09-21-20

FINRA Enforcement Turns Up Heat on Mutual Fund Direct Business and Firms That Are Brokers of Record

FINRA Enforcement Turns Up Heat on Mutual Fund Direct Business and Firms That Are Brokers of Record
Background:

For more than 20 years, regulators have expressed interest in securities firms designated as the “broker of record” for client mutual fund transactions executed directly at mutual fund sponsors. Historically that focus has been on payments made to those firms by the mutual fund sponsors and the firms’ obligations to supervise those transactions (including making sure that clients were properly profiled, and that the transactions were suitable). Over the years, some firms have addressed these regulatory concerns by designing systems and implementing policies and procedures to collect client profile and direct transaction data, developing “shadow” systems, and otherwise incorporating mutual fund direct transactions into their supervision and compliance systems.

Today:

That focus continues, as FINRA Enforcement has initiated enforcement actions centering around client impact, remediation, and issues related to transaction supervision and suitability. As a result, clients have turned to Bates to discuss and engage us on these matters. Our work has included a lookback at categories of mutual fund transactions over a period of six years to identify those that would have been flagged for further review had they gone through the firm’s supervision systems, as well as an assessment of client impact (if any) for those transactions.

Our Big Data and Compliance-related activities include, but are not limited to:
  • Intaking and processing large amounts of data from firms and dozens of relevant fund companies, addressing data cleansing and other issues to ensure data integrity thereby allowing for important analyses and scoping;
  • Applying the firms’ supervisory parameters to that data in order to identify alerts that would have been flagged for further review had the transactions been on the firms’ blotters; 
  • Correctly identifying those accounts or transactions that may have been adversely impacted and isolating them from the overall population of direct transactions that would have been flagged for further analysis;
  • Creating detailed and summary reports of transaction data that may be used to identify where there is a direct client impact because of those transactions;
  • Calculating, as appropriate, the economic impact to the client for transactions identified as at issue;
  • Creating detailed and summary reporting related to sampled transaction categories, to facilitate root cause analysis;
  • Having our Data and Compliance Teams execute manual supervision/suitability analyses (both quantitative only [e.g., switching] and putting eyes on transaction details based on individual facts and circumstances); and
  • Working with the firms and their in-house and outside counsel to summarize findings to provide to FINRA and for ultimate remediation, as necessary.

The categories of FINRA’s interest and inquiry (and our work, detailed above) include breakpoints, the appropriateness of different share class transactions, switching, concentration, conflicts of interest, compensation, and other suitability and supervision considerations. Also under consideration is our assistance with repapering accounts and otherwise addressing gaps in profile data (e.g., time horizon).

But Wait…FINRA Isn’t Stopping There…

Inquiries today do not end with mutual fund direct transactions. FINRA has also indicated that they will be looking at variable annuity direct transactions, and we will bring our extensive VA and mutual fund experience and expertise to bear in these matters.

 

Contact us today to learn how we can support your team and your clients.

David Birnbuam, Managing Director - dbirnbaum@batesgroup.com or 917-273-2682

Alex Russell, Managing Director, White Collar, Regulatory and Internal Investigations - arussell@batesgroup.com

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09-18-20

OCIE Warns Against Emerging Cyber Threat of “Credential Stuffing”

OCIE Warns Against Emerging Cyber Threat of “Credential Stuffing”

On September 15, 2020, the Office of Compliance Inspections and Examinations (“OCIE”) issued an alert urging investment advisers and broker-dealers to review their customer account protection safeguards and identity theft prevention programs. The impetus behind the alert is an increase in the number of cyber-attacks using a tactic called “credential stuffing,” observed during recent examinations.

The term applies to a sophisticated method attackers are using for gaining access to web-based and networked customer accounts. OCIE explained that credential stuffing involves attackers who “obtain lists of usernames, email addresses, and corresponding passwords from the dark web and then use automated scripts to try the compromised user names and passwords on other websites, such as a registrant’s website, in an attempt to log in and gain unauthorized access to customer accounts.”

OCIE disclosed a number of practices firms are using to mitigate this emergent risk. These include: (i) reviewing and updating policies and procedures on password protections; (ii) incorporating the use of a more robust multifactor authentication system; (iii) deploying a “CAPTCHA” test to combat automated bots used in these attacks; (iv) implementing additional controls like specialized log-in attempt monitoring (“fingerprinting”) to detect and inhibit attacks; and (v) using another layer of controls over fund transfers and access to personally identifiable information. OCIE also warned that the use of multifactor authentication programs using mobile phones “is not foolproof,” and that firms should remain alert to mobile number transfers from phone to phone.

OCIE warned firms to proactively address these emergent cyber risks, review their programs, policies and practices, and to communicate with their customers as to how they may take steps to protect their accounts and other sensitive information.

Learn more about Bates Group’s Data SecurityCybersecurity Services, and Cyber Consultants and Experts

 

For additional information and assistance, please follow the links below to Bates Group's Practice Area pages:

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09-03-20

Bates Group Summer Roundup – Catch Up on What You’ve Missed and What’s Coming Up This Fall

Bates Group Summer Roundup – Catch Up on What You’ve Missed and What’s Coming Up This Fall
Labor Day is almost here, which means those lazy, remote days of summer are coming to a close. What did you miss when you powered down this summer? 
 
We have a roundup of all the important Bates news, events and alerts from July and August as well as a sneak peek of the next few months to help you head into Fall fully prepared. 
 

NEWS

New FinCen Guidance on the CDD Rule, Cyber Fraud and Virtual Currency Scams Exploiting Twitter - 8/20/20

FINRA Roundup: Guidance on Private Placements, Digital Assets, Virtual Hearings, and Proposals - 8/6/20

Bates Group, Complidata Bring Expertise and A.I. Technology Together to Optimize AML and Compliance - 8/5/20

DOL Proposes New Class Exemption for Investment Advisers - 7/30/20

Welcome to Our New Bates Experts - 7/24/20

Bates Practice Leadership Insights: Julie Johnstone on the Changing Litigation Landscape - 7/22/20

New OCIE, FinCEN Alerts Emphasize Vigilance Against Ransomware, Imposter Scams, Money Mule Schemes - 7/16/20

 

COMPLIANCE AND REGULATORY ALERTS

SEC Issues COVID-19 Compliance Observations and Recommendations for BDs and IAs - 8/17/20

SEC Issues “Private Funds Adviser” Compliance Risk Alert - 7/2/20

 

WEBINARS AND CLE

Webinar: Covid-19 Leads to Novel Compliance Concerns - 8/20/20

CLE Webinar: Capital Market Uncertainty in the Time of COVID-19 and Potential Legal & Regulatory Impact - 8/13/20

CLE Webinar: Anti-Money Laundering and Fraud Risks In the Age of COVID-19 - 7/30/20

Bates Compliance Roundtable: Assessing, Fine-Tuning and Improving Your Business Continuity Plan - 7/15/20

CLE Webinar: Regulatory Exams and Investigations in the Age of COVID-19 - 7/9/20

View all of our On-Demand webinars and CLEs on our Recorded Programs page.

 

COMING UP

September 21-22 - Join Christine Davis, Bates Managing Director of Forensic Accounting and PLI program co-chair, and Edward Longridge, Managing Director of Bates AML & Financial Crimes, at the  PLI Pocket MBA 2020: Finance for Lawyers and Other Professionals CLE Webinar.

September 23-24 - Visit Bates Group's Interactive Virtual Booth at the SIFMA C&L Virtual Forum. Bates is a proud Silver sponsor of this online event. (And yes, we’ll be giving away wine and goodies!)

October 5 - Join SIFMA and Bates Group for our “Virtual Branch Office Compliance Visits" CLE Webinar. (Registration coming soon!)

October 8 - Join us at the annual FSDA Industry Outreach Program. Bates is a proud Platinum sponsor of this online event.

October 13-15 - Join us at the IBDC-RIAC Annual Risk Management Conference. Bates is proud to sponsor and speak at this online event.

October 19-21 - Register now for the 2020 NSCP National ConferenceBates Compliance Manging Director and NSCP Board member Linda Shirkey will be speaking on Day 1 of the conference (Session 3b. IA/PF – Understanding the SEC’s Proposed Advertising Rules). Bates is a proud Gold sponsor of this online event.

 

NEED ASSISTANCE?

For additional information and practice support, please Contact Us today, and follow the links below to Bates Group’s Practice Area pages:
 

Consulting and Expert Testimony

Retail Litigation and Consulting

Institutional and Complex Litigation

Bates Compliance

Regulatory and Internal Investigations

Bates AML and Financial Crimes

Forensic Accounting and Economic Damages

Insurance and Actuarial Services

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08-31-20

SEC Amends Definition of “Accredited Investor”

SEC Amends Definition of “Accredited Investor”

In an effort to broaden investment opportunities in private funds, the SEC expanded the definition of “accredited investor” to include a host of “natural persons” and other entities that would not otherwise qualify under the current rigorous disclosure and procedural requirements. The revised definition is intended to increase the number of investors that will have access to private investments.

In the 3-2 vote held on August 26, 2020, the Commissioners amended the definition by:

  • creating a new category for individuals holding certain professional certifications, designations or other credentials (including FINRA Series 7, 65 or 82 licenses);
  • adding a new category based on an individual’s status as a "knowledgeable employee" of a private fund;
  • expanding an existing category to include limited liability companies with assets in excess of $5 million, registered investment advisers, exempt reporting advisers and rural business investment companies (“RBICs”);
  • creating a new category for "family offices" with at least $5 million in assets under management (and their "family clients”); and
  • allowing couples in a “spousal equivalent” relationship to pool their finances for the purpose of qualifying as accredited investors.

The SEC also amended the definition of “qualified institutional buyer” to include limited liability companies and RBICs if they meet certain (unchanged) investment thresholds contained in the definition.

The SEC stated that the changes to these definitions “permit investors with reliable alternative indicators of financial sophistication to participate” in investments in “areas of the economy that disproportionately create new jobs, foster innovation, and provide for growth opportunities.”

The effective date for these amendments is 60 days after publication in the Federal Register. Bates Group will keep you apprised. 

 
Bates practice leaders, consultants and experts offer services to assist our clients’ compliance, risk, supervision, audit and business teams. Contact us today to learn more:
 

Robert Lavigne, Managing Director, Bates Compliance – rlavigne@batesgroup.com

Rory O’Connor, Director, Bates Compliance (RIA compliance) – roconnor@batesgroup.com

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08-17-20

SEC Issues COVID-19 Compliance Observations and Recommendations for BDs and IAs

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On August 12, 2020 the SEC Office of Compliance Inspections and Examinations (OCIE) staff alerted broker-dealers and investment advisers to additional COVID-19 compliance risks. The new considerations are based on the “operational, technological [and] commercial challenges” raised by the public and private sector response to the pandemic. 

OCIE staff grouped their observations and recommendations into several categories—here’s what you need to know:

Protection of investors’ assets

Based on its latest observations, OCIE recommended that firms review their practices on (i) collecting and processing investor checks and transfer requests, and (ii) around disbursements to investors, particularly concerning “unusual or unscheduled withdrawals” from retirement accounts. OCIE also recommended that firms update supervisory and compliance policies and procedures based on that review and consider additional disclosures to investors. Further, OCIE encouraged strengthening investor protections by enhancing the steps necessary to validate the identity of the investor and the authenticity of disbursement instructions. Finally, firms should ensure that seniors and other vulnerable investors have trusted contact persons in place.

Supervision of personnel

OCIE recommended that firms review and modify supervisory and compliance programs to reflect the changes made in response to COVID-19. Primarily, this refers to all operational aspects that might have changed due to the shift “to firm-wide telework conducted from dispersed remote locations.” Firms should consider (i) current levels of oversight, (ii) securities recommendations that may require additional review due to market volatility or the higher risk for fraud, (iii)  resource constraints affecting reviews of third-party managers, investments, and portfolio holding companies, and (iv) other communications or transactions occurring from remote locations or through the use of personal devices.

Practices on fees, expenses, and financial transactions

OCIE suggested firms consider whether the current pandemic and market volatility has heightened the potential for misconduct concerning financial conflicts of interest and the fees and expenses charged to investors. Among other recommendations, OCIE encouraged firms to enhance their compliance monitoring, validate the accuracy of their disclosures calculations and investment valuations, identify and review high fee transactions, evaluate risks associated with investor or client loans and update Form ADV filings (if the firm seeks financial assistance.)

Investment fraud

Firms should consider raising their awareness of the risk of investment fraud during the pandemic and enhance due diligence on investments, ensuring compliance with “best interest” standards and reporting to the SEC any suspicious activity or fraud.

Business continuity

Firms should also review their business continuity plans to address their “ability to operate critical business functions during emergency events.” Consistent with the above recommendations, OCIE suggested reviewing supervisory and compliance policies as well as security and resource support for protracted remote operations. 

Protection of investor and other sensitive information

Finally, firms should review vulnerabilities around the potential loss of sensitive information, given (i) the increased reliance on electronic communications from remote operations, and (ii) the heightened risk from fraudsters attempting to improperly access systems and accounts. OCIE recommended enhancing identity protection practices, increased trainings and strengthening system access security.

Bates Group will continue to keep you apprised.

 

Bates practice leaders, consultants and experts can help clients’ compliance, risk, supervision, audit and business teams. Contact Bates today:

Robert Lavigne, Managing Director, Bates Compliance – rlavigne@batesgroup.com

Rory O’Connor, Director, Bates Compliance (RIA compliance) – roconnor@batesgroup.com

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07-02-20

SEC Issues “Private Funds Adviser” Compliance Risk Alert

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Investment advisers that manage private equity or hedge funds (“private funds advisers”) should review and enhance their compliance procedures to protect investors from (i) improper fees and expenses, (ii) conflicts of interest that may exist between the adviser and the fund, and (iii) the misuse of material non-public information (MNPI). That is the message communicated by an Office of Compliance Inspections and Examinations (“OCIE”) Risk Alert, published June 23, 2020. The Alert identified compliance deficiencies observed by SEC staff during recent examinations of private fund advisers.

Fees and Expenses

In its examinations, OCIE observed numerous deficiencies in the disclosure and allocation of fees and expenses to clients. These include inconsistencies and misallocations of costs and expenses including failures to adequately account for (i) costs associated with due diligence and insurance; (ii) costs related to fund restructurings and “stapled secondary transactions”; (iii) expenses not permitted by fund operating agreements; (iv) expenses prohibited by contract (e.g. placement agent fees), and (v) expenses related to travel and entertainment.

OCIE also identified failures of disclosure in addition to policies and procedures that led to investor overpayments, including on operating partner compensation and services, valuation methodologies that differed from GAAP standards, and calculations for deal fees and offsets, monitoring fees and Board fees. OCIE wants firms to communicate these costs to investors clearly and effectively.

Conflicts of Interest

The OCIE observed numerous deficiencies concerning the disclosure of conflicts of interest between private fund advisers and their clients.

OCIE highlighted disclosure issues concerning allocations of investments among clients. In particular, OCIE found inadequacies in how firms are communicating potential conflicts around (i) types of investment vehicles (e.g. collateralized loan obligation funds, “flagship funds” or separately managed funds); (ii) preferential treatment regarding limited investment opportunities (e.g. opportunities offered to higher fee-paying clients, or other proprietary accounts); and (iii) different pricing on the sales of securities among clients or different capital structure allocations to different clients within a portfolio. These preferences, when undisclosed, disadvantage some investors over others and represent potential conflicts for the advisers.

The examinations also uncovered adviser arrangements that required greater conflicts disclosure to protect investors. The OCIE provided examples of advisers who failed to disclose (i) their ownership interest in a recommended investment; (ii) side arrangements with certain investors to provide preferential liquidity rights; (iii) co-investment agreements that provided different rights and opportunities; (iv) agreements with service providers (some family members) at prearranged or incentivized costs; (v) arrangements for cross-transactions related to the purchase and sales of securities between clients; and (vi) options during restructurings.  

Material Non-Public Information

The OCIE alerted advisers to examination deficiencies which appear to constitute violations of the misuse of MNPI under a firm’s Code of Ethics, as required by the Advisers Act. Generally, the staff found advisers failed to adequately address risks created by employee interactions with assorted insiders, expert network consultants, and those with technological or office access to MNPI or periodic access to information about public securities “in connection with a private investment in public equity.”

In addition, OCIE found that private fund advisers were deficient in complying with ethical requirements intended to limit risk. These include requirements to place and enforce trade restrictions on certain securities on “restricted lists,” gifts and entertainment restrictions from third parties, and the submission of transactions and holding reports related to personal securities transactions.  

Conclusion

This OCIE alert focuses on private equity and hedge fund advisers. According to the SEC, 36 percent of investment advisers manage these private funds. As with most of the alerts directed at the broader adviser market, OCIE wants these private funds advisers to review written practices and procedures and enhance supervision, where appropriate, to ensure that investor risk associated with fees and expenses, conflicts of interests and trading on material non-public information are adequately addressed. According to OCIE, identifying these deficiencies led to firms modifying their practices. Others led to no comment letters, deficiency letters, and referrals to the Division of Enforcement.

To learn more about Bates Compliance’s practice and services, please visit Bates Compliance online or contact Robert Lavigne, Managing Director and Bates Compliance Practice Leader, at rlavigne@batesgroup.com.

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06-30-20

SEC Approves FINRA Amendments on Suitability and Non-Cash Compensation Rules

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The SEC has approved final FINRA amendments to its rules on suitability and non-cash compensation. The final amendments ensure that FINRA’s rules line up with the SEC’s Regulation Best Interest (Reg BI). The FINRA rule changes became effective today, June 30th, 2020, the same date as Reg BI.

As Bates described previously, FINRA proposed these amendments in order to clear up any confusion that the preexisting rules may present concerning the go-forward standards that apply to broker-dealer recommendations to retail customers. A recent FINRA Notice on oil-related exchange traded products (see here for a recap) suggests that FINRA remains concerned that firms understand the applicability of pre-existing suitability rules to complex products under the new Reg BI standard. In this article, we review the final FINRA rule changes.

Key Rule Changes

The specific changes affect FINRA Rule 2111 (Suitability), Rule 2310 (Direct Participation Programs), Rule 2320 (Variable Contracts of an Insurance Company), Rule 2341 (Investment Company Securities), Rule 5110 (Corporate Financing Rule - Underwriting Terms and Arrangements), and Capital Acquisition Broker Rule 211 (Suitability).

Suitability

FINRA’s final rule was explicit—the suitability rule will not apply to recommendations subject to Reg BI. FINRA’s reasoning is as follows: (i) Reg BI’s care obligation, one of four enhanced obligations about to go into effect, addresses “the same conduct with respect to retail customers that is addressed by Rule 2111, but employs a best interest, rather than a suitability standard;” (ii) as a result, compliance with Reg BI “necessarily” meets the suitability standards under Rule 2111; and (iii) the rule change effectively eliminates what would otherwise be duplicative compliance obligations.

FINRA’s rule changes also include applying the newly explicit language on suitability to FINRA’s Capital Acquisition Broker Rules. That is, the suitability rule “shall not apply” to capital acquisition broker recommendations subject to Regulation Best Interest.

FINRA’s suitability rule requires a three-part compliance obligation: reasonable basis suitability, customer specific suitability and quantitative suitability. According to FINRA, this is all subsumed under Reg BI’s enhanced care obligation. However, the final rules did formally remove the “element of control from the quantitative suitability obligation,” an action meant to address instances of excessive trading in a customer’s accounts.

FINRA is not getting rid of the suitability rule—it is still needed for entities and institutions like pension funds, as well as for natural persons  who do not use recommendations for personal purposes (such as small business owners or charitable trusts.) Suitability also remains viable under other FINRA rules such as Members' Responsibilities Regarding Deferred Variable Annuities  (FINRA Rule 2330) and options (FINRA Rule 2360) where the existing rules have a suitability or suitability-like component.

Non-Cash Compensation

The approved final changes adjust FINRA rules to apply Reg BI’s conflict of interest limitations on sales contests, sales quotas, bonuses, and non-cash compensation. Under prevailing rules, FINRA had required broker dealers to have written policies designed to identify and eliminate any program that is based on the sales of specific securities or specific types of securities within a limited time period. Under the final rules, FINRA will not permit non-cash compensation arrangements that conflict with Reg BI, specifically under its rules governing direct participation programs, variable contracts for insurance companies, investment company securities, and corporate financings.

 

For more information, visit Bates Compliance online at www.batescompliance.com and the Bates Reg BI service page, as well as our educational training center for Reg BI and Form CRS webinars on demand and customized firm training.

Please do not hesitate to reach out:

Robert Lavigne, Managing Director, Bates Compliance

Julie Johnstone, Managing Director, Retail Securities Litigation

Alex Russell, Managing Director, White Collar, Regulatory and Internal Investigations

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05-28-20

Reg BI & Form CRS Countdown: One Month to Go - Exams to Start July 1, 2020

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The June 30th, 2020 implementation date for SEC Regulation Best Interest (“Reg BI”) and the corresponding Customer Relationship Summary (“Form CRS”) is only one month away.

