Risk Alert: Initial Observations Regarding Marketing Rule Compliance

  

Risk Alert: Initial Observations Regarding Marketing Rule Compliance

Contributed By: Samuel Guy, Compliance Consultant

Thomas Yates, Managing Director & Partner

                            AdvisorAssist, LLC

On April 17, 2024 the Division of Exams (“EXAMS” or “the staff”) released a Risk Alert: Initial Observations Regarding Advisers Act Marketing Rule Compliance. This Risk Alert highlights areas of focus for Advisors to stay in compliance with the Rule 206(4)-1 (the “Marketing Rule”) as discovered through the staff’s preliminary assessments and findings concerning the updated rule.

Observations Regarding the Compliance Rule, Books and Records Rule, and Form ADV

The staff's review of whether Advisors adopted and implemented written policies and procedures reasonably designed to prevent violations produced the following findings, including deficiencies:

Policies and Procedures The staff generally observed that compliance policies and procedures were updated to comply with the Marketing Rule. It was also observed that further steps were often taken; Advisors typically held training on the Marketing Rule’s requirements, Advisors implemented policies and procedures for reviewing marketing materials, and Advisors required pre-approval of marketing materials before dissemination. However, the staff also observed some common deficiencies concerning policies and procedures and the Marketing Rule, which are as follows:

• Policies and Procedures were general, informal, or not fully updated to cover all applicable marketing topics, or not properly implemented in the Advisor’s marketing materials.
• Policies and Procedures cover the General Prohibitions of the Marketing Rule, but do not cover the specific types of marketing materials utilized by the Advisor, such as testimonials or third-party ratings.

Books and Records The staff observed that Advisors updated their practices to reflect the Marketing Rule’s books and records maintenance and preservation requirements, however, some common deficiencies were also observed:

• Questionnaires or surveys used in preparation for a third-party rating were not archived.
• Social Media posts were not archived.
• Documentation to support performance claims were not maintained.

Form ADV The staff observed that Advisors updated their ADV documents in response to the Marketing Rule. However, the Staff did observe misreporting in ADV1 Item 5.L, where the Advisor utilized a certain type of marketing (i.e. Performance results, Third-party rating) that was not disclosed. Further, some Advisors had inaccuracies in ADV2 Item 14 as they were not properly disclosing their referral arrangements.

Observations Regarding Compliance with the Marketing Rule’s General Prohibitions

The staff’s review of the Marketing Rule assessed whether the Advisor’s marketing materials violated any of the General Prohibitions. Common deficiencies of these are organized by the prohibition, and are as follows:

Untrue statements of material fact and unsubstantiated statements of material fact.

The following are some instances of untrue statements in advertising materials observed by the staff during their preliminary assessment:

• Advertisements stated the Advisor was free of all conflicts of interest when conflicts did exist.
• Advertisements that misrepresent the Advisors’ business, such as misreporting the individuals performing advisory services, the qualifications of individuals employed by the Advisor, or awards granted to the Advisor.
• Advertisements that misrepresent facts about the Advisors’ investment processes, such as claiming these processes were validated by professional institutions or followed certain mandates, such as ESG, when this could not be substantiated by the Advisor.
• Advertisements in which Advisors could not substantiate investment practices, such as stating the client’s risk tolerance were considered, referencing security screening processes that did not exist, or referencing a list of approved securities that did not exist.

Omission of material facts or misleading inference.

The following are the primary instances of omission of material facts or misleading inference in advertising materials observed by the staff:

• Advisors attempted to differentiate themselves by stating they “acted in the best interest of clients” without disclosing that all Advisors have a fiduciary duty to act in the client's best interest.
• Advisors recommended certain investments in advertising materials without disclosing the compensation received by the Advisor for the recommendation.
• Advisors misrepresented the requirements of being SEC-registered. For example, Advisors implied that SEC registration represented a particular level of skill, or that the SEC had approved the firm's business practices, sometimes by including the SEC logo on their website or marketing materials.
• Advertisements containing third-party rankings did not disclose that other Advisors received the award and implied they were the sole recipient, or did not include the necessary disclosures explaining the methodology behind the ranking.
• Advertisements containing testimonials did not include context around what the testimonial was endorsing. In one instance, the Advisor included testimonials for a third-party product but represented the testimonial as being about the Advisors’ services.

Omission of material facts or misleading inference related to performance.

