SEC Penalizes Investment Advisers for Compliance Failures

In 2006 when the SEC implemented Rule 206(4)-7 of the Investment Advisers Act, the “Compliance Rule”, we all knew it was only a matter of time before the deficiencies resulting from that Rule would start to pile up. Not because advisers wish to defraud or hurt their clients, but from a general lack of understanding about what was required. Well today the SEC charged three investment advisers for failing to put in place compliance procedures designed to prevent securities law violations.

The cases are the result of a SEC initiative to proactively prevent investor harm by working closely with agency examiners to ensure that viable compliance programs are in place at firms. When SEC examiners identify deficiencies in a firm’s compliance program, those deficiencies need to be corrected before they lead to other securities law violations that could harm investors. Investment advisers that essentially ignore SEC examination warnings risk being the subject of SEC enforcement actions.

The firms being charged with compliance failures in separate cases today are Utah-based OMNI Investment Advisors Inc., Minneapolis-based Feltl & Company Inc., and Troy, Mich.-based Asset Advisors LLC. The SEC also charged OMNI’s owner Gary R. Beynon, who served as the firm’s chief compliance officer despite living in Brazil and performing virtually no compliance responsibilities. Feltl & Company, Asset Advisors, and Beynon will pay financial penalties and institute a series of corrective measures to settle the SEC’s charges.

In two of the cases, OMNI and Asset Advisors, SEC examiners previously warned the firms about their compliance deficiencies.

“Not all compliance failures result in fraud, but many frauds take root in compliance deficiencies,” said Robert Khuzami, Director of the SEC’s Division of Enforcement. “That simple truth underlies our renewed focus on identifying and charging firms and individuals that fail their legal obligations to maintain adequate compliance programs.”

Carlo di Florio, Director of the SEC’s Office of Compliance Inspections and Examinations, added, “When SEC examiners identify compliance deficiencies, firms are expected to remediate them. The Commission will take enforcement action against registrants that fail to do so.”

Advisers would be prudent to take a look at their compliance programs and see if they are up to the SEC test. If not, be proactive, time and money spent now can minimize your exposure to regulatory deficiencies and possibly fines. If your program is sound, try running a mock audit and see if you can produce everything the SEC would request in a timely manner. Compliance should be an everyday mindset, not a fire drill.

SEC Charges Prominent San Diego Financial Planner with Fraud

Full and complete disclosure to your clients is a critical component of your advisory business. This was illustrated perfectly today when the SEC charged a prominent San Diego-based financial advisor with fraud, accusing him and his firm of failing to disclose to clients a conflict of interest in an investment and lying to and misleading clients about a hedge fund he manages.

The defendant, Kevin O’Rourke, is the founder and president of Western Pacific Capital Management in Del Mar, Calif. He was named a top wealth manager by San Diego magazine in 2008 and 2010. He does not believe he did anything fraudulent and plans to fight vigorously to defend himself. However, this will cost him time, money and reputation. It takes a life time to build a reputation and just a few minutes to sully it.

Most advisors would never intentionally defraud their clients. They work very hard to do what is in their client’s best interests. They want to do all the right things, but sometimes it’s hard to know exactly what to do. The Rules are not always black and white, but subject to interpretation. That is why Advisors need knowledgeable compliance people to help them to make appropriate decisions in these gray areas. Unfortunately, knowledgeable compliance people are not inexpensive or plentiful. But they are worth their weight in gold when you compare their cost to the cost of enforcement. It has traditionally been difficult for compliance officers to measure their worth to the organization by the fine they did not receive or the deficiency that didn’t occur. But today’s action speaks to the need for compliance professionals to partner with Advisers to do what’s right for the client. Today should be the day that you thank your compliance team for protecting your reputation.

To read the full article, click here.

Rules for Registration of Securities-Based Swap Dealers and Major Security-Based Swap Participants

Based upon Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act, the Securities and Exchange Commission voted this week to propose rules that lay out the process where security-based swap dealers and security-based swap participants must register with the Commission. This proposal is now open for comment.

During the SEC’s open meeting to announce this, SEC Chairman Mary L. Schapiro commented, "Registering the major market participants in the largely unregulated security-based swap markets is a critical step toward better protecting investors. Today's proposal draws from our experience with registration rules regarding broker-dealers - rules that are familiar to many market participants."

