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The BD/IA Regulator

Providing securities regulatory, enforcement and litigation trends for broker-dealers, investment advisers and investment funds

Are Your Customer Accounts in Order? SEC Announces Sweep of Broker-Dealers and Implementation of the Customer Protection Rule Initiative

Posted in Broker-Dealer Regulation, SEC Enforcement

On June 23, 2016, the Securities and Exchange Commission (the “SEC”) announced that it would begin a coordinated effort across divisions to identify potential violations by broker-dealers of Rule 15c3-3 (the “Rule”) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). As part of this effort, also known as the Customer Protection Rule Initiative (the “CPR Initiative”), the SEC will conduct a targeted sweep of broker-dealers and encourage firms to self-report any potential violations of the Rule. The CPR Initiative is intended to address historical or ongoing violations of Section 15(c)(3) of the Exchange Act and the Rule. The CPR Initiative covers only broker-dealers and provides no assurance that individuals associated with those entities will be offered similar terms if they have engaged in violations of the federal securities laws. The SEC may also recommend an enforcement action against such individuals beyond those available under the CPR Initiative. The SEC, however, did not specify for how long the CPR Initiative would run.

Read our client alert.

Double-Check the Math: Advisers Should Not Provide Clients With Performance Data Created by Other Investment Managers Without Verifying the Information

Posted in Investment Adviser Regulation, SEC Enforcement

In a series of enforcement actions this week, the SEC made it clear that investment advisers need to substantiate the performance records of investment management firms they recommend to their clients.  In these cases, failure to do so resulted in charges of spreading “false and misleading information” in violation of Section 206 of the Advisers Act.

Although presumably it is not necessary to recalculate performance data, the SEC staff said that when “an investment adviser echoes another firm’s performance claims in its own advertisements, it must verify the information first rather than merely accept it as fact.”

The SEC found in each case that the investment adviser negligently relied on performance information related to a separately managed account strategy managed by a third-party adviser.  The advisers forwarded performance advertisements created by the third-party investment adviser without appropriately confirming the accuracy of the information in those advertisements.  As a result, the SEC said, the advisers “failed to have a reasonable basis to believe that [the] performance was accurate,” and they therefore distributed false and misleading advertisements to their clients in violation of Section 206(4) of the Advisers Act.

The advisers were also cited for failure to maintain books and records necessary to validate the performance claims.

Advisers are on notice, with these actions, that they cannot take performance claims of underlying advisers at face value.  If performance is too good to be true, it just might be . . . too good to be true.  The obligation for making sure that clients have full, fair and accurate information upon which to make investment decisions rests squarely with the adviser that has the client relationship.  Reliance on information provided by others is, without verification, apparently not reasonable.  Advisers should institute due diligence protocols to ensure that they are asking the right questions – and getting the right back-up – when it comes to performance data created by another entity.

Penalties assessed against 13 registered investment advisers caught up in the enforcement sweep ranged from $100,000 to $500,000.  All 13 firms settled without admitting or denying the charges.

CFTC Proposal to Amend CPO Reporting Rules

Posted in Enforcement

The Commodity Futures Trading Commission (“CFTC”) on August 5, 2016, issued a proposal to amend its rules governing commodity pool annual reports, which, if adopted, would permit commodity pool operators (“CPOs”) of a pool located outside the United States to use accounting standards established in certain enumerated non-U.S. jurisdictions in lieu of U.S. Generally Accepted Accounting Principles (“GAAP”) when preparing the pool’s financial statements.

The proposal would also exempt a newly formed commodity pool from the audit requirement covering the first fiscal year when the period from pool formation to the fiscal year end is three months or less, under certain conditions. A conforming amendment would be made making the relief from the auditing requirement for pools that cease operations unavailable where such an exemption has been claimed. The proposal, which generally would codify no-action relief previously granted by CFTC staff, is open to public comment until September 6, 2016, and is available here.

The proposal would expand the conditional exemption in CFTC Reg. 4.22(d)(2) from using U.S. GAAP in preparing a non-U.S. pool’s financial statements, which currently applies to the International Financial Reporting Standards (“IFRS”), to accounting standards or practices followed in the United Kingdom, Ireland, Luxembourg and Canada, provided that the jurisdiction under whose laws the pool was organized follows such standards or practices. Currently, Reg. 4.22(d)(2) is not self-executing and requires the CPO to file a notice with the National Futures Association (“NFA”), which would remain the case under the proposal.

