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FIRMA National Risk Management Training Conference New Orleans, LA April 29, 2009 Overview of Key Rules and Regulatory Developments affecting Broker Dealers, Investment Advisers etc.


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Title: FIRMA National Risk Management Training Conference New Orleans, LA April 29, 2009 Overview of Key Rules and Regulatory Developments affecting Broker Dealers, Investment Advisers etc.

FIRMA National Risk Management Training
ConferenceNew Orleans, LA April 29, 2009
Overview of Key Rules and Regulatory
Developments affecting Broker Dealers, Investment
Advisers etc.
  • Sean Gray
  • Senior Vice President
  • Director of Wealth Management Compliance
  • PNC Bank

All statements and opinions contained herein are
the sole opinion of the speaker not PNC and
subject to change without notice.
  • Refresher/Overview of NASD Rules 3012, 3013, NYSE
    Rule 342 etc. (i.e., new FINRA Rule 3130)
  • FINRA 2009 Exam Priorities and Enforcement
  • Other FINRA and B-D Regulatory Developments
  • Annual Review Tips for RIAs
  • SEC Compliance Hot Spots
  • 4 Key Areas to Focus Lori Richards
  • Custody Sweeps etc.
  • New SEC Exam Letters and Approaches
  • Other RIA Hot Topics

Regulatory Scheme
  • Ensures process owned by CEO, senior leadership
  • Assures robust reporting between senior
    leadership and compliance leader
  • Mandates annual reviews that drive continuous
    process improvement, adjustment for regulatory,
    business changes
  • Trend spotting, early warning capability clear

Annual Compliance and Supervision Certification NY
SE 342.30 NASD 3013
CEO Certification
Processes for Testing, Verification,
Enforcement and Reporting
  • Supervisory Control System
  • NYSE 342.23 NASD 3012
  • Key Requirements
  • Establish, maintain, enforce a system of
    supervisory control
  • Procedures in place to review and supervise
    customer activity and Branch/Sales/Regional/Distri
    ct Managers
  • Independent day-to-day supervision of producing

Processes for Monitoring Supervisory
Procedures (Surveillance, Corporate Audit
Reviews, Branch Inspections, Internal Reviews)
  • Supervisory Procedures
  • NYSE 342 NASD 3010
  • Key Requirements
  • Written supervisory PPs
  • Internal inspections
  • Supervision of RRs

Written Supervisory Policies and Procedures
Various impacted business areas
Note FINRA Rule 3130 (Annual Certification
of Compliance and Supervisory Processes) replaces
NASD Rule 3013 and the corresponding provisions
in Incorporated NYSE Rule 342.30 and related NYSE
Rule Interpretations (effective December 15,
  • NASD Rule 3013 Annual Certification of
    Compliance and Supervisory Processes
  • Rule 3013 requires
  • Designation of a CCO on Schedule A of Form BD
  • CEO certification that the Member firm has in
    place processes to
  • (a) establish, maintain and review policies and
    procedures reasonably designed to achieve
    compliance with NASD and MSRB rules and
    applicable federal securities laws and regulation
  • (b) modify these policies and procedures as
    business, regulatory and legislative changes and
    events dictate
  • (c) test the effectiveness of such policies and
    procedures on a periodic basis, the timing and
    extent of which is reasonably designed to ensure
    continuing compliance with applicable rules, laws
    and regulations
  • At least one annual meeting between CEO and CCO
    to discuss prescribed compliance matters
  • Members processes must be evidenced by a report
    reviewed by the CEO, and Chief Compliance Officer
    (and such others as the Member deems necessary)
    and submitted to the Members Board of Directors
    and Audit Committee
  • The CEO certification is a process certification
    and does not require performance or completion of
    any compliance testing or verification

NASD Rule 3012 Supervisory Control System
  • Supervisory control policies and procedures
    include procedures reasonably designed to review
    and supervise customer account activity, branch
    office managers, sales managers, regional and
    district sales managers and any other person
    performing a similar supervisory function
  • Rule 3012(a) requires designation of one or more
    Principals tasked to establish, maintain and
    enforce a system of supervisory control policies
    and procedures and continually improve such
    procedures as required after reviews or testing
    or in response to business or regulatory changes
  • Rule 3012 also requires procedures for senior or
    otherwise independent day-to-day supervision of
    Producing Managers account activity and
    heightened supervision of producing managers
    with 20 or more revenues generated from units
    supervised by the producing managers supervisor
  • Requires annual testing and verification of WSPs
    by January 31st of each year to demonstrate that
    they are reasonably designed with respect to the
    members activities (and those of its RRs and
    Assoc Persons) to achieve compliance with NASD
    rules and applicable securities laws and
    regulations, and the creation of additional
    policies and procedures where the need is
    identified by such testing and verification

