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The BD/IA Regulator

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

First State Charges Broker-Dealer in Connection with Violations of DOL Fiduciary Rule

Posted in Broker-Dealer Regulation, Enforcement

On February 15, 2018, the Enforcement Section of the Massachusetts Securities Division (the “Division”) of the Office of the Secretary of the Commonwealth charged a registered broker-dealer (the “Broker-Dealer”) that operated in Massachusetts with violating its own internal policies designed to ensure compliance with the U.S. Department of Labor’s (the “DOL”) Fiduciary Rule.

The DOL Fiduciary Rule

The DOL Fiduciary Rule significantly expands the scope of persons who will be deemed fiduciaries when dealing with retail retirement accounts.  Under the Rule, virtually any suggestion made by a financial intermediary to a retail retirement account regarding specific investments, investment strategies or investments advisers will result in the intermediary being deemed a fiduciary.  Certain communications with retail retirement investors will not trigger fiduciary status.  These communications include educational communications, and “hire me” communications that do not recommend a specific investment or investment strategy.

As a fiduciary, a financial intermediary is required to act in the best interest of its customer, without regard to the interests of the intermediary.  A fiduciary is also prohibited from receiving commissions and other forms of transaction-based compensation, and the fiduciary may not act as a principal in transactions effected with its client.  These prohibitions are particularly problematic for the broker-dealer industry, which was built on transaction-based compensation and often effects transactions on a principal basis.  Recognizing these problems, the DOL adopted two new prohibited transaction exemptions that, subject to numerous conditions, would permit the receipt of commissions or engaging in principal transactions.

The DOL is continuing to evaluate the Fiduciary Rule and has delayed full implementation of the Rule and related prohibited transaction exemptions until July 1, 2019.  However, on June 9, 2017, the basic requirements of the DOL Fiduciary Rule became applicable, as did the new Impartial Conduct Standards that must be met in order to receive commissions or other transaction-based compensation.  In connection with the delay in full implementation, the DOL and IRS indicated they would refrain from bringing enforcement actions against firms that were in good faith attempting to implement the new standards.

Impartial Conduct Standards

The Impartial Conduct Standards require broker-dealers and other intermediaries who advise retirement accounts and receive transaction-based compensation to: (i) act in the “best interest” of the retirement investor, considering such investor’s investment objectives, risk tolerance, financial circumstances and needs; (ii) avoid receiving unreasonable compensation; and (iii) ensure that disclosure about compensation, conflicts of interest and other matters relevant to an investor’s decision is not misleading.

The Massachusetts Complaint

The Broker-Dealer in the Massachusetts case prepared to comply with the DOL Fiduciary Rule by including provisions in its brokerage and investment advisor compliance manuals, which stated that “the firm does not use or rely on quotas . . . contests, special awards or incentives that are intended or reasonably expected to cause associates to make recommendations that are not in the best interest of [r]etirement [a]ccount clients or prospective [clients].”  The Division alleges that the Broker-Dealer failed to implement and enforce its own policy by running sales contests that rewarded associates for generating new net assets, including retirement assets.  While the Division alleges a variety of “aggressive sales practices,” the Complaint mainly discusses the use of such practices to gather assets, without necessarily specifying any instances where such sales practices influenced specific investment recommendations made to retirement investors.  The Division also alleges that the Broker-Dealer failed to inform the customers of the conflicts arising from the sales contests.  As a result, the Broker-Dealer was charged with violating the relevant provisions of the Massachusetts Uniform Securities Act.

In its Complaint, the Division seeks, among other things, a cease and desist order, disgorgement of illicit profits and an unspecified administrative fine.  The Broker-Dealer has not yet responded to the Complaint.

Our Take-Aways

The Massachusetts action is a timely reminder that the basic requirements of the DOL Fiduciary Rule are in effect, and broker-dealers as well as other financial intermediaries need to ensure that their practices comply with these new standards.  While the DOL may refrain from active enforcement prior to July 1, 2019, enforcement actions by state regulators and private civil actions may be predicated on violations of the fiduciary standards imposed by the DOL Fiduciary Rule.

In order to comply with the new standards, broker-dealers and other financial intermediaries need to review their internal compensation systems to eliminate any arrangements or practices that could reasonably be expected to incentivize brokers or other financial advisers to make recommendations that are not in the best interest of the retail retirement investor.  Sales contests or quotas that reward brokers for pushing specific products or strategies that may not be in the best interest of a retail retirement investor are problematic and should not be utilized.

