Header graphic for print

The BD/IA Regulator

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

House Passes Bill to Ease Volcker Rule and other Regulatory Requirements

Posted in Investment Adviser Regulation

The U.S. House of Representatives on January 14, 2015, voted (271-154) to pass H.R. 37, the “Promoting Job Creation and Reducing Small Business Burdens Act.  If enacted, the bill, among other things, would extend the Volcker Rule conformance date for collateralized loan obligations (CLOs) and ease requirements for investment advisers of small business investment companies (SBICs) and venture capital firms.  The bill also includes a number of measures that correct issues arising in the JOBS Act, or that otherwise are intended to promote capital formation.

Rep. Jeb Hensarling of Texas championed this bill as beginning to “get America back to work” and start growing the economy.  He said that the bill corrects some “unintended consequences” of the 2,000 page Dodd-Frank Act.

Democrats, as expected, were critical of the bill.  Rep. Maxine Waters said that the bill was intended to delay the effect of the Volcker Rule, which was designed to stop “government-supported banks from gambling with bank depositors’ money.” 

Our take.  It is encouraging to see action to reduce regulatory burden.  H.R. 37 is only a small step, and there are other aspects of the Dodd-Frank Act that Congress or the regulators should reconsider.

A more complete analysis of the bill can be found in our client alert, available here.

OCIE Publishes Exam Priorities for 2015

Posted in Investment Adviser Regulation

The National Exam Program of the SEC’s Office of Compliance Inspections and Examinations (OCIE) published its examination priorities for 2015 this week.  This year’s letter is significantly shorter than last year’s letter, and takes a more thematic, less detailed approach to the discussion of OCIE’s key focus areas.

Many of the themes in the letter are consistent with OCIE’s 2014 examination priorities as well as issues identified by the SEC staff over the course of the last year.  One notable new theme, however, is OCIE’s identification of transfer agents as “gatekeepers” that may warrant closer attention from the OCIE staff. 

OCIE also encouraged would-be whistleblowers to reach out to the staff with information about activities that may “violate the federal securities laws or otherwise [operate] to harm investors.”

OCIE identified three key areas of focus in 2015:

  • Retail investors, including retirement investing and the use of traditionally “institutional” products in the retail marketplace;
  • Market-wide risks, including structural risks and trends involving multiple firms; and
  • Data analysis, including the use of data to identify firms that appear to be involved in fraudulent or other illegal activities.

Registered investment advisers, broker-dealers, municipal advisers and transfer agents should take the time to carefully review OCIE’s letter and consider if their compliance programs adequately and appropriately address the risks identified by OCIE. 

A more complete analysis of the letter can be found in our client alert, available here.  

Heightened Scrutiny of Brokers – SEC Approves FINRA’s Proposed Background Check Rule

Posted in Broker-Dealer Regulation, FINRA Enforcement, SEC Enforcement, Uncategorized

In recent years, questions have been raised in many quarters about how brokers with questionable backgrounds have been able to move among firms and remain in the industry. FINRA has responded by enhancing a broker-dealer’s obligations for reviewing the backgrounds of its newly hired brokers.

The SEC recently approved proposed FINRA Rule 3110(e), which requires FINRA member firms to verify the information in Form U4 within 30 calendar days of filing. The proposed rule, which will take effect on July 31, 2015, is intended to improve the information that winds up in FINRA’s Central Registration Depository (CRD) and BrokerCheck. FINRA’s 2015 Regulatory and Examinations Priorities Letter (January 6, 2015) discusses its concern with “high-risk and recidivist brokers,” including firms’ due diligence on prospective hires, and highlights the proposed rule with respect to investor protection.

To read the full alert, click here.

FINRA Issues a Packed Priorities Letter for 2015

Posted in Broker-Dealer Regulation, FINRA Enforcement

FINRA opened 2015 with a lengthy and ambitious agenda of regulatory priorities. This year’s Regulatory and Examination Priorities Letter is much longer than those issued the last two years, and repeats many of those years’ priorities, while adding additional products and practices. Amidst this smorgasbord of priorities, several are highlighted in FINRA’s accompanying press release, and so might have a favored place at the table:

  • sale and supervision of interest-rate-sensitive and complex products, including alternative mutual funds;
  • controls around the handling of wealth events in investors’ lives;
  • management of cybersecurity risks;
  • treatment of senior investors; and
  • high-risk brokers and removing bad actors from the securities industry.

In the letter, FINRA seeks to unify its priorities around a set of systemic issues that it believes differentiate good firms from non-compliant firms: putting customer interests first; firm culture; supervision, risk management and controls; product and service offerings; and conflicts of interest. FINRA will use data analytics to identify potential problem areas within firms, and expects firms to use similar methods to identify problems themselves.

We summarize below some of the more significant issues raised in the letter, along with our recommendations about how to prepare for a risk-based FINRA examination of these issues. As always, the best way for a broker-dealer to prepare for a FINRA examination and avoid enforcement interest is for the firm to put itself in the head of a FINRA examiner and address the areas that FINRA is likely to examine in light of the firm’s business, history and supervisory structure.

To read the full alert, click here.

