Financial Planning Association of Central Virginia Forum 2014 Registered Investment Adviser Regulatory Update Presentation by: Jim Van Horn, Jr., Co-Managing Partner Investment Management Practice Group Hirschler Fleischer, PC June 5, 2014
Investment Adviser Regulatory Recap ( 10-14) June 21, 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act ( Dodd-Frank ) Repealed the 15-client registration exemption Modified the AUM thresholds for state v. federal registration Created new exclusions and exemptions from registration Required advisers to private funds to register with the SEC Refined the definition and regulation of family offices Added significant disclosure requirements to Form ADV Amended pay-to-play requirements Changed the dollar thresholds for qualified client exemptions from the general performance fee prohibition Required newly defined municipal advisers to register with the SEC Changed the regulation of derivative markets and swaps
Investment Adviser Regulatory Recap ( 10-14) Rulemaking Amendments to Form ADV (July 28, 2010) Political Contributions by Certain Investment Advisers (Pay-to-Play Rules) (July 1, 2010) Rules Implementing Amendments to Investment Advisers Act (June 22, 2011) Family Office Definition and Exemption (June 22, 2011) Venture Capital Fund, Private Fund Adviser and Foreign Adviser Registration Exemptions (June 22, 2011) Registration of Private Fund Advisers, Reallocation of Mid-Sized Advisers (i.e., $25mm - $100mm) from SEC to State (June 22, 2011) Reporting by Investment Advisers to Private Funds (Form PF) (October 31, 2011) Net Worth Standard for Accredited Investors (Dec. 21, 2011) Investment Adviser Performance Compensation (Feb. 15, 2012) Identity Theft Red Flags (April 10, 2013) Eliminating the Prohibition Against General Solicitation and General Advertising in Rule 506 and Rule 144A Offerings (Jul. 10, 2013) Disqualifications of Felons and Other Bad Actors from Rule 506 Offerings (Jul. 10, 2013) Broker-Dealer Reporting and Financial Responsibility Rules (Jul. 30, 2013)
Investment Adviser Regulatory Recap ( 10-14) FAQs Staff Responses to Questions about Part 2 of Form ADV (March 18, 2012) Frequently Asked Questions Regarding Mid-Sized Advisers (June 28, 2011) Staff Responses to Questions about the Custody Rule (December 13, 2011) Staff Responses to Questions about the Family Office Rule (April 27, 2012) Staff Responses to Questions about the Pay-to-Play Rule (July 27, 2012) Frequently Asked Questions about Form ADV (August 30, 2012) Frequently Asked Questions about Form PF (April 25, 2013)
Investment Adviser Regulatory Recap ( 10-14) IM Guidance Information for Newly-Registered Investment Advisers (Nov. 23, 2010) Guidance on the Testimonial Rule and Social Media (March 15, 2013) Update Compliance with Exemptive Orders (May 10, 2013) Update - Privately Offered Securities Under the Custody Rule (August 1, 2013) Status of Certain Private Fund Investors as Qualified Clients (Nov. 5, 2013) Update Fund Names Suggesting Protection from Loss (Nov. 13, 2013) Guidance on Exemption for Advisers to Venture Capital Funds (Dec. 2, 2013) Risk Management in Changing Fixed Income Market Conditions (Jan. 15, 2014) Multi-Manager Funds Aggregate Advisory Fee Rate (Feb. 24, 2014) Guidance on the Testimonial Rule and Social Media (March 28, 2014)
Investment Adviser Regulatory Recap ( 10-14) Investment Management Staff Issues of Interest Persons Who Provide Advice Solely Regarding Matters Not Concerning Securities (March 27, 2012) Advisory Contracts Transition for Newly Registered and Registering Advisers (March 30, 2012) Advisory Contracts Consent (June 15, 2012) Investment Advisers Registered with the CFTC that Advise Private Funds (November 15, 2012) Regulation of Investment Advisers: Outline and Staff Views (March 2013) Dodd-Frank Act Changes to Investment Adviser Registration Requirements (January 2013)
SEC National Exam Program Priorities (2014) Broker-Dealer and Investment Adviser Convergence Inappropriate client account brokerage v. investment advisory account Reverse churning migration of infrequently traded brokerage accounts to annual feebased accounts Evaluation of differing supervisory structures for brokers and advisers Retirement Vehicles/Rollovers/Variable Annuity Buybacks Examining sales practices of investment advisers targeting retirement-age workers to roll over 401(k) plans into higher cost investments, including whether the benefits and feature of IRA plans or other alternatives are misrepresented Examining broker-dealers and investment advisers for possible improper or misleading marketing and advertising, conflicts, suitability, churning, and the use of potentially misleading designation when recommending migration Suitability/disclosure around variable annuity buyback offers Technology Governance and supervision of information technology systems Operational capability, information security, and disaster recovery plans (DRPs) (Risk Alert, Aug. 27, 2013 Prompted by a review of responses to Hurricane Sandy)
SEC National Exam Program Priorities (2014) Rule 506(c) Offerings Review of marketing activities used in a new Rule 506(c) offering Adherence to Bad Actor rules Evaluate the due diligence conducted by broker-dealers and investment advisers used to verify accredited investor status of investors Safety of Assets and Custody Failure to recognize when an adviser has custody (e.g., the adviser serves as trustee, is authorized to write or sign checks for clients, or is authorized to make withdrawals from a client s account as part of bill-paying services) Failure to meet the custody rule s surprise examination requirements Failure to engage independent accountants for audit pooled investment vehicles Failure to satisfy the custody rule s qualified custodian requirements (e.g., commingling client, proprietary, and employee assets in a single account, or lacking a reasonable basis to believe that a qualified custodian is sending quarterly account statements to the client) Handling of physical stock certificates (especially private stock certificates)
