SEC Provides Guidance As to What Constitutes Investment Advisory Activities
The SEC's recent adoption of the controversial rule, Certain Broker-Dealers Deemed not to be Investment Advisers, does not appear to have a direct effect on the compliance practices of existing RIA firms; however, it does require significant action to be taken by brokers-dealers that are conducting what have usually been considered advisory services.
While we believe that the SEC did not go far enough in reigning in the advisory activities of BDs, the new rule does provide some much needed guidance for the industry. Here are three examples of items from the new rule that many BDs will have to address and resolve within the next two months:
Assets Under Management - BDs may provide brokerage services on an "assets under management" or fixed fee basis without registering as an advisor. This has been a point of contention throughout the industry for several years, and the SEC has ruled on the side of BDs for this one. While BDs may continue to conduct these services, they need to disclose to the investing public that their services are brokerage only and not advisory in nature. In fact, the SEC has developed specific disclosure language that BDs must use in advertising and all agreements, contracts, applications, and other forms governing the operation of non-advisory, fee based accounts. The disclosure language must be in place by July 22, 2005.
Non-Discretionary - A BD's non-advisory, fee-based services must be done on a non-discretionary basis. The SEC has correctly ruled that discretionary brokerage services should only be conducted by an investment advisor. Therefore, if you are a BD registered rep with discretionary accounts, you need to either 1) move those accounts to an advisory platform, which may mean registering as an investment advisor, or 2) release the discretionary authority. Either way, you have until October 24, 2005 to comply with this part of the rule.
No Financial Planning - BDs may not provide financial planning services. With respect to this particular issue, the SEC ruled on the side of investment advisors and industry organizations such as the Financial Planning Association. The SEC has correctly interpreted that financial planning is an investment advisory activity. According to the rule, you need to register as an investment advisor if you are a broker or dealer that 1) provides financial planning services to clients; 2) advertises financial planning services; 3) maintains a listing as a financial planning in a telephone or building directory; 4) lets it be known by word of mouth or otherwise that new financial planning clients will be accepted; or 5) uses letterhead or business cards referring to financial planning services. Again, B/Ds will have until October 24, 2005 to move these accounts to an advisory platform. However, because the advertising requirements go into effect July 22, 2005, BDs should stop advertising financial planning services by that date.
While BDs may continue to provide fee-based brokerage services and consequently not need to be registered as an investment advisor, we fully expect many BDs will get registered in order to continue providing discretionary and/or financial planning services. We also expect the debate on this issue to continue, so stay tuned to RIA Compliance Consultants for the latest information.
While we believe that the SEC did not go far enough in reigning in the advisory activities of BDs, the new rule does provide some much needed guidance for the industry. Here are three examples of items from the new rule that many BDs will have to address and resolve within the next two months:
Assets Under Management - BDs may provide brokerage services on an "assets under management" or fixed fee basis without registering as an advisor. This has been a point of contention throughout the industry for several years, and the SEC has ruled on the side of BDs for this one. While BDs may continue to conduct these services, they need to disclose to the investing public that their services are brokerage only and not advisory in nature. In fact, the SEC has developed specific disclosure language that BDs must use in advertising and all agreements, contracts, applications, and other forms governing the operation of non-advisory, fee based accounts. The disclosure language must be in place by July 22, 2005.
Non-Discretionary - A BD's non-advisory, fee-based services must be done on a non-discretionary basis. The SEC has correctly ruled that discretionary brokerage services should only be conducted by an investment advisor. Therefore, if you are a BD registered rep with discretionary accounts, you need to either 1) move those accounts to an advisory platform, which may mean registering as an investment advisor, or 2) release the discretionary authority. Either way, you have until October 24, 2005 to comply with this part of the rule.
