Adviser Regulatory & Compliance News

Fiduciary Stds Developments—August 2018

August 10, 2018

Issues related to the defunct DoL Rule continue to arise. Meanwhile comments are rolling in to the SEC on its proposals. For back-reference see our June 2018 update.

Private Funds Comparison Article

August 6, 2018

The law firm Pepper Hamilton recently published a fine article on the various private fund models. It's interesting in that it highlights new and emerging models as well as the tried and true. Here's the link: or just click the headline to this blurb.

SEC Updated Its Website

July 16, 2018

In early July, the SEC restructured its website with some notable changes for advisers and funds.

Fiduciary Stds Developments—June 2018

June 29, 2018

Given its importance, we're republishing our May update. A federal court has essentially struck down the DoL Fiduciary Standard. No appeal was made. Meanwhile, the SEC has proposed two things: (1) a "Best Interest" Standard for Broker-Dealers (and certain advisers); and (2) Form CRS which would require brokers and advisers to provide to investors a document describing their services and nature of their client relationships, i.e., a Relationship Summary. The attached page has a list of the best law firm summaries we've seen to date. Please click the heading above to access the detailed discussion and links.

Lucia v. SEC:  Supreme Court Holds SEC’s Past Hiring of Administrative Judges Unconstitutional

June 21, 2018

On June 21, 2018, the U.S. Supreme Court ruled in the appeal of the Lucia v. SEC case which has worked its way through the courts the past several years. In essence, the Supreme Court determined that the SEC’s old administrative law judges (“ALJs”) hiring practice was unconstitutional. In recent times, the SEC staff has guided appointments of ALJs. This decision resolved an outstanding split between federal circuit courts as to whether the SEC's ALJs are “officers” of the United States subject to the requirement of the Appointments Clause. The Court concluded that ALJs are “officers” who must be appointed pursuant to the Appointments Clause by the President, “courts of law,” or “heads of department.” For these purposes, the Commissioners of the SEC are deemed to be "heads of department," meaning that ALJ appointments will have to be by the Commission, courts or the President.However, the Court's decision does not resolve a variety of open questions that follow from this significant decision. Most notably, the decision throws into question the validity of the recent decisions of the ALJs that decide most of contested SEC enforcement actions.Such questions will likely take years to resolve in lower courts, and perhaps a revisit to the Supreme Court. The heading to this blurb links to an excellent summary by our friends at Ropes & Gray.

Updated Custody Q&A

June 21, 2018

The SEC's Div. of Investment Mgmt. has updated its custody Q&A page on its website. The updates primarily address advisers continuing questions and challenges regarding what is termed "inadvertent custody.," The press release which is linked to in the heading above, details specifically the additions to the Q&A for your ease of access.

Adviser Fails to Disclose to Clients a Conflict of Interest

June 8, 2018

The SEC found that an investment adviser recommended a security without disclosure to its client that it had a financial interest in the issuer of the security. The SEC stated that Larry Werbel from at least 2011 through 2014 introduced his clients to VGTel, Inc. and informed them that VGTel was as an investment opportunity. The SEC found that Werbel willfully failed to tell these clients that he was being compensated to recommend the purchase of VGTel securities. The SEC noted that this compensation agreement was an agreement with Ed Durante, a convicted felon. The SEC further noted that he failed to inform these clients that New Market Enterprises, the entity he directed his clients to send their money for the purchase of VGTel securities, was run and controlled by Ed Durante. The SEC stated that he met with Ed Durante in connection with his compensation agreement to discuss his clients' investment opportunities in VGTel.

SEC to Allow Electronic Posting of Mutual Fund and ETF Reports

June 5, 2018

The SEC adopted Rule 30e‑3 under the 1940 Act, which provides an optional “notice and access” method to allow funds to satisfy their obligations to transmit shareholder reports. Subject to conditions in the rule, a fund may make its reports and other required materials publicly accessible at a specified website address, free of charge, and send investors a paper notice of each report’s availability by mail. Funds will be permitted to satisfy their delivery obligations for shareholder reports by mailing reports in paper, delivering reports electronically to investors who have chosen this method under the SEC’s electronic delivery guidance, providing notice and website accessibility under rule 30e-3, or a combination of the above.

French-Owned Adviser Fails to Disclose Side Letter

June 4, 2018

The SEC brought an enforcement action against Lyxor Asset Management, Inc. to disclose conflicts of interest. The SEC found that Lyxor, an investment adviser, to certain of its clients arising from an agreement (Side Letter) between Lyxor and two affiliated outside asset managers (Third Party Advisers). The Side Letter called for the Third Party Advisers to make payments to Lyxor based on the total amount of Lyxor client assets placed or maintained in certain funds advised by the Third Party Advisers.

