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Regulatory Update – March

March 16, 2022
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For Investment Advisors + Broker-Dealers

  • Sweeping Ukraine/Russia Related Sanctions in the U.S. and Abroad. The U.S. announced and continues to update its sanctions against Russia in relation to the conflict in Ukraine.  These sanctions are primarily aimed at blocking access to U.S. markets by (1) major Russian financial institutions and (2) individuals close to Russian President Putin.  Several Russian banks have been removed from the SWIFT system, an international payment network used globally to process payments.  This arguably represents one of the most severe sanctions to date, as SWIFT is the main way Russia transacts with its customers in the oil and gas sector.  In the U.S. specifically, updates have been made to the OFAC/SDN List.  Under federal law, anyone subject to U.S. jurisdiction can be fined or even imprisoned for doing business with anyone on the sanctions list.  Sanctions also include prohibitions on transactions in securities issued by certain significant Russian entities.  For example, U.S. persons are prohibited from engaging in any transactions or dealings in new debt longer than 14 days maturity or new equity of 13 identified Russian companies.  Consider bookmarking the S. Treasury website and monitor for changes.  The page also includes a link to sign up for e-mail updates.

While this remains a fluid topic, firms should consider their exposure by conducting an impact analysis and implementing or updating procedures to monitor compliance.  Many firms with US-only clients and US investment strategies may identify little or no impact.  Common areas to consider:

  1. Client and Prospect Relationships: All firms, but especially those impacted by the sanctions, should diligently conduct OFAC screening and KYC procedures.  Given the dynamic nature of the changing situation, ensure that OFAC screening tools and systems are current and refreshed frequently.  If these activities are delegated to a third party, consider requesting the vendor to provide you with an update – try to ascertain how they are responding to the sanctions in their workflows and document your review.  Be deliberate and timely in your oversight.
  2. Portfolio Holdings: Components of the U.S. sanctions apply to equities, fixed income, and FX transactions connected with certain Russian entities.  This is an area where impacted firms should leverage existing portfolio compliance procedures where possible.  For example, enter pre-trade restrictions into your systems as needed, maintain, and test them.  Educate your investment team about the restrictions too – even before an idea becomes subject to pre-trade compliance, portfolio managers can save time during security selection and research stages if they know an investment will not be permissible.
  3. Issuer Operations: Sanctions include prohibited exports and other activities across multiple industries. Investment teams should consider the potential impact these sanctions may have (if any) on the operations of their portfolio companies.  Affected advisors and sub-advisors to mutual funds should consider whether disclosures to the board about any potential or realized impacts are needed.

Finally, firms located in, or serving clients in, other regions or countries should be aware of local sanctions that may differ from the US sanctions program.  Contributed by Cari Hopfensperger, Senior Director.

  • CISA Issues “Shields Up” Notification in Relation to the Conflict in Ukraine. The Department of Homeland Security’s Cybersecurity & Infrastructure Agency (CISA) recently issued a “Shields Up” notification stating that “[w]hile there are not currently any specific credible threats to the U.S. homeland, we are mindful of the potential for the Russian government to consider escalating its destabilizing actions in ways that may impact others outside of Ukraine.”  Accordingly, the notice “recommends all organizations—regardless of size—adopt a heightened posture when it comes to cybersecurity and protecting their most critical assets,” and it provides specific steps organizations can take to reduce vulnerabilities and heighten readiness.  Here are the highlights:
    • Validate remote access to your network.
    • Ensure that privileged or administrative access requires multi-factor authentication (MFA).
    • Confirm that your MFA software is up to date.
    • Step up surveillance of unexpected or unusual network behavior.
    • Ensure anti-virus and anti-malware are up to date.
    • Review your crisis response plan.
    • Sign up for CISA’s free cyber hygiene services at Free Cybersecurity Services and Tools.

Contributed by Cari Hopfensperger, Senior Director.

