The Modernized Marketing Rule for Financial Advisers

On November 4, 2022, compliance with the amendments to the advertising and cash solicitation rules in Rule 206(4)‑1 under the Investment Advisers Act of 1940 (Marketing Rule), which the Commission issued on December 22, 2020 will become mandatory.

Since the advertising and cash solicitation rules were adopted (Rule 206(4)-1 in 1961 and Rule 206(4)-3 in 1979, respectively) the advent of the internet and social media, among other things, has dramatically changed the landscape of marketing professional services. The Marketing Rule is designed to modernize rules that govern investment adviser advertisements and payments to solicitors, replacing the broadly drawn limitations and prescriptive or duplicative elements in the previous rules with more principles-based provisions, as described below.

Definition of Advertisement. The amended definition of “advertisement” contains two prongs:

  • The first prong captures communications traditionally covered by the advertising and includes any direct or indirect communication an investment adviser makes that: (i) offers the investment adviser’s investment advisory services with regard to securities to prospective clients or private fund investors, or (ii) offers new investment advisory services with regard to securities to current clients or private fund investors. The first prong of the definition excludes most one-on-one communications.
  • The second governs solicitation activities previously covered by the cash solicitation rule and includes any endorsement or testimonial for which an adviser provides cash and non-cash compensation directly or indirectly (e.g., directed brokerage, awards or other prizes, and reduced advisory fees).

General Prohibitions. Under the Marketing Rule, the following advertising practices are prohibited:

  • making an untrue statement of a material fact, or omitting a material fact necessary to prevent making the statement misleading;
  • making a material statement of fact that the adviser does not have a reasonable basis for believing it will be able to substantiate;
  • including information that would reasonably be likely to cause an untrue or misleading implication or inference to be drawn concerning a material fact relating to the adviser;
  • discussing potential benefits without providing fair and balanced treatment of any associated material risks or limitations;
  • referencing specific investment advice provided by the adviser that is not presented in a fair and balanced manner;
  • including or excluding performance results, or presenting performance time periods, in a manner that is not fair and balanced; and
  • including information that is otherwise materially misleading.

Testimonials and Endorsements. The Marketing Rule prohibits the use of testimonials and endorsements in an advertisement, unless the adviser satisfies certain disclosure, oversight, and disqualification provisions:

  • Disclosure. Advertisements must CLEARLY and PROMINENTLY disclose whether the person giving the testimonial or endorsement (the “promoter”) is a client and whether the promoter is compensated. Additional disclosures are required regarding compensation and conflicts of interest. There are exceptions from the disclosure requirements for SEC-registered broker-dealers under certain circumstances. Advisers will no longer need to obtain from each investor acknowledgements of receipt of the disclosures.
  • Oversight and Written Agreement.An adviser that uses testimonials or endorsements in an advertisement must oversee compliance with the marketing rule. An adviser also must enter into a written agreement with promoters, except where the promoter is an affiliate of the adviser or the promoter receives de minimis compensation (i.e., $1,000 or less, or the equivalent value in non-cash compensation, during the preceding twelve months).
  • Disqualification. Subject to certain exceptions, “bad actors” may not serve as promoters.

Third-Party Ratings. The rule prohibits the use of third-party ratings in an advertisement, unless the adviser provides disclosures and satisfies certain criteria pertaining to how the rating was prepared.

Performance Information Generally.  In order to deter the provision of misleading information, the rule prohibits including in any advertisement:

  • gross performance, unless the advertisement also presents net performance;
  • performance results, unless they are provided for specific time periods in most circumstances;
  • any statement that the Commission has approved or reviewed any calculation or presentation of performance results;
  • performance results from fewer than all portfolios with substantially similar investment policies, objectives, and strategies as those being offered in the advertisement, with limited exceptions;
  • performance results of a subset of investments extracted from a portfolio, unless the advertisement provides, or offers to provide promptly, the performance results of the total portfolio;
  • hypothetical performance (which does not include performance generated by interactive analysis tools), unless the adviser adopts and implements policies and procedures reasonably designed to ensure that the performance is relevant to the likely financial situation and investment objectives of the intended audience and the adviser provides certain information underlying the hypothetical performance; and
  • predecessor performance, unless there is appropriate similarity with regard to the personnel and accounts at the predecessor adviser and the personnel and accounts at the advertising adviser. In addition, the advertising adviser must include all relevant disclosures clearly and prominently in the advertisement.

