RIA Compliance Blog

Investor Losses from Oil Pricing War Could Trigger FINRA and SEC Exam Scrutiny

March 11, 2020 | Steve Parker

As the saying goes, “a rising tide lifts all boats.” This expression is commonly used in the investment world to mean that in bull markets, all portfolios tend to rise, no matter how poorly constructed. However, when the market changes directions sharply, as it has over the last thirteen trading days, poorly constructed portfolios sink more precipitously than the overall market.

The stock market has never before plunged by 18% off of its all-time high over such a short time frame. The main driver of the decline had been, prior to this week, concern over the impact that the spreading Coronavirus will have on the US economy. On Monday, March 9, however, news of an oil trade war caused a further, more precipitous decline. But the 18% decline in the market in the last few trading days represents the broad equity markets. Investors whose portfolios are overconcentrated in individual stocks or market sectors are experiencing even worse declines. To continue the boat metaphor, some portfolios will be sunk or will crash against the rocks. Continue reading ›

SEC Issues Observations on “Cybersecurity and Resiliency”

March 3, 2020 | Steve Parker

The SEC’s Office of Compliance Inspections and Examinations and (OCIE) has issued “Cybersecurity and Resiliency Observations,” which summarizes and reflects on the risks of cybersecurity its examiners have observed in thousands of examinations of broker-dealers and investment advisers over the past eight years. Fittingly, OCIE observed that one size does not fit all when it comes to cybersecurity. The paper, however, provides detailed commentary on several segments of risks and the responses to those risks. One of those areas, governance and risk management, is an area of overall concern for most firms.

As with compliance in general, an effective cybersecurity program “starts with the right tone at the top,” according to OCIE. Other studies demonstrate that without leadership support and continuous engagement, information securities policies fail. In an effective program, the firm’s C-level executives and the board must coordinate activities of several key employees and potentially outside service providers. The initial priority should be to make an inventory of cyber risks and analyze and prioritize those risks. Essentially this must be a team exercise because expertise is required from multiple quarters and points of view. Larger firms may wish to coordinate cybersecurity policies at the enterprise level, but differences among different constituencies within the enterprise may strongly suggest that policies should be addressed at the level of the subsidiary level. Factors to consider are threats from malicious insiders, unintentional breaches through regular internal operations, risks relating to remote working and traveling, and geopolitical risks.

Courts Hear Second Constitutional Challenge to SEC Administrative Enforcement Proceedings

February 24, 2020 | Steve Parker

The ability of the Securities and Exchange Commission (SEC) to prosecute enforcement actions selectively through its own administrative proceedings is under constitutional attack in cases pending in the Fifth and Ninth Federal Judicial Circuits. The Ninth Circuit case was brought by Raymond Lucia, the same former investment adviser who succeeded in a constitutional challenge to the method of appointment of the SEC’s Administrative Law Judges (ALJs) in 2018. In that case, Lucia v. SEC, the U.S. Supreme Court held that these ALJs were “Inferior Officers” for purposes of the Constitution’s Appointments Clause, meaning that they must be appointed by either the President or the SEC itself. Prior to the decision in that case, ALJs were hired pursuant to the regular civil service process applicable to federal employees. In response to the Supreme Court’s ruling, the SEC ratified the appointment of its existing ALJs.

Lucia’s new challenge, and a similar challenge brought by accountant Michelle Cochran, are pending in the Ninth and Fifth Circuits, respectively. In those cases, the plaintiffs continue to challenge the constitutionality of the SEC administrative enforcement process. Among other things, the plaintiffs argue that the procedures in place preventing the removal of the ALJs are unconstitutional and that the administrative proceedings deprive respondents of the Seventh Amendment’s guarantee of trial by jury.

Lucia is represented by the New Civil Liberties Alliance, a nonprofit organization that, according to its website, “views the administrative state as an especially serious threat to constitutional freedoms.” It assists litigants in challenging what it considers to be unconstitutional administrative processes.

Robo-Advisers Included Among SEC Examination Priorities

January 31, 2020 | Steve Parker

In our previous post, we described the SEC’s announcement of examination priorities in 2020 for the Commission’s Office of Compliance Inspections and Examinations (OCIE). In that post, we discussed areas of examination that will apply to a large percentage of registered investment advisors and other regulated entities. In this post, we focus on another priority, namely robo-advisers.

Otherwise known as automated investment platforms, “robo-advisers” have come under increased scrutiny by OCIE. The number of these advisers has increased substantially over the last four years. OCIE intends to focus on issues such as the eligibility of the robo-adviser to register with the SEC, marketing practices engaged in by robo-advisers, the ability to comply with fiduciary duty, the adequacy of the adviser’s disclosures, the effectiveness of the adviser’s compliance program, and the firm’s cybersecurity policies, procedures and practices.

