Building an investment advisory business and onboarding new clients comes

Vol. 20, No. 5 May 2013 Compliance Issues for Establishing New Client Relationships: Part 2 of 2 By Heather Traeger, Kris Easter, and Matthew Cohen Building an investment advisory business and onboarding new clients comes with a cadre of regulatory and compliance issues under the Investment Advisers Act of 1940 (Advisers Act) and other federal and state laws. In Part One of this article, which appeared in the April 2013 issue of The Investment Lawyer, we identified and discussed some of the compliance issues that advisers face when beginning new client relationships, including solicitation arrangements, disclosure documents, and investment management agreements. This Part Two will discuss custodial relationships, Employee Retirement Income Security Act of 1940 (ERISA)-related regulations, voting proxies, and other issues. I. Fiduciary Obligations A fundamental element of the relationship between an investment adviser and its clients is the fiduciary duty owed by the investment adviser to its clients. 1 Ms. Traeger is a partner, Ms. Easter is counsel, and Mr. Cohen is an associate, in the Washington, DC office of O Melveny & Myers LLP. A. Generally As a fiduciary, an investment adviser has an affirmative obligation to discharge its duties solely in the best interests of its clients. 2 This translates into putting clients interests first, acting with utmost good faith, providing full and fair disclosure of all material facts, not misleading clients, and disclosing all conflicts of interest to clients. As a fiduciary, the investment adviser must be sensitive not only to intentional wrongdoing, but

also to unintentionally rendering investment advice that is less than impartial or less than disinterested. Areas in which advisers often fall short with respect to their fiduciary duty, as indicated by Securities and Exchange Commission (SEC) enforcement cases and examination findings, include disclosure, portfolio management, employees personal trading, performance calculations, and brokerage arrangements and execution. 3 When it comes to disclosure of conflicts of interest, for example, in these and other areas of an adviser s business, the adviser needs to fully disclose to its clients the nature of the conflict of interest and may have to seek client consent to engage in the activity or identify the steps, if any, taken to mitigate that conflict. For example, an investment adviser that manages assets of multiple clients and funds must adopt and disclose a policy that sets guidelines for the allocation of investments among the various clients and funds, although the policy can allow for fairly broad latitude in allocating the investments. Another example is found when an adviser engages in principal or agency transactions pursuant to Section 206(3) of the Advisers Act. Section 206(3) provides that an adviser may not (1) acting as principal for its own account, knowingly sell any security to or purchase any security from a client or (2) knowingly effect any sale or purchase of any security for the account of a client while acting as a broker for a third party (an agency cross transaction), without, in either case, disclosing to the client before the completion of such transaction, in writing, the capacity in which the investment adviser is acting and obtaining the client s consent. 4 The appropriate disclosure will depend upon the materiality of the facts in each circumstance and the nature of the particular client s relationship with the adviser. This prohibition against self-dealing (and potential price manipulation) and acting in transactions in which the investment adviser has divided loyalties overrides any investment discretion conferred on the investment adviser by contract. Advisers should be aware of the availability in Rules 206(3)-1 through 206(3)-3T of limited exemptions from and safe harbors for compliance with Section 206(3), 5 provided that certain conditions are fulfilled. Directed brokerage arrangements are another area in which an adviser has a disclosure obligation because of the associated conflicts of interest. An adviser may have conflicts between the clients interest in obtaining best execution and the adviser s interest in receiving future referrals or, when the executing broker under a directed brokerage arrangement is an affiliate of the adviser, the adviser s and its affiliate s interest in obtaining compensation from brokerage transactions. Consequently, the adviser must provide disclosure regarding any directed brokerage arrangements in its Form ADV brochure. The adviser should include the existence and terms of its practice regarding brokerage transactions, the effect of such practices on commission charges to its clients, the effect of directing brokerage on the adviser s ability to negotiate commissions, the resulting inability to obtain volume discounts or best execution for broker-directed accounts in some transactions, the resulting disparities in commission charges, and the potential conflicts of interest arising from referrals and directed brokerage practices. 