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The BD/IA Regulator

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

SEC Approves NSCC and NYSE T+2 Rule Proposals

Posted in Broker-Dealer Regulation

On January 4, 2017, the SEC approved the National Securities Clearing Corporation’s (“NSCC”) proposed rule change to conform to the SEC’s proposed Rule 15c6–1(a) amendment and accommodate a second business day after the trade date (“T+2”) settlement cycle.  The NSCC’s rule change consists of amendments to NSCC’s Rules & Procedures (‘‘Rules’’) in order to ensure that the Rules are consistent with the anticipated industry-wide move to a shorter standard settlement cycle for certain securities from the third business day after the trade date (‘‘T+3’’) to T+2.  According to the release, the technical rule changes will help support the NSCC’s prompt and accurate clearance and settlement of securities transactions made by its members.  The NSCC will not implement the T+2 change until it files a subsequent proposed rule change to establish an effective date.

Also on January 4, 2017, the SEC approved the NYSE Arca, Inc.’s (“NYSE”) proposed rule change to accommodate a T+2 settlement cycle and conform to the SEC’s proposed Rule 15c6–1(a) amendment.  While approved, the T+3 rule will remain in effect until the NYSE announces the operative date in an Information Memo, which is expected to coincide with the SEC’s compliance date of the proposed amendment to Rule 15c6–1(a).

The SEC noted that it received no comment letters for either of the NSCC’s or the NYSE’s rule change proposals.

For additional discussions of the proposed T+2 changes, see our previous articles, here (FINRA), here (NYSE), here (SEC Rule 15c6-1(a)) and here (Structured Notes).

Uncertain Seas: European Financial and Regulatory Developments into 2017

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

“There are greater storms in politics than you will ever find at sea. Piracy, broadsides, blood on the decks. You will find them all in politics.”  —David Lloyd George, British Prime Minister, 1916-1922

“The greater the difficulty the more glory in surmounting it. Skillful pilots gain their reputation from storms and tempests” —Epictetus

Lloyd George and Epictetus may be long gone but their words have much resonance with the events of 2016. The political fallout from the UK’s vote to leave the European Union (“EU”) was immediate and brutal and Lloyd George’s words above could have been written for the events in the UK in the aftermath of the vote. Prime Minister David Cameron resigned immediately and Theresa May became the new UK Prime Minister after a short and dramatic Conservative Party leadership election contest.  The new UK government has had to plot a course for the UK to negotiate its exit from the EU, regarded by many commentators as likely to be one of the most complex political and trade negotiations ever attempted. And this in a continuing febrile political environment with many Brexit supporters suspicious that the UK government will strike a deal with the EU that will neuter the effect of Brexit, many businesses and financial institutions concerned that a “hard” Brexit could result in a swift loss of access to the EU single market and many EU politicians keen that a hard line should be taken against the UK in negotiations to deter other member states from leaving.

As if that wasn’t enough, the election in November of Donald Trump to the Presidency of the United States shocked not only the political establishment in the US but almost the entire world. Again, despite some initial jitters, financial markets have remained relatively stable in the aftermath of his election but considerable uncertainty surrounds the direction of the new administration with President-elect Trump having made inconsistent statements on the stump, at times espousing protectionist views on trade whilst calling for less financial regulation and greater fiscal stimulus. We should have more clarity on some of these issues in the coming months.

Despite the uncertainty caused by the events of 2016, we expect the implementation of the new post-financial global regulatory framework to continue. However, the direction of travel is perhaps now more uncertain than it has been for a while. In the article in the following link, we highlight the principal areas of financial regulation and other important events impacting on financial regulation in the EU that have impacted markets over the recent past, as well as how we see these areas developing in 2017 and beyond.

To access a copy, click here.

OCIE 2017 Exam Priorities: Focus on Retail, Elderly and Retirement Investors; Market Risks

Posted in Broker-Dealer Regulation, Investment Adviser Regulation

The SEC’s National Examination Program (NEA) of the Office of Compliance Inspections and Examinations (OCIE) announced that its examination priorities in 2017 will focus on three general areas: retail investors, risks specific to elderly investors and retirement investing, and assessing market-wide risks.

Read our client alert.

FINRA Issues 2017 Examination Priorities Letter

Posted in Broker-Dealer Regulation, FINRA Enforcement


Consistent with prior practice, with the arrival of the new year, FINRA has published its key examination priorities.  The letter may be found at the following link: http://www.finra.org/sites/default/files/2017-regulatory-and-examination-priorities-letter.pdf.

