Industry News

Arizona Adviser’s Outside Business Activity Constituted Unlicensed Sale of Securities

February 9, 2017 | Elizabeth Dalziel

On December 13, 2016, the Arizona Court of Appeals (“Court of Appeals”) affirmed an Arizona Superior Court’s decision finding that Patrick Shudak, an investment adviser, violated the Arizona Securities Act by acting as an unregistered securities salesperson or dealer in connection with the sale of interests in a real estate venture.

From January 2008 through July 2009, Shudak sold membership units in a company known as Parker Skylar & Associates, LLC (PSA). Neither Shudak nor PSA was registered as a securities salesperson or dealer under the Arizona Securities Act. Shudak stated in PSA’s promotional materials that the money invested in PSA would “be used to purchase and develop real property.” In reality, however, Shudak placed the money that investors put into PSA into his personal account, the personal accounts of others such as his girlfriend, and business accounts of other business that Shudak owned or had some affiliation with.

In December 2009, investors started to grow worried when Shudak stopped returning phone calls and replying to the investors’ demands for information. As a result, Shudak was obligated to stop serving as PSA manager and to give up his PSA membership. He subsequently filed for bankruptcy in April 2010.

SEC Charges Investment Advisory Firm and its Owner for Cherry-Picking Scheme

February 2, 2017 | Elizabeth Dalziel

On January 25, 2017, the Securities and Exchange Commission (“SEC”) filed a complaint in the District Court for the District of Massachusetts (“District Court”) against Strategic Capital Management, LLC (“SCM”), an investment advisory firm, and its owner, Michael J. Breton. The complaint alleges that Breton, through SCM, garnered about $1.3 million by defrauding clients using what is known as a “cherry-picking” scheme. The action follows a similar action brought by the SEC last October.

According to the SEC, cherry-picking occurs when an investment adviser “defrauds clients by purchasing stock and then waiting to see if the stock price goes up, or down, before deciding whether to keep the trades… or to put the trades into clients’ accounts.” Cherry-picking typically involves the investment adviser allocating more profitable trades to its own accounts and allocating less profitable ones to client accounts. It is a breach of fiduciary duty because it entails an investment adviser placing its interests above those of its clients.

The SEC’s complaint alleges that from about January 2010 through August 2016, Breton and SCM were investment advisers to numerous client accounts. Breton, through SCM, bought public companies’ securities using a block trading omnibus account known as a “Master Account.” Through this Master Account, Breton was permitted to make orders for both his personal accounts and his clients’ accounts.

DOL Issues Additional Guidance as Enforcement Date of Fiduciary Rule Approaches

January 26, 2017 | Patricia Klusmeyer

The Department of Labor (DOL) recently issued two new sets of FAQ guidance regarding the revised definition of fiduciary investment advice under the Employee Retirement Income Security Act of 1974 (ERISA) and the Internal Revenue Code of 1986 (Code), as well as the new prohibited transaction exemptions (PTEs). The first set of guidance is directed to retirement investors, not advisers, and answers basic questions investors may have regarding the new rule and how it will work. The second set of guidance is aimed at financial service providers and focuses mainly on the revised definition of fiduciary investment advice and the situations in which fiduciary duties will or will not attach under the new rule.

While the first set of FAQ guidance is not necessarily aimed at financial service providers, it did provide a few useful insights that I will briefly discuss here. The DOL stated that the new rule does not require advisers to indiscriminately move clients from commission-based accounts to fee-based accounts, and instead requires advisers to act in the client’s best interest when deciding what type of account to recommend. Regarding the best interest requirement, the DOL clarified that providing investment advice in a client’s best interest does not mean that advisers have a duty to find the best possible investment product for clients out of all the investments available in the marketplace. Continue reading ›

SEC Office of Compliance Inspections and Examinations Publishes its 2017 Examination Priorities

January 19, 2017 | Elizabeth Dalziel

On January 12, 2017, the Office of Compliance Inspections and Examinations (“OCIE”) of the Securities and Exchange Commission (“SEC”) published its examination priorities for 2017. OCIE selects its priorities based on practices and products that it believes to constitute significant risks to investors and the investment markets. It also receives insight from a variety of sources, such as staff from the SEC’s regional offices and other regulators. The priorities for 2017 are primarily based around protection of retail investors, protection of elderly and retiring investors, and addressing market-wide risks like cybersecurity and anti-money laundering.

