Today, the United States Securities and Exchange Commission (“SEC”) passed long-proposed changes to the disclosure statements that federally registered investment advisers provide regulators and clients. Originally, the SEC proposed changes to Form ADV Part 2 in 2000. That proposal was never adopted, but a second proposal was issued in 2008 and finally passed today.
Under current SEC regulations, the Form ADV Part II, along with Schedule F (or a document containing the same information as Part II and Schedule F), serves as the required disclosure statement that must be given to a client initially and offered annually thereafter. In past comments, Chairman Mary Shapiro described the current Form ADV Part II as a “1960s check-the-box, paper-based approach,” where as the proposed amendments would require more of a “plain English narrative discussion of an adviser’s conflicts, compensation, business activities, and disciplinary history.” Finally, the proposed amendment would require this same information to be available through the SEC’s Investment Adviser Public Disclosure (IAPD) website, so that investors, as well as the general public, would have access to this information.
The SEC is delaying the publication of the revised Form ADV Part 2 for five business days in order to work with state securities regulators on technical, state-specific changes to items and instructions. Ideally, all issues will be resolved and the same Form ADV Part 2 can be used by both SEC and state registered investment adviser firms.
According to the SEC’s press release, “[t]he amended rules and forms will be effective 60 days after publication in the Federal Register. Most investment advisers will begin distributing and publicly posting new brochures in the first quarter of 2011.” Based upon the explanation during today’s open meeting, it appears that an SEC registered investment adviser firm will be required to submit the new Form ADV Part 2 through Web IARD when filing its Form ADV Part 1 Annual Amendment submitted for the fiscal year ending on or after December 31, 2010. Form ADV Part 1 Annual Amendments must be filed no later than 90 days after a firm’s fiscal year ends. The SEC registered investment adviser will then be required to deliver the new brochure to all clients within 60 days after filing the new brochure on IARD. It appears an SEC registered investment adviser may choose to begin using the new Form ADV Part 2 before the compliance date. Investment advisers seeking initial registration with the SEC will be allowed to use the old Form ADV Part II through the end of the year, but new investment adviser firms seeking initial registration after January 1, 2011 will be required to use the new Form ADV Part 2.
Stay tuned to RIA Compliance Consultants for more information regarding the new Form ADV Part 2.
The General Assembly of the Commonwealth of Kentucky recently made several changes to the Securities Act of Kentucky which affect investment adviser representatives and their registration requirements.
First, the definition of “investment adviser representative” has been slightly changed. The term is now defined as “an individual employed by or associated with an investment adviser…and who makes any recommendations or otherwise gives investment advice regarding securities, manages accounts or portfolios of clients, determines which recommendations or advice regarding securities should be given, provides investment advice or holds himself or herself out as providing advice, receives compensation to solicit, offer, or negotiate for the sale of or for selling investment advice or supervises employees who perform any of the foregoing.”
The other major change relates to the registration of investment adviser representatives. All investment adviser representatives are now required to be registered unless they are exempt from registration under the Kentucky Securities Act. Prior to the recent changes, an individual who was a partner, officer, or director, (hereinafter “executive”) of a registered investment adviser or a person occupying a similar status or performing similar functions with an investment adviser was not required to register as an investment adviser representative. However, this exemption for executives of investment advisers is no longer valid. Therefore, all executives of registered investment advisers who meet the revised definition of investment adviser representative must complete and file a Form U4, the Uniform Application for Securities Industry Registration or Transfer, through the Central Registration Depository (CRD) system in order to remain registered as an investment adviser representative.
The final date to comply with Kentucky’s new investment adviser representative registration requirement is October 15, 2010. If you need advice or assistance regarding registration as an investment adviser representative in the State of Kentucky, any of our compliance consultants are willing to assist you.
A registered investment advisor is required to make and keep true accurate and current certain books and records relating to its investment advisory business. For investment advisors registered with the U.S. Securities and Exchange Commission (SEC), these required books and records are outlined in Rule 204-2 of the Investment Advisers Act of 1940 (“Advisers Act”). Each investment advisor registered with the SEC should familiarize itself with the requirements of this rule in relation to the documents and reports that need to be maintained, where and for how long the documents must be maintained, and how the documents may be maintained. Most books and records requirements for state registered investment advisors are the same as or similar to the SEC requirements, but you need to make sure that you familiarize yourself with the requirements of the appropriate governing authority.
