IACCP Flashcards
1
Q
Sec. 206 of Adviser’s Act
A
Anti Fraud
2
Q
Examples of Sec. 206 “Fraud”
A
- Device/scheme/artifice to defraud client/prospect
- Transaction/practice/course of biz to defraud client/prospect
- Knowingly sell any security to or purchase any security from a client when acting as principal own account w/o disclosing in writing before the completion of the trx and obtaining the client’s consent. (Principal Trade).
- Knowingly effect purchase/sale of a security for client’s account when also acting as broker for person on other side of trx w/o disclosing in writing before the completion of the trx and obtaining the client’s consent. (Agency Cross Trx.)
- Failing to conduct an annual review of policies and procedures.
3
Q
Fiduciary Duties
A
- Suitable advice;
- Full/fair disclosure of material facts;
- Disclosure of conflicts of interest;
- Loyalty/good faith;
- Seek best execution;
- Reasonable care to avoid misleading clients.
4
Q
Duty of Care
A
- Provide investment advice in best interests of client:
1 - Reasonable inquiry into client objectives (minimum inquiry into client’s financial profile);
2 - Reasonable belief that advice is in client’s best interest. - Seek best execution where the IA has responsibility to select broker-dealers to execute client trades;
- Provide advice and monitoring.
5
Q
Duty of Loyalty
A
- Put client interests ahead of own;
- Disclose all material facts to client;
- Eliminate conflicts of interest or obtain informed consent of client.
- Disclosure must be sufficiently specific;
- Disclosure/consent do not themselves satisfy duty to act in client’s best interest.
6
Q
Best execution
A
- Goal of maximizing value at the time of trx.
- Best qualitative execution (not just lowest commission).
7
Q
Define “Investment Adviser”
A
Any person or firm that:
1 - Provides advice/analysis re: securities (making recommendations to clients or providing research or opinions on securities or securities markets); and,
2 - Receives compensation for advice; and
3 - Engages in regular business of providing advice to others re: securities.
8
Q
Excluded from Def. of “Investment Adviser” - 7
A
- Domestic banks/bank holding companies;
- Lawyers/accountants/engineers/teachers if services are solely incidental;
- Broker-dealers if advisory services are incidental and no special comp.;
- Publishers of newspapers/magazines of regular circulation;
- Advice related to securities that are direct obligations of the US government;
- Nationally Recognized Statistical Rating Orgs.
- Family Offices
9
Q
Exempt from Registration - 10
A
- Intrastate advisers: all clients are w/i same state as IA’s principal business address and does not provide advice or issue reports re: securities listed on any national securities exchange;
- Only clients are insurance companies;
- Private fund advisers
- Foreign Private adviser
- VC fund advisers
- Exempt Reporting Advisers
- Charitable Organizations and Employees
- Church Plans
- Commodity Trading Advisors
- Family Offices
10
Q
Qualifying Private Fund Definition
A
Issuer that would be an Investment Company but for exclusions under Investment Company Act.
11
Q
Private Fund Adviser Definition
A
- In US if (1) acts solely as advisor to one or more qualifying private funds; and (2) AUM of less than $150M;
- Ex-US if (1) all US clients are qualifying private funds; and (2) US AUM is less than $150M
12
Q
Foreign Private Adviser Definition
A
- no place of business in the US
- fewer than 15 clients and investors in the US;
- less than $25M AUM in the US;
- does not hold itself out as IA in the US
13
Q
Define client
A
- a natural person
- natural’s person’s minor children (regardless of whether they share the same residence)
- relatives/spouse/relative of the spouse sharing the same principal residence as natural person
- Accounts/trusts for which such natural person and/or the foregoing persons are the only primary beneficiaries
- a partnership/LLC/corp./or other legal org to which the IA provides advice based on the org’s investment objectives.
14
Q
VC Fund Definition
A
- pursues VC strategy;
- makes qualifying investments;
- limits leverage;
- offers no broad redemption rights;
- has not registered under the IC Act or elected to be a business development company;
- is a private fund
15
Q
VC Fund Grandfather Rule
A
Fund considered a VC fund even if it doesn’t meet the definition if:
- Pursues VC strategy;
- Initial/final closing - Dec. 31, 2010 - July 21, 2011.
- Private fund
16
Q
Exempt Reporting Advisers Definition
A
- Advisers whose clients are all VC funds;
- Private fund advisers w/ less than $150M in assets in the US;
- Exempt from registration, but required to file portions of ADV Part 1 & SEC has exam authority.
17
Q
Family Office Definition
A
- Provide securities advice only to family clients;
- Family clients must wholly own the family office and family members and/or family entities must control the family office;
- Family office must hold itself out as an IA
18
Q
Family Member Definition
A
- Former family members, inc. spouses and adopted children/stepchildren.
- Lineal descendants of a common ancestor no more than 10 generations removed
19
Q
Family Clients Definition
A
Current and former family members, certain employees of the family office, charities funded exclusively by family clients, estates of current and former family members or key employees, trusts existing for the sole benefit of family clients, etc.
20
Q
Duty to Supervise
A
SEC can take action against IA or person associated with IA if person aided/abetted a violation of any person or “has failed reasonably to supervise, with a view to preventing violations of [the law].” No failure to supervise if:
- Established procedures and a system for applying such procedures to prevent/detect violations; and
- Person reasonably discharged duties/obligations w/o reasonable cause to believe that procedures were not being complied with
21
Q
State Registration
A
Small advisers must register in state in which they do business unless:
- Exempt from registration;
- Principal office and place of business in a state that does not regulate IAs; or
- Qualify for an exemption
22
Q
Small Advisers Definition
A
$25M or less AUM
23
Q
Mid-sized Adviser Definition
A
$25-100M AUM.
Must register with SEC if:
- IA is not required to be registered an an IA;
- If registered in the state, would not be subject to exam.
