RIA Compliance Blog

Another large group in the financial service industry has come forward to oppose authorizing the Federal Industry Regulatory Authority (FINRA) to become the self regulatory organization (SRO) for investment advisers. The American Institute of CPAs (AICPA) has voiced its desire to keep the oversight of investment advisers with the Securities and Exchange Commission (SEC).

The AICPA is the world's largest association representing the accounting profession. It is interested in the oversight of investment advisers because a number of its members work for firms that are registered or affiliated with a registered investment adviser. Members also provide audit, tax, retirement consulting, plan administration and financial planning services to their clients.

The Financial Industry Regulatory Authority (FINRA) has proposed a rule which would allow individuals who are not named as parties to a customer-initiated arbitration case to seek expungement relief by initiating "In re" expungement proceedings. Currently, unnamed persons do not have a prescribed way to seek these types of expungements, and must seek relief by:

• Asking their current or former firm that is a party to the arbitration to request expungement on their behalf;


• Seeking to intervene in the arbitration filed by the customer; or


• Initiating a new arbitration case in which the unnamed person requests expungement relief and names the customer or firm as respondent.

According to Regulatory Notice 12-8, "FINRA believes that the current options do not always adequately address a number of issues that can arise in connection with expungement requests."

The Financial Industry Regulatory Authority (FINRA) has responded to the Boston Consulting Group (BCG) study that estimated the cost of FINRA becoming the investment adviser self regulatory organization (SRO). The BCG study, which we have discussed in a previous blog, was sponsored by the Financial Planning Coalition, comprised of the Certified Financial Planner Board of Standards Inc., the Financial Planning Association and the National Association of Personal Financial Advisers. The Financial Planning Coalition, along with a number of other groups, is urging Congress to maintain investment adviser oversight by the Securities and Exchange Commission (SEC).

The BCG study concluded that, if FINRA were to become the investment adviser SRO, the one-time start-up cost would be between $200 million and $255 million, and the annual cost would be about $550 million to $610 million. In response to the BCG study, last month FINRA released its own cost estimates. According to FINRA, its start-up cost would be approximately $12 million to $15 million, with annual cost of about $150 million to $155 million. FINRA contends that the BCG projection is inaccurate because "BCG used as its base the costs for establishing the PCAOB (Public Company Accounting Oversight Board) and the CFPB from scratch. BCG used figures - set up costs for organizations that didn't even have one desk or employee to start with - and provided for only a 20% discount off the from-scratch start-up costs to allow for efficiencies in FINRA's existing infrastructure."

An independent insurance agent, Glenn Neasham, was convicted on a felony-theft charge in March for selling a complex indexed annuity to an 83-year old client in a California court. He was sentenced to spend ninety days in jail. Prosecutors claimed that Mr. Neasham's client had exhibited signs of dementia and was not capable of consenting to the transaction.

This case has stirred fear among insurance and securities agents. The state's then-insurance commissioner stated in 2010, after Mr. Neasham's arrest, that agents "who steal from vulnerable seniors will not get away with their shameful tricks." Agents are attracted to indexed annuities because they receive high commissions, which can be 12% or more of the invested amount. As a result of this case and heightened regulatory scrutiny, agents will have to think twice before selling indexed annuities to the elderly. The $14,000, or 8%, commission that Mr. Neasham received was a factor used against him to prove his criminal intent.

Numerous states have recently adopted or proposed rules that exempt hedge funds, or "private funds" from the registration requirement of those states' investment adviser laws. We have previously blogged about a number of state rules including those in Virginia, California, Maine, Massachusetts, Wisconsin, Colorado and Rhode Island. The majority of the rules are similar to one another; however, there are a few key differences. Attached is a table detailing the similarities and differences among the seven different states.

The North American Securities Administrators Association (NASAA) will be holding its annual public policy conference on May 7, 2012 in Washington DC. According to NASAA, "This year's conference is designed to bring together securities regulators, securities law professionals, financial industry representatives, consumer advocates and legislative and regulatory policymakers for an in-depth look at key financial services policy issues."

Registration will begin at 10 a.m., followed by a luncheon with a keynote address at 11:30 a.m. The featured speaker this year is U.S. Congresswoman Maxine Waters (D-CA).

According to a market study by author Delia Passim, women will make more client referrals to their financial advisers than men will. On average, women will make 26 such referrals in their lifetime, which is substantially more than the 11 that men average. These results were presented at the annual conference of the Investment Management Consultants Association.

Kathleen Burns Kingsbury of KBK Wealth Connection was one of the speakers who addressed the differences between men and women in the financial world in a workshop session entitled "Sex, Lies, and Stereotypes" at the conference. She stated that men and women are wired differently when it comes to communicating, researching and approaching a financial issue or decision.

Kingsbury believes that in order for women to makes referrals to other friends, the investment adviser must develop a personal relationship and a connection with them. She said, "If you do the right things, and in a way that fosters trust in female clients, they will connect you with their friends. They are huge referrers."

Colorado is the ninth state to adopt a private fund adviser exemption by rule. The exemption became effective on March 30, 2012. The other states that have created similar rules are California, Indiana, Maine, Massachusetts, Michigan, Rhode Island, Virginia, and Wisconsin, most of which we have already blogged about.