For Private Funds

  • SEC Proposes Sweeping Rule Changes for Private Fund Managers. Notwithstanding the separately-proposed changes to Form PF, the Securities and Exchange Commission (“SEC”) also recently proposed significant rule changes for private fund advisors (“advisors”) under the Investment Advisers Act of 1940 (“Advisers Act”).  According to the accompanying Fact Sheet, “The proposed reforms are designed to protect private fund investors by increasing their visibility into certain practices, establishing requirements to address practices that have the potential to lead to investor harm, and prohibiting advisor activity that is contrary to the public interest and the protection of investors”.   While the final outcome of the proposed rules is yet to be determined, this article outlines the most significant aspects of the proposals.  The comment period remains open until the latter of April 11, 2022 (60 days after issuance) or 30 days after its publication in the Federal Register, which as of the date this article is written (March 9th) has not yet occurred.

Quarterly Statement Rule

As proposed, advisors would be required to provide investors with quarterly statements detailing certain information regarding private fund fees, performance, and expenses.  All fees and expenses paid by the fund during the period, including fees paid by a fund portfolio company to the advisor and/or its affiliates and related persons, would be included on the statement.  Statements also would be required to disclose quarterly fund performance.  Liquid funds would be required to provide annual net total returns since inception, average annual net total returns over prescribed time periods, and quarterly net total returns for the current calendar year.  Illiquid funds would be required to report gross and net internal rate of return and gross and net multiple of invested capital for the illiquid fund to capture performance from the fund’s inception through the end of the current calendar quarter.

Private Fund Audit Rule

Private funds would be required to undertake a financial statement audit at least annually and upon liquidation and deliver the fund’s audited financial statements to investors promptly upon completion of any such audit.  This proposal is similar to what is commonly referred to as the “audit exception” under the Custody Rule, so firms complying with that exception already would see little impact from this change.

Advisor-Led Secondaries Rule

Advisors sometimes offer to existing investors the opportunity to sell or exchange their interests in a private fund to another vehicle managed by the same advisor.  This proposal would require the advisor to provide a fairness opinion from an independent third-party provider that documents the fairness of the price offered by the advisor for the existing investment to be sold.  Additionally, the advisor would be required to disclose to the investors any affiliation that the fairness opinion provider has with the advisor or any of its affiliates and/or related persons to avoid conflicts of interest.

Prohibited Activities Rule

This proposed rule would prohibit the following activities and practices:

  • Charging certain fees and expenses to a private fund including: fees for unperformed services, such as accelerated monitoring fees, and expenses related to regulatory examinations or investigations of the advisor;
  • Reimbursements, indemnification, or limitations of liability for breaches of fiduciary duties, willful malfeasance, bad faith, negligence or recklessness;
  • Reducing clawbacks for certain taxes paid;
  • Charging fees or expenses on a non-pro rata basis; and
  • Borrowing or receiving an extension of credit from a fund investor.

Preferential Rule Treatment

Preferential treatment typically in the form of side letters regarding redemptions and information provided to certain investors about portfolio holdings and/or exposures would be prohibited.  Other preferential treatment would be banned unless disclosed to all current and prospective investors.

Compliance Rule Amendments

All advisors, including those that do not manage private funds, would be required to document their Rule 206(4)-7 annual compliance reviews in writing.

Contributed by Royce Suba, Senior Director; and Doug Kamin, Managing Director.

For Broker-Dealers

  • 2022 Report on FINRA’s Examination and Risk Monitoring Program. Foreside recently published its Readers Guide on FINRA’s 2022 Report on Examinations & Risk Monitoring Programs, highlighting the topics covered and updated features of the Report.  Foreside indicated, “FINRA has been clear and consistent regarding the common deficiencies witnessed at member firms.”  On February 3rd, Foreside’s own Ginny Voos and Stephen Murphy hosted guest speaker, Kayte Toczylowski of FINRA, to discuss a series of relevant industry topics, also addressed in the recently released report.  If you missed the webinar, catch it HERE.  Be sure to check it out!  Contributed by Rochelle Truzzi, Senior Director.
  • Protecting Senior Investors from Financial Exploitation. FINRA’s amended Rule 2165 allows firms to place a hold on a securities transaction when there is a reason to suspect financial exploitation of a senior or other vulnerable adult.  Prior to this amendment, firms could only place a hold on the disbursement of funds or securities from a client’s account.  This much-needed amendment to the rule could save vulnerable investors from potentially catastrophic results in their portfolio.