The following are the primary instances of omission of material facts or misleading inference related to performance advertisements observed by the staff:

• Facts included in performance marketing materials included outdated market data information or investment products and fees that are no longer available to clients.
• Marketing materials that omitted necessary context around performance results. For instance, omitting context around fees and expenses when calculating returns, or omitting context around general market performance.
• Misrepresenting performance track record, such as stating securities were bought in client accounts when they were not, or not disclosing that the Advisor did not have clients in the model of the performance report.
• The Advisor used a benchmark index but did not properly define the index or include enough context.
• Advertisements did not disclose the time period or whether the returns were calculated from the time period defined in the material.
• Some performance results were included or excluded in an unfair or unbalanced manner. For example, an Advisor only included the performance of realized investment information in total net return and excluded unrealized investments.

Other Deficiencies

The staff observed several deficiencies related to the fair and balanced presentation of marketing materials by advisors. Notably, many advertisements failed to disclose the material risks and limitations associated with the services offered. Additionally, references to specific investment advice often lacked balance, particularly with omissions in disclosures concerning the exclusion of certain investments. The staff also noted that advisors lacked adequate policies and procedures to ensure that such information was presented fairly. Furthermore, some advertisements contained materially misleading disclosures, including some that were unreadable, compromising the clarity and integrity of the information presented to clients.

In light of these deficiencies, advisors are urged to review and enhance their compliance practices. This should include updating and strictly implementing policies and procedures, ensuring comprehensive and accurate maintenance of books and records, maintaining accurate and reflective policies to the advisor’s marketing practices and reviewing marketing materials to eliminate misleading information. By taking these steps, advisors can seek to ensure transparency, accuracy, and adherence to Marketing Rule.

AdvisorAssist has published multiple resources for Advisors as they strive to enhance their policies and procedures surrounding the Marketing Rule. Targeted Mock Examinations through AdvisorAssist are available to those who wish to test the effectiveness of their current process. We urge you to review any of the following resources, or reach out to your Compliance Consultant for further assistance:

SEC Marketing Rule Examination Sweep

SEC 2023 Priorities and the Marketing Rule – How Important is a Retrospective Review?

SEC Sample Marketing Exam Request

 

Read More

Adopted Amendment: 203A-2(e) & Internet Only Investment Advisers

 

Adopted Amendment: 203A-2(e) & Internet Only Investment Advisers

The SEC recently delivered a communication regarding their revisions to the registration of internet-only investment advisers (“IO RIAs”) under rule 203A-2(e) of the Investment Advisers Act of 1940. Here are some important points:

Audience: This rule ONLY applies to SEC Registrants that rely on the Internet Only exemption.

Timing Details for IO RIAs: The amendments will become effective on July 8, 2024. An adviser relying on the internet adviser exemption must comply with the rule by March 31, 2025.

Withdrawal: IO RIAs no longer eligible under the amended exemption must deregister with the SEC and, if applicable, register with state authorities by June 29, 2025.

Key Points

• Operational Interactive Website: IO RIAs using the internet adviser exemption must now offer services on an ongoing basis to more than one client exclusively through a website or mobile application ("operational interactive website”). This means the website must be actively functioning and capable of providing advisory services without interruption, except during minimal, unavoidable outages.
• Elimination of the De Minimis Exception: The updated rule removes the allowance for IO RIAs to have up to 15 non-internet clients within a 12-month period. Going forward, all client advisement must occur via the operational interactive website without exception.
• Form ADV Part 1 Update: IO RIAs must affirm on Schedule D of Form ADV that they maintain an operational interactive website as part of their compliance with the internet adviser exemption.

 For Advisers who rely on this exemption, further updates will be communicated moving forward regarding policy updates and best practices, but please reach out to your Consultant should you have any additional comments or concerns.

 

Read More

Adopted Amendment - DOL Prohibited Transaction Exemption 2020-02 (PTE 2020-02)

 

Adopted Amendment: Department of Labor's Prohibited Transaction Exemption 2020-02 (PTE 2020-02)

