12b-1 Fees | FINRA Rule Changes | Form ADV Disclosure | Mutual Funds | SEC Examinations | SEC News

SEC Offers Amnesty, Outreach and Exam Priorities, FinCEN CDD Deadline Looms and FINRA Posts FAQs on Exploitation of Seniors: Regulatory Update March 2018

  • SEC Enforcement Division Offers “Favorable Settlement Terms” to Advisers that Self-Report Failure to Disclose Receipt of Rule 12b-1 Fees: In a rare move, the SEC is offering to forego fines against investment advisers who self-report receiving 12b-1 fees from clients for recommending more expensive mutual fund share classes.   The offer is good until June 12, 2018.  The deal is being offered to advisers that meet the following conditions:
    1. The advisers recommended 12b-1 paying share classes of mutual funds to clients when a lower-cost share class was available;
    2. The advisers, their supervised persons, or their affiliated broker-dealers received the 12b-1 fees; and
    3. The advisers failed to disclose explicitly in Form ADV the conflict of interest associated with receiving such fees.

For more details, check out the SEC’s announcement here.  And stay tuned for an HCC Blog Post on the issue coming soon.   Contributed by Cari Hopfensperger, Compliance Consultant

  • SEC Outreach program: The SEC has announced the first 2018 CCO outreach seminar to be held on April 12 at its Washington, D.C., headquarters from 8:30 a.m. to 5:30 p.m. EST.  In-person attendance is limited to 500; a live webcast will be available at sec.gov.  Register here.   Topics of discussion include an update on National Exam initiatives, fees and expenses impacting retail investors, portfolio management trends, regulatory hot topics, cybersecurity, compliance, and rulemaking.  Check out the Agenda here.  Contributed by Heather D. Augustine, Partner and Managing Director
  • OCIE National Exam Priorities: The SEC’s Office of Compliance Inspections and Examinations (“OCIE”) issued its examination priorities for 2018, and it’s not so different from 2017. OCIE has five themes this year (instead of three):
    • Protecting retail investors, focusing on seniors and those saving for retirement;
    • Assessing compliance and risks in critical market infrastructure;
    • FINRA and MSRB;
    • Cybersecurity; and
    • Anti-Money Laundering programs.

For registered investment advisers, examiners are going to focus on disclosure of fees, financial incentives associated with certain products, conflicts of interest, and payments to affiliates.  Similar to prior years, the SEC warns that it will focus on the selection of mutual fund share classes.  A few new twists:  the SEC will be looking at “orphaned accounts” to determine whether firms are providing oversight when the representative responsible for the account leaves the firm.

Robo-advisers and wrap fee programs will also be in the crosshairs.  Predictably, examination will focus on the investment recommendations, compliance with an adviser’s fiduciary duty, and disclosure of costs and conflicts of interest.

Mutual funds and ETFs will also receive their fair share of attention.  OCIE will be looking closely at funds with poor performance and liquidity issues, and funds managed by advisers inexperienced with mutual fund regulation.  ETF funds with little secondary market trading volume will also be scrutinized.

Broker-dealers should review their best execution policies and procedures, especially with respect to municipal and corporate bonds.

Other areas of review will include cryptocurrencies and initial coin offerings, cybersecurity protection, and anti-money laundering programs.  Contributed by Jaqueline M. Hummel, Partner and Managing Director

  • SEC Gives Mutual Funds more time to Implement Liquidity Risk Management Programsand Updated its FAQs: The SEC extended the deadline for compliance with certain elements of the new liquidity risk management program rule by six months.  Rule 22e-4 requires open-end investment companies (except money market funds) to establish liquidity risk management programs.  As discussed in the SEC’s press release, the new compliance date will give funds “more time to implement the rule’s classification requirement, along with specified other elements that are tied to the classification requirement.”  The remaining provisions of the rule, including the requirements to adopt a liquidity risk management program and to limit illiquid investments to 15 percent of the fund’s portfolio, will go into effect as originally scheduled.   The compliance date for implementation of the classification and classification-related elements of the liquidity rule is June 1, 2019 for larger fund groups, and December 1, 2019 for smaller fund groups.

