The Investment Advisor's Compliance Guide, 2nd Edition

Les Abromovitz

• Verlag: The National Underwriter Company
• Jahr: 2017
• ISBN:
  9781941627945
• Thema: Business
• Thema: Investments & Securities

Given the current activities of SEC and state securities regulators, as well as the changing business and communication landscapes, investment advisors today must keep current with developments affecting compliance at all levels and in all jurisdictions. The Investment Advisor's Compliance Guide, 2nd Edition delivers a concise yet comprehensive explanation of the rules and how they affect the work you do on a daily basis—no matter where you're registered. The completely enhanced and updated Investment Advisor's Compliance Guide, 2nd Edition, provides highly practical guidance covering all of today's compliance issues, including: •The DOL's new fiduciary rule •RIA advertising, including the use of client testimonials, credentials, and performance results •The use of today's top social media platforms •Client communications, including disclosures •Recent ethical decisions Designed to go far beyond basic compliance rules, The Investment Advisor's Compliance Guide, 2nd Edition, will also help advisors avoid compliance issues, deal with client complaints, and grow their business with the confidence that their actions are well suited to withstand the strictest scrutiny from clients and regulators alike. The expert author, Les Abromovitz, J.D., has extensive experience handling compliance consulting assignments for Registered Investment Advisers (RIAs). In The Investment Advisor's Compliance Guide, 2nd Edition, he has created a completely up-to-date, reader-friendly, go-to-resource for investment advisors, vital for veterans but also a powerful training tool for those new to the field..

Chapter 1

Regulatory Oversight of Investment Advisors

It is an interesting and challenging time to be a Registered Investment Advisor (RIA). According to an article in The Wall Street Journal published on October 20, 2016, the number of RIAs has grown over the past two years to 12,000.¹ Although the SEC is allocating more examiners to oversee investment advisors, the ranks of RIAs has climbed 17 percent over the past two years. The SEC is considering whether to have third parties conduct examinations of RIAs instead of firms being examined by teams dispatched from the SEC’s Office of Compliance Inspections and Examinations (OCIE).²

The Wall Street Journal article observed that RIAs will manage more than $70 trillion of assets by the end of this fiscal year, which is up from $28 trillion ten years ago. Marc Wyatt, director of the OCIE, said the SEC is allocating more resources to keep up with the growing number of RIAs. Some experts believe that more financial advisors will migrate from broker-dealers to RIA channels because of the Department of Labor’s new Fiduciary Rule.

In The Wall Street Journal on November 1, 2016, Jean Eaglesham reported that the SEC has failed to examine thousands of the money managers it oversees, even though the Commission’s annual spending has doubled to roughly $315 million in fiscal year 2016.³ A sizeable number of RIAs have never undergone an on-site examination, even though former SEC chair, Mary Jo White, called inspections the greatest protection her agency can offer to retail investors. Wyatt said that the number of exams of RIAs increased by one-fifth in the year ending September 30. He also took note of the SEC’s specific initiatives to address high-risk conduct by newly-registered advisors and those never examined previously. About 500 RIAs become SEC-registered every year.

Although state securities regulators oversee more RIAs since the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) in 2010, they might not have the money to hire enough examiners. Some states are wrestling with drops in tax revenue and large budget shortfalls. Therefore, state securities agencies may not receive the funds needed to enforce rules and regulations that apply to RIAs. In some states, regulatory oversight is not a high priority.

Eaglesham observed that there are sharp differences in efficiency, expertise, and procedures across the SEC’s twelve offices. Each RIA examiner reviewed an average of 4.6 firms in fiscal 2015, which was almost double the 2.4 average of the slowest office. Red flags sometimes go undetected, especially among the smaller SEC-registered firms.⁴

Whether a firm is regulated by the SEC or state securities regulators, it is imperative that RIAs adhere to their compliance obligations. To ensure compliance, RIAs and Investment Advisor Representatives (IARs) must fully understand what those obligations are. To that end, it is important to explain some of the basics.

For instance, Registered Investment Advisor or “RIA” refers to the firm, not the individual. Quite often, financial professionals will incorrectly refer to themselves as “registered investment advisors,” which is the term that describes the firm itself. An “IAR” is the individual who is actually giving the advice. Adding to the confusion, the term “Investment Advisor” might apply to either the firm or the individual. As we will see in Chapter 24, advisors should not use the initials, RIA, or IAR, after their names. Securities regulators take the position that investors will mistakenly believe those initials are a designation earned by the investment advisor, which is not the case.

Often, this book will use RIA to describe any advisory firm registered with either the SEC or state securities regulators. In this book, “investment advisor” is spelled with an “or,” not an “er.” Nevertheless, the key statute governing RIAs is the Investment Advisers Act of 1940. When referring to the act itself or a rule that interprets this law, “advisor” will be spelled with an “er” as it appears in the legislation, speech, article, or quote. Therefore, you might see “advisor” spelled as “adviser” in the same sentence.

Though the Investment Advisers Act was passed in 1940, it has withstood the test of time. According to a white paper from the Morgan Lewis law firm published in October 2016, the “Advisers Act is a flexible and technologically neutral regulatory regime that has accommodated technological change, innovation in products and services, and evolving business models.”⁵ The decades-old statute, along with new rules and regulatory guidance, must now deal with emerging compliance issues such as robo-advisors, cybersecurity, cloud-based books and records, and social media.

