Welcome to the March 12, 2025 edition of On The Docket, which includes the following content:
- The SEC takes yet another action against an adviser for allegedly violating its whistleblower protection rule
- Acting Chairman announces new Crypto Task Force
- The FinCEN Beneficial Ownership Information reporting saga continues…
- Twelve additional firms snagged by the SEC’s “Off-Channel Communications” sweep, resulting in $63 million in penalties.
- “Hallmarks of broker activity” cause issues for advisers that should have also been registered as brokers
- State burdens that have no SEC equivalent
- SEC Exams: What to expect
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Happy reading.
– Chris
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The SEC takes yet another action against an adviser for allegedly violating its whistleblower protection rule
Two interesting tidbits from the settled order:
1️⃣ The settled order helpfully summarizes the history of the whistleblower protection rule itself (Rule 21F-17), which is copied at the end.
2️⃣ It was the mere fact that the employee separation agreement in question required employees to disclose to their employer whether they had previously reported possible violations of the federal securities laws to the SEC (and, as a result, forego their ability to receive post-separation payments and benefits from their employer) that violated the whistleblower protection rule.
Though the employee separation agreement contained a purported carve-out to protect whistleblowing, it did not “remedy the impeding effect of the separation agreement, which addressed past employee conduct (i.e., it required disclosure of already-made complaints to the SEC), because the carve out was prospective in application (i.e., it did not prohibit departing employees from making future complaints).
Takeaway: The SEC continues to hunt for violative employee separation agreements and whistleblower protection breaches generally.
Whistleblower Protection Rule Summary
The Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”), enacted on July 21, 2010, amended the Exchange Act by adding Section 21F, “Whistleblower Incentives and Protection.”
The purpose underlying these provisions was “to encourage whistleblowers to report possible violations of the securities laws by providing financial incentives, prohibiting employment-related retaliation, and providing various confidentiality guarantees.” To fulfill this Congressional purpose, the Commission adopted Rule 21F-17, which provides in relevant part: (a) No person may take any action to impede an individual from communicating directly with the Commission staff about a possible securities law violation, including enforcing, or threatening to enforce, a confidentiality agreement … with respect to such communications.
Rule 21F-17 became effective on August 12, 2011.
Acting Chairman announces new Crypto Task Force
Well that didn’t take long… talk about an immediate 180.
“To date, the SEC has relied primarily on enforcement actions to regulate crypto retroactively and reactively, often adopting novel and untested legal interpretations along the way. Clarity regarding who must register, and practical solutions for those seeking to register, have been elusive. The result has been confusion about what is legal, which creates an environment hostile to innovation and conducive to fraud. The SEC can do better.”
The FinCEN Beneficial Ownership Information reporting saga continues…
In short, FinCEN BOI filing obligations won’t be enforced and another interim final rule is apparently forthcoming by March 21:
Twelve additional firms snagged by the SEC’s “Off-Channel Communications” sweep, resulting in $63 million in penalties.
The settled orders contain a brief but helpful summary of the specific Recordkeeping Rule subsection at issue ↓
🌐 Read the full press release here.
“Hallmarks of broker activity” cause issues for advisers that should have also been registered as brokers
The SEC pursued 3 IARs that should have been registered as registered reps of a broker-dealer since they engaged in “hallmarks of broker activity”:
→ Solicited investors for a private investment
→ Provided investors with marketing materials
→ Advised investors on the private investment’s merits
→ Received transaction-based compensation
🌐 Three Investment Adviser Representatives Settle SEC Charges for Acting as Unregistered Brokers
State burdens that have no SEC equivalent
It’s pretty crazy that two otherwise identical advisers can be subject to such divergent rules/regs based simply on whether registered with the SEC or a state (and which state, at that).
Here’s a non-exhaustive list of state burdens that have no SEC equivalent:
→ Many states still expressly prohibit testimonials. The SEC’s marketing rule expressly permits testimonials.
→ Many states require certain advisers to maintain a minimum net worth, maintain and annually submit GAAP financials, and/or maintain a bond (typically if the adviser has discretion or custody of client assets). There is no specific net worth or GAAP financial requirement for SEC-registered advisers.
→ Some states require re-submission of client advisory agreements if any revisions or updates are made to the standard form version, even if not undergoing an exam. The SEC simply requests such agreement versions during the course of an exam.
