Securities litigation frequently raises the question of what conduct constitutes a primary violation of the federal securities laws, specifically, Rule 10b-5 and the various other antifraud provisions.  Must one make a false statement in order to be primarily liable?[1]  The Supreme Court held in Janus Capital Group, Inc. v. First Derivative Traders that only those who “make any untrue statement of material fact” may violate Rule 10b5-(b).[2]  Other questions include whether one who merely disseminates a false statement, without actually writing or “making” the statement, can be primarily liable.  And what are the contours of “scheme” liability under Rules 10b-5(a) and (c)?  The Supreme Court recently clarified some of these difficult questions in Lorenzo v. SEC. [3]

Background: Janus and Primary Liability of “Makers” of Untrue Statements

As mentioned, the Supreme Court held in Janus that only those who “make any untrue statement of material fact” may violate Rule 10b5-(b).[4]  The Court wrote that the “maker of a statement is the person or entity with ultimate authority over the statement, including its content and whether and how to communicate it.”[5]  For example, the Court noted, a speechwriter does not control the content of the speech; that content is exclusively within the control of the person who delivers it.  Under this analysis, the speechwriter is not a “maker” of the speech and therefore could not be held primarily liable under Rule 10b5-(b), even if all other elements of the violation were satisfied.[6]  Left undecided in Janus was whether one who disseminates a statement, with scienter but without control over its content, may be liable under any part of Rule 10b-5.
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The Securities and Exchange Commission (SEC) recently announced other notable examples of the scrutiny being applied to investment advisers’ disclosures of conflicts of interest.  The criticism is notably sharp on issues involving fees and costs associated with advisory services.

Of course, there are the well-publicized actions involving the disclosure of 12b-1 fees pursuant to the share class initiative. On March 11, 2019, the SEC announced that 79 investment advisory firms had agreed to return over $125 million to clients in connection with the SEC’s “Share Class Initiative.”[1]

For purposes of this short post, we’ll detail the SEC’s March 5, 2019 regulatory action involving Valley Forge Asset Management, LLC (Valley Forge).  The SEC’s action, which resulted in over $5 million in sanctions, centered on Valley Forge’s disclosures to its clients about the brokerage options available to its clients and specifically the costs and services associated with Valley Forge’s own brokerage firm.  The action is a reminder of the importance of assessing whether a conflict, or potential conflict, is actually present or just “may” be present.  In that regard, we continue to caution that an investment adviser’s use of “may” in connection with conflicts disclosures increases its regulatory risk.
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The Financial Industry Regulatory Authority (“FINRA”) recently published its Risk Monitoring and Examination Priorities Letter (the “Letter”) for 2019 and signaled its intent to expand the scope of its priorities and exam program. Unlike previous years, FINRA’s 2019 Letter took a “somewhat new approach” by identifying materially new areas of emphasis.[1] Admittedly, FINRA will continue to examine longstanding priorities detailed in prior letters,[2] but in adding “Risk Monitoring” to the title to the Letter, FINRA notified the industry it planned to broaden its exam program into three materially new priorities: (1) online distribution platforms, (2) fixed income mark-up disclosure, and (3) regulatory technology.[3]  These three new areas of focus are buttressed by other highlighted items in FINRA’s 2019 Letter: sales practice risks, operational risks, market risks, and financial risks.  At the same time, FINRA cautioned industry recipients that “[u]nlike previous Priorities Letters, we do not repeat topics that have been mainstays of FINRA’s attention over the years.”  Thus these “mainstays” are also given consideration.  The following briefly summarizes many of the important and emerging issues highlighted by FINRA:

Mainstay Areas of Exam Focus

FINRA’s 2019 Priorities Letter makes clear its exams will continue to focus on what it terms “mainstay” topics.  In fact, FINRA highlights this admonition in the first paragraph of its 2019 Letter.  And as to be expected protection of securities customers will continue to be a bedrock exam principle.  Thus protections for the customer vis-à-vis the transaction process or relative to the strength of the firm remain key areas of inquiry.  Firms should focus then on compliance obligations related to suitability, complex products, mutual fund and variable annuities share classes and break points; use of margin; OBAs and especially disclosures about such activities; private securities transactions; private placements; communications with the public; AML; best execution; fraud (including microcap fraud), insider trading and market manipulation; net capital and customer protection; trade and order reporting; data quality and governance; recordkeeping, risk management and supervision related to these and other areas.
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The Financial Regulatory Authority (FINRA) recently announced an initiative it presents as an effort to promote member firms’ compliance with rules applicable to the recommendation of 529 plans. FINRA’s initiative is designed, first and foremost, to encourage firms to engage in a self-assessment specific to their 529 plan sales as well as the supervision of such sales.  But, as with similar regulatory initiatives, this program only affords firms a degree of protection as to any issues identified by the firm if the firm self-reports to FINRA and takes corrective measures.  The decision to self-report always requires a considered approach guided by experienced securities regulatory counsel.  Of course, that calculus is dramatically impacted by the announcement of such an initiative. Thus, to avoid (or least minimize) problems with FINRA, member firms are encouraged to review their practices as well as supervisory procedures and controls with an eye on the key areas of regulatory concern.

Key Considerations

A primary factor to consider is whether your firm’s supervisory system accounts for unique aspects of 529 plans.  A supervisory system that works well for monitoring stock recommendations is not necessarily going to be reasonably designed for supervising 529 plan recommendations.  To address this key issue, firms should ensure their procedures and systemic controls are designed to:

  • Identify specific attributes relevant to the suitability of 529 plans offered by the firm and communicate these attributes to supervisory personnel;
  • Ensure the systems are designed to factor in account and/or household holdings to identify the applicability of breakpoints and other share class considerations;
  • Flag share-class recommendations that are potentially unsuitable and/or more expensive for the customer by incorporating meaningful, data-driven controls; and
  • Adequately follow-up on flagged transactions, including communications with clients by supervisory or compliance personnel.


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A former broker at a national brokerage firm was recently sanctioned by FINRA after accepting instructions to transfer assets out of a client account. The problem? The instructions were actually sent by an imposter who had obtained access to the client’s account, presumably through some form of cyber-crime.  Unfortunately, the broker unwittingly contributed to the imposter’s malfeasance by not only accepting the instructions but by also taking pro-active steps to circumvent his brokerage firm’s controls.

This action joins a list of actions taken by FINRA and state securities regulators on similar issues, which we suspect will continue to grow as regulators continue to increase their scrutiny of cybersecurity controls and practices at financial service firms.  Thus, broker-dealers and investment advisers would be wise to review and enhance, if needed, their systemic controls and incorporate training elements to reinforce their representatives’ ability to identify suspicious conduct and act appropriately to avoid becoming victims themselves.
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The regulatory framework for virtual currencies is evolving, as federal and state regulators and courts wrestle with the circumstances in which cryptocurrencies are securities.  For instance, the staff of the Securities and Exchange Commission (“SEC”) has observed that tokens, which start as securities, can become something other than a security over time as a token’s network becomes “sufficiently decentralized.”[1]  In fact, the SEC staff indicate that more comprehensive yet “plain English” guidance will be forthcoming before the end of this year.[2]  In the meantime, we highlight a recent court case considering the question.  In U.S. v. Zaslavskiy[3], a federal court considered whether a cryptocurrency can be regarded as a security.  That case involved criminal charges against Maksim Zaslavskiy accused of promoting digital currencies backed by investments in real estate and diamonds that prosecutors said did not exist.[4]  The U.S. District Judge in New York decided that the prosecutors could proceed with their case alleging that the cryptocurrencies at issue were securities for purposes of federal criminal law.

Prosecutors argued that investments offered by Zaslavskiy in two initial coin offerings (“ICOs”)—REcoin Group Foundation and Diamond Reserve Club—were “investment contracts” that were securities under the federal securities laws.  Zaslavskiy, on the other hand, filed a motion to dismiss the prosecutors’ securities fraud claims, arguing that the virtual currencies promoted in the ICOs are “currencies,” and therefore, by definition, not securities.[5]
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The Texas Lawbook has published an article by Toby Galloway and Justin Freeman, “SEC Enforces Identify Theft Red Flags Rule for the First Time: What it Means for Texas Businesses.”  The article examines the Securities and Exchange Commission’s (SEC) recently settled case involving a dually registered broker-dealer and investment adviser for violations of cybersecurity

Financial services firms occasionally implement programs for their representatives to receive incentives in connection with specific product or service offerings. For as long as firms have used such programs, securities regulators have scrutinized them. The latest iteration of regulatory attention to sale incentives, however, signals a shift in strategy that carries broader implications for financial