Adviser Regulatory & Compliance News

FAQs Regarding Disclosure of Certain Financial Conflicts Related to Investment Adviser Compensation

October 28, 2019

In mid-October the SEC's Div. of Investment Management posted a series of FAQs designed to address potential conflicts of interest arising from certain types of adviser compensation. Noting that "Compensation that an investment adviser, its affiliates or its associated persons receives in connection with the investments it recommends and related services it provides can result in the investment adviser having interests that conflict with those of its clients. Many investment advisers appear to have recognized these conflicts and responded through practices designed to address them, including through elimination, disclosure or a combination of disclosure and mitigation. However, SEC examinations staff have observed and enforcement cases have illustrated that, in some instances, investment advisers have not appropriately addressed these conflicts of interest." Noting that Rule 12b-1 payments and revenue sharing arrangements are among the more obvious potential conflict situations, the SEC also noted potential conflicts can arise from "an investment adviser’s direct or indirect receipt of service fees from its clearing broker-dealer, marketing-support payments from a mutual fund’s investment adviser, transaction fees, or receipt of payments from a mutual fund’s investment adviser to help defray the costs of educating and training its personnel regarding certain investment products." The FAQs then proceed to expand on these points. Please click on the heading to this summary to access the full SEC version of the FAQs.

Please Give Folks Accurate Performance Info, Says the SEC!

October 19, 2019

In early October 2019, the SEC published an Accounting and Disclosure Information notice, "ADI 2019-09 - Performance and Fee Issues." The notice summarizes recent findings by the DRAO, the Division of Investment Management’s Disclosure Review and Accounting Office, regarding general shortcomings in filings by advisers and funds with respect to performance and fee data. As noted by the SEC staff, "Key Takeaway: Verify the accuracy of your performance and fee disclosures prior to filing them with the Commission and providing them to investors." Please click the headline to this blurb to access the ADI.

Attorneys—Be Truthful About Clients’ Securities Offerings

September 26, 2019

File this one under: "Warning to Securities Lawyers!" In mid-September 2019, the SEC brought an action against a South Florida attorney for aiding and abetting a client's fraudulent offering and sale of securities. As part of its complaint, the SEC alleged that the attorney "knowingly falsified or omitted important facts and offered the opinion that [client's] notes likely were not securities." In addition, "According to the complaint, Atlas received a percentage of the commissions generated on the sale of 1 Global's notes, which totaled more than $600,000." So, not only did the attorney lie, he also got kick-backs from the fraudulent sale of $322 million worth of the notes. Please be sure to click the headline to this summary to access the SEC Litigation Release and its related complaint.

Caveat Emptor:  SEC’s Best Interest Fiduciary Initiatives Adopted [Updated]

September 20, 2019

It’s a matter of caveat emptor: buyer beware. After many months of consideration, investor testing/surveying, and circa 6,000 comment letters, the SEC acted in early June 2019 to enhance the protection of retail investors while not materially disrupting the existing investment industry business models and the ability of investors to choose among different types of providers such as advisers and brokers. The key measures adopted are as follows: • New Regulation BI (as in "Best Interest")…generally referred to as “Reg. BI;” • New Form CRS (i.e., "Customer Relationship Summary"); • Interpretive advice re: an investment adviser's fiduciary duties; and • An interpretation of the "solely incidental" aspect of the broker-dealer exclusion from the definition of an "investment adviser" under the Advisers Act. The new Reg. BI will go into effect in about a year (following formal publication of the new regulation). Many think that this will bring an end to the long journey and discussion regarding fiduciary duties of advisers and brokers. In reality, it really is a matter of caveat emptor both for the industry and retail investors. Much will be written in the coming months about the likely impact of the new measures. As a practical matter, advisers and brokers must review their policies and procedures (such as disclosure and customer on-boarding processes) to assure compliance in the future. PLEASE BE SURE TO CLICK THE HEADLINE TO THIS BLURB TO ACCESS AN EXTENSIVE RESOURCE COLLECTION ON THE NEW INITIATIVES. WE ARE ADDING TO THE REFERENCE LIST AS WE FIND MATERIALS.

Bloomberg:  End of Era: Passive Equity Funds Surpass Active in Epic Shift

September 12, 2019

We generally don't post news about markets and conditions. However, this is significant: the shift from active to passive management has been underway for many years, and it's accelerated this decade. According to the Bloomberg article, Morningstar data is showing that fund flows this past August tilted on balance to passive funds compared to actively managed funds. Of course, there's no knowing whether this will become a permanent trend, but it's noteworthy. Please click the headline to this blurb to be connected to the Bloomberg story.

SEC Publishes Compliance Guide for Form CRS Relationship Summary and Amendments to Form ADV

September 12, 2019

In early Sept. 2019, the SEC published a new web page designed as "A Small Entity Compliance Guide" relating to Form CRS and Form ADV compliance. The Guide provides a nicely curated set of materials and a Q&A format describing how to comply with the new requirements of Form CRS, the Client Relationship Summary adopted in June 2019 as well as related Form ADV changes. Please click the link in the headline of this article to access the original SEC document.

Investment Adviser Principal and Agency Cross Trading Compliance Issues Risk Alert

September 9, 2019

In early Sept. 2019, the SEC issued a Risk Alert by its OCIE division, providing an overview of the most common compliance issues identified by OCIE related to principal trading and agency cross transactions under Section 206(3) of the Advisers Act. These issues were identified in examinations of investment advisers over the past few years. Consistent with a series of enforcement actions for the most extreme violations, the key issues identified involve principal transactions and agency cross transactions when the adviser acts as a broker. The Risk Alert provides color and detail regarding the observed weaknesses and violations and "encourages advisers to review their written policies and procedures and the implementation of those policies and procedures to ensure that they are compliant with the principal trading and agency cross transaction provisions of the Advisers Act and the rules thereunder." Please click the headline to this article to access the complete, original Risk Alert.

Adviser Proxy Voting Guidance

September 4, 2019

In late August, the SEC published two forms of guidance regarding the proxy voting responsibilities of investment advisers. The guidance documents were not without controversy as they were adopted by a 3 to 2 vote of the Commissioners. As published, the guidance documents provide guidance and interpretations regarding the proxy voting responsibilities of investment advisers under Rule 206(4)-6 under the Investment Advisers Act of 1940 (the “Advisers Act”), and Form N-1A, Form N-2, Form N-3, and Form N-CSR under the Investment Company Act of 1940 (the “Investment Company Act”), generally with respect to: (1) ensuring advisers are voting proxies in accordance with each client’s best interests; (2) advisers properly evaluate and oversee proxy advisory firms; and (3) structuring the client relationship to make clear the investment adviser’s proxy voting responsibilities. THE ACCOMPANYING ARTICLE PROVIDES ADDITIONAL INSIGHTS AND LINKS TO THE SEC DOCUMENTS AND A VARIETY OF HELPFUL LAW FIRM MEMOS. We'll be updating these as they become available.

Adviser Violates Fiduciary Duty to Clients

September 3, 2019

The SEC brought an enforcement action against Lefavi Wealth Management, Inc. (LWM) for violating its fiduciary duty to clients in connection with its recommendation and investment of client assets in non-traded real estate investment trusts, business development companies, and private placements (Alternative Investments). From June 2014 through December 2016, the SEC found that LWM recommended and invested certain advisory client assets in Alternative Investments at a share price that reflected a 7% commission. The SEC stated that LWM failed to disclose that it could have invested advisory client assets in the same Alternative Investment at a lower share price and that LWM did, in almost all instances, recommend and invest advisory client assets in Alternative Investments with higher share prices that included seven percent commissions. LWM also failed to disclose the conflict of interest associated with its and its investment adviser representatives’ (IARs) receipt of additional compensation for investing advisory client assets in Alternative Investments at a higher share price that included a commission. According to the SEC, LWM’s practice of recommending and investing advisory client assets in Alternative Investments with embedded commissions, rather than seeking for clients lower share prices for the exact same investments, was inconsistent with LWM’s duty to seek best execution for those transactions. LWM did not adopt and implement written policies and procedures reasonably designed to prevent violations of the Advisers Act and the rules thereunder in connection with Alternative Investments.

Adviser Violates Fiduciary Duty to Client

August 26, 2019

The SEC brought an enforcement action against Laurel Wealth Advisors, Inc. (LWA) for failing to supervise an investment adviser representative (IAR) associated with LWA engaging in undisclosed “cherry-picking,” a practice of fraudulently allocating profitable trades in an omnibus account to favored accounts. The SEC stated that LWA failed reasonably to supervise the IAR who engaged in cherry-picking and failed to implement policies and procedures reasonably designed to prevent violations of the Advisers Act and its rules. More specifically, LWA had a compliance procedure to prevent conflicts of interest that required IARs to pre-clear and obtain written approval before trading in their personal accounts, but LWA did not implement that procedure until January 2015. During the relevant time period, the SEC found that LWA’s Code of Ethics as disclosed in its Forms ADV stated that it had a pre-clearance procedure for IARs’ personal trading and that the firm required all transactions be carried out in a way that put its clients’ interests before its employees’ interests. These disclosures, according to the SEC, were false and misleading because LWA did not implement the pre- clearance procedure until January 2015, and an IAR’s misconduct put his personal interests before his clients’ interests.