FSOC, At It Again, Places Asset Managers in Its Crosshairs

Posted in Investment Adviser Regulation

In seeking comment on potential risks to the U.S. financial system created by asset managers, the Financial Stability Oversight Council (FSOC) again places asset managers in its crosshairs.  This crusade potentially can lead to unnecessary, costly and counterproductive regulation of asset managers. Comments are due February 23, 2015. 

To read the full alert, click here.

Financial Services Regulatory and Enforcement Current Issues

Posted in Events

Join Morrison & Foerster on January 27, 2015 for the Financial Services Regulatory and Enforcement Current Issues seminar.  During this half-day briefing, which will take place at Morrison & Foerster’s New York office from 8:00 am – 2:10 pm, we will discuss:

  • The long arm of the Volcker Rule: How to spot issues so you are not caught short;
  • Liquid alternative investments: what to expect from the SEC
  • Money market fund regulation: will a third shoe drop, and when?
  • SEC and FINRA enforcement trends;
  • Alternative (or “virtual”) currencies: developing trends;
  • The ABCs of BDCs;
  • Cross-border derivatives issues, the ISDA stay protocol and other emerging issues; and
  • Liquidity and capital developments: LCR, NSFR, and TLAC.

Breakfast and lunch will be served.

CLE credit for this event is pending.

To register for this event, or for more information, please email Harrison Lawrence at hlawrence@mofo.com.

FINRA Sanctions Member Firm for Failure to Deliver ETF Prospectuses

Posted in Enforcement, FINRA Enforcement

FINRA recently sanctioned a broker-dealer (the “Firm”) for failure to deliver prospectuses in connection with its sale of ETFs.  FINRA also found that the Firm failed to implement a supervisory system reasonably designed to achieve compliance with securities laws and regulations governing ETF prospectus delivery.  The Firm was censured and agreed to a fine of $3 million. This fine is a significant increase in the amounts imposed by FINRA since 2011 in its disciplinary proceedings against  member firms for their failures to meet their prospectus delivery obligations (see our related blog post).

FINRA found that the Firm failed to deliver prospectuses for approximately 255,000 purchases of 160 ETFs during the period from September 2010 to November 2010.  The Firm self-reported the delivery failures to FINRA. 

According to FINRA, the Firm used manual reviews of three stock exchange websites to identify newly-listed ETFs.  If a new ETF was identified, the reviewer manually entered a code in the Firm’s automated system to trigger prospectus delivery when it sold an ETF.  FINRA found that the procedures did not require quality checks and that supervisors in fact did not perform such checks.  FINRA said that it was “reasonably foreseeable that the manual process could result in human errors, [but] the Firm’s supervisory system did not provide a sufficient process through which the Firm could detect and prevent these errors.”

FINRA also found that the Firm’s decentralized supervisory system was not reasonably designed to ensure compliance with ETF prospectus delivery obligations.  As a result of a previous FINRA matter, the Firm was required to certify that its policies and procedures regarding delivery of ETF prospectuses were reasonably designed to ensure compliance with the federal securities laws and NYSE rules.  However, when the individual who signed the 2007 certification departed the Firm, there was no longer clear ownership of ETF prospectus delivery.  FINRA said that the decentralized supervisory system contributed to the Firm’s failure to identify deficiencies in its ETF prospectus delivery process and to timely remedy the inadequacies in its manual process.  Moreover, FINRA said that the Firm did not timely respond to red flags indicating that it had experienced failures to deliver.

According to FINRA, the firm’s testing of ETF prospectus delivery that was conducted by internal audit, compliance, and operations control was conducted on a limited sample of trades.  FINRA said that the small sample size was inadequate to ensure verification of the Firm’s procedures, and internal audit did not assign an appropriate risk level to testing the ETF delivery procedures.

Our Take

Prospectus delivery continues to be an important issue for FINRA, and against the backdrop of FINRA’s generally increasing monetary penalties, the regulator could impose substantial fines for prospectus delivery failures if it finds a systemic pattern of delivery failures.  To put it another way, delivery failures resulting from gaps in procedures can add up in a hurry, and fines are often proportional to the number of failures.

Firms that sell ETFs, mutual funds, and other such products should consider reviewing their policies and procedures for prospectus delivery, with a view to addressing the deficiencies found by FINRA in this and other actions.

  • Responsibility for these procedures should be clearly assigned, with the line of governance clearly traceable to the top of the compliance structure.
  • Testing procedures should be evaluated for the scope and frequency of the tests and a clear understanding of prospectus delivery obligations.
  • Seemingly isolated instances of delivery failures should be examined, with the root cause analyzed to ensure that it is not emblematic of a larger problem.

That said, FINRA’s findings related to the failure of the Firm to ensure that the lessons of past regulatory deficiencies were not lost over time, and FINRA stressed that changes of personnel are at least as significant as the failure to meet prospectus delivery requirements.  Broker-dealers should ensure that compliance policies are not only reasonably designed to comply with the federal securities laws but that procedures are implemented to review and consider past regulatory deficiencies on a regular basis, and ensure that compliance policies and related testing protocols, adequately address such matters.