Member firms will also be able to extend the initial hold period an additional 30 business days (for a total of 55 business days), so long as the member reports the event to a state regulator or agency or a court of competent jurisdiction.  To place and extend holds on disbursements or transactions, firms must follow specific safeguards outlined in both the Rule and Notice 22-05.  As a result, member firms will have more time to work with state authorities on a potential resolution.  Firms should update their written compliance and supervisory control procedures to adjust for the additional accommodations provided by this amendment.  Contributed by Rochelle Truzzi, Senior Director.

Lessons Learned 

  • SEC Charges Twelve Additional Firms for Failure to Meet Form CRS Obligations. On February 15, 2022, the SEC charged twelve additional firms for failure to meet Form CRS obligations.  Each missed regulatory deadlines, which included the Form CRS delivery to clients and/or posting the Form CRS on the firm’s website.  In addition, the SEC found that certain firms omitted specific information and required language from their Form CRS.

The SEC has now charged 42 financial firms for failing to meet their Form CRS obligations and continues to provide guidance to assist firms in avoiding similar issues.  One recent example, the SEC’s Standards of Conduct Implementation Committee (“Committee”) published a statement in late December 2021, that provides guidance to firms on how they can improve their Form CRS and avoid the types of weaknesses observed by the Committee, including:

  • Stay away from overly technical language, including disclaimers and hedging language.
  • Provide all required information in the format prescribed in the final, rather than proposed, instructions.
  • Utilize specific references to more detailed information.
  • Provide robust yet succinct descriptions of relationships, fees, and services.
  • Don’t modify or supplement the Disciplinary History Disclosure.
  • Accurately describe affiliate relationships.
  • Refrain from using marketing language.
  • Avoid “boilerplate” explanations that could hinder transparency or comparability between firms.

Advisors should ensure the Form CRS is filed timely, delivered to clients and prospects timely, and prominently posted to the firm’s website.  Considering the observations noted above, firms should make certain that Form CRS is consistent with their business practices, Form ADV disclosures, policies and procedures, agreements, websites, social media sites, marketing materials, and discipline history if any.  Contributed by Andrea Penn, Senior Director.

  • SEC Continues Focus on Robo-Advisors. The SEC charged a NY robo-advisor with making misleading statements, breaching its fiduciary duty, and other compliance failures. From September 2018 through July 2019, the firm advertised the existence of its own proprietary funds when no such funds existed and promised investors that it would periodically rebalance their advisory accounts but did not do so.  When the firm ultimately launched a proprietary ETF in July 2019, it used its clients’ advisory assets in the amount of $13 million to provide initial seed capital to the ETF without prior disclosure to clients of any conflicts of interest.

The SEC stated that the firm marketed itself as providing advisory services compliant with Islamic, or Shari’ah, law including marketing the importance of its income purification process on its website.  However, the SEC found that they did not adopt and implement written policies and procedures addressing how it would assure Shari’ah compliance on an ongoing basis, decision-making processes, and compliance reviews and oversight.  The firm agreed to pay a $300,000 penalty and to retain an independent compliance consultant.

Important takeaways from this case include a reminder that robo-advisors, like all advisors, must take care to do what they say in marketing materials and that it is critical that compliance is aware of business and marketing activities to monitor for potential contradictions.  Additionally, this case highlights an example of where the SEC’s focus on ESG has manifested in enforcement.  Firms that state their strategies follow a specific socially conscious, or any other specific strategy, should again ensure their actual investing activities and processes support those statements.  Contributed by Andrea Penn, Senior Director.

Worth Reading, Watching, and Hearing  

Check out the latest Foreside Knowledge Center thought leadership:

To-Do Checklists for the Month of April 2022

INVESTMENT ADVISORS

  • Form 13H: Following an initial filing of Form 13H, all large traders must make an amended filing to correct inaccurate information promptly (within ten days) following the quarter-end in which the information became stale (unless they are on Inactive Status). Recommended due date: April 10, 2022. (Note: Neither the SEC nor its staff has provided guidance on the definition of “promptly” for Form 13H.)
  • Form ADV Part 2A: Registered investment advisors are required to distribute to each client an updated Form ADV Part 2A or a summary of material changes with an offer and information on how to obtain the updated Form ADV Part 2A, within 120 days of fiscal year-end. Due April 30, 2022.
  • Form ADV Part 2B: Registered investment advisors should review their Form ADV Part 2B Brochure Supplements to ensure continued accuracy.

