Registered Investment Advisers Research Articles

Are firms getting the message? Record-keeping obligations related to off-channel messaging

Several high-profile enforcement actions and significant fines brought against notable financial institutions for violations of record-keeping requirements relating to electronic communications continue to foster discussions throughout the financial services industry. This paper seeks to provide a timeline of the most notable regulatory activity and enforcement actions taken against firms. Secondarily, this paper will discuss the regulatory requirements for record-keeping and electronic communications as they relate to broker-dealers and registered investment advisers, while also highlighting significant differences between the two sets of requirements. Lastly, this paper provides guidance for financial services firms on implementing an effective compliance framework for establishing record-keeping controls that could potentially aid firms in meeting their regulatory obligations.

Caught in the web: Pitfalls of electronic communications

This paper explores the regulatory interest in and examination focus on electronic messaging at financial institutions. The regulatory landscape for recordkeeping at broker-dealers and registered investment advisers is discussed in the context of enforcement actions for alleged recordkeeping failures. Practical considerations are offered to enable compliance professionals to monitor and supervise electronic messaging.

Compliant marketing: Breaking down the New Marketing Rule

The Securities and Exchange Commission (SEC) adopted the New Marketing Rule on 4th May, 2021, giving registered investment advisers until 4th November, 2022 to comply. This New Marketing Rule (the Rule) replaced the original advertising rule that was adopted in 1961 and the original cash solicitation rule that was adopted in 1979. This much-needed update takes into consideration the modernisation of advisers' marketing efforts and combines the two old rules into one. As with any new rule, advisers run into the added challenge of interpretation. This Rule is primarily principles-based, and we do not know yet how the SEC will interpret advisers' various implementations. This paper will only address the requirements that apply to investment advisers registered with the SEC. As such, this paper will tackle the new definition of an ‘advertisement’, principles-based prohibitions, specific disclosure requirements and restrictions for performance, testimonials and endorsements, third party ratings, clarification on the applicability for private fund managers, new ADV disclosure requirements around advertising and new books and records requirements.

The crypto frontier: How US policymakers and investment advisers can address digital assets

This paper focuses on prominent issues surrounding digital assets. The lack of a comprehensive federal digital asset law has recently raised several issues for Securities and Exchange Commission (SEC)-registered investment advisers as they try to navigate new markets and new industry practices. As such, this paper addresses the current US regulatory landscape, provides a comparison of non-US approaches to digital assets and provides US policymakers with key principles they can consider for potential digital asset legislation and/or regulation. The paper also provides compliance considerations for investment advisers who currently manage digital assets, to address the evolving obligations under the US securities laws.

Navigating state data privacy laws: A guide for SEC-registered investment advisers

This paper focuses on prominent issues surrounding state data privacy laws, specifically looking at the California Consumer Privacy Act (CCPA), which was amended and expanded by the California Privacy Rights Act (CPRA), the Colorado Privacy Act (CPA) and the Virginia Consumer Data Privacy Act (VCDPA). Due to the lack of a comprehensive federal privacy law, state data privacy laws have recently raised several issues for Securities and Exchange Commission (SEC)-registered investment advisers as they try to navigate through new markets and new industry practices. As such, this paper addresses the similarities and differences between the CPRA, CPA and VCDPA. The paper also provides compliance guidance for investment advisers to address the varying obligation under these laws.

Comment Letter on Proposed SEC Private Fund Advisers Rule ('Private Fund Advisers; Documentation of Registered Investment Adviser Compliance Reviews')

Comment Letter on Proposed SEC Private Fund Advisers Rule ('Private Fund Advisers; Documentation of Registered Investment Adviser Compliance Reviews')

US SEC examination priorities for 2021: what you need to know

Purpose To summarize the U.S. Securities and Exchange Commission Division of Examinations’s recently published 2021 examination priorities. Design/methodology/approach Features short summaries of select aspects of the SEC Division of Examinations’ recently published 2021 examination priorities. Findings The SEC’s priorities for 2021 examinations include retail investor protection; information security; operational resiliency; financial technology and innovation, including digital assets; anti-money laundering; LIBOR transition, and selected areas for registered investment advisers. Practical implications Firms should consider the SEC examination priorities as they conduct their annual reviews of policies, procedures and business activities. Where firms observe deficiencies in their own practices, adjustments should be made before they find themselves the subject of an SEC investigation, examination or enforcement action. Originality/value Practical guidance for investment advisers, investment companies, municipal advisors, and broker-dealers from experienced broker-dealer, securities and investment management lawyer.

