The AdvisorAssist CCO Series: Books & Records

Books and records compliance for registered investment advisers is one of those activities that can be as simple or as difficult as one chooses to make it.

Admittedly, it does take some time and know-how to understand exactly must be maintained. But if you think about it, each of these records are really just outputted from a well-managed firm (e.g. financial statements, communication tracking, version-controlled document storage). By and large, each requirement has a purpose behind it that will help you manage your firm in a more effective and risk-managed manner.

So if you approach records retention not as a compliance requirement but as a result of sound business management, you will be amazed by how it can be simplified, while at the same time improving the effectiveness of how your firm is run.

Investment Advisor Books and Records In a Nutshell

Investment advisors are expected to make and keep true, accurate and current books and records relating to its investment advisory business. The overarching objective behind these requirements is the protection of your clients and the general public. Regulators expect advisors to be able to produce any information that may be used to substantiate their finances, support the decisions behind all of the decisions they make on behalf of their clients, and validate that they are always adhering to their fiduciary duty.

The records that advisors must maintain fall into these general categories: Compliance Program, Client Management, Trading, Marketing, and Business Management. The majority of these must be maintained by all advisors, but there are a number that depends on your specific business practices (e.g. soft dollar usage, proxy voting, custody, government-related clients, use of solicitors).
For reference, here is a link for the complete books and records requirements for investment advisors. Click Here.

Most records have a prescribed retention duration of five years (the most recent two of which must be on-site or accessible from your office). Some records must be retained for longer periods of time, or indefinitely. For example, an advertisement for a one-time event must be kept for 5 years from the date of the event (it's last use) and a Client Agreement (while the client is active) must be kept as long as you have this client under this agreement. And then you must keep for at least 5 more years.

Thankfully, regulators allow for records to be maintained electronically using cloud-based storage. When doing so, advisors must demonstrate their ability to reasonably safeguard them from loss, alteration or destruction and to prevent unauthorized access from individuals outside your firm. Scanning and storing hard copies is fine as well, as long you can attest that the retrieved record is legible, complete and true.

Through the Regulator's Eyes

It's helpful to keep in mind that the purpose of advisor records retention is to protect the general public, including your clients. Regulators expect you to be able to produce any information that may be used to substantiate your finances, support the decisions made on behalf of your clients, and validate that you are always adhering to your fiduciary duty.

Thinking through an example of a client complaint sometimes helps reveal the regulators' logic. Regulators are obliged to respond to every complaint lodged against an advisor. When doing so, they will likely want to see the documentation of everything that client received from you (historical versions of your ADV, marketing collateral), nature of the relationship (client agreement), any interim communications (client communications log), and any supporting documentation for your investment decisions.

A complete set of records will allow you to produce this history quickly and efficiently so that the regulator can come to a swift resolution.

State regulators have stepped up "books and records" examinations, especially with newly-registered advisors. Their objective is to assess not only the ability to produce these records but also the business practices that surround them. If they perceive sloppiness or indifference, they come back for a more complete examination.

CCO Best Practices

• Create an "inventory list" that includes all books and records requirements. Then, mark off those which pertain to your particular business model and practices. For example, your inventory list will include proxy voting records, but if you don't vote proxies, mark it as "NA". This way you are demonstrating that you understand that proxy voting records should be maintained, but since your agreements and ADV state that you don't, this doesn't apply.
• Don't approach records retention as a "compliance chore". The path of least resistance in the long term is to incorporate these responsibilities into your everyday activities. For instance, your client on-boarding process should include each of the activities and documents needed for compliance retention. If you are using your CRM religiously, you can be confident that all client communications are archived in an easily accessible manner as well.
• Be wary of over-reliance on third-party generated records. Your portfolio management system may not store all of the order ticket and confirmation data you need to pass muster with a regulator.
• Remain mindful of regulatory "hot spots". Hot spots include advertising (review and archiving), email/social media archiving, security of electronic storage, and documented investment decision making.
• Pay particular attention to your firm's "high risk" areas. These may include trade allocation procedures, social media advertising, soft dollars, or any area where there is a disclosed conflict of interest.
• Conduct (and document) annual due diligence on cloud storage vendors to ensure that they have appropriate physical, electronic and procedural safeguards in place to secure your data.

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Department of Labor Fiduciary Rule: Webinar Q&A

Last week, Advisors4Advisors (A4A) hosted a webinar on the DOL Fiduciary Rule change presented by members of the AdvisorAssist team. You must be a paying A4A member ($60 annually) to attend webinars, view replays, and receive CPA, CFP or IMCA CE credit. Click here for information on joining A4A, and Click here to access the webinar replay.

The following questions were raised after the webiar about the new DOL Fiduciary Rule. We cover the DOL Fiduciary Rule in more detail in a previous post

1. In RIA with Rollover, since AUM increases, but fees decrease or services increase then are you a conflict? Trusted advisor is increasing income, but client getting something for it.

A: This question seems to be asking when an Advisor is managing a client’s retirement plan assets and recommends a rollover to another vehicle, such as an IRA, since the Advisor’s assets under management (AUM) will increase but overall fees paid by the client will decrease, or services received by the client increase, then are you in a conflict? The Advisor’s compensation is increasing but the client getting something for it.

The recommendation of a rollover creates a potential for a conflict of interest. Therefore, the Advisor making the recommendation should document with the client why the rollover is in the client’s best interest. The fact that overall fees paid by the client will decrease, or services received by the client will increase with the rollover are good reason why the rollover is in the client’s best interest and therefore, should documented in the client’s profile and if it is not already in the client agreement, the client should receive notice that the Advisor is a fiduciary acting in the client’s best interest.

The definition goes on to explain what constitutes a “recommendation” and what may be excluded from that definition, such as providing certain services or information regarding the plan or IRA, such as marketing or making available to a plan fiduciary a platform or similar mechanism where the plan fiduciary may select or monitor investment alternatives; identifying investment alternatives that meet objective criteria specified by the plan fiduciary; providing objective financial data and comparisons with independent benchmarks to the plan fiduciary.

