November 20, 2023

Investment Advice Fiduciary and Prohibited Transaction Exemptions Proposal


Department of Labor Proposal: Investment Advice Fiduciary and Prohibited Transaction Exemptions 

As expected, the Department of Labor (DOL) released the Retirement Security Rule: Definition of an Investment Advice Fiduciary proposal for its 60-day comment period to the Register, along with amendments to the various Prohibited Transaction Exemption (PTE) regulations. The intent is to expand the definition of whom qualifies as an “Investment Advice Fiduciary” under ERISA, and clarify the standards set forth in PTE regulation. Per the rule proposal’s definition, a Provider is someone whom:
  • Provides investment advice or makes an investment recommendation to a “retirement investor” (i.e., a plan, plan fiduciary, plan participant or beneficiary, individual retirement account (IRA), IRA owner or beneficiary, or IRA fiduciary);
  • Receives a “fee or other compensation, direct or indirect” for the advice or recommendation; and
  • Makes the recommendation in one of the following contexts of a professional relationship where the individual investor would reasonably expect to receive sound investment recommendations that are in their best interest:The provider has discretion over the retirement investor’s investment decisions;
    • The provider makes investment recommendations to investors on a regular basis as part of his, her, or its business, and the recommendation is provided under circumstances that would indicate that the recommendation is based on the retirement investor’s particular needs or circumstances, and 
    • the advice may be relied upon by the retirement investor as a basis for making investment decisions that are in the retirement investor’s best interest; or
  • When making the investment recommendation, the provider acknowledges or represents that they are acting as a fiduciary.
The reason for expansion? The rule doesn’t cover IRAs. The current five-part test to determine if you are an Investment Advice Fiduciary is a Provider whom:
  • Renders advice to the plan as to the value of securities or other property, or make recommendations as to the advisability of investing in, purchasing, or selling securities or other property;
  • On a regular basis;
  • Pursuant to a mutual agreement, arrangement, or understanding with the plan, plan fiduciary or IRA owner, that;
  • The advice will serve as a primary basis for investment decisions with respect to plan or IRA assets, and that;
  • The advice will be individualized based on the particular needs of the plan or IRA. 
With the expansion of the “on a regular basis” item, to cover a Provider’s day-to-day business would effectively capture one-time advice recommendations; i.e whether a retirement investor should roll over their employer-sponsored 401(k) into an IRA, an annuity, or keep his or her assets in the plan. In conjunction with these changes, the DOL will be maintaining core components of the PTE 2020-02. However, this amendment will require additional disclosures to investors, which if adopted may require amendments to Advisor’s client disclosures and policies and procedures. In addition, the proposal includes enhanced language regarding the exemption’s conditions, such as the fiduciary acknowledgment requirement and a new requirement to provide a written statement of the best interest standard of care owed by the investment professional to the investor. PTE 2020-02 would furthermore be expanded to cover certain transactions involving pooled employer plans (PEP) and transactions involving “pure” robo-advice providers. AdvisorAssist will continue to monitor this proposal through its comment period in January and will communicate out further action steps as necessary. No action is needed at this time. Please contact us with any questions regarding this proposal, or your current PTE 2020-02 processes.

November 3, 2023

Investment Advisor Representative Continuing Education


Investment Advisor Representative Continuing Education 

Investment Advisor Representatives (IARs) have their hands full at year end with such items as required minimum distributions, end of year tax loss harvesting, client gifting, annual meetings, and the list goes on! A requirement, introduced in 2020, has added a yearly addition to certain IARs via the NASAA Model Rule on Investment Adviser Representative Continuing Education. Continuing education (CE) is required for every IAR registered in a jurisdiction that adopts the Model Rule. The program applies to all registered IARs of both state-registered and federal covered investment advisers in adopted jurisdictions.

IARs are free to select an approved course provider, along with applicable classes that interest them or align to their business model, so long as the IAR obtains 12 CE credits each year - 6 credits of Products and Practices and 6 credits of Ethics and Professional Responsibility.
IARs have an annual deadline to complete their CE requirement. Should they not complete their CE by December 31st the IAR will pay the registration renewal fee and become “CE Inactive”. This status will allow the IAR to continue doing business, but should the IAR not complete the CE requirement by end of year the IAR will be unable to renew his or her registration and become a status of “Fail to Renew”. If you are CE Inactive, courses completed in the current year will apply to the past year’s deficiency – so you will want to work with your provider and Firm to ensure you are covering prior/current year requirements. IARs should be aware of particular nuances to the Model Rule and CE requirements, which can be reviewed on both the NASAA FAQ and also the Program Handbook:

Newly Registered IARs: Newly registered IARs will be required to meet CE requirements by the end of their first full calendar year following the year in which they first become registered.

