Official Newsletter of Gordian Compliance Solutions, LLC.

INVESTMENT ADVISER NEWS UPDATES

SETTLEMENT IN SEC ENFORCEMENT ACTION FOR FAILURE TO ESTABLISH FORMAL CYBERSECURITY POLICY
 

The United States Securities and Exchange Commission (“SEC”) announced this past week that a St. Louis-based investment adviser has settled with the Commission after failing to establish required cybersecurity policies and procedures in advance of a breach that affected the personally identifiable information of approximately 100,000 individuals.[1]  The SEC’s investigation found that the investment adviser suffered cyber breaches over a four year period of time, during which, the adviser failed to conduct any periodic risk assessments, implement a firewall, encrypt private client data, or maintain a formal cybersecurity response plan.[2]  Without admitting fault, the St. Louis-based adviser agreed to a $75,000 penalty.[3]

Cybersecurity continues to be an exam focus for federal and state regulators in 2015.  It is important that investment advisers have a formal cybersecurity policy in place that allows for careful monitoring of their technology systems, and a periodic review of their procedures (conducted annually as a best practice).  Often, the development of a strong cybersecurity policy relies on the expertise of third-party IT providers and specialists.
 
For questions relating to the development of a formal cybersecurity policy, please contact your Gordian Compliance consultant.

CFTC FINALIZES FUTURES ASSOCATION
MEMBERSHIP REQUIREMENT

 

On September 10, 2015, the Commodity Futures Commission (“CFTC”) approved regulation 170.17, broadening the existing registered futures association (“RFA”) membership requirement.[1]  The final rule would require introducing brokers (“IB”), commodity pool operators (“CPOs”) and certain commodity trading advisors (“CTAs”) to become members of an RFA.[2]  Currently, the only RFA is the National Futures Association (“NFA”).

While registered futures commission merchants, swap dealers, and major swap participants are already required to become a member of an RFA under longstanding CFTC rules, this has not traditionally been the case for IBs, CPOs, and CTAs.[3]  In the past, IBs, CPOs, and CTAs were only required to become members of an RFA under NFA Bylaw 1101, which prohibits NFA members from dealing with nonmembers when transacting futures contracts.[4]  Under the new final rule, registered IBs, CPOs, and almost all CTAs would be required to become members of the NFA.

Regulation 170.17 will likely have no effect on IBs, CPOs, and CTAs that have claimed exemptions from CFTC registration (i.e. CPOs relying on the de minimis exemption under 4.13(a)(3)[5] and CTAs relying on 4.14(a)(9)[6]).  However, the new rule will require registered CPOs operating funds pursuant to CFTC Regulation 4.7, that trade only swaps and no futures, to become NFA registered.[7]  

Affected IBs, CPOs, and CTAs must comply with the final order no later than December 31, 2015.

 
[3] Id.
[4] Id.
[5] Id.
NEW FINCEN AML PROPOSAL IMPACTS
INVESTMENT ADVISERS

 

On August 25, 2015, the Financial Crimes Enforcement Network (“FinCEN”) proposed a rule[1] requiring certain investment advisers to establish Anti-Money Laundering ("AML") programs and report suspicious activity to FinCEN under to the Bank Secrecy Act (“BSA”).[2]  The proposed rule includes investment advisers within the definition of a “financial institution,” which would require advisers to file Currency Transaction Reports (“CTRs”), and keep records pertaining to funds transfers.[3]  FinCEN’s proposal would apply to investment advisers that are required to register with the United States Securities and Exchange Commission (“SEC”).

The proposal is the latest attempt to address the money laundering vulnerabilities of the U.S. financial system.  Generally, AML programs attempt to identify the movement of illicit funds through established U.S. institutions.  FinCen believes that “[r]equiring investment advisers to establish AML programs and file reports of suspicious activity would bring them under similar regulations as other financial institutions,” positioning them to “deter illicit actors from using them as conduits."[4]

Comments on FinCEN’s proposed rulemaking must be submitted on or before 60 days after its publication in the Federal Register.

