Home » Compliance Blog » Archives for May 2017

Month: May 2017

Mutual Fund Manager Fined and Barred from Industry for Investment, Disclosure, and Fee Violations

A fund manager was barred from the industry and ordered to pay $550,000 for multiple breaches of fiduciary duty including failure to observe the fund’s investment limitations.  According to the SEC, the respondent did not comply with the fund’s investment concentration policies, including the fund’s status as “diversified,” as described in the Registration Statement and as disclosed to the fund’s Board of Directors.   The SEC also accuses the respondent, the sole proprietor of the fund manager, with double-charging separate account clients invested in the fund.  Additionally, the SEC charges that the respondent cherry-picked trades for his personal benefit to the detriment of clients.  The SEC cites violations of the anti-fraud provisions of the Exchange Act, the Advisers Act, and the Investment Company Act.

OUR TAKE: Registered funds are highly-regulated investment vehicles that require strict adherence to the Investment Company Act, SEC rules, the Registration Statement, and the Board of Directors.  Advisers have much less flexibility with respect to disclosure and fees than separate accounts or private funds.

https://www.sec.gov/litigation/admin/2017/33-10367.pdf

The Friday List: 10 Things to Know about the DoL Fiduciary Rule

Today, we offer our “Friday List,” an occasional feature summarizing a topic significant to investment management professionals interested in regulatory issues.  Our Friday Lists are an expanded “Our Take” on a particular subject, offering our unique (and sometimes controversial) perspective on an industry topic.

Last Monday (May 22), the Department of Labor issued guidance on the implementation of the long-debated Fiduciary Rule.  Most significantly, the DoL did not further delay the basic concept that financial institutions and advisers must apply a best interest standard to advice for IRAs and other retirement accounts.  However, the DoL did back off of some of some of the compliance requirements for the rest of this year and plans to collect more information.  Below is a list of the 10 things you need to know right now about the DoL Fiduciary Rule.

 

10 Things to Know about the DoL Fiduciary Rule

 

  1. Applies to IRAs: The DoL Fiduciary Rule applies to investment advice concerning IRAs, ERISA plans, and plans covered by Section 4975 of the Tax Code.
  2. Best Interest standard starts June 9: Beginning June 9, financial institutions and advisers to covered plans must provide advice in the retirement investor’s “best interest,” which includes a duty of prudence and loyalty.
  3. BIC exemption compliance starts January 1: The extensive compliance requirements of the Best Interest Contract (BIC) exemption, which would apply to non-level fee products, are not required until January 1, 2018.
  4. DoL expects changes by January 1: During the Transition Period (June 9-January 1), the DoL will collect additional information from the industry to determine how compliance practices such as the use of mutual fund “clean shares” should re-shape the Rule.
  5. Proprietary products with commissions permitted: During the Transition Period, firms can recommend proprietary products with commissions so long as they satisfy the best interest standard.
  6. Need policies and procedures: The DoL expects firms to adopt policies and procedures necessary to ensure compliance with the best interest standard.
  7. Robo-advisers can rely on BIC exemption: Robo advisers may rely on the BIC Exemption during the Transition Period to ensure compliance with the Rule.
  8. Investment advice narrowly defined: Investment advice, for purposes of the Rule, does not include plan information or general financial, investment and retirement information.
  9. Can rely on written representations from intermediaries: The Rule does not apply if an independent fiduciary provides written representations (including negative consent) that the fiduciary is a bank, insurance company, BD, RIA, or independent fiduciary managing at least $50 Million.
  10. DoL will focus on compliance over enforcement: The DoL says it will prioritize compliance over enforcement during the Transition Period so long as firms work diligently and in good faith to comply with the Rule.

Fiduciary Rule Goes Live on June 9 without Specific Compliance Requirements

The Department of Labor has confirmed that its Fiduciary Rule will go into effect on June 9, although affected firms need not comply with all of the BIC exemption requirements until at least January 1, 2018.  In an FAQ, the DoL confirmed that financial institutions and advisers must comply with the “impartial conduct standard,” which requires a duty of prudence (professional standard of care) and loyalty (advice in the best interest of the customer).  However, firms have flexibility to determine how to ensure compliance with the best interest standard and may offer proprietary products with commissions if they ensure that they meet the impartial conduct standard and the advice is in the best interest of the customer.  Firms should “adopt such policies and procedures as they reasonably conclude are necessary.”  The DoL plans to seek additional information to determine whether to further delay full implementation or change the Rule, which applies to IRAs, ERISA plans, and IRC 4975 plans.

