10-26-20

This Week in Reg BI: SEC-FINRA Roundtable and Bates Compliance-Global Relay Webinar “REG BI - 120 Days On”

This Week in Reg BI: SEC-FINRA Roundtable and Bates Compliance-Global Relay Webinar “REG BI - 120 Days On”

Today, October 26, 2020, the SEC and FINRA staff will hold a remote public roundtable to discuss their observations on the implementation of Regulation Best Interest (“Reg BI”) and Customer Relationship Summary disclosure form (“Form CRS”) since mandatory compliance began on June 30, 2020.

Following the program, on Wednesday, October 28, 2020 at 2 pm Eastern/ 11 am Pacific, Bates Compliance will hold its own webinar with Global Relay to discuss “Reg BI - 120 Days On.”

The regulators’ long-anticipated discussion should provide clarity on Reg BI and compliance examinations generally, as well as on the sufficiency of recent Form CRS submissions with respect to the disclosure of disciplinary histories. The latter has been a source of significant public interest over the past few weeks after the SEC staff added explicit new interpretations on reporting disciplinary history in its Frequently Asked Questions on Form CRS. For more on criticisms leveled at both the Form and the industry, see this recent Wall Street Journal report.

In our upcoming webinar, Bates Compliance Managing Directors Hank Sanchez and Robert Lavigne, along with Donald McElligott (VP Compliance, Global Relay), will discuss, among other things, what they have observed since the implementation of Reg BI and Form CRS, common concerns raised by the SEC and FINRA, and ways Reg BI has impacted financial services technology and compliance.

Click here to register.


About Bates Compliance:

The Bates Compliance team helps firms implement Reg BI, Form CRS, and navigate compliance concerning investor and consumer protection standards. To learn more about Reg BI and Form CRS compliance consulting support for your firm, please visit our Reg BI service page.

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10-22-20

SEC Chair and Director of Enforcement Review the Record

SEC Chair and Director of Enforcement Review the Record

In a likely preview of the SEC Division of Enforcement 2020 Annual Report, SEC Chair Jay Clayton and Division of Enforcement Director Stephanie Avakian gave back-to-back speeches regarding the agency’s enforcement record since they took the reins in 2017. In context, these speeches presented a strong accounting of the impact the Division has had on the financial industry during their tenure. The remarks, delivered last month to the Institute for Law and Economics at the University of Pennsylvania Law School, also raised some of the important challenges to the SEC’s enforcement priorities presented by COVID-19. Here are the highlights from their speeches.

Avakian Paints the Big Picture, Shares the Numbers

Director Avakian described the Division’s key goals as investigating and recommending impactful cases that serve to protect investors, and continuing efforts to adapt to market and technological developments in order to operate effectively and efficiently.

During Chair Clayton’s tenure, she reported, the Division brought over 2,500 enforcement actions, received $14 billion ($4.3 billion in 2019, the highest on record) in financial remedies, returned over $3.3 billion to harmed retail investors, and distributed more than $350 million to whistleblowers.

Ms. Avakian described cases brought by the Division in traditional enforcement areas, highlighting the use of innovative data analysis to support investigations and actions. She named a host of financial and issuer fraud cases, key insider trading cases, Foreign Corrupt Practices Act violations, cases involving improper financial reporting disclosure (“involving virtually all aspects of the financial reporting process”), Ponzi schemes, and cases where the Division went after suitability violations by broker-dealers. She also discussed cases brought by the Division that involve complex non-traditional matters and those that implicate market integrity—such as potential fraud in initial coin offerings—and innovative remedies to address misconduct. Further, Director Avakian said the Division sought to “deter wrongdoing by holding individuals accountable.” She stated that in roughly 70% of cases, they had “pursued charges against individuals for misconduct,…including registered individuals, executives at all levels of the corporate hierarchy, including CEOs, CFOs and other high-ranking executives, as well as gatekeepers such as accountants, auditors, and attorneys.”

In continuing to focus on large public companies and financial institutions, Ms. Avakian emphasized the introduction of new approaches to protect retail customers and to further enhance the efficiency and effectiveness of the enforcement program. These include streamlining investigations through targeted requests, better communication with respondents around the benefits of cooperation, and targeted initiatives.

As to the most successful targeted initiatives, Ms. Avakian highlighted the Share Class Selection Disclosure Initiative, a self-reporting program “focused on the recurring problem of advisers failing to disclose conflicts of interest associated with the selection of fee-paying mutual fund share classes.” She reported that “the initiative resulted in the SEC ordering nearly 100 investment advisory firms that voluntarily self-reported to the Division to return nearly $140 million to investors.” (See also Bates reporting on the Share Class Disclosure Initiative.) Ms. Avakian also noted  initiatives that addressed conduct affecting vulnerable investor groups (e.g., Teachers’ and Veterans’ Initiatives) and efforts to better reward whistleblowers, and she commended the Enforcement Division and the SEC's Office of Compliance, Inspections and Examinations for their cooperation on additional efforts to improve efficiency and effectiveness.

Ms. Avakian described the unique circumstances of managing the operations of the Division and discussed at length the Division’s response to "substantial, unexpected challenges" to Chair Clayton’s announced priorities. She cited several Supreme Court cases that negatively affected the Division's enforcement powers (see Bates summary coverage regarding Lucia v. SEC and Kokesh v. SEC) in addition to the challenges of operating during the COVID-19 pandemic. (Since mid-March, the Commission “filed more than 325 new [regular] enforcement actions.”) Ms. Avakian also noted that during the relevant period, the Division opened nearly 150 COVID-related inquiries or investigations.

Chair Clayton Reviews Enforcement Record

In his address, Chair Clayton highlighted the success of the Enforcement Division in bringing meaningful cases to the Commission that had “a substantial impact on investors and the integrity of our markets.” He assessed the oversight, management and performance of the Division against several guiding principles. These included whether the actions (i) rectified harm to retail investors by returning money as "promptly as practicable;" (ii) worked to eliminate widespread fraud; and (iii) strengthened the "integrity and fairness" of the capital markets.

Chair Clayton offered examples of the Division’s work that satisfied these objectives. He noted the SEC’s Retail Task Force for its successful initiatives on Share Class Selection Disclosure and on Teacher and Veteran protections. He underscored the work of the Division in the area of Initial Coin Offerings, pointing out that the subject matter lent itself “to fraud, speculation and widespread harm,” and that the Division responded to these challenges by “issuing an investigative report confirming the application of the securities laws to the use of blockchain or distributed ledger technology to facilitate capital raising and to offers and sales of digital assets that are securities.” He contended that through a series of additional “measured yet timely actions” and the “creation of the Cyber Unit,” the Division “restored order, while leaving room for distributed ledger and other technologies to drive cost savings and innovation.”

Chair Clayton also commended the Division for its efforts during COVID-19, including (i) trading suspensions and enforcement actions against companies that were engaging in fraud (e.g., companies offering preferred access to personal protective equipment and COVID-19 tests) and other COVID-19 related claims; (ii) guidance reminding market participants about corporate controls and procedures; and (iii) the promotion of good corporate governance to ensure compliance, market integrity and investor confidence. Mr. Clayton also noted the important role the Enforcement Division played in the crafting of Regulation Best Interest, “with the interests of Main Street investors front of mind.”

Chair Clayton concluded that, based on the guiding principles, the Division was extraordinarily successful during his tenure (giving it a 12 on a scale of 10), and that, despite the challenges—including judicial limitations on SEC authority, a government shutdown and a pandemic, the Division achieved meaningful and impressive results for retail investors through a “powerful combination of deference, cooperation and support.”

Conclusion

The record is undeniably impressive. At the start of their tenure, it would have been impossible for Chair Clayton and Director Avakian and former Enforcement Co-Director Steven Pieken (who left the agency on August 14, 2020) to have anticipated the many unexpected challenges they were about to encounter. That they managed the operations and processes throughout, while keeping their eyes on a determined pre-pandemic agenda is commendable. It will be interesting to revisit these achievements in December, when the Division’s 2020 Annual Report is released. We will continue to keep you apprised.

Bates features regular coverage of SEC and regulator leadershipalertsand initiatives.

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

Regulatory and Internal Investigations

Institutional and Complex Litigation

Big Data

Retail Litigation and Consulting

Bates AML and Financial Crimes

Bates Compliance

Consulting and Expert Testimony

 

For more information about Bates Group’s Regulatory and Investigations practice, please reach out to Alex Russell, Managing Director, White Collar, Regulatory and Internal Investigations at arussell@batesgroup.com.


Upcoming Webinar: REG BI – 120 Days On. Where are we now?

Reg BI's implementation occurred on June 30, 2020 and 120 days on, Global Relay and Bates Compliance experts will assess the impact on the industry thus far.

Join our webinar to hear expert opinions from our panel of regulatory specialists:

  • Donald McElligott, VP Compliance, Global Relay
  • Hank Sanchez, Managing Director, Bates Compliance
  • Robert Lavigne, Managing Director, Bates Compliance

Date: Wednesday, October 28, 2020 Time: 11:00 AM Pacific / 2:00 PM Eastern
Duration: 45 Minutes

You will learn:

  • What has happened since REG BI came into effect
  • How it has impacted the technology side of business
  • Common concerns raised by the SEC

Register for this Webinar

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10-21-20

Upcoming Webinar: REG BI - 120 Days On

Upcoming Webinar: REG BI - 120 Days On

In 2019, the US SEC (Securities and Exchange Commission) passed the Regulation Best Interest (REG BI) rule that bound broker-dealers by law to put the best interest of their clients first.

Reg BI's implementation occurred on June 30, 2020 and 120 days on, Global Relay and Bates Compliance experts will assess the impact on the industry thus far.

Join our webinar to hear expert opinions from our panel of regulatory specialists:

  • Donald McElligott, VP Compliance, Global Relay
  • Hank Sanchez, Managing Director, Bates Compliance
  • Robert Lavigne, Managing Director, Bates Compliance

Date: Wednesday, October 28, 2020

Time: 11:00 AM Pacific / 2:00 PM Eastern

Duration: 45 Minutes

You will learn:

  • What has happened since REG BI came into effect
  • How it has impacted the technology side of business
  • Common concerns raised by the SEC

Register for this Webinar

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10-14-20

Bates is a Proud Gold Sponsor of the 2020 NSCP National Conference

Bates is a Proud Gold Sponsor of the 2020 NSCP National Conference

Join Bates Compliance at the 2020 NSCP National Conference, October 19-21, 2020. Bates is a proud Gold sponsor of this online event, which will feature regulatory sessions and 68 educational breakout sessions.

Visit Bates' Virtual Sponsor Booth in the Exhibition Hall, where attendees can chat with Bates staff, schedule 1-on-1 video meetings, view service offerings and download materials. Our online booth schedule is now open – book an appointment with us today!

Bates is a Proud Gold Sponsor of the 2020 NSCP National Conference
Linda Shirkey

Bates Compliance Manging Director and NSCP Board member Linda Shirkey will be speaking on Day 1 of the conference on the panel of Session 3b: Understanding the SEC’s Proposed Advertising Rules. (2:00-3:15 p.m.) The panel will discuss the proposed principles-based approach to overhauling the current rules.

Click Here for More Information and to Register

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10-14-20

CxO Friday Insurance Industry Roundtable - Webcast with Sheila Murphy October 16, 2020

Bates Group expert and consultant Sheila Murphy will be appearing Friday, October 16, 2020 on the Insurance Industry CxO Roundtable webcast. Ms. Murphy will be leading the panel to discuss business and market trends in the field, explore their impact on CxOs, in-house and outside counsel, and share tactical steps to effectively support stakeholders in light of these developments. Sponsored by In The House, a private network for General Counsel and other in-house attorneys.

RSVP today to secure your spot

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10-13-20

Important Takeaways from SIFMA-Bates Virtual Branch Office Compliance Visits Webinar

Important Takeaways from SIFMA-Bates Virtual Branch Office Compliance Visits Webinar

On Monday, October 5, 2020, nearly 700 Compliance, Supervision, Risk, Legal and Regulatory experts and professionals tuned in to a panel discussion covering virtual branch office inspections and the challenges facing regulators and industry supervision and compliance teams. The webinar, jointly organized by Bates Compliance and SIFMA, reviewed the current requirements and status of branch office inspections, recent regulatory relief, and compliance expectations for on-site inspection requirements going forward. The featured speakers included:

  • Jennifer Stout – CEO, Bates Group (opening remarks)
  • Jill Ehret - Director, Bates Compliance - Bates Group
  • Lou Moschetta - Senior Vice President and Deputy Director of Compliance, Wells Fargo Advisors
  • Joseph Neary - Chief Risk Officer, Cetera Financial Group
  • John O’Neill - Executive Vice President and Chief Compliance Officer, LPL Financial
  • Joseph J. Sheirer - Vice President, Member Supervision Examination Program, FINRA
  • Paul M. Tyrrell - Partner, Sidley Austin (moderator)
  • Kevin Zambrowicz - Managing Director and Associate General Counsel, SIFMA

Here are some of the highlights.

Branch Office Inspections

Led by Sidley Austin partner Paul Tyrrell, the panelists discussed the dramatically altered environment since on-site compliance and regulatory inspections ceased in March 2020 due to the pandemic. Bates Compliance’s Jill Ehret described the significant impact on firm compliance based on differences in firm size, the number of home offices, the sufficiency of technology, and the necessity of new practices and protocols to mitigate risk. SIFMA’s Kevin Zambrowicz mentioned that most branch offices are closed or are providing very limited or no onsite client services, and that so far firms are taking a conservative approach to reopening. He said that many firms are doing what they can to do inspections remotely—for most firms, “the policy…is that corporate travel is restricted,”—and are relying on technology instead of an  on-site examination component. Wells Fargo’s Lou Moschetta expects no on-site inspections for an extended period—“possibly 2nd quarter next year.”

The panelists generally agreed that the FINRA relief that extended the 2020 exam cycle through Q1 2021 was necessary, but that the extension is not long enough to complete the 2020 cycle. Zambrowicz expressed concern about the ripple effects of such a time frame for the 2021 inspection cycle, anticipating going in the direction of extended relief and remote inspections for both 2020 and 2021. Cetera Financial Group’s Joseph Neary stated that the current 2020 and 2021 deadlines are “unrealistic.” LPL Financial’s John O’Neill said that his firm has thousands of locations; as a result, they are “focusing on how to triage which branches we can get to by March 2021,” and are employing risk-based approaches to prioritize offices within a three-year cycle.

Reopening (Hypothetically Speaking)

Zambrowicz discussed efforts to address the “practicalities” of a return to onsite inspections amid re-openings, describing such a process as “exceedingly complicated.” He explained a firm’s duty to have a supervisory system in place, but noted the logistics involved for a firm staffer to visit a location in this environment, including state- and even county-level travel restrictions and the testing and quarantining around even a single visit. He stated that, without even “considering the health concerns of the examiner,” the logistics of the process were “not feasible.” He advocated for the use of remote supervision using existing technology, an approach which has already been embraced by certain regulators who have recognized the need and capability to go remote.

Moschetta furthered the point, saying that a big management concern is the volume of advisers operating from remote locations. “How many will continue to work from home? Could be thousands… No answer to that yet.”

FINRA’s Joseph Sheirer highlighted the temporary relief provided to firms from having to register locations as non-branch offices, saying, “we’ve given a pass on registering these locations, recognizing the challenges of on-site inspections.” He stated that FINRA is facing the same challenges as the industry and that unless there was a customer harm, or a threat to market integrity, the inspections that have been conducted have been all remote: “We are as virtual as you can get.” He noted that  includes remote examinations, branch office visits and enforcement programs, and said that, to date, even “on-the-record” testimony has been handled remotely.

Learning How to Adapt

Bates Compliance’s Ehret described how firms are adapting to current conditions. She said that although the focus has been on the rules and the inspections, “we should be thinking more about the review element,” which does not need to be on site. The more off-site preparation completed during the review phase, the less burden there is on the on-site element. Ehret said that firms are also thinking about other practical changes to (i) address travel limitations, including, for example, using supervisors who are closest in proximity to do onsite reviews, (ii) strengthen pre-visit questionnaires, and (iii) conduct virtual interviews.