The SEC also updated its FAQs related to the new rule.  Check out the redlined version here.  The changes relate primarily to asset classification, liquidity determinations, compliance obligations and frequency of classifications.  Contributed by Jaqueline M. Hummel, Partner and Managing Director

  • FINRA FAQs on Financial Exploitation of Seniors: FINRA has posted FAQs addressing new FINRA Rule 2165 (Financial Exploitation of Specified Adults), and amendments to FINRA Rule 4512 (Customer Account Information), both of which became effective on February 5, 2018.  The FAQs emphasize and clarify the following points, among others:
    • Temporary holds apply only to questionable disbursements of funds or securities from an account. Temporary holds cannot be placed on securities transactions nor should a firm place a blanket hold on the entire account;
    • A Trusted Contact must be a natural person age 18 or older; and
    • Firms may treat any authorized agent of a non-natural person, non-institutional account as the Trusted Contact, provided the firm complies with the disclosure requirement of Supplementary Material .06 to Rule 4512.

The FAQs also included details on when firms should seek Trusted Contact information, and what disclosures may be made to the Trusted Contact.  Contributed by Rochelle  A. Truzzi, Senior Compliance Consultant

  •  Deadline to Comply with FinCEN’s Customer Due Diligence Rule is Fast Approaching: Will you be ready to comply on May 11, 2018? Broker-Dealers will be required to (1) develop and implement procedures to identify and verify the identity of beneficial owners of accounts of legal entity customers on or after May 11, 2018; and (2) understand the nature and purpose of a customer relationship in order to develop a customer risk profile; conduct monitoring to identify and report suspicious transactions; and, on a risk basis, maintain and update customer information (“Fifth Pillar”).   The first requirement relates to legal entity customers only.  The second requirement applies to all customer accounts, whether natural persons or legal entities, opened on or after May 11, 2018.    Firms must obtain the name, address, date of birth and social security or passport number (or similar information for non-U.S. citizens) for (1) all individuals who own 25% or more of the legal entity opening an account and (2) at least one individual who has significant responsibility to control, manage, or direct the legal entity customer (i.e., CEO, CFO, COO, Managing Member, GP, President, Vice President or Treasurer).  Contributed by Rochelle A. Truzzi, Senior Compliance Consultant

Broker-Dealers Should:

  1. Develop, document (WSPs, AML Policy) and implement a client risk assessment process in order to address the Fifth Pillar. Refer to  Benefits of an Effective CDD Program and How Risk Scoring Customer Accounts Can Protect the Reputation of Your Institution, by Douglas J. Bruggeman for additional guidance.
  2. Develop, document (WSPs, AML Policy) and implement procedures to obtain the required personal information for (1) all individuals who own 25% or more of the legal entity customer and (2) at least one individual who has significant responsibility to control, manage, or direct a legal entity customer.
  3. Determine if your firm will rely on other financial institutions to perform due diligence and verification procedures for purposes of CIP and/or beneficial ownership of legal entity customers. Refer to SEC No-Action Letter to SIFMA dated, December 12, 2016.  If so, the firm should review contracts with such financial institutions to ensure the conditions set forth in the SEC No-Action letter are being met.  If not, the broker dealer should decide what action to take if a financial Institution does not comply with the conditions set forth in the no action letter.
  4. Develop training to teach associated persons about the new policies and procedures related to the Customer Due Diligence (CDD) Rule.  Contributed by Rochelle M. Truzzi, Senior Compliance Consultant
  • Form ADV Update deadline: Procrastinators beware!  The deadline for filing the Form ADV update for investment advisers with a fiscal year end of December 31 is March 31, 2018, which is a Saturday.   IARD is open on Saturday March 31, therefore the deadline for filing an annual updating amendment will NOT be extended to Monday April 2, 2018.

