SEC Non Action Recommended for Closed End Investment Company upon Subsidiary’s Registration as an Investment Adviser

The response of the SEC Chief Counsel’s Office, Division of Investment Management on November 7, 2013 recommends no enforcement action to the Commission against the Parent Company, upon the Subsidiary’s registration as an investment adviser. David Joire, Senior Counsel at the SEC Chief Counsel’s Office explained that the Parent Company is an internally managed closed end investment company that elected to be regulated as a business development company and is registered as an investment adviser. The Parent Company then entered into a Subadvisory Agreement with another Business Development Company. Now, the Parent Company is wanting to assign to its Subsidiary this Subadvisory Agreement. The Subsidiary employs all of the Parent Company’s investment personnel and other employees and is subject to the Parent Company’s supervision and control.

The conflicting issue is that if the Subsidiary Company were to serve as an investment adviser to Another Business Development Company, the Subsidiary Company would be required to register under the Adviser Act, which would trigger Section 12(d)(3) of the 1940 Act which generally provides that it is unlawful for any registered investment company to purchase or otherwise acquire any security issued by any person who is, among other things, an investment adviser registered under the Advisers Act, which is applicable to a business development company as if it were a registered closed-end investment company.

However, the Chief Counsel’s Office did not recommend such enforcement action to the Commission under Section 12(d)(3) of the 1940 Act. Supporting facts included (1) the subsidiary is organized as an LLC which limits liability to the Company’s stockholders, (2) conflicts of interest would not be present because the Subsidiary is wholly owned by the parent company, (3) the Parent Company could provide advisory services directly but conduct them through the Subsidiary for bona fide tax planning reasons, and (4) the concern of this rule was primarily to address an investment company’s ownership of an underwriting business, rather than the ownership of an advisory business. To read the Chief Counsel’s response in full, please click here.

It’s Time to Revisit Business Continuity Planning

Hurricane Sandy tested the capabilities of contingency planning along the east coast and prompted the SEC’s National Exam Program (NEP) to review the BCPs of about 40 advisers. The NEP wanted to see how Hurricane Sandy impacted the processing of securities transactions (order taking, order entry, execution, allocation, clearance and settlement) as well as delivery of funds and securities, client relations, financial and regulatory obligations and technology.

They found that insufficiently comprehensive BCPs and those that do not provide for mobile or remote access by employees are often ineffective. BCPs that concentrate technology, facilities and operations in one geographic region were vulnerable to local and regional disruptions. BCPs that do not maintain information about suppliers and vendors including contact information were less effective in dealing with business disruptions. And do-it-yourself systems maintenance is seldom effective.

The NEP also confirmed that BCPs that have been created as a result of collaboration between compliance and all business lines and operations units tend to be more effective and those BCPs that provide employees with the ability to work remotely can be more effective than those that do not. BCPs should include an inventory of critical vendors (ranked according to risk) and questions should be asked of vendors with regards to their contingency plans. BCPs should provide for proactive initiation of backup or alternative sites and facilities and should consider locating backup or additional facilities on a different power grid or in another geographic location. And redundant or mobile connectivity to the internet is an important consideration.

The core message of the Risk Alert and the Joint Publication issued by the SEC, the Commodity Futures Trading Commission (CFTC) and the Financial Industry Regulatory Authority (FINRA) is that BCPs should be the result of careful and comprehensive planning, thorough preparation, strategic redundancy and geographic diversity applied to critical supply chain providers, good internal and external communications and testing.

To learn more please click here.

If you have any questions about this article or want to make certain your business continuity plan is up to the challenge, please call Red Oak Compliance today. We are here to help.

New SEC Rule 506(d) Disqualifying Private Placement Securities Offerings if “Bad Actors” are Involved

As of September 23, 2013, the new Securities and Exchange Commission (SEC) rule 506(d) is in effect which disqualifies Rule 506(b) and (c) private placement securities offerings if certain “bad actors” are involved, causing the private placement exemption to be lost, thus deeming the issuer to have engaged in an unregistered public offering and then giving investors the right to rescind their investment for a year. Private placement participants should amend and enforce their written policies and procedures to address this matter, as proper due diligence will be a “defense” against disqualification.

The involved applicable people that cannot meet this “bad actor” status for private placement securities officers consist of the investment managers (including sub-advisors), general partners or managing members of a fund, and their principals and officers. Other involved people include any officer involved in the private placement, the placement agent, issuer, other compensated solicitors, and each of their respective directors, executive officers, and holders of 20 percent of the voting securities of such entities.

