Securities Compliance Sentinel - Analysis of Cutting Edge Securities Industry Issues

Hardly a day goes by without hearing horrible stories of a person having their identity stolen and their finances ruined as a result.  The SEC is now stepping into this hornet’s nest by adopting new rules for financial advisors who have the authority to move client funds to third parties. 

The new rules require firms to set up red flag files to track their movement of money and to watch out for identity theft.  Advisory firms must specify the red flags that they use, and how they propose to respond when such red flags are found. 

If firms do not move client funds to third parties, they will still be required to periodically review whether this status has changed, which would require implementation of the red flags.  The SEC noted some basic things that advisors can look for when it comes to possible identity theft. 

Such red flag conduct includes, among others, instructions coming from a client with a new email address; a client saying he has changed an address; a client who wants to invests in a place where he has never invested before; or a client who has requested many credit reports. 

The easiest response by any firm is to call the client to confirm the instructions.  Do not hide behind an email because the email may be bogus.  If the situation is extreme, you may need to contact law enforcement. 

Putting aside the new SEC rules, it is a worthy venture for all firms to look into their policies and procedures when handling client funds to avoid the tragedy that could result from identity theft.  Develop protocols to look for and react to possible identity theft.  Your clients will expect you to do so.

* Photo from freedigitalphotos.net

FINRA announced that it is seeking proposed rule changes to make it easier for investors to use BrokerCheck.  See http://www.finra.org/Investors/ToolsCalculators/BrokerCheck/.

These proposed amendments to FINRA Rule 2267, Investor Education and Protection, would require member firms to include a BrokerCheck reference on their websites and those of any associated person.  Additionally, FINRA Rule 8312, BrokerCheck Disclosure, would be amended to allow the public permanent access to BrokerCheck information on state or foreign settled cases against associated persons as well as permit various data downloads.

Essentially, FINRA wants to ensure that BrokerCheck remains a key resource for investors.

The Chief of the SEC's Enforcement Division's Asset Management Unit, recently, indicated that the SEC Staff is now looking at identifying hedge and private equity fund RIAs, who may have higher risk issues like previous fraud allegations.  See http://www.sec.gov/news/speech/2012/spch121812bk.htm

In particular, the SEC is looking at when RIA managers delay fund liquidation to continue to receive fees-- the so-called "zombie fund" position.  The SEC Staff is also concerned about complex and/or illiquid assets in these funds.  The SEC Staff believes that these issues will only worsen when the full impact of the JOBS Act comes on-line.  Those changes will cause greater solicitations, and could lead to greater problems.  As a result, the SEC Staff will concentrate on performance fees, incentives, valuation inflation, insider trading, and conflicts of interest.

As a result, RIAs must take precautions to ensure they avoid the SEC wrath.

The SEC's Division of Investment Management allowed a sanctioned broker-dealer official to be paid a cash solicitation fee from a RIA.  See J.P. Turner & Co. LLC, SEC No-Action Letter, avail. 9/10/12, and http://www.sec.gov/divisions/investment/noaction/2012/jpturner091012-206-4.pdf.

The SEC Staff allowed the cash fees because the sanctioned official was not engaged in cash solicitation activities in his individual capacity.  The SEC Staff granted the relief noting the firm will conduct any cash solicitation arrangement in compliance with IA Rule 206(4)-3, and will comply with the terms of the administrative order for 10 years. 

This broker has to follow the SEC rules to permit this individual to receive cash fees, any other approach would be a serious violation.

With the new year here, the SEC is beginning its registered investment adviser inspection program. 

There are, generally, routine, compliance, cause and sweep examinations and inspections.  Depending upon where your investment adviser sits, the RIAmay be subject to one of these examinations.  Generally, new RIAs are more, frequently, examined than those that have an established history.  Of course, this is different if it were part of a cause examination or a sweep examination.  Further, depending upon the type of examination, the SEC inspection will cover a broad range of matters, including, but not limited to, the form ADV, filings and reports, the financial condition, internal controls, portfolio management, conflicts of interest and brokerage and execution, among other things.

More importantly, the SEC has announced that it really is looking for a culture of compliance.  That is, the SEC will review RIAs to see the importance compliance plays at the firm by examining where risk is reported, routine reports to senior management, regular evaluation, compliance calendars, checklists and work papers, among other things.

