Riding the Robo-Advisor Wave

In an age of Instagram, Instacart, and instant gratification in general, a more tech-savvy generation is looking to a streamlined way to save and invest their money. This is evidenced by the growing number of robo-advisors entering the automated investment management arena as well as the growing AUM managed by these advisors. Earlier this week, InvestmentNews published a story announcing that LPL Financial was throwing its hat into the ring. Other independent broker dealers including Cambridge Investment Research Inc. and Commonwealth Financial Network announced their intentions to have robo-adviser offerings earlier this year. They will be entering a part of the market dominated by relative industry newbies Betterment and Wealthfront and industry mainstays Charles Schwab & Co. and Vanguard with AUM totals of $2.52 million, $2.56 million, $3 billion, and $21 billion, respectively.

While these names and figures may seem intimidating to companies trying to enter this space, fear not. Financial technology, or FinTech, is ever evolving in ways to give the consumers what they want: transparency and ease of investing. This coupled with a change in factors driving the brand loyalty of Millennials leaves the robo-advising world open for everyone with the willingness to take the risk and lead market innovation.

So what should new companies entering the robo-adviser world think about from a compliance standpoint? Having a service that is completely automated and only provided via a website and/or phone application requires that you have sound cybersecurity and privacy policies in place to detect and prevent hacking and identify theft as well has having a customized Terms of Use for advisory clients to acknowledge in order to set the expectation of how your site will work. Your automated program must also take into account how you will verify client identities and check client names against terrorist watch lists in a way that is both affective and is seamlessly integrated into your code. While Red Oak will not create the code for you, we can get your company registered and assist you with the workflow of your software in order to successfully integrate the necessary regulatory requirements. For more information, please contact us at 888.302.4594 or at sales@redoakcompliance.com.

SEC Proposes Amendments to Form ADV and Books and Records Rule

Certain Investment Advisers need to get ready for another round of changes. On June 12, 2015, the U.S. Securities and Exchange Commission (“SEC”) published a proposed rule recommending amendments to the Form ADV, the Books and Records Rule, Rule 204-2 and several other technical amendments. The proposed amendments to the Form ADV would require investment advisers to provide additional information that will help the SEC and investors to better understand the risk profile of the individual investment advisers and the industry in general. The proposed amendments to Rule 204-2 would expand the records investment advisers are required to maintain related to performance calculations communications. The following are some of the highlights of some of the proposed changes:

PROPOSED FORM ADV AMENDMENTS

Separately Managed Accounts

Several of the proposed Form ADV amendments would require investment advisers to provide more detailed information concerning separately managed accounts. The proposal states, “For purposes of reporting on Form ADV, we consider advisory accounts other than those that are pooled investment vehicles…to be separately managed accounts.” Under the proposed rule, investment advisers would be required to provide information about the types of assets held and, for certain investment advisers, the use of derivatives and borrowings in the account. Additionally, in certain circumstances, the proposed rule would require investment advisers to identify any custodians where separately managed account assets are held.

Additional Information about Investment Adviser

Under the proposal, additional questions would be added to the Form ADV. Some examples of the additional information that would be included in this area would be:

• expanded branch office information;
• information regarding the use of websites for social media platforms;
• information regarding whether the investment adviser’s chief compliance officer is compensated or employed by anyone other than the investment adviser;
• more specific information related to client types and regulatory assets under management attributable to client types;
• information regarding the number of clients that the investment adviser provided investment advisory services to but does not have regulatory assets under management for; and
• information regarding the amount of regulatory assets under management that is attributable to non-U.S. clients.

Umbrella Registration

Some investment advisers to private funds may be organized as a group of related investment advisers that are separate legal entities operating as, and appearing to investors and regulators to be, a single advisory business. Because of the way the Form ADV is currently organized, private fund advisers organized as a group of related investment advisers could have to file multiple investment adviser registration forms for the same advisory business. The SEC has proposed amendments to the Form ADV Part 1A that would simplify the process of registration for these investment advisers while providing additional and more consistent data about private fund advisers that operate in this manner.

