New Jersey Lawyer & Attorney : Stark & Stark Law Firm : New Jersey Law Blog

As we advised you in our Fall Compliance Update, on October 3, 2011, the U.S. Securities and Exchange Commission's ("SEC") new Rule 13h-1, under Section 13(h) of the Securities Exchange Act of 1934, became effective. The purpose of the new rule is to assist the SEC in identifying and obtaining trading information on market participants that are involved in a large amount of trading activity in the U.S. securities markets.

The new rule imposes new filing requirements on "Large Traders," and new recordkeeping, reporting and monitoring requirements on broker-dealers. Rule 13h-1 defines Large Trader as: any person or entity, including investment advisers, that directly or indirectly exercises investment discretion over one or more accounts and effects transactions for the purchase or sale of any [exchange-listed] security for or on behalf of such accounts, by or through one or more registered broker-dealers, in an aggregate amount equal to or greater than either 2 million shares or $20 million in a single day or 20 million shares or $200 million in a calendar month. There are a limited number of exceptions to the definition of Large Trader including trades related to gifts, distributions of estates, court-ordered transactions, exercises or assignments of options contracts, and the creation of ETFs.

Rule 13h-1 requires a Large Trader to identify itself to the SEC and make certain disclosures on Form 13H. The information requested by Form 13H includes basic identifying information, the name of the organization and any affiliates, an organizational chart, a description of the nature of the firm's business, a list of forms the firm filed with the SEC, the names of each general partner and executive officer, director and trustee, and a list of broker-dealers where the trader has an account.  The Form 13H will be kept confidential by the SEC and will be exempt from Freedom of Information Act requests.

Upon receipt of Form 13H, the SEC will assign the Large Trader an identification number known as an LTID. The Large Trader must provide its LTID to each registered broker-dealer effecting transactions on its behalf. The registered broker-dealer(s) are required to maintain records concerning the Large Trader's trades.

Organizations that are required to file Form 13H have until December 1, 2011 to do so. Please Note: Your firm is only required to file Form 13H by December 1, 2011 if your firm placed any qualifying trades from the effective date, October 3, 2011, through December 1, 2011. If your firm has not placed any trades during that time period that would require it to register as a Large Trader, the firm must file a Form 13H within ten days of qualifying as a Large Trader. After making an initial Form 13H filing, your firm must continue to file Form 13H annually.  Further, if any information contained within the form becomes inaccurate or out-dated, an amended filing must be made by the end of the calendar quarter.  If your firm has filed Form 13H, but during the previous calendar year did not place a trade that qualified as a large trade, it can make a filing to request "inactive" status and re-activate whenever necessary.

Please Note: The above discussion is a Summary only. Should you have any questions regarding how Rule 13h-1 and the Form 13H requirements will affect your firm, we remain available to address same. Should your firm be required to file Form 13H, Stark & Stark is prepared to make your initial filing and any subsequent annual filing.

Click here to obtain a copy of Form 13H.

Please Note: all 13H filings MUST be filed on the EDGAR system. Our staff can help you obtain the proper EDGAR system log-in if you do not currently use the EDGAR system.

Please contact Janet Canela (jcanela@stark-stark.com), Cathy Pike (cpike@stark-stark.com) or Ann Cirillo (acirillo@stark-stark.com) for additional information.

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Effective September 19, 2011, the Securities and Exchange Commission amended Rule 205-3 of the Investment Advisers Act of 1940 (“Advisers Act”) which generally prohibits an investment adviser from entering into, extending, renewing or performing any investment advisory services for compensation based on a share of capital gains or capital appreciation of, the funds of a client (“performance fees”). Rule 205-3 of the Advisers Act exempts an investment adviser from the prohibition against charging performance fees in certain circumstances, including when the client is a “qualified client”. 

The amended Rule 205-3 allows an investment advisor to charge performance fees if the client has at least $1 million (raised from $750,000) in assets under the management with the investment advisor immediately after engagement for advisory services or if the investment advisor believes, immediately prior to being engaged, that the client has a net worth of more than $2 million (raised from $1.5 million) (together, in the case of a natural person, with assets held jointly with a spouse).

Investment advisors should review and amend (if necessary) their disclosure documents and offering materials to comply with the amended Rule 205-3.

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Recently the SEC approved a new rule to define the term “family Office.” Pursuant to the SEC’s new definition, a “Family Office” is a firm: 1) whose only clients are family clients; 2) and is wholly owned by family clients and controlled by family members and/or family entities; and 3) does not hold itself out to the public as an investment adviser.

