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SEC Enforcement Report Comes Down Hard on Advisers; Your Chance to Sound Off About the SEC’s Proposed Advertising & Cash Solicitation Rule Changes; Mutual Funds Placed on SEC’s Naughty List; Year-End Reminders: Regulatory Update for December 2019

For Investment Advisers and Broker-Dealers:  SEC, FINRA and State Actions

SEC Declares Victory for 2019 Despite all Obstacles: Division of Enforcement Publishes Annual Report for Fiscal Year 2019. Starting with the usual self-serving statements about the Commission’s success in punishing the bad guys and returned ill-gotten gains to harmed investors, the SEC’s Division of Enforcement proudly announced the issuance of its Annual Report for Fiscal Year 2019.  The report highlights a wide range of enforcement cases, including corporate fraud, auditing failures, investment advisory issues, insider trading, and broker-dealer misconduct.  In 2019, the SEC brought 862 enforcement actions, returned roughly $1.2 billion to harmed investors, received $4.3 billion in disgorgement and penalties, suspended 271 companies, and issued nearly 600 individual bars and suspensions.  In 2018, the SEC brought 821 enforcement actions, returned $794 million to investors, received $3.945 billion in disgorgement and penalties, suspended 280 companies, and issued 550 individual bars and suspensions.  In 2019, actions against investment advisers and investment companies held the top position with 35% of cases, a significant uptick from 22% in 2018.  This increase is primarily attributable to the SEC’s Share Class Selection Disclosure Initiative.  Contributed by Jaqueline M. Hummel, Partner and Managing Director.

California Has Bigger Fish to Fry with its new Consumer Privacy Act. California’s Consumer Privacy Act of 2018 (CCPA) goes into effect on January 1st, 2020 and while the scope and complexity of the Act far exceed this scope of this newsletter, here are a few facts:

  1. The CCPA applies to for-profit firms that are “doing business” in California and meet one of the three thresholds:  (a) Generates annual gross revenue of greater than $25 million, (b) Receives or shares data of greater than 50,000 California residents annually, or (c) Derives at least 50 percent of its annual revenue by selling the personal information of CA residents.  These criteria apply whether or not the firm has a physical location in the state, but certain types of firms, such as financial institutions already covered by Gramm-Leach-Bliley, are exempt.  Conceptually, if an investment adviser collects personal information that is subject to Regulation S-P, then the CCPA does not apply to that information.  The same is true for exempt reporting advisers since they are subject to the CFPB’s Regulation P.  However, advisers can still get sued for data breaches if they have failed to implement reasonable security procedures to safeguard personal information.
  2. Amendments. Bills passed in September 2019 amended the CCPA and clarified several key aspects that should assist firms in preparing for compliance.  Among these, the definition of “personal information” has been revised and relief made available to certain businesses.
  3. Important dates. The CCPA becomes effective January 1st, and the attorney general will begin enforcement no later than July 1, 2020.  That said, in-scope firms should also note that the rule contains a look back provision under which consumers may request access to their personal information gathered by the firm for the prior twelve months.  Contributed by Cari A. Hopfensperger, Senior Compliance Consultant.

New Hampshire to Terminate RIA and BD Firms for Late Renewals. The New Hampshire Bureau of Securities Regulation (“Bureau”), warned its registrants of a new policy that becomes effective for 2020 renewals.  The Bureau eliminated the grace period once extended to broker-dealers and SEC- and state-registered investment advisers to renew their registrations.  This year, if a firm fails to renew by December 31, 2019, its registration will be terminated, and it will no longer be eligible to conduct securities or investment advisory business in New Hampshire.  Firms that violate this policy may be subject to enforcement action.  New Hampshire’s new approach is similar to Texas, where Firms and their registered individuals will already go into “Fail to Renew” status on January 1st if fees have not been paid.  Keep in mind, Web CRD and IARD will shut down for year-end at 6:00 p.m. Eastern Time on December 26th.  Don’t delay!  Contributed by Rochelle A. Truzzi, Senior Compliance Consultant.

