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On August 21, 2023, the U.S. Securities and Exchange Commission (“SEC”) issued an order imposing civil monetary penalties against Titan Global Capital Management USA LLC (“Titan”) for violations of the new investment adviser Marketing Rule, Rule 206(4)-1. The new rule had a mandatory compliance date of November 4, 2022, but advisers could voluntarily adopt the rule sooner. 

Titan elected to comply with the new rule in June 2021; however, the firm did not adopt new policies and procedures or adapt its practices as required by the new rule. Between August 2021 and October 2022, Titan violated the new Marketing Rule by advertising hypothetical performance without adopting policies and procedures reasonably designed to ensure the hypothetical performance was relevant to client’s or prospective client’s financial situation and investment objectives and also by failing to provide information underlying the hypothetical performance as required by the new rule.  Continue reading ›

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Last week the Securities and Exchange Commission issued Proposed Amendments to the “internet adviser” basis for SEC registration found in Rule 203 A-2 (e). Currently, the rule provides that an adviser who provides investment advice nearly exclusively via an interactive website is eligible to register with the SEC, as long as the adviser maintains records demonstrating that it provides investment advice to its clients exclusively through an interactive website and does not control, is not controlled by, and is not under common control with another investment adviser registered with the SEC solely in reliance on the internet adviser registration basis. An adviser can still qualify to register on this basis if it provides investment advice outside the interactive website (e.g., by telephone, in person, or via email) to not more than 15 clients in a 12-month period.

In proposing the amendments, the SEC noted that the investment management industry has experienced considerable growth and change in the 20-plus years since the rule was adopted. The proposal purports to address some of the more significant changes in the industry, particularly as it relates to the use of technology.

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On June 20, 2023, the U.S. Securities and Exchange Commission (“SEC”) issued an order against Insight Venture Management LLC (“Insight”). The SEC and Insight settled the matter to resolve allegations that the adviser charged excessive management fees caused by the adviser’s inaccurate application of its “permanent impairment” policy and that the adviser failed to disclose a conflict of interest related to these fee calculations.

Insight is an adviser that advises private equity funds. Limited partnership agreements (“agreements”) associated with some of these private equity funds stated that Insight charged management fees during the funds’ post-commitment period—the period during which a fund manager manages and looks to exit funds’ investments—based on the investor’s pro rata share of the funds’ invested capital. The agreements further stated that if Insight determined an investment suffered a “permanent impairment” in value, the adviser would remove an amount equal to the difference between the acquisition cost and the impaired value of the investment. This amount would be paid from the funds’ invested capital, which would in turn reduce the basis used to calculate fees paid by the fund to Insight. The agreements allotted Insight discretion to reverse the “permanent impairment” determination if the investment increased in value thereafter.
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The DOL recently dismissed its appeal of an earlier ruling from the U.S. District Court for the Middle District of Florida (the Court) invalidating part of the DOL’s guidance regarding application of its fiduciary duty to rollover recommendations. The guidance was in the form of an FAQ issued in connection with PTE 2020-02 that explained how a recommendation to roll over retirement assets from a plan to an IRA at the beginning of an ongoing relationship could still be subject to ERISA and/or Code fiduciary duties.

Whether an individual is providing fiduciary investment advice under ERISA or the Code is determined by the DOL’s five-part test set forth in its 1975 regulation. Generally, an individual will be deemed to be rendering fiduciary investment advice if: 1) the individual renders advice to a plan or IRA as to the value of, or advisability of investing in, securities or other property; 2) on a regular basis; 3) pursuant to a mutual agreement with the plan or IRA; 4) that the advice will serve as a primary basis for investment decisions with respect to plan or IRA assets; and 5) that the advice will be individualized based on the needs of the plan or IRA.[1]
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PTE 2020-02 is a prohibited transaction exemption under ERISA. It requires Financial Institutions, including RIAs, to meet several enumerated requirements, including adhering to the “Impartial Conduct Standards,” in order to rely upon the exemption with respect to certain transactions, including rollover recommendations. It also requires Financial Institutions to adopt policies and procedures to assure compliance with all of the substantive provisions of PTE 2020-02.