FINRA’s Sheirer highlighted the value of recent regulatory notices on remote supervision. The guidance emphasized using a risk-based approach and sharing industry best practices. He agreed that firms should consider and document changes to protocols and practices, including using new communications platforms and enhancements to virtual monitoring and supervision.

Zambrowicz said there were numerous examples of different regulators (e.g., CFTC, NFA) allowing virtual solutions to satisfy on-site requirements. Moderator Tyrrell added that recent interpretive guidance from the NFA represents an “important marker” to that end. Sheirer cautioned that while FINRA is considering making certain relief permanent, “there are still things that benefit from an on-site,” such as the ability to see space sharing that may present conflicts of interest, outside business activities, body language, and the like. Like Ehret, he focused on solutions that could enable off-site inspections, such as enhanced email review and monitoring.

Issues Pre-COVID (and Beyond)

Cetera’s Neary also emphasized pre-exam work, noting how his firm upped its requirements on electronic record keeping, email review, and centralized trading. LPL Financial’s O’Neill pointed out that the results of virtual reviews have been relatively “consistent” with pre-COVID reviews. O’Neill noted “an uptick of email use, which is good for our email review system,” .. O’Neill reiterated that “we’re not necessarily seeing a drop-off in quality or anything… So, we’re trying to look at our program and say, ‘how we can make some of this permanent?’”

Similarly, Moschetta said his firm was seeing the same sort of findings in substance and volume as those found in pre-pandemic on-site review. He said that existing and new technology processes and enhancements generally discover items such as outside business activities, private securities transactions and unreported complaints. Further, he said, the new efforts are helping their partners cope in the field know what to expect and to deliver.

Ehret noted some additional benefits. She said new technology is enabling “look backs, specialized reviews for outside business activities, identification of red flags on social media, and more documentation on office activities that are now subject to additional firm reporting.”

All Roads Lead to Virtual Supervision and Inspections

SIFMA’s Zambrowicz stated the consensus position that the evolution of technology is mitigating the need “to actually be there” and that firms should use the lessons from the current environment to recognize “the opportunities.” He said that “it is a logical next step to go virtual and that the pandemic brought to a head the natural and technological evolution of virtual supervision and inspections.”

Bates Compliance’s Ehret reiterated that most of the work required for an inspection is done prior to an on-site inspection: “The heavy lifting has already been done in review.” The way clients are currently working with their advisers is the way of the future.

SIFMA has made this program available on demand.

For more information or further questions about this program or Bates Compliance's services, please contact David Birnbaum, Managing Director, at dbirnbaum@batesgroup.com or call 917-273-2682.


About Bates Compliance:

Jill Ehret is a Bates Compliance Director based in St. Louis, MO. Ms. Ehret is a seasoned securities industry professional with over 19 years of experience bringing practical, application-based insight and approaches to broker-dealer and registered investment advisor compliance departments and issues.

Bates Compliance’s consulting practice delivers guidance and tailored compliance solutions to our broker-dealer, investment adviser and hybrid firm clients on an as-needed or ongoing basis. Our team—made up of experienced senior compliance, legal and former regulatory professionals—drafts and tests policies, procedures, and supervisory and compliance processes, recommending and implementing changes based on leading practices to enhance compliance and supervisory systems and to remediate regulatory, litigation and internal audit findings. With nearly four decades of working with leading law firms, financial services companies and regulatory bodies, Bates provides support every step of the way.

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09-24-20

Announcing Our Newest Experts

Bates Group is proud to welcome our newest experts and consultants: 

Gary Ferrari

AML, Financial Crimes, Global Compliance Risk Management

Gary Ferrari is a compliance risk management leader in global financial institutions and consulting firms. He has served in senior-level leadership positions and governance roles integral for building, executing, and remediating regulatory and financial crime/AML compliance programs throughout the U.S. and the world. Mr. Ferrari’s focus has been on the Pillars of Compliance, designing the framework, standards, and methodology for building and resourcing compliance programs, and overseeing core compliance functionality.

Full Bio

Barbara A. Halper, JD, MBA

BD-IA Compliance, Seniors and Vulnerable Investors, Compliance Testimony

Barbara Halper, Esq. is a Bates consultant and expert specializing in proactive risk assessment, training, testing, and management services that support businesses in meeting compliance-related needs with a focus on proactive services in meeting Best Interests regulatory requirements. She also provides strategic litigation and arbitration support from the sale of alternative investments. Ms. Halper’s consultation and services are designed to provide Bates’ clients with proactive measures for supervising the sale of securitized products by employees (or contractors and their employees) who may be subject to issues related to their advancing age or infirmity.

Full Bio

Timothy McClendon, CIC, CWCA

Insurance, Workers’ Compensation, Risk Management

Tim McClendon serves as an expert witness in insurance-related litigation and has over 40 years’ experience as a Certified insurance Counselor (CIC). Mr. McClendon also holds a Certified Workers Compensation Advisor (CWCA) designation and is a licensed risk manager. As a member of the Society of Certified Insurance Counselors national faculty, Tim teaches insurance courses throughout Texas and around the country including Certified Insurance Service Representatives, Certified Insurance Counselors and Ruble Seminars. He is a former “Teacher of the Year” for Professional Insurance Agents of Texas and has been a member of the adjunct faculty teaching insurance and risk management courses for the M. J. Neeley School of Business at Texas Christian University.

Full Bio

Edward Truax

Insurance and Annuities, 401K/Pension/Retirement, Elder Issues

Ed Truax is a Bates affiliate with more than 30 years of experience as a financial advisor and consultant. His focus was, and remains, the intergenerational transfer of family-owned and closely held business interests. Mr. Truax brings a wealth of experience with the suitability and sales practices of life insurance, annuity products, qualified and non-qualified retirement plans, in both individual and corporate settings. He has offered expert testimony in life insurance-related civil litigation and served as Chairman of an arbitration panel deciding matters related to insurance agency dissolution. He is experienced as a keynote speaker, sales concept trainer, and provider of continuing education.

Full Bio


Our nation-wide roster of over 165 quantitative and substantive consultants and experts span 250 unique areas of expertise. We invite you to explore our expert offerings by visiting the Bates Group’s Expert Search page.
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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

SIFMA Webinar Series - Monday, October 5, 2020 - Virtual Branch Office Compliance Visits

SIFMA Webinar Series - Monday, October 5, 2020 - Virtual Branch Office Compliance Visits

In this complimentary CLE webinar, hear directly from compliance and risk leaders, including FINRA, on the latest updates concerning virtual branch office compliance visits during our webinar. Jill Ehret (Director, Bates Compliance) will appear on the panel, moderated by Paul Tyrrell (Partner, Sidley Austin), with opening remarks by Bates CEO Jennifer Stout. October 5, 2020 at 1 p.m. Eastern, co-hosted by SIFMA and Bates Compliance.

Join us to learn more about:

  • the status of virtual branch office inspection programs;
  • rulemaking updates and FINRA Rule 3110 requirements for branch inspection programs;
  • current remote branch office inspection challenges;
  • and best practices when implementing a remote branch inspection program.

1.5 CLE credits available

More Info and to Register

Featured Speakers:

Sponsored by:

SIFMA Webinar Series - Monday, October 5, 2020 - Virtual Branch Office Compliance Visits
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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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09-17-20

FinCen Focus: Customer Due Diligence with Banking Agencies, SARs Warnings and BSA Enforcement

Just a few weeks ago, Bates highlighted a series of Financial Crimes Enforcement Network (FinCEN) compliance communications. They included new FAQs on general requirements under the customer due diligence rule (CDD) and alerts regarding cyber-enabled financial crime and scams involving fraudulent payments denominated in convertible virtual currencies.  

Since then, FinCEN has issued several important public statements. First, it joined the Federal Reserve Board, the Federal Deposit Insurance Corporation, the National Credit Union Administration, and the Office of the Comptroller of the Currency (hereafter, the “Agencies”) in clarifying specific Bank Secrecy Act/Anti-Money Laundering  (BSA/AML) due diligence requirements for customers who may be considered “politically exposed persons” (PEPs). Second, FinCEN issued a stern warning to the media and others about the publication of unlawfully disclosed information contained in suspicious activity reports (SARs). Third, FinCEN published guidelines on how it approaches enforcement of the BSA. These enforcement guidelines provide firms with insight into how FinCEN determines an “appropriate” response to violations of the statute. The FinCEN guidance comes on the heels of an updated joint statement on BSA/AML enforcement issued less than a week earlier by the Agencies. Here’s a recap.

CDD REQUIREMENTS ON PEPS

On August 21, 2020, FinCEN and the Agencies issued a statement on the BSA CDD requirements for “politically exposed persons”—a term of art used to describe foreign public officials, their family members or close associates. According to the agencies, these PEPs present a higher risk to financial institutions that their assets may contain the “proceeds of corruption or other illicit activity.”

The Agencies’ statement highlights a financial institution’s obligation to identify and report the suspicious activity of PEPs, particularly transactions that may involve the proceeds from corruption, bribery and money laundering. Consistent with the FAQs issued a few weeks ago, the Agencies clarify that the CDD rule does not create any new requirement or supervisory expectation for customers who are considered PEPs. They reiterate that under the CDD rule, banks must adopt appropriate due diligence procedures and assess the specific PEP relationship under specific facts and circumstances in order to determine the level of risk that may be present. For PEPs, financial institutions should consider assessing the types of services provided, the nature of the transactions, “geographies associated with the customer’s activity and domicile,” the PEP’s authority over government officials and access to government funds.

FINCEN WARNINGS ON PUBLICATION OF SARS

On September 1, 2020, FinCEN issued a short but stern warning about the unlawful disclosure of the contents of SARs. Stating that it was aware of media outlets that intended to publish articles based on such information, FinCEN reiterated that any unauthorized disclosure is a crime prohibited by the BSA which can “compromise law enforcement investigations, and threaten the safety and security of the institutions and individuals who file such reports.” Civil and criminal penalties can be substantial ($100,000 per incident for the former, and up to $250,000 and five years imprisonment for the latter). FinCEN stated that it has referred the information it has obtained to the U.S. Department of Justice and the Treasury Department’s Inspector General.

FINCEN ISSUES ENFORCEMENT GUIDELINES

In a statement issued on August 18,  2020, FinCEN detailed its approach to enforcement of actual or possible violations of the BSA.

The statement affirmed FinCEN’s authority as “administrator of the BSA” with “overall authority for enforcement and compliance.” FinCEN described the scope of its authority stating that it “may take enforcement actions, to include imposing civil money penalties on financial institutions, nonfinancial trades or businesses, and other persons that violate the BSA,” and to impose “civil money penalties on partners, directors, officers, or employees who participate in these violations. In this capacity, FinCEN said it has the authority to conduct examinations and to rely on examinations from other “federal functional regulators” under the BSA framework, but would “not treat noncompliance with a standard of conduct announced solely in a guidance document as itself a violation of law.”

In its statement, FinCEN  identified the actions it might take to respond to various violations, including (i) closing a matter with no additional action; (ii) issuing a warning letter (e.g., on supervision); (iii) seeking an injunction or equitable relief to enforce compliance if it suspects a violation; (iv) requiring remedial obligations in a settlement; (v) assessing a civil money penalty; and (vi) referring a case for criminal investigation or prosecution.

FinCEN also described numerous factors it uses when evaluating the disposition of a case involving compliance with specific BSA requirements (e.g., registration, recordkeeping and reporting) or the “adequacy” of a financial institution’s AML program requirements  (e.g., internal controls, trainings, testing). These factors include (i) the nature and seriousness of the violation; (ii) the impact of the violation on FinCEN’s efforts to carry out its mission, including to combat money laundering; (iii) the pervasiveness of the violation within the organization; (iv) prior history; (v) the extent of any financial gain; (vi) action taken by the institution upon discovery of the violation; (vii) timely disclosure of the violations to FinCEN; (viii) any cooperation with FinCEN and other authorities; (ix) the systemic nature of the violations; and (x) enforcement efforts by other agencies on related activity.

AGENCIES ISSUE GUIDANCE ON BSA/AML ENFORCEMENT

FinCEN’s statement came less than a week after the other Agencies issued joint guidance on when they may exercise their discretion “to issue formal or informal enforcement actions or use other supervisory actions to address BSA-related violations or unsafe or unsound banking practices or other deficiencies.”

On August 13, 2020, the Agencies set forth their enforcement policy, which is anchored in legal requirements that mandate that each Agency prescribe regulations that require insured depository institutions to “establish and maintain procedures reasonably designed to assure and monitor the institution's compliance” with the BSA and to enforce those requirements. The statement reviewed the Agencies’ approach to these obligations, ensuring that financial institution programs include the four original required components (pillars) for compliance programs: internal controls, independent testing, a designated BSA compliance officer, and staff training. The updated guidance now includes a fifth component for compliance programs (risk-based procedures for conducting customer due diligence) which was added by the CDD rule. (See prior Bates coverage here.)

The joint statement details the obligations under this fifth pillar including the requirement that an institution maintain a “Customer Identification Program” with risk-based procedures that enable the institution to form a reasonable belief that it knows the true identity of its customers.” This includes, among other elements, understanding the customer relationship in order to develop a customer risk profile, conducting monitoring, reporting suspicious transactions, and updating customer information regarding beneficial ownership. The statement also clarifies that, for the purposes of issuing mandatory cease and desist orders, the Agencies would evaluate BSA reporting and recordkeeping requirements, as well as CDD requirements, as a part of the internal controls component of the compliance program.

Generally, the Agencies stated that an enforcement action would be initiated for (i) failing to have a written BSA/AML compliance program that adequately covers the program pillars; (ii) failing to implement an adequate BSA/AML program and (iii) having defects in one or more program components. The Agencies highlighted specific types of institutional actions that might trigger an enforcement order. These include (i) rapidly expanding relationships with foreign affiliates or third parties without proper controls; (ii) failing to identify risks relating to money laundering or other illicit financial transactions; (iii) an inadequate system of internal controls to confirm customers' identities; (iv) failure to resolve independent testing deficiencies; (v) inadequate training; and (vi) failure to address a previously reported deficiency, among others.

CONCLUSION

These are important official statements on enforcement practice, procedure and priority. They are also an important indication of how the CDD Rule has affected the regulatory framework. For financial institutions facing possible enforcement action, FinCEN and the banking agencies have provided insight into their deliberations and perspective. Bates will continue to keep you apprised.

 

To discuss this article and/or learn more how Bates can help you navigate BSA/AML issues, please contact:

Edward Longridge, Managing Director and Practice Leader, Bates AML and Financial Crimes at elongridge@batesgroup.com.

Dennis Greenberg, Managing Director, Bates AML and Financial Crimes at dgreenberg@batesgroup.com

 

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

Bates AML and Financial Crimes

Artificial Intelligence and AML Optimization

Bates Compliance

Regulatory and Internal Investigations

Consulting and Expert Testimony

Retail Litigation and Consulting

Institutional and Complex Litigation

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09-16-20

Visit Bates Group’s Interactive Booth at the SIFMA C&L Virtual Forum - September 23-24, 2020

Visit Bates Group’s Interactive Booth at the SIFMA C&L Virtual Forum - September 23-24, 2020

Bates is a proud Silver sponsor of this year's SIFMA C&L Virtual Forum online event, September 23-24, 2020. Hosted by the SIFMA C&L Society, hear industry leaders’ perspectives on the current regulatory and enforcement environments, lessons learned thus far, and much more.

Stop by our virtual exhibit booth to reconnect with Bates colleagues. Speak with our representatives to find out what they are seeing and hearing and how our team of experts can help you with your virtual hearings, regulatory investigations, and compliance matters.

You will also be able to link to helpful materials (including downloadable white papers), enter our annual raffle for a bottle of world-class wine from the Pacific Northwest, and receive some giveaways.

We look forward to connecting with you at the show!

Click here for More Info and to Register
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09-14-20

CLE Webcast - PLI Pocket MBA for Lawyers and Other Finance Professionals

CLE Webcast - PLI Pocket MBA for Lawyers and Other Finance Professionals

Join A. 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. Pocket MBA is a hallmark program for attorneys whose careers have brought them into representing clients in the financial industry, but their background training lacked accounting principles and financial concepts. This program is designed to improve understanding of business strategies, accounting fundamentals and vocabulary used by management, investors, auditors and bankers. Sept. 21-22, 2020 via Live Webcast.