Advisers Act Rule 203A-2(e) permits “internet only advisers” to register with the SEC, provided certain conditions are met and maintained. Specifically, the adviser must provide investment advice to all clients exclusively through an interactive website and maintain records demonstrating that it does so. Under the rule, an adviser may provide investment advice through means other than the internet to up to fourteen clients during any twelve-month period. Undoubtedly there are some firms that registered on this basis who were either not eligible at the time or, through the evolution of their business, have strayed from the conditions required to remain eligible for registration.

SEC Announces 2020 Examination Priorities

January 24, 2020 | Steve Parker

Earlier this month, the SEC’s Office of Compliance Inspections and Examinations (OCIE) announced its examination priorities for 2020. Many of the priorities listed are similar to those identified in previous years’ priorities lists. The SEC’s approach in addressing them, however, continues to evolve to keep pace with the changing landscape of financial markets, market participants, products, technologies and risks. This post will address some of the areas that should be of concern to a large percentage of registered investment advisers (RIAs), broker-dealers and other regulated entities.

OCIE reiterated that a significant underpinning of any effective compliance program is the “tone at the top” set by C-level executives and owners. Those firms that prioritize compliance and effectively create a “culture of compliance” tend to be more successful in designing and implementing compliance plans than firms that view compliance as an afterthought or business hindrance. One of the “hallmarks” of a firm’s commitment to compliance is the presence of an “empowered” CCO who is routinely consulted regarding most facets of the firm’s operations. There is nothing new to these concepts, but it is worth noting that OCIE continues to emphasize them year after year. Although not stated in the priorities release, the degree to which a firm demonstrates a commitment to compliance often weighs heavily on decisions OCIE examiners must make regarding how deficiencies will be addressed by the Commission. All other things being equal, firms that have made mistakes but demonstrate the ability to make effective corrections will often be provided an opportunity to implement those corrections and are less likely to become the subject of an enforcement referral.

Not surprisingly, OCIE will continue to prioritize examining RIAs to assess compliance with their fiduciary duty to clients. For examinations of RIAs occurring during the second half of 2020, this will undoubtedly include the proper use of Form ADV Part 3, which RIAs are required to complete, file, and place into use with clients by June 30, 2020. Additionally, broker-dealers will be expected to implement compliance with new Regulation BI, requiring adherence to a best interest standard. The priorities list reiterates that advisers and broker-dealers must eliminate, or at least fully and fairly disclose, all conflicts of interest, as more fully explained in Investment Advisor Release 5248, issued in June of last year.

Among other priorities relevant to RIAs, OCIE also listed the protection of retail investors saving for retirement, information security, anti-money laundering programs and financial technology.

Supreme Court Refuses to Consider Unsuccessful Pay-To-Play Challenge

January 17, 2020 | Steve Parker

Earlier this week, the U.S. Supreme Court declined to take up a lower court ruling upholding the SEC’s authority to adopt and enforce FINRA’s Pay-to-Play rule, Rule 2030. That rule, which became effective in 2017, followed and was patterned after Rule 206(4)-5 under the Investment Advisers Act of 1940. Adopted in 2010, the Advisers Act Pay-to-Play rule prohibits investment adviser firms and certain of its executives and employees, including representatives, from providing advisory services to government clients within two years after the firm or those covered employees make contributions to elected officials relating to the client. Additionally, the rule prevents an adviser from directly or indirectly paying any third party to solicit advisory business from any government entity, with certain exceptions. Finally, the rule prevents an adviser from coordinating or soliciting contributions for certain government officials or candidates in situations where the adviser is either seeking the business of the government entity or providing advisory services.

In 2016 FINRA adopted Rule 2030, which is substantially similar to the Advisers Act rule. One of the chief motives for the adoption of the FINRA rule was to foreclose the possibility that registered representatives or FINRA member firms could circumvent the Advisers Act Rule, where the firms were dual registrants. Both rules have de minimis exceptions of $350.00 per election in contributions to any one official or candidate if the contributing associate was entitled to vote for the candidate, and $150.00 per official per election, to candidates for whom the associate is not entitled to vote. Both rules also have recordkeeping requirements.

Both the SEC and FINRA have enforced their respective rules through administrative enforcement actions.

Text and Chat Messages Key in Hiding Forex Traders Bid-Rigging Scheme

January 13, 2020 | Steve Parker

A federal court in the Southern District of New York is currently considering a motion filed last month that would overturn a jury verdict convicting a former Forex Trader at JP Morgan, Akshay Aiyer, of conspiring to rig bids in Forex transactions. The motion argues that the testimony of alleged co-conspirators Christopher Cummins of Citigroup and Jason Katz of Barclays was unreliable and false, and should not serve as a valid basis for the conviction.

