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Wednesday, February 15, 2012

Correction on Form U5 Leads to SEC Action for Improper Performance Claims

The United States Securities and Exchange Commission (“SEC”) recently issued an order instituting cease-and-desist proceedings against an investment adviser representative for misstating performance numbers on performance reports distributed to clients.  According to the SEC’s order, the representative overstated client performance numbers and understated losses on individual portfolio performance reports provide to his clients.  The investment adviser representative is now barred from associating with another investment adviser firm and required to pay a civil penalty of $60,000.

Prior to the order, the principals of the investment adviser representative’s employing firm discovered allegedly inaccurate performance reports and, after completing their internal review, terminated the representative.  However, the principals did not originally report the internal review on the representative’s Form U5.  The Form U5 is the official form used by investment adviser firms and broker/dealer firms to notify regulators of a licensed individual’s termination from the firm.  Several months later, after receiving advice from a consultant, the principals amended the Form U5 to fully disclose the reason for termination.  This amendment to the Form U5 drew the attention of the SEC who initiated an investigation resulting in the order.

Communications with clients is always a top focus during SEC routine examinations and the SEC’s investigation into this matter is another example of the close scrutiny placed on performance claims whether they are in marketing materials or individual reports provided to clients.  If you need guidance on the performance advertising rules and other marketing rules and regulations, RIA Compliance Consultants will be conducting a webinar, Performance Advertising for Investment Advisers, on Thursday, March 15. Additionally, if you need help implementing performance reporting procedures or reviewing performance advertising materials, RIA Compliance Consultants would be happy to assist you; click here to schedule a time to speak with one of our compliance consultants.

Wednesday, February 8, 2012

Compliance and Ethics Are Not Solely the Responsibility of an Investment Adviser’s CCO

On January 31, 2012, the U.S. Securities and Exchange Commission (“SEC”) held a Compliance Outreach Program National Seminar in Washington, D.C. for investment advisers and investment companies. In the past, these seminars were generally referred to as “CCO Outreach Programs.” During the introductory remarks for the seminar, Carlo V. di Florio, Director, Office of Compliance Inspections and Examinations for the SEC, explained the reason for the changed program title. Mr. di Florio indicated that the change is based on the SEC’s desire through both its outreach programs and its examination program to “elevate the role of compliance by underscoring that it is not a responsibility that stops at the desk of the CCO” and that the SEC’s intention is to continue its outreach and support for investment adviser’s chief compliance officers (“CCO”).

During his speech, he went on to emphasize the importance of strong risk management controls including strong compliance programs and he emphasized the importance of senior management in implementing an investment adviser’s culture of compliance throughout the firm. Mr. di Florio stated, “Strong risk management controls, including a solid compliance program, are a key responsibility of everyone in a regulated entity, but the right culture and tone at the top are especially the responsibility of senior management and the board. A CCO who does not have the full support and engagement of senior management and the board is not going to be effective, and there is nothing we want more than to help CCOs to be effective. We will focus most intently on firms where we sense that senior management and the board are not setting the appropriate tone and are failing to support key risk and control functions with adequate resources, independence, standing and authority.”

One thing that was clear in his speech is that senior management should expect to be more involved in the audit process going forward. He indicated that one thing revealed during the financial crisis was the need for better oversight at senior management levels. As a result of this, the SEC will be seeking to engage senior management on critical business, risk and regulatory issues. Senior management should take the primary role in “reinforcing the tone at the top, driving a culture of compliance and ethics and ensuring effective implementation of risk management in key business processes, including strategic planning, capital allocation, performance management and compensation incentives.”

These are some key points that an investment adviser should keep in mind this year when it is conducting its annual assessment of its written compliance program and determining how prepared it is for a regulatory exam. Investment advisers should examine the role of senior management in the compliance review process and the compliance program in general. Part of the assessment should always include an analysis of whether the investment adviser is dedicating enough resources and putting enough emphasis on the importance of the investment adviser’s compliance program.

RIA Compliance Consultants can assist you with developing, reviewing, or conducting an annual assessment of your investment adviser’s compliance program. If you are interested is speaking with one of our consultants about the support RIA Compliance Consultants can provide to your investment adviser, contact your consultant or click here to schedule a time to speak with one of our consultants.

Tuesday, February 7, 2012

The Code of Ethics Rule

Under Rule 204A-1 (“Code of Ethics Rule”) of the Investment Advisers Act of 1940 (“Investment Advisers Act”), each investment adviser registered with the U.S. Securities and Exchange Commission (“SEC”) is required to adopt and implement a code of ethics that sets forth required standards of conduct for all supervised persons of the registered investment adviser and addresses conflicts that arise from personal trading by advisory personnel. Most state securities regulators have similar requirements.