NASD Rule 3012 Supervisory Control System
  • Failure to recognize that Supervisory Control
    Procedures (SCPs) differ from WSPs
  • Need WSPs plus control process for insuring such
    procedures are adequate and current, i.e.,
    fundamental purpose of 3012
  • A firm that does not have SCPs, frequently fails
  • Designate the Principal(s) responsible for
    establishing, maintaining and enforcing the
    firms system of supv control pol proc
  • Annually test and verify supv procedures and
    amend them, when needed
  • Adequately supervise customer account activity of
    producing managers
  • Adequately supervise producing managers subject
    to HS and
  • Review, monitor and confirm transmittal of
    funds/securities from customers to 3rd parties,
    changes of address and changes of inv objs

NASD Rule 3012 Supervisory Control System
  • Testing and Verification
  • FINRA has noted that some firms failed to test
    and verify on annual basis that supv procedures
    are sufficient and reasonably designed with
    respect to activities of the member firm and its
    RRs and Assoc Persons
  • Each firm must have written testing and
    verification procedures that detail steps to be
    taken by firm to conduct testing and verification
    to identify any gaps in supv process
  • Procedures must also detail steps to be taken by
    firm for drafting and approving new procedures,
    including identification of responsible Principal
    and implementation process.
  • Failure to prepare and timely submit the Rule
    3012 annual report to firms senior management.
  • Limited Size and Resource Exception
  • One of most common 3012 finds is inaccurate
    understanding and application of this exception.
  • It only provides alternative method for who may
    perform a producing managers review
  • Failure to supervise Producing Managers
  • Must correctly identify any and all producing

NASD Rule 3012 Supervisory Control System
  • Failure to confirm, verify or follow-up with
    customers in the event of a
  • change of address
  • transmittal of funds or
  • transmittal of customer funds or securities.

Responsibility Matrix
Rule Comparison Chart
FINRA 2009 Exam Priorities
  • 3 General Categories Sales Practice Issues,
    Enterprise Control Functions, and
    Financial/Operational Controls
  • Sales Practice Issues
  • Cash Alternatives
  • Focus is result of ARS Issues, i.e., representing
    certain securities as cash alts or equiv.'s
  • 1 - Need to have reasonable basis for
    characterizing inv as cash alternative
  • 2 Need to have Procs in place to monitor
    developments to ensure inv retains
    characterization as cash alternative
  • 3 Need to perform suitability analysis
    before recommending same to customer
  • Bank Sweeps
  • Increase in recent use of bank deposit programs
    as sweep vehicles for free credit balances
  • Focus on disclosures re terms and conditions
  • Differentiation of SIPC vs. FDIC coverage
  • Methodology for calculating interest on sweep
  • Disclosure of comp earned by B-Ds and banks
    operating sweep programs as well as RRs who
    offer these programs
  • Addl exam focus on reconciliation issues
    relating to the bank where account is held.

FINRA 2009 Exam Priorities
  • Enterprise Control Functions
  • AML
  • E-Trade enforcement action
  • Focus broadly on suspicious activities related
    to securities transactions vs. solely on money
  • One size does not fit all relative to AML
  • Each firm needs to tailor program to own business
    model, risk profile, volume of transactions etc.
  • FCPA
  • Recent significant () SEC settlements
  • Addl recent focus by NYSBD
  • Reminder to members of obligation to comply,
    maintain accurate books and records, implement
    internal controls etc.
  • Protection of Customer Info and IT Security
  • Several recent SEC enforcement actions arising
    from online account intrusions
  • e.g., LPL Financial alleged failure to
    implement safeguards despite awareness that it
    had insufficient controls to protect customer
  • Members offering online customer access need to
    assess internal surveillance and implement
    measures for dealing with account intrusions

FINRA 2009 Exam Priorities
  • Protection of Customer Info and IT Security
  • Need to regularly monitor account activity to
    monitor for any note of suspicious activity
  • FINRA reminding firms to develop and implement
    written ID Theft Program pursuant to FTCs Red
    Flag Rules which the FTC will begin to enforce
    May 1st See FINRA Reg Notice 08-69
  • Outsourcing
  • NTM 05-48 states that BDs may outsource certain
    functions, but may not outsource supervision and
  • FINRA provides suggestions on how members can
    satisfy supervision/due diligence on vendors by
  • Requiring vendors to meet measurable performance
  • Meeting frequently with vendor personnel and
  • Assigning qualified personnel to monitor review
    and supervise the service providers activities
  • Need to assess risk of vendors operating in
    foreign jurisdictions and business continuity
    issues related therewith
  • FINRA will be looking for Written Procs in all
    of this space!