As in prior years, the letter covers a broad array of topics.  This year’s topics include:

  • Hiring and monitoring the activities of “high-risk and recidivist brokers;”
  • Sales practices, including protecting seniors, evaluating firm practices relating to reasonable-basis and customer-specific suitability, and monitoring product concentration;
  • Excessive and short-term trading of long-term products, such as mutual funds and closed-end funds;
  • Operational risks, including cybersecurity, supervisory controls testing, consumer protection and segregation of client assets, and anti-money laundering and suspicious activity monitoring; and
  • Market integrity issues, including best execution and trading examinations.

Of course, each member firm should read the letter carefully and assess the identified priorities in the context of its own business and business plans.  Below, we discuss a number of areas that may be of particular interest to a number of market participants and clients, including some specific items that FINRA raises in its letter.

New:  Off-Site Reviews

In the letter, FINRA indicates that in 2017 it will begin conducting electronic off-site reviews that will supplement its traditional on-site examinations.  The off-site reviews are designed to enable FINRA to review selected areas discussed in the letter, without a visit.  These off-site reviews will be conducted only as to a limited number of broker-dealers that are not scheduled for a 2017 cycle exam.  We would expect that this process will help leverage FINRA’s ability to understand market practices as to key issues.

High-Risk and Recidivist Brokers

Consistent with its recent inquiries regarding firm culture and hiring practices, FINRA will focus on the hiring and monitoring of “high-risk and recidivist brokers.”  For example, FINRA will explore the implementation of supervisory and compliance controls for such individuals.  The letter indicates that FINRA will, among other things, review whether a firm or a third-party agent reviews available public records to verify the accuracy of the relevant individuals’ form filings.

Sales Practices

  • Senior Investors:  FINRA continues to take a strong interest in protecting senior investors.  FINRA’s concern arises from its ongoing observations that brokers have continued to recommend unsuitable products to senior investors, including complex or novel exchange-traded products, structured products, leveraged and inverse exchange-traded funds, non-traded REITs, and unlisted BDCs.  FINRA reminded firms of a variety of tools that can be used to help protect elderly clients from exploitation under questionable circumstances, including contacting the investor about orders placed through an on-line brokerage account, or about instructions to transfer funds to persons who may be linked to an issuer.
  • Suitability:  FINRA remains concerned that brokers are recommending unsuitable complex products to customers.  Accordingly, examinations will assess how firms discharge their reasonable basis and customer specific suitability obligations. The letter notes:
    “…we will assess how firms conduct reasonable-basis and customer-specific suitability reviews.  This may include examining firms’ product vetting processes, supervisory systems and controls to review recommendations.  Firms should be attentive to the adequacy of their supervision and training when new products come to market, new features of existing products are introduced or market conditions change in ways that could affect product performance.  Firms that hire registered representatives who sell products with which the firm is not familiar should educate themselves on the products and then carefully evaluate their ability to supervise recommendations.  Training should ensure that registered representatives, compliance and supervisory staff understand the objectives, risks and pricing factors of the products sold, including any changes in the features of those products.”

FINRA will also focus on the controls that brokers use to monitor recommendations that could result in excess concentration in client accounts.

Social Media

FINRA will review firms’ compliance with their supervisory and record-retention obligations with respect to social media and other electronic communications.

Excessive and Short-term Trading of Long-Term Products

FINRA will evaluate firms’ ability to monitor the short-term trading of long-term products.  FINRA’s concern is that registered representatives may recommend that clients trade long-term products, including mutual funds, closed-end funds and UITs, on a short-term basis, resulting in increased costs to investors or other adverse results.  This review follows on the heels of FINRA’s September 2016 targeted exam relating to rollovers.   FINRA believes that some registered representatives are using early UIT rollovers to increase their sales credits to the detriment of clients.

In addition, FINRA urges firms to evaluate whether their supervisory systems can detect activity intended to evade automated surveillance for excessive switching activity.  For example, FINRA believes that some registered representatives may be switching customers across products to evade surveillance that focuses on switching within the same product class.

