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The BD/IA Regulator

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

OCIE Spots Issues and Alerts Registered Advisers on Most Frequent Advertising Compliance Problems

Posted in Investment Adviser Regulation

On September 14, 2017, the National Exam Program of the SEC’s Office of Compliance Inspections and Examinations (“OCIE”) published a Risk Alert outlining registered investment adviser compliance issues relating to Rule 206(4)-1 under the Investment Advisers Act of 1940 (the “Advisers Act”).  According to OCIE, these issues were most frequently identified in SEC deficiency letters sent to registered investment advisers as part of the SEC’s examination initiative focusing on advisers’ use of accolades in their marketing materials (the “Touting Initiative”).  The Risk Alert is intended to assist advisers in adopting and implementing an effective compliance program.

Misleading Performance Results

OCIE staff observed advertisements that the staff believed contained misleading performance results.

The staff observed examples of advisers that presented performance results without deducting advisory fees, and advertisements that compared results to a benchmark, but did not include disclosures about the limitations inherent in such comparisons, such as material differences between the benchmark and the strategy.  The staff also observed advertisements that contained hypothetical and back-tested performance results, but did not explain the derivation of the returns, nor did they include other potentially material information regarding the performance results.

Misleading One-on-One Presentations

OCIE observed advertisements that the staff believed contained misleading one-on-one presentations.

The staff observed examples of advisers that advertised performance results (gross of fees) in certain one-on-one presentations, but did not include potentially relevant disclosures, such as the fact that results do not reflect advisory fees charged and that client returns would be reduced by advisory fees and other expenses.

Misleading Claim of Compliance with Voluntary Performance Standards

OCIE observed advertisements that the staff believed contained misleading claims of compliance with voluntary performance standards.

The staff observed examples of advisers that claimed adherence to certain voluntary performance standards in advertised performance results.  However, according to the staff, it was not clear that they were actually adhering.

Cherry-Picked Stock Selections and Misleading Selection Recommendations

OCIE observed advertisements that the staff believed contained cherry-picked stock selections and misleading selections of investment recommendations.

The staff observed examples of advisers that included only profitable stock selections or recommendations in advertisements, and advisers that disclosed past specific investment recommendations, but did not meet the conditions of Rule 206(4)-1(a)(2).

Generally, advertisements that refer to an adviser’s past specific recommendations, that were or would have been profitable to any person, are considered “fraudulent or deceptive” unless an advertisement, and the list if it is furnished separately:

  1. States the name of each security recommended, the date and nature of each recommendation, the market price at that time, the price at which the recommendation was to be acted upon, and the market price of each security as of the most recent practicable date; and
  2. Contains a cautionary legend.

Compliance Policies and Procedures

OCIE observed that the staff believed that certain advisers did not appear to have (or did not appear to adequately implement) compliance policies and procedures reasonably designed to prevent deficient advertising practices, containing processes for:

  1. Reviewing and approving advertising materials prior to their publication or dissemination;
  2. Determining the parameters for which accounts are included or excluded from performance calculations when composites are used; and
  3. Confirming the accuracy of performance results in compliance with Rule 206(4)-1.

OCIE’s Observations from the Touting Initiative

In 2016, OCIE launched the Touting Initiative to examine the adequacy of disclosures that advisers provided to their clients when advisers included rakings, awards or other accolades in marketing materials.

Misleading Use of Third-Party Rankings or Awards

OCIE observed advertisements that the staff believed contained potentially misleading use of third-party rankings or awards, including:

  • Advertising accolades obtained through the submission of potentially false or misleading information as part of the application process;
  • Publishing marketing materials that referred to outdated and inapplicable rankings or evaluation information; and
  • Publishing advertisements that failed to disclose the relevant selection criteria for awards or rankings, or advisers who created and conducted the survey and paid a fee to participate in or distribute the results.

Misleading Use of Professional Designations

OCIE observed advertisements (and disclosures contained in Form ADV) that the staff believed contained potentially false or misleading references to professional designations.


OCIE observed advisers that published potentially prohibited statements from clients attesting to or endorsing the adviser’s services.

Generally, advertisements that refer, “directly or indirectly, to any testimonial of any kind concerning the investment adviser or concerning any advice, analysis, report or other service rendered by such investment adviser” are considered “fraudulent or deceptive” under Rule 206(4)-1(a)(1).

