An investment adviser’s code of ethics must establish standard of business conduct that the investment adviser requires of all its supervised persons. SEC Rule 204A-1 does not require an investment adviser to adopt a particular standard, but the standard chosen must reflect the fiduciary obligations of the investment adviser and its supervised persons and must require compliance with the federal securities laws.  The SEC contends that while each investment adviser firm’s code of ethics must meet certain minimum provisions, the adopted rule allows for flexibility for investment advisers to adopt individualized codes that best suit the “structure, size and nature of [investment advisers] advisory businesses.”

An investment adviser’s code of ethics must meet the needs of its individual organization while achieving a proper balance of operational and aspirational elements. In the adopting release, the SEC stated:

“We urge advisers to take great care and thought in preparing their codes of ethics, which should be more than a compliance manual. Rather, a code of ethics should set out ideals for ethical conduct premised on fundamental principals of openness, integrity, honesty and trust. A good code of ethics should effectively convey to employees the value the advisory firm places on ethical conduct, and should challenge employees to live up not only to the letter of the law, but also to the ideals of the organization.”

Although SEC Rule 204A-1 does not require investment advisers to provide specific training regarding the firms code of ethics, the adopting release states, “An investment adviser’s procedures for informing its employees about its code of ethics are critical to obtaining good compliance and avoiding inadvertent violations of the code.”  The adopting release also indicates that the following are among best practices for investment advisers:

• Holding periodic orientation or training sessions with new and existing employees to remind them of their obligations under the code of ethics;
• Requiring employees to certify that they have read and understand the code of ethics; and
• Requiring annual recertification that the employee has re-read, understands and has complied with the code.

RIA Compliance Consultants is hosting a webinar, Thursday, February 9, 2012, at 12:00pm CST, “Professional Ethics for Investment Adviser Representatives,” that will discuss the fiduciary duties of investment advisers as it relates to Section 206 of the Investment Advisers Act, including details on what it means to be a fiduciary, with supplemental examples of unethical behavior. The webinar will discuss the summary of requirements under SEC Rule 204A-1 and will expand on the reporting requirements of the rule. This webinar is intended to serve as an education tool designed to assist investment advisers in providing on-going ethics training to its investment adviser representatives. This webinar will provide up to one hour of Continuing Education credit to meet the on-going requirements for maintaining the Certified Financial Planner (“CFP”) certification, approved by the CFP Board of Standards, Inc. To register for this webinar, please click here. To speak with one of our consultants for more information on how RIA Compliance Consultants can assist your firm in implementing or reviewing your firm’s code of ethics, click here.

In recent months, the SEC has been reviewing the existing social media policies and procedures of registered investment advisers.  In the regulatory alert, the SEC documented many of its observations from these reviews and included some best practices to “assist [registered investment advisers] in designing reasonable procedures designed to prevent violations of the Advisers Act and other federal securities laws.”

One of the “hot-button” issues discussed in the regulatory alert is the use of the “Like” feature on social media sites and whether it constitutes a testimonial, which is prohibited by the Investment Advisers Act of 1940 (“Advisers Act”).  According to the regulatory alert, a third-party’s use of the “Like” feature on a registered investment advisers social media web page “could be deemed to be a testimonial if it is an explicit or implicit statement of a client’s or clients’ experience with an investment adviser or [investment adviser representative].”

In the regulatory alert, the SEC also noted that most of the firms it reviewed had policies in place for advertising, client communications and electronic communications, but no policies specific to social media.  According to the SEC, this is not sufficient and these registered investment advisers also need procedures that are specific to social media.  If this describes your registered investment adviser, now is the time to implement policies and procedures specific to social media.

RIA Compliance Consultants can help your registered investment adviser update its written policies and procedures; click here to schedule a time to discuss with one of our consultants how RIA Compliance Consultants, Inc. is able to further assist your firm. RIA Compliance Consultants has drafted detailed policies and procedures that address the compliance concerns addressed in the SEC’s regulatory release, such as the use of the “Like” feature, the retention of online communication, supervision of representatives’ use of social media and how your firm will be represented online.

Additionally, if would like further guidance, RIA Compliance Consultants has recorded a webinar, “Compliance for Social Media Site,” which analyzes many of the issues discussed in the SEC’s regulatory alert.  You can purchase a recording of this webinar by clicking here.

