Over the last few years, more and more states have enacted laws to protect vulnerable adults from financial exploitation. These laws typically apply to the conduct of registered investment advisers, broker-dealers, and their employees. Two states – Iowa and Nebraska, have passed such legislation in 2021. Two other states – Florida and Texas – have added additional protections to already existing laws. The new laws are worth studying as they point to the general tenor and structure of the laws being adopted in other states.

For example, Iowa Sec. 502.801, titled “Financial Exploitation of Eligible Adults,” includes protection for adults over 65 and certain other “dependent adults.” The law requires all broker-dealers or investment advisers to provide vulnerable adult training for its employees “appropriate to the job responsibilities” of the employee. The training must occur within one year of the employee’s hire date and must include information on how to identify actual or attempted financial exploitation of eligible adults and how to report such exploitation to the regulatory authorities. “Financial exploitation” is defined to mean “any act or omission taken by a person to wrongfully and knowingly deprive an eligible adult of money, assets, or property, or to obtain control over or otherwise use, convert, or divert the benefits, property, resources, or assets of the eligible adult by intimidation, deception, coercion, fraud, extortion, or undue influence.”

The statute permits, but does not require, certain actors to report any reasonably suspected exploitation to the securities administrator, which is the Securities and Regulated Industries Bureau of the Iowa Insurance Division (“the Bureau”). Any such report made reasonably and in good faith cannot form the basis of civil or administrative liability by the person or company making the report. Those authorized to make such reports, and therefore able to take advantage of the civil and administrative immunity provisions, are any broker-dealer, investment adviser, or any individual who has received the required training. Continue reading ›

On July 13, 2021, the Securities and Exchange Commission (“SEC”) published an order instituting administrative cease-and-desist proceedings against TIAA-CREF Individual & Institutional Services, LLC (“TIAA”). TIAA consented to this order without admitting or denying the findings except as to jurisdiction and subjection matter. The SEC’s order alleges TIAA failed to properly disclose conflicts of interest and made materially misleading statements concerning rollover recommendations they made to clients over a five-year period from 2013 to 2018.

TIAA’s policies and procedures required their investment adviser representatives, who were also dually registered as registered representatives, to present clients with four options regarding rollover recommendations when providing financial planning services. The options were:

  1. Leave client assets in their employer-sponsored retirement plans;
  2. Rolling the assets into a self-directed individual retirement account;
  3. Rolling over the assets to a new employer’s plan; or
  4. Cashing out the account value/taking a lump-sum distribution.

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Over the last five years, cybersecurity has consistently been a top priority of the Securities and Exchange Commission (“SEC”). We have written about the SEC’s focus on cybersecurity in July 2020 and January 2020. With an additional enforcement action in June, the SEC is continuing to signal that firms regulated by the SEC need to have appropriate risk management and cybersecurity controls in place. While this case study isn’t directly related to Investment Advisers, they would be wise to learn lessons from this story.

First American Financial Corporation (“First American”) is a real estate settlement services provider. In that capacity, they store certain non-public personal information (“NPPI”) of real estate purchasers and sellers. In an internal audit in 2018, an error was caught that certain NPPI stored by First American was not stored securely.

Subsequently, First American conducted a vulnerability test which culminated in a written report in January 2019. In the report, information security personnel determined that certain website URLs that First American provided to people could be replaced with different numbers to create access to NPPI that was unauthorized. Continue reading ›

In late May, FINRA issued a  press release announcing the temporary withdrawal of proposed rule changes regarding the process for obtaining expungement of customer dispute information maintained for registered representatives on WebCRD, or “BrokerCheck.”

The proposed rule changes were issued in 2017 for possible SEC approval and have previously been discussed on our blog. Since 2017, FINRA has responded to various SEC requests for additional information, and the deadline for adoption of the rule proposals has been extended. The withdrawal release cites “consultations with the SEC staff” as the basis for withdrawal of the rule proposal and concludes by restating FINRA’s commitment that it will continue to consult with, and solicit input from, the SEC and other interested parties “who share a common interest in revising” the expungement process.

