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REGULATORY UPDATE: November 2021

November 4, 2021

Regulatory Update

A Cybersecurity Reminder from Foreside’s Chief Risk Officer, Samantha Swift

As we say goodbye to October, Foreside’s Chief Risk Officer reminds us to carry forward the purpose of Cybersecurity Awareness Month – to promote the importance of cybersecurity (hygiene, best practices, and vigilance), to raise awareness of cyber risks, and to empower the public to be safer and more secure online.  Visit CISA (https://www.cisa.gov/cybersecurity-awareness-month) for valuable (and free) resources to help you reduce your exposure to these threats, which bad actors continue to exploit during this crisis period. Do your part and #BeCyberSmart!

For Investment Advisors

State and federally registered advisors should take note since states have the right to investigate firms and their representatives to protect their residents.  Here are a few of the headlines from the report:

  • Treat Client Complaints Seriously. State regulators initiated almost the same number of investigations as complaints received (Complaints received 5,498 vs. investigations initiated 5,501).  Unhappy clients can take their complaints to a state regulator, who has the authority to investigate both the firm and any named representatives.  Firms that can show documentation of the internal review of the client’s claims along with a well-reasoned response establish credibility with regulators.
  • States Hold the Key to an IAR’s Livelihood. In 2020, state regulators issued 4,413 license sanctions, including the withdrawal of more the 3,600 license applications and 801 other licensing sanctions, including barring, denying, revoking, or suspending the licenses of individuals and firms.  Firms should pay attention to basic blocking and tackling, including updating disclosures on Form U-4 and Form ADV and performing routine background checks to verify the completeness and accuracy of information provided by a potential employee.  Review state licensing requirements carefully before applying for registration.  If an IAR’s record contains issues that can be resolved before submitting a new application, then work on resolving them to avoid being denied registration.
  • Know Your Role in Protecting Senior and Vulnerable Investors. Seniors remain prime targets for fraudsters, and states are stepping in to protect them.  According to NASAA’s report, 32 jurisdictions have enacted rules or legislation that mandate reporting to a state securities regulator and state adult protective services agency when financial services professionals have a reasonable belief that an elderly or vulnerable client is being financially exploited.  Some states also allow advisors to delay disbursements when exploitation is suspected.  Firms should understand their obligations under state law and provide training to employees on how to detect, prevent, and report financial exploitation of seniors and vulnerable adults.  Check out the map maintained by Bressler and find out more about your reporting requirements under state law.  Additionally, encourage clients to name a “trusted contact,” which gives firms the ability to discuss the situation with a trusted third-party when financial exploitation is suspected, an approach endorsed by NASAA, FINRA, and the SEC.
  • Advisors Take Care: Private Offerings Provide Fertile Ground for Fraudsters. NASAA’s report warns that bad actors continue to exploit the lack of federal and state oversight of private offerings.  Consequently, state regulators opened 196 investigations and brought 67 enforcement actions involving misconduct tied to private offerings in 2020.  Firms wanting to provide private placements to their high-net worth clients should develop a solid due diligence process both before and during the life of the investment.  Failure to understand and monitor these riskier investments can lead to a lengthy and sometimes costly state regulatory action.  State securities regulators follow nationwide fraud cases and will investigate firms and IARs that sold the securities at issue.  Contributed by Jaqueline Hummel, Managing Director.
  • SEC Regional CCO Virtual Outreach. The SEC’s regional office in Chicago held a CCO Outreach webinar on September 22nd.  The agenda focused on Form CRS and highlights included:
      • Context Surrounding Recent Form CRS Enforcement Actions. Well-meaning firms may take some comfort hearing that recent Form CRS enforcement actions did not appear to result from minor technicalities.  Instead, they began with the Department of Examinations’ (“Exams”) screening for advisors and broker-dealers that did not file Form CRS by the June 30, 2020 initial filing deadline but appeared to be subject to that requirement based on other filed information with the SEC.  Those firms that failed to take proper corrective action or whose activities were viewed as highly deficient have found themselves in enforcement hot water.  (See Foreside’s September 2021 Regulatory Update and the SEC 7/26/21 Press Release for more details about these actions.)
      • Expect Exams Scrutiny of Form CRS to Continue. Exams “is not finished holding firms accountable for non-compliance” with Form CRS regulatory requirements.  As we move further away from last year’s initial filing and delivery deadlines, expect Exams to expand its focus and look deeper into the substance of disclosures provided.  Firms should ensure Form CRS is formatted, filed, and delivered properly and continually monitor the quality of their disclosures, including their consistency with other firm disclosures like Form ADV.  Panelists noted during the presentation that conflicts between these documents are commonly found in examinations.  Firms are also cautioned to take care when determining disciplinary disclosures for Form CRS, where the instructions differ from what is required on Form ADV Parts 1 and 2.
      • Illustrative Scenarios for Redelivery of Form CRS. Panelists analyzed several scenarios, submitted as questions ahead of the seminar, asking when firms are (and are not) required to redeliver Form CRS.  Although no new interpretations were necessarily shared in this discussion, the scenarios and accompanying analysis of what factors could turn a “no redelivery required” answer into a “yes” may be useful case studies for training materials.

