NCS Compliance Blog

Calculating Your Assets Under Management: Part Deux December 29, 2009

Calculating Your Assets Under Management: Part Deux

As you may recall from our last blog installment, misstating your assets under management is a serious compliance problem. In addition, asset under management calculations are likely to become even more important if the threshold for SEC registration is increased from $25 million to $100 million or somewhere in between. To refresh your memory, there are three important steps to calculate your assets under management.

Step 1: Determine if the account is a securities portfolio

An investment adviser must first determine whether an advisory account is a securities portfolio. An advisory account is viewed as a securities portfolio if at least 50 percent of its total value consists of securities. For purposes of this 50 percent test, cash and cash equivalents, such as bank deposits, certificates of deposit, bankers acceptances, and similar bank instruments, are treated as securities.

The securities portfolios used in calculating assets under management may include all of the following:

• Accounts for clients who are not residents of the U.S.
• Accounts for which an adviser received no compensation
• Family or proprietary accounts

You should be consistent in making this calculation. If you are including one account where no advisory fee was charged, you should include all of them.

Step 2: Determine if each account receives continuous and regular supervisory or management services

The second step is determining if each account receives continuous and regular supervisory or management services. Although this usually means you have discretion over the account, there may be instances where this is not the case.

There are a number of factors indicating whether an adviser is exercising continuous and regular supervisory or management services over an account, such as the following:

• Terms of the advisory agreement – The fact that an advisory agreement states that the adviser provides ongoing supervisory or management services suggests they are in fact provided. There should be no terms in the contract to negate this provision.
• Compensation – If an adviser’s compensation is based on the average value of the client’s assets over a specified period of time, the inference is that the firm does provide continuous and regular supervisory or management services to the account. In contrast, if an adviser’s compensation is based upon the amount of time spent with a client during a visit or the fee is based on a percentage of assets covered by a financial plan, the inference is that the firm does not provide continuous and regular supervisory or management services to the account.
• Management practices – An adviser’s management practices should demonstrate that the firm provides continuous and regular supervisory or management services to the account. Active management indicates that the services are continuous and regular, even if the adviser only trades occasionally.

Giving general or impersonal advice, such as in a newsletter, is unlikely to be viewed as continuous and regular supervisory or management services.

Even if an adviser does not have discretion, continuous and regular supervisory or management services may include situations where a firm allocates clients’ assets among various money managers. To include these portfolios in the firm’s assets under management, the adviser must possess discretionary authority to hire and fire those managers and reallocate the client’s assets. The discretionary authority to hire and fire managers should be spelled out clearly in the advisory agreement. In these situations, both the adviser and the money manager may be able to include these portfolios in their assets under management.

Step 3: Calculating Your Assets Under Management

If you have determined that an account is a securities portfolio and you do exercise continuous and regular supervisory or management services over it, the entire value of the account is included in the assets under management calculation. If you provide continuous and regular supervisory or management services for an advisory account where less than 50 percent of the value is made up of securities, only the actual value of the assets under management is included in the calculation.

The bottom line is that advisers must be prepared to document how they calculated assets under management. A number of deficiency letters have criticized advisers for misstating their assets under management.

NCS is interested in measuring the interest generated by this blog. If you send us an e-mail, we will enter your name in a drawing for a copy of Les’ book.

Les Abromovitz, an attorney, can be reached at NCS by calling 561-330-7645, Ext. 213, or by e-mailing him at labromovitz@ncsonline.com. Les is the author of GROWING WITHIN THE LINES: THE INVESTMENT ADVISER’S ADVERTISING AND MARKETING COMPLIANCE GUIDE (NationalUnderwriterStore.com; 800-543-0874; Amazon.com).

