Bates Research - 09-10-20

NASAA Rounds Out Busy Summer with Active Policy and Enforcement Agenda

(L-NASAA Past Presdient Christopher Gerold, R-NASAA President Lisa Hopkins as of September 2020)

The North American Securities Administrators Association (“NASAA”) continues to assert its member states’ interests in fighting for and protecting investors and consumers in the financial markets. Here we have assembled a roundup of recent NASAA actions on enforcement, model legislation and regulatory policy, as well as what to expect going forward.

Enforcement: Pandemic Task Force Results

NASAA announced that, as a result of a coordinated COVID-19 initiative, its enforcement task force disrupted 220 pandemic-related schemes to defraud investors and consumers as of August 19, 2020. The task force uses online investigative techniques to identify websites and social media posts that may be promoting investment fraud, fraudulent offerings or improper, unregistered regulated activities.

NASAA member regulators brought administrative actions, filed cease-and-desist orders, and made referrals to other regulators (and hosting companies) on 154 investment-related and 90 non-investment-related schemes. According to the NASAA task force web page, the pandemic-related schemes are characterized as inducements that (i) prey on fear and anxiety; (ii) promote safety amid uncertainty; (iii) involve cryptocurrencies or cryptocurrency-related investment products, foreign exchange (“forex”) products, or “products generally unfamiliar to inexperienced retail investors”; and (iv) promise monthly payments that would appeal to cash-strapped investors, often referring to returns as “passive income” or “cash flow.”

State Legislative Efforts: New Model Act on Whistleblowers

On August 31, 2020, NASAA adopted a new model act “to protect whistleblower confidentiality, prohibit retaliation by an employer against a whistleblower, and create a cause of action and provide relief for whistleblowers retaliated against by their employer.” The model act is intended to “help states provide a safe environment for individuals to come forward to report suspected wrongful securities practices to state securities regulators.” NASAA also highlighted that the Act provides a state’s securities regulator with the authority to make monetary awards to whistleblowers based on the amount of monetary sanctions collected in an administrative or judicial action, up to 30 percent of the amount recovered. Like other NASAA model legislation, the whistleblower act serves as a template for consideration and adoption through legislation or regulation by member jurisdictions.

State Legislative Efforts: Proposed State Restitution Funds for Victims of Securities Fraud

On July 1, 2020, NASAA proposed a model act for member jurisdictions to create a restitution fund for victims of securities law violations who were awarded restitution but who have not received full payment. Among other elements, the proposed Act would (i) establish a securities restitution assistance fund within the jurisdiction;  (ii) provide examples of funding sources for jurisdictions to consider; (iii) establish eligibility and application processes for restitution assistance; (iv) set limitations on restitution assistance awards; (v) provide that the jurisdiction is entitled to a lien in the amount of the restitution award on recovery; and (vi) grant the jurisdiction rulemaking authority to carry out the purposes of the program. Public comments are now being reviewed for amendments prior to consideration and adoption by the members (likely in September).

Regulatory Policy: Challenge to SEC “Accredited Investor” Definition

In a strongly worded statement, NASAA Past President Christopher W. Gerold expressed disappointment with the SEC for adopting an amendment expanding the definition of “accredited investor” under federal private fund regulations. The SEC recently revised the definition in order to increase the number of sophisticated investors that will have access to private investments. (See Bates Complinance Alert here.)

Mr. Gerold responded to the SEC’s deregulatory move, saying it showed “little regard for the potential adverse effects on investors and the public markets,” and that it “squandered an opportunity to … address long overdue changes to the wealth and income standards defining accredited investors.” He said that “the failure to index these standards to account for inflation has eroded the investor protections they were designed to provide,” and that the Commission “failed to protect seniors or other vulnerable investors from the inherent risks associated with the lack of transparency and liquidity that exists in the private securities marketplace.”