Our Take

OCIE’s Risk Alert highlights the staff’s attention toward adviser advertising. OCIE noted that, in response to the staff’s observations, advisers elected to remove misleading advertising language or add enhanced and clarifying language.  Advisers should review their advertisements to ensure compliance, as well as ensuring that their compliance policies and procedures are robust and up-to-date.

Financial Markets Association’s Treasury and Capital Markets Legal and Legislative Issues Conference

Posted in Events

October 25-26, 2017
Hyatt Regency
400 New Jersey Ave., NW
Washington, D.C. 20001

This day and a half conference is a valuable forum for banking and securities attorneys, senior compliance officers and regulators providing for an exchange of information, ideas and experiences on current hot topic regulatory and legislative/agency initiatives. The focus is on high-level banking and securities law, enforcement proceedings, financial holding company issues, securities underwriting and distribution, capital markets regulation and public finance. Key industry leaders, regulatory professionals and legislative participants share information about changes in the regulation landscape and current hot topic areas of regulatory and legislative initiatives, including panels of general counsels from the banking, securities and commodities regulatory agencies.

Morrison & Foerster Partner Barbara Mendelson is on the conference planning committee and will be moderating the “Banking General Counsel” panel.

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

FMA will be providing CLE/CPE credit.

DOL Proposes to Defer Full Implementation of its Fiduciary Rule Until July 1, 2019

Posted in Broker-Dealer Regulation, Investment Adviser Regulation

In April 2016, the U.S. Department of Labor (DOL) adopted a rule that significantly expands the category of persons deemed fiduciaries when providing investment recommendations to most retail retirement accounts (the “Fiduciary Rule”). On August 31, 2017, the DOL published a proposal to defer full implementation of the Fiduciary Rule until July 1, 2019.1  Persons deemed fiduciaries under this rule may not receive transaction-based compensation or engage in principal transactions with their retail retirement clients, unless they comply with a prohibited transaction exemption (PTE).  At the same time that the Fiduciary Rule was adopted, the DOL also adopted two new PTEs, the Best Interest Contract Exemption (“BIC Exemption”) and the Principal Transaction Exemption, to permit fiduciaries to receive transaction-based compensation and to act as principals subject to the strict conditions set forth in the new PTEs.

The Fiduciary Rule and the new PTEs were originally scheduled to be implemented in April 2017. Following numerous legal challenges and a presidential memorandum directing the DOL to re-examine the Fiduciary Rule, the DOL decided to proceed with partial implementation.  Thus, on June 9, 2017, the Fiduciary Rule became applicable.  However, persons now deemed fiduciaries could continue to receive transaction-based compensation or sell certain securities as principals if they complied with the impartial conduct standards set forth in the BIC and Principal Transaction Exemptions, respectively.  The impartial conduct standards require a fiduciary to (i) act in the best interests of the client, (ii) avoid false or misleading statements and (iii) charge no more than reasonable compensation for their services.  Applicability of the more onerous conditions set forth in these PTEs was originally deferred until January 1, 2018, with the DOL to conduct its re-examination of the Fiduciary Rule during the transition period.

With this most recent proposal for further delay, the DOL has acknowledged that it will require more time to “carefully and thoughtfully review the substantial commentary… and to honor the President’s directive to take a hard look at any potential undue burden.”  Although the DOL had telegraphed this proposed delay several weeks ago, there are important takeaways from the notice published on August 31, 2017.

  1. The notice strongly suggests that the DOL anticipates coordinating closely with the SEC as it proceeds with its review of the Fiduciary Rule. The notice explicitly cites the DOL’s “desire to coordinate with the SEC” as it considers changes to the Fiduciary Rule.  This should be welcome news to SEC regulated broker-dealers and investment advisers who otherwise faced the prospect of differing standards of care for differing types of accounts.
  2. It appears that the DOL believes much of the anticipated benefit of the Fiduciary Rule has already been achieved through implementation of the impartial conduct standards and the efforts many firms have undertaken to adhere to such standards. When discussing the potential harm to investors from a further delay in full implementation, the DOL states that investor losses “could be relatively small” and adherence to the impartial conduct standards should result in investors receiving “a substantial portion of the estimated gains” forecast from adoption of the Fiduciary Rule.  This perspective could indicate that the DOL will be receptive to a significant rollback of some of the deferred requirements set forth in the BIC and Principal Transaction Exemptions, as such provisions may be seen as less necessary given the benefits realized from implementation of the impartial conduct standards.
  3. At several points in the notice, the DOL emphasized the importance of providing the financial services industry with adequate time to implement any additional requirements. Noting that it wants to avoid a “costly and disorderly transition,” the DOL affirms its objective of finalizing any changes “sufficiently before July 1, 2019, to provide firms with sufficient time to design and implement an orderly transition process.”

