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The BD/IA Regulator

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

Broker-Dealer Standard of Care: The SEC Enters the Fray

Posted in Broker-Dealer Regulation, Investment Adviser Regulation

At an open meeting held earlier today, the SEC voted 4-1 to propose a package of rules, forms, and guidance designed to define a new “best interest” standard of care for broker-dealers dealing with retail investors. The proposal would also require disclosure designed to help retail investors understand their relationship with their investment professionals, and to clarify the existing fiduciary standard of care applicable to investment advisers.

Chairman Clayton notably characterized the proposals as an “important step” forward. However, it is not a panacea to fully address lingering confusion among retail investors about the differing obligations of investment professionals who deal with retail investors. Even Commissioners voting in favor of the rule acknowledged that changes to the proposals were likely.

Summary of the Proposals

In releases totaling more than 1,000 pages, including more than 1,800 footnotes, the SEC voted to propose for comment:

  • Regulation “Best Interest,” which will purportedly establish a standard of conduct applicable to broker-dealers and their registered representatives when dealing with retail investors. Notably, however, and much to the dismay of the proposal’s critics, the regulation as proposed does not define the term “best interest.” Among other things, Regulation BI will make it clear that broker-dealers cannot place their own interests above those of their clients. It will require broker-dealers to provide clients with written disclosure of the material facts related to the broker-dealer relationship, including fees and material conflicts of interest, and will require that broker-dealers adopt and implement reasonable policies and procedures designed to disclose and eliminate or mitigate material conflicts of interest arising from the broker-dealer’s financial incentives.
  • Form CRS, a client relationship summary designed to be a “simple point-of-entry” document for registered broker-dealers and registered investment advisers to provide to retail investors. As proposed, Form CRS would be limited to four pages that would provide reasonable disclosure of the relationship between an investment professional and its clients, including an outline of the types of services to be provided by the investment professional, the fees payable for those services, material conflicts of interest, and the relevant standard of care. In addition, as proposed, Form CRS will include key questions that retail investors may want to ask of their investment professionals in order to better understand the relationship and the relevant standard of care. The proposal will also limit a broker-dealer’s ability to identify itself as an “adviser” or an “advisor” unless the broker-dealer is dually registered with the SEC as an investment adviser.
  • SEC guidance interpreting the existing fiduciary standard of care applicable to investment advisers. The staff noted that the federal fiduciary standard is primarily a creature of common law that is shaped through full and fair disclosure, the specifics of which can vary from client to client. The proposed guidance would collect existing guidance in one place and summarize the SEC’s interpretation of that guidance. The release will also seek comment on whether the SEC should propose enhancements to investment advisers’ registration obligations including licensing and continuing education standards, requirements for investment advisers to provide account statements, or requirements for net capital standards applicable to investment advisers.

Issues to Consider

As Commissioner Piwowar stated in his remarks regarding the proposed best interest standard, it “sounds simple enough but the devil is in the details” and, over the coming days, we will take a deeper dive into the details of the proposals. In the meantime, however, here are some key questions that broker-dealers and investment advisers may want to consider when reviewing the proposals:

  • The proposed broker-dealer best interest standard purports to be different from the fiduciary standard applicable to investment advisers and from the existing FINRA suitability standard applicable to broker-dealers; however there appears to be a meaningful amount of overlap among those three standards. That ambiguity could confuse retail investors, and could also result in significant differences among compliance approaches among the broker-dealer community.
    • Will the need for new and enhanced policies and procedures increase the cost of compliance for broker-dealers, such that some broker-dealers may opt to leave the retail business?
  • One of the goals of the proposals is to preserve for retail investors the ability to decide how and where to seek their investment advice. In particular, the proposal seeks to preserve the pay-as-you-go transaction based compensation structure favored by broker-dealers and the asset-based fee structure favored by investment advisers.
    • Does the combination of a best interest standard, which is based in large part upon the fiduciary standard applicable to advisers, and possibly imposing on advisers certain net capital and licensing requirements similar to those currently applicable to broker-dealers start to blur the line between the two types of firms? Will this exacerbate the decline of retail broker-dealers? Is that in the best interest of retail investors?
  • The Form CRS and Regulation BI are additive disclosure, and retail investors already struggle to understand the pages of disclosure they receive when making an investment.
    • How can Form CRS, in particular, be designed to better communicate the key components of the relationship between an investment professional and its clients?  Should this include both form (including whether electronic delivery should be expanded to fully take advantage of new ways to deliver information) and content?
  • As noted by some of the Commissioners, many investment advisers follow industry standards when evaluating their compliance with their existing fiduciary duties. Some established industry standards, however, are the result of settled enforcement matters, rather than based in existing law or regulation.
    • Investment advisers should consider if some of the SEC’s proposed interpretations are supported by regulation. If not, should be the SEC be required to propose new regulations rather than simply issuing interpretive guidance?
  • Regulation BI and Form CRS each will require certain disclosures to retail clients. Form CRS is designed as a high-level summary but Regulation BE will require certain written disclosures of the scope and terms of the relationship.
    • Can Regulation BI and Form CRS be better integrated to limit the amount of new disclosure required to be provided to retail investors or to make it more understandable?


