RIA Compliance Blog

The Economist Wants Your Kids Run Over In the Name of Laissez-Faire

February 19, 2012 | Steve Parker

In a hilariously naïve opinion piece called Over-regulated America, the February 18, 2012 edition of The Economist makes “a plea for simplicity” to replace what it characterizes as the U.S.’s overly regulated financial system. In place of Sarbanes-Oxley and Dodd-Frank, it proposes that regulations not contain specific rules but rather merely “lay down broad goals” and “leave the regulators to enforce them.”

This is the so-called “principles-based regulation” that they have in Europe – the envy of the world when it comes to banking. America should return to its European roots, The Economist is saying. After all, the U.S. is “the home of laissez-faire.” (You would think the editors could have sent a fact-checker through the Chunnel to the Bibliothèque de la Sorbonne, but the point is not lost for the error). According to The Economist, there is nothing wrong with the American banking system that a big dose of European regulation won’t cure.

So instead of having a regulations manual that says, for instance, banks cannot engage in specified levels of leverage in proprietary trading, The Economist thinks it would be good enough to have a regulation that says to banks: “don’t put your capital at risk.” Although we tried that already, let’s humor (or humour) The Economist and pretend we haven’t. What would that be like?

FINRA Warns Firms on High Yield Products

February 17, 2012 | Steve Parker

Earlier this month, the Financial Industry Regulatory Authority (FINRA) released a letter addressing broker-dealer’s practices in recommending high-yield products to clients. The letter states, “FINRA is informing its examination priorities against the economic environment that investors have faced since 2008, as these circumstances have steadily contributed to conditions that foster an increased risk of aggressive yield chasing, inappropriate sales practices, unsuitable product offerings, and misappropriation and fraud.” The purpose of the letter is to warn broker-dealers not to engage in practices intended to beat the market and instead to promote what is suitable for the investor.

Investors are being urged by their brokers to engage in yield chasing, which means they are seeking higher returns on their investments. The investors in this situation may not completely understand the risk versus reward tradeoffs by investing in this manner especially when brokers are recommending more complex products as discussed in a previous blog, FINRA Wants Heightened Supervision of Complex Products. FINRA’s concerns include the full disclosure of material risks, mispricing and overcharging issues, and the suitability of products based on those underlying risks. It urged firms to increase their supervisory systems to ensure that firms are complying with regulations.
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California Extends Public Comment Date on Its Proposed Private Fund Exemption Rule

February 16, 2012 | Steve Parker

The California Department of Corporations has extended the comment period for a proposed rule to amend Rule 260.204.9 of Title 10 of the California Code of Regulations, which exempts private advisers from registration under certain circumstances. The public comment period for this exemption was extended from February 20, 2012 to March 25, 2012. To date, there are no public hearings scheduled; however comments may be mailed to the Department of Corporations.

The amended proposed rule significantly changes the current rule in place. Currently, the rule provides for an exemption for any adviser that:

Has had fewer than 15 clients in the preceding 12 months;
Does not hold itself out to the public as an investment adviser;
Does not act as an investment adviser to a registered company or a company that has elected to be a business development company; and
Either has assets under management of $25 million or more or provides investment advice solely to one or more venture capital companies.

New Registration Requirements for Non-U.S. Advisers

February 15, 2012 | Steve Parker

As a result of the Dodd-Frank Wall Street Reform and Consumer Protection Act passed on July 21, 2010, there have been significant reforms applicable to non-US advisers conducting business in the United States, including new registration requirements under the Advisers Act (the “Act”).

Non-U.S. advisers may need to register with the Securities and Exchange Commission (SEC) in order to conduct future business within the United States. A non-U.S. adviser is defined in the Advisers Act as an investment adviser that:

Has no place of business in the United States;
Has a total of less than 15 U.S. clients and investors in private funds;
Has less than $25 million in assets under management associated with the U.S. clients and investors; and
Does not hold itself out generally as a U.S. investment adviser.

FINRA Wants Heightened Supervision of Complex Products

February 8, 2012 | Steve Parker

In a move that signals the need for heightened due diligence and supervision among financial advisory firms, the Financial Industry Regulatory Authority (FINRA) released Regulatory Notice 12-03 in relation to complex products last month. It is intended to guide firms to increase their supervision of activity involving complex products such as structured notes, reverse convertibles, inverse or leveraged exchange traded funds, hedge funds and securitized products. FINRA has already brought a number of enforcement actions against firms relating to complex products, charging inadequate supervision, unsuitable recommendations and misleading price sales.

Among the problems noted by FINRA is the uncertainty of how these products will behave in the market, as opposed to theoretical projections. The notice states, “Regulators have expressed concern about complex products because the intricacy of these products can impair the ability of registered representatives or their customers to understand how the product will perform in a variety of time periods and market environments, and can lead to inappropriate recommendations and sales.”

FINRA chose not to define a complex product in the notice due to the ever changing innovation in the marketplace; however, the notice states that “any product with multiple features that affect its investment returns differently under various scenarios is potentially complex.” The notice goes on to give a non-exhaustive list of examples of complex products. FINRA advises firms that are unsure whether a product is complex to err on the side of applying their procedures for enhanced oversight to the product.
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Breakaway Advisers See Financial Benefits

February 6, 2012 | Steve Parker

According to a survey conducted by Cogent Research and sponsored by Fidelity Institutional Wealth Services (Fidelity), 76% of new independent financial advisers claim to be better off financially, and 64% of them were able to make that claim in the first six months of going independent. These numbers are based on a survey of 173 advisers who went independent in the last five years. They were unaware that Fidelity was sponsoring the research.

