Broker Dealer Regulation | Business Continuity | Conflicts of Interest | Form ADV | Form CRS | Mutual Funds | Private Funds | Regulation Best Interest | Regulatory Deadlines | SEC News | SEC Sweep Examinations

Coming Soon – Annual Form ADV Update for RIAs; SEC Answers More Questions on Reg BI and Form CRS FAQs, MA Leads the Pack by Adopting First State Fiduciary Standard Rule for Broker-Dealers, FINRA Wants to Know How Zero Commission Brokers are Making Money: Regulatory Update for March 2020

For Investment Advisers and Broker-Dealers:  SEC Actions

SEC Updates Reg BI FAQs. The SEC posted new FAQs to assist firms in complying with their obligations under Regulation Best Interest (“Reg BI”).  The new content covers what it means for a retail customer to “use” a recommendation provided by a broker-dealer, confirms that Reg BI applies when a broker-dealer makes recommendations to natural persons that are accredited investors and interprets the term “legal representative” in the context of the definition of retail customer.  Importantly, the SEC makes it very clear that a retail customer cannot waive the protections of Reg BI.  The recent release also provides guidance on when a broker-dealer can rely on the customer relationship summary (“Form CRS”) to satisfy its capacity disclosure obligation, the ‘SEC’s view of forgivable loans, and the application of Reg BI upon a broker-dealer’s recommendation of a self-directed brokerage account to a retail customer.  Finally, the SEC reiterates that under the compliance obligation under Reg BI, firms are required to establish, maintain, and enforce written policies and procedures reasonably designed to achieve compliance with Reg BI.  Contributed by Rochelle A. Truzzi, Senior Compliance Consultant.

SEC Posts FAQs on Form CRS. The SEC posted new “Frequently Asked Questions on Form CRS providing some much-needed guidance about the definition of retail investor, Form CRS delivery requirements, dealing with affiliated entities, and disciplinary disclosures.  Highlights include:

  • Private equity and hedge fund managers do not have to deliver a Form CRS to the underlying investors in their funds since the adviser’s relationship is with the fund.
  • Firms providing investment advisory services under a contract with another RIA that serves retail investors (e.g., sub-adviser) are not required to deliver a Form CRS to those retail investors.
  • Affiliated firms can prepare a single combined relationship summary.
  • Firms can prepare a relationship summary in another language, as long as an English version is provided at the same time.  Contributed by Jaqueline M. Hummel, Partner and Managing Director.

For Investment Advisers: SEC Actions

Save the Date! SEC Offers Outreach Program for Investment Advisers.  The SEC announced a seminar sponsored by its Office of Compliance Inspections and Examinations and the Division of Enforcement’s Asset Management Unit.  Since the SEC doesn’t like surprises, any burning questions you might have should be submitted in advance using the Questions for Panels form.  If you can’t make it, you can watch the live webcast at http://www.sec.gov on the day of the event.  Contributed by Jaqueline M. Hummel, Partner and Managing Director.

Annual ADV Amendments Due March 30, 2020.  Registered investment advisers are required to update their Form ADV within 90 days of their fiscal year-end, and that’s March 30, 2020, this year.  Make sure you have paid your annual updating fee since the Investment Adviser Registration Depository (IARD) system will not accept the filing unless the funds are already in the ‘firm’s account. Not sure how much to pay?  Check out IARD’s fee schedule here.  Payment options include electronic payments using E-Bill, wire transactions or ACH or check, and instructions are available here.

Need some advice on how to answer the trickier questions or enhance your conflict disclosures?  Check out our latest blog posts:  SEC’s Top 10 Hits: Investment Adviser Regulatory Review 2019 – Part 1 (under Item 2), What Your Next Deficiency Letter is Going to Say: SEC Tells Advisers What Fiduciary Duty Means (under Deficiency 4), How I Learned to Stop Worrying and Learned to Love Form ADV and Feeling your Pain: Advice on Answering Form ADV’s Trickier Questions.  Finally, look for an upcoming Hardin blog post with more tips on drafting disclosures to address conflicts of interest.  Contributed by Jaqueline M. Hummel, Partner and Managing Director.

For Broker-Dealers:  FINRA Actions

Targeted Examination Letter on Zero Commissions. FINRA is conducting a targeted sweep examination on broker-dealer decisions not to charge commissions for customer transactions. Check out the request letter here.  Firms that are not charging commissions include Charles Schwab, Fidelity, Interactive Brokers, RobinHood, TD Ameritrade (to be acquired by Charles Schwab), E*TRADE (to be acquired by Morgan Stanley), and Merrill Lynch.  Based on the request letter, FINRA is looking at how these brokers intend to make up the revenue lost from commissions.  Contributed by Jaqueline M. Hummel, Partner and Managing Director.

