3PM Regulatory Update: A Retrospective
On April 28, 2021, 3PM held a Regulatory Update for its members with guest speaker Lisa Roth from Monahan and Roth. The discussion centered on some recent regulatory updates 3PM members should be aware of.
The first topic on the agenda was SEC initiatives.
The discussion kicked off with an overview of Regulation Best Interest or Reg BI and who must comply with the obligations under this rule. Reg BI is the rule that the SEC put in place to replace the DOL’s Fiduciary Rule. The goal of Reg BI is to ensure that Broker Dealers, who do not have a Fiduciary Responsibility to their clients, recommend only those products that are in their client’s best interest.
The rule requires Registered Representatives (“RRs”) to disclose any potential conflicts of interest as well as any financial incentives they have to sell a specific product. This rule only pertains to recommendations made to and RR’s Retail Clients. If you are working institutional investors, this rule does not apply to you.
For those who do work with retail clients, Lisa went through some of the salient parts of the rule including the definition of a retail client, the disclosure obligation, and Form CRS which we learned FINRA examiners are taking a close look at.
Next, the discussion turned to the SEC’s Soley Incidental Interpretation. This is a big one for 3PMs; not so much regarding Reg BI but from the perspective of existing rules that have not been a current focus of regulators. Lisa went through the details, but given the importance of this issue, I will summarize it here as well.
The solely incidental interpretation is a complex issue, and I will not try to explain it in detail here. Suffice it to say, that is an important topic 3PMs offering fund products where compensation is based on advisory fees and/or includes a performance-based fee.
Without sounding like a regulatory, I wany to say that this issue is really facts and circumstances based. Given the nuances of each individual business and the offerings that each firm works with, there is likely no one interpretation that can be applied to all firms.
Please understand that the discussions held regarding this topic should in no way be construed as advice as to how our members should proceed in their individual business or how this rule could impact your individual ability to collect compensation. As always, 3PM suggests that you speak with a knowledgeable attorney to assess the implications of this or any discussions on regulatory rules and guidelines on your individual business. The purpose of this piece, as well as the discussion held in the Regulatory Update, is an attempt to bring to your attention the existence of this rule and the potential implications it could have on your business.
In bottom-line terms, it is generally believed that if you are selling products that are offered through a fund, you are offering a security and must be registered with FINRA. While this might be accurate in some cases, we all know that regulation is not that straight forward. The potential issue arises if you are selling a security where your compensation is based on and investment advisory fee and/or contains a performance-based fee.
Existing regulations also say that if you are collecting an advisory based fee that a 3PM must be registered as an investment advisor to do so. Similarly, BDs are not permitted to accept performance-based compensation and as such, one would be required to be registered as an investment advisor to earn this type of compensation.
The question then arises as to how you can properly register to offer a security while being paid a portion of an advisory fee and/or a performance fee? The answer could be as simple as you may need to be registered as both in order do both, but again, it’s not that easy! That is why 3PM suggests that if you are in a situation where you are offering securities and being paid a percentage of an advisory fee and/or a performance-based fee that you contact your attorney and discuss the solely incidental interpretation with them. We would hate to have any of our members be blindsided by this rule and not to be able to collect compensation earned.
More information about the solely incidental interpretation is available in SEC Release IA-5249.
The last section of SEC initiatives was a discussion of the SEC’s new Marketing Rule, which combines the SEC’s proposed advertising rule with updates they planned to make to 206 (4)3, the Solicitor Rule. The Marketing Rule is a principles-based rule and conforms in part to FINRA’s Rule 2210, Communications with the Public.
Lisa reviewed some important parts of the new rule including the new definition of an advertisement. It is also important to note that the new rule defines a single target audience for an advertisement and applies the rule equally whether you are reaching out to retail or institutional investors.
The new rule views a solicitation as a testimonial or an endorsement of an investment manager’s product. By sending out a presentation, which is considered an advertisement, 3PMs, or promoters as the rule defines us, are required to make certain disclosures regarding the relationship between the 3PM and the investment manager.
The new disclosure requirements are similar in scope to what was required by the old solicitor disclosure rule, but there are some important updates. While a signature is no longer required to be obtained when a disclosure is provided, the disclosure must now contain any conflicts of interest that might exist in the relationship between a promoter and an investment manager. The rule also provides changes to the timing of the presentation of the disclosure, which is now at the time the endorsement or testimonial is given, or when you send out the presentation book or advertisement.
Lisa mentioned that while the rule recently went into effect earlier in May, the implementation date is still 18 months out. This means we all still have time to put in place new procedures.
3PM’s regulatory committee plans to provide additional guidance and hopefully a webinar on this topic in the coming months so that our members can better understanding the requirements.
The next topic on the agenda was an update on SEC and FINRA COVID-19 Guidance. Lisa pointed out that much relief that was granted in the initial days of the pandemic, especially that included in Regulatory Notice 20-42, has expired. She urges everyone to be sure to review this notice and remember that most regulation is back to its original requirements,
The last topic of the day was regarding Cybersecurity in the WFH (Work From Home) age. Cybersecurity is an extremely important topic and one that always appears on the top of nearly every regulator’s top priorities lists. Lisa discussed that this topic is important for small firms that do not necessarily have the resources, to focus on this like the big firms do. Lisa reviewed several important areas that members should be focused on implementing in their businesses.
As always, Lisa packed a whole lot of information into a short period of time and provided many thoughtful ideas as to what members need to consider and implement to remain compliant.
If you were unable to attend the webinar, a free replay as well as a copy of the presentation used on the webinar is available on the 3PM website on the events page.
Stay tuned for our next webinar coming up soon!
Written by Donna DiMaria, Chair, 3PM Board of Directors & Founder, CEO, CCO,&
Head of Relationship Management of Tessera Capital Partners