Needless to say, we expect that the financial community will exert significant effort to fully evaluate the potential impact of the proposals. And of course, we also expect a great deal of public debate as to the pros and cons of the proposals, especially when viewed in light of the more prescriptive Department of Labor rules.

OCIE Risk Alert Identifies Key Advisory Fee and Expense Compliance Issues

Posted in Investment Adviser Regulation, SEC Enforcement

The SEC’s Office of Compliance Inspections and Examinations this week provided investment advisers with a summary of frequent compliance issues related to advisory fees and expenses that the staff is seeing in their examinations of registered investment advisers.

The Risk Alert, published April 12, 2018, is the latest in a series of similar alerts published by OCIE to educate advisers and other market participants regarding consistent risk themes it identifies in its examination program and to promote compliance. OCIE said that its objective in publishing this Risk Alert is to “encourage advisers to assess their advisory fee and expense practices and related disclosures to ensure that they are complying with the [Investment] Advisers Act, the relevant rules, and their fiduciary duty, and review the adequacy and effectiveness of their compliance programs.” The Risk Alert summarizes deficiencies identified in more than 1,500 examinations completed during the past two years.

Read our client alert.

FINRA updates its Frequently Asked Questions on new mark-up and mark-down disclosure rules for transactions in fixed income securities

Posted in Broker-Dealer Regulation, Enforcement, FINRA Enforcement

On March 19, 2018, FINRA updated its guidance on its recent amendments to Rule 2232. The new requirements, which are currently scheduled to take effect on May 14, 2018, apply to transactions with retail customers (not institutional accounts, as defined in Rule 4512(c)[1]) in corporate and agency debt securities. Beginning on the effective date, FINRA will require confirmation disclosure of additional transaction-related information, including mark-ups and mark-downs, time of execution, and a hyperlink to a web page containing information about the securities being traded. The goal of these new rules is to help retail customers better understand and compare the costs of these transactions.

By way of reminder, the amended rule provides that, if a member firm executes an offsetting principal trade in a particular security, the firm must disclose the amount of mark-up and mark-down from the prevailing market price for trades with retail customers on the same trading day in the same corporate or agency debt securities. This requirement applies only where the firm’s offsetting principal trade(s) equal or exceed the size of its trade with the retail customer. Additionally, for all retail customer transactions in corporate and agency debt securities, Rule 2232 will require disclosure of a reference and hyperlink when confirmation is electronic to FINRA’s Trade Reporting and Compliance Engine (TRACE) containing the publicly available trading data for the relevant securities. Finally, the execution time, expressed to the second, must be disclosed for all transactions with retail customers in corporate and agency fixed income securities.

In order to help member firms understand these new disclosure requirements, FINRA has published its answers to Frequently Asked Questions (FAQ) about the forthcoming changes. The initial FAQ were published in July 2017. The updated FAQ cover a number of different subject areas concerning the new rules, including:

  • FAQ 1.2.1 confirms that moves of securities from one desk to another is not considered a “transaction.”
  • FAQ 1.4 addresses the circumstances under which a transaction is considered “arm’s-length.”
  • FAQ 1.10.1 addresses the treatment of certain hybrid securities.
  • Other topics addressed by the updated FAQ include:
    • the treatment of exchange-traded securities;
    • the number of decimals that should be used when showing a mark-up;
    • per a variety of practical questions that have been raised by market participants, the methodology for determining the “prevailing market price”; and
    • the nature of the URL that must be provided on the customer’s confirmation.

FINRA previously indicated that it plans to update the FAQ from time to time. FINRA is also accepting suggestions for additional topics and questions to be included in the FAQ in the future.

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

We previously described the rule changes in more detail in the following MoFo publications here and here.

[1] Generally, institutional accounts are held by financial institutions or other persons and contain at least $50 million in assets.

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

8:30 a.m. – 9:00 a.m.

9:00 a.m. – 10:30 a.m.

Risk.net Workshop

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

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:


  • 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.


  • 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.


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.