Under the rule, family members include all lineal descendants of a common ancestor (who may be living or deceased) as well as current and former spouses or spouse equivalents of those descendants, provided that the common ancestor is not more than ten (10) generations removed from the youngest generation of family members. Furthermore, the rule accepts all children by adoption and current and former stepchildren as family members.

Included in the definition of family clients are family members (as defined above) and all of the following individuals and/or entities: 1) key employees of the family office (including executive officers, directors, trustees and general partners for the family office or its affiliated family office); 2) any other employee of the family office or any affiliated family office (other than an employee performing solely clerical, secretarial, or administrative functions) who has participated in the investment activities of the family office or any affiliated family office for at least 12 months; 3) any estate of a family member, former family member, key employee (and in some instances, a former key employee); 4) nonprofit and charitable organizations funded exclusively by family clients; 5) certain family trusts; 6) and companies wholly owned and operated for the benefit of family clients.

Family Offices are excluded from registration with the SEC. While not required to register with the SEC, those firms fitting the definition of Family Office must respond to certain questions found on Form ADV Part IA and periodically update same.

Please Note: Advisers who are currently relying upon the Family Office exemption but will no longer qualify under the new definition, must register with the SEC by March 30, 2012 (a later compliance deadline of December 31, 2013 has been established for Family Offices that manage assets of nonprofit or other charitable organizations funded by, in part, non-family assets). If you would like to discuss this blog post in more detail, please feel free to contact me in my firm's Lawrenceville, New Jersey with any questions you may have.  

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Thomas B. Lewis, Chair of Stark & Stark’s Employment Group, was quoted in the September 13, 2011 FundFire article, AllianceBernstein Sues More Departed Advisors.

The article discusses the continiuing legal battle AllianceBernstein is engaged in with financial advisors who recently left their firm and took clients with them. The firm filed suit against eight former brokers, claiming that they violated their non-solicitation agreements after they left without giving sufficient notice and taking their client lists and other confidential information with them.

Mr. Lewis comments on AllianceBernstein’s choice not to partake in the Protocol for Broker recruiting. He states, “The reason they have not joined is because they are concerned that it will make it easier for people to leave AllianceBernstein. They don’t want to join the protocol right now because there’s a great concern that there might more people who would want to leave than join, and in that situation, the protocol would not be a good mechanism for them to use.”

 

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Paul A. Lieberman, Shareholder in Stark & Stark's Securities Group, was quoted in the August 20, 2011 New York Post article, Ashton's Hard Sell With Feds.

Recently, Ashton Kutcher’s comments regarding several internet based social media companies has come under scrutiny after Kutcher authored an article for Details magazine in which he praises Tinychat, Fourquare, Arbnb and several other companies, while failing to disclose the fact that he is an investor in the companies. Now the Federal Trade Commission and the Securities Exchange Commission are questioning if this move warrants a federal investigation.

In the article, Mr. Lieberman states, “He's getting close to the line, if not crossing it, in terms of SEC regulations on insider trading."

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For those who participate in the offering/sale of variable annuities and who may be subject to FINRA examinations, I have summarized some of the key points from Mr. Ketchum’s recent speech before the Insured Retirement Institute Government, Legal and Regulatory Conference.

Exam Priorities

1. Verify customer assets exist and held at secure locations
2. Risk analysis > examiners ask right questions when enter
3. Profiles of firm’s business model and underlying risks
4. Test for compliance with customer protection rules
5. Examiners understand risks/management; looking for control breakdowns
6. Point of Sale exams – focus on branches, rather than headquarters
7. Pilot program – collect data from underwriters and manufacturers via standard request; templates being used: a) 1st round of requests sent April, 2011; and b) 2nd round of requests to VA manufacturers sent July – August 2011

FINRA Goals

FINRA is requesting broader data collection with increased analysis to spot trends and create risk-base exams.

Recent Exam findings

1. Failure to document basic customer information
2. Inadequate policy and procedures
3. Inadequate supervisory reviews > suitability
4. Training programs inadequate
5. Abusive switches and costly surrender charges
6. Over concentration of annuity products

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Advisors who are looking to move wirehouses frequently ask me where they can find information to help them make the right decision. If you’re an advisor who is thinking about going independent by joining a registered broker-dealer, becoming a registered investment advisor or you’re looking to start your own firm, there are a lot of factors that go into making this decision which require careful thought and consideration.

