California Proposes Amendments to Rules under the Corporate Securities Law of 1968
Earlier this month, the California Department of Corporations announced proposed changes to rules regulating investment advisers registered in California. According to the release, the objective in proposing the amendments is to increase uniformity with the model rules suggested by the North American Securities Administrators Association (NASAA), rules already in effect in other states, and rules established by the Securities and Exchange Commission (SEC). California is giving the public an opportunity to comment on the proposed changes. The time period for comment ends on October 30, 2007.
The proposed rules will have an impact on registered investment advisors in California, and all registered investment advisor firms doing business in California should take time to read the various releases and the text of the proposed rules. We feel the following are some of the more important changes proposed.
RIA Compliance Consultants, Inc. can help your firm comply with these proposed changes. Contact us to find out more about our written compliance manual and code of ethics drafting and reviewing services.
The proposed rules will have an impact on registered investment advisors in California, and all registered investment advisor firms doing business in California should take time to read the various releases and the text of the proposed rules. We feel the following are some of the more important changes proposed.
- Requirement to establish and maintain written procedures designed to supervise employees and ensure their compliance with securities laws.
- Incorporation of the principles governing performance-based advertising set forth in the 1996 SEC No-Action letter involving Clover Capital Management.
- Requirement to provide all clients a written disclosure document containing the same information in Form ADV Part II. While we suggest all registered investment advisors provide a disclosure document to clients, apparently this has not been a requirement in California.
- Amendment to the definition of custody and the procedures regarding custody. This rule will mirror the NASAA Model Rule for custody.
- Rule requiring the implementation of codes of ethics. The rule will copy the same requirements set forth under the SEC’s codes of ethics rule (Rule 204A-1 under the Advisers Act).
- Changes to “largely mirror” Rule 206(4)-3 of the Advisers Act which sets forth requirements that must be followed when fees are paid to solicitors.
- The adoption and implementation of a business continuity plan.
RIA Compliance Consultants, Inc. can help your firm comply with these proposed changes. Contact us to find out more about our written compliance manual and code of ethics drafting and reviewing services.
Labels: Advertising, Code of Ethics, Custody, Form ADV, Solicitors
posted by bhill at 3:00 PM
Attention Investment Advisers Registered in Illinois
Recently the Illinois Securities Department has been requesting investment advisors registered with their office provide additional information regarding disclosures made in the firm’s Form ADV. Requests for additional information have been made not only during the initial registration process but also in response to updates submitted by registered investment advisors with active registration. Additional information required has included more thorough descriptions of the services and fee arrangements offered by firms, copies of agreements entered into with third-party investment advisors, copies of privacy policy notices, and copies of Schedule H brochures used by the firm even when the wrap-fee program is sponsored by another firm. Firms registered in Illinois should be prepared to provide the additional information and documentation promptly to the Department when requested. We support the Department’s decision to ensure firms are fully disclosing all pertinent information and can substantiate compliance with investment advisory rules and regulations.
Illinois is also providing guidance regarding its interpretation and rules concerning custody. The Department interrupts an investment adviser to have custody of client accounts when question 2.I.(1) of Form ADV Part 1B (deduction of fees directly from client accounts) is checked 'yes' even if it is indirect custody, meaning the client has given permission for a third-party investment advisor to deduct fees from the client’s account. When fees are deducted from client accounts, the registered investment advisor will need to also mark Item 9.A and B of Form ADV Part 1A. As long as the firm is marking and complying with Form ADV Part 1B, Items 2.I(1) a, b, and c, the firm does not need to comply with the additional financial requirements, i.e. audited balance sheet and additional net worth and/or bonding. However, firms that deduct advisory fees but do not comply with Items 2.I.(1) a, b, and c (i.e. send invoices to clients, receive client authorization, and ensure the fee deduction is listed on the client’s account statements) will need to comply with the additional financial requirements.
If your firm is registered with the state of Illinois and has questions concerning these requirements, please give us a call.
Illinois is also providing guidance regarding its interpretation and rules concerning custody. The Department interrupts an investment adviser to have custody of client accounts when question 2.I.(1) of Form ADV Part 1B (deduction of fees directly from client accounts) is checked 'yes' even if it is indirect custody, meaning the client has given permission for a third-party investment advisor to deduct fees from the client’s account. When fees are deducted from client accounts, the registered investment advisor will need to also mark Item 9.A and B of Form ADV Part 1A. As long as the firm is marking and complying with Form ADV Part 1B, Items 2.I(1) a, b, and c, the firm does not need to comply with the additional financial requirements, i.e. audited balance sheet and additional net worth and/or bonding. However, firms that deduct advisory fees but do not comply with Items 2.I.(1) a, b, and c (i.e. send invoices to clients, receive client authorization, and ensure the fee deduction is listed on the client’s account statements) will need to comply with the additional financial requirements.
