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The BD/IA Regulator

Providing securities regulatory, enforcement and litigation trends for broker-dealers, investment advisers and investment funds

House Bill Would Ease Regulatory Restrictions to Private Fund Advisers

Posted in Fund Regulation, Investment Adviser Regulation

On September 9, 2016, the U.S. House of Representatives approved a bill that would amend the Investment Advisers Act of 1940 to modernize certain disclosure requirements and lessen regulatory burdens on private fund advisers.  The proposed amendments would not apply to advisory services provided to registered investment companies.

H.R. 5424, the Investment Advisers Modernization Act of 2016, would, among other things, direct the Securities and Exchange Commission (SEC) to amend certain specified regulations related to advertising, custody, recordkeeping, brochure delivery, and assignment of advisory contracts.

The Investment Advisers Modernization Act of 2016 would:

  1. Allow advisers organized as partnerships to change the composition of the partnership without providing notice to the SEC every time there is a change;
  2. Lift certain securities advertising restrictions on advisers that advertise to qualified investors and exempt private equity fund sponsors from certain enhanced disclosures (Form ADV, Part 2);
  3. Remove certain reporting requirements for large private equity funds to treat them like other equity funds (Form PF, Part 4);
  4. Exempt from the Proxy Voting Rule investment advisers that exercise voting authority only with respect to non-public securities;
  5. Expand the “privately offered securities” exemption under the Custody Rule so that it applies to both certificated and uncertificated securities and provides an exemption for special purpose vehicles (SPV) managed by private fund sponsors and co-investment funds that hold only one investment; and
  6. Require the SEC to waive the application of certain anti-fraud provisions to advisers to clients that advertise exclusively to
  • Qualified clients, determined as of the time of the publication or distribution of the advertisement, rather than immediately before or after entering into an advisory contract,
  • Knowledgeable employees of any private fund to which the investment adviser acts as an investment adviser
  • Qualified purchasers, or
  • Accredited investors (determined as of the time of the publication).

The sponsors of the bill said that bill intends to ease regulations on advisers to funds that invest in small businesses by easing restrictions on access to private capital.  On September 12, 2016, the Bill was received in the Senate, read twice, and referred to the Committee on Banking, Housing, and Urban Affairs.

Our take

While the bill would roll back some of recent regulatory requirements that grew out of the Dodd-Frank bill, it is seen as having little chance of being enacted.

Capital Acquisition Brokers: New Category of Broker-Dealers Provides Limited Relief for Some Investment Banking Boutiques

Posted in Broker-Dealer Regulation

The SEC recently approved a set of FINRA rules which creates a new category of broker-dealers known as Capital Acquisition Brokers or CABs. The rules were originally proposed in 2014 and will go into effect on the date set forth in FINRA’s regulatory notice regarding approval of the rules. The CAB rules are intended to provide regulatory relief for broker-dealers that limit their activities to investment banking.  However, the relief provided is limited and the constraints on what business may be conducted by a CAB may diminish the interest of many broker-dealers in using this new category.

Read our client alert.

FINRA to Conduct Targeted Exams of Unit Investment Trust Rollovers

Posted in Unit Investment Trusts

FINRA recently announced that it will be conducting an inquiry into unit investment trust (“UIT”) rollovers.  UITs generally are unmanaged registered investment companies that are comprised of a fixed portfolio of securities and have fixed life spans.  At the end of a UIT’s term, and instead of taking all or a portion of their money outright, investors are often offered the option of rolling all or a portion of their money into a new UIT created by the sponsor.  This “rollover” option is often available at a reduced sales charge.

As part of its inquiry of UIT rollovers, FINRA will be requesting certain documents and information from firms, including Written Supervisory Procedures, which are enumerated in the targeted examination letter.  The review period is from January 1, 2014 through June 30, 2016.

For additional information and background about UITs, our FAQ is available here.

OCIE Announces Adviser Supervision Practices Initiative

Posted in Investment Adviser Regulation

On September 12, 2016, OCIE published a National Exam Program Risk Alert announcing an initiative to examine the supervision practices of registered investment advisers (“RIAs”) that employ individuals with a history of disciplinary events in the financial services sector (the “Supervision Initiative”).  OCIE intends to assess RIAs’ business and compliance practices, with a particular focus on those practices related to their supervision of “higher-risk individuals.”  According to OCIE, persons with regulatory disciplinary histories may pose increased risks to advisory clients.

The Supervision Initiative will assess whether RIAs have implemented policies and procedures specific to the risks presented by employees with disciplinary histories.  Examinations will focus on those advisers’ compliance cultures and “tone at the top.”