Maintenance of books and records is something that should be covered in an investment advisor’s compliance program. It is not enough just to know what you need to maintain, an investment advisor should perform periodic testing to make sure that it is maintaining and can provide the appropriate documents. One effective method of doing this is to have a mock examination performed of your investment adviser. Take the list of required books and records and test to whether you are prepared to present all required documents and if you can do so in a timely manner. This is something that can be performed by an investment advisor’s own Compliance Department or you can hire RIA Compliance Consultants to perform this service for you.
The following are some examples of common books and records deficiencies that we find during mock examinations of investment advisors:
- Not maintaining an order memorandum or not maintaining complete information in the order memorandum as outlined in Rule 204-2(a)(3) the Advisers Act;
- Not maintaining current financial or complete financial records;
- Not maintaining proper documentation to support performance advertising figures;
- Not maintaining a list of all access persons for the past five years;
- Not maintaining access person holdings reports;
- Not maintaining records to support the firm’s duty of best execution;
- Not maintaining or unable to locate contracts the firm has executed with service providers, sub-advisors, or solicitors;
- Not able to easily or timely produce copies of requested email records; and
- Not having complete or adequate written compliance programs or having written compliance programs that are not consistent with what the firm is actually doing.
For more information and guidance on maintaining the appropriate books and records for your investment advisor, register for the Maintaining Required Books and Records webinar that will be presented by RIA Compliance Consultants on July 28, 2010.
On June 30, 2010, the United States Securities and Exchange Commission (“SEC”) unanimously adopted Rule 206(4)-5 under the Investment Advisers Act of 1940 which is designed to curtail “pay to play” practices by registered investment advisers. (Click here for a link to the SEC press release). “Pay to play” is the practice of making contributions to public officials in exchange for the award of pension management contracts. The SEC believes that these practices favor large investment advisors over smaller ones, reward political connections rather than investment skill, and give consumers sub par performances for superior prices. Therefore, the SEC adopted Rule 206(4)-5 which is designed to eliminate the pay to play practice and to level the field for investment advisers so that management contracts are awarded based upon investment skill and quality of service.
The adopted SEC Rule 206(4)-5 contains three main elements:
- First, the Rule prohibits an investment advisor from providing advisory services, either directly or through a pool investment vehicle, for two years if the investment adviser or its employees make a political contribution to an individual in a position to influence the award of a management contract. There is a de minimis exception to this rule which allows for individuals to contribute up to $350 to a candidate per election if the contributor is allowed to vote for the candidate and up to $150 per candidate per election if the contributor is not allowed to vote for the candidate.
- Second, the Rule prohibits investment advisors and its employees from soliciting or coordinating campaign contributions for candidates or political parties.
- Finally, the Rule prohibits investment advisers from paying third party solicitors, unless the third party solicitors is an SEC registered brokers dealer or registered investment adviser who will be subject to similar pay to play restrictions.
In addition to these requirements, the adopted Rule 206(4)-5 contains a provision which makes it unlawful for an investment adviser or its employees to do anything indirectly, which if done directly would violate the rule. This provision ensures that investment advisers can not use third parties to circumvent the new rule. Also, with the enactment of Rule 206(4)-5, investment advisers will need to maintain certain records regarding political contributions and payments.
The Rule, as originally introduced last July, would have banned the use of third party solicitors. However, due to responses during the “Comments” period, the SEC backed away from this position and will allow the use of third party solicitation to continue, however the solicitors must be registered with the SEC as investment advisers or broker dealers. Further, the SEC stated if third party solicitors continue to have a corruptive influence on the pension industry, then the SEC will ban the use of third party solicitors all together.
The adopted Rule 206(4)-5 applies to registered advisers as well as advisers who rely on the private adviser exception (less than 15 clients) and to unregistered advisers. Investment advisers will need to be in compliance with the Rule within six months from the date the Rule is published in the Federal Register; except for the third party ban provisions which investment advisers will have to comply within one year.
RIA Compliance Consultants recommends that all investment advisers implement politician contributions policies and procedures to ensure compliance with the adopted Rule. Also, most investment adviser policy manuals will need to be updated because of new solicitor and record keeping requirements. If you need advice or assistance in implementing procedures or updating policy manuals to ensure compliance with the adopted Rule, any of our compliance consultants are willing to assist you.
