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The Friday List: 10 Adviser Marketing Practices to Avoid

Today, we offer our “Friday List,” an occasional feature summarizing a topic significant to investment management professionals interested in regulatory issues.  Our Friday Lists are an expanded “Our Take” on a particular subject, offering our unique (and sometimes controversial) perspective on an industry topic.

Last year, the SEC’s Office of Compliance Inspections and Examinations issued a Risk Alert warning advisers to review their marketing and advertising practices.  More recently, OCIE alerted advisers to widespread noncompliance with the solicitation rule.  Meanwhile, the Enforcement Division has brought several actions alleging that adviser marketing practices violated applicable law.   With this increased scrutiny, advisers should re-assess the following marketing practices to avoid material exam deficiencies or enforcement actions:

 

10 Adviser Marketing Practices to Avoid

  1. Hypothetical Back-Tested Performance.  The SEC has consistently targeted the use of hypothetical, backtested performance, and the Enforcement Division has brought numerous cases.
  2. Gross Performance.  Although firms can present gross performance in a few limited situations, most should firms should always present performance information net of fees.
  3. Misrepresenting Investment Strategy.  Sales personnel should not make representations about investment products that are inconsistent with disclosure documents.
  4. Receiving Revenue Sharing.  The SEC will heavily scrutinize undisclosed revenue sharing that incent advisers to sell certain products.
  5. Faulty GIPS Compliance.  Claiming compliance with GIPS (CFA Institute) performance standards but failing to actually comply with those standards will draw the ire of the regulators.
  6. Cherry-Picking Performance.  The SEC will challenge firms that only show good performance of certain past specific recommendations.
  7. Testimonials.  Rule 206(4)-1(a)(1) specifically prohibits the use of testimonials. Yet, too-clever advisers keep trying to use them, resulting in enforcement actions.
  8. Lying about Credentials.  Don’t present credentials that are inconsistent with your actual work experience in an effort to market greater expertise.  
  9. Inflating AUM.  Avoid using unverifiable assets under management totals in marketing materials or on Form ADV.
  10. Claiming Clean Compliance.  When asked in an RFP to describe compliance deficiencies identified during exams, do not ignore the question or say “none” unless it’s true.

The Friday List: 10 Topics the Division of Investment Management Should Reconsider

Today, we offer our “Friday List,” an occasional feature summarizing a topic significant to investment management professionals interested in regulatory issues.  Our Friday Lists are an expanded “Our Take” on a particular subject, offering our unique (and sometimes controversial) perspective on an industry topic.

Last month, SEC Chairman Jay Clayton said that SEC no-action letters and other staff statements “are nonbinding and create no enforceable legal rights or obligations.”  He instructed the SEC staffs to “review whether prior staff statements and staff documents should be modified, rescinded or supplemented in light of market or other developments.”  More recently the Director of the Division of Investment Management, Dalia Blass, said that her division is reviewing and assessing prior staff statements.  Both Mr. Clayton and Ms. Blass invited engagement and input from the public.  With that invitation, we offer ten topics that the Division of Investment Management should reconsider as it assesses its staff positions:

 

10 Topics the Division of Investment Management Should Reconsider

  1. Custody:  The custody rule and the reams of staff FAQs have only confused the industry and ensured massive inadvertent noncompliance.  If the staff only tackles one problem, this is it.
  2. Valuation:  Please offer clear guidance on the fair valuation of securities that are not publicly traded.  The current regime is too subjective, relying on accounting interpretations and shifting market information.
  3. Proxy Voting:  Firms spend significant resources complying with the proxy voting recordkeeping and supervision requirements.  Do these rules really protect clients and shareholders?
  4. Private Funds:  Restricting private funds to 100 holders or qualified purchasers is overly restrictive.  The staff should also reconsider the definition of “accredited investor.”
  5. Leverage:  With the advent of derivatives and other forms of innovative investment products, the staff should modernize its positions on permitted leverage.
  6. Advertising:  The staff has not materially changed the adviser advertising rules in 30 years.  The new media world requires some new rules.
  7. Code of Ethics:  A significant percentage of compliance time and resources is spent on personal securities transaction compliance.  The staff should consider other less onerous schemes to prevent and punish unlawful personal trading.
  8. Affiliate Transactions:  Scholars have written entire treatises on the definition of “affiliate transaction” under the Investment Company Act.  It may be the most confusing definition in the securities laws.
  9. Disclosure:  Few retail investors read prospectuses or Form ADV.  One way to make clearer and more readable documents is too exempt issuers from securities law liability.
  10. Wrap Programs: The SEC has brought dozens of actions against wrap programs.  We would recommend that the staff adopt some definitive rules that the industry could follow.

