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Office of the Indiana Secretary of State

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Connie Lawson

Indiana Securities Division

2012 Investment Adviser Conference October 10, 2012


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Welcome

Davey Neal

Chief of Staff / Deputy Secretary of State


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The Indiana Securities DivisionMission: 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


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Crowdfunding Update

Chris NaylorSecurities Commissioner


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Indiana IA Examinations~

Fiduciary Duty/Conflict of Interest

~

Common Issues/Best Practices

Teresa CronkhiteInvestment Adviser Examiner


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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.


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Indiana IA ExamsWhat 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.


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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.

Indiana IA ExamsWhat to Expect


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Pre-Exam

Notification of upcoming exam typically done by e-mail 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.

Indiana IA ExamsWhat to Expect | Pre-Exam


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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.

Indiana IA ExamsWhat to Expect | Onsite


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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.

Indiana IA ExamsWhat to Expect | Onsite


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• 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.

Indiana IA ExamsBooks & Records


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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

Indiana IA ExamsExamination Focus


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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



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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.



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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.



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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.



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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.



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Indiana IA ExamsA 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”


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Indiana IA ExamsA 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.


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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.

Indiana IA ExamsWhat to Expect | Post-Exam


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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.

Indiana IA ExamsWhat to Expect | Resolution


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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.

Indiana IA ExamsCommon Exam Deficiencies*


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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.

Indiana IA ExamsCommon Exam Deficiencies*


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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.


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Indiana IA ExamsBest 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.


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Indiana IA ExamsBest 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.


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FIDUCIARY DUTYAnd

CONFLICTS OF INTEREST


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Fiduciary DutyWhat 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.


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FIDUCIARY DUTYBackground

□ 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)


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Fiduciary DutyViolations

Illegal Behavior: Insider Trading Conversion/Theft Failure to register securities

Unethical Behavior: Failure to disclose conflicts of interest.


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THE CORNERSTONE OFFIDUCIARY DUTY:

CONFLICTS OF INTEREST


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Common Conflicts of Interest

Brokerage Practices Financial Interests Fees Valuation Relationships


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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?


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Conflicts of Interest

Investment Adviser has two Options:

1. Avoid the conflict of interest.or

2. Disclose and manage the conflict.


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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.


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Conflicts of InterestDisclosure 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.


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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?


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Registration

Doreen Fuery, Senior Accountant


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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.”


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Annual UpdatesFirms 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.


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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.


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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.


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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.


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Amendments/Material ChangesExamples

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.


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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.


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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.


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Help is Available

Filing Forms and Paying Fees FINRA / IARD Call Center

Phone: (240)386-4848 E-Mail: [email protected]

Year End Renewal Calendar and FAQs:

www.iard.com/renewals.asp


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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

Resources


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CONTACTS

Indiana Secretary of State Connie Lawson

Securities Division

302 West Washington Street, Room E-111Indianapolis, IN 46204

Phone: (317)232-6681

Fax: (317)233-3675

Web Site: ww.sos.in.gov

Investment Adviser Examiners

Michele Foldenauer: [email protected]

Teresa Cronkhite:

[email protected]

(317) 234-7902

(317) 232-0111

Senior Accountant / Registrations

Doreen Fuery: [email protected] (317)232-0737

Chief Deputy Commissioner

Jeff Bush: [email protected] (317) 232-6681


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Questions??

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