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August 16, 2021

regulatory update


New Definition of Qualified Client Takes Effect, FINRA Speaks on Best Execution, Margin Requirements and Private Placements and More

For Investment Advisors and Broker-Dealers

Trading Restrictions Impacting Chinese Military Companies Persist but Modified Under New Executive Order.  President Biden signed Executive Order 14032 (“E.O.”) on June 3, 2021, which effectively continues the restrictions on purchasing or selling publicly traded securities of certain Chinese Military companies by amending Executive Order 13959, but adjusts the framework for those restrictions in the future.  According to the O. Fact Sheet, the scope of the restrictions has been expanded to address “the use of Chinese surveillance technology outside the PRC, as well as the use to facilitate repression or serious human rights abuses.”

Practically speaking, the new list of restricted companies has grown from 31 to 59, and OFAC has harmonized its “Non-SDN Chinese Military-Industrial Complex Companies List” with the E.O.  The E.O. (and trading restrictions on publicly traded securities of the companies listed) will be effective on August 2, 2021.  Restrictions on any securities added from now on will become effective at 12:00 a.m. ET 60 days after the company’s addition to the list.  Impacted firms monitoring compliance with the E.O. can sign up with OFAC for email updates when the list changes here.

The E.O. also clarifies some prior ambiguity associated with the original order; first, the restrictions apply only to those companies whose names match exactly and are explicitly designated.  Second, the definition of publicly-traded securities still includes American Depositary Receipts (ADRs) and other similar securities.  Additionally, OFAC published several new FAQs associated with the new E.O.  For example, FAQ 902 clarifies that a U.S. individual serving as a fund manager for a non-U.S. investment fund, or a U.S. RIA engaged as the investment advisor to a non-U.S. investment fund, would not violate the E.O. if it traded a restricted company, provided that the trade would not otherwise violate E.O. 13959, as amended (e.g., the trade is not for the ultimate benefit of a U.S. person, etc.) Refer to OFAC’s FAQ on Chinese Military Sanctions for more information, or contact us for assistance analyzing your current sanctions compliance procedures.  Contributed by Cari A. Hopfensperger, Senior Director.

Colorado Becomes the Third U.S. State to Pass Comprehensive Data Privacy Act. Governor Jared Polis signed the Colorado Data Privacy Act (the “CPA”) on July 7, 2021, and it takes effect on July 1, 2023.  In passing the CPA, Colorado becomes the third state behind California (2018) and Virginia (2021) to adopt comprehensive privacy legislation.  At a high level, the CPA applies to “legal entities that conduct business or deliver commercial products or services that are intentionally targeted to residents of Colorado; and that either:

  • Control or process personal data of more than 100,000 consumers annually; or
  • Derive revenue (or discount on the price of goods or services) from the sale of personal data and control or process the personal data of at least 25,000 consumers.”[1]

The CPA’s definition of “consumer” excludes individuals acting in a commercial or employment context), and there are categories of exemptions.  Most noteworthy for many financial service firms will be that entities subject to the Gramm-Leach-Bliley Act will fall out of scope.  For more details, check out the Worth Reading link below to a recent blog post by Joseph Duball of International Association of Privacy Professionals (“IAPP”) in The Privacy Advisor: “Colorado Privacy Act passes, professionals ponder effects.”  Contributed by Cari A. Hopfensperger, Senior Director.

For Investment Advisors

SEC Adopts Inflation-Adjusted Threshold for Qualified Clients.  Effective August 16, 2021, the net worth and assets under management tests for investment advisor “qualified clients” will increase. The SEC made the change under the Dodd-Frank Act that requires such adjustments for inflation every five years. Section 205(a)(1) of the Investment Advisors Act of 1940 (“Advisors Act”) generally prohibits an investment advisor from charging a client a performance-based fee unless the client meets the definition of a qualified client: an individual or entity, immediately after entering into an advisory contract with an RIA, with at least $1 million under management by the advisor or believed by the advisor to have a net worth of at least $2.1 million (together, in the case of a natural person, with assets held jointly with a spouse).  The new thresholds raise the bar for satisfying both tests and are effective August 16, 2021.