The Code of Ethics Rule does not require investment advisers to adopt a particular standard of conduct, but does necessitate that each investment adviser adopt a code that reflects the fiduciary obligations of the investment adviser and its supervised persons as applicable to the investment adviser’s business model. The Code of Ethics Rule sets forth minimum requirements but investment advisers are free to set higher standards for their supervised persons.

At a minimum, an investment adviser’s codes of ethics must include the following items:

1.      A standard of business conduct that the investment adviser requires of its supervised persons which reflects the fiduciary obligations of the adviser and its supervised persons;

2.      Provisions requiring supervised persons of the investment adviser to comply with applicable federal securities laws;

3.      Provisions that require all access persons of the investment adviser to report, and the investment adviser to review, their personal securities transactions and holdings periodically;

4.      Provisions requiring supervised persons of the investment adviser to report any violations of the investment adviser’s code of ethics promptly; and

5.      Provisions requiring the investment adviser to provide each of its supervised persons with a copy of its code of ethics and any amendments, and requiring its supervised persons to provide the investment adviser with a written acknowledgment of their receipt of the code and any amendments.

Additionally, each investment adviser must describe its code of ethics in its Form ADV Part 2 and provide a copy of its code of ethics to any prospective or current clients, upon request. Any amendments made to the investment adviser’s code of ethics must be provided to all supervised persons of the investment adviser and should be updated in Form ADV Part 2 accordingly.

An investment adviser’s code of ethics is an important element to any investment adviser’s compliance program. An investment adviser should review its code of ethics at least yearly as part of its annual compliance review process and make revisions as appropriate. While the investment adviser’s first obligation is to develop the code of ethics and ensure that it is meeting the minimum requirements of the Code of Ethics Rule, it is equally important that an investment adviser’s supervised persons are familiar with, understand the requirements of, and comply with the investment adviser’s Code of Ethics. At a minimum investment advisers have to obtain and maintain a signed acknowledgement of receipt of the investment adviser’s code of ethics and any amendments. Although not a requirement of the Code of Ethics Rule, developing procedures and on-going training for informing supervised persons about the investment adviser’s code of ethics is critical to creating a strong culture of compliance and avoiding inadvertent violations of the code.

RIA Compliance Consultants is hosting a webinar, Thursday, February 9, 2012, at 12:00 pm CST, “Professional Ethics for Investment Adviser Representatives.” During this webinar, one of our consultants will provide an overview of the Code of Ethics Rule. The primary focus of this webinar is to provide investment adviser representatives and supervised persons of the investment adviser with an understanding of why this rule exists and how it affects them. This webinar is intended to serve as an educational 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.

Wednesday, January 25, 2012

An Investment Advisers Code of Ethics Should Reinforce its Fiduciary Duty

In August 2004, the U.S. Securities and Exchange Commission (“SEC”) adopted Rule 204A-1 under the Investment Advisers Act of 1940 (“Investment Advisers Act”) that required registered investment advisers to adopt codes of ethics.  Under SEC Rule 204A-1, an investment advisory firm must adopt and implement a code of ethics, establishing rules and conduct all supervised persons must adhere to as a fiduciary. SEC Rule 204A-1 was adopted in attempt to create a standard of conduct that would “prevent fraud by reinforcing fiduciary principles that must govern the conduct of advisory firms and their personnel.” Section 206 of the Investment Advisers Act imposes a fiduciary duty on investment advisers by making it unlawful for an investment adviser to engage in fraudulent, deceptive or manipulative conduct. In its role as a fiduciary, an investment adviser has a duty to serve the best interest of its clients; a duty to have a reasonable, independent basis for investment advice; a duty to ensure that its investment advice is suitable to the client’s objectives, needs and circumstances; and a duty to be loyal to client.

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.

Friday, January 20, 2012

Is Your Investment Adviser Protected Against Client Claims?

Does your investment adviser have errors and omissions insurance (“E&O insurance”) to cover you and your firm in the event of an error or if a client claims your firm made an error?

While investment advisers are not required by regulation to maintain E&O insurance, RIA Compliance Consultants strongly recommends that all investment advisers maintain E&O insurance that is determined to be sufficient to cover the advisory services practice of the investment adviser firm.  As you might anticipate, legal fees can accumulate quickly even in situations where your firm is required to defend a claim that you believe to be frivolous.  E&O insurance typically will cover any settlements or judgments and the associated defense costs relating to any professional claims, including, for example, claims alleging lack of suitability, investment losses, errors in financial planning engagements, and meritless claims.

