Securities Compliance Sentinel - Analysis of Cutting Edge Securities Industry Issues

The North American Securities Administrators Association on behalf of state securities regulators, following 37 members of Congress, recently asked the SEC to exercise its authority under Dodd-Frank and do away with mandatory arbitration agreements.  Consumer groups have also jumped into this fray.

Does this signal the beginning of the end of arbitration clauses in customer agreements?  In my view, probably not, but the ability to force a customer into arbitration is likely to be curtailed.

The likely result will be that firms will have to offer a customer the option of arbitration or some other form of relief.  This does not mean that firms are not without methods to limit the costs associated with customer initiated litigation.

For example, if firms are required to let their customer proceed in a court, I would encourage the firm to require mediation as a pre-condition to a customer lawsuit.  This way, firms and the customers may be able to quickly resolve an issue without litigation.

I would also encourage firms to have venue and choice of law provisions.  In other words, force the customer to sue the firm in a particular court and pursuant to a particular state law. 

Similarly, I would recommend including a provision that requires the customer to waive a jury trial.  This may help you avoid a claimant shopping for a more favorable forum at your expense while, at the same time, expedite the ultimate resolution of the case.

Yes, it does appear as though firms may someday soon be limited in their ability to force arbitration, but you are not without tools to limit litigation.  Be creative, you can still structure your agreements to streamline litigation that may be initiated in the future.

Over the last several years, Congress and industry insiders have discussed whether it is time to merge the SEC and CFTC.  After some high-profile regulatory lapses by both agencies, Congressional studies indicated that the lapses were due, in part, to the lack of coordination and failure to share information between the agencies.  In late 2012, Representative Barney Frank introduced a bill to merge the two agencies.  Although combining the two agencies would likely streamline financial regulation, the CFTC has made changes in recent years to its structure to prevent a merger.  The largest stumbling block is the Agriculture Department, which does not want to lose control over the CFTC. 

Despite years of rumors and discussions over merging the two agencies, Congress has not come close to passing legislation for the President’s signature.  However, there are signs that the SEC and CFTC are more closely working together.  For example, the two agencies have worked together to issue final rules implementing the Dodd-Frank Act, and recently, the deputy director of the SEC’s Office of Compliance announced that the SEC and CFTC could “potentially” conduct joint exams. 

While these may seem like baby steps to those who want to see streamlined regulations under one combined agency, there is a possibility that support for combined agency could gain momentum in Congress, especially if another high profile regulatory failure embarrasses one or both organizations.  Most political observers believe that the recent bill proposed by Barney Frank is unlikely to have much support as standalone legislation, but the bill could be attached to more complex legislation in 2013.  

The SEC's Division of Corporation Finance will consider a bar on so-called "bad actors" from private offerings before announcing rules on crowdfunding under the JOBS Act.  However, we anticipate there will be an additional delay given the turnover at the SEC and the recent departure of its Corp Fin Director. 

As you have undoubtedly heard, the SEC has been criticized for delay in propounding these rules by various investor and industry groups.  The SEC is required by the JOBS Act to provide for an exemption for crowdfunding as well as disqualify those persons barred by a state authority from engaging in the securities business, convicted of a felony or misdemeanor relating to the sale of securities, or making false SEC statements.  To complicate matters, the SEC already has a pending Dodd-Frank Act rule to preclude certain "felons and bad actors" from participating in private offerings pursuant to Regulation D.  This proposed rule included certain events that occurred prior to the enactment of the Dodd-Frank Act.  Interestingly, when questioned about the delay, the SEC’s response was there were a lot of comments on this proposed rule. 

We expect that whenever the SEC finally gets around to approving final rules, the criticism and rancor should be deafening.

Ever since Dodd-Frank, there has been much concern in the RIA world regarding who would be its regulator.  At this point, RIAs can dispense with any concern that FINRA will be its regulator because FINRA pulled its hat out of the oversight ring, at least for now.

Even thought FINRA spent nearly $2 million lobbying Congress to become the SRO for RIAs, FINRA has decided that there is not enough support in Washington for it to be the regulator for RIAs.  So where does this leave RIAs?

At the moment, it seems unlikely that there will be a new SRO for RIAs any time soon.  Instead, the most likely scenario would be greater funding for the SEC to conduct more examinations than historically performed.

