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Last month at the American Law Institute’s Conference on Life Insurance Company Products, the chief of the SEC’s Office of Compliance, Inspections, and Examinations (“OCIE”) informed attendees that the agency will increase its focus on variable annuities during 2015. Also attending the conference was the Director of the SEC’s Division of Investment Management (“DIM”), who discussed his views on how to address concerns created by new trends in variable annuities and the recent growth of alternative mutual funds.

One of the reasons for the increased focus on variable annuities is that broker-dealers are beginning to sell more and more of these products to their clients, said the SEC’s chief of OCIE. As a result, OCIE exams will include discussions with broker-dealers about what the insurance companies are telling them about the products they provide to make sure broker-dealers understand the products they are selling and are accurately explaining the products to their clients.
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On November 17th, the Texas State Securities Board’s Office of Inspections and Compliance charged Mowery Capital Management, LLC (“Mowery Capital”) and one of its investment adviser representatives (collectively “Respondents”) with fraud for failing to disclose certain conflicts of interests, charging excessive fees, plagiarizing advertising material, and other material misrepresentations. The complaint requests that the state Securities Commissioner revoke Respondents’ registration with the state, levy an administrative fine, and issue a cease and desist order prohibiting any further fraudulent behavior.

When registering as a registered investment adviser, a Form ADV must be completed and filed with the appropriate securities authority. Part 2 of the Form ADV, or the “Brochure,” acts as the primary disclosure document for clients and requires the applicant to write in plain English general information about the business (i.e. types of services offered, fee schedule, business and educational background of employees), including any possible conflicts of interest the applicant may have.
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Earlier this year, the SEC Office of Compliance Inspections and Examinations (“OCIE”) sent a letter to registered investment advisers requesting information about their wrap fee programs and how their suitability for clients was determined. Most of the requested information centered around the possible misuse of wrap fee programs by advisers. OCIE examiners will want to see that adequate compliance procedures are in place, and that advisors conduct periodic reviews of their wrap fee programs to ensure that advisers are putting their clients’ interests first.

During an examination, advisers will need to disclose, among other things, the procedures and compliance policies governing their wrap fee programs, each wrap fee program used and its adviser, any brochures or marketing materials used to promote their wrap free programs, and what types of fees are covered in such programs. Advisers will also be asked to provide the SEC with its compliance policies for wrap fee programs. This may include how advisers monitor wrap accounts with high cash balances or accounts with low levels of trading, the oversight procedures of branch offices and representatives outside of those offices, best execution policies, and the initial and ongoing suitability reviews for wrap fee programs.
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In a case that underscores the importance of maintaining thorough and contemporaneous records of compliance reviews of trading records of firm personnel for both broker-dealers and registered investment advisers, on October 15th, 2014, the Securities and Exchange Commission’s Enforcement Division instituted an administrative proceeding against a former compliance officer at Wells Fargo Advisors for allegedly altering documents requested by the SEC during an insider trading investigation.

The Wells Fargo Advisors’ compliance officer was responsible for identifying suspicious trades by Wells Fargo personnel and determining, after a thorough analysis, or what was called a “look back review,” whether such trading was based on material non-public information. On September 2nd, 2010, the compliance officer began review on a set of trades in Burger King securities made by a registered representative of Wells Fargo Advisors, prior to an announcement that the private equity firm, 3G Capital Partners Ltd. (“3G Capital”), was to acquire Burger King at take it private. The findings contained within the compliance officer’s review confirmed that the registered representative and his customers bought Burger King securities ten days prior to the announcement. However, the compliance officer failed to make any additional inquiries into the trades and closed the review with “no findings.” The registered representative was later criminally charged in September of 2012, and subsequently was convicted of trading in Burger King securities on the basis of material non-public information.
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The Securities and Exchange Commission announced last week that it has charged Sands Brothers Asset Management, LLC and three of its officers with violating the custody rule as it relates to firms who manage funds in which their clients invest. Investment advisers who have custody, as defined by Rule 20642, must engage in certain “safekeeping practices.” If the adviser has custody by virtue of any reason other than the mere authority to deduct client fees from advisory accounts, one of the safekeeping requirements is that of obtaining an independent audit of fund assets. In the case of a private fund, that requirement can be met by the employment of an auditor approved by the Public Company Accounting Oversight Board who audits and reports to shareholders, (i.e., investors in the funds), annually and reports to shareholders within 120 days from the end of the fiscal year.

In its recent enforcement action, the SEC enforcement division alleged that Sands Brothers had been late in providing investors with audited financial statements. According to the Order instituting administrative proceeding, Sands Brothers was 40 or more days late in distributing the financial statements for ten different private funds for the fiscal year 2010. In the following year, the financial statements for those same funds were between six and eight months past due. In 2012, the financial statements for those funds were distributed approximately 90 days late.
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Mark Twain is alleged to have said, “When the end of the world comes, I want to be in Kentucky because everything happens there twenty years later than it happens anywhere else.”