Another aspect of the case that should be of interest to compliance officers of financial services firms was the role that text messages and group chats played in the trial of Mr. Aiver. During the trial in November 2019, Mr. Cummins testified that he and defendant Aiyer communicated via text message and private chat rooms in order to avoid being caught by the banks’ compliance personnel. Cummins pled guilty in 2017 but testified as a cooperating witness for the U.S. Justice Department in the case against Aiyer.

The cases against the US traders are only a part of a larger scheme involving other banks as well. In May 2017, the European Union levied fines totaling €1.7 Billion on Barclays, Citigroup, JPMorgan, Royal Bank of Scotland and Mitsubishi UFJ. The only firm not fined by the EU was UBS, who first detected and reported the fraudulent scheme. The importance of being able to monitor and detect these types of communications cannot be ignored.

SEC Proxy Guidance Questioned by Investor Groups

December 26, 2019 | Steve Parker

Following SEC guidance regarding investment advisers’ proxy voting obligations issued in August of this year, and rule changes proposed by the SEC consistent with that guidance a few weeks later, investor organizations, including the Council of Institutional Investors (CII), and Institutional Shareholder Services (ISS), have taken actions to challenge the guidance and he rule proposals.

In August, the SEC voted 3 to 2 to issue the new guidance and to include potential rule amendments in its regulatory agenda. In general terms, the SEC’s interpretations are designed to make all proxy voting recommendations by a proxy adviser a “solicitation” under the federal proxy rules and subject to the Securities Exchange Act of 1934 (the “Exchange Act”) and Rule 14a-9.

In a letter to the SEC in October, CII questioned the wisdom of the guidance and urged the SEC not to adopt proposed rule changes over concerns that both the guidance and the rules would weaken corporate oversight by investors and make it more difficult to replace or oppose existing management. CII claimed that both the guidance and the proposed rulemaking would increase costs, add regulatory burdens, increase litigation, and otherwise make it more expensive and difficult for investors to retain the benefits offered by proxy advisory firms. CII said in its letter that the guidance and proposed rule changes not driven by investor protection because there is no “call from the investment community” or regulatory intervention on the issue of proxy voting. Rather, CII contends that SEC made the announcement and proposals because of pressure from issuers who believe that proxy advisors are too often influential in successful corporate voting campaigns. The letter indicated that CII’s position was supported by the Comptroller for New York City and the CEO of the California Public Employee’s Retirement System, among other major institutional investors.

SEC Issues Clarifying Guidance on New Form CRS

December 5, 2019 | Parker MacIntyre

The SEC’s Divisions of Investment Management and Trading & Markets have issued guidance in the form of a set of Frequently Asked Questions (or “FAQs”) addressing the upcoming implementation of the newly-created SEC Form CRS Relationship Summary (“Form CRS”).

As previously profiled on this blog, Form CRS is a new SEC disclosure document that will be applicable to both RIAs and broker/dealers offering services to retail investors. Indeed, for RIAs, the new Form CRS will function as a new Part 3 to the RIA’s existing Form ADV. The purpose of Form CRS is to summarize basic information about the firm’s services, fees, and costs, as well as its conflicts of interest and material disciplinary events. As noted, Form CRS obligations only arise for firms dealing with “retail investors,” which the SEC defines as “natural persons” or their legal representatives, who seek to receive or receive services “primarily for personal, family or household purposes.” Full implementation of Form CRS is slated for June 30, 2020.

Supreme Court and Congress Weigh-in on Future of SEC Disgorgement

November 25, 2019 | Parker MacIntyre

Recent developments within two of the three branches of the federal government portend significant potential changes in the SEC’s ability to obtain disgorgement of ill-gotten gains in civil actions brought by its enforcement arm. Early in November, the U.S. Supreme Court decided to hear an appeal of a Ninth Circuit case, SEC v. Liu, involving the issue of whether the SEC has statutory authority to obtain disgorgement at all. Then, not three weeks later, the U.S. House of Representatives responded by passing H.R. 4344, a bill explicitly codifying the SEC’s authority to obtain disgorgement. While the ultimate decision of the high court remains months away, and the House’s action has no legal significance until a companion bill in the Senate is acted upon and the two bills are passed by both chambers, these developments are of great significance to securities litigators and SEC-watchers alike.

Disgorgement has long been a powerful arrow in the SEC’s enforcement quiver, allowing it to obtain, on behalf of aggrieved investors, reimbursement of ill-gotten gains. However, despite it having obtained billions of dollars in disgorgement in civil actions over the last few decades, no statute explicitly confers the SEC with authority to seek this remedy. Rather, lacking any express authority, federal judges have implied it in scores of decisions dating back to the 1970s. Now, that entire foundation has come into question, prompted first by the Supreme Court’s 2017 decision in Kokesh v. SEC, and now by the high court’s acceptance of the Liu appeal.