No. 27136: R628-15. Certification as an Investment Adviser

DAR File No.: 27136
Filed: 09/01/2004, 02:21
Received by: NL

RULE ANALYSIS

Purpose of the rule or reason for the change:

The Money Management Council held a public hearing on 07/07/2004 and received comments on this rule that required additional changes from the first two filings.

 

Summary of the rule or change:

The changes include: 1) a clarifying statement regarding what an investment adviser is not; 2) defines the term "soft dollar" which had been used in the rule with no clear parameters; 3) cleans up some language that was vague or not needed; 4) changes one type of insurance coverage from surety to fidelity, which is more appropriate in the case of investment advisers, and provides a tier structure on the fidelity bond coverage based on Utah public funds under management; 5) drops the percentage requirement on the errors and omissions insurance to 5% of Utah public funds under management, with a minimum of $1,000,000, from 20% based on comments that 20% was too high; and 6) clarifies language on procedures for denial or suspension of status as a certified investment adviser. (DAR NOTE: This is the second change in proposed rule (CPR) for R628-15. The original proposed new rule upon which the first CPR was based was published in May 15, 2004, issue of the Utah State Bulletin, on page 28. The first CPR upon which this second CPR is based was published in the June 15, 2004, issue of the Utah State Bulletin, on page 74. Underlining in the rule below indicates text that has been added since the publication of the proposed rule mentioned above; strike-out indicates text that has been deleted. You must view the first CPR, the second CPR, and the proposed new rule together to understand all of the changes that will be enforceable should the agency make this rule effective.)

 

State statutory or constitutional authorization for this rule:

Subsections 51-7-3(3), 51-7-18(2)(b)(vi), 51-7-18(2)(b)(vii), 51-7-11.5(2)(b), and 51-7-11.5(2)(c)

 

Anticipated cost or savings to:

the state budget:

There will be no cost or savings in the state budget as the bonding requirement is still on the investment adviser.

 

local governments:

It is still not known if the investment advisory firms will pass through the cost of bonding requirements to the public treasurer who uses such firms, but the cost may be lower as the fidelity insurance is now tiered based on total public funds under management and lower percentages.

 

other persons:

Cost of errors and omissions insurance should not increase. However, even though fidelity insurance is now based on tiered amounts, there may be additional costs to investment advisors as they may not carry fidelity insurance. The cost is not known at this time nor how many this could effect.

 

Compliance costs for affected persons:

Some firms that become certified may have to purchase fidelity insurance policies, based on public funds under management. Exact costs were unable to be determined however, as noted in the last filing (the first CPR), a general cost was approximately 1% of the amount of the policy.

 

Comments by the department head on the fiscal impact the rule may have on businesses:

The revisions on the bonds required should drop costs of insurance for most investment advisers from the previous requirement. However, overall, the investment adviser may have to increase coverage as it has been determined that investment advisers may not currently purchase fidelity insurance, or if they do it is a minimal amount.

 

The full text of this rule may be inspected, during regular business hours, at the Division of Administrative Rules, or at:

Money Management Council
Administration
Room E315 EAST OFFICE BLDG
STATE CAPITOL COMPLEX
PO BOX 142315
SALT LAKE CITY UT 84114-2315

 

Direct questions regarding this rule to:

Ann Pedroza at the above address, by phone at 801-538-1883, by FAX at 801-538-1465, or by Internet E-mail at [e-mail]

 

Interested persons may present their views on this rule by submitting written comments to the address above no later than 5:00 p.m. on:

10/15/2004

 

This rule may become effective on:

10/16/2004

 

Authorized by:

Larry Richardson, Chair

 

 

RULE TEXT

R628. Money Management Council, Administration.

R628-15. Certification as an Investment Adviser.

R628-15-1. Authority.

This rule is issued pursuant to Sections 51-7-3(3), [51-7-3(10), and ]51-7-18(2)(b)(vi) and (vii), and 51-7-11.5(2)(b)and(c).

 

R628-15-2. Scope.

This rule establishes the criteria applicable to all investment advisers and investment adviser representatives for certification by the Director as eligible to provide advisory services to public treasurers under the State Money Management Act (the "Act"). It further establishes the application contents and procedures, and the criteria and the procedures for denial, suspension, termination and reinstatement of certification. Additionally, the qualification of non-certified dealers and the use of these qualified dealers by certified investment advisers is provided for.

 

R628-15-3. Purpose.