Be Careful When Covering Your Assets Under Management December 3, 2009

You’ve found your way, intentionally or unintentionally, to the link for the National Compliance Services, Inc. (“NCS”) blog. By way of background, NCS is a leading compliance consulting firm located about a mile from the ocean in Delray Beach, Florida. This blog will focus on compliance advice for Investment Adviser Representatives (“IARs”) and Registered Investment Advisers (“RIAs”). Although my specialty is advertising and marketing compliance, I will be reaching out to NCS’ attorneys and consultants for assistance in discussing a wide variety of issues facing RIAs. NCS also has many broker-dealer experts who will help me address topics of interest to brokerage firms and registered representatives. We hope you’ll read some of our postings and will stop back again.

Although I rarely go to parties attended by investment adviser representatives (IARs), especially since I’m usually in bed by 9:30, I imagine there is shop talk. And sometimes, I’m sure, IARs talk about their firm’s assets under management.

If the IARs at the party are a competitive lot, I’m certain they discuss who is a better golfer and who has the most assets under management. Perhaps, now and then, IARs may inflate their assets under management to impress their friends and business associates.

I doubt that the SEC worries about what you say to your buddies at a party, but the Commission does care when you misrepresent your assets under management on Form ADV or in advertisements. You’re likely to get in trouble if your website, marketing materials, Facebook page, LinkedIn profile, or Form ADV misstate your assets under management.

At IA Watch’s 9th Annual IA Compliance Fall Conference 2009 held on September 21, 2009, Andrew J. Donahue of the SEC revealed that the assets under management of federally-registered advisers dropped $9.4 trillion or 22 percent. The median assets under management reported fell from $126 million to $97 million. Donahue, Director, Division of Investment Management, also noted that the SEC has experienced about 20 percent more withdrawals from registration than usual. Donahue said that about half of these withdrawals resulted from RIAs switching from SEC to state registration.

Whether your firm is SEC or state registered, you should never misstate your assets under management in your disclosure documents or in advertising materials. For example, if RIAs mention assets under management on their website, they should state the date on which assets under management were calculated. If a firm’s assets under management change significantly, the figures should be changed immediately in advertisements and marketing materials. It would be disingenuous and potentially misleading for an adviser to use old asset under management figures in marketing materials, especially if those amounts have dropped precipitously in recent months due to a decline in the market or the loss of a major client.

Newer advisers often find it difficult to attract clients, because some prospects are hesitant to deal with a smaller firm. Nevertheless, RIAs should never lead prospective clients to believe that the firm has more assets under management than it actually does. After all, you don’t want the SEC to think that Bernard Madoff is your role model. The Associated Press reported on October 2, 2009, that Madoff’s private investment business told the SEC in January 2008 that it managed assets worth $17.1 billion in 23 customer accounts. In fact, the firm had more than 4,900 open customer accounts. According to court papers, the firm told investors it had about $68 billion in assets under management.

In some instances, an adviser may have no intent to deceive the SEC, prospective clients, or IARs they meet at a party, but has merely miscalculated assets under management. Before an examiner points out your mistakes during a regulatory exam, you should familiarize yourself with the process for correctly calculating assets under management. We will give you advice on this topic in our next blog posting. If you e-mail me, I will make sure you are among the first to know about NCS’ latest blog postings.

Until you’re sure your numbers are accurate, avoid discussions of assets under management in marketing materials and advertisements, as well as at parties. I will remind you if we’re at the same party and it’s not 9:30 yet.

Les Abromovitz, an attorney, can be reached at NCS by calling 561-330-7645, Ext. 213, or by e-mailing him at labromovitz@ncsonline.com. Les is the author of GROWING WITHIN THE LINES: THE INVESTMENT ADVISER’S ADVERTISING AND MARKETING COMPLIANCE GUIDE (NationalUnderwriterStore.com; 800-543-0874; Amazon.com).

Bad Compliance Practices Die Hard November 6, 2009

I think it was in the first Die Hard movie, or perhaps the twentieth, that Bruce Willis warned the bad guy: “I’m the fly in the ointment, the monkey in the wrench.”  Unfortunately, compliance can throw a monkey wrench into the best marketing strategy.