Ms. Davis (above L) will be giving opening remarks and appearing on the panels "Accounting Fundamentals," "Financial Statements in Practice: A Case Study" and “Economic Concepts in a Litigation Context.” Mr. Longridge (above R) will be speaking on the panel "Regulatory and Legal Compliance in International Business & Trade."

Click Here for More Info and to Register
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09-11-20

CEO Message: 9/11 National Day of Remembrance

CEO Message: 9/11 National Day of Remembrance

Dear colleagues and friends,

Today marks 19 years since the tragic and devastating events of 9/11.  In remembrance of the many lives lost, the families and friends of the victims, the heroes and brave volunteers, and our colleagues and friends who were impacted, I am pausing for a moment of reflection in their honor.  I hope you will join me and help ensure they are never forgotten.

 “If we learn nothing else from this tragedy, we learn that life is short and there is no time for hate.”

- Sandy Dahl, wife of Flight 93 pilot Jason Dahl, in Shanksville, Pennsylvania, in 2002

 

Respectfully,

Jennifer Stout, CEO

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09-10-20

NASAA Rounds Out Busy Summer with Active Policy and Enforcement Agenda

NASAA Rounds Out Busy Summer with Active Policy and Enforcement Agenda

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.

 

ABOUT BATES

Bates Group has been a trusted partner to financial services firms and counsel for over 30 years, providing end-to-end solutions on legal, regulatory and compliance matters. Through our professional staff and roster of over 165 industry experts and consultants, Bates offers services in litigation consultation and testimony, regulatory and internal investigations, compliance, financial crimes, forensic accounting and damages consulting.

For regulatory and compliance solutions, please contact Robert Lavigne, Managing Director - Bates Compliance, at rlavigne@batesgroup.com.

For sensitive or complex regulatory and internal investigations, please contact Alex Russell, Managing Director - White Collar, Regulatory and Internal Investigations, at arussell@batesgroup.com.

For litigation and damages support, please contact Julie Johnstone, Managing Director - Securities and Financial Services Litigation & Consulting at jjohnstone@batesgroup.com.

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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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08-26-20

Canadian Institute of Actuaries Workshop: Filing a Business Interruption Claim

Canadian Institute of Actuaries Workshop: Filing a Business Interruption Claim

A. Christine Davis, Managing Director - Forensic Accounting and Economic Damages, will be presenting the program “Filing a Business Interruption Claim: Properly Calculating the Business Income Loss” on August 27, 2020. Joining Chris on the panel will be Bates Affiliate Expert Mark Filler and Securities Litigation Director and Expert Andrew Daniel. Presented by the Canadian Institute of Actuaries.

For more information about Bates Group’s Forensic Accounting and Economic Damages services, please visit our Practice Page.

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08-20-20

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

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

Over the past several weeks, the Financial Crimes Enforcement Network (FinCEN) has issued new guidance on customer due diligence requirements, an advisory on cyber-enabled financial crime and an alert concerning scams involving fraudulent payments denominated in convertible virtual currency. These are significant compliance communications for financial institutions and come on the heels of FinCEN’s recent alerts on imposter fraud and money mule schemes (see previous Bates coverage). Here’s what you need to know.

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

New FAQs on Customer Due Diligence

The CDD Rule, which went into effect in 2018, 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 due diligence. (FinCEN provides an active topic page on the subject which includes links to exemptive relief rulings and the latest regulatory FAQs.) On August 3, 2020, FinCEN issued new responses to FAQs concerning obligations “related to obtaining customer information, establishing a customer risk profile, and performing ongoing monitoring of the customer relationship.” The core message in this guidance is a reaffirmation that financial institutions must tailor their CDD program around customer risk.

On questions about the collection of customer information, FinCEN responded that the CDD Rule “does not categorically require” the collection of any particular information other than developing a customer risk profile, monitoring, and collecting beneficial ownership information. FinCEN emphasized that the collection of information is directly related to the level of risk, (i.e., where the customer’s risk profile is low, the collection of any specific information may not be necessary in order to understand the customer relationship.)

FinCEN reiterated that the CDD rule requires covered financial institutions to “establish policies, procedures, and processes for determining whether and when, on the basis of risk, to update customer information to ensure that customer information is current and accurate.” Consequently, while the rule does not require specific due diligence, media searches, or the collection of information concerning certain underlying transactions (e.g., identifying information on a “customer’s customer”), the level of risk determines the appropriate level of information that needs to be collected, which, ultimately, would help to alert a financial institution as to suspicious transactions.

Similarly, FinCEN noted that the CDD rule “does not prescribe risk profile categories, and [that] the number and detail of these categories can vary.” FinCEN’s broader guidance is that financial institutions should understand the types of financial crime risks that are consistent with the customer risk profile and that “any program for determining customer risk profiles should be sufficiently detailed to distinguish between significant variations in the risks of its customers.”

Concerning specific schedules for ongoing customer relationship monitoring, FinCEN relayed that there is “no categorical requirement that financial institutions update customer information on a continuous or periodic schedule.” While the specifics of a monitoring program are also based on risk, FinCEN said that a covered financial institution must update customer information as is relevant to assessing that risk and in order to “reassess the customer risk profile/rating.”

New Advisory on Cyber-Enabled Crime

Only a few weeks after FinCEN cautioned institutions about a rise in money mule schemes and imposter frauds that attempt to con investors and other consumers into deceptive transactions, FinCEN issued a new warning alerting financial institutions to indicators of COVID-19-related cyber scams. The advisory reviews “the means by which cybercriminals and malicious state actors” exploit the pandemic through malware, phishing schemes, extortion, business email compromise fraud, and exploitation of remote applications, especially against financial and healthcare systems. The advisory is based on data analysis of suspicious activity reports and law enforcement and other public reports. It describes risks and red flags for financial institutions to protect customers and legitimate COVID-19 relief efforts.

In the advisory, FinCEN identifies numerous red flag indicators and warns financial institutions to guard against:

  • potential vulnerabilities of remote applications and in virtual environments (including potential manipulation of online verification processes and compromised login credentials across customer accounts) that can jeopardize private information, compromise financial activity and disrupt business operations;
  • schemes targeting health care and pharmaceutical providers that seek the collection of personal and financial data (through malware, ransomware, phishing schemes and extortion);
  • schemes targeting municipalities and the health care industry supply chain that attempt to modify or redirect payments to new accounts (“business email compromise” (BEC) fraud schemes).

FinCEN relayed that financial institutions should consider these indicators in context given “the surrounding facts and circumstances, such as a customer’s historical financial activity, whether the transactions are in line with prevailing business practices, and whether the customer exhibits multiple indicators, before determining if a transaction is suspicious or otherwise indicative of potential fraudulent COVID-19-related activities.”

FinCEN advised financial institutions to use specific language on SARs reports and to reference (in specific fields) these COVID-19 related schemes where the circumstances or subject matter matches.

New Alert on Convertible Virtual Currency Scams

In an alert issued in late July, FinCEN addressed concerns raised by a highly public incident exploiting Twitter accounts. The scheme involved the compromise of the Twitter accounts of public figures and organizations in order to solicit fraudulent payments denominated in convertible virtual currency (CVC). The fraudsters claimed that any CVC “sent to a wallet address would be doubled and returned to the sender.”

The Twitter advisory references a prior FinCEN alert on illicit activity involving CVCs and adds to the broader concern about identifying bad actors seeking to exploit CVCs “for money laundering, sanctions evasion, and other illicit financing purposes” (e.g., those involving darknet marketplaces, peer-to peer exchangers, foreign-located Money Service Businesses, and CVC kiosks.) Together, these warnings paint a daunting picture of the finance vulnerabilities posed by virtual currencies.

In the Twitter alert, FinCEN identifies several indicators to help detect, prevent, and report potential suspicious activity related to social media posts. Among others, these include solicitations from individuals or organizations where there is no prior existing business relationship (like from celebrities or public figures) and solicitations requesting donations where the solicitor is not affiliated with a reputable organization.

Conclusion

FinCEN has had a busy summer. The agency has now warned financial institutions to be on alert for a host of threats, from simple to highly sophisticated fraud and malicious activity. The advisory on increased vulnerabilities resulting from operating during the pandemic reminds us how quickly circumstances can turn into opportunities for bad actors and how alert compliance teams must be to keep up. The advisory on virtual currency risk is an indication that there is much more work needed to protect clients in the virtual markets. Finally, FinCEN’s additional CDD Rule guidance highlights how risk-based frameworks require constant tuning in order for compliance professionals to be able to execute the practical details of their programs.

In the meantime, expect FinCEN to keep issuing these advisories. Bates Group will keep you apprised.

To discuss this article and/or learn more how Bates can help you navigate AML, please contact:
Edward Longridge, Managing Director and Pratice Leader, Bates AML and Financial Crimes at elongridge@batesgroup.com.
Dennis Greenberg, Managing Director, Bates AML and Financial Crimes at dgreenberg@batesgroup.com

For additional information, please follow the links below to Bates Group’s Practice Area pages:
Bates AML and Financial Crimes
Bates Compliance
Regulatory and Internal Investigations
Retail Litigation and Consulting
Institutional and Complex Litigation
Consulting and Expert Testimony

New FinCen Guidance on the CDD Rule, Cyber Fraud and Virtual Currency Scams Exploiting Twitter
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08-20-20

Webinar Today, August 20, 2020: Covid-19 Leads to Novel Compliance Concerns

Webinar Today, August 20, 2020: Covid-19 Leads to Novel Compliance Concerns

Topic - Covid-19 Leads to Novel Compliance Concerns: Branch Audits, Selling Away and Much More

Date/Time - Aug 20, 2020, 2:00 p.m. Eastern / 11:00 a.m. Pacific

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(L-R) Lilian Morvay, Jill Ehret, Paul Horn

 

Lilian Morvay, Bates Group Expert and Founder/CEO of the Independent Broker Dealer Consortium (IBDC) will be presenting a complimentary webinar titled "Novel Coronavirus Leads to Novel Compliance Concerns: Branch Audits and Selling Away" Thursday, August 20, 2020 at 2 p.m. Eastern.

She will be joined on the panel by Bates Compliance Director Jill Ehret, Bates Cybersecurity Expert Paul Horn (Founder/CEO, H2Cyber), moderator Dan Newman, Esq. (Partner, Nelson Mullins), Scott Sherman, Esq. (Partner, Nelson Mullins), and Melissa Tarentino (Vice President of Legal Affairs, Ladenburg Thalmann Financial Services).

Our panel of experts will explore:

  • Performing FINRA Mandated Branch Supervision and Audit Responsibilities in a Virtual World;
  • Tips & Best Practices for Reviewing OBAs and Identifying Potential Selling Away Issues in the Midst of a Pandemic;
  • Legal: Recent Actions Involving Branch Audits, Supervision and Selling Away;
  • Incorporating Virtual Supervision Into Your Newly Established Reg BI Procedures;
  • Maintaining Cyber Vigilance in the World of Virtual Supervision and Audits.

Presented by IBDC

REGISTER HERE

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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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08-06-20

FINRA Roundup: Guidance on Private Placements, Digital Assets, Virtual Hearings, and Proposals

FINRA Roundup: Guidance on Private Placements, Digital Assets, Virtual Hearings, and Proposals

Since our last regulatory update on the adoption of FINRA’s proposal to align its suitability and non-cash compensation rules with Regulation Best Interest (“Reg BI”), the self-regulatory organization issued guidance on private placement communications, recommended that firms provide information to them on digital assets, and proposed a series of new rule changes. Bates examines the details of FINRA’s updated guidance.

Guidance on Private Placement Communications

FINRA issued guidance for members who market private placements to retail investors. Private placements are non-public securities offerings that fall within specific exemptions (Reg D) from SEC registration.

FINRA reported on SEC data showing that issuers make nearly 20,000 Reg D exemption filings each year, of which nearly “4,000 new offerings identify an ‘intermediary,’ such as a broker or finder, as participating.” FINRA requires that members participating in private placements file offering documents (Rules 5122 and 5223), with an estimated 2,000 such filings received each year. FINRA acknowledged the 50% difference between the two regulators and narrowed its guidance to “the subset of private placements marketed by member firms.” Within that subset, FINRA observed that more than 40% of the placements are subject to its rules on retail communications (Rule 2210 - Communications with the Public). FINRA noted that member firms are “increasingly involved in the distribution of private placements” through online platforms and digital advertisements, suggesting that more members will be subject to FINRA communications requirements.

FINRA’s rule requires that communications from member firms must be (i) fair and not contain false, misleading or promissory statements or claims; (ii) disclose the potential risks as well as rewards associated with the investments; (iii) be accurate and (iv) offer a “sound basis to evaluate the facts” about the product. The rule also requires that a registered principal approve each communication.

FINRA observed firm deficiencies in compliance with the communications rule. Specifically, FINRA said that firm communications often fail to balance claims of the benefits of these securities with the potential risks such as their “lack of liquidity” or their “speculative nature.” Other observed communications contained “false, misleading, or promissory statements or claims such as assertions about the likelihood of a future public offering, claims about the future success of the issuer’s business model, inaccurate or misleading assertions concerning the relative risk of the offering, or projections on investment performance.”

FINRA reminded member firms that:

  • They are liable for the distribution of third-party prepared materials if the material is non-compliant with the rule (i.e., not balanced or misleading).
  • Retail communications should not project or predict returns to investors (e.g., yields, future investment performance) however, reasonable forecasts of issuer operating metrics (e.g., sales, revenues or customer acquisitions) are permissible as long as they provides a sound basis for evaluating the facts. FINRA was very specific in its guidance on appropriate issuer operating metrics, including requiring limited time periods, reasonable growth rate assumptions, operating margins within industry averages, and reasonable sales and customer acquisition forecasts in relation to the market.
  • Real estate investment programs fall within the communications rule if they are “designed to provide distributions to investors." FINRA had specific guidance about communications on the metrics around distribution rates.
  • Marketing private placements of real estate, private equity and venture capital often use a performance measure known as the internal rate of return (IRR). FINRA determined that for “completed investment programs” (where the holdings in the pool have matured or been sold), this metric would not violate the communications rule. Further, FINRA would permit the inclusion of IRR in communications materials if it is calculated in a manner consistent with the Global Investment Performance Standards (GIPS) adopted by the CFA Institute.

Recommendations on Reporting Digital Assets 

FINRA encouraged member firms to continue to report firm activities related to digital assets. The request is an extension of prior notices to firms (see here and here) to communicate to a firm’s Risk Monitoring Analyst new or planned digital asset activities such as cryptocurrencies, other virtual coins and tokens. FINRA wants to be notified of the following kinds of activities (this list is not exclusive):

  • Management, advisory services and transactions in digital assets directly or in a pooled fund investing in digital assets
  • Transactions in derivatives tied to digital assets
  • Participation in any offerings of digital assets
  • Secondary trading of digital assets
  • Custody arrangements of digital assets
  • Acceptance of cryptocurrencies from customers or mining of cryptocurrencies
  • Clearance and settlement services for virtual coins and tokens
  • The use of distributed ledger technology or any other use of blockchain technology

FINRA Recent Actions

Virtual Hearings: In response to the COVID-19 pandemic, FINRA has administratively postponed all in-person arbitration and mediation proceedings scheduled through October 2, 2020 unless the parties stipulate to proceed telephonically or by Zoom, or the panel orders that the hearings will take place telephonically or by Zoom. FINRA has created a  Virtual Hearing Guide for Arbitrators.  Further, the Office of Hearing Officers (OHO) has administratively postponed all in-person hearings of Disciplinary Proceedings scheduled through October 2, 2020. The OHO staff makes available a Virtual Hearing Guide for Parties

Expungement: FINRA amended the Codes of Arbitration Procedure for Customer and Industry Disputes to apply a minimum filing fee for all expungement requests. The effective date of the amendment is September 14, 2020. The fee applies “irrespective of whether the request is made as part of the customer arbitration or the associated person files a straight-in request, or the requesting party adds a small damages claim.” Under the amendments, FINRA will “apply a minimum process fee and member surcharge to straight-in requests, as well as a minimum hearing session fee to expungement-only hearings held after a customer arbitration or in connection with a straight-in request.”