In preparation for these exams, RIAs are strongly encouraged to review all of their documentation to see if there are any issues that maybe corrected before the SEC arrives.  Further, RIAs need to educate personnel in interfacing with the SEC so as to ensure candor and cooperation.  This training is as detailed as arranging for a conference room or office space for the SEC, and politely restricting the SEC staff from roaming freely around the offices.  When undergoing inspections, RIAs should maintain a list of all documents provided to the SEC.  A best practice would be for the RIA to appoint one person as the contact person with SEC to discuss issues and be the gatekeeper for questions coming from the SEC.  RIAs must be organized to meet with the examiners, and answer their questions candidly and provide them with the information requested so that the inspection will take as little time as possible.  Finally, advisers should be prepared to receive and respond to follow-up from the SEC, including, but not limited to, deficiencies.

Advanced planning will play a large role in ensuring a smooth SEC examination, and, hopefully, providing RIAs with some peace of mind.

The SEC's Division of Investment Management has publicly stated that it will review the regulations relating to the Investment Advisers Act of 1940 given the large influx of new RIAs as a consequence of the registration of hedge and private equity fund managers.

These new RIAs, now, account for roughly 40% of all RIAs.  IM is looking to determine if it needs to change or adapt the Advisor’s Act to deal with these new investment advisers.  Although the SEC is routinely criticized for not adapting to market changes, it seems that the SEC Staff is actually taken a pro-active approach with this issue.

Change, however, is not as quick.

The SEC inspections of RIAs have been showing that certain RIAs have poor controls in place. 

The SEC has been seeing in these inspections that the RIAs have been utilizing poor internal controls in their businesses.  Many of these reports derive from the recent new advisers to hedge and private equity funds.  These RIAs were required to be registered by the Dodd-Frank Act.

Importantly, RIAs must review their controls to ensure proper management.  There really is no excuse for having poor controls in place.

Despite past false starts and losses, the SEC has announced that it will continue to bring actions against individuals and control persons.

Many believe that such a focus by the SEC will lead to more litigation.  Further, an individual's ability to defend these actions has been severely limited since the passage of the Dodd-Frank Act.  The Dodd-Frank Act, now, allows the SEC to merely prove as the standard reckless conduct when alleging aiding and abetting violations in stark contrast to the previous standard of proving actual knowledge of the fraud being committed by another party.  Additionally, given the SEC’s recent court injunction setbacks and settlement problems with federal judges, it is possible the SEC may use its administrative courts more, especially since the remedies in both forums are nearly identical.  One exception to this switch may be, however, insider trading.

In short, if you are an individual or control person in the securities industry, there is no escape: the SEC is watching you.

RIAs are certainly in the cross-hairs of the SEC.  The SEC, recently, sanctioned a RIA for misrepresenting its use of performance models that were actually hypotheticals relating to backtested performance.  http://www.sec.gov/litigation/admin/2012/ia-3516.pdf.

The SEC alleged that the RIA played with certain computer software models providing a false impression of performance over various time periods.  The SEC claimed these models did not exist during these time periods, but were back-tested hypotheticals.  The SEC accused the RIA of violating the anti-fraud and compliance rules since the RIA was also the Chief Compliance Officer, and had no policies or procedures in place to prevent such a scheme.  The RIA had to pay a six-figure fine, and retain an outside consultant. 

Accordingly, RIAs need to have effective compliance programs to monitor these types of hypothetical models.

The SEC, recently, sued a private equity fund adviser for, among other things, allegedly violating Investment Advisers Act of 1940 Rule 206(4)-7, for failing to have procedures requiring verification of client signatures and instructions by a second person.  See http://www.sec.gov/litigation/complaints/2012/comp-pr2012-244.pdf.

The SEC stated that the RIA and its principal made certain unauthorized transactions and used clients’ funds to pay off debt owed by the principal.  The specific violations related to Rule 206(4)-7, involved the RIA’s failure in not having a second set of eyes review client signatures and other instructions.  The SEC believed this would have prevented these defalcations.  Essentially, the SEC argues that a “shadow” is necessary to avoid these unlawful acts.  Interestingly, however, this type of illegal activity alleged seems to take place even with the best of compliance programs.