Although RIAs may not have their own SRO, they will still likely have to contend with a better funded SEC.  You should anticipate and be prepared for more frequent examinations.  All bets may be off, however, if FINRA pushes once again to be the SRO for RIAs.

* photo by freedigitalphotos.net

Much like the character in the famous Nathaniel Hawthorne story, FINRA is looking force broker-dealers to wear a mark on all of their social media.  FINRA wants to amend Rule 2267, forcing member firms to have a link to BrokerCheck on the websites and all other forms of social media.

The stated purpose of doing so is to create better consumer awareness for BrokerCheck.  As it currently stands, member firms must annually provide their customers written notice regarding the existence of BrokerCheck and how to access it.  Is this move really necessary?

Unfortunately, studies mandated by Dodd-Frank reflect that consumers are generally unaware of the resource that BrokerCheck has become for consumers to review information about member firms and registered representatives.  In light of these findings, it seems like a safe bet that this rule change will come to pass.

What should member firms do in anticipation for this change? 

Make sure you push the culture of compliance at your firm.  Any reportable events will be more easily found by existing and potential customers.  Do what you can to avoid these events, and wearing the scarlet letter of BrokerCheck will be just another link in social media.

 * photo by Freedigitalphotos.net

Basically, if you are an RIA, you dread the knock on your door from the SEC (or the state) seeking to conduct some alien probe of your business operations.  Although the SEC Staff is trying to do its best to be less intrusive, let's face it, their visits will always be laced with problems.  As such, this is a basic road-map to consider in dealing with the inevitable visit.

(1)  Review SEC document requests and understand them.

(2)  Conduct a mock audit.

(3)  Prepare the exam logistics, where they will sit, who will make copies, etc.

(4)  Update code of ethics and compliance manual.

(5)  Document compliance and risk assessment communications

(6)  Review previous exam letter.

(7)  Prepare a "cheat sheet," listing what your business does, assets, models, etc.

(8)  Investigate who will be coming, how long they will be staying, etc.  Try to arrange for all necessary employees to be present.

(9)  Let employees know the SEC will be coming and tell them to be on their best behavior (yes, really!!).

(10)  Prepare to have ready all the SEC requested documents when they arrive.

(11)  Track the examiner's document requests

(12)  Obvious, but necessary to repeat, don't lie about, alter, forge, etc., any documents.

(13)  Make sure any presentation made by anyone at the firm, including the initial interview, is candid, complete and correct.  Don't lie or fake it!!

(14)  Prepare your employees before they are interviewed by the SEC examiners.

(15)  Expect the curve ball from the SEC examiners as well as their potential quirky behavior.

(16)  After the exam is done, make sure everything was produced.

(17)  It is okay to ask the SEC questions, they do not bite.  You may even be able to improve your operation by following some of their suggestions.

(18)  You should also review all areas of operation even if not asked about by the examiners, and, as such, assume nothing, meaning if nothing was said, concerns can still be expressed later.

(19)  Correct all deficiencies prior to any official letter being received, after ensuring that the fix will work within your firm.  However, do not wait to long.

(20)  When you receive the SEC's letter, understand it, and keep in mind you can disagree, but make sure you are right.  Further, express such disagreement in a respectful tone because enforcement may be in the future.

Essentially, use these examinations as a wake-up call to improve and refine your operation.

The SEC is strongly reviewing if corporations are ensuring that informants are protected.

The SEC will not permit a retaliation.  The SEC is seeking to determine if corporations are retailing against individual persons who submit internal complaints.  As one indication, the SEC is reviewing personnel files to ensure that there is no negative reference to these individuals who have informed on corporate misconduct. 

In sum, corporations need to protect themselves from this type of review.  Reporting corporate misconduct is serious enough without then being accused of retaliation.  Avoid it like the plague!!

Although the SEC’s Dodd-Frank mandated report that there should be a uniform fiduciary duty standard for broker-dealers and investments advisers is nearly two years old, we are no closer to seeing that become a reality.  The question is why. 

Some see the lack of a majority of SEC Commissioners in support a draft request for public input as the cause for delay.  The stall may continue as long as the Commission remain currently constituted.  Others think that the Department of Labor’s forthcoming rule on the definition of a fiduciary under ERISA as a possible development that may break the logjam. 

The real question that must be asked is whether a uniform fiduciary duty standard is even worth the effort.  