According to the Order, the firm’s principal allegedly grossly misstated Calhoun’s assets under management on the firm’s Form ADV in order to attract investors for two funds of funds.  According to Calhoun’s February 2009 Form ADV, the firm had $79.8 million in assets under management; the SEC’s Order alleges that the firm actually had $7 million in assets under management.  In addition, the SEC’s Order alleges that the principal misstated the assets under management for another investment adviser controlled by the principal.  For that firm, the principal regularly filed the Form ADV and stated the firm’s assets under management ranged from $24 million to $335 million, when in reality, according to the SEC, the firm had no assets under management.

On Thursday, January 12, 2012, RIA Compliance Consultants will be hosting a webinar, “Preparing your Form ADV Annual Amendment.”  During this webinar, we will review the Form ADV items that are required to be updated on an annual basis. The webinar will include a review of the ADV Part 1 instructions for calculating regulatory assets under management.  Our consultants will also discuss some of the common mistakes we see when investment advisors are filing their annual amendment. Additionally, our consultants will also address some of the other amendments and filings that may need to be made with your annual amendment, including those resulting from the recent SEC revisions to the Form ADV.  To register for this webinar, click here.

To invest in unregistered securities offerings, an investor must meet the “accredited investor” standards.  Typically, to qualify as an “accredited investor” an investor must have a net worth, alone or with a spouse, greater than or equal to $1 million.  The new rule modified the $1 million threshold to exclude the value of a person’s home.  The rule also excludes from the $1 million net worth calculation, any liabilities secured by the individual’s primary residence with certain limitations.   If secured liabilities exceed the fair market value of the residence, then the indebtedness that is greater than the value of the residence is applied against the individual’s net worth.  In addition, secured loans must have originated more than 60 days prior to the purchase of the unregistered security to prevent individuals from taking out a second line of equity on their home in order to invest in unregistered securities.  Individuals who qualified as “accredited investors” under the prior Securities Act of 1933 standards (pre-adoption of the SEC’s Dodd-Frank Act standards) may use the prior net worth standard for certain “follow-on investments.”

This new rule will go into effect 60 days after it has been published in the Federal Register.  To view the full rule release, click here.

Many investment advisers have a December fiscal year end, which would mean that the 2011 annual amendment filing is due by March 30, 2012.  This year is a little different for all investment advisers registered with the SEC.  Due to changes to the Advisers Act resulting from the Dodd-Frank Wall Street Reform and Consumer Protection Act, all investment advisers registered with the SEC must file an amendment to Form ADV by March 30, 2012 indicating the reason it will remain eligible for SEC registration or that it is no longer eligible for SEC registration and will need to become state registered.  For SEC investment advisers with a fiscal year end of October, November, or December 2011, this filing can be done in connection with your annual amendment as long as you have not done the annual amendment filing prior to January 1, 2012.  For all other SEC investment advisers, this filing should be done as an other-than-annual amendment filing.

The Form ADV instructions provide specific details regarding which Items must be updated only annually; which items must be updated “promptly” if the information becomes inaccurate in any way; and which items must be updated “promptly” if the information becomes “materially” inaccurate.  When filing an amendment to your Form ADV, all investment advisers should review the entire Form ADV to determine what information needs to be updated.  This year a review of the entire Form ADV will be especially important because the Form ADV has been revised in several ways.  The Form ADV revisions include new items, changes to existing items so as to request additional information or  information to be provided in a different manner than in the past, and modifications to the instructions for completing the Form ADV, which most notably includes revisions to the instructions for calculating “regulatory” assets under management.

Failure to update your Form ADV, in accordance with the Form ADV instructions, is a violation of SEC Rule 204-1 and similar state rules and could lead to an investment adviser’s registration being revoked.  RIA Compliance Consultants will be presenting a webinar, “Preparing Your Form ADV Annual Amendment” on January 12, 2011 at 12:00 pm CST if you would like more information regarding preparing your Form ADV amendments.  The cost for this webinar is $69.95.  Click here to register for the webinar.

