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The Securities and Exchange Commission (SEC) issued a Risk Alert on February 27 designed to help firms detect and prevent unauthorized trading in brokerage and advisory accounts. Carlo di Florio, director of the Office of Compliance Inspections and Examination, stated, “Unauthorized trading is not a new problem, and the risks it poses should be a perennial concern to financial firms as well as to regulators. We hope that the observations shared in the Risk Alert will be helpful for firms as they review their compliance and supervisory controls to detect and deter unauthorized trading.”

The Risk Alert defines the term “unauthorized trading” as a broad range of activities, including: (1) rogue or other unauthorized trading or trade execution in customer or client or propriety accounts, (2) exceeding firm limits on position exposures, risk tolerances and losses, (3) intentional mismarking of positions, and (4) creating records of nonexistent (or sham) transactions. If a firm notices a change in trading patterns, a high volume of trade cancellations or corrections, manual trade adjustments, or unexplained profits for a particular trader or client, then the firm may need to apply additional scrutiny.
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The Securities and Exchange Commission (SEC) and the Commodities Future Trading Commission (CFTC) issued a joint proposed rule and guidelines to help protect investors from identity theft enacted by Title X of the Dodd-Frank Wall Street Reform and Consumer Protection Act. This proposal currently does not apply to registered investment advisers. The SEC has recognized that registered investment advisers are unlikely to hold transaction accounts and thus would not qualify as a “financial institution.” The SEC is requesting comments on the proposed rule asking whether the rule should “omit investment advisers or any other SEC-registered entity from the list of entities covered by the proposed rule?” When the proposal is published in the federal register there will be a 60-day comment period.

Section 1088 of the Dodd-Frank Act transferred authority over parts of the Fair Credit Reporting Act (FCRA) from the Federal Trade Commission (FTC) to the SEC and the CFTC. The provisions amended section 615(e) by adding the CFTC and SEC to a list of federal agencies required to create identity theft regulations. The purpose of an identity prevention program is to detect, prevent and mitigate identity theft.
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Virginia’s previous private fund adviser exemption could be short-lived because it may be replaced by a new proposed rule. The previous rule was effective September 7, 2011 and the current proposed rule is expected to be effective on May 1, 2012. Interested persons may submit their comments on the proposed rule on or before April 12, 2012. This new rule is also currently being considered by California, Massachusetts and Rhode Island. We previously discussed the California proposed exemption rule in a blog, California Extends Comment Date on its Proposed Private Fund Exemption Rule.

Currently, the rule provides for an exemption for any adviser where the adviser advises only clients that are either a corporation, general partnership, limited partnership, limited liability company, trust or other organization that:

  • Has assets of $5,000,000 or more and
  • Receives investment advice based on the investment objectives of the entity instead of individual investment objectives, provided that the adviser was exempt from registration pursuant to §203(b)(3) of the Investment Advisers Act of 1940 and the adviser is subject to SEC rule 203 1(e).

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The Securities and Exchange Commission (SEC) is looking into two new proposals to stabilize money market funds. One of Chairman Mary Schapiro’s goals is to address the core structural weaknesses of the market. She stated, “Funds remain vulnerable to the reality that a single money market fund breaking of the buck could trigger a broad and destabilizing run.” The SEC is hoping to put both plans out for public comment, but it believes that it may adopt only one of the plans. If it chooses to adopt one, then the SEC will propose it before the end of March.

The SEC’s first proposal is to adopt a floating net asset value instead of the traditional $1 share price. This idea was also mentioned back in 2009; however it was not implemented. The second proposal would require funds to maintain a 1% capital cushion designed to absorb potential losses and to hold back at least 3% of client redemptions for 30 days.
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The Obama administration released a proposed budget last week that will boost the Securities and Exchange Commission’s (SEC) budget for the next fiscal year. The SEC claims the need for an increased budget stems from the mandatory creation of 100 rules which is required by the Dodd-Frank Act and the need to hire new examiners to regulate the market more efficiently. The proposed budget would increase the SEC’s funding by 18.5 percent from $1.32 billion to $1.57 billion.

Prior to the release of the Obama administration budget, the SEC submitted a budget request which stated that the new budget would allow for 222 new examiners. That request estimated that in 2013 it will be responsible for examining 10,000 advisers with $44 trillion in assets under management. Currently, it only has 10 examiners per $1 trillion in assets under management, a decrease since 2005 when it had 19 examiners for every $1 trillion in assets under management. The SEC is capable of reviewing only eight percent of registered advisers each year. Investment advisers have also shown a preference to be regulated by the SEC as opposed to FINRA or another self regulatory authority (SRO), as we discussed in a previous blog, BCG Report Claims FINRA Cost Will Exceed SEC Cost as RIA SRO.
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The Securities and Exchange Commission (SEC) released Final Rule No. IA – 3372 which changes the qualifications for advisers who charge performance fees. We discussed the proposed amendment to the rule in a previous blog post, Performance Based Fee Threshold Increase Sought by SEC in Proposed Order. These amendments are required by the Dodd-Frank Wall Street Reform and Consumer Protection Act, and will take effect 90 days after publication in the Federal Register, which is anticipated shortly. Until then advisers can rely on the grandfather provisions.