No Financial Planning - BDs may not provide financial planning services. With respect to this particular issue, the SEC ruled on the side of investment advisors and industry organizations such as the Financial Planning Association. The SEC has correctly interpreted that financial planning is an investment advisory activity. According to the rule, you need to register as an investment advisor if you are a broker or dealer that 1) provides financial planning services to clients; 2) advertises financial planning services; 3) maintains a listing as a financial planning in a telephone or building directory; 4) lets it be known by word of mouth or otherwise that new financial planning clients will be accepted; or 5) uses letterhead or business cards referring to financial planning services. Again, B/Ds will have until October 24, 2005 to move these accounts to an advisory platform. However, because the advertising requirements go into effect July 22, 2005, BDs should stop advertising financial planning services by that date.
While BDs may continue to provide fee-based brokerage services and consequently not need to be registered as an investment advisor, we fully expect many BDs will get registered in order to continue providing discretionary and/or financial planning services. We also expect the debate on this issue to continue, so stay tuned to RIA Compliance Consultants for the latest information.
Labels: SEC
posted by bhill at 9:10 PM
You Created a Code of Ethics, But Did You Disclose It?
Is your firm's new Code of Ethics described in your ADV Part II? Does your ADV Part II allow clients to request a copy of the Code of Ethics? This is an item that some investment advisors have overlooked. The recently effective SEC Rule 204A-1 requires all SEC registered firms to include a summary of the Code of Ethics in the Form ADV Part II, and, upon request, to provide a complete copy of the code of ethics to advisory clients.
Labels: Code of Ethics
posted by bhill at 2:45 PM
Access Persons Under SEC Rule 204A-1
It's likely that your firm has recently established an "access persons" list and received its first holding reports in order to comply with the recently effective SEC Rule 204A-1. However, is your firm actually supervising the reported transactions of the access persons and documenting such supervision?
Under Rule 204A-1, SEC registered investment advisory firms are required to establish and enforce standards of conduct expected of employees as part of its Code of Ethics. In particular, the rule focuses upon a firm's obligation to review and monitor the securities transactions by "access persons" in order to prevent inappropriate trading.
This leads to the first question -- how to define a firm's access persons. We suggest taking the conservative approach and including all of the firm's employees in addition to the firm's directors, officers, investment advisor representatives (IARs) and any employees of the IARs (if IARs are independent contractors).
The SEC defines an "access person" as the following:
Any of your supervised persons:
(A) Who has access to nonpublic information regarding any clients' purchase or sale of securities, or nonpublic information regarding the portfolio holdings of any reportable fund, or
(B) Who is involved in making securities recommendations to clients, or who has access to such recommendations that are nonpublic.
(ii) If providing investment advice is your primary business, all of your directors, officers and partners are presumed to be access persons.
In essence, these individuals are considered access persons because they are in the position to inappropriately utilize client information.
Once your firm has determined its access persons, the next step is to establish a procedure for supervising the securities transactions of those identified as access persons. Under the rule, all access persons must report their securities holdings to the firm upon becoming an access person and on an annual basis. In addition, all access persons need to report their securities transactions (direct and indirect beneficial ownership) within 30 days of the end of each calendar quarter. All private placements and initial public offering must be pre-approved by the firm.
We'd recommend that these transactions and holdings be placed in a database so that each access person's records may be cross-referenced easily against clients' transactions. The firm should review these personal transactions for inappropriate conduct like front-running, scalping, insider trading or other misuses of confidential client information.
Finally, your firm must maintain the following records for last five years: lists of its access persons; each report made by an access person; any violation and corrective action; and any decision and supporting reasons to approve an IPO or private placement for an access person.
For more discussions concerning the SEC's Code of Ethics Rule, please continue to visit this blog, Navigating the Regulatory Maze, at RIA-Compliance-Consultants.com.
Under Rule 204A-1, SEC registered investment advisory firms are required to establish and enforce standards of conduct expected of employees as part of its Code of Ethics. In particular, the rule focuses upon a firm's obligation to review and monitor the securities transactions by "access persons" in order to prevent inappropriate trading.
This leads to the first question -- how to define a firm's access persons. We suggest taking the conservative approach and including all of the firm's employees in addition to the firm's directors, officers, investment advisor representatives (IARs) and any employees of the IARs (if IARs are independent contractors).
