We are regularly approached by both our RIA (and BD too) clients, who inquire, usually around election time, how they should make political contributions. Our advice is usually do not make the political contribution and you can blame your lawyer!

However, those persons, ignoring that advice, should be concerned that the SEC, recently, fined an investment adviser for violating the Investment Advisers Act of 1940’s pay-to-play rule prohibiting an RIA from accepting compensation for 2 years following a political contribution to an official that may influence, who obtains an investment contract.  See https://www.sec.gov/litigation/admin/2018/ia-4960.pdf.  Although in this case the significant investment in the RIA’s managed fund preceded the campaign contribution, it simply did not matter. The RIA could no longer do business with the entity once the campaign contribution was made, it was simply strict liability.

Thus, we are always reluctant to recommend that a client should make a political contribution since it could cost the RIA business.

Securities attorneys routinely are asked by people in the securities industry a form of this question: “how do I get rid of the marks on my license.”  Typically, registered representatives are talking about the fact of life in the securities industry where every time some customer makes a claim, regardless of how baseless it may be, it will end up on the person’s CRD record.  Once there, it is nearly impossible to expunge.

Nonetheless, FINRA has developed over the years a process whereby a registered representative may bring an arbitration proceeding to request expungement of these items.  Such an expungement is, unfortunately, very difficult to obtain for many reasons, among others, the cost, high standards of review, and the fact there may be objections from a number of sources.  However, some registered representatives have not been dissuaded.

In particular, a recent FINRA arbitration panel ruled in favor of a registered representative, and expunged his record.  See https://www.finra.org/sites/default/files/aao_documents/17-01429.pdf.  In the Molinari matter, the registered representative was seeking expungement for some very old claims.  The customers and settlement agreements were not available given the age of the claims, and he no longer was working at the broker-dealer where the complaints were first registered.  To ensure the registered representative had at least an opportunity to be heard, the FINRA arbitration panel permitted the proceeding to move forward with the named respondent being that of the registered representative’s current firm.  The panel then reviewed the claims, and the registered representative’s involvement in said claims.  After hearing the evidence, the panel found that the claims should be expunged from the registered representative’s CRD records.

In short, with the arbitration panel’s willingness to look at the actual substance of the matter and not some formulaic process, it accomplished the ultimate goal of ensuring an accurate CRD system.  We hope other arbitration panels follow suit.

FINRA, recently, announced a major overhaul of its Central Registration Depository (“CRD”).  The first step will be a new WebCRD interface, effective June 30, 2018.  More changes will come over time with FINRA claiming all changes will be made sometime in 2021.

The CRD is the central licensing and registration system that the SEC, FINRA, and the states use to monitor securities firms.  Securities firms use the CRD system to register, make form filings, and maintain records for associated persons, among other things.  It also assists the public as well because it serves as the basis for FINRA’s BrokerCheck.  Essentially, the changes to WebCRD will make it easier for firms, when filing various forms, to obtain feedback in nearly real time about issues relating to those filings.

In sum, FINRA is finally updating an overworked and inefficient system.  However, hopefully, the changes will actually be worthwhile and of assistance to CRD users.

Today, the United States Supreme Court sent shock waves through the securities industry as well as the United States Securities and Exchange Commission’s (“SEC”) enforcement program when it held that SEC administrative law judges (“ALJ”) are “inferior officers,” and must be chosen pursuant to the appointments clause of the United States Constitution.  That is, the President with the advise and consent of the United States Senate may appoint “all other Officers of the United States, whose Appointments are not herein otherwise provided for, and which shall be established by Law: but the Congress may by Law vest the Appointment of such inferior Officers, as they think proper, in the President alone, in the Courts of Law, or in the Heads of Departments.”  See United States Constitution Article 2, Section 2, Clause 2.  Although this decision was centered on an appeal involving an SEC ALJ, it may also effect other federal agencies that use in-house judges.

