Office of the Indiana Secretary of Statewww.in.gov/sos Office of the Indiana Secretary of State Connie Lawson Indiana Securities Division 2012 Investment Adviser Conference October 10, 2012

Office of the Indiana Secretary of Statewww.in.gov/sos Welcome Davey Neal Chief of Staff / Deputy Secretary of State

Office of the Indiana Secretary of Statewww.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 Statewww.in.gov/sos Crowdfunding Update Chris Naylor Securities Commissioner

Office of the Indiana Secretary of Statewww.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 Statewww.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 Statewww.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 Statewww.in.gov/sos  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 Exams What to Expect

Office of the Indiana Secretary of Statewww.in.gov/sos 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 Exams What to Expect | Pre-Exam

Office of the Indiana Secretary of Statewww.in.gov/sos 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 Exams What to Expect | Onsite

Office of the Indiana Secretary of Statewww.in.gov/sos 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 Exams What to Expect | Onsite

Office of the Indiana Secretary of Statewww.in.gov/sos 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 Exams Books & Records

Office of the Indiana Secretary of Statewww.in.gov/sos 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 Exams Examination Focus

Office of the Indiana Secretary of Statewww.in.gov/sos  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 Indiana IA Exams Books & Records

Office of the Indiana Secretary of Statewww.in.gov/sos  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. Indiana IA Exams Books & Records

Office of the Indiana Secretary of Statewww.in.gov/sos  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. Indiana IA Exams Books & Records

Office of the Indiana Secretary of Statewww.in.gov/sos  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. Indiana IA Exams Books & Records

Office of the Indiana Secretary of Statewww.in.gov/sos  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. Indiana IA Exams Books & Records

Office of the Indiana Secretary of Statewww.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 Statewww.in.gov/sos Indiana IA Exams A Word of Caution about Senior Designations 710 IAC 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 Statewww.in.gov/sos 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 Exams What to Expect | Post-Exam

Office of the Indiana Secretary of Statewww.in.gov/sos 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 Exams What to Expect | Resolution

Office of the Indiana Secretary of Statewww.in.gov/sos  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 Exams Common Exam Deficiencies*

Office of the Indiana Secretary of Statewww.in.gov/sos  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 Exams Common Exam Deficiencies*

Office of the Indiana Secretary of Statewww.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 Statewww.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 Statewww.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 Statewww.in.gov/sos FIDUCIARY DUTY And CONFLICTS OF INTEREST

Office of the Indiana Secretary of Statewww.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 Statewww.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 Statewww.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 Statewww.in.gov/sos THE CORNERSTONE OF FIDUCIARY DUTY: CONFLICTS OF INTEREST

Office of the Indiana Secretary of Statewww.in.gov/sos Common Conflicts of Interest  Brokerage Practices  Financial Interests  Fees  Valuation  Relationships

Office of the Indiana Secretary of Statewww.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 Statewww.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 Statewww.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 Statewww.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 Statewww.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 Statewww.in.gov/sos Registration Doreen Fuery, Senior Accountant

Office of the Indiana Secretary of Statewww.in.gov/sos Annual Renewals  FINRA’s 2012/2013 IARD Renewal Program:  Calendar, Checklist, and FAQs are available online at:  Fees: RIA Firm - $50 Individual IARs - $25  Deadline to renew: December 21,  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 Statewww.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 Statewww.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 Statewww.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 Statewww.in.gov/sos Amendments/Material Changes  710 IAC (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 Statewww.in.gov/sos Amendments/Material Changes Examples  Item 1 – Identifying Information  Address, telephone number, 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 Statewww.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 Statewww.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 Statewww.in.gov/sos Help is Available  Filing Forms and Paying Fees  FINRA / IARD Call Center  Phone: (240)  Year End Renewal Calendar and FAQs:

Office of the Indiana Secretary of Statewww.in.gov/sos  North American Securities Administrators Association (NASAA)   Investment Adviser Resources  Uniform Forms  Indiana Securities Division   Laws, Regulations, Policies  Resources

Office of the Indiana Secretary of Statewww.in.gov/sos CONTACTS Indiana Secretary of State Connie Lawson Securities Division 302 West Washington Street, Room E-111 Indianapolis, IN Phone: (317) Fax: (317) Web Site: ww.sos.in.govww.sos.in.gov Investment Adviser Examiners Michele Foldenauer: Teresa Cronkhite: (317) (317) Senior Accountant / Registrations Doreen Fuery: Chief Deputy Commissioner Jeff Bush:

Office of the Indiana Secretary of Statewww.in.gov/sos Questions??