The proposed rule will be published in the Federal Register with a 60-day public comment period. The Commission will then review the comments it receives and consider those comments in determining whether to adopt the proposed rules.

To read the entire article, please click here Registration of Securities-Based Swap Dealers and Major Security-Based Swap Participants.

Social Media Sites for Registered Investment Advisers

It is official, social media madness has taken over. Do you feel like you are behind the times because you do not have a social media presence? Not sure how to approach this hot topic? Social media sites are useful business tools for investment advisers. However, you have to decide how much time you want to devote to social media and what the compliance concerns are surrounding its use.

So far the only guidance has come from FINRA, but the US Securities and Exchange Commission ("SEC") has done sweeps and definitely has this on their radar screen. While the SEC has not released any specific guidance on this topic, there are existing rules that investment advisers should be familiar with when using social media. Rule206(4) of the Investment Advisers Act of 1940 considers any information posted online by an adviser to be an advertisement. This means that all profiles and posts to social media sites would be considered advertisements that are subject to all the advertising regulations. This includes all the disclosure requirements, especially as it relates to performance.
Rule206(4)-1 of the Investment Advisers Act of 1940 prohibits testimonials so advisers have to be careful about allowing comments on their sites by clients. LinkedIn allows users to make recommendations. While these recommendations are good for promoting your business, they are considered testimonials by the SEC and are prohibited. The "Like" functionality on Facebook is another issue. The SEC will probably consider this to be a testimonial as well so this feature should be prohibited.

Remember, record retention is part of the SEC requirements and it can be quite challenging to capture all the changes that have to be archived from social media sites. This includes the instant messenger features as well as emails to and from these social media sites. You need to have a way to capture it and maintain it for not less than five years from the end of the fiscal year during which the “adviser last published or distributed the advertisement”.

While this is by no means a complete listing of everything you should take into consideration before joining the social media frenzy, it’s a good starting point.

Congress Hearing on Investment Advisor SRO

On September 13th , the House Committee on Financial Services held a hearing to discuss forming a self-regulatory organization ("SRO") for investment advisers. There have been three options floating around about this issue and the committee looked at these three options: (1) have the U.S. Securities and Exchange Commission ("SEC") charge a user fee to help fund the need for more frequent regulatory examination, (2) create an independent SRO to regulate investment advisers, or (3) give FINRA the authority to serve as the investment adviser SRO. There were eight individuals that testified in front of the Committee. The breakdown of the opinions of these individuals was very interesting. You can see what their thoughts were in the chart below:

The SEC has Published FAQs Regarding the Switch of Investment Advisers From SEC to State

The U.S. Securities and Exchange Commission (“SEC”) has posted a webpage with frequently asked questions regarding the switch of investment advisers with less than $100 million of assets under management from the SEC to state securities regulator(s). Click here to go to the SEC “FAQ” webpage.

There are only a five questions posted so far, however some of it is valuable new information. One new tidbit of information is that only RIAs located in New York and Wyoming will be required to remain registered with the SEC and will not be affected by the switch. In earlier communications it was hinted that Minnesota would be included on this list, but this is no longer the case. In addition, at the bottom of this webpage is a link to the new amended Form ADV Part 1 which is being revised to include the new investment adviser registration requirements. The new questions on the Part I will have to be answered by all investment advisors, not just the ones involved in the switch. The SEC expects this new form to be available electronically through IARD by January 1, 2012. Click here to view a copy of the amended Form ADV Part 1, here to view the instructions for filling out the amended Part 1 Appendix A and here for Appendix B.

Hopefully more questions and answers will be added in the future.

The Department of Labor - Proposed Fiduciary Definition

The Department of Labor (DOL) has proposed changes to the fiduciary definition under the Employee Retirement Income Security Act. This change has far-reaching implications for your retirement plan and individual retirement account (IRA) businesses and represents a significant adverse effect on individual investors and retirement savings.

Voting Proxies

An actively involved and voting shareholder constituency is the cornerstone to effective corporate governance. The powers vested in the shareholders to select board members by vote helps to ensure that the board members run the corporation for the benefit of the shareholders and those conflicts of interest inherent in management of the corporation by the officers and board members are mitigated to the fullest possible extent.