RIAs relying on PTE 2020-02 are required to conduct an annual retrospective review of their policies and procedures for compliance with PTE 2020-02. The retrospective review must be documented in a written report that is certified by a senior executive officer of the firm. The review must be reasonably designed to assist the RIA in detecting and preventing violations of the Impartial Conduct Standards and its policies and procedures governing compliance with PTE 2020-02.
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The SEC’s Division of Examinations recently released their Observations from Examinations of Newly-Registered Advisers. Issued as a Risk Alert, the release provides guidance for what investment advisers new to SEC registration should expect, but also warns were previously examined advisers failed to meet the SEC’s expectations.

The SEC typically initiates an examination of new-to-SEC registration investment advisers within the first year of registration. In our experience, this can occur as soon as six months after the registration is approved. The purpose of these examinations is as much informative as it is about enforcing the securities regulations. In the SEC’s own words, “[s]uch examinations allow the staff to: provide advisers with information about the Division’s examination program, conduct preliminary risk assessments, facilitate discussions regarding the advisers’ operations and risk characteristics, and promote compliance with applicable statutes and regulations.”[1]

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The Securities and Exchange Commission (SEC) recently released the 2023 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.

Over the last few years, the SEC has adopted several new rules that include compliance obligations. As the implementation dates for these new rules have passed, the SEC will prioritize examining how investment advisers have incorporate the rules into their compliance programs. While impacting a limited number of investment advisers, the amended rules include changes to the Derivates Rule and Fair Valuation Rule.[1] Continue reading ›

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On August 26, 2022, the U.S. Securities and Exchange Commission (“SEC”) issued an order settling charges against Kovak Advisors, Inc. (“Kovak”), for compliance failures related to its wrap fee program. The case highlights how important it is for an investment adviser to adopt and follow policies and procedures relating to any wrap fee program, to ensure that the adviser’s services are in the client’s best interest.

From 2015 through August 2018, Kovak offered advisory services to clients through a wrap fee program. Clients that participated in the wrap fee program paid a fee that included asset management, trade execution, and other costs. The SEC made three findings during the time Kovak offered the wrap fee program.
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The Securities and Exchange Commission announced a settled enforcement action against a registered investment adviser for violating the Custody Rule and for compliance violations associated with custody. The enforcement action, coupled with the SEC’s announcement, shows the significance that the SEC places on the safeguarding of client assets.

An investment adviser has custody when it holds client funds or securities or has the ability to obtain possession of such assets, directly or indirectly. In general, the custody rules and regulations are intended to protect client assets from misappropriation or misuse by their investment adviser. As a result, it is considered a prohibited act for an investment adviser to have custody of client funds or securities without implementing policies and procedures specifically designed to comply with the rules and regulations and prevent misuse of the assets. These policies and procedures include notice to client in certain situations, identification of the qualified custodian, and obtaining an audit or verification by an independent CPA of the client assets subject to custody. Custody can be further imparted to an investment adviser through a related party of the investment adviser.

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In this first quarter of the year, most investment advisers are working diligently to complete and file their annual updating amendment to Form ADV, including Part 2A, commonly called the “Brochure.” One of the most important requirements in drafting a Brochure is to make sure that all conflicts of interests, together with a description of how the conflict is mitigated or addressed, are fully and fairly disclosed. An administrative action brought by the SEC and settled last week illustrates, and should serve to underscore, the importance of identifying and disclosing such conflicts.

The SEC charged registered investment adviser Moors & Cabot (“M&C”) with breaching its fiduciary duty to investment advisory clients by failing to disclose conflicts of interest relating to revenue sharing payments and other financial incentives that the adviser received from two clearing brokers. The financial benefits included discounts, incentive credits and shared revenue that were contingent upon M&C meeting certain thresholds in total assets maintained in FDIC-insure bank deposit cash sweeps. M&C also received a share of margin interest the clearing firms charged to M&C’s clients who maintained margin loans. M&C also received a portion of postage and handling fees that one of the clearing brokers charged to its clients.

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