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The BD/IA Regulator

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

SEC Staff Raises Concerns Related to Cryptocurrency ETFs and Mutual Funds

Posted in Cybersecurity/Privacy, Fund Regulation

On January 18, 2018, the Securities and Exchange Commission’s (SEC) Division of Investment Management broke its relative silence regarding the recent growth of cryptocurrencies and cryptocurrency-related products. While signaling that registration of funds intending to invest substantially in cryptocurrency and related products is not on the immediate horizon, the guidance arguably provided the beginnings of a much-needed roadmap for the future development of registered open-ended funds (“mutual funds”) and exchange-traded funds (ETFs) linked to cryptocurrencies and related products.

Read our client alert.

Complimentary Teleconference – Financing Fintech: State Regulation of Marketplace Lenders as Loan Brokers or Arrangers of Credit

Posted in Events

Thursday, January 25, 2018
5:00 p.m. – 5:45 p.m. EDT

Join us for one of our upcoming monthly telephone briefings led by members of our Fintech team:

This call will be an operator-assisted call of approximately 45 minutes in duration, and will be followed by a brief Q&A opportunity. We also invite you to submit questions before the start of the call. A replay will be available upon request.

In order to RSVP for the January call, and to submit questions, please email us.

FINRA Publishes FAQs on New Measures to Prevent the Financial Exploitation of Seniors

Posted in Broker-Dealer Regulation, FINRA Enforcement

In January 2018, FINRA issued guidance on the provisions of Rule 2165 and the amendments to Rule 4512, which were approved in February 2017. The new requirements are aimed at preventing the financial exploitation of seniors, and are scheduled to take effect on February 5, 2018. The new FAQs principally reiterate prior guidance clarifying the changes. For example, a significant portion of this guidance was previously discussed in the supplemental materials that accompanied the new rules.

Generally, Rule 2165 allows FINRA members to place temporary holds on the disbursement of funds or securities from accounts belonging to customers when there is a “reasonable belief” of financial exploitation. Amendments to Rule 4512 complement this policy by requiring members to make “reasonable efforts” to acquire the name and contact information of a “trusted contact person” for each customer’s account, who can serve as a resource for the member in protecting the account from financial exploitation. The FAQs elaborate on these requirements, advising on their scope and application, in order to assist member firms in their understanding.

The FAQs highlight a number of key points concerning Rule 2165, including:

  • The rule does not apply to securities transactions, but may apply to the proceeds from such a transaction if they were to be disbursed from an account in which there is a reasonable belief of financial exploitation.
  • As stressed in previous FINRA materials, disbursements are to be analyzed separately under the rule, rather than on the basis of an entire account (although an entire account may be restricted if procedures are in place to allow legitimate transactions).
  • A temporary hold under Rule 2165 can be extended at the request of a state agency, which need not be formal; however, FINRA must keep a record of the request.

The guidance further explains the related amendments to Rule 4512, noting:

  • Any natural person 18 years or older may be designated a “trusted contact,” with the intended role of serving as a resource to the member in administering a customer’s account and protecting him or her from financial exploitation.
  • Members are authorized to disclose to trusted contacts certain information about an account in order to confirm the customer’s contact information, health status, or the identity of any legal guardian, executor, trustee, or holder of power of attorney. Members must disclose this authorization to the customer upon opening the account or upon updates to the account by the customer; this disclosure need not take any particular form.
  • The rule’s trusted contact provision applies to all non-institutional accounts, including those of non-natural persons, in which case an authorized agent on the account may be the trusted contact.
  • Members may obtain trusted contact information collectively for customers with multiple accounts.

Additional Materials:

The FAQs can be accessed on FINRA’s website here.

The full text of Rule 2165 can be found here.

The full text of Rule 4512, as amended, can be found here.

We previously discussed these new rules here.


Understanding the Standard of Care for Broker-Dealers and the Department of Labor’s Fiduciary Rule

Posted in Broker-Dealer Regulation, Investment Adviser Regulation

Until recently, broker-dealers operating in the United States weren’t subject to a fiduciary standard when dealing with their retail clients.