Nonetheless, RIAs must be vigilant in ensuring that more than one person reviews both client signatures as well as instructions, and, who knows, the “shadow” may just save the firm.

Recently, a registered investment adviser and its principal had to pay approximately $500,000 in disgorgement and penalties when they used an affiliated broker-dealer to charge clients higher commission rates.  See http://www.sec.gov/litigation/admin/2012/34-68118.pdf

The SEC found that the RIA and its principal, essentially, mislead their advisory clients by representing the clients were receiving a discount on commissions when the trades were placed through the affiliated BD.  In fact, the SEC stated these advisory clients paid higher rates than the BD charged the RIA, and the RIA and principal pocketed the difference.  The RIA did, however, disclose the potential conflict of interest in its Form ADV, but omitted any discussion on the compensation.  For good measure, the SEC also found the RIA failed to have any best execution review despite such a description contained in the Form ADV.

This enforcement action clearly portrays a more activist SEC on these issues so RIAs and their principals really need to be prepared by ensuring their Form ADVs are accuarate and disclose all conflict of interest information including fees and commissions.  Most likely, this will also be a particular concern during SEC RIA and BD exams, yet another potential hot point.

 A simple review of FINRA’s enforcement proceedings demonstrates a new norm; compliance officers are being held accountable as supervisors for rules violations.  How can a compliance officer avoid being held accountable as a supervisor?

The best way for compliance to insulate yourself is to make sure that there are clear divisions between compliance and supervisory duties.  For one, compliance officers should not be managing the day to day operations of the firm, such as hiring and firing personnel.  Instead, compliance should only make “recommendations” to supervisors when it comes to compliance issues.

Another effective tool is to have separate written supervisory procedure manuals for supervisors and compliance officers.  The firm may call the manuals two different things as well.  For example, you may want to call the compliance manual the “ethics” manual and the other the “supervisors’ manual”. 

Similarly, in those manuals, you should define the roles of those in a supervisory versus compliance capacity.  Depending upon the size of the firm, you may want to consider naming in your manuals the individuals who serve in those capacities.  The manuals should be revised every year to reflect personnel changes.

One last method to consider is for the chief compliance officer to ask the supervisors on a monthly basis whether they are aware of anything requiring a Rule 4530 disclosure. 

This guidance is no guaranty that a regulator will not try to couch compliance as supervision, but doing nothing is not an option.  Define roles, act separately, and protect yourself from being miscast as a supervisor.

In a decision that presents a pretty good “wake-up call,” the Texas Court of Appeals ruled that, when investment advisers are being sold, it should be done with a definitive contract laying out clear terms.

The Texas Court of Appeals in, Fiduciary Financial Services of South West Inc. v. Corilant Financial LP, TX. Ct. App. No. 05-10-00471-CV (July 30, 2012), reversed the lower court order awarding a purchaser over nearly $2 million in damages and attorney’s fees.  The Texas Court of Appeals indicated that the initial letter of intent for the acquisition of the stock of the registered investment adviser being purchased was too vague.  The Court stated that there was no evidence of a mutual understanding as to the terms whereby the buyer would pay the seller.  Essentially, the court found that there were missing terms, and, ultimately determined that it would not allow the supplying of an essential term since the parties did not or could not come to some agreement on that term.  Accordingly, the Court said that the letter of intent, since it was missing this essential term, would be unenforceable as a matter of law.

The court also determined that there were certain other provisions of a material nature that were left open for future negotiation.  As such, the agreement was indefinite, resulting in it being unenforceable as well. 

In short, although there is a very active market in the sale of broker-dealers and investment advisers, this case highlights the importance courts place on definitive terms in the parties’ sale agreements.  Parties must avoid this problem by ensuring that all the prerequisites are contained in their agreements.

In an interesting no-action letter, the SEC Staff stated it would not recommend enforcement action if a company did not register as an investment adviser where the company provided investment advisory services solely to its parent company and subsidiaries.  See Allianz of America, Inc., dated May 25, 2012, at http://www.sec.gov/divisions/investment/noaction/2012/allianzamerica052512-203a.htm.

