Industry News

SEC Commissioner Fears that Non-Public Guidance from Agency Staffers May Amount to “Secret Law”

May 7, 2019 | Parker MacIntyre

In a recent speech, an SEC Commissioner took the opportunity to voice her concern that the prevalence of non-public guidance now being conveyed by SEC staffers to certain market participants and their counsel is tantamount to what she terms “secret law” which, in her opinion, “crosses the line” of propriety.

SEC Commissioner Hester M. Peirce’s well-crafted speech, given in Washington at the recent SEC Speaks 2019 event, invokes imagery of the children’s novel The Secret Garden to posit her belief that the abundance and importance of non-public guidance being provided and relied upon by certain of the SEC’s divisions and offices has created a secret garden of its own within the SEC’s walls. As an example, she cites her hearing that “staff simply will not accept certain applications for entire categories of products or types of businesses for reasons not found in our rules.” Additionally, she notes hearing that “one particularly complex set of Commission rules does not matter much in practice because firms operate instead under a set of published and unpublished letters and other directives from staff.” She also references firms being examined “against the terms of draft no-action letters and notes of telephone calls with Commission staff.” In all of these cases, Peirce fears that the “line has been crossed” and that such activities amount to “secret law.”

That such “sub rosa guidance,” as she terms it, amounts to “secret law,” is in Peirce’s opinion undeniable. As she points out, while it is true that courts would be reluctant to defer to such staff guidance in a legal proceeding, it nonetheless does “as a practical matter, bind market participants, affecting the scope of their rights and obligations and limiting the range of permissible activities.”

SEC Identifies Common Compliance Issues with Reg S-P Privacy Notices and Safeguarding Policies

April 30, 2019 | Patricia Klusmeyer

The SEC’s Office of Compliance Inspections and Examinations recently conducted examinations of privacy notices and safeguarding policies of SEC-registered investment advisers and broker-dealers adopted pursuant to Regulation S-P. As a result of these examinations, the SEC issued a Risk Alert identifying common deficiencies that are important to keep in mind when adopting, implementing and reviewing compliant privacy notices and effective safeguarding policies.

Regulation S-P requires financial institutions such as investment advisers and broker-dealers to adopt written policies and procedures to safeguard nonpublic personal client information. These policies must be reasonably designed to protect the confidentiality and security of nonpublic personal client information from any anticipated threats or hazards and any unauthorized access or use. The policies should address administrative, technical, and physical safeguards.

Investment advisers and broker-dealers must also provide initial and annual privacy notices to their clients describing the types of information collected and disclosed, the types of affiliated and non-affiliated third parties the information is disclosed to and, unless exempted from the opt-out notice requirement, an explanation of the client’s right to opt out of disclosure of nonpublic personal information to a non-affiliated third party. The privacy notice should also generally describe the firm’s safeguarding policies and procedures.

SEC Solicits “Dialogue” with Public on Custody Rule Implications Raised by Crypto-Assets

March 28, 2019 | Parker MacIntyre

Recognizing the “swiftly developing” digital asset marketplace—a loosely defined sector encompassing cryptocurrencies, virtual coins or tokens (including Initial Coin Offerings or “ICOs”), and other blockchain-related financial assets—the SEC’s Division of Investment Management (the “Division”) has commenced an open-ended request for public comment on how such crypto-assets impact its decades-old Advisers Act Custody Rule (Advisers Act Rule 206(4)-2). The Division’s request for comment comes in the form of a March 12, 2019 letter to the Investment Adviser Association (“IAA”), a lobbying/trade group representing the investment advisory industry.

By way of background, the Custody Rule sets up a number of requirements for SEC-registered investment advisers that have “custody” of a client’s funds or securities. Custody is defined as “holding, directly or indirectly, client funds or securities, or having any authority to obtain possession of them.” Notably, custody includes, among other things, any arrangement under which the adviser is authorized to withdraw client funds or securities, as well as acting as general partner, or in a comparable control position, for an investment fund. The four primary obligations of an adviser having custody are that the adviser must: (i) maintain those funds or securities with a “qualified custodian;” (ii) notify the client in writing of the qualified custodian’s name, address, and the manner in which the funds or securities are maintained; (iii) have a “reasonable basis” for believing that the qualified custodian sends an account statement, at least quarterly, to each client, identifying the amount of funds/securities and setting forth all transactions in the account; and (iv) arrange for an independent public accountant to conduct an annual surprise examination in order to verify the safekeeping of the client’s funds and/or securities. The Custody Rule provides a number of exemptions to some of the above requirements; most notably, one that allows investment fund advisers to avoid the surprise exam requirement so long as audited financial statements are distributed within 120 days of the end of the fund’s fiscal year.

