March 13, 2017

Custody Rule: Standing Letter of Authorizations

There has been a level of uncertainty for Registered Investment Advisors (“RIA”) over the past year in regards to the SEC’s position on Rule 206(4)-2 (“Custody Rule”) (see the AdvisorAssist blog post on Custody for additional information) and how it applies to standing letters of authorization (“SLOA”) for a client at a qualified custodian (“Custodian”). It​ has been a common business practice for RIAs and clients to establish a SLOA at the Custodian which authorizes the RIA to instruct the Custodian to disburse client funds to a third party account or payee. Generally speaking, the intent of this practice is to minimize the administrative steps for RIAs to service the money movement requests of their clients. However, there has been much confusion by both RIAs and examiners ​as to​ which ​SLOA scenarios ​constitute custody of client funds and trigger the Custody Rule requirements for the RIA.

On February 21, 2017, the SEC provided clarity to this question through a no-action letter. The SEC confirmed their stance that the business practice of using SLOAs as instructions for payments to third parties fall under the definition of custody. Thereby requiring RIAs to disclose that they have custody of client funds. However, the SEC also provided some relief for RIAs as it relates to the independent surprise examination requirement of the Custody Rule.

The SEC advised that they would not seek enforcement action against RIAs who do​ not obtain a surprise examination as long as the RIA follow the below guidelines:

  • The client provides an instruction to the Custodian, in writing, that includes the client’s signature, the third party’s name, and either the third party’s address or the third party’s account number at a Custodian to which the transfer should be directed.
  • The client authorizes the RIA, in writing, either on the Custodian’s form or separately, to direct transfers to the third party either on a specified schedule or from time to time.
  • The client’s Custodian performs appropriate verification of the instruction, such as a signature review or other method to verify the client’s authorization, and provides a transfer of funds notice to the client promptly after each transfer.
  • The client has the ability to terminate or change the instruction to the client’s Custodian.
  • The RIA has no authority or ability to designate or change the identity of the third party, the address, or any other information about the third party contained in the client’s instruction.
  • The RIA maintains records showing that the third party is not a related party of the RIA or located at the same address as the RIA.
  • The client’s Custodian sends the client, in writing, an initial notice confirming the instruction and an annual notice reconfirming the instruction.
  • CCO Best Practices

    To ensure that you are properly dealing with custody issues AdvisorAssist recommends the best practices of:

  • Perform an assessment to determine whether or not you have custody of client assets or securities
  • Review all current SLOA to identify any that are established to send funds to an account at a different Custodian or to a third party payee.
  • RIAs have until October 1, 2017 to comply with the above described actions. Also, there will be a new requirement for RIAs to state client assets that are subject to a SLOA on their ADV1, Item 9.


    Contributors:
    Brian Young
    Conor Anderson
    Brendan Furey

    February 10, 2017

    Wyoming RIAs - Get Ready for Changes!

    In March 2016, the State of Wyoming joined the ranks of other states by implementing the Wyoming Uniform Securities Act.

    For years, Wyoming has been a sanctuary for registered investment advisors that sought registration with the U.S. Securities and Exchange Commission ("SEC"), but did not have the requisite $100 million in assets under management ("AUM").

    In other states [excluding NY], an Advisor with less than $100 million in AUM was required to register with the state securities division of their home state and other states in which the advisor had a place of business or clients exceeding a de minimis level. As Wyoming did not have formalized securities regulations, those advisors became the jurisdiction of the SEC.

    With the implementation of Wyoming’s Uniform Securities Act, Wyoming will require registered investment advisors to register with Wyoming state securities division if they have less than $100 million in AUM. The new legislation will take effect on July 1, 2017..

    The SEC has begun contacting firms that may be affected by this change. If you are in need of assistance in updating your registration or transitioning from SEC to state registration, please contact us at advisors@advisorassist.com.


    Sample [redacted] notice from the SEC:

    From: IARDLIVE [mailto:IARDLIVE@SEC.GOV]
    Sent: 09 February 2017 22:01
    To: [Advisor]
    Subject: [Advisor - CRD######]

    We are contacting you about your status as an SEC registered investment adviser with a principal office or place of business in Wyoming. As you may know, investment advisers with a principal office and place of business in Wyoming have been required to register with the SEC because the State of Wyoming has not previously regulated investment advisers. Advisers indicate this basis for SEC registration by checking the box for Item 2.A.(3) in Form ADV.

