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Tuesday, February 19, 2019

Washington Registrants - Major Amendments to Investment Advisor Rules


February 19, 2019.  The Washington Securities Division adopted amendments to Chapter 460-24A WAC of the investment advisor act.  The amendments to the law will take effect on February 18, 2019.

The amendments of the investment advisor rules include changes to: (1) examination requirements, (2) advertising, (3) custody, (4) advisory contracts, (4) compensation for performance, and (5) books and records.

Also, the changes add requirements for advisors including policies and procedures for cybersecurity and an updated code of ethics.  These updates promote investor protection, reflect the current practices of the Securities Division in its oversight of investment advisors, incorporate current federal legislation, and address NASAA model rules.

The full text of the adopted amendments (Form CR-103) are available at: https:/dfi.wa.gov/rulemaking/investment advisor-rules-amendments

**Rule Changes**

Definitions of Roles

The amendments add definitions for related terms, including: “assignment,” “chief compliance officer,” and “supervised person.”

Terms Deemed Similar to “Financial Planner” and “Investment Counselor”

Persons may no longer use titles like “financial planner” or “investment counselor” unless they are registered as an investment adviser or investment adviser representatives. The amendments clarify that terms like "financial planner" and "investment advisor" is not exclusive.  In addition, the rule includes any combinations of terms like "financial planner" and "investment advisor" that imply that a person(s) offers financial planning or investment advisory services.

Electronic Filings is now required for all materials sent to securities division

Previously, the Washington Securities Division required all its investment advisors to file application materials electronically through the Investment Advisor Registration Depository (IARD), except for those materials which IARD does not accept. For a time, the division accepted mailing in materials.  Amendments to the rule now disallow mailing in paper copies of application materials.  

The amended rule states that all materials that advisors cannot file on IARD must instead be filed by email with the Securities Division until a state electronic filing system is developed.  As such, all filings must be made in two forms: (1) IARD Electronic filing or (2) emailing of documents only.  

**SIE Exam qualifications for FINRA exam holders**

The adopted amendments incorporate FINRA’s new Securities Industry Essentials Exam (SIE). Previously, the Securities Division required investment advisers and investment adviser representatives in Washington to prove that they had passed either the Series 65 exam; or both the Series 7 and Series 66 exam.

1- New Registrants taking the Series 7 and 66 exam must pass the SIE
As of October 1, 2018, FINRA now requires persons to pass the SIE before they are eligible to sit for the Series 7 exam.  With these amendments, persons who satisfy the examination requirements by passing the Series 7 and the Series 66 examinations must now pass the SIE examination as well.

2- Existing Registrants are exempt from the SIE exam
This requirement doesn't apply to person(s) currently registered as an investment adviser or investment adviser representative, or those who registered within the two years before the date of application.

3- Series 65 exam holders still exempt from the SIE Exam
Also, persons who satisfy the examination requirements by passing the Series 65 do not need to pass the SIE exam.

Full Custodial List for Separately Managed Accounts

The amendments require investment advisers to file a complete list of all custodians of the adviser’s separately managed accounts, regardless of the percentage of the adviser’s aggregate separately managed regulatory assets under management held by the custodian.  Advisors must disclose all custodians on form ADV or separately by submitting a complete list of custodians to the Washington Securities Division.

Form ADV Part 1A requires any investment adviser, who provides supervisory or management services to separately managed accounts, to name the custodians who hold 10% or more of the adviser’s aggregate separately managed account regulatory assets under management. 

However, this creates a gap wherein the Securities Division may not have a full record of every custodian used by an investment adviser for separately managed accounts. For that reason, the Securities Division amended its rules to require advisers to file a complete list of custodians.

IARD/CRD Renewal Calendar Deadline for Annual Fees

The amended rule specifies that Advisory Firms and Investment Advisor representatives must submit renewal applications on CRD or IARD no later than the renewal application deadline set annually by FINRA (usually on/around 12/17 every year) --two weeks ahead of the securities divisions previous filing deadline.