This rule establishes a uniform standard to evaluate the financial condition and the standing of an investment adviser to determine if investment of public funds[transactions with public treasurers] by investment advisers would expose said public funds to undue risk.

 

R628-15-4. Definitions.

A. The following terms are defined in Section 51-7-3 of the Act, and when used in this rule, have the same meaning as in the Act:

1. "Certified investment adviser";

2. "Council";

3. "Director";

4. "Public treasurer"; and

5. "Investment adviser representative".

B. For purposes of this rule the following terms are defined:

1.a. "Investment adviser" means either a federal covered adviser as defined in Section 61-1-13 or an investment adviser as defined in Section 61-1-13.

b. "Investment adviser" does not mean mutual funds, commingled investment funds, private limited partnerships and similar limited liability investments through which a public treasurer may conduct investment transactions directly with issuers of the investment securities, in accordance with Section 51-7-11(1)(a) and Rule R628-2(4)A)(2).

2. "Qualified dealer" means a non-certified broker/dealer that is licensed by the Division and is qualified by the Council to conduct investment transactions on behalf of a public treasurer pursuant to an investment adviser contract not inconsistent with the Act or Rules of the Council between the public treasurer and a certified investment adviser.

3. "Soft dollar" means the value of research services and other benefits, whether tangible or intangible, that broker/dealers supply to a certified investment adviser in exchange for the certified investment adviser's business.

 

R628-15-5. General Rule.

Before an investment adviser or investment adviser representative provides investment advisory services to any public treasurer, the investment adviser or investment adviser representative must submit and receive approval of an application to the Division, pay to the Division a non-refundable fee as described in Section 51-7-18.4(2), and become a Certified investment adviser or Investment adviser representative under the Act.

 

R628-15-6. Criteria for Certification of an Investment Adviser.

To be certified by the Director as a Certified investment adviser or Investment adviser representative under the Act, an investment adviser or investment adviser representative shall:

A. Submit an application to the Division on Form 628-15 and pay to the Division the non-refundable fee described in Section 51-7-18.4(2).

B. Be licensed with the Division under its laws and rules, effective as of the date of the application. Licensing is required for all of the following:

(1) the investment adviser;

(2) its designated official as defined in R164-4-2 of the Division; and

(3) any investment adviser representative who provides investment advisory services to public treasurers in the state.

C. Have a current Certificate of Good Standing dated within 30 days of application from the state in which the applicant is incorporated or organized.

D. Have net worth as of its most recent fiscal year-end of not less than $150,000 documented by financial statements prepared by an independent certified public accountant in accordance with generally accepted accounting principles.

E. Allow the public treasurer to select the forum and method for dispute resolution, whether that forum be arbitration, mediation or litigation in any state or federal court. No agreement, contract, or other document that the applicant requires or intends to require to be signed by the public treasurer to establish an investment advisory relationship[open or maintain an account] shall require or propose to require that any dispute between the applicant and the public treasurer must be submitted to arbitration.

F. Agree to the jurisdiction of the Courts of the State of Utah and applicability of Utah law, where relevant, for litigation of any dispute arising out of transactions between the applicant and the public treasurer.

G. All Investment adviser representatives who have any contact with a public treasurer or its account, must sign and have notarized a statement that the representative:

(1) is familiar with the authorized investments as set forth in the Act and the rules of the Council;

(2) is familiar with the investment objectives of the public treasurer, as set forth in Section 51-7-17(2);

(3) acknowledges, understands, and agrees that all investment transactions conducted for the benefit of the public treasurer are required to be settled on a delivery vs. payment basis only at the treasurer's safekeeping bank and that the Certified investment adviser and any Investment adviser representative is prohibited from receiving custody of any public funds or investment securities at any time.

 

R628-15-7. Certification.

A. The initial application for certification must be received on or before the last day of the month for approval at the following month's Council meeting.

B. All certifications shall be effective upon acceptance by the Council.

C. All certifications not otherwise terminated shall expire on June 30 of each year, unless renewed.[ Renewal applications must be received on or before April 30 of each year.]

 

R628-15-8. Renewal of Application.

A. Certified investment advisers shall apply annually, on or before April 30 of each year, for certification to be effective July 1 of each year.

B. The application must contain all of the documents and meet all of the requirements as set forth above with respect to initial applications.