FINRA 2009 Exam Priorities
  • Information Barriers
  • Ongoing FINRA enforcement sweep relative to the
    control of the flow of nonpublic material info
    within member firms.
  • Firms need to have info barrier Procs tailored
    to business activities and org structures, and
    Procs to address use of restricted/watch lists,
    monitoring systems, supervision, review of
    proprietary and empee trading, review of
    questionable activities and recordkeeping
  • Rumors
  • SEC and FINRA sweeps re Circulation of Rumors
  • Recent SEC Sweep Letter to B-Ds asking about
    controls relating to prevention of rumors, e.g.,
    monitoring elec commun such as empee internet
    access, chat rooms and other websites.
  • Refer to FINRA Proposed New Rule on this topic
    Regulatory Notice 08-68 questions re
    distinguishing rumors from mkt commentary

FINRA 2009 Exam Priorities
  • Financial and Operational Controls
  • Customer Protection Rule
  • The Failure and/or Merger of several large firms
    in 08 reinforces significance of CP Rule
  • Reminder to properly compute reserve formula
    numerous recommendations provided
  • Reminder to reduce customer fully paid and excess
    margin securities to possession or control
  • Excess SIPC Protection
  • In light of recent financial events, FINRA will
    review disclosures provided to customers
    regarding excess SIPC insurance.
  • Firms that have not replaced excess SIP surety
    bond coverage offered thru CAPCO are expected to
    notify customers of reduction of coverage.
  • Also, if new arrangement have been made
    regarding excess SIPC coverage, they should be
    clearly disclosed to customers including dollar
    amount of protection available to each customer.
  • Other Financial and Operation Control areas of
    focus Inventory and Collateral Valuations,
    Funding and Liquidity, Counterparty Credit Risk,
    and Intercompany Suspense Account

Other FINRA and B-D Regulatory Developments
  • FINRA Guidance on its Enforcement Process
  • Regulatory Notice 09-17
  • Intended to assist firms and assoc persons with
    understanding how investigative process works and
    to highlight procedure safeguards in this
    process, including
  • Enforcement Procedures and Managerial Oversight
  • Conducting of Investigations
  • Sufficiency of Evidence Reviews
  • Wells Process
  • Disciplinary Advisory Committee Review
  • Indep Office of Disciplinary Affairs
  • Indep Office of Hearing Officers

Other FINRA and B-D Regulatory Developments
  • FINRA's proposed new rule - FINRA Rule 3210,
    Personal Securities Transactions for or by
    Associated Persons - is out for comment. See
    Regulatory Notice 09-22, April 21, 2009 -
    Response is requested by 6/5
  • It addresses oversight for personal trading
    activities of associated persons. FINRA used
    NASD Rule 3050 and Incorp'd NYSE Rule 407, and
    adopted additional requirements.
  • Here, in a nutshell, are the primary
  • prior written consent to open or establish, at
    another financial institution, an account in
    which securities transactions can be effected,
    and in which the associated person has a personal
    interest. dupe confirms and account statements to
    the employer firm is required.
  • written notification to firm that associated
    person intends to open and, a specific sentence
    to the effect that "he/she has a personal
    financial interest in the account." New
  • executing member must not execute any securities
    transactions in that account unless it has been
    notified that associated person obtained
    employer's written consent and he/she has
    personal financial interest in the account.
  • dupe confirms and account statements from
    executing firm must be started ASAP - i.e.,
  • employer must revoke consent if it does not
    receive in timely manner the confirms and
    statements. Employer will notify executing
    member, and must receive promptly notification
    that the account was closed. New requirement
  • for pre-existing accounts, associated person has
    15 business days to obtain employer member's
    consent to maintain the account, and to notify
    executing member of his/her new employer's name.
    Dupe confirms, statements must also be arranged.