RIA Compliance Consultants can assist you with your Form ADV amendments.  If you are interested in this service, click here to schedule a time to speak with one of our consultants.  Existing RIA Compliance Consultants’ clients should contact their consultant directly.

There are numerous changes that have been made to the Form ADV Part 1 and registered investment advisers need to devote sufficient time and resources to review, understand and properly respond to the new Form ADV Part 1 items.  

Item 1 – Identifying Information

An investment adviser must now disclose:

• the name and contact information of the investment adviser’s Chief Compliance Officer;
• if a person other than the Chief Compliance Officer is authorized to receive information and respond to questions about the Form ADV;
• if the investment adviser is a public reporting company under Sections 12 or 15(d) of the Securities Exchange Act of 1934 and provide their SEC assigned CIK number (Central Index Key number that the SEC assigns to each public reporting company); and
• if the investment adviser has $1 billion or more in assets on the last day of your most recent fiscal year and the investment adviser’s Legal Entity Identifier if applicable.

Item 2 – SEC Registration

An investment adviser is now required to disclose if they are eligible to register (or remain registered with the SEC.

The vast majority of SEC registered investment advisers will be required to indicate the following.

• If a large investment adviser firm:

An investment adviser is considered to be a large firm if the investment adviser has regulatory assets under management of $100 million (in U.S. dollars) or more, or has regulatory assets under management of $90 million (in U.S. dollars) or more at the time of filing its most recent annual updating amendment and is registered with the SEC.

• If a mid-sized investment adviser firm:

An investment adviser is considered to be a mid-sized investment adviser firm if it has regulatory assets under management of $25 million (in U.S. dollars) or more but less than $100 million (in U.S. dollars) and the investment adviser is either not required to be registered as an adviser in its home state or not subject to examination by the state securities regulator of its home state.

• If no longer eligible to remain registered as an investment adviser with the SEC:

Such investment adviser firms ares required to switch to state registration.

An investment adviser must complete Item 2.B. if it is reporting to the SEC as an exempt reporting adviser and disclose if it:

(1) qualifies for the exemption from registration as an investment adviser solely to one or more venture capital funds; qualifies for the exemption from registration because it acts solely as an investment adviser to private funds and has assets under management in the United States of less than $150 million;

(2) qualifies for the exemption from registration because it acts solely as an investment adviser to private funds and has assets under management in the United States of less than $150 million;

(3) acts solely as an investment adviser to private funds but it isno longer eligible to check box 2.B.(2) because it have assets under management in the United States of $150 million or more.

Item 5 - Your Advisory Business

An investment adviser must now disclose:

• The number of employees rather than just a range;
• The number of “employees” that are registered representatives of a broker-dealer;
• The number of “employees” that are investment adviser reps of your investment adviser firm;
• The number of “employees” that are investment adviser reps of another investment adviser firm; and
• The number of “employees” that are licensed insurance agents.

Other Item 5 Changes:

• The definition of an individual client has been change to include trusts, estates, 401(k) plans, and IRAs (but not sole proprietorships).
• The types of clients disclosed has been updated to include business development companies, other investment advisers and insurance companies.
• An investment adviser is now required to not only list the percentage of clients by number, but also by the percentage of clients based upon its regulatory assets under management.
  • The definition of regulatory assets under management has also been amended to include securities portfolios for which they provide continuous and regular supervisory or management services, regardless of whether these assets are family or proprietary assets, assets managed without receiving compensation, or assets of foreign clients.
  • The types of investment advisory activities has also been amended to include management of pooled investment vehicles and “educational seminars/workshops”
  • An investment advisor must also indicate if the investment adviser provides investment advice with respect to only limited types of investments.

Item 6 - Other Business Activities

• Listed other business activities now include futures commission merchant (broken out from commodity pool operated or trading advisor), trust company, registered municipal advisor, registered security-based swap dealer, major swap participant, accountant/accounting firm, and lawyer/law firm.
• If another business activity uses a different name from the IA name, it must be furnished on Schedule D.
• If you sell products or services other than investment advice to your clients, that business must be described on Schedule D.

Item 7 - Financial Industry Affiliations and Private Fund Reporting

• The related persons list has been changed to remove investment company and add municipal advisor, swap dealer, major swap participant, futures commission merchant trust company, and sponsor of pooled investment vehicles.
• Foreign affiliates (registered or unregistered) must be reported

• Item 7 of the Form ADV Part 1A has been changed to request more detail on services provided by firms and related persons including custodians, private funds and seminar providers.