Attention has turned to expectations for rule interpretation, regulatory examinations and enforcement. At a recent SIFMA panel discussion covering a host of priorities amid COVID-19, FINRA legal, risk and supervision executives focused on some of the immediate concerns regarding Reg BI and Form CRS.

Regulators described how Reg BI largely “took over” FINRA’s suitability rule, except as it relates to certain definitions and product categories, and they referred to proposed adjustments to the existing suitability and non-cash compensation rules in the context of Reg BI.  (See Bates report on clarifications to the suitability rule here.) 

On examinations, the regulators said that in the initial stage—the first six months after implementation—examinations on compliance with the new standards will focus on the approach to the policies, procedures and controls that firms have put in place. (See also Bates article on SEC exam guidance.)  FINRA leaders expect that they will provide further guidance sometime in late 2020, after reviewing feedback from these initial examinations. Starting sometime in 2021, FINRA said it will be taking a “harder line” on supervisory practices in their examinations.

Enforcement regulators relayed that they would be following any findings from FINRA examiners, but that, initially, FINRA cases will be likely to concern matters that would otherwise have fallen under FINRA’s suitability rule (i.e. excessive trading) rather than looking for a “gotcha” moment on new Reg BI compliance. Further, the regulators commented that while FINRA will continue to track conflicting state fiduciary standards, they are not empowered to enforce, nor will they bring actions under, these standards. Bates will continue to monitor for developments.

For more information, visit Bates Compliance online at www.batescompliance.com and the Bates Reg BI service page, as well as our educational training center for Reg BI and Form CRS webinars on demand.

Interested in learning more about the kinds of issues compliance officers are addressing now? See our recent interview with Bates’ compliance leaders Robert Lavigne and Hank Sanchez.

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05-20-20

Bates Practice Leadership Insights: What Compliance Officers are Thinking About Now

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During this transition period between what was and what will be the “new normal,” we thought it timely to provide some current thinking from top Bates’ leaders on clients’ immediate and near-term compliance challenges. While no one knows with certainty what the future holds, these “leadership conversations” are intended to share some insight from experts on the front line. For our first conversation, we caught up with Robert Lavigne, Managing Director and Bates Compliance Practice Leader, and Hank Sanchez Esq., Bates Compliance Managing Director and former SEC and FINRA regulator, to get an understanding of what they are hearing from compliance officers right now, as well as advice for compliance teams in the "new normal." Here is a recap.

Question: What are the top concerns you are hearing right now?

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Bob Lavigne: “Our compliance practice is fielding a large number of implementation questions concerning Regulation Best Interest (Reg BI). We anticipate that most firms are making good-faith efforts to be in compliance by the rule deadline, so we are preparing for—and have been heavily involved in—what we refer to as ‘Day 2’ work. This includes, just to name a few items, tuning product score cards and product rationalizations, supervisory processes, branch office inspections, compliance testing and book and records reviews.”

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Hank Sanchez: “Reg BI remains the top concern. I would only add that we are addressing many questions related to Form CRS (that is, Reg BI Customer Relationship Form disclosures), including process questions concerning how and when to deliver these forms to clients, and ensuring that language in the separate disclosure documents concerning conflicts and fees is clear and adequate.”

Lavigne: “There are of course some firms, usually small- to medium-sized, that have not yet fully prepared for the implementation of the rule. We are currently working with some to help them catch up and be compliant on June 30th.”

Sanchez: “That’s right. Those that are just now trying to catch up can still evidence the necessary ‘reasonable’ attempts to comply, but they will certainly be scrambling to catch up after July. Those firms should understand that the delay may affect their ability to complete the rest of their compliance requirements in the second half of the year.”

Question: How has the Coronavirus affected client efforts to meet the compliance deadline for Reg BI or other compliance goals? 

Lavigne: “Many firms that have diligently prepared policies, procedures and operations to meet Reg BI and Form CRS deadlines are now confronting pandemic-related challenges around training. They are also concerned with their ability to supervise and execute new policies and procedures, in part because more of their employees are working remotely.”

We are also responding to pandemic-related questions on conducting branch inspections, which would typically be done on site.  FINRA requires on-site inspections, but ‘on-site’ is more complicated now. During the pandemic, on-site will likely be remote. Some firms have delayed their branch inspections during the pandemic. Compliance teams have been limited in their ability to review, and will also have to play catch up.” 

Sanchez: “Firms are facing additional technology challenges as a consequence of COVID-19. Some firms did not have the initial ability for compliance staff to access supervision systems immediately when the lockdowns occurred and had to use work-arounds when those problems popped up. Technological issues continue to crop up in many places, including, for example, in trade reporting and surveillance for firms with trade desks.”

Question: What does post-COVID-19 compliance look like?

Lavigne: “As firms make the slow transition out of lockdown mode, they will be forced to address the fact that some ways of doing business simply will not go back to the way they were. From a compliance standpoint, firms must think seriously about the adequacy of their remote working policies and if they are scalable in a new environment.”

Sanchez: “The pandemic is accelerating and intensifying previous trends, but the bottom line is that greater reliance on remote working arrangements can cause serious and even unexpected compliance and supervisory issues, depending on how much business is being done out of someone’s home or other remote location. So, as risk assessments and business continuity plans get updated and firms prepare for contingencies that may keep brokers and advisers out of the office for extended periods of time, firm leadership will have to face the realities of more comprehensive remote compliance. This will cost firms money and maybe require additional staff as well. In the longer term, new roles may need to be defined, new techniques developed, and compliance staff will have to become more proficient in them to fulfill regulatory requirements.”

Lavigne: “I should note that our practice group is also responding to a host of non-Reg BI pandemic-related challenges which we anticipate will last for quite a while. These concerns are quite diverse. We are working on everything from work-life business culture issues to proper use (to ensure forgiveness) and disclosure around PPP loans.”

Question: What are regulators looking for at this time?

Lavigne: “Regulators are looking to see that firms are making a good faith effort at implementing changes right now, as well as looking at how firms are adapting to the changing environment. It is important for firms to make sure that policies and procedures are still being followed and, perhaps as importantly, that compliance efforts are visible throughout the organization. This means reaching out to representatives and branches proactively and in real time.  Being able to evidence your change management and implementation will be key when speaking to a regulator about your Reg BI program.” 

Sanchez: “As a practical matter, if I were a compliance director right now, I’d be most concerned about what didn’t work in the business continuity plan and getting it fixed. Next, I’d be wondering how to do post-mortem testing to ensure things were done properly during the lockdown and to identify what needs to be corrected. For instance, were supervision and surveillance programs up to the task? Did they work? What needs to be corrected? Following that, there should be thorough updates to the firm’s risk assessment (as well as the business continuity plan) to cover any new or foreseeable events—meaning, at a minimum, any shutdown of a home office for any length of time longer than a day or two.”

Lavigne: “Regulators are going to ask you whether the business continuity plan worked or not.  Firms should take the time to review what did and did not work and make sure they address the areas of concern. The answers will matter. Now is the time to address it.

Sanchez: “Beyond these heightened and immediate regulatory concerns, it is abundantly clear that directors must remain on top of firm compliance with respect to anti-money laundering and cyber programs. But it also requires compliance officers to pay attention to those areas where regulators have specifically highlighted their priorities, including continuously addressing privacy-related policies and procedures and ensuring electronic delivery of required forms to customers.”

Question: What is your outlook on the market going forward?

Lavigne: “Keeping up with compliance responsibilities during ‘normal times’ is challenging. These are not normal times. During COVID-19, even the ordinary compliance tasks present unexpected challenges. But COVID-19 also presents an opportunity to take a hard look at the entirety of your compliance and supervisory operations. We suggest that firms take this advantage to reassess old programmatic approaches to compliance and consider supervision and risk mitigation through greater use of data and technology. That may yield cost savings and regulatory benefits long-term.  

Sanchez: “During this time, taking a moment to survey the overall compliance operation would be valuable. Firm leadership should acknowledge what worked well and who made it happen. That they got it right should absolutely be recognized. For those firms that struggled, this is also an important moment. Those firms should engage in an assessment of the role of compliance management within their business. Perhaps, firm leaders may consider providing a compliance greater say when budget conversations turn to systems and staffing upgrades.

Reach out to Robert Lavigne at rlavigne@batesgroup.com and Hank Sanchez at hsanchez@batesgroup.com. For more information, visit Bates Compliance online at www.batescompliance.com.

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04-28-20

This Week at Bates: Countdown to Form CRS for IAs Webinar

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The countdown is on! By June 30, 2020, all SEC-registered IA firms must file their Client Relationship Summary (“Form CRS”) with the SEC and post on their website, then provide the Form CRS to all prospects and retail clients. Attend this complimentary webinar, specifically designed for SEC-registered IA firms, so you can tackle Form CRS with confidence. Our regulatory compliance team will guide you through the process and the following topics:

  • Tips for writing the CRS
  • Policies and Procedures, including what you need to be thinking about and what do you need to put in place
  • Getting your team ready: training, delivery, and record keeping
  • New SEC FAQs and Form CRS Alert
  • Your Questions and Answers


When: Thursday, April 30, 2020 - 12:00 PM EST/9:00 AM PST

Program Length: 1 hour

Bates Program Faculty (pictured above):

Linda A. Shirkey, Managing Director

Rory O'Connor, Director

Jennifer Sullivan, Consultant

 

Registration is required to view this Zoom webinar.

Learn More and Register Now

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04-15-20

SEC Adopts Final Rule on Variable Contract Disclosure, Effective July 1, 2020

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The SEC recently adopted new Rule 498A under the Securities Act, including various supporting amendments, to “simplify and streamline” the disclosure framework for variable annuities and variable life insurance contracts. As Bates Group described when the rule was first proposed (and subsequently thereafter – see here and here), the new rule allows for a plain-English, easy to read, concise “summary prospectus” to satisfy obligations under the securities laws concerning variable product prospectus delivery.

The summary prospectus is intended to help investors understand variable contracts through a “layered approach to disclosure” similar to the approach which has been in use for mutual funds since 2009. Under that approach, issuers of variable contracts will be able to provide essential information to consumers directly, and then must provide on-line links to additional and more detailed information (e.g., the full prospectus, underlying fund summaries and shareholder reports).  For current contract holders, issuers will be able to provide an “updated summary prospectus” which would contain a brief description of changes to the contract that occurred during the previous year along with all the basic information contained in the new summary.

In a simplified fact sheet, the SEC described that the summary prospectus must include key information, including an overview of the contract, details about fees and risks (which must appear in table format) and other disclosures related to fees, purchases, withdrawals and other contract benefits. As described in the rule package, however, this information can be complex. Variable contracts can have multi-level fee structures, e.g. mortality and expense risk issuer assessments, administrative fees, optional benefits fees, transactional charges and other insurance charges to name a few (at p.10). The SEC acknowledges this complexity, noting: “because variable contracts typically include a number of optional benefits and underlying investment options, a summary could not, by its nature, include all relevant aspects and details regarding each of these contract features.” That said, the summary prospectus is intended “to be a succinct summary of the contract’s key terms and benefits and most significant risks” (at p.14).

It is expected that these summaries and this layered approach will be far more clear and consumer-friendly, and will allow investors in these products to understand them and make more informed decisions. As Chair Jay Clayton stated upon the adoption of the rule: “investors should not have to work through hundreds of pages of disclosure to understand these products' risks, fees, and features in order to make informed investment decisions.”

The 700-plus-page final rule contains numerous technical and conforming amendments and modifies or revokes superseded existing rules and forms. For example, the rule amends the registration forms for variable contracts (Forms N-3, N-4, and N-6) in order to improve the content, format and presentation of information to investors. The rule also (i) requires that statutory prospectuses be available for free on a public website and (ii) provides other specifications on, for example, the use of the Inline eXtensible Business Reporting Language format for the submission of necessary disclosures.

The new disclosure framework on variable annuities and variable life insurance contracts becomes effective July 1, 2020. (For variable contracts that are discontinued by that date, issuers will not have to update their registration statements or provide updated prospectuses to existing investors.) As of January 1st, 2022, all Form N-3, N-4 and N-6 registration statements, and corresponding updates, must comply with the rule.

 

For more information about Bates Group’s Insurance and Actuarial services, visit our Insurance and Actuarial Practice page or contact Greg Faucher, Bates Group Insurance Practice Leader.

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04-09-20

SEC Issues Risk Alerts on Compliance with Reg BI and Form CRS

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On April 7, 2020, the SEC Office of Compliance Inspections and Examinations (“OCIE”) issued two new alerts to broker-dealers and investment advisers about the “expected scope and content” of its compliance examinations for Regulation Best Interest (“Reg BI”) and the Client Relationship Summary (“Form CRS”). Previously, SEC Chair Jay Clayton announced that the June 30, 2020 compliance deadline for Reg BI will not be delayed due to the impact of  COVID-19. These alerts, therefore, underscore the need for firms to be prepared and compliant by the deadline.

The first alert, Examinations that Focus on Compliance with Regulation Best Interest, emphasizes the OCIE’s determination to evaluate whether firms have established policies and procedures reasonably designed to achieve compliance with Reg BI, and whether firms have made reasonable progress in implementing those policies and procedures. OCIE said the examinations will focus on the four component obligations of “best interest” recommendations: those of disclosure, care, conflict of interest, and compliance.

Regarding the disclosure obligation, the OCIE said it would review all disclosures and documents that bear on the “material facts relating to the scope and terms of the relationship with the retail customer,” and “relating to conflicts of interest that are associated with recommendations.” Specifically, OCIE said it may assess the “capacity in which the recommendation is being made,” fees and costs of transactions, holdings and accounts, and material limitations on the securities or investment strategies involving securities that may be recommended to the retail customer.” To assess compliance with the obligation of care, OCIE relayed it would review the information that a firm collects from retail customers to develop investment profiles, as well as a broker-dealer’s process for having a reasonable basis to believe they are acting in the best interest of the client (i.e. factors considered when assessing the “risks, rewards, and costs of the recommendations in light of the retail customer’s investment profile”). To assess compliance with the conflict of interest obligation, OCIE stated that it would assess policies and procedures that identify potential conflicts, existing conflicts, evolving conflicts, disclosures of conflicts and mitigation of conflicts. To assess Reg BI’s compliance obligation, OCIE stated that part of its review of a firm’s written policies and procedures will focus on “controls, remediation of noncompliance, training, and periodic review and testing.” 

The second alert, Examinations that Focus on Compliance with Form CRS, emphasizes that the OCIE will evaluate whether firms have made a good faith effort to implement the new customer relationship summary requirements. After the deadline, firms must deliver these forms to their retail customers, post them on their website, and file them with the Commission (at the Central Registration Depository or Investment Adviser Registration Depository, as required).

The OCIE stated that it will review delivery considerations on Form CRS as to existing retail investors (particularly, in light of certain types of recommendations, e.g. rollovers or new services) and new retail investors (that may involve accounts involving investment strategy, order placement, or the opening of a brokerage account). OCIE also noted it will assess whether the content in the summary is adequate and accurate and that it does “not omit material facts necessary in order to make the required disclosures.” Finally, OCIE stated that it will consider certain technical compliance, e.g. that the form complies with proper formatting, that there are policies and procedures in place for updating the form, and that the firm has the attendant record-making and recordkeeping procedures.

These two alerts show that the scope of the anticipated review of compliance with Reg. BI and the CRS will be broad. SEC Chair Clayton emphasized, however, that the agency is looking to see a firm’s “good faith” compliance effort and that it understands the stresses that COVID-19 may be causing during this time.


Bates Group’s Compliance team helps firms implement Reg BI, Form CRS, and navigate compliance concerning investor and consumer protection standards. We understand that all are under great pressure during this period to achieve regulatory obligations and stand ready to support you in any way that we can. To learn more about Reg BI compliance consulting support for your firm, please visit our Reg BI service page. You may also contact Robert Lavigne, Managing Director, Bates Compliance, at rlavigne@batesgroup.com to discuss your current needs one-on-one. We have also developed a Training and CLE page for on-demand Reg BI webinars and Reg BI training for your company.

Please visit our Bates COVID-19 Practice News & Information page for recent news and regulatory announcements.

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04-01-20

Five Supervision, Control and Compliance Items You Should be Considering Now

Five Supervision, Control and Compliance Items You Should be Considering Now

Compliance is challenging to begin with, but in this new landscape, it is an even greater stretch for compliance teams to manage company-wide systems while working remotely. Here are five items you should be thinking about when addressing supervision and control functions.

1)    Mind the Deadlines: It can seem like regulatory compliance deadlines are changing daily. Extensions may be granted, but in many cases, there are caveats that must be followed to avoid being in violation. Make sure to read all regulatory releases closely, because the devil is in the details. See for example the SEC’s Form ADV filing extension and deadlines – amended and extended again…a second time within a week!

2)     Focus on What The Regulators Are Saying: We all know that when the Regulators say something is a “priority” – it really is. Regulators are urging firms to focus on transaction and personnel supervision, to review supervisory control policies and procedures under their Business Continuity Plans, to ensure effective communications with customers, and to support customer access to funds and securities. Heed this call to action. Regulators are also inquiring about firms’ Business Continuity Plans. Expect them to inquire about it on your next exam cycle. 

3)     Remote Working and Supervisory Controls: With the current volumes and financial services firms directing their employees to work remotely, supervision and control, and compliance systems may be strained, causing gaps in back office and branch supervision, and exposing vulnerabilities. Now is the time to identify those gaps and ensure that proper sales practices are in place to avoid exposure. Draw up lists and consider what is working and what is not, what can be patched for now, and what cannot wait, as well as long-term issues to address.

4)    Write Down What Worked: Pat yourself on the back for executing your business continuity plan. Take the time now to document the lessons learned. Regulators are going to ask you what worked and what did not work. Please do yourself a favor and write these down now to capture all of your team’s work. 

5)    Stay Calm: While we are all doing our best to adjust to the current reality, tensions and stress are still running high. Just remember, we made it through the dotcom crash, the 2008 credit crisis, and many other significant market and economic downturns. We are going to make it through this one, too. 

Do you need some extra assistance? Bates Can Help. Our experienced former branch office manager, admin manager, and operations manager consultants are available to assist your firm to ensure that supervisory controls and proper compliance practices are in place and are being implemented on a timely basis, and that proper sales practices are adhered to. Our consultants have successfully handled day-to-day supervisory and compliance functions as well as business interruptions, reducing risk and exposure for firms.

Contact:

Robert Lavigne - Managing Director, Compliance Practice Leader
rlavigne@batesgroup.com

Rory P. O'Connor - Director, Bates Compliance
roconnor@batesgroup.com

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03-26-20

Update: SEC Amends ADV Filing and Delivery Deadline Extensions due to COVID-19

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The SEC’s IAA Release No. 5469 on Wednesday, March 25, 2020 amends its IAA Release No. 5463 and now allows for extending the filing (March 30) and delivery (April 30) deadline dates of the Form ADV amendment to June 30, 2020 due to COVID-19 and its consequences. The SEC has also amended the notice requirements, eliminating the need to describe why the requirement cannot be met and when you expect to file. If you cannot meet the filing deadlines, you MUST do the following:

Email IARDLive@SEC.gov AND post on your website (or, if you do not have a website, notify your clients/investors directly):

  • That your firm is relying on the original Order.
Example: 
  • “Our firm, ABC Inc., CRD# xxxx, SEC# 801-yyyy, will not be filing its Form ADV amendment by March 30 or delivering it by April 30 due to the COVID-19. We are relying on the SEC IAA Release No. 5463 of Friday, March 13, 2020 for this extension."

Please contact Bates Compliance to assist your firm with Form ADV or to discuss your discrete and ongoing compliance needs:

Linda Shirkey, Managing Director

lshirkey@batesgroup.com - (281) 298-7015

 

Rory O’Connor, Director

roconnor@batesgroup.com - (860) 671-7270


ABOUT BATES COMPLIANCE

The Bates Compliance team of senior compliance staff and former regulators bring tailored regulatory compliance services, guidance, and expertise to financial services clients on an as-needed or ongoing basis to meet the evolving requirements and practices of today’s global financial services industry. Bates Compliance provides a wide range of support to financial institutions of all sizes, structures, and business models, and works with its clients to review, test, and bolster their compliance programs. Bates Compliance provides and implements solutions based on regulatory requirements and industry-accepted best practices designed to supplement and enhance compliance and supervisory systems and to remediate the results of regulatory and internal audit findings.

Go To Bates Compliance Services and Discover the Difference

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03-25-20

FINRA Warns Firms on UTMA/UGMA Account Supervision

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In a Notice issued on February 27, FINRA advised firms of their responsibilities over custodial accounts under the Uniform Transfers to Minors Act and Uniform Gifts to Minors Act (“UTMA/UGMA”). FINRA is continuing to look at whether firms have adequate policies and procedures in place to comply with UTMA/UGMA, and how those policies and procedures are operationalized. Specifically, as we previously reported, FINRA is seeking to ensure that control over accounts is passed to the beneficiaries once the minors reach the statutory age (18 or 21 in most states; an alternative age is permitted in a dozen or so other states).

