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Entering Another New Normal: Reg BI & Form CRS Next Steps; Compliance Team Takes the Hit for MNPI Process Failures; and SEC Continues Crusade Against “Inadequate Disclosure”: Regulatory Update for July 2020

For Investment Advisers and Broker Dealers

Reg BI and Form CRS are here! Now what?  After 391 long days of hand wringing, countless meetings, never-ending scenario-based questions, revisions, and the US Court of Appeals for the 2nd Circuit siding with the SEC to uphold the rule, Regulation Best Interest (“Reg BI”) and Form CRS are now effective!  With filing complete, policies and procedures implemented, and training delivered, now what?  What should firms do next?  There really is no simple answer to this question, and each firm will answer it differently depending on the business they conduct and the requirements to which they are subject.  Consider the following as you plan your next steps.

Day 1 – We did it!  Did it work?

  • Verify that your submission of Form CRS went through on WebCRD and/or IARD.
  • Confirm that your website links for Form CRS and Reg BI disclosures are working correctly and that your new account opening process includes delivering a copy of Form CRS.
  • Test to ensure that any automated methods of Form CRS notification or delivery are working as intended.
  • After the initial delivery, confirm that your team understands when to re-deliver Form CRS.

Next 30 days – What next?

  • If you identified any gaps in your policies and procedures while preparing for Form CRS and Reg BI, confirm that they have been appropriately addressed.
  • Have you uncovered problems with the new process? If so, correct them now and address any potential violations those problems may have created.
  • Consider sending additional communications to the field if questions are being raised that were not addressed in the initial training.

Beyond 30 days – Now we have some data to work with…let’s use it!

  • Survey your financial professionals
    • How is the process going for them?
    • Do they have questions?
    • What feedback are they receiving from customers?
    • Have they identified any best practices that will benefit the rest of the firm?
  • Are your financial professionals complying with the new policies and procedures?
  • Check to see if appropriate notes are entered in client files or in a client relationship management (“CRM”) system.
  • Based on your review, is additional training required?
  • Ask whether designated supervisors understand their roles and are comfortable with what they should be doing.
  • Ask your clearing firm about its role in your firm’s Form CRS and Reg BI compliance program.
    • Have they provided evidence that they are performing as promised?
    • Test a sample of the clearing firm’s production to ensure that all deliverables are taking place as intended.
  • Establish a schedule for reviewing Form CRS and Reg BI disclosures to determine if any updates are required.
  • Add a process to your compliance manual for updating Form CRS and Reg BI when a material change for the firm has occurred.

Going forward – Mitigating conflicts of interest

The best option for mitigating a conflict of interest is to eliminate it (whenever possible). Has the firm determined which newly or previously identified conflicts of interest can be eliminated?

  • If so, are steps being taken to resolve the conflict of interest?
    • If not, are all conflicts appropriately disclosed?
  • Assess the firms processes and procedures for identifying and disclosing conflicts of interest.
    • Are they functioning as intended? Or are changes required?
    • If changes are required, has the change been addressed? If not, address it.

The list above is not exhaustive, and each firm should consider its specific circumstances.  At minimum, processes must not only identify who is responsible for the oversight and testing of their new processes and procedures, but it should also establish the “how” and the “when” for these controls.  Contributed by Doug MacKinnon, Senior Compliance Consultant, and Jaqueline M. Hummel, Partner and Managing Director.

Did you know that June 15th was World Elder Abuse Awareness Day (WEAAD)? The International Network for the Prevention of Elder Abuse and the World Health Organization at the United Nations created WEAAD to “promote a better understanding of abuse and neglect of older persons by raising awareness of the cultural, social, economic and demographic processes affecting elder abuse and neglect”.  The rates of suspected financial exploitation of vulnerable persons and the regulatory spider-web of related state “report and hold” laws continue to grow.  Broker dealer and investment adviser compliance teams are tasked with maintaining policies and procedures that remain current in the face of changing regulatory requirements and for providing training to educate their staffs on what to look for and how to handle suspected fraud.  Below are several resources that can help:

Contributed by Cari A. Hopfensperger, Senior Compliance Consultant.