U.K. Adviser Fails to Disclose Compensation Earned in Recommended Third-Party Product

June 4, 2018

The SEC brought an enforcement action against deVere USA, Inc. (DVU) for failing to make full and fair disclosure to clients and prospective clients of material conflicts of interest regarding compensation obtained from third-party product and service providers. DVU’s clients are primarily U.S. residents or citizens who held U.K. defined benefit and defined contribution pensions. DVU provided investment advice to its clients in connection with the transfer of these U.K. pension assets to overseas retirement plans that qualified under the U.K. tax authority’s regulations as a Qualifying Recognised Overseas Pension Scheme (QROPS). Between at least June 2013 and March 2016, the SEC found that DVU did not disclose arrangements in which third-party product and service providers recommended by DVU in connection with its QROPS advice compensated an overseas affiliate of DVU that, in most cases, in turn compensated the DVU investment adviser representative (IAR) who had made the recommendations. The undisclosed compensation constituted the primary form of compensation received by DVU’s IARs for their advisory services. Each of these arrangements created an economic incentive for DVU to recommend a transfer to a QROPS and/or to recommend certain product and service providers.

SEC Brings a Number of Failure to File Form PF Filing Enforcement Actions

June 1, 2018

The SEC brought a number of enforcement actions against investment advisers for failing to file Form PFs, which violated the reporting provisions of Rule 204(b)-1 under the Advisers Act. Rule 204(b)-1(a) requires an investment adviser to complete and file a report on Form PF if the investment adviser: (1) is registered or required to be registered under Section 203 of the Advisers Act; (2) acts as an investment adviser to one or more private funds; and (3) as of the end of its most recently completed fiscal year, managed private fund assets of at least $150 million. Rule 204(b)-1(e) requires such advisers to file an updated report on Form PF at least annually.

New Enforcement Action Online Tool Launched by SEC

May 31, 2018

The SEC launched an online search took that includes a database of all individuals who have settled, defaulted, or contested an SEC enforcement action that resulted in a final judgment or order in federal court or an administrative proceeding. The new system is called SALI, which stands for SEC Action Lookup for Individuals. It includes any respondent/defendant and not just investment professionals. The current database extends back to 2014.

Fiduciary Stds Developments—May 2018

May 29, 2018

A federal court has essentially struck down the DoL Fiduciary Standard. No appeal was made. Meanwhile, the SEC has proposed two things: (1) a "Best Interest" Standard for Broker-Dealers (and certain advisers); and (2) Form CRS which would require brokers and advisers to provide to investors a document describing their services and nature of their client relationships, i.e., a Relationship Summary. The attached page has a list of the best law firm summaries we've seen to date.

CFTC and States Sign Enforcement Information Sharing Agreement

May 21, 2018

The Commodity Futures Trading Commission (CFTC) and North American Securities Administrators Association (NASAA) signed a mutual cooperation agreement to establish a closer working relationship between the federal commodity regulator and individual state securities agencies. The agreement provides a framework for the sharing of confidential information between the CFTC and state securities regulators in the U.S.

Adviser Allowed to Continue to Use Performance Track Record Despite Reorganization

May 8, 2018

The SEC in a no-action letter permitted the continued use of a performance record of an adviser that proposed to reorganize its structure with affiliates. South State Advisory, Inc. (SSA) and Minis (collectively, the Advisers) are wholly-owned registered investment adviser subsidiaries of South State Bank (SSB), which in turn is a wholly-owned subsidiary of South State Corporation. Each Adviser has its own management team, which reports separately to a SSB management team. Each Adviser also has its own investment committee, which is responsible for the Adviser's investment decisions and recommendations. To improve corporate efficiency, SSB proposed an internal restructuring whereby Minis would be merged into SSA (Restructuring). Following the Restructuring, Minis' business would continue as a separate business division of SSA called the "Minis Division"). The same management team that currently manages Minis would manage the Minis Division and the Minis investment committee would continue to have responsibility for the Minis Division's investment decisions and recommendations.

Chairman Clayton Testifies on the SEC’s Priorities

April 26, 2018

He provided data about the SEC’s National Examination Program (NEP), led by the Office of Compliance Inspections and Examinations (OCIE). He stated that OCIE conducts risk-based examinations of registered entities, including broker-dealers, investment advisers, investment companies, municipal advisors, national securities exchanges, clearing agencies, transfer agents and FINRA, among others. Recently, through the reallocation of resources, advancements in OCIE’s use of technology and other efficiencies, he stated that OCIE increased its examination of investment advisers by more than 40% in FY 2017 over FY 2016 – to approximately 15% of all SEC-registered investment advisers.