Adviser Personnel Fail to Disclose Receipt of Brokerage Commissions Earned from Client Trades

August 13, 2019

The SEC brought an enforcement action against MVP Manager LLC (MVP), the personnel of which received brokerage commissions from counterparties to certain transactions with MVP’s advisory-client funds without adequate disclosure to those MVP clients or to investors in the client funds. MVP’s clients are private funds that it formed to invest in venture-backed companies that have not yet conducted an initial public offering (pre-IPO companies) that MVP projects have a potential for liquidity within two to five years by sale or public listing. In three instances, MVP personnel arranged to receive a brokerage commission from the counterparty that was selling pre-IPO company securities to MVP’s advisory client. The arrangement created a potential or actual conflict of interest for MVP in advising its client funds, which MVP failed to adequately disclose.

Don’t Hire Bad Actors!  OCIE Risk Alert

August 2, 2019

Well, that's not really the SEC's conclusion. However, caution and compliance monitoring is appropriate. In late July, the SEC's OCIE arm published a Risk Alert highlighting the observations of its staff from examining and inspecting a broad spectrum of investment advisers that had hired supervised persons with disclipinary histories. The Risk Alert details the findings and makes suggestions. Notably, the highlighted summary suggestion is, "OCIE encourages advisers, when designing and implementing their compliance and supervision frameworks, to consider the risks presented by hiring and employing supervised persons with disciplinary histories and adopt policies and procedures to address those risks." Please click on the headline to this Blurb to connect to the Risk Alert.

Adviser Charged with Failing to Disclose Conflicts of Interest

July 24, 2019

The SEC brought an enforcement action against N. Gary Price a principal of registered investment adviser firm Genesis Capital LLC (Genesis), to disclose his conflicts of interest to advisory clients. From 2013 through 2015, the SEC found that Genesis’s three mutual fund advisory clients made investments in promissory notes issued by Aequitas Commercial Finance, LLC (ACF), one of numerous entities affiliated with the Aequitas enterprise, the ultimate parent of which is Aequitas Management, LLC (Aequitas). Price served on the Genesis investment committee that approved these investments. As Genesis made the ACF investments, the SEC stated that Price benefited from financial ties to Aequitas. Price held ownership stakes with Aequitas in two other businesses in the Aequitas enterprise that together received a $10 million line of credit and $3.6 million in loans from ACF—the entity from which the mutual fund clients purchased the promissory notes. Additionally, during the same time period when Genesis’s mutual fund clients were investing their money in ACF, ACF was paying management fees to another Aequitas entity, which in turn paid $8 million in fees to another firm part-owned by Price in exchange for referring investors (separate from the Genesis clients) to ACF and other Aequitas issuers. These ties created a conflict between Price’s interests and those of the mutual funds. Genesis’s written policies and procedures required it to disclose such conflicts of interest to its clients in the firm’s Form ADV Brochure. During 2014 and 2015, Price received several drafts of the Genesis ADV Brochure to review. The drafts did not adequately disclose Price’s Aequitas- related conflicts of interest, and Price did not correct this deficiency. By the end of 2015, two of the Genesis-advised mutual funds each had more than 15 percent of its net assets invested in the ACF promissory notes. In March 2016, the Commission charged ACF and several other Aequitas companies and officers with concealing the true financial condition of Aequitas while defrauding the purchasers of more than $300 million in ACF promissory notes and other Aequitas securities. In May 2016, the two mutual funds were liquidated following ACF’s default on promissory notes held by the two funds.

OCIE Issues Risk Alert Concerning the Failure of Advisers to Adequately Disclose the Disciplinary Hi

July 23, 2019

OCIE issued a risk alert that notes that that nearly half of the disclosure-related deficiencies of its exams of investment were due to the firms providing inadequate information regarding disciplinary events. For example, OCIE found that advisers: • Omitted material disclosures regarding disciplinary histories of certain supervised persons or the adviser itself. Often the disciplinary omissions related to supervised persons occurred because the advisers solely relied on these supervised persons to self-report to the firms information about their required disclosures. • Included incomplete, confusing, or misleading information regarding disciplinary events. For example, they did not, as applicable: include the total number of events, the date for each event, the allegations, or whether the supervised persons were found to be at fault (i.e., whether fines, judgments or awards, or other disciplinary sanctions were imposed). • Did not timely update and deliver disclosure documents to clients, such as updating Form ADV for new disciplinary events of supervised persons reported on CRD (e.g., Form U5s). OCIE in the Risk Alert encouraged investment advisers, when designing and implementing their compliance and supervision frameworks, to consider the risks presented by hiring and employing supervised persons with disciplinary histories and adopt policies and procedures to address those risks.

SEC Publishes Investment Adviser Fiduciary Standard of Conduct Interpretation

July 12, 2019

The SEC published in the Federal Register in its interpretation of the standard of conduct for investment advisers under the Investment Advisers Act of 1940. In its Interpretation, the SEC states that an investment adviser's fiduciary duty under the Advisers Act comprises a duty of care and a duty of loyalty. This fiduciary duty requires an adviser “to adopt the principal's goals, objectives, or ends.” This means the adviser must, at all times, serve the best interest of its client and not subordinate its client's interest to its own. In other words, the investment adviser cannot place its own interests ahead of the interests of its client. This combination of care and loyalty obligations has been characterized as requiring the investment adviser to act in the “best interest” of its client at all times.

Sack and fumble returned for TD!  Lying IA sacked by SEC….

July 11, 2019

Supposed investment adviser to many NFL and other sports stars got sacked by the SEC recently. Daryl M. Davis and his firm Parrish Group, LLC were fined and Davis barred from the industry for multiple violations. While we expect that no one reading this news blurb would engage in the activities leading to the bar and fine, the findings and facts are nonetheless illustrative of the kind of competition and puffery endemic to our industry. In this case, Davis was: (1) an unregistered IA; (2) misrepresented his client list; (3) misrepresented his firm's staffing; and (4) lied about the firm's AUM. The SEC's settlement, which can be accessed by clicking the headline to this blurb, was premised on two findings of fraud under Sections 206(1) and 206(2) of the Advisers Act.

SEC Chairman Speaks on Regulation Best Interest

July 8, 2019

In a speech in Boston, Massachusetts, SEC Chairman Clayton reminded the audience that the SEC recently adopted a package of rules and interpretations designed to enhance the quality and transparency of retail investors’ relationships with broker-dealers and investment advisers. Importantly, he stated that they bring the legal requirements and mandated disclosures for broker-dealers and investment advisers in line with reasonable investor expectations. These actions, in his view, do not attempt to favor one type of service or relationship. Rather, he stated that they are designed to increase investor protection while preserving access for Main Street investors—both in terms of choice and cost—to a variety of investment services and products.

Member Discount!  New Textbook Available:  Investment Management Regulation

July 1, 2019

We're pleased top announce that Karl is co-author of the first new textbook about the '40 Acts in over 30 years! Investment Management Regulation: An Introduction to Principles and Practices. Available now at cap-press.com Just click on the headline to this blurb above to be taken to the publisher's site. As Members you are entitled to a 30% discount at the Carolina Academic Press's site. Please use the discount code, IMR2019. Valid until Sept. 30th, 2019. If you are a professor teaching this material, you may order a free review copy at the site.

OOPS:  Check Your Agreements OOPS Clauses

June 28, 2019

An often overlooked area of agreements of all sorts, including advisory agreements, is the clause regarding out of pocket expenses. Vendors often use them to pass off large costs to clients.....so, as a client, look at the clause carefully. See if you can limit it with a maximum amount or limit what is considered an out of pocket expense. A recent SEC enforcement action against State Street Bank is a clear reminder of this issue. State Street for almost two decades charged clients for bank related messaging services---and added a nice markup for doing so without disclosing it to clients. The expense and markup were billed under the OOPS clause. So next time you review a contract, check the expenses clause, lest you cause an OOPS for your firm! Click the headline to this blurb for the full SEC release.

SEC:  Concept Release on Harmonization of Securities Offering

June 26, 2019

Advisers who offer private funds or invest in private placements encounter the challenges of the crazy quilt of private/public securities offering regulations. Aware of this growing issue, in June 2019, the SEC released a "Concept Release." The Concept Release seeks public comment on ways to simplify, harmonize, and improve the exempt offering framework to expand investment opportunities while maintaining appropriate investor protections and to promote capital formation. THE ARTICLE ACCOMPANYING THIS BLURB CONTAINS LINKS TO THE SEC DOCUMENTS.

Found:  Dechert’s Summary Site on the DoL and State Fiduciary Rules

June 5, 2019

Dechert has published an aggregation page on its website for all key actions, legislation, rulemaking, and judicial decisions regarding the Department of Labor's now dead fiduciary rule under ERISA. In addition, the page highlights and tracks the efforts of various states to implement fiduciary standards. However, the page does not integrate the SEC's efforts in this area, notably Reg. BI and related initiatives. Please click the headline to this blurb to access the Dechert site. Thanks to Dechert for making this material available.