Continuing Proposals

Cutomer Beneficiaries: FINRA proposed adopting a rule on registered persons being named a customer’s beneficiary or holding a position of trust for a customer. (See prior Bates coverage here). The proposal is an attempt to “address potential conflicts of interest that can result in registered persons exploiting or taking advantage of being named beneficiaries or holding positions of trust for personal monetary gain.” The new rule would create a uniform, national standard to govern registered persons holding positions of trust.

Operational Challenges: FINRA introduced certain proposals to address the operational challenges affecting members due to COVID-19. First, FINRA proposed temporarily extending the deadline for completed office inspections for the 2020 calendar year to March 31, 2021, effective immediately.  Secondly, FINRA proposed changes to temporarily amend certain procedural requirements, including timing and method of service. These amendments (i) allow FINRA to serve certain documents by electronic mail; (ii) require parties to file or serve documents by electronic mail in connection with specified proceedings and processes; (iii) provide extensions of time to FINRA staff and other parties “in connection with certain adjudicatory and review processes”; and (iv) allow for National Adjudicatory Council oral arguments  to be conducted by Zoom.

First Look: Upcoming Proposals

In a recent FINRA Board Meeting, the Governors approved three upcoming proposals for future notice and comment: (i) amendments to FINRA corporate financing rules to require members to file retail communications concerning specified private placements (see discussion on related guidance, above), (ii) proposed procedures to address cheating on and eligibility for qualification examinations and (iii) amendments to trade reporting rules to require the identification of certain corporate bond trades (i.e., those “priced off of a spread to a U.S. Treasury Security or that are part of a portfolio trade.”) The latter is intended to provide context on reported trades with “prices away from the current market.”

Conclusion

FINRA remains diligent in a host of areas. Its recent actions on private placements, arbitration, conflicts of interest and COVID-19-related administrative matters present examples of the scope of its mandate and its determination to keep pace. FINRA’s request to be kept apprised of broker dealer activity in digital assets suggests a broader agenda in the area. Bates will continue to monitor developments.


For FINRA arbitration and litigation matters, please see:

Litigation Services and Damages Analyses

Search for a Quantitative or Substantive Consultant or Testifying Expert

Virtual Hearing and Mediation Services

Request a Consulting or Testifying Expert

Arbitrator Evaluator™ Selection Tool

Managed Document Review Services

{image_1}

Since our last regulatory update on the adoption of FINRA’s proposal to align its suitability and non-cash compensation rules with Regulation Best Interest (“Reg BI”), the self-regulatory organization issued guidance on private placement communications, recommended that firms provide information to them on digital assets, and proposed a series of new rule changes. Bates examines the details of FINRA’s updated guidance.

Guidance on Private Placement Communications

FINRA issued guidance for members who market private placements to retail investors. Private placements are non-public securities offerings that fall within specific exemptions (Reg D) from SEC registration.

FINRA reported on SEC data showing that issuers make nearly 20,000 Reg D exemption filings each year, of which nearly “4,000 new offerings identify an ‘intermediary,’ such as a broker or finder, as participating.” FINRA requires that members participating in private placements file offering documents (Rules 5122 and 5223), with an estimated 2,000 such filings received each year. FINRA acknowledged the 50% difference between the two regulators and narrowed its guidance to “the subset of private placements marketed by member firms.” Within that subset, FINRA observed that more than 40% of the placements are subject to its rules on retail communications (Rule 2210 - Communications with the Public). FINRA noted that member firms are “increasingly involved in the distribution of private placements” through online platforms and digital advertisements, suggesting that more members will be subject to FINRA communications requirements.

FINRA’s rule requires that communications from member firms must be (i) fair and not contain false, misleading or promissory statements or claims; (ii) disclose the potential risks as well as rewards associated with the investments; (iii) be accurate and (iv) offer a “sound basis to evaluate the facts” about the product. The rule also requires that a registered principal approve each communication.

FINRA observed firm deficiencies in compliance with the communications rule. Specifically, FINRA said that firm communications often fail to balance claims of the benefits of these securities with the potential risks such as their “lack of liquidity” or their “speculative nature.” Other observed communications contained “false, misleading, or promissory statements or claims such as assertions about the likelihood of a future public offering, claims about the future success of the issuer’s business model, inaccurate or misleading assertions concerning the relative risk of the offering, or projections on investment performance.”

FINRA reminded member firms that:

  • They are liable for the distribution of third-party prepared materials if the material is non-compliant with the rule (i.e., not balanced or misleading).
  • Retail communications should not project or predict returns to investors (e.g., yields, future investment performance) however, reasonable forecasts of issuer operating metrics (e.g., sales, revenues or customer acquisitions) are permissible as long as they provides a sound basis for evaluating the facts. FINRA was very specific in its guidance on appropriate issuer operating metrics, including requiring limited time periods, reasonable growth rate assumptions, operating margins within industry averages, and reasonable sales and customer acquisition forecasts in relation to the market.
  • Real estate investment programs fall within the communications rule if they are “designed to provide distributions to investors." FINRA had specific guidance about communications on the metrics around distribution rates.
  • Marketing private placements of real estate, private equity and venture capital often use a performance measure known as the internal rate of return (IRR). FINRA determined that for “completed investment programs” (where the holdings in the pool have matured or been sold), this metric would not violate the communications rule. Further, FINRA would permit the inclusion of IRR in communications materials if it is calculated in a manner consistent with the Global Investment Performance Standards (GIPS) adopted by the CFA Institute.

Recommendations on Reporting Digital Assets 

FINRA encouraged member firms to continue to report firm activities related to digital assets. The request is an extension of prior notices to firms (see here and here) to communicate to a firm’s Risk Monitoring Analyst new or planned digital asset activities such as cryptocurrencies, other virtual coins and tokens. FINRA wants to be notified of the following kinds of activities (this list is not exclusive):

  • Management, advisory services and transactions in digital assets directly or in a pooled fund investing in digital assets
  • Transactions in derivatives tied to digital assets
  • Participation in any offerings of digital assets
  • Secondary trading of digital assets
  • Custody arrangements of digital assets
  • Acceptance of cryptocurrencies from customers or mining of cryptocurrencies
  • Clearance and settlement services for virtual coins and tokens
  • The use of distributed ledger technology or any other use of blockchain technology

FINRA Recent Actions

Virtual Hearings: In response to the COVID-19 pandemic, FINRA has administratively postponed all in-person arbitration and mediation proceedings scheduled through October 2, 2020 unless the parties stipulate to proceed telephonically or by Zoom, or the panel orders that the hearings will take place telephonically or by Zoom. FINRA has created a  Virtual Hearing Guide for Arbitrators.  Further, the Office of Hearing Officers (OHO) has administratively postponed all in-person hearings of Disciplinary Proceedings scheduled through October 2, 2020. The OHO staff makes available a Virtual Hearing Guide for Parties

Expungement: FINRA amended the Codes of Arbitration Procedure for Customer and Industry Disputes to apply a minimum filing fee for all expungement requests. The effective date of the amendment is September 14, 2020. The fee applies “irrespective of whether the request is made as part of the customer arbitration or the associated person files a straight-in request, or the requesting party adds a small damages claim.” Under the amendments, FINRA will “apply a minimum process fee and member surcharge to straight-in requests, as well as a minimum hearing session fee to expungement-only hearings held after a customer arbitration or in connection with a straight-in request.”

CONTINUING PROPOSALS

Cutomer Beneficiaries: FINRA proposed adopting a rule on registered persons being named a customer’s beneficiary or holding a position of trust for a customer. (See prior Bates coverage here). The proposal is an attempt to “address potential conflicts of interest that can result in registered persons exploiting or taking advantage of being named beneficiaries or holding positions of trust for personal monetary gain.” The new rule would create a uniform, national standard to govern registered persons holding positions of trust.

Operational Challenges: FINRA introduced certain proposals to address the operational challenges affecting members due to COVID-19. First, FINRA proposed temporarily extending the deadline for completed office inspections for the 2020 calendar year to March 31, 2021, effective immediately.  Secondly, FINRA proposed changes to temporarily amend certain procedural requirements, including timing and method of service. These amendments (i) allow FINRA to serve certain documents by electronic mail; (ii) require parties to file or serve documents by electronic mail in connection with specified proceedings and processes; (iii) provide extensions of time to FINRA staff and other parties “in connection with certain adjudicatory and review processes”; and (iv) allow for National Adjudicatory Council oral arguments  to be conducted by Zoom.

First Look: Upcoming Proposals

In a recent FINRA Board Meeting, the Governors approved three upcoming proposals for future notice and comment: (i) amendments to FINRA corporate financing rules to require members to file retail communications concerning specified private placements (see discussion on related guidance, above), (ii) proposed procedures to address cheating on and eligibility for qualification examinations and (iii) amendments to trade reporting rules to require the identification of certain corporate bond trades (i.e., those “priced off of a spread to a U.S. Treasury Security or that are part of a portfolio trade.”) The latter is intended to provide context on reported trades with “prices away from the current market.”

Conclusion

FINRA remains diligent in a host of areas. Its recent actions on private placements, arbitration, conflicts of interest and COVID-19-related administrative matters present examples of the scope of its mandate and its determination to keep pace. FINRA’s request to be kept apprised of broker dealer activity in digital assets suggests a broader agenda in the area. Bates will continue to monitor developments.


For FINRA arbitration and litigation matters, please see:

Litigation Services and Damages Analyses

Search for a Quantitative or Substantive Consultant or Testifying Expert

Virtual Hearing and Mediation Services

Request a Consulting or Testifying Expert

Arbitrator Evaluator™ Selection Tool

Managed Document Review Services

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08-05-20

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

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

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The first half of 2020 has been a very challenging time for the capital markets. With a global pandemic arising – the likes of which have not been seen in more than 100 years – U.S. economic activity has largely collapsed, and unemployment has risen to levels not seen since the Great Depression. Join Bates Group’s next CLE Webinar on Thursday, August 13th as we look at 2020 in the context of past bear markets, whether a comparison to the 1918 influenza pandemic is relevant to today, and which sectors and industries have been hardest hit by the economic disruption. The webinar will also explore the impact of COVID-19 on potential capital market-related litigation and regulatory and enforcement areas to keep an eye on. Featuring (L-R above)  co-moderators Jack McGuire of Oppenheimer & Co. and Esther Cho of Keesal, Young & Logan, along with Greg Kyle, Bates Group Director and Expert.

Registration is required to attend this Zoom webinar.

CLE credit approved in MO and CA, giving reciprocity credit to NJ and FL. NY accreditation is available through the approved jurisdiction rule. 

Date: Thursday, July 30, 2020

Time: 12:30 p.m. Eastern / 9:30 a.m. Pacific

Program Length: 1 hour

Register Here


Program Speakers:

Jack McGuire, Managing Director/Deputy General Counsel, Director Of Litigation, Oppenheimer & Co (Co-moderator)

Esther Cho, Shareholder and Chair of Executive Committee, Keesal, Young & Logan (Co-moderator)

Greg Kyle, Director and Expert, Bates Group

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08-05-20

Bates Group, Complidata Bring Expertise and A.I. Technology Together to Optimize AML and Compliance

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Bates Group and Complidata today announced a partnership to combine leading financial crime industry expertise and Artificial Intelligence (A.I.) technology together in a joint approach to assist financial institutions with tuning and optimizing their anti-money laundering operations and compliance.

Bates Group offers services including AML and financial crimes, compliance, regulatory investigations, and advisory services. Based in Belgium, Complidata is a leader in the use of A.I. to drive automation and optimization for improved regulatory compliance. The partnership will assist financial institutions with the tuning and optimization of their transaction monitoring and sanctions and name screening systems — significantly increasing efficiencies and effectiveness in their processes and procedures while reducing the percentages of false-positive alerts.

“There is significant pressure at the Board level of financial institutions to maximize the efficiencies of the organization while addressing anti-money laundering process and procedures. Exacerbating the challenge is the need to meet increasing compliance requirements by regulatory agencies with corporate headcount reductions. We’re leveraging the in-depth experience of Bates Group’s experts and with Complidata’s state-of-the-art technology to assist organizations in achieving this goal,” said Edward Longridge, Managing Director, Bates AML and Financial Crimes.

Under the partnership, Bates will provide subject matter expertise with regards to AML, financial crimes, and sanctions; provide services in design, configuration, testing, and tuning and optimization of AML, financial crime, and sanctions systems; perform AML and sanctions system reviews and model validations; develop governance and oversight processes, including policies and procedures; conduct AML and sanctions risk assessments; AML and sanctions gap assessments and audits; regulatory response support; and staffing support for AML backlogs and lookbacks.

“Bates Group has worked, for the past four decades, with hundreds of financial institutions, regulators, and other stakeholders. As a result, we have amassed a deep knowledge of the current trends and future direction of the financial services business and regulatory landscape,” said Longridge. “Our experts work with firms to prepare and assist in the implementation, review, and enhancement of compliance, risk, and supervisory programs — including testing to support firms undergoing internal and regulatory investigations, remediation and implementation, and preparation through mock exams.”

Complidata will provide A.I.-based solutions for the automation and optimization of AML/KYC processes; machine learning solutions for alert triage optimization; supervised and unsupervised learning solutions for anomaly detection, customer segmentation; network analytics for entity resolution; A.I.-based solutions for the digitization of paper trails as in Trade Finance and Corporate KYC; and intelligent OSINT retrieval.

“We are a leading provider of A.I. driven solutions to optimize and automate AML, KYC, and Sanctions programs. Complidata has introduced explainable A.I. and remain on the cutting-edge of industry advancements, including the incorporation of White-box testing. We are aligned with the latest recommendations of regulators across the globe regarding intelligibility, robustness, and stability. Our team members have been involved in more than 100 financial crime projects in Europe and around the world in finance, banking, and related industries,” said Matthias Verbeke, CEO, Complidata.

“Together, Bates Group and Complidata are well-positioned at the crossroads between technology and advisory to establish, improve, support, and manage the anti-money laundering and financial crimes best practices of financial institutions in the U.S. and across Europe and Asia,” Verbeke added.

For more information on this and other services in the U.S., visit Bates AML and Financial Crimes.

In Europe, visit https://www.complidata.io/.


About Bates Group

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. With a roster of nearly 200 financial industry and regulatory compliance experts, Bates provides solutions throughout the lifecycle of legal, regulatory, and compliance matters, offering services in AML and financial crimes, regulatory enforcement and internal investigations, compliance, risk management, litigation consultation and testimony, forensic accounting, and damages consulting.

 
About Complidata

Complidata (www.complidata.io) provides A.I.-driven Process Automation Solutions to streamline and optimize compliance processes and underlying operations across several vertical domains for FSIs. Complidata deploys these solutions as managed services, to help clients define, implement and manage the controls and achieve regulatory compliance. Complidata helps its clients to make their compliance operations more effective and efficient.

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07-30-20

DOL Proposes New Class Exemption for Investment Advisers

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More than two years after the Fifth Circuit Court of Appeals vacated the Department of Labor’s (“DOL”) fiduciary duty rule, the agency has proposed new regulations on investment advice for retirement accounts under the Employee Retirement Income Security Act (“ERISA”) and the Internal Revenue Code (“the Code”). Under the heading “Improving Investment Advice for Workers & Retirees,” the DOL (i) proposed 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) reinstated the 1975 regulation and its five-part test for defining investment advice, and (iii) made certain changes to its pre-existing prohibited transaction class exemptions consistent with the Court Order vacating the DOL’s fiduciary duty rule. Here are some of the details of the new DOL proposal.

A New Prohibited Transaction Class Exemption

The heart of the DOL proposal is a new class exemption that would be available to registered investment advisers, broker dealers, financial institutions and insurance companies that “provide fiduciary investment advice to Retirement Investors” (e.g., Plan participants and beneficiaries, IRA owners and Plan and IRA fiduciaries[1]). If granted the exemption, these institutions and professionals could receive various types of transaction payments and fees that are currently prohibited under ERISA law, including: “commissions, 12b-1 fees, trailing commissions, sales loads, mark-ups and mark downs, and revenue sharing payments from investment providers or third parties.” The exemption would also apply to advice provided on Plan roll-overs in addition to allowing financial institutions to transact to or from their own accounts.

By this proposal, the DOL is shifting its approach from one focused on narrow exemptions based on specific prohibited transactions to one which is more “principles-based.” The DOL is doing this by conditioning the exemptions on compliance with their “Impartial Conduct Standards.” These standards incorporate three elements: a best interest standard, a reasonable compensation standard and “a requirement to make no misleading statements about investment transactions and other relevant matters.”

