Articles Tagged with Policies and Procedures

With the end of the federal government’s fiscal year, the Securities and Exchange Commission (SEC) once again recently released results from the enforcement program, covering November 2022 through October 2023. The release included cumulative totals and highlighted individual cases and enforcement areas of concentration. The annual release serves as a roadmap for where the SEC is spending its resources, and what conduct will likely lead to enforcement actions.

During fiscal year 2023, the SEC’s Enforcement Division filed 3% more total enforcement actions than during 2022. This included an 8% increase in “stand-alone,” or original actions, along with increases in the number of “follow-on” administrative proceedings. These “follow-on” actions are typically filed after an associated criminal, civil, or other regulatory action, and look to impact an individual’s ability to conduct business in the securities industry.

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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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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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For the majority of investment advisers registered with either the SEC or state regulators, annual updating amendment season is once again upon us. Advisers whose fiscal year ends on December 31 are required to file their Form ADV annual amendment within 90 days or by March 31, 2023.

While investment advisers are under a continuing obligation to update their disclosure documents when certain or material information becomes inaccurate, the annual update is a universal requirement designed to ensure that the filing information for investment advisers is up to date. This serves an important function in that it allows clients and potential clients to review the publicly filed ADVs for investment advisers on FINRA’s BrokerCheck and the SEC’s IADP. Additionally, regulators review the filings and the underlying analytics to track industry trends, plan examination targets, and conduct regulatory sweeps.

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The Securities and Exchange Commission recently announced the filing of an administrative proceeding against a registered investment adviser and the investment advisers owner/CCO for failing to adopt compliance policies and procedures, a Code of Ethics, and for failing to conduct annual reviews of the same. The advisory firm is Two Point Investment Management, Inc., based in Pittsford, New York. The SEC found that the violations occurred over a 10-year period starting when the adviser first registered with the SEC in 2012.

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In what is turning out to be a busy summer at the SEC for issuing new rules and interpretations applicable to RIAs, the Commission has just released detailed guidance clarifying the proxy voting obligations of SEC-registered advisers.  This latest release comes on the heels of the agency’s landmark package of releases issued on June 5th, which, for RIAs, included rules implementing the new Form CRS (a/k/a Form ADV, Part 3) and a major interpretive release clarifying the fiduciary duty owed to clients by all advisers.  This latest release aims to clarify an adviser’s obligations arising under Advisers Act Rule 206(4)-6 (“the Proxy Rule”) relating to voting proxies for clients, specifically in the context of using the services of a “proxy advisory firm.”

The Proxy Rule provides that it is a “fraudulent, deceptive, or manipulative act” for an SEC-registered adviser to “exercise voting authority with respect to client securities” unless the adviser adopts and implements written policies and procedures designed to ensure that such voting is done in the “best interest of clients.”  The Proxy Rule also requires certain disclosures be made to clients regarding any voting done for them.  Notably, the Proxy Rule does not require advisers to vote client securities.  Indeed, many advisers choose to escape the coverage of the Proxy Rule by simply not—in any instance—voting client securities.  However, for advisers exercising any voting authority over client securities—even one share—the Proxy Rule swings into effect.  Accordingly, all such advisers opting to vote client securities will need to be in full compliance with the Proxy Rule—and should pay close attention to the SEC’s new guidance on this matter. Continue reading ›

A new Risk Alert released by the SEC’s Office of Compliance Inspections and Examinations (“OCIE”) reminds advisers of the added compliance obligations that arise when hiring representatives carrying the baggage of reportable disciplinary histories. While by no means exhorting advisers not to hire such persons, the Risk Alert nonetheless encourages advisers to properly consider the obvious compliance risks presented by such hiring practices, and, in turn, to adopt prudent policies and procedures to address those risks.

We follow OCIE’s periodic Risk Alerts closely as they not only provide insights regarding the focus of recent OCIE examinations, but also provide insights as to what OCIE management will be directing the staff to focus on in the future. This particular Risk Alert is a read-out of the results of a recent series of OCIE exams from 2017 specifically targeting advisory firms that (i) previously employed, or currently employ, any individual with a history of disciplinary events and (ii) for the most part serve retail clients. Indeed, OCIE makes special notation of its “focus on protecting retail investors” as a genesis for both the targeted exam initiative (the “Initiative”) as well as this new Risk Alert. Accordingly, advisers with a large retail customer base should pay especially close attention to the new Risk Alert.

In conducting the Initiative, OCIE’s staff focused on three areas of interest: (i) the compliance policies and procedures put into place to specifically cover the activities of previously-disciplined individuals; (ii) the disclosures relating to previously-disciplined individuals required to be made in filings and other public documents (including advertising); and (iii) conflicts of interest implicated by the hiring of previously-disciplined individuals. With this roadmap in place, the Initiative identified a variety of observed deficiencies across a range of topics, including:

The North American Securities Administrators Association—also known as “NASAA”—a cooperative association consisting of the chief securities regulators for each of the 50 United States, as well as Canadian and Mexican jurisdictions, has recently voted to adopt a model information security rule. NASAA’s new model information security rule could—if widely implemented by the individual NASAA Member jurisdictions—ultimately have a broad impact on the compliance programs of state-registered investment advisers.

Among its many roles as a confederation of individual regulators, NASAA frequently drafts and circulates “model rules” to its Members, who eventually vote on and adopt these draft rules for use by the various Member jurisdictions. A “model rule” is a familiar regulatory tool, which essentially provides a template upon which laws, rules, and other regulations can be drafted. For example, many of the individual states’ securities acts are variants of the Uniform Securities Act of 2002, a model act created by a group of legal scholars, regulators and veteran attorneys. NASAA’s new model rule is just such a template for regulators. Individual states and other jurisdictions may—at their discretion—adopt it in whole, in part, or not at all. That said, we believe that, especially given the growing importance of cybersecurity issues, it will be used more likely than not as the states come around to developing rules to parallel those already in place at the federal (SEC) level.  Continue reading ›

In its latest Risk Alert, the SEC’s Office of Compliance Inspections and Examinations (“OCIE”) heeds advisers and broker/dealers to take a fresh look at their policies and procedures in the area of electronic customer record storage in light of shortcomings discovered by OCIE’s staff as part of recently-conducted regular examinations. These shortcomings include weak or misconfigured security settings on a network storage device that, in the worst-case event, could result in unauthorized access to customer information.

OCIE Risk Alerts are highly useful resources for compliance professionals to consider as these published notices serve as a window into not only the recent experiences of OCIE staffers out in the field, but also the thinking of OCIE management as to where it will be directing its staff to focus on in future examinations. In other words, if the management of OCIE warrants it important enough to publish a Risk Alert on an particular topic, registrants can be assured that future exams will likely focus on deficiencies in that area.

This most recent Risk Alert zeros-in on deficiencies uncovered by examiners with respect to how advisers and brokers are protecting their customers’ electronic records—specifically, records kept in the “cloud” or on other types of networked storage solutions. OCIE defines cloud storage as the “electronic storage of information on infrastructure owned and operated by a hosting company or service provider.” Obviously, such storage systems may be especially vulnerable to hacking or other nefarious activities, and as such, warrant robust protections. Continue reading ›

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