Welcome to the February 2019 edition of the Best of the Law
Firms. In this feature, we recommend
some of the best recent articles and analyses authored by top investment
management lawyers. These articles offer
a more comprehensive review of the issues that we address in our daily “Our
The best law firms cranked out some great articles during
the last several weeks, perhaps feeling a post-holiday burst of energy. Paul Hastings offers a great overview of the
esoteric world of Section 13 and Section 16 filings. Morgan Lewis addresses best execution issues
when recommending mutual fund share classes.
Dechert tries to discern the future of Brexit. There were also some great pieces on
co-investments from Pepper Hamilton, political and lobbying activities from
K&L Gates, and a CFTC survey from WilmerHale.
“We’ve always done it this way” is not a legitimate excuse for failing to comply with regulatory requirements. The firm engaged in the undisclosed revenue sharing for nearly 20 years before the SEC uncovered the conflict of interest. Perhaps, the firm never considered that its longstanding practice violated the securities laws. This is why we recommend retaining a fully-dedicated and experienced chief compliance officer either as a full-time employee or through a compliance services firm.
A BDC manager’s compliance failures led to nearly $4 Million in fines, disgorgement and penalties and the loss of its advisory business. The SEC charges the firm with misallocating overhead expenses to the registered Business Development Companies it managed and with overvaluing portfolio companies. The SEC maintains that the registrant used material nonpublic information about BDC portfolio companies to benefit affiliated hedge funds that it managed. In 2014, the firm had over $2.6 Billion in assets under management but withdrew its adviser registration in 2017 following the SEC enforcement action. The SEC asserts violations of the compliance rule (206(4)-7) in addition to a laundry list of other securities laws violations.
Failure to implement an effective compliance program has consequences beyond penalties and fines. The negative impact to a firm’s and its principals’ reputations could ultimately bring down the entire franchise.
OUR TAKE: We love compliance regtech as a tool to leverage compli-pros’ efforts to uncover wrongdoing. However, over-reliance on technology without professional judgment and intervention will lead to a false sense of compliance security. An automatic hammer will not build a house without the architects and the builders.
OUR TAKE: Having policies and procedures, but taking no significant action against those who violate them, eviscerates their purpose. This compliance voodoo – the mere appearance of a compliance program – will draw the ire of the regulators.
OUR TAKE: Under-resourcing compliance is a red flag for regulators and often leads to enforcement actions. Firms should spend no less than 5% of revenue on compliance infrastructure and should spend more where their activities involve several complex processes.
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.
Every year, we offer our predictions on what will happen in the investment management regulatory world. Last year, we went 4-6 (not great on a test, but pretty good in baseball). We were right about the fiduciary rule, whistleblowers, state enforcement, and individual liability. We missed on our predictions of regulatory changes and how the industry would respond to the increased demand for bonds.
The current uncertain regulatory environment has changed our hubris to humility. Thus, it is with humble intent that we look forward to offer our 2018 predictions:
Predictions for the 2018 Regulatory Year
More states will adopt fiduciary rules. Nevada has already adopted a uniform fiduciary standard in the wake of the DoL’s delay. We expect other states (e.g. California, New York, Connecticut) to follow.
The SEC will propose a uniform fiduciary rule for retail advisers and broker-dealers. Chairman Clayton has spoken publicly about the need for the SEC to wade into the fiduciary waters. Expect a proposed rule this year.
The SEC will commence significant cybersecurity enforcement actions. The staff has done a sweep and issued guidance. We have not yet seen significant enforcement actions. We expect several this year.
There will be cases alleging C-suite wrongdoing in private equity. The SEC Enforcement Division has focused on the private equity industry for the last couple of years. Given their interest in prosecuting senior executives to deter unlawful conduct, expect a couple of big cases against private equity execs.
FINRA will bring actions against firms for hiring bad brokers. Rather than simply prosecute the brokers, FINRA will dedicate some enforcement resources to firms that fail to screen out the bad brokers, thereby making it a firm responsibility.
SEC and/or FINRA will bring cases alleging inadequate branch office supervision. Both regulators have expressed concerns about remote office supervision. Enforcement cases will ensure the industry’s attention.
The SEC will commence significant marketing/advertising cases. Seemingly out-of-the-blue, the SEC warned advisers about misleading marketing and advertising claims. We are assuming that OCIE is uncovering a lot of problems.
The SEC will propose a re-write of the custody rule. The custody rule has the right intent, but the rule itself is too open to interpretation and questions (see multiple FAQs). We think the Division of Investment Management will undertake a re-write (although maybe this is just wishful thinking.)
The SEC will propose cryptocurrency regulations. Bitcoin futures are flying high. The SEC has expressed its opinion that it should regulate cryptocurrency offerings. We expect some rules.
The SEC will re-propose the ETF rule. Plain vanilla ETFs should have a rule that allows them to proceed without an exemptive order. The SEC proposed and abandoned a rule several years ago. We anticipate that the SEC will resuscitate the effort.