SEPTEMBER 16, 2019
Welcome to PINE Advisor Solutions’ inaugural newsletter! If you’re not yet familiar with PINE, we are a Denver-based outsource solution for funds and investment managers. We offer high-touch, tailored services to private funds, mutual funds, and investment advisors. We like our clients to think of us as an extension of their staff. Outsourcing non-investment functions allows clients to focus on their core business while keeping overhead low. Our team has over 80 years of experience managing the critical non-investment functions across the alternative and registered fund space. Our experience includes acting as Chief Financial Officers, Chief Compliance Officers and Chief Operating Officers for both large and boutique investment firms.
SEC ADOPTS FORM CRS
The Securities and Exchange Commission (SEC) voted in June 2019 to adopt the proposed requirement for adviser and broker-dealer firms to complete and file the Form CRS Relationship Summary (“Form CRS”). Advisers must also provide their Form CRS to retail investors or clients with a retirement savings account initially, when opening any new account, and if there are material changes. Net worth and investment sophistication will not exempt clients from this requirement. Retail investors are defined as a “natural person, or the legal representative of such natural person, who seeks to receive or receives services primarily for personal, family or household purposes.”
Clients that are registered investment advisers to institutional separate accounts, private funds or registered funds only will not be required to file or distribute Form CRS. The SEC’s final release clarified the definition of retail investor does not include clients or prospective clients that are not natural persons, advisers and broker-dealers whose sole clients are pooled investment vehicles, including registered funds and private funds. Firms that manage only pooled asset vehicles will not be required to prepare Form CRS, even if the funds have investors that are retail investors. Also, Form CRS will not need to be completed by Exempt Reporting Advisers.
Form CRS is a two-page summary that advisors must provide to retail investors detailing their obligations and relationship. Among other topics, the document must include fees, disciplinary history, and relationship and services, which will include a description of services, additional information, and “conversation starters.” Conversation starters are pre-defined questions or statements designed to encourage clients to ask questions and establish a more knowledgeable position with respect to the Adviser and the services they offer.
The SEC stated the purpose of the form is “to reduce retail investor confusion in the marketplace for brokerage and investment advisory services and to assist retail investors with the process of deciding whether to engage, or to continue to engage, a particular firm or financial professional and whether to establish, or to continue to maintain, an investment advisory or brokerage relationship.”
Existing advisers must file their initial Form CRS beginning May 1, 2020 and no later than June 30, 2020. New advisers after June 30, 2020 will be required to include the Form CRS with their application. Firms will then have 30 days after filing to deliver their Form CRS to existing retail investor clients. Advisers must file their Form CRS as part three of their Form ADV via the Investment Adviser Registration Depository (IARD) website. Firms’ Form CRS must be in text-searchable format, and machine-readable headings for each section are required.
For firms with retail clients, as you begin putting pen to paper to complete your firm’s Form CRS, remember that PINE Advisor Solutions can help you draft, file, and maintain this along with other SEC filings.
REGISTERED INVESTMENT ADVISER VS. EXEMPT REPORTING ADVISER
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 was far-reaching legislation that sought to address correcting the causes of the 2008 financial crisis. These reforms affected all federal financial regulatory bodies. Among the many changes was the creation of an “Exempt Reporting Advisor” – “ERA” – which allows mid-sized funds that meet certain criteria to avoid some of the compliance obligations promulgated under the Investment Advisers Act of 1940 (“Adviser’s Act”).
The U.S. Securities and Exchange Commission (the “SEC”) defines an investment adviser as a “person or firm that is engaged in the business of providing investment advice to others or issuing reports or analyses regarding securities, for compensation.” In order to register with the SEC – and become a “Registered Investment Adviser” (“RIA”) – firms with over $100M in assets must file a Form ADV disclosing information about their services and fees, among other information. To maintain their status, firms must appoint a competent Chief Compliance Officer to run a compliance program that meets requirements in the Adviser’s Act.
Advisors that manage U.S.-based private funds and have under $150M in assets, and advisors with solely venture capital funds, can register with the SEC as an ERA. While ERAs do not have all the same weighty requirements as RIAs, there are overlaps in their requirements and in best practices.