Regulatory Policy: Opposition to DOL Investment Advice Proposal

In a comment letter dated August 6, 2020, NASAA opposed the Department of Labor (“DOL”)’s rule proposal on investment advice for retirement accounts under the Employee Retirement Income Security Act (“ERISA”) and the Internal Revenue Code (“the Code”). (See Bates coverage of the proposal here.) The proposal would (i) create a new “prohibited transaction class exemption” for investment advice that would allow financial institutions and investment adviser fiduciaries to receive compensation that would otherwise be prohibited under ERISA law; (ii) reinstate a five-part test for defining investment advice; and (iii) make changes to a pre-existing prohibited transaction class exemptions consistent with a 2018 Court Order vacating the DOL’s fiduciary duty rule.

In its comment, NASAA encouraged the DOL to rescind the proposal for jeopardizing the security of retirement investors, stating that “taken together, the various aspects of the Proposal will create outcomes that are the opposite of the fiduciary protections that retirement investors deserve, and that Congress intended under ERISA.” Specifically, NASAA argued that under the proposal (i) retirement savers will be misled into believing that the advice they receive adheres to fiduciary standards; (ii) investment professionals will “remain free to offer conflicted, self-interested advice”; (iii) investment professionals could decide to limit their advice to “limited scope transactions” (like rollovers), which could be characterized as discrete and not subject to appropriate scrutiny under the five part test; (iv) the investor will not have any new means to seek relief; and, generally, (v) standards of care will be distorted “through complicated tests, permissive disclosure arrangements, and self-determined controls.”

Should the proposal not be rescinded, NASAA recommends that it should be amended to simplify the five-part test and eliminate harmful loopholes. Specifically, NASAA contends that the DOL “should make clear that providing investment advice regarding rollovers is always a fiduciary act”; tighten the standards on advice concerning “sales contests, proprietary products, and limited product menus”; and strengthen and clarify requirements for minimum disclosure to investors.

Regulatory Policy: NASAA Submits Another Round of Comments on FINRA Proposal on Beneficiary Arrangements

As described in a previous Bates post, NASAA urged FINRA to strengthen a rule proposal that would create a national standard to protect seniors by requiring member firms to review and approve—in writing—an associated registered person being named a beneficiary, executor or trustee, or to hold a power of attorney on behalf of a customer. On July 30, 2020, NASAA filed a letter asking for reconsideration of its prior comment recommendations on FINRA proposed Rule 3241, which it said is “of particular interest to NASAA and its members for its implications for investor protection, particularly for seniors and persons with diminished capacities.”  

In its latest submission, NASAA asserted that (i) “registered persons should be prohibited from being named as beneficiaries or appointed to positions of trust by any customers other than immediate family members”; (ii) registered persons serving in a customer beneficiary and trust position arrangement—even if they are family members—should be required to get written approval from their firms and be subject to clear disclosure requirements; (iii) FINRA should be required to “create clear standards by establishing a baseline of information that registered persons are required to provide, and more specific guidance on considerations for firm approval”; and (iv) any accounts under these proposed arrangements should be subject to heightened supervision.  

Notable: Report on Financial Professionals with Diminished Capacity

On July 21, 2020, NASAA published a special report on diminished capacity and cognitive impairment that may affect financial professionals. Though the NASAA working group that authored the report could not determine how many professionals were affected, they noted the aging population of the industry and other concerns including alcohol and substance abuse that could impair judgment. The working group described many compliance areas that are implicated. These include issues related to standards of conduct, supervision, books and records, continuing education and fraud. The working group also assessed a variety of “methods and resources” used by firms to address these sensitive situations, highlighting their efforts at training in succession planning and recognizing red flags.

Conclusion - Looking Forward

NASAA’s significant summer activities under the leadership of Past President Christopher W. Gerold continue to demonstrate the association’s critical and assertive role in state legislation, federal and state regulatory policy and enforcement related to the financial markets. As the association transitions its leadership to President Lisa A. Hopkins (West Virginia’s Senior Deputy Securities Commissioner), we can expect continued emphasis on addressing the coronavirus pandemic and its impact on regulators, industry and investors through a new NASAA Crisis Planning and Recovery Committee announced by Hopkins, and a focus on exempt offerings and diversity, equity, inclusion and advocacy. Bates will continue to keep you apprised.


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