6 Enforcement Actions Recent enforcement actions in connection with fiduciary obligations concentrated on conflicts of interest and lack of disclosure of such issues. For example, in Oxford Investment Partners, LLC and Walter J. Clarke, the SEC brought an action against an investment adviser for alleged violations of Sections 206(1), (2) and (4) by causing clients to invest in investments in which the adviser and its principal had personal and financial interests without first disclosing these facts. The SEC stated that these actions gave rise to plain conflicts of interest. The SEC also alleged that the adviser s principal sold a stake in his advisory business to a client when faced with financial problems, and fraudulently inflated the value of the advisory firm to make the client overpay for such stake. 7 In addition, in Belsen Getty, LLC, Terry M. Deru, and Andrew W. Limpert, the SEC entered an order against Deru for violating Section 206(3) by acting as THE INVESTMENT LAWYER 2

a principal for his own account and knowingly selling securities to clients without disclosing in writing the capacity in which he was acting and obtaining the consent of the clients prior to completion of the transactions. 8 The SEC also recently entered an order against an investment adviser and its principal for violating Sections 206(1), (2), and (4) by not fully disclosing certain conflicts of interest to clients and misrepresenting the liquidity of certain investments recommended to clients. 9 In the order, the SEC found that the adviser recommended that its clients buy certain securities without disclosing that the adviser would receive compensation from the issuer of the securities with respect to such sales, or disclosing the conflicts of interest related to the adviser s recommendation that clients purchase the securities. The adviser also sold interests in a pooled investment vehicle managed by the adviser to existing clients without disclosing the conflict of interest related to the adviser s fees for managing the pooled investment, and misrepresented the liquidity of investments held by the fund. 1. Have you fully disclosed to your clients the nature of any conflicts of interest? 2. Have you developed and implemented written policies and procedures to mitigate any conflicts of interest? 3. Do you have principal and personal trading policies and do you regularly train your employees on such policies? II. Custody of Client Accounts Rule 206(4)-2 under the Advisers Act requires registered investment advisers who have custody of client assets to take specific measures to protect those assets from loss. 10 Custody is generally defined as holding, directly or indirectly, client funds or securities, or having any authority to obtain possession of them. Under the rule, an adviser has custody if a related person has custody of securities or funds of the adviser s clients in connection with advisory services provided to such clients by the adviser. Rule 206(4)-2 provides three non- exhaustive examples of circumstances that cause an investment adviser to have custody of client funds and securities. First, any arrangement (including general power of attorney) pursuant to which the adviser is authorized or permitted to withdraw client funds or securities maintained with a custodian, including the right to deduct advisory fees, upon the adviser s instruction to the custodian, would cause the adviser to have custody for purposes of the rule. Second, an adviser s receipt and possession of client funds and securities triggers custody except where the adviser receives them inadvertently and returns them to the sender within three business days. Third, an adviser is deemed to have custody under the rule if it serves in any capacity that gives the adviser or a supervised person of the adviser legal ownership of or access to client funds or securities. As a result, an adviser is deemed to have custody of a private fund s securities and assets if the adviser or a related person of the adviser serves as a general partner or managing member of the private fund. The rule requires, among other things, that a registered investment adviser that has custody of client funds or securities maintain such funds or securities with a qualified custodian. A qualified custodian includes a bank, savings association, registered broker-dealer, and other institutions enumerated in the rule. The qualified custodian must maintain such funds or securities in either a separate account in the client s name or in accounts containing only funds or securities of the adviser s clients in the name of the adviser as agent/trustee for the clients. Advisers must notify clients upon engaging a qualified custodian and keep clients informed as to any changes in the qualified custodian s information. Further, the adviser must have a reasonable basis, after due inquiry, for believing that the qualified custodian sends an account statement, at least quarterly, to each of the adviser s clients for which it maintains funds or securities. Such quarterly account statements must include all transactions from the account during the applicable period. The rule also requires, subject to certain exceptions, that an investment adviser undergo a surprise examination on an annual basis with respect to client funds and securities for which the adviser has custody. Specifically, such client funds and securities must be verified at 3 Vol. 20, No. 5 May 2013