Firms are encouraged to review their private fund subscription documents, client contracts for relevant separately managed accounts, and any related policies and procedures to address the revised levels.  The SEC’s order notes that contracts entered before this adjustment (and satisfied the then-current thresholds) will generally continue to meet this requirement.  However, if a new party is added to the contract (including an equity owner of a private investment company advised by the advisor), then the thresholds in effect at that time will apply.  (See Footnote 12 of the order.)  Contributed by Cari A. Hopfensperger, Senior Director.

[1] SB21-190 Protect Personal Data Privacy, Bill Summary:

For Private Funds – CFTC & NFA Actions

Amended CPO Form-PQR Filing Requirements are Effective. NFA Notice I-21-21 reminds registered CPOs that NFA Compliance Rule 2-46 is now effective. Initially adopted in October 2020, the CFTC amended its Rule 4.27 first, which updated CPO reporting requirements on CFTC Form CPO-PQR in a few ways.  First, it implemented a uniform quarterly reporting schedule for CFTC Form CPO-PQR for all CPOs.  Second, it streamlined CFTC Form-PQR and improved consistency with NFA Form-PQR.  Finally, it clarified that CPOs are permitted to NFA Form-PQR instead of the revised CFTC Form CPO-PQR.  The NFA then followed suit, amending its Compliance Rule 2-46 to harmonize with the amended CFTC rule.  Another noteworthy change is that CPO Members must now file NFA Form-PQR within 60 days of calendar quarter end.  Previously, the December 31st filing was due 90 days after quarter end.  The CFTC released a new FAQ to address these changes.  Contributed by Cari A. Hopfensperger, Senior Director.

For Broker-Dealers

Keeping Current with Best Execution and Payment for Order Flow. FINRA considers best execution of customer orders a critical investor protection requirement, as mentioned in Regulatory Notice 21-23 and clearly demonstrated in the SEC’s Administrative Proceeding against Robinhood Financial, LLC.  The purpose of FINRA’s notice is to provide firms with some general and specific reminders of their best execution requirements.  Regardless of whether a firm is acting as Agent or Principal, it must conduct reasonable due diligence to determine the best market to buy/sell a security so that the customer receives a price that is as favorable as possible, given prevailing market conditions.  FINRA reminds firms of several key factors to be considered when assessing a firm’s “reasonable diligence” efforts. For example, compliance with FINRA Rule 5310 requires a firm to evaluate the availability of reliable and superior prices regularly and to direct order flow to markets providing the most beneficial terms.  In addition, a firm must not allow an incentive for order flow to interfere with its efforts to obtain best execution.  Furthermore, a member firm cannot transfer its best execution obligations to another person or firm.

Specifically, firms are required to compare the execution quality customers will receive at competing markets and identify and evaluate material differences.  FINRA reminds firms of guidance regarding execution quality review standards presented in Regulatory Notice 15-46.  Order-by-order review of execution quality is required for internal executions.  If a firm does not conduct an order-by-order review, it must perform, at least quarterly, a rigorous review on a security-by-security or type-of-order basis.  Rule 5310 prescribes specific items for consideration when reviewing execution quality, such as price improvement and internalization of transactions.  Finally, FINRA reminds firms that delivering order routing and execution disclosures does not relieve a firm of its best execution duties.  Contributed by Rochelle Truzzi, Senior Director.

Changes to Interpretations of FINRA’s Margin Rule. In Regulatory Notice 21-24, FINRA provides updates and clarification to its interpretations of the minimum equity requirements set forth under Rule 4210(b).  Rule 4210 specifies initial margin requirements and limitations on withdrawals of cash or securities made from margin accounts.  FINRA rescinded Interpretation /02, broke it into five separate topics, and introduced new interpretations /021 through /025.

