SEC Risk Alert – Electronic Messaging and 2019 Exam Priorities

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Introduction

The SEC’s Office of Compliance Inspections and Examinations (“OCIE”) just delivered a holiday and new year greeting to registered investment advisers … just in case the volatile markets were not enough to keep you on your toes!  On December 14th, OCIE issued a Risk Alert related to electronic messaging and on December 20th released its 2019 examination priorities. It may be the busiest time of the year, but when OCIE talks, it is worth listening!

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Risk Alert – Observations from Adviser Exams Relating to Electronic Messaging

On December 14, 2018, OCIE issued a Risk Alert to share the results of its limited-scope examination initiative of registered investment advisers. The initiative sought an understanding of enterprise and employee use of various forms of electronic messaging. The Risk Alert addresses the regulatory risks attendant to the use of electronic messaging and the challenges confronting advisers and their employees when complying with the Investment Advisers Act. OCIE was compelled to dig into electronic messaging after noticing the increased use of social media, texting, and other types of electronic messaging apps, and the pervasive use of mobile and personally owned devices for business purposes.

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SEC Risk Alert: Investment Adviser Compliance Issues Related to the Cash Solicitation Rule

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Risk Alert 

While we were busy handing out candy, the SEC was busy handing out advice! The Office of Compliance Inspections and Examinations (“OCIE”) issued a Risk Alert on October 31, 2018 to provide investment advisers, investors and other market participants with information concerning the most common deficiencies the staff has cited relating to Rule 206(4)-3 (the “Cash Solicitation Rule”) under the Investment Advisers Act of 1940 (the “Advisers Act”). The Risk Alert is intended to assist investment advisers in identifying potential issues and adopting and implementing effective compliance programs, and generally pertains to an adviser’s use of third-party solicitors that are subject to the broader requirements of the Cash Solicitation Rule.

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IM Information Update 2018-02   Statement Regarding Staff Proxy Advisory Letters

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Information Update 

On September 13, 2018, the SEC’s Division of Investment Management issued IM Information Update 2018-02 entitled “Statement Regarding Staff Proxy Advisory Letters.” The purpose of this Update is to notify advisers of its withdrawal of two 2004 no-action letters related to proxy voting. This Update follows the Commission’s July 2018 announcement of its plans to host a Roundtable with market participants (now scheduled for November 2018) to address proxy voting topics including the voting process, retail shareholder participation and the role of proxy advisory firms.

Over the past decade the SEC has consistently conveyed concern in public discourse and in adviser examinations regarding the growing reliance by advisers on proxy consultants. In 2010 the Commission sought public comment on the issue due to concern that the SEC’s own guidance permitted advisers to fulsomely rely upon the recommendations of proxy consultants. After reviewing this condition, the SEC has determined that over-reliance by advisers on proxy consultants may introduce a conflict of interest wherein the investment adviser fiduciary duty to provide objective investment advice is jeopardized.

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OCIE Risk Alert – Compliance Issues Related to Best Execution by Investment Advisers

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Introduction
On July 11, 2018, the SEC’s Office of Compliance Inspections and Examinations (“OCIE”) issued a Risk Alert addressing deficiencies observed in their recent examinations of investment advisers’ best execution practices. For years, advisers have been required to obtain and document best execution on behalf of client account, yet firms continue to struggle with sustainable and effective best execution policy and procedure, according to SEC staff.

The Investment Advisers Act of 1940 (“Advisers Act”) establishes a federal fiduciary standard for investment advisers. As a fiduciary with responsibility to select broker-dealers and execute client trades, the adviser has an obligation to seek “best execution” of client transactions, taking into consideration the circumstances of each particular transaction. An adviser must execute securities transactions for clients in such a manner that the client’s total costs or proceeds in each transaction are the most favorable under the circumstances. Read More

SEC Risk Alert – Frequent Fee and Expense Deficiencies in Adviser Exams

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April 12, 2018:  The SEC’s Office of Compliance Inspections and Examinations (“OCIE”) issued a Risk Alert to highlight recurrent deficiencies observed in their recent examinations of investment advisers’ policies and procedures governing client fee and expense assessments. The deficiencies were identified by OCIE while conducting more than 1,500 investment adviser examinations over the past two years.  This Risk Alert emphasizes the importance of advisers’ provision of clear and thorough disclosures in Form ADV and client investment advisory agreements.  The Risk Alert further underscores prior Commission guidance relating to adviser obligations to develop, implement, and test effective risk-based compliance policies to minimize the risk of misrepresentation in client communications and the risk of misappropriation in the management of client assets.