→ Many states require that client advisory agreements reflect their state as the ‘choice of law’ state pursuant to which disputes will be governed. This becomes unwieldy for advisers registered in multiple states, and can necessitate multiple state-specific advisory agreement versions to be maintained. The SEC imposes no ‘choice of law’ requirement for client advisory agreements.
→ Many states prohibit alternative dispute resolution clauses in client advisory agreements (e.g., mediation and/or arbitration), and force disputes to be resolved in that state’s courts. The SEC (at least for now) permits alternative dispute resolution.
→ Many states prohibit client advisory agreements to be amended or assigned by passive or ‘negative’ consent (i.e., upon advance written notice to clients), and instead require client signatures for any contractual amendment or assignment. The SEC permits passive/negative consent amendments and assignments of client advisory agreements if done correctly.
→ Some states impose arbitrary caps on the advisory fee rates or amounts that can be charged to clients based on what they deem to be “unreasonable” or a “dishonest and unethical business practice”. A subset of states are quite explicit and draconian in this regard. The SEC generally considers fees in excess of 2% of AUM per annum to be excessive, but nonetheless permits higher fee rates to be charged with additional disclosure that the adviser’s fee rates are higher than normal.
→ Many states require an “itemized” invoice to be sent to clients each time the adviser charges a fee. “Itemized” generally means that the invoice should include the fee itself, the formula used to calculate the fee, the value of the assets under management on which the fee is based (if applicable), and the time period covered by the fee. The SEC does not have an equivalent fee statement itemization requirement.
→ Some states consider third-party SLOA money movement authority to constitute custody in such a way that it triggers an annual surprise custody exam from an independent public accountant. Incredibly, Tennessee even considers first-party SLOA money movement authority to require the annual surprise custody exam. Third-party SLOA money movement authority constitutes custody for SEC-registered advisers, but the annual surprise custody exam is not required if 7 (relatively straightforward) conditions are satisfied.
→ Most states require that clients be afforded a 5-day right to rescind an advisory agreement for a full refund if the adviser does not deliver Form ADV Part 2 to the client at least 48 hours prior to entering into an advisory agreement. The SEC does not enforce an equivalent right of rescission.
→ The Form ADV Part 1 version for state-registered advisers includes an additional Part 1B that requires additional disclosure re: bonding/minimum net worth requirements, judgment/liens, arbitration claims, civil judicial actions, other business activities, investments based on financial planning activities, custody, and form of organization. The Form ADV Part 2A version for state-registered advisers includes an additional Item 19 that requires additional disclosure re: executive officers and management persons, other business activities, performance-based fees, arbitration claims, civil/SRO/administrative proceedings, and securities issuer relations. The Form ADV Part 2B version for state-registered advisers includes an additional Item 7 that requires additional disclosure re: arbitration claims, civil/SRO/administrative proceedings, and bankruptcies.
→ As part of the initial application process, some states try to require out-of-state advisers to qualify and file as a ‘foreign’ business with their secretary of state, thus subjecting the adviser to additional fees and administrative overhead. An SEC-registered adviser that notice files in a state does not trigger similar demands.
→ The SEC has a statutory maximum of 45 days by which to approve or institute proceedings to deny an initial registration application. States are often not subject to any statutory application review turnaround times (or at least that are enforced), which means that an initial state registration application can potentially drag on for months.
Phew.
What did I miss?
SEC Exams: What to expect
We’ve helped a bunch of advisers convert from state to SEC registration (especially recently).
By my estimation, about 80% of these new SEC registrants were examined within the first 12-18 months of SEC registration approval.
The SEC has published two extremely helpful Risk Alerts that describe what examinees should expect during the course of this exam – including a list of commonly-requested information and documents. I also wrote an article that adds a few tips to help advisers prepare. Links to all are below:
→ Observations from Examinations of Newly-Registered Advisers
→ Investment Advisers: Assessing Risks, Scoping Examinations, and Requesting Documents
We highly encourage advisers to read the above resources and do a “dry run” of an exam to see if they can produce the info/docs requested in a timely and organized fashion.
At least to my knowledge, there is no equivalent resource published by NASAA to help state-registrants prepare for an exam by their state securities authority(ies)… because each state has its own bespoke exam process and expectations. Some modicum of state uniformity in the state-registered adviser exam experience would be welcome, but I’m not holding my breath.