The SEC Staff found that this entity need not register with the Commission as an investment adviser.  The Staff stated that, although Section 202(a)(11) of the Investment Advisers Act required anyone providing advice to others regarding securities for compensation to be registered with the SEC, this entity claimed it did not advise non-affiliated third parties, but only its parent company and wholly owned subsidiaries.  Further, the entity provided to the SEC Staff no-action letter and exemptive relief authority where other companies in similar situations were not required to be registered.  Accordingly, the SEC Staff granted the request of no action relief. 

In sum, if you can keep it in-house, registration will not be necessary.

The SEC has announced that it is extending the deadline for investment advisers to comply with its pay-to-play rule ban against third-party solicitations in order to have an "orderly transition".  The SEC is making this accommodation to account for its delay in defining the term "municipal advisor", which is exempted from the ban.  This extension will allow investment advisers and third-party solicitors additional time to adjust their respective compliance policies and procedures.

The pay-to-play rules were adopted to curb such practices.  It bars investment advisers from paying third-parties to solicit governmental customers, unless the solicitor is registered with the SEC as an investment adviser or broker-dealer subject to similar restrictions.  In June 2011, the SEC included municipal advisers to the rule's list of exempted solicitors, but the SEC has yet to define "municipal advisors", making full compliance an impossible task. 

Notwithstanding the definitional gap, the extra time will allow investment advisers and third-party solicitors the capacity to develop their policies and procedures for their pay-to-play rules.  Investment advisers and third-party solicitors should use this window to their advantage to further develop their policies and procedures, lest you be unprepared for when the SEC finally defines a municipal advisor.

Chairman Ketchum is seeking new areas of growth for FINRA.  At FINRA's annual meeting, Ketchum stated that he wanted to see FINRA take on the role as regulator for both retail professionals and institutions.  He also wants greater market transparency through the use of audited quote and trade systems.  Ketchum stated that he wants to see investors increase their use of BrokerCheck -- the system the public can use to check the background of registered representatives and broker-dealers -- so the investing public can better protect itself.  Despite this push from FINRA to grow its reach, the number of broker-dealers has been in decline.

One reason for this decline could be the increase in user fees that FINRA charges.  Another reason for the decline is the attractiveness of the registered investment adviser model, who are currently subject to SEC or state oversight depending on their size.  The SEC only examined 8% of RIAS last year, while FINRA examined 58% of its members in the same time period.  As such, RIAs are generally opposed to FINRA become their SRO, asserting that the FINRA rules-based business model does not mesh with their fiduciary duty business model.  The apparent decreased oversight of RIAs may be the ultimate reason for the decrease in broker-dealers and the increase in RIAs, which, in turn, is the likely reason that FNRA is pushing to become the SRO for RIAs.

From Ketchum's remarks, FINRAs growth model can be seen as a transparent effort to demonstrate to Congress and the SEC that it has the capacity to take on new and greater tasks.  In other words, to support FINRA's claim that it is the best choice to become the SRO for RIAs.  This political debate will likely rage on through the summer; all the while FINRA will try to do more and more to increase the perception that it is the best choice.  In the end, the most likely choice still seems to be a better funded and more active SEC.  We shall see . . .  

Recently, an investor advocacy group petitioned the SEC to prohibit brokerage firms, who offer wraparound accounts, to also provide investment advice through both a duly registered BD and investment adviser. 

This group claims that terminating this practice would resolve a very troubling regulatory issue.  The group also petitioned the SEC to ban mandatory arbitration accounts for individual retirement accounts and allow for a private right of action by investors in a court.  In any event, this group claims that its petition and potential subsequent SEC action were necessary because FINRA has refused to take any action to resolve this problem.

The groupl claims that FINRA refuse to enforce any fiduciary standard for investment advice relating to wrap accounts.  This group believes that such a "non-practice" violates the U.S. Court of Appeals for the District of Columbia Circuit's decision in 2007 in a case entitled Financial Planning Association v. SEC.  The group believes that the D.C. Circuit stated that the SEC exceeded its authority in promulgating a rule exempting from regulation broker-dealers who also provided investment advice to client fee based accounts. 

As a result of FINRA’s inaction, these dully registered wrap accounts are creating conflicts that are not being disclosed.  Further, this group claims that confusion exists in the industry, leaving retail retirement investors without any appropriate legal process for claims of breach of fiduciary duty under the Investment Advisers Act of 1940.

Although it is unlikely this petition will ever be acted upon, it is important to keep in mind that, in an election year, anything is possible, and, who knows, the SEC may consider appropriate action at some time in the future.