Most Frequent Compliance Issues – Advisory Fees and Expenses 

The following issues were deemed to be significant and prevalent in nature, although they do not constitute all fee and expense-related findings detected by OCIE.

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SEC Announces Share Class Selection Disclosure Initiative

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February 12, 2018: Investment advisers recommending mutual fund shares to advisory clients may have a disclosure problem. And yes, the U.S. Securities and Exchange Commission (“SEC”) is here to help address the problem. Yesterday the Commission announced its new self-reporting initiative, the Share Class Selection Disclosure Initiative (“SCSD Initiative”), to provide relief to advisers that have engaged in improper mutual fund recommendations on behalf of their clients. This initiative, forgiveness if you will, relates to certain mutual fund share class selections made by advisers relative to the formulation and execution of investment advice. If the offending firm promptly fesses up to the Division of Enforcement and promptly returns any non-compliant fees to harmed clients, the Division will agree not to recommend financial penalties against such advisers for violating federal securities laws. Read More

SEC Issues 2018 Examination Priorities

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February 7, 2018:  We wish our clients and colleagues a very prosperous new year and, this being the kickoff of 2018, we are all once again bestowed with the SEC National Exam Program Examination Priorities for the coming year!  We believe this informal guidance, announced February 7, 2018, can be helpful to Chief Compliance Officers as they recalibrate their compliance programs to adjust for business model evolutions or to realign their own compliance priorities following the 2017 annual review.

The following is a synopsis of the 2018 SEC examination priorities, abridged to present content pertaining primarily to investment advisers. The strategy and principles content has been extracted directly from the release to provide appropriate context to the Commission’s strategic and tactical execution of their mission.   Read More

Labor Department Officially Delays Start of Fiduciary Rule

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December 4, 2017:  Last week, the Department of Labor (“DOL”) officially announced an 18-month extension for the start of key provisions of the Fiduciary Rule. DOL announced that the special Transition Period for the Fiduciary Rule’s Best Interest Contract Exemption (“BICE”) and the Principal Transactions Exemption, and the applicability of certain amendments to Prohibited Transaction Exemption 84-24 (PTEs), will move from January 1, 2018 to July 1, 2019. The extension gives DOL time to consider public comments, review the Fiduciary Rule and related exemptions, and coordinate with the U.S. Securities and Exchange Commission and other securities and insurance regulators. The delay underscores the DOL’s objectives of protecting retirement investors and avoiding unnecessary restrictions imposed upon retirement investors by financial service firms scrambling to fully implement the rule.

The DOL action leaves in place the Fiduciary Rule, effective June 9, 2017, including the revised definitions of fiduciary and investment advice that apply to ERISA plans and IRAs. The DOL’s action continues to recognize various exemptions permitted under the rule. Financial services organizations may rely on the BICE and the Principal Transactions Exemption if they satisfy the Impartial Conduct Standards. The impartial conduct standards, also referred to as the best-interest standard, which took effect on June 9, require fiduciary advisers to adhere to a best-interest standard when making investment recommendations, charge no more than reasonable compensation for their services, and refrain from making misleading statements. Read More

2017 SEC Enforcement Division Playbook

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November 27, 2017:  The U.S. Securities and Exchange Commission (“SEC”) was established by an Act of Congress to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation. Compliance with the Investment Advisers Act, the Investment Company Act, and other federal securities statutes is highly dependent upon the adviser’s capacity to fully appreciate where the SEC is headed when they contemplate a deficiency letter, enforcement action, or referral to the Department of Justice.  For investment advisers, all aspects of the SEC mission statement have a direct correlation to the adviser’s business model, i.e., the non-compliant registered investment adviser presents an ongoing threat to undermine the Commission’s execution of its mission statement and therefore attracts significant resources and scrutiny from the regulator.

Fiscal year 2017 was by all accounts a successful year for the SEC’s Division of Enforcement. The Commission brought 754 actions and obtained judgments and orders totaling more than $3.7 billion in disgorgement and penalties. Significantly, it also returned a record $1.07 billion to harmed investors, suspended trading in the securities of 309 companies, and barred or suspended more than 625 individuals. Read More