First Out of the Starting Gate: Massachusetts’ Fiduciary Standard on Broker-Dealers and Agents.     Good news for investment advisers and investment adviser representatives —  this standard does not apply to you!  Massachusetts’ Fiduciary Standard on Broker-Dealers and Agents (“the Fiduciary Standard”), goes into effect in March 6, 2020, and applies to Broker-Dealers and their Agents only.  The final regulations will be enforced as of September 1, 2020.  The Fiduciary Standard will apply to all Broker-Dealers and Agents registered in Massachusetts, regardless of where the customer resides. For example, the Fiduciary Standard would apply to transactions between a Massachusetts registered agent and its customer who resides in Florida.  More details on this ground-breaking regulation to come in Hardin’s blog, Compliance Informer.  Contributed by Rochelle A. Truzzi, Senior Compliance Consultant.

Lessons Learned from SEC and FINRA Cases

How to Save $10 million!  Catalyst Capital Advisors (“CCA”) and Jerry Szilagyi, President, CEO, Co-Founder and majority owner of CCA, were hit with a $10 million fine for fraud, misrepresentation and failure to supervise its senior portfolio manager.  CCA manages the Catalyst Hedge Futures Strategy Fund (“Fund”), a mutual fund that invests in S&P 500 futures contracts.  Per the SEC, “A central selling point for the Fund was CCA’s risk management procedures.  In promoting such procedures, CCA and the Senior Portfolio Manager (“PM”) made material misstatements in investor-facing marketing documents and in telephone calls with investment advisers that it utilized stop-loss measures and triggers to exit positions that would limit the Fund’s losses.”  However, between December 2016 and February 2017, the Fund lost over $700 million or 20% of the Fund’s assets.  Szilagyi, who was responsible for oversight of the PM, held a call with the PM and other employees on December 9, 2017, to find out why the Fund was bleeding money.  They agreed on the call to reduce the risk of the Fund; however, the PM and Szilagyi did not take action.  Szilagyi was notified again in January that the Fund was continuing to hemorrhage money, after which he texted the PM and asked him why he had not managed the risk as agreed.  The SEC stated that “Szilagyi did not take reasonable steps to confirm, and, at that time, had not implemented procedures for detecting, whether the PM managed the Fund’s portfolio risk levels as represented.”  Subsequently, the SEC hit Szilagyi with a failure to supervise charge and cited CCA for fraud because during this period no stop-loss measures were implemented nor any “strict risk management procedures.”  Although the PM was not named in this case, the SEC has filed civil charges against him.

This is an excellent case to feature in your next compliance training with the owner or executive officers at your firm as justification for spreading out the executive decision-making.  Time and time again, cases like this demonstrate that concentrated power often leads to bad decision-making and ignorance of red flags.  We can talk about testing until our heads explode, but this case illustrates the “people” problem in compliance.  It took Szilagyi five to six weeks to check back with the PM on the requested risk reduction measures (as far as we know), placing a lot of trust in a person who controls millions of dollars.  An investment committee approach would have demonstrated better governance and enabled better oversight of the PM, the Fund and stop-loss measures.  An accountable investment committee could have followed up on the request more timely, maintained consistent and frequent communication with Szilagyi after the initial call, and provided additional surveillance of the PM, which ultimately could have saved CCA $10 million.  Contributed by Heather A. Augustine, Senior Compliance Consultant.

Poorly Written Policy Gathering Dust Leads to Trouble for Wyoming Adviser. A recent enforcement against Cannell Capital, LLC (“Cannell”) serves to remind advisers that policies and procedures need not only be adequately written, but also consistently followed, to control risks effectively.  Cannell learned this lesson when it was cited for failures in its policy on the handling of material nonpublic information (“MNPI”).

Misuse of MNPI was a significant risk area for the firm, which traded primarily in small-cap, thinly-traded securities. In carrying out its research, Cannell frequently communicated with issuers, insiders and investment bankers under non-disclosure agreements (“NDAs”) and by participating in confidential secondary offerings and PIPE transactions.  On paper, Cannell had its hands at least partially around its MNPI risks:  the firm maintained a policy prohibiting insider trading that included a process for reporting the possession of potential MNPI to the CCO, who was in turn responsible for maintaining a restricted list for firm distribution.  The firm instituted this policy in response to a prior SEC examination finding.