Only “bad actors” who commit “bad acts” after September 23, 2013 are disqualified. “Bad acts” of registered representatives of broker-dealers should already be disclosed on their Central Registration Depository (CRD). Though there are some exceptions, each disqualifying bad act that constitutes a “bad actor” and the corresponding relevant look-back timeframe are as follows:

1. Regulation A bad-actor stop-orders. 5 years.
2. U.S. Postal Service false representation orders. Longer of 5 years or duration of order.
3. CFTC orders (bar or final orders) relating to violations of any law or regulation that prohibits fraudulent, manipulative or deceptive conduct. Longer of duration of final order or 10 years from final order.
5. SEC disciplinary orders for the duration of the order, which suspends or revokes such person’s registration as a broker, dealer, municipal securities dealer or investment adviser, limits such person’s activities function or operations, or bars person from association with any entity or from participating in an offering of penny stock.
6. Suspension or expulsion for the duration, from membership or association with a national securities exchange or FINRA.
7. Criminal convictions in connection with the sale of securities or making false statements to the SEC. Issuers: 5 years. All others (including issuer executive officers and directors): 10 years.
8. SEC orders prohibiting future violations of any scienter-based anti-fraud provision, including Sections 5 and 17(a) of the Securities Act, and Sections 10(b) of the Securities Exchange Act. 5 years from date of order.
9. Court orders, judgments or decrees in connection with the purchase or sale of securities or in connection with the business of an underwriter, broker, dealer, municipal securities dealer, investment advisor. 5 years.
10. Final orders of certain regulators, including state securities commissions, state banking authorities, state insurance commissions, federal banking agencies or the National Credit Union Association, which bar the person from: (a) association with an entity regulated by such commission, (b) engaging in the business of securities, insurance or banking, or (c) engaging in saving association or credit union activities. Longer of duration of final order or 10 years from final order based on violation of fraudulent, manipulative or deceptive conduct, if applicable.

To read the complete article, please click here.

Importance of a Robust Compliance Program in a Post-Dodd-Frank World

The SEC Associate Director of Enforcement gave a speech on October 7, 2013 concerning the importance of a robust compliance and ethics program, and the SEC’s role in supporting compliance programs. He noted how the SEC’s Whistleblower Program created under the Dodd-Frank Act in October 2013 awarded over $14 million to a single whistleblower, and stated how the purpose of this program is to bolster the private sector compliance program. He pointed out how in September 2013 JPMorgan Chase agreed to pay $920 million in total penalties in a global settlement with regulators, and acknowledged that it violated the federal securities laws, and how JPMorgan recently announced it was spending billions of dollars and hiring or focusing 5,000 people to compliance/control functions.

The Associate Director went on to emphasize the importance of empowering compliance staff, and viewing them as trusted advisors that minimize risk. The SEC considers compliance programs when they decide how to credit an internal investigation. Though the SEC discusses a company’s compliance program during settlement negotiations, the Associate Director expressed his surprise at the lack of compliance culture studies during normal times. Regulators give much more credit when it can be demonstrated that misconduct is an outlier and a compliance-driven culture, rather than as a remedial step after investors have suffered losses due to the misconduct. The SEC’s 2001 Seaboard Release Framework laid out a framework which rewards the role of self-policing compliance programs that help ferret out misconduct, whereas the SEC considers a company’s compliance program as a factor in charging decisions, since the actions of compliance programs make it more likely the problem is caught early. To read the full speech please click here.

If you have any questions about this article or want to make certain your compliance program will stand up to an audit, please call Red Oak Compliance today. We are here to help.

Advisory Firms Sanctioned for Compliance Program Deficiencies

On October 23rd, as part of the SEC’s Compliance Program Initiative, the SEC has announced the sanctioning of three advisory firms and their officers. All three firms have agreed to settlements and to hire compliance consultants. The SEC National Exam Director Andrew Bowden stated “After SEC examiners identified significant deficiencies, these firms did little or nothing to address them by the next examination. Firms must fix deficiencies identified by our examiners.”

The SEC sanctioned Modern Portfolio Management and its owners G. Thomas Damasco II and Bryan Ohm for a total of $175,000 in penalties, due to failure to complete annual compliance reviews in 2006 and 2009, and for misleading statements in their investor brochure and website.

The SEC sanctioned Equitas Capital Advisors LLC, Equitas Partners LLC, owner David S. Thomas Jr., and former chief compliance officer Stephen Glisclair for a total of $225,000 in penalties, for failing to adopt and implement written compliance policies and procedures and conduct annual compliance reviews, as well as making misleading disclosures and inadvertent overbilling. The Equitas firms made false and misleading disclosures about conflicts of interest, compensation, and historical performance. To read the full story please click here.

If you have any questions about this article or want to make certain your compliance policies and procedures will stand up to an audit, please call Red Oak Compliance today. We are here to help.

Investment Adviser Fined By SEC After Hacker Uses E-Mail To Steal Client Funds

We have seen this happen too many times in the last 5 years and hate to see good intensions hurt the firm and the client. This is a valuable lesson in safeguarding your client’s assets, even if it may inconvenience them. The Securities and Exchange Commission has fined a large Massachusetts advisor, GW & Wade, $250,000 for improper custody controls after a hacker used a client's e-mail to have more than a quarter million transferred to a foreign bank.

GW & Wade had many clients sign blank letters of authorization so that when it needed to transfer funds it could do so without obtaining the client's signature. In some other cases, GW & Wade cut out signatures from previously executed letters of authorization and pasted them on new ones, the SEC said.

The practice enabled an individual to commit fraud against one of their clients. The individual hacked into a client's email account in June 2012 and sent e-mails to GW & Wade instructing them to wire funds to a foreign bank. The individual said he needed the funds that day, but was unable to call in for verification due to being in a meeting, at a funeral, etc.

