Articles Tagged with Investment Advisers Act of 1940

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

On December 21, 2018, the Securities and Exchange Commission issued an Order Instituting Administrative and Cease-and-Desist Proceedings against Hedgeable, Inc., a registered investment adviser.  Hedgeable utilizes a “robo adviser” program, which it offers to individuals, small business owners, trusts, corporations, and partnerships through both its website and social media.  The SEC’s Order alleges that from about 2016 through April 2017, Hedgeable made various misleading statements in advertising and performance data.  Hedgeable submitted an offer of settlement in order to resolve the proceeding.

According to the Order, Hedgeable launched a so-called “Robo-Index” to present comparisons of its performance against that of two unaffiliated robo advisers.  These comparisons were featured on both Hedgeable’s website and various social media sites.  The SEC found that Hedgeable’s method of preparing the Robo-Index had significant material issues.  For example, the SEC found that data from 2014 and 2015 only featured data from a small pool of Hedgeable client accounts and excluded over 1,000 other client accounts.  The SEC alleged that, because of the small sample sizes, the data likely reflected “survivorship bias,” stemming from the fact that the sample size likely only contained clients who received higher than average returns compared to Hedgeable’s other clients.  The SEC also determined that Hedgeable’s calculation methods did not correctly estimate expected returns for a standard client of the other two robo advisers.  Hedgeable allegedly produced the data in the Robo-Index using estimations of the other robo advisers’ trading models rather than using the robo advisers’ actual models. Continue reading

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

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:

In our previous post regarding state-registered investment advisers, we examined the landscape and discussed common deficiencies found in state adviser examinations.  In this post, we will discuss enforcement actions typically aimed at state-registered investment advisers, as well as current enforcement trends such as fraud pertaining to emerging markets and protection of senior investors.

Earlier in 2018, the North American Securities Administrators Association (NASAA)  published its 2018 Enforcement Report.  This report contains information and statistics regarding NASAA members’ enforcement actions in 2017 and highlights current trends in enforcement actions aimed at state-registered investment advisers.

According to the Report, NASAA members received 7,998 complaints that resulted in 4,790 investigations.  Once the investigations were completed, NASAA members initiated 2,105 enforcement actions, over half of which were administrative actions.  Criminal actions made up the second largest number of enforcement actions, followed by civil and other types of enforcement actions. Continue reading

On October 31, 2018 the Financial Industry Regulatory Authority published Regulatory Notice 18-37, which announces the commencement of the 2019 Renewal Program for registered investment advisers and broker-dealers.  The 2019 Renewal Program is set to begin on November 12, 2018.  On that day, FINRA will release Preliminary Statements to all registered firms via E-Bill.  Firms are required to remit full payment of their Preliminary Statements by December 17, 2018.

The Preliminary Statements contain various fees for renewal of state registrations and notice filings.  For individuals who are renewing their broker-dealer registrations, FINRA will assess a fee of $45.  For investment adviser firms and their representatives who are renewing their registrations, any IARD system fees will be featured on their preliminary statements.  For FINRA-registered firms that have one or more branch offices, FINRA will assess a renewal fee of $20 per branch.  FINRA will, however, waive one branch renewal fee for each FINRA-registered firm.

Firms may pay their Preliminary Statement fees via E-Bill, a wire transfer, or a check.  FINRA’s preferred method of payment is E-Bill.  If a firm does not pay the Preliminary Statement fees by December 17, it will be charged a late renewal fee.  The late fee will amount to either 10 percent of a firm’s final renewal assessment or $100, whichever is greater, but the late fee can be no more than $5,000.  FINRA also warns firms that failure to pay the Preliminary Statement fees by the December 17 deadline could result in the firms becoming unable to do business in the areas where they are registered.

The Securities and Exchange Commission recently issued three Orders Instituting Administrative and Cease-and-Desist Proceedings relating to the misuse of quantitative models in managing customers’ accounts.  Four entities affiliated with Transamerica and two individuals associated with one of those entities were charged with violating the Investment Advisers Act of 1940 (“Advisers Act”) and Advisers Act Rules.  The Orders allege that AEGON USA Investment Management LLC, Transamerica Asset Management, Inc., Transamerica Capital, Inc., and Transamerica Financial Advisors, Inc., marketed various products and investment strategies that used a “proprietary quant model” while failing to verify whether the models functioned as intended and without disclosing known risks connected with the models.  The Transamerica entities and the individuals, Bradley Beman and Kevin Giles, submitted offers of settlement to resolve the charges. Continue reading

The Securities and Exchange Commission recently issued an Order Instituting Administrative and Cease-and-Desist Proceedings against Massachusetts Financial Services Company (“MFS”), an SEC-registered investment adviser.  According to the SEC’s Order, MFS advertised hypothetical returns pertaining to its blended research stock ratings without informing clients that a number of the hypothetical portfolios’ superior returns were based on back-tested models.  Without admitting or denying the allegations in the SEC’s Order, MFS submitted an offer of settlement to resolve the matter.

According to the SEC’s Order, MFS has employed a quantitative-based research department since 2000.  In 2000, the department developed what MFS calls “blended research” strategies, which involve “combining fundamental and quantitative ratings to arrive at a blended stock score, and by using a portfolio optimization process that considers the blended scores along with risk and other portfolio constraints.”  As of May of this year, MFS had approximately $21 million in assets under management invested in blended research strategies.

The SEC’s Order alleges that from 2006 through 2015, MFS created research proofs based on the blended research analysis. The data and a bar chart describing the analysis were featured in MFS advertisements.  MFS subsequently used the bar chart in three different kinds of marketing materials: in a standard slide deck from 2006 through 2015, in responses to formal requests from clients starting in 2012, and in a white paper that discussed MFS’s blended research strategies.  These materials were marketed exclusively to institutional clients, prospective institutional clients, financial intermediaries, and investment consultants.

Oregon requires all investment advisers and broker-dealers to maintain errors and omissions insurance for at least $1 million. Under Section 59.175 “every applicant for a license or renewal of a license as a broker-dealer or state investment adviser shall file with the director proof that the applicant maintains an errors and omissions insurance policy.”  This law provides investors with recourse if they suffer losses because of an uninsured investment adviser. Presently, investment advisers in Oregon may obtain errors and omissions insurance through either the Oregon surplus lines, the Oregon risk retention markets, or both.  However, according to the Oregon Secretary of State’s Department of Consumer and Business Services, which oversees the Division of Finance and Securities Regulation, neither of those groups is “admitted” or authorized to conduct insurance business in Oregon.  As a result, the Department has decided that a temporary rule is necessary to help both Oregon investment advisers and insurance producers understand the steps they need to take to provide proof of insurance. Continue reading

As we recently highlighted, the Securities and Exchange Commission took enforcement action against three registered investment advisers for violating the pay-to-play rule applicable to advisers under the Investment Advisers Act.  Broker-dealers should be aware that in 2017 the Financial Industry Regulatory Authority announced the approval of  modifications to two rules – Rules 203 and 458, imposing similar prohibitions and limitations on capital acquisition brokers (“CABs”).  A CAB is a FINRA member firm that participates in a restricted amount of activities, such as “advising companies on capital raising and corporate restructuring, and acting as placement agents for sales of unregistered securities to institutional investors under limited conditions.”  The rules will implement “’pay-to-play’ and related recordkeeping rules to the activities of member firms that have elected to be governed by the CAB Rules.”  The new rules went into effect on December 6, 2017. Continue reading