In an effort to “further inform our consideration of how characteristics of digital assets impact the application of the Custody Rule,” the Division’s request for comment seeks public comment on a wide array of trenchant queries, including the following:

SEC Case Against Wells Fargo Adviser Highlights Need for Supervision of Account Statements Sent to Clients

March 18, 2019 | Elizabeth Dalziel

On February 19, 2019, the United States District Court for the Southern District of Ohio granted a consent judgment against John Gregory Schmidt, a former Wells Fargo Advisors Financial Network (FINET) advisor. The Securities and Exchange Commission had filed a complaint against Schmidt in September 2018, alleging that Schmidt sold securities that belonged to some of his retail brokerage customers and covertly used the proceeds from those sales to conceal shortfalls in customer accounts. According to the SEC’s complaint, Schmidt sent his customers fake account statements which overstated their account balances in order to cover up his conduct. This case demonstrates the need for broker-dealers and registered investment advisers to adopt and enforce policies that effectively give them the ability to detect the use of such fraudulent statements.

Schmidt worked as a registered representative and the branch manager of a FINET office from about December 2006 through October 2017. By October 2017, he had about 325 retail brokerage customers, many of whom were retirees who were dependent on withdrawals from their accounts to pay living expenses. Continue reading ›

Georgia Commissioner of Securities Proposes Amendments to Broker-Dealer and Investment Adviser Examination Requirements to Incorporate FINRA SIE Exam

March 1, 2019 | Elizabeth Dalziel

On February 4, 2019, the Commissioner of Securities of the State of Georgia and the Office of the Secretary of State announced its intent to amend the rules governing examination requirements for registered representatives of a broker-dealer and investment adviser representatives. According to the Commissioner, the primary purposes of these amendments are to harmonize Georgia’s rules with the Financial Industry Regulatory Authority’s new rules implementing the Securities Industry Essentials (“SIE”) Exam and to update the requirements regarding examinations to applicants. The SIE Exam, which tests a FINRA registration applicant’s knowledge of securities-related topics, was launched to simplify FINRA’s qualification examination program after the program’s efforts to address new securities products and services resulted in FINRA offering multiple exams with immense content overlap. FINRA also launched the SIE Exam in order to provide greater consistency and uniformity to the securities industry application process.

The State of Georgia requires applicants for registration as a registered representative of a broker-dealer and/or an investment adviser representative to take certain prerequisite examinations. Georgia Rule 590-4-5-.02 details the examination requirements for registered representatives, while Georgia Rule 590-4-4.09 details the examination requirements for investment adviser representatives.

The proposed amendments to Rule 590-4-5-.02, detailing registered representative examinations, would require an applicant applying for registration as a broker-dealer to present proof to the Commissioner that its personnel have passed at least one of a list of specified examinations within a two-year period preceding the date of the application. The amendments also eliminate the Series 87 Research Principal Examination as a potential examination that could be passed. The amendments also would provide that an applicant who is applying to be a registered representative would need to present the Commissioner with proof that he or she has passed the required examinations within either a two-year period immediately preceding the application date or a four-year period in the case of an applicant who has taken the SIE Exam. The amendments also provide that the Commissioner “may reserve the right to find the applicant qualified by other examinations or significant and comprehensive experience in the securities business.”

FINRA Issues Warning of Phishing Scheme Targeting Compliance Personnel

February 26, 2019 | Parker MacIntyre

FINRA has alerted its Member Firms to be on the watch for a fraudulent phishing email scheme targeted at compliance personnel. A phishing scheme typically uses email or some other type of electronic message to trick the recipient into clicking a malicious link or infected file attachment by mimicking a message from a trustworthy party. This particular scheme employs an email purportedly originating from an Anti-Money Laundering compliance officer at an otherwise apparently legitimate Indiana-based credit union. The email—which was received recently by a number of FINRA Member Firms—specifically targets compliance personnel by appearing to be a communication regarding an attempted transfer of money by a client of the recipient’s firm to the credit union which has been placed on hold due to concerns about potential money laundering. The scam is designed to get the recipient to open an attachment, which, according to FINRA “likely contains a malicious virus or malware designed to obtain unauthorized access to the recipient’s computer network.”

FINRA noted the following additional aspects of the fraudulent email that recipients should be alert for:

An otherwise legitimate reference to a provision of the USA Patriot Act allowing financial institutions to share information with each other.
An actual email address that appears to be from Europe, rather than the U.S.-based credit union.
Numerous instances of poor grammar and sentence structure.