If your firm is registered with the state of Illinois and has questions concerning these requirements, please give us a call.
posted by bhill at 1:13 PM
Implications of Deducting Advisory Fees for Nebraska Registered Advisors
The issue of custody over client funds and securities seems to be one of the most variant issues among regulators. One common form of custody is an advisor's authorization to have fees deducted directly from client accounts. While the SEC and most states consider this practice a custody situation, the procedures advisor firms must implement vary from regulator to regulator. Therefore it is important for all investment advisors to fully understand and comply with the custody requirements that apply to their firm.
For example, Nebraska state-registered advisors that deduct advisory fees directly from client accounts should be disclosing on Form ADV Part 1A that the firm has custody of client "cash and bank accounts" or "securities". Firms that deduct advisory fees from money market funds kept in client brokerage accounts should mark Item 9.A.(2) on Part 1A. Firms that deduct advisory fees from bank accounts or deduct fees from idle cash in a client brokerage account will need to mark Item 9.A.(1). The firm's authorization to deduct fees from client accounts does not affect the firm's net capital requirement as all state registered firms domiciled in Nebraska must maintain a net capital of $25,000. However, advisor firms that follow the safeguards set forth in Form ADV Part 1B, Item 2.1.(1) are provided a waiver from the Nebraska audited financial statement requirements. In order to avoid the audited financial statement requirements, the following safeguards must be met. Advisor firms must (1) attain the client's written authorization to have fees deducted from the account, (2) send a copy of the fee invoice to the custodian or trustee at the same time it is sent to the client, and (3) ensure the client's custodian sends quarterly statements indicating all disbursements from the account including the amount of the advisory fees. It is important to note that the invoice sent to a client must indicate the amount of the fee that will be deducted, the manner in which the fee was calculated, any adjustments to the fee and an explanation of such adjustment. It is vital that advisor firms actually implement procedures to fulfill these safeguards. Too many advisor firms mark the items under Form ADV Part 1B, but never follow through with sufficient procedures to ensure the safeguards are met and, therefore, are in violation of the Nebraska custody requirements.
If you have questions concerning Nebraska's requirements, your home state's custody regulations, or your firm's procedures regarding the deduction of advisory fees, please feel free to give us a call. Stay tuned to RIA Compliance Consultants as we try to stay on top of this ever-evolving issue.
For example, Nebraska state-registered advisors that deduct advisory fees directly from client accounts should be disclosing on Form ADV Part 1A that the firm has custody of client "cash and bank accounts" or "securities". Firms that deduct advisory fees from money market funds kept in client brokerage accounts should mark Item 9.A.(2) on Part 1A. Firms that deduct advisory fees from bank accounts or deduct fees from idle cash in a client brokerage account will need to mark Item 9.A.(1). The firm's authorization to deduct fees from client accounts does not affect the firm's net capital requirement as all state registered firms domiciled in Nebraska must maintain a net capital of $25,000. However, advisor firms that follow the safeguards set forth in Form ADV Part 1B, Item 2.1.(1) are provided a waiver from the Nebraska audited financial statement requirements. In order to avoid the audited financial statement requirements, the following safeguards must be met. Advisor firms must (1) attain the client's written authorization to have fees deducted from the account, (2) send a copy of the fee invoice to the custodian or trustee at the same time it is sent to the client, and (3) ensure the client's custodian sends quarterly statements indicating all disbursements from the account including the amount of the advisory fees. It is important to note that the invoice sent to a client must indicate the amount of the fee that will be deducted, the manner in which the fee was calculated, any adjustments to the fee and an explanation of such adjustment. It is vital that advisor firms actually implement procedures to fulfill these safeguards. Too many advisor firms mark the items under Form ADV Part 1B, but never follow through with sufficient procedures to ensure the safeguards are met and, therefore, are in violation of the Nebraska custody requirements.
If you have questions concerning Nebraska's requirements, your home state's custody regulations, or your firm's procedures regarding the deduction of advisory fees, please feel free to give us a call. Stay tuned to RIA Compliance Consultants as we try to stay on top of this ever-evolving issue.