least once during each calendar year by an independent public accountant, pursuant to a written agreement between the adviser and the accountant, and conducted without prior notice to the adviser of the timing of the examination and at times that are irregular from year to year. Advisers should be aware that, in addition to the requirements described above, certain heightened requirements apply where the adviser or a related person of the adviser serves as the qualified custodian (as opposed to where the related person has custody under the rule) for the adviser s clients in connection with advisory services the adviser provides to the clients. For example, the adviser or a related person may be registered with the SEC as a broker-dealer or may be a bank, and therefore able to serve as qualified custodian under the Rule. In such instances, the adviser must obtain, or its related person must obtain and provide to the adviser, an internal control report within six months of the adviser or its related person commencing the role of qualified custodian and at least once each calendar year thereafter. The internal control report must be prepared by an independent public account registered with, and subject to inspection by, the Public Company Accounting Oversight Board (PCAOB) and must meet certain other requirements outlined in the Rule. Certain heightened requirements also apply in such circumstances to any surprise examination that the adviser must undergo. The rule contains several exceptions that provide relief from one or more of its requirements. First, none of the rule s requirements apply to accounts of registered investment companies managed by an adviser. Instead, an adviser must adhere to the custody requirements in Section 17(f) of the Investment Company Act of 1940 with respect to registered investment companies managed by the adviser. Further, pooled investment vehicle assets for which an adviser has custody generally are exempt from all of the rule s requirements except the qualified custodian requirement if: the pooled investment vehicle is subject to audit at least annually by an independent public accountant registered with, and subject to inspection by, the PCAOB (as of date engagement commences and as of end of each calendar year); the adviser distributes the pool s audited financial statements prepared in accordance with generally accepted accounting principles (GAAP) to all limited partners (or members or other beneficial owners) within 120 days of the end of the pool s fiscal year; and the pool is subject to audit upon liquidation and distributes its audited financial statements prepared in accordance with GAAP to all limited partners (or members or beneficial owners) promptly upon completion of the audit. 1. Do you have procedures in place to protect client assets from loss or misappropriation? For example, have you designated the person(s) with authority to withdraw or transfer client assets from the custodial account? Do you require second-level approval to authorize any withdrawal or transfer? 2. Have you provided adequate instructions to the custodian regarding the person(s) with authority to withdraw or transfer assets from each account? 3. What steps do you take to form a reasonable belief that all clients receive periodic statements directly from any qualified custodian you select on behalf of a client? Do you receive a copy of the statements sent by the custodian to your clients? Do such statements adequately and accurately explain all account activity? III. ERISA Requirements By having clients who are employee benefit plans, fund advisers are subject to ERISA. To establish whether new investors are employee benefit plans, fund advisers typically have ERISA-related representations in the funds subscription documents. Once advisers have determined the extent of employee benefit plan participation, fund advisers should determine whether to qualify for an exemption from ERISA or operate as an ERISA fund. A. Exemptions Pursuant to the Plan Asset Regulation promulgated by the Department of Labor, THE INVESTMENT LAWYER 4

funds traditionally rely on what is commonly known as the 25% Test for their exemption from ERISA. The 25% Test exemption limits investment by benefit plan investors (as such term is defined in ERISA) to less than 25%, so as to avoid the assets of the fund being treated as plan assets of benefit plan investors for purposes of ERISA. The 25% Test is calculated as of any date and with a couple of unique aspects. Equity interests in the fund held by the adviser and its affiliates do not count toward the 25% limit. If the fund structure is a master-feeder set up, the 25% Test could apply to each feeder fund and separately to the master fund, but further analysis would be warranted in this scenario. There are other exemptions available besides the 25% Test. A fund that operates as a venture capital operating company (VCOC) or a real estate operating company (REOC) may also be exempt from ERISA. A fund qualifies as a VCOC if (1) on the day on which it makes its first long-term investment and during a pre-established 90-day annual period, at least 50 percent of its assets are invested in venture capital investments or derivative investments, as defined by ERISA, and (2) on an annual basis, the fund exercises management