According to DOL, each of these elements—which have long histories and pertinent interpretations—will now be aligned and consistent with Reg BI and prevailing securities law. As to the best interest standard, DOL affirms that investor fiduciary advice should be (i) prudent, reflecting the care, skill and diligence under prevailing circumstances and “based on the investment objectives, risk tolerance, financial circumstances, and needs of the retirement investor,” and be (ii) loyal, meaning that the advice does not place the interests of the financial adviser ahead of the interests of the retirement investor. These are familiar considerations for advisers under Reg BI.

Other specific requirements to maintain eligibility under the new broad exemption include written acknowledgements of an adviser’s fiduciary status under ERISA and the Code (see below), written communications regarding the services to be provided and any material conflicts of interest, and the adoption of policies and procedures to ensure compliance with the Impartial Conduct Standards (subject to retrospective review).

The DOL cautioned that financial institutions and professionals would be ineligible or would lose their eligibility for the exemption if, within ten years prior or following, they were “convicted of certain crimes arising out of their provision of investment advice to retirement investors.” The DOL stated, however, that should they be excluded from the broad exemption, these institutions or individuals could always apply for other, more targeted exemptions. The DOL justified this approach by saying that its more focused approach would “provide significant protections for Retirement Investors while preserving wide availability of investment advice arrangements and products.”

Further, the new proposed exemption would require disclosure of the status of the adviser under ERISA and the Code and would require providing an accurate written description of their services and material conflicts of interest. The DOL made clear that the proposed exemption would not “create any new legal claims above and beyond those expressly authorized in ERISA.”

Recognition as an Investment Advice Fiduciary: The Five-Part Test

To become eligible for the new class exemption, the DOL has effectively reinstated its’ 1975 regulation which imposed a five-part test to determine the status of an advisor. (That test had been supplanted by the DOL’s previous—and subsequently vacated—fiduciary rule; by the new proposal, DOL is adding a technical amendment which would formally reinstate the rule and test.)

For an adviser to be considered an investment advice fiduciary under ERISA and the Code, he/she must be authorized or responsible for providing investment advice and receive direct or indirect compensation “with respect to any moneys or other property” of a Plan. Specifically, the test requires the professional to:

  1. provide advice on the Plan or make recommendations on “investing in, purchasing, or selling securities or other property;”
  2. act regularly;
  3. act under an arrangement “with the Plan, Plan fiduciary or IRA owner;”
  4. provide advice which serves as the primary basis for an investment decision; and
  5. Tailor the advice for the individual “based on the particular needs of the Plan or IRA.”

Facts and circumstances will determine if the test is satisfied. Consequently, for a professional to be eligible for the exemption, he/she must establish status as an investment adviser fiduciary under this test.

The DOL’s proposal includes some guidance on the application of the test, particularly pertaining to advice concerning rollovers. For example, the DOL describes instances where an isolated recommendation to take an employee plan distribution and roll it into an IRA may fail the “regular” prong of the test, however advice to do so as part of an ongoing relationship with the client may be enough for that “regular” prong to be satisfied.  

Additional Changes

As noted above, the DOL addressed pre-existing prohibited transaction class exemptions under the new proposal in order to harmonize the results with the court’s decision to vacate the fiduciary rule. Specifically, the DOL removed two exemptions: the "Best Interest Contract Exemption" and the “Principal Transactions in Certain Assets Between Investment Advice Fiduciaries and Employee Benefit Plans and IRA” exemption. Certain other prohibited transaction exemptions that were amended in 2016, including most notably a pre-existing exemption for insurance companies and insurance agents, remain in force. However, under the proposal they would revert back to their pre-amendment forms.

The DOL highlighted that the new proposed  exemption does not cover robo-advice arrangements without the interaction of an investment professional.

Conclusion

It is clear that the timing of the DOL proposal was not accidental. It came within days of the implementation date of the SEC’s Regulation Best Interest (“Reg BI”) and shortly after a federal appellate court denied claims by several state attorneys challenging the adoption of that Reg BI regulation. As a result, the DOL made its intention to sync with the new SEC Reg BI standards framework explicit, highlighting that “the best interest standard in the new proposed class exemption is aligned with the conduct standards in the Securities and Exchange Commission's Regulation Best Interest.” Expect many comments on how the DOL’s new rules relate to Reg BI.

The proposed prohibited transaction class exemption is broader and “more flexible” than DOL’s prior exemption regime. It is based, in large part, on the temporary enforcement policy created after the court decision to vacate the DOL fiduciary rule. (FAB 2018-02.) Compliance officers that have modified their frameworks to conform with the Impartial Conduct Standards should be ahead of the curve. But, before drawing what may appear to be straightforward conclusions, it is important to remember that we have been here many times before (and that state actions on investment adviser standards are still alive and kicking.)  Bates will keep you apprised.

 

[1] The term “Plan” is defined for purposes of the exemption as any employee benefit plan described in ERISA section 3(3) and any plan described in Code section 4975(e)(1)(A). The term “Individual Retirement Account” or “IRA” is defined as any account or annuity described in Code section 4975(e)(1)(B) through (F), including an Archer medical savings account, a health savings account, and a Coverdell education savings account.


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07-24-20

Welcome to Our New Bates Experts

Bates Group is proud to welcome our newest experts and consultants: 

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Amy Bard, Esq.

Sales Practice Litigation, Compliance, Senior Investors

Amy Bard is a Bates affiliate expert with 37 years of litigation experience. After starting her career at a major Wall Street firm, she served as an Assistant District Attorney at the Manhattan District Attorney’s office, where she prosecuted major narcotic traffickers resulting from investigations by the Drug Enforcement Agency. Ms. Bard has devoted the last 20 years of her legal career to litigation in the securities and financial services arenas. As in-house counsel to UBS Financial Services, and later principal at Bressler, Amery & Ross (a national firm representing major broker-dealers and Investment advisors), she gained extensive experience arbitrating before FINRA and other regulatory tribunals.

Full Bio

 

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Paula Barnes

Retail Industry Expert, Retail Contracts, Regulatory and Compliance investigations

Bates affiliate expert Paula L. Barnes is currently Senior Counsel for Macy’s, Inc., and serves as a marketing law and retail regulatory law generalist strategically advising Macy’s, Bloomingdale’s, and Bluemercury clients on a variety of matters. Her practice areas at Macy’s include reviewing, drafting, and negotiating vendor contracts, designer collaboration and other apparel distribution/co-branding agreements, sponsorship, data analytics, technology platform agreements, and talent releases. Ms. Barnes also advises on advertising, social media, and digital marketing; corporate social responsibility strategy, including corporate diversity and inclusion efforts and multi-cultural community engagement, cause marketing, and corporate giving objectives, sustainability initiatives and green marketing and other brand protection matters. She is a member of the Macy’s Diversity and Inclusion Business Council and a 2019 participant in the company’s Strategic Leaders Institute. 

Full Bio

 

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Linda Houston

Wealth Management, Branch Management, Hiring and Recruiting, Retail Securities Litigation and Arbitration

Linda Houston is a Bates affiliate expert with nearly 20 years of leadership experience at Merrill Lynch (1999-2017) with various roles including extensive recruiting of Financial Advisors. She has hired under the known Broker Protocol agreements and was instrumental in training Market Executives nationwide on recruiting practices. Ms. Houston made over 100 recruit hires in her tenure as a Market/Managing Director, and her involvement included initial recruit discussions, proper transitions under broker protocol, financial transition packages, deferred compensation, and incentive compensation. Her in depth and personal knowledge of recruiting practices across the industry makes her a valuable resource to firms.

Full Bio

 

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Donald Mattersdorff, CFA

Investment Advisory, Risk Management, Securities Analysis (Equity and Fixed Income)

Donald Mattersdorff is a Bates affiliate expert who has over 30 years of experience as a portfolio manager and an investment advisor for families, trusts, mutual funds, and institutional clients. He is highly experienced in the construction of investment portfolios of stocks and bonds for private clients, as well as portfolio management for pension funds. He is also knowledgeable in equity and fixed income analysis, as well as economic analysis currency risk management and mean-variance portfolio optimization. Mr. Mattersdorff has additional experience in portfolio performance reporting, including portfolio performance attribution analysis.

Full Bio

 
Need a Consulting or Testifying Expert? Please visit our Expert Search to view our online roster of Bates experts and consultants or call us at 503-670-7772.
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07-22-20

Bates Practice Leadership Insights: Julie Johnstone on the Changing Litigation Landscape

As Managing Director for Bates Group's Retail Litigation practice, Julie Johnstone manages and oversees financial litigation and arbitration matters. Her team assists broker-dealer and investment advisers, banks and insurance companies, as well as State and Federal Regulators, throughout the life cycle of their retail litigation matters, from early case assessments, profit and loss reports, damage analyses, and “what if” scenarios, to expert consultation and testimony at hearing, as well as mediation and settlement support. We asked Julie to consider the state of retail litigation in light of the pandemic and to anticipate some of the long-term implications on case management and dispute resolution going forward. Here is a recap of our conversation.

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Question: The pandemic has had a significant disruptive effect on retail investors and the financial markets. Do you expect to see a surge of litigation as a consequence?

Given that the recent market decline was one of the steepest and fastest in history, we are expecting an increase in litigation, especially where investors have incurred realized losses. However, the extent of litigation could be dependent on the shape of the market recovery, and, given that the market has recovered fairly quickly, we would possibly expect to see fewer claims filed involving paper or unrealized losses. Our past experience with market volatility, as well as recent news and our discussions with clients, support this expectation.

When do you anticipate an uptick in litigation activity?

There is always a lag after a market decline before claims are filed, and services are requested at many points throughout the lifecycle of a case—that is, from pre-litigation to resolution. Our clients tell us that their pre-litigation teams are busy. We are also currently working our way through pre-pandemic claims involving strategies to enhance yield, private placements, allocation drift, alternative investments, and others.

What types of retail investor claims do you expect to be filed as result of the pandemic? 

We monitor economic trends, market events in sectors (such as oil and gas) and liquidity issues, generally. These are the kinds of indicators that provide insight for our clients and help us better understand the emerging landscape. Right now, we expect future claims related to margin and securities lending accounts, energy- and airline-related investments, and other sectors impacted by various stay-at-home orders and business closures. In addition, we expect to see claims filed with respect to volatility-linked investments, order execution, vulnerable investor issues, business interruption, employment, general suitability, and allocation issues relating to the overall market decline and volatility, just to name a few.

How will litigation practice change as a result of the pandemic?

Time will tell, but many practice details will be altered. For example, expect greater use of video conferencing in conjunction with the traditional in-person arbitrations. Our experiences under current, temporary conditions, such as managing through the delays and postponements of hearings, may offer some indications about future changes. Permanent norms have not yet been established, but in-person FINRA hearings are still being postponed through September. Where both parties agree, counsel will need to navigate whether to move forward with video hearings or continue to postpone.

Further, we’ve noticed that some of our clients are expecting that claimants might be more motivated to settle the cases that were originally scheduled for hearing during the 2020 summer, rather than having to wait for the matter to be heard at a future date. So, the new environment not only impacts procedures, but it also may have tactical and even strategic consequences as well.

In the Retail Litigation practice at Bates, we have been adapting during this period as we support our clients toward a new normal. For example, our team of experts and case managers is training to effectively use various video conferencing platforms; we have been communicating more with our clients to better understand their needs as they consider pandemic-related challenges and an increasing number of claims; and, as mentioned, we have been proactively exploring issues that are likely to result in litigation our clients will face.

Tell us more about how you are working with clients to prepare for potential litigation.

One way we are helping our clients prepare for the potential increase in litigation is through various CLE webinars, a number of which have been completed, and others which are in development. We are also publishing relevant alerts and communications. These communication efforts concern the latest thinking around financial market issues like the trading of complex products. Recent program headlines include: “Senior and Vulnerable Investor Protection;" "Potential Litigation Claims in the COVID-19 World;” “Regulatory and Litigation Issues in a Post COVID-19 World;” “Introduction to Arbitrator Evaluator & ABCs of Financial Schedules;” “Reg BI for Litigators;" and "Best Practices in Defending Margin-Related Cases." Upcoming webinars and recorded programs are listed online. 

The pandemic has increased uncertainty and some stress, but it has also accelerated change throughout the financial sector. What are the positive consequences coming out of this?

Yes, it has. This has been a very challenging time for many businesses and individuals, and Bates is no exception. As our clients have had to do, we have adapted, and I would say we have done so successfully. Bates shifted to a 100% remote workforce mid-March without missing a single client deliverable. Through the transition, and over the last few months, Bates staff have engaged technology to develop new norms for staying connected and managing work effectively.

What will you be grateful for when this pandemic is over?

The pandemic has offered a time to reflect both professionally and personally. I have reflected on the many things to be grateful for over the last few months. I am grateful to the first responders, for the ability to continue working while so many have lost their jobs, and for the ability to spend quality time with my immediate family. I look forward to seeing my friends and clients in person and to visiting my favorite establishments as they reopen. And, I am hopeful for an economic recovery that allows us all to thrive.

The current crisis presents many challenges. Bates practice leaders, consultants, and experts can help. Please contact:

Julie Johnstone, Managing Director, Retail Securities Litigation

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

A. Christine Davis, Managing Director, Forensic Accounting and Financial Crimes

Greg Faucher, Managing Consultant, Insurance and Actuarial Services

Robert Lavigne, Managing Director, Bates Compliance

Edward Longridge, Managing Director, Bates AML and Financial Crimes

 

You may also be interested in:

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

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

Bates Practice Leadership Insights: Regulatory Investigations Now and on the Horizon

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07-21-20

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

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The COVID-19 pandemic has created new compliance and regulatory risks for financial institutions. New avenues for money laundering have sprung up, presenting challenges for financial institutions facing pandemic-related resource constraints. Join Edward Longridge (Managing Director, Bates AML and Financial Crimes), Daniel Nathan, Jeanine McGuinness and Matthew Moses (Partners, Orrick Herrington & Sutcliffe LLP), and Bates AML Compliance Expert Gary Ferrari, for this CLE webinar which will examine how financial institutions can adapt their AML programs to the new financial environment and regulatory expectations.

Among other things, we will discuss:

  • Money laundering risks created by the current business environment
  • Regulatory pronouncements and expectations related to the pandemic
  • How financial institutions should assess the adequacy of their AML programs to operate effectively in this environment
  • How financial institutions should modify programs in light of the assessment

Registration is required to attend this Zoom webinar.

Date: Thursday, July 30, 2020

Time: 12:00 p.m. Eastern / 9:00 a.m. Pacific

Program Length: 1 hour

Register Here

 

Orrick, Herrington & Sutcliffe LLP is an accredited MCLE provider in the State of New York. This non-transitional continuing legal education course has been approved in accordance with the requirements of the Continuing Legal Education Board for a maximum of 1.0 credit hours, of which 1.0 credit hours can be applied toward the areas of professional practice requirement.


Program Speakers:

Edward Longridge - Managing Director, Bates AML and Financial Crimes

Daniel Nathan - Partner, Orrick Herrington & Sutcliffe LLP

Jeanine McGuinness - Partner, Orrick Herrington & Sutcliffe LLP

Matthew Moses - Partner, Orrick Herrington & Sutcliffe LLP

Gary Ferrari - Bates AML Compliance Expert

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07-16-20

New OCIE, FinCEN Alerts Emphasize Vigilance Against Ransomware, Imposter Scams, Money Mule Schemes

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In the past week, the SEC Office of Compliance Inspections and Examinations (OCIE) and the Financial Crimes Enforcement Network (FinCEN) warned financial institutions to guard against specific and increasingly prevalent types of fraud against consumers. These activities have been uncovered through examinations, suspicious activity reports (SARs), law enforcement information and public reporting. OCIE and FinCEN’s alerts follow other federal and state reports (see Bates coverage here and here) urging firms to increase vigilance against similar crisis-related misconduct.

