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Tuesday, July 24, 2012

FSI CEO Responds to DOL Letter on Study to Expand Definition of Fiduciary under ERISA

Dale Brown, President and CEO of the Financial Services Institute (“FSI”), wrote a letter to Representative John Kline, (R – MN) Chairman of the U.S. House Education and Workforce Committee and to ranking member George Miller, (D – CA) in response to comments made by Phyllis Borzi, Assistant Secretary of the Department of Labor, (“DOL”) in a letter to the same members of the Committee. Borzi told the ranking members she was disappointed with the lack of participation in the DOL’s request for data as part of its “effort to expand the definition of fiduciary under the Employee Retirement Income Security Act of 1974 (“ERISA”).”In Brown’s letter he is critical of DOL Assistant Secretary Borzi for what he calls an impractical request.

In December 2011, the DOL sent to broker-dealers and investment advisers a request for “data on every investment, every investor, and every recommendation in every context (IRAs, plans, and regular retail accounts) for the last 10 years within the next 30 days.” The request was made in mid-December,during the holiday season when many were not at full staff and as Brown states “the request came at a particularly demanding time for our members because they were dealing with year-end reporting, ongoing compliance requirements, new regulatory mandates and their securities regulators.”

Brown also criticized Borzi and the DOL because of the substance of the request. Neither broker-dealers nor investment advisers are required to maintain the type of business records requested for that long.  Brown asserts that it was unreasonable for the DOL to expect member firms to compile this amount of information in such a short time and at such a high expense. “Even if a member firm had the resources to expend, it could not possibly have been completed in 30 days.”According to Brown, FSI and its members did their best to accommodate the DOL’s request. In its effort to aid the DOL, FSI provided the DOL with its Broker-Dealer Financial Performance Studies from 2009-2011 and to date has not received any reply communication from the DOL regarding that submission.

Another criticism from Brown is the lack of coordination between the DOL and the U.S. Securities and Exchange Commission (“SEC”). The SEC is currently working on a parallel project involving fiduciary duties that is a part of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank). But according to Brown there has not been coordination between the two government organizations. “Thus far, the DOL has shown little to no interest in engaging in joint data requests or coordinated rulemaking (with the SEC).”

Stay up to date on news regarding rules and regulations with RIA Compliance Consultants.

Friday, July 20, 2012

Investment Advisers Should Consider Form U4 Obligations when Developing Written Supervisory Procedures

When a registered investment adviser is developing its ongoing compliance program, the investment adviser should develop written policies and procedures regarding the filing, retention and administration of an investment adviser representative’s Form U4.

The Form U4 Uniform Application for Securities Industry Registration or Transfer is used to register representatives of investment advisers, broker-dealers, or issuers of securities in the applicable jurisdiction and with the applicable self-regulatory organization (“SRO”). Investment advisers are required by most regulatory jurisdictions to license the investment advisers’ representatives through submission and approval of the Form U4. Investment advisers are also responsible for ensuring that any information supplied by the investment adviser representative is accurately and completely represented. Any information that is provided on an investment adviser representative’s Form U4 that is misleading, inaccurate or omits material information may result in regulatory deficiencies for an investment adviser.

As part of an investment adviser’s ongoing compliance requirements, any information that changes or becomes inaccurate on an investment adviser representative’s Form U4 should be promptly amended. According to the General Instructions for Form U4 Uniform Application for Securities Industry Registration or Transfer “An individual is under a continuing obligation to amend and update information required by Form U4 as changes occur. Amendments must be filed electronically…by updating the appropriate section of Form U4. A copy, with original signatures, of the initial Form U4 and amendments to DRPs U4 [Disclosure Reporting Pages] must be retained by the filing firm and must be made available for inspection upon regulatory request.” Some common examples of events that may require amending an investment adviser representative’s Form U4 include: a change in home address; an outside business activity or change in employment; or certain disclosure reporting events (i.e., filing personal bankruptcy or compromise with creditors, a civil judicial action, a customer complaint, arbitration, or civil litigation, a judgment or lien, certain criminal actions, and certain regulatory actions).

