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. 

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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.

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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.

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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:

Trust Advisory Group

Cowen Prime Advisors LLC

Cantella & Co., Inc

St. Germain Securities, Inc.

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!

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

 

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

With the release of the SEC Division of Examinations 2023 Examination Priorities, newly registered advisers and other SEC registered investment advisers, undergoing an examination, have begun to receive exam requests from the newest addition to the Division’s core examination review - the Advisers Act Rule 206(4)-1 (Marketing Rule).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. New and existing Advisors, must be prepared to have the Division request these policies and procedures, and request samples of active/currently used client communications pieces along with their corresponding reviews and approvals. On June 8, 2023 the SEC released the Risk Alert: Examinations Focused on Additional Areas of the Adviser Marketing Rule reiterating it’s primary areas of focus during exams:

• Policies and Procedures
• Substantiation Requirement
• Performance client communications Requirements
• Books and Records

“The Division encourages advisers to review their websites and other marketing materials for compliance with the Marketing Rule, including ensuring that they have a reasonable basis for believing they will be able to substantiate material statements of fact and that their performance client communications, including extracted performance and hypothetical performance, complies with the requirements of the Marketing Rule.”

The Staff is also conducting focused examinations, as well as broad reviews, on such topics as Testimonials and Endorsements and Third Party Rankings, Rating, and Awards. Please click here for examples of questions AdvisorAssist has seen during examinations regarding the Marketing Rule. 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. It is imperative that client communications that were approved PRIOR to the rule’s compliance date (or Advisor’s implementation date), do not receive any level of grandfather clause regarding compliance with the Marketing Rule or the Advisor’s newly published policies and procedures.

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. It is imperative that client communications that were approved PRIOR to the rule’s compliance date (or Advisor’s implementation date), do not receive any level of grandfather clause regarding compliance with the Marketing Rule or the Advisor’s newly published policies and procedures.

ACTION ITEMS:

• Compile a list of active/current client communications and re-review content against the standards now set forth within the Marketing Rule,
• Being sure to evidence this review through the Firm’s client communications/marketing review procedures stated within their compliance manuals, and record keep the review accordingly.
• Place an emphasis on enhanced requirements of the rule, such as reviewing their current marketing material to ensure that they can substantiate material statements of fact for such items as testimonials/endorsements, third party ratings, and performance client communications.
• If Advisors can not substantiate the data within their client communications, they should either obtain evidence for substantiation immediately or deactivate that client communication. 
• Keep in mind that active and current client communications can mean your website, social media pages, brochures, stationary, performance marketing, article copies, newsletters, etc.
• Review the advertisement violates any of the general prohibitions, taking into consideration the facts and circumstances of the advertisement, the nature of the audience to which the advertisement is directed, the form and content of the advertisement, and whether the Advisor can substantiate any and all claims within the piece. We urge you to review our Marketing Rule 206(4)-1 General Provisions fact sheet regarding these General Prohibitions.
• Pull all performance marketing, client communications that contain specific investment advice, and any pieces which contain third-party ratings, rankings, and awards as they each have additional review components outside of the general prohibitions.
• Evidence their retrospective review based on their policies and procedures for marketing reviews, being mindful to adequately notate these new rule components into their review and how it aligns with the Advisors implemented policies and procedures. 

Please note, this process will assist the Advisor in adequately answering the ADV questions under 5L. We have included AdvisorAssist’s Marketing Fact Sheets to assist you in this endeavor:

• Marketing Rule 206(4)-1 Performance 
• Marketing Rule 206(4)-1 Testimonials, Endorsements and Third Party Rankings 

AdvisorAssist would like to remind Advisors that it is prudent to ensure the Firm’s process of record keeping is consistent with the requirements of the Advisers Act. The record keeping obligation does not differentiate between various media, including paper and electronic communications, such as emails, instant messages, and other Internet communications that relate to the adviser’s recommendations or advice. As the Division starts its first year of exams with the new Marketing Rule components, and Advisors continue to navigate the Rule and take advantage of its newer components (such as utilizing testimonials and endorsements) AdvisorAssist urges Advisors to keep an eye on the Marketing Rule FAQ for updates. Should you have any questions, please contact your AdvisorAssist Consultant for further information.

 

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SEC Proposes Changes to Regulation S-P to Enhance Protection of Customer Information

    

SEC Proposes Changes to Regulation S-P to Enhance Protection of Customer Information

On March 15, 2023, the SEC announced proposed changes to Regulation S-P, with a comment period to remain open for 60 days and a compliance date of one year from publication. As we monitor the progress of this proposal, we would like to provide you with some critical information on the current rule and this proposal. Regulation S-P Background: Since its original adoption in 2000, Regulation S-P’s intent is to protect the privacy of consumer financial information, but with changing technology and industry changes, including remote work, the SEC believes the regulation is in need of updates. Currently Regulation S-P requires Advisors to notify clients affected by certain types of data breaches that could put clients at risk for identity theft, to implement policies and procedures to protect client data and records, and how to appropriately dispose of consumer report information. 

Click here to learn more about Regulation S-P Enhancements

The New Proposal Enhancements:

Customer Notification: Creating a minimum standard for Advisors to provide data breach notifications - as soon as reasonably possible, but no later than 30 days. 

All affected individuals whose sensitive customer information was or is reasonably likely to have been accessed or used without authorization would need to be notified. 

Incident Response Program: Requiring Advisors to adopt written policies and procedures for an incident response program to address unauthorized access to or use of customer information. 

The program would need to be reasonably designed to detect, respond to, and recover from unauthorized access to or use of customer information with applicable controls in place. These requirements may also be placed on Advisor’s relationships with third party service providers. 

Enhanced Safeguards and Disposal Rule: Creating a synonymous definition of “customer information” across the Safeguard and Disposal rules. 

Customer information would now refer to a record containing “nonpublic personal information”) about “a customer of a financial institution,” whether in paper, electronic or other form that is handled or maintained by the covered institution or on its behalf. This definition would cover nonpublic personal information that a covered institution collects about its own customers and nonpublic personal information it receives from a third party financial institution about customers of that financial institution.

Exemption to the Annual Privacy Delivery: Offering an exemption for Advisors if the firm satisfies two conditions. 

First, the Advisor can only provide nonpublic personal information to nonaffiliated third parties in accordance with the exceptions set forth in Regulation S-P, and

Second, the Advisor cannot have changed its policies and practices with regard to disclosing nonpublic personal information from the most recent delivery of its privacy notice.

Should the proposed rule be adopted by the SEC, Advisors will have a period of time to comply with the rule. AdvisorAssist will work with you to customize your policies as needed to ensure your policies address the final rule..

 

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