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Best Execution Tips, FINRA Impostors, Changes in Liquidity Disclosures for Funds and Pay-to-Play Fines: Regulatory Update for August 2018

For Investment Advisers:  SEC Actions

 OCIE Issues Risk Alert on Best Execution: The SEC’s Office of Compliance Inspections and Examinations (“OCIE”) issued a risk alert to provide investment advisers with information about the most common deficiencies found in best execution programs.  The winners are:

  1.  Failure to provide proof of the evaluation of broker-dealers responsible for executing client transactions. Advisers, including those that trade in fixed income, should perform a best execution review routinely (e.g., quarterly), and maintain documentation such as a memo or meeting minutes that includes their conclusions on the quality of execution.  Many advisers establish a brokerage or best execution committee for this purpose, but a less formal quarterly meeting with participants from trading, portfolio management, compliance, and other stakeholders may also be appropriate depending on the adviser’s business.  We recommend using a standard agenda for the meeting, including:  review of the performance of approved brokers, an analysis of commissions and other qualitative and quantitative factors considered,  proposed additions and deletions to any approved broker list, review of any soft dollar payments and any new soft dollar requests and a review of commission payments.  For retail advisers that primarily use mutual funds, best execution boils down to making sure that the investor gets the least expensive share class. Check out our blog post for more details on how retail investment advisers can meet their best execution obligations.
  2. Failure to consider materially relevant factors during a best execution review. Advisers should select the quantitative and qualitative factors are important to their business and then ensure that these factors are used to evaluate a broker-dealer’s services.  These typically include execution capability, financial responsibility and responsiveness.  As part of the review, advisers should consider creating a scorecard for their broker-dealers and periodically rating these factors.  Traders and portfolio managers should provide input on the quality of services provided.
  3. Failure to compare quality and costs of services provided by other brokers. Retail investment advisers that establish a relationship with one (or more) a broker-dealer(s) to provide execution and custody services should document their due diligence efforts.  The documentation could include a memo comparing the quality and costs of broker-dealers considered, including a discussion of the deciding factors.  The SEC also expects to see more than a cursory review of broker-dealer policies and procedures.  Finally, advisers should revisit this selection every couple of years to ensure that their clients are still receiving quality service at competitive prices.
  4. Failure to disclose best execution practices. The SEC found that many advisers did not explain to clients that certain types of accounts may trade the same securities after other client accounts and the potential impact that might have on execution prices.  For example, a firm that trades its discretionary accounts before directed or non-discretionary accounts should disclose this practice in the Form ADV Part 2A.
  5. Failure to disclose soft dollar arrangements. Advisers using soft dollars should disclose the types of products and services being obtained more specifically.  For example, the disclosure should specify that if the adviser is getting analyses and reports concerning issuers, industries, securities, economic factors and trends.  Soft dollars might also be used to compensate broker-dealers to arrange meetings with security analysts, government representatives and company and industry representatives, for attendance at research conferences, reports of third-party market strategists, earnings information (including estimates), surveys and custom research reports.  Advisers also need to disclose that some clients bear more of the cost of soft dollar arrangements than others (if true).
  6. Failure to allocate the cost of a mixed-use product or service, or provide evidence of the allocation. Advisers should maintain written documentation on how much a “mixed use” service was paid for by the firm (“hard dollars”), and how much is paid for with soft dollars.  The process for allocation should be a good faith effort to make a reasonable allocation, consistently applied.  Depending on the nature of the product or service and its actual use by the adviser, factors could include:  the amount of time the service is used for eligible purposes (to assist in the investment process) versus non-eligible purposes, how the firm uses the products or services, or the number of employees using the research for investment purposes as compared to non-investment purposes (e.g., marketing).
  7. Weak policies and procedures. The final winner should come as no surprise to anyone, since violations of the Compliance Program Rule (Rule 206-4(7)) seem to show up in every exam letter or administrative proceedings these days.  Advisers should (1) have policies and procedures on best execution, (2) follow those policies and procedures, and (3) keep written documentation of the results. For investment advisers that recommend mutual funds to their clients, best execution policies and procedures should include a review of mutual fund share class selection (check out our blog post).