2020 CRD/ IARD Renewal Programs. Please review the corresponding 2020 Renewal Calendar (Broker-Dealer or RIA/IARD), noting the following important dates in December:

    • 12/16/2019 – DEADLINE for receipt of payment in full of Preliminary Statements;
    • 12/26/2019 – LAST DAY to submit Forms U4, U5, BD, and BDW for the year.

Additional details, including payment methods, can be found in FINRA Notice 19-35 for Broker-Dealers and on the IARD Renewal Program webpage for Investment Advisers.  Hardin recommends that funds be remitted through E-Bill, in advance of the deadlines, to allow sufficient time for processing.  Contributed by Rochelle A. Truzzi, Senior Compliance Consultant.

For Investment Advisers:  SEC Actions

Speak Now or Forever Hold Your Peace! It’s Your Chance to Comment on the SEC’s Advertising and Cash Solicitation Rule Change.  It’s taken more than 60 years, but the SEC has finally proposed changes to the Advertising Rule (Rule 206(4)-1), and the Cash Solicitation Rule (Rule 206(4)-3).   The scope of the proposed amendments to the advertising rule is vast, and the SEC seems hungry for industry feedback, asking readers to weigh in on more than 400 different questions on everything from testimonials, past specific recommendations, and case studies, to performance calculations and portability.  Significantly, the proposed release redefines “advertising” more broadly than the current rule, employs a largely principles-based approach, and requires advisers to appoint a person to review and pre-approve most advertising.  Now is the time to have your voice heard!  Advisers can quickly provide comments by using the SEC’s comment form or sending an email to and include File Number S7-21-19 on the subject line.  Check out the Worth Reading section below for more resources on the proposal.

The SEC is expanding the term “compensation” under the proposed amendments to the Cash Solicitation Rule to include all forms of compensation, not just cash.  The proposal would also cover solicitation of investors in private funds, and include de minimis exemptions for solicitors (less than $100 in any 12-month period).  Contributed by Jaqueline M. Hummel, Partner and Managing Director.

Reminder: GIPS 2020. The CFA Institute adopted the 2020 GIPS Standards (“GIPS 2020”) on June 30, 2019, and, for those firms claiming compliance with the voluntary performance presentation standards, the big day is nearly here as GIPS 2020 standards become effective on January 1, 2020.  Don’t panic, though; firms have another year to update their GIPS presentations (i.e., “GIPS Composite Reports”) to comply with the new disclosure requirements.  While many of the changes in GIPS 2020 were designed to attract new types of firms to pursue GIPS compliance, firms that already claim compliance should also be aware of how the new standards impact their current policies and procedures.  For example, firms interested in presenting carve-out performance or private fund managers interested in presenting fund vs. composite performance may appreciate new flexibility in the revised standards.  Looking for details?  The CFA Institute has grouped its materials related to GIPS 2020 on a dedicated webpage and summarized the top 10 FAQs raised by firms, service providers, and others in the industry during the open comment period.  Check out our updates from October 2018 and July 2019Contributed by Cari A. Hopfensperger, Senior Compliance Consultant.

For Broker-Dealers:  SEC and FINRA Actions

Form CRS Template. Coming soon for RIAs and Broker-Dealers!  In the meantime, bookmark Hardin’s dedicated webpage for updates on all things related to Form CRS.  Contributed by Rochelle A. Truzzi, Senior Compliance Consultant.

SEC Extends SIFMA Temporary No-Action Letter Until July 3, 2023. During the extended period, broker-dealers may continue to receive payments for research services provided to investment managers subject to MiFID II that would otherwise constitute investment advice under section 202(a)(11) of the Advisers Act.  Contributed by Rochelle A. Truzzi, Senior Compliance Consultant.

SEC Dips its Toe into the Water with Blockchain The SEC granted Paxos Trust Company, LLC (“Paxos Trust”) no-action relief allowing it to launch a blockchain-based settlement platform for U.S. listed equities.  For the first time in decades there will be an option for settling U.S. listed equities other than the traditional settlement process.  Blockchain, which is more closely associated with the system powering Bitcoin, is a shared database maintained by a network of computers.  The Paxos Trust platform will not be live until one of its early adopters has received approval from the SEC to settle with Paxos.  To get to this point, Paxos has been working on the service for the past two years.  The company approached the SEC eighteen months ago and submitted its no-action request about six months ago.  The platform will allow two parties to settle securities trades directly with each other and, over the long-term, is intended to modernize the settlement process.  Contributed by Doug MacKinnon, Senior Compliance Consultant.

