Key Takeaways from the SEC Compliance Outreach Seminar

SEC Releases

Introduction

Today, November 7th, the SEC just completed their National Compliance Program Outreach Seminar.

There were opening remarks made by SEC Chair, Gary Gensler and Acting Director of the Division of Examinations, Keith Cassidy, that continued the focus on investor protection and promoting the strength of compliance.

Throughout the Seminar, the following key topics were covered below:

• Information Security and Operational Resiliency
• Registered Investment Company (RIC) Topics
• Private Fund Adviser Topics
• Marketing Rule
• Registered Investment Adviser (RIA) Topics
• Hot Topics Lightning Round

We have provided Key Takeaways from the above topics below for ease of reference.

Key Takeaways from the Seminar

• Information Security & Operational Resiliency 
  • Off Channel Communications has been a widespread industry issue.
  • For texting, they mentioned not to just ban texting as it still can occur, but to rather utilize a platform having a second device that is firm controlled or has strict monitoring.
  • Drafting of Policies and Procedures should involve multiple stakeholders.
  • Cybersecurity Training should be performed for new employees, and for current employees they should be continuously trained on new cyber threats.
  • Firms cannot have a mismatch between policy and practice (i.e., Business Continuity Plan should match the Manual).
  • If a breach was to occur, be sure to notice the institution no more than 72 hours after learning of it.
  • Examining of Third Party Vendors:
    • Vendor Selection (Be sure registrant is performing due diligence to not be exposed to more risk).
    • Continuous Monitoring (Be sure registrant has visibility and regular updates from Vendors).
    • Termination Process (Be sure that Third Party access to data is removed).
• Registered Investment Company (RIC) Topics
  • As it relates to Disclosure trends and accuracy of filings there were two (2) types of funds that were focused on:
    • Derivative Funds (focus on clearly and accurately describing the strategies risk).
    • Private Credit Funds (focus on how Advisers source and perform due diligence).
  • The timeliness of Regulatory Filings is crucial.
  • For Marketing, making sure there are accurate statements listed on the Fund website is an area they highlighted.
  • Having a proper examination regarding the success of processes and procedures is important to have implemented.
  • Continued focus on Board Oversight of Compliance Programs, Fund Service Providers, 12b-1 Fee Review, Liquidity and Risk Management Programs, and Board Meeting minutes.
• Private Fund Adviser Topics
  • They have seen deficiencies in Extracted Performance.
  • Tend to look for reasonable methodology in Marketing materials.
  • In exams, they may ask to check calculations for accuracy.
  • Hypothetical Performance:
    • See Advisers failing to identify what hypothetical performance is.
    • See Advisers pull investments from multiple unrelated portfolios. They would view this as hypothetical performance.
    • Disclosures and Pitchbooks that say something such as 20% IRR talking about a Portfolio Company Investment that the Fund offered intends to target. Need to include a Net Performance figure too to meet the requirements of D1.
    • On exams, tend to scrutinize regarding criteria used and assumptions made.
  • Challenges seen in Substantiation Requirements.
  • Independent Valuation is hardest when bringing up a Portfolio Manager from an outside place.
  • Focus on Private Credit:
    • Asset class has grown significantly in recent years and then are focusing more on them as a result of its growth.
    • Definition of Private Credit has been evolving. At times, it was broadly defined, and then continue to look at how it is defined.
    • The new Form PF provides additional detail on Private Credit strategies.
    • They have been doing exams in this space for years, so it is not new to them, but valuation, and reviewing written policies and procedures to be sure reasonably designed and implemented.
    • Look at Valuation from a conflicts of interest perspective.
    • Likely to review conflicts, especially if they are experiencing financial distress.
    • Value of Private Investments can impact performance returns.
    • Material Non-Public Information (MNPI) has been a focus, how they get in possession with it, and then what do they do with it. A generic off the shelf policy will not work, need to think about business lines, how do they overlap, what are they getting into next.
  • Prompt remediation and cooperation is incredibly important.
  • MNPI is a top focus and concern for Chief Compliance Officers as it relates to Private Funds.
  • Conflicts of Interest and Fees and Expenses are an area of focus for Private Funds.
  • Looking at the footnotes in financial statements was emphasized as an item of importance to review.
  • They are looking for those “may” disclosures when something is in fact happening.
• Marketing Rule
  • Pitchbooks, Website, expect them to be covered by the definition of advertisements. Brand content and general education are examples of items that may not be covered by the definition of advertisements.
  • Examination perspective, what they have been seeing:
    • Stock Material within one on one presentations.
    • Testimonials and Endorsements.
  • Compensating client for Third Party site comment is entanglement.
  • Conducting periodic training is important.
  • Claims on public websites for the use of AI that are not true is an example of a violation.
  • Advertised on website that it was a member of fictitious organization where it did not exist is another example of a violation.