In efforts to ensure an investment adviser is properly handling an investment adviser representative’s Form U4, an investment adviser should at a minimum ensure that its written supervisory policies and procedures address:

  • Retaining and upon request, making available for regulatory inspection, a copy of the signed initial Form U4 and a copy of each amendment to the Form U4.
  • Recording and retaining documentation of Form U4 amendments to show that changes to the Form U4 were filed in a prompt manner (within 30 days).
  • Ensuring that investment adviser representatives are fully aware and understand the information being represented on their Form U4 prior to signing the original copy and before signing and submitting any amendments that are made to the Form U4 thereafter.
  • Requiring each investment adviser representative to periodically review the representative’s current Form U4 to confirm that all information is current and accurate.

To help investment advisers further understand their responsibilities regarding the Form U4, RIA Compliance Consultants is hosting a webinar “Solutions and Answers to Form U4 and Form U5 Challenges,” on August 23, 2012, at 12:00 CDT. To register for this event, click here. If your investment adviser would like additional information on how RIA Compliance Consultants may assist your firm with services pertaining to the Form U4 and similar ongoing compliance requirements, contact your consultant if you are an existing client or click here to schedule a time to speak to one of our senior compliance consultants if you have not previously worked with RIA Compliance Consultants.

Tuesday, July 17, 2012

States Passing Privacy Laws that Conflict with FINRA and SEC Social Media Compliance Regulations

Keeping up on the new rules and regulations regarding social media use can be a difficult task for investment advisers and broker-dealers.  Recently, the U.S. Securities and Exchange Commission (“SEC”) and the Financial Industry Regulatory Authority (“FINRA”) have each issued alerts and notices to investment advisers and broker-dealers offering guidance on social media use.  The SEC issued an alert in January of this year and FINRA has issued Regulatory Notice 10-06 and Regulatory Notice 11-39; these alerts and notices generally require investment advisers and broker/dealers to monitor and archive any business communications their employees have with clients.  Now, many states and even the federal government have bills under consideration that would limit employers’ access to its employees’ social media accounts.  If these laws are passed they could make it even more difficult for investment advisers and broker-dealers to keep adequate records and ensure compliance with the social media rules and regulations.

Maryland was the first state to pass such legislation, protecting both existing and potential employees from being compelled or coerced to disclose user names and passwords for social media accounts such as LinkedIn, Facebook, and Twitter. The social media privacy law passed in Maryland states that “an employer may not request or require that an employee or applicant disclose any user name, password, or other means for accessing a personal account or service through an electronic communications device.”

Additionally, the Illinois legislature has passed similar legislation that is awaiting the governor’s signature. The proposed Illinois bill is similar to Maryland’s law, but in addition to the password and user name restrictions, the bill includes a broader provision that prohibits an employer from requesting “access in any manner to an employee’s or prospective employee’s account or profile on a social networking website.”

Legislators of several other states have introduced social media privacy bills. 

On the federal level, members of both houses of Congress have introduced the Password Protection Act of 2012 (Password Protection Act). One of the co-sponsors of the Password Protection Act, Senator Richard Blumenthal (D – CT) said he supports the bill because, “With few exceptions, employers do not have the need or the right to demand access to applicants’ private, password-protected information. This legislation, which I am proud to introduce, ensures that employees and job seekers are free from these invasive and intrusive practices.”

It appears that the primary purpose of the legislation proposed by the states is to protect the privacy rights of the employees, but it makes complying with SEC and FINRA guidance difficult for investment advisers and broker/dealers. The proposed laws limit an employer’s access to personal social media accounts; however, this creates a serious hurdle in complying with the SEC and FINRA regulatory requirements to supervise the use of social media if the investment adviser representative or broker uses their personal account for business purposes because their firms would be unable to monitor and archive the communication.

The SEC recommends that firms using social media should adopt, and review their policies and procedures periodically. “Firms should create usage guidelines on appropriate and inappropriate use of social media and should consider adopting policies and procedures to address conducting firm business on personal social media sites.” Additionally, investment advisers and broker/dealers have recordkeeping requirements that require certain communications made through social media sites to be retained.  Without access to the personal accounts, investment advisers and broker/dealers may not be able to properly monitor and retain records from these communications.  

