On July 21, 2010, the SEC unanimously approved amendments to Form ADV, Part 2, the disclosure document investment advisers are required to provide to clients. ADV Part 2 is a detailed document, explaining investment advisers’ qualifications, investment strategies and business practices.
For more than 30 years, the SEC has required registered investment advisers to deliver this written disclosure statement to clients. In 2000, the SEC proposed a complete overhaul of Form ADV. However, the overhaul did not result in a change to Part 2. Accordingly, in 2008, the SEC proposed additional amendments to ADV Part 2, which they finally approved on July 21st.
SEC Chairman Mary L. Schapiro commented that “[i]n its current form, [ADV Part 2] requires advisers to respond to a series of multiple-choice and fill-in-the-blank questions organized in a ‘check-the-box’ format. But, the format frequently does not correspond well to an adviser's business. And, in some cases, the required disclosure may not describe the adviser's business or conflicts in a way that is truly accessible to the investor.”
The new amendments will require investment advisers to provide a narrative that is “well-suited to serve investors’ needs.” The narrative will include the investment advisers’ conflicts, compensation, business activities and disciplinary history. The amendments will further require that ADV Form 2 be available electronically through the SEC website, thereby providing investors with greater and more easily attainable access to investment adviser disclosures.
Chairman Schapiro expressed the utmost confidence in the new amendments at a recent SEC open meeting, stating that the new changes “will allow clients ready access to information about advisers of a wholly different character and quality than is available under the current regime. It will enable investors to better evaluate their current advisers, or comparison shop for a new adviser that best serves an investor's needs.” Chairman Schapiro even went so far as to predict that the new disclosure requirements “may result in advisers modifying business practices and compensation policies which might pose conflicts, in ways that better serve the interests of clients.”
The amended rules will be effective 60 days after publication in the Federal Register, and investment advisers should begin distributing and publicly posting new ADV Form 2 disclosure in early 2011.
Our attorneys have experience with investment adviser and broker state registration matters, including annual and as-need ADV updates and reviews. If you or your company has concerns about the new amendments to ADV Part 2, please do not hesitate to contact us.
A copy of the SEC press release detailing the ADV Part 2 amendments is available here.
Tuesday, July 27, 2010
The Murky Waters of State Commodity Laws
State commodity laws are notoriously antiquated and hard to follow. For many precious metals dealers, it can be difficult to navigate the applicable state laws in the various states where they do business.
This difficulty arises for several reasons. First, the Model State Commodity Code (“Model Code”) was drafted in the early 1980s, and it has not been updated since its inception to account for changes in technology that affect the way legitimate precious metals dealers do business. Second, the Model Code has only been enacted as it was written by a handful of states, so there is a lack of uniformity from state to state. Third, some states, like Arizona and Montana for example, have adopted substantive provisions of the Model Code, but these provisions have been incorporated into the state securities laws, instead of a separate Chapter or Act. Finally, there are states that have chosen not to regulate commodity transactions at all or that have decided to regulate them using a different approach than that set out in the Model Code.
The Model Code originally was drafted to provide state jurisdiction over generic commodities-themed frauds because the state securities acts were inadequate to address such schemes. As a result, the Model Code devised the concept of a “commodity contract”, which is defined as “a contract for the purchase or sale of commodities, primarily for speculative or investment purposes, and not for use or consumption by the offeree or purchaser.” Therefore, this new concept was intended to provide a better means of jurisdiction over only certain commodity transactions.
Unfortunately, for precious metals dealers, the two most common schemes at the time the Model Code was drafted were centered around the sale of precious metals that were never delivered or promises to store precious metals that were subsequently never purchased. Accordingly, there are stringent provisions defining and regulating the purchase of precious metals. However, the Model Code drafters included an exemption for transactions involving the purchase of precious metals if certain very specific requirements were met. One of those requirements is that delivery must be completed within 28 days, purportedly making it easier for retailers to avoid and regulators to identify unregistered futures contracts.
Essentially, the Model Code should have streamlined the process for determining whether illegal transactions have taken place. But though the Model Code may seem straightforward on its face, the inconsistency in adoption between the states and nuances among those states that have adopted the Model Code has created a veritable trap for unwary precious metals dealers and necessitates the need for experienced counsel who are aware of the these subtle differences.
