Archives: SEC Enforcement

Back in April, the Securities and Exchange Commission sought public comments on modernizing certain business and financial disclosure requirements in Regulation S-K.  In their Concept Release, the SEC noted that some investors and interest groups have “expressed a desire for greater disclosure of a variety of public policy and sustainability matters, stating that these matters are of increasing significance to voting and investment decisions.”

48936020 - man pointing at the brown picture of oil industry components and green eco energy arranged in circle, earth in the centre, concept of environmentIn response to the SEC’s request for comment, numerous environmental groups pressed the SEC to require disclosure of environmental, social, and governance risks in companies’ public filings.  According to Law360’s Juan Carlos Rodriguez, last week the Sierra Club, Greenpeace, Friends of the Earth and several other groups urged the SEC to create uniform environmental, social, and governance (“ESG”) disclosure requirements for companies, which would enable investors to identify companies that reflect their values.

However, as Rodriguez noted in his article, there were others who cautioned the SEC against going too far with ESG disclosures.  For example, the American Fuel & Petrochemical Manufacturers advised the SEC that “Such supplemental discussion beyond the bounds of mandated disclosure enriches the public discussion of ESG issues, but may not be material and should not be conflated with disclosures made pursuant to Regulation S-K according to the longstanding principles of financial relevance and materiality upon which the securities markets rely.”

The takeaway here is that the SEC will likely begin to require ESG disclosures from companies in their public filings.  Rodriguez explained that the SEC’s investor advisory committee has noticed a “significant and growing” number of investors who rely on sustainability and other public policy disclosures to better understand a company’s long-term risk profile.  Thus, while it is unclear what those ESG disclosure requirements will be, it is likely that some additional regulations and disclosures will be forthcoming, so plan accordingly.

To read more, please visit: http://www.law360.com/environmental/articles/820522

The SEC recently created a new position associated with cybersecurity; senior adviser to the chair for cybersecurity (Christopher R. Hetner). Mr. Hetner has an extensive background in information technology and, in particular, cybersecurity.

19196909_sAccording to the SEC, Mr. Hetner will be responsible for (i) coordinating cybersecurity efforts across the SEC; (ii) engaging with external stakeholders; and (iii) enhancing SEC mechanisms for assessing broad-based market risk. This appointment could have a wide-ranging on the industry.

As we know, the SEC has made cybersecurity an exam priority over the last few years. The SEC is also actively conducting cybersecurity investigations and undertaking enforcement actions where appropriate. According to Chairperson White, the SEC is looking to bolster its risk-based approach. So what does this mean on a day-to-day basis?

Understand that the SEC has just upped the stakes. By retaining an industry expert who is solely focused on data-security related issues, the industry must be prepared for the SEC and FINRA to come after firms regardless if the firm sustains a breach or clients suffer harm as a result. Firms with weak or no data-security programs will surely be targeted.

Are you prepared to handle this even more focused mission of the SEC? If not, you need to more fully review you systems and procedures, both internally and externally facing. Are you testing your systems and procedures on a regular basis? If not, you better start.

The SEC is prepared; are you?

My friend and a legend in the securities regulatory field, Edwin Nordlinger, who served as Deputy Regional Director in the SEC’s New York office for years, was one of the nation’s premier experts on the SEC’s net capital and customer protection rules.  He taught hundreds of SEC staff members and others about these rules over the years.  However, when Ed would begin one of these lectures, he would always introduce himself by saying: “Hello, I am Ed Nordlinger from New York, where you do not go to jail for killing people, but you will go to jail if you violate the net capital or customer protection rules.”  Well, Ed, you continue to be right on point about these rules and their impact.

The SEC’s net capital rule, SEC Exchange Act Rule 15c3-1, requires firms to maintain certain capital so that the firms will be able to meet their financial obligations to customers and other creditors.  Similarly, SEC Exchange Act Rule 15c3-3, the customer protection rule, requires a firm that clears transactions to maintain certain reserve amounts to protect customers in the event of a firm failure.

