SEC and DOL Implement Several Significant Changes

Navigating Financial Advisory Transitions: A Comprehensive GuideApril 23, 2024
Regulatory Shift? The Supreme Court Challenges SEC’s AuthorityApril 18, 2024
FINRA Arbitrator Grants Expungement Of 2011 Customer Dispute For Illinois AdvisorApril 11, 2024
E-Signatures: From Convenience To Compliance MinefieldApril 11, 2024
Tucson Advisor Granted Expungement Of Disputes — One Dating Back To 1994April 5, 2024

In the first half of 2022, the Securities & Exchange Commission and the Department of Labor implemented or proposed a number of significant changes to the regulatory regime governing registered investment advisers (“RIAs”). Five regulatory developments, in particular, have generated inquiries from our existing and prospective clients.

In the hopes of relieving some tension and confusion, our team of securities attorneys and compliance specialists have compiled a list of AdvisorLaw’s top-five, most-asked questions and issues facing RIAs:

1) How does the SEC’s new Marketing and Advertising Rule impact my marketing efforts and public communication?

First, the new rule’s definition of an “advertisement” includes any direct or indirect communication from an investment adviser that: (1) offers securities-related investment-advisory services to prospective clients or private-fund investors whom the adviser advises; or (2) offers new, securities-related investment-advisory services to current clients or private-fund investors whom the adviser advises. Such communications qualify as advertisements under the SEC’s definition when (1) made to more than one person; or (2) made to one or more persons, when the communication includes hypothetical performance information that is not provided in response to an unsolicited investor request or private-fund investor.

Under this first prong, when not offering any new advisory services to existing customers, such communications do not constitute advertisements and are therefore not subject to recordkeeping, disclosure, performance reporting, and other requirements.
Similarly, one-on-one communications with prospective customers are not subject to the new rule, unless such communication involves using hypothetical performance data (e.g., model performance or back-tested performance reports).
Finally, this new rule is explicitly limited to advisory services with respect to securities and therefore does not apply to general advertisements concerning branding, market commentary, educational statements, and information pieces, or event sponsorship. Many clients have asked whether banners or brand-name materials are given out at events and whether charity sponsorships constitute advertisements —under the new rule, they do not.

The second part of the definition of “advertisement” includes “any endorsement or testimonial for which an investment adviser provides compensation, directly or indirectly, but does not include any information contained in a statutory or regulatory notice, filing, or other required communication, provided that such information is reasonably designed to satisfy the requirements of such notice, filing, or other required communication.”

This second prong of the advertisement definition now explicitly allows registered investment advisers to compensate third parties, including existing customers, to endorse or otherwise give testimonial recommendations on behalf of the RIA. Previously, RIAs were required to comply with the solicitor rules to compensate any third party for customer referrals. The new rule replaces the solicitor rule and further expands the rules to allow RIAs to compensate their customers and other, unrelated persons or entities for promoting their services to prospective customers — provided that the RIA complies with the disclosures and restrictions of the rest of the rule. If you ever wanted Tom Brady or Serena Williams to endorse your firm, the SEC’s new rule now provides you the path forward.

Our compliance professionals are helping clients to apply these new advertising rules strategically, offering new avenues for SEC-registered RIAs to efficiently and effectively promote their businesses.

2) How has the DOL Fiduciary Rule changed? Does it affect me?

Under the Employee Retirement Income Securities Act of 1974 (“ERISA”) and the Internal Revenue Code (“IRC”), parties providing “fiduciary investment advice” to plan sponsors, plan participants, and individual retirement account (“IRA”) owners may not receive payments creating conflicts of interest, unless they comply with protective conditions, often known as “prohibited transaction exemptions” (“PTEs”). On December 18, 2020, the US Department of Labor (“DOL”), which is empowered to administer ERISA, adopted PTE 2020-02, which applies to investment advisers, broker-dealer agents, insurance brokers, and other financial services professionals who advise customers and prospective customers regarding rollovers of ERISA plan assets or IRA accounts. Because such financial professionals have an economic incentive to advise customers and prospective customers to roll over ERISA and IRA assets to their management, such professionals must render advice that’s in the customers’ best interest, under the new PTE 2020-02.

The PTE 2020-02 rule, which officially went into effect in February 2022, requires the fiduciary to document and disclose in writing the specific reasons that a rollover recommendation is in the customer’s best interest. In doing so, financial advisers should consider the customer’s alternatives to a rollover, such as leaving the money in an employer’s plan or rolling the assets over to another plan or investment option. Financial professionals are expected to make diligent and prudent efforts to obtain information about the existing employee benefit plan and the customer’s interest in it, as well as the costs and benefits of choosing not to roll over the assets to the professional’s management.

Under this new rule, financial professionals advising on ERISA rollovers or the rollover of IRA assets to their management must:

acknowledge their fiduciary status in writing (the DOL rule provides standard language);
disclose their services and all material conflicts of interest;
adhere to Impartial Conduct Standards, which require the adviser to prudently investigate and evaluate investments, provide impartial advice, act with undivided loyalty to the customer when making recommendations (e.g., never place their own interests ahead of the interests of the retirement investor), charge no more than reasonable compensation, and avoid making misleading statements in connection with the advice;
adopt policies and procedures prudently designed to ensure compliance and mitigate conflicts of interest;
document that the rollover recommendation is in the customer’s best interest; and
conduct an annual retrospective compliance review.

Our clients have found it helpful to engage our trained professionals to work through the rule and its requirements with them, on a case-by-case basis, while advising customers regarding rollover transactions. We also provide comprehensive annual compliance reviews, which include retrospective reviews of rollover recommendations.