  • Interpretation /021 Minimum Equity
  • Interpretation /022 Effect of Market Value Decline Below $2,000 Equity
  • Interpretation /023 Withdrawals Below $2,000 Equity
  • Interpretation /024 Minimum Equity – Cash Account
  • Interpretation /025 Pattern Day Trader

Firms may find this notice helpful in updating their current Written Supervisory Procedures addressing margin requirements.  Contributed by Rochelle Truzzi, Senior Director

Private Placement Filing Requirements Updated to Include Retail Communications. Effective October 1, 2021, FINRA Rules 5122 (Member Private Offerings) and 5123 (Private Placements of Securities) will require subject firms to submit to FINRA retail communications that promote or recommend a private placement, not otherwise exempt from the Rule.  Web pages, pitch decks, “teasers,” fact sheets, sales brochures, and executive summaries are just some of the additional communications subject firms will be required to include in their submission.  All submissions will be made through FINRA’s Private Placement Filing System in Firm Gateway.  Contributed by Rochelle Truzzi, Senior Director.


SEC’s Division of Enforcement is Not Taking a Summer Break, Widespread Audit Failures by Private Fund Auditor, Revenue Sharing and Conflict Disclosure Charges Continue, Whistleblower Policy Failures and More: Lessons Learned and Worth Reading, Watching and Listening

Lessons Learned 

And the Award for Largest Financial Penalty Ever Issued by FINRA Goes to… Robinhood Financial, LLC (“Robinhood”). Last month, the firm was ordered to pay an unprecedented $70 million in fines and restitution for “systemic supervisory failures” that resulted in “widespread and significant harm” to customers.  The violations noted in the AWC spanned several critical components of their compliance program, including customer identification, account approval, supervision, best execution, communications with the public, and more.  Robinhood was sanctioned for distributing false or misleading information to customers, not exercising due diligence before approving customers to trade options, failing to create a reasonably designed business continuity program, failing to report thousands of customer complaints, failing to establish or maintain an adequate customer identification program, and failing to display complete market date information.  A firm must consider its size and scope of products and services when developing its compliance program.  The wise man builds his house upon a rock.  Contributed by Rochelle A. Truzzi, Senior Director.

Auditors Charged with Widespread Private Fund Audit Failures. The SEC recently settled an action with audit firm, Stockman Kast Ryan & Co. LLP, Ellen S. Fisher, CPA and David H. Kast, CPA, finding “widespread audit failures” in  several private fund audits conducted by the firm.  These include the firm’s issuance of reports for audits that were not properly conducted in accordance with PCAOB standards and the firm’s failure to meet PCAOB independence standards.  More specifically,  the firm conducted audits of funds that included a review of valuation decisions for certain hard-to-value assets.  Not only did the audit work itself fail to satisfy PCAOB standards of an  appropriate review, but oversight was also found lacking in the engagement quality review process.  The independence violations stemmed from one of the firm’s tax partners serving as atrustee or general partner for multiple investors in private funds audited by the firm, and from the firm providing bookkeeping services to one of the funds it audited.  In all, these failures caused some of their private fund clients to violate the Custody Rule..  Although the SEC’s action was against the auditor (and certain of its principals), advisors should take this latest real life example to heart – RIAs are advised to conduct reasonable and ongoing due diligence on its auditors or potentially risk getting entangled in regulatory issues outside its walls.  Contributed by Cari Hopfensperger, Senior Director.

TIAA CREF Learns Greed is Not So Good, Paying $97 Million Fine for Disclosure Failures. The SEC continues to hammer advisors for failing to disclose conflicts of interest, as shown by this case against Teachers Insurance and Annuity Association of America (“TIAA”), one of the largest providers of employer-sponsored retirement plants (“ESP”) catering to non-profit institutions.  TIAA developed a wrap-fee advisory program, the “Portfolio Advisor” offered to retirement plan participants.  Essentially, TIAA wanted to keep plan participants’ retirement nest eggs once they decided to leave their current plan due to retirement or a job change.  So, TIAA created a Portfolio Advisor to capture those IRA rollovers and used both carrots and sticks to get its Wealth Management Advisors (”WMAs”) to sell the product to investors.

