1. SEC Enforcement Actions against RIAs
In two recent consent orders entered by the Commission against RIAs (collectively, the “Orders” and each, an “Order”), the Commission elucidated its expectations regarding: (a) disclosures about forgivable recruitment bonuses;[1] and (b) compliance with the cash solicitation rule (“Cash Solicitation Rule”)[2] when using bloggers or social media influencers as referral sources.[3]
a. Forgivable Recruitment Loans/Bonuses
On June 7, 2021, the Commission sanctioned an RIA (“VPC”) for failing to disclose in VPC’s Form ADV or elsewhere[4] that its 19 investment adviser representatives (“IARs”) – each of whom was also registered with an independent broker-dealer and that broker-dealer’s affiliated investment adviser (together with their parent company, collectively “SA”) – received approximately $1 million in forgivable (recruitment) loans from SA over a ten-year period (from 2010 through 2020).[5] The loans were dischargeable over a five-year period, with forgiveness typically tied to: (1) annual revenue targets that included both brokerage commissions and advisory fees; and/or (2) the IAR remaining registered with SA’s broker-dealer for a certain number of years.
The Commission fined VPC $45,000 and ordered the firm to retain an independent compliance consultant for failing to disclose to clients the conflict of interest created by the compensation VPC’s IARs received from SA in the form of loan forgiveness. Quoting from the Order, “The incentives were particularly strong because, unlike an ordinary bonus which would simply not be paid if targets were not reached, these agreements required the IARs to pay money to [SA ].”[6]
b. Social Media Influencers and Bloggers as Solicitors
On June 3, 2021, the Commission sanctioned a Canada-based, online-only robo-adviser (“EI”)[7] that exclusively served U.S. clients for, among other things,[8] violating the Cash Solicitation Rule[9] by compensating bloggers for client referrals. According to the Order, like other social media influencers, the bloggers in question placed hyperlinks to EI’s website in or near a favorable blog posts about EI. In total, EI paid approximately $3,400 to bloggers for referring new clients to EI and approximately $12,500 in additional compensation for blogger reviews. The Commission found that EI violated the then-applicable Cash Solicitation Rule because: (1) EI did not have the required written solicitation agreement with the bloggers; (2) EI did not require the bloggers to provide the required disclosures to solicited clients; and (3) the solicited clients did not provide EI with written acknowledgment of receipt of the required disclosures before entering into an advisory contract with EI. The Commission ordered EI to pay a fine of $25,000; however, the Commission explained that the fine amount was predicated on EI’s “cooperation in a Commission investigation or related enforcement action.”[10] The Order also noted that EI voluntarily “repaid fees to investors.”[11] In other words, absent its cooperation in the Commission’s investigation and repayment of fees to investors, the sanctions would have been more severe.
2. New Rescission Standards in Tennessee for Broker-Dealers and Issuers
In the realm of state securities registration requirements (so-called “Blue Sky” laws), the securities law practitioner’s playbook has long advised that a broker-dealer or issuer that, without qualifying for an exemption for registration, has sold an unregistered security to a customer/investor, may offer rescission[12] to the customer/investor as a means of ratifying and cutting off civil liability relative to the unregistered sale. However, as a result of a new rule passed by the Tennessee Securities Division, rescission offers in Tennessee must comply with a number of additional requirements in order to shield the broker-dealer or issuer from liability.
Rule 0780-04-02-.11, which was filed in February and has been effective since May 4, 2021, provides that the benefits afforded to rescission offers by Tennessee’s longstanding (developed in the 1980s) Blue Sky policy are now contingent on the offer satisfying a number of requirements that essentially require firms to self-report violations to the Tennessee Securities Division, comply with detailed specifications in both the substance and manner of offer, and submit to the Securities Division’s fulsome oversight of the rescission process.
The full text of the new rule is set forth below:
0780-04-02-.11 RESCISSION OFFERS.
