Advisers Act Regulatory Series

Transcription

1 Clifford Kirsch, Michael Koffler, Issa Hanna and Ben Marzouk January 26, 2017 Advisers Act Regulatory Series A Look at the Year Ahead All Rights Reserved. This communication is for general informational purposes only and is not intended to constitute legal advice or a recommended course of action in any given situation. This communication is not intended to be, and should not be, relied upon by the recipient in making decisions of a legal nature with respect to the issues discussed herein. The recipient is encouraged to consult independent counsel before making any decisions or taking any action concerning the matters in this communication. This communication does not create an attorney-client relationship between Sutherland and the recipient.

2 Speakers Clifford Kirsch New York, NY Michael Koffler New York, NY Issa Hanna New York, NY Ben Marzouk Washington, DC

3 Today s Discussion Points Performance advertising recent enforcement activity Disclosing material conflicts in the aftermath of Robare SEC exam priorities for 2017 A look ahead - Amendments to Form ADV - Proposed AML Program Requirements for Investment Advisers - Implementation of Business Continuity Plans - New SEC Commission Priorities 3

4 Performance Advertising Recent Enforcement Activity Recent flurry of enforcement activity in this area is fallout from the F-Squared Investments case A brief refresher on the F-Squared case - Firm s advertising presented hypothetical, back-tested performance as actual performance - The back-tested performance was inflated by 350% compared to the actual performance of the strategy - Settled in December 2014 for $35 million 4

5 Performance Advertising Recent Enforcement Activity The fallout from the F-Squared case - Fourteen firms have now been sanctioned by the SEC for repeating F-Squared s false claims Recommended F-Squared s strategy to clients Advertised F-Squared s performance claims without verifying them - Through their own advertisements or advertisements prepared by F-Squared Additional enforcement actions are likely Key takeaways - Must have a reasonable basis to believe performance claims of another adviser are accurate before publishing treat them as your own claims - What is a reasonable basis in the eyes of SEC examiners? Certain staffers have indicated in conversations that advisers can establish reasonable basis through maintenance of copies of Global Investment Performance Standards (GIPS) performance examination reports of composites 5

6 GIPS Verification & Performance Examinations GIPS Firm Verification - Scope and purpose is to assess whether: a firm has complied with all the composite construction requirements of GIPS on a firm-wide basis; and the firm s policies and procedures are designed to calculate and present performance in compliance with GIPS - Does not ensure the accuracy of any specific composite presentation 6

7 GIPS Verification & Performance Examinations GIPS Performance Examinations - A firm may choose to also have performance examinations of specific composite presentations - May only be performed either concurrently with, or subsequent to the completion of, a GIPS firm verification - Verification and performance examination must be performed by the same verification firm - A performance examination is not required for a firm to be verified 7

8 GIPS Verification & Performance Examinations GIPS Performance Examinations - A performance examination is the detailed testing of a specific composite and its associated presentation by an independent verification firm for a specific period - A performance examination tests, for a specific composite, whether the firm has: Constructed the composite and calculated the composite performance in compliance with GIPS; and Prepared and presented the composite presentation in compliance with GIPS 8

9 Disclosing material conflicts in the aftermath of Robare Summary of case - The Robare Group ( RG ) received shareholder servicing fees from its custodian - Form ADV disclosed: IARs may receive selling compensation when acting as RRs of a BD for facilitating transactions not accurate The arrangements may create a conflict of interest - RG utilized independent compliance consultants - Factual record - RG did not make recommendations based on payments received from custodian - RG did not know which funds triggered payments - No economic harm to clients 9

10 Disclosing material conflicts in the aftermath of Robare The SEC Staff s Position - An investment adviser s material conflicts of interest must be disclosed to clients - All conflicts of interest are material and must be disclosed - RG did not adequately disclose the conflict of interest that arose from the arrangement with the custodian - RG violated Section 206 of the Advisers Act 10

11 Disclosing material conflicts in the aftermath of Robare Robare Group s Arguments - RG disclosed payments under the arrangement as 12b-1 fees - The custodial agreement disclosed that the custodian may pay the advisor for back-office, administrative, custodial support and clerical services and that these payments may create an incentive for your advisor to favor certain types of investments over others - RG did not know which funds would generate payments - RG asserted reliance on advice from independent consultants for compliance with its disclosure requirements - RG made efforts to update its disclosures over time - The amounts at issue were a small part of its income 11

12 Disclosing material conflicts in the aftermath of Robare The ALJ decision - The payments made under the arrangement created a material conflict of interest - RG failed to adequately disclose payments made under the arrangement to its clients - However, RG did not act with scienter or negligence - The ALJ dismissed the proceeding - The Division of Enforcement appealed the ALJ decision 12

13 Disclosing material conflicts in the aftermath of Robare The SEC s Decision - Payments under the arrangement involved material conflicts of interest and needed to be disclosed to clients Economic conflicts of interest are material and must be disclosed The percent or absolute amount of compensation is not determinative of materiality - RG did not adequately disclose the conflict of interest that arose from the arrangement with the custodian 13