The SEC defines an "access person" as the following:
Any of your supervised persons:
(A) Who has access to nonpublic information regarding any clients' purchase or sale of securities, or nonpublic information regarding the portfolio holdings of any reportable fund, or
(B) Who is involved in making securities recommendations to clients, or who has access to such recommendations that are nonpublic.
(ii) If providing investment advice is your primary business, all of your directors, officers and partners are presumed to be access persons.
In essence, these individuals are considered access persons because they are in the position to inappropriately utilize client information.
Once your firm has determined its access persons, the next step is to establish a procedure for supervising the securities transactions of those identified as access persons. Under the rule, all access persons must report their securities holdings to the firm upon becoming an access person and on an annual basis. In addition, all access persons need to report their securities transactions (direct and indirect beneficial ownership) within 30 days of the end of each calendar quarter. All private placements and initial public offering must be pre-approved by the firm.
We'd recommend that these transactions and holdings be placed in a database so that each access person's records may be cross-referenced easily against clients' transactions. The firm should review these personal transactions for inappropriate conduct like front-running, scalping, insider trading or other misuses of confidential client information.
Finally, your firm must maintain the following records for last five years: lists of its access persons; each report made by an access person; any violation and corrective action; and any decision and supporting reasons to approve an IPO or private placement for an access person.
For more discussions concerning the SEC's Code of Ethics Rule, please continue to visit this blog, Navigating the Regulatory Maze, at RIA-Compliance-Consultants.com.
Labels: Code of Ethics
posted by bhill at 6:20 PM
SEC Starts CCO Outreach Program
Last week the SEC wrapped up its first set of Chief Compliance Officer regional meetings. The initial seminars were held by the Pacific Regional Office in several locations throughout California. This is the first step in what the SEC has described as its "CCO Outreach" program.
The Outreach program was announced back in March during a speech by SEC Chairman William Donaldson. The speech focused on advisors to fund companies; however the program is also geared towards investment advisor firms. The program will involve several regional seminars held throughout the spring and summer. A national seminar is planned for later this year and the program will also include a periodic newsletter, CCO Observer. According to Donaldson, the program will aim to provide CCOs with information on the SEC, resources available to CCOs,and the SEC examination process, including hot topics and items examiners will be focusing on. Another goal of the program is to create a continuous dialogue between the SEC and CCOs.
This should be viewed as another positive sign from the SEC as it tries to enforce its new Advisor Compliance Programs rule. It appears that the SEC is making a serious effort to work with investment advisors and their CCOs in order to help prepare them for the SEC's new risk-based examination. Is your firm ready for an SEC examination? Have you appointed a CCO and implemented written compliance and procedures programs? We can help make sure you are compliant with the new Rule and are prepared for an SEC examination.
The Outreach program was announced back in March during a speech by SEC Chairman William Donaldson. The speech focused on advisors to fund companies; however the program is also geared towards investment advisor firms. The program will involve several regional seminars held throughout the spring and summer. A national seminar is planned for later this year and the program will also include a periodic newsletter, CCO Observer. According to Donaldson, the program will aim to provide CCOs with information on the SEC, resources available to CCOs,and the SEC examination process, including hot topics and items examiners will be focusing on. Another goal of the program is to create a continuous dialogue between the SEC and CCOs.
This should be viewed as another positive sign from the SEC as it tries to enforce its new Advisor Compliance Programs rule. It appears that the SEC is making a serious effort to work with investment advisors and their CCOs in order to help prepare them for the SEC's new risk-based examination. Is your firm ready for an SEC examination? Have you appointed a CCO and implemented written compliance and procedures programs? We can help make sure you are compliant with the new Rule and are prepared for an SEC examination.
Labels: SEC
posted by bhill at 5:33 PM
Pension Consulting - Follow the Money!
