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The BD/IA Regulator

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

SEC Staff Provides Guidance to Clarify Application of Rule Requiring Reporting of Personal Securities Transactions by Investment Adviser Personnel

Posted in Investment Adviser Regulation, SEC Enforcement

In a June 2015 Guidance Update, the staff of the Division of Investment Management clarified how the code of ethics reporting rules apply to investment advisers.

Current rules require certain advisory personnel who have access to non-public information regarding securities transactions to report their personal securities transactions to their firms, so that advisers and SEC examiners can identify improper trades or patterns of trading.  The guidance clarifies which types of accounts may take advantage of a regulatory exception to that reporting obligation.

The staff apparently was prompted to issue the guidance based upon its concern that certain advisers have tried to take advantage of the reporting exception in circumstances when the reporting persons – so-called “access persons” – may in fact have some influence or control over such accounts. Rule 204A-1 under the Investment Advisers Act requires an adviser to adopt and maintain a written code of ethics that, among other things, obligates certain access persons ‑ directors, officers and partners and its supervised persons who have access to nonpublic information regarding securities transactions – to report personal securities transactions.

The Rule includes an exception from the reporting obligation for accounts over which an access person has “no direct or indirect influence or control.”  In the guidance, the staff states that blind trusts, which are managed by a third party for the benefit of an access person who has no knowledge of specific investments made by the trustee and no right to intervene in the management of the account, qualify for the exception.

Other accounts, however, may not qualify for the exception.  The guidance states that simply providing a third-party manager with discretionary investment authority over an access person’s personal account, “by itself, is insufficient for an adviser to reasonably believe that the access person had no direct or indirect influence or control over the trust or account.”  The staff said that, in order to take advantage of the reporting exception, an adviser needs to implement compliance “reasonably designed to determine whether the access person actually had direct or indirect influence or control over . . . an account, rather than whether the third-party manager had discretionary or non-discretionary authority.”

Going Forward

Advisers should review their policies and procedures related to personal securities transactions and consider if they need to be amended to ensure, among other things, that access persons fully understand the meaning of the phrase “no direct or indirect influence or control.” Advisers may also want to obtain certifications from access persons and their third-party managers regarding whether an access person has any influence or control over such accounts.  In this regard, however, the staff cautioned that obtaining only a general certification would not necessarily meet the standards outlined in the guidance.

In short, advisers should carefully evaluate whether their existing procedures would enable the adviser to demonstrate that an access person did not, in fact, exercise influence or control over an account.  Current practices of obtaining an annual general certification of non-influence and non control from the access person and his third-party manager may no longer be sufficient to enable an adviser to rely on the reporting exception in Rule 204A-1.

SEC Commissioner: Don’t Hold CCOs Accountable for Misdeeds of Advisers

Posted in SEC Enforcement

SEC Commissioner Daniel Gallagher, in a speech on June 25, 2015, said that a perceived trend by the SEC toward “strict liability” for chief compliance officers (CCOs) is “sending a troubling message.”

The statement explains his vote against bringing two enforcement actions against CCOs.  In one case, the SEC charged a CCO with violating Rule 206(4)-7, popularly known as the adviser compliance rule, in connection with an alleged failure to ensure that the adviser’s compliance program was sufficient to assess and monitor outside activities of employees.  In the second case, the SEC found that a CCO failed to implement compliance policies and procedures that, if carried out appropriately, would have detected an alleged multi-year theft of client assets by the adviser’s president.

This trend toward strict liability, Commissioner Gallaher argued, could encourage CCOs to distance themselves from their firm’s compliance policies and procedures, lest they be held accountable for the adviser’s conduct.  Moreover, this trend could incentivize CCOs to favor less comprehensive policies and procedures that require less monitoring in an effort to avoid potential liability when the SEC “plays Monday morning quarterback.”

Part of the problem, the Commissioner said, is that the compliance rule itself is not a model of clarity and “offers no guidance as to the distinction between the role of CCOs and management in carrying out the compliance function.”  He said that the SEC should not resolve this uncertainty through enforcement actions.

While acknowledging that CCOs should be held accountable for violations of the federal securities laws, he said that the SEC should strive to avoid “perverse incentives” that will flow from targeting CCOs who are “willing to run into the fires that so often occur at regulated entities.”  The SEC, he said, should consider whether to amend Rule 206(4)-7 or provide guidance to clarify the roles and responsibilities of CCOs so that CCOs are not held accountable for the misconduct of others.

In a speech on June 29, 2015, Commissioner Luis Agular said that Commissioner Gallagher’s statement has left the impression that the SEC is too harsh with CCOs, and that CCOs are “needlessly under siege” from the SEC.”  This dialog, he said, “is unhelpful sends the wrong message, and can discourage honest and competent CCOs from doing their work.”  The cases that the SEC has brought against CCOs, he said, do not “signify the beginning of nefarious trend” to targeting CCOs, but rather involve “egregious misconduct” of CCOs.

Both Commissioners found some common ground:  they agree that CCOs play a vital role in protecting investors.

Directors’ Consideration of Adviser Profitability Discussed in Webinar Hosted by Mutual Fund Directors Forum

Posted in Fund Regulation

In a recent webinar hosted by the Mutual Fund Directors Forum (MFDF), Kelley A. Howes, an editor of the BD/IA Regulator, and Sara Yerkey, a partner at Management Practice, discussed best practices for mutual fund directors reviewing adviser profitability in the context of approving investment advisory agreements under Section 15(c) of the 1940 Act.

Under relevant judicial precedent and SEC regulation, adviser profitability is one of several factors that fund directors should consider when evaluating advisory agreements. The lack of clear guidelines regarding what constitutes a reasonable level of profitability, or an appropriate methodology for calculating such profitability, however, makes this factor particularly challenging for directors to evaluate.