14 Disclosing material conflicts in the aftermath of Robare - RG failed to exercise reasonable care and acted negligently in failing to disclose the conflicts RG failed to use degree of care a reasonably careful person would use Its reliance on compliance consultants did not satisfy the prongs of any reliance on consultant defense Any reliance on the consultants that occurred did not negate a finding of negligence because any such reliance was unreasonable under the circumstances - RG violated Sections 206(2) and 207 of the Advisers Act - Second-tier penalties of $150,000 (among firm and the 2 principals) - Commissioner Piwowar concurred with decision, but not with the imposition of civil penalties 14

15 Disclosing material conflicts in the aftermath of Robare Key Takeaways All conflicts of interest (including potential conflicts) are material and must be disclosed Disclosing that you may receive compensation is insufficient if you do in fact receive compensation/have an arrangement to receive such compensation The percentage or amount of compensation does not determine materiality Reliance on compliance consultants may (or not) be a defense to a claim of negligence under Section 206 if all of the factors are satisfied the door is open A lack of economic harm to clients does not mean there was not legal harm to clients 15

16 Highlights of SEC exam priorities for 2017 Automated Investment Advice Multi-Branch Offices Senior Investors Wrap Fee Programs 16

17 Highlights of SEC exam priorities for 2017 Automated Investment Advice - Compliance programs - Marketing - Formulating investment recommendations - Data protection - Oversight of algorithms - Disclosure of material conflicts of interest 17

18 Highlights of SEC exam priorities for 2017 Automated Investment Advice - Rule 3a-4 under Investment Company Act Safe harbor from investment company status for discretionary managed accounts so long as client receives personalized treatment and no pooling of assets Manage client account in accordance with any reasonable restriction client may impose - Challenges of satisfying the 3a-4 safe harbor Pooling investors based on questionnaire responses into high, medium and low -risk funds Sufficiently personalized treatment Allow clients to impose reasonable restriction - Threading the needle between Advisers Act and Investment Company Act 18

19 Highlights of SEC exam priorities for 2017 Automated Investment Advice - Recent regulatory scrutiny SEC Investor Alert: Automated Investment Tools (May 2015) FINRA Report on Digital Investment Advice (March 2016) Massachusetts Securities Division, Policy Statement: State Registered Investment Advisers Use of Third-Party Robo- Advisers (July 2016) - Satisfy fiduciary duty - Disclaiming responsibility to act in client s best interest - Minimum disclosure requirements SEC FinTech Forum (November 2016) 19

20 Highlights of SEC exam priorities for 2017 Multi-Branch Offices - IAs providing advisory services from multiple locations - Designing program that sufficiently supervises advisory services provided at all branch offices - SEC Risk Alert (December 2016) OCIE initiative examining compliance programs oversight of remote branch locations Investment recommendations Calculation of fees and expenses Advertisement review 20

21 Highlights of SEC exam priorities for 2017 Senior investors - Supervising advisory services provided to senior investors - Identifying financial exploitation - SEC Risk Alert (June 2015) ReTIRE Initiative Focus on advice provided to retirement accounts 21

22 Highlights of SEC exam priorities for 2017 Additional exam priorities - Wrap fee programs Disclosure consistent with practices Best execution consistent with stepping out Document appropriately and develop policies and procedures regarding step out trades SEC s recent enforcement actions - Risk-based examinations of newly registered advisers - Examination of at-risk representatives - Conflicts of interest involving share class selection - Advisers to private funds 22

23 A look ahead Amendments to Form ADV Proposed AML Program Requirements for Investment Advisers Business Continuity Plans New SEC Commission Priorities 23

24 Amendments to Form ADV Purpose of the changes - SEC examiners have finite resources - The SEC believes the new information they will collect will promote a strategic and risk-based approach to examinations Compliance date - Must file the newly amended form with your first amendment after October 1, For advisers with a December 31 fiscal year end, this means the first affected filing likely will be the March 2018 filing 24

25 Amendments to Form ADV Overview of the changes - Granular reporting regarding types of clients and regulatory assets under management (RAUM) attributable to each - Details regarding separately managed accounts - Additional identifying and background information - Codification of the umbrella registration scheme for private fund advisers 25

26 Proposed AML Program Requirements for Investment Advisers Overview of the proposed rule - Adds investment advisers to the general definition of financial institution for purposes of the BSA - Requires investment advisers to have risk-based AML programs - Requires investment advisers to file reports and maintain other records: File suspicious activity report (SAR) within 30 days for transactions involving $5,000 or more Replaces the requirement to file Form 8300 with the requirement to file a currency transaction report - Does not require a customer identification program - Delegates examination of investment advisers AML compliance to the SEC 26

27 Proposed Rulemaking BCP Purpose of the changes - Mitigate effects or minimize risks associated with natural disasters, cyber-attacks, acts of terrorism, technology failures, or the departure of key personnel - Proposed new rule 206(4)-4 would make it unlawful for an SECregistered investment adviser to provide investment advice unless the adviser adopts and implements a BCP and transition plan and conducts annual reviews - Proposed amendment to rule would require advisers to create and retain copies of all written BCPs and TPs that are in effect or were in effect at any time during the last five years, and keep records documenting annual reviews Status - Comment period ended September 6,

28 New SEC Commission Priorities New SEC Chair Uniform Standard of Care? Third-Party Audits? 28

29 Closing Clifford Kirsch New York, NY Michael Koffler New York, NY Issa Hanna New York, NY Ben Marzouk Washington, DC Save the date for the next program in our series: Thursday, April 27 29