Comments on the proposal to further defer full implementation of the Fiduciary Rule are due no later than September 15, 2017.

[1] 82 C.F.R. 41365.

Replacing Familiar Benchmarks: Preparations to Phase Out the IBORs

Posted in Fund Regulation

Long a mainstay of the financial world, the floating “IBOR” rates, based on the rates of actual or purported interbank offered loans, are now being swept slowly into the dustbin of history. The quantity, in both number and size, of existing financial products based on these floating rates is enormous, with the outstanding principal amount of such transactions globally estimated to be in the hundreds of trillions of dollars. IBORs are used extensively in numerous currencies as bases for floating rates in a wide range of transactions including derivatives, structured products, mortgages, floating rate securities and other consumer and commercial loans. A phase-out of the use of familiar benchmarks will therefore be a massive undertaking that will take many years to accomplish. In this article we review, primarily in relation to derivatives, the state of play regarding the IBORs, their possible replacements, prospects for a transition to new floating rates and some of the issues that parties to existing and new IBOR-based transactions should consider.

Read our user guide.

FINRA Fines Broker-Dealers for Sales of Non-Traditional ETFs

Posted in Broker-Dealer Regulation, FINRA Enforcement

In August 2017, FINRA entered into a consent agreement with a Georgia-based broker-dealer arising from improper practices and procedures relating to its sales of leveraged ETFs.1  The sales included ETFs that were leveraged, inverse, or both inverse and leveraged, and that were sold to retail accounts.  The action reflects FINRA’s continuing concerns about the procedures that its members have used to approve and monitor sales of these products.2

This action follows a somewhat similar action in June 2017.  In the June 2017 proceeding, FINRA determined that a broker-dealer did not perform adequate pre-sale due diligence or post-sale reviews in connection with sales of these types of ETFs, in contravention of its own written supervisory procedures.3

Supervisory Procedures and Reasonable Basis Suitability

FINRA determined that the broker-dealer did not establish and maintain a supervisory system, including written procedures, reasonably designed to ensure that its offerings of the ETFs complied with relevant rules. The firm had permitted its representatives to recommend the ETFs without establishing a general supervisory system that was sufficiently tailored to address the unique features and risks involved with these products, in violation of FINRA Rule 2010.  The firm did not perform any reasonable basis suitability analysis of these ETFs in order to understand these features and risks before offering them to retail customers. FINRA also found that the broker-dealer and its registered representatives did not fully understand the features and risks of these products, resulting in unsuitable recommendations to customers that had conservative and moderate investment objectives and risk tolerances, including a number of elderly investors, in violation of FINRA’s suitability rules, including Rules 2111 and 2010.

In 2009, when publicity increased about the risks of these products, the broker-dealer did not main any reasonable supervisory system or written procedures to monitor their recommendation.  However, at the end of 2009, following the release of FINRA Notice 09-31, the broker-dealer prohibited the offering of these ETFs that had more than 2x leveraged and/or inverse performance of the relevant underlying index, and revised its written procedures to address this prohibition.  However, the broker-dealer did not revise its procedures to address the risks posed by these ETFs that involved 2x or less, leveraged and/or inverse performance of an underlying index. Accordingly, these recommendations continued.

Similarly, the broker-dealer did not produce exception reports or any alerts in its trade review system that addressed the risks of these ETFs.4 It did not implement a supervisory system to review the recommendations of these ETFs arising from a customer’s age, investment objective, risk tolerance or financial profile.  These failures resulted in recommendations to retail investors for whom they were not suitable.

Extended Holding Periods

FINRA determined that the broker-dealer’s general supervisory procedures were insufficient to address the unique features and risks involved with these products, including that their performance over longer periods of time can differ significantly from the performance of their underlying index.  Accordingly, for several years, the broker-dealer did not develop any system or procedure to monitor, review or evaluate the length of their holding periods.