2. If an Advisor recommends that a client rollover from a 401(k), hence increasing the Advisor’s AUM and the client’s fees (regardless of investment), does not that create a conflict of interest?

A: Correct, the recommendation of a rollover creates a potential for a conflict of interest. Therefore the Advisor making the recommendation should document why the rollover is in the client’s best interest.

3. How do you get the expenses of the 401(k) that the employee was paying?

A: Clients should be able to produce documentation regarding the expenses that they are currently paying for their 401(k) plan. The Advisor will want to collect the current fee structure of their client’s 401(k) plan as a factor in making an informed recommendation about why any rollover from that plan is in the client’s best interest.

4. How do we get the expenses of the 401(k) to the client?

A: If you are trying to obtain information about a client’s 401(k) you should contact the plan sponsor. However, this question seems to be asking how do Advisors ensure they are not responsible for the expenses of a client’s 401(k).

Unless an Advisor is engaging clients in a “wrap fee” program, where the client pays a single advisory fee for the management and services of their account including custodian and brokerage fees, then the clients should be responsible for paying expenses related to the management of their account. Advisors should ensure that their client agreements and Form ADV Part 2A, Item 5(C) fully and accurately disclose which party is responsible for fees related to the account management.

Although an RIA may not be compensated by a commission or revenue sharing, Form ADV requires disclosure to clients regarding potential conflicts and compensation arrangements. Hybrid advisors receiving commission compensation will want to ensure they are satisfying the BICE. Therefore as a best practice we recommend that even firms without commission or revenue sharing fees should provide notice to retirement clients that they are providing their services in the client's best interest to uphold their fiduciary duty and review and update disclosures of any potential conflict of interest. This will ensure that you are availing your firm of the BICE and creating a presumption of compliance with the Rule.

5. If I'm an RIA and already a fiduciary, and serve ERISA qualified plans as a 3(21) advisor and 3(38) manager capacity, and already have level fees fully disclosed and transparent within Advisory Agreements. (408b2 compliant), how am I really impacted by the DOL Rule? The only thing I've read is needing to document rollovers if I will get compensated for the rollover into an IRA (versus keeping funds in a 401k Plan, for instance) - which I already do to some degree.

A: Correct. The ongoing receipt of a Level Fee such as a fixed percentage of the value of a customer’s assets under management, where such values are determined by readily available independent sources or independent valuations, typically would not raise prohibited transaction concerns for the Advisor.

Under these circumstances, the compensation amount depends solely on the value of the investments in a client account, and ordinarily the interests of the Advisor in making prudent investment recommendations, which could have an effect on compensation received, are aligned with the Retirement Investor’s interests in increasing and protecting account investments. However, there is a conflict of interest when an Advisor recommends that a participant roll money out of a plan into a fee-based account that will generate ongoing fees for the Advisor that he would not otherwise receive, even if the fees going-forward do not vary with the assets recommended or invested.

As stated in question 1, for a level fee fiduciary to recommend a rollover the Advisor should document information supporting the recommendation in the client’s profile. Additionally, if it is not already in the client agreement, the client should receive notice that the Advisor is a fiduciary acting in the client’s best interest. It is our view that this written notice can also be communicated to the client via Form ADV.

6. Are there any best practices yet regarding the type of disclosure of the compensation arrangement and conflicts of interest (slide 13) - which I already disclose in our Firm's ADV?

A: The best practices regarding disclosure of compensation arrangement and conflicts of interest will evolve as we get closer to the full implementation date of this rule, January 1, 2018. That being said, if you are not a level fee Advisor and seeking to make use of the Best Interest Contract Exemption you will want compensation arrangements and conflicts of interest disclosed in a separate Best Interest Contract or as an addition to existing agreements along with the other requirements of the Best Interest Contract Exemption.

Also in the preamble to the final rule, the Department of Labor recommended the creation of web disclosure, which they state should contain: A schedule of typical account or contract fees and service charges, and a list of product manufacturers with whom arrangements have been made to provide payments to the Advisor, including whether the arrangements impact Advisor compensation. The DOL also suggests disclosure of the business model and the Material Conflicts of Interest, including payout grids and non-cash compensation and rewards.

7. Not sure if you covered this.... what about my existing clients that generate trails?

A: At this time we do not believe that trail compensation from commission transactions based on prior recommendations would be relevant to the DOL Rule change. If it is in the client’s best interest to transition those assets to another vehicle, or if a new recommendation that would involve a commission trail should arise, those would be relevant to your compliance for your fiduciary duty and the DOL fiduciary rule, respectively.

8a. [Is there a] Conflict if [a] Fee Only RIA is NOT advisor to the qualified plan but solicits retiree to rollover to IRA? (the value added is RIA gives advise (sic) whereas existing qualified plan does not give that advice.

A: The recommendation of a rollover of retirement plan assets creates a potential for a conflict of interest. Therefore, the Advisor making the recommendation should document why the rollover is in the client’s best interest. Advisors should also be aware if any of their solicitors are making such recommendations and ensure they have documentation to support the recommendation. The statement that the IRA has more options available to it for investment, and therefore more opportunity for different strategies by means of advisory services from the RIA, can be given by the Advisor that the rollover may be in the client’s best interest given the full profile of the client.

8b. Does DOL recognize that distinction?

A: Yes. The DOL Fiduciary Rule would consider you to be a Level Fee Advisor.

8c. Am I giving client that disclosure or just adding to my ADV and client file?

A: Form ADV should be completely and accurately disclosing fees charged by the Advisor in Item 5, and any other compensation received in Item 14. Advisors are typically required to deliver Form ADV to all new clients, and existing clients annually or upon a material change. The DOL Fiduciary Rule would require full disclosure of all fees related to a client’s retirement plan assets when certain recommendations are made, such as a rollover.

