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The BD/IA Regulator

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

OCIE Gives Advisers a Heads-Up About Its Latest Sweep Examination Initiative

Posted in Investment Adviser Regulation

Last week, OCIE published a National Exam Program Risk Alert highlighting the staff’s focus on advisers’ responsibility to act consistently with their clients’ best interests. According to OCIE, its latest sweep examination, the “Share Class Initiative,” will “address the risk that registered advisers may be making certain conflicted investment recommendations to their clients.”

Like other Risk Alerts published by OCIE, this notice highlights issues and risks that OCIE staff have identified in the course of its examination program.

The Risk Alert reminds advisers that, as fiduciaries, they have an obligation to act in their clients’ best interests and must disclose material conflicts of interest, “such as the receipt of compensation for selecting or recommending mutual fund share classes.” Accordingly, the Share Class Initiative will focus on advisers’ practices related to share class recommendations and compliance oversight of that process.

The Share Class Initiative will be risk-based and focus on the following high-risk areas:

  • Fiduciary Duty and Best Execution. Examiners will review advisers’ investment practices to confirm that they are acting in their clients’ best interests and seeking best execution in connection with recommending investments in mutual funds.
  • Disclosures. Examiners will evaluate advisers’ disclosures to clients (including, without limitation, Part 2 of an adviser’s Form ADV) to ensure that they adequately disclose whether the adviser (or its supervised persons) accepts compensation for the sale of investment products, including asset-based sales charges or service fees from the sale of mutual funds. This disclosure should adequately explain any conflict of interest inherent in the receipt of such compensation.
  • Compliance Program. Examiners will review an adviser’s Rule 206(4)-7 compliance program to determine if it adequately addresses the selection of mutual fund share classes.

Our take

OCIE’s published 2016 examination priorities include a focus on investor protections and adequately addressing conflicts of interest, and the SEC has brought several enforcement actions related to advisers’ causing clients to purchase more expensive share classes of mutual funds. Over the last couple of years, FINRA has brought similar actions for failures of broker-dealers to apply eligible sales charge waivers. It is therefore not surprising that OCIE would focus on this issue. Advisers should take the opportunity to review their compliance policies, and the implementation of such policies, to ensure that they adequately address the matters identified in the Risk Alert. Doing so quickly — and promptly making any necessary changes or improvements identified in such review — could mitigate any issues identified by the staff.

Proposed Financial Disclosure Changes Could Impact Funds and BDCs

Posted in Fund Regulation

At an open meeting this week, the SEC voted to propose changes to certain disclosure rules affecting public issuers including, among others, investment companies and business development companies (BDCs).

The proposed rules would require disclosure changes when requirements in SEC rules or forms are substantially similar to or closely related to disclosure required by U.S. generally accepted accounting principles (GAAP), International Financial Reporting Standards (IFRS) or other SEC disclosure requirements.  The proposed changes seek to eliminate redundant or duplicative disclosure requirements or to integrate related disclosure requirements that require incremental information.  The SEC also noted its intent to simplify compliance efforts related to the various requirements.  Importantly, the SEC intends to ensure that issuers provide substantially the same information to investors.

Comments on the proposed rule changes are due 60 days after the date of publication in the Federal Register.

FINRA Study of Financial Literacy: Many Investors May Not Have It

Posted in Broker-Dealer Regulation

In July 2016, FINRA’s Investor Education Foundation released the findings from its National Financial Capability Study.  (FINRA’s press release may be found here: https://www.finra.org/newsroom/2016/americans-financial-capability-growing-stronger-not-all-groups-finra-foundation-study.)  A summary infographic as to the study’s findings can be found here: http://www.usfinancialcapability.org/downloads/2015_Study_Infographic.pdf

The study suggests that, while in some ways Americans have increased their financial literacy, too many Americans are lacking in this area.  For example, the study concluded that absolute levels of financial literacy are low, and financial literacy is slightly down from 2009 levels.  In 2015, only 37% of respondents to the survey answered correctly at least four of five financial literacy questions.  Only 31% of respondents were offered financial education.