IAR Multi-State Registration: An IAR is responsible for the requirements of each state they are registered in during that year, whether it is a home state or additional state, whether they add the in-scope state registration halfway through the year, or whether they withdraw from an in-scope state during the year – requirements apply. For additional considerations regarding in-scope/out-of-scope states, we urge IARs to review the NASAA FAQ for scenario examples, or reach out to state regulators.

Professional Designations: Although there are no exemptions to CE requirements, it would be prudent to work with a provider who can assist IARs in taking classes that cover the requirements for their professional designations and count toward state CE requirements as well.

Dually Registered IARs: Currently, FINRA CE content meets NASAA eligibility to count toward the six credits of Products and Practices credit hours. Dually registered IARs should work with their BD Firm to determine if additional training, such as Annual Firm Element classes, are approved to count toward their completion requirements for IAR CE.

When an IAR completes courses, the vendor/provider reports course completion to FINRA, NASAA’s vendor for program tracking. The responsibility of tracking the vendor/provider’s submission falls on the IAR and regulators urge IARs to open a FinPro account for CE tracking purposes. Advisors can also pull CE reporting through FINRA Gateway to monitor IAR annual completions.

As additional states adopt the Model Rule, CCO’s and other compliance professionals can review the NASAA Investment Advisor Representative Continuing Education training webinar for additional information, or reach out to their AdvisorAssist consultant.

October 26, 2023

Electronic Communications: Trending Fines in the Industry


Electronic Communications: Trending Fines in the Industry

As we head into the holiday season, let’s introduce a small history lesson. On December 3, 1992 the first SMS message was sent from a computer by Neil Papworth, a 22 year old engineer, to a colleague’s phone stating a simple message “Merry Christmas”. Thirty years later, we look at the wide array of communication methods available to us: email, texting, instant messaging, hundreds of applications with messaging capabilities, and video conferencing. The way we communicate is changing every day, but with those changes remain the steadfast rules of this industry - it needs to be maintained, it needs to be preserved, and it needs to be supervised.
“Finance, ultimately, depends on trust. By failing to honor their recordkeeping and books-and-records obligations, the market participants we have charged today have failed to maintain that trust.” Securities and Exchange Commission Chair, Gary Gensler
Over the past two years there has been a resounding increase in violations surrounding the Securities and Exchange Commission's ongoing recordkeeping initiative. The most recent release in September announced another ten firms charged for widespread and longstanding failures to maintain and preserve electronic communications, totalling $79 million in fines and penalties. This news came on the tailwind of August’s release where the SEC charged eleven firms with penalties totaling $289 million. In conjunction with the total fines and penalties from 2022 regarding record-keeping violations, this brings the tally to over $1.8 billion and over 50 enforcement actions. In reviewing these enforcement actions, the commonalities are:

  • Failure to reasonably supervise, with a view to prevent and detect violations of federal securities laws.
  • Failure to maintain and preserve business communications, whether it be internal or external communications.
  • Inadequate policies, procedures, and controls that are compliant and designed to detect and prevent violations.
RIAs have a fiduciary responsibility to their Clients, and recordkeeping has been vital to preserve that integrity. As technology continues to advance, so should the policies and procedures of every RIA to ensure all communications are being maintained. So, how does an Investment Advisor effectively mitigate their risk? Really, an Advisor has two options:
  • The Advisor opts to completely ban the use of personal devices and/or other various off-channel communication applications. Examples of certain control measures that can be put into place regarding this policy are:
    • Written policies and procedures stating that personal devices and other various off-channel communication applications can not be used for business purposes, and have supervised person’s attest to those policies.
    • Enhance review of supervised electronic communications (i.e email) to ensure that off-channel communication is not occurring with clients or members of the firm alike.
    • Provide training for all supervised person’s of the Advisor regarding what is and is not acceptable, and the ramifications for violations.
  • The Advisor opts to allow for the use of text-messaging and other electronic communication methods with appropriate policies and procedures in place. Examples of certain control measures that can be put into place regarding this policy are:
    • Written policies and procedures regarding personal devices and/or electronic communication applications may be utilized on an approved basis by the Chief Compliance Officer.
    • Advisors undergo a due diligence process for vendors they seek to utilize as part of the firm’s communication platform. This includes the reviewing the messaging platform for supervised person use, ensuring there are supervisory capabilities, and understanding the archiving set up.
    • Provide training for the supervised persons who use the platform and compliance reviewers who supervise the platform, and the ramifications for violations.
Advisors in need of a solution, should start with current vendors they utilize to determine if they can bundle their email, social media, website, and texting platforms which, in turn, streamlines supervision and cost as well.

