Articles Posted in Industry News

As the saying goes, “a rising tide lifts all boats.” This expression is commonly used in the investment world to mean that in bull markets, all portfolios tend to rise, no matter how poorly constructed. However, when the market changes directions sharply, as it has over the last thirteen trading days, poorly constructed portfolios sink more precipitously than the overall market.

The stock market has never before plunged by 18% off of its all-time high over such a short time frame. The main driver of the decline had been, prior to this week, concern over the impact that the spreading Coronavirus will have on the US economy. On Monday, March 9, however, news of an oil trade war caused a further, more precipitous decline. But the 18% decline in the market in the last few trading days represents the broad equity markets. Investors whose portfolios are overconcentrated in individual stocks or market sectors are experiencing even worse declines. To continue the boat metaphor, some portfolios will be sunk or will crash against the rocks. Continue reading

The ability of the Securities and Exchange Commission (SEC) to prosecute enforcement actions selectively through its own administrative proceedings is under constitutional attack in cases pending in the Fifth and Ninth Federal Judicial Circuits. The Ninth Circuit case was brought by Raymond Lucia, the same former investment adviser who succeeded in a constitutional challenge to the method of appointment of the SEC’s Administrative Law Judges (ALJs) in 2018. In that case, Lucia v. SEC, the U.S. Supreme Court held that these ALJs were “Inferior Officers” for purposes of the Constitution’s Appointments Clause, meaning that they must be appointed by either the President or the SEC itself. Prior to the decision in that case, ALJs were hired pursuant to the regular civil service process applicable to federal employees. In response to the Supreme Court’s ruling, the SEC ratified the appointment of its existing ALJs.

Lucia’s new challenge, and a similar challenge brought by accountant Michelle Cochran, are pending in the Ninth and Fifth Circuits, respectively. In those cases, the plaintiffs continue to challenge the constitutionality of the SEC administrative enforcement process. Among other things, the plaintiffs argue that the procedures in place preventing the removal of the ALJs are unconstitutional and that the administrative proceedings deprive respondents of the Seventh Amendment’s guarantee of trial by jury.

Lucia is represented by the New Civil Liberties Alliance, a nonprofit organization that, according to its website, “views the administrative state as an especially serious threat to constitutional freedoms.” It assists litigants in challenging what it considers to be unconstitutional administrative processes.

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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.

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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.

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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.

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A number of state attorneys general have filed a lawsuit against the SEC, seeking to overturn the SEC’s recently adopted Regulation Best Interest or “Reg BI.” This not unexpected move comes in the wake of simmering discontent which has built up against Reg BI ever since its adoption on June 5th. In a nutshell, consumer advocate groups, state regulators and some high-ranking SEC officials all oppose Reg BI on the grounds that it doesn’t go far enough in imposing a more rigorous standard of conduct on broker-dealer firms. This lawsuit, filed in New York federal district court, ramps-up this disagreement considerably.

Reg BI, which this blog has discussed in some detail recently, is part of a comprehensive package of new rules and interpretations released by the SEC on June 5th. Specifically, the long-awaited Reg BI replaces the prevailing “suitability” standard of conduct applicable to broker-dealers and their registered representatives with a new “best interest obligation.” While under suitability, broker-dealers were only required to ensure that that their recommendations were “suitable” in light of a customer’s investment objectives and risk tolerance, the new best interest obligation requires that a broker-dealer always act in a customer’s “best interest.” Additionally, under Reg BI, the broker-dealer cannot place its interests ahead of a customer’s interests. Continue reading

As part of its June 5th landmark issuance of multiple final rules and interpretive releases dealing with broker and advisory standards-of-conduct—which included the long-awaited Regulation Best Interest (or “Reg BI”) for broker/dealers—the SEC also published a detailed interpretive release clarifying and interpreting an investment adviser’s fiduciary duty (the “Fiduciary Release”). While this blog has already provided an analysis of the high-level contours of the SEC’s entire package of rules and releases, we now write to give readers a closer look at the Fiduciary Release, which should be of particular interest to the advisory community.

The Fiduciary Release is the culmination of a regulatory process begun on April 18, 2018, with the SEC’s publication of a draft release on advisory fiduciary duties. The SEC also published draft releases of Reg BI and the Form CRS Relationship Summary (“Form CRS”)(a new disclosure document for advisers and brokers) on that date as well. However, we note at the outset that, unlike the final Reg BI and Form CRS rules—which will not be implemented until June 30, 2020—the Fiduciary Release is effective upon formal publication in the Federal Register. Since that formal publication has already occurred, the Fiduciary Release is now effective. Additionally, we note that the Fiduciary Release is legally applicable to not only SEC-registered investment advisers, but also to state-registered advisers and other investment advisers that are exempt from registration under the federal Advisers Act.