The proposal would also amend CFTC Reg. 4.22(g)(2) to exempt from the audit requirement applicable to the Annual Report for a commodity pool’s first fiscal year when the period from pool formation to the end of the pool’s first fiscal year is three months or less. In these circumstances, the cost of an audit for the short period of time of the pool’s operation would be unduly burdensome relative to the pool’s size. To rely upon the exemption, the pool would have to have no more than 15 participants and no more than $1.5 million in capital contributions during the period from the formation of the pool to the end of the pool’s first fiscal year. For this purpose, the following persons and their capital contributions would not be counted: (i) the pool’s CPO, its commodity trading advisor, and any of their principals; (ii) a child, sibling, or parent of the participants described in (i); (iii) the spouse of any of the participants described in (i) or (ii); (iv) any relative of one of the participants described in (i) through (iii); and (v) an entity that is wholly owned by one or more of the participants described in (i) through (iv).

To rely on the exemption, a CPO would be required to obtain, prior to the date on which the annual report for the first fiscal year is due, a specified written waiver from each pool participant of the right to receive an audited annual report and include a specified legend on an unaudited annual report and the pool’s first audited annual report. The pool’s first audited annual report would be required to cover the period from the formation of the pool to the end of the pool’s first 12-month fiscal year. In addition, the CPO would be required to file a notice with the NFA along with a certification that the CPO had received the specified written waiver from each of the pool’s participants.

Finally, the proposal would make a conforming amendment to CFTC Reg. 4.22(c) making exemptive relief from the annual report audit requirement under that regulation unavailable for pools that cease operation when a CPO has not previously distributed an audited annual report or filed an audited annual report with NFA, such as the case where the CPO has claimed relief under proposed CFTC Reg. 4.22(g)(2), and the pool ceases operations before the end of its first 12-month fiscal year.

Codification of the relief provided in the proposal, which previously had been granted on a case-by-case basis through no-action letters, would appear to be a common-sense measure to provide such relief on a generalized basis.

Investment Management Legal + Regulatory Update – August 2016

Posted in Broker-Dealer Regulation, Fund Regulation, Investment Adviser Regulation, SEC Enforcement

This issue of Investment Management Legal + Regulatory Update discusses several current developments, including:

  • Next on the SEC’s Regulatory Agenda: A Chief Valuation Officer?
  • FinCEN Finalizes Customer Due Diligence Rule for Legal Entity Customers
  • SEC Proposes Business Continuity and Transition Rules for Advisers While Staff Publishes Similar Guidance for Funds
  • The Metaphysics of Systemic Risk
  • SEC Chair White to FSOC: We’re On It
  • SEC Eases Regulatory Burden for Listing Actively Managed ETFs
  • SEC Staff Throws Funds a Lifeline on Auditor Independence (For Now)
  • FINRA Study: Investors Lack Financial Literacy
  • FINRA Proposes Initial Round of Amendments to Communications Rules
  • Spotlight on BDCs
  • OCIE Launches Share Class Initiative
  • And more…

To read the full newsletter, click here.

FINRA Announces Sweep of Broker-Dealers that Sell Non-Traded BDCs

Posted in Broker-Dealer Regulation, FINRA Enforcement

In a notice published on its website on August 4, 2016, FINRA announced that it is conducting an inquiry with respect to non-traded business development companies (BDCs).  FINRA asked that the member broker-dealers send the following documents and information by September 9, 2016:

  • A list of each BDC offered by the member firm with information about the firm’s role (dealer-manager, lead dealer, etc.);
  • For each BDC offered, a list of all participating firms that have a selling agreement with the firm with respect to each registration statement and copies of form selling agreements;
  • A spreadsheet listing all members that sold the BDCs to its customer with information about the scope of the offering; and
  • A copy of the member firm’s due diligence procedures and, if not already included, a description of those procedures that the firm conducts for the BDC initially and on an ongoing basis, together with a description of the due diligence procedures that the firm conducts with other firms with which it has a selling agreement.

The request covers the period from January 1, 2015 through June 30, 2016.