These accounts are set up under state law, but they generally require the appointment of a custodian, the designation of a minor beneficiary and the deposit of assets into an account. Under UTMA/UGMA, the deposits are considered irrevocable transfers to the beneficiary. Termination of the custodianship is based on the beneficiary reaching maturity or dying, or as prescribed in some other way by state statute.

In the Notice, FINRA described special obligations of custodians beyond the broker-dealer requirements to safeguard customer assets pursuant to the securities laws. Specifically, it reviewed custodial responsibilities in light of a firm’s “Know Your Customer” (Rule 2090) and Supervision (Rule 3110) obligations. It warned members that adequate compliance requires firms to take into account termination of custodianship and changes of authority under these rules.

During firm examinations last year, FINRA found transaction authorizations and supervisory systems and procedures failings, particularly with respect to custodian terminations. As Bates noted when the 2019 Examination Report was issued, FINRA also criticized firms for allowing custodians to “withdraw, journal and transfer money from UTMA/UGMA accounts months, or even years, after the beneficiaries reached the age of majority.”

In its new Notice, FINRA highlighted that effective supervisory systems (i) track custodian terminations (from inception and by using automated tools) and (ii) provide automated alerts for representatives to communicate with custodians—and for custodians to communicate with beneficiaries—about transfers of custodial assets and relevant age milestones. It also endorsed practices concerning verification of custodian authority to manage assets after termination and account documentation concerning any post-termination relationship.


How Bates Helps

Bates works with clients to closely review their UTMA/UGMA client account records to identify the impacted populations, whether control over the accounts has transferred, and whether trading activity has occurred or commissions generated once beneficiaries have reached the statutory ages for control over the accounts. 

Bates also conducts large data analyses based on beneficiary (minor) dates of birth against the applicable ages for change of account control. This helps in identifying those accounts that should have been converted but have not, the trading done in those accounts, and the commissions earned. The resulting information is then used to respond to FINRA and discuss any remediation or other next steps.

 

For more information on how Bates Group can help your firm respond to UTMA/UGMA account inquiries, please contact:

Scott Lucas  

Bates Group Managing Director, Regulatory & Internal Investigations

t: (971) 250-4344   e: slucas@batesgroup.com

 

David Birnbaum

Bates Group Managing Director

t: (917) 273-2682   e: dbirnbaum@batesgroup.com

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03-17-20

FINRA Postponement of In-Person Arbitration & Mediation Hearings

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FINRA has announced that, in response to the evolving coronavirus disease 2019 (COVID-19), it “has decided to administratively postpone all in-person arbitration and mediation proceedings scheduled through May 1, 2020. “

“If you have an in-person hearing or mediation session that is postponed as a result of this decision, you will be contacted by FINRA staff to reschedule or discuss remote scheduling options,” said the regulator. Importantly, FINRA relayed that the postponement “does not affect other case deadlines. All case deadlines will continue to apply and must be timely met unless the parties jointly agree otherwise.”

Bates stands ready to support clients with their FINRA arbitration matters. If you are a Bates client and your case is postponed, we look forward to being in touch with you to discuss your interim case support needs.

Please also feel free to reach out to our team to discuss any of the following services: 

Litigation Services and Damages Analyses

Search for a Quantitative or Substantive Consultant or Testifying Expert

Request a Consulting or Testifying Expert

Arbitrator Evaluator™ Selection Tool

Managed Document Review Services


Contact:

 

Julie Johnstone - Managing Director - Retail Litigation

jjohnstone@batesgroup.com

 

Andrew Daniel - Director, Expert - Retail Litigation

adaniel@batesgroup.com

 

Peter Klouda - Director, Expert - Retail Litigation

pklouda@batesgroup.com

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03-16-20

SEC Extends Form ADV Filing and Delivery Deadlines due to COVID-19

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The SEC’s IAA Release No. 5463 on Friday, March 13 allows for extending the filing (March 30) and delivery (April 30) deadline dates of the Form ADV amendment by 45 days due to COVID-19 and its consequences. However, this is not an automatic extension. If you cannot meet the filing deadlines, you MUST do the following:

Email IARDLive@SEC.gov AND post on your website (or, if you do not have a website, notify your clients/investors directly):

  • That your firm is relying on this Order,
  • A brief description of why you are unable to file or deliver on a timely basis,
  • The estimated date by which you expect to file/deliver the filing.

Example: 

  • “Our firm, ABC Inc., CRD# xxxx, SEC# 801-yyyy, will not be filing its Form ADV amendment by March 30 or delivering it by April 30 due to the COVID-19 virus because of the following. We are relying on the SEC IAA Release No. 5463 of Friday, March 13, 2020 for this extension. (Pick one of the below, or change the language to fit your circumstance…)
  • Our office is working with a skeleton staff which is unable to gather required information, or
    • Critical staff for gathering information for the filing are focused on the market and client calls, or
    • We are experiencing extensive staff illness or staff are caring for ill family members and are unable to work, or
    • We are unable to receive needed information for an accurate filing from third parties within the initial filing date.
  • We expect to be able to file accurate information by (date no later than May 14, 2020) and to deliver required information to our clients by (date no later than June 13, 2020)."

Please contact us to assist your firm with Form ADV or to discuss your discrete and ongoing compliance needs:

Linda Shirkey, Managing Director

lshirkey@batesgroup.com - (281) 298-7015

 

Rory O’Connor, Director

roconnor@batesgroup.com - (860) 671-7270


About Bates Compliance

The Bates Compliance team of senior compliance staff and former regulators bring tailored regulatory compliance services, guidance, and expertise to financial services clients on an as-needed or ongoing basis to meet the evolving requirements and practices of today’s global financial services industry. Bates Compliance provides a wide range of support to financial institutions of all sizes, structures, and business models, and works with its clients to review, test, and bolster their compliance programs. Bates Compliance provides and implements solutions based on regulatory requirements and industry-accepted best practices designed to supplement and enhance compliance and supervisory systems and to remediate the results of regulatory and internal audit findings.

Go To Bates Compliance Services and Discover the Difference

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03-09-20

Bates Compliance Practice Leader Robert Lavigne Discusses Reg BI in ThinkAdvisor Article

Bates Compliance Practice Leader Robert Lavigne Discusses Reg BI in ThinkAdvisor Article

Bates Compliance Practice Leader Robert “Bob” Lavigne is quoted in a new article entitled “Reg BI Compliance Race is On,” published by ThinkAdvisor on February 24, 2020. Bob offers insight on the challenges to achieve regulatory compliance with the new SEC rule by the June 30, 2020 deadline.

Read the full article at ThinkAdvisor

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03-05-20

Facing the Coronavirus: Financial Industry Preparations, Reassurances and Contingencies

Facing the Coronavirus: Financial Industry Preparations, Reassurances and Contingencies

If you’ve been in meetings about investor communications, business travel, or other contingency planning over the past few days and weeks, you are not alone. Since the outbreak of the coronavirus (also referred to as COVID-19) and more recently, the precipitous volatility of the financial markets, financial firms have been deluged with questions from just about every stakeholder group about how to respond. Regulators are weighing in as well. Bates looks at some of the efforts to prepare and reassure everyone out there.

The Markets

Despite early attempts by Federal Reserve Board Chair Jerome Powell to reassure investors that the central bank is “closely monitoring developments and their implications for the economic outlook” and that the Board “will use our tools and act as appropriate to support the economy,” the Fed took more definitive action earlier this week by lowering the target range for the federal funds rate by 1/2 percentage point in an attempt to protect the economy from potential disruptions.

Political actors have been vocal about pressuring the Fed to do more. The President reportedly urged the central bank to be more aggressive cutting rates and suggested that Congress cut taxes. As we went to print, Congress, however, appears to be closing in on a bipartisan $8.3 billion appropriation to combat the virus. Presidential candidates, most notably former candidate Senator Warren, are advocating for substantial fiscal stimulus to address the current situation and potential spread. The Senator wrote letters to CEOs of the globally systemic important banks demanding they provide information regarding “how you evaluate the risks to your institution and its customers associated with coronavirus, the extent to which your institution is exposed to those risks and prepared to absorb their impact, and how you are monitoring the developments going forward.”  

Firm Management  

For all market participants, the priority is to make preparations to keep transactions and other financial functions operating. A spokesperson from the NYSE stated they are carefully monitoring the spread of COVID-19, and that the exchange has “robust contingency plans, tested regularly, to enable continuous operation of the NYSE exchanges should any facilities be impacted.”

Many financial firms have restricted business travel in Asia and Italy, required employees in those areas work from home, and placed other restrictions on travel and attending conferences. Some U.S. firms are restricting travel, as well. Reuters quotes financial sources discussing the preparation of back-up facilities, “splitting up critical teams into rotating shifts and physically distancing staff from one another.” Ultimately, the plans ensure that employees know what they need to do to keep the company operating. 

Backing up how prepared market participants are, Kenneth Bentsen Jr., CEO of the Securities Industry and Financial Markets Association (“SIFMA”), in an interview with Reuters relayed that  “most firms have playbooks for handling a range of business disruptions, including pandemics.” He stated that the “industry is reviewing and updating contingency plans in order to minimize any potential disruption to the financial markets that could be caused by personnel being unable to work onsite.” Plans include potentially “moving staff to backup locations away from major cities.” Bentsen conveyed that “our job is to do as much preparedness as we can . . . and to be as resilient as possible. That's been up and running for several weeks now, and we're prepared."

SEC  

On March 4, 2020, the SEC issued an Order that “provides publicly traded companies with an additional 45 days to file certain disclosure reports that would otherwise have been due between March 1 and April 30, 2020.”  In the release accompanying the Order, the SEC makes clear that companies should “continue to evaluate their obligations to make materially accurate and complete disclosures in accordance with the federal securities laws.”

To receive the relief under the newly issued Order, companies must submit a summary report explaining “why the relief is needed in their particular circumstances.” The Commission stated that it “may extend the time period for the relief, with any additional conditions it deems appropriate, or provide additional relief as circumstances warrant.” 

The SEC Division of Investment Management also issued a statement saying that it is actively monitoring the current and potential effects of the virus on investment advisers and funds. The staff noted, however, that it “would not recommend enforcement action if fund boards do not adhere to certain in-person voting requirements in the event of unforeseen or emergency circumstances affecting some or all of the directors,” as a result of “the current and potential effects of COVID‑19.” Division staff stated that its no-action position applies to board meetings held between March 4 and June 15, 2020 (with extensions as circumstances warrant.)  

Retail Investors

For retail investors, regulators have been offering up advice when considering investment concerns. On February 28, 2020, FINRA issued “Investor Tips for Turbulent Markets,” a 5-step primer for when “the stock market gets rocky” to “elevate your financial security.” While not explicitly referencing the advent of the health crisis, the primer contains key steps to “‘steady your pulse during market downturns.”  These key points include (i) revisiting financial goals to guide a sound investment approach; (ii) diversify across, and within, the major asset classes relative to your overall portfolio; (iii) automating payments to strengthen financial security; (iv) understanding the impact of changing interest rates; and (v) protecting against fraud by working with registered representatives and using FINRA’s BrokerCheck.

Conclusion

The global nature of the coronavirus challenges the broader economy in ways that are as yet unknown. Messages of preparations, reassurance, and contingency plans by market leaders are helpful to “steady the pulse” as stakeholders move forward. Bates will continue to monitor developments.

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01-23-20

FINRA Reorganizes for More Coordinated Exams, Highlights Priorities for 2020

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(photo: FINRA.org)

In his cover note accompanying FINRA’s annual Risk Monitoring and Examination Priorities letter, FINRA President and CEO Robert Cook (pictured) reminded members of significant enhancements to the examination program going forward.

Mr. Cook first described the recent reorganization of member firms into one of five business model categories: Retail, Capital Markets, Carrying and Clearing, Trading and Execution and Diversified This consolidation permits FINRA to assign each firm “a single point of accountability” that will have the “ultimate responsibility” for risk monitoring, assessment and “planning and scoping of exams tailored to the risks of the firm's business activities.”

Second, Mr. Cook highlighted the organization’s extensive efforts in preparing firms to comply with new regulations—particularly Regulation Best Interest (“Reg BI”)—that will be examination priorities for FINRA in 2020. To that end, he underscored the letter’s inclusion of practical questions that firms should consider in order to “assess and, if necessary, strengthen their compliance, supervisory and risk management programs.”

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Top FINRA Exam Priorities for 2020

See highlights of FINRA’s continuing and emerging concerns on our 2020 FINRA chart below, which keeps track of articulated priorities from year to year.

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© 2020, Bates Group LLC
Source: 2020 FINRA Regulatory and Examination Priorities Letter (Compiled by Alex Russell, Managing Director)
 

Reg BI Tops the List

Reg BI was front and center in this year’s letter. FINRA emphasized that it will continue to offer transition resources as it “reviews firms’ preparedness” prior to Reg. BI’s June 30 implementation date. After that date, however, FINRA will examine broker dealers for compliance with the new regulation, the corresponding interpretations and the new Customer Relationship Summary (“Form CRS”) requirement.

Specifically, FINRA stated it will consider in its examinations whether: (i) adequate processes and procedures are in place to assess broker dealer best interest recommendations; (ii) the firm and associated persons are applying those standards; (iii) account monitoring adequately applies to both explicit and implicit hold recommendations; (iv) recommendations to retail customers are following “express new elements of care, skill and costs;” (v) customer recommendations take into consideration reasonably available alternatives; (vi) controls are in place to prevent excessive trading; (vii) adequate disclosures are provided for; (viii) conflicts of interest are adequately covered in policies and procedures; and (ix) filing and delivery of Form CRS is adequately addressed.

Sales Supervision and Communications

FINRA reiterated past priorities, saying that it will examine supervisory obligations over the sales of complex products (private placements, variable annuities and certain fixed income products). In 2020, FINRA highlighted that it will look closely at private placement retail communications to see how firms are fulfilling their supervisory obligations when using digital platforms (texting, messaging, social media or other applications). The letter states that FINRA will consider whether private placement communications are fair, reasonable and not misleading and whether they omit material facts, adequately explain risks, or contain false statements or promises. In addition, FINRA said it will examine these communications to ascertain whether they fully explain issuer metrics or projections on performance.

On the use of digital communications tools, FINRA asks firms to review their practices and programs to ensure that a representative’s digital communications comply with review and retention requirements and to consider whether their supervisors can recognize—and follow up on—the “red flags” of unapproved communications channels.

Cybersecurity

FINRA states that “cybersecurity has become an increasingly large operational risk.” As a result, FINRA advises firms that it will examine policies and procedures to ensure that customer records and information are adequately protected. FINRA also reminded firms that cybersecurity controls should be appropriate to the firm’s scale of operations and business model. Specifically, the FINRA letter prods firms to consider their “technology governance programs” to determine whether they are “expose[d] to operational failures” that may compromise their ability to comply with a range of rules and regulations. In this respect, FINRA will evaluate the adequacy of firms’ business continuity plan to ensure that the firm has the procedures and capacity to “maintain customers’ access to their funds and securities, as well as manage back-office operations, to prevent delays or inaccuracies relating to settlement, reconciliation and reporting requirements.” FINRA stated that it will examine testing and for tracking information technology problems.

Additional FINRA examination priorities for 2020 include:

  • Trading Authorizations – FINRA will examine whether firms have the systems and supervision in place to address trading authorizations, discretionary accounts and key transaction descriptors. This includes whether firms can detect and address registered representatives exercising discretion without written client authorizations.
  • Bank Sweep Programs – FINRA will examine a broker dealer’s use of bank sweep programs (sweeping investor cash into partner banks or mutual funds) to ensure that such services are not misrepresented, and that any program arrangements as well as cash management alternatives are adequately communicated to the customer.
  • Digital Asset Investments – For firms that are considering engaging in digital asset investment activities, FINRA will examine whether they are filing the appropriate documentation for engaging in such activity, and whether their marketing and retail communications present a fair and balanced look at the risks presented. FINRA is also concerned with technology-related risk and cautioned that it will review automated systems associated with market access (such as monitoring for trading behavior, adjustments to credit limit thresholds, third party vendors and training).
  • IPO Practices – FINRA will examine a firm’s compliance with rules restricting the purchase and sale of initial equity public offerings, and on new issue allocations and distributions. FINRA wants firms to review their practices and procedures to ensure that (i) they can adequately detect and address issues of “flipping” or “spinning;”(ii) IPO allocation methodologies and “calculations of aggregate demand” are fully explained; (iii) there are adequate controls to prevent allocations to restricted persons; and (iv) the firm records and verifies information for customers receiving these allocations.
  • Best Execution – FINRA will continue to focus on compliance with best execution rules as they pertain to routing decisions and procedures for the handling of odd lots, treasuries and options (all subjects of enforcement actions in 2019). Further, FINRA said it will review processes related to handling of customer orders, including how the firm addresses conflicts of interest concerning now prohibited types of remuneration.

FINRA will also continue to examine priorities highlighted in the past, including adequate supervision and compliance over anti-money laundering and fraud, insider trading and manipulation across markets and products.

Conclusion

The priorities contained in this year’s FINRA letter are consistent with those contained in the annual report issued by the SEC’s Office of Compliance Inspections and Examinations (see recent Bates coverage). Similar to the OCIE report—which should be considered in tandem with this letter—the FINRA priorities emphasize the importance of firms preparing for Reg. BI and, more generally, for addressing vulnerabilities in compliance programs and practices. FINRA’s recent consolidation and reorganization and the identification of a “single point of accountability” should prompt firms to engage with them sooner, particularly over preparations for Reg BI, to ensure they are moving toward full compliance with these priorities.

 
For more information concerning Bates Group's Practices and services, please visit:

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Reg BI Services and Support

Broker-Dealer Compliance Services

RIA Compliance Services

Retail Litigation and Consulting

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01-22-20

Download The New Reg BI White Paper from Bates Research and Bates Compliance

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Understand what Reg BI requires now — and what more you must implement before the final deadline. 

Download our new white paper: "SEC’s Regulation Best Interest Perspectives on Firm Compliance."

 

This new two-part article, from Bates Compliance Reg BI leaders and our Bates Research team, is an overview of the current state of play on the impending SEC Reg BI rule: how we got here, what the rule requires and what firms need to have in place before the final compliance implementation date on June 30, 2020.

Regulators have announced that they will be reviewing firm’s preparedness and will examine firm’s compliance with Reg BI, Form CRS and related guidance following the deadline. It is therefore imperative that firms have a Reg BI plan in place and develop core compliance and supervisory processes and components now to achieve regulatory expectations and overcome scrutiny.


Learn More:

 
The Bates Compliance Reg BI Team is available to advise, guide and implement a selective or full suite of Reg BI services.
Explore other White Papers from Bates Research to help you understand the legal, regulatory and compliance issues at hand.

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01-16-20

OCIE to Prioritize Reg BI Compliance in 2020 Examinations

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The SEC Office of Compliance Inspections and Examinations ("OCIE") set out their 2020 examinations priorities in an annual report issued last week. The report reminds registered entities that all its priorities are within the SEC’s mandate to protect investors, facilitate capital formation, and maintain fair, orderly and efficient markets. The report is, in effect, a notice to the industry and chief compliance officers to address potential vulnerabilities in compliance programs and practices in order to minimize retail investor and market risks.

This year, OCIE leaders highlighted a wide variety of continuing and emerging concerns. Bates Group tracks these risks and articulated priorities from year to year (see chart below).

OCIE 2020 PRIORITIES

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SEC Examination Priorities Year-To-Year Comparison Chart 2020
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© 2020, Bates Group LLC
Source: OCIE 2020 National Exam Program Examination Priorities (Compiled by Alex Russell, Bates Group LLC)

OCIE explained that these priorities should be viewed in light of the rapidly changing registered investment adviser market, the recently adopted rules on broker-dealer and investment adviser conduct standards (Regulation Best Interest) and other significant financial technology and market developments. A good portion of the report is dedicated to explaining this context. Here’s what OCIE had to say.

Registered Investment Advisers: Beware

OCIE leadership explained that examination coverage for RIAs was increasingly imperative, given (i) that the OCIE is “the primary, and often only, regulator responsible for supervising this segment of financial firms;” (ii) that the number of RIAs it supervises is now 13,475, up from 11,500 five years ago; and (iii) that RIAs now have $84 trillion in assets under management, up from $62 trillion five years ago. Examinations of RIAs constituted 2,180 of the 3,089 examinations OCIE completed in FY 2019. By contrast, OCIE examined 350 broker-dealers, 110 securities exchanges, 90 municipal advisors and transfer agents and 15 clearing agencies. These numbers do not include OCIE examinations of the Financial Industry Regulatory Authority (FINRA).