Initially, the case involved a former investment adviser who was sanctioned by an SEC ALJ.  See Lucia v. SEC, https://www.supremecourt.gov/opinions/17pdf/17-130_4f14.pdf.  The United States Court of Appeals for the District of Columbia had held that SEC ALJs were not subject to the appointments clause; however, the United States Court of Appeals for the 10th Circuit had found differently.  Justice Elena Kagan authored the opinion and found that the SEC’s ALJs were very similar to tax court trial judges where the Supreme Court had previously found those judges to be inferior officers subject to the appointments clause.

Now that the Supreme Court has opened this door with the finding ALJs are inferior officers, the SEC’s ALJ’s will have to be appointed pursuant to the appointments clause in the future, and it calls into question what, if anything, will happen to the ALJs at other federal agencies.  Further, there will be the question of prior SEC cases, the Supreme Court stated that not every appointments clause violation requires a new hearing.  However, time will tell.

Additionally, although Justice Kagan specifically said it was not being addressed in this case, we may also shortly see that, since the SEC’s ALJs are now considered inferior officers subject to the appointments clause, they may also now be subject to removal by the SEC Chairman for good cause.  Such a result may provide significant power to the president to fire such ALJs at will, maybe even in a Tweet.  As for Mr. Lucia, well, he now gets a re-trial before either the full SEC or a new ALJ appointed pursuant to the appointments clause, who will determine if his “Buckets of Money” program is real or made-up.

In short, the Supreme Court has upended how the SEC does business.  Of course, we will follow how the SEC responds.

 

 

Recently, the SEC’s Director of Corporation Finance provided long overdue insight on cryptocurrencies.  In particular, he indicated that Bitcoins, Etherium, and other such coins functioning on certain decentralized platforms are not securities.  Our partner, Kristen Howell, authored a fascinating and informative alert on this topic.  See https://www.foxrothschild.com/publications/sec-bitcoin-is-not-governed-by-securities-laws/.  We commend it to anyone interested in this area.

Essentially, the SEC Staff has taken the position that, various cryptocurrencies operating from a central control group, who target passive investors, will be engaging in a securities offering while less centralization focusing in on purchasing goods or services will be less likely to be considered a security.  The SEC Staff also suggested that those interested in this field should consider seeking formal interpretive or no-action letter guidance so as to avoid the potential pitfalls.  The SEC Staff also indicated that securities registration may end up being required if there is a central group/promoter offering an increase in value; raising excess funds that are more than necessary for the actual network; having purchasers looking for a greater return than the current value; and a directed sales effort.

Thus, it is critical to seek out legal counsel before engaging in cryptocurrency networks and offerings.

For those interested in a description of the DOJ’s new corporate resolution policy, we strongly urge you to review our partner, Matt Lee’s, recent posting on this topic.  See https://www.foxrothschild.com/white-collar-compliance-defense/publications/the-justice-departments-new-corporate-resolution-policy-an-end-to-piling-on/.

In rapid succession, the SEC has issued warnings and announced sanctions against registered investment advisers for fee and expense practices, false statements regarding assets under management, and misleading performance data.  No one should be surprised that the SEC is actively seeking to uncover transgressions in the RIA field.

Initially, the SEC’s Office of Compliance Inspections and Examinations issued a Risk Alert outlining a variety of RIA failures concerning the proper calculation and disclosure of fees and expenses.   See https://www.sec.gov/ocie/announcement/risk-alert-advisory-fee-expense-compliance.  In particular, the alert detailed a series of failures that OCIE found in its examinations of RIAs, among other things, RIAs failed to properly value assets, overbill, use incorrect fees or time periods.

Similarly, the SEC also sanctioned a principal of a closed RIA for falsely stating it was subject to SEC registration.  See https://www.sec.gov/litigation/admin/2018/ia-4875.pdf.  Although we believe it admirable for someone to want to achieve SEC RIA registration status, you want to be accurate when you make this claim.  Apparently, this individual was not, and lying to the SEC will always incur its wrath.

