Articles Posted in Investment Adviser

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On February 19, 2019, the United States District Court for the Southern District of Ohio granted a consent judgment against John Gregory Schmidt, a former Wells Fargo Advisors Financial Network (FINET) advisor.  The Securities and Exchange Commission had filed a complaint against Schmidt in September 2018, alleging that Schmidt sold securities that belonged to some of his retail brokerage customers and covertly used the proceeds from those sales to conceal shortfalls in customer accounts.  According to the SEC’s complaint, Schmidt sent his customers fake account statements which overstated their account balances in order to cover up his conduct.  This case demonstrates the need for broker-dealers and registered investment advisers to adopt and enforce policies that effectively give them the ability to detect the use of such fraudulent statements.

Schmidt worked as a registered representative and the branch manager of a FINET office from about December 2006 through October 2017.  By October 2017, he had about 325 retail brokerage customers, many of whom were retirees who were dependent on withdrawals from their accounts to pay living expenses. Continue reading ›

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With annual compliance reviews in full swing this time of year, we write today to remind advisory firms to be sure to assess the sufficiency of their policies and procedures in the ever-developing area of electronic messaging.  Our note comes on the heels of a recent Risk Alert on this topic issued by the SEC’s Office of Compliance Inspections and Examinations or “OCIE,” which exhorts advisory firms to take a fresh look at their current compliance policies in light of the particular risks of non-compliance posed by the firm’s usage of electronic messaging.

“Electronic messaging,” as discussed in OCIE’s Risk Alert, refers to such mediums as text/SMS messaging, instant messaging, personal email, and personal or private messaging, but specifically excludes firm-wide email.  Notably, OCIE’s exclusion of firm email from analysis in the Risk Alert should not be read as diminishing an adviser’s compliance obligations to capture, store, and periodically review firm email communications.  Rather, as OCIE explains, “firms have had decades of experience complying with regulatory requirements with respect to firm email” and it is not as problematic from a compliance standpoint as compared to some of the newer technologies that run on third-party applications or platforms.  Continue reading ›

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On February 4, 2019, the Commissioner of Securities of the State of Georgia and the Office of the Secretary of State announced its intent to amend the rules governing examination requirements for registered representatives of a broker-dealer and investment adviser representatives.  According to the Commissioner, the primary purposes of these amendments are to harmonize Georgia’s rules with the Financial Industry Regulatory Authority’s new rules implementing the Securities Industry Essentials (“SIE”) Exam and to update the requirements regarding examinations to applicants.  The SIE Exam, which tests a FINRA registration applicant’s knowledge of securities-related topics, was launched to simplify FINRA’s qualification examination program after the program’s efforts to address new securities products and services resulted in FINRA offering multiple exams with immense content overlap.  FINRA also launched the SIE Exam in order to provide greater consistency and uniformity to the securities industry application process.

The State of Georgia requires applicants for registration as a registered representative of a broker-dealer and/or an investment adviser representative to take certain prerequisite examinations.  Georgia Rule 590-4-5-.02 details the examination requirements for registered representatives, while Georgia Rule 590-4-4.09 details the examination requirements for investment adviser representatives.

The proposed amendments to Rule 590-4-5-.02, detailing registered representative examinations, would require an applicant applying for registration as a broker-dealer to present proof to the Commissioner that its personnel have passed at least one of a list of specified examinations within a two-year period preceding the date of the application.  The amendments also eliminate the Series 87 Research Principal Examination as a potential examination that could be passed.  The amendments also would provide that an applicant who is applying to be a registered representative would need to present the Commissioner with proof that he or she has passed the required examinations within either a two-year period immediately preceding the application date or a four-year period in the case of an applicant who has taken the SIE Exam.  The amendments also provide that the Commissioner “may reserve the right to find the applicant qualified by other examinations or significant and comprehensive experience in the securities business.”

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At this time of year, it is important for registered investment advisers to assure that they are in compliance with federal and/or state rules requiring them to monitor their supervised persons’ security holdings and transactions for compliance with the firm’s code of ethics. Even seasoned compliance professionals will encounter questions regarding application of the rule from time to time. While this article is no substitute for a detailed analysis of the rule and its application to a specific firm and its supervised persons, an overview of the rule may be helpful.

As background, all SEC-registered investment advisers are required to adopt a Code of Ethics, which must describe the standards of conduct expected for representatives of the firm and address conflicts that arise from personal trading by advisory personnel. This federal requirement, which governs SEC-registered advisers only, derives from SEC Rule 204A-1, which took effect in 2005. Since then, many state securities administrators have adopted identical or similar requirements, either by adopting SEC Rule 204A-1 “by reference”—i.e., verbatim—into state law, or by crafting similar “me too” provisions. Accordingly, if your firm is SEC-registered, it will be bound by Rule 204A-1; but, if your firm is currently a state-registered adviser, it may be bound by the same or similar requirements. Continue reading ›

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On December 20, 2018, two days before the recent partial federal government shutdown began, the Securities and Exchange Commission’s Office of Compliance Inspections and Examinations announced its 2019 Examination Priorities.  As discussed previously, the shutdown resulted in the SEC operating at a quite minimal level.  Now that the shutdown is over, registered investment advisers and broker-dealers can likely expect OCIE to fully implement the following examination priorities.