Maybe I’m a die-hard compliance guy, but there are ways to advertise and market advisory services without crossing the line that will get you into trouble with the SEC or state securities regulators. In some instances, investment adviser representatives (“IARs”) and marketing gurus are used to working with FINRA rules that apply to registered representatives. They don’t always realize that the rules are different for registered investment advisers (“RIAs.”)

Subject to certain restrictions and disclosure requirements, registered representatives and broker-dealers are permitted to use testimonials in advertisements. For RIAs, however, testimonials are specifically prohibited by Rule 206(4)-1(a)(1) under the Investment Advisers Act of 1940.  Advertisements containing testimonials are viewed as inherently misleading by securities regulators, because they invariably incorporate favorable comments from clients. Even the worst advisers can find a few clients who will say nice things about them, just as the worst films manage to find a few nuggets of critical praise to use in their advertisements.

Securities regulators forbid RIAs from using testimonials in advertisements to prevent firms from cherry-picking. Suppose an RIA conducts a client survey with the hope of extracting favorable comments to use in advertisements. The RIA cherry-picks the best comments and discards the ones that say, “Hiring your firm was the worst decision of my life” or “I’m in my 90’s and still working, thanks to your bad investment advice.”

Testimonials convey the impression that every client had a positive experience with the adviser. In reality, the adviser may have solicited that endorsement or the client might be one of the few who benefited from the adviser’s advice.

It is not just comments about the adviser’s investment acumen that will be viewed as testimonials. Even comments regarding the friendliness of the staff, or the firm’s attention to customer service, could be viewed as testimonials.

Explicit or even implicit statements of a client’s experience with an investment adviser are testimonials. Let’s say you post a photo on your website where you’re surrounded by clients who are well-known in the community. Even if you don’t identify the individuals by name, these photos may be an implied testimonial for your firm. As another example, if your client is the mayor of Quahog or wherever you live, you can’t include his picture in advertisements for your firm without violating the rule prohibiting testimonials.

About once a week, an IAR comes to me with a plan to circumvent the rule barring testimonials. One marketing brainstorm I see is an attempt to put words in clients’ mouths.  The not-so-subtle testimonial goes something like this: Our clients love us; you will too. One adviser even tried to make a statement like this on his website: SEC rules prevent me from telling you how thrilled my clients are with my advice.

Others use hypothetical case studies based on real examples that purportedly demonstrate how the firm saved the day for the client and made the person’s financial dreams a reality. Not surprisingly, every hypothetical case study has a happy ending, thanks to the adviser’s investment strategies.

Since compliance may throw a monkey wrench into your marketing campaign, make certain your chief compliance officer (CCO) signs off on your plans before you go to the expense of producing a lavish video for your website or even a brochure. It is also a good idea for your CCO, or a designee, to review the invitation and marketing materials you plan to use in conjunction with a marketing seminar. The so-called free lunch seminars used by RIAs and other financial professionals are being monitored closely by securities and insurance regulators.

After facing serious criticism for failing to derail Bernard Madoff’s Ponzi scheme, the SEC is likely to be much more aggressive and thorough during examinations of RIAs. Even routine examinations may turn ugly for investment advisers and might lead to an enforcement action. Therefore, instead of viewing compliance people as the fly in the ointment or the monkey in the wrench, you might want to think of them as Sergeant Al Powell, the police officer who saves Bruce Willis and his wife at the end of the first Die Hard movie. With compliance covering your back, your marketing campaign won’t die a painful death.

Les Abromovitz is a senior consultant for National Compliance Services, Inc. Les, an attorney, is the author of Growing Within the Lines: The Investment Adviser’s Advertising and Marketing Compliance Guide (Available on Amazon.com or through NationalUnderwriterStore.com). He can be reached at 561-330-7645, Ext. 213, or at LAbromovitz@ncsonline.com.