SEC National Exam Program Priorities (2014) Marketing of Performance Identified as a core risk Use of hypothetical and back-tested performance Use and disclosure of composite performance figures (e.g., cherry picking or hide-theball) Failure to deduct fees from performance disclosures Performance record keeping and compliance oversight Failing to update the Form ADV and maintain consistency between Form ADV disclosures and marketing materials Wrap Fee Programs Failure to monitor wrap fee programs Related conflicts of interest, best execution duties, trading away and disclosure Quantitative Trading Models Have firms adopted compliance policies and procedures tailored to the model Are models used to manipulate markets Failure to maintain proper documentation in compliance with books and records rules Failure to maintain a current inventory of all firm-wide proprietary models
SEC National Exam Program Priorities (2014) Conflicts of Interest - (i.e., activities that put the interest of the adviser ahead of the clients in contravention of fiduciary duty) Compensation arrangements that may affect recommendations to clients (especially undisclosed arrangements) Improper allocation of investments opportunities Controls and disclosure associated with side-by-side management of performance-based and fee-only based accounts. Risk controls and disclosures for illiquid investments and leveraged investment products and strategies Higher risk products or strategies targeted to retail (especially retired or elderly) investors Insider Trading Failure to establish policies and procedures to handle material non-public information Failure to monitor personal and employee trades or maintain blackout lists Failure to supervise IARs for insider trading violations
SEC Presence Exams Continuing the Presence Exam Initiative Five Key Focus Areas Marketing Portfolio Management Conflicts of Interest Safety of Assets and Custody Valuation The majority of these new registered advisers manage private fund assets. Never-Before Examined Advisers Continue to target advisers that have never been examined and are not part of the Presence Exam Initiative Focused, risk-based examinations of advisers registered for more than 3 years, but not yet examined
Investment Adviser Compliance Corporate Governance SEC continues to evaluate the tone at the top Most enforcement actions involve one or more the following facts: Management was passive or uninterested in compliance Form ADVs and books and records were not updated regularly or consistent with actual practices Untrained and/or unqualified individual was named Chief Compliance Officer and/or placed in charge of compliance Written policies and procedures were forms that were never tailored to the actual operations, strategies and risks of the advisory business and did not resemble actual operations or practices No actions were taken to resolve deficiencies identified by the SEC in previous exams
Compliance Rule 206(4)-7 Written Policies and Procedures Tailor to the actual business practices of the adviser Review for adequacy and effectiveness at least annually Designate a qualified individual to be Chief Compliance Officer Maintain a compliance calendar with important dates highlighted to prompt action Rule 204(A)-1 Code of Ethics Reflects the fiduciary obligations and compliance with federal securities laws Require initial and annual securities holding reports and at least quarterly transaction reports of all personal securities transactions Require pre-clearance before a supervised person acquires any security Establish prohibitions on personal trading in securities the adviser is recommending Maintain a record of all written acknowledgements of receipt of the Code for each supervised person Maintain a record of any violation of the Code and the actions taken in response Maintain records of all personal securities holdings/transactions reports
Compliance Conduct an annual compliance review to test the effectiveness and adequacy of your compliance program Create a customized assessment of the firm s specific business operations, practices and relationship and how they have evolved since the last review Maintain a clear understanding of potential risks and conflicts and how they may arise Document all positive and negative findings Address and document the method of mitigating any negative findings Revised policies and procedures to make them effective, especially where the written policy or procedure did not work as designed Conduct a periodic review of all marketing and advertising materials Seek help! Compliance consultants Qualified attorneys Qualified accountants
Enforcement 160 140 120 100 80 60 40 20 0 Year-by-Year SEC Enforcement Statistics 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Broker-Dealer Investment Adviser/Investment Co. 686 cases in FY 2013 140 RIA/RIC cases (147 in FY 2012) 121 BD cases (134 in FY 2012) $3.4 billion in disgorgement and penalties (10% increase v FY 2012) (22% increase v FY 2011)
Enforcement Actions Compliance programs and supervisory structure Northern Lights Compliance Services, LLC (May 2, 2013) Carl D. Johns (Aug. 27, 2013) Chariot Advisors LLC (Aug. 21, 2013) Institutional Shareholder Services Inc. (May 23, 2013) Modern Portfolio Management, Inc. (Oct. 23, 2013) Equitas Capital Advisors, LLC (Oct. 23, 2013) Stephen Derby Gisclair (Oct. 23, 2013)
