NASAA Released Proposed Model Compliance Rule

On July 2, 2020, the North American Securities Administrators Association (“NASAA”) released a notice for public comment on its proposed model rule for investment adviser written policies and procedures (“the Model Rule”) under the Uniform Securities Acts of 1956 and 2002 (“the Acts”).


The Model Rule would require state-registered investment advisers (“State IAs”) to maintain written policies and procedures (“P&Ps”) designed to ensure adherence to state regulatory requirements for compliance programs while also ensuring maintenance of each State IA’s fiduciary duty to their clients.

Much like the requirements under rule 206(4)-7 of the Investment Advisers Act of 1940 (“the Compliance Rule”), the Model Rule will also require State IAs to designate a Chief Compliance Officer (“CCO”) and perform an annual review of their P&Ps to ensure continued effectiveness and adequacy.

The public is encouraged to submit comments to the NASAA regarding the Model Rule no later than August 1, 2020.


Background on the Model Rule

The Compliance Rule requires federally-registered IAs (“Federal IA”) to (1) maintain written P&Ps; (2) designate a CCO, and (3) conduct an annual review of the P&Ps to ensure their continued effectiveness and adequacy.

While the Compliance Rule does not specify which P&Ps a Federal IA should have, the Securities and Exchange Commission (“SEC”) has identified a number of practice areas that should be covered as part of a Federal IA’s P&Ps, including:

  • Portfolio management
  • Trading practices
  • Proprietary trading of the adviser
  • Personal trading activities of supervised persons
  • Advertising, sales, marketing, and solicitation
  • Fiduciary standards and prohibited sales practices
  • Retention and destruction of required books and records
  • Privacy, security, and identity theft prevention
  • Business continuity and disaster recovery

State-registered IAs have different requirements from Federal IAs but are still obligated to uphold their fiduciary duty to their clients.

The Model Rule has been designed with similar compliance requirements in mind because the NASAA believes that State IAs should be required to meet the same standards and obligations required of Federal IAs as set forth under the Compliance Rule and aims to consolidate existing NASAA model rules outlining requirements for cybersecurity, physical security business continuity, and succession planning.


Details of the Model Rule

Under the Model Rule, State IAs would now be required to maintain written P&Ps customized to their business and designed to disclose and mitigate conflicts of interest and risks to clients in order to uphold their fiduciary duty. Additionally, State IAs would have to designate a CCO and conduct annual reviews of their P&Ps just like the requirements under the Compliance Rule.

The Model Rule has been drafted in such a way as to maintain requirements inherent to State IAs’ fiduciary duties to their clients as necessitated by the Acts. As mentioned above, the Model Rule also consolidates previous model rules created by the NASAA for business continuity and succession planning, physical and cybersecurity, and privacy protections.

Under the Model Rule, State IAs’ P&Ps would need to address:

  • Supervision
  • Proxy Voting
  • Physical security and cybersecurity
  • Code of ethics, personal trading, and transaction reports
  • Material non-public information (“MNPI”)
  • Business continuity and succession planning

In addition to the P&P Manual and their annual review, the Model Rule proposes that State IAs designate a CCO and outlines that a CCO should be “’[A] supervised person with the authority and resources to develop and enforce the investment adviser’s policies and procedures. The individual designated to serve as chief compliance officer must be registered as an investment adviser representative and must have the background and skills appropriate for fulfilling the responsibilities of the position.’”

The Model Rule differs from the Compliance Rule in that it provides a prescription for who should serve in the role of CCO and that the CCO should have the ability and resources to adequately enforce a State IA’s P&Ps. It does clarify that a supervised person who is the only employee of a State IA will also serve as the CCO and that an exception will not be granted based on the size of the firm.

Read the text of the Model Rule and the NASAA’s request for comment here.


What Do These Updates Mean for State IAs?

State IAs should review the text of the Model Rule and consider responding to the NASAA’s request for public comment. The NASAA has outlined the types of responses they are seeking, including:

  • Is the proposed composition of the Model Rule suitable?
  • Should the Model Rule be divided into smaller rules?
  • Should requirements for general and supervisory P&Ps be made into separate rules?
  • Should the proposed proxy voting requirements under the Model Rule be the same as the SEC’s requirements?
  • Should the MNPI requirements be the same for State IAs as Federal IAs? Should code of ethics requirements be the same?
  • Should exceptions for code of ethics requirements for smaller State IAs be the same as Federal IAs? Should small advisers only be required to maintain records as opposed to reports?
  • Should the CCO definition be updated?

State IAs should also consider reviewing their existing P&Ps in light of the Model Rule to see if there are enhancements or other considerations that have not been addressed. For example, does the firm’s BCP address pandemics? Does the firm have a succession plan? What do the cybersecurity P&Ps include and have they been reviewed or updated? How is the firm tracking the personal trading activity of its supervised persons and monitoring its fiduciary obligations to its clients?

As these questions are asked, firms should bear in mind that each state has unique regulations and requirements and each State IAs’ P&Ps will need to be customized to its business model as well as address the requirements of the states where they are registered.

Should you or your firm have questions regarding the NASAA’s Model Rule; questions regarding the review and analysis of P&Ps; and/or require guidance or assistance with drafting updates to your P&Ps, please contact us at (619) 278-0020 to schedule a consultation. Our compliance experts are standing by to help during this difficult time.


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