For Mutual Fund Managers:  SEC Actions

Investment Companies Placed on the SEC’s Naughty List. OCIE issued a Risk Alert discussing the most often cited deficiencies and weaknesses it observed during hundreds of fund examinations over a two-year period.  Here are some of the highlights:

Violations of Rule 38a-1 of the Investment Company Act, the Fund Compliance Rule:

  • Funds failed to customize their compliance programs to address risks specific to the fund’s activities.
  • Funds failed to follow or enforce their policies and procedures, especially with respect to valuation.
  • Funds conducted inadequate service provider oversight.
  • Funds failed to conduct annual reviews of their compliance programs, or the reviews were inadequate.

Fund disclosures to shareholders were incomplete or misleading as compared to the fund’s actual activities.

The Section 15(c) Process for approving investment advisory contracts was flawed:

  • Boards failed to request or consider reasonably necessary information, such as the profitability of the fund to the adviser, economies of scale, or peer group comparisons.
  • Shareholder reports contained inadequate discussion of the basis for board approval of the advisory contract.

Fund Code of Ethics Rule:

  • Funds did not implement a code of ethics.
  • Funds failed to follow or enforce their existing code of ethics.
  • Funds did not comply with the code of ethics approval and reporting process.

Money Market Funds:

  • Fund staff did not maintain credit files with documentation to support a determination that certain securities presented minimal risk and qualified as “eligible securities.”
  • Stress test results presented to fund boards did not include the required summary of significant assumptions.
  • Funds did not implement or adopt policies and procedures related to Rule 2a-7 compliance.
  • Funds failed to post accurate or all required information, as required by Rule 2a-7, on fund websites, and required legends were missing from advertising materials.

Target Date Funds

  • Funds included incomplete or potentially misleading disclosures in prospectuses and advertisements.
  • The funds were missing or had incomplete policies and procedures.

If you are concerned about these or any other risks, contact Hardin Compliance Consulting.  We can assist you in assessing your program’s needs and implementing any changes your fund may require.  Doug MacKinnon, Senior Compliance Consultant.

Small Fund Family Liquidity Risk Management Programs.  Advisers to small mutual fund families (those with assets less than $1 billion) likely need no reminder of the final, December 1, 2019, compliance date of Rule 22e-4 under the Investment Company Act of 1940 (the “Liquidity Rule”) and the related requirements to implement a Liquidity Risk Management Program. With the arrival of this final compliance date, advisers to small fund families should have (1) obtained Board approval of the fund’s Liquidity Risk Management Program, (2) decided upon a classification process by which the fund’s investments are placed into one of four defined liquidity buckets (including whether the classification of investments will be performed by the adviser or a third party vendor, as well as inputs and assumptions relevant to that calculation, such as a Reasonably Anticipated Trade Size (“RATS”) and a material price impact (“MPI”), and (3) established the fund’s Highly Liquid Investment Minimum (“HLIM”) and related shortfall procedures OR determined that the fund is a primarily highly liquid fund.  Small fund families (with a December fiscal year-end) may find some relief in the reminder that their funds’ initial Form N-PORT filings are not due until May 2020, for the fiscal quarter ended March 31st.   Check out our prior blog post:  SEC Requires Mutual Funds to Adopt Liquidity Risk Management Programs.   Contributed by Cari A. Hopfensperger, Senior Compliance Consultant.

For Hedge Fund Managers:  NFA Actions

NFA Requires Firms to Appoint Swaps Proficiency Requirement Administrator. About the new swaps proficiency requirements becoming effective January 1, 2020, NFA Members with Associated Persons who are required to take the NFA’s Swaps Proficiency Requirements must also designate one or more Swaps Proficiency Requirements Administrators (“SPR Admins”) to coordinate enrollment and track progress.  The SPR Admin must also be an ORS Security Manager.  To assist affected firms, NFA is publishing a series of webinars designed for SPR Admins.  The last available webinar will be on December 10th and will cover the technical aspects of administering the program.  The NFA has stated that recordings will also be made available.  Register for the webinar: NFA SPR Admin Webinar and see instructions on how to register SPR Admins:  SPR Admin Form InstructionsContributed by Mark L. Silvester, Compliance Associate.