In the many cases that I have defended broker-dealers, it is hard to recall any where the claimant did not assert a claim for breach of fiduciary duty.  Moreover, many arbitrators that I have observed make the general assumption that a broker-dealer serves as a fiduciary for its clients.  In addition, some courts have already concluded that broker-dealers are fiduciaries to their customers. 

In my view, the push, to the extent that one even remains, is one of optics.  In other words, there is a perception that the public wants to see there be such a standard so some will continue to push for it.  If anyone analyzed the issue hard enough, they would probably see that broker-dealers are already often held to such a standard, such that the effort to legislate it is one that is not needed.

The SEC recently completed the Dodd-Frank mandated study on financial literacy for retail investors and it revealed, not shockingly, an absence of basic financial literacy.  The study also found that it was important for retail customers to have a better appreciation of the costs associated with their investments, as well as conflicts of interest related to transactions. 

All those years of hearing customers testify of not knowing the difference between a stock and a bond may not have been a lie.  Without basic financial literacy, how can you know your customer to make investment recommendations with a reasonable basis and satisfy the applicable rules.

These issues should not come as a surprise to you because they are fundamental things that both your clients must know and you need to certain that they know. The absence of financial literacy will lead to two bad results.  First, you do not know your customer as required.  Second, if you do not know your customer, you could not have had a reasonable basis for making your investment recommendations.  As such, you will have liability exposure if sued by this client.

So what do you do.  For one, make sure that you do what you can to make your clients financially literate.  Once you have level of comfort that your client possesses some basic understanding of investing, you are then able to make suitable investment recommendations.  Take your time with this analysis; it may be the best way to protect yourself from customer complaints.

Last year, I blogged about the newly adopted Part 165 of the CFTC regulations, which implements the CFTC’s whistleblower program under the Dodd-Frank Act.  Last week, the NFA issued a notice reminding its members that CFTC Regulation 165.19 specifically provides that a pre-dispute arbitration agreement arising under the whistleblower rules is invalid.  As a result, the NFA recommends that its members ensure that employment agreements specifically exclude claims arising under Part 165 of the CFTC Rules. 

Further, the NFA informed its members that, although NFA’s arbitration rules are mandatory at the election of the person filing a claim, the NFA would not honor any pre-dispute arbitration agreements that purport to require an associate to file a claim that arises under the whistleblower rules.  However, a member would still be obligated to arbitrate the dispute if the associate voluntarily elects to file the claim against the member firm.

The Department of Labor's head of the Employee Benefits Security Administration recently announced that the DOL is going to coordinate with the SEC on fiduciary policy, but that the DOL and SEC will maintain and pursue their own regulations.  This statement has garnered confusion and concern by many in the industry, as it should.

The primary concern with such a statement is that the SEC and DOL operate under different fiduciary duty standards.  The securities laws focus on disclosure, while the retirement law fiduciary duty that the DOL enforces prohibits conflicts of interest.  As such, how can the DOL and SEC coordinate their respective fiduciary policies when they operated under different standards.  In response to such concern, the DOL stated that there would not be one standard, but that the two will be compatible.

The DOL like the SEC has been struggling with its own fiduciary duty standard, resulting in it withdrawing a proposed fiduciary duty rule in September 2011.  Dodd-Frank vested the SEC with the authority to develop a uniform fiduciary duty standard over anyone who provides retail investment advice.  The SEC has yet to develop such a standard and has tabled doing so through the balance of 2012.

The overall uncertainty created by the respective inability of the SEC and DOL to develop a fiduciary duty standard leaves many in the retirement planning arena in the dark, leading some opponents to question whether this is even necessary.  The bad apples ultimately float to the top and can be removed from the barrel through enforcement mechanisms.  While the debate rages, confusion reigns.  Either clear rules should be adopted or the process abandoned.  The state of unrest does not help anyone.

It’s been two months since President Obama signed the JOBS Act into law (ironically, the jobs data since then have been less than great).  My, how time flies when you watch every move the SEC’s Division of Corporate Finance makes!  Or, in this case, doesn’t make.

As you might recall, some of the JOBS Act’s reforms were immediate:  already about a dozen Emerging Growth Companies have taken advantage of confidential registration statement review, and the 12(g) shareholder limit for triggering registration is currently 2000, up from 500 (and excluding employees from that count). 