    The State of Wyoming has recently adopted legislation to begin regulating investment advisers on July 1, 2017. See Wyoming Uniform Securities Act. After that date, SEC registered investment advisers will no longer be eligible for SEC registration solely on the basis of having a principal office and place of business in Wyoming. If you are an adviser with regulatory assets under management of over $100 million or you have another basis requiring you to remain registered with the SEC after the Wyoming legislation goes into effect on July 1, 2017, we encourage you to select the checkbox on Item 2 in Form ADV indicating that other basis for SEC registration as early as possible and uncheck the Item 2.A.(3) box. Additionally, if you are required to remain registered with the SEC after July 1, 2017, you should consider whether you will also be required to include Wyoming as a state in which you must provide a notice filing in Item 2.C.

    If you are an adviser that does not have another basis requiring you to remain registered with the SEC after July 1, 2017, you may be required to become registered with the State of Wyoming or other states in which you conduct business. State regulator contact information may be found at the Contact Your Regulator - NASAA webpage. You may apply for state registration by filing a new Form ADV through the IARD system (select the "Apply for registration as an investment adviser with one or more States" option) and file a partial ADV-W withdrawing from SEC registration after your state registration has been approved. Advisers that are no longer eligible for SEC registration after the Wyoming state legislation goes into effect on July 1, 2017 and who have not applied for state registration may be subject to having their SEC registration cancelled.

    You may reply to this email if you have questions or contact us at 202-551-6999.

    Regards,

    INVESTMENT ADVISER REGULATION OFFICE
    Division of Investment Management
    U.S. Securities and Exchange Commission
    100 F Street, N.E.
    Washington, D.C. 20549-8549
    P: (202) 551-6999
    www.SEC.gov

    January 26, 2017

    CCO Series: Custody

    What you need to know

    In developing policies and procedures for a registered investment advisor ("RIA") a topic that should be addressed is custody. As stated in their release, the SEC created rule 206(4)-2 under the Advisers Act, “to reflect modern custodial practices and clarify circumstances under which a RIA has custody of assets.” The rule requires a RIA that has custody of client securities or funds to implement a set of controls designed to protect those assets from being lost, misused, or misappropriated. The rule provides that, in general, a RIA should maintain funds and securities with a broker-dealer, bank, or other "qualified custodian" to avoid having custody themselves. Then, if the qualified custodian sends account statements directly to the RIA's clients, the RIA is relieved from undergoing an annual surprise custody audit. Many states have also implemented custody rules similar to 206(4)-2.

    Definition of Custody

    A RIA has custody when it holds, "directly or indirectly, client funds or securities or [has] any authority to obtain possession of them." The SEC created examples to illustrate circumstances under which a RIA has custody of client funds or securities.

    • Holding clients' stock certificates or cash, even temporarily, is custody. However, the rule acknowledges that there may be times of inadvertent receipt of funds or securities. Therefore, to avoid custody, any check or security certificate inadvertently received by a RIA must be returned to the sender or placed with the qualified custodian within three business days of receiving them.
    • A RIA has custody if it has the authority to withdraw funds or securities from a client's account, such as a power of attorney, possession of account login credentials or an authorization other than discretionary trading.
    • Acting in any capacity that gives it legal ownership of, or access to, the client funds or securities, such as acting as both general partner and investment advisor to a limited partnership is custody. As general partner, the RIA generally has authority to dispose of funds and securities in limited partnership account(s) and thus has custody.
    • Collecting prepayment of fees in an amount of $1,200 or more for services to be performed six months or more in advance. In this case, the RIA must include an audited balance sheet with its Form ADV deliveries to clients from whom the RIA has received such prepayments.

