Articles Tagged with Compliance

A recent settled SEC Order with Wedbush Securities, Inc., a dually-registered investment adviser and broker-dealer, has resulted in a censure and $250,000 fine against that firm. The genesis of this rather harsh result is what the SEC alleges to be the firm’s lack of an ability to follow-up on obvious compliance “red flags” that, in this case, pointed to an extensive and long-running “pump and dump” scheme involving one of the firm’s registered representatives. Indeed, as noted by Marc P. Berger, Director of the SEC’s New York Regional Office, “Wedbush abandoned important responsibilities to its customers by looking the other way in the face of mounting evidence of manipulative conduct.”

The SEC’s regulatory requirements compel broker-dealers to adopt policies and procedures that are sufficiently tailored to determine whether their associated persons are violating the securities laws and to prevent them from violating the securities laws. Broker-dealers are also compelled to ensure that these policies and procedures are sufficiently implemented to discover and prevent securities law violations. Continue reading

On February 4, 2019, the Commissioner of Securities of the State of Georgia and the Office of the Secretary of State announced its intent to amend the rules governing examination requirements for registered representatives of a broker-dealer and investment adviser representatives.  According to the Commissioner, the primary purposes of these amendments are to harmonize Georgia’s rules with the Financial Industry Regulatory Authority’s new rules implementing the Securities Industry Essentials (“SIE”) Exam and to update the requirements regarding examinations to applicants.  The SIE Exam, which tests a FINRA registration applicant’s knowledge of securities-related topics, was launched to simplify FINRA’s qualification examination program after the program’s efforts to address new securities products and services resulted in FINRA offering multiple exams with immense content overlap.  FINRA also launched the SIE Exam in order to provide greater consistency and uniformity to the securities industry application process.

The State of Georgia requires applicants for registration as a registered representative of a broker-dealer and/or an investment adviser representative to take certain prerequisite examinations.  Georgia Rule 590-4-5-.02 details the examination requirements for registered representatives, while Georgia Rule 590-4-4.09 details the examination requirements for investment adviser representatives.

The proposed amendments to Rule 590-4-5-.02, detailing registered representative examinations, would require an applicant applying for registration as a broker-dealer to present proof to the Commissioner that its personnel have passed at least one of a list of specified examinations within a two-year period preceding the date of the application.  The amendments also eliminate the Series 87 Research Principal Examination as a potential examination that could be passed.  The amendments also would provide that an applicant who is applying to be a registered representative would need to present the Commissioner with proof that he or she has passed the required examinations within either a two-year period immediately preceding the application date or a four-year period in the case of an applicant who has taken the SIE Exam.  The amendments also provide that the Commissioner “may reserve the right to find the applicant qualified by other examinations or significant and comprehensive experience in the securities business.”

FINRA has alerted its Member Firms to be on the watch for a fraudulent phishing email scheme targeted at compliance personnel. A phishing scheme typically uses email or some other type of electronic message to trick the recipient into clicking a malicious link or infected file attachment by mimicking a message from a trustworthy party. This particular scheme employs an email purportedly originating from an Anti-Money Laundering compliance officer at an otherwise apparently legitimate Indiana-based credit union. The email—which was received recently by a number of FINRA Member Firms—specifically targets compliance personnel by appearing to be a communication regarding an attempted transfer of money by a client of the recipient’s firm to the credit union which has been placed on hold due to concerns about potential money laundering. The scam is designed to get the recipient to open an attachment, which, according to FINRA “likely contains a malicious virus or malware designed to obtain unauthorized access to the recipient’s computer network.”

FINRA noted the following additional aspects of the fraudulent email that recipients should be alert for:

  • An otherwise legitimate reference to a provision of the USA Patriot Act allowing financial institutions to share information with each other.
  • An actual email address that appears to be from Europe, rather than the U.S.-based credit union.
  • Numerous instances of poor grammar and sentence structure.

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FINRA has announced a new self-reporting initiative covering potential violations by its Member Firms of various rules governing share class recommendations relating to 529 Plans. See FINRA Regulatory Notice 19-04 (Jan. 28, 2019). Similar to the SEC’s recent self-reporting initiative regarding mutual fund share class selection in connection with 12b-1 marketing fees (which we have blogged about last month and in May of 2018), this new FINRA initiative (the “Initiative”) offers potential leniency in return for Member Firms coming forward to self-report likely violations pursuant to the terms of the Initiative.

529 Plans are tax-advantaged municipal securities that are structured to facilitate saving for the future educational needs of a designated beneficiary. While the sale of 529 Plans is governed by the rules of the Municipal Securities Rulemaking Board (“MSRB”), FINRA is responsible for enforcing the MSRB’s rules. These rules, in turn, require that recommendations of 529 Plans be suitable in light of the customer’s investment profile, and that Member Firms selling 529 Plans have a supervisory system in place to achieve compliance with the MSRB’s rules.

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At this time of year, it is important for registered investment advisers to assure that they are in compliance with federal and/or state rules requiring them to monitor their supervised persons’ security holdings and transactions for compliance with the firm’s code of ethics. Even seasoned compliance professionals will encounter questions regarding application of the rule from time to time. While this article is no substitute for a detailed analysis of the rule and its application to a specific firm and its supervised persons, an overview of the rule may be helpful.