But the others require the SEC to pass rules before they are in effect.  The SEC was given a 90 day deadline to change Rule 506 and Rule 144A of the Securities Act to remove the ban on general solicitation in those transactions.  With 30 days left to go, the SEC has yet to offer proposed rules.  It’s not a question of whether or not this deadline will be met – it won’t – but rather, how late it’ll be.  Keep in mind that the SC has been so late enacting some of Dodd-Frank’s reforms that it is now being sued for violating the law.  I don’t think we’ll see any 506 issuers launching lawsuits anytime soon (seems like a good way of guaranteeing a little more attention from the Division of Enforcement), but there will be some grumbling. 

If anyone will be intrepid/foolish enough to sue the SEC for missing JOBS Act deadlines, I expect it would be the crowdfunding guys.  The SEC was given 270 days to pass the rules necessary to make crowdfunding happen.  I could see a nascent crowdfunder being idealistic and brash enough to attempt to force the SEC’s hand.  Of course, that would seem like a great way of ensuring that the Division of Corporate Finance regulates crowdfunding into the ground.  Given the large amount of public interest, the potential for fraud, and the appeal it might have to retail investors (of whom the SEC is extra protective), expect crowdfunding to arrive extremely fashionably late.

Finally, the JOBS Act neglected to give the SEC a deadline on the changes to Regulation A, which is essentially nothing more than adding a zero (the maximum amount that can be raised using Reg A rises from $5 million to $50 million).  So, y’know, this shouldn’t be that difficult.  Heck, I’ll do it right now.

Old: “The sum of all cash and other consideration to be received for the securities ("aggregate offering price") shall not exceed $5,000,000…”

New: “The sum of all cash and other consideration to be received for the securities ("aggregate offering price") shall not exceed $50,000,000...”

Boom.  I didn’t even break a sweat.  That said, applying Parkinson’s Law (work expands to fill the time available to complete it), I expect Reg A to be the last of the JOBS Act reforms enacted. 

The SEC will keep us on our toes this summer.  I don't blame them for the delays - they're already fairly overworked and understaffed, and the JOBS Act didn't help.  Remember to subscribe to the Securities Compliance Sentinel for updates on the  JOBS Act and all your other esoteric federal securities regulatory needs!  We’re your one-stop shop for dinner party discussion topics… if your dinner party is comprised exclusively of CPAs, lawyers and broker-dealers! (And if that’s the case, you need to go to better dinner parties).

PS and apropos of nothing:  The Transit of Venus is tonight, June 5th, around sun-set.  It only happens every 100 years or so, so don’t miss it (but don’t stare into the sun.)

One of scarier events that occurred in the 2008 financial crisis was when a money market mutual fund broke the buck; otherwise known as having its NAV go below $1.00.  Most investors have assumed (wrongfully) over the years that investments in money market mutual funds were as safe as a bank savings account, albeit with a better return.  But that was not the case.  Chairman Schapiro has vowed to press for reform.

Chairman Schapiro has championed two alternative approaches to bolster money market mutual funds.  First, move these funds to a floating NAV, as opposed to $1.00.  Second, require the funds to maintain a capital buffer, as well impose redemption limits or fees.  The SEC has yet to propose either, but that has not staved off industry opposition to both approaches who believe that either would essentially drive investors out of these funds altogether.  Moreover, the SEC has been faced with Congressional opposition, as well as divided support among SEC Commissioners.

So what does this all mean?  In the short run, it is unlikely that there will be any reform of the money market mutual fund.  In the long run, public opinion will push for reform.  Although maybe impossible to obtain, investors want the best of both worlds, the relative security of a bank but the returns of a money market mutual fund.  In the end, there will need to be some compromise to protect investors, but allow the fund industry to continue.  It seems to me that one of the two proposed alternatives will become reality.

At a recent corporate counsel meeting, the SEC’s New York Regional Director made a highly critical statment of the Dodd-Frank provision requiring the SEC either to bring a case or to inform the Enforcement Director that no case shall be filed within 180 days of a Wells Notice. 

As many are aware, the Dodd-Frank Act required that the SEC make a decision within 180 days once a Wells Notice is issued.  A Wells Notice is when the SEC Staff provides a potential person involved in an investigation with notice that it intends to recommend or is considering recommending to the Commission that some action or proceeding should be filed against that person.  The New York Regional Director seems to suggest that there is simply not enough time for the SEC Staff to decide if such an action should be brought.  He further opines that this limitation is detrimental to the SEC's enforcement program since it may be the case the SEC has not completed its factual investigation.