That said, the Massachusetts Complaint appears to focus on sales contests that were designed to reward brokers for bringing in new assets.  Sales efforts focused on bringing in new accounts could fall within the “hire me” exception.  The Complaint is not clear about the extent to which the “aggressive sales practices” included contests or other compensation arrangements that rewarded brokers for recommending specific products or for generating transaction-based commissions. In that sense, the Complaint reflects in large measure the regulator’s view that broker-dealers who are now deemed fiduciaries under the DOL Fiduciary Rule may be charged with violations under the Massachusetts state securities laws to the extent that the broker-dealers fail to enforce policies adopted to comply with the new fiduciary standards.

In any event, to better ensure compliance with the DOL Fiduciary Rule, broker-dealers should implement the following measures:

  • meet with retail retirement investors on a regular basis and make sure they have an adequate understanding of the client’s current circumstances an objectives;
  • conduct thorough diligence on all investment products offered to retail retirement investors;
  • document the basis for the agent’s conclusion that a particular investment product is in the best interest of the customer;
  • evaluate internal compensation arrangements to ensure that they do not improperly incentivize sales agents to recommend products or strategies that are not in the best interest of the client;
  • train all sales agents and supervisors to comply with the new requirements and internal policies;
  • monitor account activity with a view to detecting potential deviations from the new best interest standard;
  • establish procedures for documenting the reasonableness of compensation received from transactions with retail retirement accounts;
  • establish and enforce procedures to identify, manage and disclose conflicts of interest; and
  • revisit distribution arrangements for new issues to ensure they comply with the new standards.

For more information about the rule, see the following link or visit Morrison & Foerster’s BD/IA Regulator blog to keep abreast of all DOL Fiduciary Rule developments.

MiFID II & PRIIPs – The Early Days

Posted in Events

Friday, February 23, 2018

Registration:
8:30 a.m. – 9:00 a.m.

Workshop:
9:00 a.m. – 10:30 a.m.

Risk.net Workshop

One Moorgate Place
Chartered Accountants Hall
1 Moorgate Pl
London, United Kingdom
EC2R 6EA

The first few days of 2018 saw the implementation of two major pieces of EU legislation, MiFID II (comprising a new Markets in Financial Instruments Regulation and a recast Markets in Financial Instruments Directive) and the PRIIPs Regulation. MiFID II involves a significant overhaul of the regulation of financial markets in the EU including a significant extension of the regulation of market infrastructure. The PRIIPs Regulation is more narrowly focused but will still have a significant impact on financial markets, requiring a Key Information Document (KID) to be prepared every time an packaged investment product or insurance-based product is sold to a retail investor. There are already reports of significant teething issues in relation to the implementation of both MIFID II and PRIIPs.

During this complimentary workshop, we will look in more depth at some of the key issues in relation to the implementation of both pieces of legislation and some of the practical issues faced by firms. Topics to be discussed include:

MiFID II

  • Impact of the new product governance rules;
  • Roll-out of the trading obligation for derivatives;
  • Issues relating to the new rules relating to conflicts of interest and inducements; and
  • The new product intervention powers and their early application to CFDs.

PRIIPs

  • Uncertainties as to the scope of the Regulation and application to certain products;
  • Issues relating to performance scenario information to be included in the KID and the recent communication by the UK’s FCA;
  • Concerns over potential liability for issuers and extraterritorial scope; and
  • Problems caused by lack of grandfathering relief and application to secondary sales.

Speakers:

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

Senate Considers Legislation That Would Loosen BDC Restrictions

Posted in Investment Adviser Regulation

On January 18, 2018, the Small Business Credit Availability Act was introduced in the U.S. Senate and referred to the Committee on Banking, Housing, and Urban Affairs.  The Act would amend the Investment Company Act of 1940 to change certain requirements relating to the capital structure of business development companies (BDCs) and direct the Securities and Exchange Commission (SEC) to revise certain rules to allow BDCs to take advantage of securities offering and communication exemptions currently available to other companies.

In particular, the Act would decrease the asset coverage requirement applicable to BDCs from 200% to 150%.  BDCs would be permitted to employ leverage up to two-thirds of their total equity.  Increasing the leverage limit may allow BDCs, which are a significant source of capital for small and medium-sized businesses, to deploy additional lower risk senior capital to borrowers and potentially increase their total returns without needing to deploy higher risk junior capital in order to obtain higher yields due to the lower leverage limit.

The Act would also direct the SEC to remove the application of various securities law administrative burdens on BDCs to align with reforms currently available to other companies.  Specifically, BDCs would be included in the SEC’s definition of “well-known seasoned issuer” and permitted to file automatic shelf registration statements to expedite the securities offering process.  Additionally, BDCs that would otherwise meet the requirements of Form S-3 would be permitted to incorporate by reference their publicly filed periodic reports into the BDC’s Form N-2 registration statement.

