Conflicts of Interest | Form CRS | Investment Adviser Regulation | Regulation Best Interest | SEC Rule changes

SEC Proposes New Best Interest Standard for BDs, Conduct Standards for RIAs, Warns Advisers about Bad Billing Practices, and the EU Extends its Reach on Data Protection: Regulatory Update May 1, 2018

  • SEC Proposes “Regulation Best Interest” for Broker-Dealers: In an attempt to “enhance the quality and transparency of investors’ relationships with investment advisers and broker dealers,” the SEC has proposed and is requesting comment on a new Regulation Best Interest (the “Regulation”).  The Regulation will apply to broker-dealers and has been designed to level the playing field between broker-dealers and investment advisers by providing a proposed standard of conduct when broker-dealers recommend securities transactions or investment strategies involving securities to retail customers.  Critics, however, feel that the proposed regulation falls short of its goal and will allow broker-dealers to continue, status quo.   While Regulation Best Interest is far less invasive than the DOL Rule, it will certainly modify the way firms do business.  The goals of the Regulation are focused on protecting retail investors, requiring firms to provide clear disclosures to customers, exercise due care when recommending securities or investment strategies to customers, and address specific conflicts of interest that exist with regarding recommendations.   Contributed by Rochelle A. Truzzi, Senior Compliance Consultant
  • New Disclosure Form CRS Proposed by SEC for Retail Investors:   In addition to Regulation Best Interest, the SEC has proposed a new short-form disclosure document to help investors understand their relationship with an investment profession.  This “client relationship summary”, Form CRS, is intended to provide retail investors with information regarding the services being offered, the standard of conduct and the fees and costs associated with those services, specified conflicts of interest, and whether the firm and its financial professionals currently have reportable legal or disciplinary events.  Both broker-dealers and investment advisers would be required to provide this summary.  Advisers would be required to file through the IARD system, and broker dealers would file through the EDGAR system.   Contributed by Rochelle A. Truzzi, Senior Compliance Consultant
  •  SEC issues Proposed Standard of Conduct for Investment Advisers: Along with Regulation Best Interest and the proposed Form CRS, the SEC also issued “Proposed Commission Interpretation Regarding Standard of Conduct for Investment Advisers” (the “Adviser Conduct Proposal”), along with a request for comment on “Enhancing Investment Adviser Regulations.”  The SEC’s proposal provides clarification of the fiduciary duty of advisers, which includes (1) a duty of care, and (2) a duty of loyalty.  The duty of care includes providing advice that is in the best interest of the client, seeking best execution, and providing advice and monitoring on an ongoing basis.   The duty of loyalty requires that an investment adviser put its clients’ interests ahead of its own, prohibits unfairly favoring one client over another, and provide clients with full and fair disclosure of all material facts relating to the advisory relationship.

To enhance investment adviser regulations, the SEC is also seeking comment on a number of proposed rules.  The first would subject investment adviser representatives to standardized qualification examinations and continuing education requirements, similar to the broker-dealer requirements.  The second would require investment advisers to provide account statements, “either directly or via the client’s custodian, regardless of whether the adviser is deemed to have custody of client assets under Advisers Act Rule 206(4)-2 or the adviser is a sponsor (or a designee of a sponsor) of a managed account program relying on the safe harbor in Investment Company Act rule 3a-4.”   The third proposal is to subject investment advisers to a financial responsibility program that is similar to the broker-dealer net capital, fidelity bond, and customer protection rules.

Expect a lot of discussion about these proposals during the 90-day comment period.  Contributed by Rochelle A. Truzzi, Senior Compliance Consultant


  • SEC Risk Alert on Advisory Fee and Expenses:  The Office of Compliance Inspections and Examinations (“OCIE”) issued a risk alert warning advisers about the most common deficiencies related to fees and expenses.  The majority of the deficiencies occurred because advisers did not calculate the fees using the method agreed upon in the investment management agreement (“IMA”) with the client.  For example, advisers were cited for calculating the management fees using market value at the end of the billing cycle instead of average daily balance, as specified in the contract.  Other common deficiencies included weak or missing disclosures related to practices to refund prepaid fees when contracts are terminated before the end of a billing period, disclosures that were inconsistent with firm practice, and insufficient disclosure of additional fees and expenses that clients may incur beyond the adviser’s management fee.