    Avoiding Custody Issues

    There are several steps to take in order to avoid custody issues:

    • Due Inquiry. A RIA is required to have a reasonable basis to believe that, after due inquiry, the qualified custodian is delivering an account statement to each of your clients at least quarterly. The account statements must identify the amount of funds and of each security in the account at the end of the period and setting forth all transactions in the account during that period. In SEC Release No. IA-2968, the SEC identified common ways to satisfy due inquiry requirement:
      1. Request copies of client account statements be sent to them.
      2. Request a written confirmation from the custodian that the account statement was sent to each client.
      3. The CCO maintains his or her personal accounts at the same qualified custodian that has all of the RIA’s Client accounts and the CCO ensures that he or she receives statements at least quarterly.
    • Deduction of Fees. For a SEC registered RIA documentation of “due inquiry” is the primary safeguard for the deduction of fees to not be deemed custody. However, in addition to “due inquiry”, many states also require that in order to deduct fees from a client’s account without creating custody, the RIA must:
      1. Have written authorization from the Client to deduct advisory fees from the account;
      2. Each time a fee is directly deducted, the RIA concurrently sends the qualified custodian notice of the amount of the fee to be deducted, and client an invoice itemizing the fee including the formula used to calculate the fee, the amount of assets under management upon which the fee is based, and the time period covered by the fee;
      3. Ensure the qualified custodian sends statements, on at least a quarterly basis, to Clients showing all disbursements, including the amount of the advisory fees; and
      4. Form ADV states that the Advisor intends to use the safeguards provided in regulation, instead of the requirements for custody.
    • Linked Accounts. Since May 20, 2010, the SEC has stated in Question II.4, that the limited authority to transfer a assets between the Client's accounts maintained at one or more qualified custodians is not custody, if:
      1. the Client has authorized the RIA in writing to make such transfers and
      2. a copy of that authorization is provided to the qualified custodian, specifying the Client accounts maintained with qualified custodian.

    For transfers outside of the qualified custodian or recurring transfers, the RIA should have an authorization signed by the Client for each transfer specifying the transfer destination and the dollar amount for each transfer.

    Maintaining Custody

    For RIAs that have custody of funds or securities there are a number of requirements in order to ensure that the RIA is a “qualified custodian” for those assets.

    • Annual audited financials. A RIA with custody of Client funds or securities must have its financials audited annually and then report the balances on Part 1 of Form ADV.
    • Annual surprise examinations. The independent verification and audit of the custodied funds must occur at at a time that is chosen by the accountant without prior notice or announcement to you and that is irregular from year to year. The accountant must be registered with the Public Company Accounting Oversight Board.
    • Internal controls report. Based on the surprise examination, the accountant must issue a written internal control report with opinions as to whether controls have been placed in operation as of a specific date, and are suitably designed and are operating effectively to meet control objectives relating to custodial services, including the safeguarding of funds and securities held during the year.
    • The accurate creation of required records and their maintenance in a manner that secures them from unauthorized alteration or use and protects them from untimely destruction;
    • In addition, many states also require that RIAs with custody also maintain at least a specific amount of net capital or require a surety bond.

    What are the next steps for a CCO?

    To ensure that you are properly dealing with custody issues AdvisorAssist recommends the best practices of:

    • Perform an assessment to determine whether or not you have custody of client assets or securities, and respond appropriately, depending upon your intention to have custody or not.
    • Implement controls to ensure the proper handling of client assets and securities to avoid the abuse of the authority granted by your clients to access and manage their assets and securities.
    • Perform "due inquiry" on your custodian to ensure that each of your Clients are receiving statements at least quarterly.
    • Review your advisory agreements to ensure that you have proper authorization to deduct fees from Client accounts.
    • If your RIA receives deposit checks or stock certificates from Clients, maintain a "checks received log" and institute a policy of remitting these checks within 72 hours of receipt to the qualified custodian.
    • If your RIA maintains custody, contract with an independent accounting firm to perform surprise custody audits at least annually on the accounts over which you have custody.
    • If you are a state registered RIA, review your fee deduction process to ensure that each time a fee is directly deducted, you concurrently send the qualified custodian notice of the amount of the fee to be deducted, and the Client an invoice itemizing the fee including the formula used to calculate the fee, the amount of assets under management upon which the fee is based, and the time period covered by the fee.

    The AdvisorAssist CCO Series is a collection of blog posts that cover each of the elements of your RIA's compliance program. Each post will provide an overview of one compliance topic, including our insights on how regulators view each topic as well as some practical steps to help Chief Compliance Officers address this topic. As always, we would welcome your comments and thoughts.

    Contributors:
    Brendan Furey
    Conor Anderson

    December 15, 2016

    Exam Priorities: Multi-Branch Adviser Initiative

    Each year the SEC’s Office of Compliance Inspections and Examinations (“OCIE”) creates initiatives in order to address priorities for examinations of SEC-registered investment advisors (“Advisors”). The OCIE recently issued a risk alert about their ongoing initiative to make Advisors with multiple branch offices an examination priority. This initiative will center on examining the effectiveness of supervisory practices over advisory personnel in branch offices.