SEC NO ACTION LETTER FOCUSES ON GENERAL SOLICITATION AND INVESTOR RELATIONSHIPS
 

The United States Securities and Exchange Commission (“SEC”) issued a No Action Letter[1] on August 6, 2015, highlighting new compliance and disclosure interpretations on general solicitation (or general advertising) for offers made pursuant to Rule 502(c) and Rule 506 (b) of Regulation D under the Securities and Exchange Act of 1933.  The SEC’s No Action Letter clarified existing guidance in determining the existence of “pre-existing” and “substantive” relationships with prospective investors—in order to demonstrate the absence of general solicitation.[2]  

First, a pre-existing relationship is one formed between the issuer and prospective investor prior to engaging in the offering.  The relationship may be established through an intermediary (typically a registered broker dealer or another investment advisor).  In forming such a relationship, the SEC’s No Action Letter clarified that there is “no specific duration of time or particular short form accreditation questionnaire” that, in and of itself, establishes a pre-existing relationship with a potential investor.[3]  

Second, a substantive relationship is one where “the issuer (or a person acting on its behalf) has sufficient information to evaluate, and does, in fact, evaluate, a prospective offeree's financial circumstances and sophistication, in determining his or her status as an accredited or sophisticated investor
."[4]   The SEC noted that “the quality of the relationship between an issuer (or its agent) and an investor is the most important factor in determining whether a substantive relationship exists."[5]  "Whether an issuer has sufficient information to evaluate, and does in fact evaluate, a prospective offeree's financial circumstances and sophistication will depend on the facts and circumstances."[6]  

Though limited in scope, the SEC’s No Action Letter provides careful instruction for issuers relying on Regulation D offerings where general solicitation is prohibited.  Issuers should strive to develop policies and procedures that evaluate whether a pre-existing or substantive relationship exists with a potential investor.  Such policies should examine an investor’s financial circumstances and sophistication[7] to determine the quality of their relationship with the issuer, and how they will fit into the overall offering scheme.

 
[1] SEC No Action Letter: Citizen VC, Inc., United States Securities and Exchange Commission (August 6, 2015)
[2] SEC Issues Guidance on “General Solicitation or General Advertising, Paul, Weiss, Rifkind, Wharton & Garrison LLP (August 12, 2015)
[3] SEC No Action Letter: Citizen VC, Inc., United States Securities and Exchange Commission (August 6, 2015)
[4] Id., See also Bateman Eichler, Hill Richards, Inc. (Dec. 3, 1985)
[5] Id.
[6] Id.
[7] Id. (“We note your representation that CVC's policies and procedures are designed to evaluate the prospective investor's sophistication, financial circumstances and ability to understand the nature and risks of the securities to be offered.”)

SERVICE PROVIDERS AND RESOURCES

ASHLAND PARTNERS
 
Ashland Partners is a specialty CPA firm focused on the investment management industry. Founded in 1992, Ashland Partners is the largest and oldest verification firm with over 800 clients. In addition to GIPS consulting and verification, Ashland Partners provides strategy and model examinations, SSAE No. 16 examinations, surprise custody examinations, financial statement audits, tax services, cybersecurity services, QPAM exemption audits, and consulting.  Ashland professionals have achieved a wide variety of credentials including CPA, CFA Charters, and the CIPM Certificate. For more information, please visit their website: www.ashlandpartners.com

 

THE OFFSHORE FUNDS BLOG
 
The Offshore Funds Blog is dedicated to demystifying offshore investment funds.  The website provides a valuable insight into how offshore funds work, and why managers implement them into their advisory scheme, covering regulatory developments within the British Virgin Islands and the Cayman Islands.  The blog is an ongoing project by Harneys law firm, and includes contributions authored by a team of attorneys with over 70 years combined experience in offshore investment practice.  The Offshore Funds Blog can be accessed here: http://offshorefundsblog.com/ 

SEC RULEMAKING INDEX
 
On September 24, 2015, the United States Securities and Exchange Commission (“SEC”) announced the implementation of a new website to track the Commission’s rulemaking actions.  The website consolidates SEC rulemaking activity since 2008, including information about proposed and final rules.  The SEC’s new website can be accessed at the following address: http://www.sec.gov/rules/rulemaking-index.shtml
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