Other FINRA and B-D Regulatory Developments
  • New Office of Whistleblower
  • During March FINRA announced establishment of new
    office to expedite review of high risk tips by
    Senior Staff and ensure rapid response to those
    believed to have merit.
  • New Toll Free Number established
  • Dedicated Web Page/E-mail Address for reporting
  • Not intended to replace normal complaint process
  • New Proposal to Tighten Misconduct Reporting
  • Proposed U-4 and U-5 Rule Amendments (could be
    rolled out in May)
  • Change would requre B-Ds to disclose when a reg
    rep is in an active arbitration or civil
    complaint, even if not named as party
  • Change would also raise threshold for reporting
    misconduct described in settled customer
  • 10,000 to 15,000 increase

Other FINRA and B-D Regulatory Developments
  • Variable Annuities
  • Contd FINRA focus on VAs
  • Fifth Third Securities fined 1.75 mill by
    FINRA(4-14-09 News Release)
  • Regarding 250 unsuitable VA exchanges or
  • 197 Customers and 42 individual brokers
  • Used lists provided by bank of customers with
    maturing CDs and referrals from bank employees
    some elderly and/or unsophisticated with
    conservative investment objectives
  • One Broker 74 customers with 118 unsuitable
    exchanges shortly after joining FTS
  • Switched customers from old firm into VAs
    issued by same insurance cos with same riders
  • Ignored differences in customers ages, incomes,
    inv objecs, sophistication etc.
  • 260k in surrender charges also paid
  • N.B. NTM 07-06 Special Considerations when
    Supervising Recommendations of Newly Associated
    Registered Representatives to Replace Mutual
    Funds and Variable Products
  • Delivery of Official Statements to Customers in
    Muni Bond Sales
  • Edwards Jones fined 900k by FINRA for failure to
    deliver official statements to customers who
    purchased new-issue munies and related
    supervisory/recordkeeping failures
  • MSRB Rules require BDs selling new-issue
    munies (sold during initial distribution of bonds
    to public) to deliver copy of official
    statement to customer on or before settlement
  • Edward Jones Internal Communications referenced
    that it was not timely delivering official
  • but failed to take corrective action!

Other FINRA and B-D Regulatory Developments
  • FINRA Consolidated Rule Proposals to Address
    Supervisory Rules
  • Most significant changes as follows
  • Proposed Rule 3110 Supervision would
    consolidate NASD/NYSE Rules relating to
    supervision, and is based on NASD Rule 3010 and
    NYSE Rule 342, as well as NASD Rules 3012 and
  • Proposed Rule 3110(a)2) would require firm to
    have appropriately registered principal to
    supervise each business activity which it
    engages, regardless of whether B-D registration
    is required for that activity.
  • N.B. - existing NASD Rule 3110(2) only requires
    such principal supervision for activities for
    which registration as B-D is required
  • Uncertainty at present as to what sort of
    principal registration/supervision would be
    required for activities not requiring
  • Proposed Rule 3110(b)(3)(B) address supervision
    of dual employees of banks and B-Ds.
  • Due to adoption of Reg R which permits bank
    employees to engage in certain securities
    activities there has been call for FINRA to
    clarify application of NASD Rule 3040 to such
  • Proposed Rule would exclude from supervision
    requirement any bank-related securities
    activities of dual employees when such activities
    are included within exemptions from registration
  • Bank will be required to
  • Provide for comprehensive review of dual
    employees' securities activities
  • Employ Pol Proc reasonably designed to achieve
    compliance with the anti-fraud provisions of
    federal securities laws and
  • Give prompt notice to B-D of any dual employees
    violation of Pol Proc.

Other FINRA and B-D Regulatory Developments
  • Top Five (5) FINRA Violation Types March 2009
  • FINRA announced sanctions against 46 individuals.
  • (i) Forgeries
  • (ii) Failure to Respond to Requests for
  • (iii) Failure to Update Form U-4
  • (iv) Suitability
  • (v) 3-Way Tie Misappropriations Unauthorized
    Discretion Insurance Sales and Exchanges.
  • Supervise Your Supervisors!
  • During March 2009, (13) of the 46 disciplined
    individuals, or 28, were Registered Principals
  • Last month it was 20.
  • Important - Maintain checks and balances over
    supervisory personnel
  • after all, they could be your firm's worst