If you are an investment adviser, now is the time to ensure your marketing materials comply with the modernized Marketing Rule.

Pastore Argues Against White & Case in $650MM Financial Services Case Before Third Circuit

Arising from a $650 Million financing dispute, Pastore LLC, representing a large national investment bank, argued at the Third Circuit on September 29th. The argument was in person in Philadelphia. Pastore LLC has brought a FINRA arbitration to collect the investment banking fee. White & Case had sought to enjoin the securities arbitration in the DE Bankruptcy Court. Pastore LLC’s clients prevailed, and the DE case was dismissed. White & Case’s client appealed to the Third Circuit, arguing that the DE Bankruptcy Court had jurisdiction to hear the case.

Pastore Argues Against White & Case in $650MM Financial Services Case Before Third Circuit

Arising from a $650 Million financing dispute, Pastore LLC, representing a large national investment bank, argued at the Third Circuit on September 29th. The argument was in person in Philadelphia. Pastore LLC has brought a FINRA arbitration to collect the investment banking fee. White & Case had sought to enjoin the securities arbitration in the DE Bankruptcy Court. Pastore LLC’s clients prevailed, and the DE case was dismissed. White & Case’s client appealed to the Third Circuit, arguing that the DE Bankruptcy Court had jurisdiction to hear the case.

FINRA Fine and Suspension for Former CEO Dismissed

Pastore attorneys successfully represented the former CEO of a broker dealer in a regulatory dispute with FINRA. When Pastore was retained, FINRA was seeking a multi-month suspension, thousands of dollars in fines, and was days away from serving a complaint.  In the space of a few months, Pastore convinced FINRA to close the case without levying a dollar in fines or a single day of suspension.

Regulatory Assets Under Management Are Not Always All Assets Under Management

A daunting question that Registered Investment Advisers face in formulating their amended and annual form ADV 1 and ADV 2 (Brochure) submissions as required under the Investment Advisors act of 1940 is determining what the components of regulatory assets under management (“RAUM”) are, and providing adequate disclosure to the Securities and Exchange Commission (“SEC”) as to how and why the RAUM of some investment advisors is much less than the actual value of monies or investment vehicles managed.

Assets under management, or AUM, is a general term used throughout the financial industry that can be defined by many standards. AUM represents “investors’ equity” (like shareholders’ equity) and is an accurate representation of investors’ capital at risk (i.e., the amount of money that investors have invested in a manager’s fund(s))[1].  RAUM specifically refers to Regulatory AUM, which the SEC’s standard form of AUM[2].  The SEC developed this metric to have a consistent internal measurement, implementing a mandatory tiered registration of private investment advisers[3].  RAUM is the sum of the market value for all the investments managed by a fund or family of funds that a venture capital firm, brokerage company, or an individual registered investment advisor or portfolio manager manages on behalf of its clients[4].

In determining RAUM, the SEC specifically states that “In determining the amount of your regulatory assets under management, include the securities portfolios for which you provide continuous and regular supervisory or management services as of the date of filing the Form ADV[5].”  An account that a client maintains with a registered investment advisor is considered a securities portfolio if at least 50% of the total value of the assets held in the account consists of securities[6]. For purposes of this test, an investment advisor may treat cash and cash equivalents (i.e., bank deposits, certificates of deposit, bankers’ acceptances, and similar instruments) as securities[7].  The SEC also requires that you must include securities portfolios that are family or proprietary accounts, accounts for which no compensation for services is received, and accounts of clients who are not United States persons[8].

