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BDs Must Implement Beneficial Ownership Due Diligence by May

Pursuant to recent FINRA guidance, broker-dealers will have until May 11, 2018 to amend their Anti-Money Laundering programs to include risk-based procedures for conducting ongoing customer due diligence as required FinCEN’s Customer Due Diligence Rule.  Most significantly, BDs must identify the beneficial owner of each account and implement risk-based procedures for verifying customer identities.  FINRA and FinCEN will allow firms to obtain such information by using FinCEN’s standard certification form.  FINRA calls this beneficial ownership requirement the “fifth pillar” of a required AML program, which must also include reasonable policies and procedures, independent testing, a designated AML officer, and ongoing training.

OUR TAKE: Next May might seem like a long way off, but the work required to implement this fifth pillar will be significant.  We recommend following FINRA’s guidance and using the FinCEN form as a starting point.


Underwriter Failed to Conduct Due Diligence

A municipal underwriter was fined and censured, and its principal was suspended from the industry, for failing to conduct adequate due diligence.  The public disclosure documents for the bond offerings at issue made misrepresentations about compliance with Continuing Disclosure Agreements.  The SEC faults the underwriter for failing to conduct due diligence to determine the (in)accuracy of those misrepresentations, including its failure to check the Electronic Municipal Market Access website maintained by the MSRB.  As a result, the underwriter violated several provisions of the securities laws by failing “to form a reasonable basis for believing in the truthfulness of the [issuer’s] assertions that [it] had complied with its prior CDAs.”

OUR TAKE: Market participants have an affirmative obligation to conduct due diligence on issuers and their disclosure statements.  This obligation applies to underwriters, administrators, lawyers, consultants, and auditors, who, since the Madoff scandal, have found themselves in the regulatory cross-hairs as market watchdogs.


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.