Apparently, the New York Regional Director simply forgot the "clock" is within the SEC Staff's control.  That is, if the investigation is not complete, the SEC Staff should not issue a Wells Notice.  Further, one wonders the reason for issuing a Wells Notice prior to the SEC Staff completing its investigation, one would think the SEC Staff would wait!!   

Clearly, as far back as the inception of the Wells process, it has always been contemplated that, before the SEC Staff issued a Wells Notice to a potential defendant or respondent, the SEC Staff was ready to proceed with the matter.  It is troubling that the New York Regional Director claims that there should be more investigation after a Wells Notice is issued.  Such an approach leaves much to be desired.

In sum, the Dodd-Frank Act provision seems reasonable in light of accepted practice, and should be considered as a method for ensuring actions proceed expeditiously.

OCIE is intending to review newly registered hedge and private equity fund advisers by focusing in on certain priorities.

In particular, OCIE will review due diligence practices; fraud indicators; unknown service providers; problem custody arrangements; insider trading and front running issues; and preferential treatment to determine if there are conflicts of interest.  OCIE also intends to take a global approach and not look at any one particular issue.  OCIE's focus will, most certainly, focus in on complex entities with high frequency trading.  Such a review will include an SEC staff examination of fund governance; compliance, audit and management functions; protection of assets; and the transmission of performance data and advertising. 

These principals will guide the OCIE staff in conducting examinations along with the new OCIE examination manual. 

Today’s Wall Street Journal includes a story (subscription required) of an attorney for the SEC inadvertently “outing” a whistleblower while interviewing an executive of the whistleblower’s former employer.  The SEC attorney apparently showed the executive the whistleblower’s notebook during the interview, and the executive recognized the whistleblower’s handwriting.

Outing whistleblowers is certainly not the best way to encourage them to come forward (though the risk of exposure is made more tolerable by Dodd-Frank’s financial incentives).

The SEC, for its part, says that it followed policy in interviewing the executive, but one can expect that its attorneys will be more cognizant of inadvertently outing whistleblowers in the future.

The SEC’s gaffe is a reminder to in-house and private counsel conducting corporate internal investigations to take care not to inadvertently out their sources.  A confidential system for employees to report suspected wrongdoing is a key part of any robust internal compliance program, and often is what allows businesses an opportunity to root out and (potentially) self-report wrongdoing before the government makes the choice for them. 

Sometimes effective investigation, required reporting to regulators, or other circumstances will dictate that the confidential source’s identity be directly or indirectly revealed.  However, whenever possible, a source’s desire for anonymity should be respected, if for no other reason than to encourage others to come forward in the future.

Much has happened in nearly one since since the Dodd-Frank Act became effective, and much more remains.  According to the recent thoughts of one commentator, Kyle Colona of Compliance EX, Dodd-Frank may be doomed to fail as it faces it first year of existence.

Colona noted five factors working against the full implementation of the law: (1) the CFTC and SEC are far behind schedule; (2) the regulatory authority under the Act is shared by too many entities; (3) recent comments from the Federal Reserve Bank suggest that the Volcker Rule may not become law because of its impossibility to implement; (4) the financial services industry has unleashed a full-scale effort to defeat the full implementation of the Act; and (5) certain banks are trying to influence the public that implementation of the Volcker Rule would be bad.

I think that there is now a sixth factor that may work against the full implementation of the Dodd-Frank Act; namely, a presidential election this fall.  With the politicalclimate becoming more and more focused on the election, it is only natural that there would be less attention devoted to a law that the financial services industry is committed to pealing back or doing away with altogether.  If the President loses the election, there are some who believe that Dodd-Frank may be in trouble.  Even if the President prevails, it is unlikely that there will be full implementation because attention will surely be focused elsewhere.

Although it is unlikely that there may ever be full implementation of the Act, we need to still anticipate that many provisions of the Act will come to pass.  For example, at some point, the SEC will finally commit to the adoption of the uniform fiduciary duty rule and there will be a decision on who will serve as the SRO for investment advisors.  Dodd-Frank is not dead; it just may limp along for the next year.