9. Are [these] rules [applying] to discount brokers or robo advisors?

A: The DOL Fiduciary Rule applies to anyone making the recommendations to clients in qualified plans for a fee. ERISA contains an exemption to prohibited transactions in section 408(b)(14) that covers robo-advisors and is available for robo-advice involving prohibited transactions if its conditions are satisfied. However, robo-advisors that are Level Fee Fiduciaries may rely on the Best Interest Contract Exemption with respect to investment advice to engage the robo-advice provider for advisory or investment management services for Plan or IRA assets, provided they comply with the conditions applicable to Level Fee Fiduciaries, as discussed in question 1 above.

10a. Doesn't the rule impose a significant burden on the fee only RIA to know the fees charged in the 401(k)? Sometimes is it very hard to find this out fully. Clients don't always provide this information and it is not always correct.

A: The new rule sets forth a requirement for certain information when making a recommendation to Retirement Investors. It requires that the Advisor, when providing investment advice to the Retirement Investor, that at the time of the recommendation, such advice reflects the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims, based on the investment objectives, risk tolerance, financial circumstances, and needs of the Retirement Investor. Therefore, we would recommend performing all the necessary due diligence, whether with the client or directly with the plan sponsor of the client’s 401(k) in order to substantiate the recommendation(s) made, including current fee structure on 401(k) plans affected by the advice.

10b. Since we have no access to the 401(k), how do you confirm the information?

A: As stated in question 10a above, due diligence requirements should include gathering information from all sources available including contacting the sponsor of the plan, if needed.

11a. What do you mean by "level fee" advisor?

A: Level fee advisors are those that meet the definition of a level fee fiduciary by receiving the same compensation regardless of the particular investments the client makes, whether based on a fixed percentage of assets under management or a fixed dollar fee.

The full definition of a Level Fee Fiduciary is located in Section VIII(h) of the Best Interest Contract Exemption Final Rule

11b. Are you talking about an AUM %? or something else?

A: An Advisor whose compensation is based on the client’s assets under management would be an example of a Level Fee Fiduciary for the purposes of the DOL Fiduciary Rule.

12. Does the ADV Part II provide adequate disclosure for fee only RIAs?

A: It is our view that this written disclosure can also be communicated to the client via Form ADV.

13. Would an RIA be considered a level fee fiduciary if they charge differently for equities/bonds/cash?

A: Based on the definition of Level Fee Fiduciary above that does not sound like it would meet the requirements for the purposes of the DOL Fiduciary Rule since the Advisor would receive different compensation depending on what investments were made.

Contributors:
Brendan Furey
Michael Conlon

Analyzing the Department of Labor Fiduciary Rule

The revised Department of Labor (DOL) fiduciary rule (Rule) was published in its final form in the Federal Register and can be accessed by clicking this link. Although effective starting June 7th, 2016 the DOL has granted time for affected service providers of retirement plans to adjust to fiduciary status and partial compliance is not required until April 10, 2017 with full compliance required by January 1, 2018.

The focus here is determining if fiduciary status applies to your firm based on the advice provided to retirement plans or participants, what exemptions may apply, and what steps must be taken to maintain compliance.

Definition of Fiduciary

Under the Rule a fiduciary will now include a person providing investment advice regarding money or property within the plan for a fee or other compensation, directly or indirectly, to a plan, plan participant or beneficiary, IRA or IRA owner. Investment advice relevant to this definition include the following:

1. A recommendation as to the advisability of acquiring, holding, disposing of, or exchanging, securities or other investment property, or a recommendation as to how securities or other investment property should be invested after the securities or other investment property are rolled over, transferred, or distributed from the plan or IRA;
2. A recommendation as to the management of securities or other investment property, including, among other things, recommendations on investment policies or strategies, portfolio composition, selection of other persons to provide investment advice or investment management services, selection of investment account arrangements (e.g., brokerage versus advisory); or recommendations with respect to rollovers, transfers, or distributions from a plan or IRA, including whether, in what amount, in what form, and to what destination such a rollover, transfer, or distribution should be made; and
3. The investment advice is made, directly or indirectly (through an affiliate), by a person who:
1. Represents or acknowledges that it is acting as a fiduciary within the meaning of the ERISA or the IRS Code;
2. Renders the advice pursuant to a written or verbal agreement, arrangement, or understanding that the advice is based on the particular needs of the advice recipient; or
3. Directs the advice to a specific advice recipient or recipients regarding the advisability of a particular investment or management decision with respect to securities or other investment property of the plan or IRA.

The definition goes on to explain what constitutes a “recommendation” and what may be excluded from that definition, such as providing certain services or information regarding the plan or IRA, such as marketing or making available to a plan fiduciary a platform or similar mechanism where the plan fiduciary may select or monitor investment alternatives; identifying investment alternatives that meet objective criteria specified by the plan fiduciary; providing objective financial data and comparisons with independent benchmarks to the plan fiduciary.

The definition also clarifies that an advisor is not a fiduciary when providing advice to an independent person who is a fiduciary of a plan or IRA, if that fiduciary is a bank, insurance carrier, registered investment adviser, broker-dealer, or other person that holds or has assets under management of at least $50 million. This means the old definition has been expanded to focus on advice given to IRA owners and people rolling over their employer sponsored plan (e.g., 401(k) account) into an IRA. Finally, education and general marketing materials that a reasonable person would not view as investment recommendations are not included in the definition of retirement investment advice, so advisors may continue to provide general materials on retirement saving without triggering fiduciary duties.

As a fiduciary, an advisor must adhere to a “best interest” standard for a client, rather than a “suitability” standard for an investment product. Therefore, an advisor cannot receive fees that could be seen as creating conflicts of interest (i.e. commission or revenue-sharing), unless a qualified exemption applies.

Best Interest Contract Exemption (BICE) and Impartial Conduct Standards

This exemption, published at this link, provides relief for compensation, such as commissions and revenue sharing, that an advisor and the advisor’s employing firm might receive in connection with investment advice to retail retirement investors. The BICE requires financial institutions and advisors to acknowledge fiduciary status for itself and its advisors, adhere to basic standards of impartial conduct by giving prudent advice in the client’s best interest, avoid misleading statements, and receive only reasonable compensation. Additionally, financial institutions must adopt policies and procedures reasonably designed to mitigate any harmful impact of conflicts of interest, disclose basic information about their conflicts of interest and the cost of their advice. Level Fee fiduciaries are subject to more streamlined conditions.