Excellent Summary/Analysis of the Fiduciary Rule Status

April 8, 2018

Our friends at Eversheds Sutherland recently posted an excellent analysis of the vacatur of the DoL's fiduciary rule and its impact on plan sponsors and plan providers. By extension, advisers need to keep an eye on the continuing developments regarding the rule and SEC efforts in this area as well. We'll keep you posted on key developments. The article is linked to the heading above.

Whistleblowers Must Report to SEC to be Eligible for Awards

March 31, 2018

The United States Supreme Court has ruled that Dodd-Frank’s anti-retaliation provisions apply only to whistleblowers who report the misconduct to the SEC. In the case, the employee brought a claim under Dodd-Frank’s whistleblower anti-retaliation provisions, even though he had not reported to the SEC, because he claimed that he was fired as a result of reporting to management suspected securities law violations. The Supreme Court reversed the decision of the Ninth Circuit based on the plain reading of the statute which defines “whistleblower” as any individual who provides information relating to a violation of the securities laws to the SEC. The Court rejected the SEC rule that expanded anti-retaliation protection to those who only report internally. Looking at legislative history, the Court reasoned that “Dodd-Frank’s award program and anti-retaliation provision thus work synchronously to motivate individuals with knowledge of illegal activity” to report to the SEC.

Adviser Settles Charge that it Inadequately Disclosed Securities Lending Arrangement

March 31, 2018

The SEC charged two investment adviser subsidiaries of Voya Holdings Inc. with failing to disclose conflicts of interest and making misleading disclosures in connection with their practice of recalling securities on loan so their affiliates could receive tax benefits. According to the SEC, Voya Investments LLC and Directed Services LLC served as investment advisers to certain insurance-dedicated mutual funds offered to annuity and life insurance customers through insurance companies affiliated with the advisers. In order to generate additional income for the mutual funds and their investors, the Voya advisers lent securities held by the funds to parties looking to borrow the securities. The Voya advisers recalled loaned securities before their dividend record dates so that the advisers’ insurance company affiliates, which were the record shareholders of the funds’ shares, could receive a tax benefit based on the dividends received. But the SEC stated that the recall practice caused the funds and their investors to lose securities lending income without receiving any offsetting tax benefit. The SEC found that the Voya advisers failed to disclose the conflict of interest to the funds’ board of directors or in the funds’ prospectuses. The Voya advisers agreed to pay approximately $3.6 million to settle the charges, including more than $2 million directly to the affected mutual funds for the benefit of their investors.

SEC Grants Largest Whistleblower Awards

March 19, 2018

The SEC awarded two whistleblowers collectively nearly $50 million and a third whistleblower received more than $33 million. The previous high was a $30 million award in 2014. The awards were made in connection with Dodd-Frank enforcement cases. The SEC stated that it has awarded more than $262 million to 53 whistleblowers since issuing its first award in 2012. All payments are made out of an investor protection fund established by Congress that is financed entirely through monetary sanctions paid to the SEC by securities law violators. It further noted that whistleblower awards can range from 10 percent to 30 percent of the money collected when the monetary sanctions exceed $1 million.

Fifth Circuit Vacates Department of Labor’s Fiduciary Rule

March 16, 2018

The Fifth Circuit Court of Appeals vacated the Department of Labor’s fiduciary rule primarily on the grounds that the Department of Labor unlawfully expanded the definition of the term “fiduciary” to include commissioned brokers. The Court opined that the Department of Labor departed from the common law and contextual definition of “fiduciary” and dispensed with the criteria used for the past several decades. The Court agreed with opponents of the fiduciary rule that argued that the fiduciary rule would cause many financial service providers to exit the market for retirement advice, thereby hurting the people that the Department of Labor intends to protect.

Adviser Violates Custody Rule through Third-Party Arrangement

March 5, 2018

The SEC brought an enforcement action against Financial Fiduciaries, LLC (Financial Fiduciaries) and Thomas Batterman in connection with certain clients financial conflicts of interest created by Financial Fiduciaries’ arrangement with a third party trust company. Because of these arrangements and the fact that an employee of Financial Fiduciaries’ parent company handled funds of Financial Fiduciaries’ clients, from early 2012 to mid-2014, the SEC found that Financial Fiduciaries had custody over some of its clients’ assets while failing to implement sufficient controls designed to protect those client assets from loss or misappropriation, as required by the Advisers Act.

Falsified Performance and Marketing Materials Means Trouble

March 1, 2018

The SEC recently levied a $3 million fine on a private fund manager who falsified performance data, provided fake investment manager information, and created a misleading internet optimization campaign. In addition to the fine, the manager is also serving a five year prison term. See link in headline for link to the SEC's release.