DISCLOSURES CAN REMEDY COMPLIANCE PROBLEMS October 23, 2009

If you read the monthly newsletters published by National Compliance Services, Inc. (“NCS”), you probably know how important disclosures are. We’re not just talking about the disclosures in your Form ADV. Communications with clients and prospective clients may require disclosures to ensure that they are not false or misleading. In addition, it is quite likely that you will need to provide disclosures in conjunction with advertisements, presentations, newsletters, and websites.

Disclosures help to ensure that a communication is thorough, complete, and not misleading. Communicating with clients using social media is especially dangerous, because these messages are not typically accompanied by appropriate disclosures.

Advertisements by SEC-registered investment advisers must comply with Rule 206(4)-1 under the Investment Advisers Act. This rule prohibits ads that are false or misleading in any way. Adding the right disclosures to those advertisements may help registered investment advisers (“RIAs”) avoid an uncomfortable situation where examiners believe an ad is misleading.

Investment adviser representatives (“IARs”) often resist using disclosures. They feel that disclosures undercut the message being conveyed. In fact, thorough and robust disclosures send the message to securities regulators that you are satisfying your fiduciary obligations to clients and prospective clients.

In case you think you’re being over-regulated, please indulge me while I list the disclosures on my Denny’s free breakfast coupon:

• One coupon per check, per visit.
• Second entree must be of equal or greater value.
• Not valid with any other coupons or promotional offers.
• Coupon has no cash value.
• No change returned.
• Taxes and gratuity not included.
• Beverages not included.
• Valid at participating restaurants only.
• Selection and prices may vary.
• Only original coupon accepted.
• Photocopied and internet-printed or purchased coupons are not valid.
• No substitutions.

Amazingly, Denny’s was able to print all of those disclosures on one coupon in type that even I can read. If Denny’s feels it needs to offer all of those disclaimers to ensure that customers won’t be misled, RIAs and IARs shouldn’t take umbrage about having to use disclosures in their communications and advertisements. After all, clients turn over hundreds of thousands of dollars, even millions, not just $5.99 for a Grand Slam Breakfast.

Unfortunately, disclosures will not prevent every RIA compliance problem. For example, RIAs sometimes attempt to advertise performance results without showing the impact of advisory fees on those returns. The Clover Capital no-action letter stands for the proposition that investment performance results in RIA advertisements must be presented on a net-of-fees basis after deducting all investment advisory fees, brokerage or other commissions, and any other expenses the client actually paid or would have paid. A disclosure does not make the ad compliant, and an RIA may not bury this information in a footnote.

Another situation where disclosures won’t help is an RIA advertisement that contains a client testimonial. You may not include that testimonial in your ad, even if you disclose that it is just one person’s opinion and doesn’t necessarily reflect the experience of other clients.

In most cases, however, detailed disclosures will help to convince securities examiners that you are meeting your fiduciary obligations to clients and prospective clients. As an example, in your Form ADV, you owe a duty to provide thorough written disclosures of potential or actual conflicts of interest.

Though compliance isn’t much fun, ignoring it can jeopardize your career. You might find yourself having breakfast at Denny’s, looking at the job ads.

Les Abromovitz, an attorney, can be reached at NCS by calling 561-330-7645, Ext. 213, or by e-mailing him at labromovitz@ncsonline.com. Les is the author of GROWING WITHIN THE LINES: THE INVESTMENT ADVISER’S ADVERTISING AND MARKETING COMPLIANCE GUIDE (NationalUnderwriterStore.com; 800-543-0874; Amazon.com).

Words & Phrases That Can Cause Compliance Problems October 5, 2009

You are reading the second installment of the National Compliance Services, Inc. (“NCS”) blog. Unless your memory is as bad as mine, you may recall that we were talking about words and phrases that can get investment adviser representatives (“IARs”) and registered investment advisers (“RIAs”) in hot water with examiners. And just in case you forgot, an IAR is the person who gives the advice and manages money, while RIA refers to the advisory firm.