All advisers are encouraged to review their own best execution policies and procedures related to the common findings outlined above to identify any gaps and to promote a strong compliance program.  Contributed by Doug MacKinnon, Senior Compliance Consultant

California Issues its Own GDPR: On the heels of the GDPR in Europe, California passed a new comprehensive consumer privacy law, California Consumer Privacy Act 2018, for California residents effective January 1, 2020.  Consumers will gain more control over their personal information which includes the right to request disclosure of information the company collects, sells or shares; the right to request deletion of their information; the right to opt out of their information being shared; and the right not to be discriminated against because of choices based on personal information.  Also, the definition of personal information has been greatly expanded to encompass anything that can identify a California resident.   The law covers for-profit entities that exceed $25 million in gross revenues; that buy, sell or share personal information of 50,000 consumers or more; or derive more than 50% of their annual revenue from selling consumer information.  Between Europe and California, it stands to reason companies will probably make comprehensive changes to their systems to meet these obligations impacting consumers. For more details, check out these summaries on the new California data privacy law, one from Pillsbury available here, and another from the Harvard Business Review available hereContributed by Heather D. Augustine, Senior Compliance Consultant

SEC’s Pause in ALJ Actions Continues:  The SEC continues its halt on proceedings before its administrative law judges for an additional 30 days to August 22, 2018.   The SEC issued the original order after the U.S. Supreme Court held that the process for hiring SEC’s administrative law judges (“ALJs”) was unconstitutional in its 7-2 decision on June 21, 2018, in Raymond J. Lucia vs. Securities and Exchange Commission.  Contributed by Jaqueline M. Hummel, Partner and Managing Director


For Mutual Funds:  SEC Actions

 SEC Changes Disclosure Requirements for Liquidity Information.  The SEC recently adopted various amendments to Form N-PORT as it continues to digest industry feedback on implementing the October 2016 Investment Companies Liquidity Risk Management Programs Rule. First, funds will now be required to disclose information about the operations and effectiveness of their liquidity risk management programs (LRMP) in shareholder reports. This new narrative replaces the original requirement that funds report on Form N-PORT the aggregate percent of a fund’s portfolio in each of the four defined liquidity buckets.  Additionally, the narrative should describe any material liquidity happenings during the reporting period and how the manager addressed them. The SEC offers examples in its adopting release, including the occurrence of and response to any significant withdrawals.  The SEC also amended Form N-PORT to permit advisers to split a holding among more than one liquidity bucket in certain situations, such as a fund with multiple sub-advisers with different liquidity assessments.  Finally, funds will be required to disclose cash and cash equivalent positions on Form N-PORT quarterly.  The SEC noted this disclosure will be beneficial given that funds will no longer need to report the aggregate percent allocated to each liquidity bucket as described above.

 In its adopting release, the SEC highlighted its extensive outreach to identify potential issues associated with the effective implementation of the Investment Companies Liquidity Risk Management Programs rule.  While amendments may bring challenges as firms invest in operations, technology and human resources to prepare for these new disclosures, the SEC is demonstrating that it is listening to the comments received from the industry.

