In our previous post, we described the SEC’s announcement of examination priorities in 2020 for the Commission’s Office of Compliance Inspections and Examinations (OCIE).  In that post, we discussed areas of examination that will apply to a large percentage of registered investment advisors and other regulated entities.  In this post, we focus on another priority, namely robo-advisers.

Otherwise known as automated investment platforms, “robo-advisers” have come under increased scrutiny by OCIE.  The number of these advisers has increased substantially over the last four years.  OCIE intends to focus on issues such as the eligibility of the robo-adviser to register with the SEC, marketing practices engaged in by robo-advisers, the ability to comply with fiduciary duty, the adequacy of the adviser’s disclosures, the effectiveness of the adviser’s compliance program, and the firm’s cybersecurity policies, procedures and practices.

Advisers Act Rule 203A-2(e) permits “internet only advisers” to register with the SEC, provided certain conditions are met and maintained.  Specifically, the adviser must provide investment advice to all clients exclusively through an interactive website and maintain records demonstrating that it does so.  Under the rule, an adviser may provide investment advice through means other than the internet to up to fourteen clients during any twelve-month period. Undoubtedly there are some firms that registered on this basis who were either not eligible at the time or, through the evolution of their business, have strayed from the conditions required to remain eligible for registration.

Continue reading

Earlier this month, the SEC’s Office of Compliance Inspections and Examinations (OCIE) announced its examination priorities for 2020.  Many of the priorities listed are similar to those identified in previous years’ priorities lists. The SEC’s approach in addressing them, however, continues to evolve to keep pace with the changing landscape of financial markets, market participants, products, technologies and risks. This post will address some of the areas that should be of concern to a large percentage of registered investment advisers (RIAs), broker-dealers and other regulated entities.

OCIE reiterated that a significant underpinning of any effective compliance program is the “tone at the top” set by C-level executives and owners. Those firms that prioritize compliance and effectively create a “culture of compliance” tend to be more successful in designing and implementing compliance plans than firms that view compliance as an afterthought or business hindrance. One of the “hallmarks” of a firm’s commitment to compliance is the presence of an “empowered” CCO who is routinely consulted regarding most facets of the firm’s operations. There is nothing new to these concepts, but it is worth noting that OCIE continues to emphasize them year after year. Although not stated in the priorities release, the degree to which a firm demonstrates a commitment to compliance often weighs heavily on decisions OCIE examiners must make regarding how deficiencies will be addressed by the Commission. All other things being equal, firms that have made mistakes but demonstrate the ability to make effective corrections will often be provided an opportunity to implement those corrections and are less likely to become the subject of an enforcement referral.

Not surprisingly, OCIE will continue to prioritize examining RIAs to assess compliance with their fiduciary duty to clients. For examinations of RIAs occurring during the second half of 2020, this will undoubtedly include the proper use of Form ADV Part 3, which RIAs are required to complete, file, and place into use with clients by June 30, 2020. Additionally, broker-dealers will be expected to implement compliance with new Regulation BI, requiring adherence to a best interest standard. The priorities list reiterates that advisers and broker-dealers must eliminate, or at least fully and fairly disclose, all conflicts of interest, as more fully explained in Investment Advisor Release 5248, issued in June of last year.

Among other priorities relevant to RIAs, OCIE also listed the protection of retail investors saving for retirement, information security, anti-money laundering programs and financial technology.

Continue reading

Earlier this week, the U.S. Supreme Court declined to take up a lower court ruling upholding the SEC’s authority to adopt and enforce FINRA’s Pay-to-Play rule, Rule 2030. That rule, which became effective in 2017, followed and was patterned after Rule 206(4)-5 under the Investment Advisers Act of 1940.  Adopted in 2010, the Advisers Act Pay-to-Play rule prohibits investment adviser firms and certain of its executives and employees, including representatives, from providing advisory services to government clients within two years after the firm or those covered employees make contributions to elected officials relating to the client.  Additionally, the rule prevents an adviser from directly or indirectly paying any third party to solicit advisory business from any government entity, with certain exceptions.  Finally, the rule prevents an adviser from coordinating or soliciting contributions for certain government officials or candidates in situations where the adviser is either seeking the business of the government entity or providing advisory services.