The first priority that OCIE plans to emphasize is the protection of retail investors. Over the years, new technology has provided investors with new, innovative ways to invest their finances. As a result, the SEC and other regulators must regulate new potential risks that are bound to occur. To address the possible challenges that retail investors face, OCIE plans to implement a number of examination initiatives. For example, it plans to evaluate registered investment advisers and broker-dealers who provide electronic investment advice, such as “robo-advisers.” It also intends to pay particular attention to wrap fee programs and exchange-traded funds (“ETFs”), as well as enlarge its Never-Before-Examined Adviser Initiative program. Finally, OCIE intends to address the challenges related to investment advisers who operate on a multi-branch business model Continue reading ›

FINRA Releases Annual Regulatory and Examination Priorities Letter, Part I

January 12, 2017 | Elizabeth Dalziel

On January 4, 2017, the Financial Industry Regulatory Authority (“FINRA”) published its Annual Regulatory and Examination Priorities Letter (“Priorities Letter”). The Priorities Letter notifies firms about issues that FINRA intends to examine in 2017. It is also intended to let firms know which of these issues are relevant to their businesses so that the firms can improve their compliance with FINRA rules and their risk management programs.

According to the Priorities Letter, FINRA draws its examination priorities from both observations made in the course of regulation and suggestions from a variety of outside sources. Evidence has shown that many FINRA-registered firms have found past Priorities Letters helpful in making sure their business is in compliance with FINRA rules. Finally, FINRA assures readers of the Priorities Letter that in formulating an examination, FINRA looks to factors such a firm’s “business model, size and complexity of operations, and the nature and extent of a firm’s activities against the priorities outlined in this letter.”

FINRA intends to prioritize the following issues in 2017. Continue reading ›

FINRA Implements New Rule Requiring “Educational Communication”

December 7, 2016 | Elizabeth Dalziel

On March 23, 2016, the Securities and Exchange Commission (“SEC”) approved the adoption of FINRA Rule 2273, a rule first proposed by the Financial Industry Regulatory Authority (“FINRA”) on December 16, 2015. Rule 2273 provides that member firms who hire or associate with a registered representative must provide an “educational communication” to the representative’s former and current customers. The education communication is designed to provide customers with guidance regarding their decision whether to remain customers of that representative. Rule 2273 went into effect on November 11, 2016.

FINRA’s stated purpose for proposing Rule 2273 was to provide “customers with a more complete picture of the potential implications of a decision to transfer assets.” The belief was that otherwise, customers would simply rely on their “experience and confidence” with the representative. FINRA found that such experiences alone do not always guarantee that staying with the representative will be in the customers’ best interests. Thus, FINRA proposed the educational communication, which contains a number of questions that FINRA believes customers should ask themselves before deciding to remain with the representative. Continue reading ›

Wells Fargo Seeks to Compel Arbitration to Prevent Fake Account Lawsuits

December 6, 2016 | Elizabeth Dalziel

On November 23, 2016, Wells Fargo successfully defended a class action lawsuit relating to the recent fake account scandal, Mitchell v. Wells Fargo Bank NA. This class action lawsuit, filed by three Wells Fargo customers in the United States District Court for the District of Utah, called for at least $5 million in damages, as well as potential punitive damages, stemming from the bank’s opening of at least 2 million accounts that its customers did not authorize. However, Wells Fargo succeeded in having the case referred to arbitration, citing clauses in its account agreements compelling arbitration in the event of a dispute, as well as a September 2015 case from the United States District Court for the Northern District of California that also involved Wells Fargo’s alleged opening of unauthorized accounts. Continue reading ›