The passage of the Dodd-Frank Act in 2010 included a provision enabling the Securities and Exchange Commission to consider and propose a higher standard of care for broker-dealers – something which it has not yet done but appears intent on pursuing this year. The Department of Labor (DOL) on its own adopted a fiduciary standard in 2016 for retail clients. This has been met with much controversy and criticism. President Trump weighed into the debate, ordering the DOL in early 2017 to re-evaluate the rule and its impact, pushing the DOL to postpone the DOL rule’s full implementation to 2019.

The report explains how the rule works and its impact in practice, taking into account uncertainty as to its final version.

Read our report here.

SEC Releases Liquidity Rule FAQs

Posted in Fund Regulation, Investment Adviser Regulation, SEC Enforcement

The staff of the SEC’s Division of Investment Management released this week a series of frequently asked questions (FAQs) regarding new Rule 22e-4 (the “Liquidity Rule”). The Liquidity Rule requires non-money market mutual funds and certain exchange-traded funds (ETFs) to adopt and implement a liquidity risk management (LRM) program designed to reduce the risk that funds will be unable to meet their redemption obligations and to mitigate dilution of the interests of fund shareholders.

The FAQs relate to sub-advised funds and ETFs that meet redemptions through in-kind transfers of securities, positions, and assets other than a de minimis amount of cash (“In-Kind ETFs”), and are a timely reminder that the compliance date for the Liquidity Rule is fast approaching. Funds that, together with other investment companies in the same group of related investment companies, have net assets of $1 billion or more as of the end of their most recent fiscal year must implement an LRM program by December 1, 2018. Smaller entities have until June 1, 2019 to comply with the Liquidity Rule.

For more information, read our client alert.

SEC Enforcement Division Announces its 2018 Priorities and 2017 Results

Posted in SEC Enforcement


The Securities and Exchange Commission’s Division of Enforcement (the “Division”) has published its annual report for fiscal year 2017 (the “Report”). The Report is available at the following link: https://www.sec.gov/files/enforcement-annual-report-2017.pdf. The Report discusses the Division’s key initiatives and results in 2017[1] and its priorities for 2018.

Below, we discuss a number of areas that may be of particular interest to a number of market participants and clients, including some specific items that the Division raises in the Report.

Division’s Enforcement Agenda

In June 2017, Stephanie Avakian and Steven Peikin were appointed as co-directors of the Division. Both share the view that “[v]igorous enforcement of the federal securities laws is critical to combat wrongdoing, compensate harmed investors, and maintain confidence in the integrity and fairness of our markets.”[2] Co-Director Avakian mentioned during the 49th Annual Institute on Securities Regulation that “enforcement [of federal securities laws] is a bi-partisan issue, but we do not expect a big shift in enforcement.”[3]

There are five principles that guide the Division’s decision making (and also, arguably, its 2018 initiatives and priorities):

  1. Focus on the Main Street investor.
  2. Focus on individual accountability.
  3. Keep pace with technological change.
  4. Impose sanctions that most effectively further enforcement goals.
  5. Constantly assess the allocation of Division resources.

New: Retail Strategy Task Force

The SEC announced the creation of the Division’s Retail Strategy Task Force in September 2017.[4] The task force is dedicated to developing effective strategies and methods to identify potential harm to retail investors, and focused on harnessing the SEC’s ability to use technology and data analyt­ics to identify large-scale wrongdoing.[5]

The task force will focus not only on wrongdoing implicating the microcap market, Ponzi schemes and offering frauds (where retail investors are typically the victims), but also on misconduct at the intersection of investment professionals and retail investors.[6] Co-Director Avakian explained in a recent speech[7] that:

The issues we see in this space are extensive and often involve widespread incidents of misconduct, such as charging inadequately disclosed fees, and recommending and trading in wholly unsuitable strategies and products. Some more specific examples of some of the problems we are continuing to see:

  • Investment professionals steering customers to mutual fund share classes with higher fees, when lower-fee share classes of the same fund are available.[8]
  • Abuses in wrap-fee accounts, including failing to disclose the additional costs of “trading away” or trading through unaffiliated brokers,[9] and purchasing alternative products that generate additional fees.[10]
  • Investors buying and holding products like inverse exchange-traded funds (ETFs) for long-term investment. These can be highly volatile products that are generally intended as a hedge against exposure to downward moving markets, and that face a long-term high risk of losing their principal.[11] Yet, we are increasingly seeing retail investors holding these products long-term, including in retirement accounts.[12]
  • Problems in the sale of structured products to retail investors, including a failure to fully and clearly disclose fees, mark-ups, and other factors that can negatively impact returns.
  • Abusive practices like churning and excessive trading that generate large commissions at the expense of the investor.[13]

New: Cyber Unit

The Division’s most prominent cyber-related efforts for 2017 include (i) the SEC’s Report of Investigation that concluded that the federal securities laws may apply to certain initial coin offerings (“ICOs”) or other distributed ledger or blockchain-enabled means for raising capital, depending on the facts and circumstances;[14] and (ii) the SEC Office of Compliance Inspec­tions and Examinations’ public statement concerning endorsements of stocks and other investments by celebrities and others on social media networks.[15]

In September 2017, the SEC announced the creation of the Division’s Cyber Unit.[16] The Cyber Unit combines the Division’s cyber-related expertise and its proficiency in digital ledger technology to combat cyber-related threats to the securities markets.[17]  The unit will initially focus its efforts on the following key areas:

  • market manipulation schemes involving false information spread through electronic and social media;
  • hacking to obtain material nonpublic information and trading on that information;
  • violations involving distributed ledger technology and ICOs;
  • misconduct perpetrated using the dark web;
  • intrusions into retail brokerage accounts; and
  • cyber-related threats to trading platforms and other critical market infrastructure.[18]

On Accountability, Sanctions and Resource Allocation

  • Individual accountability:  According to the Report, individual accountability more effectively deters wrongdoing, and this is the standing enforcement rule rather than the exception.[19] In 2017, 73% of the SEC’s standalone actions involved charges against one or more individuals.[20]
  • Tailored sanctions: The Division is committed to imposing an appropriate package of remedies which will be most meaningful in furthering its enforcement objectives. Possible remedies may include obtaining monetary relief in the form of disgorgement, penalties, and asset freezes; barring wrongdoers from working in the securi­ties industry; and, when appropriate, obtaining more tailored relief, such as specific under­takings, admissions of wrongdoing, and monitoring or other compliance requirements.[21]

Considering the Division’s resources, it will focus on “allocating them to address the most significant market risks and in the most effective manner, keeping front of mind the violators who pose the most serious threats to investors and market integrity.”[22]

[1] The Report indicates that a total of 754 enforcement actions were brought in fiscal year 2017.

[2] Report, at page 1.

[3] Government Enforcement Priorities: What’s New, What’s Hot and What’s Not? 49th Annual Institute on Securities Regulation (November 10, 2017), available at https://www.pli.edu/Content/Seminar/49th_Annual_Institute_on_Securities_Regulation/_/N-4kZ1z10fx6.

[4] Press Release 2017-176, SEC Announces Enforcement Initiatives to Combat Cyber-Based Threats and Protect Retail Investors (September 25, 2017), available at https://www.sec.gov/news/press-release/2017-176.

[5] Report, at page 5.

[6] Report, at page 5.

[7] Stephanie Avakian, The SEC Enforcement Division’s Initiatives Regarding Retail Investor Protection and Cybersecurity (October 26, 2017), available at https://www.sec.gov/news/speech/speech-avakian-2017-10-26.

[8] Press Release 2017-165, SunTrust Charged With Improperly Recommending Higher-Fee Mutual Funds (September 14, 2017), available at https://www.sec.gov/news/press-release/2017-165; Press Release 2017-98, Barclays to Pay $97 Million for Overcharging Clients (May 10, 2017), available at https://www.sec.gov/news/press-release/2017-98; Cadaret, Grant & Co., Inc., Exchange Act Release No. 81274 (August 1, 2017), available at https://www.sec.gov/litigation/admin/2017/34-81274.pdf; Credit Suisse Securities (USA) LLC, Exchange Act Release No. 80373 (April 4, 2017), available at https://www.sec.gov/litigation/admin/2017/34-80373.pdf.

[9] Press Release 2016-143, SEC Charges Investment Adviser With Failing to Clearly Disclose Additional Costs to Investors (July 14, 2016), available at https://www.sec.gov/news/pressrelease/2016-143.html.

