Compliance

SEC Releases Staff Bulletin for Account Recommendations

July 7, 2022 | Charlie Jarrett

The Securities and Exchange Commission (SEC) recently released a Staff Bulletin regarding the Standards of Conduct for Broker-Dealers and Investment Advisers Account Recommendations for Retail Investors. Since the adoption of Regulation Best Interest, or Reg BI, in 2019, the SEC has issued guidance and best practices for adoption of the policies and procedures expected for compliance with the regulation. We have previously written about the best interest standard applied to retirement rollover recommendations and the SEC’s announcement of the first enforcement case being filed under Reg BI.

The Staff Bulletin, presented in a Q&A format, provides the SEC’s views on how financial professionals can fulfill their obligations to retail investors when making account recommendations. The obligations discussed include the applicable standard for making account recommendations, factors to consider when making account recommendations, how and when cost is a factor, retirement rollover considerations, client account preferences, and developing and implementing a compliance plan reasonably designed to address Reg BI.

While Reg BI and the investment adviser fiduciary standard differ, the SEC points out that both standards require an account recommendation to be in the client’s best interest and prohibits an investment adviser from placing its interest ahead of a client’s interest. Additionally, the SEC states that a firm that does not evaluate sufficient information about a retail investor, it will not have the ability to form a reasonable basis to believe its account recommendations are in the retail investor’s best interest.

Rollover Disclosure & Documentation Requirements to be Enforced Beginning July 1, 2022

May 18, 2022 | Patricia Klusmeyer

While the majority of the Department of Labor’s new fiduciary rule, Prohibited Transaction Exemption 2020-02 (“PTE 2020-02), became enforceable on January 31st, some of the requirements pertaining to rollover recommendations are set to be enforced on July 1, 2022.

As detailed in this blog post, the DOL provided transition relief in its Field Assistance Bulletin, FAB 2021-02 by extending the enforcement date of PTE 2020-02 through January 31, 2022 for investment advice fiduciaries who are working diligently and in good faith to comply with the “Impartial Conduct Standards” for any transactions that are exempted under PTE 2020-02. These standards include a best interest standard, a reasonable compensation standard, and a requirement to avoid any materially misleading statements about the recommended transaction and other relevant matters.

PTE 2020-02 also requires investment advice fiduciaries to document the specific reasons any rollover recommendations from an employee benefit plan to another plan or an IRA, from an IRA to a plan, from an IRA to another IRA, or from one type of account to another is in the best interest of the retirement investor. PTE 2020-02 further requires this documentation to be provided to the retirement investor prior to engaging in the rollover. In FAB 2021-02, the DOL announced that it would not enforce the documentation and disclosure requirements for rollover recommendations under PTE 2020-02 through June 30, 2022.
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SEC Releases 2022 Examination Priorities

April 21, 2022 | Charlie Jarrett

The Securities and Exchange Commission (SEC) recently released the 2022 Examination Priorities from the Division of Examinations, formerly known as the Office of Compliance Inspections and Examinations. This annual release provides insight into the areas that the SEC plans to highlight when examining investment advisers during the coming year.

While the SEC notes the continued impact of COVID-19 on investment advisers and the investment industry, the SEC reported an increase in examinations conducted during FY21, with the total number of completed examinations close to the pre-pandemic levels of FY19.

For FY22 examinations, the SEC will place a significant focus on (1) private funds; (2) environmental, social, and governance (ESG) investing; (3) standards of conduct: Regulation Best Interest (Regulation BI), fiduciary duty, and Form CRS; (4) information security and operational resiliency; and (5) emerging technologies and crypto-assets. Many of these focus areas, such as ESG and Regulation BI, are carried over from previous years and mark a multi-year emphasis for the SEC.

RIA Advertising Rules May Impact New Client Presentations

April 19, 2022 | Steve Parker

With the date for compliance with the new Investment Adviser Marketing Rule approaching, now is the time for registered investment advisers to consider how the new rule impacts many facets of their regular practices. One area that should be carefully evaluated is the use of “hypothetical performance.” The new rule expands the definition of an “advertisement” to include many one-on-one presentations that were not covered by the former advertising rule. Now, any one-on-one presentation that contains “hypothetical performance” is subject to the general anti-fraud provisions of the new rule, as well as to several specific conditions and limitations on the use of hypothetical performance.

The definition of “hypothetical performance” is “performance results that were not actually achieved by any portfolio of the investment adviser.” That definition expressly encompasses “targeted or projected performance returns.” The illustration of “targets” or “projections” in one-on-one presentations was previously covered by the general anti-fraud rules, but the new regime imposes more onerous requirements and may indeed prevent RIAs from using the types of illustrations they are currently routinely using with new clients and prospects.

A common approach to acquiring new clients involves presenting an illustration of how a proposed portfolio will perform. This is frequently done through the use of reporting software or publishing services such as Morningstar, Riskalyze, and others, although the adviser may have the ability to customize the inputs and the contents of the final report. Sometimes specific returns are projected, while at other times the projections will show a range or band of returns coupled by a specific probability range.

NSCP Proposes Regulatory Guidance Regarding CCO Liability

January 31, 2022 | Steve Parker

Earlier this month the National Society of Compliance Professionals, a nonprofit membership organization that supports compliance personnel and programs in the financial services industry, published a report entitled “Firm and CCO Liability Framework.” The report is designed as an aid to compliance professionals and as a proposal to regulators, including the Securities and Exchange Commission, to determine situations in which liability of Chief Compliance Officers should be mitigated.

The SEC has provided its own guidance regarding when CCOs may be held liable, some of which we have highlighted in a previous post. Additionally, the New York City Bar Association’s Compliance Committee released a comprehensive report last year that contains a description of the history of regulatory comments and guidance provided on the issue of CCO liability and proposes its own framework of liability.

The NSCP report was motivated in part by a widespread belief among compliance professionals that financial services regulators have expanded the situations in which CCOs will face liability for firm compliance failures. According to a survey contained in the report, 72% of compliance professionals share that belief. Additional survey results contained in the report include: that 35% of compliance professionals claim to have insufficient resources to adequately carry out the obligation to provide firm training on compliance issues; that 20% claim to have insufficient authority either to enforce or to develop compliance policies and procedures; and that 25% claim to be unable to meaningfully raise compliance concerns to the firm’s senior management.

SEC Fines Investment Adviser Over Variable Representative Compensation Disclosures

July 27, 2021 | Bryan Gort

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:

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

New Investment Adviser Marketing Rule Relaxes Restrictions on Use of Testimonials

April 29, 2021 | Steve Parker

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 ›

SEC Announces 2021 Examination Priorities

March 25, 2021 | Steve Parker

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.

Exchange-Traded Product Probe Results in Fines for Investment Advisory Firms

January 21, 2021 | Steve Parker

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.

SEC Multi-Branch Initiative Results in Branch Office Risk Alert

January 5, 2021 | Steve Parker

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.