Disqualification of Exemption for Private and Venture Capital Fund Advisers

The amendments remove a reference to the disqualification provisions under Regulation D Rule 505 and replace it with a reference to the disqualification provisions under Regulation D Rule 506.

Changes to Advertisements Rule

The rule identifies certain advertising practices that constitute fraudulent or misleading practices.  The amendments clarify that fraudulent or misleading practices also include written communications directed to prospective or actual clients — even if the communication does not otherwise meet the definition of an “advertisement.”

Also, the amended rule is an adaptation of the Washington’s Securities Act Interpretive Statement 21, about the use of past performance data in advertisements by investment advisers, to incorporate specific SEC guidelines.  Also, it clarifies that the client’s actual account performance in an account statement generated by a custodian is not subject to the disclosure requirements applicable to past performance data.

Finally, the Securities Division made various additions in its practices of reviewing investment adviser advertisements and written communications during field examinations

Accordingly, the amended rule provides that advertisements and written client communications must: 
  • Include the full legal name of the adviser.
  • Cite any data or information referenced from outside sources.
  • Provide information consistent with data provided on Form U4 or Form ADV.
  • Avoid using the acronyms IA, IAR, and RIA unless these terms are defined.
  • Not use senior designations in a manner inconsistent with Chapter 460-25A WAC.

Custody Rule Provisions

The Securities Division adopted amendments to the rule that specifies the requirements for investment advisers who have custody of client funds or securities. The amendment has a provision that allows a client to appoint a independent representative* to receive the client’s account statements on his or her behalf. Also, the amended rule prohibits an adviser from recommending a person to serve as the independent representative for a client.

*Who is an independent representative? ---
This can be anyone that the client appoints to receive billing sent from the advisor.

**Fees/Billing Processes**

1 - Fee Invoices (advisers who do not directly deduct fees)

The amended rule specifies that advisers who do not directly deduct fees still must still deliver fee invoices to clients. This requirement ensures that clients receive written fee invoices with enough information to understand the fees charged.

2 - Fee Invoices (advisors who directly deduct fees from client accounts)

Additional custody requirements apply to investment advisers who directly deduct fees from client accounts. Rule WAC 460-24A-106 requires these advisers to supply a fee invoice to clients. The amended rule increases the amount of information available to clients on the fee invoice. 

The fee invoice must now include the following additional information: 
  • The fee calculation. 
  • The name(s) of the custodian.

For advisers who charge (a performance fee), a disclosure must include:
  • The cumulative amount of net investment gain above which the adviser will receive performance compensation (high-water mark).

3 - Performance Fee Arrangements

The amended rule includes several changes to the performance compensation rule. Consistent with the current federal definition, the Securities Division updated the definition of “qualified client (see SEC Rule 205-3 definitions)” to raise the natural person net worth requirement from $2 million to $2.1 million.

Also, the Securities Division amended the performance compensation formula for reviewing advisory contracts and the fees held there. Performance compensation provisions now: 
  • Removed the requirement that prohibited the adviser from calculating performance fees for less than one year.
  • Substituted a requirement that the adviser does not calculate the fee more often than once per quarter.
  • Added that when a client invests mid-period in a pooled investment vehicle managed by an adviser, the adviser may prorate the compensation formula to that client for the partial period.
  • Added a requirement for a high-water mark.

**Chief Compliance Officer Duties**

The amendment specifies that the Chief Compliance Officer must administer the following: 
  • Compliance policies and procedures.
  • Material nonpublic information provisions in the policies and procedures.
  • Proxy voting policies and procedures.
  • Business continuity and succession plan.
  • Supervision procedures.
  • Code of ethics.
  • Physical and cybersecurity policies and procedures.

**Policies and Procedure Additions**

1 – Add a Code of Ethics

The amended rule requires investment advisers to adopt a written code of ethics that establishes the standards of business conduct which reflect the advisers and its supervised person's fiduciary obligations.

2- Create Cybersecurity Policies and Procedures

Another new subsection adds that advisers must keep written cybersecurity policies and procedures that ensure the security and integrity of its physical and electronic records.