 Important Dates: Large entities have a compliance date of June 1, 2019, with the first filing date of July 30, 2019.  The compliance date for small entities is March 1, 2020, with the first filing date of April 30, 2020.  Contributed by Cari A. Hopfensperger, Compliance Consultant

 Division of Investment Management provides web pages on fund disclosures.  On July 6, 2018, the SEC’s Division of Investment Management’s Disclosure Review and Accounting Office (DRAO) launched a new “Disclosure” section on its website. The section contains three separate web pages. “Fund Disclosures at a Glance” includes an explanation of DRAO’s role, disclosure principles, and risk-based framework.  The second page, Accounting and Disclosure Information, includes a collection of web resources on common disclosure topics designed primarily for practitioners and other interested readers.  The third page, Disclosure Reference Material, includes resources such as the Plain English Handbook and common fund disclosure forms. Interwoven across all three pages, “Disclosure News” highlights developments in the world of fund disclosure. Overall, this new resource has elements targeted to the general public as well as practitioners.  If leveraged by both parties, access to this information should contribute to better-crafted disclosures that are also better understood by shareholders.  Contributed by Cari A. Hopfensperger, Compliance Consultant

For Broker-Dealers:  FINRA Actions

FINRA Members: Beware of Regulatory Imposters: In its Information Notice dated July 13, 2018, FINRA warns firms about individuals posing as FINRA employees to obtain confidential information for malicious purposes.  Firms have reported receiving phone calls and emails, purportedly from FINRA, requesting sensitive information for no apparent regulatory reason.  Be suspicious of information requests from overseas telephone numbers, foreign email domains, and emails that do not end with  Broker-dealers should contact their FINRA Regulatory Coordinator if they have any concerns regarding the validity of a request for information.   Contributed by Rochelle A. Truzzi, Senior Compliance Consultant

FINRA is Requesting Information Regarding Participation in Activities Related to Digital Assets: FINRA is encouraging firms to promptly notify their Regulatory Coordinator in writing if the firm, or any of its associated persons or affiliates, engages or plans to engage in activities related to digital assets.  Regulatory Notice 18-20 provides a non-exhaustive list of the types of activities that interest FINRA.  FINRA is not interested in information related to passive investments and activities of associated persons that are subject to FINRA Rule 3210 (Accounts at Other Broker-Dealers & Financial Institutions).  FINRA wants to learn how firms deal with notifications from associated persons regarding their participation in outside activities and private securities transactions related to digital assets through July 31, 2019.  These voluntary disclosures to the Regulatory Coordinator do not replace other regulatory filing obligations, such as Form CMA for material changes in business operations and Form ATS for material changes to the types of securities traded on a platform.  Firms that previously provided this information in response to a direct request from FINRA, on the 2018 Risk Control Assessment Survey, or by submitting a continuing membership application (CMA), do not need to provide additional notice unless that information has changed.

Lessons Learned from Recent SEC and FINRA Cases:

Broker-Dealer Challenges SEC’s Authority to Enforce Bank Secrecy Act:  In June of 2018, Alpine Securities Corp. (“Alpine”) petitioned the Second Circuit to compel a U.S. District Judge to dismiss the SEC’s enforcement action against Alpine for alleged violations of the SEC’s books and records requirements.  Alpine argued that the SEC overstepped its authority by bringing an enforcement action under the Bank Secrecy Act (“BSA”).  Alpine argued that the BSA grants general examination and enforcement authority to the U.S. Treasury Department.  Although the Treasury Department delegated its examination authority over broker-dealers to the SEC, it retains the authority to impose civil penalties through FinCEN, a bureau of the Treasury.  The SEC asserts that it has the authority under the Securities and Exchange Act Rule 17a-8 to require broker-dealers to maintain certain books and records, including those required under the BSA.  The Commission charged Alpine with violating Section 17(a) of the Exchange Act by filing deficient suspicious activity reports (“SARs”) and failing to maintain or retain required SAR documentation.