Notably, the OCIE pointed out that its examination coverage rates over registered investment advisers (RIAs) may suffer in 2020 due to perennial staff shortages. However, the Office made clear that it prioritizes keeping pace with year-over-year increases in examination rates for RIAs. In FY 2018, OCIE’s examination coverage of RIAs was 17 percent, and in FY 2019 it was 15 percent. OCIE made a point of noting that the decline in the past year was the result of a 35-day lapse in appropriations, and that examinations of RIAs actually increased by 10 percent over a five-year period.

Regulation Best Interest: Be Ready

Compliance with Regulation Best Interest (Reg BI) interpretations related to the standard of conduct for investment advisers and the new Client Relationship Summary (Form CRS) are major 2020 examination priorities. The OCIE reminded firms that the compliance date for Reg BI and Form CRS is June 30, 2020, and to expect that OCIE will “engage” during its examinations on firms’ progress toward implementation of the new rules. This is significant, in part, because the SEC continues to clarify Reg BI obligations (see e.g. the revised FAQs just issued by the Division of Trading and Markets).

OCIE stated that it has already “integrated” the Reg BI interpretations into its examination program for RIAs. Beyond the compliance implementation date, its examinations will include an assessment as to a firm’s actual Reg BI implementation, “including policies and procedures regarding conflicts disclosures, and for both broker-dealers and RIAs, the content and delivery of Form CRS.”

OCIE restated past examination priorities as they relate to retail investors. (See Comparison Chart above.) These include a focus on certain complex products and vulnerable investors. Consistent with its Reg BI focus, OCIE stated that its 2020 examinations will look at disclosures relating to fees, expenses and conflicts of interest and the “controls and systems [intended] to ensure those disclosures are made as required and that a firm’s actions match those disclosures.” This includes supervision of outside business activities and “any conflicts that may arise from those activities.”

For RIAs, OCIE plans to examine whether they have fulfilled their fiduciary duties of care and loyalty. The OCIE relayed that it “has a particular interest” in the accuracy and adequacy of disclosures provided by RIAs concerning offers to clients on new and emerging investment strategies, such as strategies focused on sustainable and responsible investing, which incorporate environmental, social, and governance (ESG) criteria.

For broker-dealers, OCIE highlighted that examinations will focus on transfer agent handling of microcap distributions and share transfers, sales practices, and supervision of high-risk registered representatives. More generally, OCIE emphasized that it will assess recommendations and advice given to (i) seniors and “those targeting retirement communities” and (ii) teachers and military personnel. In conjunction with Reg BI compliance issues, OCIE said it will focus on higher-risk products like private placements, as well as on non-transparent products such as mutual funds and ETFs, municipal securities and other fixed income and microcap securities.

Industry and Technology Risk: Be Careful

The theme of information technology risk cited in the report is broad. OCIE will be “monitoring industry developments and market events” to assess broad risks and consequences for both firms and retail investors.

For registered entities, OCIE said it will examine the use of technology by third-party vendors and information security in general, including proper configuration of network storage devices and retail trading information security. The OCIE also emphasized that it will examine for (i) SEC registration eligibility, (ii) cybersecurity policies and procedures, (iii) marketing practices, (iv) adequacy of disclosures, and (v) the effectiveness of compliance programs. For RIAs in particular, OCIE said it will focus on the protection of clients’ personal financial information including on governance and risk management, access controls, data loss prevention, vendor management, training, and incident response and resiliency.

As to retail investors, on digital assets and electronic investment advice, OCIE will be examining for (i) investment suitability, (ii) portfolio management and trading practices, (iii) safety of client funds and assets, (iv) pricing and valuation, and (v) supervision of employee outside business activities.

Resources and Examinations

OCIE leaders acknowledged the resource challenges to fulfilling its mandate and said that it will continue to invest in expertise, technology tools and data analytics to “identify potential stresses on compliance programs and operations, conflicts of interest, and … issues that may ultimately harm investors.” OCIE implied that it will use these tools to determine how to select firms for examinations and remarked that “broker-dealers may be selected for examination based on factors such as employing registered representatives with disciplinary history, engaging in significant trading activity in unlisted securities, and making markets in unlisted securities.”

For RIAs, OCIE said it would look at selecting firms that have never been examined or have not been examined for years in order to determine whether compliance programs “have been appropriately adapted in light of any substantial growth or change in their business models.” In addition, OCIE stated that it will “prioritize examinations of RIAs that are dually registered as, or are affiliated with, broker-dealers, or have supervised persons who are registered representatives of unaffiliated broker-dealers.” It will examine compliance programs to address best execution risk, prohibited transactions, fiduciary advice, and conflict disclosures related to these arrangements. OCIE will also examine firms that use third-party asset managers to advise clients in order to consider the extent of these RIAs’ due diligence practices, policies, and procedures. OCIE promises to be diligent about narrowly targeting and protecting the investor information it collects and noted some of the cross-border compliance issues it faces in covering almost a thousand off-shore RIAs that manage over $10 trillion in assets.

Other Highlights

The OCIE also emphasized that it will be examining for the following:

  • Anti-Money Laundering (AML) ProgramsOCIE seeks to prioritize examining broker-dealers and investment companies for compliance with their AML obligations. In particular, the Office will review for customer identification programs and customer due diligence, beneficial ownership compliance, and Suspicious Activity Report (SARs) compliance. OCIE will also review to ensure timely and independent tests of AML programs.
  • Algorithmic Trading – OCIE will examine for controls and supervision around the use of automated trading algorithms, explaining that broker-dealers have expanded their use into multiple asset classes, which has the “potential to adversely impact market and broker-dealer stability.” This includes “the development, testing, implementation, maintenance, and modification of the computer programs that support their automated trading activities and controls around access to computer code.”
  • Broker-Dealers that Hold Cash and Securities – OCIE will be examining to determine if broker-dealers are safeguarding these assets “in accordance with the Customer Protection Rule and the Net Capital Rule,” and to check for compliance with internal processes, procedures, and controls.
  • MSRB – OCIE will prioritize review of municipal advisor fiduciary duty obligations to clients, fair dealing with market participants, and the disclosure and conduct of municipal advisers regarding conflicts of interest.” OCIE also said it will review for compliance with recently adopted MSRB rules on advertising.
  • FINRA – OCIE plans to continue to conduct risk-based oversight examinations of FINRA, including oversight of the examinations FINRA conducts of certain broker-dealers and municipal advisors.

Conclusion  

In its report, OCIE leadership deliver several messages to the firms it examines, including identifying the hallmarks of effective compliance.  Most importantly, they underscore that the people and compliance programs play a critical role and really do matter.  Effective compliance requires (i) establishing a culture of compliance for the firm; (ii) a commitment by firm executives that compliance is “integral” to firm success: and (iii) “tangible” support for compliance in all operations and throughout all levels of the firm. They stress that the chief compliance officer must be fully empowered with the “responsibility, authority, and resources to develop and enforce policies and procedures of the firm.” And, finally, they remind firms that compliance should be “incorporated” into firm operations and business developments, including product innovation and new services.

 

For more information concerning Bates Group's Practices and services, please visit:

Bates Compliance Solutions

Reg BI Services and Support

RIA Compliance Services

Broker-Dealer Compliance Services

Bates Investor Risk Assessment for Vulnerable and Senior Investors

Bates AML and Financial Crimes

Regulatory and Internal Investigations

Retail Litigation and Consulting

Institutional and Complex Litigation

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01-10-20

FINRA Releases 2020 Risk Monitoring and Examination Priorities Letter

FINRA Releases 2020 Risk Monitoring and Examination Priorities Letter

FINRA has announced their regulatory and examination priorities for the upcoming year. You can read the letter, with an introduction by FINRA President and CEO Robert Cook, here. New for this year is a focus on Regulation Best Interest (Reg BI) and Form CRS (Client Relationship Summary).

Stay tuned to the Bates News page for our commentary on FINRA’s 2020 objectives and how they may impact your legal, regulatory and compliance matters.

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01-07-20

SEC Office of Compliance Inspections and Examinations Announces their 2020 Examination Priorities

SEC Office of Compliance Inspections and Examinations Announces their 2020 Examination Priorities

The SEC’s Office of Compliance Inspections and Examinations (OCIE) has announced their exam priorities for the upcoming year. You can read the press release here.

Stay tuned to the Bates News page in the upcoming weeks for our expert commentary on the SEC's 2020 objectives, how they compare to other years, and how they may impact your legal and compliance matters in the future.

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01-06-20

Bates Group Expands Regulatory Compliance Services with Acquisition of The Advisor’s Resource, Inc.

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(L - Linda Shirkey, R - Shelley Dragon)
 

Bates Group is pleased to announce the acquisition of The Advisor's Resource, Inc. (TARI), a leading compliance consulting firm based in Texas. The acquisition further expands Bates Group’s compliance division, Bates Compliance, with greater access and resources to service Registered Investment Advisers (RIAs), as well as private equity and hedge fund firms across the United States.

Veteran compliance leader and TARI Founder & President Linda Shirkey will join Bates Group, along with Shelley Dragon, TARI’s director of client service. They will continue to serve TARI’s account base as well as other Bates clients across the United States as members of the Bates Compliance team. Shirkey and Dragon are both based in Houston, TX.

“We welcome Linda, Shelley, and the TARI clients to Bates,” said Benjamin Pappas, Bates Group President. “TARI is nationally recognized for its deep regulatory compliance expertise. With the addition of TARI, we are immediately expanding our expertise and ability to provide industry-leading regulatory compliance services in Texas, throughout the South, and nationwide.”

Ms. Shirkey noted that the acquisition of TARI by Bates Group benefits TARI clients because of the “direct match in ethics, values, and strong client focus” between Bates and TARI. “I am very excited about the deep and expanded capabilities that Bates Compliance brings to our clients,” she said.

The Bates Compliance team of senior compliance staff and former regulators bring tailored regulatory compliance services, guidance, and expertise to financial services clients on an as-needed or ongoing basis to meet the evolving requirements and practices of today’s global financial services industry. Bates Compliance provides a wide range of support to financial institutions of all sizes, structures, and business models, and works with its clients to review, test, and bolster their compliance programs.  Bates Compliance provides and implements solutions based on regulatory requirements and industry-accepted best practices designed to supplement and enhance compliance and supervisory systems, and remediate the results of regulatory and internal audit findings.


About Bates:

Bates Group (www.batesgroup.com) has been a trusted partner to our financial services clients and their counsel for over 30 years, delivering superior quality and results on a cost-effective basis. Voted a Best Securities Litigation Consulting Firm by readers of the New York Law Journal and an NYLJ Hall of Fame service provider, Bates Group provides solutions throughout the lifecycle of legal, regulatory, and compliance matters. With a roster of over 200 financial industry and regulatory compliance experts, Bates offers services in litigation consultation and testimony, regulatory enforcement and internal investigations, compliance solutions, AML and financial crimes, forensic accounting, damages, and big data consulting. 

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12-19-19

Reg BI Countdown – Is Your Firm Ready?

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Last month, we reported on FINRA's announcement that they will be conducting SEC Reg BI readiness assessments to better understand companies' Reg BI implementation preparations. In particular, regulators want to know if: 1) Your firm needs Reg BI guidance; 2) Whether you’re looking at product offerings, suitability, disclosures and conflicts; 3) How far along your firm is in comparison to peer firms; and 4) Whether you can demonstrate that your company has a thoughtful approach and operational procedures in place.

Bates Compliance helps firms achieve Reg BI readiness. Our Reg BI Team is available to advise, guide and implement a selective or full suite of Reg BI services.

 
Companies have hired us to help them:
  • Create conflicts committees
  • Identify conflicts and control summaries
  • Assess and update WSPs and compliance manuals
  • Draft Form CRS
  • Develop firm-wide employee compliance, management and operations training
  • Create a process for client disclosure documents and recordkeeping
  • Plan ongoing Reg BI consulting support, and more!

Get ahead of the regulators and begin formulating your plan today with Bates Compliance.

 

Give Bates Compliance a call today to learn about how our Compliance Solutions and Reg BI Readiness Workshops can support your firm’s SEC Reg BI Implementation efforts.

 
Contact:

Robert Lavigne, Managing Director - 508.868.6741 or rlavigne@batesgroup.com

David Birnbaum, Managing Director - 917.273.2682 or dbirnbaum@batesgroup.com

Rory O'Connor, Director - 860.671.7270 or roconnor@batesgroup.com

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11-15-19

Reg BI Countdown - FINRA Wants to Know How Your Reg BI Implementation is Coming Along

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During the 2019 SIFMA C&L New York Regional Seminar, FINRA announced that they will be conducting SEC Reg BI readiness assessments to better understand companies' Reg BI implementation preparations.

“Starting this month, “ said Bates Compliance Managing Director Robert Lavigne, “FINRA will be taking steps to check on companies ahead of this rule implementation. Companies should heed their warning and begin working on a plan.”

According to FINRA conference speakers, below is a list of what the regulators are interested in learning when they visit your firm this Q4 and in 2020:

  1. Does your firm need Reg BI guidance?
  2. Are you looking at product offerings, suitability, disclosures and conflicts?
  3. How far along are you in comparison to peer firms?
  4. Can you demonstrate that your company has a thoughtful approach and operational procedures in place?

Ready to get started or not sure where to begin? We're here to help.

Learn How Bates Compliance Can Support Your Reg BI Implementation Efforts

 

Give Bates Compliance a call today to learn about how our Compliance Solutions and Reg BI Readiness Workshops can support your firm’s SEC Reg BI Implementation efforts.

 
Contact:

Robert Lavigne, Managing Director - 508.868.6741 or rlavigne@batesgroup.com

David Birnbaum, Managing Director - 917.273.2682 or dbirnbaum@batesgroup.com

Rory O'Connor, Director - 860.671.7270 or roconnor@batesgroup.com

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11-07-19

SEC Proposes Changes to Investment Adviser Advertising and Solicitation Rules

The SEC is seeking comment on a newly issued proposal to amend two rules on investment adviser advertising and solicitor compensation.

The proposal on advertising would replace existing Investment Advisers Act (“IAA”) Rule 206(4)-1, by moving from its “broad limitations” toward a more “principles-based” approach. Generally, the new rule (i) contains prohibitions on general practices and tailors restrictions on particular practices applicable to all advertisements, (ii) tailors requirements for the presentation of performance results directed at retail investors to prevent fraud, (iii) permits—subject to disclosure requirements—testimonials and endorsements, and (iv) updates definitions (and exclusions) in order to be more flexible and to align with technology developments and the “changing profiles” of registered investment advisers. The new rule would also require firms to designate an employee to review and approve, in writing, all advertisements prior to dissemination.

Proposed amendments to the SEC cash solicitation rule (IAA Rule 206(4)-3) would expand (i) coverage over all forms of compensation (e.g. directed brokerage, awards, free or discounted services), (ii) tailor required disclosure (particularly around conflicts) by solicitors to both investors and prospects, and (iii) strengthen provisions concerning disqualifying disciplinary events. Further, barring specific exemptions, the proposal requires a written agreement between an adviser and a solicitor which spells out the solicitation activities, the compensation, and the disclosures (including delivery to investors) as required under the IAA.

The proposal also amends investment adviser registration Form ADV and the books and records rule (IAA Rule 204-2) to reflect the related changes.

Comments are due 60 days after publication of the proposal in the Federal Register. Bates Group will continue to keep you up to date throughout the administrative rulemaking process.

How Bates Compliance Can Help You:

Bates Compliance provides tailored compliance consulting solutions to financial services clients. Our compliance team includes senior compliance staff and former regulators, who test policies, procedures, supervisory and compliance processes, against industry standards, recommending changes and best practices to enhance compliance and supervisory systems, and to assist in the remediation of regulatory findings.

 

For more on Bates Compliance consulting services, please give us a call at (503) 670-7772 or contact: 

Robert Lavigne, Managing Director, Bates Compliance

Email: rlavigne@batesgroup.com   Phone: 508-868-6741

Rory O'Connor, Director, Business Development

Email: roconnor@batesgroup.com   Phone: 860-671-7270

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10-23-19

Digital Assets - Financial Agencies Remind Firms of AML Compliance Obligations

Digital Assets - Financial Agencies Remind Firms of AML Compliance Obligations

On October 11, 2019, the heads of FinCEN, the SEC and CFTC issued a joint statement to remind financial institutions of their Bank Secrecy Act (“BSA”) obligations for transactions involving “digital assets.” The statement begins with an acknowledgement by the regulators that the terminology used to describe a digital asset (or those providing financial services involving a digital asset) “may not necessarily align with how that asset, activity or service is defined under the BSA, or under the laws and rules administered by the CFTC and the SEC.” The regulators’ joint statement makes the central point that, “regardless of the label,” for purposes of compliance with the BSA, it is “the facts and circumstances underlying the asset, activity or service,” that determines the regulatory treatment of the activity.

BSA anti-money laundering obligations include the establishment and implementation of an effective program, recordkeeping and suspicious activity reporting. Agency leaders reaffirmed that "financial institutions" subject to these obligations include futures commission merchants, brokers obligated to register with the CFTC, broker-dealers and mutual funds entities obligated to register with the SEC, and money services businesses ("MSBs") obligated to register with FinCEN.

In an attempt at clarifying which agencies, or combinations of agencies, have authority over other market participants that engage in digital transactions, the regulators explained that the “nature of the digital asset related activities” would be key to determining if a person must register with the CFTC, FinCEN or the SEC. In separate additional statements, the agencies described the scope of their specific jurisdictions. The regulators noted, for example, that broker-dealer-related digital asset financial services may fall under the SEC, FinCEN and FINRA and that the BSA obligations “apply very broadly” regardless of whether the digital activity involves a “security” or “commodity.”

In additional specific comments, the Director of FinCEN reminded money transmitters and other MSBs (i.e. dealers in a foreign exchange, a check casher, an issuer or seller of traveler’s checks or money orders, or a seller or provider of prepaid access) to be mindful of recently issued interpretive guidance on the application of the BSA obligations to their businesses. (See Bates Research article on the FinCEN’s 2019 Convertible Virtual Currencies “CVC” Guidance.)

“By this joint statement, the agency heads are warning market participants engaging in digital asset transactions that they are seeking compliance with anti-money laundering requirements,” said Bates AML and Financial Crimes Managing Director Ed Longridge. “Now is the time for these players to determine whether their businesses are appropriately registered, and to have the appropriate AML programs in place.”

To learn more about Bates AML and Financial Crimes services, please contact Edward Longridge, Managing Director, Bates AML & Financial Crimes at elongridge@batesgroup.com

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10-18-19

Bates Compliance’s Reg BI Countdown Kick-Off Begins!

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October is here! That means the SEC’s Reg BI implementation deadline is right around the corner. To support your implementation efforts, Bates Compliance is rolling out the Bates Reg BI Countdown with action items to keep your compliance team on track as the June 30, 2020 implementation deadline approaches.

The Bates Compliance consulting team, made up of former CCOs and senior regulators, will be providing you with ongoing insight and deadline reminders as the implementation date approaches. Our goal is to make the implementation process easy for you and to encourage the participation of your entire team.

 

Action Item 1: Take Steps to Review Conflicts

Here are three easy steps to review potential conflicts of interest:

  1. Assemble representatives from various internal groups of your firm
  2. Appoint an individual to be the conflicts coordinator and/or a designated conflicts lead.
  3. Identify and start documenting your firm’s conflicts and mitigation controls.
 

Where can you find conflicts?

According to Bates Compliance Director Jill Ehret, high-level conflicts of interest can include:

  • Compensation payouts
  • Products offered by the firm
  • Outside Business Activities
  • Individual Conflicts
  • Investment Advisory and other financial services affiliations
  • Ownership structure of the firm

Now that you have an initial plan, you can roll up your sleeves and get to work! But just in case you need a little extra support, Bates is here to help. Bates Compliance helps firms with their Reg BI implementation, including further defining conflicts, determining your disclosure approach and mitigating risk to your firm.

Want to learn more? Please call or email Bates Managing Director Bob Lavigne at (508) 868-6741 or rlavigne@batesgroup.com.

Learn More about Reg BI Solutions from Bates Compliance.


Bates Compliance is a proud sponsor of the 2019 NSCP National Conference, October 21-23 at the Hilton Baltimore (Booth #33). Managing Director Hank Sanchez to appear on panel 10A, Wednesday, October 23rd.

Hank will also be discussing Reg BI and other "Hot Topics in Compliance" at the SIFMA C&L New York Regional Seminar on October 22nd.

Bates Compliance Director JIll Ehret and CEO Jennifer Stout will be speaking on Reg BI Developments at the IBDC 2019 Annual Conference, October 28-30 in San Diego. Bates Group is proud to be Platinum sponsor of this event.

Visit Bates Compliance at IMPACT® 2019, November 4-7 at the San Diego Convention Center (Booth #1339).

