Compliance

SEC Issues Guidance Update on Cybersecurity

May 29, 2015 | Steve Parker

Last month, the SEC division of Investment Management released Investment Management Guidance in which it discusses a number of measures that investment advisers may wish to consider when addressing cybersecurity risks. This guidance is just the last in a long list of guidance and alerts issued by the SEC and other regulators as to the need for financial firms to improve their policies and procedures dealing with cybersecurity threats.

Among the recommendations made in the current IM are that firms:

• Conduct a periodic assessment of the nature, sensitivity and location of information, what types of cybersecurity threats and vulnerabilities exist, what security controls and processes are currently in place, the impact that would occur in the event of compromise of information, and the effectiveness of the current structure confirms current structure for managing cyber security risks

LPL Financial Ordered by FINRA to Pay $11.7 Million

May 15, 2015 | Steve Parker

Earlier this month, the Financial Industry Regulatory Authority (“FINRA”) announced that it had fined LPL Financial (“LPL”) $10 million for lack of supervision in several areas of its operations, including sales of ETFs, variable annuities, REITs, and other complex products. In addition, FINRA found LPL failed to monitor trades and failed to report them to FINRA and failed to deliver more than $14 million in trade confirmations to customers. FINRA also ordered LPL to repay certain customers $1.7 million in restitution relating to the purchases of ETFs. Among FINRA’s findings were that the firm did not have a system that monitored how long customers were holding ETFs in their accounts, information that would be important in formulating advice as to whether the ETFs should have been purchased in the first place and how long the client should be recommended to hold the ETFs in their portfolios. Additionally, even though LPL had created policies limiting the concentration of ETFs in customer accounts, it failed to enforce the limits it had established and had not trained its registered representatives on the risks of those products.

With respect to variable annuities, FINRA found that in several instances, LPL had permitted said annuities to be sold without proper disclosure of surrender fees. Additionally, although LPL employed an automated surveillance system, that system failed to adequately review transactions commonly known as mutual fund “switches,” which involve a redemption of one mutual fund in order to purchase another.
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Investment Advisers and Social Media

January 2, 2015 | Chadd Reynolds

As the use of social media becomes more prevalent and popular, businesses and financial institutions have begun to utilize the new methods of communication that social media can provide. Many businesses already maintain blogs or interactive accounts like Twitter, Facebook, and Instagram as a method of marketing and interacting with clients or prospective customers. However, social media is a relatively new and constantly changing technology that can create unique and unforeseen risks to a businesses image and regulatory compliance policies. These risks are particularly acute for registered investment advisers.

In the broker-dealer world, FINRA has already adopted rules and issued regulatory notices designed to protect investors from false or misleading claims and representations and guide member firms on how to appropriately monitor their social media participation. Although not strictly applicable to pure RIAs, these rules should be viewed as best practices:

FINRA Rule 2210 and NASD Rule 3010 govern the supervision of a firm’s social media communications;

FINRA Rule 2111 requires that social media communications, if recommending a security, must be considered suitable for the targeted investors; and

Record keeping of all social media communications is required under FINRA Rule 4510.

SEC Concerns Regarding Wrap Fee Programs

November 19, 2014 | Chadd Reynolds

Earlier this year, the SEC Office of Compliance Inspections and Examinations (“OCIE”) sent a letter to registered investment advisers requesting information about their wrap fee programs and how their suitability for clients was determined. Most of the requested information centered around the possible misuse of wrap fee programs by advisers. OCIE examiners will want to see that adequate compliance procedures are in place, and that advisors conduct periodic reviews of their wrap fee programs to ensure that advisers are putting their clients’ interests first.

During an examination, advisers will need to disclose, among other things, the procedures and compliance policies governing their wrap fee programs, each wrap fee program used and its adviser, any brochures or marketing materials used to promote their wrap free programs, and what types of fees are covered in such programs. Advisers will also be asked to provide the SEC with its compliance policies for wrap fee programs. This may include how advisers monitor wrap accounts with high cash balances or accounts with low levels of trading, the oversight procedures of branch offices and representatives outside of those offices, best execution policies, and the initial and ongoing suitability reviews for wrap fee programs.
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SEC Enforcement Action Against Former Wells Fargo Advisor for Altering Requested Documents

November 17, 2014 | Chadd Reynolds

In a case that underscores the importance of maintaining thorough and contemporaneous records of compliance reviews of trading records of firm personnel for both broker-dealers and registered investment advisers, on October 15th, 2014, the Securities and Exchange Commission’s Enforcement Division instituted an administrative proceeding against a former compliance officer at Wells Fargo Advisors for allegedly altering documents requested by the SEC during an insider trading investigation.

The Wells Fargo Advisors’ compliance officer was responsible for identifying suspicious trades by Wells Fargo personnel and determining, after a thorough analysis, or what was called a “look back review,” whether such trading was based on material non-public information. On September 2nd, 2010, the compliance officer began review on a set of trades in Burger King securities made by a registered representative of Wells Fargo Advisors, prior to an announcement that the private equity firm, 3G Capital Partners Ltd. (“3G Capital”), was to acquire Burger King at take it private. The findings contained within the compliance officer’s review confirmed that the registered representative and his customers bought Burger King securities ten days prior to the announcement. However, the compliance officer failed to make any additional inquiries into the trades and closed the review with “no findings.” The registered representative was later criminally charged in September of 2012, and subsequently was convicted of trading in Burger King securities on the basis of material non-public information.
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SEC fines RIA for failure to disclosure conflicts of interest on Form ADV

July 14, 2014 | Bryan Gort

In a consented-to Administrative Order dated July 2, 2014, the Securities and Exchange Commission fined a Missouri-based Registered Investment Adviser, SignalPoint Asset Management (“SignalPoint” or “SAM”), $215,000 for breaching its’ fiduciary duty to clients.