The battle lines are being drawn over Congressman Bachus' bill which would authorize one or more self-regulatory organizations for investments advisers.  Many have believed that FINRA would be the obvious choice to take on this new role.  Not Congresswoman Maxine Waters, the second-highest ranking Democrat on the Financial Services Committee; she favors the SEC keeping oversight over investment advisers.  Her stated preference is to properly fund the SEC so that it can effectuate proper oversight of investments advisers.

Congresswoman Waters thinks that the SEC charging a reasonable user fee would be the most cost effective approach.  This approach was also endorsed through the cost analysis of Boston Consulting Group who concluded that funding a new SRO or having FINRA serve in that capacity would be significantly more expensive than properly funding the SEC.  Conversely, FINRA has circulated its own cost analysis, which attacks the Boston Consulting Group study arguing that it underestimated FINRA's ability to leverage existing staff, district offices and technology.  In other words, the ramp-up costs for FINRA to be the SRO are not as great as that being claimed.

As the debate heats up, cost will likely be a driving factor to the decision regarding who will serve as the SRO for investment advisers.  Considering the institutional knowledge that the SEC has over investment advisers, it seems to me that the most likely and cost effective approach will be a better funded SEC serving as the SRO.  The one thing that has remained clear throughout the debate, however, is that investment advisers will have an SRO at some point.  That will surely be a reality.

Recently, the SEC's newest commissioner, Commissioner Daniel Gallagher, discussed certain of his beliefs, including, among other things, that the SEC should use its exemptive authority derived from the Investment Advisers Act of 1940, to provide some relief for hedge fund and private equity investment mangers from the registration provisions of said Act. 

Gallagher believes that the full registration regime should not have been imposed upon investment managers for hedge fund and private fund advisers.  Essentially, he believes that the SEC should use its exemptive power to provide some "balm" to their predicament.  He also indicated that the SEC should rethink certain registration requirements if it does not promote capital formation.

Additionally, Commissioner Gallagher commented on the recent case of Theodore Urban, and his belief that the Commission should clarify when it believes that legal personnel are considered supervisors.  As many may know, the Commission deadlocked over the case, requiring the dismissal of the charges.  Commissioner Gallagher believes that it is important for the SEC to provide the standard for charging in-house counsel and other legal personnel in these matters.  Commissioner Gallagher hopes that the SEC will clarify this position through a Section 21A Report under the Securities Exchange Act of 1934.  He, however, said that there has not been a suitable case to do so as of yet. 

Commissioner Gallagher also has indicated that he believes that the SEC needs to provide a better framework to work with in-house legal and compliance officers of broker-dealers and investment advisers.  He believes that the SEC should utilize these individuals to accomplish its mission.  He also thinks that, if these individuals are engaged, as opposed to challenging them, or causing them liability, the SEC would be more likely to uncover fraud and protect investors.

Finally, as we move forward, it will be interesting to see if Commissioner Gallagher will influence the SEC to change.

The SEC issued an alert intending that firms detect and prevent unauthorized trading in brokerage and advisory accounts. 

This release related to certain risks the SEC’s Office of Compliance Inspections and Examinations found in its investigations and examinations.  OCIE had reports of unauthorized trades and rogue trading by traders, portfolio managers, brokers and others.  The SEC warned firms that they must take action to ensure that such trading does not occur in the future.

Accordingly, firms must be cognizant that the SEC is looking at these issues, and will bring actions if need be.

Much has happened in nearly one since since the Dodd-Frank Act became effective, and much more remains.  According to the recent thoughts of one commentator, Kyle Colona of Compliance EX, Dodd-Frank may be doomed to fail as it faces it first year of existence.

Colona noted five factors working against the full implementation of the law: (1) the CFTC and SEC are far behind schedule; (2) the regulatory authority under the Act is shared by too many entities; (3) recent comments from the Federal Reserve Bank suggest that the Volcker Rule may not become law because of its impossibility to implement; (4) the financial services industry has unleashed a full-scale effort to defeat the full implementation of the Act; and (5) certain banks are trying to influence the public that implementation of the Volcker Rule would be bad.