[10] WFG Advisors, L.P., Exchange Act Release No. 78189 (June 28, 2016), available at https://www.sec.gov/litigation/admin/2016/34-78189.pdf.

[11] U.S. Sec. & Exch. Comm’n, Office of Investor Education and Advocacy, Leveraged and Inverse ETFs: Specialized Products with Extra Risks for Buy-and-Hold Investors (August 1, 2009), available at https://www.sec.gov/investor/pubs/leveragedetfs-alert.htm.

[12] Press Release 2017-46, Morgan Stanley Settles Charges Related to ETF Investments (February 14, 2017), available at https://www.sec.gov/news/pressrelease/2017-46.html.

[13] Press Release 2017-180, SEC Detects Brokers Defrauding Customers (September 28, 2017), available at https://www.sec.gov/news/press-release/2017-180; Press Release 2017-2, SEC Charges Two Brokers With Defrauding Customers (January 9, 2017), available at https://www.sec.gov/news/pressrelease/2017-2.html.

[14] Report, at page 5 citing  Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO (July 25, 2017), available at https://www.sec.gov/litigation/investreport/34-81207.pdf.

[15] Report, at page 5 citing Statement on Potentially Unlawful Promotion of Initial Coin Offerings and Other Investments by Celebrities and Others (November 1, 2017), available at https://www.sec.gov/news/public-statement/statement-potentially-unlawful-promotion-icos.

[16] Press Release 2017-176, SEC Announces Enforcement Initiatives to Combat Cyber-Based Threats and Protect Retail Investors (September 25, 2017), available at https://www.sec.gov/news/press-release/2017-176.

[17] Report, at page 4.

[18] Report, at page 4.

[19] Report, at page 2.

[20] Report, at page 11.

[21] Report, at page 2.

[22] Report, at page 3.

FINRA Provides Preview of 2018 Rulemaking Activity

Posted in Broker-Dealer Regulation

In a December 20, 2017 press release, FINRA announced that, at its final Board of Governors meeting for 2017, it approved the filing of several proposed amendments to its rules.

The rule proposals will include the following:

  • Capital Formation: the proposed rule amendments that would remove certain potential impediments to capital formation; in particular, Rules 5130 (Restrictions on the Purchase and Sale of Initial Equity Public Offerings) and 5131 (New Issue Allocations and Distributions) would be amended to exempt additional persons and certain transactions from the scope of the rules, modify current exemptions to enhance regulatory consistency, and address unintended operational issues.
  • Suitability and Churning: FINRA’s principal suitability rule, Rule 2111,¹ would be amended to allow cases to be brought for churning of customer accounts based on the broker’s recommendation of an excessive number of trades, without the need to prove that the investor had no control over the account.
  • Research Reports on Covered Investment Funds: FINRA proposes to amend Rules 2210 (Communications with the Public) and 2241 (Research Analysts and Research Reports) to conform these rules to the Fair Access to Investment Research Act of 2017 (the “FAIR Act”). The FAIR Act is designed to eliminate restrictions and to reduce burdens for broker-dealers issuing research reports on a variety of investment funds, such as registered investment companies, ETFs, etc.
  • Outside Business Activities and Private Securities Transactions: a new proposal is intended to reduce unnecessary burdens. While requiring registered persons to provide their member firms with prior written notice of a broad range of outside activities, broker-dealers would only have a duty to reasonably assess a narrower set of activities that are investment-related, and potentially more likely to raise potential investor-protection concerns. The proposal also would generally exclude from the rule a registered person’s personal investments and work performed on behalf of a firm’s affiliate, and would eliminate supervisory obligations for non-broker-dealer outside activities, such as investment advisory activities conducted at an unaffiliated third-party adviser.²

We will provide additional information as more detail about the proposals, and their potential impact, emerge.

[1] For a summary of current Rule 2111, our FAQs may be found here.

[2] As previously discussed in this publication here, FINRA has conducted a retrospective review of these rules, which led in part to the new proposal. In FINRA’s December 2017 report as to examination findings (our summary is available here), FINRA expressed concern as to a variety of issues that have arisen in terms of compliance.