Stay tuned for RIA Compliance Consultants for further updates on social media compliance for investment advisers.

Monday, July 16, 2012

New Suitability Rule for Broker-Dealers is Similar to Fiduciary Duty of Investment Advisers

There has been a lot of discussion over the last year on the different standards for broker-dealers and investment advisers. Under current regulatory requirements, broker-dealers do not have a fiduciary duty to their clients. Broker-dealers must abide by the anti-fraud provisions of the Securities Act of 1933 (“Securities Act”) and the Securities Exchange Act of 1934 (“Exchange Act”) and must follow rules instituted by exchanges they are members of and the rules of the Financial Industry Regulatory Authority (“FINRA”). Investment advisers are largely governed by the Investment Advisers Act of 1940 (“Investment Advisers Act”), rules promulgated under the Investment Advisers Act, and state laws. Pursuant to the Investment Advisers Act, investment advisers have a fiduciary duty to their clients. Having a fiduciary duty to clients means that by regulation investment advisers are held to a higher standard than the standard that applies to broker-dealers. A study conducted by the U.S. Securities and Exchange Commission (“SEC”) in 2011 found that the average investor did not understand the difference between a broker-dealer and an investment adviser.

A new rule that took effect Monday, July 9th for broker-dealers looks similar to a fiduciary standard. Ron Rhodes, professor of law, Certified Financial Planner (“CFP”) and a scholar on the subject, recently explained that FINRA Rule 2111 imposes a duty of care on broker-dealers but falls short of imposing a duty of loyalty. The FINRA Rule creates a new suitability standard for broker-dealers: recommendations should be made in the “best interests” of their clients. In order for recommendations to be in the best interest of clients a broker-dealer or associated person needs to reasonably gather information from the client before then making a recommendation that fits the investor’s circumstances. Broker-dealers have a due diligence obligation to conduct reasonable basis suitability, customer-specific suitability, and quantitative suitability.

The “best interest” suitability standard is similar to an investment adviser’s fiduciary duties. “The suitability requirement that a broker-dealer make only those recommendations that are consistent with the customer’s best interests prohibits a broker from placing his or her interests ahead of the customer’s interests.” Investment advisers in their fiduciary duty must act in the best interest of their client and disclose any conflicts of interest that may be present. According to Rhodes, one major difference is that investment advisers acting in their fiduciary duty must select or recommend the best product while broker-dealers must select a product that meets the suitability requirements.

 Following the approval of the rule by the SEC in 2010, FINRA issued Regulatory Notice 11-25 to offer guidance on the rule. Earlier this year FINRA came out with Regulatory Notice 12-25 that further clarified the rule. According to FINRA, the new rule “imposes broader obligations on firms and associated persons regarding recommendations of investment strategies involving a security or securities.” FINRA Rule 2111 “would cover a recommended investment strategy involving a security or securities regardless of whether the recommendation results in a securities transaction or even mentions a specific security or securities.”

 Rhodes believes that the biggest change for broker-dealers is the indication by FINRA that broker-dealers must document and support their investment strategies. As a result of FINRA Rule 2111, broker-dealers should document why they chose the strategy and why other strategies were rejected. Rhodes believes imposing this requirement to broker-dealer reps is effectively requiring service more akin to the ongoing monitoring and supervision/application of an investment strategy that provided by investment advisers.

FINRA Rule 2111 also broadens the investment traits that broker-dealers and associated persons must attempt to collect from clients before making a recommendation. Prior to the new rule, broker-dealers were required to gather information on other investments, financial situation and needs, tax status, and investment objectives. The additional traits included in FINRA Rule 2111 are customer’s age, investment experience, time horizon, liquidity needs and risk tolerance. Broker-dealers and investment advisers should make it a practice to obtain these traits in any due diligence investigation of a client prior to making recommendations. Furthermore, FINRA Rule 2111 broadens what is considered an investment strategy to include recommendations to “hold” a security or securities. The recommendation to hold must be an explicit one. An implicit recommendation to hold, for example by being silent, would not apply to FINRA Rule 2111.

