Published on Nov 15th, 2022 |

Key Takeaways From Each Topic Covered During The SEC Compliance Program Outreach National Seminar

SEC Releases

Brief Introduction

Today, November 15th, the SEC just completed their Compliance Program Outreach National Seminar, which covered multiple important areas.

SEC Chair, Gary Gensler, opened the Seminar with a focus on protecting investors and that “good counselors lack no clients” and that it is important to understand business models, rules to those models, and how they apply.

A brief update for SEC Exams was provided in the introduction, stating that if there was on-going Fraud, the SEC would go on site for Exams. Opportunities for on-site Exams, if it does not require emergency, demonstrating that they are pivoting to something that is different, but with a little bit more on-site activity in the future.

The following takeaways are in order of the topics covered during the Seminar today.

Fiduciary Interpretation and Form CRS

Fiduciary Interpretation and Form CRS

  • Division of Examinations:
    • Reg BI is mostly on the Broker Dealer side
      • It mainly covers Disclosure, Care, Conflicts of Interest, and Compliance
      • Exams would be looking to see if Firms have reasonably designed policies and procedures, if they went into effect, and the overall operational effectiveness of the policies and procedures
    • Risk Alert on Compliance with Form CRS
      • Focus on the delivery of CRS to retail clients and customers
      • Checked to see if the CRS is filed with IARD and posted on Firm’s websites
      • EXAMS is looking at content, determining if it includes required information, and if the information true and accurate
      • Updates within 30 days of being materially inaccurate, was it updated?
      • Evaluating how Firms highlight the most recent changes
      • EXAMS is coming up with initiatives on how to determine Compliance with Reg BI and CRS
      • EXAMS conducted a large number of Exams nationally, many resulted in deficiency letters and a few enforcement referrals, typical deficiencies, failing to follow policies and procedures, website failures, and general instructions to follow Form CRS
      • Focused on Compliance with Form CRS Requirements
        • Questions from EXAMS:
          • Did Adviser or Firm make initial filings?
          • Was there proper delivery of the document to retail clients?
          • Was the CRS posted on the website?
          • Was regulatory history disclosed?
          • Did Firms comply with disclosure requirements?
          • Did Firm adopt compliance policies and procedures for CRS?
        • Common Failures Discovered from EXAMS:
          • Failure to file Form CRS
          • Failure to provide CRS to clients
          • Failure to provide CRS timely to customers
          • Failing to post CRS on website, or in an easily accessible or prominent location
          • Website not updated with most current CRS
          • Inaccurate discipline history
          • Failure to maintain accurate records or delivery of CRS
          • Inadequate Compliance Program
          • Not in Compliance with other federal securities law
          • Inaccurate or inadequate Form ADV Disclosure
          • Problematic Marketing Materials
      • When initiatives are conducted it is made to help the Advisers, and helps them identify deficiencies. Initiatives help inform policy regarding Industry interpretation of Compliance, and it helps ensure Compliance within the Industry

New Marketing Rule

New Marketing Rule

  • Recent Marketing Rule Risk Alert:
    • EXAMS has no interest in surprising people
    • Describing initial efforts for Compliance with the Marketing Rule
    • Statements and material fact used in advertisements need to be substantiated, this will be an issue they are focused on
    • 18 months preparing for new amended Rule
      • As of November 4th, materials used need to comply with the requirements
      • They are going to focus on process, policies and procedures, and training employees on how they are going to use the materials
      • Have to explain to team members what they need to do, and what it is that the Firm is expecting from them
  • Future Marketing Rule Risk Alerts:
    • Anticipate additional risk alerts in the future announcing other pieces of reviews
    • Want to have enough of a view of the industry first to paint a clear picture of how it is complying
  • Caution using same materials with one person exemption, they are probably still going to consider it an ad
  • Performance Advertising:
    • What is performance/performance advertising?
      • Idea of what is performance comes up with looking at performance related metrics
      • Very facts and circumstances specific
      • Ask whether performance metrics trying to be shown could be an issue and mislead investors
    • Greatest challenges for Advisers for how to present performance?
      • Complying with the model fee provision and determining when an adviser can use model vs performance fees
      • Trying to show hypothetical performance to retail investors
      • Social Media, thinking through when a communication is attributable to the adviser
    • General prohibitions apply to all advertisements and all parts of an advertisement. Many Advisers focused on the performance section and it is encouraged that folks do not forget about the general prohibitions, many reminders were in the initial release as well about the general prohibitions
    • Case studies still need to comply with sub section D
  • Hypothetical Performance:
    • Why SEC is concerned with hypothetical performance?
      • Performance does not reflect actual losses
      • Thoughts on whether Advisers need to publicly disclose?
        • Yes, Advisers need to provide public information on how they advertise, new requirement in Form ADV Part 1A, most Advisers will not meet this requirement until the Annual Update in 2023
  • Enforcement perspective on the Marketing Rule
    • Prohibits hypothetical performance unless policies and procedures are made, sufficient information is made, and provide some information about risk and limitations of hypothetical performance
  • Parts of new marketing rule not similar to cases of old regime?
    • New Rule has a fair and balanced requirement for adviser choosing time period of performance
      • does not require explicit misleading statement
    • Will see cases for cherry picking time period of performance
    • Net performance alongside gross performance, SEC often did not charge because of the lack of precedent on the issue, it will be fairly easy to identify the issue with the new rule
    • Substantiation, if advertisement includes materials statement of fact and opinion, charge can be brought for failure to substantiate and have it readily available
    • Firm may have to withdraw advertisement if Portfolio Manager goes to a new Firm or leaves, could be cases they bring in the future as it could not have been brought in the future
  • Questions from Audience:
    • If there is no compensation for Google Review, that would not be classified as an Ad, client can always write a bad review (pending facts and circumstances)
    • They are going to listen and review facts and circumstances very carefully
    • Have to have belief that they can substantiate, have the ability to substantiate upon demand
    • Encourage Advisers to have policies and procedures as materials go out
  • Holiday Gifts to Clients with a way of being foul with the Rule?
    • If compensation is above the de minimis, the testimonial requirements will apply

