Category Archives: new hedge fund regulations

Regulation S-ID Identity Theft Rules

Identity Theft Red Flag Rules Effective November 20, 2013

Pursuant to new SEC and CFTC rules, many registered managers, including private fund managers are now required to have identity theft programs in place.  Such managers will need to have robust policies in place in order to be compliant with the new rules.  Such policies will include: staff training for appearance of red flags, procedures for dealing with red flags, certification of procedures from administrators and/or custodians dealing with investor/customer accounts.

Below we have reprinted an article from the Compliance Focus blog maintained by Sansome Strategies LLC, a regulatory and compliance consulting company described in greater depth below.  The article reprinted below can be found here.


Identity Theft Issues for Investment Advisers and Futures Participants
Jennifer Dickinson, Sansome Strategies

A little-known provision of the Dodd-Frank Act shifted responsibility over existing identity theft rules from the Federal Trade Commission to the Securities and Exchange Commission (“SEC”) and the Commodity Futures Trading Commission (“CFTC”). The rules became effective May 20, 2013 and certain entities regulated by the SEC and CFTC will need to comply by November 20, 2013.


SEC and CFTC registrants that are “financial institutions” or “creditors” and that offer or maintain “covered accounts” for their clients will need to comply with the identity theft rules:

  • Financial institution: a bank, credit union or other person who holds a transaction account belonging to a consumer (a transaction account is one that permits withdrawals, payment orders, transfers or similar means for making payments to third parties);
  • Creditor: any person that regularly extends, renews or continues credit to others.
  • Covered account: any account that a financial institution or creditor offers or maintains:
    1. Primarily for personal, family or household purposes that involves or is designed to permit multiple payments or transactions; and
    2. There is a reasonably foreseeable risk to customers or to the safety and soundness of the financial institution or creditor from identity theft, including financial, operational, compliance, reputation or litigation risks. Examples include: for the SEC, brokerage or mutual fund accounts that permit wire transfers or other payments to third parties; for the CFTC, margin accounts.

Who will be affected, and how?

On the SEC side, broker-dealers, investment companies and investment advisers are considered financial institutions. On the CFTC side, commodity pool operators and commodity trading advisers will be considered creditors if they:

  • Regularly extend, renew or continue credit or arrange for the extension, renewal or continuation of credit; or
  • Acting as an assignee of an original creditor, participate in the decision to extend, renew or continue credit.

Firms that meet these definitions are required to implement reasonable policies and procedures that:

  • Identify “red flags” to prevent identity theft in the covered accounts they manage, and document them in the compliance program. Red flags can exist in the types of accounts the firm manages, the manner in which accounts are opened or accessed, and the firm’s previous experiences (if any) with identity theft;
  • Provide for monitoring accounts on an ongoing basis to detect red flags;
  • Respond appropriately to red flags;
  • Is periodically updated to reflect any changes in risks; and
  • Describe the various appropriate responses to red flags.

Whether a firm will meet the definitions will depend significantly on its client base and account structures. Traditional RIAs and other firms that manage accounts for individuals or family offices should look closely at those accounts to determine the types of activities that will be processed in them. A firm that handles bills or other third-party payments on behalf of its clients will need to undertake the most review and implement the most rigorous compliance program contemplated by the rules.

At first blush, fund managers may assume that these rules will not apply to them; however, care should be taken to ensure that investors’ accounts are set up to receive and hold investment amounts, and the only transfers permitted will be for management fees, performance allocations to the manager/general partner as applicable, and withdrawals by (and most importantly, back to) the investor to minimize identity theft risks. Even so, additional procedures around investor intake and withdrawal may need to be implemented.

CPOs and CTAs may undertake a similar evaluation and should also look at their investment strategies to determine the extent to which they meet the creditor definition.

Finally, even if a firm is not registered with the SEC or CFTC, identity theft can be a significant reputational and litigation risk for if they handle third-party payments on behalf of clients or investors. Accordingly state registrants and exempt firms should consider implementation as a best practice.