Many broker-dealers are speculating that this new rule and the FINRA Regulatory Notices are signs that they will soon be held to the same fiduciary standard as their investment adviser counterparts. To keep up to date on any new rules or regulations, stay connected with RIA Compliance Consultants.

Wednesday, July 11, 2012

The Executive Compensation Clawback Full Enforcement Act

Barney Frank (D – MA) recently introduced a bill that would prohibit individuals working for financial institutions from insuring against possible losses, including from having to repay illegally-received compensation or from having to pay civil penalties. The Executive Compensation Clawback Full Enforcement Act (“the Act”) holds “officers, directors, employees or other institution related parties personally liable” and does not allow them to hedge against the personal liability with insurance.

It is our analysis that the Act would apply to limit the coverage available to investment advisers via errors and omissions (E&O) insurance coverage. The Act as proposed would apply to any “nonbank financial company who is required by a Federal financial regulatory law that provides for personal liability, or any rule or order promulgated by a Federal financial regulatory agency to repay previously earned compensation or pay a civil money penalty.” A nonbank financial company “means a company that is incorporated or organized under the laws of the United States or any state and predominantly engaged in financial activities”  and would include investment advisers.

E&O insurance protects professionals from various claims including negligence. Investment advisers are not required to carry E&O insurance but it is highly recommended that investment advisers carry E&O coverage. As we have previously discussed, E&O insurance covers settlements, judgments, and defense costs of investment advisers. The Act would prohibit the use of insurance to cover costs related to an individual’s violation of a federal law or regulation which holds the individual personally liable. The Act would not prohibit liability protection via insurance coverage for  violations of any law that does not contain provisions for personal liability.

The purpose of the bill according to the Financial Services Committee-Democrats is to “prevent circumventing provisions of federal law that are designed to hold individuals personally responsible when their actions negatively affect their financial firms.” The proposal in intended to prevent situations where individuals responsible for firm management could purchase insurance and make high risk decisions without facing any personal accountability. If passed, this bill removes that layer of protection and creates a built in deterrent for the individual.

The bill was introduced by Rep. Frank on May 30th. RIA Compliance Consultants will keep you up to date on the progress of this legislation.

Tuesday, July 10, 2012

SEC Guidance for Investment Adviser Due Diligence When Using Services Providers

Due diligence can be defined as the level of judgment and care a reasonable person would take before entering into an agreement or transaction.  As part of an effective compliance program investment advisers must conduct due diligence not only when selecting investments for clients but also when outsourcing services to third-party service providers.   The importance of outside service provider due diligence was discussed as an examination focus area by the  U.S. Securities and Exchange Commission (“SEC”) during their 2009 CCOutreach Regional Seminars.   During the seminar, the SEC noted that “advisers should review each service provider’s overall compliance program for compliance with the federal securities laws and should ensure that service providers are complying with the firm’s specific policies and procedures.”  During a routine examination,  SEC examiners will  “review an adviser’s disclosures, contracts with clients, and contracts with service providers to determine whether the services and reporting obligations are consistent with disclosures and that all obligations are adequately addressed and overseen by the adviser.”

The SEC went on to state that due diligence requires that investment advisers outsourcing services investigate and examine the service providers to ensure they are following securities laws and complying with their agreement.  Signs that an investment adviser is deficient in its due diligence include “failing to adopt or maintain policies and procedures relating to the firms’ use of service providers; inadequate oversight of services providers; and/or failing to disclose any affiliations and related conflicts of interest related to the use of a service provider.”

SEC examiners also look at whether “the investment adviser represents that the service provider is independent when, in fact, the firms are under common control or otherwise have a close connection that should be disclosed, the investment adviser periodically verifies that the fees deducted from client accounts are consistent with contractual terms, and if the investment adviser recommends other managers to clients, does the adviser have policies and procedures regarding researching and monitoring separate account managers and mutual funds.”

