808 Ky. Admin. Regs. 10:450

Current through Register Vol. 51, No. 5, November 1, 2024

Section 808 KAR 10:450 - Examples of dishonest or unethical practice for investment advisers and investment adviser representatives

RELATES TO: KRS Chapter 292, 17 C.F.R. 275.206(4), 15 U.S.C. 78, 80b

NECESSITY, FUNCTION, AND CONFORMITY: KRS 292.500(3) authorizes the commissioner of the Department of Financial Institutions to promulgate administrative regulations necessary to carry out the provisions of KRS Chapter 292. KRS 292.336(7) and (8) authorize the commissioner to promulgate administrative regulations prohibiting unreasonable charges or other compensation of investment advisers and prescribing standards for the conduct of business by investment advisers and investment adviser representatives which the commissioner finds appropriate in the public interest and for the protection of investors. This administrative regulation establishes requirements concerning dishonest and unethical practices by investment advisers and investment adviser representatives and clarifies the consequences of engaging in unacceptable conduct or practices.

Section 1. Definitions.

(1) "Advertisement" means any notice, circular, letter, or other written communication addressed to more than one (1) person, or any notice or other announcement in any electronic or paper publication, by radio or television, or by any other medium, that offers any one (1) of the following:

(a) Any analysis, report, or publication concerning securities;

(b) Any analysis, report, or publication that is to be used in making any determination as to when to buy or sell any security or which security to buy or sell;

(c) Any graph, chart, formula, or other device to be used in making any determination as to when to buy or sell any security, or which security to buy or sell; or

(d) Any other advisory service regarding securities.

(2) "Investment adviser solicitor" means a person or entity that, directly or indirectly, solicits a prospective client for, or refers a prospective client to, an investment adviser.

Section 2.

A person who is an investment adviser or an investment adviser representative shall be a fiduciary and shall have a duty to act primarily for the benefit of the person's clients. An investment adviser or investment adviser representative shall not engage, either directly or indirectly, in unethical or dishonest practices. The following acts and practices shall constitute a breach of fiduciary duty or a dishonest and unethical practice, and violations may result in a fine, suspension, or revocation in proportion to the seriousness of the offense:

(1) Recommending to a client to whom investment advisory, management, or consulting services are provided the purchase, sale, or exchange of any security without reasonable grounds to believe that the recommendation is suitable for the client based on information furnished by the client after reasonable inquiry concerning the client's investment objectives, financial situation and needs, and any other information known by the investment adviser;

(2) Exercising any discretionary power in placing an order for the purchase or sale of securities for a client without obtaining written discretionary authority from the client within ten (10) business days after the date of the first transaction placed pursuant to oral discretionary authority, unless the discretionary power relates solely to the price at which, or the time when, an order involving a definite amount of a specified security shall be executed, or both;

(3) Inducing trading in a client's account that is excessive in size or frequency in view of the financial resources, investment objectives, and character of the account considering that an investment adviser or investment adviser representative may directly benefit from the number of securities transactions effected in a client's account;

(4) Placing an order to purchase or sell a security for the account of a client without authority to do so;

(5) Placing an order to purchase or sell a security for the account of a client upon instruction of a third party without first having obtained a written third-party trading authorization from the client;

(6) Borrowing money or securities from a client unless the client is a broker-dealer, an affiliate of the investment adviser, or a financial institution engaged in the business of loaning funds;

(7) Loaning money or securities to a client unless the investment adviser is a financial institution engaged in the business of loaning funds or the client is an affiliate of the investment adviser;

(8)

(a) Misrepresenting to any advisory client, or prospective advisory client, the qualifications of the investment adviser or any employee of the investment adviser;

(b) Misrepresenting the nature of the advisory services being offered or fees to be charged for the service; or

(c) Omitting to state a material fact necessary to make the statements made regarding qualifications, services, or fees, in light of the circumstances under which they were made, not misleading;

(9) Providing a report or recommendation to any advisory client prepared by someone other than the adviser without disclosing that fact;

(10) Charging a client an unreasonable advisory fee in light of the fee charged by other investment advisers providing similar services;