HEDGE/PRIVATE FUND ADVISORS

  • Form PF for Large Liquidity Fund Advisors: Large Liquidity Fund Advisors must file Form PF with the SEC on the IARD system within 15 days of each fiscal quarter-end.  Due April 15, 2022.
  • 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 Foreside offers a convenient and economical blue sky filing service to help firms manage this complicated monthly task?  Give us a call to discuss your needs further.  Due April 15, 2022.
  • Distribute Audited Financial Statements for Private Funds: Private fund investment advisors should have their funds audited by an independent, PCAOB-registered accountant and deliver the audited financial statements to the funds’ investors within 120 days of the end of the funds’ fiscal year (for funds with December 31, 2021, year-end, the date is April 30, 2022). The deadline for private funds that are fund of funds is 180 days of the funds’ fiscal year-end. That’s June 29, 2022, for funds with December 31 year-end.
  • Form PF Annual Amendment: Form PF Annual Amendment is due within 120 days of fiscal year-end for all private fund advisors other than “large hedge fund advisors” and “large liquidity fund advisors.”  Due April 30, 2022.
  • Form PF Quarterly Update: Form PF quarterly update is due for “large hedge fund advisors” and “large liquidity fund advisors” who did not submit information relating to their other private funds with their fourth-quarter filing. Due April 30, 2022.

BROKER-DEALERS

  • Annual Reports for the Fiscal Year-End January 31: 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 Date April 1, 2022 (Conditional 30-Day Extension may be available).
  • Annual Entitlement User Account Certification: FINRA requires firms to conduct an annual review of the FINRA application user accounts established for firm personnel and ensure that access and entitlements are appropriate for the personnel’s role and responsibilities. The certification period typically begins in early January and ends approximately 30 days later. The Super Account Administrator (“SAA”) is responsible for conducting the review, amending, and deleting user accounts/entitlements as necessary, and submitting the certification through WebCRD. Only the SAA has access to this certification. Failure to complete the certification by the established deadline will result in all user accounts associated with the firm to be suspended until the certification is complete. The due date for 2022 has not yet been announced, but firms will have 90 days to complete the process.  Due date to be announced.
  • FINRA Accounting Support Fee: Quarterly invoice to support the GASB budget. Based on the municipal securities the firm reported to the MSRB. De Minimis firms (that owe less than $25) will not receive an invoice. Invoices are sent to the firm via WebCRD’s E-Bill and payable beginning April 2022.
  • Customer Complaint Quarterly Statistical Summary: For complaints received during the first FINRA Rule 4530 requires Firms to submit statistical and summary information regarding complaints received during the quarter by the 15th day of the month following the calendar quarter. Due April 15, 2022.
  • Quarterly FOCUS Part II/IIA Filings: For Quarter ending March 31. FINRA requires that member firms file a FOCUS (Financial and Operational Combined Uniform Single) Report Part II or IIA quarterly. Clearing firms and firms that carry customer accounts file Part II and introducing firms file Part IIA.  Due April 25, 2022.
  • Quarterly Form Custody: SEC requires that member firms file Form Custody under Securities Exchange Act Rule 17a-5(a)(5) for the quarter ending March 31. Due April 25, 2022.
  • Supplemental Statement of Income (“SSOI”): For the quarter ending March 31. FINRA requires firms to submit additional, detailed information regarding the categories of revenues and expenses reported on the Statement of Income (Loss) page of the FOCUS Report Part II/IIA. Due April 28, 2022.
  • Supplemental Inventory Schedule (“SIS”): For the month ending March 31. 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 April 28, 2022.
  • Annual Reports for Fiscal Year-End February 28: 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 April 29, 2022.
  • SIPC-3 Certification of Exclusion from Membership: For firms with a Fiscal Year-End of March 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 April 30, 2022.
  • SIPC-6 Assessment: For firms with a Fiscal Year-End of September 30. 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 April 30, 2022.

MUTUAL FUNDS

  • 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 April 7, 2022.

 

 

 

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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.