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!

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SEC Amends Record-Keeping Requirements for Investment Advisors

 

SEC Amends Record-Keeping Requirements for Investment Advisors

The SEC has made amendments to record-keeping requirements, Rule 275.206(4)-2, for Registered Investment Advisors. The amendments focus on maintaining accurate and up-to-date records of allocations, confirmations, and affirmations (as defined below) related to securities transactions subject to Rule 15c6-2(a). These changes apply universally to registered investment advisors and include provisions for maintaining records electronically. The rule was finalized on May 5, 2023 with the Federal Registrar and has a compliance date of May 28, 2024.

Let's start with the definable terms within the rule language:

Allocation - Refers to how Advisors divide a trade among different client accounts or distribute securities trades made simultaneously.

Confirmation and Affirmation - Refers to message exchanges between the Advisor and Broker-Dealer/Custodian to verify trade details, for accurate settlement of trades executed on behalf of clients/investors. This also includes confirmation of the execution of the trade. 

With these changes, Advisors are now required to archive the following:

• The date and time stamp indicating when the trade allocation and trade affirmation occurred. 
• Details, sent or received, about each confirmation received, any allocation made, and each affirmation.

Securities transactions subject to Rule 15c6-2(a) refers to “All Securities”, with certain exemptions, as follows:

• Exempted Securities (e.g. Private Funds)
• Government Securities
• Municipal Securities
• Commercial Paper
• Bankers’ Acceptances
• Commercial Bills
• Security Based-Swaps

Be on the lookout for communications regarding enhanced policies and procedures, along with industry best practices as we continue to review rule requirements. Please do not hesitate to reach out to your Compliance Consultant should you have any questions.

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SEC Charges Five Advisory Firms for Custody Rule Violations

  

SEC Charges Five Advisory Firms for Custody Rule Violations

On September 5, 2023, the SEC announced Custody Rule related charges against five investment advisers, with fines totalling more than $500,000. These charges come on the tailwind of the 2022 charges of nine investment advisers, with fines totalling more than $1 million. According to the order, the firm’s failed to do one or more of the following:

• Have audits performed
• Deliver audited financials to investors in a timely manner
• Ensure a qualified custodian maintains client assets
• Failure to disclose custody, and amend ADV information accordingly

“The Custody Rule and the associated Form ADV reporting obligations are core to investor protection,” said Andrew Dean, Co-Chief of the SEC Enforcement Division’s Asset Management Unit. “We will continue to ensure that private fund advisers meet their obligations to secure client assets.”

AdvisorAssist reminds their clients of their obligations concerning custody. An Advisor may be deemed to have custody when:

• A Supervised Person of an Advisor is appointed as executor, conservator, or trustee for an estate, conservatorship, or personal trust or have power of attorney for a client unless, the appointment of these roles is through familial obligation or through a personal relationship, and not as a result of employment with an advisor.
• An Investment Advisor Representative or Supervised Persons maintains client personal login credentials.
• An Advisor has check writing or discretionary money movement authority to third parties. However, and Advisor may not be subject to the independent, surprise examination requirement of the custody rule, for standing letters of authorization to third parties, provided the standing instructions meet the seven conditions test, per the February 17, 2017 No-Action Letter .
• If you are an Advisor to a private fund, you are deemed to have custody of the fund's assets. As such, the fund[s] must be audited annually by an independent public accountant registered with the Public Company Accounting Oversight Board (PCAOB), where audited financials must be delivered to investors within 120 days of the fiscal year end (180 days for fund of funds).

Generally, a registered investment advisor who is deemed to have custody of retail client assets will be required to maintain these assets as a "qualified custodian." Further, they must ensure that the Qualified Custodian is delivering statements to the client on an at least quarterly basis.

Should a firm touch upon any of the stated items related to custody, it is imperative that they reach out to their AdvisorAssist consultant for further assistance.

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Securities and Exchange Commission Adopts Final Rules for Private Funds

  

Securities and Exchange Commission Adopts Final Rules for Private Funds

The U.S. Securities and Exchange Commission (SEC) has implemented significant reforms aimed at enhancing the regulation of private fund advisors to safeguard the interests of investors and maintain the integrity of financial markets. These new rules address certain practices that could pose risks and harm to investors and private funds, ensuring greater transparency and protection for those who invest directly or indirectly in private funds.

Key Requirements:

• Quarterly Statements: Private fund advisors, registered with the SEC, will be required to provide investors with quarterly statements. These statements will detail information about private fund performance, fees, expenses, and compensation paid to the advisor.
• Private Fund Audits: Registered private fund advisors must arrange for annual financial statement audits for the funds they advise. This measure aims to ensure accurate valuation of private fund assets and prevent misappropriation.
• Advisor-Led Secondaries: When offering existing fund investors options to sell or convert their interests, advisors must obtain a fairness or valuation opinion. Additionally, advisors must disclose any significant business relationships related to these transactions.
• Restricted Activities: Restrictions are in place for private fund advisors from engaging in activities that conflict with investor interests, including charging certain fees without disclosure and consent from investors, allocating regulatory expenses to the fund, and reducing clawback amounts.
• Preferential Treatment: Advisors are prohibited from offering preferential terms to certain investors regarding redemptions or portfolio information. Exemptions may apply, where preferential treatment must be disclosed to all investors.
• Compliance Documentation: Private fund advisors must document their annual compliance reviews in writing. This will help assess adherence to rules and identify potential compliance weaknesses

