On March 2, 2011, the Securities and Exchange Commission proposed rules to require certain financial institutions, broker-dealers and investment advisers with $1 billion or more in assets, to disclose their incentive-based compensation practices and prohibit such institutions from having compensation arrangements that encourage inappropriate risks.
1) Disclosures about Incentive-Based Compensation Arrangements
Annual Filing with appropriate federal regulator information including:
Narrative description of the components of the firm’s incentive-based compensation
Description of the firm’s policies and procedures governing such arrangements
A statement of why the firm believes the structure will help prevent it from suffering a material financial loss and/or why it does not provide covered persons with excessive compensation
2) Prohibition on Encouraging Inappropriate Risk
General prohibition against establishing or maintaining an incentive-based compensation arrangement that encourages inappropriate risks by providing excessive compensation, or that could lead to material financial loss – deemed assumption unless arrangements meet certain standards
“Covered persons” include executive officers, employees, directors, or principal shareholders
Prohibitions for larger financial institutions – specific requirements for executive officers and certain other designated individuals at financial institutions with $50 billion or more in total consolidated assets – 3 year deferral at least 50% of incentive-based compensation and must be adjusted for losses incurred
3) Establishing Policies and Procedures
A covered financial institution would be barred from establishing such arrangement unless the arrangement has been adopted under policies and procedures developed and maintained by the institution and approved by its board of directors.
Comments: should be received within 45 days after it is published in the Federal Register.
Assuming the rules are approved, financial institutions will need to significantly alter policies and procedures regarding incentive-compensation arrangements to ensure and monitor compliance with the requirements. Please contact our firm if you need experienced legal representation and advice if you need assistance updating your written supervisory procedures, providing comments to the SEC, or any other regulatory or arbitration related legal assistance at firstname.lastname@example.org.
As reported in Investment News on February 15, 2011, the SEC began a sweep of registered investment advisers and investment advisory firms to gather information about their use of social media such as Facebook, Twitter, LinkedIn, blogs and others. The sweep also focuses on gathering more information about policies and procedures that govern the use of social media, retention of records of employees’ use of social media, including non-business use and networking sites, and training provided to employees on the use of social media.
The SEC letter issued to advisers requests the following documents or information within an adviser’s possession or custody or subject to an adviser’s control:
- All documents sufficient to identify the adviser’s involvement with or usage of social media websites, including, without limitation:
- Twitter, including, without limitation, AdvisorTweets.com;
- Reddit; RSS; and
- Blogs and micro-blogs.
- All documents concerning any communications made by or received by the adviser on any social media website, including, without limitation, snapshots of documents responsive to Item 1, above.
- All documents concerning adviser’s policies and procedures related to the use of social media web sites, without limitation:
- All policies and procedures concerning any communication posted on any social media website;
- All policies and procedures concerning any prospective communications to be posted on any social media website; and
- All policies and procedures concerning any ongoing monitoring or review process related to communications posted on any social media website.
- All documents concerning policies and procedures concerning a third party’s use of any social media website maintained by adviser, including, without limitation:
- All policies and procedures concerning any communication posted by a third party, including, without limitation, actual or prospective clients of adviser, on any social media website maintained by adviser;
- All policies and procedures concerning any approval processes for prospective communications to be posted by a third party, including, without limitation, actual or prospective clients of adviser, on any social media website maintained by adviser; and
- All policies and procedures concerning any ongoing monitoring or review processes related to communications posted by a third party, including, without limitation, actual or prospective clients of adviser, on any social media website maintained by adviser;
- All documents concerning policies and procedures related to the use of social media websites by adviser’s personnel for personal, non-business related matters.
- All documents concerning personnel training and education related to the use of social media websites, whether for personal, non-business related, or business related matters.
- All documents concerning any informal or formal disciplinary action of personnel related to the use of social media for personal, non-business related, or business-related reasons.