In 2016 FINRA adopted Rule 2030, which is substantially similar to the Advisers Act rule.  One of the chief motives for the adoption of the FINRA rule was to foreclose the possibility that registered representatives or FINRA member firms could circumvent the Advisers Act Rule, where the firms were dual registrants. Both rules have de minimis exceptions of $350.00 per election in contributions to any one official or candidate if the contributing associate was entitled to vote for the candidate, and $150.00 per official per election, to candidates for whom the associate is not entitled to vote.  Both rules also have recordkeeping requirements.

Both the SEC and FINRA have enforced their respective rules through administrative enforcement actions.

Continue reading

A federal court in the Southern District of New York is currently considering a motion filed last month that would overturn a jury verdict convicting a former Forex Trader at JP Morgan, Akshay Aiyer, of conspiring to rig bids in Forex transactions. The motion argues that the testimony of alleged co-conspirators Christopher Cummins of Citigroup and Jason Katz of Barclays was unreliable and false, and should not serve as a valid basis for the conviction.

Another aspect of the case that should be of interest to compliance officers of financial services firms was the role that text messages and group chats played in the trial of Mr. Aiver. During the trial in November 2019, Mr. Cummins testified that he and defendant Aiyer communicated via text message and private chat rooms in order to avoid being caught by the banks’ compliance personnel. Cummins pled guilty in 2017 but testified as a cooperating witness for the U.S. Justice Department in the case against Aiyer.

The cases against the US traders are only a part of a larger scheme involving other banks as well. In May 2017, the European Union levied fines totaling €1.7 Billion on Barclays, Citigroup, JPMorgan, Royal Bank of Scotland and Mitsubishi UFJ. The only firm not fined by the EU was UBS, who first detected and reported the fraudulent scheme. The importance of being able to monitor and detect these types of communications cannot be ignored.

Continue reading

Following SEC guidance regarding investment advisers’ proxy voting obligations issued in August of this year, and rule changes proposed by the SEC consistent with that guidance a few weeks later, investor organizations, including the Council of Institutional Investors (CII), and Institutional Shareholder Services (ISS), have taken actions to challenge the guidance and he rule proposals.

In August, the SEC voted 3 to 2 to issue the new guidance and to include potential rule amendments in its regulatory agenda. In general terms, the SEC’s interpretations are designed to make all proxy voting recommendations by a proxy adviser a “solicitation” under the federal proxy rules and subject to the Securities Exchange Act of 1934 (the “Exchange Act”) and Rule 14a-9.

In a letter to the SEC in October, CII questioned the wisdom of the guidance and urged the SEC not to adopt proposed rule changes over concerns that both the guidance and the rules would weaken corporate oversight by investors and make it more difficult to replace or oppose existing management.  CII claimed that both the guidance and the proposed rulemaking would increase costs, add regulatory burdens, increase litigation, and otherwise make it more expensive and difficult for investors to retain the benefits offered by proxy advisory firms.  CII said in its letter that the guidance and proposed rule changes not driven by investor protection because there is no “call from the investment community” or regulatory intervention on the issue of proxy voting.  Rather, CII contends that SEC made the announcement and proposals because of pressure from issuers who believe that proxy advisors are too often influential in successful corporate voting campaigns.  The letter indicated that CII’s position was supported by the Comptroller for New York City and the CEO of the California Public Employee’s Retirement System, among other major institutional investors.

Continue reading

The SEC’s Divisions of Investment Management and Trading & Markets have issued guidance in the form of a set of Frequently Asked Questions (or “FAQs”) addressing the upcoming implementation of the newly-created SEC Form CRS Relationship Summary (“Form CRS”).

As previously profiled on this blog, Form CRS is a new SEC disclosure document that will be applicable to both RIAs and broker/dealers offering services to retail investors. Indeed, for RIAs, the new Form CRS will function as a new Part 3 to the RIA’s existing Form ADV. The purpose of Form CRS is to summarize basic information about the firm’s services, fees, and costs, as well as its conflicts of interest and material disciplinary events. As noted, Form CRS obligations only arise for firms dealing with “retail investors,” which the SEC defines as “natural persons” or their legal representatives, who seek to receive or receive services “primarily for personal, family or household purposes.” Full implementation of Form CRS is slated for June 30, 2020.