OUR TAKE: Can we stop now?  We actually think the current state of affairs makes the most sense i.e. require a best interest standard without specifically mandating how firms must comply.  The Investment Advisers Act takes that approach, and it has worked pretty well since 1940.

https://www.dol.gov/sites/default/files/ebsa/about-ebsa/our-activities/resource-center/faqs/coi-transition-period.pdf

Top 5 Regulatory Alerts – April 2017

Here are our Top 5 Regulatory Alerts for April 2017, ranked by significance.  We have also included the Top 5 most read Alerts (other than Best of the Web and Top 5).

 

Top 5 Regulatory Alerts – April 2017

  1. ADVISER FAILED BEST EXECUTION WHEN RECOMMENDING 12B-1 FUND CLASS (4/5/17)
  2. BROKERS CAN BLOCK DISBURSEMENTS TO SENIOR INVESTORS UNDER NEW FINRA RULE (4/3/17)
  3. ADVISER JAILED FOR FRAUD BASED ON EMAILS THAT CROSSED STATE LINES (4/17/17)
  4. SEC BARS DUAL-HATTED EXECUTIVE FOR INADEQUATE FORM ADV DISCLOSURES (4/4/17)
  5. LAWYER BARRED FOR FAILING TO CONDUCT ADEQUATE DUE DILIGENCE (4/11/17)

  

Most Read – April 2017

  1. SEC ACCUSES RISK MANAGEMENT PROFESSIONAL OF INSIDER TRADING (4/26/16)
  2. SEC BARS DUAL-HATTED EXECUTIVE FOR INADEQUATE FORM ADV DISCLOSURES (4/4/17)
  3. MASSACHUSETTS FINES LARGE BD $1 MILLION FOR SALES CONTEST (4/13/17)
  4. ADVISER JAILED FOR FRAUD BASED ON EMAILS THAT CROSSED STATE LINES (4/17/17)
  5. ADVISER FAILED BEST EXECUTION WHEN RECOMMENDING 12B-1 FUND CLASS (4/5/17)

Best of the Web – April 2017

 

“I have learned that nothing is certain except for the need to have strong risk management, a lot of cash, the willingness to invest even when the future is unclear, and great people.” (Jeffrey R. Immelt)

 

Welcome to the April 2017 BOTW.  While we await major (minor?) regulatory changes, the regulatory professionals offer guidance allowing everybody to catch up on ongoing challenges.  ACA ominously asks about your BD’s message archive, Dechert provides a guide to fund financing, and Schulte sees opportunities in registered closed-end funds.  We also like Cohen’s guidance on selling a private company and Skadden’s cybersecurity due diligence guide.  Things may look cloudy, but April showers…

 

What is Lurking in Your Broker-Dealer’s Message Archive? (ACA)

The ABCs of Fund Finance: Credit Facilities for Secondaries Funds and Funds of Funds (Dechert)

Untapped Opportunities in the Registered Alternative Closed-End Fund Space (Schulte Roth & Zabel)

The Emerging Need for Cybersecurity Diligence in M&A (Skadden)

The Sale of a Privately Held Company (Cohen)

Recent Tax Developments that May Impact the Private Equity Industry (Seward & Kissel)

Navigating Yates Memo Minefield and Broadening of Excess Side-A DIC D&O Insurance Policies (Perkins Coie)

FINRA Proposal Allows Selective Custom Performance Projections in Marketing Materials (Drinker)

Independent Sponsors in the Lower Middle Market (podcast) (Pepper Hamilton)

The SEC Sends a Stern Reminder That It Is Serious About Punishing “Spoofing” and “Layering” Schemes in the Securities Markets (K&L Gates)

Effect of the MIFID II Research Regime on US Investment Managers (Morgan Lewis)

How to Identify Inside Information – A Helpful Guideline Provided by the Italian Securities and Exchange Commission (Paul Hastings)

SEC Warns Advisers and Broker-Dealers to Protect against Ransomware

 

The SEC’s Office of Compliance Inspections and Examinations (OCIE) issued a Risk Alert about recent ransomware attacks and offered some best practices for smaller firms for dealing with ransomware incidents.  Based on a recent review of 75 registrants, the OCIE staff recommends that firms perform a cyber-risk assessment, conduct penetration and vulnerability tests, and ensure software maintenance including adequate software patches.  The OCIE staff stressed the importance of developing a “rapid response capability.”  OCIE found widespread deficiencies among advisers during its review: 57% did not conduct penetration and vulnerability testing and 26% did not conduct periodic risk assessments of critical systems.