Amendments to NFA Promotional Material Rules and Interpretive Notices. On January 1, 2020, amendments clarifying the applicability of NFA Compliance Rules 2-29 and 2-36 and related Interpretive Notices become effective.  These amendments are intended to better reflect current technology and business practices and address the use of hypothetical performance in promotional material by CPO members operating under a Rule 4.7 exemption.  Rule 2-36 was also amended to specify that Forex Dealer Members and their associates must comply with specific provisions of Rule 2-29.  Contributed by Mark L. Silvester, Compliance Associate.

Lessons Learned from SEC and FINRA Cases

What We’ve Got Here is a Failure to Communicate.  Compliance is complicated and messy.  As this case demonstrates, it takes more than compliance personnel to identify conflicts of interest and best execution issues.  An effective compliance program requires coordination and communication among all departments in a firm to identify, address and manage risk.  Hefren-Tillotson, Inc., (“Hefren”) a dually-registered investment adviser and broker-dealer, agreed to a cease-and-desist and settlement offer with the SEC for violations of Section 206(2) of the Advisers Act, which states it is unlawful “to engage in any transaction, practice, or course of business which operates as a fraud or deceit upon any client or prospective client”.  Hefren signed a Fully Disclosed Clearing Agreement with an unaffiliated clearing firm in 2002 that charged Hefren $7.95 for clearing and execution services on each trade.  Hefren, in turn, passed this charge on to its clients.  By 2012, this clearing and execution charge was reduced to $6.00 per trade, but Hefren continued to charge its clients $7.95 per trade and kept the $1.95 difference.  This practice was not disclosed in the firm’s Form ADV Part 2A and the firm failed to explain that it was a conflict of interest because other Clearing Firms may not provide the same accommodation.  It also incentivized the adviser to trade more frequently.

So, how does a compliance officer figure out that the clearing fee has been reduced, but the firm is keeping the difference if not told directly?  It would be difficult for a compliance analyst doing a best execution review to pick it up by looking at trading activity since no changes would be evident in the client records and trade blotter.  Presumably, the CFO or finance team is renegotiating the terms of the clearing agreement with the approval of the CEO or President.  The CCO should be involved in the process, or at the very least, provided a copy of the final agreement.  Compliance should also review the firm’s financials at least annually to understand the revenue streams and to accurately update the ADV if needed.  And if the CFO does not have a background in financial services, the CCO should meet with the CFO regularly to discuss compliance matters.  The SEC noted in the release that “Scienter is not required to establish a violation of Section 206(2), but rather such violation may be based on a finding of negligence… and Hefren willfully violated Section 206 (2).”  Executives and employees with the ability to identify red flags and alert the CCO of issues they see regarding fees, employee compensation and revenue make all the difference in running a compliant firm.  Contributed by Heather D. Augustine, Senior Compliance Consultant.

Respect Your Elders!  FINRA came down hard on registered representatives Ami Forte and Charles Lawrence for other reps who might consider exploiting their senior and vulnerable clients.  In less than one year, the pair generated over $9 million in commissions by effecting more than 2,800 unsuitable transactions in the accounts of a customer who had dementia.  Both Forte and Lawrence have been barred from association with any FINRA member firm in any capacity.  The case raises the obvious question:  where were the supervisors or compliance officers?  Were they asleep at the switch?  Make sure your firm has developed and implemented sound supervisory procedures to prevent and detect exploitation of senior and vulnerable clients.  If you need help, please contact Hardin Compliance.  Contributed by Rochelle A. Truzzi, Senior Compliance Consultant.