Principal Transactions Exemption

The other main exemption from the Rule is the Principal Transactions Exemption, published at this link, which permits advisors to sell or purchase certain debt securities and other investments out of their own inventories to or from plans and IRA owners. The exemption applies even though this transaction results in payment to the advisor. However, similar to the BIC exemption, the advisor must adhere to Impartial Conduct Standards and disclose to the client any conflicts of interest in order to make use of the exemption.

How should a Chief Compliance Officer respond to the Rule?

In all cases, the advisor will want to retain documentation of compliance with this new rule, including contracts, policies, procedures, and disclosures, to support your Books & Record requirements. However, there are no additional record retention requirements for detailed data on inflows, outflows, holdings, and returns for retirement plan or IRA clients.

Chief Compliance Officers should review the information in their Form ADV Part 2A and client agreements to determine whether or not they are acting as a fiduciary based on the recommendations provided to clients regarding retirement plans, participants, beneficiaries or IRAs, and ensuring that their client agreements and ADV contains all disclosures required by the Rule regarding conflicts of interest and compensation arrangements, including a statement as to whether or not they are a fiduciary.

Although an RIA may not be compensated by a commission or revenue sharing, Form ADV requires disclosure to clients regarding potential conflicts and compensation arrangements. Hybrid advisors receiving commission compensation will want to ensure they are satisfying the BICE. Therefore as a best practice we recommend that even firms without commission or revenue sharing fees should provide notice to retirement clients that they are providing their services in the client's best interest to uphold their fiduciary duty and review and update disclosures of any potential conflict of interest. This will ensure that you are availing your firm of the BICE and creating a presumption of compliance with the Rule.

Contributors:
Brendan Furey
Michael Conlon

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The AdvisorAssist CCO Series: Section 13 Filings

Source: Wikipedia

Along with maintaing a clear understanding of the Investment Advisers Act of 1940, chief compliance officers of RIA firms should also have a working knowledge of a handful of rules under the Securities Exchange Act of 1934. Section 13 filings (specifically, 13f, 13d, 13g and 13h) are among these. While the nature of these filings are applicable to larger RIA firms, we recommend that every RIA's compliance manual reference these rules so that you can demonstrate to regulators that you understand them and that you are aware of the types of events that may necessitate these filings.

Section 13(f), 13(h), 13(g) and 13(d) In a Nutshell

Advisors that have any form of significant control over certain publicly-traded securities must report details of these holdings so that regulators, issuers and exchanges can monitor any concentrated positions among market participants.

For Form 13F filing purposes, the SEC maintains a quarterly list of "13F Securities" that can be found here. Note that this list includes exchange-traded funds (ETF) as well.

A copy of SEC Form 13f can be found here.

It is also important that advisors understand the definition of "beneficial ownership." Beneficial ownership occurs when your firm has (or shares):

• Power to either vote or direct the voting of proxies
• Power to dispose of or direct the disposition of a security

Through the Regulator's Eyes

One of the primary charges of securities regulators is to maintain orderly and transparent markets. As fiduciaries and participants in regulated securities markets, RIA firms are expected to disclose and report any of their security positions to assist regulators, issuers and exchanges to maintain orderly markets and monitor trading activity that could influence security prices or control over issuers.

CCO Best Practices

• For registered investment advisors that are required to (or could potentially trigger the need to) make Section 13 filings, incorporate these deadlines into your compliance calendar.
• For small registered investment advisors, be sure that these rules are incorporated into your compliance manual so that you can demonstrate to regulators your awareness of the rules.
• Where possible, develop rules, reports or workflows in your portfolio management so that you can monitor (either pre- or post-trade) positions that must be filed.
• At least once a year, perform a test using your trade blotter to ensure that all filing requirements have been fulfilled. Document this testing so regulators can see that you have proper controls in place.

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

Brian Lauzon

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A Regulatory AUM Primer for RIAs

The SEC and states are aggressively reviewing the reported regulatory AUM of advisors. Calculating your regulatory AUM (“RAUM”) under this new definition often requires a close inspection of the service you are providing, the role you play for clients, and how you receive compensation

The SEC (and states) define “regulatory assets under management” as assets where the advisor provides “continuous and regular supervisory or management services.” Here are some guidelines to help you determine which of your clients’ assets should be counted towards your RAUM under this new definition.

1. How do you describe your services in advisory agreements?
If your advisory agreement for a particular client indicates that you provide ongoing management services, this suggests that these assets should be counted towards “regulatory AUM.” But before doing so, advisors should read on to be certain.
2. How are you compensated for your advisory services?
If your advisory fees are calculated based on your client’s average market value over a specific time period, this suggests continuous and regular supervisory or management services. Other advisory fee arrangements, however, would suggest otherwise. For example:
• Time-based. If your advisory fee is based on the amount of time spent with a client
• Project-based. If you charge a one-time financial planning fee based on the assets covered under a plan
3. How do you manage your clients’ assets?
In the following instances you would likely count these assets as regulatory AUM:
• If you have discretionary authority to allocate client assets among third-party asset managers
• If you allocate client assets to other managers (as a “manager of managers”), but only if you have discretion to hire and fire these managers and/or reallocate among these managers or if you recommend that clients hire/fire or reallocate among managers.
• If you do not have discretionary authority (but otherwise satisfy the definition of “continuous and regular supervisory or management services”) and provide recommendations to your clients on their holdings, you should count these assets as regulatory AUM if you are responsible for arranging or effecting transactions after your client accepts your recommendations.