For Investment Advisers

Form CRS and the Land of Oz…State considerations for Form CRSIt is July 2020, and despite COVID-19 restrictions and the investment advisory community operating from their business continuity plans – federally registered investment advisers with retail clients filed their initial Form CRS.  While most SEC-registered RIAs will now turn their attention Form CRS delivery, state registered investment advisers wait for the other shoe to drop.

On the whole, state regulators have expressed general concern that both Reg BI for broker-dealers and the SEC’s Interpretation of Fiduciary Duty for investment advisers are not strong enough to protect investors.  Massachusetts, for example, has finalized its own fiduciary duty standard for broker-dealers and agents which will begin to be enforced on September 1, 2020.

On the investment adviser front, most state securities regulators are considering whether they will require Form CRS to be completed and delivered by state investment advisers.  Rhode Island stepped forward and issued a Securities Bulletin requiring Rhode Island state-registered investment advisers to file Form CRS through IARD by uploading it alongside Form ADV Part 2A by June 30, 2020.  The Bulletin also states that it is a “best practice” as a fiduciary for advisers to deliver Form CRS to their retail clients.  Hardin Compliance will monitor state law as it develops regarding fiduciary duty for broker-dealers and investment advisers. Contributed by Carolyn W. Mendelson, Senior Compliance Consultant.

West Virginia Enacts Senior Safe Legislation. West Virginia has joined twenty-nine other states, FINRA, and Congress by passing its own state financial exploitation statute to protect seniors and dependent adults from financial fraud and fraud attempts.  West Virginia’s Protection of Eligible Adults from Financial Exploitation Act becomes effective on September 5, 2020.  Similar to other “mandatory reporting” states, the West Virginia law:

  • Requires broker-dealers and state investment advisers to investigate and, as needed, report reasonably suspected financial exploitation to the state’s Securities Commission and adult protective services.
  • Permits firms to contact a trusted third party of the accountholder (so long as the trusted contact is not suspected as a perpetrator) about the suspected exploitation.
  • Permits a firm to temporarily hold disbursements or transactions for the account holder so long as the firm reports the suspected fraud, advises the account holder, and continues the firm’s own investigation.

Click here for more details about this legislation and how to comply with it.  Contributed by Carolyn W. Mendelson, Senior Compliance Consultant.

For Mutual Fund Managers 

Temporary Relief extended for In-Person Board Meetings.  This new order extends the time for relief from the in-person fund board meeting requirement until no earlier than December 31, 2020.  The SEC’s original order was set to expire on August 15, 2020.  Contributed by Cari A. Hopfensperger, Senior Compliance Consultant.

Lessons Learned 

Another Adviser Nailed for Inadequate Handling of Material Nonpublic Information. This is the second enforcement recently where the SEC fined an adviser for inadequate policies and procedures for handling material nonpublic information without alleging actual insider trading.  (See Hardin’s analysis of the SEC’s enforcement action against Cannell Capital in March.)  In this case, private equity adviser, Ares Management LLC (“Ares”), invested in debt and equity of a public company.  Ares’ equity position gave it the right to appoint two directors.  The employee-director appointed also served on Ares’ investment committee.  Ares’ policies and procedures included use of a restricted list, and the public company was added when the Ares’ employee was appointed to the board.  If the Investment Committee wanted to trade the public company’s shares, pre-clearance was required and enforced through “hard restrictions” coded into the firm’s order management system (“OMS”).  The pre-clearance process entailed compliance (1) confirming with the issuer that the trading window for directors was open and (2) verifying with the employee-director whether the firm possessed material nonpublic information at that time.  Procedures then required compliance personnel to document the pre-clearance process in the OMS.

