In a Risk Alert published today on the new Marketing Rule, the SEC announced that there will be a number of upcoming specific national initiatives designed to verify adviser compliance with the new Rule, which requires full compliance by November 4, 2022.
Don’t assume you can disclose away all conflicts of interest – that’s the latest warning and reminder from the SEC to investment advisers and broker-dealers from a recently-published staff bulletin.
As a reminder, an SEC-registered adviser owes clients a fiduciary duty of loyalty to eliminate a conflict of interest or, at a minimum, make full and fair disclosure of the conflict of interest such that a client can provide informed consent to the conflict.
In the bulletin, the staff pointed out several circumstances where conflicts must be eliminated and not merely disclosed. For example, the staff believes that eliminating a conflict is appropriate where the conflict is of a nature and extent that it would be difficult for the adviser to provide full and fair disclosure, and the investment adviser cannot mitigate the conflict such that full and fair disclosure and informed consent are possible.
Signaling its increasing scrutiny on investment advisers managing crypto assets, the SEC and CFTC recently jointly proposed a rule that would require private fund managers who are required to file Form PF to report information on digital asset investments held by their private funds.
The release defines a “digital asset” as an asset that is issued or transferred using distributed ledger or blockchain technology including, but not limited to, virtual currencies, coins, and tokens.
Among other things, reporting managers would need to provide a good faith estimate of the percentage of the reporting fund’s net asset value invested in digital assets as well as the dollar value of long and short positions in digital assets.
I often get asked what and how much information an investment adviser must gather from clients in order to ensure that it can satisfy its fiduciary duty of care to make suitable recommendations in the best interest of its clients.
By way of background, the duty of care requires an SEC-registered adviser to establish a reasonable understanding of the client’s objectives. How an adviser establishes this reasonable understanding can vary based on nature of the client, the scope of the adviser-client relationship, and the nature and complexity of the anticipated investment advice
For retail investors, the SEC has explained that this duty requires, at a minimum, that the adviser make a reasonable inquiry into the client’s financial situation, level of financial sophistication, investment experience, and financial goals. Yet, depending on the circumstances, more information may be required. For example, an adviser undertaking to formulate a comprehensive financial plan for a retail client would generally need to obtain a range of personal and financial information about the client, such as current income, investments, assets and debts, marital status, tax status, insurance policies, and financial goals.
Advisers should review the information they are collecting from clients to ensure that they are satisfying their fiduciary duty of care.
One of the most challenging and yet important things for investment advisory firms with investment adviser representatives (IARs) operating from multiple locations to do is to ensure that such IARs are being reasonably supervised to prevent their violation of securities laws.
The SEC is keenly focused on this topic, as demonstrated by an enforcement action announced last week where an investment adviser was fined $400,000 for failing to supervise an IAR that engaged in improper allocation of trades that resulted in preferred treatment for the IAR and his family members, at the expense of the IAR’s clients.
This risk is particularly acute for investment advisers who retain IARs to “tuck in” under the adviser’s umbrella, and yet such IARs essentially continue to run their own practices under such umbrella. This risk has also been exacerbated since the pandemic where advisers allow employees to work remotely for significant periods of time.
Advisory firms should not leave it to IARs to ensure their own compliance with the firm’s compliance policies and procedures. Advisers must ensure that there are appropriate touchpoints with such IARs to ensure that the IARs are complying with the firm’s policies and procedures.