Compliance

DOL Releases Final Fiduciary Rule

April 20, 2016 | Patricia Klusmeyer

The Department of Labor (“DOL”) released the final version of its new fiduciary rule on Wednesday April 6, ending months of widespread speculation and apprehension in the financial services industry. The DOL appears to have heard the thousands of public comments asking for more clarification and simplification, particularly as related to the Best Interests Contract (“BIC”) exemption. The final rule contains some notable deviations from the proposed rule.

As we discussed in an earlier blog post, the former definition of fiduciary for providing investment advice to a covered employee benefit plan under the Employee Retirement Income Security Act of 1974 (“ERISA”) and the Internal Revenue Code of 1986 (“Code”) stated that financial advisers were generally only fiduciaries if such investment advice was given on a regular basis and pursuant to a mutual understanding that the advice would serve as the primary basis for investment decisions and would be individualized to the particular needs of the plan. This definition typically encompassed only financial advisers in established and ongoing relationships with their clients, such as investment advisers who provided investment advice to covered plans. Meanwhile, broker-dealers and insurance agents were generally excluded, and broker-dealers were only held to the same suitability standard for retirement plans that applies to their recommendations made to non-retirement plans.

CFPB Issues First Cybersecurity Order Against Payment Platform for Deceptive Practices

March 18, 2016 | Patricia Klusmeyer

The Consumer Financial Protection Bureau (“CFPB”) recently instituted a cybersecurity enforcement action against an online payment platform, Dwolla, Inc., in the form of a consent order. This consent order is significant because it is the first time the CFPB has sought to institute an enforcement action in the cybersecurity arena after it was given the authority to do so under the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”), highlighting the increasing emphasis being placed by financial regulators on cybersecurity practices. The Securities and Exchange Commission (“SEC”), Financial Industry Regulatory Authority (“FINRA”), and the Federal Trade Commission (“FTC”), among others, have all been quite active in policing data security practices of financial institutions in recent years. The SEC even listed cybersecurity control procedures of registered broker-dealers and investment advisers as one of its examination priorities for 2016.

The Dodd-Frank Act gives CFPB supervisory authority over providers of consumer financial products or services. It also authorizes CFPB to take enforcement action to prevent unfair, deceptive or abusive acts or practices from these providers. In this case, Dwolla allegedly made several exaggerated claims regarding the strength of its data security practices that the CFPB found to be deceptive within the meaning of the Dodd-Frank Act.

SEC Charges Fund Manager with Fraudulently Misleading Investors

March 11, 2016 | Patricia Klusmeyer

The Securities and Exchange Commission (“SEC”) recently brought an administrative proceeding against unregistered fund manager Steven Zoernack and his firm, EquityStar Capital Management, LLC (“EquityStar”), for engaging in allegedly fraudulent conduct in violation of federal securities and investment adviser laws. Mr. Zoernack and EquityStar allegedly concealed Mr. Zoernack’s criminal history, used false identities, and distributed false and misleading marketing materials, among other things, in their bid to lure investors.

As alleged, Mr. Zoernack created EquityStar in May of 2010 to serve as the investment adviser for two private investment funds, Global Partners and Momentum. Between 2011 and 2014 Mr. Zoernack actively sought investors for the two funds, managing to sell approximately $5.6 million of interests in Global Partners and Momentum. As EquityStar’s managing member and sole employee, he handled all activities of the firm and drafted all marketing and offering materials. In the furtherance of these activities, Mr. Zoernack allegedly made many material misrepresentations to investors and prospective investors regarding himself and EquityStar.

Final DOL Fiduciary Rule Predicted to Significantly Alter Sale of Annuity Products

March 8, 2016 | Patricia Klusmeyer

As the Department of Labor’s (“DOL’s”) proposed fiduciary rule awaits final adoption, market participants are starting to predict how it will affect retirement investment advice given that financial advisers such as broker-dealers, investment advisers, insurance companies, and other financial institutions, as well as their representatives, may soon be subjected to heightened fiduciary standards. Specifically, the sale of annuity products is predicted to face a large amount of change given its commission-based nature.

