Articles Posted in Industry News

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The SEC has released the results of the 686 2013 enforcement actions it filed in federal court, which resulted in $3.4 billion in sanctions against offenders. Of the $3.4 billion, securities violators were required to disgorge illegal profits of approximately $2.257 billion and pay penalties of approximately $1.167 billion. The chairperson of the SEC, Mary Jo White, stated, “A strong enforcement program helps produce financial markets that operate with integrity and transparency, and reassures investors that they can invest with confidence.”

The 2013 total sanction amount is 10 percent higher than 2012 and 22 percent higher than 2011. In 2013, the SEC pursued many categories of enforcement actions including:

– Broker-dealers (121)
– Delinquent Filings (132)
– Foreign Corrupt Practices Act (5)
– Financial Fraud/Issuer Disclosure (68)
– Insider Trading (44)
– Investment Adviser/Investment Co. (140)
– Market Manipulation (50)
– Securities Offering (103)
– Other (23)

The SEC highlighted certain enforcement programs on which they had focused in 2013 and programs that they will emphasize for the foreseeable future. The SEC is focused on making sure gatekeepers, people that have special duties to ensure that the interests of investors are protected, safeguard and protect investors’ rights.
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On the same day that it released rule amendments allowing some Rule 506 offerings to be sold through public solicitation, the SEC proposed an additional set of rule amendments for those offerings. While the newly adopted rule primarily concerns verification of accredited investor status, the additional proposals relate more to the materials used by issuers to solicit those investors.

Currently, offerings under Regulation D require a Form D to be filed 15 days after the first sale; no prefiling is required. The proposal, however, would require that any offering to be sold using general solicitation would require that Form D be filed with the SEC 15 days prior to any solicitation. The SEC has also proposed a temporary rule, Rule 510T, which would go further and require all solicitation material to be filed with the SEC prior to its first use. Under the proposal, this temporary rule would expire in two years.

In addition, the proposed rule changes would require solicitation materials to include legends informing recipients of certain facts relating to the securities offered, such as the requirement that all investors must be accredited, that regulators have not approved the offering and that the securities have transfer restrictions. The proposal also extends to private funds the Rule 156 requirements currently relating to investment company advertising materials.
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The Securities and Exchange Commission (“SEC”) recently adopted long-awaited rule changes required by the 2012 Dodd-Frank Act that will allow some offerings under Rule 506 to be offered using general solicitation. At the same time, the SEC proposed a set of additional changes that would further regulate this new type of offering.

Offerings under Rule 506, which provides one of the three operative safe harbor offering alternatives under Regulation D, have been prohibited from using any form of public solicitation since the rule’s inception in 1982. However, Congress responded to calls from industry seeking easier and less expensive ways to raise investment capital by creating the “crowdfunding” exemption and by loosening the public solicitation prohibition for Rule 506 offerings.

The rule amendment creates a new subsection 506(c), which provides that public solicitation is allowed if the offering is limited to accredited investors and the issuer takes reasonable steps to verify each investor’s accredited status. Although the rule does not enumerate specific verification procedures or even create a defined safe harbor, the issuing release describes a “principles-based” approach to verification and discusses a number of verification alternatives that may be considered adequate.
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The North American Securities Administrators Association (NASAA) released preliminary numbers this month showing that the number of enforcement cases brought by state regulators doubled during 2011. During that year, states brought about 400 cases compared to 208 cases brought during 2010. This increase is due in large part to an expansion of state examinations as a result of the Dodd-Frank financial reform law. Dodd-Frank gave the states examination authority for some approximately 2,400 “mid-sized” advisers (firms with less than $100 million in assets under management) which are required to switch from SEC to state registration.

As a result of the switch, some former SEC firms that haven’t been examined in many years, if ever, by the SEC now find themselves subject to a state examination and can also look forward to being examined by the state more frequently.
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Proposed legislation designed to create a self-regulatory organization (SRO) for investment advisers may not be acted on during this Congressional session, according to its sponsor, Rep. Spencer Bachus (D-Ala.). Rep. Bachus, Chairman of the House Financial Services Committee, said earlier this week that no consensus has developed regarding any proposal relating to enhancing investment adviser oversight and that, therefore, no action is imminent.

There has been increasing interest and legislative activity over the past several months relating to investment adviser examinations. While there is almost universal agreement that examination coverage should be increased, there is a sharp division among industry members, regulators and legislators about how to accomplish that goal.

Most observers agree that Rep. Bachus’s bill, if passed, would lead to the Financial Regulatory Authority (FINRA) becoming the SRO for investment advisers. Adviser organizations have split over supporting the bill, with the Financial Services Institute (FSI) as a supporter, and the Investment Adviser Association (IAA) and the American Institute of CPAs strongly opposed. Other investment adviser organizations have also come out in opposition to the Bachus bill, as has the North American Securities Administrators Association (NASAA).
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According to an InvestmentNews poll, 58.7% of 293 advisers who responded to a recent survey support the option of the Securities and Exchange Commission (SEC) charging user fees to defray the costs of increased examinations. This is an increase from a year ago when only 27.8% of 335 responding advisers supported the user fee approach. The poll also concluded that 74.7% of advisers said they oppose permitting the Financial Regulatory Authority (FINRA) from becoming the self regulatory organization (SRO) for advisers.