3 – Prepare a Business Continuity and Succession Plan

The amendments now require investment advisers to adopt a written business continuity and succession plan. Previously, the requirement for a business continuity plan was found solely in the recordkeeping rule. The new rule lays out the required contents of the business continuity and succession plan.

4 - Policies must include protection of Material Non-Public Information

A new section of the rule requires investment advisers to effectuate policies and procedures that prevent the misuse of sensitive and private information by the investment adviser or any affiliated person of the adviser.  Previously, this requirement appeared solely in the unethical business practices rule. The new section was added as a stand-alone rule to highlight its importance.

**Advisory Contracts**

The amended rule clarifies and reflects the standards applied by the Securities Division during its review of advisory contracts. The amendments specify that an adviser must keep a written advisory agreement with each client, and that the contract must include the full name of the investment adviser. 

Also, the advisory contract must include the following statements: 
  • The adviser must not assign a contract through implied or negative consent.
  • The adviser will deliver the brochure at least 48 hours before the client signs the advisory agreement or provide that the client has a right to end the contract within 5 business days.
  • The adviser must get the consent of the client before revising any material terms of the contract.
  • The Adviser owes a fiduciary duty to the client.
  • If the adviser manages a pooled investment vehicle, each investor in the pool is a client.
  • The contract must not waive the adviser’s compliance with any rule adopted under the Securities Act of Washington.

The amendments formalize the requirements routinely imposed on consulting contracts during the investment adviser licensing process.  For that reason, the advisory contracts of most Washington-registered advisers currently meet the above requirements.  Also, the amended rule applies only to new or revised contracts entered after the effective date of the rule amendments.

Brochure Delivery Rule

The amended rule specifies when an adviser must supply other-than-annual delivery of the brochure (e.g. material changes).  Also, the amendments specify that if the adviser delivers the brochure using a passive delivery system, such as a website or portal, the adviser must notify clients by email when the brochure is available on the system.

Training Regarding Financial Exploitation of Elderly (or Vulnerable) clients

The amendments adopted a new rule to remind advisers of the existing requirement to train employees about the financial exploitation of vulnerable adults.

**Books and Records**

The amendment includes the following changes to the books and records rule: 
  • Removes the requirement that the adviser must keep “original” records of written client communications. Instead, it says that the adviser must keep “physical or electronic” records
  • Adds a requirement that the adviser must keep documentation of the client’s authorization for each non-discretionary transaction.
  • Specifies the type of client profile information the adviser must support to determine suitability, and states that the adviser must make reasonable efforts to, at least, update this information annually.
  • Specifies that the adviser must keep written fee billing information and a record of services provided to clients during each billing period.
  • Clarifies that electronic records and data must be accessible to state examiners.
  • Adds a requirement to keep a code of ethics.
  • Adds a requirement to keep physical and cybersecurity policies and procedures.

Unethical Business Practices

The amended rule adds that it is an unethical practice for advisors to do any of the following: 
  • Access a client’s account using their unique identifying information (such as username and password); 
  • Fail to provide advisory fee billing information. 
  • Fail to establish, maintain, and enforce its policies and procedures.
  • Fail to supply the training regarding the financial exploitation of vulnerable adults.


Compliance and Business Management

FIN Compliance (FinCompliance.io) is a consortium of compliance services including: RIA Consults-Roberson Consults Group, a compliance consulting firm, RIA Review, a compliance-management software tool (SaaS), B-D Review, a RIA/Broker-Dealer compliance management software tool, and FINLancer is a business management portal featuring:  E-signature tools; Invoicing integration, Vendor Directory, continuity directory*, business client document portal, and more (available by Q3 2019).  Access all services on one site: FINCompliance.io.

Impact

FIN Missions (FINmissions.com) provides business support group sessions for other entrepreneurs.  In addition, Cory has volunteered for more than fifteen youth programs in locations such as like S. Korea, China, S. Africa, Thailand, and India.





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