Prior to the formation of SignalPoint, the Principals of SignalPoint were registered as registered representatives and investment adviser representatives for a dually-registered broker-dealer and investment adviser. In 2008, the principals asked the dually-registered broker-dealer and investment adviser to allow them to have ownership and control of SignalPoint but were told that they could not have an ownership in an outside RIA.
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Alabama Joins the Crowd: State Crowdfunding Exemption

June 16, 2014 | Parker MacIntyre

The Alabama Legislature passed a crowdfunding exemption bill this April, but the bill is still awaiting the Governor’s signature to become effective. Alabama is the eleventh state to enact legislation or develop regulations on this topic. Other states that have adopted crowdfunding exemption bills include, Washington, Idaho, Wisconsin, Michigan, Kansas, Georgia, Tennessee, Indiana, Maryland, and Maine.

Similar to the approach taken by other states, Alabama’s new legislation is intended to unlock capital and increase access to it for local small businesses and entrepreneurs. While it is still uncertain how successful state measures such as these will be in achieving the goal of increased capital access, the ability of small business owners to raise capital should be enhanced through the relaxation of some of the previous constraints. It is important to note, however, that regulatory agencies will require strict adherence to the new standards in return for less-regulated access to capital. Businesses using the Alabama crowdfunding exemption, and other, similar state exemptions, bear the burden of ensuring its sale of unregistered securities does not run afoul of restrictions governing them.
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SEC Investment Advisor 2014 Compliance Outreach Program

March 25, 2014 | Parker MacIntyre

On January 30, 2014, the Securities and Exchange Commission hosted a compliance outreach program for investment companies and investment advisors. The national seminar, which was jointly sponsored by the Office of Compliance Inspections and Examinations and the Asset Management Unit of the Division of Enforcement, was held at the SEC headquarters in Washington, D.C.

The seminar outlined the priorities of SEC Divisions or Programs as well as general regulatory priorities of the SEC in the coming years. These priorities included the Wrap-Fee Programs, General Solicitation under the JOBS Act, Cybersecurity, and IABD Harmonization. One program of note that will be taking on more importance over the next two years is the Examination Initiative. The National Examination Program intends to review a substantial percentage of registrants that have not had an examination in the last three years. These examinations will take the shape of either a Risk Assessment Exam or a Presence Exam.
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SEC Announces Plans to Examine Never-Before Examined RIAs

March 13, 2014 | Steve Parker

On February 20, 2014, the Securities and Exchange Commission announced that it is launching an initiative, through its Office of Compliance Inspections and Examinations (“OCIE”), to conduct examinations of investment advisers that have been registered with the SEC for 3 or more years but who have never been examined. That same day, OCIE sent letters to all RIAs that have never been examined in order to provide them with information about the new initiative, which is being conducted under the National Exam Program (“NEP”).

The notice letter describes the two distinct approaches of the initiative as “risk assessment” and “focused reviews.” The former approach is designed to allow OCIE to obtain a better understanding of a particular RIA, and may include an overall review of the adviser’s activities with focus on the firm’s compliance program and disclosure documents and underlying facts. The latter, or “focus review” approach, includes a comprehensive risk-based examination of those advisers identified as having a higher risk area of business or operations. The focus-review examinations will focus on one or more of the firm’s compliance program, filings and other disclosure documents, marketing, portfolio management, and/or safety of client assets.

OCIE disclosed that not all RIAs receiving the letter would, in fact, be examined. Firms that receive the letter, however, would be well advised to prepare for an examination in any event, which usually means nothing more than maintaining and sharpening, where necessary, their policies and procedures so that they are adequate to assure compliance with SEC regulations, and contain clear and well-defined processes and responsibilities.
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FINRA Wants Heightened Supervision of Complex Products

February 8, 2012 | Steve Parker

In a move that signals the need for heightened due diligence and supervision among financial advisory firms, the Financial Industry Regulatory Authority (FINRA) released Regulatory Notice 12-03 in relation to complex products last month. It is intended to guide firms to increase their supervision of activity involving complex products such as structured notes, reverse convertibles, inverse or leveraged exchange traded funds, hedge funds and securitized products. FINRA has already brought a number of enforcement actions against firms relating to complex products, charging inadequate supervision, unsuitable recommendations and misleading price sales.

Among the problems noted by FINRA is the uncertainty of how these products will behave in the market, as opposed to theoretical projections. The notice states, “Regulators have expressed concern about complex products because the intricacy of these products can impair the ability of registered representatives or their customers to understand how the product will perform in a variety of time periods and market environments, and can lead to inappropriate recommendations and sales.”

FINRA chose not to define a complex product in the notice due to the ever changing innovation in the marketplace; however, the notice states that “any product with multiple features that affect its investment returns differently under various scenarios is potentially complex.” The notice goes on to give a non-exhaustive list of examples of complex products. FINRA advises firms that are unsure whether a product is complex to err on the side of applying their procedures for enhanced oversight to the product.
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