The key here is the extent to which you monitor your client’s portfolios, needs and objectives. Infrequent rebalancing or trading (in and of itself) does not necessarily mean that your advisory services are not “continuous and regular.” According to the SEC, you do not provide continuous and regular supervisory or management services for clients where you provide:

• Market timing recommendations (but have no ongoing management responsibilities)
• Impersonal investment advice (like a newsletter)
• Guidance on an initial asset allocation (without continuous and regular monitoring and reallocation)
• Advice on an intermittent or periodic basis (i.e. upon client request, in response to a market event, or just at pre-specified points in time, like quarterly or annual reviews, or employee education seminars for defined contribution plans)

What about “held away” accounts?
Accounts that are “held away” follow the same logic. If you provide “continuous and ongoing” services for these accounts (and your advisory agreements and services are consistent with the tests noted here) then they may be counted towards regulatory AUM. This includes situations where you serve as a 3(21) or 3(38) fiduciary on ERISA (e.g. 401(k) or other defined contribution plans) assets. If you provide plan-level recommendations or are charged with implementing changes to the plan, you should count these towards your regulatory AUM.

Brian Lauzon

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Top 10 AdvisorAssist Blog Posts from 2012

Here's some weekend reading: Top ten most popular AdvisorAssist Blog Posts from 2012.

Happy new year and thank you for following us!

SEC Announces "Presence Exams" for New RIAs

RIA Technology "Integration" Can Mean Many Things

Advisory Boards Bring the "Wisdom of Crowds" into Your Practice

Trends that will drive content marketing into your RIA's Marketing Plan

Cloud Computing for RIAs

"Regulatory Assets Under Management" Defined

RIA Key Person Risk: What are the options?

Regulators are Looking at the Accuracy of Advisors' AUM

Close the Perception-Reality Gap with Effective Client Surveys

A Business Model Structure to Help Advisors Manage Their Practices

Brian Lauzon

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Why you should run your business like it's for sale (even if it isn't)

The topic of RIA "enterprise value" is becoming increasingly mainstream throughout our industry.

What are the drivers of enterprise value and what can be done in the near term to improve the value that could potentially be placed on your RIA?

Hint:  All of the factors that potential acquirers expect or value are the same as those that will benefit your firm’s owners and employees today.

Check out our latest WealthManagement.com article here to learn more.

Brian Lauzon

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SEC Announces "Presence Exams" for New RIAs

In a recent letter sent to newly-registered RIAs, the U.S. Securities and Exchange Commission (SEC) has announced the roll out of its new National Exam Program ("NEP"). The NEP is a new two-year initiative to conduct "focused", "risk-based" examinations of newly registered advisory firms that manage private funds (e.g. hedge funds, private equity funds).

A copy of the SEC letter can be found here.

These examinations may cover any area of your firm's compliance obligations but will initially focus on the following topics that are deemed to be high risk:

• Marketing
• Portfolio Management
• Conflicts of Interest
• Safety of Client Assets
• Valuation

The NEP initiative will be rolled out in three phases:

1. Engagement Phase.  The NEP will inform registered firms about their obligations, provide outreach resources that are geared towards educating advisors of these responsibilities. 
2. Examination Phase.  NEP staff will notify those firms that will be subject to examination and perform these examinations.
3. Reporting Phase.  The NEP will report its observations to the SEC and the public.

What does this mean for your SEC-registered firm?

For newly-registered SEC advisors that manage a hedge fund, private equity fund or other private fund, now will be a good time to review your compliance policies and procedures as well as your Form ADV.  Be mindful that even if there have not been any significant changes within your firm since your initial registration, check your Form ADV for consistency with your business model and advisory services.  

Just because your ADV was sufficient to receive initial SEC approval, it does not necessarily mean that it adequately reflects of your business.  Examinations are the only way for regulators to confirm any potential errors of omission or commission (no pun intended!). 

How about state-registered advisors?

We have seen an unprecedented number of examinations being held within the first 6-12 months after regulatory approval.  While each state will take an independent approach to RIA examinations, we believe that the likelihood of examinations at the state level will be as high as it has ever been in the past.

Next Steps

All RIAs should:

• Review their compliance policies and procedures to ensure that they adequately prevent, detect and correct any violations of federal and state securities laws.
• Review their Form ADV 1, 2A and 2B's to confirm that each is consistent with their advisory business and their investment adviser representatives.

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Regulators are Looking at the Accuracy of Advisors' AUM

Have you been diligent about calculating and reporting regulatory AUM for your RIA?

Dan Jameison of InvestmentNews.com put out a great article about an RIA firm that allegedly has mis-calculated assets under management.

The firm was setting AUM at $25 million over the past several years (the former SEC minimum threshold). The assets were not accurate and the state believed that they included assets under their broker-dealer affiliation, which are not assets of the RIA.
The Massachusetts Securities Division has denied registration to this RIA firm and they no longer qualify for SEC registration. Effectively, they are out of business.

Read the full story at InvestmentNews.com

Here is a recap of the current rules related to calculating your RIA's "Regulatory Assets Under Management".
Advisors must quantify the amount of assets they manage. Advisors must calculate "Regulatory Assets Under Management", which is slightly different from the asset calculations you are used to. Here are the key components to the calculation:

Securities Portfolio

Include the securities portfolios for which you provide continuous and regular supervisory or management services as of the filing date. An account is a securities portfolio if at least 50% of the total value of the account consists of securities. For purposes of this 50% test, you may treat cash and cash equivalents (i.e., bank deposits, certificates of deposit, bankers acceptances, and similar bank instruments) as securities.

You must include securities portfolios that are:

1. Your family or proprietary accounts;
2. Accounts for which you receive no compensation for your services; and
3. Accounts of clients who are not United States persons.

For purposes of this definition, treat all of the assets of a private fund as a securities portfolio. For accounts of private funds, include in the securities portfolio any uncalled commitment pursuant to which a person is obligated to acquire an interest in, or make a capital contribution to, the private fund.

Value of Portfolio

Include the entire value of each securities portfolio for which you provide continuous and regular supervisory or management services.

If you provide continuous and regular supervisory or management services for only a portion of a securities portfolio, include as regulatory assets under management only that portion of the securities portfolio for which you provide such services.