I think that there is now a sixth factor that may work against the full implementation of the Dodd-Frank Act; namely, a presidential election this fall.  With the politicalclimate becoming more and more focused on the election, it is only natural that there would be less attention devoted to a law that the financial services industry is committed to pealing back or doing away with altogether.  If the President loses the election, there are some who believe that Dodd-Frank may be in trouble.  Even if the President prevails, it is unlikely that there will be full implementation because attention will surely be focused elsewhere.

Although it is unlikely that there may ever be full implementation of the Act, we need to still anticipate that many provisions of the Act will come to pass.  For example, at some point, the SEC will finally commit to the adoption of the uniform fiduciary duty rule and there will be a decision on who will serve as the SRO for investment advisors.  Dodd-Frank is not dead; it just may limp along for the next year.

The Co-Chief of the SEC’s Asset Management Enforcement Unit, recently, informed the public that the Staff will be paying particular attention to private equity firms.

The SEC Staff will be using the information it compiled from its risk assessment review of private equity firms in this endeavor.  These reviews will take note of valuations as well as other items including fees charged, broker dealer fees and tax and audit fees allocated to funds and investors.  No doubt much of the Asset Management Unit's focus will be a review of investment advisers/managers as well as fund structures.   

Nonetheless, the unit will, specifically, use the Aberrational Performance Initiative, the study that flagged hedge fund performance that appeared inconsistent with a fund's strategy or benchmarks.  The SEC Staff believes that this initiative will allow it to detect fraud earlier or prevent it, as the case may be.  The SEC Staff also warned that investment advisers with less than $25,000,000 in assets under management still must have strong compliance programs.  Essentially, the SEC Staff is suggesting no one is exempt.

In sum, we should expect to see more private equity funds on the SEC Staff's radar in the future.

The SEC published a small entity compliance guide for investment advisers relating to the new Form PF.  These new reporting requirements affect SEC registered investment advisers with at least $150 million dollars in assets under management.  Some of these new guidelines will also apply to CFTC commodity pool operators and commodity trading advisers.

The SEC registered advisers will be divided into 2 groups, small advisors and large advisers.  The definitional requirements for large advisers are specific and may require certain calculations, however.  Clearly, large advisers have assets under control of anywhere between a billion dollars and more.  For the purposes of the Form PF, all other advisers would be considered small private advisers.

Generally, an investment adviser is a small business pursuant to the Investment Advisers Act and the Regulatory Flexibility Act if it has assets under management of less than $25 million dollars.  As such, these advisers will, generally, have no reporting requirements on a Form PF.  However, for those advisers, who are not defined as a small business, there may be certain reporting requirements.  For example, advisers with over $150 million dollars in private fund assets under management, but are not large advisors must file a Form PF once a year within 120 days at the end of the fiscal year.  Large private advisers must file a Form PF within 60 days.  Moreover, the requirements for advisers with over $150 million dollars, but who are not large advisers, are less than those of large private fund advisers.  Essentially, the more money you have under management, the more information you must provide.

In short, advisers should consult with securities counsel to ensure accurate reporting in the future.

Although the SEC’s rulemaking deferral regarding the uniform fiduciary standard has gained much press, the SEC's other rulemaking initiatives pursuant to the Dodd-Frank Act march on, and will have a significant effect on broker dealers and investment advisors in the upcoming year.

In particular, the SEC has scheduled a joint SEC-CFTC report to Congress on stable value contracts, and the adoption of rules pertaining to trade reporting, data elements and real time public reporting for security-based swaps.  Further, the SEC and CFTC will define key terms for swap products and intermediaries as well as security-based swap clearing agencies.  The SEC will also look to register and regulate security swap based data repositories and for mandatory clearing of security-based swaps.  Additionally, the SEC will look at the end user exceptions for the mandatory clearing of security-based swaps. 

The SEC will also consider a permanent rule to register municipal advisors this year.  However, certain controversial rules relating to conflict materials rule finalization and resource extraction disclosures as well as corporate governance rules relating to executive compensation claw backs, performance disclosure pay, compensation ratio and hedging policies have been pushed forward to the first part of this year.  Moreover, the SEC still has not set up certain offices that the Dodd-Frank Act required including, but not limited to, the credit ratings and municipal securities oversight function offices.  Currently, the SEC believes these functions are being performed by its Division of Trading and Market's Staff. 