Presidential Executive Order May Impact ESG Investing

June 1, 2019

While not covered in the Dechert paper on ESG investing (see our May 31 blog posting), a recent Presidential Executive Order is an example of how ESG investing may be impacted by the vagaries of politics. In early April 2019, an Executive Order was issued directing the Department of Labor ("DOL") to assess, among other things, how the energy industry is being impacted by the proxy voting of retirement plans. Specifically, the Order directs DOL to do the following, within 180 days of the date the Order was issued: 1. Complete a review of available data filed with DOL by retirement plans subject to the ERISA in order to identify whether there are discernible trends with respect to such plans’ investments in the energy sector; 2. Provide an update to the Assistant to the President for Economic Policy on any discernible trends in energy investments by such plans; and 3. Complete a review of existing DOL guidance on the fiduciary responsibilities for proxy voting to determine whether any such guidance should be rescinded, replaced, or modified to ensure consistency with current law and policies that promote long-term growth and maximize return on ERISA plan assets. A copy of the order can be accessed by clicking the headline to this blurb.

Dechert Paper on ESG Investing

May 31, 2019

ESG investing---investing with with environmental, social or governmental socially conscious screens---has been a hot topic in the industry on and off for the past 30+ years. Dechert recently published an excellent short paper on the "Unintended Consequences of Investing According to Environmental, Social and Governance Principles." The paper notes that lack of coherence and standards regarding such investments. Notably advisers are cautioned to keep in mind the sometimes disparate regulatory requirements of different governments, and how they might clash, when developing their firm's ESG screens. Please click the headline to this blurb to access the article.

Adviser Charged with Overcharging Clients

May 28, 2019

The SEC charged with Stephen Brandon Anderson with defrauding clients by overcharging advisory fees of at least $367,000. According to the SEC, Anderson owned and operated River Source Wealth Management, LLC, a now-defunct registered investment adviser in North Carolina. River Source’s primary revenue stream was customer advisory fees. Customer agreements provided that those fees would be based on each customer’s assets under management. The SEC found, however, that in 2015 and 2016, Anderson overcharged a majority of his clients. The amount and percentages of the overcharges varied according to the SEC but, in the aggregate, amounted to approximately 40% more than the agreed-upon maximum customer advisory fees. The SEC further noted that Anderson misled his clients about the reason he transferred their assets from River Source’s long-time asset custodian, falsely stating that it was his decision and that the separation was “amicable.” In fact, as the SEC stated that the asset custodian ended the relationship with River Source after it noticed irregular billing practices and failed to receive sufficient supporting documentation from Anderson. Furthermore, the SEC found that Anderson made material misstatements in reports filed with the SEC, including overstating River Source’s assets under management by at least $34 million (18%) in 2015 and $61 million (35%) in 2016, and failed to implement required compliance policies and procedures.

It’s in the Clouds!  OCIE Alert on Use of Cloud Storage for Records

May 24, 2019

In late May 2019, OCIE issued an Alert for advisers and broker-dealers entitled, "Safeguarding Customer Records and Information in Network Storage – Use of Third Party Security Features." The Alert is derived from the exam experience of OCIE, wherein it detected a variety of weaknesses at advisers and brokerage firms using cloud storage. The Risk Alert "highlights risks associated with the storage of electronic customer records and information by broker-dealers and investment advisers in the cloud and on other types of network storage solutions." OCIE noted that in its exam experience, some advisers and brokers have compliance problems with respect to the privacy and potential identity theft of their client data. Please click the headline to this blurb to access the Risk Alert.

FinCEN Alert on Illicit Activities Involving Crypto Currencies

May 13, 2019

In conjunction with its issuance of Guidance on crypto currencies ("CVCs"), FinCEN in early May 2019, issued an "Advisory on Illicit Activity Involving Convertible Virtual Currency." The Advisory was issued "to assist financial institutions in identifying and reporting suspicious activity concerning how criminals and other bad actors exploit convertible virtual currencies (CVCs) for money laundering, sanctions evasion, and other illicit financing purposes, particularly involving darknet marketplaces, peer-topeer (P2P) exchangers, foreign-located Money Service Businesses (MSBs), and CVC kiosks. Virtual currencies, particularly CVCs, are increasingly used as alternatives to traditional payment and money transmission systems. As with other payment and money transmission methods, financial institutions should carefully assess and mitigate any potential money laundering, terrorist financing, and other illicit financing risks associated with CVCs. This advisory highlights prominent typologies and red flags associated with such activity and identifies information that would be most valuable to law enforcement, regulators, and other national security agencies in the filing of suspicious activity reports (SARs)." As a practical matter, advisers should be reviewing and updating their policies and procedures to deal with CVCs, most notably the anti-money laundering and SAR policies and procedures. Please click the headline to this blurb to access the Advisory.

FinCEN Issues Helpful Crypto Guidance

May 13, 2019

Bitcoin, ICOs, and various other types of crypto currency offerings have been the talk of the markets over the past few years. The regulatory agencies have struggled with classifying and regulating these offerings and enterprises. In early May 2019, FinCEN issued a Guidance document entitled, "Application of FinCEN’s Regulations to Certain Business Models Involving Convertible Virtual Currencies." FinCEN derives its powers in part from the Bank Secrecy Act ("BSA") and issued the Guidance with reference to the BSA. As noted in the document, "This guidance does not establish any new regulatory expectations or requirements. Rather, it consolidates current FinCEN regulations, and related administrative rulings and guidance issued since 2011, and then applies these rules and interpretations to other common business models involving CVC engaging in the same underlying patterns of activity." Given the interest of many advisers in crypto currencies and ICOs, we thought it would be helpful to alert you to the Guidance, which can be accessed by clicking the headline to this blurb.

FAST Act Rules effective

April 25, 2019

Enacted in late March, a series of amendments to Regulation S-K and related rules and forms are now effective. Such amendments are designed to modernize and simplify certain disclosure requirements applicable to public companies, investment advisers and investment companies. These amendments implemented several of the recommendations in the SEC Staff’s November 2016 Report on Modernization and Simplification of Regulation S-K mandated by the FAST Act. For most advisers the changes will have little impact. For some, the most noteworthy changes included a simplification of MD&A disclosure and a significant reduction of the need for registrants to submit confidential treatment requests when omitting information from their exhibit filings. These amendments were originally proposed in October 2017 and received relatively little attention. Please click the headline to this blurb to access the SEC release.

SEC Div of Inv Mgmt legal staff replenished

April 20, 2019

In mid-April the SEC announced the hiring (from other SEC departments) of two new deputy chief counsels. This helps restaff the legal area after last fall's departure of some key folks including former Chief Counsel Doug Scheit. Please click the headline to this summary to access the SEC's press release.

Risk Alert Re:  Regulation S-P Compliance:  Privacy Policies

April 19, 2019

Privacy policies and relevant regulatory compliance have been on-going challenges for advisers. The SEC's exam staff have noted that they often observe issues in these areas at advisers. Growing out of the exam program is a recent Risk Alert which focuses on key issues observed by the OCIE staff during their exams. Key areas of issues are: 1. timely disclosure of privacy policies to clients and opt-out provisions 2. need for written documentation of privacy policies and procedures 3. policies which have not been properly implemented or not reasonably designed to safeguard customer records and information Please click on the headline to this summary to access the SEC announcement and Risk Alert.

New Investor Education Campaign

April 12, 2019

In early April, the SEC announced a new investor education program including several TV and other media public service announcements. As noted on the investor.gov site, "The SEC’s Office of Investor Education and Advocacy launched a public service campaign to empower Main Street investors to take control of their financial future. The campaign encourages investors to use the free tools and unbiased information available on Investor.gov to get answers to their questions about investing. Videos from the Good Questions campaign are available...." Please click the headline to this summary to access the SEC's site and materials.

The Future of Investment Mgmt monograph

March 27, 2019

From time to time we discover some good reads. A few months ago, the CFA Institute Research Foundation published a wonderful short monograph on the future of the industry. The arc and scope of the research paper by Ronald N. Kahn, managing director and global head of systematic equity research at BlackRock, is comprehensive, starting with the roots of the investment advisory industry to the current trends and projecting what things will look like in 5-10 years. It's a short, good read and paints a pretty optimistic picture despite several seemingly negative trends (e.g., passive investing, fee compression, etc.). Please click the headline to link to the document and enjoy the read!

Cross-Trading Fraud

March 22, 2019

Cross-trading remains a fertile ground for fraudulent behavior. A recent SEC enforcement action is illustrative: a private fund manager and COO was barred from the industry for a cross-trading fraud he facilitated. Basically, the manager sold securities from one client to a private fund managed by the firm at an artificially low price because the adviser and manager failed to obtain required third-party bids. Rather, the manager obtained manipulated prices for the securities which the fund purchased at a discount, which benefited the manger due to his holdings of the fund. An industry bar and $400,000 fine resulted. Please click the headline to be linked to the enforcement action.

Stradley Enforcement Summary and Discussion

March 18, 2019

Law firm Stradley Ronon issued a fine summary of SEC adviser and fund enforcement activities this week.Noting the government shutdown and SEC staff turnover, the authors explain that only 13 settled administrative actions involved Advisers Act violations during fiscal year 2018. For 2019, they predict vigorous enforcement in support of protecting retail investors. Click the headline to access the report.

