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The BD/IA Regulator

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

CFTC Staff Issues Interpretation Regarding Position Limits Aggregation by Passive Investors in Commodity Pools

Posted in Fund Regulation

On May 2, 2018, staff of the Division of Market Oversight of the Commodity Futures Trading Commission (“CFTC”) issued an interpretation regarding CFTC Reg. 150.4(b)(1), 17 CFR 150.4(b)(1), which provides an exemption from the CFTC’s position limits aggregation rules for certain passive investors in commodity pools (CFTC Staff Letter No. 18-12).

In general, market participants are required to aggregate all positions in accounts for which the person, by power of attorney or otherwise, directly or indirectly controls trading or holds a 10 percent or greater ownership or equity interest, absent an exemption. CFTC Reg. 150.4(b)(1) provides an exemption from aggregation to a person who is a passive investor (i.e., a person that is a limited partner, limited member, shareholder, or other similar pool participant) that holds a 10 percent or greater ownership or equity interest in a commodity pool, unless the person is excluded by one of the three exceptions contained in the regulation.

The requestor of the interpretation asked the CFTC staff to consider a situation in which a large institutional investor, through its passive ownership interest in private equity or venture capital funds that retain the right to invest in commodity interests and thus are considered commodity pools, might indirectly own more than 10 percent of an underlying “portfolio company” in which the pool was invested. Such portfolio companies were operating companies that might be engaged in commercial operations in the agricultural and energy sectors. The requestor sought clarification that it would not be required to aggregate any commodity interest positions that might be held by these portfolio companies by virtue of its indirect ownership interest through its passive pool investment.

The CFTC staff’s interpretation clarifies that, so long as the institutional investor is otherwise eligible for the aggregation exemption in CFTC Reg. 150.4(b)(1) (i.e., a passive investor in a commodity pool eligible to rely upon the exemption and not excluded through one of Reg. 150.4(b)(1)’s three exemptions) and did not either control trading for, or have another relationship with, the portfolio company that would require aggregation (such as an express or implied agreement to trade in concert), the investor would not be required to “look through” the commodity pool to aggregate the positions of the underlying portfolio companies invested in by the pool with its own positions. In other words, the interpretation clarifies that the institutional investor’s CFTC Reg.150.4(b)(1) aggregation exemption with respect to its investment in a commodity pool extends to its 10 percent or greater indirect interest (via the pool) in portfolio companies for which it does not control trading or have another relationship requiring aggregation. The interpretation notes, however, that it does not apply in a situation in which a passive investor invests in alternative or parallel funds with the intention to circumvent position limits.

The interpretation is available here.

Retail Client Confusion Regarding Broker-Dealers and Investment Advisers: Call Me by Your Name

Posted in Broker-Dealer Regulation, Investment Adviser Regulation

In a speech on May 2, 2018 regarding the SEC’s recent proposed broker-dealer standard of conduct, Jay Clayton, Chair of the Securities and Exchange Commission (SEC), commented as follows on retail investor confusion over whether their financial service providers are investment advisers or broker-dealers:

“‘Financial advisor,’ ‘financial consultant,’‘wealth manager.’  Your financial professional may have any of a number of different titles that firms use to advertise their services.”

Because of the perceived confusion caused by the titles and names used by broker-dealers and their personnel in particular, the SEC stated in its release proposing a new client relationship summary (Proposed Form CRS) that broker-dealers and their personnel should be restricted from using the specific terms “adviser” or “advisor” when communicating with retail investors (i.e., all natural persons).  According to the SEC, these terms are too close to the term “investment adviser” and should not be used except by a registered investment adviser or by the supervised persons of a registered adviser, in order to avoid investor confusion.

The SEC requests comment on a number of issues related to its proposal, including:

  • Are there additional terms that should be restricted? For example, wealth manager, financial consultant, financial manager, money manager, investment manager, or investment consultant?
  • Is it necessary to put restrictions on the use of names or titles in light of the proposed new Form CRS?
  • Should the proposed restrictions be limited to communications with retail investors?

Our Take

As the SEC itself states in its Form CRS proposal, “both broker-dealers and investment advisers provide investment advice to retail investors, but the regulatory regimes and business models under which they give that advice are different.”  These differences—in compensation structures, conflicts, disclosure obligations, and standards of conduct—can be difficult even for well-trained investment management professionals to perceive and understand.  As a result, it is not clear that simply banning the terms “adviser” and “advisor”—even in conjunction with a new relationship summary—will adequately prevent retail investor confusion.  However, the SEC has put forth a reasonable plan for at least beginning to address investor confusion, and that plan will hopefully only be improved upon during the comment period.