A bad choice of words in advertisements and marketing materials can cause problems for RIAs during regulatory examinations. RIAs must comply with Rule 206(4)-1 under the Investment Advisers Act of 1940. Among other prohibitions, Rule 206(4)-1 forbids content that is false or misleading in any way.

Advisers often rely on marketing mavens to prepare content and that can lead to compliance problems. Many frequently-used words and phrases might potentially be false or misleading, such as:

• Unparalleled service
• Best of breed investment managers
• Best in class products and services
• Best of the best strategies
• Premier investment adviser
• Revolutionary investment strategies
• One of a kind approach to managing portfolios

As RIAs struggle to create content for websites and other advertisements, they often pull words and phrases out of the air that may have no basis in fact. RIAs often boast that they utilize cutting-edge or state-of-the-art technology and offer world-class research. The Associated Press reported on October 2, 2009, that Bernard Madoff’s firm made “claims of being on the cutting edge of technology,” even though the firm used outdated systems and kept paper records of financial activity.

Obviously, Madoff’s lies about the firm’s technological capabilities were just the tip of the iceberg. Nevertheless, when choosing words and phrases for advertisements, it is always a good idea to avoid the use of superlatives and exaggerations, particularly when these terms cannot be substantiated. Instead of claiming that the firm will create an investment portfolio that is “best-suited” for the client, it is better to say, “well-suited.”

Similarly, it is also a bad idea for firms to refer to themselves as “investment gurus” or the “top advisers in their field.” An examiner may question those descriptions, and prospective clients might find the adviser to be pompous. These descriptions may be deemed to be false or misleading if there is not concrete evidence to support them.

RIAs should also refrain from generalizations, such as “most financial advisers put their interests ahead of yours.” An alternative is to use a more positive approach by saying, “We always put your interests ahead of our own.”

RIAs often go too far in describing their reputation in the investment community. RIAs sometimes claim that a member of the firm is a well-known expert or that the adviser is nationally recognized, even though a quick Google search indicates otherwise. Unless there is proof to substantiate it, that statement may be viewed as false or misleading.

Robust disclosures in plain English are always the right choice of words. These disclosures help to ensure that clients and prospective clients will not misinterpret statements made by an adviser.

In addition, a bad choice of words might be construed by clients and prospective clients as a guarantee, which may lead to problems down the road. There is a clear distinction between telling clients that the RIA will work with them in an effort to help them reach their goals as opposed to making assurances that they will succeed.

Nuance is extremely important when choosing the right words for advertisements and other communications. There is a difference between saying that an IAR has longstanding ties to the community and describing the individual as a pillar of the community.

RIAs and IARs should be meticulous when writing client communications and advertisements. That hastily drafted e-mail or text message sent as you are rushing off to lunch may lead to heartburn later. As you struggle to make the right choice of words, remember that you might be at a loss for words if an attorney or examiner asks you to explain them.

Les Abromovitz, an attorney, can be reached at NCS by calling 561-330-7645, Ext. 213, or by e-mailing him at labromovitz@ncsonline.com. Les is the author of GROWING WITHIN THE LINES: THE INVESTMENT ADVISER’S ADVERTISING AND MARKETING COMPLIANCE GUIDE (NationalUnderwriterStore.com; 800-543-0874; Amazon.com).

A Bad Choice of Words Can Hurt RIAs September 2, 2009

You are reading the first installment of the National Compliance Services, Inc. (“NCS”) blog. By way of background, NCS is a leading compliance consulting firm located about a mile from the ocean in Delray Beach, Florida. This blog will focus on compliance advice for Investment Adviser Representatives (“IARs”) and Registered Investment Advisers (“RIAs”). Although my specialty is advertising and marketing compliance, I will be reaching out to NCS’ attorneys and consultants for assistance in discussing a wide variety of issues facing RIAs. NCS also has many broker-dealer experts who will help me address topics of interest to brokerage firms and registered representatives.

