What to do Before the SEC Comes

The Securities and Exchange Commission (“SEC”) is continuing to focus on their exam initiative. They are working to complete more exams than ever before, especially for those firms that have not been audited before. One best practice that everyone should implement is to create an introductory presentation for the SEC Examiners.

An introductory presentation is your chance to tell the examiners all about your firm, your business model and your compliance program. This can help the examiners understand how your firm operates and focuses them on the key areas to review for your type of firm.

Remember this is not a sales pitch. You are not trying to sell the examiners on becoming clients, you are trying to help them understand there is no fraud or deception at your firm. A PowerPoint is a very effective format for this presentation and your Chief Compliance Officer needs to be present during the meeting. If your chief Compliance Officer is comfortable presenting, let him/her lead this initial meeting.

So put together a PowerPoint now so you are not caught by surprise and under the gun to produce dozens of documents and try to create a compelling presentation. The presentation should include your organizational structure, firm history, all conflicts of interest, your compliance culture, mission statement, client base, services provided, your marketing strategy and risks.

Also remember this presentation is a living document so you need to update it at least semi-annually so that it remains relevant.

Brokers Go Rogue and Sell Unauthorized Private Placements for 14 Years

The Securities and Exchange Commission (“SEC”) has fined and censured a broker-dealer/registered investment adviser $450,000, fined and suspended a supervisor for twelve months for failing to stop two rogue brokers from selling an unauthorized private placement for which they received commissions and barred permanently and fined the two rogue brokers.

According to the SEC, the brokers sold the fund to over 125 clients in a 14-year period using the firm's offices and sent the clients statements from the firm's client reporting system. The SEC faults the firm for failing to adopt reasonable policies and procedures governing the use of its client reporting system and the supervisor for allowing the brokers to select which files to be reviewed every year rather than taking a random sample.

To read the complete Administrative Proceedings Document, please click here.

The regulators are looking at consolidated statements since they are so easy to fabricate. Firms should never allow manual changes to be made to client reporting documents. There should also be base reporting templates that are made available after they have been reviewed by compliance for representatives to use with clients. There are specific disclosures that need to be included on these statements.

Firms also must ensure that supervisors stay in line with the compliance program and follow the firm’s policies and procedures, including those involving selling away. If you have any questions about how your reporting system works or could be improved, please give us a call to discuss.

Rep Barred for Churning

The Financial Industry Regulatory Authority (FINRA) announced today that it has permanently barred Richard Adams, a former registered representative of Caldwell International Securities Corp., from the securities industry for churning customers’ accounts and other securities rule violations. Adams also failed to report a dozen unsatisfied judgments and liens on his U4 Registration Form as required by FINRA rules.

FINRA found that from July 2013 to June 2014, Adams excessively traded and churned the accounts of two customers generating more than $57,000 in commissions. At the same time, the excessive trading activity in these accounts resulted in over $37,000 in customer losses.

Brad Bennett, FINRA’s Executive Vice President and Chief of Enforcement, said, “A key element of retail investor protection is the aggressive pursuit of brokers who churn and excessively trade customer accounts. FINRA has no tolerance for brokers who place commissions ahead of what is suitable and appropriate for their customers.”

In settling this matter, Adams neither admitted nor denied the charges, but consented to the entry of FINRA’s findings.

Investors can obtain more information about, and the disciplinary record of, any FINRA-registered broker or brokerage firm by using FINRA’s BrokerCheck. FINRA makes BrokerCheck available at no charge. In 2014, members of the public used this service to conduct 18.9 million reviews of broker or firm records. Investors can access BrokerCheck at www.finra.org/brokercheck or by calling (800) 289-9999. Investors may find copies of this disciplinary action as well as other disciplinary documents in FINRA’s Disciplinary Actions Online database. Click here to read the full press release.

While this may be an extreme example it still illustrates why it is prudent to document transactions in client accounts, whether it be through notes from client meetings, calls, or simply showing how a trade is suitable for their current situation.