Eighty-six percent of the advisers claimed that all or most of their clients moved with them. It was reported that thirty-nine percent of their clients were immediately supportive of their decision, forty-three percent were initially surprised but then supportive, and eighteen percent were initially concerned but ultimately became supportive of the decision.
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Georgia Securities Commissioner Proposes Rule Amendments

February 3, 2012 | Steve Parker

The Georgia Commissioner of Securities has proposed twelve amendments to investment adviser and broker-dealer rules it promulgated late last year under the Georgia Uniform Securities Act. Although some of the amendments deal with housekeeping issues and typographical errors, several are substantive and of interest to industry participants and their counsel.

A proposed change to Rule 590-4-2-.03 would clarify that Rule 505 Form D filings under the Uniform Limited Offering Exemption must be made within 15 days after the first sale of securities in the state, rather than 15 days prior to the sale, as required by the rule as originally adopted.

The second proposed amendment applies to registration of securities by non-profit entities under Rule 590-4-2-.07, often used for so-called “church bonds.” Under the rule as originally adopted, the application of NASAA Statements of Policy relating to church bonds was permissive rather than mandatory: “The Statements of Policy … may be applied, as applicable, to the proposed offer or sale of a security …” and “may serve as the grounds for the disallowance of the exemption” provided by the Act. Under the amendment, the use of the NASAA Policies is now mandatory, the “may” having been replaced by “shall” in both cases.
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SEC Charges Hedge Funds and Individuals In Insider Trading Scheme

February 2, 2012 | Steve Parker

The Securities and Exchange Commission (SEC) has filed a proposed settlement, subject to court approval, for insider trading violations against seven fund managers and analysts along with two multi-billion dollar hedge fund advisory firms, Diamondback Capital Management LLC and Level Global Investors LP. According to the SEC, individuals with both firms received nonpublic, material information about Dell Inc. and Nvidia Corp. The cases charge illicit gains exceeding $62.3 million for the Dell trades and $15.7 million for the Nvidia trades.

The seven individuals named in the SEC complaint are Sandeep Goyal, Jesse Tortora, Todd Newman, Spyridon Adondakis, Anthony Chiasson, Jon Horvath and Danny Kuo. Goyal is charged with obtaining quarterly earnings information from an insider at Dell and telling Diamondback Analyst Tortora, who in turn tipped his portfolio manager Newman. Tortora also allegedly tipped three other people: Horvath, Kuo, and Adonakis, an analyst at Level Global who tipped his manager, Chiasson. In turn, Kuo allegedly obtained nonpublic, material information about Nvidia and tipped Tortora and Adondakis. SEC Enforcement Division Director Robert Khuzami said, “These are not low-level employees succumbing to temptation by seizing a chance opportunity. These are sophisticated players who built a corrupt network to systematically and methodically obtain and exploit illegal inside information again and again at the expense of law-abiding investors and the integrity of the markets.”
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SEC Postpones “Fiduciary Duty Rule” Again

February 1, 2012 | Steve Parker

One year ago, the Securities and Exchange Commission (SEC) staff recommended that a uniform fiduciary standard be applied to both broker-dealers and investment advisers. Recently, however, the SEC postponed a corresponding rule proposal for a second time.

In January, SEC Chairman Mary Schapiro sent a letter to Congressman Scott Garrett, Chairman of the House Capital Markets Subcommittee, stating that it needs to gather additional information for an economic analysis of the impact of a standard of care regulation. Although the SEC had previously set it for action in 2011, that time frame has now been changed to “date to be determined.” The SEC has already designated specific time frames for 51 other rules and reports required by the Dodd-Frank Act.

In the letter to Rep. Garrett, Chairman Schapiro wrote, “SEC staff are drafting a public request for information to obtain data specific to the provision of retail financial advice and the regulatory alternatives. In this request, it is our hope commentators will provide information that will allow commission staff to continue to analyze the various components of the market for retail financial advice.”
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SIFMA To FINRA: Change Punishment for Unpaid Promissory Notes

January 30, 2012 | Steve Parker

In a letter sent to the Financial Industry Regulator Authority (FINRA) last November, the Securities Industry and Financial Market Association (SIFMA) wants FINRA to give harsher punishments to brokers who have failed to pay back promissory notes to firms. It specifically sought to prevent brokers from being able to plead poverty to escape arbitration payment orders. The purpose of the notes is to provide cash for recruiting and retention incentives. They are typically designed as forgivable loans as long as the broker stays at the firm for a specified amount of time. If the brokers choose to leave early, then they are required to pay back the note.

As a result of not paying the promissory note back, firms have gotten more aggressive in filing arbitration claims for repayment, and in most cases the firm wins. In 2011, there were 778 promissory note cases filed which is a decrease from 2010 during which 1,152 cases were filed. If a broker does not pay the promissory award, FINRA files an action against him/her that could lead to suspension. Once a monetary award has been issued in a FINRA arbitration proceeding, the broker has 30 days to pay the award. If the broker can show an inability to pay back the note; however, he/she will not be suspended and can continue to work for another firm.
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