Specifically, OCIE staff cautioned SEC registrants, including broker-dealers, investment advisers and investment companies, as well as registrant service providers, of an increase in the number and nature of ransomware attacks. FinCEN cautioned institutions about a rise in money mule schemes and imposter frauds that attempt to con investors and other consumers into deceptive transactions. Here are the highlights:

OCIE Warns Firms to Monitor for Ransomware

OCIE staff describes “ransomware” as “a type of malware designed to provide an unauthorized actor access to institutions’ systems and to deny the institutions use of those systems until a ransom is paid.” The systems in question usually affect the “integrity and/or the confidentiality” of customer data.

OCIE is concerned about recent reports that the latest attacks directed at both SEC-registered institutions and their service providers are becoming increasingly sophisticated. The purpose of the alert was not to offer a one-size-fits-all approach to protect against ransomware (such a solution does not exist), but rather to highlight recent observations on the subject so that firms can strengthen their “cybersecurity preparedness and operational resiliency.” 

OCIE staff recommends that firms review and update incident response and resiliency policies, procedures and plans. Such a review should include  (i) contingency and recovery plans for various denial of service scenarios, (ii) procedures for notification of an event, incident escalation, and stakeholder communications; (iii)  processes for material event and suspicious activity reports (SARs); (iv) notification procedures for law enforcement and customers; (v) restoration of service processes; and (vi) backup applications to ensure the operation of critical services.

OCIE also wants firms to heighten their awareness of cyber-risk and boost their cybersecurity training and test responses through, for example, phishing email exercises. Further, OCIE wants firms to review and tighten their access management systems with the “least privileged access” in mind. This requires firms to configure controls “so users operate with only those privileges necessary to accomplish their tasks.” Finally, the staff recommends that firms review and strengthen their “perimeter security capabilities” including firewalls, detection systems, email security and web proxy systems in order to manage their network and “prevent unauthorized harmful traffic.”

The OCIE staff referenced other SEC cybersecurity guidance and offered additional links from the Cybersecurity and Infrastructure Security Agency (CISA) of the Department of Homeland Security (see here for an alert describing a particular ransomware threat) and the FBI (see here for a 2019 ransomware alert). Staff reminded firms that cybersecurity compliance was an examination priority.

FinCEN Warns Firms to Look for Imposter Fraud and Money Mule Schemes

FinCEN’s advisory focusing on money mule schemes and imposter scams is a kind of primer on reporting suspicious consumer fraud activity. In the advisory, FinCEN discussed the nature of these particular frauds, relevant indicators that should raise institutional red flags and additional information to be included for SARs reports.

Imposter Scams

FinCEN defines imposter scams as involving an actor “contacting a target under the false pretense of representing an official organization, and coercing or convincing the target to provide funds or valuable information, engage in behavior that causes the target’s computer to be infected with malware, or spread disinformation.”

COVID-19-related imposter scams include bad actors posing as IRS officials, the CDC, the World Health Organization, and non-profit health and academic institutions. FinCEN noted the many tools used by these actors to defraud the vulnerable, the elderly and the unemployed including the use of social media, telephone and robocalls, text messages, websites, and emails, as well as off-line activities such as “door-to-door collections” and flyers.

FinCEN emphasized that the objective of these scammers is primarily to target customers directly. As a result, FinCEN wants financial institutions to be aware of indicators on customer accounts that should trigger firms to be alert. COVID-19 red flags include bad actors offering to “verify, process or expedite” stimulus payments or other benefits under the Economic Impact Payments program, or prepaid debit cards under the Coronavirus Aid, Relief, and Economic Security (CARES) Act. Other attacks seek to obtain confidential financial information for some health-related purpose like contact tracing. FinCEN warns that institutions should be on guard against phishing emails ostensibly coming from government or non-profits, but that use commercial domains (e.g., “dot-com”). Other red flags include solicitations which are publicly unverifiable and often contain errors like misspellings. FinCEN said that these indicators, in context, may be considered suspicious for reporting purposes.

Money Mule Schemes

FinCEN defines a “money mule” as any “person who transfers illegally acquired money on behalf of or at the direction of another.” FinCEN highlighted COVID-19 money mule schemes in three categories: good-Samaritan, romance, and work-from-home, the latter presenting as an offering for a work-from-home job which involves the target agreeing to “move funds through accounts or to set up a new account” on behalf of the “business.”

The agency describes distinctions among an “unwitting or unknowing money mule,” a “witting money mule” and a “complicit money mule,” all defined by the person’s awareness, motivation and level of participation in the larger scheme. FinCEN says that all three types of money mules are deployed in COVID-19 schemes.

Red flags pertaining to COVID-19 that should trigger firms to be alert for money mule schemes include, among others: (i) receipt of transactions that do not fit a customer’s profile (e.g., overseas transactions, purchase of convertible virtual currency); (ii) unsatisfactory answers to “know your customer” inquiries;  (iii) the opening of new bank accounts in the name of a business (possibly at multiple banks) and someone other than the customer transferring funds out of the accounts; (iv) receipt of multiple unemployment insurance payments within the same time period or from numerous employees (with ACH payment names that don’t match the account holder);  (v) deposits that get diverted quickly “via wire transfer to foreign accounts;” (vi) documents related to the “employer” showing the use of a free email server rather than a company-specific email; and (vii) out-of-the-ordinary requests from the customer’s new employer to send and receive funds through the customer’s personal account (especially for individuals claiming to be U.S. citizens or servicemen currently abroad.)

SARs Reporting

FinCEN also provided very specific instructions for filling out SARs reports on COVID-19-related scams. FinCEN advised financial institutions to use specific language and to reference (in specific fields) this imposter scam/money mule scheme advisory on SARs reports where the circumstances or subject matter matches. Proper reporting on this activity, FinCEN states, will improve “law enforcement’s abilities to identify actionable SARs…and pull information to support COVID-19-related investigations.”

Conclusion

These issues are not new, but they have been taking on additional urgency since the advent of the pandemic. “The two alerts reinforce the risk-based approach to firm compliance obligations and highlight the necessity to consider context and a customer’s historical financial activity, among other facts and circumstances, when making determinations on reporting potential suspicious activity,” said Edward Longridge, Managing Director and Head of Practice, Bates AML & Financial Crimes.

 
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07-15-20

Virtual Event: NSCP 2020 Midwest Regulatory Interchange

Virtual Event: NSCP 2020 Midwest Regulatory Interchange
Linda Shirkey

The NSCP 2020 Midwest Regulatory Interchange with the SEC, DOL and FINRA is taking place on July 24, 2020. This event will provide an informal virtual setting for Investment Adviser, Private Fund and Broker-Dealer industry professionals to hear from the regulators and ask questions. Bates Compliance Managing Director Linda Shirkey (pictured) will be speaking on the SEC Discussions panel at 9 a.m. Mountain Time, 11 a.m. Eastern.

For more information and to register, please visit the NSCP event page.
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07-13-20

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

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Join Bates Compliance's roundtable discussion, featuring Rob Guldner (RIA CCO, Advisor Group) and Sandra Grannum, (Partner, Faegre Drinker Biddle & Reath, LLP), along with Bates Compliance Managing Directors Hank Sanchez and Linda Shirkey, and Director Rory O'Connor.

Our industry experts will address Business Continuity Plan (BCP) design and implementation, including:

  • Unanticipated issues, gaps, and shortcomings that companies may have endured as a result of the COVID-19 pandemic
  • Precautionary measures that companies can consider to improve their current BCP plans and help ensure the safety and health of their employees returning to in-office jobs
  • How best to prepare for significant future business disruptions and a COVID resurgence

Registration is required to attend this Zoom webinar.

Date: Wednesday, July 15, 2020

Time: 12:00 p.m. Eastern / 9:00 a.m. Pacific

Program Length: 1 hour

Click Here For More Information and To Register

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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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06-26-20

Bates Practice Leadership Insights: Regulatory Investigations Now and on the Horizon

Bates continues our practice leadership conversations this week with Alex Russell, Managing Director of Bates’ White Collar, Regulatory and Internal Investigations Practice. Alex’s team supports corporations, financial services firms, law firms and regulators by bringing technical, big data analytics and managerial expertise to a variety of disputes and investigations. He also co-leads Bates’ big data analytics service and manages matters involving the assessment of economic damages. We asked Alex about regulatory investigations, big data and the issues firms and their legal counsel are currently concerned about. Here is a recap of our conversation.

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Question: How has the pandemic affected your clients right now?

Generally, I would say that firms are under considerable and increasing pressures created by market uncertainty. The added pressures come not only as a direct consequence of market declines and volatility, but also from the way that regulators, customers, employees and even litigants react to it—often exacerbating problems by layering on top their own concerns and urgencies. Add to that the very real challenges of working remotely (including issues as disparate as cybersecurity and childcare), and it is fair to say that our clients are operating in a very difficult environment. The top concern that I hear, from nearly everyone, is that there are just not enough hours in the day to get done what needs to get done.

Let’s talk first about regulatory investigations. Do you expect an uptick in investigative activity as a consequence of this market volatility?

Absolutely. But this should not be a surprise. The regulators have been very vocal, in public and private, that they are minding the store and fulfilling their oversight and investigative responsibilities. And they are intent on proving it. At Bates, we are already seeing an uptick in such regulator activity, but as with prior market dislocations, we should adjust our expectations and prepare for these current regulatory investigative priorities to play out over the next several years.

Can you be more specific? What sort of regulatory enforcement matters, for example, should we expect?

Some are very easy to see coming; anything involving leverage for example, whether in the form of margin, the use of options, or leveraged ETFs / structured products themselves. We’ve had ascending markets for so long that leverage has become a normal part of the market again, and may have even been extended into areas that the regulators will deem inappropriate. Fraud claims will also rise, from penny stock’s touting COVID-19 vaccines, to individuals running Ponzi like schemes that are exposed when new investments dry up. Uncertainty creates an opportunity for many different types of fraudsters to take advantage of that confusion to the detriment of investors. The increased pressure on reps to try and sustain the income level they need will tempt some to bend the rules in ways that are sure to prompt action. It seems unlikely that the regulators will stop pursuing the fee-based actions (12b-1, 529, revenue sharing) that they have been pursuing over the last few years, so I expect those to continue as well. We’ve handled well over 30 of those types of investigations and claims for our clients, and we have not seen any indication of those slowing down at all. The list goes on.

What is the outlook in the white collar space?

Market manipulation schemes, in particular penny stock pump-and-dump schemes will show up quite regularly, and have already started to do so. Similarly, insider trading allegations around the use of material non-public information will be a source of steady activity, in addition to many of the same actions (fraud, for instance) that will also be the target of regulatory scrutiny. We’ve been steadily working on insider trading, and market manipulation matters even more so, pre-COVID-19 and expect to handle quite a few more after this. Interestingly, many of our recent pump-and-dump matters have been in a criminal rather than civil context, I am curious to see if that trend reverses itself or if the pandemic will accelerate the trend of criminal indictments.

How will big data shape this conversation?

The analysis of big data will play a critical role in helping to resolve many of the issues being raised. Since these issues will cut across firms as a whole, the analysis would be infeasible without the use of big data. Many of the regulators are already reporting sharp increases in the alerts being generated by big data analysis for market surveillance. For instance, FINRA noted a 200% increase in alerts around best execution, wash sales, spoofing, and layering. Regulators are using the tools of big data analysis to “spot risk bubbling up,” and those same tools can help firms identify risk internally, conduct their own investigation and analysis, and resolve the underlying issues. Big data will be a critical part of identifying what will show up when Regulators examine firm behavior, and in responding to claims made by the regulators on the basis of big data analysis. Enforcement actions will likely intensify as a result of these developments.

In many cases, we have taken on large-scale investigations by serving as a critical external resource for big data and analytics assignments. This lets our clients’ internal personnel focus their resources on their essential, day-to-day tasks.  Since the onset of COVID-19, we have also been asked to provide insight into peer practices and to collate trend information gathered through interaction with the regulators. This has been positively received by our clients, who feel forearmed with useful information prior to interacting with regulatory staff.  Clients appreciate being able to speak with our staff knowing that they have dealt with the same or similar issues on behalf of other clients, and that we have the technical skills to perform efficient, accurate, and insightful quantitative analysis. That combination of skills and awareness of how the regulators are treating certain issues has allowed us to assist counsel in delivering positive outcomes for their clients.

What final thoughts are you offering to clients at this time?

First, work diligently to maintain your pre-pandemic compliance processes and procedures, and document your efforts. Second, keep up with regulators’ current expectations of firm practices. To the extent possible, talk to peers and counterparts in other firms to find out what they are seeing, what is working and what isn’t. Third, review the available data out there and do what you can to form an accurate picture of how the industry is responding to the challenges this crisis has created. Finally, use all available information to forecast developing trends so you can spot the opportunities and avoid the pitfalls.

 

The current crisis presents many challenges. Bates practice leaders, consultants, and experts can help. Please contact:

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

Edward Longridge, Managing Director, Bates AML and Financial Crimes 

Christine Davis, Managing DirectorForensic Accounting & Economic Damages

Dennis Greenberg, Managing Director, Third Party Risk Management Services

 
You may also be interested in:

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

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

 
Don't miss our Webinar July 9, 2020: Regulatory Exams and Investigations in the Age of COVID-19. Presented by Bates Group and Eversheds Sutherland.

Click Here to Register for this Zoom Webinar

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06-18-20

FINRA Special Alert Offers Observations on COVID-19 Remote Work and Supervisory Practices

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FINRA issued Special Alert Notice 20-16 to share COVID-19-related off-site transition and supervisory practice information. The information was derived from recent FINRA discussions with small, mid-sized and large firms. FINRA cautioned that they “have not yet evaluated these practices in our examination programs,” but, nonetheless suggested that firms consider whether they are “applicable” and whether they would enhance supervisory systems and compliance programs during this period.

Bates has been reporting on COVID-19-related guidance since the pandemic began and maintains a topic page on the subject with links to both federal regulatory sites (including FINRA’s resources page) and Bates news and information. Here we take a closer look at FINRA’s observations on firm efforts to transition to remote work environments and to supervise remote work activities.

Remote Work Environment Transition Practices

FINRA reports that firms took a wide range of steps to enhance their compliance efforts and their ability to serve customers from remote locations. FINRA categorizes these steps in four areas: customer assistance, off-site work protocols, staff communications and cybersecurity.

For customers, firms took immediate steps to provide contact and branch office closure information on their web sites and to route customer calls and requests for appointments through a centralized hub. For employees, firms added procedures to better monitor and to record the location of staff, and to continuously update contact information for “compliance, legal, operations and other departments.”

Some firms adjusted communications practices to minimize the risk that staff “would use personal or unapproved systems and technology to conduct firm business.” FINRA stated, for example, that firms were providing (i) “all-hands” videoconferences on operations; (ii) “clear guidance” on working remotely; (iii) technology hardware “to better equip staff to work from home” and (iv) virtual trainings on new and approved technology platforms and applications.

Further, firms reported that they increased their use of virtual trainings and other efforts with respect to cybersecurity and the confidentiality of firm and customer information. Firms disclosed that they were issuing frequent internal reminders on compliance with material non-public information requirements. In addition, firms communicated precautions around “maintaining a private workspace from home,” including extra care when working near family or friends. Firms also said they were enhancing the oversight of their “critical information” technology vendors.

Remote Work Supervisory Practices

FINRA relayed that while firms expressed confidence that they were “relatively prepared” to supervise associated persons working from home (i.e. through the use of “checklists, surveillance tools, incident trackers, email review and trade exception reports”), some firms described additional steps they took to ensure that their supervisory practices and procedures were followed. These additional steps cover (i) overall supervision, (ii) trading supervision, (iii) supervision over customer communications and (iv) branch inspections.

Firms reported many steps to strengthen general supervision of associated persons working in remote locations. In anticipation of the lock-down, for example, some firms described special efforts to test and perform a “gap analysis” to ensure adequate remote compliance with documentation requirements. Firms also set up processes to identify emerging issues or trends gleaned from “increased alerts, exception reports and customer complaints.” These processes supported additional firm guidance to supervisors acting on these concerns, including coaching and “over-escalating” identified issues.

Some firms strengthened their existing “electronic supervisory checklists with attestations and electronic affirmation via voting buttons.” As to other general supervision issues, firms said they improved their overall communications efforts by requiring frequent and regular senior leadership meetings, opening communications channels between supervisors and compliance staff and by establishing feedback mechanisms from staff to promote best remote office practices.