Recently, the SEC found a firm to have violated the customer protection rule, and settled the matter with the firm whereby the firm agreed to pay a fine of $358 million and a total amount of $415 million.  https://www.sec.gov/news/pressrelease/2016-128.html.  Further, the SEC also charged the firm’s regulatory reporting officer and financial operations principal for aiding and abetting the violations by misleading regulators about the real reason behind certain transactions that caused the violations.  In particular, the SEC claimed that the firm used synthetic securities transactions solely to reduce the reserve calculation and release capital.  The firm also apparently used non-qualifying bank accounts that could be subject to bankruptcy if the firm were to fail.

The real kicker, however, is the SEC’s announcement that it plans to undertake a targeted sweep of firms to find potential violations by other firms of the customer protection rules.  Of course, the SEC also encouraged firms to self-report any potential violations of the customer protection rule.

In short, Ed, after all these years, you are still right.  Firms need to seriously undertake compliance with these rules, or there will be significant consequences.  Accordingly, although the rules may seem technical with no fraud or customer losses, the SEC plans major activity to ensure compliance.

Core ValuesThe SEC recently commenced an enforcement action against an investment advisory firm and its principal in connection with the failure to disclose material conflicts of interest in connection with new mutual funds that the firm recently created and managed. The SEC is seeking disgorgement and an injunction against the firm and its principal.

Clients of the firm paid a fee for investment advice. Initially, the clients were invested in an ETF program. The firm subsequently created its own mutual funds that it managed for a fee.
Without disclosing that it would be paid both an investment advisory fee and fees for managing the mutual funds, the firm moved its clients into the mutual funds, which mirrored the investments in the ETF program. So why did the SEC take issue with this?

For one, the firm did not disclose the conflict of interest associated with this new strategy. The conflict of interest is that the firm is going to be paid two fees for an investment program that was the same as the prior program for which clients were only charged one fee.

Interestingly, the SEC in its complaint does not contend that the charging of two fees is per se improper. Instead, the issue is the fact that the firm did not disclose the conflict to its client before shifting the investment program. So what does this mean?

It all comes down to disclosure. If you disclose all conflicts of interest in sufficient detail, you may be able to avoid these types of enforcement issues.

The SEC recently announced that an equity advisory firm and its owner agreed to pay more than $3.1 million to resolve charges that they improperly engaged in brokerage activity, as well as charging fees without registering as a broker-dealer.  In other words, the firm acted like a broker-dealer but never bothered to register as one.

The SEC’s investigation demonstrated that the firm performed brokerage services in-house, instead of using investment banks or broker-dealers to handle the acquisition and sale of portfolio companies for a pair of equity funds they advised.  Interestingly, the firm disclosed to its customers that it would provide brokerage services and charge customers a fee for doing so.

The problem is that the firm provided those services itself even though it was not registered to do so.  This action should serve as warning, particularly for firms who may be engaged in Reg. D offerings.

money and calculatorIf part of the offering you find yourself engaged in the sale of securities, you better be registered as a broker-dealer to be doing so.  Alternatively, you could have retained the services of a broker-dealer to sell interests in the fund.  The law is clear; you need to do one of the two.

Another point of interest is that the SEC uncovered this improper conduct through an ordinary examination of the investment advisory firm.  In other words, there was no customer complaining that it suffered any harm.  So what lessons are to be learned?

For one, only broker-dealers can engage in brokerage services.  Second, the SEC in its exam process is looking for such activity and going after it.  Don’t make the same mistake; register as a broker-dealer or retain one to provide those services for you.