With the SEC's recent focus upon pension consulting, it's incumbent upon the chief compliance officers of investment advisors to review again whether their firms are properly disclosing the conflicts of interest that may exist with their pension consulting services and then supervising, mitigating and/or eliminating such conflicts.
Since the relationships and apparent methods for compensation aren't always obvious, this may be a challenge for those compliance officers that aren't experts in this business line.
Our advice is to start this process by following the money. In other words, look at how your firm is being compensated. Is your firm receiving compensation directly from the pension client, or is the money manager paying indirect compensation to the pension consultant?
For purposes of those disclosures required by the SEC rules, here are a few items that most likely should be disclosed.
1) Conferences - Does your firm host a conference for its pension clients? Are money managers charged a sponsorship or exhibit fee? Does your firm provide training to money managers and trustees, but only charges money manager staff? Does your firm tend to recommend these money managers more often than other money managers?
2) Software - Does your firm sell software to money managers, which analyzes clients' performance? Similarly, Are these money managers recommended more often than others?
3) Marketing Services - Does your firm sell marketing services to money managers?
4) Affiliated B/D - Does your firm direct its pension clients to pay pension consulting fee through directing transactions/commissions to an affiliated B/D? Is this disclosed? Is best execution taking place? If so, how is this documented?
5) Referral Fees from Unaffiliated B/D - Does your firm direct its pension clients to an unaffiliated B/D that then pays a referral fee?
6) Employees Dual Registered as Reg Reps - Are your investment advisor reps serving pension clients also registered representatives and receiving compensation for trades placed by the pension client.
7) Gifts/Entertainment/Trips - Are your investment advisor reps receiving gifts from money managers? Are you tracking such gifts, entertainment or trips?
8) Change of Money Manager - Does your firm charge a "search fee" or receive additional brokerage commissions when terminating a pension client's money manager?
9) Additional Money Manager Accts. - Do your pension consultants seek or obtain brokerage transactions from other accounts managed by the money manager?
Once you identify these disclosure items, you need to consult with your experts to properly tailor your response. (This blog entry is certainly no substitute for consulting with your compliance expert on the specifics of your situation, and how it should be handled. Our goal is to make sure you're aware of the issue.)
As alluded to in the SEC report, it's likely that the disclosures need to be more than a mere reference stating that services are provided by the pension consultant to the money manager. The best practice is spelling out to the pension client that the same money managers being recommended by the pension consultant are also paying the pension consultant for other services. Depending upon the circumstances, this disclosure may need to include the dollar amounts being paid by such money managers so the client can truly grasp the extent of the conflict.
It's also important to recognize that disclosure isn't enough. The investment advisor serving as a pension consultant is a fiduciary, which means that these practices creating the conflicts will have to be carefully managed/supervised/mitigated or completely eliminated if the potential conflict is too great. Under the new Chief Compliance Officer Rule, the SEC will expect the CCO to formalize policies and procedures to address these conflicts.
Finally, the last wild card to throw into the mix -- some of these pension consulting compensation practices creating a conflict might be considered by the Dept. of Labor (DOL) to constitute "prohibited transactions" under ERISA even with the proper disclosure in your ADV, which will have to be addressed in a seperate blog entry at a later date.
Since the relationships and apparent methods for compensation aren't always obvious, this may be a challenge for those compliance officers that aren't experts in this business line.
Our advice is to start this process by following the money. In other words, look at how your firm is being compensated. Is your firm receiving compensation directly from the pension client, or is the money manager paying indirect compensation to the pension consultant?
For purposes of those disclosures required by the SEC rules, here are a few items that most likely should be disclosed.
1) Conferences - Does your firm host a conference for its pension clients? Are money managers charged a sponsorship or exhibit fee? Does your firm provide training to money managers and trustees, but only charges money manager staff? Does your firm tend to recommend these money managers more often than other money managers?
2) Software - Does your firm sell software to money managers, which analyzes clients' performance? Similarly, Are these money managers recommended more often than others?
3) Marketing Services - Does your firm sell marketing services to money managers?
