Articles Posted in Industry News

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Last month, the SEC division of Investment Management released Investment Management Guidance in which it discusses a number of measures that investment advisers may wish to consider when addressing cybersecurity risks. This guidance is just the last in a long list of guidance and alerts issued by the SEC and other regulators as to the need for financial firms to improve their policies and procedures dealing with cybersecurity threats.

Among the recommendations made in the current IM are that firms:

• Conduct a periodic assessment of the nature, sensitivity and location of information, what types of cybersecurity threats and vulnerabilities exist, what security controls and processes are currently in place, the impact that would occur in the event of compromise of information, and the effectiveness of the current structure confirms current structure for managing cyber security risks

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In the wake of the re-proposal by the U.S. Department of Labor of its so-called “Fiduciary Rule,” there are a number of questions regarding how the rule if adopted, will impact those providing financial advice to employee benefit plans and other retirement plans including IRAs and ERISA plans in general. The most obvious impact of the rule would be to bring those not currently fiduciaries, including registered representatives of securities broker-dealers and the broker-dealer firms themselves, into the realm of fiduciary advice providers. The higher standard of care that would apply necessarily implies a need for more thorough disclosures of potential conflicts of interest, including incentivized compensation such as commissions, 12b-1 fees and the like.
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Earlier this month, the Financial Industry Regulatory Authority (“FINRA”) announced that it had fined LPL Financial (“LPL”) $10 million for lack of supervision in several areas of its operations, including sales of ETFs, variable annuities, REITs, and other complex products. In addition, FINRA found LPL failed to monitor trades and failed to report them to FINRA and failed to deliver more than $14 million in trade confirmations to customers. FINRA also ordered LPL to repay certain customers $1.7 million in restitution relating to the purchases of ETFs. Among FINRA’s findings were that the firm did not have a system that monitored how long customers were holding ETFs in their accounts, information that would be important in formulating advice as to whether the ETFs should have been purchased in the first place and how long the client should be recommended to hold the ETFs in their portfolios. Additionally, even though LPL had created policies limiting the concentration of ETFs in customer accounts, it failed to enforce the limits it had established and had not trained its registered representatives on the risks of those products.

With respect to variable annuities, FINRA found that in several instances, LPL had permitted said annuities to be sold without proper disclosure of surrender fees. Additionally, although LPL employed an automated surveillance system, that system failed to adequately review transactions commonly known as mutual fund “switches,” which involve a redemption of one mutual fund in order to purchase another.
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Delaware has adopted a rule exempting “private fund advisers” from the state’s unlawful conduct provision, including the provision requiring registration as an investment adviser. Under the new rule, a private fund adviser is exempt from Delaware Securities Act unlawful conduct provisions if: (1) neither the private fund adviser nor any advisory affiliates are subject to an event that would disqualify an issuer under federal Regulation D, Rule 506(d)(1); (2) the private fund adviser files with the Director through the IARD each report and amendment that an exempt reporting adviser is required to filed with the SEC under SEC Rule 204-4; and (3) the private fund adviser pays the investment adviser registration fee of $300.

A “private fund adviser” is defined as “an investment adviser who provides advice solely to one or more qualifying private funds, other than a private fund that qualifies for the section (3)(c)(1) investment company act exclusion.” A “qualifying private fund” is a private fund meeting the SEC rule 203(m)-1 “qualifying private fund” definition.
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Last month at the Annual Conference of the Securities and Exchange Commission (“SEC”), the Commission revealed its enforcement statistics for 2014, including a record number of enforcement actions (755) and monetary relief obtained ($4.1 Million). The Commission also announced its current initiatives including a continued emphasis in the use of data analytics in both regulation and enforcement investigations. Among the areas of emphasis highlighted at this year’s conference were insider trading, financial reporting and auditing cases, inadequate internal controls for public companies, enhanced scrutiny of auditors and other reporting gatekeepers, and Foreign Corrupt Practices Act enforcement.

In addition, 30 trials were conducted in 2014 by the Commission, the most trials in over a decade. By contrast, the Commission tried only 6 cases in 2013. Two-thirds of the trials were in federal court, while one-third were before Administrative Law Judges.
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On February 4, 2015, the SEC issued cease and desist orders against three investment advisers that fraudulently maintained registration with the SEC by listing Wyoming as their principal place of business on their Forms ADV. These three incidences highlight Wyoming’s unusual landscape for investment advisers.