Business Insurance reported late last week that the Securities and Exchange Commission will award $5-6 million to a whistleblower who provided information on securities violations that would have been “nearly impossible” for the SEC to detect on its own.  Such an award would be the third larges award ever granted to a whistleblower by the SEC.  This also comes on the heels of a $3.5 million whistleblower award from the week before.  whistleblower

The takeaway is that the SEC continues to heavily incentivize company insiders to report possible securities violations.  It is critical to have internal controls and monitoring to catch these problems before a whistleblower runs into the SEC.  Self-reporting can drastically reduce exposure to damages and fines, but if you do not have proper compliance checks in place, you may never even catch the problem yourself.  Routine internal investigations and a rigorous compliance and monitoring system will go a long way to preventing and spotting securities issues early, and thereafter managing and mitigating the fallout.

It was great speaking at the May 17 New York NSCP regional conference on risk issues facing firms where Ernie Badway and I discussed cyber-security, risk issues, regulatory matters, issues involving elder clients and ways compliance personnel can protect themselves.  For those of you who could not make the conference, these topics are frequently discussed in our various publications.  Feel free to access them here and use them as you see fit.  Core Values

The SEC recently charged four investment advisors who allegedly used free dinners to entice older clients to their firm. At these dinners, these individuals allegedly provided fraudulent marketing materials to the attendees and ultimately did not invest all of the money that they were given.whistleblower

Granted these four advisors may just be bad apples and not an indictment of the use of free lunches or dinners to attract new clients and money. However, if you do engage in these types of “seminars”, this enforcement action should be a wake-up call.

The SEC and FINRA have made it very clearly how they intend to approach marketing efforts directly at seniors. Both regulators will be taking a hard look at these types of seminars used to attract elder investors.

So, if you are going to offer a free meal, make sure that you are giving something of value to your prospects. Do everything on the up and up when offering these types of opportunities because your regulator is watching.

Over the years that I have defended broker-dealers and investment advisors, a more robust overview of outside business activity (OBA) disclosures would have gone a long way to disprove a number of claims. So where did these firms go wrong?

The biggest issue that I have seen is a firm’s willingness to take the OBA of a representative or IAR at face value and not do any more due diligence. In one instance, that due diligence could have unraveled a Ponzi scheme at its inception, instead of years after the facts and millions of dollars lost.money and calculator

In that case, the representative disclosed a beneficial interest in another business and that certain of his clients used that other business for tax preparation services. Although that other entity was not subject to the firm’s authority, the firm could have done more than nothing.

For one, the firm could have conditioned its approval of the OBA on the representative providing bank account statements for the other firm so that the FINRA-regulated firm could have assessed the scope of its clients using that other firm. By doing so, the firm could have uncovered that its clients were transferring money in not insignificant sums from their brokerage accounts to this third-party.

Conversely, if the representative refused or unable to get these statements, the firm could have denied approval of the OBA. Although this extra step may not have exonerated the firm from its representative’s use of the OBA to perpetrate a fraud, it would have provided a solid argument that it should have no liability because the representative acted outside the scope of his authority.

The moral of the story is that there is no perfect system for assessing OBAs. The important thing, however, is to take nothing at face value. Ask questions and push for information. If your employee is unwilling or unable to get that information, then the best thing is to not approve the OBA and lay the foundation for a defense if you are ever questioned about your employee’s outside business activity.

It is no secret that FINRA and the SEC are sharply focused on issues regarding elder clients, including severe disciplinary action. There is another elder “issue” that must be kept in the forefront as well; senior designations.

Senior designations are “certifications” that financial advisors tag onto their other designations like CFA, etc. Such designations are meant to give an advisor an air of credibility or specialization when it comes to servicing elder clients.whistleblower

However, not all such designations are legitimate. Indeed, some are no different than the secret decoder rings we used to get out of a box of cereal. So what should you do?

You should not let any of your advisors tout any such designations unless and until you have had a chance to vet the legitimacy of the designation and the entity that is promoting it. Is there any sort of testing and continuing education requirement to maintain this designation? Have FINRA or the SEC ever commented on this designation and/or the entity that may be promoting it?

The key to any sort of senior designation is for you to conduct proper due diligence to ensure its legitimacy. Otherwise, you run the risk of running afoul with your regulator for allowing your advisors to tout a specialization that does not exist.