• Under management by another person; or
• That consists of real estate or businesses whose operations you “manage” on behalf of a client but not as an investment.

Now that we’ve discussed the two key components, (i) Identifying the Assets; and (ii) Quantifying the Assets - Here’s the How!!
(i) Determine which assets constitute "Continuous and Regular Supervisory or Management Services". You provide continuous and regular supervisory or management services with respect to an account if:

• You have discretionary authority over and provide ongoing supervisory or management services with respect to the account; or
• You do not have discretionary authority over the account, but you have ongoing responsibility to select or make recommendations, based upon the needs of the client, as to specific securities or other investments the account may purchase or sell and, if such recommendations are accepted by the client, you are responsible for arranging or effecting the purchase or sale.

You should consider the following factors in evaluating whether you provide continuous and regular supervisory or management services to an account.

1. The Advisory Contract. If you agree in an advisory contract to provide ongoing management services, this suggests that you provide these services for the account. Other provisions in the contract, or your actual management practices, however, may suggest otherwise.
2. Compensation. If you are compensated based on the average value of the client’s assets you manage over a specified period of time that suggests that you provide continuous and regular supervisory or management services for the account. If you receive compensation in a manner similar to either of the following, that suggests you do not provide continuous and regular supervisory or management services for the account.

• You are compensated based upon the time spent with a client during a client visit; or
 
• You are paid a retainer based on a percentage of assets covered by a financial plan.
• Management practices. The extent to which you actively manage assets or provide advice bears on whether the services you provide are continuous and regular supervisory or management services. The fact that you make infrequent trades (e.g., based on a “buy and hold” strategy) does not mean your services are not “continuous and regular.”

You should consider the following examples in evaluating whether you provide continuous and regular supervisory or management services to an account.Examples of providing continuous and regular supervision:

1. Have discretionary authority to allocate client assets among various mutual funds;
2. Do not have discretionary authority, but provide the same allocation services, and satisfy the criteria set forth in Instruction 5.b.(3);
3. Allocate assets among other managers (a “manager of managers”), but only if you have discretionary authority to hire and fire managers and reallocate assets among them; or
4. You are a broker-dealer and treat the account as a brokerage account, but only if you have discretionary authority over the account.

Examples of NOT providing continuous and regular supervision:

1. Provide market timing recommendations (i.e., to buy or sell), but have no ongoing management responsibilities;
2. Provide only impersonal investment advice (e.g., market newsletters);
3. Make an initial asset allocation, without continuous and regular monitoring and reallocation; or
4. Provide advice on an intermittent or periodic basis (such as upon client request, in response to a market event, or on a specific date (e.g., the account is reviewed and adjusted quarterly).

(ii) Determine the value of those assets identified above:
Determine your regulatory assets under management based on the current market value of the assets as determined within 90 days prior to the date of filing this Form ADV. Determine market value using the same method you used to report account values to clients or to calculate fees for investment advisory services. In the case of a private fund, determine the current market value (or fair value) of the private fund’s assets and the contractual amount of any uncalled commitment pursuant to which a person is obligated to acquire an interest in, or make a capital contribution to, the private fund.
Examples:
You should consider the following examples in calculating your value of Regulatory Assets Under Management.
The client's portfolio consists of the following:

Stocks and Bonds	$6,000,000
Cash and Cash Equivalents	$1,000,000
Non-securities (collectibles, commodities, real estate, etc.)	$3,000,000
Total Assets	$10,000,000

Let’s run through some Key Questions:

1. First, is the account a securities portfolio? The account is a securities portfolio because securities as well as cash and cash equivalents (which you have chosen to include as securities) ($6,000,000 + $1,000,000 = $7,000,000) comprise at least 50% of the value of the account.
2. Second, does the account receive continuous and regular supervisory or management services? The entire account is managed on a discretionary basis and is provided ongoing supervisory and management services, and therefore receives continuous and regular supervisory or management services.
3. Third, what is the entire value of the account? The entire value of the account ($10,000,000) is included in the calculation of the adviser's total regulatory assets under management.

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FINRA off the table for 2012

July 31, 2012

For the moment, FINRA as an Self Regulatory Agency is off the table. H.R. 4624 (the “Investment Adviser Oversight Act of 2012”), which would subject RIA firms to the absurd rule making, inspection and enforcement authority by FINRA, is off the table of this session of Congress.

Not a time for celebrating...

FINRA and its advocates have taken a step back to come up with a better argument and hope the SEC makes no progress on funding, increased exam coverage and credibility. Expect to see this come back in the next session!

As a lesser of two evils, the discussion on RIA Exam Fees is back in circulation. 

On July 25, 2012, Rep. Maxine Waters (D-Calif.) proposed a bill that would would permit the SEC to impose user fees on SEC-registered investment advisors (note SEC only) that will be used solely to enhancing the SEC's examination program.

We see this as a likely reality that more fees are in store for advisors. This will also pave the way for states to implement exam fees.

Sadly, we have yet to see a bill that suggests the SEC actually review its methodology. 

That's politics. We'll keep you apprised of the developments.

February, 2013 Update

Citing a lack of "strong momentum," FINRA has stepped out of the ring and has backed off their efforts to convince Congress that they should oversee registered investment advisors. No doubt they are strategizing on their next move so we will most likely see them resurface at some point. Our view remains that FINRA's long term approach to regulating broker dealers and registered representatives is not a good fit for regulating fiduciaries.

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Q&A From Our Recent SEC to State Webinar

We recently hosted a webinar on the SEC to State transition for mid-sized RIAs.  For those that could not attend, we are posting the Q&A from this session. (We have also posted the presentation slides here.)

Q:  Can I continue to use my existing client advisory agreement? Will there be any grandfathering?

A:  Advisors must amend their advisory agreements to comply with any state-specific requirements that will apply to them. Requirements for agreements will vary state to state.

Q:  Does my compliance manual need to be tailored for each state?