Other FINRA and B-D Regulatory Developments
  • SEC to prohibit Brokers from voting Proxies
  • SEC to eliminate NYSE rule allowing brokerage
    firms to vote proxies of investor clients
  • Shareholder Activists long pushed to end this
  • Occurs when clients dont vote
  • Argument is that Brokerage Firms typically vote
    the way management suggests
  • Under current rule, brokers can vote client
    proxies on routine votes, e.g., uncontested
    director elections etc.
  • Rule change effective 12/31/09
  • FINRA to Propose Expanding BrokerCheck to
    Permanently Disclose Disciplinary Histories of
    Former Brokers
  • FINRA proposing a major expansion of its
    BrokerCheck service to make records of final
    regulatory actions against brokers permanently
    available to the public, regardless of whether
    they continue to be employed in the securities
  • Under current rules, a broker's record generally
    becomes unavailable to the public two years after
    he or she leaves the securities industry and is
    therefore no longer under FINRA's jurisdiction.
  • FINRA estimates there are more than 15,000
    individuals who have left the securities industry
    after being the subject of a final regulatory
    action and whose disciplinary history is not
    currently available on BrokerCheck.
  • FINRA filed its rule proposal to expand
    BrokerCheck with the SEC late last week. The SEC
    will publish the proposal in the Federal Register
    and solicit public comment in the near future.

Movement towards consistent Fiduciary
  • SIFMA recommendation to Harmonize IA and BD
  • 2007 Rand Corp Study (SEC commissioned) that
    Financial Service providers duties or standards
    of care e.g., fiduciary, suitability etc.
    contributed to investor confusion
  • Also, ERISA and IRC (for IRAs) have different
    definitions of fiduciaries and prohibitions on
    conduct that differ from IA Act and state
    fiduciary law concepts
  • SIFMA recommends Universal Standard of Care
    fundamentals of fair dealing investors can expect
    from all Financial Service providers whether
    financial planner, investment adviser,
    broker-dealer, bank, insurance agency or any
    other type of financial services provider.

Movement towards consistent Fiduciary Standard
  • State Farm CFP Approach
  • During 2008 Certified Financial Planner Board of
    Standards, Inc. added a fiduciary standard to
    its Code of Ethics
  • Reported that State Farm (which sells annuities,
    mutual funds, financial advice and slate of
    insurance products) instructed approx. 270 Agents
    who are CFPs to abandon the designation
  • Other Insurance Companies reportedly exploring
    same approach
  • State Farm has asked CFP Board to exempt
    insurance sales from definition of financial
  • Concerns primarily revolves around the imposition
    of fiduciary standard when selling insurance
    and legal risk related therewith
  • FINRA SEC - Consistency in Investor
  • Primary issue regarding investor protection
    differences between IA and BD channels is
    difference between IA fiduciary standards and
    BDs rule requirements, e.g., suitability
  • Need to explore whether fiduciary standard can
    effectively be applied to broker-dealer selling
    activities and, if there are problems - make a
    strong effort to resolve those problems.
  • IAs believe Fiduciary Standard is more
    customer-protective that suitability standard
    of B-Ds
  • B-Ds maintain that suitability standard is
    sufficiently rigorous and that IAs are more
    lightly regulated than brokers
  • In any event, IAs should look forward to more
    audits population of RIAs increased 30 since

RIA Annual Review Requirements
  • Rule 206(4)-7 - Compliance Rule requires RIA
    to adopt and implement written policies and
    procedures reasonably deigned to prevent a
    violation of the feral securities
  • Compliance Rule also requires Annual Review of
    Pol Proc to consider any compliance matters
    that arose during prior year, any changes in the
    business activities of the adviser of affiliates,
    and any changes in the Advisers Act or applicable
  • Top 10 List for IA Annual Reviews
  • 1. Review any and all past Deficiency Letter
    ensure all deficiencies noted were
  • 2. Perform Gap Analysis of existing controls,
    e.g., list of client complaints over last 12
    months, branch/compliance exam deficiencies,
    Internal Audit findings and other red flags
    noted on exception reports
  • 3. Evaluate any changes in business products or
    services over last year
  • 4. Determine if any new Rule Promulgations,
    Guidance Statements or No-Action Letters could
    impact your Pol, Proc or processes update, if
    needed. s
  • 5. Consider Mock SEC exam to provide assessment
    of tone at the top, strength of Pol Proc and
    adequacy of compliance testing
  • 6. Define Roles and Responsibilities of all
    associated persons
  • How will you meet requirements?
  • Who is responsible for same?
  • What methods will be followed?
  • 7. Develop and deploy appropriate Training
  • Fiduciary duty to disclose all material info to
  • Review ADV, contracts and other sales/mkt
  • 9. Develop Annual Review Committee and Compliance
  • 10. Compliance is Everyones Responsibility
  • Interview personnel to test knowledge of Pol
    Proc, sales practices etc.