1) By the authority delegated to the commissioner in T.C.A §§ 48-1-103(b)(11) and 48-1-116, rescission offers are exempt from T.C.A § 48-1-104 if all requirements set forth in this rule are met. All rescission offers that do not meet the requirements of this rule must comply with the registration requirements of T.C.A. § 48-1-104.
2) No rescission offer exempted by this rule may be conducted in this state without obtaining the Division’s prior written approval of the offer.
3) Any person seeking approval to conduct a rescission offer pursuant to this rule shall first notify the Division in writing. Such notice shall include:
a. A description of the securities sold;
b. The dates the securities were sold;
c. The names of the Tennessee investors who purchased the securities;
d. When the violation was discovered, if applicable;
e. How the violation was discovered, if applicable; and
f. A draft copy of the proposed rescission offer document(s).
4) The draft copy of the proposed rescission offer document(s) must include the following information:
a. A statement specifying why the rescission offer is being conducted;
b. Disclosure of all material facts regarding the rescission offer as well as any material facts that have arisen with respect to the issuer and the investment since the initial sale(s) of securities;
c. Notice of the investor’s right to rescind the purchase and recover the consideration paid plus interest at the legal rate from the date the subscription amount was paid by the investor, calculated in accordance with T.C.A. § 48-1-122(k);
d. A statement specifying the amount of time in which the investor must elect to accept or reject the offer of rescission, which shall be no less than thirty (30) days from the date the investor received notice of the offer;
e. A statement describing the effect of the failure of an investor to accept or reject the rescission offer within the designated time period;
f. A description of the procedure for accepting or rejecting the rescission offer;
g. A statement that the offeree may wish to consult with independent counsel before deciding to accept or reject the rescission offer so as to be fully informed about the risks and the consequences attached to either choice; and
h. Any other such information as the Division may deem appropriate and necessary for the protection of investors.
5) The Division reserves the right to review the rescission offer by applying the same standards for a registered offering under the following rules:
a. 0780-04-02-.03;
b. 0780-04-02-.04; and
c. 0780-04-02-.06.
6) A summary of the results of the rescission offer shall be provided to the Division in writing within thirty (30) days of the offer’s conclusion. The summary shall include:
a. The names of the investors accepting the offer;
b. The names of the investors declining the offer; and
c. Certified mailing receipts for investors who declined to respond to the offer.
7) Successful completion of a rescission offer does not relieve the offeror of any civil or administrative liability available under the Act.
[2] Advisers Act Rule 206(4)-3.
[4] The verbiage of the Order acknowledges that effective conflicts disclosures may be made outside of the Form ADV.
[5] VCP Order, supra note 1. In submitting the Offer of Settlement, VCP neither admitted nor denied the findings contained in the Commission’s Order.
[7] EI Order, supra note 3. In submitting the Offer of Settlement, EI neither admitted nor denied the findings contained in the Commission’s Order.
[8] EI was also cited for violating the Advisers Act Rule 206(4)-1 (the “Advertising Rule”) for the inclusion of misleading performance data on its website and an ineffective compliance program evidenced by the Advertising and Solicitation Rule violations. Id.
[9] In December 2020, the Commission adopted amendments to Rule 206(4)-1 to create a new marketing rule, which supersedes the former Advertising Rule and Cash Solicitation Rule. SEC Press Release, SEC Adopts Modernized Marketing Rule for Investment Advisers (December 22, 2020), https://www.sec.gov/news/press-release/2020-334. RIAs may choose to comply with either the old regime or the new regime between May 4, 2021 and November 4, 2022. See https://www.sec.gov/rules/final/2020/ia-5653.pdf However, RIAs’ compliance with the new rule during this period must be entirely within the parameters of new rule – cherry picking from one regime and the other is not permitted. See https://www.sec.gov/investment/marketing-faq.
[10] EI Order, supra note 3, at 5.
[12] Rescission is the legal remedy by which a purchaser is put in the position that he or she would have been had a transaction never occurred. Customers who bought an unregistered security that is performing well at the time the rescission offer is made typically reject the offer, thereby terminating their ability to later seek redress in court on the basis that the security was not registered at the time of purchase.