Since GW & Wade had pre-signed letters of authorization and did not have procedures to confirm the identity of the transfer requests, the funds were wired without the client's knowledge or authorization.

The fraud wasn't discovered until three separate wires totaling $290,000 had been sent to a foreign bank. Even though GW & Wade compensated the client for all the losses, they were still negligent and the SEC fined them and required them to hire an outside consultant to review all their compliance policies.

We understand the desire to help the client out and not inconvenience them, however, in today’s world, you have to verify that you are actually doing what the client asked not what the hacker wants.

To read the full story, please click here.

If you have any questions about this article or want to make certain your compliance policies and procedures will stand up to an audit, please call Red Oak Compliance today. We are here to help.

Former SEC Official Recommends that the SEC Should Not Prosecute CCOs

John Walsh is urging the new SEC Chairman Mary Jo White to refrain from prosecuting chief compliance officers, utilize alternative enforcement tools, and avoid efforts to set new enforcement records. Mr. Walsh believes that the SEC should encourage compliance professionals and not prosecute them for the conduct of others. Mr. Walsh stated that compliance professionals “are not adjunct to the agency” but instead comprise “a private sector profession dedicated to raising business standards.” He argued, “If the current trend continues and compliance professionals become regulatory guarantors of their firms, the future of the profession may be at risk.” Mr. Walsh also believes the SEC should use multiple remedies including private conversations, speeches, informal actions such as deficiency letters, disclosures, training, and other creative remedies. Mr. Walsh urges Ms. White to de-couple enforcement from examinations.

To read the full letter please click here.

SEC Looking at Variable Annuity Contract Provisions

The Securities and Exchange Commission is worried that life insurance companies are taking advantage of vague language in VA contracts to make substantial changes that could hurt investors. It appears that the most recent example from The Hartford Financial Services Group Inc., is what has set this concern in motion. Hartford began applying a series of new restrictions to existing contracts. The most controversial amendment places investment restrictions on existing account balances for a number of contracts. Certain clients with the Lifetime Income Builder rider will need to switch to a number of more conservative investments. These more conservative options include a number of funds that call for a minimum 40% allocation to fixed income. Clients who don't respond by Oct. 4 could have their rider terminated. The SEC is expected to establish standards for the full disclosure of all such conflicts in the contracts. To read the full story, please click here.

Adviser and Principals Charged with Stealing from Public Pension Plan

The SEC filed suit against an Adviser and its five principals which included the Adviser’s General Counsel and Chief Compliance Officer, for stealing money from a public pension plan. According to the SEC, the Adviser managed real estate assets for the Detroit Police and Fire Retirement System. The SEC claims that the Adviser took money from a cash account and purchased two shopping centers in California without obtaining permission from or notifying the plan. The SEC stated that the adviser failed to disclose the purchases for several years despite multiple opportunities to do so (i.e. reporting, Board presentations. The principals of the Adviser did not want to disclose the investment because the properties dropped in value soon after the purchase. The SEC has alleged that the General Counsel and Chief Compliance Officer knew about the unlawful use of funds and assisted in the conspiracy to withhold the information from the pension plan.

One has to wonder whether the DOL will join in prosecuting these principals since their fraud involved ERISA assets. To read the rest of case information, please click here.

FINRA Focused on e-Mail Retention

Last week FINRA fined LPL Financial LLC $7.5 million for e-mail violations. This is the largest fine brought by FINRA solely for e-mail violations, but it is indicative of the regulator's increased focus in this area.

FINRA is concerned and firms will continue to be targets of disciplinary actions for failing to retain and review business-related e-mails, especially where fast growth and increased regulatory requirements overtake stretched compliance resources, legal sources said.

In settling the case against LPL, FINRA said that as the firm “rapidly grew its business, failed to devote sufficient resources to update its e-mail system, which became increasingly complex and unwieldy.” “ Fast-growing firms and systems are always a challenge,” said FINRA enforcement chief Brad Bennett. “Compliance and legal are being asked to do more with the same resources.”

A review of FINRA e-mail cases include nine settlements with broker-dealers year-to-date, not including the LPL case. The total fines amounted to $1.65 million. These cases include Next Financial Group Inc. that agreed in May to pay FINRA a $250,000 fine to settle an e-mail case. Securities America Inc. was fined $100,000 in April, and in February, five broker-dealers owned by ING Groep NV were fined $1.2 million.

A study conducted by the law firm Sutherland Asbill & Brennan LLP found a sharp increase in e-mail-related violations last year. The law firm said FINRA fines shot up to $6.5 million in 2012, an increase of 81% from the prior year. It counted 63 e-mail cases in 2012, up from 57 cases in 2011. Sutherland included all cases where e-mail violations were part of the case, regardless of how minor. To read the full study, please click here.

We know that firms often struggle with the technology used for retaining e-mails, and glitches can occur that compliance officials may not be aware of. Also, individual brokers may fail to inform their broker-dealers about using outside or personal e-mail. Compliance policies and procedures need to take this into account when they are designed and implemented.