Registered Fund Topics

Registered Fund Topics

  • Valuation and Board Oversight
    • Board must evaluate pricing services
    • New Rule shifts it more to the front end rather than back end
    • Makes process more up front to make sure process is set up for in the beginning rather than the end
  • Fee, Expenses, Disclosures, Advisory Process:
    • Require greater consistency and transparency
    • Funds also required to provide full financial statements, financial highlights, and to make them available online
    • Board has to approve every Advisory Contract
  • Reviewing Advisory Contract Approval Process:
    • Helpful to look at 15c submissions and notes year after year
  • Derivatives Risk Management:
    • Gives examiners something more reasonable to examine
    • Helpful to have a more holistic approach on derivative usage
    • Valuation:
      • More material to look at process rather than just the result
    • They believe there are tools to now look at processes rather than the end result
  • Single Stock by itself is not an Index
  • Hot Topics for enforcement in this area:
    • For ESG, more and more investor money is going into that space, there has been an increase in attention by the SEC
    • It is an all agency approach on examination, rule making by the SEC
    • Books and Records another hot topic as well on the enforcement side
  • Overall Compliance Concerns noted in Exams:
    • NAV Errors
    • Affiliated Transactions

ESG Related Topics

ESG Related Topics

  • No rules stating Firms must have specific ESG Policies and Procedures, more ESG that is integral to a Firm’s business and is advertised, the more risk there is
  • Firm may want to consider what ESG policies and controls to have in place
  • Include CCO as a member of the committee, allows Compliance people to apply the knowledge from a Compliance perspective
  • SEC is going to be reviewing comments very carefully as they work through a final rule
  • Anticipated interplay between Proposed Rule and Existing Rule (Compliance Rule)
    • They believe it was more reaffirming, not looking to break new ground
    • Making sure that policies and procedures ensure disclosures holding out for investors and clients are actually happening, control of proxy voting, using certain screens for portfolio management relating to ESG
    • Nothing that is a break from what they have been talking about for several years
  • Actions Enforcement Division has been taking regarding ESG:
    • Task force goal is to work proactively, works with other offices throughout the SEC
    • Analyzes disclosure Compliance issues relating to Investment Adviser and Funds ESG Strategies
  • RIAs and Funds are increasingly offering and evaluating investments relating to ESG
  • Task force is coordinating the use of effective resources through data analysis
  • Examples of cases brought into the ESG areas:
    • In a simple sense, it is say what you mean, and mean what you say
    • ESG Driven or Investment Processes must make sure Marketing Materials are not misleading

Private Fund Adviser Topics

Private Fund Adviser Topics

  • 3 categories of Exams why they may be examining Firms
    • Internal initiatives, may see high risk, potential issues in Private Fund Space
    • Support broader, national initiatives, could be working with one of the regions to address a high risk Firm
    • Tips, complaints, referrals, they do a number of those in the Private Fund units as well
  • Expect to be having on going dialogue and subsequent document requests
  • They are starting to do Exams in the field again, still at a point where it is in certain situations, coordinating with the Firm if there are certain protocols as far as on-site, and also where individuals of the Firm are located too
  • Primary focus is on conflicts of interest, evaluate in 3 different lenses:
    • Actual practices of the Firm
    • Looking at disclosures
    • Internal Controls, policies and procedures to address the conflicts
  • Looking at cross trades or any cross-fund transactions is a big focus
  • Continue to look at Funds with high or excessive leverage
  • Common deficiencies on the back end:
    • Most issues boil down to a disconnect of disclosure and practice
    • Affiliate relationships of Advisers and how they invest
    • Disclosure that has evolved, earlier Funds to more recent Funds
  • Monitoring deficiencies is important
  • Key Focus Areas of Fees and Expenses:
    • Relationship with affiliates, how they are compensated
    • Fee offsets and calculating the Capital base
    • Misallocation of co-investment expenses
      • Co-investment can be an area fraught with risk
    • Still an anticipation for fee and expense issues moving forward
  • Marketing Rule in the Private Fund Space:
    • Performance:
      • People who are drafting disclosures and unknowns to performance tables, sit down with CFO or whoever prepares the numbers
      • Many Firms have taken this very seriously
  • They will want to know what is being disclosured and if it is transparent, need to understand the inputs that go into the process, need to understand policies and procedures around that
  • Enforcement matters on new Marketing Rule:
    • Too early to tell at this time as it relates to that matter

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