To ensure the WMAs met their fiduciary obligations to clients, TIAA adopted written policies and procedures requiring WMAs to present clients considering a rollover with the four options, including (i) leaving their assets in the current ESP, (ii) rolling assets over into an individual retirement account (including the Portfolio Advisor Accounts), (iii) rolling assets into a new employer’s plan, or (iv) taking a lump-sum distribution.  Unfortunately, the memo from compliance did not make it to the sales team. The SEC’s administrative action asserted that WMAs received lucrative bonuses and pressure from their managers to sell the Portfolio Advisor for five years.

The lesson learned from this case is that even large institutions with adequate legal and compliance resources can still get it wrong.  Although there will always be pressure to maintain and increase assets under management, advisors should put their clients’ interests first.  Contributed by Jaqueline M. Hummel, Managing Director.

SEC Continues to Hammer Advisors on Disclosure Failures in Revenue Sharing Cases. In addition to the eye-popping $97 million fine against TIAA discussed above, the SEC reported three more cases involving disclosure failures and fiduciary breaches in June and July, including Kestra Private Wealth Services, LLC, Germain Investment Management, Inc., and Crown Capital Securities, L.P.  These cases all involve a registered investment advisor with a broker-dealer affiliate. So, where did these advisors go wrong?  The SEC findings included:

  • Fiduciary breaches for failing to disclose revenue-sharing arrangements, where an affiliated broker-dealer received a revenue share for certain mutual funds and cash sweep vehicles.
  • Best execution breaches for selecting mutual fund share classes that paid revenue sharing to an affiliated broker-dealer, when cheaper share classes of the same funds were available
  • Compliance program rule (Rule 206(4)-7) violations for failing to adopt and implement procedures to disclose these conflicts of interest, to make recommendations of mutual fund share classes and cash sweep options that were in the best interests of clients.
  • Crown Capital Securities had the added distinction of failing to self-report under the SEC’s Share Class Selection Disclosure Initiative.

Most advisors should be acutely aware of the issues cited in these cases.  In most exams, the SEC Division of Examinations reviews a firm’s general ledger, specifically looking for sources of revenue other than advisory fees.  Firms should understand their revenue streams, especially when the funds are coming out of their clients’ pockets.  Finally, the SEC has expanded an advisor’s best execution obligations to include recommendations of cash sweep options. Advisors should regularly review cash sweep options to determine whether they are the best options from the client’s perspective.   Contributed by Jaqueline M. Hummel, Managing Director.

Does Your Compliance Manual Violate Whistleblower Rules? In an administrative proceeding against Guggenheim Securities, LLC. (“GS”), the SEC found the firm willfully violated SEA Rule 21F-17 by including verbiage in its compliance manual stating, “Employees are strictly prohibited from initiating contact with any Regulator without prior approval from the Legal or Compliance Department. This prohibition applies to any subject matter that might be discussed with a regulator[…].  Any employee that violates this policy may be subject to disciplinary action by the Firm.”  

This prohibition was intended to address the proper handling of inbound regulatory inquiries. GS adopted a separate Whistleblower Policy that complied with Rule 21F-17. Nonetheless, the SEC determined that the firm violated the spirit of Rule 21F-17, which prohibits any person from taking any action to impede an individual from communicating directly with the Commission staff about a possible securities law violation.  The finding resulted in a civil money penalty of $208,912.  This determination was reached despite the SEC’s acknowledgment that it was “ unaware of any specific instances in which a GS employee was prevented from communicating with SEC staff about potential securities law violations.”

How many of us have included similar language in our manuals, all with good intent?  Luckily, the administrative proceeding also describes Guggenheim’s remedial efforts, which can assist you in updating your procedures manual.  Contributed by Rochelle A. Truzzi, Senior Director.


