Compliance

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 ›

Robo-Adviser Settles Charges with SEC for Making Misleading Statements

January 25, 2019 | Elizabeth Dalziel

Demonstrating its regulatory interest in the robo adviser industry, on December 21, 2018, the Securities and Exchange Commission issued an Order Instituting Administrative and Cease-and-Desist Proceedings against Wealthfront Advisers, LLC, a registered investment adviser which uses a software-based “robo adviser” platform in servicing its clients. The action is the second case against robo advisers filed on the same day. Wealthfront submitted an offer of settlement in light of the proceeding.

According to the SEC’s Order, Wealthfront utilizes a proprietary tax loss harvesting program (“TLH”) to help its clients garner tax benefits. These tax benefits would typically come through selling assets at a loss, which could potentially be used to reduce income or gains and create a lower tax liability. From October 2012 onward, Wealthfront has featured whitepapers on its website that provide information about the TLH strategy. 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 ›

SEC Settles Charges with Robo Adviser for Making False Statements About Investment Performance

January 15, 2019 | Elizabeth Dalziel

On December 21, 2018, the Securities and Exchange Commission issued an Order Instituting Administrative and Cease-and-Desist Proceedings against Hedgeable, Inc., a registered investment adviser. Hedgeable utilizes a “robo adviser” program, which it offers to individuals, small business owners, trusts, corporations, and partnerships through both its website and social media. The SEC’s Order alleges that from about 2016 through April 2017, Hedgeable made various misleading statements in advertising and performance data. Hedgeable submitted an offer of settlement in order to resolve the proceeding.

According to the Order, Hedgeable launched a so-called “Robo-Index” to present comparisons of its performance against that of two unaffiliated robo advisers. These comparisons were featured on both Hedgeable’s website and various social media sites. The SEC found that Hedgeable’s method of preparing the Robo-Index had significant material issues. For example, the SEC found that data from 2014 and 2015 only featured data from a small pool of Hedgeable client accounts and excluded over 1,000 other client accounts. The SEC alleged that, because of the small sample sizes, the data likely reflected “survivorship bias,” stemming from the fact that the sample size likely only contained clients who received higher than average returns compared to Hedgeable’s other clients. The SEC also determined that Hedgeable’s calculation methods did not correctly estimate expected returns for a standard client of the other two robo advisers. Hedgeable allegedly produced the data in the Robo-Index using estimations of the other robo advisers’ trading models rather than using the robo advisers’ actual models. Continue reading ›

SEC Investigating Investment Advisers That Did Not Self Report Under 12b-1 Initiative

January 9, 2019 | Steve Parker

Following several enforcement actions brought against registered investment advisers that received 12b-1 fees when institutional shares were available to be purchased in clients’ advisory accounts, in February of this year the Securities and Exchange Commission announced an initiative under which firms could self-report the receipt of “avoidable” 12b-1 fees since 2014. Under the so-called Share Class Selection Disclosure Initiative (SCSDI), advisers who self-reported receiving 12b-1 fees under those circumstances would be subject to an SEC enforcement action but would receive favorable treatment in such a case. Such favorable treatment included no recommended civil penalties as long as the firm agreed to disgorge all avoidable 12b-1 fees received.

In order to participate in the SCSDI, however, firms were required to report to the SEC by June 12, 2018. In announcing the SCSDI, the SEC indicated that firms that did not self-report may be subjected to harsher sanctions if their practice was later discovered.

In recent weeks through information available through clearing firm data and public sources the SEC has identified RIAs that may have received 12b-1 fee but chose not to self-report. Some of these firms are receiving subpoenas or requests for information and testimony. Whether the failure to report was justified and/or the original receipt of the 12b-1 fees were not improper are questions that the SEC Enforcement Staff will be evaluating during its investigations. In some limited circumstance a firm might be able to justify receipt of the questioned fess, and also might be excused from or ineligible for the self-reporting initiative. Continue reading ›

South Carolina Court of Appeals Vacates Securities Commission Sanction for Lack of Due Process

December 20, 2018 | Elizabeth Dalziel

In October 2018, the South Carolina Court of Appeals vacated a $540,000 civil penalty that the South Carolina Securities Commissioner had imposed against John M. McIntyre and his company, Silver Oak Land Management, LLC. The Commissioner imposed the penalty upon a determination that McIntyre and Silver Oak Land Management had committed securities fraud in the offer, sale, and management of various limited liability company interests. The Court of Appeals, however, found that in the course of a hearing the Commissioner conducted, the Commissioner did not grant McIntyre and Silver Oak Land Management adequate procedural due process. Continue reading ›

Recent SEC Order Clarifies CCO and Other Firm Manager Liability

December 10, 2018 | Parker MacIntyre

The SEC routinely hears appeals arising from FINRA disciplinary proceedings, and in turn issues “Adjudicatory Orders” announcing its decisions. To the extent that these Orders are issued by vote of the full Commission, they stand as highly useful guidance to industry players on the thoughts of the SEC’s ultimate leadership. In a recent Adjudicatory Order, the SEC articulated its current position on Chief Compliance Officer (“CCO”) liability for securities regulatory violations, as well as the liabilities of other members of a securities firm’s senior management for failure to supervise the CCO. See Application of Thaddeus J. North for Review of Disciplinary Action Taken by FINRA, Order of the Commission, Rel. No. 34-84500 (Oct. 29, 2018).