rights (within the meaning of the Plan Asset Regulation) with respect to the management of the operating company. Advisers may satisfy the latter requirement by obtaining a board seat in conjunction with the fund s first investment if it entails the right to substantially participate or influence the operating company s management. A fund qualifies as a REOC if it (1) invests in real estate which is managed or developed with respect to which the fund has the right to substantially participate directly in the management or development activities, and (2) on an annual basis is, in the ordinary course of its business, engaged directly in real estate management or development activities. B. Operating as an ERISA Fund If the assets of the Fund are deemed to include benefit plan assets, or if the investment adviser chooses to operate as such, the fund will be considered an ERISA fund and be subject to ERISA s reporting and disclosure requirements, as well as the bonding, the fiduciary responsibility, and the prohibited transaction provisions of ERISA and the Internal Revenue Service (IRS) Code. The investment adviser must be registered with the SEC and acknowledge its status as a fiduciary (within the meaning of ERISA) with respect to each investor that is a benefit plan investor during all such times as the assets of the fund are treated as plan assets for purposes of ERISA. The investment adviser, for practical purposes, should qualify as a qualified professional asset manager (within the meaning of US Department of Labor Exemption 84-14) during all such times as the assets of the fund are treated as plan assets for purposes of ERISA. The investment adviser must also deliver available information to each benefit plan investor in order for such investors to make their annual filings of Form 5500 with the Department of Labor, as well as reasonable information held by the investment adviser to assist such investors compliance with Section 408(b)(2) of ERISA with respect to the fees charged by the investment adviser. The investment adviser must further acknowledge that it will use its best efforts to avoid any prohibited transactions under Section 406 of ERISA or Section 4975 of the IRS Code with respect to each benefit plan investor. For example, unless a statutory or class exemption is available, or an individual exemption is obtained from the Department of Labor, advisers are prohibited from cross trading with benefit plan assets, as the Department of Labor views such transactions as prohibited transactions under Section 406(b) of ERISA. In addition, ERISA fund advisers have specific obligations with respect to voting proxies and tendering shares (see below for a more general discussion on proxy voting). Finally, ERISA fund advisers are subject to ERISA s prudent man standard that requires such adviser to discharge its duties solely in the interests of the ERISA fund with the care, skill, prudence, and diligence under the circumstances that a prudent man acting in a similar manner with appropriate knowledge would use in a similar situation. To meet the prudent man standard, an ERISA fund adviser should give appropriate consideration to the surrounding facts and circumstances that such adviser should 5 Vol. 20, No. 5 May 2013

know are relevant to a particular investment decision. 1. If operating as an ERISA fund, have you established procedures for providing information necessary for such investors annual filings of Form 5500 and compliance with Section 408(b)(2) of ERISA? 2. Do you have procedures in place to help prevent cross trading with benefit plan assets? IV. Anti-Money Laundering In general, advisers currently are not subject to rules implemented by the Financial Crimes Enforcement Network (FinCEN), a bureau of the US Department of Treasury (Treasury), requiring them to establish anti-money laundering (AML) programs. 11 In 2003, FinCEN proposed an AML Program Rule for investment advisers, but subsequently withdrew its proposal. Advisers that are US persons, however, are subject to regulations implemented by the US Office of Foreign Assets Control (OFAC), a Bureau of the Treasury that administers and enforces economic sanctions programs primarily against countries and groups of individuals, such as terrorists and narcotics traffickers. Advisors should ensure their compliance programs incorporate procedures for compliance with OFAC rules. As a best practice, many investment advisers have implemented AML Programs as part of their overall compliance programs. Investment advisers that want to comply voluntarily with FinCEN s AML Program requirements to prevent money laundering under US federal law and ensure compliance with OFAC should develop and implement policies and procedures for knowing their clients and the source of their clients funds. This Customer Identification Program (CIP) should include risk-based procedures for verifying the identity of each client to the extent reasonable and practicable. The procedures should be tailored to the types of risks presented by the various accounts maintained by the adviser and the methods for opening such accounts. Overall, the adviser s procedures should enable the adviser to form a reasonable basis for believing it knows the true identity of each client. In addition, the CIP procedures