 To address the deficiencies highlighted in the Risk Alert, advisers should consider:

  1. Adopting a robust account onboarding process that requires a review to ensure that that billing information for each client is consistent with the terms of the IMA and has been entered correctly;
  2. Instituting periodic transactional testing of fees (such as by operations or accounting during the invoicing process) as well as forensic testing by compliance (such as in the course of the annual compliance program review) to ensure that the fees are being calculated in accordance with the IMA’s terms;
  3. Reviewing Form ADV Part 2A disclosures periodically to ensure that fee billing and fee calculation practices are accurately disclosed (including avoiding the use of “may” when a practice “is” occurring);
  4. For private and mutual fund advisers, implementing controls and compliance testing of fund expense processing to ensure that expenses paid by funds are in accordance with fund documents and related disclosures; and
  5. Correcting any billing or expense processing errors pro-actively and promptly.

 In spite of our best efforts, process and system developments, mistakes happen.  But advisers that are proactive in correcting an issue, analyzing its cause(s) and revising practices accordingly, will be better off in the long run.  Contributed by Cari A. Hopfensperger, Compliance Consultant

  • Large Fund Groups Face New Form N-PORT Filing Deadline: Advisers to mutual funds are likely becoming increasingly familiar (and potentially frustrated) with two new regulatory filings associated with the SEC’s Investment Company Reporting Modernization Rules, Form N-PORT and N-CEN.  The SEC recently updated its related FAQs and announced its decision to postpone initial filings of Form N-PORT for large ($1+ billion) and small fund groups until April 30, 2019 and April 30, 2020, respectively.  This decision was in large part related to cybersecurity enhancements that are underway at the SEC and which are expected to impact the EDGAR system – the intended recipient of both filings.  While this additional time is intended to ensure any EDGAR issues related to their enhancements are resolved well in advance of the N-PORT filing date, the industry is not breathing any sighs of relief.  Large fund groups specifically will still be required to prepare and maintain the data needed to complete the Form N-PORT beginning June 1, 2018.  Although it will not need to be filed, this information will also be subject to inspection upon request by the SEC. Small fund groups will not need to prepare the necessary data until the initial filing deadline in April 2020.

 Form N-PORT filings, which will contain firm, portfolio and security level data, and ultimately replace Form N-Q, will be required 30 days after each month end.  Filings will be non-public for the first sixth months following the initial filing deadline.  After September 30, 2019, Form N-Port filings will be made public, but only filings for the third month of each fund’s fiscal quarter. Given the number of data points required, the likelihood that the data points may reside in disparate internal systems, and the requirement filing in XML format via EDGAR, firms may wish to get a jump on this impending filing soon.  More specifically, firms are advised to begin reviewing the location of this data within their firms, evaluating the logistical aspects of this new filing and considering whether technology service providers can help.  Advisers may also benefit from establishing a regular dialog with administrators and other fund service providers to understand what their roles will (or may) be in the process.

 Registered investment companies will also begin filing the new Form N-CEN on an annual basis after the compliance date of June 1, 2018.  Filings in XML format will be due via EDGAR 75 days after a fund’s fiscal year end and require funds to report enhanced and updated census-type information on a wide range of compliance, risk assessment, and policy-related matters.  Form N-CEN filings will be publicly available.  Similar to the Form N-SAR, which will be rescinded, all funds will need to complete sections A and B, with sections D, E and F only applicable to certain types of funds.   Contributed by Cari Hopfensperger, Compliance Consultant

  •  European General Data Protection Regulation (GDPR) Goes Live May 25 – Should you be Worried?  European General Data Protection Regulation or GDPR comes into force on May 25, 2018, and requires investment managers, funds, banks, and broker-dealers, with operations in Europe or information about individuals in Europe, to comply with a broad set of data privacy and security obligations.  If you have an office, employees, or natural persons who are clients that reside in the European Union, this regulation may apply to your firm.