- Currently only applies to WY and NY
24
Q
Buffer Zone
A
$90-110MM AUM
25
NY IA Registration
IA whose principal office and place of business is NY must register with state up to $25M and with SEC over $25M.
26
RAUM
AUM = Securities portfolios to which IA provides "continuous and regular supervisory or mgmt services."
- Securities portfolio = at least 50% of the total value of the account consists of securities. (Cash and cash equivalents are counted as securities.)
- 50% rule does not apply to private funds - value of all assets of private fund must be counted.
Must include (1) family or proprietary accounts; (2) accounts for which IA receives no comp; (3) accounts of clients who are not US persons.
Must not include (1) assets managed by another person; (2) real estate or businesses that are not managed as investments; (3) commodities.
RAUM should be calculated on a gross basis.
Private funds: AUM should be valued at market value (or fair value if market value is not available).
27
Exemptions from Prohibition on Registration - 5
- Pension Consultants - w/ min. value of $200M
- Affiliated Advisers - IA's controlling/controlled by SEC-registered IA with same principal office and place of business;
- New IAs - expectation that firm will be eligible w/i 120 days
- Multi-state - mid-sized IA if required to register w/ 15 or more states;
- Internet advisers
28
ADV Updates - timing
- Annually, w/i 90 days of IA's fiscal year end (annual updating amendment);
- Whenever certain changes occur:
- Adding or removing a relying adviser
- Identifying info (item 1), Form of org (item 3), custody (item 9), disclosure info (item 11), schedule R (info) becomes inaccurate.
- successions (item 4), participation of interest in client trx (item 8) or control persons (item 10) becomes materially inaccurate.
29
Investment Adviser Representative
- Supervised person regularly solicits, meets with, or communicates with firm clients;
- Has 5+ natural clients and 10%+ of the clients are natural persons.
- Not HNW clients -- i.e., Qualified Clients don't count.
30
Supervised Person
Employee who provides investment advice and is subject to supervision/control of IA.
31
Qualified Clients
$1M AUM;
$2.1M net worth, not including house.
"Qualified Purchasers" ($5M AUM); or
Executives/partners at IA.
32
Form PF - who must file?
- RIA that advises one or more "private funds" with at least $150M RAUM;
- IA registered with CFTC as commodity pool operator or commodity trading adviser, and registered as IA with SEC, and has at least $150M RAUM.
33
Private fund definition
Hedge fund, liquidity fund, PE fund, real estate fund, securitized asset fund, VC fund, other private fund.
34
Form PF - when to file?
Annual w/i 120 days of end of FY.
Except large PF advisers:
- Liquidity fund adviser w/ at least $1B RAUM = quarterly w/i 15 days of end of quarter;
- Hedge fund adviser w/ at least $1.5B in RAUM = quarterly w/i 60 days of end of quarter;
- PE adviser w/ at least $2B in RAUM= annually w/i 120 days of FY end
- If a firm is no longer required to file, must file final Form PF no later than the last day on which its next Form PF would be timely.
35
Aggregating AUM for Form PF
- Assets of managed accounts that pursue same investment objective and strategy and invest side by side in substantially same positions as PFs advised by IA; and
- assets of PFs advised by any of IA's "related persons." (other than separately operated).
36
B&R - how long?
Generally, in "easily accessible place" 5 years from end of FY during which last record entry was made - first 2 years in an appropriate office of IA.
37
B&R - what records?
- Organizational records - maintain in principal office and for 3 years after termination of IA:
- Accounting records;
- Portfolio Management records;
- Business Agreements/Arrangements;
- Client relationship materials;
- Marketing records
- Code of Ethics/Personal Securities Transactions
- Compliance Programs
- Political Contributions
- Electronic Records
38
B&R Organizational Records
- Formation documents, corporate articles, partnership agreements, by-laws, certificates of formation.
- Minute books;
- Ownership records of the entity.
39
B&R Accounting Records
- Journals (include cash receipts and disbursement records);
- Ledgers;
- Bank account info.
- Bills and statements;
- Trial balances, financial statements, etc.
40
B&R Portfolio Management Records
- Memos re: each order given by the IA to buy/sell any security, including:
- Modification/cancellation of the order/instruction;
- Terms/conditions of the order/instruction;
- Identity of person who recommended trx to client and person who placed order;
- Account for which order was entered and date of entry;
- ID of bank/broker/dealer that executed; and
- Any designation of orders entered per use of a discretionary power.
- Research files
- Account and trading communications.
- Client securities trx records;
- Securities reference reports
41
B&R Business Agreements/Arrangements
All written agreements or arrangements entered by IA with any party or otherwise relating to IA's business.
42
B&R Client relationship materials
- Client Agreements/arrangements.
- Proxy voting materials:
- P&P, proxy statements, record of each vote cast; any document that was material to making voting decision; copies of written client RFIs re: voting and written responses.
- Communications w/ clients - broad.
- Discretionary powers;
- Powers of attorney;
- Disclosure document delivery
43
B&R - IAs with custody - what add'l records must be maintained?
Must keep add'l records:
- Journals;
- Separate ledger accounts;
- Confirmations;
- Securities records;
- Internal control reports.
44
B&R - Marketing records
- Marketing materials sent to 10 or more persons.
- Maintain for 5 years after end of FY during which IA last published/disseminated marketing communication.
- Not generally required to maintain names/addresses of person to whom IA sent marketing communication;
- Performance material - all materials necessary to show basis for any performance calculation.
- Solicitor material:
- Written agreement establishing solicitation agreement;
- Copies of IA's disclosure documents and copies of the separate disclosure documents prepared by solicitors/delivered to clients;
- Copies of signed/dated acknowledgement of receipt of IA's and solicitor's written disclosure documents.
45
B&R - Code of Ethics
- Copy of current code of ethics and any code adopted w/i past 5 years.