On June 30, 2010, the Commissioners of the Securities and Exchange Commission (“SEC”) will vote on whether to restrict investment advisers from participating in “pay to play” transactions with public officials. The purpose of the proposed rule is to eliminate potential corruption from the process of awarding management contracts for public retirement funds. If approved, the rule would prohibit investment advisers from making or soliciting political contributions to or for officials who are in a position to award the management of pension funds.
Last July, in an effort to limit pension fund corruption, the SEC considered a rule that would have banned the use of “placement agents,” individuals or firms hired by investment advisers to influence politicians who are responsible with awarding pension management contract. However, the SEC has backed away from this position and is seeking to restrict investment advisers from participating in “pay to play” practices, which according to the SEC undermines the fairness of the government’s selection process of investment advisers.
Currently, the SEC does not prohibit investment advisers from making political contributions to government entities or officials. A contribution is defined as “any gift, subscription, loan, advance, deposit of money, or anything of value made for the purpose of influencing an election for a federal, state or local office, including any payments for debts incurred in such an election. It would also include transition or inaugural expenses incurred by a successful candidate for state or local office.” “Government entities” include “all state and local governments, their agencies and instrumentalities, and all public pension plans and other collective government funds.” “Government officials” includes “an incumbent, candidate or successful candidate for elective office of a government entity if the office is directly or indirectly responsible for, or can influence the outcome of, the selection of an investment adviser or has authority to appoint any person who is directly or indirectly responsible for or an influence the outcome of the selection of an investment adviser.”
Pursuant to Release 2010.2 published on June 28, 2010 by the Investment Adviser Registration Depository (“IARD”), the Investment Adviser Public Disclosure (“IAPD) database now allows users to search for investment adviser representatives. Prior to the release, investment advisers and investment adviser representatives submitted registration and licensing information to the IARD; however, only information for investment adviser firms was available on the IAPD database. With Release 2010.2, effective June 28, 2010, the information investment adviser representatives have provided on Form U4 is publicly available through the IAPD database.
The information published by the IAPD includes qualifications, such as licenses, professional designations, and any exams passed; previous employment, including a list of firms where the investment adviser representative was previously registered, as well as any employment within the last ten years both inside and outside the securities industry; and a disclosure section which details any customer disputes or disciplinary events on the investment adviser representative’s record. The published information is obtained through Form U4, which is a registration and licensing form used by securities regulators to collect information about investment adviser firms and investment adviser representatives. Both investment adviser firms and investment adviser representatives are required to ensure this information is accurate and up-to-date.
Section 31(a) of the Investment Company Act of 1940 (“ Investment Company Act”) requires that each registered investment adviser “maintain and preserve” records of accounts, correspondence, memorandums, tapes, discs, papers, books, and other documents or transcribed information. These books and records are to be maintained for a period of five years and are subject to random periodic inspection by the U.S. Securities and Exchange Commission (“SEC”). Likewise, under Rule 204-2 of the Investment Advisers Act of 1940 (“Investment Advisers Act”), the SEC requires certain books and records to be maintained by a registered investment adviser regardless of whether of the investment adviser is associated with a registered investment company.
A recent example where the SEC has initiated a disciplinary action as a result of a periodic record inspection is In the Matter of Diane M. Keefe. In this regulatory enforcement action, the SEC brought an action against Diane Keefe, an employee of a registered investment adviser, when the SEC, while conducting a period examination, discovered that Keefe did not maintain accurate records.
Diane Keefe, a former employee of Pax World Management Corp., a registered investment adviser, was found to have willfully violated Section 34(b) of the Investment Company Act for failure to maintain accurate books and records. Section 34(b) of the Investment Company Act prohibits investment advisors from making any untrue statement of material fact in a document that is required for record keeping pursuant to Section 31(a) of the Investment Company Act.
Keefe served as the portfolio manager of the Pax World High Yield Fund (“Fund”). The Fund’s filed registration statements state that an Investment Committee was responsible for overseeing the Fund’s investments. Keefe created handwritten notes that falsely represented that the Investment Committee was overseeing the investments of the Fund. However, the Fund’s board had never even assembled the Investment Committee.
The administrative law judge suspended Keefe for twelve months from association with a registered investment adviser or broker-dealer. Keefe has appealed her suspension and the case has been remanded for further fact-finding determinations.
