All posts tagged SEC

Form ADV Part 2A Item 14.A requires advisers to disclose compensation from non-clients received for providing investment advisory services to clients, as well as resulting conflicts and how the adviser addresses such conflicts. Compensation can include situations where the investment adviser obtains some type of financial incentive for recommending certain investments to a client. These arrangements could potentially impair an investment adviser’s ability to provide impartial advice.

The Asset Management Unit of the SEC has undertaken an enforcement initiative to shed more light on undisclosed compensation arrangements between investment advisers and brokers. For instance, on September 2, 2014, the SEC instituted administrative proceedings against an investment adviser, The Robare Group, Ltd., and its founders.

According to the SEC’s order, Robare Group committed fraud when it failed to disclose to clients that it was party to a compensation agreement with a broker-dealer that entitled Robare Group to a percentage of every dollar its clients invested in certain mutual funds offered by the broker-dealer. The SEC charged that this arrangement was not adequately disclosed to investors. For a number of years, Robare Group completely failed to disclose the arrangement on its ADV. Even though Robare Group eventually revised its ADV to disclose the arrangement, they failed to properly identify the potential conflicts of interest created by the arrangement. Moreover, the SEC took issue with way Robare Group described the arrangement. Robare Group disclosed that it “may” receive compensation from the broker when it was already receiving payments.

This should be an important lesson to investment advisers. Given the SEC’s recent emphasis on the subject, investment advisers should carefully scrutinize the way it discloses economic benefits to clients to make sure the disclosure is accurate and complete.

If you need assistance or have questions about disclosure of economic benefits, the Investment Advisor Rep Syndicate has experience with various investment advisor compliance issues.

The SEC has approved FINRA Rule 2081 that would disallow brokers from conditioning settlement of a customer dispute on a customer’s consent to the broker’s request for expungment from the Central Registration Depository (“CRD”). The CRD is the licensing and registration system used by all registered securities professionals. The system enables public access to information regarding the administrative and disciplinary history of registered personnel, including customer complaints, arbitration claims, court filings, criminal matters and any related judgments or awards. Because of the open nature of information available to its investors, registered professionals would like sensitive matters, such as customer complaints, expunged from the record.

The purpose of Rule 2081 is to make sure that full and reliable customer dispute data remains available to the public, brokerage firms, and regulators to prevent concealment by prohibiting the use of expungement as a bargaining chip to settle disputes with a customer. Furthermore, it allows regulators to make informed licensing decisions about brokers and dealers and improve FINRA’s transparency on broker-dealer complaint histories. This prohibition applies to both written and oral agreements and to agreements entered into during the course of settlement negotiations, as well as to any agreements entered into separate from such negotiations. The rule also precludes such agreements even if the customer offers not to oppose expungement as part of negotiating a settlement agreement and applies to any settlements involving customer disputes, not only to those related to arbitration claims.

On one hand, Rule 2018 will make it more difficult for brokers to sanitize their CRD report from a past claim, ensuring that future investors can more accurately assess the quality and integrity of a registered securities professional, ensuring protection from potential fraud and abuse.  On the other hand, settlements are a significant part of resolving FINRA claims in a timely manner.  If more FINRA claims reached arbitration, then the average FINRA claim would take substantially longer to adjudicate.  Ultimately, Rule 2081 could dissuade broker-dealers from settlement prior to arbitration because they may want to take their chances in arbitration, making an already potentially slow moving process, slower.

When investigating historical use of expungement in arbitration, pursuant to SEC Release No. 34-72649, the SEC found “despite the very narrow permissible grounds and procedural protections designed to assure expungement is an extraordinary remedy…, arbitrators appear to grant expungement relief in a very high percentage of settled cases.” In order to even seek expungement, FINRA Rule 2080 requires a showing that (1) the claim, allegation or information is factually impossible or clearly erroneous; (2) the registered person was not involved in the alleged investment-related sales practice violation, forgery, theft, misappropriation or conversion of funds; or (3) the claim, allegation or information is false.

In approving Rule 2081, however, the SEC cautioned FINRA that the new rule should not be the last word on the subject of expungement and that FINRA should continue to consider making improvements to the expungement process. In this regard, even though “the proposed rule change is a constructive step to help assure that the expungement of customer dispute information is an extraordinary remedy that is permitted only in the appropriate narrow circumstances contemplated by FINRA rules,” the SEC nonetheless remains concerned about “the high number of cases where arbitrators grant brokers’ expungement requests.” SEC Release No. 34-72649

Official rule language:

2081. Prohibited Conditions Relating to Expungement of Customer Dispute Information.

No member or associated person shall condition or seek to condition settlement of a dispute with a customer on, or to otherwise compensate the customer for, the customer’s agreement to consent to, or not to oppose, the member’s or associated person’s request to expunge such customer dispute information from the CRD system. See Regulatory Notice 14-31.