(11) Failing to disclose to clients in writing before any advice is rendered any material conflict of interest relating to the adviser, or any of its employees, including:

(a) Compensation arrangements connected with advisory services to clients which are in addition to compensation from these clients for advisory services; or

(b) The amount of any commissions to be received for executing transactions pursuant to advice given;

(12) Failing to disclose to clients in writing all potentially conflicting divisions of loyalty in connection with a transaction, and failing to obtain the written consent of the client to proceed with the transaction in accordance with the following requirements:

(a) Any transaction in which a person acts as an investment adviser for one (1) party to that transaction and in which the person (or any person controlling, controlled by, or under common control with the adviser) acts as a broker-dealer for both the advisory client and another person on the other side of the transaction shall be subject to this disclosure and consent requirement, and the client shall be provided a written confirmation for each transaction, which contains the following:

1. A statement of the nature of the transaction;

2. The date of the transaction;

3. An offer to furnish, upon written request, the time of the transaction; and

4. The source and amount of any other remuneration the adviser received or will receive in connection with the transaction. If the investment adviser is not participating in a distribution when the advisory client is purchasing the security or a tender offer when the advisory client is selling the security, the confirmation may state that the investment adviser has been or will be receiving other remuneration and that the source and the amount of this remuneration will be furnished upon the client's written request;

(b) The disclosure and consent requirements of subsection (12)(a) of this section apply to each contemplated transaction and shall be complied with every time the transaction occurs unless the adviser complies with the provisions of subsection (12)(c) of this section;

(c) If the disclosure and consent requirements of subsection (12)(a) of this section prospectively cover more than one (1) transaction, the adviser is responsible for ensuring that the client receives at least annually, with or as part of a written statement or summary of the client's account, written disclosure of the following:

1. The total number of these transactions since the date of the last statement or summary;

2. The total amount of all commissions or other remuneration the adviser received or will receive in connection with the transactions; and

3. A conspicuous statement that the client may revoke the written consent previously given by providing written notice of the revocation to the adviser; and

(d) Any transaction in which the same adviser recommended the transaction to both a seller and a purchaser of a security shall be a dishonest or unethical practice regardless of any disclosure and consent;

(13) Failing to disclose to clients in writing before any advice is rendered any material fact with respect to the financial and disciplinary information required to be disclosed by 17 C.F.R. 275.206(4)-4 (SEC Rule 206(4)4);

(14) Guaranteeing a client that a specific result will be achieved with advice which will be rendered;

(15) Using any advertisement that does the following:

(a) Refers to any testimonial of any kind concerning any advice, analysis, report, or other service rendered by the adviser or representative unless it meets the following requirements:

1. The testimonial clearly discloses whether the person giving the testimonial is a client or promoter;

2. The testimonial clearly discloses whether the person giving the testimonial is compensated;

3. An adviser or representative using a testimonial provided by a promoter has entered into a written agreement with a promoter; and

4. The adviser or representative and testimonial comply with all provisions of 17 C.F.R. 275.206(4)-1 Rule 206(4)-1 of the Investment Advisers Act of 1940, commonly known as the SEC marketing rule, effective December 22, 2020;

(b) Refers to past specific recommendations of the adviser or representative that were or would have been profitable, except that an adviser or representative may furnish or offer to furnish a list of all recommendations made by the adviser or representative within the immediately preceding period of not less than one (1) year if the list also includes the following:

1. The name of each security recommended, the date and nature of each recommendation, the market price at that time, the price at which the recommendation was to be acted upon, and the most recently available market price of each security; and

2. A legend on the first page in prominent print or type that states that recommendations made in the future may not be as profitable as the securities on the list;

(c) Represents that any graph, chart, formula, or other device being offered can in and of itself be used to determine which securities to buy or sell, or when to buy or sell them;

(d) Represents that any graph, chart, formula, or other device being offered will assist any person in making that person's own decisions without prominently disclosing in the advertisement the limitations and the difficulties with respect to its use;

(e) Represents that any report, analysis, or other service will be furnished for free or without charge, unless the report, analysis or other service actually is or will be furnished free and without any direct or indirect condition or obligation;

(f) Represents that the Department of Financial Institutions has approved any advertisement; or