Overlap – same rules apply to ERAs and RIAs:
- AML – subject to restrictions of the Office of Foreign Asset Control (“OFAC”)
- Privacy – must keep a written information security program, have an employee in charge of said program, and send a Privacy Notice to clients
- SEC exams – ERAs are included in routine exams; all the more reason to make sure you have all the necessary policies and best practices in place
- Compliance Manual & Code of Ethics – required for RIAs; best practice for ERAs
- Form ADV – while an RIA files a Form ADV 1, 2A & 2B, an ERA files only a portion of the ADV 1
- Recordkeeping – ERAs do not need to meet the same recordkeeping obligations as an RIA, but it is considered a best practice to do so
- Anti-Fraud Rules – General anti-fraud rules apply to both – no misleading statements or omissions of material fact – but RIAs have additional rules, including restrictions on advertising
Issues such as cherry-picking performance is not allowed under the anti-fraud rules, and therefore applies to ERAs
Once an ERA calculates that it manages over $150M in assets, generally on its annual filing, it has a 90-day grace period to update its SEC registration to an RIA. By taking time to put best practices into place when you are an ERA, the transition to RIA is easier and the foundation is already laid. PINE can do the heavy lifting to prepare these documents and filings for your firm. We offer ongoing compliance support including advisor registration and regulatory filings, compliance manual and code of ethics creation and updates, annual reviews, employee education and more. Please reach out learn more about our compliance and CFO services, and how we can lighten your workload so you can focus on managing money.
SEC APPROVES FIRST NON-TRANSPARENT ACTIVELY MANAGED ETFS
In April 2019, the SEC paved the way for the first actively-managed non-transparent ETF (“ActiveShares ETFs”) – one that will not need to provide daily portfolio holdings transparency – by granting exemptive relief to Precidian Investments. Until now, all actively-managed ETFs have been required to show daily holdings, which helps provide transparency into the value of underlying holdings. Holdings transparency can help market makers value an ETF, but on the flip side, it provides more insight into a portfolio manager’s strategies, thereby decreasing their “edge.”
|Daily Portfolio Transparency
||No, but any securities without readily available market quotations would be publicly disclosed
||Transactions directly with APs
||Transactions with APs through unaffiliated broker-dealers actin on an agency basis, using a confidential account
||Exchange publishes an “intraday indicative value” every 15 seconds during the trading day
||Exchange publishes a VIIV once per second throughout each trading day; ETF advisers, with board oversight, are responsible for the calculation process
||Securities and other instruments that trade on US exchanges contemporaneously with the ETF shares and cash and cash equivalents; no illiquid investments may be made
Precidian has already entered into license agreements with over 20 firms, including BlackRock and Nationwide. Through this model, Precidian allows licensed managers to offer ActiveShares ETFs by collecting an ongoing fee by licensing out its technology and process. Alternatively, Precidian will act as a sponsor and handle regulatory obligations. Precidian already has competition, as several other firms have filed for their own non-transparent ETFs.
ActiveShares’ fees will be higher than traditional index funds, and it will be required to outline how it differs from traditional ETFs – including costs and risk – on its prospectus cover. It will be interesting to see how the potential automation of active management will stack up against traditional active managers’ performance in the long run.
The Securities and Exchange Commission’s (SEC’s) Office of Compliance Inspections and Examinations (OCIE) has announced a third cybersecurity sweep. This sweep will reportedly focus on the cybersecurity practices of registered investment advisers (“RIAs”) and will specifically include RIAs with multiple offices and those recently involved in mergers and/or acquisitions.
If you have yet to focus on your firm’s cybersecurity, OCIE’s announcement highlights that the SEC’s concerns around cybersecurity are not going away. The reality of daily breaches and hacks combined with the watchful eye of regulatory bodies should put ensuring your firm has dedicated the proper resources towards cybersecurity at the top of your list.
Investment advisers should note that the SEC will continue to focus on, among other areas, governance and risk assessment, access rights and controls, data loss prevention, vendor management, training, and incident response. If you outsource your critical business functions conducing proper due diligence on your vendors to ensure they have strong cybersecurity policies in place is imperative.
WE’LL SEE YOU THERE
- – ICI Presents: The State of the Fund Industry, October 1st
– NRS Fall 2019 Compliance Conference, October 15th – 18th