The attorneys of Cosgrove Law, LLC have a unique knowledge and understanding of state and federal commodity regulations and exemptions, with an emphasis in the area of precious metals. Our firm is a member of the Industry Council for Tangible Assets that has compiled a 500-page, nationally recognized 50 state commodities survey. Our attorneys regularly provide advice to commodity dealers about relevant state and federal regulations and assist in internal review of company procedures. As part of our firm’s compliance services, we are also available to conduct audits or assist in developing an audit program to ensure ongoing compliance.
This difficulty arises for several reasons. First, the Model State Commodity Code (“Model Code”) was drafted in the early 1980s, and it has not been updated since its inception to account for changes in technology that affect the way legitimate precious metals dealers do business. Second, the Model Code has only been enacted as it was written by a handful of states, so there is a lack of uniformity from state to state. Third, some states, like Arizona and Montana for example, have adopted substantive provisions of the Model Code, but these provisions have been incorporated into the state securities laws, instead of a separate Chapter or Act. Finally, there are states that have chosen not to regulate commodity transactions at all or that have decided to regulate them using a different approach than that set out in the Model Code.
The Model Code originally was drafted to provide state jurisdiction over generic commodities-themed frauds because the state securities acts were inadequate to address such schemes. As a result, the Model Code devised the concept of a “commodity contract”, which is defined as “a contract for the purchase or sale of commodities, primarily for speculative or investment purposes, and not for use or consumption by the offeree or purchaser.” Therefore, this new concept was intended to provide a better means of jurisdiction over only certain commodity transactions.
Unfortunately, for precious metals dealers, the two most common schemes at the time the Model Code was drafted were centered around the sale of precious metals that were never delivered or promises to store precious metals that were subsequently never purchased. Accordingly, there are stringent provisions defining and regulating the purchase of precious metals. However, the Model Code drafters included an exemption for transactions involving the purchase of precious metals if certain very specific requirements were met. One of those requirements is that delivery must be completed within 28 days, purportedly making it easier for retailers to avoid and regulators to identify unregistered futures contracts.
Essentially, the Model Code should have streamlined the process for determining whether illegal transactions have taken place. But though the Model Code may seem straightforward on its face, the inconsistency in adoption between the states and nuances among those states that have adopted the Model Code has created a veritable trap for unwary precious metals dealers and necessitates the need for experienced counsel who are aware of the these subtle differences.
The attorneys of Cosgrove Law, LLC have a unique knowledge and understanding of state and federal commodity regulations and exemptions, with an emphasis in the area of precious metals. Our firm is a member of the Industry Council for Tangible Assets that has compiled a 500-page, nationally recognized 50 state commodities survey. Our attorneys regularly provide advice to commodity dealers about relevant state and federal regulations and assist in internal review of company procedures. As part of our firm’s compliance services, we are also available to conduct audits or assist in developing an audit program to ensure ongoing compliance.
Monday, July 26, 2010
SEC Approves New Rules For Investment Adviser’s ADV, Part 2
SEC registered Investment Advisers are required to give each of their customers a copy of Part 2 of their Form ADV, commonly referred to as “the brochure.” According to the SEC, the brochure is supposed to explain the Investment Adviser’s investment strategies and business practices, and yet it may not describe them “in a way that is truly accessible to the investor.” Early last week, amendments to the current format of the brochure were approved by the Commission unanimously. According to the SEC, “these changes are designed to provide clients with greater information about the individuals who will provide them with investment advice.” Since Investment Advisers owe their clients the highest of fiduciary duties when it comes to peoples’ life savings, “greater information” doesn’t seem like a bad idea. For a full copy of the SEC’s press release regarding the amendments, click here.
Two of the more critical amendments require the Investment Adviser to disclose any disciplinary or legal event relevant to the client’s evaluation of the integrity of the Investment Adviser as well as background information regarding information about the specific individuals that will be serving the clients. Currently, certain large national Investment Advisers distribute slick brochures that fail to disclose legions of customer lawsuits and that hype up the background of only high-profile managers who actually have no contact whatsoever with the client or his or her portfolio.
Wednesday, July 21, 2010
FINRA Files Proposed Revised Discovery Guide with SEC
On July 12, FINRA filed a new Discovery Guide with regard to FINRA arbitrations for approval by the SEC. The Guide provides guidance to parties on which documents parties should exchange without arbitrator or staff intervention, and to arbitrators in determining which documents customers and member firms or associated persons are presumptively required to produce in customer arbitrations. This new Discovery Guide will replace the existing Guide, which was approved by the SEC in 1999. The process of updating the Guide has been an ongoing undertaking in one form or another since 2004.
