Office of the Indiana
Secretary of State
Connie Lawson
Indiana Securities Division
2012
Investment Adviser Conference
Office of the Indiana Secretary of State
Octoberwww.in.gov/sos
10, 2012
Welcome
Davey Neal
Chief of Staff / Deputy Secretary of State
Office of the Indiana Secretary of State
www.in.gov/sos
The Indiana Securities Division
Mission: Protect Investors and Minimize Burdens on
Capital Formation
 The Indiana Securities Division regulates:
 Investment Advisers & Investment Adviser Representatives
 Broker-Dealers
 Security Agents / Registered Representatives
 Mortgage brokers
 Collection agencies
 Franchisors
 Continuing Care Retirement Centers
Office of the Indiana Secretary of State
www.in.gov/sos
Crowdfunding Update
Chris Naylor
Securities Commissioner
Office of the Indiana Secretary of State
www.in.gov/sos
Indiana IA Examinations
~
Fiduciary Duty/Conflict of
Interest
~
Common Issues/Best Practices
Teresa Cronkhite
Investment Adviser Examiner
Office of the Indiana Secretary of State
www.in.gov/sos
GOALS FOR THE SESSION
 Develop a partnership.
 Create open communications.
 Answer questions today and in the
future.
 Take the mystery out of the
examinations.
 Assist in the success of our RIA
community and Indiana investors.
Office of the Indiana Secretary of State
www.in.gov/sos
Indiana IA Exams
What to Expect
 Our goal in examining state-registered Investment
Advisers is to protect investors and legitimate businesses
in Indiana.
 Two Types of Examinations
 Routine > generally a standard comprehensive exam
 For Cause > there for a reason, sometimes a
focused exam
 The Examination will be conducted where the books
and records are located.
Office of the Indiana Secretary of State
www.in.gov/sos
Indiana IA Exams
What to Expect
 Routine exams are typically a four-part process.
 Pre-Exam
 On-Site
 Post-Exam
 Resolution
 Onsite portion of exam typically lasts one day.
 Usually one - perhaps two examiners.
Office of the Indiana Secretary of State
www.in.gov/sos
Indiana IA Exams
What to Expect | Pre-Exam
Pre-Exam
 Notification of upcoming exam typically done by email a few days in advance with a list of documents
to have available.
 A request to delay an examination date is rarely
granted.
 Some exams may be unannounced.
Office of the Indiana Secretary of State
www.in.gov/sos
Indiana IA Exams
What to Expect | Onsite
Onsite
 Identify contact/point person for the examiner.
 Initial interview conducted by examiner.
 Tour of the office
 Where are trades completed?
 Where are client files?
 Where is the copier?
 Where can I work?
 Examiners prefer to work in a quiet space.
 Interview: Questions about your business and business
practices.
Office of the Indiana Secretary of State
www.in.gov/sos
Indiana IA Exams
What to Expect | Onsite
Onsite
 Be prepared with requested documents readily
available.
 Have key personnel available to answer questions.
 Exit interview (optional).
 The examiner explains what comes next. May be
done onsite or may come after the actual visit, but
not required.
Office of the Indiana Secretary of State
www.in.gov/sos
Indiana IA Exams
Books & Records
• 710 IAC 4-9-7, the Indiana Administrative
Code, gives the books and records
required by the State of Indiana for
Investment Advisers.
• Failure to keep accurate books and
records can be an indication of unethical
business practices.
Office of the Indiana Secretary of State
www.in.gov/sos
Indiana IA Exams
Examination Focus
State IA examinations generally include the following
areas:
 Books and records
 Financials
 Advisory Contracts
 Form ADV Part I and II
 Fees
 Investment Activities vis-à-vis suitability info
 Complaints
 Advertising and Marketing
 Conflicts of interest: Disclosures
 Custody
 Supervisory/Compliance Procedures
 Business Practices
Office of the Indiana Secretary of State
www.in.gov/sos
Indiana IA Exams
Books & Records
 Financial Information:
 Balance Sheet and P&L
 Journals – including cash receipts and
disbursement records, and any other records of
original entry
 Ledgers – general
 All bank information – checkbook, bank
statements, cancelled checks and cash
reconciliation
 All bills – all bills or statements paid or unpaid
Office of the Indiana Secretary of State
www.in.gov/sos
Indiana IA Exams
Books & Records
 Each order memoranda – Details of purchase, sale,
modification.
 Written Communication – copies of all
communication relating to investment advice,
recommendations, order execution, etc.
 List of Accounts – all accounts that adviser has with
notation of discretionary authority with respect to the
funds, securities or transactions of any client.
 Power of Attorney – All powers of attorney and other
evidence granting any discretionary authority by client
to the adviser.