- All documents concerning record retention policies and procedures concerning the involvement with or usage of, whether for personal, non-business related, or business-related matters, any social media website maintained by adviser by:
- The adviser;
- Adviser’s personnel; and
- Any third party.
At the same time, FINRA’s Social Networking Task Force is meeting next month to discuss updating its guidance on how advisers should use social-networking sites. The previous guidance was issued in Regulatory Notice 10-06.
Please contact our firm if you need assistance responding to any letter from the SEC or FINRA, modifying your policies and procedures, assessing your compliance risks, responding to any regulatory examination, or any other regulatory or arbitration related legal advice at email@example.com.
The SEC Division of Trading and Markets extended, but amended by increasing the conditions, for broker-dealers relying on registered investment advisers to perform customer identification program (“CIP”) requirements. On January 11, 2011, the SEC agreed to extend for two years the position taken in a 2004 No-Action Letter (and subsequent extensions in 2005, 2006, 2008 and 2010), which permitted broker-dealers to rely upon registered investment advisers to perform CIP as a result of the Securities Industry and Financial Market Association’s request for No-Action relief on behalf of its member broker-dealers. Section 326 of the USA PATRIOT Act of 2001 requires financial institutions (including broker-dealers) to obtain, verify and record information that identifies each person opening an account (see FINRA, Customer Identification Notice).
The PATRIOT Act requires financial institutions to establish to establish Anti-Money Laundering Programs (“AML Program Rule”) and to have a Customer Identification Program (“CIP”), implemented by 31 C.F.R. § 103.121. The CIP regulation provides that a financial institution may rely on another financial institution subject to the Act, see 31 C.F.R. § 103.121(b)(6), but registered investment advisers are not a financial institution subject to the AML Program Rule requirements of the PATRIOT Act (rules were proposed, but withdrawn by FinCEN). The No-Action Letter issued in 2004 first provided no-action relief allowing a broker-dealer to rely upon a registered investment adviser (“RIA”) to perform some or all of its CIP obligations by treating the RIA as if were subject to the AML Program Rule, which was subsequently and modified in 2005, 2006, 2008 and 2010.
The No-Action Letter issued on January 11, 2011 (“2011 No-Action Letter”) further modifies the requirements for no-action relief by requiring that broker-dealers to undertake appropriate due diligence of the registered investment adviser (RIA) and enter into an agreement with specific performance and production obligations.
Conditions Required in Order to Rely on the 2011 No-Action Letter
In the 2011 No-Action Letter, the Division of Trading and Markets will not recommend enforcement under Rule 17a-8 under the Securities Exchange Act of 1934 if a broker-dealer treats an investment adviser as if were subject to an AML Program Rule for purposes of 31 C.F.R. § 103.121(b)(6) provided that other provisions of the CIP Rule are met, and:
- the broker-dealer’s reliance on the investment adviser is reasonable under the circumstances (discussed below)
- the investment adviser is a U.S. investment adviser registered with the SEC under the Investment Advisers Act of 1940; and
- the investment adviser enters into a contract with the broker-dealer in with specific performance and production obligations (discussed below)
Agreement with the Registered Investment Adviser
The broker-dealer must enter into a contract with the registered investment in which the investment adviser agrees that:
- it has implemented its own AML Program consistent with the requirements of 31 U.S.C. 5318(h) and will update such AML Program as necessary to implement changes in applicable laws and guidance;
- it (or its agent) will perform the specified requirements of the broker-dealers CIP in a manner consistent with Section 326 of the PATRIOT Act;
- it will promptly disclose to the broker-dealer potentially suspicious or unusual activity detected as part of the CIP being performed on the broker-dealer’s behalf in order to enable the broker-dealer to file a Suspicious Activity Report, as appropriate based on the broker-dealer’s judgment;
- it will certify annually to the broker-dealer that the representations in the reliance agreement remain accurate and that it is in compliance with such representations; and
- it will promptly provide its books and records relating to its performance of CIP to the SEC, to an SRO that has jurisdiction over the broker-dealer, or to authorized law enforcement agencies, either directly or through the broker-dealer, at the request of (i) the broker-dealer, (ii) the SEC, (iii) an SRO that has jurisdiction over the broker-dealer or (iv) an authorized law enforcement agency.
