Articles Posted in Industry News

The Division of Examinations of the Securities and Exchange Commission (SEC) recently released a Risk Alert relating to the Advisory Fee Initiative titled “Division of Examinations Observations: Investment Advisers’ Fee Calculations.” Under this Initiative, the SEC conducted approximately 130 examinations of SEC-registered investment advisers focusing on how advisory fees are disclosed and charged, particularly to retail clients.

Since 2018, the SEC has included the disclosure of the costs of investing in its list of yearly exam priorities. The Division of Examinations has focused on whether advisers have adopted policies and procedures reasonably designed to produce fair and accurate fee assessments, and whether those fees are disclosed to clients in a manner such that clients understand the costs of the advisory services provided.

During the Initiative, the Division’s review included: (1) the accuracy of the fees charged by the examined advisers; (2) the accuracy and adequacy of the examined advisers’ disclosures; and (3) the effectiveness of the examined advisers’ compliance programs.

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As anticipated, on October 25, 2021, the Department of Labor extended its previously adopted policy regarding delayed enforcement of Prohibited Transaction Exemption 2020-02 (“PTE 2020-02). This policy extension extended the deadline for enforcement of PTE 2020-02, allowing investment advisers who are investment advice fiduciaries additional time to comply with the exemption.

Sometimes referred to as “Fiduciary Rule 3.0,” PTE 2020-02 provides exemptions from the prohibited transaction rules for investment advice fiduciaries with respect to employee benefit plans and individual retirement accounts (IRAs). PTE 2020-02 allows an investment advice fiduciary to advise an ERISA Plan or an IRA and receive variable compensation. In this context, “variable compensation” means compensation that varies based on the advice provided, such as a commission.  For example, even though an investment adviser will receive “additional fees” by recommending that a client or potential client roll over 401(K) assets into an IRA to be managed by the adviser as a fiduciary, such a recommendation will not be deemed a prohibited transaction if the requirements of PTE 2020-02 are met. In order to take advantage of PTE 2020-02, however, the adviser must meet several conditions, which we outlined in a blog post earlier this year.

In 2018, the DOL issued Field Assistance Bulletin (FAB) 2018-02, a temporary enforcement policy that explained the DOL would not pursue prohibited transaction claims, nor conclude that persons are violating the prohibited transaction rules if an investment advice fiduciary can demonstrate it worked in good faith and reasonable diligence to comply with “Impartial Conduct Standards” for transactions that would have been exempted under the previously vacated 2016 rule. Those impartial conduct standards include providing investment advice in the client’s best interest, receiving only reasonable compensation, and avoiding any materially misleading statements. FAB 2018-02 was set to expire on December 20, 2021.

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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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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.

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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 ›

In July 2020, the Securities and Exchange Commission issued supplemental guidance relating to the duties of investment advisers with respect to proxy voting. This follows guidance issued in 2019, which we have discussed before. The prior guidance was issued in connection with amended rules finalized at the same time which dealt with proxy solicitations under the federal securities laws. Those amendments were designed to grant companies that issue stock to obtain advisory firms’ recommendations on proxy issues in advance of the proxy submission deadline. As a result, the issuer has time to submit additional materials as part of the proxy solicitation.

As a result of the new rules, proxy voting services will be forced to share their voting recommendations with the issuers of the securities at or prior to the providing the recommendations to their institutional clients, and if issuers submit additional information in response, must also disclose such information to the clients. The proxy advisers must also disclose any conflicts of interest that might exist that could reasonably be expected to influence their recommendations.

The effective date of the amended rule is 60 days after publication. Proxy advisory firms must comply with the amendments by December 1, 2021. The supplemental guidance became effective on September 3, 2020. Continue reading ›

Earlier this week, the SEC’s Office of Compliance Inspections and Examinations (OCIE) issued a risk alert in which it discussed ongoing deficiencies identified during compliance examinations of investment advisers that advise private funds. This risk alert follows on the heels of other SEC activity relating to private fund advisers, including enforcement referrals, deficiency letters, and informal guidance.

The deficiencies discussed in the risk alert fall into three broad categories: disclosures relating to fees; disclosures relating to conflicts of interests; and sufficiency of a firm’s policies relating to nonpublic material information and its internal enforcement of such policies. The purpose of this risk alert was to provide guidance to private fund advisers regarding steps they should take to improve their compliance policies and program, while simultaneously advising investors in private funds of the types of issues to be aware of when dealing with private fund advisers. Many investors in private funds are pensions or other qualified retirement plans, charities and endowments, and families who have family offices.

This blog post focuses on the portion of the risk alert relating to fees and expenses. Continue reading ›

Earlier this month the SEC’s Office of Compliance Inspections and Examinations (OCIE) issued two related risk alerts on the subjects of Form CRS and Regulation Best Interest (Reg BI). The purpose of the risk alerts was to provide investment advisers and broker-dealers information regarding the anticipated scope and content of the examinations OCIE will conduct following the compliance date for Regulation Best Interest, and the filing deadline for Form ADV, Part 3. In this post, we summarize the risk alert relating to Reg BI.

The initial broker-dealer examinations will focus on whether firms have established policies and procedures reasonably designed to comply with Regulation Best Interest’s for distinct obligations: the duty to disclose; the duty of care; the duty to avoid or disclose conflict of interest; and the duty to adopt compliance procedures. In addition to assessing whether a registrant has adopted policies and procedures reasonably designed to comply with Regulation BI, the examinations will also assess the operational effectiveness of those procedures.

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As the saying goes, “a rising tide lifts all boats.” This expression is commonly used in the investment world to mean that in bull markets, all portfolios tend to rise, no matter how poorly constructed. However, when the market changes directions sharply, as it has over the last thirteen trading days, poorly constructed portfolios sink more precipitously than the overall market.

The stock market has never before plunged by 18% off of its all-time high over such a short time frame. The main driver of the decline had been, prior to this week, concern over the impact that the spreading Coronavirus will have on the US economy. On Monday, March 9, however, news of an oil trade war caused a further, more precipitous decline. But the 18% decline in the market in the last few trading days represents the broad equity markets. Investors whose portfolios are overconcentrated in individual stocks or market sectors are experiencing even worse declines. To continue the boat metaphor, some portfolios will be sunk or will crash against the rocks. Continue reading ›

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