    As of the date of this newsletter, a recording of the Chicago Outreach is not yet available on the SEC’s site, but keep an eye out here for updates.  The New York regional office hosts its own CCO Outreach event on November 2nd, with a broader agenda.  Find details hereContributed by Cari Hopfensperger, Senior Director.

    For Broker-Dealers and Investment Advisors

    • DOL Agrees to Back Off on Enforcement of Compliance with ERISA Fiduciary Obligations for Rollover Advice until January 31, 2022. The Department of Labor (DOL) granted a reprieve for investment advisors that recommend IRA rollovers to ERISA plan participants from compliance with the documentation and disclosure standards imposed by Prohibited Transaction Exemption 2020-02 (“PTE 2020-02”).  In December 2020, the DOL adopted PTE 2020-02 to allow investment advisors and broker-dealers to receive otherwise prohibited compensation, including commissions, 12b-1 fees, revenue sharing, mark-ups, and mark-downs in certain principal transactions.  Although this seemed like good news, the DOL significantly changed its interpretation of the “five-part fiduciary test[[1]]” in the exemption’s preamble.  As a result, the new definition of investment advice under ERISA now includes a recommendation to a plan participant to roll over his or her assets from the plan to an IRA.  This is a significant change because, in the past, the DOL did not consider advice to roll assets out of an ERISA plan as fiduciary advice subject to ERISA.

    As an ERISA fiduciary, an advisor cannot receive compensation for advising a plan participant to roll over his or her 401(k) assets into an IRA managed by that advisor since this is prohibited under ERISA.  Unless, however, the advisor complies with a prohibited transaction exemption, such as PTE 2020-02.

    The exemption went into effect on February 16, 2021, but the DOL and the IRS originally agreed to extend their non-enforcement policy until December 20, 2021.  The policy has been extended until January 31, 2022, for “investment advice fiduciaries who are working diligently and in good faith to comply with the impartial conduct standards for transactions that are exempted in PTE 2020-02.”  Contributed by Jaqueline M. Hummel, Managing Director.