An adequate E&O policy will cover the investment adviser firm and all of its employees and representatives.  Most E&O insurance policies offer up to $1 million in coverage annually, although investment adviser firms with higher amounts of assets under management are advised to maintain more coverage.  Investment adviser firms are advised to attain an E&O policy that is tailored to the advisory services offered by the firm.  You should carefully review E&O policy provisions with your legal counsel and insurance broker to make a determination that the coverage provided by the E&O policy is sufficient coverage for the advisory services that your firm offers.  As an example, many policies do not extend coverage to claims related to private funds.  If your firm provides advisory services related to private funds, it is strongly recommended that you ensure that the E&O policy in place provides coverage for such activities.  If there is no coverage for such activities, then you either need to obtain insurance that will cover such activities or alternatively, need to amend the advisory services offered to eliminate activities for which your firm does not have insurance coverage.

Tuesday, January 17, 2012

SEC Gives Further Guidance on Social Media Use by Advisers

On January 4, 2012, the U.S. Securities and Exchange Commission’s (“SEC”) Office of Compliance Inspections and Examinations released a regulatory alert discussing the use of social media by investment advisers.

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.

Wednesday, January 11, 2012

SEC Brings Enforcement Action for Misrepresentations on Form ADV

The U.S. Securities and Exchange Commission (“SEC”) recently issued an Order Instituting Administrative and Cease-and-Desist Proceedings against Calhoun Asset Management, LLC (“Calhoun”) and its principal for, among other things, making false and misleading statements on Calhoun’s Form ADV.

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.

Tuesday, January 10, 2012

Final Renewal Statements Now Available in the IARD/Web CRD System

Final Renewal Statements for registered investment advisors are now available in the IARD/Web CRD system. These statements will reflect the final registration statuses of the investment advisor firm and its representatives as of December 31, 2011. Final Renewal Statements will reflect that the investment advisor is  ”Paid In Full,” has an “Amount Due,” or “Failed to Renew.”

All investment advisors should retrieve their Final Renewal Statements to verify the accuracy of this final reconciled statement. Investment advisors who’s Final Renewal Statement reflects an amount due must ensure that FINRA is in receipt of the full payment amount by no later than February 3, 2012. If an investment advisor’s Final Renewal Statement reflects a “Failed to Renew” status, you are advised to immediately contact each jurisdiction where your firm is required to be registered and/or notice field to determine the appropriate reinstatement procedures you must take.

If after reviewing your firm’s Final Renewal Statement, your firm discovers any discrepancies on the final statement, you must report, in writing, any errors to FINRA by February 3, 2012. With your letter of discrepancy, include a copy of your firm’s Final Renewal Statement and any supplemental documentation that would support your claim. If your renewal account had a credit balance as of January 3, 2012, the credit balance was transferred to your Daily Account. Investment advisors can leave the balance in the Daily Account for future needs or can request a refund. Instructions for requesting a refund can be found on the IARD website. For more information on the IARD renewal program, click here.

If you would like more information on how RIA Compliance Consultants may assist you with renewals, please click here to schedule a time to speak to one of our Senior Compliance Consultants. If you are an existing client of RIA Compliance Consultants, please contact your Senior Compliance Consultant directly.

Wednesday, January 4, 2012

SEC Modifies Standard for Accredited Investors

The U.S. Securities and Exchange Commission (“SEC”) has modified the rules used to determine whether an individual is qualified to invest in certain unregistered securities offerings.  The amendments were adopted as part of the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”).

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.

Tuesday, January 3, 2012

Form ADV Annual Amendment Filings

For most registered investment advisers, it is now time to file an amendment to your Form ADV.  Pursuant to Rule 204-1 under the Investment Advisers Act of 1940 (“Advisers Act”), all investment advisers registered with the U.S. Securities and Exchange Commission (“SEC”) must file an amendment to the Form ADV at least annually, within 90 days of the investment adviser’s fiscal year end and more frequently if required by the instructions to Form ADV.  Most state securities regulators have similar rules and the Form ADV Instructions specifically indicate that the update instructions apply to “SEC and State Registered Advisers.”

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.

 

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* RIA Compliance Consultants, Inc. ("RCC") is not a law firm and does not provide legal services. A compliance consulting relationship with RCC is not provided those legal and professional protections that normally exist under an attorney-client relationship. For more information, please visit our Disclosures webpage.

The determination to use a third-party compliance services provider is an important decision and should not be based solely upon advertisements or self-proclaimed expertise. A description or indication of limitation of our compliance services does not mean that an agency or board has certified RCC as a specialist or expert in investment advisor compliance. All potential clients are urged to make their own independent investigation and evaluation of RCC.

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