Our take

It is possible that customers of today’s broker-dealers, as a whole, would score higher than the pool of individuals surveyed in connection with the study.  This is because, in general, broker-dealer customers tend to have greater financial resources, and more access to investor education resources, including those provided by the broker-dealer themselves.  However, the study is a useful reminder that broker-dealers need to be very careful to ensure that customers do in fact understand the products that they are buying.  Investor suitability should never be taken for granted.

SEC Proposes Business Continuity and Transition Rules for Advisers While Staff Publishes Similar Guidance for Funds

Posted in Fund Regulation, Investment Adviser Regulation

The SEC’s Division of Investment Management published regulatory guidance on June 28, 2016, highlighting the need for registered investment company complexes to review their business continuity plans to ensure they are sufficiently robust to mitigate potential exposures and disruptions and consider the backup processes and redundancies of critical service providers.  On the same day, the Commission proposed rules that would require registered investment advisers to adopt and implement business continuity and transition plans reasonably designed to address risks related to an adviser’s ability to operate in the event of a significant disruption.

Business continuity plans for registered investment companies

The Commission initially addressed fund business continuity plans (BCPs) when it adopted Rule 38a-1 under the Investment Company Act of 1940 (Rule 38a-1), which requires funds to adopt and implement formal compliance programs.  Rule 38a-1, the Staff guidance says, also requires oversight of the BCPs of critical service providers to a fund complex.

The guidance draws heavily on Staff observations of fund operations made during examinations of fund complexes and their advisers.  The guidance focuses on how fund complexes should consider whether the backup processes and redundancies of critical service providers are sufficient to maintain continuity of fund operations during a significant business disruption.

The thrust of the guidance is that fund complexes should observe, monitor and evaluate the ability of critical service providers to weather disruptions caused by cyber security breaches or operational failures, including procedures for coordinating communications among various constituencies, including fund investors.

Among other things, fund complexes should consider how to monitor business interruption incidents that could hinder the ability of a service provider to provide uninterrupted services to the fund.  Moreover, the guidance suggests that fund complexes should understand how the BCPs of various services providers are interconnected so that they are better prepared to deal with operational crises.  In the Staff’s view, fund complexes should consider and be prepared to address “what if” scenarios.

The guidance states that fund boards should discuss with the fund’s adviser and other critical service providers the steps being taken to mitigate the risks associated with potential business disruptions.  Consistent with Rule 38a-1, board oversight should consider the robustness of a fund complex’s BCP, including the fund complex’s plans for dealing with disruptions affecting critical service providers.

BCPs for investment advisers

The SEC proposed a new rule which would require SEC-registered investment advisers “to adopt and implement written business continuity and transition plans reasonably designed to address operational and other risks related to a significant disruption in the investment adviser’s operations.”

The basis of the rule is the fiduciary responsibility of investment advisers to take steps to protect clients if the adviser is not able to provide advisory services.  The inability to provide services can arise from operational difficulties resulting from, among other things, natural disasters, acts of terrorism, cyber attacks, technological failures or even the departure of key personnel.

The proposed rule also would require investment advisers to address transition planning.  Transitions can result from an adviser exiting the advisory business (voluntarily or involuntarily) or a decision by a fund board to terminate an investment advisory contract.

Specifically, the proposed rule would require investment advisers to adopt and implement a written business continuity and transition plan and to review the plan at least annually.  As proposed, a plan must address business continuity after significant disruption of operations and business transitions as described above.  The plans must address, among other things:

(i)      maintenance of critical operations and systems and the protection, backup and recovery of data;

(ii)     pre-arranged alternate physical location(s) of the adviser’s office(s) and/or employees;

(iii)     communications with clients, employees, service providers and regulators;

(iv)     identification and assessment of third-party services critical to the operation of the adviser; and

(v)      transitions, including the possible winding down of the adviser’s business, or the transition of the adviser’s business to others in the event the adviser is unable to continue providing advisory services.

The SEC asked for public comment as to, among other things, whether the proposed rule is necessary in the first place or whether the issues can be addressed through regulatory guidance similar to the guidance it published for registered investment companies.