Currently, under the Employee Retirement Income Security Act of 1974 (“ERISA”) and the Internal Revenue Code of 1986 (“Code”), financial advisers are generally only fiduciaries if they provide investment advice or recommendations for compensation to employee benefit plans or participants and such advice is given on a regular basis and pursuant to a mutual understanding that the advice will serve as the primary basis for investment decisions and will be individualized to the particular needs of the plan. While investment advisers already have fiduciary duties under the Investment Advisers Act of 1940, the current narrow definition of fiduciary under ERISA and the Code generally does not encompass broker-dealers.

FINRA Files Revised Pay-to-Play Rule Proposal with SEC

February 15, 2016 | Patricia Klusmeyer

The Financial Industry Regulatory Authority (“FINRA”) recently filed its revised pay-to-play rules proposal with the Securities Exchange Commission (“SEC”). Investment advisers have been awaiting FINRA’s pay-to-play rules ever since the SEC announced last year that it would not recommend enforcement action against an investment adviser or its associated persons for the payment to a third party for the solicitation of a government entity for investment advisory services until either FINRA or the Municipal Securities Rulemaking Board (“MSRB”) had adopted its own pay-to-pay rules for broker-dealers.

Pay-to-play activities involve the practice of making cash or in kind contributions, or soliciting others to make those contributions, to state or local officials or other government entities as an incentive for the receipt of government contracts. Pursuant to Rule 206(4)-5, investment advisers are prohibited from providing a government entity with investment advisory services for compensation within two years of contributing monetarily to that government entity. In addition, and of particular interest here, under Rule 206(4)-5 investment advisers may not provide payment to any third party to solicit a government entity for investment advisory services on behalf of the investment adviser unless that third party is a registered investment adviser, a registered broker-dealer, or a registered municipal adviser.

SEC Releases Examination Priorities for 2016

February 9, 2016 | Patricia Klusmeyer

The Office of Compliance Inspections and Examinations (“OCIE”) of the Securities Exchange Commission (“SEC”) recently released its Examination Priorities for 2016. These examination priorities provide valuable insight into what OCIE perceives to be the greatest risk to investors and what it will be focusing its efforts on throughout the year. This year its overall goals stayed approximately the same as last year: 1) protecting investors saving for retirement; 2) assessing market-wide risks; and 3) using data analytics to identify and examine illegal activity.

In regards to its goal of protecting investors saving for retirement, OCIE intends to continue its Retirement-Targeted Industry Reviews and Examinations (“ReTIRE”) initiative which focuses on the suitability of investment recommendations made to investors, supervision and compliance procedures, conflicts of interest, and marketing practices. It will also continue to review the supervision procedures of branch offices of SEC-registered entities and fee selections which can lead to reverse churning. New areas of focus include exchange-traded funds (“ETFs”) which OCIE intends to examine for compliance with various regulatory requirements. It will focus on sales strategies, trading practices, disclosures, excessive portfolio concentration, and suitability, and will pay particularly close attention to niche or leveraged/inverse ETFs. In addition, variable annuities have become a large part of many investors’ retirement plans and OCIE intends to assess the suitability of these sales as well as the adequacy of disclosures. Lastly, OCIE will examine public pension advisers to ensure these advisers are not engaging in any pay-to-play activities or giving undisclosed gifts in return for appointments or other favors.

SEC Publishes Guidance on Avoiding Mischaracterization of 12b-1 Fees

February 3, 2016 | Patricia Klusmeyer

The Securities and Exchange Commission (“SEC”) recently published guidance on the characterization of mutual fund fees, specifically 12b-1 distribution fees and sub-accounting fees, as part of their ongoing Distribution-in-Guise Initiative. Pursuant to Rule 12b-1 under the Investment Company Act of 1940, payments made by mutual funds (“funds”), to financial intermediaries from fund assets for the distribution of fund shares must be paid pursuant to a Rule 12b-1 plan that has been approved and adopted by the fund’s shareholders and Board of Directors (“Board”). In recent years the SEC has noticed that there are various fees being paid to intermediaries, in addition to distribution fees, that are being characterized as non-distribution-related fees and are not being paid pursuant to a Rule 12b-1 plan. Those fees include sub-transfer agent fees, administrative sub-accounting fees, and other shareholder servicing fees (collectively “sub-accounting fees”).

