advisers act regulatory series - eversheds sutherland · 2020. 5. 12. · testimonial or...

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Fourth Quarter UpdateAdvisers Act Regulatory Series

December 12, 2019Clifford Kirsch, Michael Koffler, Brian Rubin, John Walsh, Issa Hanna, Ben Marzouk and Bria Adams

Eversheds Sutherland

Speakers

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Clifford KirschNew York, NY+1 212 389 [email protected]

Michael KofflerNew York, NY+1 212 389 [email protected]

Ben MarzoukWashington DC+1 202 383 [email protected]

Issa HannaNew York, NY+1 212 389 [email protected]

Bria AdamsWashington DC+1 202 383 [email protected]

Brian RubinWashington DC+1 202 383 [email protected]

John WalshWashington DC+1 202 383 [email protected]


Today’s discussion:

Fourth Quarter UpdateAdvisers Act Regulatory Series

─ SEC’s Proposed Amendments to the Adviser Advertising and Cash Solicitation Rules

─ SEC Form CRS FAQs─ SEC Staff Adviser Compensation FAQs─ SEC’s Focus on Cash Sweep Programs─ SEC Examination and Enforcement Update – Looking Ahead to

2020─ Planning for the 2020 Form ADV Update Season

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Proposed Amendments to the Advertising Rule and Cash Solicitation Rule for Investment Advisers


Overview

─ On November 4, 2019, the SEC issued a proposal to modernize the rules under the Advisers Act addressing advertisements (“Advertising Rule”) and payments to solicitors (“Solicitation Rule”)

─ The proposal seeks to update the existing advertising framework governing investment advisers to reflect advances in technology, communication mediums and evolution in industry practice

─ Advertising Rule Takeaways• Replace the current rule’s broad limitations with principles-based provisions• Permit the use of testimonials, endorsements, and third-party ratings, subject to certain conditions • Tailor requirements for presenting performance results based on an advertisement’s intended audience

─ Solicitation Rule Takeaways• Expand the current rule to cover solicitation arrangements involving all forms of compensation, rather than

only cash• Introduce a new de-minimis and non-profit exceptions• Update who is disqualified from acting as a solicitor

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Advertising Rule Proposed Definitions

─ Advertisement• Any communication, disseminated by any means, by or on behalf of an investment

adviser, that (i) offers or promotes investment advisory services or (ii) seeks to obtain or retain advisory clients or investors in any pooled investment vehicle advised by the adviser.

• Exclusions• Live oral communications that are not broadcast on radio, television or the internet• Responses to unsolicited requests for specified information other than:

• A communication to a retail person that includes performance results• A communication that includes hypothetical performance

• Advertisements, other sales material, or sales literature about a registered investment company or a business development company and is within the scope of rule 482 or rule 156 under the Securities Act

• Information required to be contained in a statutory or regulatory notice, filing or other communication

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Advertising Rule: General Prohibitions─ An advertisement may not:

• Include an untrue statement of material fact or omit a material fact;

• Include a material claim or statement that is unsubstantiated;• Include an untrue or misleading implication about, or be

reasonably likely to cause an untrue or misleading inference to be drawn concerning, a material fact relating to the adviser;

• Discuss or imply any potential benefits without clear and prominent discussion of associated material risks or other limitations;

• Refer to specific investment advice provided by the adviser that is not presented in a fair and balanced manner;

• Include or exclude performance results, or present performance time periods, in a manner that is not fair and balanced; and

• Otherwise be materially misleading7


Advertising Rule: Performance Information

─ Testimonials and Endorsements• Proposal would permit testimonials (client statements) and

endorsements (third party statements) if the adviser (or testimonial or endorsement) prominently discloses that:

• The testimonial was given by a client or investor/the endorsement was given by a non-client or non-investor, as applicable and

• If applicable, cash or non-cash compensation was paid by the adviser in connection with obtaining the testimonial or endorsement

─ Third Party Ratings• Proposal would permit third-party ratings if the adviser:

• Reasonably believes that any questionnaire/survey used in preparing the third-party rating makes it equally easy for a participant to provide favorable and unfavorable responses, and is not designed or prepared to produce any predetermined result; and