 

Lessons Learned from Recent SEC and FINRA Cases:

Fund Administrator Fined by SEC for Failing to Detect Asset and NAV Errors  Ignorance is not bliss. The SEC fined Fund Administrator Gemini Fund Services, LLC (“Gemini”) for causing Daniel Thibeault, Managing Director of the GL Beyond Income Fund (“GL Fund”) and GL Capital Advisors to violate Sections 206 (1) and 206 (2) of the Investment Advisers Act.  Gemini was contracted to act as the mutual fund administrator, fund accountant, and transfer agent for the GL Fund.  Gemini was calculating an inflated NAV for the GL Fund and transmitting the inflated NAV to NASDAQ based on fictitious loans created by Thibeault. The SEC stated that Gemini did not have knowledge that Thibeault created fake loans to divert assets to his personal and business bank accounts.  However, Gemini did know that for 11 months the GL Fund’s custodian was not booking the fake loans because they did not have proof of the loans’ existence and were not counting the assets, but Gemini continued to report the inflated NAV. In addition, Gemini never notified the GL Fund’s Board of Directors nor the investing public of the discrepancies.   Gemini was fined more than $550,000, required to hire a compliance consultant, and slapped with a cease and desist order.  As with the Apex Fund Services case last year, the SEC will not hesitate to go after the supporting actors albeit attorneys, fund administrators or custodians who help facilitate fraud on investors.  It sends a message that the investors come first and not the firm paying the bills if discrepancies occur and are not addressed properly.  It’s hard to imagine the rationale on turning a blind eye to the red flags in this scenario. It’s also a great example why it’s important for registered investment advisers to conduct due diligence on their current and new service providers to uncover these types of violations.   Contributed by Heather Augustine, Senior Compliance Consultant

Broker Ignored Compliance Training and Churned Accounts: The SEC’s Complaint filed against Zachary S. Berkey (“Berkey”) and Daniel T. Fischer (“Fischer”), former registered representatives of Four Points Capital Partners LLC, is a classic scenario that you may want to include as part of your firm’s 2018 Firm Element Continuing Education Plan.  The Complaint has all the components of a thrilling, “what-not-to-do” training module including: violations of the antifraud provision of the federal securities laws; violations of both the reasonable-basis suitability and customer-specific suitability obligations of a registered representative; material misrepresentations and omissions to customers; churning of customer accounts; and, unauthorized trading.  Both Berkey and Fischer (the “Defendants”) recommended a high cost, in-and-out trading strategy to clients without any reasonable basis to believe the recommendations were suitable for anyone.  Predictably, the strategy proved to be unsuitable for certain clients based on the clients’ individual financial needs and investment profiles.  While the Defendants collected a combined sum of $281,000 in commissions, the customer accounts in question suffered aggregate losses in excess of $573,000.  The Complaint filed by the SEC reported, “The average annualized cost-to-equity ratio was 58.19% for the Berkey accounts and 70.26% for the Fischer accounts,” which rises way beyond the 20% indicator of excessive trading [Note to firms: if you are not currently doing so, you should enhance your review of client accounts to include a review of annualized turnover and cost-to-equity ratios].  The SEC is seeking to have each of the Defendants enjoined from committing, aiding and abetting, or otherwise engaging in activities set forth in the complaint.  In addition, the SEC is requesting disgorgement of any ill-gotten gains and civil monetary penalties.  Contributed by Rochelle Truzzi, Senior Compliance Consultant

FINRA Suspends President of BD Firm for Failure to Supervise Inexperienced CCO:  In a recent letter of Acceptance Waiver and Consent (“AWC”)(No. 2012033566204), FINRA imposed a six-month suspension and a $10,000 fine on Wayne Ivan Miiller, president of Accelerated Capital Group, Inc. for a failure to supervise the firm’s Chief Compliance Officer for not addressing her concerns regarding a registered representative’s excessive trading activity.   The firm’s Chief Compliance Officer told Miiller that she was having trouble analyzing the firm’s trade blotter and mutual fund switch reports, and requested better reporting tools.  Even with the help of a compliance consultant, the CCO was still unable to perform adequate trade monitoring, but Miiller ignored this red flag.  The CCO also told Miiller that a registered representative was engaging in excessive trading of Class A mutual fund shares, but once again, Miiller failed to act.  Ultimately, FINRA found Miiller violated NASD Rule 3010(a) and FINRA Rules 3110(a) and 2010 for failing to adequately supervise the CCO and address her concerns regarding the registered representative.  Like any other employee, Chief Compliance Officers should be given the right tools and support to do the job. Additionally, the CCO’s position is key to managing risk, so firm management should understand what the CCO is doing and whether the job is being done adequately.  contributed by Jaqueline M. Hummel, Partner and Managing Director

 Worth Reading:

 Cybersecurity, the SEC and You:  The SEC has a website that consolidates it cybersecurity resources.