Share Class Initiative Yields Fruit, Unfortunately

March 16, 2019

As we reported earlier this year,in February the SEC announced its Share Class Selective Disclosure Initiative offering a certain form of clemency for self-reporting advisers. In recent years, the SEC has investigated via sweep and targeted exams numerous advisers for their mutual fund share sales practices, finding a variety of fraudulent and inappropriate practices. In mid-March, the SEC staff announced that 79 advisers had self-reported and paid $125 million is restitution to investors. Click the headline for the full SEC press release and report.

Comments sought on digital assets and the Custody Rule

March 15, 2019

In early March, the SEC published a letter to Karen Barr, President of the Investment Adviser Assoc. seeking public comments on how the Custody Rule works for/with digital assets (e.g. bitcoin). The Division of Investment Mgmt’s request for comments includes several aspects (some of which are not Custody Rule-specific), including: (1) the treatment of digital assets for purposes of the Custody Rule; (2) how such assets are custodied (specifically whether advisers are relying on state-chartered trust companies or foreign financial institutions such custody; (3) how such custodians have performed in their duties; (4) the most appropriate ways to address concerns about adviser misappropriation of client digital assets and how to effectively leverage address the hazards of misappropriation; (5) if losses arise, how to remedy them effectively; and (6) whether advisers regard digital assets as “securities” for the purpose of determining whether they meet the definition of an investment adviser and their registration and reporting obligations. Please click on the headline to this blurb to access the letter.

Adviser Found to Have Conducted a Faulty Auction Process

March 15, 2019

The SEC brought an enforcement action against a registered investment adviser, Talimco, LLC (Talimco), in connection with the sale of a mortgage loan participation by one of its clients, a collateralized debt obligation, to another one of its clients, a commercial real estate investment fund (Fund). The SEC stated that Talimco, which owed a fiduciary duty to both the seller and buyer, breached its duty to the seller in violation of Section 206(2) of the Advisers Act by failing to seek out willing bidders for the asset. As part of the sale process, Rogers, Talimco’s chief operating officer, convinced two unwilling parties to agree to bid on the asset by assuring each of them that it would not win the auction. As a result of these actions, the SEC found that the collateralized debt obligation was deprived of the opportunity to obtain multiple bona fide bids for the asset. The Fund, which won the auction, later sold the asset at a profit, resulting in Talimco receiving management and performance fees.

Adviser Charged with Various Compliance Violations

March 11, 2019

The SEC charged Ascension Asset Management, LLC (Ascension) for not having a compliance manual and conducting annual compliance reviews. The SEC found from in or about October 2004 until November 2015, Ascension did not adopt and implement any written compliance policies and procedures required by Advisers Act Rule 206(4)-7(a). During this same time period, the SEC stated that Ascension did not conduct the reviews required by Advisers Act Rule 206(4)-7(b). Gooder, the founder of Ascension, despite being Ascension’s sole control person, failed to take any steps to prepare the required written compliance policies and procedures or conduct the required reviews for Ascension.

Wells Fargo Found to Have Breached Its Fiduciary Duty to Clients When Recommending Funds

March 11, 2019

The SEC brought an enforcement action against Wells Fargo Clearing Services, LLC and Wells Fargo Advisors Financial Network, LLC, finding breaches of fiduciary duty and inadequate disclosures in connection with mutual fund share class selection practices and the fees the Wells Fargo companies received pursuant to Rule 12b-1 under the Investment Company Act of 1940 (Rule 12b-1 fees). During the period January 1, 2014 to July 31, 2015, the Wells Fargo companies purchased, recommended, or held for advisory clients mutual fund share classes that charged 12b-1 fees instead of lower-cost share classes of the same funds for which the clients were eligible. The Wells Fargo companies received 12b-1 fees in connection with these investments. According to the SEC, the Wells Fargo companies failed to disclose in their Forms ADV or otherwise the conflicts of interest related to (a) their receipt of 12b-1 fees, and/or (b) their selection of mutual fund share classes that pay such fees. The Wells Fargo companies received 12b-1 fees for advising clients to invest in or hold such mutual fund share classes. Please click the heading to this blurb to link to the litigation release.

SEC Creates Chief Risk Officer Position

February 28, 2019

The SEC created a new position called the “Chief Risk Officer.” Gabriel Benincasa was named the SEC’s first Chief Risk Officer. This position will primarily focus on the agency’s risk management and cybersecurity efforts. The Chief Risk Officer will coordinate the SEC’s efforts to identify, monitor and mitigate key risks facing the SEC. The Chief Risk Officer is housed within the SEC’s Office of the Chief Operating Officer. The Chief Risk Officer will also serve as a key adviser on other matters related to enterprise risks and controls.

Maryland Joins Fiduciary Standard Hunt

February 8, 2019

Maryland is joining the effort of states to regulate securities brokers and insurance agents as fiduciaries. Legislation was introduced this week in the Maryland state house containing a brief provision that would require brokers and insurance agents to act as fiduciaries in the best interests of their customers, i.e., "without regard to" their own financial interests. Maryland's actions are part of a larger trend of states seeking to regulate fiduciary standards. The bill entitled the "Financial Consumer Protection Act of 2019" can be accessed by clicking the heading to this article.

Continued State Action on Fiduciary Standards

January 25, 2019

Our friends at the Wagner Law Group have published a nice summary of state actions regarding establishment of fiduciary standards for advisers. Nevada is the latest state to propose a fiduciary standard. The article is reprinted below--please click the headline to access the reprint.

Gov’t Shutdown Impacts SEC and Industry

January 9, 2019

The on-going government shutdown has had some severe impacts on the SEC and its Div. of Investment Management. According to our discussions with various compliance folks and '40 Act counsel, the impacts are increasingly troublesome for their clients. Impacts include: inability to complete registration of new advisers; inability to get effectiveness of fund registration statements (other than those going automatically effective); and administrative actions and cases have ground to a halt as have inspections and examinations. In other branches of the SEC activities impacted by the shutdown include review of financial filings like 10Ks under the '34 Act and the review of IPO offerings/registrations under the '33 Act.

OCIE Risk Alert on Electronic Messaging

December 25, 2018

OCIE released a Risk Alert on Dec. 14, 2018 concerning the use of electronic messaging systems by registered investment advisers and their personnel. The Alert cites the staff’s observations from an initiative in 2018 that surveyed advisers regarding their use of electronic messaging. The Alert “reminds” advisers of their obligations regarding business communications under the Advisers Act that may apply to electronic messages. Electronic messages are defined very broadly and include “written business communications” via text message, instant message, personal/private message, personal email, personal websites and social media posts that are “conducted on the adviser’s systems or third-party applications...or platforms” or sent on adviser computers, adviser-issued mobile devices or personally owned devices that are used for business purposes, but not emails via an adviser’s email system. A key point made in the Alert is the need of Advisers to improve their relevant systems, policies and procedures regarding such electronic messages and systems. The headline to this story has a link connecting you to the Risk Alert.

ROBO Advisers Charged with Making False Disclosures

December 21, 2018

The SEC brought enforcement actions against against two robo-advisers for making false statements about investment products and publishing misleading advertising. The proceedings are the SEC’s first enforcement actions against robo-advisers. The SEC found that Redwood City, California-based Wealthfront Advisers LLC , a robo-adviser with over $11 billion in client assets under management, made false statements about a tax-loss harvesting strategy it offered to clients. Wealthfront disclosed to clients employing its tax-loss harvesting strategy that it would monitor all client accounts for any transactions that might trigger a wash sale – which can diminish the benefits of the harvesting strategy – but failed to do so. Over a period of more than three years during which it made this disclosure, wash sales occurred in at least 31 percent of accounts enrolled in Wealthfront’s tax loss harvesting strategy. The SEC’ also found that Wealthfront improperly re-tweeted prohibited client testimonials, paid bloggers for client referrals without the required disclosure and documentation, and failed to maintain a compliance program reasonably designed to prevent violations of the securities laws. The SEC in a separate enforcement action found that New York City-based Hedgeable Inc., a robo adviser which had approximately $81 million in client assets under management, made a series of misleading statements about its investment performance. According to the order, from 2016 until April 2017, Hedgeable posted on its website and social media purported comparisons of the investment performance of Hedgable’s clients with those of two robo-adviser competitors. The performance comparisons were misleading because Hedgeable included less than 4 percent of its client accounts, which had higher-than-average returns. Hedgable compared this with rates of return that were not based on competitors’ actual trading models. The SEC also found that Hedgeable failed to maintain required documentation and failed to maintain a compliance program reasonably designed to prevent violations of the securities laws.

OCIE Releases Exam Priorities

December 20, 2018

The SEC's Office of Compliance Inspections and Examinations (OCIE) released its 2019 examination priorities. OCIE publishes its exam priorities annually to promote transparency of its examination program and provide insights into the areas it believes present potentially heightened risk to investors or the integrity of the U.S. capital markets. In this release, OCIE focused on digital assets, cybersecurity, and matters of importance to retail investors, including fees, expenses, and conflicts of interest. OCIE's examination priorities are broken down into six categories: (1) compliance and risk at registrants responsible for critical market infrastructure; (2) matters of importance to retail investors, including seniors and those saving for retirement; (3) FINRA and MSRB; (4) digital assets; (5) cybersecurity; and (6) anti-money laundering programs.