With the advent of Modern Portfolio Theory and Active Management, the majority of investors retain professional managers and advisers to select and implement investment strategies to help maximize return and minimize risk; nevertheless, investors are not always aware that they retain their proxy voting responsibilities or they assume that their professional managers will vote proxies on their behalf. While investors may provide their managers and advisers the discretion to vote proxies on their behalf, the process in and of itself can create conflicts of interest as the interests of the manager and/or advisor may not always be aligned with the interests of the shareholders.

Consumer Privacy

Financial markets and the financial services industry in general operate on some of the most sophisticated technology currently available. Technology has allowed greater transparency, lower costs, increased client access and greater efficiencies; however, with greater use of technology comes the possibility of its misuse. With the advent of the internet, information, both public and private, can be quickly collected and disseminated; information, especially accurate consumer information, is a highly prized commodity for producers as well as consumers.

Regulator Mind Reading

Being a CCO is a very demanding job. CCOs have to balance being the bad guy with remaining open so that people feel comfortable interacting with them. They have to keep the lines of communication open while maintaining control. It’s like a high wire act at the circus, one misstep and you better have a safety net. And with the Dodd-Frank Act and the ever changing regulatory environment, the CCOs balancing act is even more precarious.

Being able to read a regulators mind would be a very useful ability for a Chief Compliance Officer to possess. But absent that ability, reviewing the cases brought by regulators against firms can give you a pretty good idea of what’s on their mind. When I look at the cases brought by the SEC in May, I wonder if Chief Compliance Officers realize they are in the regulators crosshairs. CCOs may be the police for the industry but the regulators are internal affairs.

SEC Alleges Former Employee of Investment Adviser Aided and Abetted the Violation of SEC Rule 204-2 (Books & Records Requirements)

On June 6, 2011, the U.S. Securities and Exchange Commission ("SEC") charged a long time employee at Bernard L. Madoff Investment Securities LLC ("BMIS") with "aiding and abetting violations of Section 204 and Rule 204-2 of the Investment Advisers Act of 1940 (the Adviser Books and Records Violations)."

The SEC alleges that BMIS, "failed to make, maintain on its premises, or keep accurate, certain books and records required by law." The SEC noted several examples where the firm failed to maintain accurate cash receipts, disbursement records, accurate ledgers, and failed to keep true and accurate bank statements, cancelled checks and cash reconciliations. This is a violation of the Books and Records requirements. The SEC alleges that as an employee in investment advisory operations, the BMIS employee assisted in falsifying documents, making repeated material misrepresentations, and generated fictitious account statements; thus, violating the Investment Advisers Act of 1940, Rule 204-2 and perpetuating the firm's violations. One has to wonder how many more BMIS employees have yet to be charged?

Insider Trading

Hedge fund founder Raj Rajaratnam was found guilty on five counts of conspiracy and nine counts of securities fraud involving insider trading. This is a big victory for the government and a vindication of their aggressive use of phone taps to fight Wall Street crimes.

SEC Publishes Notice Regarding Inflation Indexing of Performance Fee Rule

The Securities and Exchange Commission today provided public notice of its intention to raise certain dollar thresholds that would need to be met before investment advisers can charge their clients performance fees. This would satisfy Section 418 of the Dodd-Frank Act which requires the SEC to issue an order to adjust these dollar thresholds for inflation by July 21, 2011 and every five years thereafter.

Social Media Hot Topics

There have been a lot of discussions lately regarding the regulatory landscape in the financial services sector. I know everyone has Dodd-Frank on the mind these days; however another significant hot topic is Social Media. It is a topic of discussion at every conference I have attended this year.

Over the last couple of months the IIROC (Investment Industry Regulatory Organization of Canada) has issued their guidance on social media, FINRA announced their examination priorities for 2011 and the SEC sent our sweep letters regarding the use of social media. It’s clear with all the attention social networking has generated that it is not a fad that’s going away and the regulators are serious about making sure it’s done in a compliant manner.

So what does it mean when I say “in a compliant manner”? Well first and foremost it means that you have policies and procedures that are reasonably designed to supervise and train your representatives and staff about how to use or not use social media sites. One thing that has been made perfectly clear is that a policy that says you do not allow social networking and attestations from your representatives stating they do not use social media is not considered sufficient by the regulators.