The Friday List: 10 Reasons Why the SEC Hates Wrap Programs

Today, we offer our “Friday List,” an occasional feature summarizing a topic significant to investment management professionals interested in regulatory issues.  Our Friday Lists are an expanded “Our Take” on a particular subject, offering our unique (and sometimes controversial) perspective on an industry topic.

The SEC hates wrap programs.  Nobody at the SEC has actually said that, but the regulator’s actions support that conclusion.  Nearly every year, OCIE targets wrap programs as an exam priority.  Over the last couple of years, the Enforcement Division has brought case after case alleging that wrap programs violated applicable provisions of the Advisers Act.  In response, we have advised compli-pros at firms that offer wrap programs to conduct serious reviews and testing to make sure their programs don’t become Enforcement examples.  Today, we offer 10 reasons why the SEC hates wrap programs.

 

10 Reasons Why the SEC Hates Wrap Programs

  1. Weak due diligence: Wrap Sponsor Pays $97 Million for Inadequate Due Diligence
  2. Favoring affiliates:  Adviser Didn’t Fully Disclose Financial Incentive to Recommend Affiliated Wrap Program
  3. Reverse churning: Wrap Sponsors to Pay over $9.5 Million to Settle Share Class and Reverse Churning Charges
  4. Overbilling: Large Wrap Sponsor Pays $18.3 Million for Compliance Problems in Business Sold 8 Years Ago
  5. (Not) best execution: Wrap Sponsors Fined for Failing to Disclose Trading Away Commissions
  6. Step-out trading: Wrap Sponsor Did Not Evaluate Trading Away by Portfolio Managers
  7. Trading away: Wrap Sponsor Fined for Failing to Monitor Trading Away Practices
  8. Double-charging: Failure to Heed Compliance Consultant’s Recommendations Results in Enforcement Action
  9. Lower share classes available: Wrap Sponsor Failed to Update Compliance Policies for Lower Share Classes
  10. Inadequate Form ADV disclosure: SEC Imposes $300,000 Fine for Wrap Program ADV Missteps

The Friday List: 10 Examples of Brokers Behaving Badly

Today, we offer our “Friday List,” an occasional feature summarizing a topic significant to investment management professionals interested in regulatory issues.  Our Friday Lists are an expanded “Our Take” on a particular subject, offering our unique (and sometimes controversial) perspective on an industry topic.

The debate about the now-vacated DoL fiduciary rule and the recently proposed Regulation Best Interest continues.  We have argued that a uniform fiduciary standard should apply to both retail brokers and advisers.  Why?  We accept the position that retail consumers should not have to hire a lawyer to determine the advice standards to which his/her financial professional adheres.   More significant, however, is that brokers behave badly and need a higher standard.  An academic study that was first published in 2016 reported that 7% of broker-advisers have misconduct records, prior offenders are 5 times more likely to engage in misconduct, and 44% of brokers fired for misconduct are re-employed within a year.  The authors concluded: “We find that financial adviser misconduct is broader than a few heavily publicized scandals.”   They also argued that a more stringent standard would help the industry by improving the low reputation of financial professionals.  Our reporting of cases also shows endemic broker misconduct.  In today’s list, we highlight examples of brokers behaving badly, which should inform the debate on a uniform fiduciary standard.

 

10 Examples of Broker Behaving Badly

  1. Stealing from clientsA broker exploited a weakness in his firm’s control systems that allowed third party disbursements, enabling him to misappropriate $7 Million from clients.
  2. Churning.   A broker recommended an unsuitable in-and-out trading strategy that generated significant commissions.
  3. Misrepresenting disciplinary recordA broker’s website claimed he never had a complaint, even though several customers filed and settled complaints over the course of an 8-year period.
  4. Misusing client information. A broker shared nonpublic personal information (including holdings and cash balances) about clients with a person no longer affiliated with his firm.
  5. Revenue sharing.   A broker received undisclosed revenue sharing on mutual fund trades from the clearing broker.
  6. Undisclosed markups/markdownsAn interdealer failed to disclose markups and markdowns on securities traded for clients.
  7. Commission kickbacksA trading supervisor demanded commission kickbacks from junior traders to whom he assigned clients.
  8. Pump-and dumpA broker engaged in an ongoing penny stock pump-and-dump scheme.
  9. Bribing public officials.    A broker spent nearly $20,000 on hotels, meals and concert tickets to bribe a public plan official to secure brokerage business from a public plan.
  10. IPO kickbacks.   A broker and his client conspired in a kickback scheme whereby the customer would pay back 24% of his profits in exchange for preferred IPO and secondary offering allocations.