Cosgrove Law Group, LLC has experience with financial industry disputes including representing investors in recouping their losses and registered representatives seeking expungement. We also provide training, information, and compliance for registered professionals through the Investment Adviser Rep Syndicate .

Authored by Mercedes Hansen

Social media such as Facebook, Twitter, LinkedIn, or blogs have become popular mechanisms for companies to communicate with the public. Social media allows companies to communicate with clients and prospective clients, market their services, educate the public about their products, and recruit employees. Social media converts a static medium, such as a website, where viewers passively receive content, into a medium where users actively create content. However, this type of interaction poses certain risks for investment advisers and this topic has been a hot button for securities regulators.

The SEC previously issued a National Examination Risk Alert on investment adviser use of social media. As a registered investment adviser, use of social media by a firm and/or related persons of a firm must comply with applicable provisions of the federal securities laws, including the laws and regulations under the Investment Advisers Act of 1940 (“Advisers Act”). The Risk Alert noted that the various laws and regulations most affected by social media are anti-fraud provision, including advertising, compliance provisions, and recordkeeping provisions. Advisers Act Rule 206(4)-7 requires firms to create and implement social media policies, and periodically review the policy’s effectiveness.

Anti-fraud provisions with respect to advertising are probably most affected by the use of social media. All social media use and communications must comply with Rule 206(4)-1. While advertising policies should already be included in a firm’s compliance manual, such policies may not be sufficient enough to address some of the concerns with advertising in the context of social media. Establishing a specific policy to address social media may be prudent.

The area of advertising that has caused the most confusion is the prohibition on the use of testimonials. The SEC has previously defined testimonial to include a statement of a client’s experience with, or endorsement of, any investment adviser. Firms and IARs must ensure that third-party comments on their social media sites do not constitute a testimonial. Furthermore, the SEC vaguely discussed whether the popular “like” function on many social media sites would be deemed a testimonial:

“[T]he staff believes that, depending on the facts and circumstances, the use of “social plug-ins” such as the “like” button could be a testimonial under the Advisers Act. Third-party use of the “like” feature on an investment adviser’s social media site 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 IAR. If, for example, the public is invited to “like” an IAR’s biography posted on a social media site, that election could be viewed as a type of testimonial prohibited by rule 206(4)-1(a)(1).”

The types of policies that firms must create concerning advertising and testimonials depend greatly on the function of a specific website. For instance, approving the firm or IARs use of certain websites may turn on whether that website allows for review and approval of third-party comments before such comments are posted on the site or whether the “like” function can be disabled. A firm’s monitoring capabilities and the latitude it wants to provide employees with respect to personal use of social media cannot be ignored either.

The SEC has outlined various factors that should be considered by an investment adviser when evaluating the effective of their compliance program. These factors are:

  • Usage and content guidelines and restrictions on IAR use of social media whether on behalf of the firm or for personal use;
  • Mechanisms for approval of social media use and content;
  • Monitoring of social media use by the firm and IARs and the frequency of monitoring;
  • Consideration of the function or risk exposure of specific social media sites;
  • Establishing training and requiring IAR certification;
  • Whether access to social media poses information security risks; and
  • Firm resources that can be dedicated to implementation of social media policies.

There are various considerations firms must take into account when establishing social media policies or evaluating the effectiveness of its existing policies. If your firm needs assistance, the Investment Adviser Rep Syndicate can assist with creation or review of such policies.

          Too many small and mid-size investment advisory firms fail to adequately self-audit.  There – I said it.  Do you agree with me?

         There was much debate and wrangling over the SEC to state regulatory transition prompted by the Dodd-Frank Act.  The state regulators vowed that they had the capacity to regulate and audit the over 3,000 mid-sized RIA’s that came under their purview with the increase in the SEC AUM threshold.  And they have been living up to their vow.  As such, small to mid-size independent RIA’s are more likely to be subjected to a routine exam.  In just the first six months of 2013, state regulators conducted over 1,000 audits, finding over 6,000 deficiencies.  In my experience, the vast majority of these firms fail to retain outside legal counsel for routine guidance, to assist with self-audits, or to step in quickly when the regulators arrive at the front door.

         A couple of years back, my law firm represented an investment advisor representative whose small satellite office was subjected to a routine state exam.  The regulators found a myriad of problems a self-audit would have discovered.  Rather than accepting responsibility for the exam deficiencies, the RIA threw the representative under the bus and blasted him on his U-5.  An arbitration panel subsequently awarded our client almost $3.5 million.  Regular counsel and self-exams would have been a lot less expensive.

         Not long after that case, I served as an expert witness for an investor whose representative steered her towards unregistered securities purportedly backed by real estate in England.  The small RIA’s CCO couldn’t even define a security during the hearing.  A more robust audit program would have unveiled the representative’s arguably well-intentioned but utterly ignorant advice regarding the investment contracts.

         So my admittedly self-serving advice is this: if you are a small or mid-sized RIA, budget for consistent legal advice and self-exams.  Saving a buck on compliance isn’t even “penny wise”.