Fee-Based Annuities Get a Boost, More Resources on Reg BI and Form CRS, States get Tough on Crypto Scams, and SEC Speaks on Proxy Voting: Regulatory Update for September 2019

For Investment Advisers: IRS and SEC Actions

IRS Ruling Allows Advisers to be Paid out of Fee-Based Annuities. Nationwide and a few other insurers, including Lincoln Financial and Great American Life, have received private letter rulings from the Internal Revenue Service that allow advisory fees to be paid out of non-qualified annuities without being taxed as a distribution. This is a big win for advisers who want to offer fee-based annuities to their clients. By way of background, non-qualified annuities are purchased outside of a retirement or other tax-advantaged account. Qualified annuities are purchased in retirement accounts, such as a 401(k) plan or an IRA. A fee-based annuity, whether variable or fixed, charges an on-going asset-based fee instead of a commission. Insurers created this product to be sold by registered investment advisers.

The big stumbling block for advisers wanting to offer non-qualified annuities was the expense. Deducting the advisory fee from a non-qualified annuity was considered a distribution, creating a taxable event for the client. Conversely, withdrawals for advisory fees from qualified annuities are considered an expense of the taxpayer’s financial plan and are not taxed as a distribution. The letter ruling changes the IRS prior position for the tax treatment of advisory fees for non-qualified annuities; now, they are considered an expense of the annuity contract. The IRS private letter ruling requires that the advisory fees meet these conditions: the fee must be authorized by annuity owner, must be used only to pay for the management of the annuity, and cannot exceed 1.5% of the assets under management (the cash value of the annuity contract). Although IRS private letter rulings only apply to those insurers who have received them, it is expected that insurance companies will follow Nationwide’s lead and request similar relief. For more information about the recent IRS private rulings that allow advisers to be paid out of fee-based annuities, read this thorough and well-thought-out analysis by Michael Kitces Contributed by Jaqueline M. Hummel, Partner and Managing Director.

At Long Last… the SEC provides Guidance on Voting Client Proxies. After ten years of discussion, the SEC has issued guidance for investment advisers on how to fulfill their proxy voting responsibilities (the “Guidance”). Here are some highlights:

  1. Advisers are not required to accept the authority to vote client securities.
  2. Advisers and their clients can agree to limit the scope of the adviser’s proxy voting authority. The Guidance provides some examples of how to limit this authority, such as only voting on corporate events (e.g., mergers and acquisitions), or always voting as recommended by the issuer’s management. The SEC acknowledges that in some situations, the cost of voting a proxy could exceed the benefit to the client or the vote may not have a material effect on the value of the investment. In those cases, the adviser and client can agree not to waste resources on determining and casting a vote.
  3. Advisers should look at whether certain proxy voting issues require more detailed analysis than simply applying general proxy voting guidelines (e.g., routine matters versus non-routine).
  4. Advisers should sample the proxy votes cast as part of its annual review of compliance policies and procedures to determine whether the votes are being cast consistently with the firm’s voting policies and procedures.
  5. Advisers that hire proxy voting firms to provide voting recommendations and execute votes should test to verify that the votes were cast following the adviser’s stated policy and procedures.
  6. For certain matters where the adviser’s proxy voting policies and procedures are silent, or the matter is controversial, advisers should consider whether to institute a “higher degree of analysis” for determining how to vote in the client’s best interest.

The SEC also had a few recommendations for investment advisers when selecting proxy voting advisory firms.

  • Perform due diligence on the proxy voting firm to determine whether it has capacity and competency to adequately analyze the matters for which the investment adviser is responsible for voting;
  • Review the proxy voting firm’s process for making its recommendations, and its process for dealing with and disclosing conflicts of interest;
  • Determine whether the proxy voting firm has the resources required to handle the proxy voting process, in terms of staff, operations, and technology.

Finally, the SEC also recommended periodically reviewing the proxy voting firm’s process for obtaining the most accurate and up-to-date information on voting issues. Contributed by Jaqueline M. Hummel, Partner and Managing Director

For Investment Advisers and Broker-Dealers

What’s New with Regulation Best Interest and Form CRS Relationship Summary? Industry participants are coming together to tackle the onerous work stemming from Reg BI and Form CRS. This is great news as we can all benefit from each other’s experiences, insights, and yes, even mistakes. I encourage CCO’s to join their local roundtables. If one doesn’t exist in your area, see how you can start one! There are many articles from industry professional associations and organizations, law firms, consulting firms, and regulators providing guidance on how to prepare for the June 30, 2020, implementation deadline. Below are a few of our favorites:

The SEC also recently launched “Welcome to Investor.gov/CRS,” which contains information for investors about Regulation BI and Form CRS, including a series of videos on topics that include “Brokers and Investment Advisers: Knowing the Difference” and “Brokers and Investment Advisers: How they are Paid.” Form CRS requires a link to this site.

