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The BD/IA Regulator

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

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.

Division of Investment Management Eases Compliance Deadline for New ADV Filing Requirement

Posted in Investment Adviser Regulation, SEC Enforcement

Currently pending amendments to Form ADV have a compliance date of October 1, 2017 and, as of that date, an adviser filing an initial Form ADV or an amendment to an existing Form ADV must use the revised Form ADV. In an August 2017 “Information Update,” the staff of the Division of Investment Management gave some breathing room to advisers who don’t have enough information to respond to new questions required by recent amendments to Form ADV.  The guidance applies to any investment adviser that must make an “other-than-annual” amendment to its Form ADV between October 1, 2017 and the date of its next annual amendment to Form ADV.

The staff acknowledged industry concerns that some of the information required to respond to new or amended questions in Form ADV Item 5 and related Schedule D may not be readily available, since such information was previously not required.  In particular, existing systems may not have captured data necessary to provide an adviser’s regulatory assets under management and borrowings in its separately managed accounts that correspond to ranges of gross notional exposure as of the end of its last fiscal year.

The staff noted that the IARD system, through which Form ADV must be filed, does not allow forms to be filed without completing all applicable fields.

The Division of Investment Management staff said that, in these circumstances, it will not recommend enforcement action if an adviser does not have enough data to provide a complete response to a new or amended question in Item 5 or the Schedule D sections related to Item 5 during the period from October 1, 2017 to the date of its next annual amendment to Form ADV.  Instead, an adviser should respond “0” as a placeholder in order to submit its Form ADV on the IARD system and should include a corresponding note in the “Miscellaneous” section of Schedule D reflecting that a placeholder value of “0” was entered.

The Guide to Social Media and the Securities Laws

Posted in Broker-Dealer Regulation, Investment Adviser Regulation

The growing use of social media has created challenges for federal securities regulators, who must enforce antifraud rules that were written at a time when the prevailing technology was the newspaper.

This Guide summarizes how regulation has evolved in the face of the growing use of social media.  Our guide discusses the principal areas of focus for SEC-reporting companies, registered investment advisers, registered investment companies, and registered broker-dealers that use social media.

Read our Guide to Social Media and the Securities Laws.

In addition, readers may also be interested in our FAQs about the FINRA Communication Rules and our FAQs about Liability of Public Companies and Companies in Registration for Website and Social Media Content.

Does a Proposal for Further Delay in Implementation of the DOL Fiduciary Rule Suggest Major Changes Are Coming?

Posted in Broker-Dealer Regulation, Investment Adviser Regulation

On August 9, 2017, the U.S. Department of Labor (DOL) submitted to the Office of Management and Budget (OMB) a proposal to delay until July 1, 2019 the implementation date for those portions of the DOL’s fiduciary rule that are not currently applicable.  The fiduciary rule was originally adopted by the DOL in April 2016, with a scheduled implementation date of April 2017.  Following a February 2017 presidential memorandum directing the DOL to re-evaluate the effects of the rule, DOL opted for partial implementation, while deferring implementation of other portions for further study.

The rule’s expansion of the term “fiduciary” to cover a broad range of brokers and other financial professionals became applicable on June 9, 2017.  On that same date, two new prohibited transaction exemptions, the Best Interest Contract Exemption (“BIC Exemption”) and the Principal Transactions Exemption, became available.  However, most of the conditions set forth in these controversial exemptions did not become applicable and, during a transition period scheduled to end on January 1, 2018, compliance with these exemptions only requires adherence to the impartial conduct standards. (That is, the fiduciary must act in the best interest of the client, the fiduciary may not receive unreasonable compensation, and it may not make false or misleading statements.)  Under the proposal currently being reviewed by OMB, the transition period would be extended to July 1, 2019.

The full text of the proposal to further delay implementation is not yet publicly available.  Once cleared by OMB, the proposed delay will likely be subject to public comment before any formal action is taken by the DOL on the proposal. Therefore, at this stage, the duration of any delay is not clear, nor do market participants have the benefit of DOL’s explanation for its proposal.

Nonetheless, it seems reasonable to infer from the proposal for an 18-month delay that the DOL has concluded that it needs substantial additional time to adequately consider the issues relating to full implementation of the fiduciary rule.  Among the issues to be considered are the limited scope of the Principal Transactions Exemption, and the detailed and challenging contract and disclosure requirements set forth in both the BIC and Principal Transaction Exemptions.  Making these exemptions workable is crucial if retail retirement investors are to have access to products sold by broker-dealers on a principal basis, and if retail retirement investors wish to continue to have commission-based rather than fee-based accounts.  Although it is far too early to project the final outcome, the likelihood of major changes to the BIC and Principal Transaction Exemptions appears to have increased in light of the further delay proposed by DOL.

The Brattle Group and Morrison & Foerster Seminar – Core Principles for Financial Regulation

Posted in Events, Investment Adviser Regulation

Tuesday, September 12, 2017
8:30 a.m. – 10:00 a.m.