- Record of any violation of code of ethics;
- Record of each written acknowledgement of receipt of the code by supervised persons.
46
B&R - Personal Securities Transactions
- Record of access persons for past 5 years;
- Access persons' holdings and trx reports;
- Record of preapprovals.
47
B&R - Compliance Programs
- P&P for past 5 years;
| - Documentation of annual review.
48
B&R - Political Contributions
- Names/titles/business and residence addresses of each covered associate;
- Gov't entities to which IA provides advisory services for past 5 years;
- Direct/indirect contributions.
49
Define Covered associate
IA executives;
Employee who solicits a government entity for the investment adviser and any person who supervises, directly or indirectly, such employee;
PAC controlled by the investment adviser or by another covered associate.
50
Brochure Rule
- ADV 2A
- Disclosure re: IA's business practices, types of clients, conflicts of interest (and how addressed), disciplinary action, summary of material changes.
- Delivered to each client/prospect before or at the time IA enters K.
- Wrap fee clients receive separate wrap fee disclosure document.
- Filed with SEC; publicly available.
51
Wrap Fee Program Definition (ADV 2A, Appx. 1)
- bundled investment management and brokerage services for one fee.
- delivered at/before services.
52
Brochure Delivery
- Deliver to clients before or at the time IA enters into advisory K;
- Not required to be delivered to registered investment companies, business development companies or clients receiving impersonal advice that are charged less than $500/yr.
- W/i 120 days of end of FY, IA must deliver updated brochure or a summary of material changes w/ offer to provide full copy of brochure (w/ website address and telephone #);
- Or, promptly when becomes materially inaccurate.
53
Brochure Supplement Delivery
- Initially given to each client (including sophisticated clients) at or before advisory services.
- Promptly when becomes materially inaccurate or new disciplinary event is added.
- Statement of material changes can be delivered instead of full supplement.
- Not filed publicly.
54
Brochure Recordkeeping
- Copies of brochure/supplement should be maintained in client file.
- Maintain a record of dates that each brochure and supplement, each amendment and summary was given to any client or any prospect that subsequently becomes a client.
- No requirement that proof of client receipt be maintained, but it's a best practice.
55
Brochure Supplement (ADV 2B)
- Advisory personnel on whom client relies for investment advice:
- supervised person who gives advice to client and has direct client contact;
- any supervised person w/ discretionary authority over client account.
- if a team, just the 5 persons with greatest day-to-day responsibility.
- Education, college, age, number of years in industry, etc.
56
Form CRS (ADV Part 3)
- Info re: retail client's relationship with IA, related services and fees.
- Deliver at/before when new retail investor engages IA or for existing clients:
- when new account is opened;
- recommendation to roll over assets from a retirement account into a new or existing account or investments;
-
57
Retail Investor Definition
- Natural person, or legal rep of natural person, who seeks or receives services primarily for personal, family or household purposes.
58
Insider Trading (204A)
- IAs required to establish, maintain and enforce written P&P reasonably designed to prevent misuse of material, nonpublic info by IA and any person associated with IA
59
Codes of Ethics
- IAs must adopt/enforce code of ethics that includes:
- Standard of business conduct for supervised persons;
- Requirement that supervised persons comply with applicable securities laws;
- Requirement that access persons report, and adviser review, personal securities transactions and holdings periodically;
- Requirement that access persons pre-clear personal investments in IPOs or limited offerings;
- Requirement that supervised persons report violations to IA's CCO;
- Requirement that IA provide each supervised person receive code and each supervised person provide written acknowledgement of receipt.
60
Access Person definition
supervised person w/ access to MNPI; or involved in making securities recommendations to clients.
- presumption that directors, officers and partners are access persons.
61
Personal securities reporting
- Access persons;
- Complete report of holdings of reportable securities w/i 10 days of becoming an access person and at least annually thereafter.
- Quarterly Transaction reports: all reportable personal security trx must be reported no later than 30 days after calendar quarter end.
- Annual/quarterly holdings reports must contain title/type of reportable security, exchange ticker symbol or CUSIP, number of shares, principal amount of securities; name of broker/dealer/bank where access person maintains account; date on which report was submitted.
- Initial must be current as of 45 days.
62
Reportable Securities Exclusions
- Direct obligations of US gov't;
- money markets;
- shares of money market funds;
mutual funds;
- units of a UIT (open end ETFs);
63
Personal securities reporting exclusions
- Accounts over which access person has no influence or control;
- Automatic investment plans;
- Duplicative info contained in broker trade confirmations or account statements.
64
IA Contracts
- Must be in writing;
- No performance fees (except under certain circumstances);
- Must include provision prohibiting assignments w/o client consent.
65
Assignment Definition
Direct or indirect transfer of an IA contract by an advisor or any transfer of a controlling block of an adviser's outstanding securities.
66
Advisory Fees Based on AUM
- no specific rules, but if fees are higher than typical, must be disclosed that services may be obtained for less elsewhere.
- fees should be reasonable
67
Performance fees
- Prohibited except for qualified clients ($2.1M net worth not including home or $1M AUM); private funds, non-US residents, ERISA clients; certain knowledgeable employees of IA.
68
Rebate of performance fees
- Ok if IA discloses rebate terms to all clients participating and applies them fairly/consistently
69
Directed brokerage
- IA must disclose potential negative results to client, including acct may pay higher brokerage commissions, receive less favorable prices and forego savings from batched orders.
70
Principal Transactions
IA, acting as principal for own account, cannot buy/sell security from/to client unless IA discloses it to the client in writing prior to settlement and client has given consent.
71
Agency Cross Transactions
- IA is also broker-dealer or has affiliated broker-dealer, and advisory client transactions are effected through that broker-dealer.