The rules enacted since the statute was passed implement and interpret the Investment Advisers Act. The language in a statute usually provides a broad framework for the act, and rules help to clarify what Congress’ intent was in passing the law. For example, the SEC passed rules to clarify Section 206 of the Investment Advisers Act. Rule 206(4)-1, the Advertising Rule, delineates what types of advertisements are prohibited. Rule 206(4)-2 spells out an RIA’s obligations when the firm takes custody of a client’s funds or securities. These rules, and several others, bring clarity to an RIA’s obligations arising from Section 206.

Impact of the Dodd-Frank Act on RIAs

The regulatory climate for RIAs was significantly impacted by the Dodd-Frank Act, which was signed into law on July 21, 2010. The threshold for SEC jurisdiction over RIAs was increased to $100 million in regulatory assets under management.

Subject to certain exceptions, RIAs with regulatory assets under management of less than $100 million are regulated by the states. Each state imposes different registration requirements on an RIA that conducts business there. As a result, an RIA may be required to register in many different states. Because these registration requirements may be unduly burdensome, the Dodd-Frank Act provided relief to an RIA that must register in at least fifteen states. A firm meeting that description has the option of being registered with the SEC. The SEC has retained jurisdiction over the so-called mid-sized investment advisors in New York, since that state does not conduct examinations of RIAs. The Commission also oversees all investment advisors in Wyoming.

The Dodd-Frank Act did not resolve the issue of whether all financial services professionals should be held to a fiduciary standard. The law authorized the SEC to impose a fiduciary duty on registered representatives who provide investment advice to clients. Although the SEC recommended that broker-dealers be subject to the same fiduciary standard as RIAs, it is not certain that this harmonization of regulation will occur anytime soon. With the election of President Trump, experts have predicted that the SEC will not enact a uniform fiduciary standard for brokers and IARs. For now, brokers, IARs and certain financial professionals are subject to the Department of Labor’s Fiduciary Rule when they make recommendations relating to an investor’s qualified retirement savings plan. This is separate and distinct from any fiduciary rule promulgated by the SEC.

As a result of the Dodd-Frank Act, the definition of “qualified client” described in Rule 205-3 under the Investment Advisers Act was changed. Effective on September 19, 2011, the SEC issued an order raising two of the three thresholds that determine whether an RIA is permitted to charge its clients performance fees. As we will see in Chapter 14, an investment advisor registered with the SEC may not charge incentive or performance-based fees unless the person is a qualified client. State-registered investment advisors may face different restrictions if they intend to charge performance fees. The threshold was adjusted for inflation on June 14, 2016.⁶ The accredited investor definition is also likely to be expanded. That definition determines which investors are permitted to participate in private placements.

The Dodd-Frank Act gave the SEC the authority to pay financial rewards to whistleblowers that provide new and timely information about securities law violations. Among the many eligibility requirements, the whistleblower’s information must lead to a successful SEC enforcement action resulting in more than $1 million in monetary sanctions.

Publicly Available Information for Investors

The goal of regulatory reform is to protect investors. The Investment Adviser Public Disclosure (IAPD) website enables investors to electronically access information regarding firms, as well as the individuals working for RIAs. The online system is connected to FINRA’s BrokerCheck^® database, which discloses registered representatives’ disciplinary record.

Investors can visit the IAPD website to obtain a great deal of information regarding IARs and the firms for whom they work. The IAPD website offers this advice to investors:

You can search for an Investment Adviser firm on this website and view the registration or reporting form (“Form ADV”) that the adviser filed. This website will also search FINRA’s BrokerCheck system and indicate whether an entity is a Brokerage firm. Investment advisers file Form ADV to register with the SEC and/or the states. Some advisers that do not have to register with the SEC or the states (“Exempt Reporting Advisers”) must nonetheless complete some of the questions in Form ADV for purposes of reporting to the SEC and/or the states. Form ADV contains information about an investment adviser and its business operations. Additionally, it contains disclosure about certain disciplinary events involving the adviser and its key personnel.

You can also search for an individual investment adviser representative and view that individual’s professional background and conduct, including current registrations, employment history, and disclosures about certain disciplinary events involving the individual. The information about investment adviser representatives that appears on this website is collected from individual Investment Adviser Representatives, Investment Adviser firm(s), and/or securities regulator(s) as part of the securities industry’s registration and licensing process. Individuals that are Registered Representatives of a Brokerage firm that are listed in FINRA’s BrokerCheck system will also appear in search results.⁷

Because of the IAPD website and a wealth of additional online information, investors can easily conduct due diligence of the RIAs and IARs they wish to engage. Accordingly, it is imperative that RIAs and IARs play by the rules and keep their reputations intact.

Definition of an Investment Advisor

Section 202 of the Investment Advisers Act defines an investment advisor as:

any person who, for compensation, engages in the business of advising others, either directly or through publications or writings, as to the value of securities or as to the advisability of investing in, purchasing, or selling securities, or who, for compensation and as part of a regular business, issues or promulgates analyses or reports ...