Compliance Strategies

The rules identify five specific categories that every compliance program should address:

  • Alerts, notifications or other warnings received from consumer reporting agencies or other service providers;
  • Presentation of suspicious documents;
  • Presentation of suspicious personal information (e.g., an unexpected or unusual address change);
  • Unusual usage of a particular account; and
  • Notices from customers, victims of identity theft, law enforcement agencies or others regarding possible identity theft in an account.

Employees should be trained to identify the above and any other red flags that are specific to the firm’s business.

Appropriate responses to a red flag incident will vary significantly depending on the circumstances. The rules mention:

  • Monitoring an account for evidence of identity theft;
  • Contacting the customer;
  • Changing passwords, security codes or other devices that permit access to an account;
  • Reopening accounts with new numbers;
  • Refusing to open an account;
  • Closing an existing account;
  • Refraining from collection activities on an account;
  • Notifying law enforcement; and

Determining that a response is warranted in a particular instance.

Other, proactive safeguards can include standardizing the forms and processes used to effect transactions in client accounts, designating a person or team of people to handle those transactions under supervision (and training them to detect identity theft), preparing and reviewing a daily transaction blotter, requiring additional approvals and documentations for higher risk transactions and implementing PINs or security questions and client call-backs, to name a few.

To the extent that safeguards are client or investor-facing (such as call-backs, PINs or other identity verification tools), these should be standardized and clients/investors notified of the procedures so they know what to expect. Obtaining client’s acknowledgment of these processes via the investment advisory or subscription agreement is a good way to handle this clearly and consistently.

To ensure compliance by November 20, 2013, we encourage all firms to reach out to their compliance consultant or legal counsel as soon as possible. Rolling out the program early will afford plenty of time to refine it by the deadline.


About Cole-Frieman & Mallon LLP

Cole-Frieman & Mallon LLP provides legal services to the investment management community.  Please reach out to us through our contact form or call Bart Mallon directly at 415-868-5345 if you have questions on implementation. 

About Sansome Strategies LLC

Sansome Strategies is a compliance consulting firm specializing in high-touch, outsourced compliance services for businesses in the investment management industry. Clients include investment advisers, futures managers, broker-dealers, hedge funds, and private equity firms. Sansome Strategies provides tailored compliance management solutions to the unique needs of each client and is focused on helping clients build and enhance their business by simplifying the compliance and regulatory process.  Sansome Strategies is wholly owned by Karl Cole-Frieman and Bart Mallon.  For more information, please contact Sansome Strategies here.

JOBS Act Proposed Regulations Passed

Fund Managers Allowed to Advertise According to New Rules

Additional Regulations Proposed by SEC

The long-awaited JOBS Act proposed regulations which will allow private fund managers to generally solicit investors for a private fund offering were finalized today.  In addition, the SEC proposed additional regulations with respect to offerings in which there has been a general solicitation.

We will be able to provide more detailed information on these developments over the coming days, but for now the following links provide helpful information:

  • SEC Adopting Release – Release No. 33-9415; No. 34-69959; No. IA-3624; File No. S7-07-12RIN 3235-AL34; Eliminating the Prohibition Against General Solicitation and General Advertising in Rule 506 and Rule 144A Offerings
  • SEC Proposing Release – Release No. 33-9416; Release No. 34-69960; Release No. IC-30595; File No. S7-06-13 RIN 3235-AL46;Amendments to Regulation D, Form D and Rule 156 under the Securities Act
  • JOBS Act Ban on General Solicitation Lifted for Fund Managers – blog post from Sansome Strategies (compliance firm)

Below is some direct language from the adopting and proposed releases.  Please contact us if you have questions on the releases or how they may relate to a proposed offering.