Due diligence should not be completed on a one-time basis, but investment advisers should regularly investigate and review their service providers. Some examples of due diligence the SEC has observed from investment advisers include:

  • Periodically reviewing the qualifications and oversight capabilities with respect to the specific services that the adviser has delegated to the service provider
  • Evaluating the effectiveness of the reports prepared by the service provider for the adviser and the appropriateness of the frequency with which the reports are produced
  • Ensuring that the service providers are performing all contracted functions
  • Verifying that its service providers are aware, compliant, and current with regard to the federal securities laws and firm policies and procedures
  • Making periodic on-site visits to the service provider’s facilities to view operations in action

If your firm has questions on how to meet its fiduciary duty to perform due diligence on third-party service providers, Jarrod James – Vice President and Senior Compliance Consultant with RIA Compliance Consultants, Inc. and Michael Forker – Compliance Consultant with RIA Compliance Consultants, Inc., will be presenting their webinar, “Conducting Service Provider Compliance Due Diligence,” on July 12, 2012, at 12:00pm CDT.   Please register online for the webinar or you can contact us to set up a time to speak with one of our compliance consultants.

Thursday, July 5, 2012

De-registration Looms for Mid-Sized Financial Advisers that Have Not Filed

Mid-sized investment adviser firms that did not register with one or more state securities regulators by the June 28, 2012, deadline are in danger of being de-registered by the U.S.  Securities and Exchange Commission (SEC) as early as this week.  However, the first wave of terminations may not occur until September according to a staff member from the SEC who spoke with one of our Senior Compliance Consultants earlier this year.  Investment advisers that did not file an amendment to Form ADV Part 1 confirming their registration status by the March 31, 2012, deadline and/or have not filed a state registration application, if no longer SEC eligible; face the highest risk for untimely termination.

The Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) requires most mid-sized investment adviser firms with between $25-100 million in assets under management to switch from registration with the SEC to state securities regulators. The deadline for mid-sized investment advisers to make the switch and register with states was June 28, 2012. The SEC staff member speculated that investment advisers that are making the switch and filed their annual amendment to Form ADV Part 1 and state registration applications but are waiting on state securities regulators should be okay as long as they promptly comply with any additional requirements of the state securities regulators.

Investment advisers that are de-registered by the SEC and not approved at the state level must immediately cease holding themselves out as investment advisers, cease providing investment advice and may not receive fees from clients.  Any fees accepted during the time while the investment adviser is not registered must be returned to the clients.

The SEC announced the transition period for mid-sized investmetn adviser firms to move from SEC to state registration last year and began sending personal reminders to investment advisers in April of this year.  For an investmet adviser that has not properly registered, it is our understanding that the SEC will send out notices informing the adviser that it has 20 to 30 days to take action before facing de-registration.  According to the North American Securities Administrators Association (“NASAA”), an estimated 3,200 investment adviser firms are making the switch from SEC to state registration.

You need to take immediate action if your investment adviser firm has not filed a required state registration.  RIA Compliance Consultants can help. RIA Compliance Consultants 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 adviser, please contact your consultant. If you are a new client that would like to speak with us regarding the services we can provide, please contact us to schedule a time to speak with one of our consultants.

Tuesday, July 3, 2012

Due Diligence of Broker-Dealers Often Overlooked by Investment Advisers

Due diligence needs to be an important component for any investment adviser compliance program.  As we discussed earlier, due diligence should not be limited to recommending investments, but must also be employed when recommending or using third party service providers.  In our opinion, one of the most important, if not the most important, outside service provider decisions made by investment advisers are the selection of a recommended broker/dealer.  In fact, many investment advisers require clients to use a particular broker/dealer.  However, far too many investment advisers fail to perform adequate due diligence on this important selection.  We hear from many investment advisers that they fully understand broker/dealer best execution reviews are expected, but are not completed because of reasons such as (1) the broker/dealer they work with is large and reputable, (2) the investment adviser only selects mutual funds so best execution doesn’t matter or (3) the differences between broker/dealers are so slight that due diligence is unnecessary.  Because of these reasons and others such as time and cost constraints, broker/dealer best execution reviews and due diligence is a matter often neglected by investment advisers.