Among other things the proposed rule changes included:

  • Establishing a new category of arbitrators trained and qualified to decide expungement cases, and maintaining a roster of those arbitrators who will decides such cases;
  • Eliminating the process for ranking arbitrators that are appliable to other industry and customer arbitrations;
  • Prohibiting stipulations or agreements to allow the case to be decided by fewer than three arbitrators chosen from the special panel;
  • Requiring a broker who is named in the underlying arbitration to seek expungement in that arbitration;
  • Imposing stricter time limits within which brokers may request expungement; and
  • Limiting situations in which a party to a customer dispute – such as a broker-dealer – can request expungement relief for an unnamed party, such as a registered representative of that broker-dealer.

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Rule 206(4)-1 under the Investment Advisers Act, known as the “Marketing Rule,” becomes effective on May 4, 2021. Full details of the new rule and the related amendments to the Books and Records Rule and for ADV can be reviewed in the SEC’s adopting release. The new rule changes many aspects of the current guidance applicable to advertising by SEC-registered investment advisers, some of which is drawn from no-action letters and other informal releases. Advisers must come into compliance with the new rule within eighteen months of the effective date or by November 4, 2022. Firms may choose to come into compliance at any time between the effective date and the compliance date, but the SEC has warned that RIAs may not choose to implement parts of the new rules at different times. Rather, a firm must implement and be prepared to comply with the entirety of the new rule on a single date within the eighteen-month compliance period. The rule does not, on its face, apply to state-registered RIAs, who should continue to follow the rules applicable to the states in which they conduct business. Some state rules mirror or adopt the SEC advertising rules in some respects.

One of the most important changes relates to using what has historically been referred to as “testimonials,” or statements by clients regarding their experience with an adviser. The current rule 206(4)-1, titled “Advertisements by Investment Advisers,” states that any advertisement by an adviser that uses a “testimonial of any kind” is deemed fraudulent, deceptive or manipulative. Although “testimonial” is not defined in the current rule, the SEC consistently interpreted the term as a statement of a client’s experience with, or endorsement of, an investment adviser. Under the new rule, however, testimonials as traditionally understood are permitted as long as firms comply with a number of requirements. Continue reading ›

Earlier this month, the Securities and Exchange Commission announced the examination priorities for registered investment adviser and broker-dealer examinations to be conducted in 2021 by the SEC’s Division of Examinations (formerly the Office of Compliance Inspections and Examinations).

The list included a continued focus on conflicts of interest, including examining for compliance with Reg BI (for broker-dealers) and with an investment adviser’s fiduciary duty. Among the matters examined will be whether RIAs comply with care and loyalty duties that arise from the fiduciary duty. Whether firms have taken appropriate steps to mitigate, disclose or eliminate conflicts of interest will continue to be a focus, with an emphasis on whether customers received enough information to be the basis of informed consent. The Division will also continue to prioritize examining information regarding investment products that carry elevated risks, such as certain ETFs, municipal securities, private placements, variable annuities, and microcap securities.

Not surprisingly, the Division will also focus on two areas that were emphasized over the last two years to varying degrees: ESG-related risks and disclosures and proxy voting practices. RIAs who offer asset management based on ESG principles will be questioned regarding their representations regarding products or services provided, including representations regarding third-party managers or products. The Division will also examine to ensure that proxies have been voted consistent with customer’s desires to invest in ESG focused investments.

Business continuity and disaster recovery plans will be a focus this year, including whether lessons learned during the pandemic have appropriately informed changes to such plans. A greater emphasis will also be placed on climate-related risks, due to greater instances of climate hazards experienced in recent years attributable to climate change. These types of issues will be of heightened concern for examinations of critical market participants such as clearing firms and market makers.

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Even before Robinhood Financial LLC entered the spotlight late last month for having halted trading in Game Stop during that company’s unprecedented short squeeze, Robinhood had already been charged with allegedly violating state securities laws in connection with its business practices. In December of last year, the Securities Division of the Massachusetts Secretary of the Commonwealth sued Robinhood, alleging that the company had engaged in aggressive marketing tactics aimed at young, inexperienced customers. The complaint was based in large part on alleged violations of the duty to act in customers’ best interest, as required by regulations adopted in March 2020 imposing upon broker-dealers the same fiduciary duty applicable to investment advisers operating within the Commonwealth.