Labels: Custody
posted by bhill at 1:52 PM
Kansas Securities Regulator Suspends IA Firm
Earlier this fall, the Office of the Kansas Securities Commissioner entered an order to summarily suspend the investment advisor registration of a state firm located in Overland Park, Kansas. According to the Commissioner’s Press Release, the “firm committed fraud by informing a client that his funds were maintained in an account at a brokerage firm when, in fact, the funds were pooled with the funds of other investors in a second account controlled” by the advisor firm’s president. The firm also apparently did not fully cooperate with the state examiners during their investigation. This enforcement action serves as example as to how Kansas securities regulator will respond when an investment advisor attempts to circumvent state securities laws.
The Kansas Securities Commissioner has also become more visible through a series of television and radio advertisements encouraging the investing public to conduct its own investigating before hiring a Kansas based financial professional. In conjunction with these efforts to educate the public, Kansas has initiated a proactive approach to regulatory examinations and has already conducted numerous audits. As a result, it’s imperative that investment advisors located in Kansas ensure that they are implementing effective compliance programs and controls.
If your firm is located in Kansas and wants to discuss how RIA Compliance Consultants can help your firm meets its regulatory requirements, please give us a call at 877-345-4034.
The Kansas Securities Commissioner has also become more visible through a series of television and radio advertisements encouraging the investing public to conduct its own investigating before hiring a Kansas based financial professional. In conjunction with these efforts to educate the public, Kansas has initiated a proactive approach to regulatory examinations and has already conducted numerous audits. As a result, it’s imperative that investment advisors located in Kansas ensure that they are implementing effective compliance programs and controls.
If your firm is located in Kansas and wants to discuss how RIA Compliance Consultants can help your firm meets its regulatory requirements, please give us a call at 877-345-4034.
Labels: Custody, Enforcement
posted by bhill at 1:29 PM
Custody Interpretations Can Be Confusing
According to a letter from the State of Washington dated January 3, 2006, Washington regulators now deem investment advisors to have custody when they have the ability to directly withdraw fees from client accounts. This is the case even when the advisor firm attains the client's authorization, provides a fee notice to the client, and ensures the fee disbursement is disclosed on the client's account statement. Therefore, state registered advisor firms that engage in this practice and are located in Washington must answer affirmatively to ADV Part 1A, Item 9 (Custody). However, the State of Washington also explained that if the firm is deemed to have custody for this reason alone, the firm does not need to meet the minimum net worth requirements for firms with custody or attain audited financial records. This is the case so long as the firm receives client authorization to debit advisory fees directly from the client account, provides a fee deduction notice to clients, and ensures the fee disbursement is disclosed on the client's account statement.
This is an example of the inconsistency in the way that "custody" is interpreted between regulators. For example, the SEC has determined that deducting investment advisory fees directly from client accounts is also a form of custody; however, it alone does not require the investment advisor firm to mark ADV Part 1A, Item 9 in the affirmative.
Do you have a full understanding of your regulator's approach to defining custody? If you have any questions on what is custody and what additional rules must be followed if your firm is deemed to have custody, please give us a call.
This is an example of the inconsistency in the way that "custody" is interpreted between regulators. For example, the SEC has determined that deducting investment advisory fees directly from client accounts is also a form of custody; however, it alone does not require the investment advisor firm to mark ADV Part 1A, Item 9 in the affirmative.
Do you have a full understanding of your regulator's approach to defining custody? If you have any questions on what is custody and what additional rules must be followed if your firm is deemed to have custody, please give us a call.
Labels: Custody
posted by bhill at 7:47 PM
Custody Requirements for Advisors to Hedge Funds
If you are an advisor to a private fund (i.e. hedge fund or pooled investment vehicle) do you know if you are deemed to have custody? If so, is your Form ADV Part I completed correctly?
According to SEC Rule 206(4)-2(c)(1)(iii), the definition of custody includes an investment advisor with “any capacity (such as a general partner of a limited partnership, managing member of a limited liability company or a comparable position for another type of pooled investment vehicle, or trustee of a trust) that gives you or your supervised person legal ownership of or access to client funds or securities.” In other words, if your investment advisor firm is the general partner (or similar status) of a hedge fund that it also manages, the advisor firm is deemed to have custody.