At the onset, let’s make sure everyone is on board with the terminology we will be using. RIA refers to the advisory firm. In contrast, an IAR is the person who gives advice and/or manages money for the RIA.

On a recent flight to Pittsburgh which we still call home, a woman was texting someone while walking down the aisle of the crowded plane. Naturally, I was extremely pleased because I prefer that the boarding process be painfully slow to ensure that the flight is delayed.

Aside from rolling my eyes, I whispered to my wife, “I hope that woman isn’t an IAR for an RIA and she isn’t texting a client or prospective client.” Boring guy that I am, I made the same comment as I watched her send off a hastily-written e-mail before the flight attendant insisted that she shut off her Blackberry.

The reason I get uptight about IARs texting clients or prospective clients is because they may be violating their fiduciary obligations and the Investment Advisers Act of 1940. A bad choice of words can create turbulence for an RIA’s compliance program. Having now beaten the aircraft metaphor to death, let’s look at why RIAs and IARs should be extremely careful when e-mailing or texting clients and prospective clients.

All communications with clients must be truthful, representative, complete, and not misleading. Unfortunately, those requirements are likely to be overlooked in a quick e-mail or text message. Normally, communications with existing clients are not advertisements which are subject to Rule 206(4)-1 under the Investment Advisers Act. Nevertheless, if circumstances suggest that the purpose of a written communication is to offer additional advisory services or attract new clients, it may be viewed by the SEC as an advertisement that is subject to Rule 206(4)-1.

Rule 206(4)-1(a)(5) prohibits advertisements that contain any untrue statement of a material fact or that is otherwise false or misleading. The danger is that poorly chosen words may prove to be false or misleading to clients and prospective clients.

A recent deficiency letter addressed to an RIA from the SEC’s Chicago regional office, set forth the standard for judging whether an advertisement is false or misleading. Relying on Spear & Staff, Inc., Advisers Act Release No. 188 (March 25, 1965), the examiner wrote, “When appraising advertisements by investment advisers in light of the rule, the advertisements must be measured from the viewpoint of a person unskilled and unsophisticated in investment matters.”

Therefore, RIAs and IARs must be able to present and discuss their strategy and expertise without confusing less sophisticated prospective clients. Aside from the potential compliance problems, using investment jargon that goes over the head of prospective clients is no way to connect with them on an interpersonal level.

Unless a presentation is made to institutional or sophisticated investors, RIAs may wish to avoid complex charts, graphs, and statistics that may overwhelm members of the audience. Before the presentation is used for marketing purposes, IARs should run it by their Chief Compliance Officer and test-drive the content on someone with minimal financial knowledge to determine if he or she understands the key points being made.

Marketing hype is always a bad choice of words. IARs should avoid referring to themselves as the foremost authority on a particular subject, unless they can justify that description when examiners come for a visit. You must be able to provide proof that the description is accurate and not false or misleading.

RIAs should avoid using any word or phrase that may be construed as marketing hype and is not a demonstrable fact. For example, many RIAs claim their investment strategies are “unique,” even though their approach is very similar to other firms. Although clients’ needs and situations may be properly described as “unique,” the word may not be an apt description of the firm’s strategies or approach. Similarly, many RIAs describe their money management strategies as “innovative,” even though they are quite traditional.

Stay tuned for our next blog installment. We will be looking at words and phrases that can get you into hot water with examiners.

Les Abromovitz, an attorney, can be reached at NCS by calling 561-330-7645, Ext. 213, or by e-mailing him at labromovitz@ncsonline.com. Les is the author of a new book called, GROWING WITHIN THE LINES: THE INVESTMENT ADVISER’S ADVERTISING AND MARKETING COMPLIANCE GUIDE (NationalUnderwriterStore.com; 800-543-0874; Amazon.com).