Although the rule has been finalized, advisors have some time before they are required to adhere to these new rules. Below is the implementation timeline:

• Private Fund Audit Rule and Quarterly Statement Rule: Compliance is required in ~18 months
• Advisor-Led Secondaries Rule, Preferential Treatment Rule, and Restricted Activities Rule for advisors with more than $1.5 billion AUM: Compliance is required in ~12 months
• Advisor-Led Secondaries Rule, Preferential Treatment Rule, and Restricted Activities Rule for advisors with less than $1.5 billion AUM: Compliance required ~18 months

AdvisorAssist is closely monitoring industry best practices, interpretations, and any additional guidance the SEC may provide. We anticipate more clarity from the SEC as feedback comes in, and have begun the process to fully analyze and formulate guidance to help ensure adherence to the new private fund rule if they apply to your firm. Please reach out anytime if you need assistance or have questions in the meantime.

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Misrepresentations in Hypothetical Performance Leads to SEC’s First Marketing Rule Enforcement Case

  

Misrepresentations in Hypothetical Performance Leads to SEC’s First Marketing Rule Enforcement Case

FAQs, Risk Alerts, and press releases can provide valuable insight into the SEC’s thought process on rule language, maybe even more so than the rule itself. On August 21, 2023, the SEC announced its first violation of 206(4)-1 The Marketing Rule, in a case that also touches other hot button industry items. The SEC found that Titan Global Capital Management USA LLC (Titan), used misleading hypothetical performance metrics in advertisements, and had several other compliance failures, leading to fines totaling $192,454 in disgorgement and an $850,000 civil penalty for affected clients. From August 2021 to October 2022, Titan made misleading statements on their website regarding the Advisor’s hypothetical performance. These statements included annualized performance yielding a high mark of 2,700% for their crypto strategy. These results did not disclose material information, such as the fact that the annualized projections assumed performance based on the first three weeks of the strategies performance data, nor taking into light economic/market conditions, or other applicable risk factors. AdvisorAssist has engaged with Sean P. Gilligan CFA, CPA, CIPM, Managing Partner of Longs Peak Advisory Services, as an industry expert and provider of guidance with GIPS compliance and investment performance measurement, analysis, and reporting to comment on some key data points of this case:

“Periods less than a year should never be annualized. This has always been a requirement under the GIPS standards, but even without being a GIPS compliant Advisor, I think most SEC examiners would have considered this to be misleading - even prior to the new Marketing Rule. Then you add in such a volatile and risky asset like crypto, where repeating a return earned over 3 week period for an entire year, would not be a likely scenario.”

Furthermore, Titan failed to adopt and implement the required policies and procedures regarding the Marketing Rule:

“Having policies and procedures to determine who can receive hypothetical performance is one of the key updates made clear in the new marketing rule.” said Gilligan, “When working with firms that want to use hypothetical performance, we always emphasize the importance of having these policies and to limit the distribution to only those that can reasonably be expected to understand what they are presenting.”

AdvisorAssist has guided on the importance of a retrospective review of Advisor’s active client communications in our recent blog post, and stressed how regulatory examinations are focused on components of the Marketing Rule by providing sample request letters to clients.

As a reminder, an Advisor should treat any form of communication to Clients that is designed to solicit or maintain advisory service (“Client Communications”) as covered by regulations under Securities Laws. This includes written communications on a one-to-one basis to existing, or prospective, advisory Clients designed to offer advisory services, or maintain the existing Client, are subject to the general prohibitions under the Marketing Rule.

In conjunction with adopting applicable policies and procedures, as Mr. Gilligan stated above, it is imperative that the discloses for all client communications all relevant criteria used and assumptions made in calculating the hypothetical performance, and discloses sufficient information to allow the intended audience to understand the risks and limitations associated with hypothetical performance.

AdvisorAssist can support you with questions you may have regarding your current performance advertising and/or Marketing Rule policies and procedures. Please contact us today!

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SEC Rule Proposal: Conflicts of Interest Associated with the Use of Predictive Data Analytics by Broker Dealers and Investment Advisers

 

SEC Rule Proposal: Conflicts of Interest Associated with the Use of Predictive Data Analytics by Broker Dealers and Investment Advisers

The financial sector has been speculating at guidance regarding the use of AI technology, and on July 26, 2023 the SEC stepped forward with their rule proposal on the use of predicative data analytics and these technological advancements. Although these systems can be optimized for investor interests, if not properly supervised, these technologies can effectively cause conflicts to arise and harm the end investor. The proposal defines these technologies as a “covered technology”, used in a firm’s engagement or communication with an investor/prospect:

“Any analytical, technological, or computational functions, algorithms, models, correlation matrices, or similar methods or processes that optimize for, predict, guide, forecast, or direct investment-related behaviors or outcomes of an investor. “

Per the proposal, if an Advisor uses, or may foreseeably use, a covered technology during client interactions the Advisor must:

• Evaluate and identify any conflict of interest associated with the use of covered technology in investor interactions, and determine whether any conflict of interests exists that place the firm’s or its associated person’s interest ahead of investors’ interests.
• Eliminate or neutralize the effect of conflicts of interest if discovered.
• Have written policies and procedures reasonably designed to prevent violations of the rule.
• Adhere to record-keeping requirements of the rule.

AdvisorAssist will continue to monitor this proposal as it goes through its comment period. Should you have any questions, please contact your AdvisorAssist Consultant for further information.

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