New Definition of Qualified Client Takes Effect, FINRA Speaks on Best Execution, Margin Requirements and Private Placements and More: Regulatory Update for August 2021


For Investment Advisers and Broker-Dealers

Trading Restrictions Impacting Chinese Military Companies Persist but Modified Under New Executive Order. President Biden signed Executive Order 14032 (“E.O.”) on June 3, 2021, which effectively continues the restrictions on purchasing or selling publicly traded securities of certain Chinese Military companies by amending Executive Order 13959, but adjusts the framework for those restrictions in the future. According to the E.O. Fact Sheet, the scope of the restrictions has been expanded to address “the use of Chinese surveillance technology outside the PRC, as well as the use to facilitate repression or serious human rights abuses.”

Practically speaking, the new list of restricted companies has grown from 31 to 59, and OFAC has harmonized its “Non-SDN Chinese Military-Industrial Complex Companies List” with the E.O. The E.O. (and trading restrictions on publicly traded securities of the companies listed) will be effective on August 2, 2021. Restrictions on any securities added from now on will become effective at 12:00 a.m. ET 60 days after the company’s addition to the list. Impacted firms monitoring compliance with the E.O. can sign up with OFAC for email updates when the list changes here.

The E.O. also clarifies some prior ambiguity associated with the original order; first, the restrictions apply only to those companies whose names match exactly and are explicitly designated. Second, the definition of publicly-traded securities still includes American Depositary Receipts (ADRs) and other similar securities. Additionally, OFAC published several new FAQs associated with the new E.O. For example, FAQ 902 clarifies that a U.S. individual serving as a fund manager for a non-U.S. investment fund, or a U.S. RIA engaged as the investment adviser to a non-U.S. investment fund, would not violate the E.O. if it traded a restricted company, provided that the trade would not otherwise violate E.O. 13959, as amended (e.g., the trade is not for the ultimate benefit of a U.S. person, etc.) Refer to OFAC’s FAQ on Chinese Military Sanctions for more information. Contributed by Cari A. Hopfensperger, Senior Director.

Colorado Becomes the Third U.S. State to Pass Comprehensive Data Privacy Act. Governor Jared Polis signed the Colorado Data Privacy Act (the “CPA”) on July 7, 2021, and it takes effect on July 1, 2023. In passing the CPA, Colorado becomes the third state behind California (2018) and Virginia (2021) to adopt comprehensive privacy legislation. At a high level, the CPA applies to “legal entities that conduct business or deliver commercial products or services that are intentionally targeted to residents of Colorado; and that either:

  • Control or process personal data of more than 100,000 consumers annually; or
  • Derive revenue (or discount on the price of goods or services) from the sale of personal data and control or process the personal data of at least 25,000 consumers.”[1]

The CPA’s definition of “consumer” excludes individuals acting in a commercial or employment context), and there are categories of exemptions. Most noteworthy for many financial service firms will be that entities subject to the Gramm-Leach-Bliley Act will fall out of scope. For more details, check out the Worth Reading link below to a recent blog post by Joseph Duball of International Association of Privacy Professionals (“IAPP”) in The Privacy Advisor: “Colorado Privacy Act passes, professionals ponder effects.” Contributed by Cari A. Hopfensperger, Senior Director.

For Investment Advisers

SEC Adopts Inflation-Adjusted Threshold for Qualified Clients. Effective August 16, 2021, the net worth and assets under management tests for investment advisor “qualified clients” will increase. The SEC made the change under the Dodd-Frank Act that requires such adjustments for inflation every five years. Section 205(a)(1) of the Investment Advisers Act of 1940 (“Advisers Act”) generally prohibits an investment adviser from charging a client a performance-based fee unless the client meets the definition of a qualified client: an individual or entity, immediately after entering into an advisory contract with an RIA, with at least $1 million under management by the adviser or believed by the adviser to have a net worth of at least $2.1 million (together, in the case of a natural person, with assets held jointly with a spouse). The new thresholds raise the bar for satisfying both tests and are effective August 16, 2021.


Current Threshold

New Threshold

Assets Under Management Test

at least $1,000,000

at least $1,100,000

Net Worth Test

at least $2,100,000

at least $2,200,000

Firms are encouraged to review their private fund subscription documents, client contracts for relevant separately managed accounts, and any related policies and procedures to address the revised levels. The SEC’s order notes that contracts entered before this adjustment (and satisfied the then-current thresholds) will generally continue to meet this requirement. However, if a new party is added to the contract (including an equity owner of a private investment company advised by the adviser), then the thresholds in effect at that time will apply. (See Footnote 12 of the order.) Contributed by Cari A. Hopfensperger, Senior Director.