Our take

FINRA’s terse announcement may reflect a concern that non-traded BDCs are attracting more retail investors.  Although FINRA did not indicate why it is requesting this information, the notice suggests that FINRA is looking more closely into the market for non-traded BDCs.  We expect to see more from FINRA on this topic.

CFTC Proposed Registration Relief for Non-U.S. Futures Commission Merchants, Commodity Pool Operators, Commodity Trading Advisors and Introducing Brokers

Posted in Investment Adviser Regulation

On July 27, 2016, the U.S. Commodity Futures Trading Commission (“CFTC”) proposed amendments to its rules (“Proposed Rules”) that loosen the conditions for exemption from registration as a futures commission merchant (“FCM”), commodity pool operator (“CPO”), commodity trading advisor (“CTA”) and introducing broker (“IB”) for non-U.S. persons who act solely on behalf of persons located outside the United States, or on behalf of certain international financial institutions (“IFIs”), in connection with commodity interest transactions (including swaps).  The Proposed Rules essentially would codify and expand previously issued staff no-action relief.  They are subject to a 30-day comment period, which closes on September 6, 2016. The Proposed Rules are available here.

CFTC Regulations 3.10(c)(2)(i) and 3.10(c)(3)(i) currently provide an exemption from FCM, IB, CPO or CTA registration with respect to commodity interest transactions (including swaps) executed bilaterally or made on or subject to the rules of a designated contract market (“DCM”) or swap execution facility (“SEF”), if:

  • The FCM, IB, CPO or CTA is located outside the United States;
  • The FCM, IB, CPO or CTA acts only on behalf of persons located outside the United States; and
  • The commodity interest transaction is submitted for clearing through a registered FCM.

The last condition means that bilaterally executed swaps or swaps executed on a SEF would have to be cleared in order for an FCM, IB, CPO or CTA to rely on the exemption from registration, even if the swap was not required to be cleared under CFTC rules.

In response to a request for relief, the CFTC staff issued a no-action letter earlier this year that clarified that non-U.S. IBs, CPOs or CTAs are not subject to the clearing requirement condition contained in the registration exemption if the swap is not required to be cleared.  A similar no-action letter was provided for relief from registration as an IB or CTA for non-U.S. intermediaries acting for International Financial Institutions (“IFIs”), such as the International Monetary Fund, that may have headquarters or significant presence in the United States, but, because of their unique attributes and multinational status, the CFTC staff believed that relief was warranted.

The Proposed Rules will remove the clearing requirement from CFTC Regulations 3.10(c)(2)(i) and 3.10(c)(3)(i) (and remove the references to bilateral execution, DCMs and SEFs), which will allow a non-U.S. person to be eligible for a registration exemption as an FCM, IB, CPO or CTA if, in connection with commodity interest transactions, the non-U.S. person acts solely on behalf of persons located outside the United States or on behalf of an IFI.  For this purpose, the Proposed Rules would add a definition of IFI to include certain enumerated institutions as well as any the CFTC may designate.  The Proposed Rules make clear that the registration exemption does not absolve any person from compliance with the Commodity Exchange Act or CFTC Rules, including any applicable clearing requirement for futures or swaps that the CFTC has determined are required to be cleared.

If adopted, the Proposed Rules will provide welcome registration relief for non-U.S. asset managers and other intermediaries who effectuate transactions in U.S. derivatives markets (including bilaterally executed swaps) acting in the capacity of FCMs, IBs, CPOs or CTAs solely on behalf of persons located outside the United States.

Update on Regulatory and Legal Issues Affecting European Structured Products Issuances

Posted in Events

Thursday, August 18, 2016
Registration/Breakfast: 8:00 a.m. EDT
Seminar: 8:30 a.m. – 9:30 a.m. EDT

Morrison & Foerster LLP
250 West 55th Street
New York, NY 10019

This presentation will give an update of legal and regulatory issues that are currently of particular significance in relation to structured products issuances in Europe including:

  • Impact of Brexit on structured products issuances in the UK/EU;
  • Update on the PRIIPs Regulation and the new KID requirement due to come into effect from the beginning of 2017;
  • The new EU Benchmark Regulation due to come into effect from the beginning of 2018;
  • Update on MiFID II which is now due to come into effect from the beginning of 2018; and
  • Impact of Capital Markets Union and proposed new Prospectus Regulation.


For more information, or to register, please click here.

CLE credit is pending for New York and California.