The Friday List: The Risks of the Dual-Hat Model for CCO and/or FINOP

Today, we offer our “Friday List,” an occasional feature summarizing a topic significant to investment management professionals interested in regulatory issues.  Our Friday Lists are an expanded “Our Take” on a particular subject, offering our unique (and sometimes controversial) perspective on an industry topic.

We hate the practice of dual-hatting i.e. appointing a senior executive with non-regulatory responsibilities as a Financial and Operations Principal or Chief Compliance Officer.  The SEC, through several enforcement actions, also appears to dislike the practice, which it alleges to have caused a wide variety of regulatory breakdowns.  The dual-hat model also exposes senior executives to direct personal liability.  In today’s list, we offer 10 significant risks of the dual-hat model identified in a series of SEC enforcement actions.  For reference, we have included links to our blog posts where you can read more.

 

10 Risks of the Dual-Hat CCO or FINOP Model

  1. Failure to supervise executive conduct.
  2. Taking undisclosed fees and/or overbilling.
  3. Under-resourcing the compliance function.
  4. Ignoring cited exam deficiencies.
  5. Engaging in conflicts of interest.
  6. Inadequate disclosure.
  7. Not conducting required annual compliance reviews.
  8. Using a stock “off-the-shelf” compliance manual.
  9. Failure to implement compliance policies and procedures.
  10. Not properly calculating net capital.

The Friday List: 2018 Examination Priorities

Today, we offer our “Friday List,” an occasional feature summarizing a topic significant to investment management professionals interested in regulatory issues.  Our Friday Lists are an expanded “Our Take” on a particular subject, offering our unique (and sometimes controversial) perspective on an industry topic.

Both FINRA and the SEC OCIE staff recently released their 2018 examination priorities.  Today’s list synthesizes their missives into the 10 most significant regulatory priorities for investment management firms.   Several of these priorities are new this year including cryptocurrency, wrap fee programs, and thinly-traded securities.  Others such as AML, suitability and best execution are regulatory greatest hits that appear nearly every year.   Compli-pros should use these letters to prepare their compliance programs and exam readiness.

 

10 Most Significant 2018 Examination Priorities

 

  1. Disclosure of fees and expenses: Both OCIE and FINRA champion full transparency of fees and expenses so that clients can make informed decisions and understand possible conflicts of interest.
  2. Cryptocurrency:  Expect a lot of attention paid to initial coin and cryptocurrency offerings including recommendations, disclosure, volatility, and security.
  3. Cybersecurity:  The regulators want to ensure that firms implement adequate cyber policies and procedures to protect client information and data systems.
  4. AML and KYC:  This is an area that both regulators have identified for many years, although the focus has moved to customer due diligence and firms’ gatekeeper role to keep securities markets safe.
  5. Protecting senior investors: Both regulators want to protect senior investors.  The SEC focuses on recommendations to retirement accounts.  FINRA will review compliance with rules to prevent exploitation.
  6. Wrap fee programs: The SEC continues its persecution and prosecution of wrap fee programs, including due diligence, best execution, and conflicts.
  7. Thinly-traded ETFs and microcaps:  The regulators have raised the red flag about recommending thinly-traded securities that are subject to market manipulation and pay exorbitant commissions.
  8. High risk brokers:  FINRA wants firms to enhance hiring and supervision practices to keep bad actors out of the industry.
  9. Suitability: Firms must implement procedures to vet products and train reps.
  10. Best execution:  FINRA is particularly concerned about order-routing practices and resulting conflicts of interest.

The Friday List: Top 6 Findings from our 2017 Compliance Survey

Today, we offer our “Friday List,” an occasional feature summarizing a topic significant to investment management professionals interested in regulatory issues.  Our Friday Lists are an expanded “Our Take” on a particular subject, offering our unique (and sometimes controversial) perspective on an industry topic.