    What you need to know

    The OCIE perceives an increase in Advisors having numerous branch offices and operations that are geographically dispersed from the main office. With this increase in the use of a branch office model additional and unique risks are created. In particular, the design and implementation of a compliance program and the supervision of people and processes in branch offices. There are risks that those individual(s) responsible for compliance and oversight will not be able to review adherence to and/or enforce the use of policies and operating procedures.

    Review of Compliance Programs

    Under SEC Rule 206(4)-7, Advisors are required to implement written policies and procedures reasonably designed to prevent and detect violations of the Advisers Act and related rules by Advisors and their supervised persons. According to the risk alert, during examinations, Advisors will be asked about the oversight of the staff at branch offices and the exam will review the staff’s compliance with your policies and procedures. Through interviews of the staff and inspection of books and records, the exam will assess the:
    • Implementation of policies and procedures in the branch offices.
    • Supervision structure, including an assessment of how such supervision is tailored to the unique risks in particular branches.
    • Role and empowerment of compliance personnel charged with overseeing branch offices, including their level of access to documents and relevant information.
    • Accuracy of information on filings regarding branch offices, including Form ADV, as compared to actual business practices.

    Review of Investment Recommendations

    As a fiduciary, an Advisor has an obligation to act in the best interests of its clients and to identify and disclose any material conflict of interest. According to the risk alert, during the examination, the Advisor will be asked about the process for formulation of investment recommendations and the management of client portfolios at branch offices. In particular the exam will focus on policies and procedures and supervisory controls that cover the following:
    • Oversight. Supervision and review of investment recommendations made to clients within specific branch offices and across branch offices, including processes and controls regarding investment authority, suitability of the investment advice, and any due diligence that the adviser has told clients is undertaken with respect to investments.
    • Conflicts of Interest. Identification, management, and disclosure of conflicts of interest that arise through branch office activities and personnel, including conflicts arising from various compensation arrangements and supervised persons’ outside business activities.
    • Allocation of Investment Opportunities. Allocation of investment opportunities among client accounts, including how branch offices’ trading activity is monitored and what disclosures are made to clients regarding trade allocation.

    Additional Areas of the Review

    In addition, the exam may focus on assessing compliance and testing controls in one or more of the following risk areas:
    • Fees and Expenses. The calculation of fees and other expenses, including the effectiveness of controls over the billing and invoicing processes.
    • Advertising. Controls over advertisements, such as the process for reviewing and approving advertisements, particularly those created or disseminated by its branch offices.
    • Code of Ethics. The implementation of the code of ethics, including oversight and monitoring of personal securities transactions and whether have properly identified access persons at branch offices.
    • Custody. Controls related to the identification of accounts which the Advisor maintains custody and the involvement of branch office personnel in making such determinations.

    CCO Best Practices

    To avoid these deficiencies at your firm AdvisorAssist recommends the best practices of:
    • Perform an annual review of your books and records archive to ensure you are keeping the required documentation.
    • Review your compliance program documents to ensure that they are up to date and correct.
    • Ensure your staff certifies their understanding and adherence to your compliance program at least annually.
    • Test your staff’s adherence to the policies and procedures in your compliance program at least annually.
    • Compile all of your findings into summary reports to document the annual completion of your oversight responsibilities.
    • Conduct formal meetings with any compliance staff in any branch locations to demonstrate supervision to and compliance by those branches.

    AdvisorAssist’s CCO Series: Exam Priorities is a series of articles that will help your firm understand and prepare for the most common compliance exam topics. Our goal is to help you increase your confidence that your firm remains “exam ready” as well as some practical steps to help Chief Compliance Officers address this topic.
    Contributors:
    Brendan Furey
    Brian Young

    December 13, 2016

    CCO Series: Trade Errors

    What you need to know

    In developing policies and procedures for a registered investment advisor ("RIA") a topic that should be addressed is trade errors. To uphold the fiduciary duty owed to clients of your RIA, your policies and procedures should cover how you handle errors that may occur when trading in a client's account.

    Should a trading error occur in a client's account managed by an RIA there are critical response items to consider in order to uphold your fiduciary duty. By having these compliance components in place you can then demonstrate to a regulator that you are compliant in this aspect of your overall compliance program.