Investment advisor firms that fall under the definition of custody must meet a number of additional requirements. Under SEC Rule 206(4)-2, “it is a fraudulent, deceptive, or manipulative act, practice or course of business . . . for you to have custody of client funds or securities unless" the following are satisfied:
1. A qualified custodian maintains those funds and securities in a separate account for each client or in accounts that contain your clients’ funds and securities, under your name as agent or trustee for the clients;
2. You notify your clients in writing of the qualified custodian’s name, address, and the manner in which the funds or securities are maintained, when the account is opened and when any changes to this information occur;
3. You verify the delivery and accuracy of account statements prepared by the qualified custodian, or, if you send account statements to clients, an independent public accountant must conduct a surprise audit of those funds and securities at least once each calendar year (please keep in mind that account statements must be sent to each limited partner, member or other beneficial owner); and
4. A client may designate an independent representative to receive, on her behalf, notices and account statements.
The Rule 206(4)-2 does allow for some exceptions of “certain privately offered securities”. According to the Rule, advisors “are not required to comply with this section with respect to securities that are:
A. acquired from the issuer in a transaction or chain of transaction not involving any public offering;
B. uncertificated, and ownership thereof is recorded only on books of the issuer or its transfer agent in the name of the client; and
C. transferable only with prior consent of the issuer or holders of the outstanding securities of the issuer.
While these exceptions do provide some relief for advisors to hedge funds, they are only available if the advisor is audited at least annually and then distributes the audit findings to all limited partners, members, or beneficial owners. The audit findings must be distributed within 120 days (or 180 days in the case of an advisor to a fund of funds) of the advisor’s fiscal year end. In addition, an advisor may satisfy its obligation to deliver account information (as described under number three above) to investors by distributing the audited financial statements to investors.
Finally, advisors need to ensure their ADV Part I is completed correctly. Item 9.A. and 9.B. require advisors to disclose if they maintain custody of cash or bank accounts and securities.
For many newly registered advisor firms, the custody rules seem intimidating and overwhelming. However, the SEC views these rules as extremely important and are sure to be reviewed during a regulatory examination. If you have questions on how to meet these requirements or would like us to conduct a mock exam, please give us a call today.
According to SEC Rule 206(4)-2(c)(1)(iii), the definition of custody includes an investment advisor with “any capacity (such as a general partner of a limited partnership, managing member of a limited liability company or a comparable position for another type of pooled investment vehicle, or trustee of a trust) that gives you or your supervised person legal ownership of or access to client funds or securities.” In other words, if your investment advisor firm is the general partner (or similar status) of a hedge fund that it also manages, the advisor firm is deemed to have custody.
Investment advisor firms that fall under the definition of custody must meet a number of additional requirements. Under SEC Rule 206(4)-2, “it is a fraudulent, deceptive, or manipulative act, practice or course of business . . . for you to have custody of client funds or securities unless" the following are satisfied:
1. A qualified custodian maintains those funds and securities in a separate account for each client or in accounts that contain your clients’ funds and securities, under your name as agent or trustee for the clients;
2. You notify your clients in writing of the qualified custodian’s name, address, and the manner in which the funds or securities are maintained, when the account is opened and when any changes to this information occur;
3. You verify the delivery and accuracy of account statements prepared by the qualified custodian, or, if you send account statements to clients, an independent public accountant must conduct a surprise audit of those funds and securities at least once each calendar year (please keep in mind that account statements must be sent to each limited partner, member or other beneficial owner); and
4. A client may designate an independent representative to receive, on her behalf, notices and account statements.
The Rule 206(4)-2 does allow for some exceptions of “certain privately offered securities”. According to the Rule, advisors “are not required to comply with this section with respect to securities that are:
A. acquired from the issuer in a transaction or chain of transaction not involving any public offering;
B. uncertificated, and ownership thereof is recorded only on books of the issuer or its transfer agent in the name of the client; and
C. transferable only with prior consent of the issuer or holders of the outstanding securities of the issuer.
While these exceptions do provide some relief for advisors to hedge funds, they are only available if the advisor is audited at least annually and then distributes the audit findings to all limited partners, members, or beneficial owners. The audit findings must be distributed within 120 days (or 180 days in the case of an advisor to a fund of funds) of the advisor’s fiscal year end. In addition, an advisor may satisfy its obligation to deliver account information (as described under number three above) to investors by distributing the audited financial statements to investors.
Finally, advisors need to ensure their ADV Part I is completed correctly. Item 9.A. and 9.B. require advisors to disclose if they maintain custody of cash or bank accounts and securities.
For many newly registered advisor firms, the custody rules seem intimidating and overwhelming. However, the SEC views these rules as extremely important and are sure to be reviewed during a regulatory examination. If you have questions on how to meet these requirements or would like us to conduct a mock exam, please give us a call today.
Labels: Custody, Hedge Funds
posted by bhill at 7:15 PM