 Written Agreements – All written agreements
entered into by adviser with any client.
Office of the Indiana Secretary of State
www.in.gov/sos
Indiana IA Exams
Books & Records
 Records/Beneficial Ownership – a record of every
transaction in a security in which the adviser or any
representative has acquired any direct or indirect
beneficial ownership.
 Copy of Brochure – a copy of each written statement
and each amendment or revision of your brochure.
Including delivery dates and any material changes to
Part 2 of your Form ADV.
 Written Acknowledgment of Solicitor – if applicable
maintain a record for each client that was obtained by
adviser by means of a solicitor to whom a cash fee
was paid the adviser.
Office of the Indiana Secretary of State
www.in.gov/sos
Indiana IA Exams
Books & Records
 Documents for Performance Figures – if
applicable, keep a written record of all accounts,
books, internal work papers, and any other records or
documents necessary to form the basis for or
demonstrate the calculation of the performance rate
of return of all managed accounts or securities.
 Written Litigation & Complaints – adviser must
keep a file containing a copy of all written
communication received or sent regarding any
litigation involving the adviser.
 Suitability Information – written information about
each investment advisory client that is the basis for
making any recommendation or providing any
investment advice to such client.
Office of the Indiana Secretary of State
www.in.gov/sos
Indiana IA Exams
Books & Records
 Copies of U-4 – Copies, with original signatures of
the investment advisers and the investment adviser
representatives of each initial Form U-4 and each
amendment to the disclosure reporting pages (DRPs
U-4).
 Business Form Documents – Partnership articles,
articles of incorporation, charters, minute books, stock
certificates, etc., if applicable.
 Government Documents- a file must be kept
containing each document that was filed with or
received from any state or federal agency that
pertains to the investment adviser or its
representatives.
Office of the Indiana Secretary of State
www.in.gov/sos
Indiana IA Exams
A Word about Designations…
Remember:
 “RIA” is the firm – not the IAR.
 Keep designations to a minimum: “CFP,” “ChFC,”
“PFS,” “CFA” and “CIC” are all valid designations.
 If you use any of these on your cards or stationery, we
will verify that you are a member in good standing with
the certifying organization.
 “CHSG”
Office of the Indiana Secretary of State
www.in.gov/sos
Indiana IA Exams
A Word of Caution about Senior Designations
710 IAC 4-10-2 Senior-specific certifications and
designations:
 Use of a designation implying certification or training in
advising senior citizens may be a dishonest and
unethical practice.
 Certifications may be acceptable if given by an
organization credited by:
 The American Standards Institute
 The National Commission for Certifying Agencies; or
 An organization on the U.S. Department of Education’s list
entitled “Accrediting Agencies Recognized for Title IV
Purposes” and the designation issued does not primarily apply
to sales or marketing, or both.
Office of the Indiana Secretary of State
www.in.gov/sos
Indiana IA Exams
What to Expect | Post-Exam
Post-Exam
 Once examiner has left the office, the exam is not
over.
 Frequently the examiner requests additional
documents or information from the adviser or the
custodian.
 May take one to several weeks depending on
responses from IA and/or custodian.
 Once post-exam work is complete, an exam report
is prepared.
Office of the Indiana Secretary of State
www.in.gov/sos
Indiana IA Exams
What to Expect | Resolution
Resolution
 Deficiency/cautionary letter may be sent.
 Registrant must respond to the
deficiency/cautionary letter in writing, within a set
amount of time.
 Once all deficiencies have been satisfactorily
addressed, exam is closed.
 Certain issues may be referred to enforcement for
action.
Office of the Indiana Secretary of State
www.in.gov/sos
Indiana IA Exams
Common Exam Deficiencies*
 Incomplete, inadequate, or no contract with clients.
 Incomplete or no written supervisory/compliance
procedures.
 Non-compliance with supervisory procedures
 Failure to send/document sending disclosure
documents annually
*Any could result in enforcement action.
Office of the Indiana Secretary of State
www.in.gov/sos
Indiana IA Exams
Common Exam Deficiencies*
 Inaccurate or incomplete Forms ADV Part 1 or 2.
 Failure to update for material changes and/or annually.
 ADV Part 1 and 2 do not reflect same information.
- Example: IA is a broker-dealer shown in Part 1, but not
disclosed in Part 2.
 Fee Inconsistencies between Part 1 and Part 2.
* Could result in enforcement action.
Office of the Indiana Secretary of State
www.in.gov/sos
Indiana IA Exams:
Enforcement Actions
Common Enforceable Actions:
•
•
•
•
•
•
•
Unregistered IAR at firm *
Fees are inconsistent with contract *
Missing or inaccurate contracts *
ADV not updated
Failure to file Form 506D with state for private fund
Failure to cooperate with examiners *
Firm failed to register firm and securities *
* Could be viewed as criminal.