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10-03-19

SEC Turns Up Heat on Share Class Selection Disclosure, Now Focusing on Other Forms of Compensation

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At a discussion forum on SEC enforcement examination initiatives in mid-September, the Director of the Office of Compliance Inspections and Examinations expressed shock that inappropriate share class recommendations are still appearing on exams. His comment suggests some surprise that last year’s Share Class Selection Disclosure Initiative might not have been totally effective in delivering the message that representatives must disclose to conflicts that may be associated with share selection to retail investors.

Bates Group has been warning financial practitioners to pay attention to these issues since the initiative was launched. In previous coverage, Bates alerted those that did not participate in the initiative that they would face additional penalties and closer scrutiny. The new emphasis and broader examination focus on additional forms of compensation that can cause conflicts of interest is a direct consequence of the SEC’s initiative. In particular, ongoing issues concerning share class disclosure may be caused in part by Broker-Dealer representatives or entities that may have migrated to the Investment Adviser side without fully understanding additional share classes available to them, noted the SEC.

In addition to focusing on firms that did not self-report by the deadline of the SEC’s Share Class Selection Disclosure Initiative, the SEC Enforcement Division is also now zeroing in on revenue-sharing payments and other forms of representative compensation or cost offsets.

 

Revenue Sharing and Other Potential Conflicts:

Many of the allegations in these types of enforcement cases revolve around whether or not there was adequate disclosure around the revenue generated by the firm as a result of share class selection, beyond merely the 12b-1 fees directly attached to the different share classes offered.

A “revenue sharing agreement” is when a firm has an agreement with a clearing or custody firm to share the fee revenue from mutual fund positions. As explained by Bates Group Securities Litigation and Regulatory Enforcement Managing Director Alex Russell, “a common example is when a mutual fund pays a fee to a particular platform provider or clearing firm for offering a fund on its website and providing other support services. These fees may be shared by the clearing firm with firms that have positions in that fund held at the clearing firm.”

Recent enforcement actions by the SEC underscore the point: one firm paid $2.5 million including disgorgement, penalties and prejudgment interest related to conflicts of interest caused by inadequate disclosure of its receipt of 12b-1 fees, as well as revenue-sharing fees. (Notably, the SEC also identified fees saved as a result of share class selection on behalf of clients.) Another action was initiated against a firm, which had disclosed that it would receive revenue sharing for investments within a particular program via its clearing firm, but then failed to disclose that it had “differing financial incentives depending on which products it selected for its customers.”

On Monday, the SEC announced a settlement with 16 additional self-reporting firms returning $10 million to impacted investors. Simultaneously, they also concluded their investigation of another firm that did not participate in self-reporting and, as a result, incurred a penalty equivalent to one-third of disgorged fees (excluding applicable prejudgment interest).

The Commission also announced a $37 million settlement with another firm last Friday, in which it identified conflicts of interest and inadequate disclosures regarding both revenue sharing and reductions in expenses incurred with the clearing broker as a result of selecting higher-cost mutual fund share classes for clients. In this case, the reduction in costs came in the form of avoiding ticket charges that would have been paid by the firm had they selected lower-cost share classes for client accounts. The Commission also noted the concentration of client holdings in firm-specific proprietary mutual funds within impacted accounts as well.

As we were preparing to print, it was reported that the SEC ordered a hybrid firm to return nearly $1.5 million as part of a settlement, due to “the firm having invested clients in more expensive mutual fund share classes, which provided the firm with financial benefits, without disclosing this conflict to clients.”

Given that the SEC is taking such a hard look at how revenue sharing agreements are disclosed to clients, as well as other forms of compensation that can cause conflicts of interests, Russell recommends that firms be proactive and review their disclosures for revenue sharing arrangements and other forms of compensation to ensure they are consistent with the SEC’s current interpretations.  

 

About Bates:

Bates Group stands ready to support firms in their Share Class and Revenue Sharing-related enforcement matters. Bates is actively engaged in providing assistance to firms responding to inquiries around revenue sharing, providing analysis of large volumes of data to identify accounts that have been impacted by revenue sharing arrangements, without inappropriately remediating those that have not been impacted.

Recently, on behalf of over twenty major national and regional financial institutions, Bates provided important assistance to firms and their counsel participating in the SEC’s Share Class Selection Disclosure Initiative and related SEC Examinations, as well as to firms addressing FINRA’s recent 529 Share Class Initiative. As a result, those companies have avoided unwarranted remediation costs as well as reputational harm.

Contact:

 

Alex Russell, Managing Director, Securities Litigation and Regulatory Enforcement 

email: arussell@batesgroup.com phone: 971-250-4353

 

David Birnbaum, Managing Director

email: dbirnbaum@batesgroup.com phone: 917-273-2682

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09-23-19

OCIE Issues Risk Alert on Principal Trading and Cross Transaction Compliance Obligations

OCIE Issues Risk Alert on Principal Trading and Cross Transaction Compliance Obligations

The SEC Office of Compliance, Inspections and Examinations (OCIE) issued a Risk Alert to remind investment advisers of their compliance obligations for principal trading and agency cross transactions involving clients. Specifically, OCIE alerted investment advisers of their responsibility to comply with disclosure and consent requirements under the Investment Advisers Act and that, except for specific circumstances related to cross trades, the rules require compliance on a “transaction-by-transaction basis – blanket disclosure and consent are not permitted.”

OCIE highlighted “the most common deficiencies” concerning principal trading and agency cross transactions raised in firm examinations over the past three years. For principal transactions, these include failures to (i) provide written disclosures to individual clients or obtain required client consent; (ii) obtain client consent before each trade; and (iii) “provide sufficient disclosure” concerning potential conflicts and transaction terms. OCIE also found principle transaction compliance deficiencies for advisers working with pooled investment vehicles, noting the applicability of the rules and consent requirements for such vehicles. For cross transactions, OCIE observed failures to (i) disclose engagements in agency cross transactions, and (ii) produce documentation to demonstrate the written consent, confirmation, and disclosure compliance.

OCIE cautioned advisers to “review their written policies and procedures and the implementation of those policies and procedures to ensure that they are compliant with the principal trading and agency cross transaction requirements.” According to Robert Lavigne, Managing Director, Bates Compliance, “Firms have to ensure their disclosures are being made to clients, so that they fully understand the conflicts relating to this type of transaction prior to providing consent to the firm.”

How Bates Compliance Can Help You:

Bates Compliance provides tailored compliance consulting solutions to financial services clients. Our compliance team includes senior compliance staff and former regulators, who test policies, procedures, supervisory and compliance processes, against industry standards, recommending changes and best practices to enhance compliance and supervisory systems, and to assist in the remediation of regulatory findings.

For more on Bates Compliance consulting services, please give us a call at (503) 670-7772 or contact: 

Robert Lavigne, Managing Director, Bates Compliance

Email: rlavigne@batesgroup.com   Phone: 508-868-6741

Rory O'Connor, Director, Business Development

Email: roconnor@batesgroup.com   Phone: 860-671-7270


Coming Up:

Look for Bates Compliance leaders at the SIFMA C&L Charlotte Regional and the IAA Leadership Conference in Nashville. 

Bates Compliance is a proud sponsor of the 2019 NSCP National Conference, October 21-23 at the Hilton Baltimore. Booth #33

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07-29-19

OCIE Examines Investment Adviser Oversight of Supervised Persons with Disciplinary History

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The SEC Office of Compliance, Inspections and Examinations (OCIE) issued a Risk Alert to address compliance and disclosure issues raised in examinations covering the oversight practices of SEC-registered investment advisers “that previously employed, or currently employ, any individual with a history of disciplinary events.” The Risk Alert is part of OCIE’s “Supervision Initiative,” consisting of over fifty examinations of advisers, who collectively manage $50 billion in assets for approximately 220,000 clients.

During the examinations, which occurred in 2017, OCIE found deficiencies related to disclosures, compliance and supervisory practices, as well as conflicts of interest. OCIE found that almost half of the disclosure-related deficiencies were due to advisers providing inadequate information regarding disciplinary events, including, (i) omitting material disclosures regarding disciplinary histories, (ii) providing incomplete, confusing, or misleading information concerning  disciplinary events, (iii) not providing timely updates and delivery of disclosure documents to clients, such as form ADV reported on CRD, and (iv) inaccuracies in supervised persons’ self-attestations.  

During their examinations, OCIE found common compliance and supervisory deficiencies, including failures to (i) set appropriate standards of business conduct for their supervised persons; (ii) determine whether fees charged by supervised persons were disclosed or whether the services were performed; (iii) oversee supervised person’s compliance with advertising rules; and (iv) monitor activities of supervised persons, particularly those who work from remote locations.

The examinations also exposed failures to ensure that supervised persons were executing their compliance responsibilities, failures to monitor the appropriateness of client account types, failures to maintain accurate books and records, inconsistent policies and procedures and insufficiencies in advisers’ annual reviews.

Finally, OCIE reported finding conflict of interest issues related to undisclosed compensation arrangements, including forgivable loans that were made to advisers contingent upon certain client-based incentives.

Improving Compliance:

OCIE proposed a number of ways that firms could address the weaknesses in their compliance frameworks related to supervised individuals with a prior history of disciplinary events. These include (i) adopting specific policies and procedures and enhancing due diligence practices prior to hiring supervised  persons; (ii) enhancing due diligence through written policies and background checks, (iii) establishing heightened supervision practices, including written policies and procedures, when overseeing supervised persons with certain disciplinary histories and over persons operating out of remote offices, and (iv) adopting policies and procedures addressing client complaints related to supervised persons.

Compliance Takeaways: What Should Your Firm Be Doing Now?

  1. Firms should review policies and procedures to ensure they contain clear guidance on the hiring/onboarding of persons with a disciplinary history.
  2. Firms should implement background checks into the onboarding process, as well as assess heightened supervision program standards for supervised persons with background histories necessitating heightened supervision.
  3. Compliance departments should review practices and develop a risk-based approach to reviewing remote locations.

How Bates Group Helps You:

Bates Group brings tailored compliance consulting solutions to financial services clients. Our compliance team includes senior compliance staff and former regulators, who test policies, procedures, supervisory and compliance processes, recommending changes and best practices to enhance compliance and supervisory systems, and to remediate the results of regulatory and litigation findings.


For more on Bates Group’s Compliance Consulting, please give us a call at (503) 670-7772 or contact: 

Robert Lavigne, Managing Director, Compliance

Email: rlavigne@batesgroup.com   Phone: 508-868-6741

Rory O'Connor, Director, Business Development

Email: roconnor@batesgroup.com   Phone: 860-671-7270

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07-16-19

Regulation Best Interest Now Published in Federal Register: What Does This Mean for Your Firm?

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The formal publication by the Federal Register on July 12, 2019, of Regulation Best Interest (“Reg BI”) triggers final effective and compliance dates for the rulemaking package.

The Reg BI rule and additional interpretations establish the relationship standards between broker dealers and investment advisers and their retail clients. For broker-dealers, the Reg BI package is intended to “enhance the standard of conduct beyond existing suitability obligations and make clear that a broker-dealer may not put its financial interests ahead of a retail customer when making recommendations."

The rule package also offers interpretive guidance for investment advisers who have fiduciary obligations to investors, requires that both broker-dealers and investment advisers provide a new Client Relationship Summary (“CRS”) to retail investors, and provides an interpretation of the “solely incidental” provision of the Investment Advisers Act. That provision exempts broker-dealers who provide investment advice from registration requirements if the advice is "solely incidental" to the conduct of their business, and if they don't receive "special compensation." (See here for additional detail of the overall package.)  

With its publication in the Federal Register, the interpretive guidance for investment advisers and clarifications of the “solely incidental” exclusion for broker-dealers are in effect. For both investment advisers and broker-dealers, Reg BI and Form CRS will become effective on September 10, 2019, with full compliance required by June 30, 2020, one year from the date of the rulemaking package adoption.

 

Bates Group helps firms navigate the compliance challenges presented by the new Reg BI requirements. Please visit our Reg BI service page or contact:

Robert Lavigne, Managing Director, Bates Compliance Solutions - rlavigne@batesgroup.com

Rory O'Connor, Director, Compliance - roconnor@batesgroup.com

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06-05-19

SEC Adopts Regulation Best Interest

SEC Adopts Regulation Best Interest

By a 3-to-1 margin, the SEC voted to approve its long-debated Regulation Best Interest (“Reg BI”) at an open meeting today.

In April 2018, the SEC proposed the set of rulemakings and interpretations designed to establish clear relationship standards between broker-dealers and investment advisers and their retail clients. Reg BI consists of three parts. The first part requires a broker-dealer to act in the “best interest” of a client investor. This new standard will “enhance the standard of conduct [for broker-dealers] beyond existing suitability obligations and make clear that a broker-dealer may not put its financial interests ahead of a retail customer when making recommendations." The second part provides additional interpretive guidance for advisers who have fiduciary obligations to investors under law. The third part requires that both broker-dealers and investment advisers provide a new Client Relationship Summary (“CRS”) to retail investors. The CRS highlights key differences between investment advisers and broker-dealers based on the types of services offered, and links to a dedicated page on the Commission’s education website.

The SEC also approved a new interpretation of the “solely incidental” provision of the Investment Advisers Act of 1940. The new interpretation exempts broker-dealers who provide investment advice from registration requirements if the advice is "solely incidental" to the conduct of their business, and if they don't receive "special compensation."

Stay tuned to the Bates news page for a complete report on the final version of the SEC’s Regulation Best Interest, implementation dates and how the new rule may impact your legal, regulatory and compliance obligations.

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05-13-19

FINRA Issues Guidance on Anti-Money Laundering Compliance Obligations

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In a new Regulatory Notice, FINRA provided guidance on reporting and monitoring suspicious activities under a member firm’s anti-money laundering (“AML”) compliance program.

FINRA Rule 3310 requires member firms to develop and implement a written AML program reasonably designed to achieve and monitor compliance with the requirements of the Bank Secrecy Act (BSA) and related regulations. In general, this includes the detection and reporting of transactions by a broker-dealer that “involves or aggregates funds or other assets of at least $5,000, and the broker-dealer knows, suspects or has reason to suspect that the transaction” (i) contains funds from an illegal activity; (ii) is designed to evade regulations under the BSA; (iii) does not appear to have a "reasonable explanation;" and (iv) might be facilitating criminal activity. Broker-dealers must report such activity by filing a suspicious activity report (SAR).

The FINRA guidance provides numerous examples of potential money laundering “red flags” for firms to “consider incorporating” in their compliance programs. FINRA highlighted these examples under various categories, including customer due diligence and interactions with customers, deposits of securities, securities trading, money movements, insurance products and other indicators of suspicious customer behavior.

Furthermore, FINRA noted that these guidelines are not comprehensive and that firms should be “aware of emerging areas of risk, such as risks associated with activity in digital assets.” FINRA also stated that the new guidelines are intended “to assist broker-dealers in complying with their existing obligations” and “do not create any new requirements or expectations.”

To learn more about Bates Group’s AML and Financial Crimes services, please contact:

Edward Longridge, Managing Director, Financial Crimes - elongridge@batesgroup.com

 

See here for a recent conversation with Managing Director Edward Longridge on AML compliance issues.

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05-02-19

SEC Enforcement Investigating Firms That Did Not Self-Report

SEC Enforcement Investigating Firms That Did Not Self-Report

The SEC's Enforcement Division has now initiated investigations against firms that did not self-report by the deadline of the SEC’s Share Class Selection Disclosure Initiative. (See Bates Alert for background on the Initiative.)

As recently reported, enforcement actions for firms that did not self-report are expected to have a “broader focus than the initiative,” focusing on “compensation that can cause conflicts of interest” including “revenue-sharing payments.”

Our Support Of Your Firm

Bates stands ready to support firms in their Share Class-related enforcement matters. Bates has deep, proven experience and expertise in share class analysis, covering disclosures, compensation and conflicts of interest.

Recently, on behalf of over sixteen major national and regional financial institutions, Bates provided important assistance to firms and their counsel participating in the SEC’s Share Class Selection Disclosure Initiative and related SEC Examinations, as well as to firms addressing  FINRA’s recent 529 Share Class Initiative. As a result, those companies have saved thousands of dollars in remediation costs and avoided reputational harm.

Bates Group helps firms review their policies and procedures for share class selection, disclosures and compensation practices. We perform data analysis, identifying an appropriate methodology to narrow the focus to only adversely impacted accounts, performing calculations and providing remediation and interest figures for use with regulators. Bates also helps firms review current supervisory and compliance practices to ensure they are properly designed to identify and mitigate these conflicts. Most importantly, after consultation with counsel, we provide reporting that can be used directly with the SEC.

Contact US

Whether you are facing an enforcement or remediation effort, please contact us to discuss how we can help you to address your share class-related needs.

Alex Russell, Managing Director, Securities Litigation and Regulatory Enforcement 

email: arussell@batesgroup.com phone: 971-250-4353

David Birnbaum, Managing Director

email: dbirnbaum@batesgroup.com phone: 917-273-2682

 

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04-11-19

FINRA Is Scrutinizing UTMA/UGMA Accounts

FINRA Is Scrutinizing UTMA/UGMA Accounts

In June 2018, Bates Group published an article reporting on deficiencies identified by FINRA in its exam findings which may trigger further scrutiny. In that article we noted FINRA’s focus on the Uniform Transfer to Minors Act (UTMA), among other exam topics. FINRA is looking at whether firms have adequate policies and procedures in place to comply with the UTMA and Uniform Gifts to Minors Act (UGMA), and how those policies and procedures are operationalized. Specifically, as we reported, it is seeking to ensure that control over accounts is passed to the beneficiaries once the minors reach the statutory age (18 or 21 in most states; an alternative age is permitted in a dozen or so other states).


How Bates Helps

Bates is working with clients to closely review their UTMA/UGMA client account records to identify the impacted populations, whether control over the accounts has transferred, and whether trading activity has occurred and commissions have been generated once beneficiaries have reached the statutory ages for control over the accounts. 

In particular, we are conducting large data analyses based on beneficiary (minor) dates of birth against the applicable ages for change of account control. We then help identify those accounts that should have been converted but have not, the trading done in those accounts, and the commissions earned. The resulting information is then used to respond to FINRA and discuss any remediation or other next steps.

For more information on how Bates Group can help your firm and counsel respond to UTMA/UGMA account inquiries, please contact us:
Scott Lucas  
Bates Group Managing Director, Regulatory & Internal Investigations
(971) 250-4344 
slucas@batesgroup.com
 
Bates Group Managing Director
(917) 273-2682
 
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03-08-19

Alert: FINRA Releases FAQs with Important Information About Its 529 Plan Share Class Initiative

Alert: FINRA Releases FAQs with Important Information About Its 529 Plan Share Class Initiative

FINRA’s 529 Plan Share Class Initiative (“Initiative”) self-reporting deadlines have been pushed back one month to allow firms additional time to review their supervisory systems, procedures and past transactions to identify sales of 529 plan share classes. The extension also allows firms more time to consider additional information made available by FINRA (Frequently Asked Questions “FAQs”) and to determine whether to self-report.

The Initiative, designed to promote compliance with rules governing 529 plan recommendations and sales, requires firms to identify and remedy potential supervisory and suitability violations and to return money to impacted investors. Firms that participate in the Initiative “will avoid any fine that FINRA might otherwise impose in an Enforcement action concerning the firm’s failure to supervise the suitability of 529 plan share class recommendations. In addition, a firm that participates in this Initiative will have the benefit of a discussion with FINRA about the steps it plans to take to remediate its supervisory failures and pay restitution to customers.”

The new deadlines are now April 30, 2019 for firms to provide FINRA Enforcement with notice that they will self-report, and May 31, 2019 for confirming their eligibility by submitting the additional information specified in Regulatory Notice 19-04.

The 18 FAQs address a series of qualitative and substantive concerns about the Initiative. For example, FINRA provides additional information on the types of 529 plan-related supervisory procedures that participating firms might seek to review, and also commits to working with firms to identify appropriate risk-based ways to analyze transactions, and then to work collaboratively with firms to fix any supervisory deficiencies and remediate affected customers. FINRA also clarifies existing guidance by, for example, asserting that the Initiative is not establishing a per se rule on suitability or changing existing obligations or duties. 

Following the FAQ release, Robert Lavigne, Managing Director, Bates Compliance Solutions, recommends:

"Firms should assess the procedures that were in place during the review period to ensure they were reasonably designed to properly supervise the sales of 529 plans, as well as the share class selection. They should also perform testing to verify there was not a breakdown in the share class selection and approval process that may have led to unsuitable transactions.“
 

Bates Group has been encouraging firms to prepare for this Initiative since its inception. As for the extended deadlines, Alex Russell, Managing Director of Securities Litigation & Regulatory Enforcement at Bates stated:

“Firms participating in FINRA’s 529 Plan Share Class Initiative now have additional time to meet FINRA’s qualitative and quantitative expectations. Addressing the challenges we previously identified, like obtaining plan sponsor data, compilation and formatting, and transaction analysis, remain key to being responsive to FINRA.”
 