The Act will be considered by the Committee before it is possibly sent to the full Senate for review.  A companion bill that would similarly update rules governing BDCs was advanced with bipartisan support by the U.S. House Financial Services Committee in November 2017.

OCIE Announces Its 2018 Examination Priorities

Posted in Broker-Dealer Regulation, Fund Regulation, Investment Adviser Regulation

The SEC’s Office of Compliance Inspections and Examinations (OCIE) has published its 2018 examination priorities. Not surprisingly, it will continue to focus on the protection of retail investors and ensuring that registrants are appropriately disclosing or resolving conflicts of interest. In addition, OCIE will pay particular attention to developments in cryptocurrencies and initial coin offerings (ICOs). OCIE also identified its oversight of FINRA and the MSRB as an area of focus, which should be of particular interest to broker-dealers and municipal securities dealers.

Read our client alert.

2018: Business As (Un)usual – European Financial & Regulatory Developments into 2018

Posted in Broker-Dealer Regulation, Fund Regulation, Investment Adviser Regulation, Research

2017 in the UK and the rest of Europe seems to have been primarily a year devoted to implementation – both of political decisions already made and of legislation that had already been enacted.  On the political front, Brexit continued to dominate many conversations around EU financial services.  Theories circulated that EU decisions on various equivalence and passporting provisions, intended to be based on regulatory system comparisons, were being delayed for political reasons linked to the continued non-finalization of a deal on the post-Brexit relationship between the UK and the rest of the EU.  After Brexit, it is likely that UK financial services entities will lose the benefit of EU financial “passports” and may need to try and utilize the existing provisions on equivalence for non-EU countries.  Equivalence is a recognition from the EU that the non-EU country’s financial regulations and supervision are of the same standard as those of the EU.  Given that the UK, as a member state of the EU, already has such standards in place, granting equivalence status to the UK post-Brexit would be a logical step.  However, politics and logic make strange bedfellows.  UK financial services entities will be watching this area closely in 2018.

Read our annual outlook report, where we set out our summary of the progress of some important areas of financial regulation in 2017 and look ahead to expected developments in 2018.

Tax Reform Webinar Series

Posted in Events

Wednesday, February 7, 14 and 21, 2018
1:00 p.m. – 2:00 p.m. EST

Morrison & Foerster and Wolters Kluwer Webinar Series

The Tax Cuts and Jobs Act of 2017 (H.R.1), signed into law by President Trump on December 22, 2017, is the most sweeping change to the U.S. tax code in decades. This historic bill impacts every taxpayer, and calls for lowering the individual and corporate tax rates, repealing the ACA’s shared responsibility requirement, enhancing the child tax credit, and more.

Morrison & Foerster and Wolters Kluwer will host a complimentary three-part webinar series focusing on three of the most impactful areas within the tax overhaul:

Session 1: Tax Changes Affecting Holders of Pass-Through Vehicles
Wednesday, February 7, 2018; 1:00 p.m.–2:00 p.m. EST

Session 2: Corporate Taxation — Domestic Tax Law Changes
Wednesday, February 14, 2018; 1:00 p.m.–2:00 p.m. EST

Session 3: Corporate Taxation — International Tax Changes
Wednesday, February 21, 2018; 1:00 p.m.–2:00 p.m. EST

Speakers:

Wolters Kluwer will provide CLE credit.

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

10th Annual Structured Products Association Legal, Regulatory & Compliance Update

Posted in Broker-Dealer Regulation, Events, Investment Adviser Regulation

Monday, February 5, 2018
6:00 p.m. – 8:30 p.m.

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

The Structured Products Association and Morrison & Foerster are pleased to host this annual Legal, Regulatory & Compliance Update for friends, clients and members on February 5, 2018.

Join us for a timely presentation on current developments in the legal-regulatory-compliance landscape. This presentation will cover a wide range of topics related to structured products.

Topics:

  • Tax reform update and considerations;
  • FINRA priorities letter and SEC retail task force and priorities;
  • The DOL’s Fiduciary Rule and the status of the SEC’s proposed Rule;
  • Moving away from LIBOR and LIBOR fallback measures; and
  • Structured note issuance platforms.

This event is traditionally standing-room only, so kindly register today. Hors d’oeuvres and cocktails will be served at the beginning and the end of the event, respectively. The event is closed to press.

To RSVP, please click here.