The Colorado rule exempts investment advisers who manage one or more "venture capital funds," as defined by Rule 203(l)-1 under the Investment Advisers Act of 1940 ("Advisers Act"), and who comply with the SEC Rule 204-4 reporting requirements. Investment advisers that are relying on this exemption will not be required to file the SEC Rule 204-4 reports with the Colorado Securities Commissioner. The rule also incorporates by reference the "grandfather" provision in Rule 203(l)-1(b) under the Advisers Act. Similar to the rules adopted in other states, it also exempts investment adviser representatives who are employed by or associated with an investment adviser that is already exempt under a private fund exemption. Finally, any investment adviser who is subject to disqualification under the "bad boy" provisions in Rule 262 of SEC Regulation A will not be entitled to the exemption.

Typically, offshore funds are not subject to regulation under the U.S. securities regulations as long as they are not sold to U.S. citizens or residents. Offshore funds were not liable for fraud under §10(b) of the Securities Exchange Act unless they met the standards for the "conduct or effects" test. The test focused on:

• Whether the wrongful conduct occurred in the United States; and


• Whether the wrongful conduct had a substantial effect in the United States or upon United States citizens.

The "conduct or effects" test was rejected in Morrison v. Nat'l Austl. Bank Ltd. in 2010. The court established a new transactional test that stated that §10(b) and Rule 10b-5 do not apply extraterritorially, but only apply to "transactions in securities listed on domestic exchanges and domestic transactions in other securities." The court stated that domestic transactions should focus on the purchase and sale of securities. The case did not specifically define the term "domestic transactions," however, because the parties to the case were foreign and the dispute occurred outside the United States.

House Financial Services Committee Chairman Spencer Bachus (R-AL) has reintroduced his bill calling for a self-regulatory organization (SRO) for investment advisers. The bill has a Democratic co-sponsor, Rep. Carolyn McCarthy (D-NY), indicating that it may have some bipartisan support. Rep. Bachus said that the bill was drafted in response to a Securities and Exchange Commission (SEC) study which showed that the SEC does not have sufficient resources to adequately monitor and regulate the 12,000 registered investment advisers. The SEC examined only 8% of advisers in 2011, which is significantly less than the 58% of broker-dealers that were examined.

The bill calls for the creation of one or more SROs which would be called a "National Investment Adviser Association" (NIAA). NIAA would report to the SEC, and investment advisers with retail customers would be required to become members. The bill provides an exception from the membership requirement for investment advisers with less than $100 million in assets under management. The bill gives individual states the authority to regulate those investment advisers as long as the states conduct periodic on-site examinations.

On April 11, 2012, the Securities and Exchange Commission (SEC) announced it will accept comments prior to creating rules required by the Jumpstart Our Business Startups (JOBS) Act. The SEC believes it is important to hear the public's opinion before releasing proposed rules. It previously requested comments before rulemaking when the Dodd Frank Wall Street Reform and Consumer Protection Act was passed.

The SEC will disclose all information pertaining to the JOBS Act on its website. This will include all meetings with interested parties. The meeting participants must provide an agenda of intended topics in advance, which will be released to the public. The participants will also be encouraged to submit written comments to the public file in order for other interested parties to review the information.

Two states have created a time-table to help mid-sized firms make the switch from Securities and Exchange Commission (SEC) supervision to state regulated supervision. As a result of the Dodd-Frank Wall Street Reform and Consumer Protection (Dodd-Frank) Act, those investment advisers with $100 million or less but more than $25 million in assets under management will be required to register with the state or states in which they do business instead of the SEC. We have already discussed the switch in Mid-Sized Advisers Should Have Already Commenced Transition. Both Iowa and Missouri are helping mid-sized firms in their state by creating time-tables and providing guidance for the transition.

According to American Century Investments' third annual Financial Professionals Social Media Adoption Study, more advisers are starting to use various forms of social media for professional uses. The results were drawn from an online survey of 300 financial professionals who are employed as financial advisers, brokers or registered investment advisers. The participants were members of Research Now, and they averaged fourteen years in the financial industry.

The study showed an increase in the use of smartphones and other mobile devices to access social media websites than in previous years. Approximately 35% of advisers claimed to use smartphones for social media access, which is up from the 27% in 2011. Also, there was an increase in advisers who used mobile devices such as iPads and other tablets for access from 11% last year to 22% in 2012. The majority of financial advisers; however, still access social media through laptop and desktop computers.

As a result of the Dodd Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank), mid-sized firms of less than $100 million in assets under management should make the switch from Securities and Exchange Commission (SEC) oversight to state regulatory oversight. Most advisers know that under the newly adopted SEC rules, mid-sized advisers that were SEC registered prior to Dodd-Frank must remain SEC registered through the first quarter of 2012, and then complete their switch to state regulation by June 28, 2012. Firms wishing to switch should have already completed the state registration process to become effective in the state or states in which the adviser is registering.

It was estimated by this time that 3,200 firms would have made the switch to state regulation. However, spokesman John Nester for the SEC announced that as of April 5, a little more than 1,900 firms claimed that they were no longer eligible for SEC registration and needed to make the switch.

The Florida Legislature has recently passed a law which imposes harsher penalties for those who sell unregistered securities. The bill, HB 777, was signed into law by Governor Rick Scott on April 6, 2012. The bill will take effect July 1, 2012. As a result, the lowest permissible sentence for violations is increased.

The bill provides that all those who do not register securities offerings with the state's Office of Financial Regulation may be charged with a third-degree felony at a higher level than previously allowed. A third-degree felony in the state of Florida carries up to a five year prison sentence. Broker-dealers, appointed persons, and issuers of securities who do not register with the Office of Financial Regulation are also subject to the same penalty.