 

Bates Group’s 529 Qualitative and Quantitative Support

 
Qualitative Support:

Within the FAQs, FINRA explicitly—in bold print—emphasizes the need to conduct a qualitative review in deciding whether to participate in the Initiative. Bates Group’s experienced team of professionals, including experts experienced in sales practice, supervision, suitability and compliance, supports firms in their qualitative review of their supervision and compliance programs in support of 529 plan sales. Bates performs qualitative reviews of 529 plan share class programs, offering supervisory reviews and assessments to test your firm’s systems and procedures, including suitability of transactions and training.

Quantitative Support:

Bates Group has supported and is engaged to support in-house and outside counsel in response to this and prior regulatory share class initiatives, investigations and arbitrations, and break-even analysis work. This includes mining large datasets and providing clear and usable analysis regarding the relative cost of selecting particular share classes in light of the plan beneficiaries’ ages, the difference in fee levels of the classes, and class breakpoints. In connection with FINRA’s announcement, we can help determine instances where a less-expensive share class of the same fund may have been available and the difference in fees paid by impacted clients.

 

For more information about how Bates Group can help, please contact us today:

 
Alex Russell, Managing Director, Securities Litigation and Regulatory Enforcement

email: arussell@batesgroup.com phone: 971-250-4353

David Birnbaum, Managing Director

email: dbirnbaum@batesgroup.com phone: 917-273-2682

Robert Lavigne, Managing Director, Bates Compliance Solutions

email: rlavigne@batesgroup.com phone: 508-868-6741

Scott Lucas,Managing Director, Regulatory and Internal Investigations

email: slucas@batesgroup.com phone: 971-250-4344

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02-27-19

Four Challenges Facing Firms Ahead of FINRA’s 529 Share Class Initiative April 1st Deadline

Four Challenges Facing Firms Ahead of FINRA’s 529 Share Class Initiative April 1st Deadline

Firms participating in FINRA’s 529 Plan Share Class Initiative should act now to meet the regulator’s approaching April 1st deadline to self-report violations and submit a plan to remediate harmed clients. 

“Given the number of challenges firms face in assessing the potential impact on clients related to 529 plan share class purchases, firms should immediately begin to address the initiative,” warns Alex Russell, Bates Group Managing Director of Securities Litigation and Regulatory Enforcement. These challenges include:

  • Timing – Firms are facing a limited amount of time in which to assess the need to self-report 529-related supervisory failures. Firms must respond by 12:00 am EST, April 1, 2019, to participate in the initiative, with the results of their self-evaluation due by May 3, 2019. Given that the period firms are being asked to review is from January 2013 to June 2018, there is very little time to spare if you think self-reporting might be in your firm’s best interest.
  • Plan Sponsor Data – Firms may need to go to the plan sponsors in order to obtain the transaction-level data necessary to conduct the evaluation and to make a determination as to whether or not to self-report. Given that the data needs extend back to 2013 or earlier, this can be a time-consuming process for the plan sponsors. This adds another time component to the already shortened time frame to make the self-reporting determination, potentially leaving your firm very little time to conduct the actual data analysis.
  • Analyzing the Data Plan Sponsors may provide data back in disparate formats, including different fields, or failing to populate certain fields consistently within their data. Given how far back the request extends, they may have changed formats or their own providers during the period at issue. Compiling the data together into a single usable resource for review can create a strain for firms whose resources already have full-time responsibilities and may not be able to complete the analysis in the short time provided by FINRA. Whether an individual review or a statistics-based approach is adopted, you must review all transactions in some fashion.
  • Failure to Self-Report – Firms who do not self-report will potentially be subject to additional sanctions, whereas those who participate are likely to be required to make restitution payments only. In some instances, the penalties assessed in prior matters have amounted to as much as two thirds of the required restitution, so the possibility of additional sanctions should be a meaningful part of your firm's decision making on whether or not to self-report.

Further details and insight are provided in two recent Bates Group releases: Planning Your Response to FINRA’s 529 Initiative — Q&A with Bates Managing Director Alex Russell and “Bates Compliance and Regulatory Alert: FINRA Rolls Out Its 529 Plan Share Class Initiative - Is Your Firm Ready to Address It?"

Bates is ready to help you and your firm. Contact us with your 529 Share Class questions or for assistance in evaluating your firm's course of action when responding to FINRA’s initiative. Call (503) 670-7772 or email contact@batesgroup.com.

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02-25-19

Planning Your Response to FINRA’s 529 Initiative — Q&A with Bates Managing Director Alex Russell

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Bates Research recently conducted a Q & A session with Alex Russell, Managing Director of Securities Litigation & Regulatory Enforcement at Bates, to discuss FINRA's new 529 Share Class Initiative. Alex talks about responding by FINRA's deadline and potential pitfalls firms should keep in mind when preparing their response.

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Bates Research: What is FINRA's 529 Plan share class initiative -- and deadline?

Alex Russell: FINRA is providing firms with an opportunity to review their activity in and around 529 plans, allowing firms to self-report where supervisory violations may have occurred during the period of January 2013 through June of 2018. Similar in nature to the SEC’s Share Class Selection Disclosure Initiative last year, FINRA is concerned that share class recommendations were made to clients that are inconsistent with the accounts’ investment objectives. In particular, FINRA is asking firms to ensure that 529 plan recommendations took into account breakpoint discounts, sales charge waivers, and other fees in determining suitability. Depending on the facts and circumstances of each client (in particular the age of the plan beneficiary) FINRA believes that economically disadvantageous share classes may have been selected, wherein the expenses incurred by the client are greater than they need to be. Firms must provide a response by April 1, 2019 in order to participate in the self-reporting initiative. 

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BR: What is required to be included a firm's response?

AR: Firms must provide written notification to FINRA by 12:00am EST on April 1, 2019 of their intent to self-report.  A firm that has submitted their intent to self-report then has until May 3, 2019 to provide the following information back to FINRA:

  1. A list of the 529 plans sold by the firm, including the 529 plan name and the dates the firm offered each 529 plan.
  2. The total aggregate principal amount invested in each 529 plan sold by the firm during the disclosure period.
  3. A description of the firm’s supervisory systems and procedures relating to 529 plan sales during the disclosure period.
  4. A description of the changes to the firm’s supervisory systems and procedures that the firm has implemented or will implement in order to strengthen compliance with its supervisory obligations. To the extent the firm identifies changes that have not yet been implemented, the firm should identify the individual supervisor at the firm who is responsible for the implementation.
  5. The firm’s assessment of potential impact on customers of supervision weaknesses, including a description of the firm’s methodology for assessing impact on customers and a description of the firm’s proposal to make restitution payments to harmed customers.
  6. Any other information the firm believes would assist Enforcement in understanding the firm’s assessment of an account’s expected investment horizon, the suitability of the firm’s recommendations, or the reasonableness of the firm’s supervisory system regarding share class recommendations

Bates has been actively assisting clients with item 5 above.

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BR: What are some of the nuances/pitfalls in planning a firm's response?

AR: There are a number of challenges firms face in assessing the potential impact on clients related to 529 plan share class purchases.  One of which is data availability from plan sponsors – sponsors may have difficulty producing the relevant data, especially for older time periods, given different record retention policies, plans changing hands, etc.  Of particular note, while the review period is January 2013 to June 2018, FINRA notes that the period for calculating restitution may extend further into the past (as alluded to in footnote 16 to Notice 19-04) making getting data all the more difficult.  Beyond that firms must also decide whether to review for possible supervisory failures on a client specific basis, or to apply a “statistical approach” that would group multiple clients into different impact categories and proceed to analyze the potential harm to those clients on an aggregated basis.  Considerations such as whether to use a standard estimate for fee differentials, or breakpoints as of a certain point in time, versus using the exact fee rate differentials during the entire review period as well as the breakpoints in place at the time of purchase give firms even more to consider.  Careful curation of the data, as well as access to historical information on share classes, are crucial to successful reporting and are both areas Bates can assist with.

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BR: What are the risks for not responding?

AR: FINRA’s Member Supervision and Enforcement divisions will continue to examine and investigate member firms’ activity around 529 plans throughout 2019.  Firms who choose not to self-report that are later found to have supervisory failures related to 529 plans during the course of an exam will likely result in additional sanctions beyond those made available for firms that do self-report under the initiative.  Under the umbrella of the initiative Enforcement will recommend that participating firms make restitution payments to all impacted clients and accept a censure, but will face no fine.  In some instances, Enforcement may decide that no formal action is necessary and may resolve the matter informally or with no further action taken.  Both the potential for an informal resolution, no further action, or the absence of a fine in the event that action is taken, create a strong incentive for firms that believe they may have had 529 plan supervisory failures during the relevant period to self-report.

 

Support for Firms:

Bates has deep and proven experience and expertise in share class disclosure matters. Most recently, on behalf of over a dozen major national and regional financial institutions, Bates provided important assistance to firms and counsel participating in the SEC’s Share Class Selection Disclosure Initiative and related SEC Examinations.

To support firms facing FINRA’s 529 Plan disclosure and remediation initiative, Bates Group can help by providing solutions to identify and address accounts and clients impacted by share class selection. Bates performs data analysis, examines regulatory reporting, reviews share class selection policies and disclosure practices, identifies methodology and impacted accounts, performs calculations and provides remediation amounts. Most importantly, after consultation with counsel, Bates' disclosure and remediation plan culminates in a report which can be used directly with regulators. For more information, see our original alert here.

Bates is ready to help you and your firm. Please contact us today.

Alex Russell, Managing Director, Securities Litigation and Regulatory Enforcement 
email: arussell@batesgroup.com phone: 971-250-4353
 
David Birnbaum, Managing Director
email: dbirnbaum@batesgroup.com phone: 917-273-2682
 
Robert Lavigne, Managing Director, Bates Compliance Solutions
email: rlavigne@batesgroup.com phone: 508-868-6741
 
Scott Lucas, Managing Director, Regulatory and Internal Investigations
email: slucas@batesgroup.com phone: 971-250-4344

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02-15-19

Bates Group’s FINRA 529 Share Class Initiative Support for Firms

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Last week, Bates sent a time-sensitive Alert concerning FINRA’s new Share Class Initiative. The initiative is similar to the SEC’s Share Class Initiative that focused on mutual funds in advisory accounts, except that FINRA’s focus is on 529 savings plans.

Bates has deep and proven experience and expertise in share class disclosure matters. Most recently, on behalf of over a dozen major national and regional financial institutions, Bates provided important assistance to firms and counsel participating in the SEC’s Share Class Selection Disclosure Initiative and related SEC Examinations. As a result of these efforts, companies have saved thousands of dollars in remediation costs and avoided reputational harm.

The deadline to self-report and provide FINRA with a remediation plan is April 1, 2019. FINRA cautions that “if a firm does not self-report under the 529 Initiative but FINRA later identifies supervisory failures by that firm, any resulting disciplinary action likely will result in the recommendation of sanctions beyond those described under the initiative.”

Bates is available to help you and your firm. Please contact us today.

Alex Russell, Managing Director, Securities Litigation and Regulatory Enforcement 
email: arussell@batesgroup.com phone: 971-250-4353
 
David Birnbaum, Managing Director
email: dbirnbaum@batesgroup.com phone: 917-273-2682
 
Robert Lavigne, Managing Director, Bates Compliance Solutions
email: rlavigne@batesgroup.com phone: 508-868-6741
 
Scott Lucas, Managing Director, Regulatory and Internal Investigations
email: slucas@batesgroup.com phone: 971-250-4344
 

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02-13-19

The State of Play on Cryptocurrency Regulation

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For legislators and regulators, writing rules for crypto-related assets requires balancing the tension between innovation and entrepreneurship, and between sound markets and investor protection. In previous articles, Bates Research has described some of the definitional challenges which directly affect which agencies govern crypto assets: the SEC asserts jurisdiction over most initial coin offerings (ICOs) as securities (but not Bitcoin or Ether), while the CFTC asserts jurisdiction over Bitcoin futures and options. To FinCEN the subject is simply a currency (and, thereby, subject to Bank Secrecy Act [BSA] and Know Your Customer [KYC] obligations); to the IRS, it’s just another capital asset. Regulators of all stripes continue to issue warnings, advisories, guidance and in some cases—as in NASAA’s crypto-sweep—take enforcement actions that remind everyone that the States also have an interest in asserting their authority. In this article, we review recent developments in the ongoing debate over regulating crypto, including legislative proposals, and regulatory activity by leadership at the SEC, the CFTC and FINRA.

SEC Commissioner Hester Peirce on First Principles

In a February 8th speech titled “Protecting the Public While Fostering Innovation and Entrepreneurship: First Principles for Optimal Regulation,” SEC Commissioner Hester Peirce described the challenges facing regulators that want to apply old models of regulation to cryptocurrencies. She argued that applying securities laws and legal tests (as to what is or is not a security) to virtual currencies and ICOs will negatively impact cryptocurrency development and investment.

The Commissioner raised many questions as to whether tokens are securities for purposes of raising funds. In a pointed comment, she explained that “enforcement actions are not my preferred method for setting expectations for people trying to figure out how to raise money.” Then she announced that the SEC staff is working on "supplemental guidance" to "help people think through whether their crypto-fundraising efforts fall under the securities laws."

Beyond the token issue, however, Commissioner Peirce questioned how certain crypto trading platforms may differ from exchanges or alternative trading systems designed for traditional securities. She also questioned how traditional regulation may need to change to accommodate these differences. Further, she raised important questions about the regulation of exchange-traded products based on Bitcoin or other cryptocurrencies.

In a final cautionary note she stated: “We owe it to investors to be careful, but we also owe it to them not to define their investment universe with our preferences.”

CFTC Setting Stage for Ethereum Futures

On December 11, the CFTC announced that it was seeking public comments to better understand “the technology, mechanics, and markets for virtual currencies beyond Bitcoin, namely Ether and its use on the Ethereum Network.” Currently, Bitcoin is the only regulated network trading in futures. The outcome of this CFTC effort may be a futures trading framework for Ether that will likely impact the agency’s broader approach to virtual currency futures, options and swaps. Such a result would further strengthen the CFTC’s authority to define and regulate such classes of crypto assets. 

FINRA Seeks Feedback, but Wants Compliance

As Bates Group described previously in July 2018, FINRA issued regulatory guidance stating it was monitoring developments in the digital asset market. As a result, FINRA requested that firms notify it if they or their associated persons or affiliates, “engage[], or intend[] to engage, in any activities related to digital assets…” The Notice stated that firms must disclose “purchases, sales or executions of transactions in digital assets, pooled funds that invest in digital assets; or derivatives tied to digital assets.” FINRA said that firms should provide these updates to their regulatory coordinator until July 31, 2019, along with disclosure of any facilitation activities such as clearing or settlement of digital assets.

In its 2019 Risk Monitoring and Priorities Examination Letter, FINRA alluded to this effort, saying that “some firms have demonstrated significant interest in participating in activities related to digital assets.” FINRA asserted that it will be reviewing “firms’ activities through its membership and examination processes related to digital assets and assess firms’ compliance with applicable securities laws and regulations and related supervisory, compliance and operational controls to mitigate the risks associated with such activities.” Specifically, FINRA noted it will “consider how firms determine whether a particular digital asset is a security and whether firms have implemented adequate controls and supervision over compliance with rules related to the marketing, sale, execution, control, clearance, recordkeeping and valuation of digital assets, as well as AML/Bank Secrecy Act rules and regulations.”

Legislative Proposals

Congressional representatives have also jumped into the debate. While regulators are asking for more input from the market, legislators are offering sweeping solutions. Though the current climate would not suggest that legislation that could significantly alter the crypto landscape can pass, several bills—some bipartisan—were introduced in the waning days of the last Congress. Perhaps the most-discussed bill comes from Representatives Darren Soto (D-FL) and Warren Davidson (R-OH), who introduced the Token Taxonomy Act.

The bill, expected to be reintroduced in the new Congress, would, among other things, (i) amend securities laws to exclude digital tokens from the definition of a security, (ii) adjust taxation of virtual currencies held in individual retirement accounts, (iii) create a tax exemption for exchanges of one virtual currency for another, and (iv) create an exemption from taxation for gains realized from the sale or exchange of virtual currency for other than cash. The bill also serves to define the term “digital token” and to clarify the application of securities laws to certain companies that use blockchain.

The Token Taxonomy Act is a reaction to startups fleeing offshore and to the downturn in the market. That downturn, is generally perceived to be due to SEC securities designations and other uncertainties and costs of U.S. regulation. SEC Commissioner Peirce referred to this legislation in her recent address, noting that Congress has the power to clear up many uncertainties by “simply requiring that at least some digital assets be treated as a separate asset class.”

Other bipartisan bills introduced last year, such as the Virtual Currency Consumer Protection Act and the Virtual Currency Market and Regulatory Competitiveness Act were also intended to reduce regulatory uncertainty, bring business back to the United States, and examine ways to encourage the development of the market.

Conclusion

The debate over current and future government regulation of cryptocurrencies may come down to reworking the definitions and legal tests that force them uncomfortably into traditional regulatory categories. It is also possible that the future may be a prolonged period of uncertainty punctuated by enforcement interpretations, conflicting agency guidance and short-lived rules. There is even a possibility that some legislative action could create an entirely new alternative regulatory framework. What can be discerned from Commissioner Peirce’s insight, the CFTC and FINRA market inquiries, and the recently proposed legislative fixes, is that any or all of these outcomes are possible.

The best that market participants can do is to keep up with these developments, do their best to anticipate regulators’ expectations, and attempt to develop compliance risk frameworks accordingly.

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02-01-19

FINRA Rolls Out Its 529 Plan Share Class Initiative - Is Your Firm Ready to Address It?

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On the heels of the SEC’s 12b-1 Share Class Initiative, FINRA just announced its own Share Class Initiative. FINRA’s Share Class Initiative sets a deadline of April 1, 2019 for firms to self-report 529 savings plan share class violations and to provide FINRA with a plan to remediate harmed clients.  FINRA seeks to promote compliance with its supervision and suitability rules regarding share-class recommendations to clients with 529 savings plans (“529 plans”). FINRA’s initiative is also intended to allow firms to “identify and remediate any defects” in their systems and procedures and to “compensate any customers harmed by supervisory failures.” See FINRA Regulatory Notice 19-04.

Bates Group’s Proven Experience with the SEC’s Share Class Initiative Will Help Your Firm with FINRA’s 529 Plan Initiative

Bates has deep and proven experience and expertise in share class disclosure matters. Most recently, on behalf of over a dozen major national and regional financial institutions, Bates provided important assistance to firms and counsel participating in the SEC’s Share Class Selection Disclosure Initiative and related SEC Examinations.

Case Studies:
  • Working with data from our clients’ internal systems and/or major custody and clearing firms, we determined the extent of 12b-1 fees received during the applicable time period and identified the availability of lower-cost alternative share classes that were available for purchase. We then provided the correct information for filing with the SEC, assisted in the remediation process to individual accounts, and provided additional reporting by FA and other requested information and schedules as requested by counsel. 
  • As a result of our prior work for clients supporting them through FINRA and SEC examinations and investigations, we are able to determine the cost impact on clients by comparing the share class purchased to lower share classes of the same fund that could have been purchased.  In those instances, we calculated the differential in fees as well as interest on that differential, and assisted in making remediation payments to their impacted clients.
  • We have also assisted clients in dozens of retail litigation cases involving share class suitability.  Many of these disputes contend that investors should have been invested in class A shares instead of the class B or class C shares purchased.  Bates has modeled account profits and losses, sales loads, operating expenses and total cost of ownership (sales loads plus operating expenses) of actual mutual fund positions held (typically B share or C share classes) versus hypothetical investments of the same fund in a different share class (typically A shares) to assist our clients. 

Bates Group’s 529 Disclosure and Remediation Plan

To support firms facing FINRA’s 529 Plan disclosure and remediation initiative, Bates has created a plan that provides essential end-to-end steps and solutions to identify and address accounts and clients impacted by share class selection. We perform data analysis, examine regulatory reporting, review share class selection policies and disclosure practices, identify methodology and impacted accounts, perform calculations and provide remediation amounts. Most importantly, after consultation with counsel, our disclosure and remediation plan culminates in a report which can be used directly with regulators. Our plan includes back-end steps to clear exceptions, track client communications, and update written supervisory policies, procedures, and compliance programs.

FINRA Cautions Against Waiting to Take Action

In its Regulatory Notice, FINRA cautions that “if a firm does not self-report under the 529 Initiative but FINRA later identifies supervisory failures by that firm, any resulting disciplinary action likely will result in the recommendation of sanctions beyond those described under the initiative.” Enforcement also notes that it will provide “no assurance that individuals associated with these firms will be offered similar terms if they sold 529 plans to customers in violation of MSRB rules, or violated any securities laws.”