• Makes certain discloses (or if the third-party rating prominently discloses)

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Advertising Rule: Performance Information

─ The proposed rule would prohibit including in any advertisement: • gross performance results unless it provides (or offers to provide promptly) a

schedule of fees and expenses deducted to calculate net performance; • any statement that the calculation or presentation of performance results has been

approved or reviewed by the Commission; • related performance unless it includes all related portfolios; provided that related

performance may exclude any related portfolios if: • the advertised performance results are no higher than if all related portfolios had been

included; and • the exclusion of any related portfolio does not alter the presentation of the time periods

prescribed by the rule; • performance results of a subset of investments extracted from a portfolio, unless it

provides or offers to provide promptly the performance results of all investments in the portfolio

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Advertising Rule: Performance Information in a Retail Advertisement

─ Proposal would prohibit including hypothetical performance in any advertisement unless the adviser:• Adopts and implements policies and procedures reasonably designed to ensure that

the performance is relevant to the financial situation and investment objectives of the recipient;

• Recipient must have an objective for which hypothetical performance makes sense• Recipient must have the financial and analytical resources analyze the underlying

assumptions and qualifications of the hypothetical performance • Provides sufficient information to enable the recipient to understand the criteria

used and the assumptions made in calculating the performance; or• Provides (or, if recipient is a non-retail person, provides or offers to provide)

sufficient information to enable recipient to understand the risks/limitations of the hypothetical performance

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Advertising Rule: Performance Information in a Retail Advertisement

─ The proposed rule would provide additional protections for an advertisement targeted to a retail audience, including:• requiring the presentation of net performance with equal prominence

(calculated over the same time period and using the same methodology); and

• requiring generally the presentation of the performance results of a portfolio or aggregation of related portfolios across 1-, 5- and 10-year periods.

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Advertising Rule: Pre-Use Review and Approval

─ The proposed rule would require advertisements to be reviewed and approved in writing by a designated employee before dissemination, except for advertisements that are:• communications disseminated only to a single person or household or to

a single investor in a pooled investment vehicle; or • live oral communications broadcast on radio, television, the internet or

any other similar medium.

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Solicitation Rule: Scope

─ All Forms of Compensation. The proposed rule would apply regardless of whether an adviser pays cash or non-cash compensation to a solicitor. Non-cash compensation would include directed brokerage, awards or other prizes, and free or discounted services.

─ Extension to Private Fund Investors. The proposed rule would apply to the “solicitation” of current and prospective investors in private funds (i.e., classic brokerage activity).

─ Exempt Arrangements. The proposed rule would substantially retain the current rule’s partial exemptions for (i) solicitors that refer investors for impersonal investment advice, and (ii) solicitors that are employees or otherwise affiliated with the adviser. These arrangements would no longer be subject to the current rule’s written agreement requirement. The proposed rule would also add two new full exemptions for (i) de minimis compensation to solicitors, and (ii) advisers that participate in certain nonprofit programs.

─ Disqualified Solicitors. The proposed rule contains an expanded list of disciplinary events for which persons could be disqualified from acting as a solicitor, subject to an expanded exception.

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Solicitation Rule:Written Agreement and Oversight

─ Under the proposed rule, an adviser that compensates a solicitor for solicitation activities would be required to enter into written agreement with the solicitor, unless an exemption applies. The proposed rule would require that the written agreement include:• a description of the solicitation activities and compensation; • a requirement that the solicitor perform its solicitation activities in accordance with

the anti-fraud provisions of the Advisers Act; and • a provision that designates the solicitor or the adviser to provide the client (or

private fund investor), at the time of any solicitation activities (or if a mass communication, as soon as reasonably practicable thereafter) with a separate disclosure

─ The adviser must have a reasonable basis for believing the solicitor has complied with the written agreement

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Solicitation Rule:Disclosure Requirements

─ The proposed rule would modify the current solicitor disclosure to include additional information about a solicitor’s conflict of interest in making a referral. • The separate disclosure must state the following:

• The adviser’s name;• The solicitor’s name;• A description of the adviser’s relationship with the solicitor; • The terms of any compensation arrangement, including a description of the

compensation (to be) provided to the solicitor;• A description of any potential material conflicts of interest on the part of the

solicitor resulting from the adviser’s relationship with the solicitor and/or the compensation arrangement; and

• The amount of any additional cost to the client (or private fund investor) as a result of the solicitation.