- IA cannot execute unless (1) client executes written consent; (2) IA sends each client written confirmation at or before completion of trx, including nature of trx, date, time, and source and amount of remuneration; (3) IA sends each client annual written disclosure identifying number of transactions and commissions during that period; (4) conspicuous statement that written consent may be revoked at any time by written notice from client; (5) no trx is effected where the same IA recommended the trx to both seller and purchaser.
72
Cross-trades
IA arranges trade between two client w/o acting as broker or dealer on either side.
- No addressed in Advisers Act, but be careful.
73
Advertisement Prohibitions
- Testimonials;
- Past specific recommendations (except those that list all recommendations for at least a year with a cautionary legend);
- Reps that any graphs/charts/formulas can, by themselves, be used to determine which securities to buy/sell unless accompanied by explicit disclosures;
- Reps that service will be provided free of charge unless it's actually free;
- No false/misleading facts.
74
Client Lists in Ads
- Ads
- Must not use performance based criteria to determine which clients to include;
- Must include disclaimer: "It is not known whether the listed clients approve or disapprove of the IA"
- List must include objective criteria used to determine which clients to include.
75
Article Reprints
- Ads
Ok if article is prepared by unbiased third party and do not include statement of client's experience or client endorsement.
76
Ratings
- Ads
- May be testimonials, but no action if:
- Ratings do not emphasize favorable client responses or ignore unfavorable ones;
- Ratings would represent all, or a statistically valid sample of, responses;
- Questionnaire distributed to clients would not be prepared to produce any pre-determined result;
- Research firm would not provide subjective analysis - merely assign numerical ratings.
77
Testimonials in Social Media
- Ads
Ok, but: (1) IA must not have the ability to affect which public commentary is included or how it is presented on the social media site; (2) commenting must not be restricted; (3) site must allow for viewing of all public commentary and update comments real-time; (4) site must publish content independent of IA; (5) IA must publish all unedited comments re: IA; and (6) IA must not highlight or give prominence to a subset of testimonials.
78
Past specific recommendations
- Ads
- Generally prohibited.
- IAs may list all securities recommended for the past year with (1) name of each security; (2) date/nature of each recommendation; (3) market price at time of rec; (4) price at which rec was acted upon; (5) most recent market price; (5) disclosure that past recs are not an indication of future results.
79
Unsolicited requests by clients for info re: past recommendations
- Not ads
80
Use of "RIA" or "Investment Counsel"
- IA prohibited from representing that it has been approved or endorsed by SEC;
- Cannot use "RIA" - must spell out "Registered Investment Adviser;
- Cannot use "investment counsel" unless principal business of IA is rendering investment advice and substantial part of business is "investment supervisory services"
81
Using Performance Info
Misleading if it implies, or if a reader would infer, something about the IA's competence or future investment results that would not be true if all material facts were included.
82
Clover Capital
Guidelines for advertising actual/model performance results.
83
Actual/model performance results (Clover)
Misleading if (1) fails to disclose effect of material market or economic conditions on results; (2) doesn't reflect deduction of advisory fees/commissions/expenses (custodial fees do not need to be deducted); (3) fails to disclose reinvestment of dividends/other earnings; (4) claims potential for profit w/o disclosing possibility of loss; (5) compares model/actual results to index w/o disclosing all material facts relevant to comparison; (6) fails to disclose material conditions, objectives, strategies used to obtain results portrayed.
84
Model performance results (Clover, add'l)
Misleading if fails to disclose (1) limitations inherent in model results; (2) if conditions/objectives/strategies of model changes materially and the effect of the change; (3) that securities contained in or strategy followed does not relate to strategy currently offered by IA; (4) if clients had results materially different from results in model.
85
Actual performance results (Clover, add'l)
Misleading if fails to disclose if results only pertain to select group of clients, basis on which selection was made, effect of practice on results.
86
Gross v. Net of Fees
Can show gross fees if (1) both gross and net fees receive equal prominence; (2) presented in format that's easy to compare; (3) be accompanied by disclosures.
87
Fees (one on one presentations)
Ok to just use gross performance with sophisticated prospective clients if the following is provided (by IA or consultant) in writing at time of presentation: (1) disclosure that performance fees do not reflect deduction of IA fees; (2) disclosure that client's return will be reduced by IA fees/expenses; (3) disclosure that IA fees are in IA's ADV Part 2; (4) representative example showing effect of fees, compounded over years, on total value of portfolio.
88
Portability of performance results
Misleading unless; (1) person who managed account at successor IA were also primarily responsible for achieving prior performance results; (2) accounts managed at predecessor were similar to current accounts; (3) all accounts that were managed in substantially similar manner are advertised (unless exclusion of account would not result in materially higher performance); (4) ad is consistent with staff interpretations; (5) ad includes all relevant disclosures, including that performance results were for predecessor accounts.
89
GIPS
Global Investment Performance Standards
CFA Institute
More expansive than IA performance standards.
No legal requirement to comply, but if you claim compliance and don't, fraud under IA.
- Required guidelines: (1) make available full list of firm composites and make each composite performance available upon request. (2) calculate all returns after the deduction of the actual trading expenses incurred during the period.
90
Advertisement Recordkeeping
Keep copy of ads sent to 10 or more persons.
| If purchase/sale of security is made, IA must maintain memo describing reason for recommendation.
91
Performance Recordkeeping
- Keep ads and all data supporting performance for entire performance period.
- 5 years after end of FY when ad was last disseminated.
- If based on managed accounts, IA may retain all account statements reflecting debits, credits and transactions in client account and all work sheets necessary to demonstrate calculation of performance data.
92
Performance Data: Client Lists
- Performance based data may not be used to pick which clients to include;
- Disclaimer: "It is not known whether the listed clients approve/disapprove of IA services."
- Disclose objective criteria used to determine which clients to include.
93
Custody Definition
- Possession of client assets (unless received inadvertently and returned w/i 3 days);
- Any arrangement (including general power of attorney) where IA can withdraw client assets (e.g., write checks or deduct fees from client assets);
- Anything that gives IA or supervised person legal ownership of or access to client assets (e.g., acting as GP of an LP or pooled investment vehicle or trustee of a trust).