C. The application must be accompanied by an annual certification fee as described in section 51-7-18.4(2).

D. A Certified investment adviser whose certification has expired as of June 30 may not function as a Certified investment adviser until the investment adviser's certification is renewed.

 

R628-15-9. Post Certification Requirements.

A. Certified investment advisers shall notify the Division of any changes to any items or information contained in the original application within 30 calendar days of the change. The notification shall provide copies, where necessary, of relevant documents.

B. Certified investment advisers shall maintain licensing with the Division and registration as an investment adviser under the Investment Advisers Act of 1940 throughout the term of any agreement or contract with any public treasurer.

C. Certified investment advisers shall [have and]provide written evidence of insurance coverage and shall maintain insurance coverage as follows:

(1) [surety bond]fidelity coverage based on the following table:[of not less than twenty percent (20%) of Utah public funds under management; and]

 

TABLE

Utah Public funds under management          Percent for Bond

          $0 to 25,000,000         10% but not less than 1,000,000

  25,000,001 to 50,000,000          8% but not less than 2,500,000

  50,000,001 to 100,000,000         7% but not less than 4,000,000

  100,000,001 to 500,000,000        5% but not less than 7,000,000

  500,000,001 to 1,250,000,000      4% but not less than 25,000,000

1,250,000,001 and higher            Not less than 50,000,000

 

(2) errors and omissions coverage equal to [twenty]five percent ([20]5%) of Utah public funds under management, but not less than $1,000,000 nor more than $10,000,000 per occurrence.

D. Certified investment advisers shall provide to the public treasurer the SEC Form ADV Part II prior to contract execution.

E. Certified investment advisers shall file annual audited financial statements with all public treasurers with whom they are doing business and with the Division.

F. Certified investment advisers shall fully disclose all conflicts of interest and all economic interests in qualified dealers and other affiliates, consultants and experts used by the Investment adviser in providing investment advisory services.

G. Certified investment advisers shall act with the degree of care, skill, prudence, and diligence that a person having special skills or expertise acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims.

H. Certified investment advisers shall exercise good faith in allocating transactions to qualified dealers in the best interest of the account and in overseeing the completion of transactions and performance of qualified dealers used by the Investment adviser in connection with investment advisory services.

I. Certified investment advisers shall fully disclose to the public treasurer any self-dealing with subsidiaries, affiliates or partners of the Investment adviser and any ["]soft dollar["] benefits to the Investment adviser for transactions placed on behalf of the public treasurer.

J. Certified investment advisers shall fully and completely disclose to all public treasurers with whom they do business the basis for calculation of fees, whether and how fees may be adjusted during the term of any agreement, and any other costs chargeable to the account. If performance-based fees are proposed, the disclosure shall include a clear explanation of the amount of the fee at specific levels of performance and how prior losses are handled in calculation of the performance-based fee.

K. Certified investment advisers shall not assign any contract or agreement with a public treasurer without the written consent of the public treasurer.

L. Certified investment advisers shall provide immediate written notification to any public treasurer to whom advisory services are provided and to the Division upon conviction of any crime involving breach of trust or fiduciary duty or securities law violations.

M. Not less than once each calendar quarter and as often as requested by the public treasurer, Certified investment advisers shall timely deliver to the public treasurer:

(1) copies of all trade confirmations for transactions in the account;

(2) a summary of all transactions completed during the reporting period;

(3) a listing of all securities in the portfolio at the end of each reporting period, the market value and cost of each security, and the credit rating of each security;

(4) performance reports for each reporting period showing the total return on the portfolio as well as the accrual basis return and the net return after calculation of all fees and charges permitted by the agreement; and

(5) a statistical analysis showing the portfolio's weighted average maturity and duration as of the end of each reporting period.

 

R628-15-10. Notification of Certification.

The Director shall provide a list of Certified investment advisers and Investment adviser representatives to the Council at least semiannually. The Council shall mail this list to each public treasurer.

 

R628-15-11. Criteria for Qualification of a Non-Certified Dealer.

A. Before a Certified investment adviser uses a non-certified dealer to conduct investment transactions on behalf of a public treasurer, the investment adviser must submit an application for each non-certified dealer for qualification by the Division.

B. The application must include:

(1) Proof of licensing with the Division under its laws and rules, effective as of the date of the application, of the following:

(a) the broker-dealer;

(b) any agents of a firm doing business in the state.

(2) A Certificate of Good Standing, obtained from the state in which the applicant is incorporated or organized.

