RIA Compliance Blog

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.

SEC Fines Investment Adviser Over the Use of Hedge Clause in Advisory Agreement

February 22, 2022 | Steve Parker

Last month, the SEC commenced an administrative enforcement action that highlights the significance of its change in guidance over the use of “hedge clauses” in investment advisory agreements. Recall that in IA-5248, the SEC’s 2019 interpretive release that addressed the standard of conduct for investment advisers, the Commission withdrew the 2007 No-Action Letter previously issued in Heitman Capital Management, LLC (Feb. 12, 2007) (“Heitman Letter”). Prior to IA-5248, the Heitman Letter had frequently been relied upon by investment advisers to permit the use of hedge clauses, or clauses purporting to limit an adviser’s liability, as long as the clause contained an affirmative statement that it should not be construed to waive unwaivable claims under federal and state securities laws. Because the SEC concluded that the Heitman Letter had been often misconstrued, IA-5248 expressly withdrew it.

Prior to the issuance of the Heitman Letter in 2007, the SEC had rather consistently prohibited the use of hedge clauses. The Heitman Letter, however, constituted a departure from that previous near-blanket prohibition. In Heitman, the SEC staff stated that the use of a hedge clause that limits the adviser’s liability except for gross negligence or willfulness may under some circumstances be permitted, depending on “all the surrounding facts and circumstances.” Among the circumstances to be considered were whether it was written in plain English, whether it had been highlighted and explained to the client personally, whether there was a heightened explanation of the types of claims that were not waived, and whether impacted clients had access to other professional “intermediaries” upon whom they relied. After the Heitman Letter, the use of hedge clauses by investment advisers proliferated, not always consistently with the Heitman guidance.

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 Releases Observations from Examinations Relating to Advisory Fees

November 30, 2021 | Charlie Jarrett

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.

Department of Labor Extends PTE 2020-02 Temporary Enforcement Policy

November 4, 2021 | Steve Parker

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.

States Continue to Adopt Laws to Help RIAs Protect Vulnerable Adults

September 8, 2021 | Steve Parker

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 ›

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 SEC Cybersecurity Enforcement Case

July 8, 2021 | Bryan Gort

Over the last five years, cybersecurity has consistently been a top priority of the Securities and Exchange Commission (“SEC”). We have written about the SEC’s focus on cybersecurity in July 2020 and January 2020. With an additional enforcement action in June, the SEC is continuing to signal that firms regulated by the SEC need to have appropriate risk management and cybersecurity controls in place. While this case study isn’t directly related to Investment Advisers, they would be wise to learn lessons from this story.

First American Financial Corporation (“First American”) is a real estate settlement services provider. In that capacity, they store certain non-public personal information (“NPPI”) of real estate purchasers and sellers. In an internal audit in 2018, an error was caught that certain NPPI stored by First American was not stored securely.

Subsequently, First American conducted a vulnerability test which culminated in a written report in January 2019. In the report, information security personnel determined that certain website URLs that First American provided to people could be replaced with different numbers to create access to NPPI that was unauthorized. Continue reading ›

FINRA Withdraws Expungement Rule Proposals

June 8, 2021 | Steve Parker

In late May, FINRA issued a press release announcing the temporary withdrawal of proposed rule changes regarding the process for obtaining expungement of customer dispute information maintained for registered representatives on WebCRD, or “BrokerCheck.”

The proposed rule changes were issued in 2017 for possible SEC approval and have previously been discussed on our blog. Since 2017, FINRA has responded to various SEC requests for additional information, and the deadline for adoption of the rule proposals has been extended. The withdrawal release cites “consultations with the SEC staff” as the basis for withdrawal of the rule proposal and concludes by restating FINRA’s commitment that it will continue to consult with, and solicit input from, the SEC and other interested parties “who share a common interest in revising” the expungement process.

Among other things the proposed rule changes included:

Establishing a new category of arbitrators trained and qualified to decide expungement cases, and maintaining a roster of those arbitrators who will decides such cases;
Eliminating the process for ranking arbitrators that are appliable to other industry and customer arbitrations;
Prohibiting stipulations or agreements to allow the case to be decided by fewer than three arbitrators chosen from the special panel;
Requiring a broker who is named in the underlying arbitration to seek expungement in that arbitration;
Imposing stricter time limits within which brokers may request expungement; and
Limiting situations in which a party to a customer dispute – such as a broker-dealer – can request expungement relief for an unnamed party, such as a registered representative of that broker-dealer.

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 ›