94
Examples of Custody
- Bill paying services (IA can withdraw funds/securities from client account to pay bills);
- Online access to client accounts (usernames and pws);
- Check writing authority (but not checks drawn by clients and made payable to third parties);
- Debiting advisory fees;
- Receipt of checks made to clients (IA receives checks and fails to return them promptly to sender);
- Money transfers: to avoid triggering custody, client must provide signed authorization w/ name and acct numbers at institutions;
- SLOA (standing letter of authorization) is custody, but SEC will not enforce if: (1) client provides written instruction to custodian, including client signature, third party name and third party address or account #; (2) client authorizes the IA, in writing, to direct transfers to the third party; (3) qualified custodian performs verification of the instruction; (4) client can terminate/change instruction; (5) IA has no authority to designate or change third party; (6) IA maintains records that show third party is not related party of IA; (7) qualified custodian sends client initial notice confirming instruction and annual notice reconfirming instruction.
95
Qualified Custodians
- Registered broker dealers, banks, savings association, futures commission merchants;
- non-US financial institutions that customarily hold financial assets for customers.
- NOT insurance companies registered in states where they conduct business.
96
Custody - notices to clients
- Notify client, in writing, where/how client assets will be maintained - promptly after opening account for client and following any changes to information.
- Not required if client opens account;
- Provide client with name/address of custodian and manner in which assets are held;
- If IA provides its own account statement, must urge client to compare statements with those from the custodian.
97
Custody - account statements for clients
IA must have reasonable basis, after due inquiry, for believing that the qualified custodian sends account statements to clients detailing their holdings, at least quarterly.
e. g.:
- IA arranges for custodian to mail/email IA copies of the account statements;
- custodian provides confirmation to the IA that it is sending statements quarterly;
- IA can access/review statements on custodian website and custodian sends notice that it sent client account statements or confirms that client accessed them via the website.
- IA contacts clients periodically to confirm that they received account statements directly from custodian.
98
Custody - Annual surprise exam
- IA with custody must undergo annual surprise exam by independent public accountant.
- Accountant must: (1) notify SEC within 1 business day of any material discrepancies; (2) submit Form ADV-E within 4 days of resignation, termination, or removal.
99
Custody - Annual surprise exam exceptions
- If IA has custody solely because it has authority to deduct advisory fees from client accounts.
- If related person has custody and is "operationally independent" of IA.
- If the IA uses SLOAs and meets requirements.
- Pooled investment vehicles if (1) pool's financial statements are audited regularly and audited statements are distributed to pool's investors w/i 120 days after close of pool's FY and (2) qualified custodian sends quarterly account statements to each pool investor and IA obtains surprise exam of pool's assets; IA must obtain annual internal control report.
100
Custody - Form ADV disclosure
IA must (1) identify all related persons and which, if any, serve as qualified custodians; (2) disclose whether it or any related person serves as a qualified custodian of IA's clients and dollar amount of client assets in custody; (3) report whether and how audits/exams/internal control reports are conducted; (4) report month in which last exam occurred; (5) identify accountant(s) and type of engagement; (6) explain that clients will receive account statements from broker-dealer and urge clients to compare statements to IA statements.
101
Custody - Dually registered IAs/broker-dealers
"dually registered entities" subject to surprise exam requirement.
IA will not be deemed to have custody of assets held by a related broker-dealer if IA does not provide investment advice.
102
Custody - recordkeeping for related persons
IA's must keep copy of (1) internal control report from related person; (2) memo describing basis on which the IA determined that a related person with custody of client assets is operationally independent; (3) written agreement w/ accountant re: surprise exam.
103
Compliance P&P - Custody
Must address safeguarding of client assets.
- Background and credit checks on employees,
- Require authorization of more than 1 employee before executing transactions;
- Limit number of employees who can interact with custodians;
- Test effectiveness of custody controls;
- Segregate duties of IA personnel and custody personnel.
104
Cash payments for client solicitations ("cash solicitation rule")
- IA may engage employees or third parties to solicit new IA clients.
- IA may not pay a cash fee for referrals unless (1) IA is registered under Advisers Act; (2) solicitor is not disqualified; (3) cash fee is paid per written agreement (copy retained by IA); (4) requirement that solicitor must, at the time of any solicitation activities, provide client with current copy of IA brochure and separate disclosure document; (5) IA makes an effort to confirm that solicitor complies with agreement.
105
What does solicitor have to provide to prospective clients?
At time of solicitation, solicitor must provide prospective clients with copy of IA brochure and separate written disclosure containing:
- solicitor's name;
- IA's name;
- nature of relationship b/t solicitor and adviser;
- statement that solicitor is to be compensated by IA;
- terms and description of comp;
- amount, if any, that will be charged to the client in addition to the advisory fee and the difference among clients in fees if that difference is attributable to the solicitation agreement.
- IA receives from the client prior to or at the time of entering an IA agreement a signed and dated acknowledgement from client that client received above materials from solicitor.
106
Political Contributions - Pay to Play
- If IA or "covered associate" makes a contribution to a gov't official who can influence the award of the government's business, AI is prohibited from receiving comp for providing IA services to that entity for 2 years - "time out period."
-
107
Covered Associate
GP, managing member, executive officer, or other individual with similar status/function; or employee who solicits a gov't entity for the IA; or PAC controlled by IA.
108
Look back period for new Covered Associates
6 months if they do not solicit gov't clients
109
Political contributions - exceptions
De minimis ($350 or $150)
110
Recordkeeping for IAs that provide svcs to government entities or covered investment pools in which gov't entity is an investor
- All names/titles/business and residential addresses of all covered associates; all gov't entities to which IA has provided services in the last 5 years; all contributions made to an official of a gov't entity or political party or PAC; name/business address of each regulated person to which the IA agrees to provide direct/indirect payment to solicit a gov't entity.