Regardless of how valid the reasons not to conduct broker/dealer due diligence may be, the fact is outside service provider due diligence and broker/dealer best execution are issues regulators take seriously and remain a focus during routine examinations.  Investment advisers need to implement a system to conduct due diligence reviews of any third party hired to work on behalf of the firm, including broker-dealers.  Investment advisers cannot simply rely on information provided by the broker-dealer. Before using or recommending a broker-dealer to clients, an investment adviser must conduct an independent due diligence investigation to ensure, among other things, clients receive best execution of transactions.

At a minimum, we recommend investment advisers conduct a background check of the broker/dealer via the Financial Industry Regulatory Authority (“FINRA”) Broker Check, review publicly available information about the broker/dealer available on the internet, review the range and quality of services available, and review the reliability in executing trades and keeping records. While there are no set rules as to what an investment adviser must do to satisfy due diligence obligations, the presence of any “red flags” must alert it to the need for further inquiry.  As a fiduciary, providing a thorough investigation of broker/dealers used or recommended to clients is necessary for investment advisers.

Investment advisers also have the duty to investigate and obtain best execution of client transactions. The U.S. Securities and Exchange Commission (“SEC”) has communicated that best execution is not necessarily determined by the lowest possible transaction cost. Investment advisers must systematically and periodically evaluate the best execution practices of their broker/dealers to ensure that services meet their standards. Some of the criteria an investment adviser should consider are:

  • Trading expertise;
  • Execution capabilities;
  • Access to underwritten offerings and secondary markets;
  • Reliability in executing trades and keeping records;
  • The number of primary markets that will be checked; and
  • Timeliness of trade execution

Investment advisers should conduct a due diligence review of broker/dealers and best-execution before approving a broker/dealer and going forward at least annually if not more frequently. To demonstrate its due diligence an investment adviser should retain records documenting both the process and results of its investigation.

To learn more about performing due diligence on broker-dealers and best execution of client transactions sign up for RIA Compliance Consultants’ upcoming webinar “Conducting Service Provider Compliance Due Diligence Reviews.”  The webinar will be held on July 12, 2012, at 12 p.m. CDT.  RIA Compliance Consultants can assist you with establishing policies and procedures for your broker/dealer due diligence review or performing your review.  If you are an existing client of RIA Compliance Consultants interested in discussing how we can assist your investment adviser, please contact your consultant. If you are a new client that would like to speak with us regarding the services we can provide, please contact us to schedule a time to speak with one of our consultants.

Thursday, June 28, 2012

The Importance of Conducting Service Provider Due Diligence Review for Investment Advisers

Many investment advisers choose to engage third-party service providers to perform a number of important services for their firm and their advisory clients.  There are third-party service providers offering a number of important services to investment advisers.  Some of the services include client and portfolio management software systems, marketing of advisory services, referring clients to the investment adviser, calculating investment valuations, proxy voting, financial reporting, and maintaining required books and records.  However, when a service provider is utilized, the investment adviser still retains its fiduciary responsibilities for the delegated services.  As a result, investment advisers should develop strong compliance policies and procedures for performing due diligence when selecting and retaining third-party service providers.

While most investment advisers understand the due diligence process as it relates to recommending investments, many investment advisers neglect or cut corners when performing the due diligence process of third-party service providers. Establishing these relationships that will ultimately affect a client requires an investment adviser to have a system in place to conduct reviews to determine that the relationships are in the best interest of the clients and are in compliance with investment adviser regulations.  In fact, regulators have issued deficiencies to investment advisers that have failed to establish adequate due diligence policies and procedures even when no harm has been done to a client.