The Supervision Initiative examinations will include the following key areas:

  • Compliance Program. Examiners will review an RIA’s practices surrounding its hiring processes, ongoing reporting obligations, employee oversight practices, and complaint handling processes under Rule 206(4)-7 under the Advisers Act, including whether the RIA fosters a robust compliance culture.
  • Disclosures. Examiners will likely review the RIA’s practices regarding its disclosures of regulatory, disciplinary, or other actions, with a focus on assessing the accuracy, adequacy, and effectiveness of such disclosures, including those on the RIA’s Form ADV.
  • Conflicts of Interest. Examiners will assess the RIA’s or supervised persons’ conflicts of interest, with a particular focus on conflicts that may exist with respect to financial arrangements (g., unique products, services, or discounts) initiated by supervised persons with disciplinary histories.
  • Marketing. Examiners will review the RIA’s advertisements, including pitchbooks, website postings and public statements, to identify any conflicts of interest or risks associated with supervised persons who have a history of disciplinary events.

Our take

The Supervision Initiative should come as no surprise to RIAs, since OCIE alluded to the initiative and its use of data analytics in its Examination Priorities for 2016, which we wrote about here.  The Supervision Initiative also mirrors, to some extent, FINRA’s interest this year in “compliance culture,” which similarly emphasized the issues surrounding the hiring of individuals with disciplinary records.  While many RIAs are already sensitive to hiring individuals with disciplinary histories, firms should review their hiring records to determine if they are likely to draw OCIE’s attention.  Firms should also review their compliance policies and procedures to ensure that they are robust, identify high-risk individuals, and mitigate the risks that these individuals may pose.

The SEC Adopts Amendments to Form ADV and Recordkeeping Rule: Advisers Now Required to Disclose Information About Separately Managed Accounts

Posted in Fund Regulation, Investment Adviser Regulation

The Securities and Exchange Commission (SEC) recently amended Form ADV to require investment advisers to disclose more information about their separately managed account business, aggregate data related to the use of borrowings and derivatives, and disclose information about other aspects of their advisory business, including branch office operations and the use of social media. The amendments also streamline registration and reporting for “umbrella registrations” made by groups of private fund advisers operating a single advisory business.

Read our client alert.

Are Your Customer Accounts in Order? SEC Announces Sweep of Broker-Dealers and Implementation of the Customer Protection Rule Initiative

Posted in Broker-Dealer Regulation, SEC Enforcement

On June 23, 2016, the Securities and Exchange Commission (the “SEC”) announced that it would begin a coordinated effort across divisions to identify potential violations by broker-dealers of Rule 15c3-3 (the “Rule”) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). As part of this effort, also known as the Customer Protection Rule Initiative (the “CPR Initiative”), the SEC will conduct a targeted sweep of broker-dealers and encourage firms to self-report any potential violations of the Rule. The CPR Initiative is intended to address historical or ongoing violations of Section 15(c)(3) of the Exchange Act and the Rule. The CPR Initiative covers only broker-dealers and provides no assurance that individuals associated with those entities will be offered similar terms if they have engaged in violations of the federal securities laws. The SEC may also recommend an enforcement action against such individuals beyond those available under the CPR Initiative. The SEC, however, did not specify for how long the CPR Initiative would run.

Read our client alert.

Double-Check the Math: Advisers Should Not Provide Clients With Performance Data Created by Other Investment Managers Without Verifying the Information

Posted in Investment Adviser Regulation, SEC Enforcement

In a series of enforcement actions this week, the SEC made it clear that investment advisers need to substantiate the performance records of investment management firms they recommend to their clients.  In these cases, failure to do so resulted in charges of spreading “false and misleading information” in violation of Section 206 of the Advisers Act.

Although presumably it is not necessary to recalculate performance data, the SEC staff said that when “an investment adviser echoes another firm’s performance claims in its own advertisements, it must verify the information first rather than merely accept it as fact.”

The SEC found in each case that the investment adviser negligently relied on performance information related to a separately managed account strategy managed by a third-party adviser.  The advisers forwarded performance advertisements created by the third-party investment adviser without appropriately confirming the accuracy of the information in those advertisements.  As a result, the SEC said, the advisers “failed to have a reasonable basis to believe that [the] performance was accurate,” and they therefore distributed false and misleading advertisements to their clients in violation of Section 206(4) of the Advisers Act.

The advisers were also cited for failure to maintain books and records necessary to validate the performance claims.

Advisers are on notice, with these actions, that they cannot take performance claims of underlying advisers at face value.  If performance is too good to be true, it just might be . . . too good to be true.  The obligation for making sure that clients have full, fair and accurate information upon which to make investment decisions rests squarely with the adviser that has the client relationship.  Reliance on information provided by others is, without verification, apparently not reasonable.  Advisers should institute due diligence protocols to ensure that they are asking the right questions – and getting the right back-up – when it comes to performance data created by another entity.

Penalties assessed against 13 registered investment advisers caught up in the enforcement sweep ranged from $100,000 to $500,000.  All 13 firms settled without admitting or denying the charges.