Red Oak Compliance Solutions is available to help. We can provide guidance on all of your compliance needs. For more information or to request information on how we can help, please contact us.

Dallas Trader Charged with Front Running

The Securities and Exchange Commission announced fraud charges and an asset freeze this week against a trader at a Dallas-based investment advisory firm, Cushing MLP Asset Management, who improperly profited by placing his own trades before executing large block trades for firm clients that had strong potential to increase the stock's price.

The SEC alleged that Daniel Bergin, a senior equity trader, secretly executed hundreds of trades through his wife's ahead of large client orders. Bergin concealed his lucrative trading by failing to disclose his wife's accounts to the firm and avoiding pre-clearance of his trades in those accounts.

"Bergin's misconduct is particularly egregious because his firm depended on him to manage market exposure and risk for its investments. Instead, he pitted his clients' financial interests against his own," said David R. Woodcock, Director of the SEC's Fort Worth Regional Office.

According to the SEC's complaint, Bergin realized at least $1.7 million in profits in his wife's accounts from 2011 to 2012 as a result of his illegal same-day or front-running trades. More than $520,000 of the $1.7 million represents profits from approximately 132 occasions in which Bergin placed his initial trades in his wife's account ahead of clients' trades.

According to the SEC's complaint, more than $1.8 million was withdrawn since July 2012 from a trading account belonging to Bergin's wife that was undisclosed to his firm. Most of the withdrawals were large transfers to her bank account. To read the full complaint, please click here.

Advertising Fines Continue to Rise

Sutherland Partners reviewed FINRA’s monthly disciplinary notices and found that in 2012 FINRA brought slightly more disciplinary actions but assessed a double-digit increase in fines. This was the fourth consecutive year of increase in the number of cases filed and the second straight year of growth in the amount of fines. Sutherland also identified the top enforcement issues for FINRA in 2012, as well as emerging trends.

Advertising was the fourth-biggest fine generator in 2012. FINRA reported 50 cases involving alleged advertising violations in 2012, which resulted in fines of $10.4 million. This is an 11% increase over 2011. Please click here for the full survey.

With the recent fines to LPL for failure to archive all emails, firms need to ensure that they also capture all advertising and archive it. Red Oak Compliance Solutions has a technology solution, AdMaster to help you with all your advertising review needs. Take that next step to ensure you are covered and can respond appropriately to all regulatory requests. Call us today for a demo of AdMaster.

SEC Fines Firm for Confidential Proxy Voting Violations

A large proxy advisory firm is being required to pay a $300,000 fine and retain an independent compliance consultant for failure to implement policies and procedures that would prevent employees from disclosing confidential voting information about proxy voting. The SEC claims that an employee received tens of thousands of dollars in tickets and meals for providing confidential client voting information. The SEC alleged that the firm knew that a proxy solicitor entertained firm employees to curry favor but did nothing to understand or prevent this from occurring. Even though the firm had a Code of Ethics which prohibited the disclosure of material nonpublic information, the firm failed to implement procedures and allowed all employees access to the client voting information; failed to audit employee access; did not train employees about their relationships with proxy solicitors; failed to require reporting and/or pre-clearance of gifts and did not review e-mails.

This shows that once again failure to have adequate policies and procedures is never a good excuse for a bad ending. Policies and procedures must be reasonably designed and these obviously were not according to the SEC. To read the full SEC case, please click here.

Cherry Picking Trades

The SEC has initiated an action against a firm that is not required to be registered. The SEC has stated that the firm cherry-picked profitable trades. The firm principals used a third party bank to custody client accounts and told the bank how to allocate block trades several days after executing the trades through large brokerage firms. According to the SEC, over a four-year period, more than 75% of 13,500 trades allocated to the principals were profitable, and fewer than 25% of trades allocated to clients were profitable. The SEC noted that the principals did not make any compensation from the adviser but relied solely on their personal trading profits. The SEC indicated that "same-day or pre-trade allocations are considered best practices because they protect against unfair allocation schemes such as cherry picking." Moreover, "it is an industry standard...to have a written trade allocation policy."

You can click here to read the full story.

SEC Chairman Mary Jo White Wants to Focus Additional Resources on Investment Advisers

In testimony before a Congressional Subcommittee, SEC Chairman Mary Jo White described how the proposed 2014 SEC budget would add significant additional resources to supervise investment advisers. She indicated that the new budget would include funds to hire 250 additional examiners "to increase the proportion of advisers examined each year, the rate of first-time examinations, and the examination coverage of investment advisers and newly registered private fund advisers." Another 60 jobs would be added to "improve oversight and examination functions related to broker-dealers, clearing agencies, transfer agents, self-regulatory organizations (SROs), and municipal advisors." She also stated that another 131 hires would be added to the Enforcement staff. She believes more funds were necessary for "expanding oversight of investment advisers and improving their regulation and compliance -- a point at which investors are most at risk of being defrauded and harmed." To read the full testimony about budget priorities, please click here.

