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The BD/IA Regulator

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

Auditor Independence No-Action Relief Extended

Posted in Fund Regulation

In a letter dated September 22, 2017, the SEC staff agreed to extend previous relief that enables registered fund groups to fulfill regulatory requirements under Regulation S-X if the accounting firm auditing the funds’ financial statements is not in compliance with Rule 2-01(c)(1)(ii)(A) of Regulation S-X (the “Loan Provision”).

Rule 3520 adopted by the Public Company Accounting Oversight Board (PCAOB) requires an auditing firm and its associated persons to be independent of their audit clients.  Under the PCAOB’s rules, audit firms are required to provide prospective clients with a written description of the relationships existing between the auditor and its clients.  Auditors make similar representations to existing clients annually.

The SEC takes the position that an accounting firm is not independent of its audit clients if it has a “lending relationship with any entities having a record or beneficial ownership of more than ten percent of any entity within the investment company complex of an audit client.”  Since certain financial institutions may hold more than 10 percent of the outstanding shares of a fund for the benefit of their underlying clients, and such financial institutions may from time to time have lending relationships with an audit firm or its associated persons, compliance with the Loan Provision of Regulation S-X is difficult to monitor and enforce.  In June 2016, therefore, the SEC staff agreed that it would not object to a fund group using financial statements that were audited by an accounting firm that failed to comply with the Loan Provision as long as the audit firm’s judgment remained “objective and impartial.”

The original no-action relief was temporary and set to expire 18 months after its issuance, or in December 2017.  Fund groups and audit firms who have been relying on the prior no-action relief will be relieved that the staff has determined to extend the previous relief.  Unlike the prior relief, there is no specific term for this relief, although it will be withdrawn if the PCAOB makes changes to the Loan Provision that address the SEC staff’s concerns.

For the time being, fund groups can continue to rely on their auditor’s independence as long as it continues to represent that it is objective and impartial with respect to the issues encompassed in its engagement.  In this regard, as noted by the SEC staff, since investors rely on audited financial statements in making their investment decisions, fund audit committees should still take care in reviewing any relationships between the funds’ auditor and the funds to ensure that the auditors meet the “independent and impartial” standard.

NASAA Survey Finds Seniors Are Most Vulnerable to Financial Fraud

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

On August 21, 2017, the North American Securities Administrators Association (“NASAA”) released a survey on senior citizens and financial exploitation. The survey of the state securities regulators highlighted, among other things, the need for the securities regulators to take a stronger role in prevention and detection.

The survey was conducted internally among NASAA’s membership of 67 state, provincial, and territorial securities administrators in the 50 states, the District of Columbia, Puerto Rico, the U.S. Virgin Islands, Canada, and Mexico, between July 24, 2017 and August 4, 2017. 36 regulators from NASAA member organizations responded. A summary of the findings is below:

  • There is greater awareness of the investment fraud or exploitation risks seniors face now than there was a year ago.
  • In the past year, there has not been a decrease in cases or complaints involving senior financial fraud or exploitation.
  • Agencies that reported an increase in cases or complaints involving senior financial fraud or exploitation have taken steps to diminish fraud, including investor education and senior outreach, adopting the NASAA Model Act to Protect Vulnerable Adults from Financial Exploitation, enforcement, etc. In fact, 52% of the surveyed jurisdictions have adopted legislation/regulation based on NASAA’s Model Act to Protect Vulnerable Adults from Financial Exploitation.
  • Despite adopting legislation/regulation, the majority of agencies continue to receive reports of suspected senior financial fraud or exploitation.
  • 77% of respondents have been successful in using disbursement holds to stop exploitation.
  • Most cases of senior financial fraud or exploitation go undetected until it is too late.
  • 75% of respondents believe that broker-dealers and investment advisers are not doing enough to prevent senior fraud.
  • 82% of respondents believe the “silent generation” is the most vulnerable to financial fraud.

A copy of the NASAA survey is available here.

Both the SEC and FINRA have stressed the importance of protecting elderly investors from financial exploitation, and have noted that the problem is only expected to grow as our population ages. A summary of FINRA’s activities and guidance relating to senior investors may be found here. In 2017, FINRA issued Regulatory Notice 17-11, and announced that it had received SEC approval on a rule proposal addressing the financial exploitation of seniors. The rule proposal, which becomes effective in February 2018, involves a two-step approach to protecting investors: (1) firms will be required to make reasonable efforts to obtain the name and contact information for a trusted contact person for a customer’s account and (2) firms will be permitted to place a temporary hold on a disbursement of funds or securities when there is reasonable belief of financial exploitation.¹  In addition, both FINRA and the SEC’s Office of Compliance Inspections and Examinations have identified this area as one of their examination priorities.

Our Take

The survey is yet another indication that many regulators are quite keen to take steps to help root out the financial exploitation of seniors. Broker-dealers can expect a continuing regulatory focus on the steps that they are taking to prevent this form of exploitation, and potentially, additional regulatory action in the future at the state level, in addition to FINRA’s continuing attention.

[1] Our firm’s discussion of the new rules may be found here.

PLI Webinar – Shadow-Boxing in 2017: An Update on Shadow Banking Reform

Posted in Events, Fund Regulation

Tuesday, September 26, 2017
12:00 p.m. – 1:00 p.m. EDT
5:00 p.m. – 6:00 p.m. BST

The Financial Stability Board has been spearheading a review of “shadow banking” entities and activities since the onset of the financial crisis.  Pursuant to the FSB’s work, many regulatory reforms have been introduced at both national and international level in a wide-range of different areas.  At the recent G-20 meeting in Germany, the FSB published an assessment of present shadow banking activities and the adequacy of reforms and policy tools that have been introduced since the financial crisis.  Issues to be covered during the presentation include:

  • Current aspects of shadow banking giving most concern to the G20;
  • Money market fund regulation and recent MMF Regulation finalized by the European Union;
  • Repos and effect of recent reforms;
  • Investment funds exposed to shadow banking risks; and
  • Impact of crowdfunding and peer to peer lending growth.


PLI will provide CLE credit.

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

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.