The Minnesota Department of Commerce (“Department”) recently conducted a series of routine exams of investment adviser firms registered in Minnesota to analyze their compliance with certain regulations applicable to investment advisers. We have spoken to several industry groups and have given presentations at industry conferences about our exam program, and have received feedback from attendees requesting more information about common deficiencies noted during our exams. This email, which accompanies a letter also sent by mail to investment advisers registered in Minnesota, is intended to bring to your attention four common deficiencies that the Department found in many of its exams. We ask that you review your firm’s compliance operations and policies to determine whether these concerns may apply to your firm, and if so, take steps to ensure your compliance with the applicable laws and rules. Failure to do so may result in administrative disciplinary action for those entities required to register as investment advisers in Minnesota, and/or civil penalties of up to $10,000 per violation pursuant to Minn. Stat. § 45.027, subd. 6 (2014).
The common deficiencies are as follows:
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Form ADV Annual Renewal and Updates: Failure to file an annual updating amendment to Form ADV within 90 days of the end of the investment adviser’s fiscal year, or more frequently if the information in the ADV is or becomes inaccurate or incomplete, failure to file an ADV Part 2A and 2B and failure to file an update as required by Minn. Stat. § 80A.61 (d), Minn. Rule 2876.4061 and the Form ADV instructions.
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Bonding Requirements: For investment advisers that have custody or discretionary authority over client funds or securities, failure to post with the administrator a surety bond or an irrevocable letter of credit with the administrator as required by Minn. Rule 2876.4115.
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Custody Safeguards: Failure to send invoices to clients and custodians at the time fees are directly deducted from clients’ accounts as required by Minn. Rule 2876.4116, subp.1.F.
- IAR Registration: Failure to register individuals that meet the definition of “investment adviser representatives” in Minn. Stat. § 80A.41 (17) and that are not exempt from registration.
Included below is a fact sheet which summarizes the common deficiencies, the applicable law, and the corrections required. If you find that your firm is deficient in any of the above noted items, please take corrective action immediately.
Additionally, if you are no longer doing business as an investment adviser in Minnesota, please file a Form ADV-W on the Investment Adviser Registration Depository (“IARD”) system to withdraw your registration in Minnesota. Information on filing a form ADV-W is available at: https://www.iard.com/pdf/formadvw_guide.
If you have any questions you may contact us at 651-539-1638 or Securities.Commerce@state.mn.us.
Sincerely,
Brian Edstrom
Director of Securities
Minnesota Department of Commerce
85 7th Place East, Suite 500,
Saint Paul, MN 55101
Common Deficiencies
1. Annual renewals and updates
The Department‘s examiners identified a number of investment advisers that have not filed an annual updating amendment to Form ADV within 90 days of the end of the investment adviser’s fiscal year, or more frequently if the information is or becomes inaccurate or incomplete. Additionally, further review of Minnesota registrants identified a number of investment advisers that have not filed an ADV Part 2A and 2B, or have failed to file an update as required.
Investment advisers are also reminded that their annual registration renewal must include the fee required by Minn. Stat. § 80A.65, subd. 2, and a copy of the surety bond required by Minn. Rule 2876.4115, if applicable. (More information on this bonding requirement is described below.)
Form ADV Part 1: Registered investment advisers are required to file Form ADV with the Investment Adviser Registration Depository (“IARD”) in order to apply for registration. The Form ADV must be prepared in accordance with Form ADV instructions. Thereafter, an updating amendment to Form ADV must be filed annually within 90 days of the end of the investment adviser’s fiscal year, and more frequently if required by the instructions to Form ADV. In addition to making annual filings, investment advisers must promptly file a correcting amendment if the information or record contained in the form is or becomes inaccurate or incomplete in a material respect. (see Minn. Stat. §§ 80A.58, 80A.61, 80A.67, 80A.82 and Minn. Rules 2876.4061 and 2876.4117).