In order to explain the uniqueness of these orders, some background on investment adviser regulation will be provided. Originally, investment advisers were prohibited from registering with the SEC under the Investment Advisers Act if it managed under $25 million in assets or met a designated exemption. In July 2011, that threshold was increased to $100 million. If an investment adviser does not meet or exceed the $100 million threshold, it is still required to register with the states in which they maintain their principal place of business. Wyoming is unique in that it does not regulate investment advisers. Any investment adviser with its principal place of business in Wyoming must therefore, according to the amendments to Section 203A of the Investment Advisers Act, register with the SEC.
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In an effort to inform investors about common fraudulent activities involving individual retirement accounts (“IRAs”), the North American Securities Administrators Association (“NASAA”) has issued an Advisory on third-party custodians of self-directed IRAs and other qualified plans. The advisory was issued to describe the roles and responsibilities a third-party custodian of a self-directed IRA has and to hopefully dispel some of the common misconceptions investors have about third-party custodians. In particular, NASAA warns investors that IRA custodians’ duties are limited to report information to the IRS, and such custodians do not provide any assurance that the IRA owner’s investments are protected against loss.

When creating an IRA, an investor must find an IRS-approved custodian for the account. Custodians are typically banks or brokerage firms. Once the account is opened, investors can deposit funds into the account and invest in opportunities available through the custodian. With a self-directed IRA, the investor has full control over what the funds in the account are invested in, unlike mutual funds or other types of savings accounts.
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In a speech given at The New York Times Dealbook Opportunities for Tomorrow Conference in New York at the end of 2014, SEC Chair Mary Jo White detailed an extensive plan to increase the agency’s scrutiny of asset managers. Her speech highlighted many of the important issues currently facing the SEC in regulating the asset management industry and its planned response to those issues.

Chair White began by noting the evolution of the asset management industry and the tools currently utilized to protect investors and their assets. In 1940, when the Investment Advisers Act was first passed, there were a total of $4 billion in assets under management at 51 firms, compared to the now over $63 trillion of assets under management at over 22,000 firms. Chair White also noted that almost half of all U.S. households own mutual funds. In addition to mutual funds, asset managers also increasingly recommend modern, sophisticated products like ETFs and derivatives. Registered funds have significantly increased the size and complexity of derivates used in asset management.
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On February 3, 2015, H.R. 686, a bill creating a registration exemption for M&A Brokers, was introduced in the House of Representatives and referred to the Committee on Financial Services. This new bill is identical to Section 401 of H.R. 37, which included other financial regulations and had passed the House on January 14, 2015. H.R. 686 essentially duplicates the M&A Broker section – Section 401 of H.R. 37. Introducing this M&A Broker proposal as its own bill could signal a possible lack of confidence of behalf of lawmakers that an adequate amount of votes are available to pass H.R. 37 in the Senate and a hope that Section 401 can make it on its own and become law.

As discussed in previous posts, the M&A Broker exemption proposed by Congress in H.R. 37 – and now in H.R. 686 – fails to address the “grey area” of unregistered actors who participate in private placement of securities that are not M&A transactions. These Private Placement Brokers play an important and integral part for smaller businesses trying to raise capital. Having the M&A Broker exemption on its own in H.R. 686, and not with other significant financial regulations, may allow for amendments to be added more easily. Hopefully one of those amendments would be a Private Placement Broker exemption.

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The Broker-Dealer section of the North American Securities Administrators Association (“NASAA”) recently sent out a notice of request for comment on a proposed uniform state model rule (“Model Rule”) that would exempt merger and acquisition brokers (“M&A Brokers”) from state securities registration if certain requirements were met. While NASAA’s proposed Model Rule is similar to the recent SEC No-Action letter concerning M&A Brokers and the exemption for M&A Brokers provided by HR 37, there are some notable differences. Comments on the Model Rule must be submitted to NASAA by February 16, 2015.

First, this post will lay out the three current proposals by SEC staff, Congress, and NASAA to create an M&A Broker registration exemption. Second, a comparison between all three will be made in order to highlight how each body plans to regulate and define the scope of the exemption for M&A Brokers. Each comparison will be broken up into key aspects of each proposal’s efforts to create an exemption for M&A Brokers. Third, this post will emphasize the need to create an exemption, along with M&A Brokers, that will encompass other important unregistered actors: Private Placement Brokers.
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