A:   Yes.  Your compliance manual must reflect any specific requirements of the states in which you will be registered. It is a challenge when you have multiple states as you must reflect the rules of one state without contradicting other states. As you only want one manual, each policy should reflect the common requirements for all states and then specifically note items that differ in a given state. 

Q:  Are there some states that will move my registration along quicker than others?

A:   Definitely.  Our suggestion is to prioritize your "primary" or "home" state since other states will likely hold your application until you are approved by your primary state.

Q:  If my fiscal year end does not fall on December 31, 2011, do I need to amend by March 30, 2012?

A:  Yes. ALL advisors must file an ADV Amendment between 1/1/12 and 3/30/12 to update assets and confirm their registration status.

Q:  What date must I use for calculating regulatory assets under management? December 31, 2011? What if my FYE is not December 31?

A:  Advisors may use any date between January 1 and March 30 to determine regulatory assets under management.  This is the case for ALL advisors, regardless of fiscal year end.  If you are SEC-registered on December 31, 2011 and you have less than $90M in AUM then you will have to switch.

Q:  What if the state does not approve my firm before the June 28, 2012 deadline?

A:  Regulators have been silent on this.  Our recommendation is to submit (and document) all filings as early as possible.  If you do not get approved by June 28th, you will at least be able to demonstrate that you have made a good-faith effort to transition your firm. If you mail everything in late June, it will become much more difficult to make this claim. Do not withdraw SEC registration until all states have approved your firm.

If you have any additional questions, visit our SEC to State portal or email us. 

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"Regulatory Assets Under Management" Defined

AdvisorAssist's Brian Lauzon discusses the SEC's new definition of "regulatory assets under management" in this guest post on the ByAllAccounts blog.  Click here to read.

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The Big Switch: Key Dates for RIAs Moving from SEC to State

With all the details finalized, the "Big Switch" is in full swing.  For the estimated 3,200 RIAs that will be impacted by these new rules, here are some important dates to keep in mind.

January 1, 2012:  If you are currently registered or pending with the SEC, you must amend your ADV no later than March 30, 2012.  New advisors filing in 2012 must have $100 million or more within 120 days

January 3, 2012:  Existing mid-size advisors can begin their SEC to state transition.

January 1, 2012 to March 30, 2012:  Existing mid-size SEC advisors may select any date in this range for calculation of their "regulatory assets".

March 30, 2012:  Deadline for ADV amendment for all advisors (SEC, State or transitioning)

June 28, 2012:  Deadline for withdrawal from SEC registration.

Needless to say, this transition can be complicated and will impact a significant number of RIAs.  If you have any questions, feel free to drop us a note at support@advisorassist.com.

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Potential help for RIA's moving from SEC to state?

The North American Securities Administrators Association (NASAA) has provided a dedicated resource to help investment advisors switch from SEC to state oversight.  


This switch will affect most investment advisors with assets under management between $25 million and $100 million with a principal office and place of business in a state where investment advisers are required to be registered and are subject to examination.  (Investment advisors in Wyoming and New York are not affected by the switch due to the lack of a formalized securities oversight process.)

The "IA Coordinated Review Program" is available to any investment advisor that must register in four or more states.  To be included in the IA Coordinated Review Program, click here to fill out the NASAA form.  The IA Coordinated Review Program will be available through March 30, 2012.  


We estimate that over 3,000 advisors will be impacted by "the switch."  Each of these firms will need to determine which states their firm and IARs must register in, while dealing with a number of regulatory changes that are coinciding with "the switch", including a new definition for "assets under management" and new ADV questions.  So if you plan on engaging a compliance consultant or utilizing the NASAA program, we recommend that you DO NOT wait until the last minute!


For more information on the NASAA Switch Program, click here to visit the IA Switch Resource Center. 
Feel free to contact AdvisorAssist to discuss how "the switch" will impact your RIA.

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SEC to State Transition

Attention: Mid Size Advisors!

As 2011 comes to a close, many of you are busy planning for the new year. Don’t forget to add SEC to State transition planning to your list.

In July 2010, President Obama signed the Financial Reform Bill into law as the Dodd-Frank Act, which set forth rules to require “mid-size” SEC advisors that are under $100 million in assets under management to transition their registration with the Securities and Exchange Commission (“SEC”) to the one or more state regulators based on the applicable state laws. The SEC postponed the dates for compliance from the July 2011 timeframe to 2012, which is nearly upon us. This regulatory change is estimated to affect approximately 3,200 advisors, which is more that 25% of those currently registered with the SEC. 

The final amended rules provide for a bit more flexibility than the initial July 2010 plan as it  was originally signed into law. While the threshold for which investment advisers must register with the SEC will still move to $100 million, the SEC pushed back the compliance dates into 2012 and created a “buffer” in an attempt to avoid unnecessary back and forth filings. They also hoped to reduce the confusion around this transition with the additional time and communication on the matter. While the additional time and the buffer will certainly be helpful to advisors, the final rules certainly do not alleviate the confusion!

The “Buffer”

The amended rule now includes a provision for a buffer of $10 million above or below the $100 million threshold to avoid unnecessary frequent SEC and State switches based on market swings. An advisor must register with the SEC if it exceeds $110 million in assets under management. The buffer also provide for existing SEC advisors whose assets may temporarily drop to remain SEC registered if their assets do not drop below $90 million. So where’s the confusion?

And the critical dates for compliance...