SEC Adopts Rules Allowing Broker-Dealers to Issue Research Reports on Mutual Funds and ETFs

November 30, 2018

The SEC adopted rules and amendments designed to promote research on mutual funds, exchange traded funds, registered closed-end funds, business development companies, and similar covered investment funds. These changes reduce obstacles to providing research on investment funds by harmonizing the treatment of such research with research on other public companies. The Commission took this action in furtherance of the mandate in the Fair Access to Investment Research Act of 2017 (FAIR Act). The rules and amendments generally establish a safe harbor for a broker or dealer to publish or distribute research reports on investment funds under certain conditions. This new safe harbor is similar to a regulatory safe harbor that currently exists for research reports about public companies.

Adviser Fails to Provide Advisory Fee Discounts

November 19, 2018

The SEC brought an enforcement action against Retirement Capital Strategies, Inc. (RCS) for failing to apply advisory fee discounts to certain client accounts contrary to its disclosures, representations to clients, and its advisory agreements. From January 2010 through February 2018, RCS offered clients an advisory fee between 0.4% and 1.5% of their assets under management based on fee breakpoints described in a fee schedule that reduced the advisory fee as client assets under management increased. RCS’s fee schedule was incorporated by reference in client advisory agreements, distributed to clients upon request, and, starting in 2011, disclosed in RCS’s Form ADV Part 2A filed with the SEC. RCS’s written policies and procedures manual stated that RCS was to conform its client fees and fee billing practices to those described in the Form ADV and in the advisory agreements provided to clients. In certain instances, however, RCS failed to apply the breakpoint discounts. As a result, RCS improperly calculated advisory fees and thereby overcharged certain clients.

Report Released on Investor Testing of the Proposed Relationship Summary for Advisers and Brokers

November 14, 2018

Continuing efforts to enhance investor understanding of adviser and broker services, the SEC’s Office of the Investor Advocate recently made available a report on investor testing conducted by the RAND Corporation. The investor testing gathered feedback on a sample Relationship Summary issued in April 2018 as part of a package of proposed rulemakings and interpretations designed to enhance the quality and transparency of investors’ relationships with investment advisers and broker-dealers. Results were clear: investors still don't really understand their relationship (fiduciary or otherwise) with advisers and brokers.....“Based on my discussions with many retail investors over the last several months, it is clear to me that too many retail investors are not aware of the material aspects of their relationships with their investment professionals,” said SEC Chairman Jay Clayton.The report is available for review and comment on the SEC’s website: simply click on the heading to this blog posting.

Adviser Found to Have Substandard Compliance Program

November 6, 2018

The SEC brought an enforcement action against Pennant Management Inc. (Pennant) for negligently failing to perform adequate due diligence and monitoring of certain investments contrary to representations in its Form ADV Part 2A and in certain communications with its clients, ultimately contributing to substantial losses. From May 2013 to September 2014, the SEC stated that Pennant advised clients to purchase interests in facilities and other investments containing repurchase agreements (repos) originated by a repo counterparty, First Farmers Financial (FFF). The investments underlying the FFF repos consisted of 26 loans that Pennant believed were guaranteed by the U.S. Department of Agriculture (USDA). During the initial due diligence of FFF, the SEC found that certain concerning information was not escalated to Pennant’s Investment Committee or senior management, and although Pennant represented that it would advise clients of ongoing due diligence and monitoring of repo counterparties, it failed to adequately do so. In particular, despite concerns regarding the legitimacy of the investments starting in April 2014, Pennant continued to offer the FFF repos to clients. By the end of September 2014, Pennant determined that FFF had forged paperwork and that all of the FFF repos were fraudulent. In addition to the due diligence and monitoring failures, from January 2012 to June 2014, the SEC noted that Pennant’s compliance program lacked sufficient resources and Pennant failed to reasonably design and implement certain policies and procedures. Further, between at least April 2013 and April 2014, Pennant did not consistently follow its repo allocation policy disclosed in its Form ADV Part 2A and failed to maintain records related to repo client indications of interest and trade allocations.

New SEC Risk Alert: Investment Adviser Compliance Issues Related to the Cash Solicitation Rule

November 4, 2018

Just in time for Halloween the SEC revealed the spooky realities of widespread non-compliance by advisers wit the cash solicitations rule, Rule 206(4)-3 under the Advisers Act. Based on a survey of the past 3 years of examination experience and resulting deficiency letters, the SEC issued a Risk Alert. the Alert identifies the most common weaknesses and issues, including failures to: (i) ensure that third party solicitors provide adequate disclosure documents to clients; (ii) receive a timely signed and dated client acknowledgement of receipt of the adviser brochure and the solicitor disclosure document; (iii) execute required agreements with third party solicitors; and (iv) conduct adequate due diligence to determine whether solicitors complied with agreements. The complete Risk Alert can be accessed by clicking the heading to this blog posting.

Social Media Compliance Guide

October 22, 2018

The law firm Mayer Brown recently published an excellent and comprehensive Social Media Compliance Guide for Issuers, Brokers and Advisers. This is a really helpful publication and can be accessed by clicking the heading to this blog post.

Fund Boards May Rely on CCO Reps Re:  Affiliated Transactions

October 15, 2018

On October 12, 2018, the staff of the SEC issued a no-action letter easing mutual fund board burdens regarding affiliated transactions, such as cross-trades between funds managed by the same investment adviser. In the no-action letter, the SEC stated that it would not recommend enforcement action for violations of Sections 10(f), 17(a), or 17(e) of the Investment Company Act of 1940, (the “1940 Act”) if a fund board receives from the fund’s CCO, no less frequently than quarterly, a written representation that any transactions effected in reliance on Rules 10f-3, 17a-7, or 17e-1 under the Act (“Affiliated Transactions Exemptive Rules”) complied with procedures adopted by the board pursuant to the relevant Affiliated Transactions Exemptive Rules, rather than the board itself reviewing affiliated transaction details on a quarterly basis and making such compliance determinations. The no-action letter appears to be an product of a recent SEC initiative to review and reevaluate fund directors’ responsibilities. The full text of the no-action letter can be found by clicking the heading to this posting.

NASAA State Prosecutions Report for 2017

October 15, 2018

On October 10, 2018, NASAA, the North American Securities Administrators Association, released its summary report on prosecutions by state securities administrators for the 2017 year. The Report reveals that there was significant increase in state prosecutions of both investment advisers and securities brokers, with NASAA reporting that state securities regulators conducted 4,790 investigations in 2017 and took 2,105 enforcement actions overall. These actions led to more than $486 million in restitution ordered returned to investors, fines of $79 million and criminal relief of 1,985 years, including incarceration and probation. The complete report can be accessed by clicking the heading to this blog post.

Private Fund Firm Prosecuted for Failure to Deliver Audited Financials

October 1, 2018

Private fund firms continue to struggle with SEC oversight and compliance requirements, as evidenced by a recent administrative order, This case illustrates two typical issues: the custody rule requirements and the fundamental requirement that firms adopt and/or properly implement written compliance policies and procedures. "An SEC investigation revealed that [the firm], which was not subjected to an annual surprise examination at any time, failed to timely distribute annual audited financial statements to investors in numerous private investment funds that it advised in each year since it registered with the Commission in 2012. The SEC investigation further revealed that [the firm] failed to adopt and implement reasonably designed written policies and procedures and failed to review at least annually its policies and procedures, as required by the compliance rule." The case is illustrative of the care which private fund advisers should be approaching their duties. The full case can be accessed by clicking the heading to this blog post.

First Adviser Enforcement Action under the Identity Theft Red Flags Rule

September 28, 2018

In late September, the SEC settled an administrative action regarding Voya Financial Advisors, Inc. (VFA). The action cites VFA's failure to adequately protect customer information following a six-day cyber attack in 2016. The SEC’s order cites two key components: (1) violations of the Safeguards Rule under Regulation S-P (which is routinely used by the SEC in cyber security enforcement actions against broker-dealers and investment advisers) and (2) the first enforcement action for a violation of the Identity Theft Red Flags Rule under Regulation S-ID, which requires certain SEC registrants to create and implement programs to detect, prevent and mitigate identity theft. With the constant barrage of cyber security attacks on advisers, this action clearly signals the SEC's intent to enforce the protections it has adopted. Please click the heading for this posting to access the administrative order.