Are Robo-Advisors Actually an Unregistered Investment Company… Along With Some Human RIAs, Too?

Michael Kitces talks about the fine line between providing standardized investment portfolios and running an unregistered investment company.  Check out his explanation of Rule 3a-4 of the Investment Company Act!

Not all Index Funds are Created Equal:   Mike Limbacher from Fi360 explains some index funds can be poor choices for investors.

What’s a Reasonable Fee?  Fred Reish recommends working with a bench-marking service to help investment advisers gauge whether their fees meet the Department of Labor’s fiduciary standard.

Filing Deadlines and To Do List for March

 FOR INVESTMENT MANAGERS:   

  •  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 31, 2018).

 FOR LARGE HEDGE FUND ADVISERS:

  •  Form PF:  For Large Hedge Fund Advisers this Form must be filed within 60 days of each quarter end on the IARD system (March 1, 2018).
  • Initial Form PF:  Hedge Fund Advisers that have reached $1.5 billion regulatory assets under management (“RAUM”) attributable to hedge funds as of December 31, 2018 must make initial filing (the initial quarterly Form PF filing within 60 days of quarter end if an adviser’s hedge fund RAUM exceeds $1.5 billion as of the previous quarter end).  (March 1, 2018)

  MUTUAL FUNDS AND HEDGE FUNDS:

  •  Reaffirm YOUR CPO and CTA Exemptions: Firms that claim exemptions from Commodity Pool Operator (“CPO”) registration under CFTC Rule 4.5 or CTFC Rule 4.13(a)(3) (the “de minimis exemption”), or Rules 4.13(a)(1), 4.13(a)(2), 4.13(a)(5), and firms that claimed an exemption from Commodity Trading Adviser (“CTA”) registration pursuant to CFTC Rule 4.14(a)(8) must re-affirm those exemptions by March 1, 2018 or those exemptions will be automatically withdrawn.

FOR REGISTERED COMMODITY TRADING ADVISERS 

  • CFTC CPO-PQR Form (All Schedules): Large Commodity Pool Operator Form CPO-PQR is required to be filed with the NFA for all Large Commodity Pool Operators by March 1, 2018.

FOR BROKER DEALERS

  • Annual Audit Reports for the Fiscal Year-End December 31, 2017:  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 is March 1, 2018. 
  • Supplemental Inventory Schedule (“SIS”): For the month ending January 31, 2018. 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 is March 1, 2018. 
  • SIPC-7 Assessment: For firms with a Fiscal Year-End of December 31, 2017.  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 is March 1, 2018. 
  • SIPC-6 Assessment: For firms with a Fiscal Year-End of July 31, 2017.  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 is March 2, 2018. 
  • SIPC-3 Certification of Exclusion from Membership: For firms with a Fiscal Year-End of January 1, 2018 AND claiming 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 is March 2, 2018. 
  • Rule 17a-5 Monthly and Fifth FOCUS Part II/IIA Filings:  For period ending February 28, 2018. 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 is March 23, 2018.
  • Supplemental Inventory Schedule (“SIS”): For the month ending February 28, 2018. 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 is March 28, 2018. 
  • SIPC-6 Assessment: For firms with a Fiscal Year-End of August 31, 2017.  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 is March 30, 2018. 
  • SIPC-3 Certification of Exclusion from Membership: For firms with a Fiscal Year-End of February 28, 2018 AND claiming 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 is March 30, 2018. 

Hardin Compliance Consulting provides links to other publicly-available legal and compliance websites for your convenience. These links have been selected because we believe they provide valuable information and guidance.  The information in this e-newsletter is for general guidance only.  It does not constitute the provision of legal advice, tax advice, accounting services, or professional consulting of any kind.