Specifically, the proposal would require an applicant, as part of an application for IAR registration, to complete, sign, notarize, and return to the Division a “CORI Acknowledgement Form.” An application would not be deemed complete until the Division has received the form.  The form would then be used as authorization to conduct a review of the Massachusetts Criminal Offender Record Information (CORI) of the applicant.

This proposal would affect the registration procedure for all applications for IAR registration.  We are seeking comments from financial firms that may be affected by this regulatory change.  In addition, the proposal contains other updates and changes to the investment adviser regulations.  All comments on those proposals are also requested.

The Request for Comment and the Proposed Regulations are available on the Division’s website at http://www.sec.state.ma.us/sct/sctidx.htm.    The comment period will end on Wednesday, May 15, 2013.  Additionally, a public hearing will be conducted at 10:00 AM on Wednesday, May 15, 2013 to receive any oral comments, views and arguments relating to the proposed action.  Details as to the hearing location and the comment submission process are available in the Request for Comment referenced above.

Should you have any questions, please contact our office at (617) 727-3548.

The guidance from the Division of Investment Management is the first in its “IM Guidance Update” series, which will offer the staff’s views on emerging legal issues. The goal of the guidance is to increase transparency and enhance compliance with federal securities laws and regulations.

Mutual funds and other investment companies are required to file certain advertisements for review by Financial Industry Regulatory Authority (FINRA). The SEC staff has learned that out of an abundance of caution, many mutual funds and other investment companies may file materials on their social media sites with FINRA unnecessarily.

The IM Guidance Update provides examples of the kinds of communications that the staff believes would be subject to a requirement to file with FINRA and examples of communications that would not trigger a filing requirement.

“Marketing and performance advertising is an inherently high-risk area due to the highly competitive nature of the investment management industry. Aberrational performance of certain registrants and funds can be an indicator of fraudulent or weak valuation procedures or practices. The staff will also focus on the accuracy of advertised performance, including hypothetical and back- tested performance, the assumptions or methodology utilized, and related disclosures and compliance with record keeping requirements. Where feasible, the staff will also review changes in advertising practices related to the JOBS Act, which requires modification of the rules restricting general solicitations.”

The SEC’s proposal called Regulation SCI would replace the current voluntary compliance program with enforceable rules designed to better insulate the markets from vulnerabilities posed by systems technology issues.

Self-regulatory organizations, certain alternative trading systems, plan processors, and certain exempt clearing agencies would be required to carefully design, develop, test, maintain, and surveil systems that are integral to their operations. The proposed rules would require them to ensure their core technology meets certain standards, conduct business continuity testing, and provide certain notifications in the event of systems disruptions and other events.

“While it’s not possible to prevent every technological error that market participants may commit, we must ensure that our regulations are designed to minimize their impact on our markets and ultimately investors,” said SEC Chairman Elisse B. Walter. “Reg SCI would provide more explicit technology and control standards to help ensure that our markets remain resilient against technological vulnerabilities.”

“Studies have shown that few investors realize that the standard of care they receive depends on the type of investment professional they use. And often investors do not know which type of financial professional they are relying on,” said SEC Chairman Elisse B. Walter. “This request for information will help us in our ongoing consideration of alternative standards of conduct for certain broker-dealers and investment advisers, as well as potential harmonization of other aspects of regulation in this area.”

Specifically, the SEC is requesting data and other information from the public and interested parties about the benefits and costs of the current standards of conduct for broker-dealers and investment advisers when providing advice to retail customers, as well as alternative approaches to the standards of conduct.

• Failure to recognize that they have custody, such as situations where the adviser serves as trustee, is authorized to write or sign checks for clients, or is authorized to make withdrawals from a client’s account as part of bill-paying services
• Failure to meet the custody rule’s surprise examination requirements
• Failure to satisfy the custody rule’s qualified custodian requirements, for instance, by commingling client, proprietary, and employee assets in a single account, or by lacking a reasonable basis to believe that a qualified custodian is sending quarterly account statements to the client.

In addition, for advisers to audited pooled investment vehicles, the examinations found some failed to meet requirements to engage an independent accountant and demonstrate that financial statements were distributed to all fund investors.

“Because the safeguarding of assets is central to investor protection, it is critical that investment advisers follow our rules when they maintain custody of their clients’ funds,” said SEC Chairman Elisse B. Walter.

“We take deficiencies in this area very seriously and want to put advisers on alert about the importance of complying with the custody rule,” said OCIE Director Carlo V. di Florio. “It is a key component of our investment adviser examination program.”