MFS Found to Have Made Misleading Statements About Hypothetical Stock Returns

August 31, 2018

The SEC brought an enforcement action against Massachusetts Financial Services Company (MFS) for making material misstatements and omissions to certain of its advisory clients and others concerning hypothetical stock returns associated with MFS’s blended research stock ratings. The SEC stated that MFS offered investors blended research strategies that combined research ratings from MFS’s fundamental analysts and quantitative models to manage portfolios of stocks for client investment. The SEC found that from 2006 to 2015, MFS advertised that the basis of its blended research philosophy was that fundamental and quantitative management styles excel in differing market conditions, and that blending fundamental and quantitative stock ratings could over time yield better returns than either type of ratings alone. To illustrate the validity of its claim that blending two sources of ratings was better than one source alone, MFS advertised the results of a hypothetical portfolio of stocks rated “buy” by both MFS’s fundamental analysts and quantitative models. In its advertisements, MFS showed how this hypothetical portfolio had annualized returns from 1995 forward that exceeded the annualized returns of either a hypothetical portfolio of fundamental “buy” rated stocks or a hypothetical portfolio of quantitative “buy” rated stocks.

AEGON Fails to Properly Oversee the Use of Its Quantitative Models

August 27, 2018

The SEC found that between July 2011 and June 2015, AEGON USA Investment Management, LLC (AUIM), a registered investment adviser, violated certain provisions of the federal securities laws in connection with the offer, sale, and management of 15 quantitative-model-based mutual funds, variable life insurance investment portfolios, and variable annuity investment portfolios (Products) and separately managed account (SMA) strategies (Strategies). AEGON marketed all of the Products and Strategies as managed using a proprietary quant model, and highlighted, when marketing certain of the Products and Strategies, their “emotionless,” “model-driven,” or “model- supported” investment management process and described how the models were supposed to operate. The SEC stated that these claims necessarily implied that the models worked as intended. The SEC found, however, that AEGON launched the Products and Strategies without first confirming that the models worked as intended and/or without disclosing any recognized risks associated with using the models. During the summer of 2013, AUIM (acting as the subadviser of the Products and Strategies) discovered that certain of the models contained errors and concluded that that these errors rendered at least one of the models “to not be fit for purpose.” AUIM stopped using, running, or relying on at least one of the models in September 2013. AUIM and TAM (the adviser of the Products) failed to disclose the models’ errors and AUIM’s decision to stop using the model to the board of trustees of Transamerica Funds.

Hedge Fund Adviser Fails to Implement Adequate Compliance Program

August 22, 2018

The SEC brought an enforcement action against Aria Partners GP, LLC for failing to implement a compliance program consistent with its obligations as a registered investment adviser. Among other things, this led to a failure to disclose to all investors in one of those private funds all their options to redeem their investment in the fund. The fund’s Limited Partnership Agreement (LPA) required 90 days’ written notice for redemptions. However, Aria Partners had an informal policy, which was not disclosed to all investors in the fund, of accommodating investors’ requests to provide partial redemptions on significantly less notice than 90 days. In addition, Aria Partners granted full redemptions to a limited number of investors on 60 days’ notice, while similarly situated investors were held to the 90 day notice period. These practices resulted in materially different full redemption amounts for two investors in 2015, when the fund lost value in a short period.

Adviser Charged with Misleading Its Clients about the Nature of its Investment Program

August 21, 2018

The SEC brought an enforcement action against Biltmore Wealth Management LLC, an investment adviser located in California. From at least June 2014 through August 2015, the SEC stated that Biltmore raised about $2.2 million from ten investors, eight of whom were pre-existing clients of Biltmore, to invest in Biltmore Capital, L.P. (Fund), a private fund. The SEC found that Biltmore misled the Fund and investors by claiming the Fund would invest primarily in leading growth stocks, but instead caused the Fund to make substantial trades in risky stock options and options on the SPDR S&P 500 ETF, which attempts to replicate the return of the S&P 500 (“SPY options”). Biltmore also misrepresented to investors that the Fund’s risk would be mitigated by “stops” that would limit its losses to just 7-8%, but the Fund’s losses often exceeded those limits. In monthly letters to Fund investors, Biltmore mischaracterized the source of the Fund’s returns and losses by failing to disclose that the Fund’s options trading, particularly its trading in SPY options, was the main driver of its few profits and many losses. Ultimately, the undisclosed SPY options trading caused the Fund to lose nearly all of its value in August 2015, and it was dissolved in November 2015.

Limitations of Compliance Automation

August 17, 2018

A recent SEC settlement with Ameriprise reveals the limitations of automated compliance monitoring systems. Basically, their systems failed to catch fraud by several reps who stole over $1 million from clients.

Adviser Charged with Cherry Picking Investment Recommendations for Its Own Benefit

August 17, 2018

The SEC charged BKS Advisors LLC, an investment adviser and Roger T. Denha, an investment adviser representative of BKS, with engaging in fraudulent trade allocation, or “cherry-picking.” BKS is a Michigan limited liability company with its principal place of business in Southfield, Michigan. Denha executed his cherry-picking scheme according to the SEC by unfairly allocating purchases of securities between his favored accounts (including his personal and family accounts) and his other BKS clients’ accounts. Denha disproportionately allocated profitable trades to the favored accounts, and disproportionately allocated unprofitable trades to the accounts of certain advisory clients. He executed his scheme by buying the securities in an omnibus account and then waiting to allocate until after he had an opportunity to see whether the securities had increased in price.

Faulty Trading Away Practices of Third-Party Portfolio Management Firms in its Wrap Programs

August 14, 2018

The SEC brought an enforcement action against Lockwood Advisors, Inc. (Lockwood) for failing to adopt and implement policies and procedures reasonably designed to prevent violations of the Advisers Act and the rules thereunder in connection with its assessment, oversight, and disclosure of the trading away practices of the third-party portfolio management firms in its wrap programs. From at least 2008, and continuing on an ongoing basis to the present, the SEC stated that Lockwood’s policies and procedures failed to require that material information about trading away: • would be obtained and considered by Lockwood prior to making the third-party portfolio management firms available to clients in its wrap programs; and/or • would be disclosed to clients directly or through their third-party registered investment advisers.

Fiduciary Stds Developments—August 2018

August 10, 2018

Issues related to the defunct DoL Rule continue to arise. Meanwhile comments are rolling in to the SEC on its proposals. For back-reference see our June 2018 update.

Adviser Adopts Faulty Cross Trading Procedures

August 10, 2018

The SEC brought an enforcement action against Hamlin Capital Management, LLC because of its deficient arrangement of cross trades of certain non- rated, thinly-traded, fixed income securities, the pricing of which resulted in undisclosed favorable treatment of certain of its advisory clients over others. From at least November 2011 through March 2016, the SEC found that Hamlin, a registered investment adviser, routinely engaged in cross trade transactions between two or more Hamlin client accounts. Hamlin’s pricing method for the cross trades resulted in it favoring certain of its clients over others in two ways: • when arranging cross trades, Hamlin generally arranged for the buy-side of the transaction to be executed at the security’s bid-side indicative quotation (Bid Price) obtained for month-end valuation purposes from various pricing brokers, who were typically the underwriters of the same bond, and arranged for the sell-side of the transaction at a small discount from that Bid Price. Hamlin failed to disclose that, by cross trading securities at the Bid Price, rather than obtaining and using an average or midpoint between the Bid Price and an ask-side evaluation quotation, Hamlin’s use of the Bid Price had the effect of favoring the purchasing clients in the transactions over the selling clients, even though Hamlin owed both the same fiduciary obligations; and • with respect to certain fixed income securities, Hamlin challenged the pricing broker’s bid-side evaluation quotations and requested prices higher than recent trades in the secondary market, without adequate documentation of the basis provided to the pricing broker for the challenge. Hamlin then arranged for the execution of cross trades at these higher levels, without undertaking any assessment as to whether the securities were available on similar or better terms for its buying clients in the secondary market. As a result, Hamlin’s buy-side advisory clients paid more than they would have paid had securities been available for purchase in the secondary market at terms similar to prior trades.

Knowledge Leaders Failed to Disclose Soft Dollars Arrangement Conflicts of Interest

August 9, 2018

The SEC found that Knowledge Leaders Capital, LLC used client commissions under Section 28(e) of the Securities Exchange Act, commonly called “soft dollars,” to purchase approximately $1 million in research over a three-year period from a firm affiliated with an individual that was, at the time, the Managing Director of Knowledge Leaders and also functioned as its chief investment officer (CIO). While Knowledge Leaders approved the CIO’s company as a soft dollar recipient and approved the payments made to the CIO’s company for use of its research software, Knowledge Leaders failed to identify (and as a result, failed to disclose to clients) the financial conflicts of interest created by Knowledge Leaders using soft dollars to pay a company owned and controlled by Knowledge Leaders’ CIO. As a result, the SEC found that Knowledge Leaders violated Section 206(4) and Rule 206(4)-7 thereunder by failing to adopt and implement written policies and procedures reasonably designed to prevent violations of the Advisers Act in connection with the identification and disclosure of conflicts of interest relating to the use of soft dollars.

Private Funds Comparison Article

August 6, 2018

The law firm Pepper Hamilton recently published a fine article on the various private fund models. It's interesting in that it highlights new and emerging models as well as the tried and true. Here's the link: https://www.pepperlaw.com/resource/32924/25E0 or just click the headline to this blurb.