Garbage In, Garbage Out: Morgan Stanley’s Epic Fail Caused by Flawed Tools and User Error.  In the wake of last year’s SEC Share Class Selection Disclosure (“SCSD”) Initiative, advisers investing client assets in mutual funds have become more acutely aware than ever of the Commission’s scrutiny of mutual fund share class selection and disclosures surrounding conflicts of interest arising from financial incentives associated with 12b-1 fees.  Many firms have sought to ensure that client assets are invested in the least expensive classes possible, including by requiring the use of FINRA’s Fund Analyzer or proprietary systems.  At first glance, these tools seem great – clients are getting the most cost-effective share class, advisers are acting in clients’ best interests – but what happens when the algorithm is flawed?  November administrative and cease-and-desist proceedings against Morgan Stanley Smith Barney LLC (“MSSB” or the “Firm”) demonstrated that the SEC won’t be satisfied with attempts, however well-intentioned, that fail to result in the selection of the most economical share class for client assets.

In 2008, MSSB’s predecessor, Morgan Stanley, developed an automated mutual fund share class selection system (the “MFSCI”), which was incorporated directly into the Firm’s order entry system and was designed to automate the selection of the most cost-effective share class by analyzing customer-specific data, including current fund family holdings, planned future purchases and time horizon.  The system, however, was flawed.  Operating errors resulted in the Firm’s failure to provide the most beneficial share class in two specific circumstances:  When retirement accounts with recurring trades transferred in from other brokerage firms, they did not receive MFSCI’s analysis; and when MSSB advisors failed to confirm whether retirement accounts met specific minimum eligibility criteria.  In both cases, clients missed out on available sales charge waivers.  The system also had a coding issue as it could not account for sales charge waivers available to charitable organizations.  Additionally, the Firm failed to use the calculator for legacy retirement plan brokerage customers until 2012, although it had been deployed in 2009 for other accounts.

These issues resulted in the Firm’s failure to recommend and sell the least expensive share classes available, contrary to the representations it made to clients and in breach of its fiduciary duty.  From July 2009 through 2016, clients overpaid by millions in the form of upfront sales charges that should have received waivers, CDSCs, and higher ongoing fees and expenses from purchases of share classes other than the most cost-effective for which they were eligible.  The SEC found that MSSB violated Sections 17(a)(2) and 17(a)(3) of the Securities Act, ordering disgorgement and a penalty of $1.5 million.  Contributed by Mark L. Silvester, Compliance Associate.

Worth Reading

Filing Deadlines and To-Do List for December 2019


  • 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 December 15, 2019.
  • Annual Renewal Program for IARD System: The IARD Renewal Program facilitates the annual renewal of investment adviser (IA) firms and their IA representatives’ (IARs) registrations with jurisdictions/states.  Preliminary renewal statements for the IARD system were released on November 11, 2019, and are accessible only through the E-Bill System.  Renewal statements reflect the registration renewal fees and annual system processing fees for all IARs and state-registered IA firms.  The deadline for the receipt of preliminary statement payment is December 16, 2019.  Questions?  Check out the FAQs, which are now updated with 2020 IARD Renewal Program details.


  • 2020 Preliminary Renewal Statement is due in full on Monday, December 16, 2019.
  • Supplemental Inventory Schedule (“SIS”): For the month ending October 31, 2019. 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 date December 2, 2019.
  • Statement Regarding Independent Public Accountant: Due no later than December 10thof each year, unless your engagement is of a continuing nature, providing for successive engagements. Due date December 10, 2019.
  • Rule 17a-5 Monthly and Fifth FOCUS Part II/IIA Filings:  For the period ending November 30, 2019. For firms required to submit monthly FOCUS filings and those firms whose fiscal year-end is a date other than a calendar quarter.  Due date December 24, 2019. 
  • Annual Audit Reports for Fiscal Year-End October 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 date December 30, 2019. 
  • Supplemental Inventory Schedule (“SIS”): For the month ending November 30, 2019. 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 date December 30, 2019. 
  • SIPC-3 Certification of Exclusion from Membership: For firms with a Fiscal Year-End of November 30, 2019, 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 date December 30, 2019. 
  • SIPC-6 Assessment: For firms with a Fiscal Year-End of May 31, 2019.  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 date December 30, 2019. 
  • SIPC-7 Assessment: For firms with a Fiscal Year-End of October 31, 2019.  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 date December 30, 2019. 

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