The Department of Labor (DOL) recently announced significant amendments to Prohibited Transaction Exemption (PTE) 2020-02, which affects Registered Investment Advisors (“RIA”). As we continue through our research on these amendments we are learning that nothing has changed from our guidance since the DOL released its initial communication on PTE-2020-02, and that our guidance still aligns with the amendments, as all RIA’s are subject to a fiduciary standard. That said, here’s what you need to know about the amendment to PTE-2020-02: Effective Date - The amended rule takes effect on September 23, 2024. The DOL is granting this practical buffer through a designated phase-in period, to give RIAs the appropriate amount of time to make adjustments in order to adhere to the amended rule. There are two (2) material changes we wanted to highlight as it relates to this amendment: Inclusion of the Fiduciary Standard: The amendment to PTE 2020-02 allows investment advice fiduciaries to receive compensation that would otherwise be prohibited under the Employee Retirement Income Security Act of 1974 (ERISA) and the Internal Revenue Code. The amendment provides a further definition of what is constituted as “Fiduciary Advice” based on the following five-part test:

• they provide investment advice for a fee,
• on a regular basis,
• pursuant to a mutual understanding,
• that the advice will serve as a primary basis for investment decisions, and
• that the advice is individualized.

Based on the above, this applies to the majority of RIA’s, registered with the SEC and/or various state regulators, who provide ongoing investment advice to clients. The following are key features to meet the Fiduciary Standard:

• Fiduciary Acknowledgment: RIAs must formally acknowledge their fiduciary status in writing to retirement investors. This declaration is crucial as it reaffirms the advisor’s role and the associated responsibilities.
• Conflict Disclosure: Advisors must fully disclose the services provided and any material conflicts of interest to their clients. Transparency is key to maintaining trust and adherence to fiduciary duties.
• Impartial Conduct Standards:
1. Care Obligation - Advisors must provide advice that reflects the care, skill, prudence, and diligence under prevailing circumstances that a prudent person would exercise.
2. Loyalty Obligation: The interests of the retirement investor must always be placed ahead of the advisor’s or the firm’s interests.
3. Reasonable Compensation: The compensation for advice must not exceed what is considered reasonable within the industry.
4. No Misleading Statements: Advisors must avoid making statements that could mislead retirement investors about investment transactions and other relevant matters.

Clarity Related to Retirement Investors The amendments now clarifies that this exemption applies to investment recommendations to “Retirement Investors”, which is inclusive of plans, plan participants, beneficiaries, IRAs, IRA owners and beneficiaries, and plan fiduciaries with discretionary authority. Although implied, this was not clear in the earlier release of the exemption. Now this answers a lot of questions on whether or not IRAs are subject to the rule. AdvisorAssist is closely monitoring industry best practices, interpretations, and any additional guidance the DOL may provide. We anticipate more clarity from the DOL as feedback comes in, and have begun the process to fully analyze and formulate guidance to help ensure adherence to amendments to PTE 2020-02. Please contact your Consultant for further questions regarding this amendment.  

Read More

FinCEN Proposal: Anti-Money Laundering Program and Suspicious Activity Report Filing Requirements

 

Proposed Rule: Anti-Money Laundering Program and Suspicious Activity Report Filing Requirements for Registered Investment Advisers and Exempt Reporting Advisers

Contributed By: Gabrielle Magdziarz

                           Senior Compliance Consultant

                             AdvisorAssist, LLC

On varying occasions, the Financial Crimes Enforcement Network (FinCEN) has submitted rule proposals regarding the need for Registered Investment Advisors (RIAs) and Exempt Reporting Advisors (ERAs) to be subject to comprehensive anti-money laundering and countering the financing of terrorism (AML/CFT) measures. FinCEN’s recent synopsis is driven by the 2024 Investment Adviser Risk Assessment, which identified several illicit finance and national security risks such as sanctioned individuals, corrupt officials, tax evaders, and other criminal actors using RIAs to gain access to US Markets. Furthermore, the risk assessment identified cases of foreign adversaries, including China and Russia, investing in early-stage companies through RIAs to access sensitive information and emerging technology. The proposal would include RIAs and ERAs in the definition of “financial institution” under The Bank Secrecy Act (BSA). Under the BSA, RIAs and ERAs would be required to:

• implement an AML/CFT program;
• file certain reports, such as Suspicious Activity Reports (SARs), with FinCEN;
• keep records such as those relating to the transmittal of funds (i.e., comply with the Recordkeeping and Travel Rule); and
• fulfill other obligations applicable to financial institutions subject to the BSA and FinCEN’s implementing regulations.