Adviser Violates Advisers Act by Failing to Provide Pre-Paid Advisory Fees to Clients Who Terminated

July 20, 2018

The SEC found that Beverly Hills Wealth Management, LLC (BHWM) and Margaret Black, its primary owner, violated the Advisers Act by withholding prepaid, unearned advisory fees totaling $131,000 from 63 departing clients who requested terminating their advisory relationship with BHWM despite representations made in its Form ADV brochures and advisory agreements. Specifically, the firm and Black initially refused to recognize clients’ e-mails and mailed requests as proper termination notices, instead demanding that the clients send written requests with a “wet signature,” which request was contrary to the disclosures made to clients in both the Forms ADV, Part 2A (the “Firm Brochures”) and its advisory contracts. Additionally, between March 2013 and April 2018, BHWM and Black continually omitted material facts and made false and misleading statements regarding BHWM’s financial condition in its Firm Brochures. Specifically, the SEC fount that the firm failed to disclose that it was insolvent and financially unable to repay its loans during this entire time despite representing in thirteen Firm Brochures issued between March 2013 and April 2018 that “[w]e do not have a financial condition or commitment that impairs [our] ability to meet contractual and fiduciary obligations to clients.” In fact, BHWM had borrowed $700,000 just to keep the business afloat. The SEC stated that since 2014, BHWM has been in default on the loans and currently owes an additional $75,000 in unpaid interest.

SEC Updated Its Website

July 16, 2018

In early July, the SEC restructured its website with some notable changes for advisers and funds.

Fiduciary Stds Developments—June 2018

June 29, 2018

Given its importance, we're republishing our May update. A federal court has essentially struck down the DoL Fiduciary Standard. No appeal was made. Meanwhile, the SEC has proposed two things: (1) a "Best Interest" Standard for Broker-Dealers (and certain advisers); and (2) Form CRS which would require brokers and advisers to provide to investors a document describing their services and nature of their client relationships, i.e., a Relationship Summary. The attached page has a list of the best law firm summaries we've seen to date. Please click the heading above to access the detailed discussion and links.

Lucia v. SEC:  Supreme Court Holds SEC’s Past Hiring of Administrative Judges Unconstitutional

June 21, 2018

On June 21, 2018, the U.S. Supreme Court ruled in the appeal of the Lucia v. SEC case which has worked its way through the courts the past several years. In essence, the Supreme Court determined that the SEC’s old administrative law judges (“ALJs”) hiring practice was unconstitutional. In recent times, the SEC staff has guided appointments of ALJs. This decision resolved an outstanding split between federal circuit courts as to whether the SEC's ALJs are “officers” of the United States subject to the requirement of the Appointments Clause. The Court concluded that ALJs are “officers” who must be appointed pursuant to the Appointments Clause by the President, “courts of law,” or “heads of department.” For these purposes, the Commissioners of the SEC are deemed to be "heads of department," meaning that ALJ appointments will have to be by the Commission, courts or the President.However, the Court's decision does not resolve a variety of open questions that follow from this significant decision. Most notably, the decision throws into question the validity of the recent decisions of the ALJs that decide most of contested SEC enforcement actions.Such questions will likely take years to resolve in lower courts, and perhaps a revisit to the Supreme Court. The heading to this blurb links to an excellent summary by our friends at Ropes & Gray.

Updated Custody Q&A

June 21, 2018

The SEC's Div. of Investment Mgmt. has updated its custody Q&A page on its website. The updates primarily address advisers continuing questions and challenges regarding what is termed "inadvertent custody.," The press release which is linked to in the heading above, details specifically the additions to the Q&A for your ease of access.

Adviser Fails to Disclose to Clients a Conflict of Interest

June 8, 2018

The SEC found that an investment adviser recommended a security without disclosure to its client that it had a financial interest in the issuer of the security. The SEC stated that Larry Werbel from at least 2011 through 2014 introduced his clients to VGTel, Inc. and informed them that VGTel was as an investment opportunity. The SEC found that Werbel willfully failed to tell these clients that he was being compensated to recommend the purchase of VGTel securities. The SEC noted that this compensation agreement was an agreement with Ed Durante, a convicted felon. The SEC further noted that he failed to inform these clients that New Market Enterprises, the entity he directed his clients to send their money for the purchase of VGTel securities, was run and controlled by Ed Durante. The SEC stated that he met with Ed Durante in connection with his compensation agreement to discuss his clients' investment opportunities in VGTel.

SEC to Allow Electronic Posting of Mutual Fund and ETF Reports

June 5, 2018

The SEC adopted Rule 30e‑3 under the 1940 Act, which provides an optional “notice and access” method to allow funds to satisfy their obligations to transmit shareholder reports. Subject to conditions in the rule, a fund may make its reports and other required materials publicly accessible at a specified website address, free of charge, and send investors a paper notice of each report’s availability by mail. Funds will be permitted to satisfy their delivery obligations for shareholder reports by mailing reports in paper, delivering reports electronically to investors who have chosen this method under the SEC’s electronic delivery guidance, providing notice and website accessibility under rule 30e-3, or a combination of the above.

French-Owned Adviser Fails to Disclose Side Letter

June 4, 2018

The SEC brought an enforcement action against Lyxor Asset Management, Inc. to disclose conflicts of interest. The SEC found that Lyxor, an investment adviser, to certain of its clients arising from an agreement (Side Letter) between Lyxor and two affiliated outside asset managers (Third Party Advisers). The Side Letter called for the Third Party Advisers to make payments to Lyxor based on the total amount of Lyxor client assets placed or maintained in certain funds advised by the Third Party Advisers.

U.K. Adviser Fails to Disclose Compensation Earned in Recommended Third-Party Product

June 4, 2018

The SEC brought an enforcement action against deVere USA, Inc. (DVU) for failing to make full and fair disclosure to clients and prospective clients of material conflicts of interest regarding compensation obtained from third-party product and service providers. DVU’s clients are primarily U.S. residents or citizens who held U.K. defined benefit and defined contribution pensions. DVU provided investment advice to its clients in connection with the transfer of these U.K. pension assets to overseas retirement plans that qualified under the U.K. tax authority’s regulations as a Qualifying Recognised Overseas Pension Scheme (QROPS). Between at least June 2013 and March 2016, the SEC found that DVU did not disclose arrangements in which third-party product and service providers recommended by DVU in connection with its QROPS advice compensated an overseas affiliate of DVU that, in most cases, in turn compensated the DVU investment adviser representative (IAR) who had made the recommendations. The undisclosed compensation constituted the primary form of compensation received by DVU’s IARs for their advisory services. Each of these arrangements created an economic incentive for DVU to recommend a transfer to a QROPS and/or to recommend certain product and service providers.

SEC Brings a Number of Failure to File Form PF Filing Enforcement Actions

June 1, 2018

The SEC brought a number of enforcement actions against investment advisers for failing to file Form PFs, which violated the reporting provisions of Rule 204(b)-1 under the Advisers Act. Rule 204(b)-1(a) requires an investment adviser to complete and file a report on Form PF if the investment adviser: (1) is registered or required to be registered under Section 203 of the Advisers Act; (2) acts as an investment adviser to one or more private funds; and (3) as of the end of its most recently completed fiscal year, managed private fund assets of at least $150 million. Rule 204(b)-1(e) requires such advisers to file an updated report on Form PF at least annually.

New Enforcement Action Online Tool Launched by SEC

May 31, 2018

The SEC launched an online search took that includes a database of all individuals who have settled, defaulted, or contested an SEC enforcement action that resulted in a final judgment or order in federal court or an administrative proceeding. The new system is called SALI, which stands for SEC Action Lookup for Individuals. It includes any respondent/defendant and not just investment professionals. The current database extends back to 2014.

Fiduciary Stds Developments—May 2018

May 29, 2018

A federal court has essentially struck down the DoL Fiduciary Standard. No appeal was made. Meanwhile, the SEC has proposed two things: (1) a "Best Interest" Standard for Broker-Dealers (and certain advisers); and (2) Form CRS which would require brokers and advisers to provide to investors a document describing their services and nature of their client relationships, i.e., a Relationship Summary. The attached page has a list of the best law firm summaries we've seen to date.

CFTC and States Sign Enforcement Information Sharing Agreement

May 21, 2018

The Commodity Futures Trading Commission (CFTC) and North American Securities Administrators Association (NASAA) signed a mutual cooperation agreement to establish a closer working relationship between the federal commodity regulator and individual state securities agencies. The agreement provides a framework for the sharing of confidential information between the CFTC and state securities regulators in the U.S.

Adviser Allowed to Continue to Use Performance Track Record Despite Reorganization

May 8, 2018

The SEC in a no-action letter permitted the continued use of a performance record of an adviser that proposed to reorganize its structure with affiliates. South State Advisory, Inc. (SSA) and Minis (collectively, the Advisers) are wholly-owned registered investment adviser subsidiaries of South State Bank (SSB), which in turn is a wholly-owned subsidiary of South State Corporation. Each Adviser has its own management team, which reports separately to a SSB management team. Each Adviser also has its own investment committee, which is responsible for the Adviser's investment decisions and recommendations. To improve corporate efficiency, SSB proposed an internal restructuring whereby Minis would be merged into SSA (Restructuring). Following the Restructuring, Minis' business would continue as a separate business division of SSA called the "Minis Division"). The same management team that currently manages Minis would manage the Minis Division and the Minis investment committee would continue to have responsibility for the Minis Division's investment decisions and recommendations.