Continue reading

Recent developments within two of the three branches of the federal government portend significant potential changes in the SEC’s ability to obtain disgorgement of ill-gotten gains in civil actions brought by its enforcement arm. Early in November, the U.S. Supreme Court decided to hear an appeal of a Ninth Circuit case, SEC v. Liu, involving the issue of whether the SEC has statutory authority to obtain disgorgement at all. Then, not three weeks later, the U.S. House of Representatives responded by passing H.R. 4344, a bill explicitly codifying the SEC’s authority to obtain disgorgement. While the ultimate decision of the high court remains months away, and the House’s action has no legal significance until a companion bill in the Senate is acted upon and the two bills are passed by both chambers, these developments are of great significance to securities litigators and SEC-watchers alike.

Disgorgement has long been a powerful arrow in the SEC’s enforcement quiver, allowing it to obtain, on behalf of aggrieved investors, reimbursement of ill-gotten gains. However, despite it having obtained billions of dollars in disgorgement in civil actions over the last few decades, no statute explicitly confers the SEC with authority to seek this remedy. Rather, lacking any express authority, federal judges have implied it in scores of decisions dating back to the 1970s. Now, that entire foundation has come into question, prompted first by the Supreme Court’s 2017 decision in Kokesh v. SEC, and now by the high court’s acceptance of the Liu appeal.

Continue reading

As discussed in our most recent posting on this blog, the SEC has proposed a wholesale rewrite of its existing advertising and cash solicitation rules. While that last post delved into the specifics of the SEC’s proposed amendment of its advertising rule, in this installment, we take up the Commission’s plans for revamping its cash solicitation rule.

The SEC’s Release No. IA-5407, published on November 4th, aims to modernize both rules to reflect the dramatic changes seen in technology and the advisory industry since the initial adoption of these rules decades ago. While just a proposal for now, it offers the best view into what any ultimate final rules will probably look like. At this stage, RIAs and other industry participants are closely reviewing both proposed rules, and many will be submitting public comments to the SEC as permitted pursuant to the Commission’s public comment process. While the public comment process runs a fixed 60 days, the ultimate publication of final rules is at the SEC’s discretion.

Continue reading

On November 4th, the SEC released for public comment proposed replacements to its decades-old advertising and cash solicitation rules. The proposed rules, which are accompanied by almost 500 pages of explanatory text, are now subject to the SEC’s “notice and comment” process, whereby interested persons will have 60 days to file comments to the SEC, after which time the SEC will likely issue final versions of the new rules. While the content of the final rules ultimately adopted by the SEC may differ substantially from the versions now being circulated, the current proposals are the most likely outcome at this point in time and offer valuable insight into the SEC’s thinking in this area.

According to the SEC, both the advertising and cash solicitation rules are ripe for updates and modernization as a result of “changes in technology, the expectations of investors seeking advisory services, and the evolution of industry practices.” Notably, the advertising rule (Advisers Act Rule 206(4)-1) has been largely untouched since its adoption in 1961. Likewise, the cash solicitation rule (Advisers Act Rule 206(4)-3) has not been amended since its adoption in 1979. In this installment of our blog, we will outline some of the more salient points of the SEC’s proposal to replace the advertising rule. Look for our discussion of the proposed cash solicitation rule amendment in an upcoming post.

Continue reading

In a recent administrative order, the Securities Division (the “Division”) of the South Carolina Office of the Attorney General has adopted a new exemption from investment adviser registration for private fund advisers. This move is significant as, until now, South Carolina was one of fewer than 10 states not providing some form of exemptive relief to private fund advisers. New private fund advisers seeking to set up operations in South Carolina may utilize the new exemption immediately. Additionally, existing private fund advisers currently registered with the Division may invoke the exemption and de-register so long as such advisers are in compliance with the exemption’s provisions and all other applicable law. As the southeastern United States has become an increasingly popular venue for private fund advisers in recent years, South Carolina’s new exemption should be well-received by the private capital industry.

As noted, most states exempt private fund advisers from registration obligations arising under those states’ “Blue Sky” investment advisory laws. Such obligations arise as a result of the fund manager (typically a separate legal entity serving as the fund’s General Partner or Managing Member) exercising control over and managing the fund’s securities portfolio. In other words, because the fund manager has discretionary authority to manage the fund’s investment portfolio, and receives compensation for this service (typically in the form of a management fee and a performance allocation), the fund manager generally satisfies the definition of an “investment adviser” under prevailing law.

Continue reading