OCIE listed six examination priorities for 2019: (1) matters of importance to retail investors, especially seniors and investors saving for retirement; (2) compliance and risk in registrants who are tasked with overseeing critical market infrastructure; (3) focus on FINRA and MSRB; (4) digital assets; (5) cybersecurity; and (6) anti-money laundering.  According to OCIE, this is not an exhaustive list, and one can expect OCIE to cover other issues in its examinations.  However, OCIE has concluded that these issues “present potentially heightened risk to investors or the integrity of U.S. capital markets.” Continue reading ›

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Demonstrating its regulatory interest in the robo adviser industry, on December 21, 2018, the Securities and Exchange Commission issued an Order Instituting Administrative and Cease-and-Desist Proceedings against Wealthfront Advisers, LLC, a registered investment adviser which uses a software-based “robo adviser” platform in servicing its clients. The action is the second case against robo advisers filed on the same day. Wealthfront submitted an offer of settlement in light of the proceeding.

According to the SEC’s Order, Wealthfront utilizes a proprietary tax loss harvesting program (“TLH”) to help its clients garner tax benefits. These tax benefits would typically come through selling assets at a loss, which could potentially be used to reduce income or gains and create a lower tax liability. From October 2012 onward, Wealthfront has featured whitepapers on its website that provide information about the TLH strategy. Continue reading ›

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As the partial federal government shutdown, which began at midnight on December 22, 2018, now approaches its fifth week, we write to update our readers on the shutdown’s specific impact on the SEC and securities regulatory activities.  While we have previously discussed many of these points with our clients who currently have matters pending before the SEC, below is more general information regarding the SEC’s most significant functions.

The SEC was able to operate fully and conduct regular business for a limited number of days following the commencement of the general federal shutdown, but was forced to effectively close its doors on December 27, 2018.  Since then, the agency has been operating at a very minimal level with a skeleton crew of staffers able to respond to only emergency situations.  As described on the SEC’s home page, the remaining staff is available to respond only to “emergency situations involving market integrity and investor protection, including law enforcement.”  The vast majority of the SEC’s employees have been furloughed and are not reporting to work at this time.  That said, we note that a number of familiar online filing platforms, such as EDGAR, IARD, and CRD, all remain fully operable. Continue reading ›

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Following several enforcement actions brought against registered investment advisers that received 12b-1 fees when institutional shares were available to be purchased in clients’ advisory accounts, in February of this year the Securities and Exchange Commission announced an initiative under which firms could self-report the receipt of “avoidable” 12b-1 fees since 2014.  Under the so-called Share Class Selection Disclosure Initiative (SCSDI), advisers who self-reported receiving 12b-1 fees under those circumstances would be subject to an SEC enforcement action but would receive favorable treatment in such a case. Such favorable treatment included no recommended civil penalties as long as the firm agreed to disgorge all avoidable 12b-1 fees received.

In order to participate in the SCSDI, however, firms were required to report to the SEC by June 12, 2018. In announcing the SCSDI, the SEC indicated that firms that did not self-report may be subjected to harsher sanctions if their practice was later discovered.

In recent weeks through information available through clearing firm data and public sources the SEC has identified RIAs that may have received 12b-1 fee but chose not to self-report. Some of these firms are receiving subpoenas or requests for information and testimony.  Whether the failure to report was justified and/or the original receipt of the 12b-1 fees were not improper are questions that the SEC Enforcement Staff will be evaluating during its investigations.  In some limited circumstance a firm might be able to justify receipt of the questioned fess, and also might be excused from or ineligible for the self-reporting initiative. Continue reading ›

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In October 2018, the South Carolina Court of Appeals vacated a $540,000 civil penalty that the South Carolina Securities Commissioner had imposed against John M. McIntyre and his company, Silver Oak Land Management, LLC.  The Commissioner imposed the penalty upon a determination that McIntyre and Silver Oak Land Management had committed securities fraud in the offer, sale, and management of various limited liability company interests.  The Court of Appeals, however, found that in the course of a hearing the Commissioner conducted, the Commissioner did not grant McIntyre and Silver Oak Land Management adequate procedural due process. Continue reading ›

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The SEC’s Office of Compliance Inspections and Examinations (“OCIE”) periodically issues “Risk Alerts” highlighting common deficiencies encountered by its staff during routine investment adviser compliance exams. These Risk Alerts serve the dual purpose of providing advisers with both useful insight into the results of recent OCIE examination activity as well as advance warning of areas that OCIE may be paying closer attention to in the future. Accordingly, a recent Risk Alert issued by OCIE details the most common deficiencies the staff has cited relating to Rule 206(4)-3 (the “Cash Solicitation Rule” or “Rule”) under the Investment Advisers Act of 1940. See National Exam Program Risk Alert, Investment Adviser Compliance Issues Related to the Cash Solicitation Rule (Oct. 31, 2018).

By way of background, the Cash Solicitation Rule prohibits SEC-registered investment advisers from paying a cash fee, directly or indirectly, to any person who solicits clients for the adviser unless the arrangement complies with a number of conditions specified in the Rule, including that the fee must be paid pursuant to a written agreement to which the adviser is a party. Notably, the Rule discerns between solicitors that are affiliated with the registered adviser versus those that are not, setting-up more comprehensive requirements for the latter third-party solicitors. For example, third-party solicitors must provide potential clients with both a copy of the adviser’s Form ADV Part II (or other applicable brochure) and a separate written solicitor’s disclosure document containing specific data about the solicitation arrangement—including the terms of the solicitor’s compensation. Moreover, with respect to third-party arrangements, the Rule obliges advisers to: (i) collect a signed and dated acknowledgment from every potential solicited client that such client has in fact received the adviser’s brochure and the solicitor’s disclosure document; and (ii) make a “bona fide effort” to ascertain whether the solicitor has complied with its duties under the Rule.

In this context, OCIE cited the following as the most noteworthy deficiency areas encountered by its front-line examiners:

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