Whether an Advisor allows the activity or not, having the appropriate testing and supervision measures in place is the best line of defense. Effective supervision, due diligence and proper training are key when it comes to mitigating risk. If you are questioning whether your supervised persons are utilizing personal text messaging or emails to communicate with clients, or that your policies, procedures, and controls are inadequate please contact us today!

October 25, 2023

Division of Examinations: 2024 Examination Priorities


Division of Examinations: 2024 Examination Priorities

Each year, the Division of Examinations (“the Division”) of the U.S. Securities and Exchange Commission (“SEC”) publishes its Examination Priorities for the upcoming year. This is the first year the Division has published their priorities to align with the beginning of the fiscal year, with the intent to inform new and current registrants of key risks, trends, and examination topics. Below are the key elements that we believe are of the utmost importance for registered investment advisors. Compliance Programs 
The Division remains focused on Advisors maintaining effective and compliant programs that align with the Advisor’s business model, the corresponding annual reviews that address the effectiveness of the compliance program, and any applicable conflicts related to the Advisor. A typical exam will include a review of program and disclosure documents focusing on such topics as:
  • Custody
  • Valuation
  • Portfolio Management
  • Brokerage and Execution
  • Conflicts of Interest
  • Compliance Issues
  • Supervision and Oversight
  • Compensation  
Currently, the Division has stated the following topics are deemed priority review items during an exam:

Communications and Marketing: It is critically important for Advisors to ensure that they have adopted and implemented written policies and procedures reasonably designed to prevent violations of the Marketing Rule, and have amended their Form ADV to appropriately disclose marketing related information. Advisors should review their current and prospective marketing material to ensure that they can substantiate statements made within their content, and that testimonials/endorsements, third party ratings, and performance advertising align with rule requirements. 

Compensation: The SEC will continue their focus on Advisor’s compensation structures. Examiners will review Advisor’s conflicts of interest and their related client disclosures, as seen in such regulatory initiatives as the Mutual Fund Share Class Sweep and Money Market Fund/Sweep Vehicles Initiative. The concern is whether an Advisor is adhering to their fiduciary obligations when attempting to maximize their revenue through forms of additional compensation via their advice, implementation of investment products, or how fee breakpoints are calculated and processed. 

Valuation: Advisors must ensure that there are compliant policies and procedures for the valuation of illiquid investments, such as commercial real-estate or private placements. When securities are not properly valued it will affect the billing of client assets, and affect performance considerations which can be detrimental and misleading to investors.

Safeguarding Client Information: Due to larger market events, geopolitical concerns, and the proliferation of cybersecurity attacks the Division will focus on Advisor’s policies and procedures (especially Regulations S-P and S-ID), governance practices, and cyber incident responses. Their reviews of policies and procedures will attempt to determine if controls are reasonably designed to safeguard customer records and information, whether the controls are implemented via a third party vendor or the Advisor itself.

Accurate and Timely Regulatory Filings: Regulatory filings, including the Form CRS, must be accurate, complete, and timely.  Client’s must be fully aware of the services, fees, disciplinary history, and conflicts of interest of an Advisor.  If not accurate, this would be deemed misleading.

Lastly, examiners will also be mindful in understanding the Advisors approach to initial and ongoing due diligence for third party vendors, branch oversight, electronic communications, and implementation procedures for material changes of  Advisor’s agreements with clients.

Private Fund Advisors
The SEC will continue their focus on Advisors to Private Funds and their policies and procedures, contractual requirements, calculation and allocation of fees and expenses, and custody. The Division will focus on Fund’s portfolio management techniques, especially when risks are present to the fund, for example inflation or withdrawal rate. Examiners will look for adequate controls, policies, and procedures regarding timely Form PF and Form ADV updates, especially in regard to Private Fund audits by an independent qualified auditor and distribution of Private Fund audited financial statements.