RIA Annual Review Requirements Contd
  • Some Addl Ideas for tweaking Annual Review
  • Revise process for documenting relationships w/
    counterparties, e.g., failure of Lehman Bros.
  • Scan recent SEC enforcement efforts over last
    year which could spotlight areas of concern
  • Re-visit your process for identifying new law and
    regs, e.g., Regulatory Update Tracking Report
  • May want to implement quarterly vs. annual
    process in this regard, i.e., in light of volume
    of recent changes

Review your Compliance Program!SEC Staff Speech
Lori Richards, March 2009
  • Need to maintain Evergreen" Compliance Program
  • State of constant improvement
  • Identify and address new issues and compliance
  • Incorporate new forensic tests and new
    technology and
  • Reasonably deigned to prevent a violation of the
    federal securities
  • RIA should take a fresh look at
  • Inadequate disclosure amongst Top 5 most common
    deficiencies that SEC Examiners found in exams
    last year and consistently a most frequent exam
  • Need to review DISCLOSED vs. ACTUAL practices
  • Conflicts created by bus. arrangements/affiliation
  • Compensation arrangements w/ solicitors, finders
    or other providers
  • Fees paid by clients to IA or affiliates
  • Use of client commissions to pay for
  • Are you delivering disclosure docs to clients as
    required and making approp. filings w/ SEC
  • This is an area Examiners will look at!

Review your Compliance Program!SEC Staff Speech
Lori Richards, March 2009 Contd
  • RIA should take a fresh look at contd
  • Custody Rule Reminder client assets must be
    held by qualified custodian and such custodian
    must provide advisory client with at least
    quarterly statement
  • If assets held by RIA itself annual indep.
    Surprise Audit required, e.g., verification of
    client holdings
  • In light of recent Ponzi schemes and other
    frauds, SEC will focus on controls over custody.
    According, key steps to take
  • Compliance Staff should obtain (sample or
    otherwise) client statements sent out by
  • Compliance Staff should compare client statements
    with Advisory records
  • Compliance Staff should review Advisors
    reconciliation process
  • Compliance Staff should take addl steps to
    confirm assets when custody is with the adviser
    or affiliate
  • Compliance Staff should review client account
    statements sent by Adviser to ensure consistency
    w/ reports of custodian

Review your Compliance Program!SEC Staff Speech
Lori Richards, March 2009 Contd
  • RIA should take a fresh look at cond
  • Performance claims must be accurate
  • Conflicts exist advisory fees may be pegged on
    performance, marketing significance of
    performance claims and natural inclination to
    deliver bad news.
  • Accordingly, this area will continue to be focus
    of CCOs and SEC Examiners
  • Recent SEC Exam Findings
  • Overstating firms performance returns, AUM, or
    length of operation
  • Not including disclosures necessary to prevent
    performance claims from being misleading, e.g.,
    whether results reflect dividends, differences w/
    index used to compare advisers performance etc.)
  • Inappropriately incl/excl info or data in
    composites, e.g., advertising past specific
  • Best Practices
  • Retain outside firm to verify performance claims
  • Conduct special tests to ensure complete records
    re marketing/performance advertisements
  • Periodic review of marketing materials to ensure
    info is truthful and not misleading

Review your Compliance Program!SEC Staff Speech
Lori Richards, March 2009 Contd
  • RIA should take a fresh look at cond
  • Under Compliance Rule , Compliance Pol Proc
    should be designed to prevent violations from
    occurring, to detect violations that have
    occurred, and to correct promptly any such
  • Accordingly, SEC has cautioned against making
    resource reductions to Compliance Programs
  • When conducting Annual Review of Pol Proc
    adequacy, CCO should consider adequacy of
    resources and SEC Examiners
  • If lack of resources undercuts CCOs ability to
    perform effective review or undercuts ability to
    implement, CCO should include this in CCO Annual
    Report or other indication of Annual Review.
  • When conducting Annual Review of Pol Proc
    adequacy, CCO should consider adequacy of
    resources and SEC Examiners
  • Other considerations
  • Leverage work by other Functional Groups, e.g.,
    Internal Audit and/or Risk Management
  • Leverage and/or invest in technology to provide
    front-end compliance monitoring

Increased Focus on Custody
  • March 9, 2009 SEC OCIE Letter to IA Assoc. and
    Managed Funds Assoc requesting that they inform
    membership of recent IA Exam focus which
    requires independent confirmation of investor
  • Letters state
  • SEC May contact various 3rd parties
  • Including custodians, administrators, auditors,
    hedge fund investors and advisory client TO
  • New SEC Exam Letters
  • Two Sweeps unusual to have 2 sweeps going on
    at same time!
  • Custody
  • Generally, similar to past Custody Letters, but
    also asks for extensive info relative to all
    services providers (not just custody service
  • May want to ask the SEC for clarification in this
  • Rumors
  • Started last fall
  • New Exam Document Request Letter
  • Shorter than past Letters (7 Pages)
  • Similar to past exam requests
  • Will seek to speak with Compliance Officer, plus
    staff responsible for risk management, port mgt,
    trade execution, research, back office/admin, IT,
    AML and marketing.