The alert notes that the recent findings of custody deficiencies have resulted in a range of actions. These included remedial measures by advisers, such as drafting, amending or enhancing their written compliance procedures, policies or processes, changing their business practices, or devoting more resources or attention to custody issues. OCIE’s National Exam Program also has made referrals to the SEC’s Division of Enforcement where appropriate.

The bulletin by the SEC’s Office of Investor Education and Advocacy (OIEA) describes the requirements of the custody rule, including the requirement for custodians to send account statements to investment advisory clients at least every quarter. The bulletin notes that even though the custody rule provides enhanced protections to investors, it is not a substitute for investors’ own oversight and monitoring of their investments.

“Investors should always ask questions — including questions about the custody issues discussed in this Investor Bulletin — when considering an investment,” said OIEA Director Lori Schock. “Asking questions and monitoring investments are key ways to protect yourself from investment fraud.”

The National Examination Program (NEP) of the SEC’s Office of Compliance Inspections and Examinations recently released its examination priorities for 2013. The NEP release addresses both market-wide priorities and priorities for each of the NEP’s four distinct program areas: (i) investment advisers and investment companies; (ii) broker-dealers; (iii) clearing and transfer agents; and (iv) market oversight.

This Compliance Alert newsletter includes a synopsis of the investment adviser examination priorities portion of the NEP release. For those of you who want to view the full text of the release (recommended) you can click on the following link:

Examination Priorities for 2013

In addition, please visit the U.S. Compliance Consultants blog for additional commentary on these important issues.

The NEP release looks at ongoing risks, new and emerging issues and policy topics.

Ongoing Risks

The SEC anticipates that the ongoing risks selected as focus areas for investment advisers in 2013 will include:

Safety of Assets

The SEC will continue to utilize a risk-based verification process to confirm the safety of client assets and compliance with custody requirements. The SEC will review the measures taken by registrants to protect client assets from loss or theft, the adequacy of audits of private funds and the effectiveness of policies and procedures in this area. The SEC will focus on whether advisers are:

• Appropriately recognizing situations in which they have custody as defined in the Custody Rule;
• Complying with the Custody Rule’s surprise exam requirement;
• Satisfying the Custody Rule’s qualified custodian provision; and
• Following the terms of the exception to the independent verification requirements for pooled investment vehicles.

Conflicts of Interest Related to Compensation Arrangements

The SEC will review financial and other records to identify undisclosed compensation arrangements and the conflicts of interest that they present. These activities may include undisclosed fee or solicitation arrangements, referral arrangements and receipt of payment for services allegedly provided to third parties.

Marketing/Performance

The SEC will focus on the accuracy of advertised performance, including hypothetical and back-tested performance, the assumptions or methodology utilized and related disclosures and compliance with record keeping requirements.

Conflicts of Interest Related to Allocation of Investment Opportunities

Advisers managing accounts that do not pay performance fees side-by-side with accounts that pay performance-based fees face unique conflicts of interest. While reviewing portfolio management practices, the SEC will confirm that the registrant has controls in place to monitor the side-by-side management of its performance-based fee accounts, such as certain private investment vehicles, and registered investment companies, or other non-incentive fee-based accounts, with similar investment objectives, especially if the same portfolio manager is responsible for making investment decisions for both kinds of client accounts or funds.

New and Emerging Issues

The SEC anticipates that the new and emerging risks for investment advisers in 2013 will include:

New Registrants

The SEC intends to launch a coordinated national examination initiative designed to establish a meaningful presence with newly registered advisers. The initiative consists of four phases: (i) engage with the new registrants; (ii) examine a substantial percentage of the new registrants; (iii) analyze examination findings; and (iv) report to the industry with observations.

Dually Registered IA/BD

It is not uncommon for a financial professional to conduct brokerage business through a registered broker-dealer that she does not own or control and to conduct investment advisory business through a registered investment adviser that she owns and controls, but that is not overseen by the broker-dealer. This business model presents multiple conflicts. Among other things, the SEC will review how financial professionals and firms satisfy their suitability obligations when determining whether to recommend brokerage or advisory accounts, the financial incentives for making such recommendations, and whether all conflicts of interest are fully and accurately disclosed. In addition, the staff will review dually registered firms’ policies and procedures to understand if such policies and procedures provide guidelines for when a financial professional makes a securities recommendation to a customer with a broker-dealer account versus an investment adviser account.

New and Emerging Issues

The SEC anticipates that the policy topics for investment advisers in 2013 will include:

To prevent advisers from obtaining business from government entities in return for political “contributions” (i.e., engaging in pay to play practices), the SEC recently adopted and subsequently amended, the Pay to Play rule. The SEC will review for compliance in this area, as well as assess the practical application of the rule.