Adopting Release (regulation effective 60 days after publishing in Federal Register)

SEC Summary:

The amendment to Rule 506 permits an issuer to engage in general solicitation or general advertising in offering and selling securities pursuant to Rule 506, provided that all purchasers of the securities are accredited investors and the issuer takesreasonable steps to verify thatsuch purchasers are accredited investors. The amendment to Rule 506 also includes a non-exclusive list of methods that issuers may use to satisfy the verification requirement for purchasers who are natural persons. … We are also revising Form D to require issuers to indicate whether they are relying on the provision that permits general solicitation or general advertising in a Rule 506 offering.

New Regulation 506(c)(2)(ii) will read as follows:

The issuer shall take reasonable steps to verify that purchasers of securities sold in any offering under paragraph (c) of this section are accredited investors. The issuer shall be deemed to take reasonable steps to verify if the issuer uses, at its option, one of the following non-exclusive and nonmandatory methods of verifying that a natural person who purchases securities in such offering is an accredited investor; provided, however, that the issuer does not have knowledge that such person is not an accredited investor:

(A) In regard to whether the purchaser is an accredited investor on the basis of income, reviewing any Internal Revenue Service form that reports the purchaser’s income for the two most recent years(including, but not limited to, Form W-2, Form 1099, Schedule K-1 to Form 1065, and Form 1040) and obtaining a written representation from the purchaser that he or she has a reasonable expectation of reaching the income level necessary to qualify as an accredited investor during the current year;

(B) In regard to whether the purchaser is an accredited investor on the basis of net worth, reviewing one or more of the following types of documentation dated within the prior three months and obtaining a written representation from the purchaser that all liabilities necessary to make a determination of net worth have been disclosed:

(1) With respect to assets: bank statements, brokerage statements and other statements of securities holdings, certificates of deposit, tax assessments, and appraisal reports issued by independent third parties; and

(2) With respect to liabilities: a consumer report from at least one of the nationwide consumer reporting agencies; or

(C) …

(D) In regard to any person who purchased securities in an issuer’s Rule 506(b) offering as an accredited investor prior to the effective date of paragraph (c) of this section and continues to hold such securities, for the same issuer’s Rule 506(c) offering, obtaining a certification by such person at the time of sale that he or she qualifies as an accredited investor.

New Regulation Proposal Release (comment period open for 60 days)

SEC Summary:

… the[se] proposed amendments to Regulation D would require the filing of a Form D in Rule 506(c) offerings before the issuer engages in general solicitation; require the filing of a closing amendment to Form D after the termination of any Rule 506 offering; require written general solicitation materials used in Rule 506(c) offerings to include certain legends and other disclosures; require the submission, on a temporary basis, of written general solicitation materials used in Rule 506(c) offerings to the Commission; and disqualify an issuer from relying on Rule 506 for one year for future offerings if the issuer, or any predecessor or affiliate of the issuer, did not comply, within the last five years, with Form D filing requirements in a Rule 506 offering. The proposed amendmentsto Form D would require an issuer to include additional information about offerings conducted in reliance on Regulation D. Finally, the proposed amendments to Rule 156 would extend the antifraud guidance contained in the rule to the sales literature of private funds.


Cole-Frieman & Mallon LLP is a boutique law firm focused on providing legal services to private fund managers.  Bart Mallon can be reached directly at 415-868-5345.

Hedge Fund Advertising After SEC JOBS Act Vote

One of the most anticipated votes for the hedge fund industry is happening today when the SEC votes on the JOBS Act implementing regulations (for information on the proposed changes, please click here).  Presumably the SEC will allow certain private fund managers to generally solicit which means that managers will have expanded options when it comes to advertising.  This is expected to create a new category of service providers to fund managers seeking to maximize visibility.

We will of course continue to provide information on the new regulations as soon as they are released.  Below is a guest post from Mark Macias which highlights certain marketing strategies that managers might want to consider after the JOBS Act vote.


How to Prepare for the Anticipated SEC Changes on Hedge Fund Advertising
By Mark M. Macias

Most hedge funds, private equity groups and venture capitalists will be at a disadvantage when the SEC lifts the prohibition on general solicitation, which is expected to occur in 2013. The decades-old marketing ban has prevented many financial groups from developing an online infrastructure that is crucial to marketing a service to investors.

