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. Continue Reading You WILL (not May) Face the Heat

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. Continue Reading What You Should Know About FINRA’s Exam Priorities for 2019

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.

Continue Reading 529 Problems, but FINRA Ain’t One

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] Continue Reading Federal Court Evaluates When Cryptocurrency May Constitute a Security in a Criminal Case

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 provisions of the federal securities laws: the Safeguards Rule and the Identity Theft Red Flags Rule. The landmark action has clear application not only to the securities industry but for all businesses, even those not in the financial sector.

READ HERE: SEC Enforces Identity Theft Red Flags Rule for the First Time: What it Means for Texas Businesses

 

The Massachusetts Securities Division (MSD) recently announced that it is seeking comments on a proposed format to standardize the disclosure of investment advisory fees.[1]  This step should be noted by investment advisers across the country.

After all, fee transparency is generally not a controversial objective—especially because fees are publicly disclosed on advisers’ Form ADV Part 2.  Further, regulators and clients may view the publication of simplified fee tables as a means to recognize efficiencies by disrupting existing business models.  Moreover, the focus on fee disclosures lines up with the broader conversation about fiduciary duties in the financial services industry.  Finally, the MSD is viewed as a leader amongst securities regulators and has previously led a similar fee disclosure effort for broker-dealers.  These realities suggest it may not be long before your state’s securities regulator considers a similar approach for registered investment advisers.  While the utility of a public, standardized “fee table” is debated, investment advisers should prepare for scrutiny—in the near term—on the form and quality of their fee disclosures.

Continue Reading Investment Advisers and Fee Disclosures