FINRA Charges Oppenheimer & Co. for Multiple Compliance Failures

December 2, 2016 | Elizabeth Dalziel

On November 17, 2016, the Financial Industry Regulatory Authority, Inc. (“FINRA”) issued a Letter of Acceptance, Waiver and Consent (“AWC”), in which Oppenheimer & Co., Inc. (“Oppenheimer”) agreed to settle numerous charges. Pursuant to the AWC, Oppenheimer will be fined $1.575 million. It will also be required to make remediation payments of $703,122 to seven arbitration claimants and $1,142,619 to customers who qualified for but did not receive applicable sales charge waivers pertaining to mutual funds.

Many of the violations related to FINRA Rule 4530. Rule 4530(f) requires FINRA members promptly to provide FINRA with copies of certain civil complaints and arbitration claims. Rule 4530(b) provides that if a FINRA member realizes that it or an associated person has violated any securities or investment-related laws that have widespread or potential widespread impact to the firm, the member must notify FINRA. The notification should take place within either 30 calendar days after the determination is made or 30 calendar days after it reasonably should have been made.

According to FINRA’s findings, Oppenheimer failed to file in excess of 350 of these required filings. Moreover, FINRA found that when Oppenheimer did make the required filings, the disclosures were, on average, more than four years late.

Federal Court Denies Motion to Block DOL Fiduciary Rule

November 28, 2016 | Patricia Klusmeyer

The U.S. Circuit Court of Appeals for the District of Columbia recently denied a motion brought by the National Association for Fixed Annuities (NAFA) to enjoin the implementation of the new Department of Labor (DOL) fiduciary rule. This is the first court decision on a legal challenge to the rule. There are currently several other lawsuits against the DOL seeking to overrule the new DOL fiduciary rule that await decision.

NAFA is an insurance trade association that represents insurance companies, independent marketing organizations, and individual insurance agents. NAFA has been very vocal in its opposition to the new DOL fiduciary rule, stating that the new rule will have “catastrophic consequences for the fixed indexed annuities industry” and that meeting the April 2017 deadline is “almost an impossibility for the industry.” Along with other opponents to the rule, NAFA believes the rule will lead to higher compliance costs and will greatly increase litigation risk.

Nebraska Proposes Amendments to its Investment Adviser, Broker Dealer and Securities Registration Rules

November 25, 2016 | Steve Parker

Nebraska has proposed multiple changes to its securities laws, including changes to investment adviser registration requirements, changes related to broker dealers and agents, and changes relating to securities registration procedures.

As the proposed changes relate to investment advisers, Nebraska proposes to eliminate the Form IAR and to substitute registration through the CRD/IARD system. An original application for registration would be required to contain Form ADV, Part 2 for the firm and a brochure supplement for each investment adviser representative. An original application would also be required to contain copies of all other promotional or disclosure literature expected to be provided to clients and perspective clients in Nebraska. The proposed rule would eliminate from the registration renewal requirements, the current requirements of submission of Form IAR and the promotional and disclosure literature. The rules would align Nebraska with the annual updating amendment requirements of other states, by requiring submission of annual updating amendments to Form ADV within 90 days of the end of the fiscal year. Additionally, the rule would require firms to submit other-than-annual amendments to Form ADV as required by the Form ADV instructions.

The proposed rule would also require brochure delivery to clients in a manner consistent with the requirements of most other states. For example, delivery of Part 2 and a brochure supplement for each individual that provides investment advice and has direct contact with the client, or exercises discretion over the client’s assets in Nebraska either at the time of entering into an advisory contract or within 48 hours before entering into the contract. If the delivery is made at the time the contract is entered into, the client must be given the right to terminate the contract without penalty within 5 days of entering into the contract. Either an annual update or summary of material changes must be delivered to each client within 120 days after the end of the firm’s fiscal year.