SEC Official Raises Broker-Dealer Registration Question for Private Equity Firms

The Chief Counsel of the SEC’s Division of Trading and Markets, David Blass, raised concerns during his speech given April 5th, that private equity fund sponsors may be ignoring broker-dealer registration and licensing requirements when selling fund shares or transacting with portfolio companies. Mr. Blass explained that broker-dealer registration and representative licensing requirements are triggered when firm personnel focus on selling fund shares and receive transaction-based compensation. He described activities that may require broker-dealer registration: marketing fund shares, soliciting or negotiating transactions, and handling investor funds or securities. He explained that the issuer exemption (Rule 3a4-1) is very narrow and would not likely be available to most private equity personnel involved with fundraising. Mr. Blass further stated that broker-dealer registration may be required when fund sponsors receive investment banking or success fees for transactions involving portfolio companies. Mr. Blass rejected any argument that private equity firms should be exempt from broker-dealer registration and stated: “Unless prepared to register as a broker, a person should not engage in activities that trigger registration.” He also discussed the consequences of failing to register including possible rescission of all securities transactions involving unregistered personnel.

To read the full text of his speech please click here.

Law to Speed Advisor Registrations

On Tuesday, a state senate committee unanimously approved a bill that would make Florida a "notice-filing" state, which means that representatives of out-of-state SEC registered financial firms seeking to do business in Florida would be automatically approved upon filing their application, and at that point could immediately begin offering advice to clients in the state. Final passage would bring Florida in line with almost every other state's registration process. Only five states aside from Florida -- Connecticut, Maine, Nevada, Texas and Vermont -- haven't adopted a notice-filing system. Please click here to read the full story.

SEC Concerned About Small Adviser’s Compliance Programs

Elisse Walter, in a recent speech to NASAA voiced her concerns about the often ineffective compliance programs at smaller advisory firms. She said, "We recognize that small firms present special challenges. For example, many of them don't have comprehensive compliance programs in place. Many more have off-the-shelf programs that aren't tailored to their actual businesses." She further said that CCOs that have multiple job responsibilities "have too many priorities on their plates to devote adequate time to compliance efforts." Additionally, they have "conflicting responsibilities — concerns about cost, privacy, investment strategies and so on." She emphasized the benefits of continued cooperation and sharing between the SEC and the state regulator and stated that securities regulators need more resources to examine more advisers. One thing is clear from this speech, the SEC has concerns about small advisers and wants to help the state regulators get out and audit them effectively. To read the full speech, please click here.

Red Oak Compliance Solutions is available to help with any questions you may have about this release or any others. We can provide guidance on all of your compliance needs. For more information or to request information on how we can help, please contact us.

Private Fund Enforcement

A private fund sponsor has agreed to settle an enforcement action alleging that its violations of the custody and compliance rules allowed a rogue employee to misappropriate client funds. According to the SEC, the adviser sponsored private funds investing in real estate that produced annual dividends which were to be paid to investors. One of the principals delegated to an "administrative and clerical" employee the task of preparing the dividend checks. The SEC alleges that the clerical employee wrote checks to himself, thereby misappropriating client funds. The SEC charges that the firm had custody of the funds' assets but violated the compliance rule (206(4)-2) by failing to send quarterly account statements or an annual fund audit to clients. The SEC also charges the firm for failing to conduct an annual review of the firm's compliance policies and procedures as required by the compliance rule (206(4)-7). To read the full accounting, please click here.

SEC Adopts Rules to Help Protect Investors from Identity Theft

The Securities and Exchange Commission voted unanimously to adopt rules requiring broker-dealers, mutual funds, investment advisers, and certain other entities regulated by the agency to adopt programs to detect red flags and prevent identity theft.

The SEC adopted the rules jointly with the Commodity Futures Trading Commission (CFTC) in accordance with the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.

“Under these rules, certain businesses regulated by the SEC and CFTC would be required to adopt and implement programs to detect and respond to indicators of possible identity theft,” said SEC Chairman Mary Jo White. “These rules are a common-sense response to the growing threat of identity theft to all Americans who invest, save, or borrow money.”

The final rules will become effective 30 days after publication in the Federal Register, and the compliance date will be six months after the effective date.

To read the full release please click here.

FINRA Sanctions Shows Number of Fines Jump by 15%

Sutherland Asbill & Brennan recently released an analysis of the 2012 FINRA disciplinary actions. The analysis shows an increase in enforcement actions and fines. Total actions increased for the fourth year in a row. FINRA filed 1541 actions last year as compared to 1488 in 2011. This is the fourth consecutive year that enforcement actions have increased. Total fines increased by a much greater margin from $68 million in 2011 to $78.2 Million in 2012.

Sutherland identified the top enforcement issues (based upon total fines) as suitability, due diligence especially of complex products and alternative investments, research reports, advertising, and exchange-traded funds, especially inverse and leveraged ETFs. Each of these categories had fines ranging from $7.6 million to $19.4 million.

Sutherland also identified the following FINRA enforcement trends and areas of focus: supersized fines of more than $1 Million, complex product cases, electronic communication, and Auction Rate Securities. To read the full report, click here.