• July 21, 2011 to January 1, 2012 -- An existing mid-size investment advisor registered with the SEC will be required to remain registered with the SEC (Note that some states are recommending an early switch to manage workflow.  However, the SEC expects you to remain registered until 2012).
• July 21, 2011 to January 1, 2012 -- Any existing state investment advisor with assets between $25 million and $100 million will not be permitted to register with the SEC and must remain registered with the state(s).
• July 21, 2011 to January 1, 2012 -- Any new investment advisor with assets between $25 million and $100 million will not be permitted to register with the SEC and must remain registered with the state(s).
• Fall 2011 -- Some state regulators are encouraging mid-size advisors that do not expect to remain eligible for SEC registration in 2012 to begin their transition. Now is the time to fully understand your registration status and options.
• January 1, 2012 -- If you are currently registered or have a registration pending with the SEC on or after January 1, 2012 you must file an amendment to your ADV no later than March 30, 2012 to indicate eligibility to remain SEC registered.
• January 1, 2012 -- Also effective January 1, 2012, mid-size advisors registered with the SEC that are no longer eligible for SEC registration can begin filing amendments to their ADV indicating their ineligibility.
• January 1, 2012 to March 30, 2012 -- An existing SEC advisor may select the date for calculation of the “regulatory assets” provided the date is within 90 days of the filing. The SEC has also added the flexibility in determining what constitutes regulatory assets to include proprietary accounts and the accounts of family where no fees are charged.
• March 30, 2012 -- Deadline to file the above mentioned amendment to Form ADV.
• June 28, 2012 -- 90 days following the March deadline, all advisors must be properly registered with the applicable state regulators and withdraw their SEC registration. Note: If you don’t withdraw on June 28, 2012, the SEC cautions it will do if for you. Make sure you are not put out of business!

When to transition?

If your firm is a mid-size advisor, you need to take a realistic self-assessment now. What is your current situation? What do you expect your assets under management to be in Q1 2012? 

With so many firm’s transitioning, major backlogs are a certainty. For instance, California expects in excess of 900 transitions alone. Of the 3,000 advisors, many will be required to register in several state jurisdictions. Facing this enormous task, the understaffed securities division is asking advisors to start their transitions this fall and remain dually registered for a short period of time.

To help guide you in the planning, we created a table of actionable dates based on various scenarios:

Who does not transition?

• Investment advisors are to remain SEC registered if exempt or excluded in a state where their principal office is located.
• Mid-size investment advisors with their primary place of business in New York and Wyoming are excluded from the transition as they are not subject to examination by state regulators.

Investment advisors required to register in 15 or more states can register with the SEC. Be careful here. This means that you would required to register, not voluntarily deciding to register in 15 states!

Resources?

NASAA Switch Schedule
NASAA IA Switch FAQ
Final Rule - IA -3221 (amendment for switch)
IARD System Schedule

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Changes to Form ADV Part 1

A new version of Form ADV Part 1 was released by FINRA on November 7, 2011.

The next time your firm logs onto the IARD system to file an amendment to your Form ADV Part 1, you will be prompted to answer several new questions and also confirm (re-answer) certain existing questions

Below we have listed the Items that have been updated and summarized many of the changes that were implemented (We focus on the significant changes here. To be certain that your RIA addresses all of the updates thoroughly, it would be best to review with your compliance consultant or attorney.).

Item 1
Item 1 specifically asks advisors to identify contact information for the firm’s Chief Compliance Officer and also provides an option to include one additional regulatory contact person.

Advisors are also now asked the following questions:

• Are you a public reporting company under Sections 12 or 15(d) of the Securities Exchange Act of 1934? If "yes," provide your CIK number.
• Did you have $1 billion or more in assets on the last day of your most recent fiscal year?
• Provide your Legal Entity Identifier if you have one?

Item 5
ADV Part 1 Item 5 now asks that advisors specifically identify the exact number (as opposed to ranges) of employees that fall into each functional category. We believe that this was partially motivated by an interest in adding clarity to staffing levels among the increasingly large number of smaller RIAs.

This section also now asks advisors about the “percentage of clients that fall into various categories”. The previous version of ADV Part 1 asked only for the approximate percentage that each type of client comprised of the total number of clients. The new version requests the same breakdown but also asks for the approximate amount of regulatory assets under management (reported in Item 5.F. of ADV Part 1) attributable to each type of client.

Advisors should note that the list of client types was expanded and now includes “business development companies,” “other investment advisers”, and “insurance companies.” This higher level of granularity will likely reduce reliance on the "other" category, and improving transparency to investors.

Item 5 also asks advisors to disclose what percentage of their clients are non-United States persons.

Item 6 and Item 7
Working with our clients in the past, we have noticed frequent confusion around the differences between Item 6 and Item 7 of ADV Part 1, specifically regarding when a “business activity” impacts Item 6 versus Item 7.

The list of “business activities” in each of these sections has doubled. While this expansion will likely alleviate some confusion, advisors should carefully review this updated list (particularly the responses related to “broker-dealer” and “registered representatives”.

Item 8
While we’re on the topic, Item 8 now asks for some additional information about your broker-dealer relationships. Specifically, if you have client discretion for broker-dealer selection, Item 8.E. now asks if this broker-dealer a “related person.” This addition further helps identify and disclose potential conflicts of interest.

The new version of the ADV drills down deeper into the benefits that advisors receive from broker-dealers, asking specifically about "soft-dollar benefits." If the advisor does receive "soft-dollar benefits," they are asked to affirm that the service(s) received are eligible under 28(e) of the Exchange Act. This change seems to bifurcate benefits received by participating on an institutional wealth platform and benefits received via soft-dollars.

In addition to asking advisors if they compensate individuals for referrals, the new Item 8 also asks if the advisors themselves are compensated for referrals.

Item 9
For advisors that do have custody of some assets, the new Item 9 drills down into those assets and asks: “If you or your related persons have custody, how many persons, including, but not limited to, you and your related persons, act as qualified custodians for your clients in connection with advisory services?

Item 11
Item 11 relates to disciplinary events. The new version first asks advisors if any of the events described in the disciplinary questions involve you or any of your supervised persons specifically. This broadens the scope of the questions to anyone you supervise.

Item 11 generally requires advisors to describe disciplinary events that involve advisory affiliates, which include:

(1) all current employees (excluding employees performing only clerical, administrative, support or similar functions);

(2) officers, partners, or directors (or any person performing similar functions); and

(3) all persons directly or indirectly controlling you or controlled by you.

If you have any questions about how these changes impact you firm, please do not hesitate to reach out to AdvisorAssist.

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