That bit of “wisdom” is more than a bit unfair to Kentucky, but it has proven true in connection with investment adviser law. In an interesting judicial opinion earlier this year, the Kentucky Court of Appeals reached the same conclusion that the federal courts reached over thirty years ago on essentially the same issue. The Kentucky Court held that an investment manager who was paid to manage the brokerage accounts of two clients was “an Investment Adviser” under the Kentucky Securities Act (“KSA”), even though he never discussed with or recommended securities transactions to the clients.The case demonstrates how concepts that are taken for granted and seem to be well-settled and beyond dispute by financial professionals, regulators and seasoned professionals in the investment adviser arena can sometimes lead to protracted and uncertain litigation.

The case is Lawrence Rosen v. Commonwealth of Kentucky, Department of Financial Institutions, et al.. At issue were enforcement charges by Kentucky’s Department of Financial Institutions (“DFI”) against one Lawrence Rosen (“Rosen”) who operated a sole proprietorship under the name Larry Rosen Company out of his home in Louisville, Kentucky. Rosen had entered into contracts with two clients under which Rosen would be compensated by payment of 10% of the gross proceeds of option sales, dividends, and interest received for all transactions that he made in the course of managing the accounts of the two clients. The contracts gave Rosen complete discretion over all securities traded in the accounts, meaning that he was not required to obtain any approval prior to implementing a transaction. Rosen performed both contracts by purchasing and selling securities in both clients’ accounts and by receiving the compensation as set forth in a contract. He conducted all these activities without registering under the KSA.
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Earlier this year, the SEC announced one of its focus areas for examinations in 2014 would be cybersecurity. The SEC Office of Compliance Inspections and Examinations published a Cybersecurity Initiative Risk Alert in April that provides a sample request for information and documents, which are designed to determine the preparedness of a firm for a cybersecurity threats. Examples of questions asked include:

– Please provide a copy of the Firm’s written business continuity of operations plan that addresses mitigation of the effects of a cybersecurity incident and/or recovery from such an incident if one exists;

– Does the Firm have a Chief Information Security Officer or equivalent position? If so, please identify the person and title. If not, where does principal responsibility for overseeing cybersecurity reside within the firm?;

– Please provide a copy of the Firm’s procedures for verifying the authenticity of email requests seeking to transfer customer funds. If no written procedures exist, please describe the process.

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The Indiana Securities Division recently issued an emergency rule to explain new distinctions in Indiana’s crowdfunding exemptions, which became effective July 1, 2014. Indiana’s new rule is similar to Georgia’s “Invest Georgia” rule, which we have previously profiled.

The Invest Indiana Crowdfunding Exemption, Sec. 23-19-2-2(27), permits Indiana-organized entities to offer or sell securities for intrastate offerings to Indiana residents only. The exemption requires the Indiana-organized entity to file with the Indiana Securities Division SEC Form D, which clearly states “Indiana Only” on the first page, and to include a cover letter identifying that the filing is for the 23-19-2-2 (27) exemption, and to include a $100 filing fee. The Exemption details the requirements for both issuers and investors in regards to an Invest Indiana offering.
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In a consented-to Administrative Order dated July 2, 2014, the Securities and Exchange Commission fined a Missouri-based Registered Investment Adviser, SignalPoint Asset Management (“SignalPoint” or “SAM”), $215,000 for breaching its’ fiduciary duty to clients.

Prior to the formation of SignalPoint, the Principals of SignalPoint were registered as registered representatives and investment adviser representatives for a dually-registered broker-dealer and investment adviser. In 2008, the principals asked the dually-registered broker-dealer and investment adviser to allow them to have ownership and control of SignalPoint but were told that they could not have an ownership in an outside RIA.
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The Alabama Legislature passed a crowdfunding exemption bill this April, but the bill is still awaiting the Governor’s signature to become effective. Alabama is the eleventh state to enact legislation or develop regulations on this topic. Other states that have adopted crowdfunding exemption bills include, Washington, Idaho, Wisconsin, Michigan, Kansas, Georgia, Tennessee, Indiana, Maryland, and Maine.

Similar to the approach taken by other states, Alabama’s new legislation is intended to unlock capital and increase access to it for local small businesses and entrepreneurs. While it is still uncertain how successful state measures such as these will be in achieving the goal of increased capital access, the ability of small business owners to raise capital should be enhanced through the relaxation of some of the previous constraints. It is important to note, however, that regulatory agencies will require strict adherence to the new standards in return for less-regulated access to capital. Businesses using the Alabama crowdfunding exemption, and other, similar state exemptions, bear the burden of ensuring its sale of unregistered securities does not run afoul of restrictions governing them.
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