A key takeaway from this case is that the SEC continues to pursue broker-dealers for failing to file SARs.  Recent high profile cases, including those against Merrill Lynch (SEC and FINRA imposed $26 million in fines) and Wells Fargo (SEC fined Wells Fargo $3.5 million) and more recently against Aegis Capital Corporation (SEC and FINRA imposed fines of $1.3 million), show just how seriously the SEC considers these filing obligations.  Broker-dealers should ensure not only that they have policies and procedures in place, but that the SARs being filed are complete, accurate and provide sufficient details about the activity.  Supervisors and executives should also take note of the Aegis case where SEC also charged the firm’s CEO and two of its AML compliance officers.  Contributed by Rochelle A. Truzzi, Senior Compliance Consultant

Lifestyles of the Rich and Famous and their Books and Records:   It seems that Fidelity trader Thomas Bruderman’s infamous bachelor party that included dwarf tossing has been lost to the mists of history. Lavish spending has resurfaced in the brokerage world once again.   In the matter of BGC Financial L.P. (“BGC”), the SEC did not take kindly to the broker-dealer’s mischaracterizations of compensation, gifts, entertainment and expenses on its financials and in violation of its policies.  The SEC cited the firm for violations of the books and records rules in Section 17(a)(1) of the Securities Exchange Act and Rule 17 a-3 for incorrectly booking these expenses as travel and entertainment, and for violating firm policy by using firm funds for personal expenses.  Shining a light into the world of high-flying brokers and their benefits, the SEC found that BCG provided one broker with $600,000 worth of New York sports team tickets as part of his employment package. The tickets were described as “personal property” of the broker, which he used, sold or donated to charities, and only occasionally took clients to the games.  The SEC found tickets were incorrectly booked on the firm’s financials as “travel and entertainment” expenses instead of compensation in BGC’s general ledger. The firm also reimbursed the same broker to the tune of $100,000 for an international trip for him, eight members of his team and three friends for his birthday.  No customers attended, according to his expense reports.  And if that’s not enough, for four years the firm reimbursed this broker for thousands of dollars in expenses for international trips without adequate documentation of business purpose.

This broker was not the only recipient of the firm’s largesse.  The firm also reimbursed two brokers for concierge services, car services and tickets used by clients when the brokers were not present.  The expenses were booked as entertainment expenses, instead of as gifts, in violation of the firm’s gift policy. The brokers also failed to get pre-approval for these gifts, as required by firm policy.

In addition to the obvious lesson that firms should keep accurate books and records, this case indicates that a lax compliance culture leads to big regulatory trouble. In most of the situations, the brokers received pre-approval from their supervisors indicating that lavish spending on bachelor parties and trips to Las Vegas did not raise any red flags with the supervisor or the FINOP.   The SEC also noted that the firm’s compliance policies were well written, and stated that “records related to entertainment are ‘often requested by the regulators’ and ‘must be accurate,’ or we will have ‘books and records’ violations.” The specific references in the policies to regulator requests could indicate that expense reporting was an issue in the firm and management failed to act.  The SEC’s order does not discuss whether the broker-dealer’s annual audit identified these issues, which should have flagged the compensation issues and the large dollar amounts of entertainment expenses.  Maybe the issues were identified in audit reports and not corrected, which could be the reason the SEC hit BGC with a $1.25 million fine.  Of course, BGC had also deleted some phone recordings requested by the SEC, which may have raised the Commission’s ire.  In any event, this case reflects the importance of compliance having a good relationship with the Finance department and understanding the process for approving expenses, required documentation, as well as the scope and results of external audits. Chief Compliance Officers can use this case as a cautionary tale for annual compliance training, and as a basis for updating testing procedures to dig deeper into gifts and entertainment.  Although this case is specific to broker-dealers, registered investment advisers have a corresponding books and records requirement, and policies requiring reporting of gifts and entertainment should also be reviewed and tested.  Contributed by Heather D. Augustine, Senior Compliance Consultant

Petty Offenses under Pay-to-Play Rules Result in Major Fines for Advisers.  In three separate cases, advisers were fined $100,000 to $500,000 for violations of Rule 206(4)-5(a)(1) which bans an adviser from providing investment advisory services for compensation to a government entity for two years following a contribution by the adviser or its covered associates to any elected official or candidate of such government entity whose office may have influence on the selection of an investment adviser.