Item 8 – Participation or Interest in Client Transactions

• An investment adviser must now disclose whether they receive of any compensation for client referrals.

Item 9 – Custody

• An investment adviser is required to identify the number of custodians used in connection with those assets where the firm has custody and Schedule D of the Form ADV has been revised in order for firms to provide more detail about these arrangements.

Item 11 – Disclosure Information

An investment adviser will be required to indicate if any of the responses in Item 11 relate to any of their supervised persons.

Schedule D of Form ADV

Section 6 of the Schedule D has had significant changes that will require an investment adviser to provide details of their business activities

• Section 6.A. must disclose the name of any other business (if different from your investment adviser’s name).
• Section 6.B. must describe your investment adviser’s primary business (if not investment advisory) or other products and services.

Section 7 of the Schedule D has been added to require private fund managers and those investment advisers with related or affiliated entities that are private funds to provide responses to another 40 to 60 questions depending upon the investment adviser’s activities.

• Under Section 7.A., an investment adviser must identify the type of each related person (same as Item 7.A.), describe the control relationship with each related person, and disclose the registration status of each related person.
• Section 7.B(1) covers any private fund your firm advises.  An investment adviser must identify the name and exemption status of each private fund; describe the ownership, advisory services, and private offering of each private fund; and identify each fund’s auditors, prim broker, custodian, administrator and marketer(s).

Section 7.B(2) requires an investment adviser to disclose whether the investment adviser solicits clients to invest in each private fund.

The SEC attributed this increase to a “significant reorganization” to the SEC’s Enforcement Division.  According to the SEC, in the 2009 and 2010 fiscal years, the Enforcement Division “flattened its management structure, revamped the way it handles tips and complaints, facilitated the swift prosecution of wrongdoers through a formal program that encourages cooperation from individuals and companies in the SEC investigations, and created national specialized units in five priority areas involving complex and higher risk areas of potential securities laws violations.”  These changes appear to be effective because the Enforcement Division filed more enforcement actions in 2011 than it ever had before.

According to Angel, requiring investment advisers to hire external auditors is the best solution for several reasons.  Angel suggests that requiring audits by external auditors would increase the frequency of examinations and would allow the SEC staff to focus more on “for-cause examinations.”  Also, he suggests that allowing investment advisers to choose their auditor would lower the prices for such services and result in better service.  Angel stated that the SEC has already “started down this path by requiring RIA firms that have custody of customer assets to have surprised audits once a year.”

Under Angel’s suggested plan, external compliance reviews would be conducted every five years and compliance audits would be “tailored to the size and risk of the firms.”  These reviews would be conducted by qualified industry professionals who hold certain designations like the CFA or CPA and have experience working as an examiner.

Angel dismissed the use of an SRO for several reasons.  He notes that SROs have “a strong financial incentive to side with the industry against the consumer.”  He references that one of the findings of  the investment adviser oversight study that was required by Section 914 of the Dodd-Frank Act was that the only area where the SEC’s investment adviser oversight is deficient is in examination frequency.  According to this study, the SEC is still meeting expectations for the rulemaking process and is adequately addressing other industry deficiencies.  Based on this, Angel concludes that forming an SRO or allowing FINRA to serve as the SRO for investment advisers is the wrong approach.  According to Angel, “[An] SRO’s industry expertise makes it, in theory a better rule-setter,” but the SEC does not have an issue with serving as a rule-setter.  Therefore, Angel states that “[e]stablishing a new SRO with new rulemaking authority whose rules must be approved (and likely micromanaged) by the SEC merely adds another level of bureaucracy.”

Stayed tuned to RIA Compliance Consultants for further updates as we will continue to follow this story.