Additionally, it is extremely important to stay on top of your U4 information. There is a 30 day window to update your U4 for any reportable event. Not sure if something needs to be reported? Let us know, we are here to help.

Social Media and Testimonials

With advances in technology providing access to more information and opinion than ever before, investment advisers (IA) and investment advisory representatives (IAR) must be vigilant in how they use Social Media in their advertising and marketing. Social Media is often used to build relationships and more than ever to let people express their views and opinions. IA’s and IAR’s can easily run afoul of the Security and Exchange Commission’ (SEC) Testimonial Rule 206(4)-1(a)(1). Fortunately, the SEC’s Department of Investment Management issued guidance last year to help us better understand appropriate and inappropriate uses of Social Media.

Rule 206(4)-1(a)(1) states, “[i]t shall constitute a fraudulent, deceptive, or manipulative act, practice, or course of business . . . for any investment adviser registered or required to be registered under [the Advisers Act], directly or indirectly, to publish, circulate, or distribute any advertisement which refers, directly or indirectly, to any testimonial of any kind concerning the investment adviser or concerning any advice, analysis, report or other service rendered by such investment adviser.”

And while “testimonial” is not defined in the Rule, the SEC staff has consistently interpreted that term to include a “statement of a client’s experience with, or endorsement of, an investment adviser.” Between the Rule itself and the staffs’ interpretation of what a testimonial is, there has been limited ability to include comments by clients about their experience with an IA or IAR in advertising. Recent guidance does indicate that as long as certain conditions are met it may be possible.

Notable changes in the SEC’s position include:

• The publication of an article by an unbiased third party regarding the adviser’s investment performance unless that article includes a statement of a client’s experience with or endorsement of the adviser.
• An advertisement that contains non-investment related commentary regarding an IAR, such as regarding an IAR’s religious affiliation or community service.

When using third party commentary it is important to understand that it must be unbiased and independent of the IA or IAR. As long as the IA or IAR has no ability to affect the commentary or how the public commentary is presented on an independent social media site the testimonial prohibition may not be implicated. It is essential that ALL (unedited) public commentary is made available and updating of new commentary is on a real-time basis. If the IA or IAR drafts or submits commentary or if the IA or IAR has the ability to suppress some or all of a commentary, the testimonial rule would be implicated. Also prohibited would be an IA or IAR compensating a social media user for authoring the commentary.

When referencing commentary on independent Social Media sites in advertising, IA’s and IAR’s can direct the public by stating, “see us on [independent social media site]” to let clients/prospective clients know that they can research public commentary about the IA or IAR but they could not publish any testimonials from the independent Social Media site in their own advertising without implicating the testimonial rule.

For more information (including the use of client lists/photos and fan or community webpages) please see the SEC’s IM Guidance Update #2014-04: GUIDANCE ON THE TESTIMONIAL RULE AND SOCIAL MEDIA

Red Oak stands ready to assist IAs and IARs with all their social media questions.

End of Year Reminder

It may only be the beginning of August, but it’s time to start focusing on the end of year routine all registered investment advisers must endure in order to remain in compliance with the Rules and Regulation under which they operate. The time period of October 1 through December 31 is a busy time for all of us. But that is especially true for the small investment adviser trying to service its clients and keep up with the ever mounting compliance requirements that the regulatory world keeps throwing at them.

In the midst of end of quarter billings, winding up the year-end financials, preparing for the impending tax season, scheduling year end portfolio reviews with clients, watching the markets while also attending a myriad of Halloween parties, working on travel arrangements for the holidays with the significant other, Christmas shopping and attending a host of holiday parties and school holiday events, it is important to remember the small things that are also important to be done. These things include funding your renewal account with FINRA, reviewing your Form ADV Parts 1 and 2 to ensure they are up to date and reviewing the Form U4 to make sure it is up to date.

So make sure you set time aside to go over the ADV’s, review your contracts, take a look at the Form U4 and most importantly, make sure you fund your renewal account with FINRA.

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.