The facts of the case involve findings by FINRA that the CCO (Mr. North) of a multi-office 50+ representative brokerage firm violated FINRA rules by failing to establish a reasonable supervisory system for the review of electronic correspondence, failing to reasonably review electronic correspondence, and failing to report a relationship with a statutorily disqualified person. Specifically, despite being the person responsible for reviewing the firm’s electronic communications, the record showed that for a roughly two-year period North completely failed to review any Bloomberg messages/chats (such messages making up 85% of the firm’s electronic communications). North testified that he “did not understand” his firm’s Smarsh e-mail retention/retrieval system, and further attributed his failure to review electronic communications to that activity being “boring.” Separately, North failed to either independently investigate or report to FINRA his knowledge of a material relationship between one of his firm’s registered representatives and a statutorily-disqualified person. This particular failure came despite North’s knowledge that the representative had paid the disqualified person over $150,000, had executed a services agreement with that person, and that FINRA was actively investigating the matter.

On these facts, the SEC upheld FINRA’s disciplinary action as “clearly appropriate” in light of North’s “egregious” conduct in “fail[ing] to make reasonable efforts to fulfill the responsibilities of his position.” Notably, “North ignored red flags and repeatedly failed to perform compliance functions for which he was directly responsible.”

Overview of State-Registered Investment Advisers and Current Regulatory Issues, Part 2

December 6, 2018 | Elizabeth Dalziel

In our previous post regarding state-registered investment advisers, we examined the landscape and discussed common deficiencies found in state adviser examinations. In this post, we will discuss enforcement actions typically aimed at state-registered investment advisers, as well as current enforcement trends such as fraud pertaining to emerging markets and protection of senior investors.

Earlier in 2018, the North American Securities Administrators Association (NASAA) published its 2018 Enforcement Report. This report contains information and statistics regarding NASAA members’ enforcement actions in 2017 and highlights current trends in enforcement actions aimed at state-registered investment advisers.

According to the Report, NASAA members received 7,998 complaints that resulted in 4,790 investigations. Once the investigations were completed, NASAA members initiated 2,105 enforcement actions, over half of which were administrative actions. Criminal actions made up the second largest number of enforcement actions, followed by civil and other types of enforcement actions. Continue reading ›

SEC Proposes Rule Changes Regarding Disclosures About Variable Annuities and Variable Life Insurance Contracts

November 15, 2018 | Elizabeth Dalziel

On October 30, 2018 the Securities and Exchange Commission announced amendments to rules and forms designed to improve disclosures made to clients regarding variable annuities and variable life insurance contracts. According to the SEC, the purpose of the proposed amendments is to assist investors in comprehending the characteristics of variable annuities and variable life insurance contracts and the risks associated with those investment products. The proposed amendments would allow financial institutions who offer variable annuities and variable life insurance contracts to give a summary prospectus to investors, which would satisfy the financial institutions’ disclosure obligations. The SEC has invited the public to comment on both the proposed amendments and the hypothetical summary prospectus samples created and included in the proposed rule. The comment period will run through February 15, 2019. Continue reading ›

FINRA Regulatory Notice Announces Commencement of 2019 Renewal Program

November 7, 2018 | Elizabeth Dalziel

On October 31, 2018 the Financial Industry Regulatory Authority published Regulatory Notice 18-37, which announces the commencement of the 2019 Renewal Program for registered investment advisers and broker-dealers. The 2019 Renewal Program is set to begin on November 12, 2018. On that day, FINRA will release Preliminary Statements to all registered firms via E-Bill. Firms are required to remit full payment of their Preliminary Statements by December 17, 2018.

The Preliminary Statements contain various fees for renewal of state registrations and notice filings. For individuals who are renewing their broker-dealer registrations, FINRA will assess a fee of $45. For investment adviser firms and their representatives who are renewing their registrations, any IARD system fees will be featured on their preliminary statements. For FINRA-registered firms that have one or more branch offices, FINRA will assess a renewal fee of $20 per branch. FINRA will, however, waive one branch renewal fee for each FINRA-registered firm.

Firms may pay their Preliminary Statement fees via E-Bill, a wire transfer, or a check. FINRA’s preferred method of payment is E-Bill. If a firm does not pay the Preliminary Statement fees by December 17, it will be charged a late renewal fee. The late fee will amount to either 10 percent of a firm’s final renewal assessment or $100, whichever is greater, but the late fee can be no more than $5,000. FINRA also warns firms that failure to pay the Preliminary Statement fees by the December 17 deadline could result in the firms becoming unable to do business in the areas where they are registered.