The Implementation of the New Form ADV 2:

• U.S. Securities and Exchange Commission (“SEC”) registered investment advisors and most state registered investment advisors were required to prepare and electronically submit the new Form ADV Part 2 Brochure.  An SEC registered investment advisor was required to begin providing the new ADV Part 2A Brochure to all new and perspective clients upon submission of the revised document through the IARD system and was required to deliver a copy of the ADV Part 2A to existing clients within 60 days of filing it through the IARD system.  The SEC issued an extension for some SEC registered investment advisors regarding the delivery of the Form ADV Part 2B supplemental brochures.  An SEC investment advisor that was registered with the SEC as of 12/31/2010 and had a fiscal year end between 12/31/2010 and 4/30/2011 had until 7/31/2011, to prepare and begin delivering the new Brochure Supplements to new and prospective clients.  These SEC registered investment advisors had until 9/30/2011 to deliver the appropriate Brochure Supplements to all existing clients. Additionally, investment advisors that were newly registered with the SEC from 1/1/2011 through 4/30/2011 had until 5/1/2011 to prepare and begin delivering brochure supplements to new and prospective clients and had until July 1, 2011 to deliver the Brochures Supplements to existing clients.  All other investment advisors registered with the SEC were required to meet the delivery requirements specified in the initial adopting release. State registered investment advisors should review the state’s Form ADV delivery requirements to determine if any revisions were made and to ensure that they are complying. Investment Advisors must keep Form ADV Part 2 brochures current by updating them at least annually and promptly when any information in the brochure becomes materially inaccurate.

The “Switch” For Mid-Sized Investment Advisors:

• On July 21, 2011 the adopted rules and form changes to implement the transition of mid-sized investment advisors (between $25 and $100 million in assets under management) from SEC to State regulation became effective. All investment advisors that are SEC registered as of 12/31/2011 must file a Form ADV Part 1 amendment (regardless of the investment advisor’s fiscal year end) by March 30, 2012 to confirm the investment advisor’s eligibility to remain SEC registered or to begin the transition to state registration.  Amendments will be made to the Form ADV to reflect the regulatory changes related to the transition of regulation for mid-sized investment advisors.  Additional revisions to the Form ADV will also be implemented.

Exemptions for Advisors to Venture Capital Funds, Private Fund Advisors With Less Than $150 Million in Assets Under Management, and Foreign Private Advisors:

• On July 21, 2011, the SEC adopted rules to implement new exemptions from the investment advisor registration requirements for advisors to certain private funds.  The new rules defined a “venture capital fund,” provide an exemption from registration for advisors with less than $150 million in private fund assets under management in the United States, and clarifies the meaning of certain terms included in a new exemption from registration for “foreign private advisors.”

Whistleblower Provision:

• A provision under the Dodd-Frank Act gives the SEC the authority to reward whistleblowers and enhances the retaliation penalties and procedures that protect whistleblowers.

Additional, noteworthy changes made include:

• The dollar amount that must be met before performance fees can be charged by investment advisors was raised to adjust for inflation.

• Adopted rules defining the term “family office” as it relates to investment advisors and those managing their own family’s financial portfolios.

For more information regarding regulatory changes made in 2011, register for our webinar, “2011 Review – Are You Aware of the Changes in 2011 and Is Your Investment Advisor on Track for 2012?,” hosted Thursday, November 10^th at 12:00 Central. The cost for this webinar will be $59.95. To register, please click here.

RIA Compliance Consultants can help you with updating your compliance program to comply with the new regulatory requirements or can assist you with switching from SEC to state registration.  If you are an existing client of RIA Compliance Consultants interested in discussing how we can assist your investment advisor, please contact your consultant. If you are a new client that would like to speak with us regarding the services we can provide, please click here to schedule a time to speak with one of our consultants.

• “All SEC Investment Advisers must file an annual updating amendment before March 30, 2012, whether you have a pending State Application or have not yet submitted a [California] application. Your firm can submit the CA Application at the same time the annual updating amendment is filed.”

• “If your firm’s application is submitted and approved prior to January 1, 2012, you may elect to either have your firm’s CA registration approved for 2011 OR request that the [California Department of Corporations] hold the completed application and approve it effective January 1, 2012.” Those firms that receive approval prior to January 1, 2012 and wish to be approved for CA registration for 2011 would be required to pay two renewal fees, once in 2011 and again in 2012.”

For additional information regarding transitioning your investment adviser firm from SEC to California state registration, please click here to register for RIA Compliance Consultants free webinar, hosted October 20, 2011 at 12:00 Central.