FINRA’s CEO Wants Consolidated Rules for Investment Advisers and Brokers

On March 14th in Washington, Richard Ketchum the CEO of FINRA repeatedly remarked about the SEC’s inability to adequately oversee registered investment advisers. "If investors are to be protected, investment advisers need to be examined regularly and vigorously. It's as simple as that, and it is not happening under our current system," Ketchum stated. Ketchum also advocated brokers and investment advisers being governed by the same set of rules. To read the full article, please click here.

Massachusetts Proposes Criminal Background Checks for Advisers

The Massachusetts Securities Division has issued a proposal that would require a criminal background check of every person registering as an investment adviser representative. The proposed rule would require each person applying for registration to complete an acknowledgement form allowing the Massachusetts regulator to access the Criminal Offender Record Information system“ iCori”.

Massachusetts tends to be a leader among the states and proposes new rules that other states also adopt. We would not be surprised to see this spread throughout the country. To read the full story please click here.

New SEC Social Media Guidance

The SEC has posted guidance regarding whether certain interactive content posted in a real-time electronic forum (i.e., chat rooms or other social media) (“interactive content”) should be filed under the filing requirements of Section 24(b) of the Investment Company Act of 1940 (“1940 Act”) or Rule 497 under the Securities Act of 1933 (“1933 Act”) if it is not required to be filed under Financial Industry Regulatory Authority (“FINRA”) Rule 2210.

Whether a communication needs be filed depends on the content, context, and presentation of the communication and requires an examination of the underlying substantive information transmitted to the social media user and consideration of any other facts and circumstances, such as whether the interactive communication is merely a response to a request or inquiry from the social media user or is forwarding previously-filed content. The SEC has provided excellent examples in this release to help us understand where the line may lie in regards to filing.

To read the complete SEC guidance, please click here.

Red Oak Compliance Solutions is available to help with any questions you may have about this release or any others. We can provide guidance on all of your compliance needs. For more information or to request information on how we can help, please contact us.

SEC's Exam Priorities

The staff of the SEC’s National Examination Program Office of Compliance Inspections and Examinations (“NEP”) has published its examination priorities "to communicate with investors and registrants about areas that are perceived by the staff to have heightened risk." The staff highlighted the following issues: asset verification and custody including surprise exams and qualified custodians; undisclosed compensation arrangements either paid to an adviser from a product or paid by an adviser to a third party solicitor; performance reporting and advertising including aberrational performance claims and the accuracy of calculations; allocation of investment opportunities especially where advisers manage assets subject to a performance fee side-by-side with other clients; and fund governance including disclosure to fund boards and board oversight of service providers. The staff also identified new and emerging issues of focus: private equity and hedge fund managers newly registered because of Dodd-Frank; how dually registered firms decide whether to provide brokerage or advisory services; and the growing use of alternative products in registered fund structures. The staff makes clear that the priorities listed "are not exhaustive" but that the "NEP expects to allocate a significant portion of its resources throughout 2013 to the examination" of these issues.

Compliance personnel need to take this publication to heart and re-assess where they are at in regards to these exam priorities before the SEC arrives for an exam. Please click here to read the full release.

Red Oak Compliance Solutions is available to help. We can provide guidance on all of your compliance needs. For more information or to request information on how we can help, please contact us.

Adviser Applications- Common Deficiencies Notice

The Texas State Securities Board, the regulatory agency governing state registered investment advisers, recently issued a notice advising of common deficiencies found in investment adviser applications. While this information was compiled and release by the state, the notice serves as a general reminder of the importance of the information included in the Form ADV Parts 1 and 2 as well as other documents such as the client advisory agreement. Per the notice, the most common deficiencies were related to inconsistencies between Form ADV Part 1 and the Part 2 narrative primarily in the disclosure of types of clients, methods of compensation and fee schedules, and services offered.

To read the notice, please click here.

Red Oak Compliance Solutions is available to help. We can provide guidance on all of your compliance needs. For more information or to request information on how we can help, please contact us.

SEC Requires Adviser to Retain Outside Compliance Consultant

The SEC recently required a registered investment adviser to retain an outside compliance consultant for two years to help them build and implement a robust compliance program.

The registered investment adviser agreed to this to settle SEC charges that it failed to implement an adequate compliance program. The SEC alleges that two successive chief compliance officers were internal employees that had little compliance experience or training. The firm failed to conduct and document annual compliance reviews and tried to use written supervisory procedures from a predecessor broker-dealer firm as an adviser compliance manual.

Please click here for the full story.

SEC Initiatives Directed at Private Equity

The Chief of the Asset Management Unit in SEC Enforcement gave a speech on January 23, 2013 concerning their initiatives directed at private equity. The areas of concern discussed included valuation, insider trading and conflicts of interest that can lead to misappropriation, deal cherry-picking and other areas of misconduct. The SEC appears to have developed a level of expertise in the private equity space that was absent when registration requirements were introduced. The speech also outlined various cases the SEC has brought against private equity firms and other private fund firms that had similar issues. To read the full speech please click here.

Bridgewater’s Caution Highlights Vendor Risks

One of the world’s largest global hedge funds, Bridgewater Associates, has taken an unusual step to address their operational risk. They have hired a second fund administrator, Northern Trust, to verify the accuracy of their primary fund administrator’s work on an ongoing basis. While Bridgewater’s move is unusual and much too expensive for smaller advisers, it does show just how much pressure there is on advisers to validate and supervise all areas of operations. For the complete story please click here.