PROPOSED RECORD KEEPING REQUIREMENTS AMENDMENTS

One of the proposed revisions to Rule 204-2 would require investment advisers to maintain performance calculations and communications that the investment adviser circulates or distributes to “any person” instead of “ten or more persons” as currently stated in Rule 204-2. Additionally, the SEC is proposing an amendment to require investment advisers to maintain originals of all written communications received and copies of written communications sent by an investment adviser relating to the performance or rate of return of any or all managed accounts or securities recommendations.

The SEC has opened a 60 day response period for investment advisers to provide feedback regarding the proposed amendments. Comments will be accepted until August 11, 2015. To read the full please, please click here.

Investment advisers should continue to monitor developments regarding the proposed changes. Red Oak Compliance Solutions can help you with any questions and provide assistance with getting your documents in order.

RIA Firms: Are You Properly Registered in the States You Have Clients?

We regularly encounter this question when working with investment advisors interested in establishing their own new RIA firms, or existing firms going through the renewal process at the end of the year. It is critical to be properly registered in the states you have clients in since you cannot charge advisory fees if you are not.

Because most states follow the same general rules pertaining to the “de minimis exemption,” RIA firms must register or notice file under the following circumstances:

• The RIA firm has a physical office location in the state
• The RIA firm has more than 5 clients residing in the state
• The RIA firm is actively soliciting in the state

It is also important to understand how the regulators define “clients”. When counting clients in a state, remember that members of the same household count as a single client. So, if you are managing assets for a married couple, residing in a state, that household counts as a single client.

At present, there are only two states that require an RIA Firm to notice file or register before taking on a single client. Those states are Texas and Louisiana. This is important to take into consideration if you are considering growing your business by expanding into other states or if one of your clients moves to a new state.

As always, because states often make regulation changes, it is a good idea to check with either your state regulator or RIA compliance consultants to confirm the latest RIA registration and notice filing requirements.

Everyone at Red Oak Compliance Solutions stands ready to assist you with any questions regarding this or any other compliance matters.

Red Flags for Senior Investors

Older Americans have often been and continue to be the targets of various fraud including investment fraud. The SEC issued an Investor Alert for seniors in June of this year to help investors become more familiar with common “red flags.” The following are among the more prevalent practices to be aware of.

Promises of High Returns with Little or No Risk. Always high on the list, promises of high returns with little or no risk should cause concern. The SEC cautions that all investments carry some level of risk and that the potential for greater returns generally comes with greater risk. Seniors should avoid “can’t miss” or “guaranteed return” investment offers. The old adage “buyer beware” still offers sound advice.

Unregistered Persons. In an age where technology makes verifying the qualifications of investment professionals so easy, it is difficult to understand how often unregistered and unqualified fraudsters can find people ready to invest with them. Technology is not always easily adopted by some older Americans so it is important to have multiple options for individuals to find answers. Regulators have provided a number of ways to research the background of individuals and firms including registration/license status and disciplinary history:

• Search Security and Exchange Commission (SEC)’s Investment Adviser Public Disclosure (IAPD) online database.
• Search Financial Industry Regulatory Authority (FINRA)’s BrokerCheck online database.
• Contact State securities regulator.
• Contact SEC’s Office of Investor Education and Advocacy: (822) 732-0330

Red Flags in the Financial Professional’s Background. The records of SEC, FINRA and State securities regulators can be used to identify potential problems of a financial professional including a) employment at firms that have been expelled from the securities industry, b) personal bankruptcy, c) termination, d) being subject to internal review by an employer, e) a high number of customer complaints, f) failed industry qualification examinations, g) federal tax liens and h) repeatedly moving firms among others.

Pressure to Buy Quickly. High pressure sales tactics in any industry should be considered a red flag but when used by investment professionals the best advice is to walk away. Avoid “act now” offers and requests to make immediate decisions without allowing time for you to research the professional or the product/service being offered.