Enforcement Actions Failure to disclose allocation errors; cross trades Western Asset Management Company (Jan. 27, 2014) Performance and background claims Oppenheimer Asset Management Inc. (Mar. 11, 2013) ZPR Investment Management, Inc. (Apr. 4, 2013) Best execution Manarin Investment Counsel Ltd. (Oct. 2, 2013) A.R. Schmeidler & Co., Inc. (July 31, 2013) Goelzer Investment Management, Inc. (July 31, 2013) Soft dollar payments Instinet, LLC (Dec. 26, 2013)
Enforcement Actions Custody Further Lane Asset Management, LLC (Oct. 28, 2013) GW & Wade, LLC (Oct. 28, 2013) Knelman Asset Management Group, LLC (Oct. 28, 2013)
Enforcement Actions Modern Portfolio Management, Inc. (Oct. 23, 2013) Owners failed to correct ongoing compliance violations at the firm despite prior warnings from SEC examiners. One location on MPM s website misleadingly represented that the firm had more than $600 million in assets. However, on its Form ADV filing to the SEC during that same time period, it reported that the firm s assets under management were $359 million or less. The firm failed to conduct any compliance review in at least two years, notwithstanding the mandate of Advisers Act Rule 206(4)-7 that requires such a review and deficiency letters identifying the shortcoming. Owners failed to determine whether the designated chief compliance officer was familiar with SEC guidance governing performance advertising, but nonetheless made the chief compliance officer responsible for the review and approval of such advertising. Owners agreed to be censured and pay a total of $175,000 in penalties. Owners must complete 30 hours of compliance training, and MPM has agreed to designate someone other than owners or the prior CCO to be its chief compliance officer.
Enforcement Actions Western Asset Management Company (Jan. 27, 2014) WAM purchased $50 million of the initial offering of a $500 million private placement. The preliminary prospectus stated that an eligible purchaser excluded employee benefit plans subject to ERISA. Through a coding error (changing the security type from asset-backed security to corporate debt, WAM s automated compliance system, relied on to ensure compliance with restrictions regarding the type of securities that could be acquired for various accounts, incorrectly stated that the private securities were ERISA eligible. In October 2008 the firm learned from an email sent by a former institutional client that the private securities were not ERISA eligible. WAM identified the accounts impacted but did not immediately correct the error or notify the clients. Eventually the securities were sold at a loss. Clients were never informed. SEC alleged that the should have promptly disclosed the error to clients no later than December 2008 and that WAM had violated Section 206(2) (anti-fraud provision) and Rule 206(4)-7 (policies and procedures rule). The firm also failed to have adequate compliance policies and procedures requiring the notification of clients. To resolve the matter the firm agreed to implement a series of undertakings and consented to the entry of a cease and desist order, a censure and an agreement to pay disgorgement of $8,111,582, prejudgment interest and a civil money penalty of $1 million.
Enforcement Actions Klein and Michael Shechtman (September 20, 2013) Klein runs an RIA and was charged by the SEC in September 2013 with insider trading of King Pharmaceutical (King) stock prior to Pfizer s acquisition of the company. Klein learned about the planned acquisition from an attorney who worked for King. The attorney and Klein were friends and the attorney was a client of Klein s investment firm. The insider tip was allegedly conveyed at a dinner at the attorney s home. Klein bought shares of King for himself and 46 clients, including the attorney. After the acquisition was announced, Klein sold the King stock for himself and his clients, netting over $300,000 in profits. SEC did not demand that Klein or his firm be barred from the securities industry in the initial complaint
Enforcement Actions The Broken Windows Policy The theory that when a window is broken and later fixed, this signals that disorder will not be tolerated. When a broken window is not fixed, it sends a signal that breaking windows will bear no consequences. Chairman Mary Jo White (2013) The same theory can be applied to our securities markets minor violations that are overlooked or ignored can feed bigger ones, and, perhaps more importantly, can foster a culture where laws are increasingly treated as toothless guidelines.
Available for Questions Hirschler Fleischer, PC - multispecialty law firm headquartered in Richmond, Virginia. Attorneys at Hirschler Fleischer focus in specific specialty areas law such as investment management, commercial real estate, mergers and acquisitions, and alternative energy. Serving clients across the United States, Hirschler Fleischer prides itself on providing clarity in an increasingly complex maze of structural, financial, legal and regulatory dynamics surrounding each of these areas. Jim Van Horn, Jr. - Jim is co-chair of the IM Practice Group and he focuses his practice on representing institutional investors, private investment funds and other market participants in connection with a variety of transaction and compliance matters. Jim also advises investment advisers, wealth managers and broker-dealers concerning federal and state regulatory compliance and industry best practices. He can be reached at the following: James W. Van Horn, Jr. Hirschler Fleischer, PC The Edgeworth Building 2100 East Cary Street Richmond, VA 23223 (T): 804-771-9541 (E): jvanhorn@hf-law.com
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