Other RIA Hot Topics - Potpourri
  • 2008 RIA Exam Stats
  • SEC Examined 1,521 IA Firms in 2008 15 of total
    number of RIAs and 30 of all AUM
  • Increase of 140 over 2007
  • Includes 400 quick hit exams of new RIAs
  • 68 Deficiency Letters
  • 4 Enforcement Referrals
  • 28 (approx.) No further action
  • This number spiked likely due to 400 quick
  • TOP 5 DEFICIENCIES NOTED (relatively consistent
    year to- year)
  • Disclosures and Filings
  • Compliance Rule
  • Personal Trading
  • Performance Advertising and Marketing (i.e.,
    related to Disclosure)
  • Portfolio Management
  • New approaches to IA Exams and Enforcement
  • Exploring ways to leverage 3rd parties in
    oversight of IAs, i.e., without SEC abdication
    of responsibility
  • 400 SEC Staff to examine approx. 11,000 RIAs
  • RIA numbers 50 increase since 2001
  • Note Madoffs brokerage operations reviewed
    regulatory, but IA Business never reviewed after
    2006 registration

Other RIA Hot Topics - Potpourri
  • No Excuses Attitude from Examiners
  • Clear Expectation that firms should be prepared
    to be examined
  • Examiners will be less tolerant of delays in
    document production
  • Delays could result in enforcement
  • New RAVE Exams
  • Surprise SEC Exam whereby examiners show up in
    the morning and request to speak with several
    people at the firm and leave within a few hours
  • RAVE Amounts to short, focused SEC exam of a
    new Adviser that takes a day or less
  • Outsourcing Compliance
  • Remember you need to indentify CCO on form ADV!
  • Recent IA Week Investigation reflected approx. 40
    firms who failed to identify CCO on ADV
    (potential SEC Violation)
  • CCO needs to be an Individual who is a
    supervised person
  • Outsourcing Compliance is generally acceptable to

Other RIA Hot Topics Potpourri Contd
  • Code of Ethics Interns, Temps, Consultants etc.
  • Generally agreed that temps, interns and
    consultants are not required (by SEC) to be
    subject to Firms Personal Trading Rules
  • Best Practice include anyone who has access to
    material, non-public info that could be misused
    for insider trading
  • Caveat once covered by Polices, be sure to
    monitor them!
  • Getting dup trade confirms from temps can be a
  • Alternative do not place them under your Policy
    but reinforce (training etc.) the need to be
    careful with proprietary info etc.
  • Be careful of temps that are around for months
    and months.
  • Possibilities
  • Have temps sign confidentiality agreement
    warranting not to trade on any material NPI they
    come across
  • Have them agree to black-out period on trading
    that is in sync with your firms Policy or
  • Have agreement with flat out prohibition against
    buying or selling securities /derivatives while
    supporting your Firm

NB FINRA rules on BD side are clearer in
this regard so if your Firm is Dually Registered,
you should subject temp staff to all your Pol
Other RIA Hot Topics Potpourri Contd
  • Recent SEC Rumors Sweep
  • 2nd Sweep of late in addition to Custody focus
  • Began last Fall, around time of short-selling
  • Generally, give IAs 2 weeks to send in plethora
    of docs covering August 08 end of 08
  • SEC is requesting
  • Whether Firm initiated, conducted or concluded
    any reviews or investigations into the
    malicious creation, spread, or use of false or
    misleading rumors related to securities
  • Types of training material offered to staff about
    rumor mongering
  • Changes Firm has undertaken in how it monitors
    use of Internal chat rooms, message boards
    and/or websites
  • Should develop Rumor Policy
  • Look to FINRAs Proposed Rule on Rumors for
  • Should remind staff that it is rumor mongering is
    illegal an can result in allegations of market
  • Staff should be cautioned against spreading info
    outside the Firm unless based on public releases
    by an issuer or reliable source
  • Staff should be instructed to contact CCO or
    Supvr if they may have received false info from
    outside the Firm
  • Risk Based Policy e.g., smaller advisers
    trading in Mutual Funds may require abbreviated
    or no Policy at all