Free Meals. Be aware that “free lunch” seminars are often used to attract new clients and to sell investment products not to educate the public. The SEC recommends that if you plan to attend one, you should not commit to purchasing anything or opening an account while at the seminar. They say that even if the free meal does not come with a high-pressure sales pitch, you should expect the “hard sell” in subsequent contacts from the person selling the investment.

Additional Resources

• A Guide For Seniors: Protecting Yourself Against Investment Fraud
• Social Media and Investing: Tips for Seniors
• “Free Lunch” Investment Seminars: Avoiding the Heartburn of a Hard Sell: A FINRA Investor Alert about “free lunch” investment seminars.

Red Oak Compliance Solutions is here to help if you have any questions.

SEC Charges Investment Adviser for Inflating Hedge Fund Prices

The Securities and Exchange Commission (“SEC”) recently charged a Greenwich, Conn.-based investment advisory firm and its two owners with fraudulently inflating the prices of securities in the hedge fund portfolios they managed.

The SEC investigation found that AlphaBridge Capital Management told investors and its auditors that it obtained independent price quotes from broker-dealers for certain unlisted, thinly-traded residential mortgage-backed securities. Instead, AlphaBridge gave internally-derived valuations to broker-dealer representatives to pass off as their own. The inflated valuation of these assets caused the funds to pay higher management and performance fees to AlphaBridge. AlphaBridge and its owners Thomas T. Kutzen and Michael J. Carino agreed to pay $5 million to settle the charges.

“The integrity of the portfolio valuation process is critical to fund investors, especially when it involves illiquid securities,” said Julie M. Riewe, Co-Chief of the SEC Enforcement Division’s Asset Management Unit. “AlphaBridge claimed to use market-grounded price quotes from brokers when in fact it relied on its own rosy view of market conditions to price its portfolio.” To read the full press release click here.

This is a good reminder that advisors should document sources when showing performance, whether it be readily available data regarding market indexes, listed securities or more illiquid offerings. For advisors creating their own portfolios and valuations this illustrates the importance of utilizing data from resources that have a reputation of being reliable and remaining fair and balanced in portfolio valuation. Red Oak Compliance Solutions is here to help you through the process.

SEC Charges Investment Adviser with Cherry-Picking

The Securities and Exchange Commission (“SEC”) recently issued fraud charges against an investment adviser and the adviser’s owner for improper trade allocation. The charges stemmed from the adviser’s alleged allocating of options trades that appreciated in value during market hours to his personal and business accounts while allocating options that declined in value to the client accounts.

It appears that for some time the SEC’s enforcement division has been monitoring for improper trade allocation, referred to as “cherry picking”, by analyzing large volumes of trade allocation data from registered investment advisers in order to identify instances of cherry picking. According to Julie M. Riewe, Co-Chief of the SEC Enforcement Division’s Asset Management Unit, without a client bringing these types of issues to the attention of the SEC, fraudulent trade allocations are typically difficult to detect. Therefore, they devised the monitoring program to identify specific custodians providing institutional services to investment advisers and their clients in order to allow them to more efficiently monitor trade allocations.

The SEC’s Asset Management Unit and regional offices in Boston and Los Angeles have led this data monitoring program to help in the detection and prevention of cherry picking. The process combines monitoring of the advisers trades allocations and statistical analysis to determine the likelihood of profitable trades allocated to non-client accounts. Please click here to read the full story.

It is critical that advisers have a robust surveillance and monitoring system to detect trade allocation issues. If you are unsure how your trade allocations are being monitored or would like a review of your current system, let Red Oak Compliance Solutions assist you.

Cybersecurity Assessment Tool

The Federal Financial Institutions Examinations Council is providing a Cybersecurity Assessment Tool that institutions can use to help identify risks and evaluate their policy. While this tool was not designed for broker-dealers and investment advisers, it may be useful to help with their cybersecurity compliance efforts.

Click here to view the tool.