The increased willingness of advisers to pay user fees suggests that there could be more support for the bill soon to be introduced by Rep. Maxine Waters (D-CA) that would authorize the SEC to charge user fees for advisers to cover or defray the costs of examinations. Rep. Waters’s bill would combat the SRO bill introduced by Rep. Spencer Bachus (R-Al) and Carolyn McCarthy (D-NY).
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The Financial Industry Regulatory Authority (FINRA) released a Regulatory Notice in May clarifying its new suitability rule, Rule 2111. The rule, which was approved by the Securities and Exchange Commission (SEC) in November 2010, will be implemented on July 9, 2012. The Notice is intended to answer industry questions and provide guidance on the new rule.

According to FINRA, the new rule imposes the same obligations as the predecessor rule and related case law. It is intended to clarify and codify three main suitability obligations.

The first obligation is reasonable-basis suitability, which has two components: a broker must (1) perform reasonable diligence to understand the nature of the recommended security or investment strategy involving a security or securities, as well as the potential risks and rewards, and (2) determine whether the recommendation is suitable for at least some investors based on that understanding.

The second obligation is customer-specific suitability, in which the broker must have a reasonable basis to believe that a recommendation of a security or investment strategy is suitable for the particular customer based on the customer’s investment profile.
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The Financial Services Institute (FSI) Chair, Joe Russo, recently released a letter stating that the FSI supports the Financial Industry Regulatory Authority (FINRA) as the new self-regulatory organization (SRO) for investment advisers. Russo stated that the FSI has conducted two polls of its financial adviser members to determine whether they support FINRA as the SRO and 75% agreed that FINRA should become the SRO.

FSI has been asked by a number of critics why it has not advocated repealing the Dodd-Frank Wall Street Reform and Consumer Protection Act. In response, FSI says that the act will likely not be repealed as a practical matter. Therefore, FSI has decided to focus its legislative efforts on securing for its members the least intrusive of the three options for investment adviser regulation posed by the Securities and Exchange Commission (SEC). Those options are (1) the SEC charging user fees to fund more examiners, (2) FINRA becoming the dual SRO for broker-dealers and investment advisers, or (3) creating a new SRO.
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As a result of the Dodd-Frank Wall Street Reform and Consumer Protection Act, the Government Accountability Office (GAO), a non-partisan investigative agency of Congress, conducted a study which criticized the Securities and Exchange Commission’s (SEC) oversight of the Financial Industry Regulatory Authority (FINRA). The purpose of the study was to determine how the SEC has conducted its oversight of FINRA, including the effectiveness of FINRA rules, and how the SEC plans to enhance its oversight.

The GAO found that both the SEC and FINRA do not conduct retrospective reviews of the impact of FINRA’s rules. As a result, the GAO believes that “FINRA may be missing an opportunity to systematically assess whether its rules are achieving their intended purpose and take appropriate action, such as maintaining rules that are effective and modifying or repealing rules that are ineffective or burdensome.” The GAO also noted that the SEC does not conduct sufficient oversight over FINRA’s governance and executive compensation. The SEC has responded to the survey by saying that it is focused primarily on oversight of FINRA’s regulatory departments, which the SEC claims has the biggest impact on investors.
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The Project on Government Oversight (POGO), on May 29, wrote to Rep. Spencer Bachus (R-AL) and Rep. Barney Frank (D-MA) opposing the self-regulatory organization (SRO) bill that was reintroduced in the House of Representatives in April. We discussed the bill in a previous post, SRO Redraft Bill Reintroduced. POGO joins a long list of groups, including the Investment Advisers Association, the Financial Planning Coalition and the American Institute of CPAs, opposing the bill. POGO is particularly opposed to the Financial Industry Regulatory Authority (FINRA) becoming the SRO because it believes that “FINRA’s regulatory effectiveness is undermined by its inherent conflicts of interest, its lack of transparency and accountability, its lobbying expenditures, and its executive compensation packages, among other issues.”

The letter addresses each area of concern POGO has relating to FINRA becoming the SRO for investment advisers. First, POGO states that FINRA’s “conflicted mission” will lead “to cozy ties with the industry.” POGO says the conflict arises because FINRA collects fees from member firms and is also charged with regulating the investment adviser industry. POGO believes that FINRA’s “inherently conflicted self-funding model has contributed to an incestuous relationship between FINRA and the industry it is tasked with regulating.” In contrast, POGO contends that government agencies are not conflicted because they must comply with federal ethic laws and agency regulations designed to alleviate the conflicts.
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