For the 4th straight year, Cipperman Compliance Services conducted its compliance survey to determine best practices and attitudes toward compliance.  Our findings show an industry that is beginning to accept compliance as integral to the business, perhaps in response to prospective clients.  However, our findings also show significant numbers of firms that do not have confidence in their compliance programs, continue to dual-hat senior executives, and spend significantly more in other areas.  Below are the top 6 findings from our recent survey.

 

Top 6 Compliance Survey Findings

 

  1. Compliance Attitude Improving:  Over 80% of asset managers believe that compliance helps business, ensures honesty, or protects the franchise.  These percentages have increased over the last several years.
  2. Client Interest Growing: Nearly 2/3 of asset managers report that prospective clients review the compliance function before engaging.
  3. Regulatory Concern:  Over 40% of alternative managers and 25% of asset managers do not believe their compliance programs could withstand regulatory scrutiny.
  4. Compliance vs. Legal Spending: Most respondents across all categories spend significantly more on legal resources than compliance resources.
  5. Cybersecurity:  While most firms believe they have adopted adequate cybersecurity policies, most are not confident in their cybersecurity.
  6. Dual-Hatting:  Only slightly more than half of alternative managers have a fully-dedicated CCO, while the other 40%+ rely on dual hatted executives.

The Friday List: Top 10 Compliance Technology Tools

Today, we offer our “Friday List,” an occasional feature summarizing a topic significant to investment management professionals interested in regulatory issues.  Our Friday Lists are an expanded “Our Take” on a particular subject, offering our unique (and sometimes controversial) perspective on an industry topic.

As the compliance profession has matured since adoption of the compliance rule in 2004, many innovative firms have developed technologies to help chief compliance officers and their organizations more effectively manage regulatory risk.  Under pressure to do more with less, almost all compli-pros utilize one or more of these tools to ensure an effective program.  Below, we list the top 10 areas where technology tools can help CCOs adopt a reasonably designed compliance program in an environment of expanding obligations and responsibilities.

Top 10 Compliance Technology Tools

  1. Personal Trading:  Probably the most-used compliance technology, several firms offer excellent products to collect and manage personal trading monitoring and pre-clearance as required by the Code of Ethics.
  2. Email Review:  Just the sheer number of emails transmitted, even in the smallest firms, begs for the implementation of an automated email review system.
  3. Cybersecurity:  There is an entire industry of technologies employed for threat assessment and penetration testing as well as remediation and protection.
  4. Portfolio Management:  One of the biggest risk areas involves portfolio dispersion and failures to invest in accordance with client mandates.  Several technologies can monitor for non-compliant trading.
  5. Anti-Money Laundering: A developing area, we have seen some excellent tools to help comply with AML and KYC requirements.
  6. Performance Reporting:  Performance reporting (and related recordkeeping) can be better managed by software tools that avoid human intervention, thereby ensuring accurate calculations and ease of presentation.
  7. Marketing Review:  We like several tools that manage the workflow and document management requirements of the marketing review process.  Such tools maintain a library of drafts for regulatory inspection.
  8. Best Execution:  All money management firms must ensure best execution.  Several technologies are available to measure and demonstrate how a firm selects and executes trades.
  9. Regulatory Reporting:  If your firm still does Form PF or 13F manually, consider a software tool that can help you pull data and populate the forms.
  10. Financial Reporting:  First adopted for mutual fund financial statements, larger firms should consider some of the financial reporting tools that create financial statements, thereby reducing outside fees and human error.

The Friday List: 10 Things to Know about the DoL Fiduciary Rule

Today, we offer our “Friday List,” an occasional feature summarizing a topic significant to investment management professionals interested in regulatory issues.  Our Friday Lists are an expanded “Our Take” on a particular subject, offering our unique (and sometimes controversial) perspective on an industry topic.

Last Monday (May 22), the Department of Labor issued guidance on the implementation of the long-debated Fiduciary Rule.  Most significantly, the DoL did not further delay the basic concept that financial institutions and advisers must apply a best interest standard to advice for IRAs and other retirement accounts.  However, the DoL did back off of some of some of the compliance requirements for the rest of this year and plans to collect more information.  Below is a list of the 10 things you need to know right now about the DoL Fiduciary Rule.