─ The proposed rule would eliminate the current rule’s requirement that the adviser obtain from each client acknowledgment of receipt of the disclosure.

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SEC Form CRS FAQs


Form CRS FAQs

─ On November 26, 2019, the SEC’s Division of Investment Management and Division of Trading and Markets staff released its first set of FAQs on compliance issues related to Form CRS. The SEC staff expects that additional FAQs will be added to this list over time• Not approved by the SEC, and only represents views of SEC staff

─ Guidance on two issues:• Format of the Form CRS Relationship Summary• Delivery obligations of Form CRS

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Form CRS FAQs

─ Relationship Summary Format • Q: Can firms prepare and deliver three different relationship summaries,

one for each type of service that it offers?• No.• Each broker-dealer or investment adviser must prepare only one relationship

summary summarizing all of the principal relationships and services it offers to retail investors.

• e.g., a single Form CRS must be prepared for an investment adviser offering wrap fee program, 401(k) plan advice, and discretionary asset management for high net worth clients.

• To the extent a dually registered firm prepares a single relationship summary addressing both brokerage and investment advisory services (rather than two separate relationship summaries), the firm must summarize all of the principal brokerage and investment advisory relationships and services the firm offers to retail investors.

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Form CRS FAQs

─ Relationship Summary Format • Q: How do firms create machine-readable headings to comply with

General Instruction 7.A.(i) to Form CRS?• Form CRS General Instruction 7.A.(i) requires Form CRS to be filed using a

“text-searchable format with machine-readable headings.”• Consult with the specifications and instructions provided by the software

provider of the application that the firm is using to create the PDF of its relationship summary in order to determine how to make the headings machine readable.

• Offers specific instructions for making machine-readable headings in Microsoft Word and Adobe.

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Form CRS FAQs

─ Delivery Requirements• Q: Can a firm satisfy its relationship summary delivery requirement with

respect to its existing retail investor clients by including the relationship summary with the mailing of its June 2020 quarterly account statements (e.g., within one week after June 30, 2020)?

• Yes. • A firm may deliver the relationship summary separately, in a bulk delivery to

clients, or as part of the delivery of information that the firm already provides, such as the annual Form ADV update, account statements or other periodic reports.

• If the relationship summary is delivered in paper format as part of a package of documents, a firm must ensure that the relationship summary is the first among any documents that are delivered at that time.

• Administrative and logistical challenges with mail vendors.• If the relationship summary is delivered electronically, it must be presented

prominently in the electronic medium (e.g., direct link or in body of email), and must be easily accessible for retail investors.

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Form CRS FAQs

─ Delivery Requirements• Q: Does an investment adviser to pooled investment vehicles – such as

hedge funds, private equity funds, and venture capital funds, where such pooled investment vehicles have natural person investors – need to deliver Form CRS to these funds?

• No.• Investment adviser delivery requirement applies only to retail investors who

have entered into an investment advisory contract with the adviser.• These types of pooled investment vehicles would not meet the definition of a

“retail investor,” and therefore a relationship summary would not need to be delivered.

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SEC Staff Adviser Compensation FAQs


SEC Staff Adviser Compensation FAQs

─ On October 18, 2019, the staff of the SEC’s Division of Investment Management released frequently asked questions (FAQs), which discuss certain compensation arrangements and related disclosure obligations arising from an investment adviser’s fiduciary duties and from Form ADV requirements

─ The FAQs provide guidance on disclosure requirements related to:• conflicts of interest regarding compensation that an adviser receives in connection with

recommended investments; • adviser conflicts related to mutual fund share class recommendations;• adviser conflicts related to receipt of revenue sharing payments; and • material amendments to Form ADV.

─ The guidance specifically notes that it does not alter or amend applicable law and has no legal force or effect, nor does it create any new or additional obligations for advisers

─ No duty of care guidance

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SEC Staff Adviser Compensation FAQs (cont.)

