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.

There are two important regulatory reasons for monitoring outside business activities: (a) Form ADV disclosure purposes, and (b) Form U4 disclosure purposes. A registered investment advisor is required to disclose to clients all potential and real conflicts of interests including outside activities of the firm and its related persons. Item 8 of Form ADV Part II outlines specific business activities or affiliations of the firm’s related persons that must be disclosed. These include affiliations with institutions such as banks, real estate brokers, and broker/dealers. Individuals listed under Item 6 of Form ADV Part II need to provide detailed business background for the preceding five years. Finally, Item 7.C. of the Form ADV Part II may require the registered investment advisor firm to provide a description of the supervised person’s outside activity and the amount of time spent on that activity.

In addition to disclosing outside activities on the Form ADV, investment advisor representatives (“IARs”) must disclose their employment history for the previous 10 years and their current outside business activity on the Form U4. It is the investment advisor representative’s ultimate responsibility to keep the Form U4 current and complete, particularly his/her employment and other business background.

Registered investment advisors need to be cognizant of the 30 day deadline for making material updates to the Form ADV and Form U4. Whenever an individual or firm’s outside business activities change, those activities need to be updated on the Form ADV and/or Form U4 within 30 days of the change.

Jarrod James, Vice President of RIA Compliance Consultants, will be the featured speaker during our webinar, “Addressing Outside Business Activities and Conflicts of Interest,” on Tuesday, September 15, 2009 from 12:00 p.m. to 1:00 p.m. CST.

Purchase your webinar seat for $59.95:
www.RIA-Compliance-Consultants.com/webinars.

An outside business activity may create an incentive to the registered investment advisor that is not in the best interests of the client. For example, an investment advisor representative that is also an insurance agent may decide to recommend a particular insurance product based on an incentive to sell the product (e.g. higher commission, soft-dollars, trips, marketing allowance) rather than recommending the product solely based on the needs of the client. This is a classic conflict of interest that must be disclosed to investment advisory clients. A registered investment advisor’s failure to disclose outside business activities and the outside business activities of its supervised persons is an all-too-often deficiency during examinations by the U.S. Securities and Exchange Commission (“SEC”) and state securities regulators.

A related type of deficiency is the failure to adequately monitor and approve outside business activities considered investment related. Certain financial related activities are considered higher risk for conflicts of interest between an investment advisor representative (“IAR”) and his/her clients and even his/her firm. These activities include wholesaling investment products, affiliation with a broker/dealer, acting as a mortgage broker, working for a second registered investment advisor, and serving as a limited partner or managing member of a private investment. Before a registered investment advisor allows its supervised persons (which includes all officers, directors, partners, investment advisor representatives and employees) to engage in these types of activities, it is imperative that the supervised person fully disclose the activity and provide detailed documentation of how the activity will impact their affiliation with the registered investment advisor. If the activity does not comply with the registered investment advisor’s compliance policies and procedures, the registered investment advisor should not approve the activity.

For more information and guidance regarding outside business activities common to many registered investment advisors and to learn some best practices with respect to disclosure and mitigation of conflicts of interest, please consider attending our webinar, “Addressing Outside Business Activities and Conflicts of Interest,” on Tuesday, September 15, 2009 from 12:00 p.m. to 1:00 p.m. CST.

Purchase your webinar seat for $59.95 at www.RIA-Compliance-Consultants.com/webinars.

If the proposed rule is passed, the scope of broker-dealer supervisory responsibilities will go beyond written approval for the outside business activity and arguably will require supervision of all approved outside business activities. As a result, the offer of investment advisory services by representatives affiliated with a broker-dealer would be subject to supervision by broker-dealer principals. If this truly is the intent of proposed rule 3110, it is a significant departure from previous FINRA guidance on this issue. Notice to Members 94-44 had indicated that investment advisory activities that did not include the RR/IA’s participation in the execution of a securities transaction would require notification of the investment advisory activity to the broker-dealer firm but would not require record keeping and supervision of the transactions. Notice to Members 96-33 again clarified that supervision of specific transactions by a FINRA member firm would be required only if the registered representative who is also an investment adviser (“RR/IA”) “participates in the execution of a securities transaction such that his or her actions go beyond a mere recommendation, thereby triggering the record keeping and supervision requirements” for the broker-dealer firm. See NTM 96-33. It appears that the current version of the proposed rule may be an attempt to broaden the scope of the supervisory responsibility of broker-dealer firms in that it could require broker-dealer firms to supervise investment advisory activities at a level beyond notification and with such supervision to potentially include record keeping, and approval or disapproval at the transaction level. Consequently, investment advisors affiliated with a broker-dealer would be required to obtain prior written approval from their broker-dealer for investment advisory activities.