Today's post is the penultimate of this series covering the recently signed JOBS Act, and covers the Act's Title I – Reopening American Capital Markets to Emerging Growth Companies.  Check back later this week for more on Crowdfunding and a recap on who the JOBS Act really helps and who needs to be watch out. Or, instead of periodically checking back, you can simply subscribe to the Securities Compliance Sentinel for updates sent straight to your inbox's spam folder.    

Title I of the Act, Reopening American Capital Markets to Emerging Growth Companies (or RACMEGC, so named because the Congressional acronym gurus probably exhausted themselves coming up with the JOBS Act), purports to address the IPO decline by creating a category of “Emerging Growth Companies” and relieving those companies of some reporting requirements.  Unlike most of the JOBS Act, this part became effective immediately upon the President’s signature last week - no need to wait for the SEC. 

So, what’s an “Emerging Growth Company” (EGC)?  Essentially, an EGC is an issuer with gross revenues under $1 Billion last year (and that hasn’t issued more than $1 Billion in debt during the last 3 years).  An issuer can remain an EGC for up to 5 years following its IPO.  If an issuer is deemed a large accelerated filer, then they lose EGC status. 

EGCs are exempt from some of the disclosure and reporting requirements of Dodd-Frank and Sarbanes-Oxley (SOX).  The Dodd-Frank stuff is boring: they don’t need to hold the (non-binding, merely advisory, totally feeble) Say-On-Pay votes, or the make disclosures on executive pay.  Shareholders have only thrown a hissy fit about executive pay when a Company’s stock price is in the dumps, and these weren’t particularly costly reporting requirements to comply with (most companies should have at least a vague idea of what they pay their named executive officers), so nothing too exciting yet. 

But Title I goes on to exclude EGCs from Section 404(b) of SOX, which requires a public company’s auditors to sign off on the company’s internal control.  It also preempts (for EGCs only) any move by the Public Company Accounting Oversight Board to require audit firm rotation or have the auditing firm include a discussion and analysis in its reports.  (Both are being considered by the PCAOB right now).  Moreover, the JOBS Act fiddles with Section 7(a) of the Securities Act, so an EGC won’t need to present more than 2 years of audited financial statements in its IPO registration statement and only need to give the financial data required by Item 301 of Reg. S-K for the same period they give audited financials.  Right now, the requirements are the last 3 and 5 years, respectively; the JOBS act effectively makes both 2 years. 

Rightly or wrongly, SOX has been blamed by many for the decline of the American IPO.  Unlike the other provisions of the JOBS Act, this change at least seems aimed at making it easier (read: cheaper) for an “emerging” company to go public.  That said, I think once you get around $1 Billion in revenues, you aren’t emerging anymore: you’ve emerged. 

 $1 Billion is quite a lot of money.  Certainly more than I have in under my mattress. SEC Commissioner Luis Aguilar estimated that this threshold would cover 98% of IPOs.  Professor Ritter has that number closer to 94%.  Either way, this means that it covers pretty much damn near everyone.  This provision has seen almost as much ink spilled over it as Crowdfunding.  One claim I keep seeing is that investors will avoid EGCs like teetotalers avoid dimly lit dive bars, favoring companies that bask in the disinfecting rays of sunlight that come from more disclosure.  I don’t buy it.  You might see a few companies that qualify for EGC status making more rigorous disclosures anyway, but I suspect these will be limited to issuers with checkered pasts.  Of course, if I’m wrong, then there is no harm in reducing this regulatory burden, because any rational issuer will prefer to take on the more onerous disclosures in order to appease investors (and thereby improve the stock price, which tends to be the metric that drives management decisions).

Gail Collins weighed in on the JOBS Act today in a column glibly titled “The Senate Overachieves”.  Normally, I love her work – everything she does is glib, and I honestly feel there is a glib shortage in America – but this time I believe her winking nonchalance has descended into full-on flippancy.  Worse than that, I’m pretty disappointed that she couldn’t work into the column that Mitt Romney once drove to Canada with the dog strapped to the roof.  But I digress.

Securities regulation is a serious matter (and kind of my job).  That doesn’t mean we can’t have fun discussing it, but great zingers can only go so far.  Dismissing reforms because they let smaller businesses avoid excessively expensive auditing requirements makes sense, even if this means reducing (by a small amount) Sarbannes-Oxley’s reach.  Just because Sarbannes-Oxley and Dodd-Frank were passed to correct egregious regulatory gaps doesn’t mean that they cannot still overreach.  If anything, it makes just such overreaching more likely.

