Articles Posted in CCOs

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.

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With annual compliance reviews in full swing this time of year, we write today to remind advisory firms to be sure to assess the sufficiency of their policies and procedures in the ever-developing area of electronic messaging.  Our note comes on the heels of a recent Risk Alert on this topic issued by the SEC’s Office of Compliance Inspections and Examinations or “OCIE,” which exhorts advisory firms to take a fresh look at their current compliance policies in light of the particular risks of non-compliance posed by the firm’s usage of electronic messaging.

“Electronic messaging,” as discussed in OCIE’s Risk Alert, refers to such mediums as text/SMS messaging, instant messaging, personal email, and personal or private messaging, but specifically excludes firm-wide email.  Notably, OCIE’s exclusion of firm email from analysis in the Risk Alert should not be read as diminishing an adviser’s compliance obligations to capture, store, and periodically review firm email communications.  Rather, as OCIE explains, “firms have had decades of experience complying with regulatory requirements with respect to firm email” and it is not as problematic from a compliance standpoint as compared to some of the newer technologies that run on third-party applications or platforms.  Continue reading ›

The SEC routinely hears appeals arising from FINRA disciplinary proceedings, and in turn issues “Adjudicatory Orders” announcing its decisions. To the extent that these Orders are issued by vote of the full Commission, they stand as highly useful guidance to industry players on the thoughts of the SEC’s ultimate leadership. In a recent Adjudicatory Order, the SEC articulated its current position on Chief Compliance Officer (“CCO”) liability for securities regulatory violations, as well as the liabilities of other members of a securities firm’s senior management for failure to supervise the CCO. See Application of Thaddeus J. North for Review of Disciplinary Action Taken by FINRA, Order of the Commission, Rel. No. 34-84500 (Oct. 29, 2018).

The facts of the case involve findings by FINRA that the CCO (Mr. North) of a multi-office 50+ representative brokerage firm violated FINRA rules by failing to establish a reasonable supervisory system for the review of electronic correspondence, failing to reasonably review electronic correspondence, and failing to report a relationship with a statutorily disqualified person. Specifically, despite being the person responsible for reviewing the firm’s electronic communications, the record showed that for a roughly two-year period North completely failed to review any Bloomberg messages/chats (such messages making up 85% of the firm’s electronic communications). North testified that he “did not understand” his firm’s Smarsh e-mail retention/retrieval system, and further attributed his failure to review electronic communications to that activity being “boring.” Separately, North failed to either independently investigate or report to FINRA his knowledge of a material relationship between one of his firm’s registered representatives and a statutorily-disqualified person. This particular failure came despite North’s knowledge that the representative had paid the disqualified person over $150,000, had executed a services agreement with that person, and that FINRA was actively investigating the matter.

On these facts, the SEC upheld FINRA’s disciplinary action as “clearly appropriate” in light of North’s “egregious” conduct in “fail[ing] to make reasonable efforts to fulfill the responsibilities of his position.” Notably, “North ignored red flags and repeatedly failed to perform compliance functions for which he was directly responsible.”

On December 15, 2014, the North American Securities Administrators Association (“NASAA”) launched an online electronic filing system to be used for issuers filling Form D, Rule 506 offerings with state securities regulators. The purposes of this new electronic filing depository (“EFD”) website, according to NASAA president William Beatty, are to provide an efficient and streamlined process for regulatory filings and to allow for increased transparency for investors.

Issuers seeking an exemption under Rule 506 must meet certain requirements in order to avoid having to register their public or private offerings with the SEC or state regulators. However, those issuers must still file a notice of exempt offering of securities, or “Form D,” with the SEC and state securities regulators. Instead of the longer and more tedious process of registering with securities regulators, Form D requires only limited information about the issuer, the investors, and the securities offered.
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