While these sub-accounting fees may in some cases be valid non-distribution-related fees, if they directly or indirectly compensate at all for any distribution-related activities, they are improperly labeled. Because of the importance of this issue given that fund fees directly impact investor returns and inherently involve conflicts of interest, the SEC has published guidance to assist funds in ensuring that distribution-related fees are being properly labeled and disclosed in a Rule 12b-1 plan as required. This potential problem was brought to the SEC’s attention after a recent sweep examination of various market participants including mutual funds, investment advisers, transfer agents, and broker-dealers.

Hedge Fund Manager Settles Charges with SEC for Overcharging on Fees and Overvaluing Assets

January 26, 2016 | Patricia Klusmeyer

A Denver-based alternative fund manager was recently charged by the Securities Exchange Commission (“SEC”) with engaging in fraudulent behavior regarding the handling of its futures fund, The Frontier Fund (“TFF”). The alternative fund manager, Equinox Fund Management LLC (“Equinox”), allegedly overcharged management fees to its investors and overvalued certain assets.

Equinox is registered as an investment adviser with the SEC and thus owes its investors certain fiduciary duties, one of which is to act in the best interests of its investors by being accurate and complete with its registration statements and SEC filings. Equinox, however, allegedly failed to meet those duties by misrepresenting in their TFF registration statements that management fees were based on the net asset value of the assets, when in reality they were based on the notional trading value of the assets. The notional trading value takes into account both the amount invested and the amount of leverage used in the underlying investments, and is significantly higher than net asset value.

Common Mistakes to Avoid in Form ADV Annual Updates

January 22, 2016 | Patricia Klusmeyer

Filing annual updating amendments to Form ADV is an important requirement for all registered investment advisers. All information contained in Parts 1 and 2 of Form ADV must be both accurate and complete. Unfortunately, this is not always the case, and the Securities Exchange Commission (“SEC”) and state regulators have not hesitated in bringing enforcement actions against investment advisers who misrepresent or fail to disclose certain information in their annual filings and amendments.

Based on 1170 routine state-coordinated investment adviser examinations in 2015, as reported by the North American Securities Administrators Association (“NASAA”), the most common errors that are routinely found on Form ADVs include inconsistencies between Form ADV Part 1 and Part 2, inconsistencies between fees charged and fees listed on the ADV, inconsistencies between services provided and services described in ADV, misrepresentations in business description, overstatements or understatements of assets under management, and failure to disclose conflicts of interest.

Texas Securities Board Approves Advisory Payments to Retiring Advisers

December 28, 2015 | Steve Parker

In a letter dated December 11, 2015, the Texas State Securities Board (“Board”) granted a no-action request by Managed Financial Service Corporation, Inc. (“MFSC”) that paves the way for a retiring investment adviser representative to receive continuing compensation after retirement. The Board confirmed that it would not commence or seek enforcement proceedings against either MFSC or a specified retiring investment adviser representative if certain procedures were followed. MFSC and its retiring representative requested the no-action letter in order to implement a plan under which the retiring representative would continue to receive compensation derived from the residual value of the work as an investment adviser for certain accounts.

The no-action was requested based on a concern, predominant in the investment adviser industry, that receipt by a retired adviser representative of ongoing advisory fees or a portion of advisory fees received by a successor adviser or firm would subject the retired representative to discipline for conducting business without registration.

The no-action relief granted by the Board is similar to the practice in the brokerage industry that has been codified in FINRA Rule 2040 (b) in which, prior to that date, was sanctioned by a FINRA no-action letter issued to Merrill Lynch in March 2012.
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