Failure to Disclose Law
The Securities and Exchange Commission announced an enforcement action against an investment advisory firm that failed to properly prepare clients for additional transaction costs beyond the “wrap fees” they pay to cover the cost of several services bundled together.
In wrap fee programs, subadvisers typically use a sponsoring brokerage firm to execute their trades on behalf of clients, and the costs of those trades are included in the annual wrap fee that each client pays. An SEC investigation found that Richmond, Va.-based RiverFront Investment Group disclosed to investors in Forms ADV that client trades were typically executed through the sponsoring broker so the wrap fee would cover the transaction costs. But RiverFront actually used brokers besides the wrap program sponsor to execute the majority of its wrap program trading, resulting in additional costs to clients for those transactions. While RiverFront did disclose that some “trading away” from the sponsoring broker could occur, the firm inaccurately described the frequency, rendering its disclosures materially misleading.
RiverFront agreed to settle the SEC’s charges. “Investors were misled about the overall cost of selecting RiverFront to manage their portfolios,” said Sharon Binger. “Investors in wrap fee programs pay one annual fee for bundled services without expecting to pay more, so if subadvisers like RiverFront trade in a way that incurs additional costs to clients, those costs must be fully and clearly disclosed upfront so investors can make informed investment decisions.”
The SEC’s National Exam Program has included wrap fee programs among its annual examination priorities, particularly assessing whether advisers are fulfilling fiduciary and contractual obligations to clients and properly managing such aspects as disclosures, conflicts of interest, best execution, and trading away from the sponsor. The SEC’s order against RiverFront finds that the firm violated Sections 207 and 204 of the Investment Advisers Act of 1940 and Rule 204-1(a). Without admitting or denying the findings, RiverFront agreed to be censured and pay a $300,000 penalty, and the firm must post on its website on a quarterly basis the volume of trades by market value executed away from sponsors and the associated transaction costs passed onto clients.
Investment Adviser Law
The Securities and Exchange Commission proposed a new rule that would require registered investment advisers to adopt and implement written business continuity and transition plans. The proposed rule is designed to ensure that investment advisers have plans in place to address operational and other risks related to a significant disruption in the adviser’s operations in order to minimize client and investor harm.
“While an adviser may not always be able to prevent significant disruptions to its operations, advance planning and preparation can help mitigate the effects of such disruptions and in some cases, minimize the likelihood of their occurrence, which is an objective of this rule,” said SEC Chair Mary Jo White. “This is the latest action in the Commission’s efforts to modernize and enhance regulatory safeguards for the asset management industry, which includes rules previously proposed that would modernize the information reported to the Commission and investors, enhance fund liquidity management, and strengthen the regulation of funds’ use of derivatives.”
Business continuity and transition plans would assist advisers in preserving the continuity of advisory services in the event of business disruptions – whether temporary or permanent – such as a natural disaster, cyber-attack, technology failures, the departure of key personnel, and similar events.
The proposed rule would require an adviser’s plan to be based upon the particular risks associated with the adviser’s operations and include policies and procedures addressing the following specified components: maintenance of systems and protection of data; pre-arranged alternative physical locations; communication plans; review of third-party service providers; and plan of transition in the event the adviser is winding down or is unable to continue providing advisory services. The plans would be required to address these elements that are critical to minimizing and preparing for material service disruptions, but would permit advisers to tailor the detail of their plans based upon the complexity of their business operations and the risks attendant to their particular business models and activities.
The proposed rule and rule amendments also would require advisers to review the adequacy and effectiveness of their plans at least annually and to retain certain related records.
In addition to the proposed rule, SEC staff issued related guidance addressing business continuity planning for registered investment companies, including the oversight of the operational capabilities of key fund service providers.
The proposal will be published on the SEC’s website and in the Federal Register. The comment period will be 60 days after publication in the Federal Register.
Smaller Reporting Company
In 2016, the SEC issued proposed rule amendments that would increase the financial thresholds in the definition of smaller reporting company as used in the SEC’s rules and regulations. If adopted, the proposal would expand the number of registrants that qualify as SRCs.
Under the proposed rule amendments, a company would qualify as an SRC if it is not an excluded issuer and has either:
• Less than $250 million in public common equity float as of the last business day of their most recently completed second fiscal quarter.
• For companies with a zero public common equity float, less than $100 million in revenue during its previous fiscal year.
A company that loses SRC status:
• Because its public common equity float increases above $250 million would not be able to regain SRC status until it could determine that its public common equity float fell below $200 million as of the last business day of its second fiscal quarter.
• Because its annual revenue exceeds $100 million and it has zero public common equity float would not be able to regain SRC status until it could determine that its annual revenue fell below $80 million for the preceding fiscal year.
The proposed rules would also amend the definitions of accelerated filer and large accelerated filer to eliminate the provision in each that specifically excludes SRCs but would preserve the provision regarding the size of companies that are subject to the accelerated filer disclosure and filing requirements. As a result, companies with $75 million or more of public common equity float would maintain SRC status under the amended definition, but would become subject to the requirements that apply currently to accelerated filers, including the: (a) Reduced timing to file periodic reports; and (2) Requirement that accelerated filers provide the auditor’s attestation of management’s assessment of internal controls over reporting required by Section 404(b) of the Sarbanes-Oxley Act of 2002.
The proposed rule amendments do not affect the scope of existing SRC scaled disclosure requirements.
Failure to Disclose Lawyer Free Consultation
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