4) Affiliated B/D - Does your firm direct its pension clients to pay pension consulting fee through directing transactions/commissions to an affiliated B/D? Is this disclosed? Is best execution taking place? If so, how is this documented?
5) Referral Fees from Unaffiliated B/D - Does your firm direct its pension clients to an unaffiliated B/D that then pays a referral fee?
6) Employees Dual Registered as Reg Reps - Are your investment advisor reps serving pension clients also registered representatives and receiving compensation for trades placed by the pension client.
7) Gifts/Entertainment/Trips - Are your investment advisor reps receiving gifts from money managers? Are you tracking such gifts, entertainment or trips?
8) Change of Money Manager - Does your firm charge a "search fee" or receive additional brokerage commissions when terminating a pension client's money manager?
9) Additional Money Manager Accts. - Do your pension consultants seek or obtain brokerage transactions from other accounts managed by the money manager?
Once you identify these disclosure items, you need to consult with your experts to properly tailor your response. (This blog entry is certainly no substitute for consulting with your compliance expert on the specifics of your situation, and how it should be handled. Our goal is to make sure you're aware of the issue.)
As alluded to in the SEC report, it's likely that the disclosures need to be more than a mere reference stating that services are provided by the pension consultant to the money manager. The best practice is spelling out to the pension client that the same money managers being recommended by the pension consultant are also paying the pension consultant for other services. Depending upon the circumstances, this disclosure may need to include the dollar amounts being paid by such money managers so the client can truly grasp the extent of the conflict.
It's also important to recognize that disclosure isn't enough. The investment advisor serving as a pension consultant is a fiduciary, which means that these practices creating the conflicts will have to be carefully managed/supervised/mitigated or completely eliminated if the potential conflict is too great. Under the new Chief Compliance Officer Rule, the SEC will expect the CCO to formalize policies and procedures to address these conflicts.
Finally, the last wild card to throw into the mix -- some of these pension consulting compensation practices creating a conflict might be considered by the Dept. of Labor (DOL) to constitute "prohibited transactions" under ERISA even with the proper disclosure in your ADV, which will have to be addressed in a seperate blog entry at a later date.
Labels: Pensions
posted by bhill at 11:52 AM
SEC Guidance Is Arriving for New CCOs
Are you a newly appointed Chief Compliance Officer of an SEC registered investment advisory firm, but not completely sure of the full breadth of your responsibility? If so, you definitely aren't alone.
Last fall, the SEC's Compliance Programs of Investment Companies and Investment Advisers Rule went into effect. Although Rule 206(4)-7 requires investment advisors (registered with the SEC) to appoint a Chief Compliance Officer, it doesn't enumerate the specific responsibilities of the CCO. Guidance from the rule is limited. It provides that the CCO administer the compliance policies and procedures of the firm and be competent and knowledgeable; and the position should also be given full responsibility and authority to develop and enforce appropriate policies and procedures and have a position of sufficient seniority and authority within the organization.
In recent months, the SEC has started to provide additional comments about the role and responsibilities of the CCO. For example, the Associate Director of the Office of Compliance Inspection and Examinations recently spoke on the subject before the Managed Funds Association. During the speech the Associate Director laid out 24 specific duties and functions that he believes all CCOs should perform or consider performing. He also discussed the new rule in more detail and provided direction regarding the selection of a CCO. RIA Compliance Consultants recommends that CCOs read the entire text of his comments. This attempt at clarification is welcomed news, and hopefully a sign of what we can expect in the future.
Last fall, the SEC's Compliance Programs of Investment Companies and Investment Advisers Rule went into effect. Although Rule 206(4)-7 requires investment advisors (registered with the SEC) to appoint a Chief Compliance Officer, it doesn't enumerate the specific responsibilities of the CCO. Guidance from the rule is limited. It provides that the CCO administer the compliance policies and procedures of the firm and be competent and knowledgeable; and the position should also be given full responsibility and authority to develop and enforce appropriate policies and procedures and have a position of sufficient seniority and authority within the organization.