Navigating the Custody Rule: A guide for investment advisers

This paper focuses on prominent issues surrounding the Custody Rule (Rule 206(4)-2) of the Investment Advisers Act of 1940. The Custody Rule has recently raised several issues for Securities and Exchange Commission (SEC)- registered investment advisers as they try to navigate through new markets and new industry practices. As such, this paper addresses the SEC’s recent guidance regarding custody with respect to standing letters of authorisation, asset transfers between client accounts, inadvertent custody, access to client log-in information, trustee relationships, the COVID-19 pandemic and non-delivery versus payment (DVP) transfer arrangements.

The state of state fiduciary laws for broker-dealers: Predicting the impact of state laws on SEC’s Regulation Best Interest enforcement

On June 30, 2020, US broker-dealers became subject to Regulation Best Interest (Regulation BI), a new standard of conduct imposed by the Securities and Exchange Commission (SEC) after a decade of debate and rulemaking. Regulation BI requires a broker-dealer recommending any securities transaction or investment strategy involving securities (including account recommendations) to act in the ‘best interest’ of the retail customer. Intended to address the different standards of care that registered broker-dealers and registered investment advisers owed their retail clients, Regulation BI tops the list of 2021 priorities for both the SEC and the Financial Industry Regulatory Authority (FINRA), the-self regulatory organisation that governs broker-dealers. In the coming year, initial SEC and FINRA enforcement actions regarding Regulation BI will illuminate the types of conduct or practices that regulators believe violate the new rule. As the federal regulators begin to define what Regulation BI does and does not permit, they do so against the backdrop of some state securities regulators who claimed that Regulation BI would not adequately protect investors. In response to Regulation BI, several states proposed or enacted their own different standards of conduct for broker-dealers. This paper describes the current and proposed fiduciary duties imposed on broker-dealers under state laws, the states’ ongoing assessment of Regulation BI and the resulting pressure that may be brought to bear on the SEC and FINRA as they begin to enforce Regulation BI.

A guide for chief compliance officers of registered investment advisers on how to develop, conduct and maintain an effective and robust annual testing programme

Every investment advisory firm is unique. Each has a different organisational structure, strategy and service offering and different operational approaches, personnel dynamics and company cultures. There is only one thing I can think of that is consistent from firm to firm: every investment adviser that is registered with the Securities and Exchange Commission (SEC) has to adhere to the same set of rules and regulations. Under Rule 206(4)-7 of the Investment Advisors Act, advisers are required to maintain policies and procedures, conduct an annual review to support those policies and procedures, and designate an individual at the firm as a chief compliance officer (CCO) to administrator the policies and annual review, often referred to in its entirety as a compliance programme. Accomplishing the task of this compliance programme can feel daunting considering that the SEC’s rules and regulations are vast, intricate and confusing. With this in mind, I developed a methodology for tackling the annual compliance review that — time and time again — has made my clients’ jobs easier. This approach is based on simplicity, practicality and customisation. I use it with every one of our clients. And it is my goal to share it with every new, newish and multi-hatted CCO to help make their lives easier.