In May 2012, the broker-dealer implemented a monthly report reflecting the holdings of these ETFs in retail customer accounts.  However, FINRA determined that the broker-dealer’s supervisors did not receive guidance on how to evaluate holding periods or address the risks related to long-term holding periods.  As a result, even after these reports were generated, many retail customer accounts held these ETFs for long periods (in some cases, more than 1,000 days).5  Retail customers holding these ETFs for extended periods of time incurred significant losses.

Accordingly, FINRA determined that the broker-dealer violated, for example, FINRA Rule 2010, due to its failure to establish and maintain a supervisory system, including written procedures, reasonably designed to achieve compliance with applicable rules for the sales of these products.


As a result of these factors, the broker-dealer consented to several sanctions:

  • censure;
  • a fine of $100,000; and
  • restitution to certain customers in the amount of approximately $500,000.

Our Take

FINRA’s notices have made clear that it intends to carefully scrutinize broker-dealer procedures when complex securities are sold, particularly when they result in losses to vulnerable investors.  Broker-dealers are strongly encouraged to periodically review their written supervisory procedures to ensure that they reflect the products that are being offered, and FINRA’s guidance.

In particular, broker-dealers, before offering complex products to retail customers, should be able to demonstrate that they conducted an adequate reasonable basis suitability analysis, and trained their registered representatives as to their features and risks.  Some products, such as the ETFs in question, are not designed to be held for significant periods of time; monitoring systems must be appropriately tailored to monitor the holding periods for these products, and to determine whether they are consistent with firm recommendations.

[1] The agreement may be found here.

[2] For example, in FINRA Regulatory Notice 09-31 (2009), FINRA highlighted a variety of its concerns relating to sales of these products, including that they are typically not suitable for retail investors who plan to hold them for more than a single trading session.  For example, FINRA has explained that broker-dealers “must understand the terms and features of the funds, including how they are designed to perform, how they achieve that objective and the impact that market volatility, the ETF’s use of leverage, and the customer’s intended holding period will have on their performance.”

[3] See Coastal Equities, Inc. (“Coastal”), which may be found here.

[4] Similarly, in Coastal, the broker-dealer did not have exception reports relating to these types of ETFs, and did not implement a system to monitor their holding periods and losses.

[5] In addition, there was a 15-month period in which the broker-dealer ceased to produce these holding reports due to technical issues.

Teleconference: Canadian Bail-in and TLAC – Impact on Capital Markets Transactions

Posted in Events

Wednesday, September 13, 2017
11:00 a.m. – 12:00 p.m. EDT

Morrison & Foerster and Osler, Hoskin & Harcourt Teleconference

During this teleconference, the panelists will address the proposed Canadian federal rules relating to (a) Bank Recapitalization (Bail-in) Conversion Regulations and (b) Total Loss Absorbing Capacity (TLAC). These rules are expected to have a significant impact on how the major Canadian banks (D-SIBs) offer debt securities in Canada, the U.S. and elsewhere. In particular, the speakers will focus on navigating a variety of issues:

  • The expected regulatory framework and capital requirements;
  • Changes to debt offering programs, including indenture terms and covenants;
  • Changes to offering documents delivered to investors;
  • The impact on structured note offerings; and
  • The process for compensating debtholders.


  • Kashif Zaman, Partner, Osler, Hoskin & Harcourt LLP
  • Lloyd Harmetz, Partner, Morrison & Foerster LLP

CLE credit is pending for California and New York.

For more information, or to register for this complimentary teleconference, please click here.

OCIE Provides Insight into Issues Identified in Recent Cybersecurity Sweep

Posted in Broker-Dealer Regulation, Cybersecurity/Privacy, Fund Regulation, Investment Adviser Regulation

The National Exam Program of the SEC’s Office of Compliance Inspections and Examinations (OCIE) recently published its observations from the second generation of its Cybersecurity Initiative. It reported overall improvement in firms’ cybersecurity awareness and preparedness, but said there is plenty of room for improvement. The staff noted that many firms have failed to adopt procedures reasonably tailored to their specific needs, and identified how firms can develop a more robust control environment.

OCIE examined 75 firms, including broker-dealers, investment advisers, and registered funds. It said that it conducted more validation and testing of the firms’ policies and procedures than during prior cybersecurity examinations and focused its testing on: (1) governance and risk assessment; (2) access rights and controls; (3) data loss prevention; (4) vendor management; (5) training; and (6) incident response.

Read our client alert.