On trading supervision, firms added to their oversight by tightening controls and adding new special elements to supervisory checklists. Specifically, firms enhanced their oversight capabilities by requiring additional prescreens, additional supervisory approvals (with attestations), additional testing of traders’ remote technical capabilities, and by increasing the frequency and thresholds for certain trade reporting and alerts. Further, some firms reported additional monitoring of supervisory activities and increasing the frequency of “check-ins” with traders.

In addition to supervision of customer communications through existing methods, some firms added several more layers of oversight. These include increasing the frequency of email review, enhancing communication surveillance, expansion of using recorded lines for orders, and disabling certain features of communications platforms in order to ensure full and accurate recordkeeping.

Finally, FINRA asked firms about their branch office inspections. Some firms reported that they created a temporary remote branch office inspection plan which relies on technology and video and electronic document review. Firms made clear, however, that such inspection plans merely defer the required onsite inspections to a later time and that when pandemic restrictions are lifted they will prioritize high-risk, on-site branch inspections.

Conclusion

In this Notice, FINRA documented a broad range of methods firms have devised to transition to remote offices and to supervise associated persons. These steps are, of course, a proactive way for firms to fulfill their obligation to implement a reasonably designed supervisory system appropriate for the firm’s size and business model. FINRA recommends that firms contact their designated Risk Monitoring Analyst with questions about these or other methods undertaken during this time. FINRA is once again setting the expectation that firms need to fully consider their compliance practices carefully during this time. Bates will continue to monitor and summarize these regulatory compliance developments.

Bates Compliance practice leaders and consultants are available to answer your questions on compliance, risk, supervision and audit matters to help you through this period. Please reach out.

Contact:


Join us on July 15th, 2020 for a Bates Compliance Business Continuity Webinar. 

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06-15-20

Bates Media Mentions: Bob Lavigne and Hank Sanchez Quoted in Investment News and AdvisorHub articles

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Robert Lavigne, Managing Director and head of Bates Compliance, and Hank Sanchez, Managing Director, Bates Compliance are both quoted in the Investment News cover article “The Sound of Silence,” concerning Reg BI and Form CRS, published on June 1, 2020 (print edition).

Link to Investment News

 

Mr. Lavigne is also quoted in the June 4, 2020 AdvisorHub article "J.P. Morgan Securities Unfurls New Comp Plan on Eve of Reg BI."

Link to AdvisorHub

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06-12-20

Bates Group Response to COVID-19 (Updated)

As the news and impact of COVID-19 continue to evolve, I am reaching out to update you on the steps that Bates Group is taking to promote the health and safety of our employees, consultants, and clients, as well as ensure uninterrupted operations during this crisis.

Bates Lake Oswego Office: The Bates Group Lake Oswego office remains closed and our employees will continue to work remotely. Until further notice, our office will also remain closed to vendors and visitors, unless there is an essential need. When our offices do reopen, Bates employees will have the option to continue to work remotely, and Bates Group will limit the number of employees, ensure social distancing, require personal protective equipment as necessary, and adhere to strict cleaning requirements and gathering restrictions.

Travel Restrictions:  Bates Group continues to suspend business travel until further notice.  Non-essential travel should be limited and consistent with state or local guidelines.

Remote Work / Telework:  Bates continues its flexible work arrangements and employees continue to work remotely. 

Bates Group’s IT Department continues to improve infrastructure and security, and the ability to work and collaborate remotely ensures that Bates is able to deliver high-quality services without interruption. In addition, ongoing remote work and system stress tests continue to validate that our IT infrastructure fully supports our new normal.

Meetings and Events:  Bates will continue to suspend work-related participation in any in-person public events or gatherings.  As with travel restrictions, we will regularly review this restriction and update with any changes.  

Bates Group will continue to monitor developments and adhere to federal, state, and local guidance. 

 

For the latest updates on COVID-19, please review the following:

Please do not hesitate to reach out to me or members of the leadership team with any questions.

Thank you,

Jennifer Stout, CEO
email: jstout@batesgroup.com
main: 503-670-7772

updated: 6/12/2020
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06-11-20

NASAA Annual Report Flags Cyber Risk, Investment Adviser Exam Deficiencies and Best Practices

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The highlight of the North American Securities Administrators Association’s (“NASAA”) 2020 Investment Advisor Section Annual Report on state-registered investment advisers is the growing concern by state regulators over cybersecurity preparation and practice. Based on firm examinations in 41 U.S. jurisdictions during the first half of 2019, NASAA found that cybersecurity deficiencies are on the rise. The issue has taken on new urgency in the wake of the pandemic.

In the annual report, published during the height of the panedemic, NASAA publicized its members’ adoption of an information security and privacy model rule to address some of these concerns and provided a list of best practices to assist investment advisers in developing and implementing effective compliance procedures. In addition, NASAA offered some general statistics on the condition of the industry and noted committee and project successes over the past year.  Here’s a closer look.

Cybersecurity Remains Top Issue

The main concern in the report—the rise of cybersecurity-related deficiencies across state adviser firms—was based on information that is now nearly a year old. This is significant because the pandemic has only exacerbated many of the issues raised in guidance presented since then. (See, e.g. Bates coverage of SEC Office of Compliance Inspections and Examinations Report.) According to the NASAA report, the top five cybersecurity-related deficiencies among state registered investment advisers were: (i) a lack of cybersecurity vulnerability testing; (ii) a lack of procedures regarding securing or limiting access to devices; (iii) a lack of procedures related to internet connectivity; (iv) weak or infrequently changed passwords; and (v) inadequate cybersecurity insurance.

The data showed that these deficiencies were present in 26% of examinations, up from 23% in the last 2017 analysis. NASAA noted that the problem is acute for the state-registered investment adviser community, given that “three fourths of the nearly 18,000 state-registered investment advisers are 1- to 2-person shops.” Because these advisers have limited resources, they are considered to be particularly vulnerable to attacks.

Alex Glass, Indiana Securities Commissioner and Chair of NASAA’s Investment Adviser Section, suggested that NASAA’s new information security and privacy model rule should help. He stated that the new rule “represents a significant step toward enhancing the cybersecurity and privacy practices of state-registered investment advisers.” As Bates described previously, the new rule requires investment advisers to adopt policies and procedures related to the security of both physical and digital information, including that a firm (i) establish an “organizational understanding to manage information security risk to systems, assets, data and capabilities;” (ii) provide “safeguards to ensure delivery of critical infrastructure services;” (iii) be able to detect, (iv) be able to take action in case of, and (v) be able to restore any capabilities or services after, an “information security event.”

In the annual report, NASAA encouraged firms to review their Cybersecurity Checklist and related Guidance. These documents detail assessment areas that can help to detect cyber vulnerabilities, and to recover from cybersecurity breaches. The material was prepared by NASAA’s Cybersecurity and Technology Project Group, which noted in their status update that it was turning its attention to developing materials “on how firms can prepare and plan to meet demands in a shifting landscape of cybersecurity threats.”

The security and privacy model rule was also part of last year’s agenda of NASAA’s Regulatory Policy and Review Project Group. In their status update for NASAA’s annual report, the Group listed an ambitious agenda including a host of ongoing initiatives on new model rules. These include proposals on investment adviser policies and procedures, a code of ethics, proxy voting procedures, and investment adviser representative continuing education, Further, the Project Group said it was working with investor, advocacy and industry groups on investment adviser fee models, unpaid arbitration awards and drafting guidance on standing letters of authorization, among other topics.

Additional Compliance Guidance

In the annual report, NASAA offered a checklist of best practices to assist firms generally in the development of compliance practices and procedures. The items on the checklist respond to some of the deficiencies found in NASAA’s comprehensive state examinations. The checklist suggests that firms should review their: (i) Form ADVs, (ii) contracts, (iii) policies and procedures for the preparation and maintenance of financial records with electronic data backup; (iv) client profiles and client suitability documentation, (v) written compliance and supervisory procedures manual, including business continuity plans and information security policies/procedures; (vi) privacy policies and (vii) custody safeguards, especially for direct fee deductions.

Comparison of Deficiencies Found in State Examinations

NASAA’s Investment Adviser Operations Project Group compiled a comparison of the state-registered investment adviser firm examination deficiencies over the past biannual periods. The group found that books and records deficiencies (59%) presented the most compliance challenges. Registration deficiencies (49%), contract deficiencies (44%), cybersecurity concerns (26%), and fee-related matters (21%) followed. Overall, NASAA reported that the number of deficiencies in every category except cybersecurity decreased.

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Source: NASAA 2020 IA Section Report

In their status update, NASAA’s Operations Group announced the completion of examiner tools to “help examiners review Form ADV Part 1 and 2 for consistency and agreement with the advisory contract,” as well as a stand-alone Licensing Module “to help licensing personnel review and document issues with investment adviser registrations.”

Additional State Registered Investment Adviser Data

NASAA reminded readers that state regulators oversee all investment advisers with assets under management of $100 million or less. The report provides a host of additional and comparative data on state investment advisers. For example, eighty percent (80%) of state investment advisers are small businesses located in “most every town in every state across the country.” The vast majority of clients—eighty-two percent (82%) of nearly 750,000 clients—are retail investors. Sixteen percent (16%) are high-net-worth individuals. The top services provided by these state advisers to clients are portfolio management for individuals (83%) followed by financial planning services (64%). For a significant majority of clients, adviser fees are charged as a percentage of assets under management (84%). Fifty-three percent (53%) of clients are charged an hourly fee, and fifty percent (50%) are charged on a fixed-fee basis.

Conclusion

The current COVID-19 crisis has exacerbated many of the cybersecurity concerns raised in NASAA’s annual report. Between the SEC OCIE report and this NASAA report, firms should be focusing on how best to tailor their cybersecurity efforts to protect their customers and preparing for the next examination.

 

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

Robert Lavigne, Managing Director, Bates Compliancerlavigne@batesgroup.com

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

Dennis Greenberg, Managing Director, Third Party Risk Managementdgreenberg@batesgroup.com

 
Need cybersecurity support? Learn more about Bates Group’s Cybersecurity Compliance capabilities and Consultants.

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06-10-20

CLE Webinar: Reg BI for Litigators - The New Game Changer

CLE Webinar: Reg BI for Litigators - The New Game Changer

Starting on June 30, 2020, recommendations of securities to retail customers will be governed by SEC Regulation Best Interest (“Reg BI”). The new rule “enhances firms’ standard of conduct beyond existing suitability obligations by, among other things, requiring firms to act in the retail customer’s best interest at the time the recommendation is made, without placing the financial or other interests of the firm ahead of the interests of the retail customer."

In this webinar, join Bates Group Director and nationally recognized expert Bruce Cramer when he presents “Reg BI for Litigators.” Topics will include an overview of the SEC’s Reg BI and the Customer Relationship Summary (“Form CRS”), duties, conflict of interest, disclosure, and care obligations, Reg BI’s impact on FINRA’s retail suitability rule, potential claims, discovery, and more.

Register Now for this Complimentary Webinar

 

When: Thursday, June 18, 2020 – 12:30 p.m. Eastern/ 9:30 a.m. Pacific

Program Length: 1 hour

CLE Credit pending in CA, MO. Reciprocal credit eligible in NY, NJ, FL.

 

Registration is required to attend this Zoom webinar.

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06-09-20

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

Bates continues our practice leadership conversations this week with Edward Longridge, Managing Director of Bates Anti-Money Laundering and Financial Crimes Practice, for his views on the matters most pressing for AML officers right now. Here is a recap of our conversation.

Question: How has the financial anti-money laundering agenda and/or regulatory enforcement framework been affected by the pandemic?  

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Edward Longridge: For AML and fraud departments, two trends have presented themselves since the advent of COVID-19. First, there has been an increase in the number of Coronavirus-related scams, and, in particular, scams targeting the elderly. Fraudsters and money launderers are taking advantage of what they perceive to be opportunities for criminal activity in the current environment. These heightened activities are putting extra pressure on compliance teams to adapt and perform.

Second, the regulators have not taken their foot off the pedal. Expectations, during this time when systems are being stressed, have only increased. While it is true that FinCEN requested financial institutions to contact them if they are having difficulties in the timeliness of Suspicious Activity Report (“SAR”) filings, and though, in certain cases, regulatory exams may be delayed, AML departments must still meet—and indeed exceed—their obligations to fully comply with regulatory rules and expectations. In short, AML and Fraud departments need to be on an increased watch during the pandemic now, and for the foreseeable future.

Question: What should AML officers be focusing on in the next several months? 

There remains uncertainty over how long COVID-19 will last. Even after cities and states reopen, it is anticipated that there will be a large percentage of the population who will opt to work remotely. AML compliance systems will need to adapt to this change as a more permanent reality.

Further, the virus has changed people’s spending habits. This will, no doubt, continue. As a consequence, AML officers should review their transaction monitoring scenarios and rules to tune and adapt them to the changes in transactional behavioral patterns caused by the coronavirus.

Question: Is there a particular area that banks should be paying attention to that may not seem so obvious? 

Yes. Banks should be vigilant over increased fraud attempts and changes in the patterns of their customers’ transaction activity. One area for banks and broker-dealers to pay close attention to is AML volumes. With teams working remotely, firms may find it hard to keep up with the non-stop volume of transaction monitoring alerts which can lead to an increase in backlogs. Banks and broker-dealers should adjust their resources accordingly.

Question: What does post- recovery look like? 

Nobody can realistically foresee all the consequences of what is to follow in the next six months. That said, states will open in phases and will likely take a cautious, staggered approach to avoid a second wave of infections. How successful they will be is unknown.

Financial institutions will need to pay close attention to ensure their offices are compliant with all city, state and federal health guidelines. For example, they may have to reconfigure for social distancing in the office, possibly including redesigned desk space. Firms may also need to rotate their staff between remote and onsite so that not everyone is in the office on the same day. While it is anticipated that regulators will take an understanding approach with financial institutions, AML and financial crimes departments cannot afford to let up.

Question: What type of support are clients looking for now? 

In addition to our ongoing efforts helping clients establish and execute effective AML and financial crimes compliance programs, we are working with a number of parties on third-party risk management. This covers a wide range of topics, including vendor risk management, VPN matters, and cyber security/data security. Several firms have also turned to us recently to help them keep up with their transactional volumes.

Given the prevalence of new scams posed by bad actors, the added stresses placed on compliance programs and systems by remote working arrangements, and the unrelenting demands by regulators to fulfill their anti-money laundering and anti-fraud obligations, firms are under significant pressures. We continue to assist them in these efforts.


The current crisis presents many challenges. Bates practice leaders, consultants, and experts can help. Please contact:

Edward Longridge, Managing Director, Bates AML and Financial Crimes 

Christine Davis, Managing Director, Forensic Accounting & Economic Damages

Dennis Greenberg, Managing Director, Third Party Risk Management Services

 

For further reading, you may also be interested in:

Bates Practice Insights: What Compliance Officers are Thinking About Now

AML Compliance Report: FinCEN Says Hold the Line, FFIEC Updates Exam Manual

White Paper: The Challenges of AML Leadership

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06-05-20

New Capital Market Insights White Paper: Bear Markets, Black Swan Events and Volatility

New Capital Market Insights White Paper: Bear Markets, Black Swan Events and Volatility

The first part of this year has been challenging for the equity markets. With a global pandemic suddenly arising—the likes of which have not been seen in more than 100 years—U.S. economic activity largely halted, and unemployment skyrocketed, reaching in excess of 40 million initial unemployment claims in just 10 weeks. By some estimates, the gig economy, or “1099 workforce,” comprises an additional 20 million people.

Will the economy experience a V-shaped recovery and quickly bounce back or is the recovery likely to be a long, protracted U-shape? That remains a key question. One thing is clear though, life in the time of corona is currently very challenging for people, the economy, and the markets—and much is uncertain.

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The sudden appearance of a severe global pandemic is just the most recent example of a “black swan event” roiling the markets. By definition, black swans are rare and seldom seen, and as such are difficult, if not impossible, to predict. They can be triggered by either unexpected market, economic, or external factors such as geopolitical, war, or terrorist events.

In our new Capital Insights report we examine in detail bear markets, black swan events, and volatility to gain some perspective on how the recent—or current?—bear market compares with historical periods.