Investment advisers need to have in place a system to conduct a due diligence review of any third-party hired to work on behalf of or provide services on behalf of the investment adviser or to provide services to clients based on the recommendations of the investment adviser.  In order to implement and enforce a due diligence process, investment advisers should develop written policies and procedures outlining their due diligence process. An investment adviser’s due diligence policies and procedures should be designed to ensure that each third-party is properly investigated before an agreement is signed and the third-party does work on behalf of the investment adviser. The policies and procedures developed relating to the due diligence process should include documenting and retaining records related to the due diligence review.  Documentation should include the information gathered during the review process and well as the findings and results of the review.  It is important to develop a strong paper trail regarding the due diligence process so that when faced with a regulatory exam or investigation the investment adviser can demonstrate that a reasonable investigation was conducted  prior to establishing a relationship with any third-party.

It is also important to keep in mind that the due diligence review process is not a one-time process completed only at the time the initial relationship is established.  Ongoing due diligence is crucial and its absence creates a critical weakness in an investment adviser’s compliance program. Depending on the type of relationship and the services being provided by the third-party, quarterly or annual reviews should be conducted to examine any possible material changes that may be made to the third-party’s business practices and to re-evaluate factors analyzed during the initial due diligence review of the third-party.

If you would like more information regarding an investment adviser’s fiduciary duty to perform due diligence on third-party service providers, RIA Compliance Consultants is hosting a webinar, “Conducting Service Provider Compliance Due Diligence,” on July 12, 2012, at 12:00pm CDT.   During this webinar, our consultants will provide advice on what items should be covered during an investment adviser’s initial due diligence review and as well as what should be included in follow-up reviews.  Click here to register for this webinar.

RIA Compliance Consultants can help your investment adviser develop policies and procedures to implement a third-party service provide due diligence process.  If you would like to discuss how RIA Compliance Consultants can assist you, contact your consultant if you are an existing client or click here to schedule a time to speak with one of our consultants if you have not previously worked with RIA Compliance Consultants.

Thursday, June 21, 2012

State Registered Investment Advisers Should Expect Increase in Examinations After the Switch

As we have discussed in a previous newsletter article, investment advisers switching registration from the U.S. Securities and Exchange Commission (“SEC”) to state securities regulators are likely to see an increase in examinations. According to the North American Securities Administrators Association (“NASAA“), “firms switching to state regulation for the first time can expect thorough inspections generally on a more frequent basis than they may have experienced before.”

The switch is a result of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”). Under the law, investment advisers with between $25 and $100 million in assets under management are required to make the move to state regulation.  According to NASAA an estimated 3,200 investment adviser firms are making the switch.

Many investment advisers making the transition from federal to state registration may not have much experience with regulatory examinations. According to testimony earlier this year from SEC Chairman Mary Shapiro the SEC examined only about 8% of investment advisers in 2011.  She further testified that “about forty percent of registered investment advisers have never been examined.” State investment adviser examination numbers are drastically different.  John Morgan, Securities Commissioner for the State of Texas, recently testified that “a majority of states examine investment advisers at a rate that is on average at least once every four years.”

The testimony from these two securities regulators demonstrates a stark difference. Investment advisers making the switch from the SEC to state registration should familiarize themselves with state investment adviser regulations in preparation for the examinations.

All SEC registered investment advisers had until March 30, 2012, regardless of their firm’s fiscal year end, to file an amendment to their Form ADV Part 1 to report their reason for eligibility to remain SEC registered or to report that they are no longer eligible for SEC registration. If your investment adviser was subject to the filing requirements and has not filed, immediate action must be taken to comply.

All SEC registered investment advisers that report they are no longer eligible for SEC registration have until June 28, 2012, to file an ADV-W to withdraw their SEC registration. All SEC registered investment advisers that must withdraw their SEC registration and “switch” to the appropriate state securities registration will need to be approved by the appropriate state regulators no later than June 28, 2012.

Investment advisers switching to state registration need to make sure that their compliance programs are updated to comply with the applicable state investment adviser regulations.  RIA Compliance Consultants can help your firm update its compliance program or perform a mock regulatory review to test your firm’s readiness for a regulatory exam.  If you would like to discuss how RIA Compliance Consultants can assist you, please contact your consultant if you are an existing client or click here to schedule a time to speak with one of our consultants if you have not previously worked with RIA Compliance Consultants.

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