The SEC notes that “[f]or purposes of this definition, treat all of the assets of a private fund as a securities portfolio, regardless of the nature of such assets[9].”  The SEC does advise, however, that assets either the under management by another person or entity or assets that consists of real estate or businesses whose operations you “manage” on behalf of a client but not as an investment are excluded from the RAUM calculation[10].

RAUM also requires that supervision of these accounts be “continuous and regular.”  This term is defined by the SEC in two ways.  The advisor must have either discretionary authority over investments and provide on-going supervisory or management services, or, if they do not have discretionary authority over the account, they must have on-going responsibility to select or make recommendations based upon the needs of the client, as to specific securities or other investments the account may purchase and sell[11].  If such recommendations are accepted by the client, then the adviser is responsible for arranging or effecting the purchase or sale and satisfies the definition of “continuous and regular[12]”.

The SEC also uses three separate factors to determine whether supervision of assets is “continuous and regular.” The first factor is whether there was an advisory contract in place between the parties.   If the investment advisor agrees in an advisory contract to provide ongoing management services, this suggests that you provide these services for the account[13]. Other provisions in the contract, or the actual management practices, however, may suggest otherwise.  The second factor is the form of compensation received[14]. If the advisor is compensated based on the average value of the client’s assets managed over a specified period, this suggests that the advisor provides continuous and regular supervisory or management services for the account[15].  The third factor is the extent to which the assets are actively managed or whether advice is regularly provided to the client[16]. Note that no single factor is determinative, and the specific circumstances should be viewed in their entirety[17].

In summation, AUM is a method used to compute the total market value of investments that are managed by registered investment advisors on behalf of clients. RAUM is the SEC’s regulatory from of AUM. RAUM consists of the accounts that are made up of 50% or more of securities that are continuously and regularly managed by the registered investment advisor overseeing the facilitation and management of the client’s accounts.

[1] “Assets Under Management,” Investopedia, https://www.investopedia.com/terms/a/aum.asp, accessed February 5, 2021.
[2] Form ADV Instructions, https://www.sec.gov/about/forms/formadv-instructions.pdf, accessed February 5, 2021.
[3] Id.
[4] “Assets Under Management,” Investopedia, accessed February 5, 2021.
[5] Form ADV Instructions, accessed February 5, 2021.
[6] Id.
[7] Id.
[8] Id.
[9] Id.
[10] Id.
[11] Calculating Regulatory Assets Under Management – Wagner Law Group, https://www.wagnerlawgroup.com/resources/investment/calculating-regulatory-assets-under-management, accessed February 5, 2021.
[12] Id.
[13] Form ADV Instructions, accessed February 5, 2021.
[14] Id.
[15] Id.
[16] Id.
[17] Id.

Pastore & Dailey Successfully Represents Broker Dealer Regarding Errors in Filings

Pastore & Dailey successfully obtained a favorable stipulation and agreement with the Connecticut Department of Banking on behalf of a large national registered broker-dealer.  The Department of Banking conducted an investigation into the broker dealer and concluded that the broker-dealer has failed to file a timely U5, included misinformation on a U4, and failed to renew its registration for the calendar year. Following our successful representation, the broker dealer was able to amend its filings and receive a favorable stipulation and agreement with the Department of Banking.

FINRA Fines Member Firms for Violation of Its Recordkeeping Provisions and Issues Cybersecurity Warning

FINRA fined twelve of its largest member firms a combined $14.4 million for violation of its Rule 4511 and SEC Rule 17a-4(f) for their failure to keep hundreds of millions of electronic documents in a WORM or “write once, read many” format.  The WORM format is designed to ensure that important firm records including customer records containing Personally Identifiable Information are not altered after they are written.