Form ADV Part 2: Minn. Rule 2876.4061 requires Minnesota investment adviser applicants to file Part 2 of Form ADV (the Brochure and Brochure Supplement) with the IARD. Investment advisers are required by Minn. Rule 2876.4117 to provide new and prospective clients with a Brochure and Brochure Supplement for each “supervised person” doing business in Minnesota. The Brochure and Supplement must be written in plain English and, each year, the investment adviser must deliver (or offer to deliver) Part 2 or a summary of material changes to each client, without charge. Investment advisers must also keep and maintain in their records, a copy of each such Brochure or amendment, along with a record reflecting the dates on which it was offered to any client or prospective client. The Brochure is intended to provide important information to help clients and prospective clients evaluate the firm’s qualifications and services. Therefore, it is essential that the information provided in the Brochure is materially correct and not misleading, and that it is updated promptly when changes are required.
2. Bonding requirements for certain investment advisers
The Department’s exams identified a number of investment advisers that have not submitted information regarding a bond required by Minn. Rule 2876.4115. Investment advisers registered or required to be registered under the Minnesota Securities Act, Minn. Stat. § 80A having custody of or discretionary authority over client funds or securities are generally required to obtain insurance or post a bond or other satisfactory form of security in an amount of at least $25,000, but not to exceed $100,000, as required by Minn. Stat. § 80A.66 (f).
Investment advisers that continuously maintain $100,000 or more in net capital are exempt from this requirement. However, an investment adviser registered or required to be registered under the Minnesota Securities Act that has custody of client funds or securities shall maintain at all times a minimum net worth of $35,000. An investment adviser registered or required to be registered under the Minnesota Securities Act that has discretionary authority over client funds or securities but does not have custody of client funds or securities must maintain a minimum net worth of $10,000 at all times.
Investment advisers with custody must continuously maintain a net worth of at least $35,000. However, if the investment adviser has custody solely because of an authorized fee deduction or because it advises pooled investment vehicles, it is exempt from this net worth requirement.
Investment advisers with discretion but no custody must continuously maintain a net worth of at least $10,000. However, if the investment adviser does not have custody OR discretion, it is exempt from this net worth requirement.
Investment advisers that accept prepayment plans of more than $500 per client six or more months in advance must continuously maintain a positive net worth. Net worth is defined by Minn. Rule 2876.4112, subp. 5 as “an excess of assets over liabilities as determined by GAAP” but shall not include certain intangible and/or illiquid assets.
3. Custody safeguard requirements for certain investment advisers
Another common deficiency that the Department has identified in its exams is the failure of some investment advisers to send an invoice to the client and custodian at the time that any deduction of advisory fees is made from a client’s account, as required by Minn. Rule 2876.4116, subp.1.F.
Investment advisers that have custody as defined by Minn. Rule 2876.4116, subp. 3 by having fees deducted directly from a client’s account must provide certain safeguards. These safeguards include the following:
- The investment adviser must obtain written authorization from the client to deduct advisory fees from the account held by a qualified custodian;
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Each time a fee is directly deducted from a client account, the investment adviser must concurrently:
- Send the qualified custodian an invoice reflecting the fee amount to deduct; and
- Send the client an invoice itemizing the fee, including the formula used to calculate the fee, the amount of assets under management upon which the fee is based, and the time period covered by the fee.
- The investment adviser must provide notification to the Administrator that the investment adviser intends to use the safeguards (notification is required on Form ADV, Part 1B.I/Custody).
4. Investment adviser representative registration
The Department also found that investment advisers have failed to register personnel acting as investment adviser representatives as required by Minn. Stat. § 80A.58(a). Pursuant to Minn. Stat. § 80A.41(17), an ‘investment adviser representative’ includes: “any individual employed by or associated with an investment adviser or federal covered investment adviser and who makes any recommendations or otherwise gives investment advice regarding securities, manages accounts or portfolios of clients, determines which recommendation or advice regarding securities should be given, provides investment advice or holds herself or himself out as providing investment advice, receives compensation to solicit, offer, or negotiate for the sale of or for selling investment advice, or supervises employees who perform any of the foregoing.” Some exclusions from this definition are noted in Minn. Stat. § 80A.41(17)(A)-(D).
Any individual who meets this definition must be registered as an investment adviser representative, unless exempt from registration pursuant to Minn. Stat. 80A.58(b) or (e). Individuals employed by an investment adviser who only perform clerical or ministerial acts are generally excluded from the definition of an investment adviser representative.
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