Office of the Indiana Secretary of State
www.in.gov/sos
Indiana IA Exams
Best Practices
 The Securities Division recommends:
• Review and revise Form ADV and disclosure brochure
annually to reflect current and accurate information.
• Prepare separate fee statements for clients showing
valuations, calculations and amount.
• Review and update all contracts, as needed.
• Prepare and maintain client profiles, including suitability.
• Prepare and maintain all required records including
financial records.
• Keep accurate financial records.
Office of the Indiana Secretary of State
www.in.gov/sos
Indiana IA Exams
Best Practices
• Back-up electronic data and protect records.
• Prepare and keep a business continuity plan updated.
• Complete a compliance review at least annually.
• Prepare and distribute a privacy policy initially and annually.
• Review and revise all advertisements, including website and
performance advertising, for accuracy.
• Implement appropriate custody safeguards, if applicable.
•
Review solicitor agreements, disclosure and delivery
procedures.
Office of the Indiana Secretary of State
www.in.gov/sos
FIDUCIARY DUTY
And
CONFLICTS OF INTEREST
Office of the Indiana Secretary of State
www.in.gov/sos
Fiduciary Duty
What it is:
□
A fiduciary duty is a legal or ethical
relationship of confidence of trust between two
or more parties.
□ A fiduciary owes the client duties of:
1. Due care,
2. Utmost good faith,
3. Obedience,
4. Loyalty,
5. Disclosure.
Office of the Indiana Secretary of State
www.in.gov/sos
FIDUCIARY DUTY
Background
□
SEC v. Capital Gains Research Bureau (1963)
○ RIA was “scalping” shares of stocks recommended to clients.
○ Supreme Court held that this was:
• Fraud, and a
• Violation of Section 206(2) of the Adviser Act of 1940 because
– The Adviser failed to disclose the material conflict of
interest of the activity.
□ Other Sources of Fiduciary Duty:
○
○
○
○
Section 36(a) of Investment Company Act of 1940
Blue Sky Laws (State Securities Laws)
ERISA Laws
Broker Dealer Rules/Laws
(i.e. the July 9, 2012 FINRA’s new suitability rule for broker
dealers)
Office of the Indiana Secretary of State
www.in.gov/sos
Fiduciary Duty
Violations
 Illegal Behavior:
 Insider Trading
 Conversion/Theft
 Failure to register securities
 Unethical Behavior:
 Failure to disclose conflicts of interest.
Office of the Indiana Secretary of State
www.in.gov/sos
THE CORNERSTONE OF
FIDUCIARY DUTY:
CONFLICTS OF
INTEREST
Office of the Indiana Secretary of State
www.in.gov/sos
Common Conflicts of Interest





Brokerage Practices
Financial Interests
Fees
Valuation
Relationships
Office of the Indiana Secretary of State
www.in.gov/sos
Underlying Question
In all Activities to Avoid
Potential Conflicts of Interest:
Is a certain activity or relationship
inhibiting the investment adviser
or representative from acting in the
best interests of the client?
Office of the Indiana Secretary of State
www.in.gov/sos
Conflicts of Interest
Investment Adviser has two
Options:
1. Avoid the conflict of interest.
or
2. Disclose and manage the conflict.
Office of the Indiana Secretary of State
www.in.gov/sos
Conflicts of Interest:
Avoidance
• Effective, but not always realistic.
• An IA striving to be wholly conflict-free may
ultimately fail to provide certain other
benefits, products or services to its clients
– Example: IA may receive research from the
broker-dealer where it directs client trades. This
research may, in turn, increase the adviser’s
effectiveness in serving its clients.
Office of the Indiana Secretary of State
www.in.gov/sos
Conflicts of Interest
Disclosure and Management
Disclosure does not lessen your fiduciary duty
or responsibilities to manage the conflict
appropriately:
– Disclosure is only part of managing the conflict of interest;
– Disclosure must be effective and updated, as appropriate;
– Policies and procedures must be in place to ensure that the
conflict does not adversely affect clients.
Disclosure is crucial where the IA is dually registered
and may be “switching hats” as representatives do.
Clients do not understand differing standards of
care.
Office of the Indiana Secretary of State
www.in.gov/sos
Conflicts of Interest
Questions to Remember
1.
Is a certain activity or relationship inhibiting the IA or the IAR
from acting in the best interests of the client?
2.
If so, should the IA avoid the activity or disclose and manage
it?
3.
Has the firm completed sufficient due diligence to ensure
that the firm and the IARs are making appropriate
disclosures and recommendations?
4.
How do the policies and procedures assist in managing the
conflict?
5.