Marketing a fund with the media is drastically different than marketing a product to the public. Credibility must be established from the start before the media will even consider putting your portfolio manager on TV or quoting him as a financial expert. He may manage a $100 million portfolio, but the media is not going to take his word for it without seeing evidence of his expertise. This is why it’s so crucial for all funds to establish credibility now with a strong online presence before the new proposed SEC rules on advertising go into effect.

Here are some marketing strategies your fund should consider as it undergoes an online marketing and media campaign to reach new investors.

First – the media. Credibility matters in life, but it especially matters for journalists. Whenever a portfolio manager is pitched as an expert to the media, journalists will quietly and overtly measure his expertise, integrity and experience in the financial industry. Journalists will want to see proof on why this portfolio manager should be the best expert to add color to the market.

This is why your fund needs to establish a website now to start building credibility in the online world. If a reporter doesn’t see an online presence on your fund, credibility questions will be raised. This doesn’t mean you won’t succeed with a media placement, but it will be a much harder story sell to the media if you can’t support or show why your fund manager is an expert. You can establish credibility quickly by writing editorials on the market and submitting them to influential business news sites, like the Huffington Post, Business Insider, trade magazines, etc. Writing a book on your industry will also give you another avenue to position yourself as an expert.  Here are a few credibility questions you should be able to address and answer before your fund pursues media placements.

  • What makes you qualified to speak on this topic?
  • How many years of experience have you spent in the industry?
  • How big is your fund in comparison to others?
  • What part of your daily routine is spent reinforcing your expertise?
  • What do you know as an insider that other investors would want to know?

Once you establish credibility, how do you get the media’s attention? How do the news producers and newspaper editors decide what to print and publish? Most people ask this question like there is a magical formula that scientifically reveals whether a story should be pursed or scrapped. If it were this easy to identify news stories, you can bet the formula would have been hacked and posted on the Internet by now. The fact is news selection is an art and just like any other profession, involving creativity, opinions and experiences, it is subjective to where you stand.

News is a public service, which means your story must provide a service to the public. It sounds simplistic, but many people don’t grasp that concept. They assume the media is entitled to do feature stories on the public in the name of public service. No, the media is entitled to do stories that benefit and help the public with information that is relevant today. And in today’s saturated media market where ratings and unique viewers drive advertising rates, a story idea will have a better chance of getting picked up by the media if it has an inherent tease value. In essence, this is a story that draws readers in because they are intrigued.

One of the biggest factors that will decide whether a story makes the evening news or morning newspapers involves timeliness. News is from the root “new,” which means you must find a new and unique element to pitch if you expect the media to pursue a story on you or your fund. If your story is old news, then you need to find a new way to spin it by finding an angle that is tied to a timely matter. For example, if you are a Middle East fund, trying to get publicity in the US, tie your fund to a current event. Currently, there are protests throughout Turkey and Egypt. What are these protests doing to the stock market in those countries? How will a new leader in those countries impact the economic stability? How is the (local) currency market reacting on the international stage? Those are all questions you can pose to position your portfolio manager as an expert and in a timely manner. Here are a few questions to help you discover a newsworthy angle for your fund.

  • What is different about my fund? How does this personally relate to investors reading this publication? The more you can define it, the better your chances for a successful media placement.
  • How does my fund impacted by international events?
  • What is the timely element with my fund?
  • Is there a personal story to tell about my fund, like maybe the portfolio manager has overcome a personal obstacle or has survived through several decades of difficult financial times? What can we learn from this portfolio manager?
  • Is there a new trend arising in my field that will affect the pocket books of consumers? For example, is the rising cost of wheat starting to put a damper on profits for bagel shop or Italian restaurant owners? Will my business soon be forced to raise prices on the menus because the price of wheat keeps rising?
  • Does your fund have a direct impact on technology, materials or energy, reshaping the future? If so, what is that innovation and how will it change lives? What trend is it leading?