According to the complaint, Robinhood failed to act in the best interests of its customers and exposed them to unnecessary trading risks. The Company directed its market at young, inexperienced investors. When they opened accounts, the Company encouraged its customers to use the trading platform frequently and approved unqualified clients for options trading. Although not mentioned in the suit, a 20-year old college student from Illinois committed suicide last summer because he mistakenly thought he owed over $700,000 based on options trades he had made using the Robinhood platform. Earlier this week his parents sued Robinhood, making allegations that echoed the Massachusetts regulator’s charges.

Continue reading ›

Last month, the U.S. Department of Labor announced that it has finalized the new “fiduciary rule” proposed during the Trump administration, creating a new exemption to the fiduciary standards that investment advisers must comply with when servicing ERISA accounts and IRAs Specifically, the new rule – Prohibited Transaction Exemption 2002-02 – creates an exception to ERISA’s prohibited transaction rules and similar rules under the Internal Revenue Code. The DOL issued a Fact Sheet summarizing the rule and its impact.

The new exemption grants investment advisers more latitude and in dealing with such accounts. The exemption applies to both SEC and state-registered investment advisers, broker-dealers, banks, insurance companies, and their employees, agents, and representatives that serve as investment advice fiduciaries. The exemption is slated to become effective February 16, 2021. Some have speculated, however, that the new Biden administration may withdraw the rule and pursue a more restrictive one similar to the 2016 exemption adopted during the Obama administration.

After the US Court of Appeals for the Fifth Circuit struck down the Obama-era fiduciary rule in 2018, the DOL issued a Field Assistance Bulletin (FAB 2018-02), that was a temporary policy that provided relief under the prohibited transaction rules to investment advice fiduciaries, provided they worked in good faith the follow the “impartial conduct standards” that had been codified in the vacated rule. The impartial conduct standards require that an adviser act in the client’s best interest, receive only reasonable compensation and refrain from misleading clients. The new final rules, designed to supersede FAB 2018-02, were proposed in June 2020. FAB 2018-02 will remain in effect for 365 days following the publication of the new rule in the Federal Register, while the exemption will become effective 60 days after publication. Continue reading ›

Late last year, the SEC announced the settlement of five enforcement cases against RIA firms relating to their recommendations and purchases of complex exchange-traded products (ETPs) in clients’ accounts. The settlements – against Benjamin F. Edwards & Co., Royal Alliance Associates, Inc., Securities America Advisors, Inc, Summit Financial Group, Inc., and American Portfolios Financial Services. The actions were announced in connection with the SEC’s ETP initiative.

These cases may be the first of many, and they followed a joint statement from SEC Chairman and division heads in October of last year indicating that firms would be examined relating to their use of complex ETPs. However, the SEC has not formally announced a new initiative on the subject. Earlier in 2020, the SEC had resolved a similar charge against Wells Fargo resulting in a $35 million fine.

Generally, the products in question were those that track market volatility and are designed as short-term investments. Typically, these products are tied to the CBOE volatility index or VIX. Examples of such products are the VelocityShares Daily Inverse VIX Short Term Exchange-Traded Notes and the ProShares VIX Short-Term Futures ETF, both of which are tied to the performance of the S&P 500 VIX Short-Term Futures Index. The product offering materials describe the objectives of these products as to manage trading risks on a daily basis, and warn that their use over periods longer than a single day is not suitable, as the risk control objective will not be met by using them over such longer period. The issuers’ materials clearly describe that the products could lead to substantial losses when held in portfolios over periods longer than a single day.

Late last year, the SEC’s Office of Compliance Inspections and Examinations (OCIE), now known as the Division of Examinations, issued a compliance risk alert warning investment advisers to ensure that their compliance programs are uniform and are uniformly applied across all branch office locations.

The alert summarized the findings from OCIE’s two-year Multi-Branch Initiative, in which it examined nearly 40 advisers’ main offices and their respective branches. Most of the advisers included in the initiative had 10 or more branches that were widely dispersed from the main office. Primarily, the report emphasized that compliance risks relating to supervising personnel and processes are heightened when the branch office has policies or procedures that differ from those of the main office.

In the report, OCIE further explains that more than half of the examined firms had policies and procedures that were either inaccurate or not consistently applied among branches, or both. Almost all firms had at least one compliance defect. Many of the deficiencies related to unrecognized custody of client funds, inadequate or inconsistent fee billing practices, failure to recognize and disclose conflicts of interests, or differences in portfolio management practices or other ways in which the firm’s advisers formulate or deliver investment advice.

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