111
Proxy Voting requirements
- Adopt/implement written P&P designed to ensure that proxies are voted in best interest of clients. Must include how IA addresses material conflicts of interest.
- Disclose to clients how they can obtain info re: how proxies were voted.
- Describe to clients the IA's proxy voting P&P and, upon request, furnish copies to clients.
- Maintain records.
112
Proxy voting books and records
- Copies of all P&P;
- Copy of each proxy statement that IA receives re: client securities.
- Record of each vote cast by IA on behalf of client.
- Copy of any document created by IA that was material to making voting decision.
- Copy of each written client request for info and written response by IA.
- NOT NECESSARY to keep evidence of annual offer of P&P to clients.
113
Compliance P&P rules
- Adopt/implement written P&P reasonably designed to prevent violation of the IA, detect violations, and correct violations;
- Review P&P annually for adequacy and effectiveness of implementation;
- Designate CCO to administer P&P;
- Maintain records of the P&P and annual reviews.
114
CCO attributes
Knowledge, competence, empowerment
115
Compliance P&P for RIAs must include
- Portfolio management processes;
- Trading practices;
- Proprietary trading;
- Accuracy of disclosure;
- Safeguarding client assets;
- Recordkeeping;
- Valuation/fees;
- Privacy;
- Business continuity;
- Social Media
- Cybersecurity
- Compliance with Exemptive Orders
- Red Flags of Identity Theft
- Due Diligence for Selecting Alternative Investments
116
Rule 38a-1 of Investment Company Act (Compliance Programs for ICs)
- Ensure that registered investment companies (funds) have internal programs to comply with federal securities laws.
(1) adopt/implement written P&P, including P&P that provides for oversight of compliance by the fund's service providers.
(2) the board, including a majority of independent directors, must approve the fund's P&P as well as P&P for each service provider (can review summaries);
(3) designate a CCO (must be approved by board, including a majority of independent directors). CCO may be removed only by the board and must meet separately with the fund's independent directors at least annually;
(4) annual review and annual report - written report must be provided to the Board;
- - Report to include material changes to fund p&p, recommendations for changes, and material compliance matters.
(5) recordkeeping of all p&p for at least 5 years.
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Compliance P&P for investment companies must include
Same as for RIAs plus:
- IC Act requires funds to sell and redeem shares at prices based on current net asset value (NAV) and pay redemption proceeds promptly.
- Funds must calculate NAV using market value of portfolio securities when available or, if not available, fair value.
- Must segregate investor orders received before the fund prices its shares (that day's price) from those received after fund prices shares (next day's price).
- Identification of affiliated persons
- Protection of MNPI
- Market timing
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Disclosure brochure cover page
"The information in this brochure has not been approved or verified by the US SEC or by any state securities authority.
119
Reg BI
Requires broker-dealers and their associated persons to act in the best interest of a retail customer when recommending a securities transaction or investment strategy involving securities.
120
Rule 3A-4 of Investment Company Act (wrap fee program - safe harbor)
Wrap fee programs may be viewed as funds if multiple accounts are traded simultaneously and treated similarly.
Safe harbor if:
1 - Each account gets individualized treatment;
2 - Access for clients to consult with IAs.
3 - Ability to impose reasonable restrictions;
4 - Quarterly statements to clients re: account activity.
5 - Indicia of ownership of securities is retained by each client;
6 - If mutual funds are the securities managed:
(1) -- Fee disclosures;
(2) -- Clients may purchase mutual funds directly w/o IA's service.
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Aggregation
- Equitable distribution of transactional costs.
- No client favored over another.
- Each participating client gets average share price for all the IA's transactions in that security on a given day.
- All trx costs shared pro rata.
- Personal trades included?
- Only if IA adheres to "fair process / SMC Capital" standards (see below).
- If order is only partially filled, clients take priority.
- Aggregation must be disclosed in Form ADV and separately to clients and broker-dealers.
122
Allocation
IA must allocate all investment opportunities among eligible clients promptly and fairly (and document it).
- Written policy for fair/equitable allocation of trades should be disclosed on Form ADV 2A, Item 12.
- Pro rata basis is generally considered fairest.
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Accredited investor
$200K annual income (or $300 joint with spouse).
$1M net worth;
"certain knowledgeable people."
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Fair Process / SMC Capital
Before entering aggregated order, prepare written "Allocation Statement".
- If order is filled entirely, allocate per allocation statement.
- If not, allocate pro rata.
- May be allocated differently than allocation statement if clients are treated fairly, reason is explained in writing and approved by CCO no later than 1 hour after opening of markets the next day.
125
Trade Errors
Client must not be disadvantaged; must be made whole.
IA should bear the cost of any errors - cannot use soft dollars to correct error.
All errors should be documented.
126
Pricing and valuation of securities
Ensure fair, accurate, current valuations.
Esp. hard to price or illiquid securities (illiquid investments, foreign issues, micro cap stocks).
Least attention should be paid to large cap stocks.
127
Agency/Principal Trx Disclosures.
Must be disclosed in ADV1 and to client in writing before the transaction.
Disclosure must include:
- IA's original purchase price for any security it sells to client;
- Price the IA expects to receive on resale;
- Price at which security could be bought/sold elsewhere.
- Client must give consent before trx settles.
- No prospective/blanket disclosures.
128
Agency Cross Trade
IA is also a broker-dealer and IA client transactions are made through that broker dealer.
- Must disclose in writing and obtain consent prior to trx.
- IA sends to each client written confirmation b/f completion of trx including nature of trx, date, and annual written disclosure identifying total number of transactions since the data of the last statement or summary and total of all commissions.
129
Principal Trade
IA, acting as principal for own account, buys/sells security to client.
- Must disclose trx in writing and client must give consent.