Comments on the SEC’s proposal may be submitted for 90 days following its publication in the Federal Register.

SEC Proposes Simplified Relationship Summary for Broker-Dealers and Investment Advisers to Use with Retail Investors

Posted in Broker-Dealer Regulation, Investment Adviser Regulation

In the third release comprising part of the package of proposed rules and forms related to broker-dealers’ and investment advisers’ standards of conduct, the SEC proposed a new disclosure document to be used by registered broker-dealers, registered investment advisers, and dual registrants. The new client relationship summary, or “Form CRS,” would provide certain basic disclosures to retail investors at the account opening stage. Form CRS would be an additive disclosure; it is not designed to replace existing disclosures provided to clients or potential clients, or filings made with the Commission. It would be supplemented by disclosures, made on a periodic basis or at the point-of-sale, as might be required to ensure that retail investors are fully informed of material conflicts of interest and other relevant information.

This alert is one in a series of Client Alerts on recent SEC proposals regarding regulation of broker-dealers and investment advisers.

Read our client alert.

Enforcement Issues FAQs on the Share Class Selection Disclosure Initiative

Posted in Enforcement, Investment Adviser Regulation, SEC Enforcement

On May 1, the SEC’s Division of Enforcement issued a series of frequently asked questions (FAQs) related to its Share Class Selection Disclosure Initiative (“SCSD Initiative”). The SCSD Initiative, which was originally announced February 12, 2018, provides that the Enforcement Division will agree to recommend to the Commission standardized, favorable settlement terms for investment advisers who self-report possible securities law violations related to their failure to make certain disclosures concerning mutual fund share class selection.

Under the SCSD Initiative, the cut-off date for self-reporting is June 12, 2018.


Over the last several years, the SEC filed several administrative actions against investment advisers that failed to adequately disclose to clients conflicts of interest arising from the receipt of 12b-1 fees for investing clients in, or recommending that clients invest in, a mutual fund share class that paid the adviser a 12b-1 fee when a lower cost share class was also available. The SEC took issue with the fact that such entities disclosed that they “may” receive 12b-1 fees and that such fees “may” create a conflict of interest. According to the SEC, such disclosure is not compliant with provisions of the Investment Advisers Act of 1940 that require disclosure of an adviser’s material conflicts of interest related to its mutual fund share class selection practices.

The FAQs

Among other things, the recent FAQs clarify that an adviser can rely on the SCSD Initiative only with respect to the specific self-reporting opportunity outlined in the original announcement. The Enforcement Division will not extend the SCSD Initiative settlement terms to other instances where an adviser failed to disclose conflicts of interest related to other fees received in connection with recommending, purchasing, or holding higher cost share classes. The Enforcement Division also confirmed that it does not plan to recommend fundamentally different settlement terms for advisers based on the relative “severity and scope” of an adviser’s conduct.

Importantly, the FAQs clarify that an adviser that has been or is being examined by the SEC’s Office of Compliance Examinations and Inspections (OCIE) cannot rely on its interactions with OCIE as self-reporting for purposes of the SCSD Initiative. The only way to ensure that the Enforcement Division will recommend favorable SCSD Initiative settlement terms is for the adviser to self-report as described in the initial announcement. The Division made it clear that “advisers that have been or are being examined by OCIE regarding the issues covered by the SCSD Initiative but, as of February 12, 2018, had not been contacted by the Division regarding possible violations related to their failures to disclose the conflicts of interest associated with mutual fund share class selection,” are eligible to participate in the SCSD Initiative, regardless of the outcome of the OCIE exam.

The FAQs also provide clarity regarding how the Division staff intends to determine the amount of disgorgement an adviser will be asked to make, how an adviser should determine if a lower fee share class was “available,” and that an adviser would be eligible to participate in the SCSD Initiative if it failed to disclose conflicts related to both (i) making an investment decision in light of the receipt of 12b-1 fees and (ii) selecting the more expensive class of shares. Importantly, any adviser entering into a settlement pursuant to the SCSD Initiative would be required to make certain specific undertakings, including an evaluation of whether existing clients should be moved to a lower cost share class, moving any such clients, and notifying its clients of the settlement terms.

Our Take

The FAQs clarify that the Division does not intend to extend the June 12, 2018 deadline to self-report and that advisers are encouraged to consult with experienced counsel to determine if participation in the SCSD Initiative would have any collateral consequences. Although it is unlikely that entering into a settled administrative action would be without any consequences, if an adviser does not do so, and is later determined to not have fully complied with its disclosure obligations regarding receipt of 12b-1 fees, it is likely that any collateral consequences of a resulting enforcement action would be more severe.