    • State of Ohio Updates
      • Elder Abuse Reporting. Mandatory reporting of suspected elder abuse by investment advisors (RIAs) and investment advisor representatives (IARs) has been required since 2019 in Ohio; however, revised rules require new reporting by IARs and permit delaying transactions in certain cases.  Additionally, Ohio saw a significant increase in elder abuse cases reported during the pandemic.  As a result, the Ohio Department of Family Services launched a new elder abuse awareness campaign to educate and remind the public how to report suspected abuse. In Ohio, anyone can use the State Referral Line (855) OHIO-APS (855-644-6277) to report cases of suspected abuse.  For information on Ohio and other states, consult the Bressler Senior and Vulnerable Investor Issues Map for up-to-date requirements each state has for protecting our senior and vulnerable investors.
      • Ohio Securities Salesperson and Investment Adviser Representative Registration Rule Changes Beginning September 30, 2021. The State of Ohio (OH) now requires qualification exams for registered representatives (RR) and IAR registrations requested on Form U4 submissions.  RR registrations will require reps to pass the Series 63 exam, while IAR registrations will require passing the Series 65 exam.  This rule change will not affect individuals who are currently registered or eligible to re-register in Ohio. For additional information on the rule changes, visit the Ohio Department of Commerce’s Proposed Rules  Contributed by Doug MacKinnon, Director.
  • The 2022 Renewal Program is Underway. November marks the beginning of the annual renewal cycle for broker-dealers, registered representatives, investment advisors, and investment advisor representatives (IARs).
      • Mark your calendar with these important dates:
        • November 8, 2021 – Preliminary Statements available on IARD and FINRA Gateway.
        • December 13, 2021 – Payment Due Date when Preliminary Statements must be paid in full.
        • December 26, 2021 – CRD/IARD System Shuts down at 6:00 PM Eastern Time.
  • Encourage registered representatives and investment advisor representatives to review their personal industry records via the Financial Professional Gateway (FinPro), BrokerCheck, or IAPD;
  • Review your roster of registered representatives and/or IARs for inaccuracies or deficiencies;
    • Broker-dealer firms may begin to submit post-dated Forms U5 and BR terminations as early as October 18th. Starting November 1st, firms can initiate Forms BD-W and ADV-W filings with a termination date of December 31st.
  • For more detailed information about the 2022 Renewal Program, including the complete timeline, payment methods, helpful tips, and FAQs check out the following:

    FINRA Annual Renewal Overview

    IARD Renewal Program Overview

    NOTE:  Failure to remit payments timely will result in late fees.  Additionally, jurisdictions may automatically terminate registrations, resulting in the firm’s inability to conduct securities business in those jurisdictions as of January 1, 2022.   Contributed by Cari Hopfensperger and Rochelle Truzzi, Senior Directors.

    For Broker-Dealers

    • FINRA “Encourages” Members to Consider Updating Their AML Programs. On June 30th, FinCEN issued the first Anti-Money Laundering and Countering the Financing of Terrorism National Priorities policy to combat terrorism and other illicit financing.  The identified priorities are (1) corruption, (2) cybercrime, (3) terrorist financing, (4) fraud, (5) transnational criminal organization activity, (6) drug trafficking, (7) human trafficking, and (8) proliferation financing.  FinCEN intends to issue regulations at a future date (December of 2021) that will specify how firms should incorporate the priorities into their risk-based AML program.  In the meantime, FINRA encourages firms to begin considering the potential impacts of the priorities, such as whether updates to red flag procedures or technology used to monitor and investigate suspicious activity may be needed.  Firms can also expect upcoming examinations to touch upon these preliminary efforts to understand and plan for updates in light of FinCEN’s published priorities and should take care to document this review during their next AML Program review.  Contributed by Rochelle Truzzi, Senior Director.
    • FINRA, NASAA, and SEC Urge Investors to Establish a Trusted Contact to Increase Investor Protection. FINRA and the North American Securities Administrators Association (NASAA) recently joined forces with the SEC on this new campaign, encouraging investors to provide a trusted contact for their accounts.  Since the release of FINRA Rule 2165 (Financial Exploitation of Specified Adults) back in 2018, investors have been reluctant to provide their broker with a trusted contact person, stating concerns about privacy and control over their assets.  This initiative is intended to help investors understand the benefits of naming a trusted contact person and the limitations of a trusted contact person’s authority on an account.  This is a good piece for brokers and advisors to share with their clients who may be leery about designating such a person.  Contributed by Rochelle Truzzi, Senior Director.