Other RIA Hot Topics Potpourri Contd
  • ADV Recordkeeping Enforcement Case
  • Merrill Lynch gave clients a Disclosure Statement
    considered an Alternative to its Form ADV, Part
  • 204-3 allows for a Copy of Part II or a written
    document containing at least the information then
    so required by Part II of Form ADV
  • However, there was no recordation of dates when
    clients received such Statements
  • Violation of Rule 204-2
  • Demands record of the dates that each written
    statement, and each amendmentwas given, or
    offered to be given, to any client or prospective
    client who subsequently becomes a client.
  • Expensive Lesson - 1 Million Fine imposed!

Other RIA Hot Topics Potpourri Contd
  • Penalties for Adviser Act Violations to Increase
  • CMPs hiked for 1st time in 4 Years
  • e.g., Insider Trading penalty increased to 1.42
  • Hedge Fund Registration
  • Bill Introduced in Congress Hedge Fund
    Transparency Act of 2009
  • Will close loophole previously used by hedge
    funds to escape definition of investment
    company under 40 Act
  • New Legislation will mandate that hedge funds
  • Register with SEC
  • Maintain books and records that the SEC may
  • Cooperate with any request by the SEC for
    information or examination and
  • File information form with the SEC
    electronically, at least once a year.
  • N.B. Bill would also mandate AML Programs for
    Investment Companies

Other RIA Hot Topics Potpourri Contd
  • Potential Books and Records Changes
  • Rule 204-2 created in early 60s
  • Potential changes
  • Require IAs to maintain some
  • Only an option today!
  • May have to create and produce searchable and
    sortable electronic records of trading data for
    managed accounts, client lists, code of ethic
    breach logs etc.
  • Update proposed communications retention
  • Keep more categories of correspondence
  • Re clients, advice, performance, compliance,
    commission, as well as audits, regulatory etc .
  • SEC Imposters
  • Reports of bogus Examiners
  • Attempt to trick IAs and others into revealing
    private information
  • Using tricks such a purporting to be conducting
    an emergency exam or the like
  • Make sure your IA personnel do not share info
    with suspicious callers
  • Validate with SECs personnel locator 202

Other RIA Hot Topics Potpourri Contd
  • Reg S-P Recent Enforcement Actions
  • S-P requires that firms implement reasonably
    adequate policies and procedures to safeguard
    customer information. 
  • LPL alleged failed to safeguard customer
  • PI of 10,000 customers vulnerable to identity
    theft, "following a series of hacking incidents
    involving LPL's online trading platform." 
  • LPL settled the SEC's charges without admitting
    or denying anything, and agreed to pay a fine of
  • The SEC noted that the firm conducted an internal
    audit in mid-2006. 
  • That audit identified inadequate controls
    relating to guarding customer information and
    noted, according to the SEC, that there was a
    risk of hacking. 
  • The hacking incidents began around July 2007,
    and, at that time, the SEC alleges that LPL had
    not implemented increased security measures
    despite actual awareness of the risks.

Other RIA Hot Topics Potpourri Contd
  • Reg S-P Recent Enforcement Actions- Contd
  • Recruiting Issues
  • Woodbury Financial - allegedly misused clients
    personal info related to the firms recruitment
    of RRs and Advisers
  • Woodbury allegedly allowed recruits to provide
    client NPPI (e.g., SS s, account numbers,
    DOBs) before becoming associates with Woodbury
    so that Woodbury (on recruits behalf) could
    pre-populate account transfer and new account
    forms with certain client info.
  • Next Financial Group - 125k Penalty (June 2008)
    re Reg S-P and recruiting-type infractions

Other RIA Hot Topics Potpourri Contd
  • Enforcer Role for CFP Board?
  • Proposal to make CFP Board the Rule Setter and
    Enforcer for nations hundreds of thousands of
    unregulated planners
  • Attempt to reverse growing impetus of FINRA to
    expand domain to planners and advisers.
  • FPA, NAPFA etc. argue FINRA not suited to
    regulate services (often fee-based) that
    financial planners provide
  • CFP Board employs approx. 55 people vs. 3,000 at
  • CFP Board limited powers, e.g., decertify a
    certificate holder vs. FINRAs power to impose
    penalties, suspensions, expulsions etc.

  • THE END!
  • Sean Gray
  • Senior Vice President and Director of Wealth
  • Compliance
  • PNC Bank
  • (215) 585-5545