Regulation SHO

FINRA indicates that it will continue to assess firms’ compliance with SEC Regulation SHO.  The letter notes:

“In light of recent SEC enforcement actions, FINRA will focus on the locate process to ensure firms have reasonable grounds to believe securities are available for borrowing prior to accepting a short sale.  FINRA will assess firms’ preparation and use of the easy-to-borrow list as well as evaluate the adequacy of firms’ automated locate models.  FINRA has observed fails-to-deliver on settlement date, when locates are granted without the requisite reasonable grounds to believe that the security could be borrowed. Firms should continue to monitor their close-out processes and ensure that they appropriately close out fails-to-deliver by the designated close-out date pursuant to Rule 204 of Regulation SHO.”

Our Take

As is usually the case, FINRA’s letter is useful because it highlights what broker-dealers should expect from FINRA this year, and it offers practical examples. This year’s letter is noteworthy for its focus on objective criteria and factual processes, which should help broker-dealers prepare an appropriate course of action.

A Case of Appendicitis: SEC Staff Guidance on Sales Load Variation Disclosures Sends Funds Scrambling

Posted in Fund Regulation

A recent Guidance Update published by the SEC’s Division of Investment Management has sent funds scrambling to beef up prospectus disclosures to accommodate changes to fees charged by financial intermediaries before the Department of Labor’s “conflicts of interest” rule kicks in on April 10, 2017.

Read our client alert.

Unfinished Business: SEC Chair White Reveals New Rules Ready to Go

Posted in Broker-Dealer Regulation, Fund Regulation

In a letter dated December 12, 2016, to the Chair of the Senate Committee on Banking Housing and Urban Affairs, SEC Chair Mary Jo White took issue with a request to defer consideration of new rulemaking during the post-election period.  Citing the SEC’s Canons of Ethics, the outgoing Chair reminded the Senate that it must act independently in performing its duties, “without fear or favor.”

The letter is noteworthy because it reveals new rules that “are ready for Commission consideration,” including, among others rules concerning:

  • investment company use of derivatives (Rule 18f-4)
  • web transmission of shareholder reports (Rule 30e-3)
  • capital, margin and segregation requirements for security-based swap dealers and major security-based swap participants
  • recordkeeping rules and notification requirements for security-based swap dealers and major security-based swap participants
  • orderly liquidation of certain broker-dealers
  • proposed disclosure rules for bank holding companies

None of these initiatives come as a surprise because Chair White has listed them as part of a long-standing agenda.  The letter, however, serves as a useful reminder that the SEC is duty-bound to act independently and resist political pressure from any source.  Chair White noted that, historically, the SEC has enacted important rules during comparable post-election periods.  The SEC, she said, should not “deviate from its historical practice of independently carrying out its duties.”

Our take

With each passing day, the likelihood that Chair White will achieve the regulatory initiatives on her long-standing agenda fades.  Chair White’s inability to complete her long-standing agenda due to political pressure should be a wake-up call to Congress that it should respect the SEC’s independence, not impede it.

Former New York Pension Official and Two Broker-Dealers Charged In Pay-To-Play Scheme

Posted in SEC Enforcement

On December 21, 2016, the SEC charged the former Director of Fixed Income for the New York State Common Retirement Fund (the “NYSCRF”) with allegedly steering billions of dollars of NYSCRF assets to two broker-dealers in exchange for hotel room stays, restaurant outings, jewelry, concert tickets and vacations.  In total, according to the SEC, the former Director allegedly received $180,000 in undisclosed gifts.  The SEC alleged violations of Section 10(b) of the 1934 Act and Rule 10b-5 thereunder and Section 17(a) of the 1933 Act.  While differing from one another in certain respects, both Sections encompass anti-fraud provisions.  The two broker-dealers are also charged in the same action.

According to the complaint, the former Director had investment responsibility for approximately $50 billion of NYSCRF assets.  The NYSCRF is the third-largest public pension fund in the United States, and as of March 31, 2016, had approximately $178 billion in assets held in trust for pension benefits.

At the time the former Director arrived at the NYSCRF, according to the complaint, neither broker-dealer was executing trades on behalf of the NYSCRF.  However, the SEC alleged that, within three months, trade- execution business with both broker-dealers increased significantly.  The SEC alleged that by the end of the 2016 fiscal year, $2.38 billion and $1 billion in fixed-income trades were executed by the two broker-dealers, respectively.  The increase in business (and the associated brokerage commissions), according to the SEC, coincided with the lavish gifts allegedly given to the former Director.

For background on the application of pay-to-play to investment advisers, see our earlier post.