In the Sofinnova case, an exempt reporting adviser (ERA) continued to collect investment management fees for eight months following a $2,500 contribution by a covered associate to a gubernatorial candidate with the ability to influence investments by one of the firm’s investors, a state retirement plan.  The plan was already an investor in the firm’s closed-end fund at the time of the contribution and upon request, the contribution was returned.  Nonetheless, the SEC issued $120,000 fine, noting that the intent to influence an adviser appointment decision is not required to be a violation.  In the matter of Oaktree Capital Management, L.P., three covered associates contributed $500 to $1,400 to candidates with the ability to influence investments by certain existing governmental investors in the firm’s private closed-end funds.  Oaktree was fined $100,000 and agreed to stop collecting management fees from these investors during the requisite two-year ban.  In the matter of Encap, a similar fact pattern emerged, though the contributions (and the subsequent fine) were larger.  Contributions leading to the violation totaled just over $90,000 with a resulting fine of $500,000.

Key take-aways?  First, the amount of the contributions need not be material – the total contributions made by Sofinnova and Oaktree were $2,500 and $2,900, respectively.  Second, ERAs must comply with the same pay to play rule as RIAs.  Third, requesting the return of the contribution may be beneficial for compliance management purposes but does not eliminate the two-year ban on fees. Fourth, the two-year time-out applies even when a government plan is already a client or investor before a contribution is made. ERAs and RIAs should carefully consider their political contribution procedures to ensure that, where the firm or a covered associate makes any political contribution outside the de minimis thresholds, the firm does not collect management fees from any client over which the receiving candidate has investment influence during the two-year ban.  Preclearance procedures are a valuable and important control for many firms, but these cases highlight a need to dig deeper.  Contributed by Cari A. Hopfensperger, Compliance Consultant

 Using Squeaky Clean Reputation Service Results in Black Marks for Advisers:   The SEC announced five settled proceedings against two registered investment advisers, three investment adviser representatives (IARs) and marketing consultant Leonard Schwartz for violations of the Rule 206(4)-1(a)(1), also known as the Testimonial Rule. The cases involved Romano Brothers & Company, HBA Advisors, LLC and Jaime Enrique Biel, William M. Greenfield and Brian S. Eyster, and marketing consultant Leonard S. Schwartz.   Except for the Romano Brothers case, all the other cases involved Mr. Schwartz, a marketing consultant and president of Create Your Fate, LLC.  Mr. Schwartz sold his Squeaky Clean reputation service to some investment advisers, telling them that his social media marketing efforts were “100% compliant.”  The service involved soliciting positive reviews of investment advisers from their clients and getting them posted on,,, and  One adviser, described in the proceeding against Mr. Schwartz as Advisor A, quickly realized that the testimonials solicited by Create Your Fate and posted on the internet violated the Testimonial Rule, and requested that they be removed.   Advisor A also provided Mr. Schwartz with the text of the Testimonial Rule, and a link to the SEC’s guidance on the rule, and suggested that this rule applied to other advisers using his service. Although Mr. Schwartz didn’t remove the testimonials until months later, Advisor A was able (presumably) to avoid trouble with the SEC by having proof that it acted quickly to prevent further violations of the rule.

The first lesson learned from this case is to perform due diligence on your service providers.  The advertising rule under the Advisers Act is complicated, and firms should determine whether their marketing consultants have an understanding of the rule and its interpretations.  Moreover, marketing consultants, like other service providers, have very limited liability. They are not subject to extensive regulations, and, except for Mr. Schwartz, are generally not subject to SEC sanctions.  Another key takeaway from this case is that any marketing initiatives should be discussed with compliance.  Even in situations where testimonials are on an independent third-party site like, the fact that an adviser then purchases an advertisement on that links to the testimonials can be viewed as a violation of the Testimonial Rule.  A final lesson from this case is never trust anyone who tells you that their marketing is “100% compliant” or who uses the phrase “Squeaky Clean Reputation.”   Contributed by Jaqueline M. Hummel, Partner and Managing Director