Finding a unique angle is not as difficult as it may sound. You just need to open your mind to timely events that impact and influence your fund. If your fund is geared towards a niche audience, like cyber security, scan the headlines in the business sections of various newspapers for possible tie-ins to current events.

The founder of MACIASPR, Mark M. Macias, has worked inside the newsrooms of NBC, CBS, KTVK, the Arizona Republic and King World Productions. As the Executive Producer with WNBC in New York, Macias approved and vetted story ideas from publicists, reporters, producers and viewers. He was also Executive Producer for a national business show that was syndicated by NBC. You can read more on his PR Firm at


Cole-Frieman & Mallon LLP is a boutique law firm focused on the investment management industry.  Bart Mallon can be reached directly at 415-868-5345.

Outsourced Compliance Company – Sansome Strategies LLC

Clients, Friends and Readers:

We are pleased to announce the launch of Sansome Strategies LLC, a high-touch outsourced compliance company.  Sansome Strategies will focus on RIAs and hedge fund managers as well as those firms operating in the commodities/futures and derivatives spaces.

As we all know, increased regulatory oversight, through both the passage of laws and the promulgation of new regulations, have changed (and will continue to change) the operating landscape for investment managers.  This is no more true than in the derivatives space where managers have now found themselves subject to CFTC oversight.  Combined with the Dodd-Frank mandate requiring hedge fund and private equity fund managers to register as investment advisers, the demand for outsourced compliance consulting services has dramatically increased.

Sansome Strategies enters the consulting space at this important time and aims to provide both large and small managers with competent and practical consulting advice.

The press release announcing the launch is found below.  For more information, please see the Sansome Strategies website.

Please also visit the Sansome Strategies blog, ComplianceFocus.


Sansome Strategies LLC Introduced as New Compliance Consulting Firm with Commodities Focus

San Francisco-Based Firm Specializes in Outsourced CCO Services

SAN FRANCISCO, CA – May 2, 2013 – Announced today is the launch of Sansome Strategies LLC, a compliance consulting firm specializing in high-touch, outsourced compliance services for firms in the investment management industry. Aiding hedge fund managers, commodity pool operators and CTAs, private equity firms, futures managers, and other investment managers, Sansome Strategies offers expertise in streamlining regulatory processes and tailoring compliance outsourcing arrangements to a business’ specific needs.

Sansome Strategies’ head of compliance operations is Jennifer Dickinson, who has extensive experience with private fund compliance, both with respect to investment adviser and futures regulation. Prior to joining Sansome Strategies, Dickinson was a Senior Compliance Consultant at Gordian Compliance Solutions, LLC. Dickinson has been a Chief Compliance Officer at several large investment managers, and worked at the law firms of Cole-Frieman & Mallon LLP and Pillsbury Winthrop Shaw Pittman LLP. “Sansome Strategies will be a perfect fit for those firms seeking one-off compliance solutions, as well as firms that need an institutional quality compliance consultant,” Dickinson said. Ghufran Rizvi, COO of Standard Pacific Capital, LLC in San Francisco agrees, “I have known Ms. Dickinson for many years. She is a great business partner and Sansome Strategies will be a valuable addition to the compliance consulting space.”

Sansome Strategies’ expertise with futures managers and commodity pool operators differentiates the firm in a crowded field and is unique in the compliance consulting industry. The firm is backed by Karl Cole-Frieman and Bart Mallon, partners and founders of Cole-Frieman & Mallon LLP, which has one of the largest private fund practices in California. “There is significant and increasing demand for a compliance firm that understands both registered investment advisers and CFTC registered firms,” according to Karl Cole-Frieman. “Changes in the CFTC’s registration and exemption requirements have forced more managers into registration,” Bart Mallon notes, “and we have not seen the existing compliance companies prepared to address this demand.”

With Sansome Strategies, clients can pick and choose from an array of options, including a completely or partially outsourced compliance program, or opt for advisory, educational, or training services only. Sansome Strategies collaborates with business management and staff to structure, implement, and maintain their compliance program. Sansome Strategies features a client-centric business model, putting a heavy focus on customized services and collaboration.