 The GDPR applies to entities established in the European Union and to entities not established in the European Union (i) when they process personal data of natural persons (“data subjects”) who are in the EU, and (ii) where the data processing activities are related to offering of services to such natural persons in the EU. For GDPR purposes, “processing” includes simply collecting, recording and storing information.  An investment adviser providing investment advice to EU individuals is considered to be providing “services” under the GDPR.

 So servicing a client in the EU could require your firm to comply with GDPR, and the penalties for non-compliance are severe. As of May 2018, European Supervisory Authorities can impose administrative fines of up to 20 million Euros or 4% of total worldwide turnover of the preceding financial year, whichever is the higher.  For more information, check out the website: by Jaqueline M. Hummel, Partner and Managing Director


  • BEA 5-year Benchmark Survey on Foreign Direct Investment in the U.S.:  The U.S. Commerce Bureau of Economic Analysis (“BEA”) has mandated the filing of a BE-12 Report by May 31, 2018.  The BE-12 Report must be completed by any U.S. entity where 10% or more of the U.S. entity’s voting interests are owned, directly or indirectly, by one or more foreign persons (the “10% threshold”).   A filer has to complete one of three forms, the BE-12A, BE-12B or BE-12C.  The form to be completed depends on (i) the entity’s ownership, and/or (ii) its assets, sales or gross operating revenues or net income.  For more information, check out BEA’s website here.   Contributed by Jaqueline M. Hummel, Partner and Managing Director

 Lessons Learned from Recent SEC and FINRA Cases:

SEC Nails Three Advisors for Fiduciary Failures when Selecting Mutual Fund Share Classes.  The SEC released three settlement orders where investment advisers failed “to disclose conflicts of interest and violated their duty to seek best execution by investing advisory clients in higher-cost mutual fund shares when lower-cost shares of the same funds were available.”  The firms had to reimburse investors to the tune of $12 million, as well as pay penalties ranging from $250,000 to $900,000.  Check out our blog post discussing these cases:  Why the SEC is Obsessed with Mutual Fund Share Class Selection and Disclosure (and why you should be too).

Adviser Marketed Misleading Hypothetical Back-tested PerformanceWishful thinking is the formation of beliefs and making decisions according to what might be pleasing to imagine instead of by appealing to evidence, rationality, or reality. In the matter of the Securities and Exchange Commission (“SEC”) vs. Arlington Capital Management, Inc. and Joseph F. LoPresti, CCO, the SEC decisively pointed out that wishful thinking is not a basis for advertising hypothetical back-tested performance. In 2010, Arlington and LoPresti started using model portfolios – the Proactive Asset Allocation Strategy (PAAS) — to invest client assets.  From 2012-2015, the firm issued a series of advertisements that contained hypothetical back-tested results. Each time the model was updated, Arlington would restate its performance results as if the new version of the model had been in effect during the entire period. The advertisements either did not disclose that the results were hypothetical and continuously being adjusted as the models were improved or contained disclosures that were not given the appropriate prominence. All advertisements were approved by LoPresti as the CCO.

In addition to being required to revise the firm’s advertising policies and procedures, naming a new CCO, and hiring a compliance consultant, both Arlington and LoPresti were required to pay civil monetary penalties, collectively totaling $200,000. Further, Arlington was required to post the entire SEC order prominently on their website, send a notice of the posting to all existing clients, and update the firm’s ADV.  Lesson learned from this case is that if your firm is going to advertise hypothetical back-tested performance, understand that heightened disclosure is required, including clearly and prominently identifying the nature of the performance on the actual performance page.  Write parameters into the policy and procedures, talk to the portfolio managers and analysts to understand the breadth and scope of the calculations, and train marketing personnel on the disclosure requirements. It takes a village to provide accurate disclosures in this arena. Wishful thinking will not give you a pass with the SEC.  Contributed by Alison R. Palmeri, Esq., Compliance Associate, and Heather Augustine, Senior Compliance Consultant.