Worth Reading, Watching and Hearing

Colorado Privacy Act passes, professionals ponder effects. Joseph Duball of the International Association of Privacy Professionals (“IAPP”) considers the impacts of Colorado’s entry into the state privacy law arena in this thoughtful blog post.

SEC Announces Annual Regulatory Agenda.  Check out the SEC’s full Spring 2021 Unified Agenda of Regulatory and Deregulatory Actions.

The Securities Compliance Podcast: Lessons from The Front Lines – The Many Shades of ESG.  Episode 5 of Season 2 of this information-packed podcast features David Curran, the Chief Sustainability and ESG Officer at Paul Weiss and tackles several key elements of the ESG compliance challenge.  For another deep dive, check out Hester Pierce’s recent speech: “Chocolate Covered Cicadas”.

If you want to charge CCOs in ‘wholesale’ compliance failures, parse out level of resources, participation, cooperation, obstruction: NYC Bar Association says in proposed enforcement framework. Brian Monroe of the Association of Certified Financial Crime Specialists offers his perspective on the NY Bar’s recent Framework on CCO Liability.

FinCEN Anti-Money Laundering and Countering the Financing of Terrorism National Priorities. Pursuant to provisions in the amended Bank Secrecy Act, FinCEN recently published its first “government-wide priorities for anti-money laundering and countering the financing of terrorism.”

Filing Deadlines and To-Do List for August 2021

  • Form 13F: Form 13F Quarterly Filing for Q2 2021 is due for advisors within 45 days after the end of the calendar quarter. Due date is August 16, 2021.
  • Blue Sky Filings (Form D). Advisors to private funds should review fund blue sky filings and determine whether any amended or new filings are necessary.  Generally, most states require a notice filing (“blue sky filing”) within 15 days of the first sale of interests in a fund, but state laws vary. Did you know that Hardin Compliance Consulting offers a convenient and economical blue sky filing service to help firms manage this complicated monthly task?  Learn more here and give us a call to discuss your needs further.  Due August 15, 2021.
  • Form OBS: For the Quarter ending June 30, 2021. 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 August 2, 2021.
  • Rule 17a-5 Monthly and Fifth FOCUS Part II/IIA Filings: For the period ending July 31, 2021. For firms required to submit monthly FOCUS filings and those firms whose fiscal year-end is a date other than a calendar quarter. Due August 24, 2021.
  • Supplemental Inventory Schedule (“SIS”): For the month ending July 31, 2021. 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 August 27, 2021.
  • Annual Reports for Fiscal Year-End June 30, 2021: FINRA requires that member firms submit their annual 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 August 30,
  • SIPC-7 Assessment: For firms with a Fiscal Year-End of June 30.  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 August 29, 2021.
  • SIPC-3 Certification of Exclusion from Membership: For firms with a Fiscal Year-End of July 31 AND claiming an 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 August 30,
  • SIPC-6 Assessment: For firms with a Fiscal Year-End of January 31, 2019. 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 August 30,
  • Form CPO-PQR (June 30 Quarter End): Small, Mid-Sized and Large Commodity Pool Operators are required to file Form CPO-PQR quarterly with the NFA. Due date is August 31, 2021.

Form N-MFP.  Form N-MFP (Monthly Schedule of Portfolio Holdings of Money Market Funds) reports information about the fund’s holdings as of the last business day of the prior calendar month and must be filed no later than the fifth business day of each calendar month.  Due date is August 7, 2021.

Form N-PX.  Registered investment companies (other than small business investment companies) are required to annually file Form N-PX, containing the fund’s proxy voting record for the most recent twelve-month period ended June 30.  Due date is August 31, 2021.


This article is not a solicitation of any investment product or service to any person or entity. The content contained in this article is for informational use only and is not intended to be and is not a substitute for professional financial, tax or legal advice.