Rogue Brokers and the Limits of Agency Law

Rogue brokers and their counterparts among registered investment advisers—overall a relatively small but persistent cohort among securities-market professionals—defraud their clients, execute unauthorized transactions, or otherwise betray the trust clients necessarily repose in them. Many rogues are recidivists: fired by one firm, they move to another and often engage in new misconduct. Firms that appear to welcome rogues may enhance the risks of harm imposed on clients as well the adverse reputational consequences that follow for the industry and its regulators. This paper, written as a chapter for a forthcoming book, introduces the vocabulary and structures of common law agency as a framework to examine structural features that underlie the challenges posed by individual rogues. This framework is also helps to situate the distinct role of securities-market regulation. The paper incorporates the results and implications of other scholars’ recent quantitative inquiries into securities-market rogues as well as other cohorts daunted by recidivists, in particular law-enforcement officers and insurance producers. A securities-market rogue links two distinct types of agent-principal relationships: (1) between an individual representative and the firm with which the professional is associated; and (2) between the firm, its representative, and the clients or customers with whom the representative interacts on the firm’s behalf. Both types of relationships are characterized by asymmetries that work to the disadvantage of investors, especially so for unsophisticated retail investors. This is because an individual rogue and the firm represented by the rogue have access to material information unavailable to the investor, in particular textured information about the rogue’s history and present propensities as well as the firm’s own practices. Separately, a firm’s powers of control over its representatives exceed an investor’s powers of control as a principal in an agency relationship once the investor engages the broker or adviser. Although agency-law doctrine accounts for both asymmetries, its responses operate only retrospectively once a client suspects problems with an account. In contrast, regulation can facilitate several distinct strategies for proactive intervention; it also can expand liability to encompass personnel charged with supervisory responsibilities. Within this framework, the paper examines recent proposals from FINRA to address persistent concerns with individual rogues and broker-dealer firms that employ them.

The Importance of Financial Misconduct of Institutional Investors on Corporate Social Responsibility

This study analyzes the effect of institutional investors with disciplinary history (IDH) on the corporate social responsibility (CSR) activities of investee firms. We use Registered Investment Advisers’ reported violations of laws and regulations to the Securities and Exchange Commission to identify IDH. We find that IDH discourage firms’ engagement in CSR activities and attribute this regularity to institutions’ disregard for social norms. Further, we find that both activist and non-monitoring IDH appear to drive the discouragement of CSR activities but that the investment horizon of investors does not appear to drive our results. We conduct extensive robustness tests to address endogeneity issues by employing two-stage least squares regression, regression discontinuity and difference-in-difference identification strategies. The results continue to hold when we conduct additional robustness tests such as propensity-score matching (PSM) methodology of entropy balancing approach. Overall, our results suggest that institutional investors’ track record of financial misconduct has an economically significant negative impact on investee firms’ CSR activities.

The Worst of Both Worlds? Dual-Registered Investment Advisers

As fiduciaries, Registered Investment Advisers (RIAs) must place client interests ahead of their own. Many fiduciaries are dual-registered as brokers (DRs) and have potential conflicts of interest including revenue sharing from mutual funds, receiving asset-based fees and transaction-based commissions on the same security, and preferential treatment of affiliated mutual funds. Regulators frequently discipline DRs for these conflicts. DRs charge their retail RIA clients higher fees than their brokerage clients or clients of independent RIAs. Finally, DRs prefer institutional share classes of the same underperforming mutual funds they offer brokerage clients. Many DRs appear to fall short of the fiduciary standard.

Decoding the SEC rulemaking package on standards of conduct for investment professionals

PurposeTo provide an overview of the US Securities and Exchange Commission’s (SEC’s) recently proposed rulemaking package relating to standards of conduct for investment professionals. The three proposals included: interpretation regarding the standard of conduct of investment advisers under the Investment Advisers Act of 1940; Form CRS which both registered investment advisers and registered broker-dealers would have to provide to retail investors; and proposed regulation best interest.Design/methodology/approachReviews and summarizes the three individual proposals.FindingsThe SEC has proposed this rulemaking package in order to meet three goals: enhance retail investor protection and decision making, preserve investor choice and cost, and raise retail investor awareness of whether they are doing business with a registered financial professional. The SEC is looking for feedback, particularly from retail investors, on whether these proposals would achieve the SEC’s goals.Originality/valueSummarizes the three proposals in a manner that provides insight into how investment advisers and broker-dealers would be required to conduct business with retail investors if the proposals are adopted in the current form.

Are Robo-Advisors Fiduciaries?

This paper addresses whether robo-advisors are “fiduciaries.” The simple answer is “yes.” As registered investment advisers, robo-advisors are deemed to be “fiduciaries” that owe a fiduciary duty of loyalty to their customers and can be liable for breach of fiduciary duty. But that is only half of the equation. Merely labeling robo-advisors as “fiduciaries” does not signify what fiduciary standard of care they are subject to, which should be of most interest to investors and regulators and is the subject of this paper.