The 2011 No-Action Letter specifically lists whom the RIA must provide its books and records on direct request (as opposed to a request of the broker-dealer), which includes the self-regulatory agency with jurisdiction over the broker-dealers, such as FINRA.
Due Diligence Requirements
Of importance, the 2011 No-Action Letter requires that the reliance of the broker-dealer on the registered investment adviser (RIA) must be reasonable. To establish reasonableness of the reliance, a broker-dealers must undertake “appropriate due diligence on the investment adviser…commensurate with the broker-dealer’s assessment of the anti-money laundering risk presented by the investment adviser and the investment adviser’s customer base.” The due diligence must be undertaken at both “the outset” of the relationship with the RIA and “updated during the course of the relationship, as appropriate.”
In particular, prior to any reliance on the RIA, broker-dealers must assess the AML risks of the investment adviser and its customer base and must update the due diligence during relationship, depending on such risks and circumstances arising subsequent to establishment of the relationship. Therefore, broker-dealers will need to establish procedures to address how they will conduct the requisite due diligence, and in particular the AML risks associated with both the investment adviser and its customer base, and the extent and timing of ongoing due diligence depending on such risks.
In addition, a broker-dealer may choose to not rely on the no-action relief of the 2011 No-Action Letter while still contractually delegating the implementation and operation of its CIP to a registered investment adviser, but the broker-dealer will remain solely responsible for assuring compliance with the CIP Rule; thus, a broker-dealer must actively monitor the operation of its CIP and assess its effectiveness.
Broker-dealers relying on the 2011 No-Action Letter should adopt reasonable procedures to address their due diligence requirements and review any existing agreements to verify such agreements contain appropriate performance and production obligations on the registered investment adviser. For additional assistance regarding due diligence procedures or drafting effective agreements with registered investment advisers, please contact Evans & Kob PC at firstname.lastname@example.org.
On December 28, 2010, the Securities and Exchange Commission issued Release No. IA-3129, which among other things extended the compliance date for Part 2B of the Form ADV, the brochure supplement and rules related to delivery of the supplement for registered investment advisers under the Investment Advisers Act of 1940.
Previously, the SEC adopted amendments to the Investment Advisers Act of 1940 to require registered investment advisers to provide clients with a brochure and brochure supplements written in plain English. The brochure contains information about the advisory firm, while the supplement contains information about the advisory personnel. Without the extension discussed below, most existing advisers would be required to deliver brochure supplements to new and prospective clients no later than March 31, 2011 and to existing clients no later than May 31, 2011. The extension only applies to the following:
Existing Registered Investment Advisers
Investment Advisers registered with the SEC as of December 31, 2010, and having a fiscal year ending on December 31, 2010 through April 30, 2011, now have until July 31, 2011 to begin delivering brochure supplements to new and prospective clients and until September 30, 2011 to deliver supplements to existing clients. The dates remain unchanged for those with fiscal years ending after April 30, 2011.
Newly-registered Investment Advisers
Advisers filing applications for registration from January 1, 2011 through April 30, 2011, have until May 1, 2011 to begin delivering brochure supplements to new and prospective clients and until July 1, 2011 to deliver supplements to existing clients. The dates remain unchanged for those filing applications for registration after April 30, 2011.
California Department of Corporations – Securities Regulation Division
The Securities Regulation Division of the California Department of Corporations also is extending the deadline to be consistent with the SEC.
Please contact our firm if you need assistance completing your brochure supplement, Form ADV, responding any regulatory issue, modifying your policies and procedures, assessing your compliance risks, ror any other regulatory or arbitration related legal advice at email@example.com.