Amended Custody Rule

Rule 206(4)-2’s adopting release regarding custody provides a definition of “custody” and interpretative guidance by providing discussion and clarification of the most common examples of what is, and what is not, custody. Under the amended Rule, an adviser has custody (and thus must comply with the above new amended Rule requirements) if it holds client funds or securities directly or indirectly, or if it has any authority to obtain possession of them.

Ability to Debit Account for Fees: An adviser has custody if it has the ability to debit the client’s account for payment of advisory fees. However, per the above, this type of custody will not require the adviser to indicate that it has custody on Form ADV, undergo an annual surprise CPA examination, nor provide an audited financial statement if assets are held by a qualified custodian who sends quarterly statements directly to the client.

Ability to Sign Checks or Withdraw Funds: An adviser has custody if it has a power of attorney to sign checks on a client’s behalf, to withdraw funds or securities from a client’s account, and/or to dispose of client funds for any purpose other than authorized trading would be deemed to have custody and subject to the above referenced annual surprise CPA examination.

Possession of Bank Account or Credit Card Information: An adviser who maintains possession of client bank account or credit card information for the purpose of the adviser debiting/charging said accounts to pay the adviser’s fee, would be deemed to have custody and be subject to the annual CPA surprise examination.

Possession of Stock Certificates: An adviser has possession of client funds or securities if it holds client stock certificates, even temporarily, because such possession puts those assets at risk of misuse or loss. However, the Rule specifically excludes inadvertent receipt by the adviser of client funds or securities, so long as the adviser returns them to the sender within three (3) business days of receiving them. An adviser may continue to meet with clients to prepare or compile documents, including stock certificates, for forwarding by the client to a custodian or third party, without the adviser having custody. However, if the client were to leave the stock certificate in the possession of the adviser thereafter, such possession would most likely not be inadvertent, and would result in custody of client assets.

Possession of Signed Checks: An adviser’s possession of a check drawn by the client and made payable to a third party does not amount to custody of client funds by the adviser. However, an adviser would have custody of client funds if it holds a check drawn by the client and made payable to the adviser with instructions to pass the funds through a custodian or to a third party.

Trustee Service: The adviser would be deemed to have custody when it (or a related person as defined under the Adviser Act, including any access person) acts as both trustee and investment adviser of a trust. In these situations, the adviser shall be subject to the above referenced annual surprise CPA examination. However, the adopting release did clarify that it would not view an adviser to have custody of the funds or securities of an estate, conservatorship, or trust solely because the supervised person has been appointed in these capacities as a result of a family or personal relationship with the decedent, beneficiary or grantor (and not a result of employment with the adviser). If the adviser or its related person is a Co-Trustee, the adviser shall be relieved of the surprise examination requirement if the co-Trustee is a qualified custodian or the trust Grantor (which will not be applicable for irrevocable trusts).

Adviser’s 401k Plan: If any member of the Adviser serves as a trustee to the Firm’s qualified retirement plan, and the Adviser also serves as the investment adviser to the plan, the Adviser would be deemed to have custody and be subject to the annual CPA surprise examination. This adverse custody determination also applies if the qualified plan is self-directed but the Adviser manages certain assets allocation models from which the participants may choose.

Possession of Client 401k Passwords: An adviser who maintains possession of client 401k passwords for the purpose of allocating the client’s retirement account among the investment options provided under the plan shall be deemed to have custody and correspondingly be subject to the annual CPA surprise examination if the plan web site permit’s the adviser (regardless of whether the adviser has any intention to do so) to electronically (via the web site) to compromise the integrity for the underlying assets or beneficiaries (i.e., the ability to make account distributions and/or change account beneficiaries).

Investment Partnerships: An adviser has custody if it acts in any capacity that gives the adviser legal ownership of, or access to, client funds or securities. An advisory firm that acts as both general partner and investment adviser to a limited partnership, by virtue of its position as general partner, generally has authority to dispose of funds and securities in the limited partnership’s account and thus has custody of client assets. The SEC also indicated that this example applies equally to an adviser that acts as both managing member and investment adviser of a limited liability company or another type of investment vehicle. See discussion above and below relative to annual audited financial statement exception from surprise examination and custody control review

If you have any questions regarding custody or any other compliance questions or concerns, Red Oak is always here to help you.

How to Calculate Regulatory Assets Under Management

There seems to be a lot of confusion surrounding the issue of how to calculate regulatory assets under management. There is some good guidance surrounding this in the IARD training manual under Section 5.

First you must determine whether each client’s account satisfies the definition of a securities portfolio. An account will be treated as a securities portfolio if at least fifty percent of its total value is made up of securities. Cash and cash equivalents, including bank deposits and certificates of deposit, are viewed as securities. If fifty percent or more of the account value is comprised of securities, the entire account value is counted when calculating the adviser’s regulatory assets under management. A securities portfolio includes:

• Assets of foreign clients;
• Family or proprietary assets; and
• Assets managed without any kind of compensation.