Insanity is Doing the Same Thing Over and Over Again and Expecting Different Results:  New Silk Route Advisors, L.P. found out the hard way what happens when you fail to comply with the Advisers Act Custody Rule (Rule 206(4)-2).  For six years in a row, this private fund manager failed to distribute the annual audited financial statements to the limited partners in its funds by the 120-day deadline.  The SEC fined the adviser $75,000.  Aside from the obvious lesson about meeting the delivery deadline, a key takeaway from this case is to learn from your failures.  New Silk Route consistently failed to meet the financial statement deadline each year, but, according to the SEC, did not change its processes or procedures to prevent future failures.  Contributed by Jaqueline M. Hummel, Partner and Managing Director

Worth Reading:

Issues to Consider when Billing on Assets under Advisement:  Great discussion by Michael Kitces about charging fees on held-away assets.

Beware of Social Media Consultants:  Doug Cornelius at Compliance Building highlights the dangers of hiring social media consultants who do not understand the advertising rules under the Advisers Act.

Help! My Aging Advisor’s Cognitive Decline:  Julie Ragatz at Barrons provides an interesting read on dealing with a decline in an investment adviser’s competence.

Compliance Testing Survey:  The Investment Adviser Association released the results of its 2018 compliance testing survey.  The hottest topic?  Cybersecurity.

Regulation of Investment Advisers by the U.S. Securities and Exchange Commission:  Robert Plaze, who served as Deputy Director of the Division of Investment Management at the SEC, updated this classic resource on RIA regulation.

What I Learned About Working Parenthood after My Kids Grew Up:  Avivah Wittenberg-Cox writes that aging has its advantages.  This article hit home for me!

 Filing Deadlines and To Do List for August


  •  Form 13F: Form 13F Quarterly Filing for Q2 2018 is due for advisers within 45 days after the end of the calendar quarter.  Due date is August 14, 2018.
  • Form PF for Large Hedge Fund Advisers: Large hedge fund advisers must file Form PF within 60 days of each quarter end on the IARD system.  Due date is August 29, 2018.


  • CFTC CPO-PQR Form: Large Commodity Pool Operator Form CPO-PQR (June 30 quarter-end report) required to be filed with the NFA for Commodity Pool Operators.  Due date is August 29, 2018.
  • NFA Form CPO-PQR:  Small and Mid-Sized Commodity Pool Operators are required to file NFA Form CPO-PQR.  Due date is August 29, 2018.


  • Form OBS: For the Quarter ending June 30, 2018.  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 date is August 1, 2018.
  • Rule 17a-5 Monthly and Fifth FOCUS Part II/IIA Filings:  For period ending July 31, 2018. For firms required to submit monthly FOCUS filings and those firms whose fiscal year-end is a date other than a calendar quarter.  Due date is August 23, 2018. 
  • Supplemental Inventory Schedule (“SIS”): For the month ending July 31, 2018. 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 date is August 28, 2018. 
  •  Annual Audit Reports for Fiscal Year-End June 30, 2018:  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 date is August 29, 2018.
  • SIPC-7 Assessment: For firms with a Fiscal Year-End of June 30, 2018.  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 date is August 29, 2018.
  • SIPC-3 Certification of Exclusion from Membership: For firms with a Fiscal Year-End of July 31, 2018 AND claiming 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 date is August 30, 2018. 
  • SIPC-6 Assessment: For firms with a Fiscal Year-End of January 31, 2018.  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 date is August 30, 2018. 


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 Hardin Compliance Consulting provides links to other publicly-available legal and compliance websites for your convenience. These links have been selected because we believe they provide valuable information and guidance.  The information in this e-newsletter is for general guidance only.  It does not constitute the provision of legal advice, tax advice, accounting services, or professional consulting of any kind.