Furthermore, the proposal would grant information-sharing provisions between and among FinCEN, law enforcement government agencies, and certain financial institutions to RIAs, along with subjecting RIAs to the “special measures” imposed by FinCEN pursuant to Section 311 of the USA PATRIOT Act. Nuances to this proposal to highlight are the following:

• The proposal will not include the requirement to have a customer identification program that aligns with BSA requirements, nor beneficial ownership requirements for legal entity customers via the Customer Due Diligence rule. It is expected both these requirements will come with joint SEC rule proposals down the line.
• The proposal will not require RIAs to apply AML/CFT program or SAR filing requirements to mutual funds they advise, as mutual funds are already defined as “financial institutions” under the BSA.
• Finally, FinCEN will be delegating examination authority to the SEC for compliance with the BSA and FinCEN’s implementing regulations.

At this time, no action is required for RIAs or ERAs. The proposal will remain in a comment period through April 15, 2024. Should the rule become effective, compliance will be required on or before 12 months from the final rule’s effective date.

Read More

Navigating the New Independent Contractor Rule: Insights for Registered Investment Advisors

 

Contributed By: Thomas Yates

                           Managing Director & Partner

                             AdvisorAssist, LLC

Over the recent weeks, we have received inquiries regarding the U.S Department of Labor final rule on defining “independent contractor” under the Fair Labor Standards Act (FLSA) and what that means for registered investment advisors (“RIA”). Although we are not specialists in employment law, nor are we attorneys, we have consulted with legal experts to help break down the rule in regard to W-2 employees and 1099 Independent Contractors (collectively “Supervised Person(s)”) at an RIA. We note that Supervised Persons can be either Investment Adviser Representatives (“IAR”) or client administrative support persons, or other persons that are subject to the Advisor’s Compliance Program. Our goal is to provide Advisors with a basic understanding of rule language to help guide RIAs to compliance with federal wage-and-hour laws, as applicable.

The Essence of the New Rule 

The rule's emphasis on the "economic reality" of the employment relationship underlines the importance of determining whether a worker is genuinely operating an independent business or is economically dependent on the employer. 

The rule focuses on six key factors, including the worker’s opportunity for profit or loss and the nature of control over the work, among others. This holistic approach encourages a deeper analysis beyond mere contractual terms to the actual practices and dynamics of the working relationship between the RIA and the Supervised Person. 

To simplify, here is how AdvisorAssist views the six conditions, and helps Advisors assess whether or not their Supervised Persons can be deemed Independent Contractors:

Opportunity for Profit or Loss: If a Supervised Person can earn more by the more work they put in, clients obtained, and/or the result of their investment management, which could result in additional income earned, they can be perceived as operating as an independent contractor.

Investments by the Worker and Employer: If the Supervised Person spends their own money to purchase tools, technology, or any other resources, at their discretion, to provide their services, this would suggest that they are likely acting as an Independent Contractor.

Degree of Permanence of the Relationship: If the Supervised Person is an IAR and can leave at their own discretion, and take their clients to another RIA, this suggests that they are likely acting as an Independent Contractor.

Nature and Degree of Control: If an RIA’s degree of control over the Supervised Person is only exercised due to the necessity to comply with regulatory requirements, and nothing more, this suggests that they are likely acting as an Independent Contractor.

Extent to Which the Work is Integral to the Potential Employer’s Business: If the Supervised Person does not participate in the day to day operations of the RIA or does not influence management-level decisions, where they solely work with their own clients, suggests that they are likely acting as an Independent Contractor.

Worker’s Skill and Initiative: Generally, Supervised Persons are considered “specialized” in their type of work, as they are trained to operate in this industry and if the Supervised Person is an IAR, are required to obtain a certification to provide investment advice. However, being specialized does not automatically mean a Supervised Person is working in the capacity of an Independent Contractor. Rather, the RIA should assess whether or not the Supervised Person’s skill/application is “in connection with business-like initiative”. This is a broad statement but should go into the overall analysis when determining a Supervised Person's contribution to a firm's growth vs. their intent to specifically service their own clients.

Ultimately, if Supervised Persons are compensated through fees for the services provided to clients, demonstrating minimal economic dependence on the firm, aligns well with the Independent Contractor status. Conversely, a Supervised Person on a salary or hourly wage, especially those without a direct link between compensation and client services rendered or who rely heavily on the firm for their economic sustenance, may not fit the Independent Contractor definition.

Conclusion When completing the Form U4 for a Supervised Person who is an IAR, it is essential to accurately disclose their employment status in Section 1 of the form. This section specifically inquires whether the IAR maintains an independent contractor relationship with the firm. Proper classification is crucial because it is a regulatory filing, and the way an IAR is classified must be properly reflected.