If you have advised any of your clients to invest in a private fund, all of the assets are treated as a securities portfolio. You are required to determine the private fund’s current market value or fair value in order to calculate regulatory assets under management.

For all accounts that meet the definition of a securities portfolio you must determine if the accounts receive continuous and regular supervisory or management services. This is the case if you have discretion over the account or if you are responsible for evaluating specific securities or other investments based upon the client’s financial situation and make recommendations. You must be also be responsible for arranging or placing the purchase or sale of those investments. If you use third party money managers you must have the authority to hire or fire the managers.

The following should not be considered assets under management: (1) assets reviewed as part of a financial plan; (2) assets managed by a third party money manager where you do not have discretion to hire or fire the money manager; (3) assets held in an account where you are paid a commission and are not responsible for ongoing management services; (4) assets reviewed or consulted only at the specific request of the client and the final implementation decision is left to the client.

You should not deduct the following from your AUM calculation:

• Unpaid accrued liabilities;
• Outstanding loans; or
• Securities purchased on margin.

FINRA Exam Priorities

It’s that time of year again and FINRA has published its Exam Priorities Letter which highlights areas of significant focus in their audit program. These priorities represent FINRA’s assessment of the key issues they will focus on in 2013. The areas highlighted in their letter include:

Under Business Conduct and Sales Practices

• Suitability and Complex Products (FINRA Rule 2111)
• Business Development Companies (BDCs)
• Leveraged Loan Products
• Commercial Mortgage Backed Securities (MBS)
• High-Yield Debt Instruments
• Structured Products
• Exchange Traded Funds and Notes (ETFs and ETNs – particularly those using leverage)
• Non-Traded REITs
• Closed-End Funds
• Municipal Securities
• Variable Annuities
• Cyber-Security and Data Integrity
• Microcap Fraud
• Private Placement Securities
• Anti-Money Laundering
• Automated Investment Advice
• Branch Office Supervision

Insider Trading

Firms must be vigilant in safeguarding material, non-public information, and should periodically assess information barriers and risk controls to ensure they are adequate. FINRA provides some examples of risk controls that firms should assess to make sure their insider trading controls are adequate.

Financial and Operational Priorities

• Guarantees and Contingencies
• Margin Lending Practices
• Leverage and Liquidity

Market Regulation Priorities

• Algorithmic trading
• High Frequency Trading Abuses
• Alternative Trading Systems (ATS)
• Options Origin Codes
• Large Options Position Reporting (LOPR)
• Fixed-income (including best execution)

For more complete information on the key issues outlined above, please read the entire letter by clicking here.

As always, if you need any help with your compliance program or have any questions, please contact us. Our team at Red Oak is always here to help guide you through the regulatory quagmire.

Social Media Risk - Negative Posts

Social Media, like many things in the financial services industry has a lot of risks that need to be handled appropriately. FINRA and the SEC have issued rules and guidance to help Advisers regulate this regulatory maze but they fail to give specific instructions. Instead they leave it up to the Adviser's Compliance Officer to create reasonable policies to monitor social media use.

There are a few risk areas we feel compelled to discuss here so that Advisers have a little better idea of how to handle certain circumstances.

One such circumstance is what an Adviser should do if someone adds a negative comment to their social media site. Human nature’s first instinct is to delete it. However, this is a very bad idea. You need to report anything that would be considered a complaint to your Compliance Officer. If you are unsure whether it rises to the level of a complaint, you should consult your Compliance Officer. You should never respond to anything that is a complaint and if it is not a complaint, remember anything you put on your site is visible to everyone. Translated that means be careful that you are projecting the image you want for yourself and your firm and never put anything negative in writing on your social media site.

This is your site and you are responsible for everything on it. So use your Compliance Officer for guidance, always follow the regulations and never forget this is a public forum, visible to just about everyone. If someone posts something that is inappropriate, remove it immediately and let your Compliance Officer know what happened. You should also let the individual know that this is unacceptable and provide guidance on what can and cannot be posted. Remember, your image and brand are at stake, so view all comments through that lens.

Mistakes do happen so if something is posted in error, either remove it or correct and repost it.

Advisers also need to carefully monitor their Privacy settings to make certain their content is only visible to those they want it to be visible to. Since social media sites make numerous updates to how their application works, Advisers need to monitor the social media vendors for updates that may require them to update their privacy and account settings.

Social media is evolving at an unbelievable rate, Advisers need to be ready to ride the wave and information is the key to controlling the ride.

Private Placements of Securities Effective Date

On December 3, 2012 the SEC Approved New FINRA Rule 5123 Regarding Private Placements. FINRA Rule 5123 requires each FINRA member that sells an issuer’s securities in a private placement, subject to certain exemptions, to file with FINRA a copy of any private placement memorandum, term sheet or other offering document the firm used, within 15 calendar days of the date of the sale, or indicate that it did not use any such offering documents.

Firms must file the required offering documents electronically through FINRA’s new private offering filing system through the FINRA Firm Gateway.

In addition, firms must submit filings regarding member firm private offerings (MPOs), as required by FINRA Rule 5122 (Private Placements of Securities Issued By Members), through the same FINRA Gateway system.

Click here for the full regulatory notice 12-40.