Takeaways

─ Adviser’s use of the word “may” • If the adviser knows that it has an arrangement in place that will affect even some clients or

recommendations at some time, it must clearly explain the existence of the arrangement, who will be impacted, and when and in what circumstances they will be impacted

─ Updates related to share class recommendations or revenue sharing as part of an adviser’s Form ADV annual updates must be included in Item 2 – Summary of Material Changes

─ Highlights the third-party payment arrangements of most significant interest to the staff at this time

─ Full and fair disclosure of compensation in Form ADV includes instances where there is a reduction or avoidance of an expense an adviser would incur

─ Conflict of interest disclosures will need to be examined in greater detail and could require enhancement

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SEC Staff Adviser Compensation FAQs (cont.)

─ The FAQs also listed a number of examples of material facts related to share class conflicts:• The existence and effect of different incentives and resulting conflicts

• Different share classes are available in the same fund• How differences in sales charges, transaction fees and ongoing fees impact an investment over time• Adviser financial interests based on share class selection that conflict with client interests

• Nature of the conflict• Does it arise out of differences in compensation received by the adviser or its affiliates, or any

incentives shared between the adviser and clearing firm?• Are there limitations imposed by the adviser or clearing firm on the share classes available?• Are there differing practices based on initial and ongoing recommendations?

• How conflicts are addressed• What are the factors and circumstances under which an adviser recommends share classes with

different fee structures?• Does the adviser offset or rebate some or all of the additional costs that are imposed on its client, and

if so, under what circumstances?

─ The FAQs also provide some limited guidance regarding material facts related to revenue sharing conflicts

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SEC Focus on Cash Sweep Programs


Cash Sweep Exams and Investigations

─ Exams

─ Co-Director of Enforcement’s Speech

─ Investigations

─ Issues• Rates of return/amount paid to firms• Value of FDIC insurance• Requirement that clients must monitor FDIC accounts• Incomplete FDIC coverage• Inappropriate charging of advisory fees

─ Steps to consider taking

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SEC Examination and Enforcement Update –Looking Ahead to 2020


Division of Enforcement’s Annual Report

─ Initiatives and Areas of Focus • Focus on the Retail Investor

• Share Class Selection Disclosure Initiative • In March 2019, the SEC ordered 79 investment advisers to return more than $125 million to affected

investors• In September 2019, the SEC ordered another 16 advisory firms to return an additional $10 million to

affected investors • Focus on Cyber-Related Misconduct

• Two years ago, the Division of Enforcement created a Cyber Unit to combat cyber-related threats by focusing Enforcement resources and expertise on, among others things, violations involving distributed ledger technology, cyber intrusions, and hacking to obtain material, nonpublic information

• In fiscal year 2019, members of the Cyber Unit and other staff throughout the Division investigated and recommended to the Commission many significant cases in these areas

─ Enforcement• The SEC brought 862 enforcement actions (526 standalone cases, 210 follow-on proceedings, 126

deregistration proceedings)• 36% of the SEC’s standalone cases in fiscal year 2019 concerned investment advisory and

investment company issues

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Hot Topics for 2020

─ Robo-advisers

─ Vulnerable populations (seniors, teachers and military)

─ ESG

─ Alternative data

─ Share classes and revenue sharing

─ Central risk books

─ Zero commissions

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2020 Form ADV Update Season


Preparing for Your Firm’s 2020 Form ADV Update

─ Deadline: 90 days following the end of the firm’s fiscal year

─ Unprecedented scrutiny of ADV disclosures by SEC staff

─ How to disclose conflicts? Which conflicts to disclose?

─ Form CRS

─ Other areas of focus

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Questions?

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eversheds-sutherland.com© 2019 Eversheds Sutherland (US) LLPAll rights reserved.

Clifford KirschNew York, NY+1 212 389 [email protected]

Michael KofflerNew York, NY+1 212 389 [email protected]

Ben MarzoukWashington DC+1 202 383 [email protected]

Issa HannaNew York, NY+1 212 389 [email protected]

Bria AdamsWashington DC+1 202 383 [email protected]

Brian RubinWashington DC+1 202 383 [email protected]

John WalshWashington DC+1 202 383 [email protected]

advisers act regulatory series - eversheds sutherland · 2020. 5. 12. · testimonial or...

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