The firms included Wells Fargo & Co., RBC Capital Markets, LPL Financial, RBS Securities, SunTrust Robinson Humphrey, Georgeson Securities Corp and PNC Capital Markets.  FINRA also found that these firms violated its Rule 3110, Supervision, and several other SEC recordkeeping provisions, Securities Exchange Act Section 17(a) and Rules 17a-4 (b) and (c), thereunder.

FINRA noted that such records must be maintained in order to ensure member firm compliance with investor protection rules and that over the last decade the volume of such data being stored electronically has risen exponentially.  In a cybersecurity warning, FINRA stated:

there have been increasingly aggressive attempts to hack into electronic data repositories, posing a threat to inadequately protected records, further emphasizing the need to maintain records in WORM format.

P&D is pleased to note that its newest partner, John R. “Jack” Hewitt is one of the country’s foremost cybersecurity authorities, and a major part of his practice is advising broker-dealers, RIAs and banks on their adherence to SEC, FINRA, CFTC and state cybersecurity requirements.  Among other things, he advises firms on information security programs, guides them through cyber-incidents and represents them in the event of a regulatory inquiry.  Mr. Hewitt regularly conducts cybersecurity audits for broker-dealers and investment advisers, and was the SEC appointed independent outside consultant in the first major SEC cybersecurity enforcement action.  He is the author of Cybersecurity in the Federal Securities Markets, a BloombergBNA publication, and Securities Practice & Electronic Technology, an ALM treatise. Mr. Hewitt is the Co-Chair of the American Bar Association, Business Section, White Collar Crime Subcommittee on Cybersecurity.

Read FINRA’s official announcement

NYS DFS Cybersecurity Regulation Webinar 4/20/17: Presented by P&D’s Jack Hewitt and CohnReznick’s Jim Ambrosini

John R. Hewitt, Partner at Pastore & Dailey LLC, and Jim Ambrosini, Managing Director at CohnReznick Advisory, will be conducting a complimentary Webinar on Thursday, April 20, 2017 at 12:00 PM EDT.  Mr. Hewitt is recognized as a national authority in cybersecurity and Mr. Ambrosini is a leader in cybersecurity and technology assurance service offerings at CohnReznick.

Mr. Hewitt and Mr. Ambrosini will discuss the New York State’s Department of Financial Services (DFS) regulation, effective as of March 1, 2017, providing an overview of the regulation, a summary of what controls must be in place, how to implement controls using a risk-based approach, key DFS regulation issues, and how to develop a roadmap towards compliance.

Please join us for this Webinar on April 20, 2017 at 12:00 PM EDT by registering below:

https://event.on24.com/eventRegistration/EventLobbyServlet

Broker’s U5 Overturned

Pastore & Dailey successfully argued for the correction of a bond trader’s Form U5 before a FINRA Arbitration Panel. This trader’s former employer, a worldwide banking institution, misrepresented the reason for the termination of his employment. Pastore & Dailey convinced the Panel to rule that the wording must be changed to reflect the reality. Contested expungement hearings are rare, and the re-writing of a U5 by a panel in such a situation is extraordinary. Pastore & Dailey is pleased that it could achieve this result, the correct result, for its client.

Should All Financial Advisors Bear the Obligations of Fiduciary Duty?

As of today, in the retirement and savings plan matters, money managers are not required to register as fiduciaries. The Department of Labor (“DOL”) is about to clarify the situation by wiping out the difference that exists between financial advisors and broker dealers in regard to their responsibilities in retirement advices.

A fervent debate is currently on regarding whether the fiduciary duty should be applicable to broker dealers. Under section 3(21)(A)(ii) of the Employee Retirement Income Security Act (“ERISA”), a fiduciary advisor is a person who “renders investment advice for a fee or other compensation, direct or indirect, with respect to any moneys or other property of such plan … .” In other words, the fiduciary advisor has to act solely in another party’s interests. The main corollary of this principle, for the fiduciary, is to avoid any conflicts of interest between itself and its clients.