On July 28, 2010 RIA Compliance Consultants will be conducting a webinar on the topic of maintaining investment adviser required books and records pursuant to SEC Rule 204-2 issued under the Investment Advisers Act. Individuals can register for this webinar, or any of our other upcoming webinars, by clicking here.
In 2009, the State of Michigan adopted several amendments to the Michigan Uniform Securities Act. One of the major amendments to the Michigan Securities Laws requires all investment adviser representatives to be licensed.
Under Michigan’s revised definition of “investment adviser representative,” all individuals who make recommendations or give advice, manage accounts, determine recommendations or advice, provide investment advice, solicit for the sale of investment advice or supervise any individual conducting such activities are considered investment adviser representatives and must be licensed.
To register as an investment adviser representative, an individual must make a Form U4 filing with FINRA’s CRD/IARD System. As part of this filing, an individual must submit proof that within the previous two years, the individual has passed either the Series 65 or both the Series 7 and the Series 66 examinations. Individuals may apply for a waiver of the exam requirements, which waiver request must be submitted by August 2, 2010.
The final date to comply with Michigan’s new investment adviser representative registration requirements is November 1, 2010. However, due to an anticipated high number of filings, the State of Michigan has stated that licensing may take 60 days from the time a filing is submitted. Therefore, it is recommended that individuals submit their investment adviser representative application prior to September 1, 2010 to prevent any lapse in registration. If you need advice or assistance regarding the filing of an investment adviser registration application, any of our compliance consultants are willing to assist you.
On June 21, 2010, the U.S. Securities and Exchange Commission (“SEC”) charged a New York based registered investment adviser and three affiliated firms with the fraudulent management of collateralized debt obligations (“CDOs”) tied to mortgage backed securities. The SEC alleges that ICP Asset Management LLC, and its owner/president Thomas Priore, made fraudulent misrepresentations that earned the firm several million dollars in advisory fees and also caused four CDOs to lose tens of millions of dollars.
According to the SEC’s complaint, the defendants caused the CDOs to enter into several prohibited transactions at inflated prices so the firm could collect larger advisory fees. In some instances, the defendants caused the CDOs to purchase assets from other firm clients at prices well above the market price. The SEC further alleges that the defendants made misrepresentations about these transactions to both investors and the trustees of the CDOs.
The defendants are charged with violating their fiduciary duty as investment adviser, which requires all investment advisers to conduct their business in a manner that is in their clients’ best interest. Robert Khuzami, the Director of the SEC’s Enforcement Division, characterized the firm’s actions as violating their fiduciary duty by putting their own interests ahead of their clients and taking “advantage of a distressed market to line their own pockets.”
Seeking a permanent injunction, disgorgement of profits, and other monetary penalties, the SEC’s complaint also charges the defendants with participation in prohibited transactions, failure to maintain required books and records, and other charges in violation of Sections 204 and 206(1)-(4) of the Investment Advisers Act of 1940; SEC Rules 204-2, 206(4)-7, and 206(4)-8; the Securities Act of 1933; and the Securities Exchange Act of 1934.
The Division of Investment Management of U.S. Securities and Exchange Commission (“SEC”) recently updated ”Staff Responses to Questions About the Custody Rule.” (For a link to Staff Responses click here). In the updated responses, the Division provided new guidance concerning a variety of issues related to the custody rule. Two important issues discussed by the SEC clarify an investment adviser’s ability to request checks from a client account and situations where an investment adviser has online access to client pension accounts through the client’s ID number and password.
Question II.5
Q: Does an adviser have custody if it has authority to instruct the qualified custodian that maintains a client’s account to remit the funds or securities from the account to the same client at his or her address of records?
A: We do not interpret the authority to instruct the qualified custodian maintaining a client’s account to remit the funds or securities from the account to the same client at his or her address of record as having custody if (1) the client has granted such authority to the adviser in writing and a copy of that authorization is provided to the qualified custodian, and (2) the adviser has neither the authority to open an account on behalf of the client nor the authority to designate or change the client’s address of record with the qualified custodian. (Posted May 20, 2010).
Question II.6
Q: If an adviser has the ID number and password to a client’s pension fund account to rebalance and adjust investments in the account, does the adviser have custody?
A: The adviser has custody if password access provides the adviser with the ability to withdraw funds or securities or transfer them to an account not in the client’s name at a qualified custodian. (Posted May 20, 2010).
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