The SEC’s Standard of Conduct Proposals Would Raise the Bar on Investment Advisers

Posted in Investment Adviser Regulation

According to the SEC, its April 18, 2018 release proposing an interpretation of the standard of conduct for investment advisers is intended to “reaffirm – and in some cases clarify – certain aspects of the fiduciary duty that an investment adviser owes to its clients under section 206” of the Investment Advisers Act of 1940. As discussed in greater detail in this alert, however, the proposed interpretation, if adopted, appears to expand the parameters of the fiduciary duty standard and could require advisers to take on additional regulatory obligations.

This alert is one in a series of Client Alerts on recent SEC proposals regarding regulation of broker-dealers and investment advisers.

Read our client alert.

SEC Proposes a New Standard of Care for Broker-Dealers: Regulation Best Interest

Posted in Broker-Dealer Regulation

On April 18, 2018, the SEC introduced new Regulation Best Interest for broker-dealers and their associated persons when dealing with retail customers. This alert provides background of broker-dealer regulation, an overview of Regulation Best Interest, and our take on what this means for broker-dealers going forward.

This alert is one in a series of Client Alerts on recent SEC proposals regarding regulation of broker-dealers and investment advisers.

Read our client alert.

FINRA Proposes Amendments to Quantitative Suitability Rules

Posted in Broker-Dealer Regulation

On April 20, 2018, FINRA issued proposed amendments to Rule 2111’s “quantitative suitability” provisions. According to FINRA, the proposal is designed to more effectively counter the problem of “churning,” or excessive trading in customer accounts.

As discussed below, the proposal arrives shortly after the SEC’s proposal of “Regulation BI” and illustrates how these two regulators will need to coordinate in order to ensure that broker-dealers are not subject to inconsistent sets of rules.

The proposal, issued in Regulatory Notice 18-13, may be found here. We have previously discussed the three main obligations imposed by Rule 2111 (reasonable-basis suitability, customer-specific suitability and quantitative suitability) in Frequently Asked Questions which may be accessed here.)

Summary of the Change

FINRA’s new proposal addresses Rule 2111’s quantitative suitability requirements.

The quantitative suitability obligation currently requires a FINRA member (or associated person) who has “actual or de facto control” over a customer account to have a reasonable basis to believe that a series of recommended transactions, even if suitable when viewed in isolation, are not excessive and unsuitable for the customer when taken together in light of the customer’s investment profile. Excessive trading or “churning” of a customer’s account will typically violate this rule.

The proposed rule amendments would remove the concept of “control” that is currently needed to demonstrate a violation. Under the existing rule, if a broker does not control a customer’s account, the quantitative suitability obligation does not apply when the broker recommends a series of transactions, even if that series of transactions is excessive and unsuitable. Under the proposed amendments, a broker’s conduct would violate the rule even if the broker only recommended the relevant transactions, if the level of trading was excessive and unsuitable for the customer.

Why Now?

In connection with the proposals, FINRA noted that it has reconsidered the appropriateness of the “control” requirement due to its experience with the rule, the other requirements of the rule and, in light of current events, the SEC’s proposed Regulation BI (we discuss the newly-proposed Regulation BI in this blog entry). FINRA notes that Regulation BI, while incorporating a prohibition on excessive trading, does not have a “control” requirement like the one found in current Rule 2111.

FINRA noted that it is not always clear when there is “actual” or “de facto” control over an account. To the extent that de facto control may depend upon whether the customer follows the broker’s advice routines, because it cannot independently evaluate the recommendation, the customer must admit that it lacks sophistication in order to make a claim under the existing provision. This can be the case even where it is otherwise clear that the broker recommended the relevant transactions and that they were excessive. In effect, the control element appears to create an unwarranted defense for otherwise unscrupulous brokers.


FINRA is optimistic that the proposal would impose only modest compliance burdens on members. This is because FINRA believes that most firms already routinely perform compliance reviews for excessive trading activity, whether or not a broker “controls” the relevant account. However, if the proposal is enacted, some member firms may need to update their written supervisory procedures to reflect the change.

Request for Comments

The comment period for this proposal will extend until June 19, 2018. FINRA has set forth a variety of specific and general questions relating to the proposal, including the potential economic impact. FINRA is also seeking confirmation that members do in fact review accounts for excessive trading, whether or not the broker “controls” the account.

Our Take

We think that it is likely that the SEC and FINRA will coordinate to some extent their rulemaking activities in the next several months, especially while market participants comment on proposed SEC Regulation BI. A degree of harmonization will be needed to ensure that broker-dealers will be subject to SEC rules and FINRA rules that work together effectively and render their compliance obligations clear.