Worth Reading:

Brokers May Have to Put Customers FirstMatt Levine provides his entertaining perspective on the SEC’s latest slew of announcements and rule proposals.

SEC National Compliance Outreach boiled down to about 1,000 words.  Check out Lorna Schnase’s Summary of the SEC outreach meeting for RIAs and ICs.  She boils it down to the essentials, so you get the big picture without all the self-congratulation!

Morgan Lewis’ Summary on GDPR’s Requirements: and GDPR: Q & A for Investment Advisers and Private Fund Managers from Foley Hoag:  Good resources on the new regulation.

K&L Gates Alert on BE-12:   Bureau of Economic Analysis is requesting more data to determine and quantify the size and economic significance of foreign direct investment in the United States.  Private funds with material foreign investment should check this out.

Three things define effective compliance training — and here’s what they are:  Ricardo Pellafone provides some great advice for re-tooling your compliance training.

Filing Deadlines and To Do List for May


  •  Form 13F:  Form 13F quarterly filing is due for Q1 2018 within 45 days after the end of the calendar quarter. Due date is May 15, 2018.


  •  Form PF for Large Hedge Fund Advisers: Large hedge fund advisers must file Form PF within 60 days of each quarter end on the IARD system. Due date is May 30, 2018.
  • Cayman investment funds must complete their Common Reporting Standard (“CRS”) report and file with Cayman Islands Tax information agency (“TIA”) with respect to the immediately preceding calendar year.  Due date is May 30, 2018.
  • Cayman investment funds required to report must complete their FATCA report and file with Cayman TIA with respect to the immediately preceding calendar year.  Due date is May 30, 2018.
  • BEA 5-year Benchmark Survey on Foreign Direct Investment in the U.S.: The U.S. Commerce Bureau of Economic Analysis (“BEA”) has mandated the filing of a BE-12 Report by May 31, 2018.  The BE-12 Report must be completed by any U.S. entity where 10% or more of the U.S. entity’s voting interests are owned, directly or indirectly, by one or more foreign persons (the 10% threshold”).


  • CFTC CPO-PQR Form:  Large Commodity Pool Operator Form CPO-PQR (March 31 quarter-end report) required to be filed with the NFA for Commodity Pool Operators. Due date is May 30, 2018.
  • CFTC Form CPO-PQR:  Small and Mid-Sized Commodity Pool Operators are required to file NFA Form CPO-PQR.   Due date is May 30, 2018.


  • Form OBS: For the Quarter ending March 31, 2018.  Unless subject to the de minimis exception, all clearing, self-clearing, and carrying firms and those firms that have a minimum dollar net capital requirement equal to or greater than $100,000 and at least $10 million in reportable derivatives and other off-balance sheet items must submit Form OBS as of the last day of a reporting period within 22 business days of the end of each calendar quarter via eFOCUS.  Firms that claim the de minimis exemption must affirmatively indicate through the eFOCUS system that no filing is required for the reporting period.   Due May 1, 2018.
  • Rule 17a-5 Monthly and Fifth FOCUS Part II/IIA Filings:  For period ending April 30, 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 May 23, 2018. 
  • Supplemental Inventory Schedule (“SIS”): For the month ending April 30, 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 May 29, 2018. 
  • Annual Audit Reports for Fiscal Year-End March 31, 2018:  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 May 30, 2018.
  • SIPC-3 Certification of Exclusion from Membership: For firms with a Fiscal Year-End of April 30, 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 May 30, 2018.
  • SIPC-6 Assessment: For firms with a Fiscal Year-End of October 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 May 30, 2018.
  • SIPC-7 Assessment: For firms with a Fiscal Year-End of March 31, 2018.  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 May 30, 2018.

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