FINRA Warns Firms to Finalize Forms U4 and U5 Today! SEC Withdraws Proxy Voting Letters, GIPS Proposes Changes: Regulatory Update for October 2018

by Hardin Compliance Consulting LLC

For Investment Advisers: 

SEC withdraws Prior Guidance on Proxy Voting Firm Independence.  The SEC’s Division of Investment Management issued an Information Update officially withdrawing two no-action letters on proxy voting issued back in 2004, shortly after the adoption of Advisers Act Rule 206(4)-6.  That rule, also known as the Proxy Voting Rule, requires investment advisers to adopt and implement policies and procedures for voting proxies in the best interest of clients, including a means for addressing conflicts of interest that might arise between the adviser’s interests and those of its clients.  Interestingly, however, advisers are not required to vote clients on behalf of clients.  If advisory firms take on that responsibility, however, then they must adopt the policies and procedures for voting and disclose them to clients.  The two no-action letters, Egan-Jones Proxy Services (issued May 27, 2004) and Institutional Shareholder Services, Inc. (issued September 14, 2004), are no longer available on the SEC’s website, but they allowed advisory firms to rely on the recommendations of an independent third party for voting proxies when a conflict arose.  Firms were required to perform due diligence to ensure that the proxy voting firm could make its recommendations impartially and in the best interest of clients.

This Information Update comes on the heels of SEC Chairman Jay Clayton’s announcement that staff statements “are nonbinding and create no enforceable legal rights or obligations of the Commission or other parties.”  Although the withdrawal made news, it will probably have a negligible effect on advisers’ use of proxy voting firms.  For many, the administration of the voting process and the research required to understand all the issues take too much time and effort without giving clients much discernable benefit.  Moreover, the Staff Legal Bulletin No. 30 on Proxy Voting was not withdrawn, which provides similar guidance on proxy voting service providers as the two no-action letters.  Contributed by Jaqueline M. Hummel, Partner and Managing Director

SEC Proposes New Rule for ETF Approval.  The SEC recently proposed Rule 6c-111 under the Investment Company Act of 1940 which codifies existing exemptive relief for exchange-traded funds (ETFs).  The new rule would allow ETF issuers to launch their funds without having to obtain an exemptive order from the SEC.  The proposed rule would apply to any ETF structured as an open-end fund and would apply to both index-based and actively managed ETFs. The proposed rule would not apply to unit investment trusts, ETFs structured as a share of a multi-class fund, and leveraged and inverse ETFs.  Contributed by Jaqueline M. Hummel, Partner and Managing Director

GIPS 2020: Proposed Changes to the Standards May Make Compliance Easer:   The CFA Institute recently released the revisions for the Global Investment Performance Standards (GIPS) 2020 in an Exposure Draft for public comment.  One of the goals of this draft is to make the standards more accessible to alternative investment managers and managers of pooled funds since many have not embraced the standards.

The proposed changes will most directly impact:

  • Asset managers that manage limited and broadly distributed funds. The Exposure Draft outlines several proposed changes applicable to firms with commingled funds.  A key change is that a GIPS compliant firm would not be required to create a composite for pooled funds where the pooled fund would be the only constituent of the composite.  Managers of limited distribution funds would create a GIPS Pooled Fund Report instead.  The Exposure Draft allows GIPS firms to create composites that “represent the strategies the firm offers as a segregated account” and may optionally present a GIPS Pooled Fund Report for pooled funds rather than include them in a composite.
  • Alternatives managers. The Exposure Draft provides options regarding the valuation of private market investments. The draft proposes three options to satisfy the external valuation requirement: (1) an external valuation, (2) review of valuation inputs by an outside party, or (3) a financial statement audit.
  • Asset owners. The proposed 2020 GIPS has been reorganized so that asset owners and asset managers will now refer to specific portions of the standards applicable to their firm type, with the Advertising Guidelines applying to both and existing in a third section. This should be a welcome enhancement to asset owners who were previously forced to wade through each topical section (and requirements applicable only to asset managers) to identify the relevant portions of the standards.

 Other key concept changes in the Exposure Draft include a distinction between limited and broadly distributed funds.  The draft also provides more flexibility for showing performance.  The draft allows GIPS firms to use different performance reports based on the type of investment vehicle: GIPS Composite Reports (the traditional GIPS compliant presentation), GIPS Pooled Fund Reports (applicable to limited and broadly distributed funds) and Asset Owners Reports.

Additional revisions include: (1) a return to permissible uses of carve-outs, (2) an option for firms to use money-weighted returns (MWR or IRR) in certain situations, (3) tweaks to the portability standards, and (4) modifications to the GIPS Advertising Guidelines that are intended to provide firms with more flexibility surrounding how they present the claim of GIPS compliance.

