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.

Culture of Compliance: Do You Put Your Money Where Your Mouth Is?

You will often hear regulators and compliance professionals speak about the need for investment advisers and broker dealers to establish a culture of compliance within their firms. Instituting this type of atmosphere requires more than simply creating a compliance manual and code of ethics. Establishing a culture of compliance also means dedicating knowledgeable staff and sufficient resources to insure that your firm properly implements your compliance program. Last August, we sited a survey by Cipperman Compliance Services which indicated that the compliance function in the surveyed firms was underfunded and understaffed.

The survey’s finding came to fruition for one firm on June 23, 2015, when the Securities and Exchange Commission (SEC) settled an administrative proceeding against an investment adviser for, among other things, failure to complete their annual compliance review and failure to implement and enforce provisions of its policies and procedures and code of ethics. The SEC indicated that these failures were caused substantially because the adviser’s President “dedicated insufficient resources to compliance, which contributed substantially” to the failures of their compliance program. Not only did senior management of the adviser hire a Chief Compliance Officer with limited experience, they failed to provide the CCO with adequate guidance regarding his duties and required him to have various additional job functions ranging from research analyst to CFO. The CCO realized that he needed help to fulfill his compliance responsibilities and made multiple requests for help to senior management. In response, they expressed that their primary concern was serving their clients and did not provide the CCO with any additional resources. Ultimately, an SEC exam found that the advisory firm failed to complete its annual compliance review for two consecutive years and had multiple code of ethics violations related to its trading program. The SEC’s sanctions included monetary fines totaling $285,000 and the suspension of its President from acting in a supervisory role for a twelve month period.

While serving your clients may be your primary concern, serving a suspension because you failed to provide resources to your compliance program could hinder your ability to do so. It is also completely unnecessary. As noted by the SEC, one of the remedial acts undertaken by the adviser was eventually retaining a compliance consultant to help monitor their compliance program reviews and act as a compliance resource to the firm’s employees. Should you find that your CCO is stretched thin or fear that your compliance program is threatening to jeopardize your business, Red Oak is here to help you enhance your program and aid in its implementation.

Please click here to read the full SEC order.

Title IV of the JOBS Act of 2012

As of June 19, 2015 it will become much easier for small business startups to raise capital, as Title IV of the Jumpstart Our Business Startups Act of 2012 (“Act”) goes into effect. The new Act revises some of the regulation that, combined with limitations on availability to capital, has made it difficult, costly and time consuming for startups to get off the ground. The Act accomplishes this with the removal of the accredited investor requirement, an individual with a net worth of $1M or more or $200,000 in annual income, for small startups wishing to raise large sums of money, as well as eliminates the wait to be approved by state regulatory bodies and the requirement to issue quarterly reports and list their shares on an exchange. Additionally there is a “test the water” provision which allows startups to run their ideas by the media and investors before they are required to spend the money on a formal proposal to be reviewed by the Securities and Exchange Commission.

On June 19 small startups will be able to raise money, values of $20M to $50M, through crowdfunding programs. This means that any individual of adult age residing in the United States will be able to take part in small offerings.