Contrary to its policy, the Firm did not maintain a formal restricted list but relied on emails, phone calls and conversations, documents on a shared drive, and using trade restrictions on its order management system.  The SEC ruled this patchwork of methodologies insufficient to constitute a restricted list.  Moreover, the SEC found the policy failed to provide parameters for determining what constitutes MNPI, making it possible for the CCO to impose or lift restrictions when convenient, rather than under a specific set of circumstances.  The firm also relied on self-reporting of MNPI to the CCO, and the policy failed to monitor common sources of MNPI, such as discussions with issuers and investment bankers, especially those involving NDAs.

Firms should take note that the SEC did not find a misuse of MNPI in Cannell’s trading activity, but brought this enforcement action anyway because of its inadequate policies and procedures.  This case highlights the value of basic compliance testing of restricted list procedures, conducting a proper assessment of the risk associated with MNPI to ensure that policies and procedures are appropriate, and ensuring that procedures over time remain responsive to prior exam findings.  Recidivist conduct will always remain a regulatory red flag.  Contributed by Mark L. Silvester, Compliance Associate.

Worth Reading

Filing Deadlines and To-Do List for March 2020

INVESTMENT MANAGERS

  • Form ADV Annual Updating Amendment: Existing registered advisers must update and file an amended Form ADV within 90 days of their fiscal year-end (Forms 1A and 2A). The filing fee must be deposited into the adviser’s IARD account before the filing can be submitted. The due date for 2020 is March 30, 2020. Check out the Form ADV quick reference guide here.
  • IARD Fees: SEC-registered advisers and exempt reporting advisers are required to pay IARD fees before the submission of the Form ADV annual amendment (by March 30, 2020).
  • State Filings: A registered investment adviser and an exempt reporting adviser may be required to make a state notice filing in any state in which an adviser has a specified number of clients, called “Notice Filings.” Notice filings may be made on Form ADV by checking the relevant box in Part 1A and depositing the appropriate state fees into the adviser’s IARD account. Exempt reporting advisers may also be required to register as an investment adviser in some states. Notice filing and investment adviser registration requirements differ from state to state. Each adviser should check the requirements for any relevant state in which it operates or has clients. The due date is within 90 days of the adviser’s fiscal year-end on March 30, 2020.

HEDGE/PRIVATE FUND MANAGERS

  • Blue Sky Filings (Form D). Advisers to private funds should review fund blue sky filings and determine whether any amended or new filings are necessary.  Generally, most states require a notice filing (“blue sky filing”) within 15 days of the first sale of interests in a fund, but state laws vary. Did you know that Hardin Compliance Consulting offers a convenient and economical blue sky filing service to help firms manage this complicated monthly task?  Learn more here and give us a call to discuss your needs further.  Due March 15, 2020.
  • Exempt Reporting Advisers Form ADV Filing: Exempt Reporting Advisers (i.e., exempt private funds advisers and venture capital advisers) need to update Form ADV Part 1A within 90 days of the adviser’s fiscal year-end on March 30, 2020.
  • Annual Reports for 4.7 Exempt CPOs: Exempt CPOs must electronically file audited annual reports, including statements of financial condition, statements of operations, and appropriate footnotes, for their pools with the NFA and distribute them to their investors by March 30, 2020.

REGISTERED COMMODITY POOL OPERATORS

  • Form CPO-PQR (All Schedules): Large Commodity Pool Operators are required to file Form CPO-PQR annually with the NFA by March 2, 2020.
  • CFTC Form CPO-PQR Schedule A must be filed by small CPOs (i.e., CPOs with less than $150 million in aggregated gross pool AUM as of the close of business on any business day during a calendar year), by March 30, 2020.
  • CFTC Form CPO-PQR Schedules A and B must be filed by mid-sized CPOs (at least $150 million to $1.5 billion in aggregated gross pool AUM as of the close of business on any business day during a calendar year) by March 30, 2020.
  • CPO Members must distribute an Annual Report, certified by an independent public accountant, to pool participants within 90 days of the pool’s fiscal year-end. CPOs are also required to file this report electronically with NFA using EasyFile. The filing must be made by March 30, 2020.