Timeline.  To facilitate the comment process on the Exposure Draft, the CFA Institute released a separate question document.  Comments can be submitted through December 31, 2018, and the adoption of the revised GIPS standards is planned for mid-2019 with an effective date of January 1, 2020.  We are closely monitoring developments related to the GIPS 2020 initiative and look forward to sharing additional details with you over the coming months.  Contributed by Cari A. Hopfensperger, Compliance Consultant

State of Pennsylvania Bans Advisers from using Client Usernames and Passwords for Custody Accounts.  The Pennsylvania Department of Banking and Securities issued a position letter on September 25, telling state-registered investment advisers and their investment adviser representatives to stop using client usernames and passwords to access client custody accounts. (The SEC issued a similar warning in an OCIE Risk Alert in 2017.)  Citing public policy concerns, the Department Staff stated that accessing a client’s custodial account through using the client’s password or username will be considered a “dishonest and unethical business practice” in Pennsylvania and a potential custody violation.  Advisers currently using client usernames or passwords should take the following steps:

  • Immediately stop using client usernames and
  • Contact affected clients before October 25, 2018 in writing and advise the clients to change their passwords and security questions immediately.
  • Retain records of the written communication to affected clients as part of the firm’s required books and records.

The deadline for compliance is October 25, 2018.   Federally registered advisers should also pay attention to this notice.  Although the SEC is the primary regulator for federally covered advisers, states can go after SEC-registered advisers for violations of state securities laws that amount to fraud.  Department Staff in Pennsylvania intend to initiate administrative actions against advisers if it spots them using client passwords and usernames after October 25, 2018.  Contributed by Carolyn W. Mendelson, Esq., Senior Compliance Consultant

For Broker-Dealers:  FINRA Actions


For Broker-dealers and Registered Investment Advisers:  all pending Forms U4 and U5 that are open after 11:00 p.m. Eastern Time on Friday, September 28th will become READ-ONLY.  Firms should submit any pending filings by end of business on September 28th to avoid having to re-generate new filings.  Please review your Firm’s filing queues and submit pending filings as soon as possible.  Here’s what is says on FINRA’s Firm Gateway:

CRD Release 2018.09 – Implementation Saturday, September 29, 2018

Release 2018.09 changes will be effective Mon., Oct. 1, 2018, and will have significant impact to firms. It will incorporate consolidated registration and qualification rule changes, the new Securities Industry Essentials (SIE) exam, revisions to the representative-level qualification exams, changes to how related information is displayed in CRD, as well as supporting changes to Forms U4 and U5.

Firms should note that this release will include changes to the “Examination Requests” and “SRO Registrations” sections of the Form U4 as well as the “SRO Partial Termination” section of the Form U5, which will support the consolidated registration rule changes. To assist firms in requesting registrations on the Form U4 SRO Registration section, a feature will be added to CRD to auto-select valid registrations previously maintained. As a result of these changes, any pending (in-process) Forms U4/U5 filings not submitted by 11 p.m.,ET, Fri., Sept. 28, will become invalidated and converted to “read-only.” Users who still need to submit any invalidated filings will have to recreate them; firms are advised to plan accordingly.

Please review the following resources:

2018.09 Release Notes

Take Note Regarding FINRA’s New Financial Industry Affiliate Waiver Program:  Since our last update, we received questions about whether participants in the new Financial Industry Affiliate Waiver Program will be required to complete Regulatory Element Continuing education during the seven-year waiver period? If yes, how will participants be notified of their continuing education obligations?  The answer is to the first question is, “Of Course!”  How else would FINRA be able to collect your regulatory element continuing education fees?  Participants will continue to be subject to the Regulatory Element program and must complete their obligations during the 120-day CE window.  FINRA will directly notify eligible individuals of upcoming Regulatory Element CE via email, and it will provide them with an interface to the FINRA CE Online System™ so that they can complete the requirement within the 120-day window. Eligible individuals will be responsible for providing FINRA their contact information, including a valid email address, and for updating such information. Eligible individuals will also be responsible for paying the CE fee.  Contributed by Rochelle A. Truzzi, Senior Compliance Consultant

Does Your Firm Effect OTC Trades in Equity Securities on a Net Basis? Trading on a net basis is basically a principal transaction where the broker-dealer executes the purchase into inventory and the sale to the client simultaneously but at different prices.  These are similar to riskless principal transactions as a result of timing but do not meet the definition of riskless principal transaction due to the difference in price.  These transactions must comply with the following Rules based on the net price of the transaction: FINRA 2124 – Net Transactions with Customers; FINRA 2121 – Fair Prices and Commissions; FINRA 5310 – Best Execution and Interpositioning;   FINRA 5320 – Prohibition Against Trading Ahead of Customer Orders; and Rule 611 of Regulation NMS –  Order Protection Rule

If your firm trades in equity securities on a net basis, review the applicable section(s) of your Written Supervisory Procedures manual and ensure that the Rules listed above are addressed.    Contributed by Rochelle A. Truzzi, Senior Compliance Consultant

WARNING! Contracts with Your 3rd Party Recordkeeping Service Providers May be in Violation of SEA Rule 17a-4: According to FINRA Regulatory Notice 18-31, the SEC considers contractual provisions allowing a service provider to delete or destroy a broker-dealer’s records as a result of non-payment by the broker-dealer to be inconsistent with the retention and undertaking requirements set forth in SEA Rule 17a-4.  Destruction of records under such circumstances may result in SEC action against both the broker-dealer and the third party service provider.  Please take a moment and review your contracts today.   Contributed by Rochelle A. Truzzi, Senior Compliance Consultant

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Updated: May 25, 2018:

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JD Supra's principal place of business is in the United States. By subscribing to our website, you expressly consent to your information being processed in the United States.

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Privacy Officer
JD Supra, LLC
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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