Despite the risk profile associated with this situation, the Investment Committee decided to invest in public equity of the issuer, to the tune of 17% of the issuer’s shares outstanding.  As required for each trade, compliance verified that the trading window for insiders was open and the employee-director stated that the firm was not in possession of MNPI.  However, procedural breakdowns occurred according to the SEC:

  • The Firm did not deploy existing optional information barrier procedures to wall off the director from the firm’s investment decision making process.
  • Compliance testers responsible for confirming the existence of MNPI with the employee-director were left to self-determine whether the information described by the employee-director was material or not. This review was found to lack the depth warranted by the level of risk.  Policies and procedures also lacked sufficient detail to guide compliance personnel in this analysis and there was insufficient oversight for more experienced professionals to jump in.
  • While the OMS was updated consistently with a hard restriction for securities on the restricted list, documentation of the pre-clearance process was inconsistent and sometimes missing.

Similar to the Cannell enforcement, the SEC again focused solely on procedural failures in the compliance department.  Although we are not privy to what else may have been going on here, it’s safe to say that CCOs should be on alert.  Documenting careful and thoughtful completion of procedures is advised.  But CCOs should also be cautious that front-line compliance reviewers are not left with too much responsibility and too little guidance or oversight when performing complicated analyses. For example, if a tester is responsible for determining whether information is material, then the tester needs extensive training and development opportunities.  Alternatively, if the tester is not responsible for the higher-level review, then the procedures should include instructions on when to escalate.  This case demonstrates again that simply “checking the box” without thinking deeper is not going to cut it.  Finally, CCOs should take steps to limit the compliance department’s responsibility for the firm’s conduct.  Tis action makes no mention of potentially faulty judgment of the employee-director or the investment committee – all of this fell on compliance.  Ultimately, compliance is everyone’s responsibility and a firm’s compliance manual should support this by distributing responsibility where appropriate.  Contributed by Cari A. Hopfensperger, Senior Compliance Consultant. 

The Fat Lady Has Not Sung Yet… the SEC Continues its Crusade against “Inadequate Disclosure” of Mutual Fund Fees. In April, the SEC settled the last three share class selection cases with advisers who self-reported under its Share Class Selection Disclosure Initiative.  But the SEC is not stopping there, continuing to bring cases against advisers for failing to “adequately disclose all material facts” resulting from investing clients in mutual fund share classes that generate 12b-1 fees and shareholder servicing fees where the adviser and its representatives benefited from those fees.  For example, in settlements with Vescio Asset Management LLC and William Vescio, US Bancorp  Investment, Inc. (USBI) and Oxbow Advisors, LLC, the SEC appears to be taking a cut and paste approach, using essentially the same language in all three cases describing the disclosure failures:

To meet this fiduciary obligation, [the Investment Adviser] was required to provide its advisory clients with full and fair disclosure that is sufficiently specific so that they could understand the conflicts of interest concerning [the Investment Adviser’s] advice about investing in different classes of mutual funds and could have an informed basis on which they could consent to or reject the conflicts. [The Investment Adviser] did not adequately disclose all material facts regarding the conflict of interest that arose when it invested advisory clients in a share class that would generate 12b-1 fee revenue for [the Investment Adviser’s IARs] as registered representatives of a broker-dealer while a share class of the same fund was available that would not provide [the Investment Adviser’s IARs] with that additional compensation.

In the US Bancorp Investment, Inc. (USBI) case, USBI, as a dual registrant, also received shareholder servicing fees from mutual funds.  USBI did not share these fees with its representatives. Nonetheless, the SEC found that the firm failed to adequately disclose the conflict that resulted from recommending fund share classes that paid out those fees, since USBI received them and had a financial incentive to recommend share classes that paid these fees.