The SEC’s stated objective in issuing the Fiduciary Release is to “reaffirm” and “clarify” the longstanding fiduciary duty of an investment adviser as expressed in section 206 of the Advisers Act. Recognizing that this fiduciary standard has been developed over decades via case law in the form of judicial opinions as well as through SEC enforcement proceedings and no-action letters, the SEC notes that the Fiduciary Release is not intended to be the “exclusive resource” for articulating the fiduciary standard. Importantly, the Fiduciary Release does not explicitly declare any revisions to the advisory standard of conduct (as does Reg BI vis-à-vis broker/dealers).

SEC Chairman Jay Clayton recently announced, on behalf of the Commission, a significant change in policy as to how the SEC will consider requests for disqualification waivers made by respondents in SEC enforcement proceedings where a settlement offer is being negotiated. We think that Clayton is to be applauded for this move as the new policy should prove to be a fairer and more efficient alternative to the status quo that has prevailed in recent years, most notably because it will give respondents a heightened degree of certainty regarding “collateral consequences” of an enforcement settlement.

First a bit of background. While the majority of SEC enforcement proceedings are resolved with a settlement agreement between the SEC and the respondent resulting in fines, restitution to investors, or other sanctions, a secondary or “collateral” consequence of the settlement may be statutory disqualification under the securities laws of the respondent (or an affiliate) from some otherwise permissible activity. A prime example is the so-called “bad-boy” provisions of Reg D, which, among other things, prohibit persons subject to SEC cease-and-desist orders or other SEC disciplinary orders from raising capital in a Reg D private placement. Another example is the prohibition on receipt of cash fees for solicitation under Rule 206(4)-3 of the federal Advisers Act where the solicitor is subject to certain SEC disciplinary orders. As noted by Clayton, “[t]he effects of these collateral consequences can vary widely depending on the scope of the businesses and operations of the entity and, in practice, range from immaterial to extremely significant.”  Continue reading

The Massachusetts Securities Division (“MSD”) has announced the adoption of new rules requiring that investment advisers registered with the MSD provide, to clients and prospective clients, an additional one-page stand-alone disclosure document specifically detailing the adviser’s fee schedule. This new disclosure document or “Fee Table” will need to be “updated and delivered consistent with the existing requirements for Form ADV (including the Brochure).” The new rules, which were adopted pursuant to the MSD’s notice and comment process, take effect—and will be enforced—commencing on January 1, 2020.

While only applicable to advisers registered with the MSD, the new rules requiring the Fee Table could portend similar future action by additional states. Moreover, the new rules come on the heels of the SEC’s June 5th high profile standard-of-conduct releases (which we have previously chronicled) that also include a new stand-alone disclosure document for SEC-registered advisers to be known as Form CRS. If the MSD’s actions here are in fact echoed by additional states, it could cause potential headaches for the RIA industry, as this would require RIAs operating in multiple states to conform to multiple differing disclosure document regimes. Additionally, with the new Form CRS (applicable to SEC-registered advisers only) beginning to circulate at about the same time, an assortment of new documents being presented to clients may cause marketplace confusion as well.  Continue reading

The SEC, on June 5th, adopted a comprehensive set of rules and interpretations that will have a profound effect on the brokerage and advisory industries going forward, first and foremost by revising the standard-of-conduct applicable to broker-dealers and their registered representatives in dealings with retail customers. Even casual observers will likely be familiar with the various proceedings just concluded at the SEC, which resolve debates that have raged in the investment industry for decades as to the need to align the higher fiduciary “standard-of-conduct” applicable to investment advisers with the lesser suitability standard applicable to broker-dealers. While the June 5th releases do not equalize the two standards—as many commentators would have desired—they do significantly raise the standard applicable to broker-dealers from suitability to “best interests.” The SEC’s releases number four separate documents, each covering a distinct aspect of the standard-of-conduct controversy, and run over 1200 pages. Accordingly, this note will seek to identify the major headlines from the various releases. Look for future writings, wherein we will explore the nuances of the June 5th releases in greater detail.

As noted, the SEC released a package of Final Rules and Interpretive Releases comprising four separate components: (1) Final Rules implementing Regulation Best Interest (“Reg BI”), the new enhanced standard for brokers; (2) Final Rules implementing a new Form CRS Relationship Summary (“Form CRS”), a new disclosure document applicable to both brokers and advisers (that, for advisers, will function as a new Part 3 to Form ADV); (3) an Interpretive Release clarifying the SEC’s views of the fiduciary duty that investment advisers owe to their clients; and (4) an Interpretive Release intended to more clearly delineate when a broker-dealer’s performance of advisory activities causes it to become an investment adviser within the meaning of the Advisers Act. All four components of the regulatory package were approved by a 3-1 vote of the SEC’s Commissioners, with Commissioner Robert Jackson being the sole dissenter.

While the June 5th releases are the culmination of a decades-long controversy, they are the proximate result of a formal rulemaking commenced on April 18, 2018, at which time the SEC published initial proposed versions of Reg BI, Form CRS and the advisory interpretations. The Final Rules for Reg BI and Form CRS will become effective 60 days after they are formally published in the Federal Register; however, firms will be given a transition period until June 30, 2020 to come into compliance. The two Interpretive Releases will become effective upon formal publication.  Continue reading