The revisions to the Guide include: 1) substantive changes to the Guide's introduction; 2) changes in the list of documents the firm or associated person shall be required to produce in all customer cases; and 3) changes in the list of documents the customer will be required to produce in all customer cases.
An example of a substantive change in the introduction of the Guide is an expansion of the discussion on confidentiality to include a statement relating to the burden of establishing that documents require confidential treatment. This statement enumerates factors that arbitrators should consider when deciding questions about confidentiality. The factors include:
The revisions to the Guide include: 1) substantive changes to the Guide's introduction; 2) changes in the list of documents the firm or associated person shall be required to produce in all customer cases; and 3) changes in the list of documents the customer will be required to produce in all customer cases.
An example of a substantive change in the introduction of the Guide is an expansion of the discussion on confidentiality to include a statement relating to the burden of establishing that documents require confidential treatment. This statement enumerates factors that arbitrators should consider when deciding questions about confidentiality. The factors include:
- Whether the disclosure would constitute an unwarranted invasion of personal privacy (e.g., an individual's social security number, or medical information);
- Whether there is a threat of harm attendant to disclosure of the information;
- Whether the information contains proprietary confidential business plans and procedures or trade secrets;
- Whether the information has previously been published or produced without confidentiality or is already in the public domain;
- Whether an excessively broad confidentiality order could be against the public interest or could otherwise impede the interests of justice; and
- Whether there are legal or ethical issues which might be raised by excessive restrictions on the parties.
Tuesday, July 20, 2010
THE U.S. DEPARTMENT OF LABOR PROVIDES A HELPING HAND FOR EMPLOYEE BENEFIT PLAN FIDUCIARIES
On July 16, 2010, the U.S. Department of Labor issued an interim final rule aimed at enhancing disclosure requirements to fiduciaries of employee benefit plans. Specifically, the rule requires that certain service providers disclose specified information to assist plan fiduciaries in assessing the reasonableness of contracts or arrangements, including the reasonableness of the compensation paid for services and the conflicts of interest that may affect a service provider’s performance of services to the plan.
As the Department of Labor points out, in recent years, employee benefit plans have undergone a number of changes to improve efficiency and reduce the cost of administrative services for the plans and their participants. However, these changes are quite complex, making it difficult for plan fiduciaries to understand what service providers are actually paid for the specific services they render. Nonetheless, ERISA § 404(a)(1) provides in pertinent part that:
In order to comply with Section 404(a)(1), fiduciaries must have access to information sufficient to determine the reasonableness of the compensation paid for administrative services. The interim final rule is intended to provide fiduciaries with this key information by requiring certain service providers to disclose both the direct and indirect compensation they receive in connection with the services they provide to the plan. According to Phyllis Borzi, Assistant Secretary for the Employee Benefits Security Administration, the rule should allow plan fiduciaries to make more informed decisions about plan services, including the costs of services and potential conflicts of interest.
In addition to protecting and assisting plan fiduciaries, the Department of Labor believes that “mandatory proactive disclosure will reduce sponsor information costs, discourage harmful conflicts, and enhance service value.”
A complete copy of the final interim rule is available here.
As the Department of Labor points out, in recent years, employee benefit plans have undergone a number of changes to improve efficiency and reduce the cost of administrative services for the plans and their participants. However, these changes are quite complex, making it difficult for plan fiduciaries to understand what service providers are actually paid for the specific services they render. Nonetheless, ERISA § 404(a)(1) provides in pertinent part that:
[A] fiduciary shall discharge his duties with respect to a plan solely in the interest of the participants and beneficiaries and—
(A) for the exclusive purpose of:
(i) providing benefits to participants and their beneficiaries; and
(ii) defraying reasonable expenses of administering the plan.
In order to comply with Section 404(a)(1), fiduciaries must have access to information sufficient to determine the reasonableness of the compensation paid for administrative services. The interim final rule is intended to provide fiduciaries with this key information by requiring certain service providers to disclose both the direct and indirect compensation they receive in connection with the services they provide to the plan. According to Phyllis Borzi, Assistant Secretary for the Employee Benefits Security Administration, the rule should allow plan fiduciaries to make more informed decisions about plan services, including the costs of services and potential conflicts of interest.