130
Soft Dollars
Arrangements under which "research products" are obtained by an IA from a broker-dealer in exchange for the direction by the IA of client brokerage transactions to the broker-dealer.
- Must be provided by broker-dealer.
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Examples of Soft Dollars
- Advice = directly or through publications or writings – value of securities, advisability of investing in, purchasing or selling securities, or the availability of securities or purchasers or sellers of securities.
- Analyses or reports = issuers, industries, securities, economic factors, trends, portfolio strategy, performance of accounts.
- Pre-post trade analytics.
- Market, financial, economic data.
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Not Soft Dollars
```
Physical items (e.g.. computers).
Mass marketed publications.
```
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Sec. 28(e) of SEC Act of 1934 (safe harbor - best execution)
Safe harbor from liability for breach of fiduciary duty for paying more than lowest commission rate if manager determines in good faith that the amount of commission was reasonable in relation to the value of the brokerage and research services provided by the broker-dealer.
134
Mixed Use Soft Dollars
- IA must make reasonable allocation of the cost of the product according to use.
- The portion that provides assistance with investments may be paid for by commission $s.
- Ineligible services (physical things, etc.) must be paid for by IA.
- Example: portfolio management software used to calculate client returns
135
Best Execution
Best "qualitative execution". Can consider:
```
o Value of research provided;
o Commission rates charged;
o Ability to negotiate commissions;
o Ability to obtain volume discounts;
o Ability to maintain confidentiality;
o Execution capability;
o Communications and admin abilities.
o Financial responsibility;
o Responsiveness to IA.
```
136
Related person / Advisory Affiliate
Advisory affiliate = (1) officers, partners, directors or any person performing similar functions; (2) all persons directly/indirectly controlled by IA; (3) all current employees (other than admin/support staff).
Related person = any advisory affiliate and any person that is under common control with IA.
137
Trade Order Memo Must include
- terms and conditions of the order, instruction, modification or cancellation;
- person connected with the investment adviser who recommended the transaction to the client and the person who placed/entered such order;
- the account for which entered, the date of entry, and the bank, broker or dealer by or through whom executed where appropriate.
- Orders entered pursuant to the exercise of discretionary power shall be so designated.
DOES NOT NEED TO INCLUDE NAME OF EXCHANGE.
138
ADV1 - disciplinary info - when IA can stop reporting
- 10 years+ or any pending matter resolved in IA's favor.
- Unless the event was so serious that it remains currently material to a client's evaluation of the IA.
- What's "material?"
- Distance of the entity or individual from the advisory function;
- Nature of the infraction;
- Severity of the sanction;
- Time elapsed (10 years).
139
ADV1 - ownership info?
Schedule A - direct owners w/ 5% or more ownership interest in the firm.
Schedule B - indirect owners: 25% owners of direct owners, their 25% owners, etc.
140
ADV 2 - Item 5 - Fees and Comp
IA's must provide fee schedule and disclose to clients whether fees are negotiable unless the brochure is delivered only to clients who are qualified purchasers ($5MM AUM).
141
ADV 2 - Item 18 - Financial Info.
- If IA requires prepayment of more than $1200 in fees per client, 6 months or more in advance, the firm must provide an audited balance sheet.
- Must disclose any financial condition that is "reasonably likely to impair the IA's ability to meet contractual commitments to clients."
142
Form CRS Updating
No annual updating requirement. Must be updated w/i 30 days whenever any information becomes materially inaccurate. Changes must be communicated to existing retail clients w/i 60 days.
143
Reg. S-P delivery requirement:
Provide to customers an initial privacy notice no later than when the customer relationship is established and annual privacy notices only if the firm discloses client information to non-exempt third parties.
144
Gardner Russo & Gardner No Action Letter
- IA would not be acting as principal for its own account wrt trx involving certin private funds where a cross transaction happened b/t a client account and an account in which the IA and any of its controlling persons, in aggregate, own 25% or less.
145
Schedule 13D
For any person/entity that acquires beneficial ownership of more than 5% of the outstanding shares of any class of equity security.
- Must be filed w/i 10 days after acquisition.
- Copies must be provided to each exchange where security is traded as well as to the issuer.
- Must be amended "promptly" to reflect material changes of more than 1%.
146
Schedule 13G
May be filed instead of 13D if person/entity acquired more than 5% but less than 20% of shares as a "passive investor."
- Must be filed w/i 45 days after end of calendar year when obligation arose.
- Or, if ownership exceeds 10% at the end of any given month, initial 13G within 10 days of the end of the month.
147
Form 13F
Quarterly report that is required to be filed by all institutional investment managers with at least $100 million.
- Must file w/i 45 days after the last day of the year in which the threshold is initially met and then 45 days after the end of each quarter.
148
Form 13H
Large trader reporting - trx equal to or greater than 2M shares or $20M during any calendar day, or 20M shares or $200M during any calendar month
- Must initially file w/i 10 days of meeting threshold. Then, within 45 days after the end of each calendar year.
- Market participants can voluntarily register as large traders even if they have not yet met threshold.
149
ADV1 Schedule A/B
Schedule A = direct owners 5%+
| Schedule B = indirect owners 25%+
150
Notice Filing
Federally covered advisers must make a notice filing with the state if they have a place of business in the state or have 6 or more clients in that state in a twelve-month period, regardless of place of business.
151
RAUM must include:
(1) family or proprietary accounts; (2) accounts for which IA receives no comp; (3) accounts of clients who are not US persons.
152
RAUM must not include
(1) assets managed by another person; (2) real estate or businesses that are not managed as investments; (3) commodities.
153
ADV2 not Required to be delivered to...
Not required to be delivered to registered investment companies, business development companies or clients receiving impersonal advice that are charged less than $500/yr.
154
SLOA - when will SEC not consider custody?