About Sansome Strategies

Headquartered in San Francisco and with a nation-wide scope of services, Sansome Strategies is a compliance consulting firm specializing in high-touch, outsourced compliance services for businesses in the investment management industry. Serving investment advisers, futures managers, hedge funds, broker-dealers, private equity firms and businesses ranging from entrepreneurial start-ups to multi-billion dollar international institutions, Sansome Strategies prides itself on tailoring compliance management solutions to the unique needs of each client. Comprised of securities industry professionals with years of experience in the financial and regulatory industries, Sansome Strategies’ mission is to simplify the compliance process, minimize risk, and lower costs, with the core goal of helping clients focus on building and enhancing their business. The firm also publishes ComplianceFocus a compliance blog designed to be a practical and accessible resource to the investment management community. For more information please visit Sansome Strategies at:

For more information, please contact:

Jennifer Dickinson
Sansome Strategies LLC

JOBS ACT – SEC Proposes New Changes to Rules 506 and 144A

The JOBS Act, enacted earlier this year, directed the SEC to remove prohibitions on general solicitation and general advertising and revise rules on the resale of securities by large institutional investors. On August 29th, the SEC issued a proposed rule to modify Rules 506 and 144A of the Securities Act, which deal with general solicitation and advertising and resales of securities by large institutional investors, respectively.

Rule 506

Under the proposed rule, companies issuing securities would be permitted to use general solicitation and general advertising to offer securities if the following conditions have been met:

  • The issuer takes reasonable steps to verify that the purchasers of the securities are accredited investors.
  • All purchasers of securities are accredited investors, because either:
    • They come within one of the categories of persons who are accredited investors under existing Rule 501.
    • The issuer reasonable believes that the meet one of the categories at the time of the sale of the securities.

The proposed rule would use a set of factors to determine if an issuer has taken the necessary steps to verify a purchaser is an accredited investor. These factors include:

  • The issuer takes reasonable steps to verify that the purchasers of the securities are accredited investors.
  • The amount and type of information that the issuer has about the purchaser.
  • The nature of the offering, meaning:
    • The manner in which the purchaser was solicited to participate in the offering.
    • The terms of the offering, such as a minimum investment amount.

Form D

The proposed rule would also affect Form D, which issuers must file with the SEC when they sell securities under Regulation D. The revised form would contain a new separate box for issuers to check if they are claiming the new Rule 506 exemption that would permit general solicitation and general advertising.

Rule 144A and QIBs

The Rule 144A exemption is a safe harbor under Section 5 of the Securities Act of 1933 that essentially allows unlimited resales of certain unregistered securities of US and foreign issuers not listed on a US securities exchange or quoted on a US automated inter-dealer quotation system to “qualifying institutional buyers” (QIBs). A QIB is an entity acting for its own account or the accounts of other qualified institutional buyers that in the aggregate owns and invests on a discretionary basis at least $100 million in securities of issuers that are not affiliated with the entity. For hedge funds and private funds this means an unregistered fund or entity that owns or invests at least $100 million in securities of unaffiliated issuers and a registered fund manager acting for its own account or the accounts of other QIBs that in the aggregate owns and has discretions over at least $100 million in securities of unaffiliated issuers. Even if a manager is a QIB, each fund itself must have $100 million in securities to qualify as a QIB.

Under the proposed rule, offers of securities could be made to investors who are not QIBs as long as the securities are sold only to persons whom the seller and any person acting on behalf of the seller reasonably believe are QIBs.


The modification of Rule 506 would allow companies to advertise and solicit the sales of securities in ways that they had not been able to do so previously. The effect on Rule 144A would be to permit the offers of securities to investors who are not QIBs but persons whom the seller reasonably believes are QIBs.


Cole-Frieman Mallon & Hunt LLP, an investment management law firm which provides legal services to the hedge fund industry. Bart Mallon can be reached directly at 415-868-5345.