For Private Funds – CFTC & NFA Actions

Amended CPO Form-PQR Filing Requirements are Effective. NFA Notice I-21-21 reminds registered CPOs that NFA Compliance Rule 2-46 is now effective. Initially adopted in October 2020, the CFTC amended its Rule 4.27 first, which updated CPO reporting requirements on CFTC Form CPO-PQR in a few ways. First, it implemented a uniform quarterly reporting schedule for CFTC Form CPO-PQR for all CPOs. Second, it streamlined CFTC Form-PQR and improved consistency with NFA Form-PQR. Finally, it clarified that CPOs are permitted to NFA Form-PQR instead of the revised CFTC Form CPO-PQR. The NFA then followed suit, amending its Compliance Rule 2-46 to harmonize with the amended CFTC rule. Another noteworthy change is that CPO Members must now file NFA Form-PQR within 60 days of calendar quarter end. Previously, the December 31st filing was due 90 days after quarter end. The CFTC released a new FAQ to address these changes. Contributed by Cari A. Hopfensperger, Senior Director.

For Broker-Dealers

Keeping Current with Best Execution and Payment for Order Flow Obligations. FINRA considers best execution of customer orders a critical investor protection requirement, as mentioned in Regulatory Notice 21-23 and clearly demonstrated in the SEC’s Administrative Proceeding against Robinhood Financial, LLC. The purpose of FINRA’s notice is to provide firms with some general and specific reminders of their best execution requirements. Regardless of whether a firm is acting as Agent or Principal, it must conduct reasonable due diligence to determine the best market to buy/sell a security so that the customer receives a price that is as favorable as possible, given prevailing market conditions. FINRA reminds firms of several key factors to be considered when assessing a firm's “reasonable diligence” efforts. For example, compliance with FINRA Rule 5310 requires a firm to evaluate the availability of reliable and superior prices regularly and to direct order flow to markets providing the most beneficial terms. In addition, a firm must not allow an incentive for order flow to interfere with its efforts to obtain best execution. Furthermore, a member firm cannot transfer its best execution obligations to another person or firm.

Specifically, firms are required to compare the execution quality customers will receive at competing markets and identify and evaluate material differences. FINRA reminds firms of guidance regarding execution quality review standards presented in Regulatory Notice 15-46. Order-by-order review of execution quality is required for internal executions. If a firm does not conduct an order-by-order review, it must perform, at least quarterly, a rigorous review on a security-by-security or type-of-order basis. Rule 5310 prescribes specific items for consideration when reviewing execution quality, such as price improvement and internalization of transactions. Finally, FINRA reminds firms that delivering order routing and execution disclosures does not relieve a firm of its best execution duties. Contributed by Rochelle Truzzi, Senior Director.

Changes to Interpretations of FINRA’s Margin Rule. In Regulatory Notice 21-24, FINRA provides updates and clarification to its interpretations of the minimum equity requirements set forth under Rule 4210(b). Rule 4210 specifies initial margin requirements and limitations on withdrawals of cash or securities made from margin accounts. FINRA rescinded Interpretation /02, broke it into five separate topics, and introduced new interpretations /021 through /025.

  • Interpretation /021 Minimum Equity
  • Interpretation /022 Effect of Market Value Decline Below $2,000 Equity
  • Interpretation /023 Withdrawals Below $2,000 Equity
  • Interpretation /024 Minimum Equity – Cash Account
  • Interpretation /025 Pattern Day Trader

Firms may find this notice helpful in updating their current Written Supervisory Procedures addressing margin requirements. Contributed by Rochelle Truzzi, Senior Director

Private Placement Filing Requirements Updated to Include Retail Communications. Effective October 1, 2021, FINRA Rules 5122 (Member Private Offerings) and 5123 (Private Placements of Securities) will require subject firms to submit to FINRA retail communications that promote or recommend a private placement, not otherwise exempt from the Rule. Web pages, pitch decks, “teasers,” fact sheets, sales brochures, and executive summaries are just some of the additional communications subject firms will be required to include in their submission. All submissions will be made through FINRA’s Private Placement Filing System in Firm Gateway. Contributed by Rochelle Truzzi, Senior Director.

1 SB21-190 Protect Personal Data Privacy, Bill Summary:

Photo Credit: Photo by timJ on Unsplash.

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