Our take

The guidance and the proposed rules should come as no surprise to those who follow the progression of regulations following efforts by the Financial Stability Oversight Counsel (FSOC) to portray investment advisers as creators of systemic risk to the global financial system.  These actions are part of the SEC’s efforts to get ahead of FSOC’s attempts to regulate investment advisers and funds.  While the Staff’s observations on BCPs for registered investment companies take the form of guidance, it is not a coincidence that they dovetail with the Commission’s proposed rules to require registered investment advisers to adopt and implement BCPs.  The guidance and the proposed rules, if adopted, add yet another subtle level of scope and complexity to responsibilities of fund directors and registered investment advisers.

Master Class – Index Regulation and Outsourcing Index Administration

Posted in Events

Thursday, July 28, 2016
Registration/Breakfast: 8:00 a.m. EDT
Seminar: 8:30 a.m. – 9:30 a.m. EDT

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

Please join Morrison & Foerster and Markit at our Master Class in New York City.

With the increased regulation of benchmark indices and index governance in Europe, market participants already are focused on compliance.  Regulation and scrutiny likely will not be limited to indices that are true benchmarks, but may well also affect proprietary indices.  During this joint program, we will discuss:

  • IOSCO and ESMA guidance on indices and proposed EU legislation;
  • Guidance and scrutiny of index governance policies and procedures;
  • Index methodologies and best practices;
  • Outsourcing index maintenance and sponsorship; and
  • Legal, regulatory and business considerations.

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

CLE credit is pending for New York and California.

PLI Webcast – Brexit: Implications for Securities and other Financial Transactions

Posted in Events

Thursday, July 7, 2016
11:00 a.m. – 12:00 p.m. EDT

On 23 June 2016, the UK electorate voted narrowly in favour of the UK leaving the European Union. The result of this vote will have broad and wide reaching economic and political consequences, and a major impact on businesses with operations in the UK/EU or that issue securities in the EU or contract with EU parties. This program will provide an overview and discussion of the possible effect of a so-called “Brexit” on EU issuances of securities and transactions in other financial instruments. In particular, we will discuss the impact of a Brexit on:

  • the continued applicability of the Prospectus Directive and other EU securities regulation;
  • access to the EU “passport” for multi-jurisdictional EU offerings;
  • the “home member state” of a non-EU securities issuer;
  • disclosure “best practice”;
  • the EU Capital Markets Union, including the proposed new Prospectus Regulation (“PDIII”).


  • Peter Green
    Partner, Morrison & Foerster LLP
  • Jeremy Jennings-Mares
    Partner, Morrison & Foerster LLP

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

FINRA Proposes Amendments to Communications Rule to Help Clarify Application to Debt Research Reports

Posted in Research

On June 24, 2016, FINRA proposed amendments to its communications rule, Rule 2210, to help clarify the application of Rule 2210 to debt research reports, in light of the new debt research rule, Rule 2242.  The implementation date for the proposed amendments is July 16, 2016, which is the current effective date for Rule 2242.

The proposed amendments help clarify Rule 2210 in four main respects.  First, the proposed amendments would (1) streamline the scope of approval permitted by supervisory analysts to specifically reference the definition of “debt research report” in Rule 2242(a)(3) and (2) add a specific reference to the exceptions to such definition under Rule 2242(a)(3)(A), thus making the references to debt research-related retail communications consistent with the references to equity research-related retail communications.  The proposed amendments also would maintain the ability for a supervisory analyst to approve other research communications (e.g., research on options), provided that the supervisory analyst has technical expertise in the product area and any other required registrations for such product.  Second, the proposed amendments would make the exception from pre-use approval requirements under Rule 2210(b)(1)(D)(i) consistent for debt and equity research communications.  Third, the proposed amendments would (1) except debt research reports from the disclosure requirements of Rule 2210(d)(7) (applicable to retail communications that include a recommendation of securities) and (2) except public appearances by debt research analysts from the disclosure requirements of Rule 2210(f)(2) (applicable to an associated person recommending a security) for consistency purposes.  Fourth, the proposed amendments would make technical changes to Rules 2210(d)(7) and (f)(5) to make the rule language more readable.

The text of the proposed amendments to Rule 2210 is available at:  http://www.finra.org/sites/default/files/rule_filing_file/SR-FINRA-2016-021.pdf