Investment Adviser Oversight Act of 2012

Bauchus-McCarthy Bill to Authorize IA SRO

House Financial Services Committee Chairman Spencer Bachus (R-LA) and Rep. Carolyn McCarthy (D-NY) today introduced the payday loans

Investment-Adviser-Oversight-Act-of-2012.pdf”>Investment Adviser Oversight Act of 2012. The bill would allow for the creation of a self regulatory organization (SRO) for investment advisers, similar to FINRA for broker-dealers. Below we have reprinted the press release from the House Financial Services Committee website which can also be found here.

In addition to the press release, we will be posting other thoughts related to this story in the coming days and weeks. Links to this story will appear below along with other articles we have already posted on this topic:


Chairman Bachus and Rep. McCarthy Propose Bipartisan Bill for More Effective Oversight of Investment Advisers

Washington, Apr 25 –

Financial Services Committee Chairman Spencer Bachus and Rep. Carolyn McCarthy, a member of the Committee, introduced bipartisan legislation today to create more efficient and effective oversight of the retail investment advisory industry.

Chairman Bachus and Rep. McCarthy introduced their proposal in response to a Securities and Exchange Commission (SEC) study that revealed the agency lacks resources to adequately examine the nation’s nearly 12,000 registered advisers. As part of its study, which was a requirement of the Dodd-Frank Act, the SEC recommended a self-regulatory organization as one option for Congress to consider as it looks for ways to help the agency monitor the industry.

The Bachus-McCarthy bill would authorize one or more self-regulatory organizations (SROs) for investment advisers funded by membership fees.

Investment advisers and broker-dealers often provide indistinguishable services to retail customers, yet only 8 percent of investment advisers were examined by the SEC in 2011 compared to 58 percent of broker-dealers.

“The average SEC-registered investment adviser can expect to be examined less than once every 11 years. That lack of oversight, particularly in the aftermath of the Madoff scandal, is unacceptable,” said Chairman Bachus. “Bad actors will naturally flow to the place where they are least likely to be examined. Therefore, it is essential that we augment and supplement the SEC’s oversight to dramatically increase the examination rate for investment advisers with retail customers.

“Customers may not understand the different titles that investment professionals use but they do believe that ‘someone’ is looking out for them and their investments. For broker-dealers that is true, but for investment advisers, it is all too often not true and that must change,” concluded Chairman Bachus.

The legislation would amend the Investment Advisers Act of 1940 to provide for the creation of National Investment Adviser Associations (NIAAs), registered with and overseen by the SEC. Investment advisers that conduct business with retail customers would have to become members of a registered NIAA. The SEC would have the authority to approve the registration of any NIAA.

The legislation permits the SEC to suspend or revoke an NIAA’s registration, or censure or impose limits on an NIAA’s activities and operations, if the SEC finds that the NIAA has violated the Advisers Act, SEC rules or its own rules. The SEC would also be able to suspend or revoke an NIAA’s registration if the association has failed to enforce compliance with any provision by an NIAA member firm or associated person.

The proposal requires the SEC to determine whether an NIAA has the capacity to carry out the purposes of the Advisers Act and to enforce compliance by its members and their employees with the Advisers Act, the SEC’s rules, and the NIAA’s rules before the association can register as an NIAA.

The proposal also recognizes the authority given to the states over small investment advisers in Title IV of the Dodd-Frank Act by preserving state authority over investment advisers with fewer than $100 million in assets under management, so long as the state conducts periodic on-site examinations.

In addition, the SEC must determine that the NIAA’s rules:

  • are designed to prevent fraud and protect investors;
  • are consistent with the Advisers Act and fiduciary duties under the Act and state law;
  • do not impose any burden on advisers that is not in the public interest or for investor protection;
  • provide for periodic examinations of members and their related persons, and for coordination of those examinations with the SEC and state securities authorities;
  • assure a fair representation of the public interest and the investment adviser industry in its selection of directors and administration of its affairs, and provide that a majority of its directors do not come from the securities industry; and
  • provide for equitable allocation of dues and fees and establish appropriate disciplinary procedures for members and their associated persons that violate the Advisers Act, SEC rules or NIAA rules.

