Legal Risk Management Tips

There are many reasons why an investment adviser representative (“IAR”) or registered representative (“RR”) might decide to change companies or "break away" from a registered investment adviser or broker-dealer.  Even when an individual has a strong relationship with his or her current employer, there may be are a variety of compelling motivations to make a change.  Jacko Law Group, PC (“JLG”) has seen an increase in activity where IARs and RRs are forming their own independent businesses or combining with other existing investment advisers and broker-dealers. 

For Registered Investment Advisers (“RIAs”), acquiring another investment adviser’s practice can often serve as an efficient means for quickly increasing the assets under management and profitability of the RIA, while also adding scale and efficiency to client services.  However, in light of the numerous regulatory and corporate considerations involved in such corporate combinations careful analysis and planning should be conducted prior to entering into a definitive agreement.  Not only will the acquiring RIA face legal and compliance obstacles, but the selling RIA often has a personal connection to the business being sold that needs to be considered. 

Last month, the Office of Compliance Inspections and Examinations (“OCIE”) of the U.S. Securities and Exchange Commission (“SEC”) issued its examination priorities for 2016.[1] This letter, issued annually as part of the SEC’s National Exam Program, allows registrants the opportunity to focus its compliance program efforts on those areas of particular interest to the staff.  This month’s Legal Tip will highlight some of the most notable areas that could impact the compliance programs of investment advisers, investment companies, broker-dealers, and advisers to private funds.  At the conclusion of this summary, will provide certain risk management tips for firms to consider when advancing their compliance programs in 2016.  

A Focus on Private Equity

The past year has seen interesting developments for private equity funds and, in many cases, their recently registered investment advisers.  Ever since Andrew Bowden’s “Spreading Sunshine in Private Equity” speech[1] that announced private equity’s emergence as a focus area for the Securities and Exchange Commission (“SEC”), the industry has seen a steady increase in the amount of regulatory attention and scrutiny on private equity advisers and funds.[2]  While much of the focus has centered on fees and expenses, other important compliance areas are certainly fodder for the SEC’s Division of Enforcement.

As part of its “Fiscal Year 2015 Financial Report” released by the U.S. Securities and Exchange Commission (“SEC”) last month, the SEC discussed how “first-of-their-kind” and “high impact” cases highlighted a strong year of enforcement actions.  According to the report, the SEC ended the fiscal year of 2015 (which for the SEC concludes on September 30th) having filed a record 807 enforcement actions, representing an increase of seven percent (7%) over the prior year’s number of enforcement actions.  Of the 807 enforcement actions, a record 507 were independent actions for violations of federal securities laws and 300 were either actions against issuers who were delinquent in making required filings with the SEC, or administrative proceedings seeking bars against individuals based on criminal convictions, civil injunctions, or other orders.

In Part 1 of our Considerations for Forming and Operating a California LLC series, we discussed the entity structure of an LLC and initial considerations that should be taken including jurisdiction, the operating agreement and default rules including new rules for formation, duties owed by members, members’ authority, ownership interests and indemnification. In Part 2 we will explore tax treatment, other entities, raising capital, and staying compliant.

The first step in the process of any new business is deciding which entity structure the new company will utilize.  However, this process is also riddled with possible pitfalls.  Taking the time to understand the pros and cons of any entity structure is vital to the short and long-term success of the company.  In this two-part series, we will focus on one such business entity type – the Limited Liability Company (“LLC”), and will describe the entity structure, governing rules in the State of California and some common pitfalls to avoid when registering and operating your company as an LLC.

Ever since the financial crisis of 2008, we have witnessed an increase in registered investment advisory business growth.  Traditional brokers are “breaking away” to form their own independent businesses and existing registered investment advisers are joining forces with other advisers in order to accelerate growth opportunities in the marketplace.  Also, mergers and acquisitions are becoming more and more common place as a result of strategic transition and business succession planning.  Each of these scenarios has a series of regulatory compliance considerations the business must face, whether on the breakaway path or on the merger and acquisition side.  This month’s legal tip will focus on those considerations that businesses should keep in mind prior to implementing the transition plan.

Over the past few years, more and more firms are diversifying services and products. In an effort to support this business development and attract new talent, broker-dealers (“BDs”) are permitting associated persons to affiliate with independent, non-affiliated investment advisory firms (“IAs”) and vice-versa, which allows the representative to conduct both brokerage business (as a registered representative or “RR”) through the BD and advisory services (as an investment adviser representative or “IAR”) through the IA. This also allows for greater prospective client development opportunities, which leads to revenue generation.  However, with more diversity come greater compliance challenges that necessitate engagement of legal counsel during particular transactions. This legal tip will provide important information regarding challenges compliance officers have in overseeing the “hybrid” business model, with a case study involving special considerations for supervision of outside business activities and revenue flow. 

One important decision in the lifecycle of a growing company is when to hire its first in-house counsel.  Frequently, this issue arises at a time in the evolution of an organization before there is a need for a full-time employee in this role or room in the corporate budget for a highly compensated general counsel.  Other factors may drive the decision of whether to hire an internal attorney including costs, how the function will integrate with the current management and whether there is enough work for a full time employee.  When to devote resources to this role is equally important as how to devote those resources.