The SEC upheld sanctions against a broker-dealer because the concurring partner’s daughter served as the subjects’ financial operations principal, thereby violating independence requirements. The auditing firm, a solo practice, hired an independent contractor to serve as Engagement Quality Reviewer (EQR) with respect to 14 audits of 7 broker-dealers over a 2-year period. Although the firm knew that the EQR’s daughter served as FINOP of the broker-dealers, the SEC opines that the respondents acted at least recklessly by failing to understand that the relationship violated independence rules. The SEC faulted the respondents for failing to consult either the regulators or private advisors. The SEC also rejected the argument that the financial statements complied with applicable rules, because the failure to ensure independence is itself a violation of accounting rules. The SEC notes the close relationship between the EQR and his daughter, who learned the business from her father and assumed several FINOP engagements following her father’s withdrawal due to FINRA sanctions.
Accounting firms cannot provide FINOP services for the broker-dealer clients for whom they also provide auditing services. In case there was any doubt, this case makes clear that the EQR is part of the engagement team, and a close familial relationship with the FINOP violates independence.
The SEC fined and censured a non-traded REIT sponsor for acting as an unregistered broker-dealer and using unlawful marketing tactics. The fund sponsor, bypassing the use of a registered broker-dealer, marketed the REITS on its website, through social media, and on the radio and collected 3% of the offering proceeds. The sponsor also used radio endorsement adds to market the REITs and subsidized an investor relations team to follow up with interested investors. The SEC asserts that the sponsor violated Section 15(a) of the Exchange Act by operating as a broker-dealer without registration. The SEC also charges the firm with using marketing materials that did not comply with the Securities Act’s prospectus requirements.
Now, what? Will the SEC, in conjunction with the industry, offer some solutions to these difficult questions? Or, will the regulator continue to push the crypto-industry to the Wild West corners of the securities markets including offshore jurisdictions and private networks?
Let’s rename this “The Compliance Officer Full Employment Act.” Compli-pros at broker-dealers will have to rework all of their Written Supervisory Procedures, revise client agreements, create disclosures, and eliminate all prohibited conflicts. Compliance offices at investment advisers must address the new Form CRS requirement and implement new client onboarding procedures while figuring out the changes required by the investment adviser fiduciary interpretation. And, we only have 12 months to get this all done.
Fund managers that engage in selling efforts must register as broker-dealers unless they can take advantage of the issuer exemption (Rule 3a4-1), which prohibits the receipt of specific transaction-based compensation.
The only controversy here is whether performance information should need to comply with Rule 482. To keep performance information consistent probably makes life simpler for investors, broker-dealers, and the staff at the SEC and FINRA. Regardless, we still believe that the SEC should take a fresh look at Rule 482 given the proliferation of investment products beyond open end funds investing in publicly-traded securities.
The new disclosure rules will add transparency to how broker-dealers assess and choose alternative trading venues and ensure institutional customers have information about fees, rebates, and payments for order flow.
Firms such as banks and consultants should take notice that the SEC and/or FINRA will take action for failure to preserve required records. Consult your compli-pro to ascertain the records required by Rules 17a-3 and 17a-4.
The CCO should review the compliance manual or WSPs and ensure s/he understands and undertakes all designated responsibilities. If the CCO can’t or won’t follow the procedures, then s/he must revise the procedures to satisfy regulatory requirements while reflecting the firm’s accurate allocation of authority.
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.