While advisers are generally unable to accept performance fees, there are exceptions. For example under certain circumstances, a client may become a “qualified client,” under Rule 205-3, meaning he or she is deemed to be capable of bearing the risks associated with performance fee arrangements. Under the new rule, an adviser may charge performance fees to “qualified clients” who have at least $1 million of assets under management for that definition to apply. Under the previous rule, $750,000 in assets were required to be under management. Also, the net worth of an investor may also be a qualification for an exception. The amended rule raises the minimum net worth standard for qualified clients from $1 million to $2 million. (The other “qualified client” basis includes clients who immediately before entering the advisory contract are either executive officers, directors, trustees, general partners of the adviser or employees of the adviser and who have participated in the adviser’s investment activities for at least twelve months. This definition has not changed with the amendment.)
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In a hilariously naïve opinion piece called Over-regulated America, the February 18, 2012 edition of The Economist makes “a plea for simplicity” to replace what it characterizes as the U.S.’s overly regulated financial system. In place of Sarbanes-Oxley and Dodd-Frank, it proposes that regulations not contain specific rules but rather merely “lay down broad goals” and “leave the regulators to enforce them.”

This is the so-called “principles-based regulation” that they have in Europe – the envy of the world when it comes to banking. America should return to its European roots, The Economist is saying. After all, the U.S. is “the home of laissez-faire.” (You would think the editors could have sent a fact-checker through the Chunnel to the Bibliothèque de la Sorbonne, but the point is not lost for the error). According to The Economist, there is nothing wrong with the American banking system that a big dose of European regulation won’t cure.

So instead of having a regulations manual that says, for instance, banks cannot engage in specified levels of leverage in proprietary trading, The Economist thinks it would be good enough to have a regulation that says to banks: “don’t put your capital at risk.” Although we tried that already, let’s humor (or humour) The Economist and pretend we haven’t. What would that be like?

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Earlier this month, the Financial Industry Regulatory Authority (FINRA) released a letter addressing broker-dealer’s practices in recommending high-yield products to clients. The letter states, “FINRA is informing its examination priorities against the economic environment that investors have faced since 2008, as these circumstances have steadily contributed to conditions that foster an increased risk of aggressive yield chasing, inappropriate sales practices, unsuitable product offerings, and misappropriation and fraud.” The purpose of the letter is to warn broker-dealers not to engage in practices intended to beat the market and instead to promote what is suitable for the investor.

Investors are being urged by their brokers to engage in yield chasing, which means they are seeking higher returns on their investments. The investors in this situation may not completely understand the risk versus reward tradeoffs by investing in this manner especially when brokers are recommending more complex products as discussed in a previous blog, FINRA Wants Heightened Supervision of Complex Products. FINRA’s concerns include the full disclosure of material risks, mispricing and overcharging issues, and the suitability of products based on those underlying risks. It urged firms to increase their supervisory systems to ensure that firms are complying with regulations.
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The California Department of Corporations has extended the comment period for a proposed rule to amend Rule 260.204.9 of Title 10 of the California Code of Regulations, which exempts private advisers from registration under certain circumstances. The public comment period for this exemption was extended from February 20, 2012 to March 25, 2012. To date, there are no public hearings scheduled; however comments may be mailed to the Department of Corporations.

The amended proposed rule significantly changes the current rule in place. Currently, the rule provides for an exemption for any adviser that:

  • Has had fewer than 15 clients in the preceding 12 months;
  • Does not hold itself out to the public as an investment adviser;
  • Does not act as an investment adviser to a registered company or a company that has elected to be a business development company; and
  • Either has assets under management of $25 million or more or provides investment advice solely to one or more venture capital companies.

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As a result of the Dodd-Frank Wall Street Reform and Consumer Protection Act passed on July 21, 2010, there have been significant reforms applicable to non-US advisers conducting business in the United States, including new registration requirements under the Advisers Act (the “Act”).

Non-U.S. advisers may need to register with the Securities and Exchange Commission (SEC) in order to conduct future business within the United States. A non-U.S. adviser is defined in the Advisers Act as an investment adviser that:

  • Has no place of business in the United States;
  • Has a total of less than 15 U.S. clients and investors in private funds;
  • Has less than $25 million in assets under management associated with the U.S. clients and investors; and
  • Does not hold itself out generally as a U.S. investment adviser.

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