(g) Contains any untrue statement or omission of a material fact, or that is otherwise false or misleading;

(16) Disclosing the identity, affairs, or investments of any client unless required by law to do so, or unless consented to in writing by the client;

(17) Taking any action, directly or indirectly, with respect to those securities or funds in which any client has any beneficial interest, if the investment adviser has custody or possession of the securities or funds when the adviser's action is subject to and does not comply with the provisions of 808 KAR 10:020 relating to the custody;

(18) Entering into, extending, or renewing an advisory contract unless the contract is in writing and discloses the following:

(a) The nature of the advisory services to be provided;

(b) The time period that the contract remains in effect;

(c) The advisory fee and the formula for computing the fee;

(d) The amount of the prepaid fee to be returned if there is contract termination or nonperformance;

(e) Whether the contract grants discretionary power to the adviser and, if so, the terms of the discretionary power;

(f) Whether the contract grants custody of client funds to the adviser and, if so, the terms of the custody; and

(g) That the adviser shall not assign the contract without the prior written consent of the client;

(19) Including in an advisory contract any condition, stipulation, or provision binding any client to waive compliance with any provision of the Securities Act of Kentucky, KRS Chapter 292, 808 KAR Chapter 10, or of the Investment Advisors Act of 1940, 15 U.S.C. 80b;

(20) Paying compensation, directly or indirectly, to an investment adviser solicitor unless the investment adviser makes the payment in accordance with the requirements of 17 C.F.R. 275.206(4)-3) (SEC Rule 206(4)-3);

(21) Engaging in any act, practice, or course of business which is fraudulent, deceptive, or manipulative contrary to the provisions of Section 206(4) of the Investment Advisors Act of 1940, 15 U.S.C. 80b-6(4), whether or not the investment adviser is registered or required to be registered under 15 U.S.C. 80b-3;

(22) Failing to provide all material information with respect to any dealings with or recommendations to any advisory client in violation of KRS 292.320;

(23) Committing any act involving a client, the client's assets, or any business records which would constitute a criminal offense;

(24) Lying to or otherwise misleading a representative of the Department of Financial Institutions conducting an authorized examination or investigation;

(25) Failing to make requested records available to or otherwise impeding a representative of the Department of Financial Institutions conducting an authorized examination or investigation;

(26) Failing to respond in a timely manner to a written request from an authorized representative of the Department of Financial Institutions for:

(a) Information;

(b) An explanation of practices or procedures;

(c) A response to a complaint filed with the department; or

(d) A response to a written statement of findings from an examination.

(27) Failing to pay and fully satisfy, or attempting to avoid payment of, any final order, judgment, or arbitration award resulting from an investment-related, client or customerinitiated arbitration or court proceeding, unless alternative payment arrangements are agreed to, in writing, and complied with between:

(a) The client and the investment adviser or investment adviser representative; or

(b) Between the customer and the broker-dealer or the broker-dealer agent; or

(28) Failing to pay and fully satisfy any fine, civil penalty, order of restitution, order of disgorgement, or similar monetary payment obligation imposed upon the investment adviser or investment adviser representative by the Securities and Exchange Commission, the securities or other financial services regulator of any state or province, or any selfregulatory organization.

Section 3. The provisions of this administrative regulation shall apply to federally covered advisers, as defined in KRS 292.310, operating in Kentucky to the extent that the conduct alleged is fraudulent or deceptive, or as otherwise permitted by the National Securities Market Improvement Act of 1996, 15 U.S.C. 78, and the Investment Advisors Act of 1940, 15 U.S.C. 80b.

Section 4. The commissioner may determine that an activity not included in the examples identified in Section 2 of this administrative regulation constitutes a dishonest or unethical practice if the activity is similar to an enumerated activity.

808 KAR 10:450

35 Ky.R. 1110; Am. 1777; eff. 2-6-09; 37 Ky.R. 2503; 2849; eff. 7-1-11; Crt eff. 2-27-2020; 49 Ky.R. 1679, 2102; eff. 8/1/2023.

STATUTORY AUTHORITY: KRS 292.336(7), (8), 292.337, 292.500(3)