  • Adviser would be reliable for Third Party content if they ended up producing it.
  • Biggest challenge on implementing the Marketing Rule was around what is considered performance. The Rule does not adopt a definition of performance. Annualized Return, IRR is considered performance. Sharpe ratio or attribution effects generally not considered performance. Yield is a complex area regarding if it is or is not performance.
  • Many Firms have stopped including attribution effect or yield as performance in their marketing materials.
  • If Adviser changes fees, they should go back and recalculate performance based on new fee schedule.
  • Challenges have been seen for performance time periods (as applicable).
  • Hypothetical Performance:
    • Numerous Advisers were advertising Hypothetical Performance to mass audiences without adopting sufficient policies and procedures to ensure it was relevant to the investment objectives of the intended audience.
    • Many Firms have stopped putting any Hypothetical Performance in their marketing materials.
    • Issues in examinations related to Hypothetical Performance are (1) missing the issue entirely in target and projections, (2) interactive analysis tools that present the likelihood of investment styles and outcomes and (3) supposed to describe the universe of investments considered in analysis and determine which investment to select.
  • Testimonials and Endorsements:
    • Social Media Influencers, TV Advertisements, and various new technologies allowing people to reach firms in new ways have been impacted the most on this area. Advisers should really take consideration when going into these type of arrangements.
    • Required disclosures for certain advertisements in endorsements need to be present.
    • Inconsistency of a third party method versus a third party endorsement, issues with recognition and categorizing appropriately have been identified.
  • Third Party Ratings:
    • Examination issues identified:
      • Firm said they were rated Top 12 by Barron’s when they were actually rated Top 1200 by Barron’s.
      • Firm claimed its principal was one of the top wealth managers for the past 14 consecutive years, but there was nothing to support that.
      • Have seen Advisers saying they have had rating in select years, but no supporting information supporting those ratings in select years.
      • Advisers failing to disclose they paid the Third Party Rating logos, application fees, or heightened exposures.
• Registered Investment Adviser (RIA) Topics
  • Best Execution issue where there were cheaper share classes available and that was a duty of care and loyalty issue.
  • Wrap Fees is another common area where issues have been seen.
  • Leveraged ETFs or any exotic product could present fiduciary issues in an advisory context.
  • As it relates to compensation arrangements, conflicts of these arrangements is an important focus area.
  • Documentation is crucial to have an effective 206(4)-7 Annual Review Report that includes testing.
• Hot Topics Lightning Round
  • T+1
    • Investment Advisers are affected by T+1 because it altered books and records requirements.
    • Division of Examinations:
      • Evaluating compliance with the books and recordkeeping requirements relating to T+1.
      • Want to understand how Advisers are adapting and implementing changes to their programs based on the change.
      • They have seen that Advisers were prepared for this Rule.
  • Artificial Intelligence (AI)
    • Division of Examinations has found that AI has been rapidly implemented.
    • Examiners will be continuing to conduct examinations with an AI focus based on the various issues.
    • Key regulatory areas Firms should focus on:
      • Develop written compliance procedures to reflect controls around these systems.
      • Disclosures need to reflect accurate implementation of AI (do not exaggerate involvement of AI).
      • Have well documented due diligence process in place, it is important that Firms understand how these Third-Party systems use data.
    • Avoid boilerplate AI disclosures:
      • During exams, they look to ensure that Firms are accurately reflecting their usage of AI as compared to disclosures.(accurate, needs to truly represent what is going on in order to meet fiduciary duty).
      • Say what you do, do what you say, was the consistent message they provided.
    • SEC takes stance of being technology neutral, expect them to enforce the same laws that they have been enforcing when it comes to AI. Advisers need to be sure they are meeting their fiduciary obligations.
    • Firms need to make sure safeguards are in place relating to customer privacy, MNPI, etc.
    • Recommends that Firms stay up to date to stay compliant and for their own internal benefit.
  • Internet Adviser Exemption from SEC Registration
    • The Rule did a few main things:
      • Required Investment Adviser using exemption to have an operation, interactive website.
      • Internet based clients must give all advice though an operational interactive website.
    • Division of Examinations has noticed:
      • A rush to register.
      • ¼ of those have de-registered.
      • Half of those they examined did not have a working product.
      • A lot of others were half baked products.
      • They had poor compliance programs.
        • New Rule clears a lot of this up because if you do not have an operational website or app, you cannot register.
    • Issues seen in exams:
      • Suitability (not enough information is being collected to accurately determine suitability for the client).
      • Custody (transfers directly between clients).
      • Performance Reporting (combining actual performance with back tested performance).

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