Finally (and this is a pet peeve with us), the SEC also sanctioned a RIA for using misleading performance data.  See https://www.sec.gov/litigation/admin/2018/ia-4885.pdf.  The RIA was caught using hypothetical back-tested performance data– a pretty big no-no.  We are constantly advising RIA clients of the pitfalls in using any type of performance data, and this case illustrates how closely the SEC will look at its use.

In sum, RIAs have to be careful the SEC is watching.

 

 

Not one for making people feel at ease, the SEC’s Division of Investment Management has indicated that it is not comfortable with investment companies investing in cryptocurrencies and similar products.

In a letter sent to industry groups, the SEC’s IM Director indicated that the Staff had numerous concerns over funds investing in these instruments.  The concerns boiled down to 5 categories:  valuation, liquidity, custody, arbitrage, potential manipulation and other risks.

The SEC Staff is concerned that funds will not be able to properly value the crypto-assets in question, or reduce them to cash if necessary.  Further, the SEC Staff had serious questions concerning if a fund custodian would be able to properly validate the very existence and location of the assets as well ensure that there would be no arbitrage opportunities for insiders that could harm investors.  Similarly, the SEC Staff was also concerned about the potential for volatility in the cryptocurrency market as recently witnessed in South Korea.

Additionally, the SEC Staff raised concerned that the cryptocurrency markets lack regulation, and could be subject to market manipulation and potential fraud.  These investments also potentially lend themselves to cybersecurity issues such as hacking and the lack of safeguards to protect against these invasions.  The SEC Staff also suggested that funds would not be able to sufficient risk disclosures and transparency in their prospectuses to cover their requirements, and, thus, the funds would like the appropriate risk disclosures to their shareholders.  Finally, the SEC Staff was concerned that there would not be appropriate suitability determinations by those who market and sell these funds– broker-dealers and registered investment advisers– that would ensure their suitability and fiduciary obligations when recommending cryptocurrency investments to the public.

In sum, this may be the millionth (note: exaggeration) time this year, the SEC has made it known that it does not like cryptocurrency investments.  Clearly, the SEC is trying to send a message, therefore, those interested in cryptocurrency markets should beware.

In a recent speech, new SEC Chairman Jay Clayton warned lawyers, who advice clients on bitcoins and initial coin offerings (“ICOs”), to be aware the SEC is lurking out there waiting to pounce.  Of course, he did not say it exactly like that, but he might as well have used those exact words.

Clayton stated that the SEC Staff is monitoring (he called it being on “high alert”) lawyers, who advice clients on these transactions.  Apparently, the SEC believes that certain lawyers may be advising clients to skirt the federal securities laws in the process.  In particular, he mentioned that ICOs were becoming more problematic.  ICOs are essentially mechanisms to raise capital for start-ups.  Additionally, despite the SEC’s pronouncement to the contrary that ICOs and bitcoins are governed by the federal securities laws, Clayton claims the SEC Staff has seen lawyers structure ICOs resembling securities transactions, and then claim the bitcoins are not securities.  For the record, the SEC has already brought several enforcement actions in this space to stop fraudulent activity.

Nonetheless, Chairman Clayton’s remarks are extraordinary because, given the lack of a judicial or statutory framework in this area, he is essentially suggesting lawyers have to be more certain as a legal matter in their opinions than Congress, the courts, and even his own agency.  Such a position is remarkable, and represents a titanic shift in the SEC’s previous policy of only going after lawyers who engage in fraudulent conduct.  I warned of this very possibility in an article I wrote several years ago, and the new administration apparently wants to continue the practice.  See http://www.foxrothschild.com/publications/the-empire-strikes-back-the-secs-new-assault-on-lawyers/.

Finally, Chairman Clayton’s warning is a sad commentary on the failure of a government regulator to actually address the real issue, and instead scapegoat a likely target.  Instead of twisting and misinterpreting Shakespeare’s famous and often misused quote “let’s kill all the lawyers” (Henry VI,” Part II, act IV, Scene II, Line 73), it would have been probably more worthwhile for Chairman Clayton to outline a set of new SEC specific rules or regulations in this area so that lawyers would be able to provide a definitive framework for their clients, who undertake ICOs or other bitcoin transactions.