About Bates Group's Share Class Support:

Regulatory Investigations and Enforcement

Bates Group supports counsel in FINRA and SEC share class investigations and arbitrations, and break-even analysis work. This includes mining large datasets and providing clear and usable analysis as to the relative cost of selecting particular share classes in light of the plan beneficiaries’ age, the difference in fee levels of the classes, and the breakpoints of the classes.  In connection with FINRA’s announcement, we can help determine instances where a less expensive share class of the same fund may have been available and the difference in fees paid by impacted clients.

Compliance Solutions

Bates works with clients to develop programs to help mitigate conflicts of interest associated with mutual fund share class selection. We develop procedures relating to due diligence, approval, ongoing reviews and disclosures. Additionally, we assist firms with testing these and other types of conflicts-related programs to ensure compliance with internal policies and procedures, as well as regulatory requirements and expectations.

Contact Bates today to put our proven Share Class Experience to Work for your firm:

 
Alex Russell, Managing Director, Securities Litigation & Regulatory Enforcement 
email: arussell@batesgroup.com phone: 971-250-4353
 
David Birnbaum, Managing Director
email: dbirnbaum@batesgroup.com phone: 917-273-2682
 
Robert Lavigne, Managing Director, Bates Compliance Solutions
email: rlavigne@batesgroup.com phone: 508-868-6741
 
Scott Lucas, Managing Director, Regulatory and Internal Investigations
email: slucas@batesgroup.com phone: 971-250-4344
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11-30-18

BCS Alert: FINRA’s Susan Schroeder Previews 2019 Enforcement Priorities

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At the November 2018 SIFMA C&L New York Regional Seminar, Susan Schroeder, FINRA’s Executive Vice President and Head of Enforcement, discussed some of FINRA’s enforcement priorities heading into 2019. You can expect these to be included when the official list comes out in January. (See here for FINRA’s 2018 enforcement priorities.)

Products

In 2019, FINRA will continue its focus on several products and activities we have alerted readers to, including the trading of Unit Investment Trusts (UITs), specifically early UIT exchanges; sales of mutual fund share classes and placing clients in inappropriate classes; and sales of variable annuities and life insurance products. The latter is the subject of an extensive SEC rule proposal which would leverage technology and create a “layered disclosure approach” to variable annuities and life insurance contracts.

Suitability

FINRA will continue to enforce rules intended to reduce the incidence of inappropriate and unsuitable sales of products.

Quantitative Suitability

Ms. Schroeder warned attendees that FINRA will continue reviewing for excessive trading/churning (quantitative suitability). Back in September, Bates Research discussed how FINRA continues to deploy RegTech tools as it seeks to curb excessive trading/churning.

Cryptocurrency

Ms. Schroeder pointed to FINRA’s focus on cryptocurrency-related investment products. In July, Bates Research reported that FINRA issued a Regulatory Notice encouraging each Member Firm “to promptly notify FINRA if it, or its associated persons or affiliates, currently engages, or intends to engage, in any activities related to digital assets, such as cryptocurrencies and other virtual coins and tokens.” Ms. Schroeder shared with attendees that, in September, FINRA charged a broker with securities fraud and the unlawful distribution of an unregistered cryptocurrency security. It was the first time FINRA had filed such a charge in connection with cryptocurrencies. Firms should expect that FINRA will continue to monitor for this kind of activity.

Margin Lending Abuse

Ms. Schroeder noted that FINRA will also continue to focus on Margin Lending abuse. Earlier this year, FINRA announced it would review margin loans and securities-backed lines of credit for whether “firms maintain controls reasonably designed to prevent excessive margin lending,” whether the loans are suitable and whether customers are provided with adequate risk disclosures.

Anti-Money Laundering (“AML”)

Ms. Schroeder told the audience to expect “some AML cases” in 2019. See here for a recent conversation on AML compliance issues with Bates Group’s Director of Financial Crimes, Edward Longridge.

 

Bates has the requisite experience to support our clients in these areas. For additional information and assistance, please follow the links below to Bates Group's Practice Area pages:

Bates Compliance Solutions

Regulatory and Internal Investigations

Retail Litigation and Consulting

Institutional and Complex Litigation

Financial Crimes

Consulting and Expert Testimony

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11-14-18

Risk Alert: OCIE to Conduct Exams on Mutual Funds and ETFs, Review Oversight of Boards of Directors

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Staff members at the SEC Office of Compliance Inspections and Examinations ("OCIE") issued a Risk Alert November 8th informing market participants that they will be conducting a series of examination initiatives on regulatory compliance of mutual funds and exchange-traded funds. The purpose of the new regulatory exams is to assess how firm policies and operations manage fund risks and conflicts, and how current efforts affect retail investors who could be disadvantaged. The OCIE stated that the examinations will focus on the activities of certain categories of mutual funds, exchange traded funds and advisers, and the adequacy of the oversight of the compliance programs of those funds by boards of directors.

The OCIE listed and described the following categories of funds and advisers for examination:

  • Index funds that track custom-built indexes
  • Smaller ETFs and/or ETFs with little secondary market trading volume
  • Mutual funds with higher allocations to certain securitized assets
  • Funds with aberrational underperformance relative to their peer group
  • Advisers relatively new to managing mutual funds
  • Advisers who provide advice to both mutual funds and private funds that have similar strategies and/or are managed by the same portfolio managers

Highlighted areas for review include: (i) policies and procedures of the Funds or their advisers intended to address risks and conflicts, including Funds’ board oversight of the compliance program; (ii) disclosures and shareholder communications (by Funds to investors in prospectuses, and advisers to Fund boards) regarding risk and conflicts, and (iii) Fund, adviser and board’s processes meant to assess practices and controls and oversight related to risks and conflicts. The OCIE is encouraging registrants to “reflect upon their own practices, policies and procedures” and to improve their supervisory, oversight and compliance programs.

How Bates can Help:

Regulatory and Internal Investigations

Bates Group is positioned to provide specialized analyses that can include an examination of the performance of the fund versus the custom-built index, accounting for changes in the construction or calculation of the index itself; a review of the securitized assets and the valuation approach taken with those assets as held within the funds, including modeling the performance of the funds without those assets included; and custom analyses to contextualize the performance of specific funds against peer funds in instances where a fund has underperformed. In all instances, Bates applies our extensive experience analyzing large-scale data along with our deep industry expertise to provide clients with a strong narrative to take to regulators and/or internal review boards in response to mutual funds and ETF inquiries.

Compliance Solutions

Bates Group works with clients to develop programs to help mitigate conflicts of interest associated with investment companies and exchange-traded funds. We develop procedures relating to due diligence, approval, ongoing reviews, disclosures and board reporting. Additionally, Bates assist firms with testing policies, procedures and conflicts-related programs to ensure compliance with regulatory requirements and expectations. Bates’ experienced professionals are well positioned to perform assessments and develop enhancements that will meet regulatory expectations and industry leading practices.

For more information concerning the above Alert, Contact:

Scott Lucas, Managing Director, Regulatory and Internal Investigations - slucas@batesgroup.com

Robert Lavigne, Managing Director, Bates Compliance Solutionsrlavigne@batesgroup.com.

Or contact us by phone at (503) 670-7772

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11-02-18

Alert: OCIE Recommends IAs Review Compliance Procedures on Cash-Based 3rd-Party Client Solicitation

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On October 31st, the SEC Office of Compliance Inspections and Examinations issued a Risk Alert informing investment advisers, investors and other market participants of the most common compliance deficiencies related to the so-called Cash Solicitation Rule (Investment Advisers Act, Rule 206(4)-3).

The rule carves out exceptions to the general prohibition against paying a cash fee, directly or indirectly, to a third party solicitor who refers clients to an investment adviser. (For an SEC Division of Investment Management description of the rule obligations, see here under the section titled “Restriction on Payment of Referral Fees.”)

The Alert lists numerous deficiencies observed by OCIE staff during recent examinations, including, (i) a failure to secure third party solicitation agreements; (ii) inadequate – or failure to provide – disclosure to prospective clients; (iii) a failure to obtain written client acknowledgments of receipt of necessary disclosures; and (iv) failures to determine whether third party solicitors are complying with the required agreements.

Investment advisers should make sure that disclosure documents and solicitation agreements are in sync with the Cash Solicitation Rule and that compliance programs are reviewed and revised as necessary.

For more information concerning Bates Compliance Solutions, including addressing Cash Solicitation Rule deficiencies, please contact us by phone at (503) 670-7772 or email Robert Lavigne, Managing Director, Bates Compliance Solutions at rlavigne@batesgroup.com.

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10-11-18

Alert: FINRA Consolidating Exam and Risk Monitoring Programs

Alert: FINRA Consolidating Exam and Risk Monitoring Programs

On October 1, FINRA announced that it will consolidate its Examination and Risk Monitoring Programs under a single structure. When completed in 2019, the move will incorporate business conduct, financial compliance and trading compliance under one unified framework.

The decision is a result of recent deliberations under FINRA360, the organization’s ongoing self-evaluation and improvement initiative. In April, FINRA issued a Progress Report which identified areas of improvement for the Examination Program. The Report concluded that “central to this effort is an ongoing and evolving risk-monitoring program, under which each member firm is assigned a regulatory coordinator responsible for communicating regularly with the firm, understanding its business, and identifying potential risks to the firm, investors and markets.” The announced single framework model will “create a single point of accountability for the examination of firms” and is expected to “better direct and align examination resources to the risk profile and complexity of member firms.”

New Executive Vice President of Member Supervision, Bari Havlik will oversee the consolidation process through 2019.

For information concerning Bates Compliance Solutions, please contact us by phone at (503) 670-7772 or email Robert Lavigne, Managing Director, Bates Compliance Solutions at rlavigne@batesgroup.com.

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07-23-18

Compliance & Regulatory Update:  More FINRA UIT Warnings and Enforcement

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In a recent Bates Group article covering FINRA’s 2018 Annual Conference highlights, we reported that Michael Solomon, FINRA’s Senior Regional Director, warned of specific exam deficiencies that may trigger compliance scrutiny. In particular, he urged firms to protect investors against representatives attempting to “gam[e] the system” by trading Short Term Unit Investment Trusts (“UITs”).

FINRA has put teeth into that warning by bringing enforcement actions against firms in connection with their representatives’ “offending” UIT client sales activity. In one recent case, a firm submitted, and FINRA accepted, a Letter of Acceptance, Waiver and Consent (“AWC”) settling a matter in which FINRA found the firm to have violated FINRA and NASD Rules “by failing to establish, maintain and enforce a supervisory system and written supervisory procedures reasonably designed to detect and prevent unsuitable short-term trading in UITs.” Among FINRA’s findings, the AWC noted that: “[O]n several occasions, [the firm’s] representatives recommended that their customers use the proceeds from the short-term sale of a UIT to purchase another UIT with identical investment objectives. As a result of this trading, customers paid excess sales charges.”

The AWC is an additional cautionary note reminding firms that short term trading of UITs raises suitability concerns because of their long-term nature, their structure, and upfront costs. FINRA found that “during the relevant period, the firm had no surveillance or exception reports designed to detect unsuitable short-term trading” of UITs.

 

Bates and UIT Support

Bates Group has significant experience assessing and documenting a firm’s trading activity as it relates to the suitability of the sale, purchase and exchange of UITs and other securities. On behalf of our clients, we produce customized reports that analyze and summarize UIT trading, and we serve as independent expert support in evaluating, negotiating and addressing regulatory investigations and enforcement actions. For purposes of client remediation, we are also able to review data across entire UIT trading platforms over a period of years to identify amounts to be remediated back to clients.

If you are facing an investigation or enforcement matter, let us help devise and execute a strategy using our data collection and analysis methods, and, where necessary, provide remediation and/or internal disciplinary assistance.

 

To learn more, please contact Scott Lucas, Managing Director, Regulatory and Internal Investigations, at slucas@batesgroup.com or by phone at 503-670-7772.

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07-19-18

Alert: Common “Best Execution” Deficiencies in Recent Examinations

Alert: Common “Best Execution” Deficiencies in Recent Examinations

The SEC has highlighted frequent “best execution” deficiencies found in some recent examinations of investment advisers. As described in a new Office of Compliance Inspections and Examinations (“OCIE”) Risk Alert, investment advisers have a fiduciary obligation to seek “best execution” of client transactions. The Alert cites longstanding Commission guidance on the subject, which states that “the determinative factor [in an adviser’s best execution analysis] is not the lowest possible commission cost but whether the transaction represents the best qualitative execution for the managed account.”

The OCIE found a range of compliance deficiencies: investment advisers often failed to (i) conduct periodic or systematic reviews of broker-dealers' best execution performance; (ii) consider the costs and quality of services available from other broker-dealers; (iii) evaluate other “qualitative factors” such as “the broker-dealer’s execution capability, financial responsibility, and responsiveness to the adviser;” (iv) consider “materially relevant factors” during best execution reviews such as the “full range and quality of a broker dealer’s services in directing brokerage;” and (v) “solicit and review input from the adviser’s traders and portfolio managers.”

The OCIE also found failures to keep adequate books and records on allocations involving “soft-dollar” arrangements. Full and fair disclosure of these research and/or brokerage service arrangements is a requirement on Form ADV. In addition, OCIE found inadequate policies and procedures in place to assess best execution compliance, and that advisers often did not follow internal policies regarding the “ongoing monitoring of execution price, research, and responsiveness of their broker-dealers.”

The OCIE Alert cautions investment adviser firms to make sure that their compliance programs are reviewed and revised as necessary to ensure compliance with these best execution obligations.

 

For more information concerning Bates Compliance Solutions, including support to address best execution deficiencies, please contact us by phone at (503) 670-7772 or email Robert Lavigne, Managing Director, Bates Compliance Solutions at rlavigne@batesgroup.com.

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05-23-18

Update: Customer Due Diligence Rule Now in Effect

Update: Customer Due Diligence Rule Now in Effect

Despite some last minute pushback, the Financial Crimes Enforcment Network’s (FinCEN) long-anticipated Customer Due Diligence Requirements for Financial Institutions (CDD Rule) became fully effective on May 11th. The CDD Rule, which was proposed initially in August 2014, amends Bank Secrecy Act regulations to clarify and strengthen customer due diligence obligations for financial institutions. FINRA stated that the purpose behind the CDD Rule is “to improve financial transparency and prevent criminals and terrorists from misusing companies to disguise their illicit activities and launder their ill-gotten gains.”

The CDD Rule requires covered financial institutions to develop procedures to identify and verify a customer’s beneficial owners when an account is opened, and to establish risk-based procedures for conducting ongoing customer due diligence. Bates Group has been following the developments of the CDD Rule (see, e.g. here, here and here) including the most recent publication of FinCEN FAQs and the application of FINRA Rule 3310 Anti-Money Laundering (AML) Compliance. The FINRA rule requires members to have an AML written policy in order to ensure understanding of the nature and purpose of customer relationships and for developing a customer risk profile. It also requires firms to conduct ongoing monitoring to identify and report suspicious transactions and to maintain and update customer information.

Regulator emphasis on AML enforcement continues to be a high priority. Firms will need to ensure that their AML programs are reviewed and revised as necessary to ensure compliance with the CDD Rule. Learn more about Bates' AML Compliance Services and AML Investigations. For more information, please contact us by phone at (503) 670-7772 or email Robert Lavigne, Bates Compliance Solutions Managing Director at rlavigne@batesgroup.com to set up an appointment today.

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05-22-18

Update: DOL Issues Non-Enforcement Policy on Fiduciary Rule

Update: DOL Issues Non-Enforcement Policy on Fiduciary Rule

Following the recent federal court decision to vacate the fiduciary duty rule (See Bates report here), the Department of Labor released a Field Assistance Bulletin setting forth a temporary enforcement policy applicable to investment advice fiduciaries. The new policy is intended to address uncertainty about fiduciary obligations formerly required by the DOL rule, or under the Best Interest Contract Exemption, the Principal Transactions Exemption and certain amended prohibited transaction exemptions (collectively PTEs).

The DOL acknowledged that in response to obligations imposed by these rules and exemptions, “many financial institutions created and implemented compliance structures designed to ensure satisfaction of the impartial conduct standards.”

The new temporary policy states that “for the period from June 9, 2017, until after regulations or exemptions or other administrative guidance has been issued, the Department [of Labor] will not pursue prohibited transactions claims against investment advice fiduciaries who are working diligently and in good faith to comply with the impartial conduct standards for transactions that would have been exempted in the BIC Exemption and Principal Transactions Exemption, or treat such fiduciaries as violating the applicable prohibited transaction rules.” Further, the DOL stated that “the Department will not treat an adviser’s failure to rely upon such other exemptions as resulting in a violation of the prohibited transaction rules if the adviser meets the terms of this enforcement policy.”

The launch of the debate over the “Best Interest” rule and investor adviser guidance may eventually resolve issues arising for firms from the vacated rule, but not in the short term. For questions regarding compliance with applicable standards, please contact Bates Group by phone at (503) 670-7772 or email Bates Compliance Solutions Managing Director Robert Lavigne to set up an appointment today.

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05-02-18

Update: SEC Releases Share Class Selection Disclosure Initiative FAQs

Update: SEC Releases Share Class Selection Disclosure Initiative FAQs

The SEC Division of Enforcement issued guidance in the form of Frequently Asked Questions (FAQs) on its Share Class Selection Disclosure Initiative (SCDI). The SCDI “seeks to protect advisory clients from, and return money to, those affected by undisclosed conflicts of interest.” 

Bates Group has closely monitored and reported on SCDI developments (see here and here) ahead of the June 12, 2018 deadline for advisers to conduct a self-analysis, address any issues, and self-report. The FAQs, released May 1st, provide detailed answers on questions raised by the initiative, including adviser eligibility and the distribution of funds to clients. 

Upon close review of the FAQs, Bates recommends the following:

  1. Registered Investment Advisors (“RIAs”) should continue to work with counsel to determine if they will self-report by the deadline.
  2. Firms may need to review their methodology for identification and inclusion of funds based on the FAQs, including reviewing fund prospectuses.
  3. Firms should review their billing practices to identify areas where offsets to 12b-1 fees have been provided and/or memorialized.
  4. RIAs should follow up on the needs that occasioned self-reporting, including the development of new policies and procedures, product selection, client and regulatory disclosures, and supervisory and compliance updates.

BATES’ SHARE CLASS DISCLOSURE PLAN: HOW WE CAN HELP

To support advisers facing Share Class Selection Disclosure issues, Bates has developed a roadmap and implementation plan that provides essential end-to-end steps and solutions to identify and address accounts and impacted mutual funds. We perform data analysis, examine regulatory reporting, review share class selection policies and disclosure practices, identify methodology and impacted accounts, perform calculations and provide remediation. Most important, after consultation with counsel, our roadmap culminates in a report that can be used directly with the SEC. Our plan includes back-end steps to clear exceptions, track client communications, and update written supervisory policies, procedures and compliance programs.

TIME IS RUNNING OUT TO PARTICIPATE IN THIS PROGRAM

Please contact Robert Lavigne, Managing Director, Bates Compliance Solutions, to discuss your share class selection policies and procedures and disclosure practices, and how Bates can help your firm take advantage of this SEC initiative.

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Direct: 508-868-6741

Email: rlavigne@batesgroup.com

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04-23-18

Update: SEC Mutual Fund Share Class Disclosures

Update: SEC Mutual Fund Share Class Disclosures

The SEC Division of Enforcement announced a "Share Class Selection Disclosure Initiative" intended to protect and reimburse investors from an adviser’s conflict of interest. (Click here for Bates Alert.)

The new initiative offers an incentive to advisers and related individuals and entities to review and potentially self-report conflicts of interest, as they relate to the adviser’s collection of 12b-1 fees, as well as its disclosure of such fees, that are in violation of fiduciary duties imposed under the Investment Advisers Act The SEC initiative encourages the adviser to self-report the conflict and return the money to investors. If the advisor takes these actions, the Division of Enforcement will recommend that the Commission accept favorable settlement terms and not impose civil penalties that would otherwise have been imposed. Investment advisers that do not self-report and reimburse may face stronger sanctions.

The deadline to conduct this analysis, address these issues, and self-report is Tuesday, June 12, 2018 – which is only seven weeks away.


Bates’ Share Class Disclosure Plan: How we can help

To support advisers facing Share Class Selection Disclosure issues, Bates has developed a roadmap and implementation plan that provides essential end-to-end steps and solutions to identify and address accounts and impacted mutual funds. We perform data analysis, examine regulatory reporting, review share class selection policies and disclosure practices, identify methodology and impacted accounts, perform calculations and provide remediation. Most important, after consultation with counsel, our roadmap culminates in a report that can be used directly with the SEC. Our plan includes back-end steps to clear exceptions, track client communications, and update written supervisory policies, procedures and compliance programs.

Time is running out to participate in this program.

Please contact Robert Lavigne, Managing Director, Bates Compliance Solutions, to discuss your share class selection policies and procedures and disclosure practices, and how Bates can help your firm take advantage of this SEC initiative.