should address the following: (1) what methods an adviser will take to verify the identity of the natural persons with authority or control over client accounts where the client is not a natural person; (2) what steps the adviser will take if it is not able to form a reasonable belief that it knows the true identity of the client including, among other considerations, when it should not open an account or the terms under which the client may conduct transactions while the adviser continues to try to verify the client s identification; (3) the process by which an adviser will determine if a customer appears on any list of known or suspected terrorists or terrorist organizations issued by any federal government agency and the steps advisory personnel should take to follow any directives issued in connection with such lists; and (4) the provision of notice to prospective clients regarding the adviser s identity verification process. Advisers to non-natural person clients should consider requiring new clients to make representations in their subscription agreements relating to the source of such clients funds, including: (1) that the client has implemented a CIP as required under Section 326 of the USA PATRIOT Act and the regulations promulgated thereunder by the Treasury (CIP Rule); (2) that the client has conducted the required internal due diligence; and (3) that the client and its customers or beneficial owners are not named on the List of Specially Designated Nationals and Blocked Persons maintained by OFAC. An adviser that manages private funds should consider including certain information in a private fund s subscription documents. For example, in the event of delay or failure by the subscriber or client to produce any information required for verification purposes, an adviser may want to refuse to accept a subscription or cause the withdrawal of any such investor from a fund. The investment adviser may also want the ability to suspend the payment of any distributions payable to such investor if the adviser reasonably deems it necessary to adhere to its AML procedures and to satisfy any anti-money laundering regulations on a voluntary basis. THE INVESTMENT LAWYER 6

A. Reliance by Financial Institutions Pursuant to FinCEN s CIP Rule, a brokerdealer may rely on another financial institution to perform any procedures of the broker- dealer s CIP with respect to customers of the brokerdealer that are opening accounts or already have accounts with the other financial institution provided certain conditions are satisfied. The SEC Staff has provided no-action relief permitting broker-dealers to treat an investment adviser as if it were subject to AML regulations and to rely on the investment adviser to perform the CIP procedures. Advisers therefore may want to consider their relationships with broker-dealers in determining whether or not to comply voluntarily with CIP rules. Pursuant to SEC Staff no-action relief, broker-dealers may rely on a US investment adviser that is registered as an adviser with the SEC to verify the identity of a shared customer for purposes of the CIP Rule if such reliance is reasonable and the adviser contractually agrees to certain terms. Under the conditions of the relief, an adviser must contractually agree that: It has implemented its own AML Program consistent with the specified requirements of the Bank Secrecy Act and will update its Program as necessary to comply with any changes to the law; It will perform the specific requirements of the broker-dealer s CIP consistent with relevant laws and rules; It will promptly disclose to the broker- dealer potentially suspicious or unusual activity detected in carrying out the broker-dealer s CIP to enable the broker-dealer to file a SAR as necessary; It will certify annually to the broker- dealer that the representations in the reliance agreement remain accurate and that it is in compliance with such representations; and It will promptly provide its books and records relating to its performance of the CIP on behalf of the broker-dealer to the SEC or a self-regulatory organization with jurisdiction over the broker-dealer upon request. Additionally, a broker-dealer must engage in some due diligence to assess the money laundering risk presented by an investment adviser or its customer base to determine if reliance on that investment adviser is reasonable under the circumstances. The foregoing requirements were promulgated by a no-action position taken by the SEC Staff in 2011, 12 and were recently reaffirmed and extended until January 2015. 1. Does your compliance program incorporate procedures for compliance with OFAC rules? 2. Have you analyzed the types of risks presented by your various clients and tailored a CIP to address such risks? 3. If you provide advisory services to pooled investment vehicles, have you drafted your subscription agreement to require investors to produce any information required for verification purposes? 