Chairman Clayton Testifies on the SEC’s Priorities

April 26, 2018

He provided data about the SEC’s National Examination Program (NEP), led by the Office of Compliance Inspections and Examinations (OCIE). He stated that OCIE conducts risk-based examinations of registered entities, including broker-dealers, investment advisers, investment companies, municipal advisors, national securities exchanges, clearing agencies, transfer agents and FINRA, among others. Recently, through the reallocation of resources, advancements in OCIE’s use of technology and other efficiencies, he stated that OCIE increased its examination of investment advisers by more than 40% in FY 2017 over FY 2016 – to approximately 15% of all SEC-registered investment advisers.

Excellent Summary/Analysis of the Fiduciary Rule Status

April 8, 2018

Our friends at Eversheds Sutherland recently posted an excellent analysis of the vacatur of the DoL's fiduciary rule and its impact on plan sponsors and plan providers. By extension, advisers need to keep an eye on the continuing developments regarding the rule and SEC efforts in this area as well. We'll keep you posted on key developments. The article is linked to the heading above.

Whistleblowers Must Report to SEC to be Eligible for Awards

March 31, 2018

The United States Supreme Court has ruled that Dodd-Frank’s anti-retaliation provisions apply only to whistleblowers who report the misconduct to the SEC. In the case, the employee brought a claim under Dodd-Frank’s whistleblower anti-retaliation provisions, even though he had not reported to the SEC, because he claimed that he was fired as a result of reporting to management suspected securities law violations. The Supreme Court reversed the decision of the Ninth Circuit based on the plain reading of the statute which defines “whistleblower” as any individual who provides information relating to a violation of the securities laws to the SEC. The Court rejected the SEC rule that expanded anti-retaliation protection to those who only report internally. Looking at legislative history, the Court reasoned that “Dodd-Frank’s award program and anti-retaliation provision thus work synchronously to motivate individuals with knowledge of illegal activity” to report to the SEC.

Adviser Settles Charge that it Inadequately Disclosed Securities Lending Arrangement

March 31, 2018

The SEC charged two investment adviser subsidiaries of Voya Holdings Inc. with failing to disclose conflicts of interest and making misleading disclosures in connection with their practice of recalling securities on loan so their affiliates could receive tax benefits. According to the SEC, Voya Investments LLC and Directed Services LLC served as investment advisers to certain insurance-dedicated mutual funds offered to annuity and life insurance customers through insurance companies affiliated with the advisers. In order to generate additional income for the mutual funds and their investors, the Voya advisers lent securities held by the funds to parties looking to borrow the securities. The Voya advisers recalled loaned securities before their dividend record dates so that the advisers’ insurance company affiliates, which were the record shareholders of the funds’ shares, could receive a tax benefit based on the dividends received. But the SEC stated that the recall practice caused the funds and their investors to lose securities lending income without receiving any offsetting tax benefit. The SEC found that the Voya advisers failed to disclose the conflict of interest to the funds’ board of directors or in the funds’ prospectuses. The Voya advisers agreed to pay approximately $3.6 million to settle the charges, including more than $2 million directly to the affected mutual funds for the benefit of their investors.

SEC Grants Largest Whistleblower Awards

March 19, 2018

The SEC awarded two whistleblowers collectively nearly $50 million and a third whistleblower received more than $33 million. The previous high was a $30 million award in 2014. The awards were made in connection with Dodd-Frank enforcement cases. The SEC stated that it has awarded more than $262 million to 53 whistleblowers since issuing its first award in 2012. All payments are made out of an investor protection fund established by Congress that is financed entirely through monetary sanctions paid to the SEC by securities law violators. It further noted that whistleblower awards can range from 10 percent to 30 percent of the money collected when the monetary sanctions exceed $1 million.

Fifth Circuit Vacates Department of Labor’s Fiduciary Rule

March 16, 2018

The Fifth Circuit Court of Appeals vacated the Department of Labor’s fiduciary rule primarily on the grounds that the Department of Labor unlawfully expanded the definition of the term “fiduciary” to include commissioned brokers. The Court opined that the Department of Labor departed from the common law and contextual definition of “fiduciary” and dispensed with the criteria used for the past several decades. The Court agreed with opponents of the fiduciary rule that argued that the fiduciary rule would cause many financial service providers to exit the market for retirement advice, thereby hurting the people that the Department of Labor intends to protect.

Adviser Violates Custody Rule through Third-Party Arrangement

March 5, 2018

The SEC brought an enforcement action against Financial Fiduciaries, LLC (Financial Fiduciaries) and Thomas Batterman in connection with certain clients financial conflicts of interest created by Financial Fiduciaries’ arrangement with a third party trust company. Because of these arrangements and the fact that an employee of Financial Fiduciaries’ parent company handled funds of Financial Fiduciaries’ clients, from early 2012 to mid-2014, the SEC found that Financial Fiduciaries had custody over some of its clients’ assets while failing to implement sufficient controls designed to protect those client assets from loss or misappropriation, as required by the Advisers Act.

Falsified Performance and Marketing Materials Means Trouble

March 1, 2018

The SEC recently levied a $3 million fine on a private fund manager who falsified performance data, provided fake investment manager information, and created a misleading internet optimization campaign. In addition to the fine, the manager is also serving a five year prison term. See link in headline for link to the SEC's release.

SEC Cybersecurity Guidance for Public Companies

February 28, 2018

The SEC has issued interpretive guidance to assist public companies in preparing disclosures about cybersecurity risks and incidents. While not targeted at or designed for investment advisers, the Guidance is nonetheless very insightful and helpful for advisers in understanding cybersecurity issues, the SEC's perspective, and the expectations that are developing in the public company space especially regarding disclosure of incidents. Click the headline to link to the Guidance.

SEC Compliance Outreach Seminar in April

February 14, 2018

The SEC recently announced its 2018 outreach program national seminar for investment companies and investment advisers. The event is intended to help CCOs and other senior personnel at investment companies and investment advisory firms to enhance their compliance programs for the protection of investors. We've been to these in the past and they are invaluable for insights and guidance on the SEC's current regulatory and examination focus points. Please click the heading above to be linked to the announcement and registration pages.

SEC Offers Advisers Potential Amnesty for Self-Reporting of Fund Share Revenue Sharing Violations

February 13, 2018

On Feb. 12, the SEC announced a new initiative designed to encourage advisers to self-report inappropriate mutual fund share class revenue sharing arrangements. These arrangements generally arise when an adviser counsels clients to purchase higher commission or fee producing mutual fund share classes when less costly ones are available. Typically, there is a lapse in disclosure to the client underlying the sale, which can be viewed as fraudulent. According to the SEC press release, "Under the Share Class Selection Disclosure Initiative..., the [Enforcement] Division will agree not to recommend financial penalties against investment advisers who self-report violations of the federal securities laws relating to certain mutual fund share class selection issues and promptly return money to harmed clients." Please click the heading for the full announcement.

Examination Priorities 2018 Released

February 8, 2018

The SEC has released its 2018 exam priorities. The key themes are a continuation of past trends, organized around five themes: 1. Matters of importance to retail investors, including seniors and those saving for retirement; 2. Compliance and risks in critical market infrastructure; 3. Financial Industry Regulatory Authority (FINRA) and Municipal Securities Rulemaking Board (MSRB); 4. Cybersecurity; and 5. Anti-Money laundering programs. See link embedded in the title of this news blurb to link to the full document.

SEC Investor Bulletin: Investment Adviser Sponsored Wrap Fee Programs

January 5, 2018

In early December the SEC published an Investor Bulletin updating and outlining the basics of wrap fee programs from an investor's perspective. The Bulletin is instructive on the SEC's current advice and views of such programs, which are growing rapidly. Notably at the end of the Bulletin the SEC references several key enforcement actions regarding such programs. Click the heading of this blurb for a link to the Bulletin.

Senate Confirms Peirce and Jackson as New Commissioners

December 22, 2017

The full Senate on confirmed by voice vote Hester Pierce, a Republican, and Robert Jackson, a Democrat, to be Commissioners of the SEC. The SEC now has its full allotment of commissioners. Mr. Jackson, a professor at Columbia University, and Ms. Peirce, a senior research fellow at George Mason University, will join the SEC after they are sworn in. Chairman Jay Clayton and Commissioners Michael Piwowar and Kara Stein are the other three Commissioners.

ICOs:  the Chairman Speaks

December 20, 2017

When the SEC Chairman speaks, folks listen. On Dec. 11, SEC Chair Clayton issued a lengthy "statement" on the current wave of initial coin offerings (ICOs) (see our Nov. 13 story on the basics), focusing on whether ICOs are treated as securities under the federal securities laws. He noted that, while not all tokens may be securities, simply calling a token something else does not bring an offering outside the SEC’s purview. “Key hallmarks” of tokens being securities include, in the SEC’s view, when an issuer emphasizes the possibility for ICO tokens to appreciate in value or encourages a secondary market for tokens. Clayton’s statement, along with recent SEC efforts to stop certain ICOs, indicate that increased enforcement activity in this area will continue. Click the heading to access the Statement.