In sum, the SEC’s Dodd-Frank Act rule making is still ongoing and will continue as it moves forward.

Among other criticism lodged against the SEC was its inability to conduct routine examinations of investments advisors beyond a small sampling in any given year.  Dodd-Frank required an analysis of whether investments advisors should have their own self-regulatory organization to conduct some examinations because the SEC lacked the resources to comprehensively examine them.  Three options are being considered; (1) provide additional funding to the SEC; (2) give the responsibility to FINRA; or (3) create a new SRO.

A recent study by the Boston Consulting Group has found that it would cost investment advisors twice as much money to pay an SRO than it would to properly fund the SEC.  In a related study, BCG found that the overwhelming majority of investment advisors surveyed preferred to have continued SEC oversight than have FINRA act as their SRO regardless if it cost more to properly fund the SEC.  Investment advisors even preferred the creation of a new SRO over giving oversight responsibility to FINRA.

The key take away from this study is economics.  In this age where the public is clamoring for more oversight, the least expensive avenue to pursue that oversight is to have the SEC funded in a manner that would allow it to conduct more meaningful examinations across a greater sector of investment advisors.  Plus, this course avoids the unnecessary overlap, bureaucracy and increased costs if FINRA's jurisdiction is expanded to include investment advisors.  Where money talks, investment advisors should expect that the SEC will maintain oversight over you.  But do not expect the status quo; you should expect increased funding and a dramatic increase in examinations over a greater segment of investment advisors.  In the end, the devil you know is better than the devil you do not know.

Although the use of social media has been embraced by many industries, it is of particular concern for investment advisors and broker-dealers.

In many situations, the use of these outlets touch upon several areas.  For investment advisors and broker-dealers, the advertising requirements under the Investment Advisors Act of 1940 and certain Securities Exchange Act of 1934 provisions may be implicated when one uses social media, including various features on Linked In or Facebook.  Additionally, recordkeeping is a critical function required by both acts since this information must be maintained.  Further, it is likely that those who work for either and use social media sites, may require supervision.  Additionally, when one uses these types of communications, there are various regulations that require the firms to monitor these third party communications to ensure that, among other things, non-public information is not disclosed.  Firms would also be required to apply their audit function to these media policies and procedures internally, to determine if the procedures are effective.  Moreover, the SEC, FINRA and the states may begin to regulate these types of social media in amore forceful manner. 

As such, although social media venues may present certain benefits, the risk is palpable.

Ernest Badway will be speaking at a Citrin Cooperman event on October 27, 2011, on the topic of Advisors and Fund Managers. Please contact Alyssa Parrilla, 212.697.1000 Ext. 1838, aparrilla@citrincooperman.com, to RSVP. 

In January 2001, the Securities and Exchange Commission (“SEC”) recommended the implementation of a uniform fiduciary duty standard for broker-dealers and registered investment advisors. Significant debate has followed regarding the potential parameters and scope of such a duty. Recently, the Securities Industry and Financial Markets Association (“SIFMA”), a lobbying group for large broker-dealers, proposed a framework for a uniform fiduciary duty.

Although SIFMA reiterated its support for such a standard, it also recommended against applying the fiduciary duty found in the Investment Adviser Act of 1940 to broker-dealers, stating that it would adversely impact “choice, product access and affordability of customer services”. Among other things, SIFMA proposed a new fiduciary duty for broker-dealers to accommodate broker-dealer conduct that would otherwise be in violation of the 40 Act.

In doing so, SIFMA recommended that, in its rulemaking, the SEC “provide the necessary rule-based guidance regarding when the fiduciary duty begins and ends and what disclosures and consents, if any, are necessary to satisfy the duty where a broker-dealer gives “advice involving principal trading, structured products, hybrid accounts, complex investment strategies, concentrated positions, and receipt of commissions and differential loads for different products.” To implement this standard, SIFMA proposed that it be articulated in the initial customer agreement. SIFMA also recommended that the fiduciary duty apply on an account-by-account basis.

By implementing a new fiduciary duty standard unique to broker-dealers, SIFMA believes that the SEC will properly take into account the distinctions in the law between registered investment advisers and broker-dealers while taking customer service into account. It remains to be seen if SEC heeds this call to action, or if the SEC simply rubbers stamps the 40 Act fiduciary duty standard to broker dealers.