Next month, we will take a detailed look at Form CRS. Contributed by Rochelle A. Truzzi, Senior Compliance Consultant.

States Continue to Find Trouble Brewing in Crypto Markets. State and Canadian provincial securities regulators continue to pursue a coordinated cryptocurrency sweep through the North American Securities Administrators Association (“NASAA”), bringing enforcement cases and investigations against certain actors in this fledgling industry.

NASAA recently reported that its “Operation Cryptosweep” has netted, to date, over 85 enforcement actions and pursued more than 330 inquiries and investigations regarding cryptocurrency investment products. As stated by NASAA, “[T]he task force [has] identified hundreds of ICOs in the final stages of preparation before being launched to the public. These pending ICOs were advertised and listed on ICO aggregation sites to attract investor interest. Many have been examined … [and a] number of these investigations [have] resulted in enforcement actions.”

These enforcement actions commonly cite crypto-space actors and platforms for offering and selling unregistered or non-exempt securities, acting as unregistered broker-dealers, and committing securities fraud. According to NASAA, Texas and New York have been especially active in this sweep with the Texas State Securities Board issuing 13 “cease and desist orders” and the New York State Attorney General’s office sending out 13 “Information Demand Letters” to virtual currency trading platforms or “exchanges” requesting information about their business practices. The full list of enforcement actions brought in connection with “Operation Cryptosweep” can be found here. NASAA’s coordinated crypto sweep is ongoing. Contributed by Carolyn W. Mendelson, Senior Compliance Consultant.

For Broker-Dealers: FINRA Actions

Do You Need to Register as a Municipal Advisor? If your firm “provides advice to or on behalf of a municipal entity or obligated person with respect to municipal financial products or the issuance of municipal securities, including advice with respect to the structure, timing, terms, and other similar matters concerning such financial products or issues; or undertakes a solicitation of a municipal entity or obligated person”, it meets the definition of a Municipal Advisor and must register or qualify for an exemption or exclusion from the definition of Municipal Advisor. FINRA issued Regulatory Notice 19-28 to remind firms of their supervisory obligations when conducting investment-related activities with municipal clients. Contributed by Rochelle A. Truzzi, Senior Compliance Consultant.

For Mutual Fund Managers: SEC Actions

SEC Staff Issues No-Action Letter on Hiring Affiliated Sub-Advisers without Shareholder Approval. Since the mid-’90s, the SEC has regularly offered multi-manager open-end funds an exemption from requiring shareholder approval to appoint a new sub-advisor if certain conditions were met. These conditions included that the fund must obtain shareholder approval and include disclosure in the fund’s prospectus. Traditionally, the SEC granted this relief to unaffiliated sub-advisors only. Over time, the staff granted relief to sub-advisors that were wholly-owned by the fund or its adviser but left sub-advisors that were only partially owned by the fund or its adviser without relief. To close this gap, the SEC issued new exemptive relief in May of this year to the Carillion funds (“Carillion Order”). In addition to covering partially and wholly-owned sub-advisors, the Carillion Order established a set of new conditions that differed in some respects from the original conditions. In this August 9, 2019 no-action letter, the SEC has clarified that funds may continue to rely on previously granted exemptive relief without being required to seek an amendment to that “Prior Multi-Manager Order,” provided the fund complies with the new conditions established in the Carillion Order in their entirety. Contributed by Cari A. Hopfensperger, Senior Compliance Consultant.

For Hedge Fund Managers: NFA/CFTC Actions

New Dues for CPO/CTAs Engaged in Swap Activities. The NFA released Notice I-19-15 in June, reminding its members of a new annual surcharge of $1,750. The surcharge applies to NFA Members, including CPOs and CTAs, that are currently approved or are pending approval as swap firms. The surcharge becomes effective on January 1, 2020, and will be included on all invoices for dues of affected Member firms payable after that date. Firms can check swap approval status on the NFA’s BASIC system, and swap-approved Member firms that are not engaged in swaps activities or are not otherwise required to be a swap-approved firm can withdraw swap approval status (and avoid this surcharge) by completing Form 7-W using NFA’s Online Registration System (ORS). Contributed by Cari A. Hopfensperger, Senior Compliance Consultant.

Photo Credits: Photo by Anton Sharov on Unsplash

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Hardin Compliance Consulting LLC

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Updated: May 25, 2018:

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Privacy Officer
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10 Liberty Ship Way, Suite 300
Sausalito, California 94965

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Privacy Officer
JD Supra, LLC
10 Liberty Ship Way, Suite 300
Sausalito, California 94965

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