(3) With respect to applicants who are not primary reporting dealers, financial statements, prepared by an independent certified public accountant in accordance with generally accepted accounting principles, indicating that the applicant has, as of its most recent fiscal year end:

(a) Minimum net capital, as calculated under rule 15c3-1 of the Securities and Exchange Act of 1934 (17 CFR 240.15c3-1(2004)), of at least 5% of the applicant's aggregate debt balances, as defined in the rule, and;

(b) Total capital as follows:

(i) of at least $10 million or;

(ii) of at least $25 million, calculated on a consolidated basis, with respect to an applicant which is a wholly-owned subsidiary.

 

R628-15-12. Grounds for Denial, Suspension or Termination of Status as a Certified Investment Adviser.

Any of the following constitutes grounds for denial, suspension, or termination of status as a Certified investment adviser:

A. Denial, suspension or termination of the Certified investment adviser's license by the Division.

B. Failure to maintain a license with the Division by the firm or any of its Investment adviser representatives conducting investment transactions with a public treasurer.

C. Failure to maintain the required minimum net worth and the required surety bond.

D. Requiring the public treasurer to sign any documents, contracts, or agreements which require that disputes be submitted to mandatory arbitration.

E. Failure to pay the annual certification fee.

F. Making any false statement or filing any false report with the Division.

G. Failure to comply with any requirement of section R628-15-9.

H. Engaging in any material act in negligent or willful violation of the Act or Rules of the Council.

I. Failure to respond to requests for information from the Division or the Council within 15 days after receipt of a request for information.

J. Engaging in a dishonest or unethical practice. "Dishonest or unethical practice" includes but is not limited to those acts and practices enumerated in Rule R164-6-1g.

K. Being the subject of:

(1) an adjudication or determination, within the past five years by a securities or commodities agency or administrator of another state, Canadian province or territory, or a court of competent jurisdiction that the person has willfully violated the Securities Act of 1933, the Securities Exchange Act of 1934, the Investment Advisers Act of 1940, the Investment Company Act of 1940, the Commodity Exchange Act, or the securities or commodities law of any other state; or

(2) an order entered within the past five years by the securities administrator of any state or Canadian province or territory or by the Securities and Exchange Commission denying or revoking license as a broker-dealer, agent, investment adviser, or investment adviser representative or the substantial equivalent of those terms or is the subject of an order of the Securities and Exchange Commission suspending or expelling the person from a national securities exchange or national securities association registered under the Securities Exchange Act of 1934, or is the subject of a United States post office fraud order.

 

R628-15-13. Procedures for Denial, Suspension, or Termination and Reinstatement of Status.

A. Where it appears to the Division or to the Council that grounds may exist to deny, suspend, or terminate status as a Certified investment adviser, the Council shall proceed under the Utah Administrative Procedures Act, Chapter 46b, Title 63 ("UAPA").

B. All proceedings to suspend a Certified investment adviser or to terminate status as a certified investment adviser are designated as informal proceedings under ("UAPA").

C. In any hearings held, the Chair of the Council shall be the presiding officer, and that person may act as the hearing officer, or may designate another person from the Council or the Division to be the hearing officer. At the close of the hearing, other members of the Council may make recommendations to the hearing officer after the close of the hearing.

D. The Notice of Agency Action as set forth under UAPA, or any petition filed in connection with it, shall include a statement of the grounds for termination, and the remedies required to cure the violation.

E. [After the date of service of the Notice of Agency Action, the]A Certified investment adviser and its Investment adviser representative[s shall not conduct any] who has received a Notice of Agency Action alleging violations of the Act or these rules, may continue, in the discretion of the public treasurer, to conduct investment transactions with [any]the public treasurer [if so ordered]until the violations asserted by the Money Management Council[. The order issued by the hearing officer on behalf of the Council at the conclusion of the proceedings shall lift this prohibition if the order allows the Certified investment adviser to keep its status as a Certified investment adviser] in the Notice of Agency Action becomes subject to a written order of the Council or Agency against the adviser or adviser representative, or until the Council enters an order indicating that public funds will be jeopardized by continuing investment transactions with the adviser or adviser representative.

 

KEY: cash management, public investments, securities regulation, investment advisers

2004

51-7-3(3[1])

51-7-18(2)(b)(vi)

51-7-18(2)(b)(vii)

51-7-11.5(2)(b)

51-7-11.5(2)(c)