In all three cases, the SEC found that the investment adviser firms:

  • Breached their fiduciary duty to seek best execution by putting advisory client assets into mutual fund share classes that charged 12b-1 fees and shareholder servicing fees when lower-cost share classes were available;
  • Failed to adequately disclose the conflict of interest in selecting share classes that paid 12b-1 fees and shareholder servicing fees (a violation of Section 206(2) of the Advisers Act); and
  • Failed to adopt and implement compliance policies and procedures reasonably designed to prevent violations of the Advisors Act (a violations of Rule 206(4)-7) when selecting mutual fund share classes.

Each firm was required to reimburse clients and pay penalties.  USBI’s penalty was the largest at $2.4 million, OxBow’s was $90,000, and Vescio’s was $40,000.

The SEC is focusing very specifically on disclosing the conflict of interest the adviser and its financial professionals have when selecting mutual fund share classes that provide them with 12b-1 fees and shareholder servicing fees.  Surprisingly, in the USBI case, its policy during the five years at issue was to recommend that clients purchase No-Transaction-Fee (NTF) load-waived Class A shares that paid 12b-1 fees and shareholder servicing fees.  On the surface, this appears to be a fair policy, since clients are not required to pay a transaction fee or a front-end load.  Moreover, Class A shares typically have lower expense ratios than Class C shares.  The SEC’s greatest concern appeared to be the fact that clients were not told that USBI had a vested interest in selecting the mutual fund share classes since the firm would receive additional revenue.  The SEC was also concerned that institutional share classes, which generally have no 12b-1 or shareholder servicing fees, were also not being considered for clients who might qualify.

The important takeaway here is that advisers need to provide “full and fair disclosure that is sufficiently specific” in Form ADV Part 2A.  Most advisers have gotten the message that the SEC strongly frowns upon the receipt of 12b-1 fees attributable to mutual fund investments in advisory accounts.  But advisers have a continuing obligation to look for the lowest cost share class.  Here are my thoughts on what this disclosure might look like:

About Mutual Fund Investments

As an investment adviser, our firm has the discretion to select from various share classes offered by the mutual funds.  Some share classes pay 12b-1 fees and shareholder servicing fees to broker-dealers and their representatives, including Class A, Class B and Class C shares.  These fees are meant to compensate broker-dealers for distribution expenses and the costs of servicing client accounts, and are charged to fund shareholders as fund expenses.  Generally, Class A shares charge lower 12b-1 fees as compared to Class B and C shares.

Our Firm’s Financial Advisors are also registered representatives of the broker-dealer and receive a portion of 12b-1 fees attributable to client assets invested mutual funds.  This means that that our Firm and your Financial Advisor have a financial incentive to invest your assets in certain mutual fund share classes to receive these additional fees. [To mitigate this conflict, our firm now credits client accounts with any 12b-1 fees received.]  [Our Firm, in its capacity as a broker-dealer/ or our affiliated broker-dealer also receives shareholder servicing fees from certain mutual fund share classes. This presents a conflict of interest for our [Firm].  Unlike 12b-1 fees, our Financial Advisors do not receive any part of the shareholder servicing fees which mitigates the conflict. [discuss range of shareholder servicing fees and whether this is a significant source of revenue for the firm.]

There are other share classes that do not charge 12b-1 fees and shareholder servicing fees, such as Institutional Class shares (I-Shares).  Because I-Shares have lower expenses, they produce higher returns than other share classes of the same fund.  I-Shares are only available to investors that can make a substantial minimum investment, ranging from $25,000 to $1 million.  In some cases, mutual funds agree to waive the minimum investment requirement.  Ask your Financial Advisor if I-Shares are available to you.

Clients may also buy mutual funds directly from a mutual fund company.  Mutual Fund companies offer “investor class” shares to retail investors that do not charge any sales loads or commissions.  Ask your Financial Advisor about this option.

Contributed by Jaqueline M. Hummel, Partner and Managing Director.