As background, all SEC-registered investment advisers are required to adopt a Code of Ethics, which must describe the standards of conduct expected for representatives of the firm and address conflicts that arise from personal trading by advisory personnel. This federal requirement, which governs SEC-registered advisers only, derives from SEC Rule 204A-1, which took effect in 2005. Since then, many state securities administrators have adopted identical or similar requirements, either by adopting SEC Rule 204A-1 “by reference”—i.e., verbatim—into state law, or by crafting similar “me too” provisions. Accordingly, if your firm is SEC-registered, it will be bound by Rule 204A-1; but, if your firm is currently a state-registered adviser, it may be bound by the same or similar requirements. Continue reading

On December 20, 2018, two days before the recent partial federal government shutdown began, the Securities and Exchange Commission’s Office of Compliance Inspections and Examinations announced its 2019 Examination PrioritiesAs discussed previously, the shutdown resulted in the SEC operating at a quite minimal level.  Now that the shutdown is over, registered investment advisers and broker-dealers can likely expect OCIE to fully implement the following examination priorities.

OCIE listed six examination priorities for 2019: (1) matters of importance to retail investors, especially seniors and investors saving for retirement; (2) compliance and risk in registrants who are tasked with overseeing critical market infrastructure; (3) focus on FINRA and MSRB; (4) digital assets; (5) cybersecurity; and (6) anti-money laundering.  According to OCIE, this is not an exhaustive list, and one can expect OCIE to cover other issues in its examinations.  However, OCIE has concluded that these issues “present potentially heightened risk to investors or the integrity of U.S. capital markets.” Continue reading

Demonstrating its regulatory interest in the robo adviser industry, on December 21, 2018, the Securities and Exchange Commission issued an Order Instituting Administrative and Cease-and-Desist Proceedings against Wealthfront Advisers, LLC, a registered investment adviser which uses a software-based “robo adviser” platform in servicing its clients. The action is the second case against robo advisers filed on the same day. Wealthfront submitted an offer of settlement in light of the proceeding.

According to the SEC’s Order, Wealthfront utilizes a proprietary tax loss harvesting program (“TLH”) to help its clients garner tax benefits. These tax benefits would typically come through selling assets at a loss, which could potentially be used to reduce income or gains and create a lower tax liability. From October 2012 onward, Wealthfront has featured whitepapers on its website that provide information about the TLH strategy. Continue reading

As the partial federal government shutdown, which began at midnight on December 22, 2018, now approaches its fifth week, we write to update our readers on the shutdown’s specific impact on the SEC and securities regulatory activities.  While we have previously discussed many of these points with our clients who currently have matters pending before the SEC, below is more general information regarding the SEC’s most significant functions.

The SEC was able to operate fully and conduct regular business for a limited number of days following the commencement of the general federal shutdown, but was forced to effectively close its doors on December 27, 2018.  Since then, the agency has been operating at a very minimal level with a skeleton crew of staffers able to respond to only emergency situations.  As described on the SEC’s home page, the remaining staff is available to respond only to “emergency situations involving market integrity and investor protection, including law enforcement.”  The vast majority of the SEC’s employees have been furloughed and are not reporting to work at this time.  That said, we note that a number of familiar online filing platforms, such as EDGAR, IARD, and CRD, all remain fully operable. Continue reading

On December 21, 2018, the Securities and Exchange Commission issued an Order Instituting Administrative and Cease-and-Desist Proceedings against Hedgeable, Inc., a registered investment adviser.  Hedgeable utilizes a “robo adviser” program, which it offers to individuals, small business owners, trusts, corporations, and partnerships through both its website and social media.  The SEC’s Order alleges that from about 2016 through April 2017, Hedgeable made various misleading statements in advertising and performance data.  Hedgeable submitted an offer of settlement in order to resolve the proceeding.

According to the Order, Hedgeable launched a so-called “Robo-Index” to present comparisons of its performance against that of two unaffiliated robo advisers.  These comparisons were featured on both Hedgeable’s website and various social media sites.  The SEC found that Hedgeable’s method of preparing the Robo-Index had significant material issues.  For example, the SEC found that data from 2014 and 2015 only featured data from a small pool of Hedgeable client accounts and excluded over 1,000 other client accounts.  The SEC alleged that, because of the small sample sizes, the data likely reflected “survivorship bias,” stemming from the fact that the sample size likely only contained clients who received higher than average returns compared to Hedgeable’s other clients.  The SEC also determined that Hedgeable’s calculation methods did not correctly estimate expected returns for a standard client of the other two robo advisers.  Hedgeable allegedly produced the data in the Robo-Index using estimations of the other robo advisers’ trading models rather than using the robo advisers’ actual models. Continue reading

Following several enforcement actions brought against registered investment advisers that received 12b-1 fees when institutional shares were available to be purchased in clients’ advisory accounts, in February of this year the Securities and Exchange Commission announced an initiative under which firms could self-report the receipt of “avoidable” 12b-1 fees since 2014.  Under the so-called Share Class Selection Disclosure Initiative (SCSDI), advisers who self-reported receiving 12b-1 fees under those circumstances would be subject to an SEC enforcement action but would receive favorable treatment in such a case. Such favorable treatment included no recommended civil penalties as long as the firm agreed to disgorge all avoidable 12b-1 fees received.

In order to participate in the SCSDI, however, firms were required to report to the SEC by June 12, 2018. In announcing the SCSDI, the SEC indicated that firms that did not self-report may be subjected to harsher sanctions if their practice was later discovered.

In recent weeks through information available through clearing firm data and public sources the SEC has identified RIAs that may have received 12b-1 fee but chose not to self-report. Some of these firms are receiving subpoenas or requests for information and testimony.  Whether the failure to report was justified and/or the original receipt of the 12b-1 fees were not improper are questions that the SEC Enforcement Staff will be evaluating during its investigations.  In some limited circumstance a firm might be able to justify receipt of the questioned fess, and also might be excused from or ineligible for the self-reporting initiative. Continue reading