In addition to protecting and assisting plan fiduciaries, the Department of Labor believes that “mandatory proactive disclosure will reduce sponsor information costs, discourage harmful conflicts, and enhance service value.”
A complete copy of the final interim rule is available here.
Friday, July 16, 2010
SIXTH CIRCUIT COURT OF APPEALS AFFIRMS 12-YEAR SENTENCE FOR INVESTMENT ADVISER CONVICTED OF VIOLATING INVESTMENT ADVISERS ACT
On Wednesday of this week, the Court of Appeals for the Sixth Circuit affirmed the conviction of Ohio investment adviser Mark Lay. See U.S. v. Lay, 2010 WL 2757123 (CA.6, July 14, 2010). Lay was indicted for violating 15 U.S.C. § 80b-6(2) and (4) for engaging in a course of business which operated as a deceit upon his client and engaging in a practice that was deceptive or manipulative. Specifically, Lay was accused of violating a leverage cap of 150% within an advisory agreement and then failing to disclose that failure to his client.
On appeal, Lay argued unsuccessfully that the District Court should have granted him relief after the jury convicted him because the alleged victim – The Ohio Bureau of Worker’s Compensation – wasn’t actually a client to whom he owed a fiduciary duty. The Court concluded that a reasonable jury could have found Lay guilty of investment adviser fraud for failing to disclose his leveraging activity to his client -- even if the 150% was merely a guideline, rather than an agreed upon cap.
The District Court opinion affirmed by the Appellate Court provides a thorough and detailed review of the jury instructions utilized at trial. A review of the instruction’s expansive definitions of Investment Adviser Act terminology – such as “scheme” and “deceptive” – may very well prompt some sleepless nights for investment advisers who never even considered the possibility of imprisonment. See U.S. v. Lay, 566 F.Supp.2d 652 (N.D. Ohio 2008).
On appeal, Lay argued unsuccessfully that the District Court should have granted him relief after the jury convicted him because the alleged victim – The Ohio Bureau of Worker’s Compensation – wasn’t actually a client to whom he owed a fiduciary duty. The Court concluded that a reasonable jury could have found Lay guilty of investment adviser fraud for failing to disclose his leveraging activity to his client -- even if the 150% was merely a guideline, rather than an agreed upon cap.
The District Court opinion affirmed by the Appellate Court provides a thorough and detailed review of the jury instructions utilized at trial. A review of the instruction’s expansive definitions of Investment Adviser Act terminology – such as “scheme” and “deceptive” – may very well prompt some sleepless nights for investment advisers who never even considered the possibility of imprisonment. See U.S. v. Lay, 566 F.Supp.2d 652 (N.D. Ohio 2008).
Wednesday, July 14, 2010
SEC Approves FINRA’s Proposal to Expand BrokerCheck Disclosure
Yesterday, the Financial Industry Regulatory Authority (FINRA), announced in a News Release that its proposal to expand the information made available through its database, BrokerCheck, was approved by the Securities and Exchange Commission.
According to the FINRA News Release, “the changes will increase the number of customer complaints reported publicly; extend the public disclosure period for the full record of a broker who leaves the industry from two years to 10 years; and, make certain information about former brokers available permanently, such as criminal convictions and certain civil injunctive actions and arbitration awards against the broker.”
The changes will be implemented in two phases. The first is slated for August and will add historic complaints. Finally, during the fall months, the full 10-year record for brokers who exited the industry will be made public. The additional information should be fully available to the public by the end of the year.
We have previously contemplated the issues surrounding additional disclosure on our blog. This posting can be accessed here.
According to the FINRA News Release, “the changes will increase the number of customer complaints reported publicly; extend the public disclosure period for the full record of a broker who leaves the industry from two years to 10 years; and, make certain information about former brokers available permanently, such as criminal convictions and certain civil injunctive actions and arbitration awards against the broker.”
The changes will be implemented in two phases. The first is slated for August and will add historic complaints. Finally, during the fall months, the full 10-year record for brokers who exited the industry will be made public. The additional information should be fully available to the public by the end of the year.
We have previously contemplated the issues surrounding additional disclosure on our blog. This posting can be accessed here.
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