Advisor In Transition has set up an online guide for wirehouse advisors on the move. The tools and resources offered on this site are designed to help advisors make informed decisions and ensure a smooth transition to a new firm. The site offers information from some of the country’s top professionals in the industry to help you decide which avenue is right for you.

 

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Pursuant to Regulatory Notice 11-10, firms must electronically file specified events and quarterly customer complaint information pursuant to Rules 3070 and NYSE Rule 351 through a new process which becomes effective on July 1, 2011. Compliance Officers should cross reference Regulatory Notice 11-06, as well as become familiar with the automated application disclosure events and conflicts sections which are new.

FINRA has modernized its systems of self-reporting misconduct by mandating that electronic filings be made within 30 days of the determination that the Firm or an Associated Person committed a reportable violation. Member firms are required to self report violations. This process, however, allows FINRA and, uncertain circumstances the public, earlier access to such information. The new methodology creates consistency and clarity in the filing process. 

What:  There is a menu in the FINRA automated application system, containing new dropdown items for reporting of events corresponding with Rule 4530 information. The numeric codes previously used will be eliminated.  (See footnotes 8 and 9 of Regulatory Notice 11-10) Batch submissions are possible via a file transfer protocol. There is also a new hyperlink for access.

When:  Reporting must be accomplished within 30 calendar days after the Firm has made its conclusion, based upon the “reasonable person” standard, that either the Firm or one of its Associated Persons has committed a reportable violation.

Why:  A Broker-Dealer or Associated Person is required to self report violation of the securities, commodities, financial, investment related law, rule, regulation or SRO standard of conduct.

How to Report:  (1) Firm designates an individual to make an internal investigation and complete a report. The designated firm individual would then access the system and utilize the dropdown menu to make the report. (2) An update of the firm’s written supervisory procedures to reflect the compliance process concerning Regulatory Notice 11-10 should also be considered.

Who:  Firms’ internal decision making for self reporting must be done by an experienced and trained individual. The “reasonable person” standard is applied to the conclusion that a violation occurred. The internal decision maker must review the conduct and consider its impact, including potential, actual, and widespread impact to the firm, its customers and brokers.  Conduct that must also be considered when making a report:

• any material failures of the firms’ policies and procedures; and
• whether or not the specific violation has involved numerous clients, material errors, significant dollar amounts and/or patterns or series of events that are related

In order to support the firms’ good faith reasonable determination, the firms’ decision making individual must be able to support the conclusions reached as to whether the event requires disclosures with relevant documentation for each filing or the decision that no filing is required. The Firm should assure that Associated Persons understand that they are required to promptly inform the proper individual at the Firm of any reportable event. Rule 4530 includes findings of financial, business, or professional misconduct which may result in civil litigation, arbitration proceedings or regulatory matters. Note that non-securities insurance products are covered.

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Thomas B. Lewis, Chair of Stark & Stark's Employment Group, was quoted in the February 18, 2011 Wall Street Journal article, US Trust Asks Employees to Confirm Broker Protocol Doesn't Apply. The article discusses a memo Bank of America sent to its U.S. Trust banking employees which asked them to acknowledge that they are not subject to an industry-wide agreement on how
brokers leave firms for new jobs. Mr. Lewis states, "the memo appears to include new rules and that it is a "questionable" assertion that U.S. Trust isn't a Protocol member."
 

Mr. Lewis was also quoted in the February 22, 2011 Wall Street Journal article, US Trust's 'Garden Leave' May Start Trend. The article is a follow up to the Febryary 18th article in which Mr. Lewis states, "Garden leave provisions apply to many senior executives. They haven't typically been applied to financial advisers until now, however, mainly because they cripple their ability to convince clients to stick with them during the transition. Sixty days is an eternity in the brokerage world."

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Panel of experts-moderated by TD's Schweiss provides insight, likely next steps for SEC studies
TD Ameritrade Institutional held its 2011 National Conference yesterday in San Diego, California, entitled, The Real Impact of Financial Regulatory Reform. The conference featured a panel of investment professionals who offered up differing views and opinions on how to implement new regulations for the SEC. Thomas D. Giachetti, Chair of Stark & Stark’s Securities Group, served as a featured panelist.

Mr. Giachetti stated, “Advisors are the bastard stepchildren of the SEC.”  By that, he meant that those on the Commission—both on the Commission level and the staff level—don’t understand the business models of RIAs who advise individual clients. As for the SEC’s SRO report, Giachetti (left) said he believed the best solution would be to create an entirely new self-regulatory organization to oversee all fiduciary advisors.

You can read a report on the full conference online here.

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