The webinar was one of a series of educational events on critical issues for fund directors hosted by MFDF.  A transcript of the webinar is available here.

Still Spry at 75: Reflections on the Investment Company Act and the Investment Advisers Act

Posted in Broker-Dealer Regulation, Investment Adviser Regulation

Jay Baris, an editor of the BD/IA Regulator, recently published “Still Spry at 75: Reflections on the Investment Company Act and the Investment Advisers Act” in the July issue of Investment Lawyer: Covering Legal and Regulatory Issues of Asset Management.

This article reflects on the 75th anniversary of the enactment of two of the crowning legislative achievements of the last century: the Investment Company Act of 1940 (Investment Company Act) and the Investment Advisers Act of 1940 (Investment Advisers Act).

More information:

Investment Management
Jay Baris


OCIE Launches Sweep Examination of BD/IA Retirement Investments

Posted in Broker-Dealer Regulation, Investment Adviser Regulation

The SEC’s Office of Compliance Inspections and Examinations (OCIE) is launching a sweep examination that will target the retirement-based savings activities of broker-dealers and investment advisers.

The multi-year Retirement-Targeted Industry Reviews and Examinations (ReTIRE) Initiative, to be run by OCIE’s National Examination Program, will focus on higher risk areas of sales, investment and oversight processes, with an emphasis on potential harm to retail investors.

Specifically, the ReTIRE examination initiative will focus on, among other things:

  • Whether broker-dealers and advisers have a reasonable basis for investment recommendations for retirement-related advice and products;
  • How advisers and broker-dealers manage and disclose conflicts of interest to their clients;
  • Adequacy of supervision of compliance controls, especially across multiple offices and among representatives with outside business activities; and
  • Adequacy of brochures, sales materials and disclosures to retail investors.

One of OCIE’s stated goals is to encourage advisers and broker-dealers to “reflect upon their own practices, policies and procedures” and to promote improvements in supervision, oversight and compliance programs.  In anticipation of OCIE’s sweep program, broker-dealers and advisers should review their compliance policies and procedures relating to retirement products to ensure that they pass muster.

A First: The SEC Lodges Broker-Dealer Registration Charges Against Sellers of Investments Through the EB-5 Program

Posted in Broker-Dealer Regulation, SEC Enforcement

For the first time, the SEC brought a settled administrative proceeding against sellers of investments through the federal EB-5 Immigrant Investor Program for failure to register as broker-dealers.  Previous SEC actions related to the EB-5 program alleged fraudulent conduct in the sales of investments.

The EB-5 program is administered by the U.S. Citizenship and Immigration Services (USCIS).  Among other things, it provides an opportunity for legal residency for foreigners who invest in “regional centers” that promote economic growth, improved regional productivity, job creation and increased domestic capital investment in specific geographic areas and industries in the United States.

The SEC found that two affiliated entities, one located in the U.S. and the other in Hong Kong, used a website to solicit foreign investors for EB-5 investments.  Neither of the entities was an approved regional center, although they had relationships with regional centers to which they directed investors. In at least ten instances, the SEC said, the potential investors were already located in the United States on temporary visas.

After initial contact by a potential investor, the two firms helped the potential investor determine which regional center would be most appropriate and put the potential investor in touch with the identified regional center.  If an investor was successful in obtaining a temporary green card, the firms received a commission from the regional center that was calculated as a fixed percentage of the administrative fee paid by investors to the regional center; in other words, they received transaction-based compensation, which is one of the hallmarks of acting as a broker-dealer.

The firms were censured and ordered to cease and desist from violating the broker registration requirements of section 15(a) of the Securities Exchange Act of 1934.  In an unusual move, the SEC and the two firms agreed to additional proceedings to determine if the firms will have to disgorge any ill-gotten gains and/or pay civil money penalties

This enforcement action shows that the SEC is continuing to scrutinize sales of investments pursuant to the EB-5 program, and is looking at regulatory issues as well as fraud.  Regional centers participating in the EB-5 program, and entities that solicit potential investors for regional centers and who are paid a transaction-based fee for introducing such investors to the regional centers, are reminded that investing through a regional center may involve the sale of a security. If so, entities and individuals that solicit investors for a regional center may be acting as broker-dealers, and may be required to register with the SEC.  In order to avoid this outcome, regional centers should conduct careful due diligence to ensure that none of the activities of a solicitor, including responding to inquiries from potential investors in an EB-5 program, are conducted in the United States and that any potential investor through such a program is not located in the United States. For more information about broker-dealer registration requirements associated with the EB-5 program, see our Client Alert.

Money Market Funds Stress-Testing Changes Imminent

Posted in Fund Regulation

The compliance date for new rules included in the SEC’s money market fund reforms is fast approaching. Among other things, the reforms include changes to stress-testing requirements, disclosure requirements, net asset value (NAV) calculations, and minimum liquidity thresholds.

In a recently published article, Money Market Mutual Funds: Stress Testing and the New Regulatory Requirements, professionals from NERA Economic Consulting offer practical insights into the implementation of the new stress- testing requirements. Through a series of hypothetical scenarios, NERA demonstrates implementation of the new requirements and addresses a number of issues that money market fund boards and advisers should consider when implementing the new stress-testing standards and assessing the results.

Recent SEC cases, such as a December 2014 ALJ opinion finding that an adviser to money market funds and the funds’ portfolio manager misled a fund’s board with respect to the fund’s risk exposure to credit, make clear that money market funds remain squarely in the SEC’s viewfinder. Advisers and fund boards should be aware of the money market fund regulatory environment, and proactive about ensuring that they are ready to implement the new regulatory requirements in the spring of 2016.

The complete article is available here.