3) Proposed Changes To CyberSecurity Procedures

On February 9, 2022, the SEC authorized the publication of proposed regulations expanding cybersecurity and risk-management requirements applicable to registered investment advisers, including a mandate that RIAs implement a formal cybersecurity program and maintain records and reporting procedures for cybersecurity incidents. These new regulations, which would be memorialized in new rule 206(4)-9 under the Advisers Act and new rule 38a-2 under the Investment Company Act, would specifically:

require advisers and funds to adopt and implement written policies and procedures that are reasonably designed to address cybersecurity risks;
require advisers to report significant cybersecurity incidents to the SEC on newly-proposed Form ADV-C;
enhance adviser and fund disclosures related to cybersecurity risks and incidents in disclosure brochures and marketing materials; and
require advisers and funds to create, maintain, and update cybersecurity-related books and records.

Some of the more controversial aspects of the proposed rule include:

requiring advisers and funds to report “significant cybersecurity incidents” within 48 hours of the adviser having a “reasonable basis” to conclude that such incident has occurred;
the amendment of any material changes to information reported on Form ADV-C within 48 hours of the material change;
the implementation of policies to assess cybersecurity risks and enforce the security standards set forth in the proposed rule;
oversight of third-party service providers, some of whom are not subject to the proposed cybersecurity rule, to mitigate the risk of service providers that have access to the adviser’s or fund’s network; and
requiring RIAs to conduct periodic reviews of their cybersecurity program, on at least an annual basis, with documentation of the program’s effectiveness.

The comment period has ended for this proposed rule, and SEC staff is now considering the comments for the adoption of a final rule. Though the text of the final rule is still uncertain, the proposal itself demonstrates the SEC’s commitment — as expressed in numerous annual examination priorities lists — to push the investment management industry to adopt strong procedures to protect customers from identity theft, confidential information disclosure, and financial loss through breaches of information-protection protocols.

A comprehensive cybersecurity program should protect your business and your clients. AdvisorLaw’s CyberProtection Program is specifically designed to assist RIAs in implementing the appropriate information-security procedures and maintaining adequate documentation to demonstrate compliance in safeguarding the information entrusted to such fiduciaries. Learn more about our CyberProtection Program.

Citing the significant amount of assets managed through private funds, and their substantial impact on the market for securities and investment products, the SEC has proposed new rules governing the management, accounting, disclosure, and offering of such private funds by registered and exempt reporting advisers.

A few significant components of the proposal include:

the implementation of annual audits by independent auditors for every private fund;
quarterly (unaudited) reporting on private-fund holdings, performance, fees, and expenses;
limitations on the preferential treatment of certain investors, such as side letters and other, similar arrangements;
required written summaries and fairness opinions of material business relationships; and
restrictions on certain activities deemed contrary to investor interest by the SEC.

Many advisers have voiced concern that their alternative investments company could violate state and federal securities laws due to the complicated and significant requirements governing private-fund investments, recommendations, and management of private pools. We know how challenging compliance can be with the constantly shifting laws and standards governing these kinds of investments.

AdvisorLaw has both in-depth knowledge of the creation and structuring of private funds and the knowledge required to provide guidance for ongoing compliance with relevant rules, regulations, and laws. Learn more about our ongoing compliance services.

5) Keeping Form CRS/ADVs Up-To-Date And Organized

In case all of these regulatory changes weren’t enough to keep you up at night, trying to ensure compliance with your Form ADV surely will.

Do you have concerns about the conflicts-of-interest disclosures in the Form CRS?
How do you account for assets under management for purposes of SEC and state registration?
Do you have custody of customer assets due to your relationships with customers (e.g., as a trustee of a trust, as an executor of a will, as power of attorney for a customer, though a direct-fee deduction, etc.)?
Have you crossed a threshold for registration or notice filing in a particular state or jurisdiction?
What are the registration requirements for investment adviser representatives who work remotely?

SEC and state examinations routinely find deficiencies in firms’ disclosures on their Forms ADV and CRS. Although these deficiencies rarely result in significant monetary sanctions or licensing restrictions, some more egregious violations have resulted in punitive action. In July of 2021, the SEC charged 21 investment advisors and six broker-dealers, after they admitted to failing to “timely submit and distribute” their Forms CRS to their customers. This past February, agreements involving Forms CRS were reached with another 12 firms. To stay compliant with updates and material amendments and mitigate the time that regulators are likely to spend on deficient disclosure issues, firms should implement periodic reviews of ADV and CRS disclosures and delivery.

Do you or your RIA need assistance providing accurate filings, documentation, or disclosures in a timely manner? AdvisorLaw can help you get back to focusing on growing your business and gathering and managing your RIA assets. Learn more about how we can help your Forms ADV and CRS stand up to scrutiny.

Contact Us Today

All of the new and proposed regulations that we’ve mentioned come with their own set of requirements and considerations, including disclosures, updates to policies and procedures, and annual review and documentation requirements. Firms may need to implement new compliance policies, hire additional compliance specialists, and adapt to the new responsibilities imposed by the latest regulatory developments.

AdvisorLaw is a trusted source in the financial services industry. We know firsthand how time-consuming compliance can be. It’s a full-time job that requires research, attention to detail, and efficient organization — a task that shouldn’t fall solely on the RIA owner.

We work with dozens of RIAs each year, providing ongoing and individual compliance support services to new and existing RIAs. We’re always willing to offer counsel to RIAs and financial advisors alike for issues pertaining to compliance, regulatory investigations, broker protocol, and mergers and acquisitions.

Contact us today for a complimentary consultation.