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

Join us as presenters from Morrison & Foerster LLP and The Brattle Group share their views and predictions regarding:

  • the Presidential Orders relating to deregulation;
  • the Treasury Department’s initial report regarding the core principles of financial regulation;
  • the Financial CHOICE Act and its principal provisions;
  • the areas of regulatory reform as to which compromise may be possible; and
  • the likely path forward for regulatory reform and what you should expect in 2017.


  • Elaine Buckberg, The Brattle Group
  • Chris Laursen, The Brattle Group
  • Oliver Ireland, Morrison & Foerster LLP
  • Anna Pinedo, Morrison & Foerster LLP

CLE credit is pending for California and New York.

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

Eighth Circuit Says No Standing for Fund of Funds’ Shareholders Under Section 36(b)

Posted in Fund Regulation

On July 24, 2017, the U.S. Court of Appeals for the Eighth Circuit affirmed a district court ruling that a shareholder of a fund of funds lacks standing under Section 36(b) of the Investment Company Act of 1940, as amended (the “1940 Act”), to challenge investment advisory fees paid by the underlying funds.

The plaintiff, a 401(k) plan on behalf of its participants, originally sued the investment adviser of six target-date funds in which it invested. The target-date funds are structured as “fund of funds” and invest in other mutual funds (“underlying” or “acquired” funds) managed by the same investment adviser. The plaintiff alleged that the investment adviser breached its fiduciary duty under Section 36(b) of the 1940 Act and sought to recover “unfair and excessive fees.” Each target-date fund charged an advisory fee of 0.03% of total net assets. The acquired fund fees and expenses (“AFFE”) for each target-date fund ranged from 0.59% to 0.75% of the fund’s total net assets.  The plaintiff did not challenge the target-date funds’ advisory fees, but only the AFFE.

Section 36(b) of the 1940 Act limits shareholder suits to breaches of fiduciary duty regarding compensation of payments paid by a mutual fund or its shareholders. The plaintiff argued that it had standing to challenge the underlying funds’ fees to the extent that they were paid indirectly by the target-date funds. The court rejected this argument.

Here, the acquired fund fees at issue were paid by the underlying funds, which are separate investment companies, not by the [target-date funds] in which [plaintiff] was a shareholder. As with any enterprise, adviser fees and other costs reflected in the AFFE reduced the net asset value of the underlying fund paying the fees, which in turn reduced the value of the [target-date funds’] shareholdings in the underlying fund. But the mere reduction of an asset’s value does not mean that the reduction was paid by the asset’s investors. To take an example from the corporate world, an increase in a subsidiary’s operating expenses adversely affects the value of the parent corporation’s investment, but the increased expense is not paid by the parent corporation or its shareholders.

The plaintiff also argued, among other things, that the district court’s ruling “would allow excessive fees to be buried at the underlying fund level and render the fees immune from any challenge under Section 36(b) where most or all of the underlying funds are held by the funds of funds.” The court noted that, in this case, unaffiliated investors hold varying percentages of the outstanding shares of the underlying funds. The court said that the independent directors of each fund would still have responsibility to rigorously review management fees, and the SEC would have authority to bring Section 36(b) actions.

Our Take

Section 36(b) provides a private right of action solely to “a security holder of [a] registered investment company on behalf of such company, against [its] investment adviser,” and it limits such claims to those regarding compensation or payments of a material nature that are paid by the registered investment company or its shareholders. The standard is clear: standing to bring a Section 36(b) case is limited to shareholders of a particular fund. This decision represents an appropriate plain meaning interpretation of Section 36(b) of the 1940 Act.

We note that all registered funds must disclose AFFE in their prospectus. These fees are viewed as an expense to be considered by shareholders of a fund in assessing the costs of investing in a particular fund, including its investment management strategy. They are not a fee giving rise to direct potential liability under Section 36(b) of the 1940 Act. To the extent any Section 36(b) cause of action exists with respect to an underlying fund, it belongs solely to the shareholders of that fund.

Howey Got Here: SEC Issues Guidance on Token Offerings

Posted in Fund Regulation

The Howey test lives on—now in a lesson in what not to do when it comes to token offerings.

Token offerings, also known as “initial token offerings,” “token launches,” “token sales,” “initial coin offerings,” or “ICOs,” represent a new capital-raising method being explored by many emerging companies; venture, hedge, and private equity funds; large and well-established corporations; and others hoping to raise significant amounts of money quickly and from a broad base of potential participants.

Yesterday, the U.S. Securities and Exchange Commission spoke formally on the topic for the first time, disappointing some individuals and issuers that had hoped tokens might fall outside of the definition of “securities” and clarifying that the platforms on which these tokens are traded may need to register as securities exchanges. The SEC also issued an investor bulletin on initial coin offerings as part of its investor-education and investor protection mission.

Read our client alert.