Standards of Conduct
The SEC continues to focus on fundamental principles of fiduciary responsibility and duty to clients. Examiners will evaluate the quality of investment advice provided, particularly in relation to various products and strategies. They will also review the Advisors robustness of their investment processes such as suitability assessments, cost and risk evaluations, and conflict of interest management.

Evaluation of Investment Advice: Examiners will focus on the evaluation of investment advice provided to clients. Specifically the concern around various products, investment strategies, and account types that are considered complex in nature. Complex products like derivatives and leveraged ETFs, high-cost and illiquid options such as variable annuities and non-traded REITs, and unconventional strategies targeting rising interest rates are a sample of mentioned items. There is an expectation that appropriate due diligence is performed before the investment advice is rendered. This allows the Advisor to substantiate the appropriateness of their investment recommendations, especially when considering certain client types such as seniors.
Client’s Best Interest: To ensure appropriateness of investment advice, the Advisor must have a process in place for making initial and ongoing suitability determinations, which should consider best execution, cost and risk evaluation, investment restrictions, and conflict of interest management. Further, the Advisor should adopt policies to evaluate reasonably available alternative products. Determining Client’s best interest should also include how an Advisor handles conflicts of interest by either mitigating or eliminating them.
Compensation Arrangements: Advisors have a fiduciary obligation to be transparent regarding their compensation arrangements with clients and affiliates. Disclosures are required for Advisor’s compensation for services provided to clients, including valuation methods, and alternative compensation arrangements such as cash sweep programs/mutual fund share classes.

Additionally, exams will include reviews of any economic incentives that an Advisor has to recommend products, services, or account types and how that affects investment advice, such as share class selection or proprietary products. This enhances last year’s priority where exams included conflict of interest disclosures and whether the disclosures are sufficient in scope that a client can provide informed consent to the conflict, whether express or implied. The inquiry will focus on whether the firm has tailored and established policies and procedures to identify and periodically review conflicts of interest, in alignment with the Firm’s business model, compensation structure, and product lineup

Crypto Assets and Emerging Financial Technologies

The Division will continue its focus and exams on certain types of investments such as crypto/crypto related products and services, along with emerging financial technology such as mobile apps, robo-advisors, and additional online solutions. Due to recent events in the crypto asset market the Division will continue to monitor and select applicable registrants for examination which will focus on the offer, sale, or recommendation of, advice regarding and trading in crypto or crypto-related assets. Furthermore, the Division will assess the following:

  • The registrants’ requirements under the standards of care in crypto or crypto relates assets
  • Whether the registrant reviews and updates their compliance and risk practices, and disclosures accordingly
  • New or never examined registrants offering crypto or crypto-related assets

In particular, the Division will focus on the tools and methods offered via digital engagements through RIAs:

  • Recommendations being provided via electronic channels such as social media or social trading platforms.
  • Whether representations align with Marketing Rule requirements
  • Are applicable disclosures and controls in place
  • Are recommendations being made in the client’s Best Interest
  • Risks that may be associated with this method of business practice

Please remember that the Division communicates these as PRIORITIES, and should not be relied upon as an all-inclusive list of all focus areas. To read the full report, click here: Division of Examinations 2024 Examination Priorities.

October 5, 2023

When Revenue Becomes a Conflict: Mutual Fund Share Classes & Cash Sweep Programs


When Revenue Becomes a Conflict

Mutual fund share class selection and cash sweep programs are two of the most common forms of revenue sharing, turned into undisclosed conflict of interest, facing the industry over the past few years. After multiple Division self-reporting initiatives, exam sweeps, and enforcement cases, press releases like the AssetMark Inc. case are still hitting the wire…but why?

The most recent SEC order found that AssetMark Inc. agreed to pay over $18 million, of which $8.5 million is to be distributed to harmed investors, because the firm failed to provide full and fair disclosure for several items:

  • AssetMark received economic benefits from assets held in certain no-transaction-fee mutual funds, but it failed to disclose to clients that lower-fee share classes were available, but these share-classes had no payout for AssetMark.
  • AssetMark assisted the affiliate custodian in setting the fee received for operating the cash sweep program, which reduced interest payments to clients.