 

10 Things to Know about the DoL Fiduciary Rule

 

  1. Applies to IRAs: The DoL Fiduciary Rule applies to investment advice concerning IRAs, ERISA plans, and plans covered by Section 4975 of the Tax Code.
  2. Best Interest standard starts June 9: Beginning June 9, financial institutions and advisers to covered plans must provide advice in the retirement investor’s “best interest,” which includes a duty of prudence and loyalty.
  3. BIC exemption compliance starts January 1: The extensive compliance requirements of the Best Interest Contract (BIC) exemption, which would apply to non-level fee products, are not required until January 1, 2018.
  4. DoL expects changes by January 1: During the Transition Period (June 9-January 1), the DoL will collect additional information from the industry to determine how compliance practices such as the use of mutual fund “clean shares” should re-shape the Rule.
  5. Proprietary products with commissions permitted: During the Transition Period, firms can recommend proprietary products with commissions so long as they satisfy the best interest standard.
  6. Need policies and procedures: The DoL expects firms to adopt policies and procedures necessary to ensure compliance with the best interest standard.
  7. Robo-advisers can rely on BIC exemption: Robo advisers may rely on the BIC Exemption during the Transition Period to ensure compliance with the Rule.
  8. Investment advice narrowly defined: Investment advice, for purposes of the Rule, does not include plan information or general financial, investment and retirement information.
  9. Can rely on written representations from intermediaries: The Rule does not apply if an independent fiduciary provides written representations (including negative consent) that the fiduciary is a bank, insurance company, BD, RIA, or independent fiduciary managing at least $50 Million.
  10. DoL will focus on compliance over enforcement: The DoL says it will prioritize compliance over enforcement during the Transition Period so long as firms work diligently and in good faith to comply with the Rule.

The Friday List: 10 Ways Compliance Contributes to Firm Value

Today, we offer our “Friday List,” an occasional feature summarizing a topic significant to investment management professionals interested in regulatory issues.  Our Friday Lists are an expanded “Our Take” on a particular subject, offering our unique (and sometimes controversial) perspective on an industry topic.

Senior executives may view spending on compliance as a necessary evil or a cost of doing business.  While compliance spending is certainly necessary and a cost, the compliance function, properly structured and implemented, can significantly contribute to a firm’s value.  We believe the added value can actually exceed the cost, and compliance spending can be viewed more broadly as an investment in the business.  So, for today’s list, we offer 10 ways that compliance contributes to firm value.

 

10 Ways Compliance Contributes to Firm Value

 

  1. Avoid Fines and Penalties:  All firms want to avoid the punitive and unplanned fines, penalties, and disgorgement associated with enforcement actions that a good compliance program can prevent.
  2. Protect Individual Reputations:  The SEC names a corporate officer in over 80% of enforcement actions.  Your name in an enforcement action could be career-ending, especially if you are barred from the industry.
  3. Attract Institutional Clients: Most institutional investors conduct Operational Due Diligence that includes an in-depth review of the compliance program.  A weak compliance program can disqualify a firm regardless of investment performance history.
  4. Increase Firm Multiple: Potential acquirers will assess a firm’s compliance program as a factor in the multiple offered.  An inadequate compliance program means more risk, and more risk means a lower multiple.
  5. Improve Operations:  Very often, the compliance procedures serve as a starting point for operational and desk procedures.  Also, the discipline of drafting and implementing procedures will serve as an example for finance, portfolio management, and product development.
  6. Reduce Executive Time:  Fewer compliance problems and the associated decline in operational problems means less time spent by executives dealing with non-productive headaches.
  7. Lower Legal Expenses:  A good compliance function will reduce the number of questions requiring outside counsel.  Firms will incur significant legal expenses when confronted with an avoidable enforcement action.
  8. Preserve Reputation:  An enforcement action undermines a firm’s reputation, the most valuable asset of any investment management firm.  Blue chip firms like to do business with other blue chip firms that have a reputation for integrity.
  9. Attract Employees: A quality compliance program will create a credible firm attractive to quality employees.  A “cowboy culture” will repel the top-notch employees needed to grow into an institutional franchise.
  10. Freedom from Fear:  You wouldn’t drive a car without good brakes.  Just like good brakes, a good compliance program allows firm management to move fast and seek new opportunities without fear of an unknown regulatory breakdown.