Pay to play violations: an SEC focus

PurposeTo explain and analyze the SEC’s January 17, 2017 announcement of settlements with ten investment advisory firms related to charges that those firms violated Rule 206(4)-5, known as the “Pay-to-Play Rule,” of the Investment Advisers Act of 1940.Design/methodology/approachExplains the Pay-to-Play Rule, its applicability to investment advisers, the de minimis and returned contribution exceptions, and the Rule violations cited by the SEC, and draws conclusions for the benefit of registered investment advisers and exempt reporting advisers.FindingsThe settlement included censures, civil money penalties, and recovery of compensation earned for firms’ failure to abide by the Rule, most often involving relatively small contributions by single covered individuals.Practical implicationsIn light of these settlements, registered investment advisers and exempt reporting advisers may wish to review the adequacy of their policies and procedures with respect to the Pay-to-Play Rule and the effectiveness of their implementation.Originality/valuePractical analysis and guidance from an experienced lawyer with a specialty in investment management.

SEC targets broker-dealer implications of transaction-based deal fees

Purpose To explain a US Securities and Exchange Commission (SEC) enforcement action against a registered investment adviser to private equity funds for allegedly providing brokerage services in connection with the acquisition and disposition of the securities of portfolio companies while not being registered as a broker dealer, making undisclosed use of fund assets, and failing to adopt policies and procedures designed to prevent the alleged violations. Design/methodology/approach Describes the services provided by the investment adviser, the compensation paid, and the SEC’s other bases for enforcement, and draws conclusions for private equity fund advisers. Findings The SEC has begun pursuing transaction-based compensation paid to private equity fund advisers relating to portfolio company transactions as illegal brokerage commissions. The Commission also continues to target the adviser’s undisclosed use of client fund capital, especially in private equity funds. Originality/value Practical explanation by experienced investment management lawyer.

Cybersecurity enforcement actions: is the SEC bringing strict liability cases?

Purpose To analyze how the US Securities and Exchange Commission (SEC) has sanctioned broker-dealers (BDs) and registered investment advisers (RIAs) when cybersecurity breaches have occurred and to discuss whether the SEC is imposing a strict liability approach. Design/methodology/approach Describes the cyber-attack of a small RIA, the remedial steps the RIA took after the attack, the SEC’s enforcement action, why this particular case is noteworthy, and the case’s implications for RIAs and BDs. Findings RIAs and perhaps BDs may face strict liability from the SEC if they are victims of cybersecurity attacks. Practical implications Firms may want to address the likelihood of an SEC enforcement action if a breach occurs by reviewing recent enforcement actions, SEC reports and statements, and FINRA reports and statements. Originality/value Discusses the possible future of SEC enforcement actions regarding cybersecurity breaches.

Financial Illiteracy Meets Conflicted Advice: The Case of Thrift Savings Plan Rollovers

In order to assess the quality of financial advice that Americans receive, the authors examine advice in a situation where bad advice is least likely to occur: advice given to pension participants concerning rollovers from a very low-fee pension plan. Bad advice in that circumstance would indicate that some pension participants are receiving really low-quality advice and that existing regulations are not protecting them. Bad financial decision making can be due to a combination of a lack of financial literacy and conflicted advice from advisers who know that many people are insensitive to differences in fees. This article sheds light on both the demand and supply sides of the market for financial advice by examining rollovers from the Thrift Savings Plan for federal government workers, which charges extremely low fees—less than 3 basis points for all of its investment options. The authors present evidence from three small surveys they conducted relating to advice for broker-dealers, advice from Registered Investment Advisers, and participant knowledge about fees as an explanation for why participants take bad advice. By analyzing issues related to TSP rollovers, this article sheds light on the broader topic of rollovers to IRAs and the still-broader topics of the quality of financial advice that people receive and how that is affected by the fiduciary standard.

The Post Dodd-Frank-Act Evolution of the Private Fund Industry: Comparative Evidence from 2012 and 2015

This comparative survey study examines the private fund industry’s reactions and adjustments to a rapidly evolving regulatory framework, three years after the first application of mandatory registration and disclosure rules for private fund advisers under the Dodd-Frank Act. Using two datasets (2012: N = 94; 2015: N = 69) for a population of 1267 registered investment advisers to add an historical time series perspective, the author analyzes and compares survey respondents’ short- and long-term estimations of industry effects. The data suggest that immediate and short-term concerns have given way to adaptation to the changes.