OUR TAKE: Cybersecurity has become one of the most significant compliance issues facing investment management firms.  CCOs and their bosses must take action to address outside threats.  We recommend reviewing the SEC’s 2014 guidance.

https://www.sec.gov/files/risk-alert-cybersecurity-ransomware-alert.pdf

CMBS Trader Lied to Clients about Pricing

 

The SEC fined and barred an investment bank’s head CMBS trader for lying to customers about pricing, spreads, and compensation over a 2-year period.  According to the SEC, the defendant oftentimes used elaborate stories and doctored documents to support his untrue statements.  The SEC asserts that clients relied on the incorrect information when making purchase/sale decisions.  The SEC maintains that the respondent knowingly ignored compliance policies requiring truthfulness in dealings with customers.   The defendant benefitted through higher discretionary bonuses resulting from his illicit activities, thereby making him directly liable for securities fraud.

OUR TAKE: It is noteworthy that the SEC took action against the trader himself rather than his firm, which presumably avoided liability because it had implemented adequate policies and procedures.  SEC Commissioner Piwowar has previously indicated that the SEC should pursue individuals rather than firms.

http://www.sec.gov/litigation/complaints/2017/comp-pr2017-102-chan.pdf

Wrap Sponsor Pays $97 Million for Inadequate Due Diligence

A large bank agreed to pay $97 Million, including a $30 Million fine, for compliance failures in its wrap programs.  The bank represented in marketing materials and Form ADV that it performed significant initial and ongoing manager due diligence.  However, according to the SEC, during a 5-year period from 2010 to 2015 (when it sold its wrap business), the respondent failed to perform such due diligence on several programs and managers because of a lack of internal resources and miscommunications between functions, even though the bank continued to charge significant account level fees to provide such services.  The respondent was also charged with overbilling clients as well as using more expensive mutual fund share classes when lower-fee classes were available.  As part of the settlement, the bank agreed to pay $3.5 Million in customer remediation and $49.7 Million in fee disgorgement in addition to interest and the fine.

OUR TAKE:  Over the last 2 years, the SEC has warned about wrap programs (See e.g. SEC 2017 Exam Priorities Letter) and has brought several cases against wrap sponsors alleging a number of violations: trading away, reverse churning, revenue sharing, mutual fund share classes.  In this case, the SEC adds a requirement that the fees charged must be commensurate with the due diligence services provided.  This analysis appears borrowed from mutual funds where Boards must ensure the reasonability of fees charged.  We recommend that compli-pros perform an internal sweep of wrap practices before the SEC shows up at the front door.

https://www.sec.gov/litigation/admin/2017/33-10355.pdf

FINRA Posts Social Media and Digital Content Guidance

FINRA has published a Regulatory Notice that provides guidance on the content, recordkeeping, and supervision of certain digital communications.  FINRA clarifies that text and chat messages with clients must be retained as customer communications to the same extent as written or email communications.  FINRA also offers guidance on when broker-dealers adopt or become entangled when using hyperlinks and other third party content.  Sharing content through hyperlink will make a firm responsible for the third party content unless the third party site is dynamic, ongoing, and not influenced by the firm.  However, a firm may not use a link to a third party that the “firm knows or has reason to know contains false or misleading content.”  FINRA also offers guidance on the use of native advertising, mandating that such content disclose the firm’s name, any relationship, and whether mentioned products or services are offered by the firm.  FINRA will allow unsolicited third party opinions posted on social media sites (e.g. “likes” on Facebook) so long as a registered representative does not subsequently endorse the third party opinion.  FINRA makes clear that the guidance does not change prior rules and does not interpret SEC rules that apply to advisers.

OUR TAKE: Give FINRA credit for its ongoing regulatory guidance that reflects evolving social media and digital content.  The guidance on texts, chats and hyperlinks are fairly reasonable.  The challenge for compliance officers is to find emerging technologies and systems to capture the emerging content.

https://www.finra.org/sites/default/files/notice_doc_file_ref/Regulatory-Notice-17-18.pdf