Crowdfunding does present a larger potential for hucksters to shill worthless stock.   But that is still fraud, and still illegal, regardless of the medium used to do it. 

For what it’s worth, I think a lot of securities regulation are misguided attempts to treat symptoms of the problems rather than the problems themselves.  So long as there are massive incentives to innovate new products and skirt regulatory requirements, firms will do so, and will pay their lawyers handsomely to make it happen within the confines of the law.

Rather, I believe that approaches towards fixing the fundamental flaws in the market must be addressed.  No recession or crisis will be caused by minimized auditing of mid-cap companies, or small start-ups raising a few hundred thousand over the internet.  As I noted in my last post, regulations that incentivize companies to stay small in order to avoid disproportionately larger regulatory burdens are counterproductive.

Instead, we need to work to realign the incentives of market participants with the incentives of the economy in general.  The Economist mentioned the interim Kay review last week, “it is easy to forget what the main economic functions of the equity markets are supposed to be.”  I agree with John Kay, the review’s author: the markets should promote long-term growth, not short-term profits.  And, for what it’s worth, Warren Buffet, Judge Richard Posner and Nassim Taleb, among others, also agree (oh my, am I clumsy! Just dropping those names all over the place!).

So, Gail’s barbed wit hit the wrong target this time, not unlike how some regulations aimed to prevent awful abuses end up frustrating legitimate businesses from growing.  The JOBS Act has its flaws too: the "emerging growth companies" that get to avoid some of the registration requirements of the '33 Act are defined to include companies with $1 Billion in revenue.  If you make $1 Billion, you aren't emerging anymore.  You've emerged.  But these call for sensible amendments, not lambasting the entire bill. 

The SEC published a small entity compliance guide for investment advisers relating to the new Form PF.  These new reporting requirements affect SEC registered investment advisers with at least $150 million dollars in assets under management.  Some of these new guidelines will also apply to CFTC commodity pool operators and commodity trading advisers.

The SEC registered advisers will be divided into 2 groups, small advisors and large advisers.  The definitional requirements for large advisers are specific and may require certain calculations, however.  Clearly, large advisers have assets under control of anywhere between a billion dollars and more.  For the purposes of the Form PF, all other advisers would be considered small private advisers.

Generally, an investment adviser is a small business pursuant to the Investment Advisers Act and the Regulatory Flexibility Act if it has assets under management of less than $25 million dollars.  As such, these advisers will, generally, have no reporting requirements on a Form PF.  However, for those advisers, who are not defined as a small business, there may be certain reporting requirements.  For example, advisers with over $150 million dollars in private fund assets under management, but are not large advisors must file a Form PF once a year within 120 days at the end of the fiscal year.  Large private advisers must file a Form PF within 60 days.  Moreover, the requirements for advisers with over $150 million dollars, but who are not large advisers, are less than those of large private fund advisers.  Essentially, the more money you have under management, the more information you must provide.

In short, advisers should consult with securities counsel to ensure accurate reporting in the future.

Although the SEC’s rulemaking deferral regarding the uniform fiduciary standard has gained much press, the SEC's other rulemaking initiatives pursuant to the Dodd-Frank Act march on, and will have a significant effect on broker dealers and investment advisors in the upcoming year.

In particular, the SEC has scheduled a joint SEC-CFTC report to Congress on stable value contracts, and the adoption of rules pertaining to trade reporting, data elements and real time public reporting for security-based swaps.  Further, the SEC and CFTC will define key terms for swap products and intermediaries as well as security-based swap clearing agencies.  The SEC will also look to register and regulate security swap based data repositories and for mandatory clearing of security-based swaps.  Additionally, the SEC will look at the end user exceptions for the mandatory clearing of security-based swaps. 

The SEC will also consider a permanent rule to register municipal advisors this year.  However, certain controversial rules relating to conflict materials rule finalization and resource extraction disclosures as well as corporate governance rules relating to executive compensation claw backs, performance disclosure pay, compensation ratio and hedging policies have been pushed forward to the first part of this year.  Moreover, the SEC still has not set up certain offices that the Dodd-Frank Act required including, but not limited to, the credit ratings and municipal securities oversight function offices.  Currently, the SEC believes these functions are being performed by its Division of Trading and Market's Staff. 