SEC Cybersecurity Guidance for Public Companies

February 28, 2018

The SEC has issued interpretive guidance to assist public companies in preparing disclosures about cybersecurity risks and incidents. While not targeted at or designed for investment advisers, the Guidance is nonetheless very insightful and helpful for advisers in understanding cybersecurity issues, the SEC's perspective, and the expectations that are developing in the public company space especially regarding disclosure of incidents. Click the headline to link to the Guidance.

SEC Compliance Outreach Seminar in April

February 14, 2018

The SEC recently announced its 2018 outreach program national seminar for investment companies and investment advisers. The event is intended to help CCOs and other senior personnel at investment companies and investment advisory firms to enhance their compliance programs for the protection of investors. We've been to these in the past and they are invaluable for insights and guidance on the SEC's current regulatory and examination focus points. Please click the heading above to be linked to the announcement and registration pages.

SEC Offers Advisers Potential Amnesty for Self-Reporting of Fund Share Revenue Sharing Violations

February 13, 2018

On Feb. 12, the SEC announced a new initiative designed to encourage advisers to self-report inappropriate mutual fund share class revenue sharing arrangements. These arrangements generally arise when an adviser counsels clients to purchase higher commission or fee producing mutual fund share classes when less costly ones are available. Typically, there is a lapse in disclosure to the client underlying the sale, which can be viewed as fraudulent. According to the SEC press release, "Under the Share Class Selection Disclosure Initiative..., the [Enforcement] Division will agree not to recommend financial penalties against investment advisers who self-report violations of the federal securities laws relating to certain mutual fund share class selection issues and promptly return money to harmed clients." Please click the heading for the full announcement.

Examination Priorities 2018 Released

February 8, 2018

The SEC has released its 2018 exam priorities. The key themes are a continuation of past trends, organized around five themes: 1. Matters of importance to retail investors, including seniors and those saving for retirement; 2. Compliance and risks in critical market infrastructure; 3. Financial Industry Regulatory Authority (FINRA) and Municipal Securities Rulemaking Board (MSRB); 4. Cybersecurity; and 5. Anti-Money laundering programs. See link embedded in the title of this news blurb to link to the full document.

SEC Investor Bulletin: Investment Adviser Sponsored Wrap Fee Programs

January 5, 2018

In early December the SEC published an Investor Bulletin updating and outlining the basics of wrap fee programs from an investor's perspective. The Bulletin is instructive on the SEC's current advice and views of such programs, which are growing rapidly. Notably at the end of the Bulletin the SEC references several key enforcement actions regarding such programs. Click the heading of this blurb for a link to the Bulletin.

Senate Confirms Peirce and Jackson as New Commissioners

December 22, 2017

The full Senate on confirmed by voice vote Hester Pierce, a Republican, and Robert Jackson, a Democrat, to be Commissioners of the SEC. The SEC now has its full allotment of commissioners. Mr. Jackson, a professor at Columbia University, and Ms. Peirce, a senior research fellow at George Mason University, will join the SEC after they are sworn in. Chairman Jay Clayton and Commissioners Michael Piwowar and Kara Stein are the other three Commissioners.

ICOs:  the Chairman Speaks

December 20, 2017

When the SEC Chairman speaks, folks listen. On Dec. 11, SEC Chair Clayton issued a lengthy "statement" on the current wave of initial coin offerings (ICOs) (see our Nov. 13 story on the basics), focusing on whether ICOs are treated as securities under the federal securities laws. He noted that, while not all tokens may be securities, simply calling a token something else does not bring an offering outside the SEC’s purview. “Key hallmarks” of tokens being securities include, in the SEC’s view, when an issuer emphasizes the possibility for ICO tokens to appreciate in value or encourages a secondary market for tokens. Clayton’s statement, along with recent SEC efforts to stop certain ICOs, indicate that increased enforcement activity in this area will continue. Click the heading to access the Statement.