How is the compliance “tested” to ensure the conflict is
being managed?
Office of the Indiana Secretary of State
www.in.gov/sos
Registration
Doreen Fuery, Senior Accountant
Office of the Indiana Secretary of State
www.in.gov/sos
Annual Renewals
 FINRA’s 2012/2013 IARD Renewal Program:
 Calendar, Checklist, and FAQs are available online at:
www.iard.com/renewals.asp
 Fees: RIA Firm - $50
Individual IARs - $25
 Deadline to renew: December 21, 2012.
 Registrants who fail to renew by 12/31:
 Inactive on 1/1, and the firm is no longer a
“Registered” Investment Adviser.
 Any advisory business is “unregistered activity.”
Office of the Indiana Secretary of State
www.in.gov/sos
Annual Updates
Firms must annually update Form ADV within
90 days following FYE.
Update even if no changes.
Update must include AUM.
Review all contact information.
Update Form ADV, Parts 1 and 2, and any
Brochure Supplements.
Office of the Indiana Secretary of State
www.in.gov/sos
Annual Updates
After initial registration, no paper or
electronic documents are submitted to the
Securities Division.
Do not submit Balance Sheet. Submit only
upon Division’s request.
Office of the Indiana Secretary of State
www.in.gov/sos
Assets Under Management (AUM)
 Up to $100 Million
• must be registered with State unless the
firm is required to register in 15 or more
States, then the firm will register with SEC.
 Between $100 - $110 Million
• may choose to register with the SEC.
 Greater than $110 Million
• required to register with the SEC.
Office of the Indiana Secretary of State
www.in.gov/sos
Amendments/Material Changes
710 IAC 4-9-16(c): If any information in Items
1, 2, 3, 4, 5, 9, 10, or 11 of ADV, Part 1 or any
item in ADV, Part 2 (excluding Item 14)
becomes inaccurate or misleading for any
reason, the RIA must promptly file an
Amendment to Form ADV to correct the
inaccurate or misleading information.
 “Promptly” means within 30 days.
Office of the Indiana Secretary of State
www.in.gov/sos
Amendments/Material Changes
Examples
 Item 1 – Identifying Information
 Address, telephone number, email address, location of books
and records.
 Item 5 – Information about Your Business
 Number of registered employees, compensation arrangements,
significant increase / decrease in AUM.
 Item 6 – Other Business Activities
 Become licensed insurance agent or BD agent
 Item 11 – Disclosure Information
 Disciplinary information.
Office of the Indiana Secretary of State
www.in.gov/sos
Registering New IARs
Dual Registration is allowed in Indiana.
Exam Requirements:
 Series 65
or
both Series 7 and 66.
 Professional Designation in lieu of exams:
 CFP, ChFC, PFS, CFA, CIC (update U-4)
 Other States’ waivers do not automatically apply
to Indiana.
Office of the Indiana Secretary of State
www.in.gov/sos
Registering New IARs
File Form U-4 through FINRA
 Apply for RA registration in Indiana with RIA firm.
 Fingerprint Requirement – Maybe
 If not currently registered as a BD agent, and not
applying for BD agent registration, then
fingerprints are required.
 Inkless L-1 System
 Do not send cards to the Securities Division.
Office of the Indiana Secretary of State
www.in.gov/sos
Help is Available
 Filing Forms and Paying Fees
 FINRA / IARD Call Center
 Phone: (240)386-4848
 E-Mail: iard@finra.org
Year End Renewal Calendar and FAQs:
www.iard.com/renewals.asp
Office of the Indiana Secretary of State
www.in.gov/sos
Resources
 North American Securities Administrators
Association (NASAA)
 www.nasaa.org
 Investment Adviser Resources
 Uniform Forms
 Indiana Securities Division
 http://www.in.gov/sos
 Laws, Regulations, Policies
 http://www.in.gov/sos/securities/2409.htm
Office of the Indiana Secretary of State
www.in.gov/sos
CONTACTS
Indiana Secretary of State Connie Lawson
Securities Division
302 West Washington Street, Room E-111
Indianapolis, IN 46204
Investment Adviser Examiners
Michele Foldenauer:
mtfoldenauer@sos.IN.gov
Teresa Cronkhite:
tcronkhite@sos.IN.gov
Phone: (317)232-6681
Fax: (317)233-3675
Web Site: ww.sos.in.gov
(317) 234-7902
(317) 232-0111
Senior Accountant / Registrations
Doreen Fuery: dfuery@sos.IN.gov
(317)232-0737
Chief Deputy Commissioner
Jeff Bush: jabush@sos.IN.gov
(317) 232-6681
Office of the Indiana Secretary of State
www.in.gov/sos
Questions??
Office of the Indiana Secretary of State
www.in.gov/sos