FINRA has accepted comments regarding the proposed rule and many in the financial industry have voiced concerns including that the language of the proposed rule is vague and that the proposed rule is too broad, overlaps with the jurisdiction of other regulators, and that the rule may conflict with rules which restrict the release of client information without client approval. Marc Menchel, executive vice president and general counsel of FINRA has commented that FINRA is not trying to expand its jurisdiction with this rule proposal and that FINRA believes that broker-dealer firms should be supervising the investment advisory business in which the representatives of their firm engage. See “Brokers, Advisers Blast FINRA Proposal”, Investment News, June 30, 2008. In response to comments submitted, FINRA may amend the proposed rule or provide clarification related to the language of the proposed rule. Additionally, the Securities and Exchange Commission would need to approve FINRA’s proposed rule before it could take effect. FINRA encouraged all interested parties to comment on the rule proposal by June 13, 2008. FINRA has not yet submitted the rule proposal to the SEC.

The following is an excerpt directly from the Ohio Securities Bulletin:

The [Ohio] Division of Financial Institutions stated a position in its Mortgage Brokers and Lenders Letter No. 2006-2 that could potentially affect investment advisers. The Division cited the prohibition against mortgage brokers or loan officers “obtaining a referral fee from a party with a related interest in the transaction” found in R.C. section 1322.071(B)(3). The Letter notes that a “person acting as an investment adviser urging the refinancing or purchase of property who also acts as the loan officer in the same transaction effectively is obtaining fees through a self-referral.”

The Letter added that “the notion of borrowing one’s home equity to invest in the market is a risky strategy, which should not be undertaken where there is a significant conflict of interest arising from considerations of the mortgage broker or loan officer’s own profit or remuneration when counseling such an investment strategy.” The Division concluded that acting as both an investment adviser and a loan officer in the same transaction is an “improper and dishonest practice” which violates R.C. 1322.07(C) and recommended that registrants and licensees review their policies regarding the matter.

Both state and SEC registered investment adviser firms with affiliated banks or mortgage brokers in Ohio or investment adviser representatives acting as loan officers or mortgage brokers in Ohio need to review their business practices and supervisory policies and procedures in light of this letter.

An investment advisor is required to disclose to clients all potential and real conflicts of interests including outside activities of the firm and its related persons. Item 8 of ADV Part II outlines specific business activities or affiliations of the firm’s related persons that must be disclosed. These include affiliations with institutions such as banks, real estate brokers, and broker/dealers. Individuals listed under Item 6 of ADV Part II need to provide detailed business background for the preceding five years. Finally, Item 7 of the Part II requires the firm to provide a description of the outside activity and the amount of time spent on that activity.

In addition to disclosing outside activities on the Form ADV, advisor representatives must disclose their employment history for the previous 10 years and their current outside business activity on the Form U4. It is an advisor representative’s ultimate responsibility to keep the Form U4 current and complete; particularly his/her employment and other business background.

Investment advisors need to be cognizant of the 30 day deadline for making material updates to the Form ADV and Form U4. Whenever an individual or firm’s outside business activities change, those activities need to be updated on the Form ADV and/or Form U4 within 30 days of the change. Moreover, as a best practice, investment advisors should consider requiring its officers, directors, investment advisor representatives and employees to complete an outside business disclosure form on an annual basis. If you have questions regarding these requirements or want to discuss practical applications for the monitoring of outside business activities, please give us a call today.

Financial Statements – If your advisor firm is registered with one or more states, you may be required to submit certain financial statements to the state regulators on an annual basis. Many states have certain net worth or net capital requirements. Some states also have surety bond requirements. Most states that have these provisions require advisor firms to substantiate they are in compliance with the rules by submitting financial statements. In some cases the financial statements must be submitted at the end of the firm’s fiscal year and in some states the financial records must be submitted at the end of the calendar year. In addition to any forms the firm may have to submit directly to regulators, it is essential the firm has updated all of its financial records under the regulatory books and records requirements. This is true for state and SEC registered advisor firms.

Form ADV Annual Amendment – The SEC and almost all states require advisor firms to amend their Form ADV on at least an annual basis in the form of an Annual Amendment. The Annual Amendment must be completed within 90 days after an advisor firm’s fiscal year end. Since the majority of advisor firms coordinate their fiscal year end with the end of the calendar year, the Annual Amendment has become a requirement that must be completed at the beginning of each year for most firms. The main item that must be updated on the Annual Amendment is the firm’s assets under management. Other items such as, but not limited to, the number of accounts, clients, employees, and advisor representatives should also be updated. The Annual Amendment can also be used to disclose any material changes. Keep in mind, however, that material changes need to be disclosed within 30 days no matter when they take place. Material changes include items such as, but are not limited to, reportable disciplinary and financial disclosures, changes in advisory programs, changes in fee arrangements and changes in billing practices.

Outside Business Activities and other Form U4 Amendments – The end of the year is a great time to remind all employees and advisor representatives to officially disclose their outside business activities to the firm. The disclosure of outside business activities must be done for three important reasons. Those reasons are to ensure the individual’s Form U4 is current and up to date, ensure the firm’s Form ADV does not need to be amended due to an individual’s business activities, and finally, so the firm can determine if an individual’s outside activities are in conflict with the firm’s policies and in conflict with a client’s best interests. In addition to disclosing outside business activities, updating other items on the Form U4 must also be completed when those items are materially inaccurate.