FINRA Invites Member Firms to Self-Report Potential Share Class Selection Violations

February 15, 2019 | Parker MacIntyre

FINRA has announced a new self-reporting initiative covering potential violations by its Member Firms of various rules governing share class recommendations relating to 529 Plans. See FINRA Regulatory Notice 19-04 (Jan. 28, 2019). Similar to the SEC’s recent self-reporting initiative regarding mutual fund share class selection in connection with 12b-1 marketing fees (which we have blogged about last month and in May of 2018), this new FINRA initiative (the “Initiative”) offers potential leniency in return for Member Firms coming forward to self-report likely violations pursuant to the terms of the Initiative.

529 Plans are tax-advantaged municipal securities that are structured to facilitate saving for the future educational needs of a designated beneficiary. While the sale of 529 Plans is governed by the rules of the Municipal Securities Rulemaking Board (“MSRB”), FINRA is responsible for enforcing the MSRB’s rules. These rules, in turn, require that recommendations of 529 Plans be suitable in light of the customer’s investment profile, and that Member Firms selling 529 Plans have a supervisory system in place to achieve compliance with the MSRB’s rules.

First Quarter Brings Code of Ethics Reporting Into Focus

February 12, 2019 | Parker MacIntyre

At this time of year, it is important for registered investment advisers to assure that they are in compliance with federal and/or state rules requiring them to monitor their supervised persons’ security holdings and transactions for compliance with the firm’s code of ethics. Even seasoned compliance professionals will encounter questions regarding application of the rule from time to time. While this article is no substitute for a detailed analysis of the rule and its application to a specific firm and its supervised persons, an overview of the rule may be helpful.

As background, all SEC-registered investment advisers are required to adopt a Code of Ethics, which must describe the standards of conduct expected for representatives of the firm and address conflicts that arise from personal trading by advisory personnel. This federal requirement, which governs SEC-registered advisers only, derives from SEC Rule 204A-1, which took effect in 2005. Since then, many state securities administrators have adopted identical or similar requirements, either by adopting SEC Rule 204A-1 “by reference”—i.e., verbatim—into state law, or by crafting similar “me too” provisions. Accordingly, if your firm is SEC-registered, it will be bound by Rule 204A-1; but, if your firm is currently a state-registered adviser, it may be bound by the same or similar requirements. Continue reading ›

What Firms Can Expect Now That the SEC is Back at Work

January 31, 2019 | Elizabeth Dalziel

On December 20, 2018, two days before the recent partial federal government shutdown began, the Securities and Exchange Commission’s Office of Compliance Inspections and Examinations announced its 2019 Examination Priorities. As discussed previously, the shutdown resulted in the SEC operating at a quite minimal level. Now that the shutdown is over, registered investment advisers and broker-dealers can likely expect OCIE to fully implement the following examination priorities.

OCIE listed six examination priorities for 2019: (1) matters of importance to retail investors, especially seniors and investors saving for retirement; (2) compliance and risk in registrants who are tasked with overseeing critical market infrastructure; (3) focus on FINRA and MSRB; (4) digital assets; (5) cybersecurity; and (6) anti-money laundering. According to OCIE, this is not an exhaustive list, and one can expect OCIE to cover other issues in its examinations. However, OCIE has concluded that these issues “present potentially heightened risk to investors or the integrity of U.S. capital markets.” Continue reading ›

SEC Effectively Closed as Federal Shutdown Approaches its Fifth Week (But Some Filing Platforms Remain Fully Operable)

January 18, 2019 | Parker MacIntyre

As the partial federal government shutdown, which began at midnight on December 22, 2018, now approaches its fifth week, we write to update our readers on the shutdown’s specific impact on the SEC and securities regulatory activities. While we have previously discussed many of these points with our clients who currently have matters pending before the SEC, below is more general information regarding the SEC’s most significant functions.

The SEC was able to operate fully and conduct regular business for a limited number of days following the commencement of the general federal shutdown, but was forced to effectively close its doors on December 27, 2018. Since then, the agency has been operating at a very minimal level with a skeleton crew of staffers able to respond to only emergency situations. As described on the SEC’s home page, the remaining staff is available to respond only to “emergency situations involving market integrity and investor protection, including law enforcement.” The vast majority of the SEC’s employees have been furloughed and are not reporting to work at this time. That said, we note that a number of familiar online filing platforms, such as EDGAR, IARD, and CRD, all remain fully operable. Continue reading ›