“Investment advisers have a fundamental duty to disclose conflicts between their own financial interests and those of their clients. Here, AssetMark failed to disclose multiple financial conflicts of interest where AssetMark and its affiliated custodian reaped significant financial benefit from decisions it made.” - Andrew Dean, Co-Chief of the SEC Enforcement Division’s Asset Management Unit

Furthermore, over the past few years the SEC has peppered in several money market sweep vehicle and fund cases where Advisors have failed to disclose revenue sharing related to clients' funds held in cash sweep vehicles, a few examples of which are below:

The SEC’s Share Class Initiative has cumulatively returned well over $125 million to retail clients from Advisors who directly or indirectly received 12b-1 fees for client investments without adequate disclosure, including disclosures that were inconsistent with policies and procedures. At AdvisorAssist, we remind clients that as part of an Advisor's fiduciary duty to clients, Advisors should endeavor to purchase the lowest-cost share class available to clients when recommending a particular mutual fund and maintain policies and procedures which align to the Advisor’s true business practices. AdvisorAssist encourages Advisors to review their mutual fund holdings, whether purchased or transferred in, and if a client is invested in a share class that is potentially not the lowest cost, Advisors need to ensure the firm has proper documentation substantiating why the client is holding the position. Examples of why the holding isn't converted to the lowest share class may include, but are not limited to:
  • Tax implications
  • Dollar-cost averaging
  • It does not meet the minimum investment
  • Investment time horizon
  • The availability of lower share classes at the custodian
When it comes to money market funds or sweep vehicles, similar conflicts exist in regard to revenue sharing and cost to client. Enforcement actions boil down to Advisors choosing money market or cash sweep vehicles when lower or no-cost options were available to clients and where Advisors would not have received any revenue sharing. Also, Advisors breached their fiduciary duty by failing to provide full and fair disclosure of its money market fund selection practices, failing to consider additional funds/vehicles available, and related conflicts of interest to its advisory clients. To that end these Advisors willfully violated Sections 206(2) and 206(4) of the Investment Advisers Act of 1940 and Rule 206(4)-7 thereunder.

An Advisor can not place the Firm’s financial interests ahead of their clients, and regulator’s continue to maintain that if the industry reaps financial benefit from clients – there will be regulatory action. If you have any questions or concerns please contact your consultant to discuss!

September 13, 2023

SEC Marketing Rule Examination Sweep Continues


SEC Marketing Rule Examination Sweep Continues

On September 11th a Press Release from the SEC announced charges against nine Advisors for hypothetical performance advertising violations as part of the SEC’s initial sweep into Marketing Rule Violations. These charges related to promoting hypothetical performance on the Advisor’s websites to the general public without adopting and/or implementing policies and procedures as required by the rule. Additionally, two firms were found to have failed to retain appropriate copies of the advertisements within the Firm’s books and records. All nine firms agreed to settle, were censured, and must pay $850,000 in combined damages. Gurbir Grewal, the SEC’s Director of the Division of Enforcement, emphasized the Commission’s view that hypothetical performance advertising poses an elevated risk to prospective investors, and the importance of firms adopting policies and procedures under the new rule to mitigate this risk. He also made it clear that until the Commission is satisfied that that is the case, they will continue their ongoing sweep to ensure investment advisor’s compliance with the Marketing Rule. AdvisorAssist reminds Advisors that the Marketing Rule is applicable to SEC-registered firms and certain State-registered firms who have adopted it. Under the rule, an Advisor is permitted to include hypothetical performance in an advertisement, provided that the Advisor:

  • Adopts policies and procedures reasonably designed to ensure that the hypothetical performance is relevant to the likely financial situation and investment objectives of the intended audience of the advertisement
  • Provides sufficient information to enable the intended audience to understand the criteria used and assumptions made in calculating the hypothetical performance
  • Provides sufficient information to enable the audience to understand the risks and limitations of using hypothetical performance to make investment decisions.
    • Important Note: Hypothetical performance should only be distributed to clients and/or prospective clients who have access to the resources to independently analyze such information and who have the financial expertise to understand the risks and limitations of such types of presentations.
  • Maintain the relevant data and documentation that supports the hypothetical performance figures presented.

Considering the SEC’s stance on continuing targeted examinations, Advisors are urged to review AdvisorAssists blog post regarding the need for a retrospective review of all marketing pieces, the AdvisorAssist SEC Sample Marketing Exam Request and take advantage of our Mock Examination Services should they have concerns or feel the need to enhance current procedures. This is the tenth hypothetical performance related violation the SEC has released in less than a month, the first which you can review in the AdvisorAssist blog post released in August.

If you have any questions or concerns please contact your consultant to discuss!