MUTUAL FUNDS

  • Form N-PORT (Large Fund Complexes).  Large fund families (those with greater than $1 billion in assets) must file Form N-PORT reporting month end information for each month-end in each fiscal quarter no later than 60 days after fiscal quarter-end.  For funds with a December 31 fiscal year-end, the due date is March 2, 2020.  The funds must also prepare the information reported on Form N-PORT within 30 days after every month-end and retain these records, which are subject to SEC inspection.
  • Form N-MFP.  Form N-MFP (Monthly Schedule of Portfolio Holdings of Money Market Funds) reports information about the fund’s holdings as of the last business day of the prior calendar month and must be filed no later than the fifth business day of each calendar month.  Due date is March 6, 2020.
  • Form N-CEN.  Form N-CEN reports should be filed no later than 75 days after a registered investment company’s fiscal year-end.  For funds with a December 31 fiscal year-end, the due date is March 12, 2020.  Note: This due date applies to all funds, except for unit investment trusts, whose Form N-CEN reports are due no later than 75 days of the calendar year-end.

BROKER-DEALERS

  • Annual Audit Reports for the Fiscal Year-End December 31, 2019: FINRA requires that member firms submit their annual audit reports in electronic form. Firms must also file the report at the regional office of the SEC in which the firm has its principal place of business and the SEC’s principal office in Washington, DC.  Firms registered in Arizona, Hawaii, Louisiana, or New Hampshire may have additional filing requirements.  Due March 2,
  • Supplemental Inventory Schedule (“SIS”): For the month ending January 31. The SIS must be filed by a firm that is required to file FOCUS Report Part II, FOCUS Report Part IIA or FOGS Report Part I, with inventory positions as of the end of the FOCUS or FOGS reporting period, unless the firm has (1) a minimum dollar net capital or liquid capital requirement of less than $100,000; or (2) inventory positions consisting only of money market mutual funds.  A firm with inventory positions consisting only of money market mutual funds must affirmatively indicate through the eFOCUS system that no SIS filing is required for the reporting period.  Due March 2, 2020.
  • SIPC-6 Assessment: For firms with a Fiscal Year-End of July 31. SIPC members are required to file for the first half of the fiscal year a SIPC-6 General Assessment Payment Form together with the assessment owed within 30 days after the period covered.  Due March 1,
  • SIPC-3 Certification of Exclusion from Membership: For firms with a Fiscal Year-End of January 31 AND claiming an exclusion from SIPC Membership under Section 78ccc(a)(2)(A) of the Securities Investor Protection Act of 1970. This annual filing is due within 30 days of the beginning of each fiscal year.  Due March 1,
  • Rule 17a-5 Monthly and Fifth FOCUS Part II/IIA Filings: For the period ending February 29, 2020. For firms required to submit monthly FOCUS filings and those firms whose fiscal year-end is a date other than a calendar quarter.  Due March 24, 2020.
  • Supplemental Inventory Schedule (“SIS”): For the month ending February 29. The SIS must be filed by a firm that is required to file FOCUS Report Part II, FOCUS Report Part IIA or FOGS Report Part I, with inventory positions as of the end of the FOCUS or FOGS reporting period, unless the firm has (1) a minimum dollar net capital or liquid capital requirement of less than $100,000; or (2) inventory positions consisting only of money market mutual funds.  A firm with inventory positions consisting only of money market mutual funds must affirmatively indicate through the eFOCUS system that no SIS filing is required for the reporting period.  Due March 27,
  • SIPC-6 Assessment: For firms with a Fiscal Year-End of August 31. SIPC members are required to file for the first half of the fiscal year a SIPC-6 General Assessment Payment Form together with the assessment owed within 30 days after the period covered.  Due March 29,
  • SIPC-7 Assessment: For firms with a Fiscal Year-End of January 31. SIPC members are required to file the SIPC-7 General Assessment Reconciliation Form, together with the assessment owed (less any assessment paid with the SIPC-6) within 60 days after the Fiscal Year-End.  Due March 29,
  • SIPC-3 Certification of Exclusion from Membership: For firms with a Fiscal Year-End of February 29 AND claiming an exclusion from SIPC Membership under Section 78ccc(a)(2)(A) of the Securities Investor Protection Act of 1970. This annual filing is due within 30 days of the beginning of each fiscal year.  Due March 30,
  • Annual Audit Reports for the Fiscal Year-End January 31, 2020: FINRA requires that member firms submit their annual audit reports in electronic form. Firms must also file the report at the regional office of the SEC in which the firm has its principal place of business and the SEC’s principal office in Washington, DC. Firms registered in Arizona, Hawaii, Louisiana, or New Hampshire may have additional filing requirements. Due Date March 31, 2020.

 

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Have a compliance question or want an independent review of your compliance program?  Hardin Compliance can help!  Call us today at 1.724.935.6770, or visit our website at www.hardincompliance.com for more information.

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