In sum, the SEC’s Dodd-Frank Act rule making is still ongoing and will continue as it moves forward.

As part of the requirements of the Dodd-Frank Act, the SEC was compelled to seek information from the public as to retail investors' financial literacy. 

The SEC issued a release asking for comments on the type of information retail investors use in choosing financial advisors or brokers.  The SEC also sought information on investor purchases,  investment products and services.  Additionally, the SEC sought comment on investment expenses and conflicts of interest, as well as if these transactions could be more transparent to retail investors.

The SEC’s comment period is for 60 days.  More information is at http://www.SEC.gov/news/press/2012/2012-12.htm.

A year ago, the SEC published its study commissioned under Dodd-Frank and recommended the implementation of a uniform fiduciary duty standard.  Much debate has prevailed since that announcement.  Will registered representatives be subject to the same fiduciary duty as investment advisors?  Will registered representatives be subject to some form of hybrid fiduciary duty standard?  According to a recent SEC announcement that went without much fanfare, in 2012, at least, the answer will be none of the above.

The SEC has punted once again on making a definitive conclusion regarding the implementation of a uniform fiduciary duty standard.  Broker-dealers should not assume that there will never be such a standard, only that a formal adoption will be at least another year away.  In that time, the SEC will surely complete the long-debated cost benefit analysis of the need for such a standard.  Indeed, the SEC may ultimately conclude that the adoption of FINRA Rule 4530 and the changes to the suitability and know your customer standards were more than adequate such that there may be no need to have a formal standard.  Registered representatives may already be effectively subject to their own fiduciary duty.  Indeed, depending upon where you reside, courts have already concluded that you are subject to a fiduciary duty.

Regardless of what happens in 2013, once thing is for certain.  FINRA is increasing its enforcement efforts and will surely focus on conformity with its new rules.  The safest course for broker-dealers is to make sure you have adequate compliance programs to address this heightened regulatory environment, or you will be totally unprepared when there is a formal uniform fiduciary duty standard.

The SEC adopted a rule requiring hedge fund and private equity fund advisors to report systemic risk data.  The new Form PF was jointly developed by the SEC and the CFTC in consultation with members of the Financial Stability Oversight Council, to satisfy Dodd Frank Act Sections 404 and 406. 

In particular, for hedge, private equity, and liquidity funds, the information required on the Form PF is tiered so that detailed information will be required from larger private advisors as opposed to smaller ones.  The minimum reporting requirement will be for those funds with $150 million dollars of assets under management, and smaller private fund advisors will not be required to file the form at all.  Further, there will be additional information required of those advisors managing at least $1.5 billion dollars.  According to the SEC, this requirement will only effect approximately 230 advisors in the United States.  Many of these advisors will have 60 days from the end of the quarter to prepare this information while smaller advisors will have 120 days to file such information.  For the largest advisors, filings must begin by June 15, 2012, while all others must file after December 15, 2012.

Of course, there is no certainty that this information will be effectively used to assess risk, or that there will be any benefit from these filings.

I read this interesting piece on the NYTimes.com today, "Pushing Back on Clawbacks" which describes how D&O insurers are now offering protection against a clawback.  The companies argue that "the policies don’t undermine financial reforms because they don’t cover fraud or intentional wrongdoing."  Sure, you could have made that argument a few years ago when SOX was the only financial reform in town, but not anymore.

Dodd-Frank's clawback provision (Sec. 954) is specifically aimed at faultless mistakes: whenever a reporting company issues an accounting restatement, it clawsback the compensation awarded in error.  Compare this to SOX Sec. 304, which requires misconduct and claws back all all incentive-based compensation, and you can see how Dodd-Frank is both broader (no misconduct required!) yet also narrower (just the difference between what you got and what you should have got).  

Sec. 954 was intended to force directors and officers to think longer term than before.  Its goal is to prevent perfectly legal methods of goosing short-term profits (and thus bonuses tied to them or share prices) at the expense of long term growth potential. 

Federal regulators have not yet issued rules on Sec. 954, but they intend to during the first half of the coming year.  They will also address the new executive compensation disclosure requirements, which includes a requirement to disclose the company policy on hedging against incentive based compensation.  I would be shocked if the SEC does not include clawback insurance as an example of "hedging."  But I wouldn't be surprised if it allows companies to continue to take out these insurance policies, leaving the matter to shareholders to vote on with their say-on-pay votes.