In recent months, the SEC has started to provide additional comments about the role and responsibilities of the CCO. For example, the Associate Director of the Office of Compliance Inspection and Examinations recently spoke on the subject before the Managed Funds Association. During the speech the Associate Director laid out 24 specific duties and functions that he believes all CCOs should perform or consider performing. He also discussed the new rule in more detail and provided direction regarding the selection of a CCO. RIA Compliance Consultants recommends that CCOs read the entire text of his comments. This attempt at clarification is welcomed news, and hopefully a sign of what we can expect in the future.
Labels: Compliance Program
posted by bhill at 8:33 PM
SEC Warns Investment Advisors That Conflicts Related to Pension Consultants Need to Disclosed & Mitigated
Does your investment advisory firm serve as a pension consultant? If so, then you need to carefully review the Staff Report Concerning Examinations of Select Pension Consultants released by the SEC on Monday, May 16, 2005.
The SEC advises that many pension consultants/investment advisors examined as part of its sweep have incorrectly concluded that they aren't fiduciaries to their clients and correspondingly aren't adequately disclosing all material conflicts of interest and mitigating/eliminating such conflicts.
The SEC provided the following as examples of policies and procedures that pension consultants should address:
Policies and procedures to ensure that the firm's advisory activities are insulated from its other business activities, to eliminate or mitigate conflicts of interest in its advisory activities. Such policies and procedures would include those governing the process used to identify and/or monitor money managers or mutual funds for an advisory client, to prevent considerations of a money manager's or mutual funds other business relationships with the consultant or its affiliates;
Policies and procedures to ensure that all disclosures required to fulfill fiduciary obligations are provided to prospective and existing advisory clients, particularly regarding material conflicts of interest arising from arrangements between the consultant and its affiliates and the money managers and mutual funds that the consultant recommends to a client during a manager search or for whom the consultant is providing ongoing monitoring services. Policies/procedures should be designed to ensure adequate disclosure concerning the consultant's compensation, including when the pension consultant receives compensation from brokerage transactions from advisory clients or money managers; and
Policies and procedures to prevent conflicts of interest or disclose material conflicts of interest with respect to the use of brokerage commissions, gifts, gratuities, entertainment, contributions, donations and other emoluments provided to clients or received from money managers.
Every investment advisor providing consulting services to pension plans should use this as an opportunity to conduct a thorough review of its practices and disclosures.
The SEC advises that many pension consultants/investment advisors examined as part of its sweep have incorrectly concluded that they aren't fiduciaries to their clients and correspondingly aren't adequately disclosing all material conflicts of interest and mitigating/eliminating such conflicts.
The SEC provided the following as examples of policies and procedures that pension consultants should address:
Policies and procedures to ensure that the firm's advisory activities are insulated from its other business activities, to eliminate or mitigate conflicts of interest in its advisory activities. Such policies and procedures would include those governing the process used to identify and/or monitor money managers or mutual funds for an advisory client, to prevent considerations of a money manager's or mutual funds other business relationships with the consultant or its affiliates;
Policies and procedures to ensure that all disclosures required to fulfill fiduciary obligations are provided to prospective and existing advisory clients, particularly regarding material conflicts of interest arising from arrangements between the consultant and its affiliates and the money managers and mutual funds that the consultant recommends to a client during a manager search or for whom the consultant is providing ongoing monitoring services. Policies/procedures should be designed to ensure adequate disclosure concerning the consultant's compensation, including when the pension consultant receives compensation from brokerage transactions from advisory clients or money managers; and
Policies and procedures to prevent conflicts of interest or disclose material conflicts of interest with respect to the use of brokerage commissions, gifts, gratuities, entertainment, contributions, donations and other emoluments provided to clients or received from money managers.
Every investment advisor providing consulting services to pension plans should use this as an opportunity to conduct a thorough review of its practices and disclosures.
Labels: Pensions
posted by bhill at 10:00 PM