4. Do any broker-dealers with which you have a relationship rely on you to fulfill their CIP requirements? If so, have you established a process for ensuring you adhere to the requirements promulgated by the no-action position taken by the SEC? 5. Do you have a training program for your employees regarding AML and, in particular, CIP, obligations? V. Voting Proxies Investment advisers typically have the authority to vote proxies on behalf of their clients holdings. Unless the advisory contract explicitly reserves or assigns the proxy voting authority to the client, investment advisers will retain such proxy voting authority. With proxy voting authority, advisers have a fiduciary duty to vote such proxies in the best interests of clients. To effectuate this fiduciary duty, some investment advisers establish proxy committees that manage the proxy voting process and engage third-party proxy voting services. Notwithstanding, rules under the Advisers Act require registered advisers that have proxy voting authority to meet four obligations with respect to such authority. 13 Rule 206(4)-6, governing proxy voting, imposes three of these obligations and Rule 204-2 imposes the fourth. First, investment advisers with proxy authority must establish and maintain written 7 Vol. 20, No. 5 May 2013

policies and procedures for such proxy voting. The policies and procedures must be designed to ensure that proxy voting by the adviser will be conducted in the best interests of clients. The policies and procedures must also address how conflicts of interest are treated. Second, investment advisers must describe their written proxy policies and procedures to clients, indicate that a copy is available upon request, and provide a copy to the client if requested. Third, investment advisers must inform clients how they can obtain information on the advisers proxy voting history. Finally, pursuant to Rule 204-2(c)(2) under the Advisers Act, advisers must create and maintain five types of records in connection with proxy voting: (1) a copy of the proxy policies and procedures; (2) copies of all proxy statements received for the securities owned by the fund; 14 (3) copies of all votes cast on behalf of the fund; (4) records of all client requests for proxy voting information and responses thereto; and (5) any material records created in the course of the advisers proxy voting decision-making process. 15 1. Do your written policies and procedures address the unique types of conflicts of interest that may arise with respect to proxy voting for your clients? 2. Do your procedures assign responsibility for monitoring corporate actions and making voting decisions? 3. Does your disclosure to clients accurately and concisely describe how you will handle the proxy voting process? VI. Red Flags In early 2012, the SEC and the Commodity Futures Trading Commission (CFTC) proposed rules to help protect clients from identity theft by requiring investment advisers to create programs to detect and respond appropriately to suspicious activity or red flags. 16 The rules proposed by the SEC would require the adoption of a written identity theft program (Program) that would include reasonable policies and procedures that identify and detect relevant suspicious activity, respond appropriately, and involve periodic updates. The periodic updates would be to reflect changes in the risks to clients and to the safety and soundness of the adviser s business from identity theft. The Program would be in connection with the opening of a new client account, as well as any existing client account, and be tailored to the investment adviser s business activities. Along with the proposed rules, the SEC proposed guidelines designed to provide investment advisers assistance in the development and administration of their Program. While the SEC s and CFTC s proposed rules were not finalized by the date this article went to print, they are modeled (as required by the statute) after the Federal Trade Commission s (FTC) Red Flags Rule that currently is applicable to certain fund advisers. The FTC s Red Flags Rule requires certain financial institutions to implement an identity theft prevention program designed to detect red flags of identity theft in day-today operations. For purposes of the Red Flags Rule, the FTC s definition of financial institutions includes institutions that hold transaction accounts, including mutual funds that offer accounts with check writing or debit card privileges. Investment advisers to such funds would therefore fall under the FTC s jurisdiction with respect to the Red Flags Rule and be required to develop an identity theft prevention program that includes reasonable policies and procedures that: (1) identify relevant patterns, practices, and specific forms of red flag activity that indicate possible identity theft; (2) incorporate business practices to detect red flags; (3) detail an appropriate reaction to any red flags detected to prevent and mitigate identity theft; and (4) must be updated periodically. The Red Flags Rule also provides guidelines for the establishment and maintenance of the identity theft prevention program, including examples of red flags to detect. The Red Flags Rule further requires a financial institution to train personnel to effectively monitor and administer its identity theft prevention program. 1. Have you analyzed the possible risks of identity theft associated with your business? 2. Have you developed and implemented policies and procedures tailored to the unique risks you have identified? Do such procedures establish processes to help identify THE INVESTMENT LAWYER 8