    Lessons Learned 

    • Out of Sight, Out of Mind – Advisor Continued to Charge Clients Fees for No Services After IARs Departed. Two Investment Advisor Representatives (IARs) left the firm, and although the impacted clients were charged management fees for over five years, they received no services from the firm or notification that their IARs had left during that time.  Secondarily, the firm also failed to disclose a financial interest with a third-party portfolio manager who was recommended to the advisor’s clients.  The Firm, its founder, and the Chief Compliance Officer were all named in the action, and the latter is barred from serving as a CCO for at least three years.  Firms are reminded to establish a robust process to offboard IARs.  Clients remaining with the advisor should be reassigned to new IARs to ensure uninterrupted servicing and be notified of the change.  Compliance officers should also ensure that their testing program reviews the results of this process.  For one, a comparison between accounts billed for a period against trading activity in client accounts could help identify accounts billed with no activity for further research.  Finally, advisors and CCO’s are reminded yet again of the importance of identifying and disclosing relationships and financial interests that pose a potential conflict.  Contributed by Cari Hopfensperger, Senior Director.
    • Probability of Human Error is Considerably Higher than That of Machine Error” ~Kenneth Appel.  MMLIS, a subsidiary of MassMutual Holdings, settled with the Commonwealth of Massachusetts for failing to adequately supervise a registered representative who used social media to promote GameStop stock.  The case involved the infamous “Roaring Kitty,” the name adopted by registered representative Keith Gill and used on several social media platforms to discuss his investment strategies.  Gill essentially encouraged investors to buy GameStock stock, which Massachusetts asserts “contributed to diminished investor confidence in the securities markets.”  Consequently, the securities division found MMLIS failed to adequately supervise its registered representative’s social media activity.

    But perhaps the more important lesson learned in this case comes from MMLIS’ failures related to the firm’s trade surveillance system. In addition to Gill’s extensive social media presence, he also engaged in substantial trading activity in GameStop, which the firm’s surveillance system could have flagged if MMLIS had not disabled the system’s excessive trading rule. Advisors should take note: it is not enough to install a personal trading surveillance system.  The system should be appropriately programmed and periodically tested to ensure that it’s capturing problematic trading activity.  MMLIS ended up paying a $4 million fine and hiring a compliance consultant to help it beef up its supervisory procedures to fix this issue.  Contributed by Jaqueline Hummel, Managing Director.

    • A Precarious House of Cards and a Royal Flush of Violations. This case, another where the advisor, its principal, and its Chief Compliance Officer are all named, addresses several violations and offers a fascinating list of “what not to do.”   For one, the advisor overstated its performance in a sub-advised account, resulting in overcharged performance-based fees.  The amounts overstated were not small – reporting and charging the client on gains that, in reality, were only half the amount claimed.  And, when the SEC came knocking, the client’s demand to be reimbursed for the overage remained unresolved by the advisor.  Additionally, the firm materially overstated assets under management and performance (again) in marketing materials and could not produce records to substantiate why the returns used for marketing differed so significantly from client accounts invested in the strategy.  The downward spiral continued with the advisor’s erroneous registration with the SEC in the first place.  It reported regulatory assets under management (RAUM) ranging from $100-$300 million for four years when actual RAUM ranged from only $8.6-$22.5 million.  A compliance consultant advised the firm to de-register with the SEC, and the firm then filed for state registration in California.  However, California abandoned the application after the advisor failed to respond to over 70 different deficiencies identified in their registration materials.  Finally, at rock bottom, the SEC called out the firm’s meager 12-page compliance manual, as the CCO herself was named in the action, fined, and barred from the industry for at least one year.

    While this conduct may seem so egregious to lack practical take-aways for well-meaning firms, we can still find value in some fundamental reminders:  Reasonable controls and oversight were certainly missing here, but those will only get a firm so far – the CCO must be knowledgeable and empowered to design reasonable policies and procedures to prevent, detect and, correct violations.  Some rules are technical and nuanced, such as advertising and calculating RAUM.  Less experienced CCO’s can fill gaps with an outside compliance expert but should be prepared to justify ignoring their recommendations thoughtfully.  Finally, firms that leave issues unresolved do so at their peril – in this case, an unresolved compliant and registration deficiencies contribute to this cautionary tale.  Contributed by Cari Hopfensperger, Senior Director.