Former RIA COO Barred from Industry. In our May 2019 Regulatory Update we discussed this case where the SEC charged Richard Diver, co-founder and Chief Operating Officer of M&R Capital Management, for stealing $6 million from the firm and its clients over seven years.  As COO, Mr. Diver was responsible for managing the firm’s revenues and expenses, including payroll and client billing. He used his position to inflate his salary and to overbill clients.  Diver confessed when confronted by the CEO.  Mr. Diver has settled the matter with the SEC, and has been barred from working in the industry indefinitely.

One of the main takeaways from this case is that higher risk activities should include a system of checks and balances.  Even if you trust your COO, a second set of eyes reviewing client billing is an essential safeguard, both for preventing fraud and for revealing flaws in the process.  Contributed by Jaqueline M. Hummel, Partner and Managing Director.

Worth Reading

Filing Deadlines and To-Do List for July 2020


  • 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. Recommended due date: July 10, 2020. (Note: Neither the SEC nor its staff has provided guidance on the definition of “promptly” for Form 13H.)
  • Annual Entitlement User Certification: FINRA requires firms to conduct an annual review of its IARD user accounts and ensure that access and entitlements are appropriate for each user’s role and responsibilities. The Super Account Administrator (“SAA”) is responsible for conducting the review, amending and deleting user accounts/entitlements as necessary, and submitting the certification through IARD.  Only the SAA has access to this certification, and a Quick Reference Guide to the entitlement process is available on the IARD site.  This year, the certification period opened on April 20th and must be completed by July 20, 2020.
  • Form CRS: Advisers to Retail Clients (as that term is defined in Regulation Best Interest (Reg BI) must file deliver their Form CRS to all existing retail investors before July 30, 2020.  Refer to Hardin’s dedicated Reg BI webpage for templates and additional information.


  • Form PF for Large Liquidity Fund Advisers: Large liquidity fund advisers must file Form PF with the SEC on the IARD system within 15 days of each fiscal quarter-end. Due date is July 15, 2020.
  • Blue Sky Filings (Form D). Advisers 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 July 15, 2020.

BROKER-DEALERS  (* Filing extensions may be available)

  • 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. Due date to be determined.
  • Customer Complaint Quarterly Statistical Summary: For complaints received during the second 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 July 15, 2020.
  • Quarterly FOCUS Part II/IIA Filings: For Quarter ending June 30. 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 July 24,
  • Quarterly Form Custody: SEC requires that member firms file Form Custody under Securities Exchange Act Rule 17a-5(a)(5) for the quarter ending June 30. Due July 24,
  • Supplemental Statement of Income (“SSOI”): For the quarter ending June 30. 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 July 29,
  • Supplemental Inventory Schedule (“SIS”): For the month ending June 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 July 29, 2020.
  • Annual Audit Reports for Fiscal Year-End May 31, 2020: 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 July 30,
  • SIPC-3 Certification of Exclusion from Membership: For firms with a Fiscal Year-End of June 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 July 30,
  • SIPC-6 Assessment: For firms with a Fiscal Year-End of December 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 July 30,
  • SIPC-7 Assessment: For firms with a Fiscal Year-End of May 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 the Fiscal Year-End. Due July 30,
  • Form OBS: For the Quarter ending June 30. 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 July 31,


  • 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 July 7, 2020.
  • Form N-PORT (Small Fund Complexes, May 31 Fiscal Quarter End).  Small fund families (those with less than $1 billion in assets) with a fiscal quarter end of May 31, must file Form N-PORT reporting month end information for each month-end in each fiscal quarter no later than 60 days after fiscal quarter-end.  In this initial filing, Form N-PORT funds must report information for the months of March, April, and May 2020.  Due date is July 30, 2020Funds must also prepare the information reported on Form N-PORT within 30 days after every month-end and retain these records, which are subject to SEC inspection.


Partner with Hardin Compliance

Have a compliance question or want an independent review of your compliance program?  Hardin Compliance can help!  Call us today at 1.724.935.6770, or visit our website at for more information.


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.

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