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04-19-18

Alert: SEC Proposes “Regulation Best Interest”

Alert: SEC Proposes “Regulation Best Interest”

At an open meeting, the Securities Exchange Commission voted 4-1 to propose a set of rulemakings and interpretations designed to establish clear relationship standards between broker dealers and investment advisers and their retail clients. The SEC prescription comes on the heels of the 5th Circuit Court of Appeals decision to vacate the Labor Department’s stricter “fiduciary duty rule” promulgated under the Obama administration.

The SEC described the 400-plus page "Regulation Best Interest" proposal as requiring broker-dealers to act in the best interest of a customer “when making a recommendation of any securities transaction or investment strategy involving securities to a retail customer.” For investment advisers, the SEC proposed certain interpretations explaining aspects of fiduciary duties that they owe to clients.

In a fact sheet distributed at the meeting, the SEC provided an outline of three compliance obligations that would be required under Regulation Best Interest. First, the SEC proposal would require that brokers disclose all “key facts” about potential conflicts, including compensation with respect to specific investment products. Second, broker-dealers would be required “to exercise reasonable diligence, care, skill, and prudence, to (i) understand the product; (ii) have a reasonable basis to believe that the product is in the retail customer’s best interest; and (iii) have a reasonable basis to believe that a series of transactions is in the retail customer’s best interest.” Finally, the SEC proposal would require broker dealers “to establish, maintain and enforce policies and procedures reasonably designed to identify and then at a minimum to disclose and mitigate, or eliminate, material conflicts of interest arising from financial incentives.”

In furtherance of these objectives, the SEC introduced a new “short-form" disclosure document (Form CRS) for investment advisers and broker dealers which would serve to summarize the customer or client relationship. The form, which will be no more than four pages, will highlight key differences in the types of services offered, as well as the legal standards of care for each.  In addition, the short form disclosure proposal would restrict certain broker-dealers servicing retail investors from using the terms “adviser” or “advisor” as part of their name or title.

There will be a 90-day public comment period on Regulation Best Interest after its publication in the Federal Register. Bates will undertake a comprehensive review and analysis of the proposal. For more on the implications of the proposed rule, please contact Bates Compliance Solutions Managing Director, Robert Lavigne at rlavigne@batesgroup.com.

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04-13-18

Alert: FINRA Solicits Comments on Proposed Outside Business Activities Rule

Comments must be submitted by April 27, 2018 on a FINRA proposal to consolidate rules on outside business activities of registered persons. Specifically, FINRA is proposing a consolidation of FINRA Rule 3270 ("Outside Business Activities of Registered Persons") and FINRA Rule 3280 ("Private Securities Transactions of an Associated Person"). The proposal contains a number of amendments intended “to reduce unnecessary burdens while strengthening investor protections.”

The proposed new rule would (i) require registered persons to provide prior written notice of outside activities to firms that employ them, (ii) reduce certain firm obligations regarding risk assessments in order to focus firms on activities that may raise investor protection concerns, (iii) eliminate supervisory and recordkeeping obligations for many specific outside activities (including unaffiliated third party advisory activities), and (iv) hold a member firm responsible for approved activities that are dependent on a registered person's association with the member.

FINRA is seeking comment on any unaddressed economic effects of the proposal including on the application of the proposed rule to registered persons, the effect on members' obligation to conduct risk assessments and the removal of supervisory obligations on outside activities.

Click here to read comment letters submitted thus far.

Learn More

For assistance with your existing policy and procedures, including supervisory programs and activities, please contact Bates Compliance Solutions at BCS@batesgroup.com.

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03-09-18

Alert: New SEC Share Class Selection Disclosure Initiative

Over the past several years, the U.S. Securities and Exchange Commission ("Commission") filed numerous actions in which an investment adviser failed to make certain required disclosures to its clients related to an advisers selection of mutual fund share classes. Specifically, the Commission has been concerned about advisers’ selecting mutual fund share classes that paid the adviser or its related entities or individuals a fee pursuant to Rule 12b-1 of the Investment Company Act of 1940 ("12b-1" fee) when a lower-cost share class for the same fund was available to clients.

The Commission’s Division of Enforcement new Share Class Selection Disclosure Initiative is intended to identify and promptly remedy potential violations of this nature. The initiative offers an incentive to advisers and related individuals and entities to review and potentially self-report conflicts of interest, as they relate to the adviser’s collection of 12b-1 fees, as well as its disclosure of such fees, that are in violation of fiduciary duties imposed under the Investment Advisers Act.

Fees collected on certain mutual fund share classes in excess of fees which would have been paid from available lower-cost share classes of the same fund should be reviewed for potential violations. For those advisers that self-report possible violations relating to their failure to make the necessary disclosures and that remediate excess fees plus interest, the Division of Enforcement will recommend that the Commission accept favorable settlement terms and not impose civil penalties that would otherwise have been imposed. The SEC cautions investment advisers to examine their share class selection policies and procedures and disclosure practices.

Bates Group can help advisers review their share class selection policies and procedures and disclosure practices. In addition, Bates Group can help advisers review current supervisory and compliance practices that are designed to identify and mitigate these conflicts. Please contact us if your firm needs assistance.

 

How Bates Can Help

Compliance Solutions

Bates works with clients to develop programs to help mitigate conflicts of interest associated with mutual fund share class selection. We develop procedures relating to due diligence, approval, ongoing reviews and disclosures. Additionally, we assist firms with testing these, and other types of conflicts-related programs to ensure compliance with internal policies and procedures, as well as regulatory requirements and expectations.

Regulatory and Internal Investigations

Bates Group supports counsel in FINRA and SEC share class investigations and arbitrations, and break-even analysis work. This includes mining large datasets and providing analysis presentations in a clear and usable manner for use by counsel with regulators and boards. In connection with the Division of Enforcement’s announcement, we can help determine instances where a less expensive share class of the same fund may have been eligible and the difference in fees paid by clients.

 

Two Case Studies

  • A recent investigation involved a FINRA Annual Sales Practice Exam where FINRA inquired about the oversight of the trading in class C shares across the entire platform at a particular brokerage firm. Representing the brokerage firm, Bates Group reviewed trades of class C shares against the customers’ client profiles to ensure that they were made within the firm’s guidelines. Bates Group’s summary reports helped the firm satisfy FINRA’s inquiry.
 
  • In response to an SEC notice to a client firm that B shares of  a company sold to its clients were not (in certain instances) appropriate, Bates Group created a hypothetical model replicating the trading activity in an alternative class versus the actual share class purchased. The Bates Group analysis evaluated the total P/(L) and compared the underlying sales charges and total operating expenses. Providing a cost of ownership comparison (which included such items as historical operating expense ratios, dividend detail, front end loads/CDSC rates, NAV, etc.) helped to resolve the issues raised by the SEC.

 

About Bates

The Bates Compliance Solutions team of experienced compliance professionals provide comprehensive offerings for broker-dealer and registered investment adviser clients, assisting them with supervision, compliance, risk, AML, and internal audit functions. BCS can assist you by performing as-needed or ongoing reviews and guidance to meet your regulatory compliance obligations. Our seasoned professionals closely review and test policies and procedures, supervisory and compliance processes, and the related practices involved in operating your business, recommending changes and industry standards to supplement and enhance clients' compliance and supervisory systems, and remediate the results of regulatory, litigation, and internal audit findings and decisions. Our Regulatory Investigations practice team works closely with regional and multi-national financial services firms, law firms, and federal and state regulators.  Our role is that of a partner to our clients and their counsel, bringing our technical, industry and managerial expertise to address the issues and support their work through a full and final resolution.

 

Contact

Robert Lavigne, Managing Director, Bates Compliance Solutions

Scott Lucas, Managing Director, Bates Regulatory and Internal Investigations

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02-07-18

SEC Announces 2018 Examination Priorities

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The SEC has announced their 2018 examination priorities, which you can read about here.

In the coming weeks, stay tuned to Bates Research for our expert commentary on the SEC’s 2018 objectives and how they may impact your legal, compliance and enforcement matters.

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01-08-18

2018 FINRA Priorities Announced

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FINRA has announced their regulatory and examination priorities for the upcoming year. You can read the letter, with an introduction by CEO Robert Cook, here.

Stay tuned to Bates Research for our commentary on FINRA’s 2018 objectives and how they may impact your legal, regulatory and compliance matters.

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11-29-17

Alert: FINRA Regulatory Notice 17-40

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FINRA Issued Regulatory Notice 17-40 on November 21, 2017 to provide guidance to firms regarding Anti-Money Laundering program requirements under FINRA Rule 3310, following the adoption of FinCEN's Final Rule to Enhance Customer Due Diligence (CDD) Requirements for Financial Institutions.

FinCEN’s CDD Rule became effective July 11, 2016. Member firms must be in compliance with its provisions by May 11, 2018.

 

FINRA Regulatory Notice 17-40

 

Please also see Bates Group’s recent report on FinCEN's Customer Due Diligence Requirements for Financial Institutions by Bates Expert Susan Berger.

 

About Bates Compliance Solutions

Bates Compliance Solutions (“BCS”) is a dedicated team of regulatory and compliance consultants that bring unique and tailored solutions to U.S. and global financial firms. 

Please contact Bates Compliance Solutions Managing Director Michael Bernardo to discuss your CDD Rule implementation plan: mbernardo@batesgroup.com.

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11-15-17

FinCEN Customer Due Diligence Rule Implementation Deadline Approaching

by Susan Berger, AML/BSA Consulting and Testifying Expert

 

Covered financial institutions must assess and enhance their AML programs to be in compliance with the specific requirements of the new Rule by May 11, 2018. Is your firm ready?

Background

 

Two new AML requirements must be satisfied by the May 11 deadline:

Beneficial Owner Identification: Covered financial institutions must implement procedures to identify and verify each beneficial owner of and a control person for each new account of a “legal entity” customer.

AML Compliance Program: Covered financial institutions must add a “fifth pillar” to their AML programs: Using the information obtained by CDD, firms must understand the nature of the customer relationship to develop a risk profile and use that profile for AML monitoring and surveillance.

“Legal Entity” Identification

 
Who is a covered financial institution?

If your firm is a federally regulated bank, federally insured credit union, securities broker or dealer, futures commission merchant, introducing commodities broker, or mutual fund company subject to Bank Secrecy Act (“BSA”) AML requirements, it is a covered financial institution and subject to the Rule.

Who/What is a legal entity customer?

With certain exceptions contained in the Rule, a “legal entity” customer is any customer other than a natural person, unincorporated association or sole proprietorship. For example, a corporation, a general and a limited partnership, and a limited liability company are all legal entity customers.

Some legal entity customers are excluded from the Rule, e.g., public companies registered on a national stock exchange; bank holding companies; financial institutions regulated by a federal functional regulator or a bank regulated by a state banking regulator; foreign regulated financial institutions that are subject to equivalent ownership and control disclosure requirements.

While SEC-registered investment advisors are not specifically covered, the practical effect of that exclusion remains to be seen, as discussed below.

Who is a “Beneficial Owner”? Who is a Control Person?

A beneficial owner is each individual who, directly or indirectly, owns 25% or more of the equity interest in or controls more than 25 % of the voting power of a legal entity customer.

The definition and requirements of a beneficial owner include control person, defined as a single individual with significant responsibility to control, manage or direct a legal entity customer. Examples include the CEO, President, COO, CFO, Managing Partner, General Partner, Managing Member, and Managing Director. That person may be but need not also be a beneficial owner.

The identification and verification procedures for beneficial owners/control persons are similar to those for individual customer identification. FINCEN has even provided a form for covered financial institutions to use for purposes of collecting this information.

The financial institution may rely on the beneficial ownership information provided by the customer, so long as it has no knowledge of facts that would reasonably call into question the reliability of the information. The financial institution must maintain records of beneficial ownership and may rely on another financial institution for the performance of these requirements, to the same extent as under the existing CIP rules.

The New “Fifth Pillar"

 

Prior to the issuance of this Rule, the BSA required covered financial institutions to maintain an AML program comprising “four pillars”:

  1. Development of internal policies, procedures, and controls;
  2. Designation of an AML compliance officer;
  3. Development of an employee training program; and
  4. Creation of an independent audit function to test programs.

The new Rule adds a “fifth pillar” for AML compliance programs.

The fifth pillar elements include:

  1. Performing customer identification and verification (CIP);
  2. Performing beneficial ownership identification and verification;
  3. Understanding the nature and purpose of the customer relationship to develop a risk profile of the customer; and
  4. Monitoring for suspicious transactions and, on a risk-basis, maintaining and updating customer information.

In its executive summary of the Rule, FinCEN noted that many of these fifth pillar elements are familiar to AML compliance professionals (e.g., element one is already an existing BSA/AML program requirement, and elements three and four have been implicitly required in order to comply with the BSA/AML duty to detect and report suspicious activity).

Only element two – the beneficial ownership identification and verification requirement – is truly new.

The beneficial ownership identification is added to assist law enforcement in conducting investigations of financial crimes by enabling them to identify the individuals who may be hiding behind legal entities and legal entity accounts to disguise the origins and movement of criminal activities and proceeds. Because the European Union and other jurisdictions already have such a requirement, and the US has been criticized for not fully imposing one, firms can expect that this Rule will be the focus of regulators and criminal law enforcement authorities.

Is Your Firm Ready?

 

Covered financial institutions must assess and enhance their AML programs to be in compliance with the specific requirements of the new Rule by May 11, 2018. There is no expectation that FinCEN will entertain an extension.

Please do not assume that just because your firm is not a covered financial institution (e.g., Registered Investment Advisor) that there will be no impact from the Rule. Covered financial institutions will also expect their counterparties and customers to provide this information. Some large covered financial institutions may take this opportunity to “scrub” all their data on existing relationships and not limit themselves to complying with the Rule only for new accounts.

 

Bates Group is ready to help you implement the CDD rule. For more information, please contact us by phone at (503) 670-7772 or email Bates Compliance Solutions Director Michael Bernardo at mbernardo@batesgroup.com to set up an appointment today.

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10-25-17

FINRA Update: New Arbitration Proposals, Identifying High Risk Brokers

In two notices issued last week, the Financial Industry Regulatory Authority addressed a few longstanding issues. First, FINRA proposed expanding the legal options available to investors when filing a claim against an inactive firm or associated person. Second, FINRA requested comments on allowing compensated non-attorney representatives to continue to represent customers in disputes between investors and broker-dealers. Comments on both are due December 18, 2017. In addition, FINRA Executive Vice President of Regulatory Operations Susan Axelrod offers insight on how FINRA is identifying high risk brokers.

FINRA Proposes New Arbitration Options for Investors

FINRA is proposing amendments to the Code of Arbitration Procedure for Customer Disputes to address the issue of unpaid customer arbitration awards in specific circumstances. Regulatory Notice 17-33 describes such circumstances as “situations where a firm or associated person is no longer in business either at the time the claim is filed or during a pending arbitration.”

The notice provides the rationale behind allowing investors in those circumstances to “evaluate the likelihood of collecting on an award” and to “make an informed decision about whether to proceed in arbitration, to file the claim in court or to amend [a] claim to add other respondents from whom the customer may be able to collect.” FINRA staff identified 278 out of 1,328 customer cases closed “by hearing or by papers” from 2014 to 2016 where a firm or an associated person would have been identified as inactive under the proposed amendments.

Generally, the amendments are intended to allow customers to reconsider their litigation strategy once notified of the change in status of the respondent. The amendments would provide customers more latitude to withdraw an arbitration claim, amend pleadings, postpone hearings, and receive a refund of filing fees.

FINRA is requesting comments and submissions on all aspects of the proposed amendments including economic impacts, data and other quantitative measures.

FINRA Wants Feedback on Non-Attorney Representation in Arbitration Cases

FINRA moved on a longstanding proposal to examine the “efficacy” of allowing compensated non-attorney representatives (“NARs”) to represent customers. Regulatory Notice 17-34 requests feedback on questions related to forum users’ experiences with NAR firms.

FINRA reports receiving numerous complaints about NARs, which typically represent investors with claims of $100,000 or less. Some of the complaints include: (i) employing "inappropriate business practices,” (ii) requiring non-refundable fees in retainer agreements, (iii) representing parties in contravention of state law, and (iv) pursuing frivolous claims to elicit settlements, among others.

The FINRA Code of Arbitration and Mediation Procedure allows NARs to represent clients in arbitrations subject to certain exceptions. However, according to the notice, there are no rules of professional conduct applicable to NAR firms, and NARs are not subject to licensing or supervision regarding their practices. In addition, NARs are not subject to malpractice insurance requirements. As a result, investors have little recourse if a NAR firm negligently represents or defrauds them.

Bates retail litigation expert Ralph Cursio was recently interviewed on the subject of NARs by Investment News, which you can read about here.

FINRA is considering whether it should restrict representation of parties by NAR firms. To determine whether restrictions should be put in place – and the extent of those restrictions – FINRA is looking for answers to a broad set of questions seeking information on forum user experiences, barriers to attorney representation, economic impacts and costs and benefits. FINRA Director of Dispute Resolution Richard Berry stated that dealing with the concerns around NARs are “among FINRA’s arbitration-related priorities” for 2018.

Addendum: FINRA Keeps a Ranking List of “Bad Apples”

According to a recent report, FINRA Executive Vice President for Regulatory Operations Susan Axelrod revealed that FINRA has been keeping a list and ranking the 634,403 brokers that it oversees. Bates Group has been following developments on FINRA’s response to recidivist actors.

The report states that “the list is compiled based on a broker's prior regulatory disclosures, disciplinary actions and employment history.” Though Ms. Axelrod stated that the ranking would be used for “internal guidance,” the possible disclosure of the list, inadvertently or through some cyber breach, gives some cause for concern. The article notes that as far back as the 2015 Annual Report, FINRA has been “using real-time data to help us identify individual brokers who pose a significant risk to investors or the industry,” and that the “potential rogue brokers could become the subject of examinations conducted by a special FINRA exam unit established earlier this year.”

Bates will keep you informed as these and other FINRA developments unfold.

 

Continue the conversation with Bates at the SIFMA C&L Society New York Regional Conference on November 1st. Stop by our booth for a demo of Arbitrator Evalutor, Bates' powerful new arbitrator selection tool.

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08-31-17

OMB Approves DOL Fiduciary Rule Delay

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On August 28, 2017, the Office of Management and Budget approved the Department of Labor’s (DOL) 18-month Fiduciary Duty Rule (Rule) delay request, extending the Transition Period and applicability of certain requirements and exemptions of the Rule until July 1, 2019. As of the writing of this note, the DOL announced that they will file a 15-day comment period, set to appear in the Federal Register in coming days, giving the DOL time to draft and submit for comment a more streamlined version of various components of the Rule and exemptions.

Most notably, the delay in the applicability date of the additional Rule requirements includes the class action provision of the Best Interest Contract Exemption. Note that this extension does not relieve providers of retirement advice any exemption from compliance with the Transition Period requirements, including the Impartial Conduct Standards. Bates Compliance Solutions will keep you posted on continuing developments.

If you should have any questions or need assistance managing your DOL Fiduciary Duty Rule strategy and implementation, please contact Michael Bernardo, Managing Director of Bates Compliance Solutions, at 732-904-1548 or mbernardo@batesgroup.com.

 

About BCS

Bates Compliance Solutions (BCS) is composed of experienced former regulators and compliance professionals, including CAMS-certified experts, who provide world‐class Compliance and Regulatory services and support for new and existing Broker-Dealer, Registered Investment Adviser (RIA) and hybrid firms at prices that are more than competitive. BCS offers custom-tailored front office, governance, compliance, risk, and audit solutions, including DOL Fiduciary Duty Rule strategy, on a case-by-case basis or as continuous, ongoing advice and support.

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10-28-15

Regulatory Alert

David Grim, the Director of the SEC's Division of Investment Management, testified on October 23, 2015, before the House Subcommittee on Capital Markets and Government Sponsored Enterprises. At the outset he noted that there are approximately 12,000 investment advisers registered with the SEC, with almost $67 trillion in regulatory assets under management, which represents an 8 percent increase in the past year.

Mr. Grim described a number of Investment Management initiatives the SEC had undertaken recently, including proposing a new program that would call for Third Party Compliance Reviews and another instituting an organizational change focusing on Risk Monitoring.

He stated that the Investment Management Division staff is working in conjunction with the staff of the SEC's Office of Compliance Inspections and Examinations (OCIE) to develop a recommendation for the Commission's consideration that, if proposed and adopted, would establish a program of third-party compliance reviews for registered investment advisers. Mr. Grim pointed out that the reviews would not replace examinations conducted by OCIE, but would supplement them in order to improve compliance by registered investment advisers.

He also stated that pursuant to Section 965 of the Dodd-Frank Act, the Division of Investment Management had established a new risk and examinations office to monitor trends in the asset management industry and to carry out the Division's limited inspection and examination program.

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