    Worth Reading, Watching, and Hearing

    Filing Deadlines and To-Do List for November and December 2021

    INVESTMENT ADVISORS
    • Form 13F: Form 13F quarterly filing for Q3 2021 is due for advisors within 45 days after the end of the calendar quarter. Due date is November 15, 2021.
    • Annual Renewal Program for IARD System: The IARD Renewal Program facilitates the annual renewal of investment advisor (IA) firms and their IA representatives’ (IARs) registrations with jurisdictions/states. Preliminary renewal statements for the IARD system will be available on November 8, 2021, and will be accessible only through the E-Bill System.  Renewal statements reflect the registration renewal fees and annual system processing fees for all IARs and state-registered IA firms.  The deadline for the receipt of the preliminary statement payment is December 13, 2021.  Questions?  Keep an eye out for 2022 FAQs, which still reflect 2021 Renewal Program details as of the date of this newsletter but are typically updated each fall for the upcoming year.
    HEDGE/PRIVATE FUND ADVISORS
    • 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. Due November 15, 2021.
    • Form PF for Large Hedge Fund Advisors: Large hedge fund advisors must file Form PF within 60 days of each quarter-end on the IARD system. Due date is November 29, 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.  Due December 15, 2021.
    REGISTERED COMMODITY POOL OPERATORS
    REGISTERED COMMODITY TRADING ADVISORS
    MUTUAL FUND ADVISORS
    • 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 November 5, 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 December 7, 2021.
    BROKER-DEALERS
    • Annual Reports for the Fiscal Year-End August 31, 2021. FINRA requires that member firms submit their annual audit 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 November 1, 2021.
    • FINRA 2022 Renewal Program Preparations: Consult the FINRA website to access important dates and information regarding the 2022 Renewal Program. Be sure to update your calendars and ensure your Renewal Account is sufficiently funded.
    • Form OBS: For the Quarter ending September 30th. 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 November 2, 2021.
    • Rule 17a-5 Monthly and Fifth FOCUS Part II/IIA Filings: For the period ending October 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 November 24, 2021.
    • SIPC-7 Assessment:For firms with a Fiscal Year-End of September 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 November 29, 2021.
    • Annual Reports for Fiscal Year-End September 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 November 29, 2021.
    • SIPC-3 Certification of Exclusion from Membership: For firms with a Fiscal Year-End of October 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 November 30, 2021.
    • SIPC-6 Assessment:For firms with a Fiscal Year-End of April 30, 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 November 30, 2021.
    • Supplemental Inventory Schedule (“SIS”):For the month ending October 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 November 30, 2021.
    • Statement Regarding Independent Public Accountant: Due no later than December 10th of each year, unless your engagement is continuing, providing for successive engagements. Due December 10, 2021.
    • 2022 Preliminary Renewal Statement is due in full. Consult the FINRA website for specific Due December 13, 2021.
    • Rule 17a-5 Monthly and Fifth FOCUS Part II/IIA Filings: For the period ending November 30, 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 December 23, 2021.
    • Supplemental Inventory Schedule (“SIS”):  For the month ending November 30. 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 December 29, 2021.
    • Annual Reports for Fiscal Year-End October 31, 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 December 30, 2021.
    • SIPC-3 Certification of Exclusion from Membership: For firms with a Fiscal Year-End of November 30 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 December 30, 2021.
    • SIPC-6 Assessment: For firms with a Fiscal Year-End of May 31. 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 December 30, 2021.
    • SIPC-7 Assessment: For firms with a Fiscal Year-End of October 31. 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 FYE. Due December 30, 2021.

     

    [1] The five-part test defines an ERISA fiduciary as someone who, for a fee, (i) provides investment advice to an ERISA plan, plan fiduciary, plan participant, or IRA owner (ii) on a regular basis (iii) pursuant to a mutual agreement.  The advice must (iv) serve as the primary basis for an investment decision, and (v) be individualized based on the particular needs of the plan, plan participant, or IRA owner.

     

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.