Recently, the United States Supreme Court clarified the scope of the fiduciary duty under ERISA – Tibble v. Edison International, No. 13-550 (U.S. 2015). The Supreme Court expressed that a fiduciary “has a continuing duty to monitor trust investments and remove imprudent ones. This continuing duty exists separate and apart from the fiduciary’s duty to exercise prudence in selecting investments at the outset.”

Some financial services providers do not seem concerned about the possibility of a higher standard – i.e., they already support these basic safeguards in their work policy. Others who are under the pressure of their executives demanding large profit-return, seem to “forget” some of these principles and claim that they will not be able to serve their clients or stay in business if such a rule came into effect.

Who Takes the Lead?

Although initially the Securities and Exchange Commission (“SEC”) regulated broker dealers and investment advisors, it has delegated a large part of its prerogatives related to the broker dealers to the Financial Industry Regulatory Authority (“FINRA”). Nevertheless, when investment advice and securities transactions are related to savings and retirement plans the DOL also has a say in the matter.

Industry groups have widely expressed their concerns with the idea of a fiduciary standard commitment for broker dealers. The fact that the DOL is conducting the project understandably makes the financial services industry skeptical as the connection between them and the DOL is much less privileged than with the SEC or FINRA.

Financial services providers would welcome a consistent and coordinated interpretation of this new standard by the DOL and SEC; divergence between regulators would not serve anyone and would confuse both providers and clients. Trustees believe the industry and investors would be better served if the SEC took the lead and the DOL incorporated the standard guidelines in its interpretation of ERISA.

The Crisis Aftermath

Investment advisors – who provide investment advices – undertake to strictly respect the fiduciary duty. The objectives and interests of their clients must be their priorities when they suggest securities acquisitions. Any conflict of interest must be avoided or at least fixed in the Clients favor.

As opposed to advisors, broker dealers – who only execute securities transactions – have so far not been required to follow the fiduciary duty principle. However, as they suggest the purchase of securities, they are held to submit suitable products to their clients in regard to their financial situation and investment objectives. However, FINRA “suitability” standard does not mean that the products sold must be the best in respect to the purchaser profile.

During the latest financial crisis, many people learned the hard way that, even though those brokers were managing their savings, they were not fiduciaries and, consequently, were not held by the fiduciary duty. Thereafter, Congress adopted the Dodd-Frank Wall Street and Consumer Protection Act, with the intent to have the SEC examine the need of a new uniform federal fiduciary rule both for brokers and advisors. The SEC did so, and in 2011 released that a uniform standard would be appropriate.

At the same time, the DOL – which enforces among others the ERISA – implemented its own set of regulations in this matter with the intent to put some safeguards in place regarding retirement and savings accounts. In its new regulations, it focuses mainly on the conflict of interest facet of the fiduciary duty in respect to retirement accounts.

Two Week Extension

In 2010, the DOL wished to expand the definition of Fiduciary Duty under the ERISA but, eventually, overwhelmed by the industry pressure, had to withdraw it. In February 2015, President Obama asked the DOL to move ahead on its fiduciary rule.

Although Senators from both sides asked the DOL to extend the comment period, arguing that the matter is too complex to be commented in 75 days, the latter extended the period only for two weeks. Rule makers bode that a longer extension of this period could be prejudicial for their project.

http://newoak.com/wp-content/uploads/Defining-Fiduciary-POV-F3.pdf

https://www.grantthornton.com/~/media/content-page-files/financial-services/pdfs/2013/BD/130905_Secuirities_Adviser_Newsletter_October2013_130925%20FIN.ashx

http://www.forbes.com/sites/ashleaebeling/2015/04/14/dol-issues-proposed-fiduciary-rule-2015-version/

https://www.asppa.org/News/Browse-Topics/Details/ArticleID/4515

http://www.investmentnews.com/article/20150515/FREE/150519925/dol-extends-comment-period-on-fiduciary-duty-proposal