely-watched move, the SEC voted 3-2 this past Wednesday to expand the definition of an “accredited investor” to include both state-registered and SEC-registered investment advisers with $5 million or more in assets. Accredited investors are those who are permitted to purchase unregistered securities such as those typically sold in a private placement. The current definition includes individuals or married couples with $1 million or more in investments and individuals with $200,000 in annual income or total income with a spouse of $300,000.

Also added to the definition are individuals who hold Series 7, 65, and 82 licenses. Those correspond to examinations for the general securities agent or representative, the investment adviser representative, and the private placement agent, respectively. “Knowledgeable employees” of a private fund are now also accredited investors. In addition to the new categories included, the Commission established a framework whereby additional categories of sophisticated investors can be added to the definition over time.

The Commission also voted not to adjust upward for inflation, the traditional wealth-based definition of “accredited investor.” The issue exposes a fundamental debate about the adequacies of protections that currently exist in the private securities market, as well as issues of class-based access to markets.

US Supreme Court Disgorgement Ruling Leaves Open Questions

August 18, 2020 | Steve Parker

Earlier this summer, the US Supreme Court handed down a highly anticipated decision clarifying the powers of the Securities and Exchanges Commission in civil enforcement proceedings. The court ruled by a margin of 8 to 1 that the SEC can obtain disgorgement from a defendant because disgorgement is a form of equitable relief. As such, the remedy is based on district courts’ inherent powers to enter remedies based on fairness and equity. But we anticipate that the lower courts will still have difficulty in answering questions relating to the equitable remedy with uniformity, most likely resulting in those questions eventually coming back to the high court for resolution.

The case, Liu v. SEC, involved a lower court’s order that a married couple must pay $27 million in disgorgement as a result of the husband’s raising that amount from Chinese investors in a fraudulent EB-5 offering. The funds were ostensibly raised to fund a new cancer clinic, but ultimately the funds were misused. The husband funneled some of the money to the wife and some to other related companies. Both husband and wife were paid millions of dollars in salaries alone. The disgorgement award held both husband and wife jointly and severally liable for the full amount.

The trial court ordered the couple to disgorge the full amount raised in the fraudulent scheme as “ill-gotten gains.” The defendants challenged the amount of disgorgement imposed on several grounds, including that the amount should be offset by legitimate expenses incurred by the defendants. A disgorgement award that was not limited to net profits, they argued, constituted a penalty and therefore, could not be imposed consistent with other limitations on awards of civil penalties. Continue reading ›

SEC Signals Ransomware Risk to Investment Advisers is High

July 31, 2020 | Bryan Gort

The Securities and Exchange Commission (“SEC”) recently published its sixth risk alert on cybersecurity since 2014. In this alert, the SEC focused on how its regulated firms protect themselves against ransomware risk. I previously wrote about the SEC’s last risk alert on ransomware here.

Ransomware is malware that stops a user from accessing either part or all of the data within their network or other systems until a ransom is paid. For ransomware to be effective, it must gain access to network data in some form or fashion, usually through user error, such as a user clicking a link, downloading a file, or doing something else which affirmatively provides the ransomware access to data. From there, the hacker typically encrypts data and demands payment to unencrypt it.

There are varying studies, but up to 90% of financial services firms, including investment advisers, broker-dealers and investment companies, report that they have been targeted by ransomware. The SEC also reports that these targeted attacks have gotten more sophisticated in nature over the last few years, which necessitates greater allocation of resources from firms to protect themselves.

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.