F-Squared Related Action Brought Against an Investment Adviser

December 8, 2017

The SEC brought an enforcement action against Horter Investment Management, LLC that was related to a prior enforcement action against F-Squared. The SEC stated that the matter arises from misstatements made by registered investment adviser Horter to certain of its advisory clients concerning F-Squared Investments, Inc.’s materially inflated, and hypothetical and back-tested, performance track record for its AlphaSector strategy. The SEC noted that from January 2012 to October 1, 2013, in reliance on F-Squared’s false statements, Horter disseminated AlphaSector advertisements falsely stating: (a) assets had been invested in the AlphaSector strategy from April 2001 to September 2008; and (b) the track record had significantly outperformed the S&P 500 Index from April 2001 to September 2008. In fact, no F-Squared or other client assets had tracked the strategy from April 2001 through September 2008. In addition, the SEC found that F-Squared miscalculated the historical performance of AlphaSector from April 2001 to September 2008 by incorrectly implementing signals in advance of when such signals actually could have occurred. Because of this inaccurate compilation of historical data by F-Squared, Horter advertised the AlphaSector strategy by using hypothetical and back-tested historical performance that was inflated substantially over what performance would have been if F-Squared had applied the signals accurately. As a result, Horter violated Sections 206(2) and 206(4) of the Advisers Act and Rule 206(4)-1(a)(5) thereunder by publishing, circulating, and distributing advertisements that contained untrue statements of material fact.

SEC Commissioner Stein Speaks on Adviser Issues

December 7, 2017

SEC Commissioner Kara Stein spoke at the at Investment Company Institute’s 2017 Securities Law Developments Conference on a number of investment management issues including those impacting advisers. After speaking about ETFs and fund disclosure issues, she discussed the relationship between an investment adviser and its client. She spoke about the debate around standards of conduct, are conflicts of interest. She stated that conflicts can result from a number of sources and relationships, but some of the most significant are those resulting from compensation arrangements. She stated that this is true whether compensation is transactional or fee-based; each can incentivize certain behaviors that may not be in the best interests of a particular customer or client. She then stated that brokers and advisers should be required to mitigate these conflicts, and the standard of conduct by which they provide advice can help ensure that that happens. She posed the question of whether it is better to have multiple standards or one standard that fits all; the question ought to be whether the standard is appropriate for the conduct in which the person is engaging. She concluded by noting that disclosure has always been an important piece of this puzzle for the SEC and the securities laws, and there are clearly existing models on both the broker-dealer and investment adviser sides. She stated that we all know that providing disclosure, and ensuring that those disclosures are effective, are very different things; certain academic evidence notes that disclosure leads advisers to be even more biased by seeming to absolve them from paying attention to their advisees’ interests. In effect, disclosure has limited utility for both the investor and the professional providing it to the investor.

Private funds and managers:  Dealing with the Seemingly Crazy Broker-Dealer Requirements

December 2, 2017

For private fund managers, the tricks and traps of selling their funds can be maddening! Believe me, I've been there. All sorts of issues: is the fund exempt? Do placement agents and finders have to be registered as a broker or dealer or personnel of one? Etc.! Foley & Lardner recently published a short guide to navigating the broker-dealer rules. Click the headline to get the publication.

ALJ’s Officially Ratified and Appointed

December 2, 2017

Addressing a nettlesome issue, the SEC Commissioners formally ratified the appointment of the SEC's administrative law judges. The ratification attempts to defuse a constitutional issue re: the appointment of the judges and the validity of their actions some of which have been challenged in court. Click the link in the heading to read the SEC's press release.

DoL Rule Update:  the Final Say

November 29, 2017

Should be final...maybe! After many months of wrangling, by a notice published in the Federal Register on November 29, 2017, the Department of Labor extended from January 1, 2018, until July 1, 2019, the date for compliance with the full conditions in its new “investment advice” fiduciary definition and related exemptions, which became generally applicable on June 9 of this year. A great Eversheds summary and schedule for implementation is available by clicking the heading.

Global Securities Litigation Overview

November 23, 2017

One of the challenges money managers and investment advisers face is the need to protect their investors against the myriad of scams and frauds. Securities litigation has gone global, and Dechert recently prepared a nice summary of the state of global securities litigation. Click the title to access the link.

SEC Div. of Enforcement 2017 Annual Report

November 22, 2017

The SEC's Enforcement Division recently issued its Annual Report. Please use the link in the heading to access it directly. Bottom line: enforcement actions vs. advisers were down a bit from 2016. For the next year, the report notes that we can expect greater focus on cyber security and on protection of retail investors.

Flip a Coin:  ICO Basics

November 13, 2017

Cryptocurrencies, ICOs, coin offerings......they're all the buzz right now. Do you understand them? Do you realize that ICOs have raised more $$ this year than venture capital funds have? If your PMs or even clients haven't approached you yet on ICOs and cryptocurrencies, they will soon. Pepper Hamilton recently hosted an educational session, which they've posted on-line, both a podcast and slide deck. Check it out. Click the heading above for this link: A REVIEW OF INITIAL COIN OFFERINGS: AND WHAT THEY MEAN FOR THE INSTITUTIONAL INVESTOR COMMUNITY, 11/07/2017