and detect relevant suspicious activity and to respond appropriately to threats? 3. Do you regularly train your employees to identify emerging risks and vulnerabilities and red flags? VII. Conclusion The above discussion provides only a broad overview of the obligations triggered with respect to onboarding new clients. Other considerations not discussed include, for example, tax related matters (for example, Foreign Account Tax Compliance Act (FATCA)) and the SEC s new lost securities rule. 17 Investment advisers should consult their counsel as to the full array of compliance issues applicable to their specific business. Once educated on the various compliance obligations for new clients, investment advisers should develop and maintain policies and procedures addressing each such obligation. Although such policies and procedures may include a checklist for requirements related to onboarding new clients, a checklist should be a starting point for compliance. Advisers should also initiate annual internal evaluations and routinely update such policies and procedures to ensure that they are working, they are working in the manner described in the adviser s disclosure, and they are current with developments in the law or industry practice. Notes 1. See January 2011 Study by SEC Staff entitled, Study on Investment Advisers and Broker-Dealers, available at http://www.sec.gov/news/studies/2011/913studyfinal.pdf. 2. SEC v. Capital Gains Research Bureau Inc., et. al., 375 U.S. 180 (1963). 3. A September 2012 Internet article stated that breach of fiduciary duty was the number one complaint in FINRA arbitrations. See Breach of Fiduciary Duty No. 1 Complaint in FINRA Arbitration Cases, available at http://www.advisorone.com/2012/09/25/ breach-of-fiduciary-duty-no-1-complaint-in-finra-a. 4. Section 206(3) applies not only to transactions by advisers that are also broker-dealers, but also to transactions effected by a broker-dealer affiliated with an investment adviser. 5. See generally, Adoption of Rule 206(3)-1 Under the Investment Advisers Act of 1940 and Termination of Temporary Rule 206(3)-1(T) Under that Act, Release No. IA-470 (Aug. 20, 1975). See also, Rules Implementing Amendments to the Investment Advisers Act of 1940, Release No. IA-1633 (May 15, 1997), Temporary Rule Regarding Principal Trades with Certain Advisory Clients, Release No. IA-2653 (Sept. 24, 2007), and Temporary Rule Regarding Principal Trades with Certain Advisory Clients, Release No. IA-3522 (Dec. 20, 2012). 6. In the Matter of Mark Bailey & Co. and Mark Bailey, Advisers Act Release No. 1105 (Feb. 24, 1988). 7. In the Matter of Oxford Investment Partners, LLC and Walter J. Clarke, Advisers Act Release No. 3412 (May 30, 2012). 8. In the Matter of Belsen Getty, LLC, Terry M. Deru, and Andrew W. Limpert, Securities Act Release No. 9336 (Jul. 11, 2012). 9. In the Matter of Western Pacific Capital Management, LLC and Kevin James O Rourke, Securities Act Release No. 67891 (Sep. 19, 2012). 10. See generally, Custody of Funds or Securities of Clients by Investment Advisers, Release No. IA-2968 (Dec. 30, 2009); see also Custody of Funds or Securities of Clients by Investment Advisers, Release No. IA-2176 (Sep. 25, 2003). 11. Certain investment advisers, however, are subject to rules implemented by the Board of Governors of the Federal Reserve System that require non-bank subsidiaries of bank holding companies to report suspicious activity by filing a Suspicious Activity Report (SAR). 12. The no-action relief is substantially similar to a noaction position SEC Staff took in 2004, and again in 2005, 2006, 2008, and 2010. 13. In adopting Rule 206(4)-6, the SEC noted that the rule did not alter or reduce any fiduciary duty applicable to any investment adviser or person associated with an investment adviser. Consequently, unregistered advisers should be mindful of their fiduciary obligations to clients if they have proxy voting authority. See generally, Proxy Voting by Investment Advisers, Release No. IA-2106 (Jan. 31, 2003). 14. An adviser may rely on proxy statements filed in the SEC s EDGAR system instead of maintaining its own copies. Rule 204-2(c)(2). 15. Investment advisers to registered investment companies should be aware of mutual funds proxy voting obligations to shareholders. In addition to having policies and procedures for proxy voting and disclosure of such procedures, mutual funds must publicly disclose their proxy voting history. See also Disclosure of Proxy voting Policies and Proxy Voting Records by Registered Management Investment Companies, Release No. 33-8188 (Jan. 31, 2003). 16. See generally Identity Theft Red Flags Rules, Investment Company Act Release No. 29969 (Feb. 28, 2012). 17. New Exchange Act Rule 17AD-17 requires a paying agent to send notice to a client who has not cashed a check for six months. Advisers who contract with another entity to act as paying agent and are not distributing payments to security holders themselves would be excluded from the rule requirements. 9 Vol. 20, No. 5 May 2013

Copyright 2013 CCH Incorporated. All Rights Reserved Reprinted from The Investment Lawyer May 2013, Volume 20, Number 5, pages, 28 36, with permission from Aspen Publishers, Wolters Kluwer Law & Business, New York, NY, 1-800-638-8437, www.aspenpublishers.com