(1) client provides written instruction to custodian, including client signature, third party name and third party address or account #; (2) client authorizes the IA, in writing, to direct transfers to the third party; (3) qualified custodian performs verification of the instruction; (4) client can terminate/change instruction; (5) IA has no authority to designate or change third party; (6) IA maintains records that show third party is not related party of IA; (7) qualified custodian sends client initial notice confirming instruction and annual notice reconfirming instruction.
155
Gramm-Leach Bliley Act
Implements Reg S-P.
156
Reg S-P goals and application
Privacy of Consumer Financial Information and Safeguarding Personal Information.
Core principles: (1) Notice and (2) the right to opt out.
Applies to customers who are consumers - individuals only.
Restricts information sharing with non-affiliated third parties (affiliates and persons jointly employed by your firm and non-affiliated third parties are ok).
157
Reg S-P what info is protected
Nonpublic personal information = personally identifiable financial information and any list or grouping created from such info (not publicly available info that IA has formed a reasonable belief is publicly available).
158
Reg S-P who is protected?
Consumers v. customers.
Consumer = individual seeking to obtain or who has obtained a financial product or service for personal, family or household purposes. (Not if he only provides basic info in connection with a RFI or if he is a grantor or beneficiary of a trust).
Customer = consumer w/ "continuing relationship" with the firm.
159
Reg S-P - Requirements
Notice, opt out, safeguarding P&P
160
Reg S-P Notices
Initial and annual notices:
Consumer - not required unless firm discloses nonpublic info to non-affiliated third party (if so, initial notice must be provided before disclosure).
Customer - initial notice no later than establishment of customer relationship; annual notice. (But annual notices not required if (1) firm ahs not changed P&P re: disclosure since last notice and (2) firm does not share non public personal info with nonaffiliated third parties.
Notices must be in writing (or electronic) - not oral.
Must contain: categories of info that firm collects, categories that firm may disclose, categories of affiliates / nonaffiliated third parties to whom firm discloses info, categories of NPPI about former customers that firm discloses, explanation of right to opt out, disclosures under Fair Credit Reporting Act, description of firm's security policies.
Notices must be "clear and conspicuous."
161
Reg S-P Short form Notice
Firm may provide short form initial notice with an opt out provision to consumer who is not a customer. Must state that complete disclosure re: privacy policies is available upon request.
162
Reg S-P Opt out form
"Reasonable" = check off boxes, 30 day opt out, prompt compliance w/ opt out request unless/until revoked in writing.
Firms don't have to provide a right to opt out to share with affiliated entities or where firm needs to use info to transact business for the customer.
163
Reg SP P&P
"Safeguard Rule"
- IA must adopt P&P designed to ensure (1) security/confidentiality of customer records and info; (2) protect against threats; (3) protect against unauthorized access.
Must address the administrative, technical and physical safeguards established for the protection of customer records.
164
Reg S-AM
Limits use of info from an affiliate to solicit a consumer for marketing purposes, unless the consumer has been given notice and a reasonable opportunity to opt out.
165
Identity Theft Red Flag Rules
IAs, broker-dealers or mutual funds ("financial institutions" or "creditors") must identify, detect and respond to "red flags" indicating identity theft.
Entities that hold "covered accounts" must develop and implement a written identify theft program.
P&P should: (1) identify red flags; (2) detect red flags; (3) respond to red flags; (4) update program; (5) train staff. Must be overseen by entity's BOD or senior management.
166
2015 OCIE Exam Sweep Summary - Risk Alert
Exams focused on cybersecurity governance, identification and assessment of cybersecurity risks, protection of networks and information, risks associated with remote customer access and funds transfer requests, risks associated with vendors/third parties, detection of unauthorized activity.
167
SEC div. of IM 2015 Guidance
Three elements of risk management program: (1) assessment; (2) strategy; (3) implementation.
168
2015 OCIE Exam Initiative - Risk Alert
6 areas of focus: (1) governance and risk assessment (2) access rights and controls; (3) data loss prevention; (4) vendor management; (5) incident response; (6) Training.
169
AML Program Requirements
P&P: Development of internal P&P to prevent the firm from being used for money laundering or financing terrorist activities and to achieve and monitor compliance with the applicable provisions of the BSA.
AML Person: designation of someone responsible for AML program.
AML Training: Ongoing employee training program.
AML Testing: independent testing of AML program compliance.
170
OFAC
Treasury Dept. Office of Foreign Asset Control
| US persons are forbidden from entering into trx w/ persons on the SDN list or the subject of OFAC sanctions.
171
Client Verification
KYC.
Verify identity using: (1) name; (2) address; (3) SSN or taxpayer ID; (4) gov’t issued photo id.
Client and prospective client names should be checked against the OFAC list of blocked entities/people:
SDN: specially designated nationals list.
SDTs: specially designated terrorists.
172
High risk clients
Senior foreign political figure;
Clients in jurisdictions designated high risk.
Clients whose funds originate from offshore banks.
Suspicious clients.
173
Currency Transaction reports
IA’s required to report to IRS the receipt of cash including cash equivalents totaling more than $10K in one trx or two or more related trx.
174
Suspicious Activity Reports
• IA’s not required to file, but FinCEN encourages voluntary filing when suspected or known violations of law are detected.
• Reporting party is forbidden to notify any person involved in trx that suspicious activity was reported.
• It is a crime to engage knowingly in any transactions with proceeds from illegal $.
“knowingly” includes “willful blindness.”
• Retain relevant info for 5 years for info used as a basis for filing a SAR.
175
Suspicious Activity “red flags”
* Reluctance to provide requested/required info;
* Inconsistent or unexplained discrepancies in names, addresses, etc.
* Attempts to avoid recordkeeping or cash reporting;
* Investment trx inconsistent with stated objectives;
* Frequent transfers of cash to offshore/foreign entities;
* Frequent deposits of cash under $10K to avoid CTR reporting.
* Lack of concern about trx costs or profitability of investments.