It is important to note, that this rule does not change an RIA’s responsibility to supervise its Supervised Persons, nor does it change the RIA’s obligations to act as a fiduciary. However, RIAs should consider how this rule would impact them from an employment law perspective. It is necessary for RIAs to ensure they maintain a robust employment policy to ensure adherence to the Department of Labor’s rules on the classification of its employees and ensure that wage-and-hour laws are in fact adhered to, helping mitigate the internal legal risk posed to the RIA.

While AdvisorAssist is not an employment law firm, we feel it is prudent that RIAs have a basic understanding of these conditions to help determine whether or not a Supervised Person can be classified as an Independent Contractor. We want to emphasize however, that all six factors, ranging from the worker’s opportunity for profit or loss, the relative investments by both parties, the permanence of the relationship, the degree of control, the integral nature of the work to the employer’s business, to the worker’s skill and initiative, must be considered in holistically. There is no single category that would determine a Supervised Person’s status, as all six categories as a whole should be assessed to an RIA determine a Supervised Person’s employment status with the RIA. With all this in mind, if RIAs ever do question the appropriate classification of a Supervised Person, do not hesitate to reach out to an employment attorney, as RIAs should want to ensure that they have the appropriate legal backing in these classification decisions.

Read More

Modernization of Beneficial Ownership Reporting in 2024

 

Modernization of Beneficial Ownership Reporting in 2024

After 50 years the SEC has decided to adopt amendments to long-standing reporting requirements for beneficial ownership under Sections 13(d) and 13(g) of the Securities and Exchange Act of 1934. Starting in Q4 2024, the amendments will require Form D/G Filers to provide more timely information regarding their beneficial ownership in the following manner:

• 13D Filers
• The deadline for the initial 13D filing has been shortened from 10 days to 5 business days
• Amendments to 13D filings are required to be reported within 2 business days
• 13G Filers
• Qualified Institutional Investors and Exempt Investors: Initial filing deadline shortened from 45 days after year end, to 45 days after the end of the calendar quarter.
• Passive Investors: Amendments of ownership changing 5% or more shorten the filing deadline from 10 days to 5 business days.
• All amendments generally required to be filed 45 days after the calendar quarter in which a material change occurred rather than 45 days after the calendar year in which any change occurred.  
• Require Schedule 13D and 13G filings be made using a structured, machine-readable data language, XML, via the SEC Edgar System.

The amendment also provides guidance with respect to “formation of a group”, and it is of the Commission’s view that the determination of whether two or more persons are acting as a group does not depend solely on the presence of an express agreement and that, depending on the particular facts and circumstances, concerted actions by two or more persons for the purpose of acquiring, holding, or disposing of securities of an issuer are sufficient to constitute the formation of a group.

Compliance with the revised Schedule 13G filing deadlines will be required beginning on Sept. 30, 2024. Compliance with the structured data requirement for Schedules 13D and 13G will be required on Dec. 18, 2024. Compliance with the other rule amendments will be required upon their effectiveness. The final rule, and fact sheet can be found within the SEC’s press release.

AdvisorAssist is in the process of reviewing rule requirements for enhancements to applicable manual language, and compliance tasks. We will be releasing further communication regarding this rule update as needed, but should you have any questions, please contact your Compliance Consultant.

Update - March 2024: On the tailwind of this adopted amendment, the SEC announced that they settled charges against a New York-based Investment Advisor (IA) for its failure to make timely ownership disclosures. This failure led to an agreed upon $950,000 civil penalty to settle the SEC’s charges. 

Although the Advisor disclosed its ownership of more than 5% of the common stock in question in December 2021, the Advisor did not properly file its change in control status and increased ownership in the position as required by federal securities laws. Please review the full press release here.

AdvisorAssist wants to remind Advisors, especially with the upcoming adopted amendments, that if the Advisor has exceeded the 5% threshold, the Advisor is required to file an initial Section 13D or G promptly and then an annual filing thereafter. In accordance with Rule 13d‐1(h), a firm may file Schedule 13G (shorter form) as long as the shares are not held with control intent – and the pitfall with our NY based IA in this scenario. 

Having appropriate controls in place is imperative for supervising security thresholds for accurate and timely reporting, which includes a process for aggregating trades across various custodians. Advisors should also contact their custodians to determine if they monitor if the firm needs to file Form 13D or G. 

Read More