    What is a Trade Error?

    The most common trade error is buying the wrong security or the wrong amount. Here are a few other examples of events that are considered trade errors:

    • Trading in the wrong client account
    • Trading in the wrong direction (buy vs. sell)
    • Trading at the wrong price (limit orders, etc)
    • Incorrect block trade allocation
    • Violation of client account restriction (tobacco, oil, military)
    • Violation of client account suitability (aggressive vs conservative)
    • Delayed execution of trade instructions
    • Duplicate execution of trade instructions

    How to handle trade errors

    Even if the error does not fit into one of these examples you should discuss any potential or actual trade errors with your CCO to ensure compliance. CCOs should then document the event within their trade error log and save all related documentation for the RIA's books and records. You should then consider communicating with the clients as needed to explain events in their statements or other irregular trading activity. Most trade errors can be resolved prior to settlement by the custodian if they are promptly discovered and communicated.

    Reviewing policies and procedures

    Advisors should ensure their policies and procedures require the disclosure of trade errors to the CCO and that trade errors are documented in the Advisor's trade error log. The log should also include any related backup or other documentation, that the trade errors are resolved in a way that makes the client whole and absolves the client of consequences of the Advisor's error. Additionally, trade errors should be reviewed at least annually by the CCO or their delegate to ensure that any reasonable changes to the Advisor's business practices that could eliminate future errors is considered for implementation. During this annual review the CCO or delegate should also update the Advisor's trade error policy as needed to ensure it accurately reflects how trade errors are resolved.

    What are the next steps for a CCO?

    To ensure that you have a compliant trade error policy and procedure AdvisorAssist recommends the best practices of:

    • Ensure any trade errors are documented in your firm's trade error log
    • Keep documentation related to any trade errors as needed to demonstrate the error and its resolution
    • Remain aware of any changes to trade error policies and procedures that may be imposed by your custodian and update your internal policies as appropriate
    • Communicate your trade error policy and procedure to your supervised persons involved in trading activities
    • Complete an annual risk assessment to review your trade error policy and procedures
    • Complete an annual review of your trade error log to ensure errors are documented and resolved according to your policy and procedures

    The AdvisorAssist CCO Series is a collection of blog posts that cover each of the elements of your RIA's compliance program. Each post will provide an overview of one compliance topic, including our insights on how regulators view each topic as well as some practical steps to help Chief Compliance Officers address this topic. As always, we would welcome your comments and thoughts.

    Contributors:
    Michael Conlon

    November 8, 2016

    Annual Renewal 2017 - Calendar of Events

    As we approach the end of 2016 the preparations for your 2017 Annual Renewal have begun. You may have already received notices directly from the applicable states.

    As a client of AdvisorAssist we will manage the annual renewal process. Here are important dates to remember in the coming months.

    FINRA, as the administrator of the online regulatory systems, has a full calendar of deadlines at www.finra.org/sites/default/files/crd-renewal-program-calendar.pdf

    November 14: Preliminary Statements Issued

    FINRA will likely email you a Preliminary Statement that summarizes your firm's current registrations and applicable renewal fees. There is no need to send this to AdvisorAssist. We will proactively obtain and verify the accuracy of these statements. Once validated, we will communicate your funding requirements directly to you.

    December 16 (FINAL DEADLINE): Payment of Renewal Fees

    To maintain the registration of your firm and investment advisor representatives ("IARs"), you must pay the required fees in full by December 16, 2016. In advance of this deadline, AdvisorAssist will provide step by step instructions on how to process payment of the renewal fees.

    January 3: Review your Final Renewal Statement

    FINRA will provide a Final Renewal Statement to reconcile any refunds due or additional fees owed. AdvisorAssist will review this reconciliation to ensure accuracy. AdvisorAssist will also recommend additional registrations/notice filings that should be made in calendar year 2017.

    Annual Renewals: Common Deficiencies

    Here are a list of common deficiencies that we will look to avoid:

    • Funding Issues
    • Incorrect ADV Content
    • Missing Registrations or Notice Filings
    • Excessive Registrations or Notice Filings
    • Investment Advisor Representative (IAR) Registrations

    If you are not an AdvisorAssist Compliance Client and are seeking assistance with the Annual Renewal process, please contact us at: byoung@advisorassist.com

    Contributors:
    Brian Young