Click here to view a copy of the bill.

Key Leaders Agree an SRO Will Result in More Effective Oversight and Stronger Protection for Investors

SEC Chairman Mary Schapiro: “I think self-regulatory organizations, with close oversight from the federal government – can bring tremendous value to the protection of investors. So, it’s an area we are willing to explore because even though our budget is growing, we’re likely to never have all the resources we need to do everything that we’d like to do and the extent to which we can leverage SROs, accounting firms, whistleblowers, I am game to do that because I think it will allow us to do a better job.”

Testimony before the Capital Markets, Insurance and Government Sponsored Enterprises Subcommittee, July 14, 2009

Former SEC Commissioner Roberta Karmel: “After the financial meltdown of 2008 and the Madoff bankruptcy, it would seem the height of political irresponsibility to allow the current inadequacies in the SEC’s examination capabilities to continue.

New York Law Journal, June 16, 2011

Consumer Federation of America’s Director of Investor Protection Barbara Roper: “Having spent the better part of two decades arguing for various approaches to increase SEC resources for investment adviser oversight with nothing to show for our efforts, we have been forced to reassess our opposition to the SRO approach. Specifically, we have concluded that a properly structured SRO proposal would be a significant improvement over the status quo.”

Testimony before the Senate Banking, Housing and Urban Affairs Committee, July 12, 2011

SEC Chairman Mary Schapiro: “…we have to find a way to have better oversight of intermediaries who have such enormous interplay with retail investors, and an SRO is one of the vehicles to do that.”

Testimony before the House Financial Services Committee, September 15, 2011

Securities Industry and Financial Markets Association Chairman John Taft: “In the case of broker-dealers and independent investment advisers who provide personalized investment advice to retail customers, we believe comparable examination, oversight, and enforcement is most practically and readily achievable through use of an SRO.”

Testimony before the Subcommittee on Capital Markets and Government Sponsored Enterprises, September 13, 2011

SEC Commissioner Elisse Walter: “We also have precedent, spanning more than seven decades, that SROs can significantly enhance the Commission’s examination and enforcement resources relating to its regulated entities … We need to address this issue now. It must not be relegated to another day—as has happened in the past. For far too long, in the investment advisory area, the Commission has been unable to perform its responsibilities adequately to fulfill its mission as the investor’s advocate, and investment advisory clients have not been adequately protected. This must change.”

Statement on Study Enhancing Investment Adviser Examinations, January 2011

House Budget Resolution FY 2012, Report 112-58: “During a time when trimming the deficit is imperative, the SEC should create headroom in its budget by streamlining and making more efficient its operations and resources; defraying taxpayer expenses by designating self-regulatory organizations (subject to SEC oversight) to perform needed examinations of investment advisors; and enhancing collaboration with other agencies, such as the Commodity Futures Trading Commission, to reduce duplication, waste, and overlap in supervision.”

Department of the Treasury: “Treasury notes the rapid and continued convergence of the services provided by broker-dealers and investment advisers and the resulting regulatory confusion due to a statutory regime reflecting the brokerage and investment advisory industries of decades ago. An objective of this report is to identify regulatory coverage gaps and inefficiencies. This is one such situation in which the U.S. regulatory system has failed to adjust to market developments, leading to investor confusion. Accordingly, Treasury recommends statutory changes to harmonize the regulation and oversight of broker-dealers and investment advisers offering similar services to retail investors. In that vein, Treasury also believes that self-regulation of the investment advisory industry should enhance investor protection and be more cost-effective than direct SEC regulation. Thus, in effectuating this statutory harmonization, Treasury recommends that investment advisers be subject to a self-regulatory regime similar to that of broker-dealers.”

Blueprint for a Modernized Financial Regulatory Structure, March 2008


Cole-Frieman Mallon & Hunt LLP provides legal and investment adviser registration and compliance services to the hedge fund community. Bart Mallon can be reached directly at 415-86-5345.