Download this white paper

 

Other Bates Research White Papers

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06-04-20

CEO Message: Standing up to Racial Injustice

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To my valued colleagues, clients, and community:

Over the past week I have struggled to find the right words to express my feelings about the events unfolding in our country. I have also debated whether to make a public statement.  However, I think the time has come for me to stand up and speak out from my position as a leader.  I have been horrified by the deaths, incarcerations, and racial inequalities of Black Americans and our country’s inability or unwillingness to make the changes to stop them.  I am deeply saddened by the tragic killing of George Floyd in Minneapolis last week as well as so many other black lives that have been lost over too many years.  While I am dismayed by the violence and destruction that have since followed, I recognize that civil disobedience can be an important catalyst for change.

It is time for us to come together to create change actively and urgently on both systemic and individual levels.  The acts of racism, discrimination and violence must end.  Institutional racism built into our core systems of housing, education, and jobs must be recognized and replaced by opportunities for all.  I am using this forum to state that I stand in solidarity with those fighting to eradicate racial injustice, and I pledge to learn how to be an ally to and actively support the Black community. 

Bates is a firm that has always embraced and thrived on change.  Right now, and into the future we will embrace the call for change among us to support and champion anti-racist values.  Over the coming months Bates will critically re-examine itself and its decisions and look for other ways to promote and uphold our values.  Last year we joined Partners in Diversity, a local non-profit focused on diversity, equity, and inclusion, which gives our team opportunities to participate in workshops and discussions, as well as access to their job board.  We also added a dedicated recruiter to our People and Culture team to help build a quality and diverse pipeline of candidates.

I encourage you to stand with me, and I am seeking to partner with others to open my eyes to even greater possibilities for inclusion and equality.

Finally, I end with this powerful quote from Bryan Stevenson of the Equal Justice Initiative:

“I’m sixty years old and have been practicing law for thirty-five years. I have a lot of honorary degrees and went to Harvard. And I still go places where I am presumed dangerous. I have been told to leave courtrooms because the presumption was that I was the defendant and not the lawyer. I have been pulled out of my car by police who pointed a gun on me. And I can just tell you that, when you have to navigate this presumption of guilt, day in and day out, and when the burden is on you to make the people around you see you as fully human and equal, you get exhausted. You are tired. And I would argue that the black people in the streets are expressing their fatigue, their anger, and their frustration at having to live this menaced life in America.”

I look forward to further dialogue and action. 

– Jennifer   

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06-04-20

Oil-Related ETP Recommendations: FINRA Reminds Firms of Suitability and New Reg BI Obligations

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Concern about recommendations of complex financial products for retail investors has been at the center of the debate over changing standards for broker-dealers and investment advisers. With full implementation of the heightened Regulation Best Interest (Reg BI) requirements less than a month away, FINRA issued a Notice reminding firms of their sales obligations when offering recommendations on complex oil-related exchange-traded products (ETPs).

The FINRA Notice is straightforward. It describes dramatic volatility in the oil market, related ETP product complexity and risk, suitability obligations and soon-to-be-in-force Reg BI obligations on those firms and registered representatives that trade in these products. FINRA’s Notice, therefore, provides an important case study not only as to the specific expectations of firms that trade oil-related ETPs, but also on how the self-regulator appears to be handling concerns about recommendations to retail clients of complex products in a volatile market. Here’s a closer look.

Oil-Related ETPs

Oil-related ETPs are complex financial products. They are listed securities that “provide exposure” based on “the performance of an index, benchmark, or actively-managed strategy.” As such, they meet the description set forth in a previously issued FINRA Notice as having features that “make it difficult for a retail investor to understand the essential characteristics of the product and its risks.”

FINRA describes these risks in the context of a representative’s ability to explain them to retail investors. Specifically, FINRA cautioned that firms must understand how tracking futures contracts and indices actually works, how certain conditions currently existing in the market, for example, contango and backwardation, can affect performance, and how ETP securities perform relative to the price of the commodity in the cash market. Further, FINRA warned that firms must comprehend (i) differences among varying ETPs in order to advise clients on how they can be used within an investment strategy, (ii) differences and risks based on product structures—such as the difference between commodity pools which hold futures assets and exchange-traded notes which hold debt—and (iii) risks from different ETPs concerning “structural features,” such as those with provisions for accelerated terminations or suspensions of new issuance.

According to FINRA, current market conditions are highlighting these risks. A decline in oil demand (due in part to COVID-19), has led to a plunge in cash market values which has had a significant impact on the market for futures and ETP indices. (FINRA repeatedly warned that firms must understand and explain to retail investors the differences between the spot market and ETPs). Extreme volatility in several oil-linked ETPs has led to ETP terminations and suspensions and has exacerbated investor losses.

Compliance with Suitability and Reg BI

FINRA warned firms that oil-related ETP recommendations require representatives to fully comprehend the terms, features and risks of these complex products. FINRA also advised firms that sales obligations on these complex products require compliance with rules on suitability (Rule 2111), communications with the public (Rule 2210), and supervision (Rule 3110). After June 30, 2020, oil-related ETP recommendations will require compliance with Reg BI.

FINRA noted that both customer-specific suitability and reasonable-basis suitability were “particularly relevant” to oil-related ETPs. The former requires a reasonable basis to believe that a recommendation or strategy is suitable for a specific customer based on a “customer's investment experience, risk tolerance, liquidity needs, investment objectives, and financial situation and needs.” Reasonable-basis suitability requires that the firm “perform reasonable diligence to understand the nature and risks of the transaction or strategy, and then to determine whether there is a reasonable basis to believe that the recommendation is suitable for the investor.”

FINRA pointed out that in less than a month, recommendations of ETPs to retail clients “will be governed” by Reg BI, and firms must act in the client’s best interest at the time the recommendation is made, “without placing the financial or other interests of the firm ahead of the interests of the retail customer.” (See recent Bates article describing FINRA’s recent proposal to modify the suitability rule.)

Public Communications and Supervision

FINRA advised firms that public communications of oil-related ETPs should “balance” the benefits of these securities with “a clear description of the risks,” (including those related to contango an backwardation), and that firms “may not omit any material fact or qualification that would cause such a communication to be misleading.” Specifically, FINRA said that public communications must describe the “speculative nature of futures investments and must explain clearly that the ETP’s price will not track directly the spot price of oil.” Further, FINRA warned firms that risk disclosure in a prospectus “does not cure otherwise deficient disclosure in sales material, even if the sales material is accompanied or preceded by the prospectus.”

On compliance with supervisory obligations, FINRA reminded firms to establish and maintain a reasonably designed and tailored supervisory system that takes into account the complexity of any offering of oil-related ETPs in the context of the firm’s customer base. FINRA relayed that firms must conduct training for registered representatives about the terms, features and risks of these products as well as on the suitability of recommendations, given the “investor’s time horizon, impact of time and volatility on the ETP’s performance.”

Conclusion

FINRA issued this Notice because of volatility in the market for oil-related ETPs, the resulting ETP terminations and suspensions, and consequent investor losses. The self-regulator’s emphasis on sales practice reinforces the message that sales of these complex products meet the requirements of FINRA’s suitability, communications and supervision rules, and fall under the new Reg BI standard commencing at the end of the month. Bates will continue to keep your posted on developments.

 

For more information, please do not hesitate to reach out to Bates:

Julie Johnstone, Managing Director, Retail Securities Litigation 

Robert Lavigne, Managing Director, Bates Compliance

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

 

To Learn More About Reg BI, please visit our Reg BI Service page.

Contact us to speak with a suitability or Reg BI expert.

Join us on June 18, 2020 for Bates Group’s Reg BI for Litigators CLE program: Registration Link

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06-03-20

Bates Group Partners with Linda Tuck Chapman and Ontala for Third Party Risk Management Services

Bates Group is proud to announce our partnership with Ontala Performance Solutions, led by internationally acclaimed expert Linda Tuck Chapman, to expand Bates’ risk services to include the critical area of third-party risk management.

Linda Tuck Chapman is President of Ontala Performance Solutions Ltd.; creator and Faculty for "Certified Third Party Risk Management Professional" (C3PRMP), delivered in partnership with SIG University; and author of Third Party Risk Management: Driving Enterprise Value.

“Many companies have outstanding outsourcing capabilities but do not have strong third-party continuity, governance, and review plans,” said Benjamin Pappas, Bates Group President. “Third-party issues represent a major risk for companies, their managers, and even their board members who may personally face fines or regulatory action. As a recognized financial services industry expert, Linda, in partnership with Bates, brings deep, actionable insight and exceptional expertise to clients in third-party risk management, governance, and optimization. The partnership is a perfect fit in expanding our risk portfolio and value to financial industry clients.”

Initially, our combined team will offer:
  • Maturity and Effectiveness Assessments for third-party/vendor risk management programs
  • Comprehensive Services for monitoring & controlling third-party “Work-From-Home” risks
  • Third-party Risk Assessments, Controls Evaluations and Contract Reviews to ensure all controls, performance, and compliance requirements protect your organization
  • Proven Training and Education for all stakeholders at all levels, either as classroom and eLearning.

“Our strategic partnership brings a powerful blend of specialized expertise, hands-on experience, and outstanding practitioners to the market,” said Tuck Chapman. "Managing third-party relationships by criticality and risks has never been more important. The global crisis makes us hyper-aware that trustworthy relationships are vital. Implementing an effective third-party risk management program will bring comfort that your decisions are risk-informed and resilient.”

“Despite, and because of, all that we are dealing with in business and the economy today, it has never been more critical for financial services firms to maintain best practices in the areas of anti-money laundering (AML) and financial crimes—across all relationships. Bates and Ontala bring expert recommendations, technical, and consulting services needed to survive and thrive in the financial services industry today,” said Edward Longridge, Managing Director, Bates AML & Financial Crimes.

Visit Bates' Third Party Risk Management Services

 

For more information, please contact: Dennis Greenberg, Managing Director at dgreenberg@batesgroup.com or 914-588-3965

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06-02-20

Introducing Bates Group’s Business Interruption Litigation Support

Introducing Bates Group’s Business Interruption Litigation Support

The COVID-19 pandemic has had a far-reaching impact on businesses across the country and throughout the world, putting strain and pressure on the insurance industry more than ever before.

Bates Group’s industry-leading insurance, forensic accounting and economic damages experts stand ready to assist Insurers and agents in the many challenges they face as result of the pandemic, including pre-litigation claims reviews and multi-faceted support should a matter proceed to litigation. Our insurance litigation team works side-by-side with regional and multinational insurance companies, reinsurance firms, underwriters and their in-house and outside counsel. 

Bates experts and consultants have experience handling claims across the following types of insurance coverage:
  • Commercial Property Business Interruption
  • D & O Liability
  • Property & Casualty
  • Builders Risk
  • Bad Faith
  • Force Majeure
  • Named Peril Coverage
  • All Risk Coverage
  • Employment Practices Liability
  • Excess/Umbrella Liability
  • Eligible Employee 

For more information, please visit our Business Interruption service page or contact:

Andrew Daniel, Director, Securities Litigation Expert and Consultant - adaniel@batesgroup.com

A. Christine Davis, Managing Director, Forensic Accounting and Commercial Damages - cdavis@batesgroup.com

Sheila Murphy, Insurance, Litigation and Regulatory Expert- smurphy@batesgroup.com

Greg Faucher, Managing Consultant, Insurance and Actuarial Practice Leader - gafucher@batesgroup.com

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05-29-20

CLE Webinar: Employment Claims and Potential Economic Damages – What to Expect in the “New Normal”

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Join moderator Sheila Murphy (Consultant, Bates Group) and A. Christine Davis (Managing Director of Forensic Accounting and damages expert, Bates Group) along with three accomplished employment lawyers, Maureen Bogue (Founder, Pacific Employment Law), Jeanine Conley Daves (Shareholder, Littler Mendelson P.C.), and Elizabeth Thompson (Counsel, Kilpatrick Townsend & Stockton LLP), as they explore and address employment-related litigation issues, including wage and hour and potential economic damages claims, stemming from COVID-19.

CLE Credit pending in CA, MO. Reciprocal credit eligible in NY, NJ, FL.

Registration is required to attend this Zoom Webinar.

Click Here to Register Now!

 
Program Faculty:

Sheila Murphy, Esq. (Moderator), Consultant, Bates Group

Sheila Murphy is a Bates Group expert and consultant with over 30 years of legal, insurance, regulatory and retail litigation experience. Prior to joining Bates, Ms. Murphy served MetLife in various legal roles. Most recently, as Senior Vice President and Associate General Counsel, Ms. Murphy led the Regulatory and Retail Litigation Unit, which provided strategic advice on litigation and regulatory matters for MetLife's U.S. insurance and financial products businesses. Her team counseled on broker-dealer, compliance and public policy issues as well as advised on litigation and regulatory matters. Ms. Murphy has received numerous industry awards throughout her career and has been a speaker and panelist for various continuing education and industry-related symposia.

A. Christine Davis, Managing Director, Forensic Accounting and Economic Damages, Bates Group

A. Christine Davis is Managing Director of Forensic Accounting and Financial Crimes, based in Bates Group’s San Francisco office. Christine has over twenty-six years of forensic accounting, audit, tax and dispute consulting experience. In addition to being a CPA in California and New York, she is a Certified Valuation Analyst and holds the Certified in Financial Forensics credential issued by the American Institute of Certified Public Accountants. She also holds an arbitrator certificate. Christine is frequently retained as a consulting and testifying expert for complex commercial litigation and regulatory matters and as a forensic accountant for fraud or accounting investigations. As a financial, accounting or damages expert, she assists in all phases of litigation by providing calculations, analytical insight, discovery assistance, and expert testimony by deposition, in arbitrations and at trial in federal and state courts.

Maureen Bogue, Founder, Pacific Employment Law

Maureen Bogue has 25 years of experience as an employment litigator and counselor, and has represented employers of all sizes in state and federal courts and in arbitration.  She has significant experience defending employers in wage and hour claims (including class actions), as well as claims for discrimination, harassment, failure to accommodate and related employment claims.  She also represents employers in EEOC and EDD audits. Ms. Bogue has been conducting workplace investigations for 20 years and is often retained to investigate claims of harassment, discrimination or retaliation asserted against senior members of management.

Jeanine Conley Daves, Shareholder, Littler Mendelson P.C.

Jeanine Conley Daves has represented many of the nation’s leading companies in employment-related disputes and workplace investigations. She has successfully tried cases in both state and federal court and has significant experience litigating race, age, gender, religion and disability discrimination lawsuits, wage and hour class and collective actions and whistleblower and retaliation claims. Jeanine advises and counsels clients in all industries, particularly the manufacturing, retail, financial services and media and entertainment industries and has represented clients before numerous government agencies. She navigates clients through all areas of employment law, from hiring to termination.

Elizabeth Thompson, Counsel, Kilpatrick Townsend & Stockton LLP

Elizabeth Thompson has a multi-faceted practice focusing on employment and complex commercial litigation, trade secret protection, and employment advice and counseling. She has broad experience representing employers in overtime class actions, wrongful termination, and discrimination cases. Elizabeth counsels clients in all aspects of the employment relationship including wage and hour law, reductions in force, high-risk terminations, disability accommodations, sexual harassment complaints, and compliance with the overlapping requirements of the many federal, state, and local employee leave and wage replacement laws. She regularly advises executives with private and publicly traded companies in the negotiation of employment agreements and severance agreements.

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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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05-21-20

NASAA Seeks to Disrupt Fraud, Moves to Online Exams; FINRA Warns of Pandemic Scams

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State and federal regulators are pressing firms to increase vigilance against crisis-related misconduct and other vulnerabilities in order to protect investors. The North American Securities Administrators Association (NASAA) recently took several public steps in response to COVID‑19 challenges, including forming a COVID-19 Enforcement Task Force that will identify and stop the latest potential threats to investors, publishing an on-line jurisdictional resource to track state securities administrator responses to the pandemic (including links to regulatory relief or operational information by jurisdiction).

Meanwhile, FINRA shared some “insights” for investors against the latest fraudulent schemes by issuing a notice advising that firms take “appropriate measures” concerning heightened investor risk during the pandemic. In those alerts, FINRA details the most prevalent scams and recommended practices for both investors and firms to combat them. Here’s a closer look.

NASAA Coronavirus Task Force to Root Out Fraud

According to President and Chief of the New Jersey Bureau of Securities Christopher W. Gerold, the primary objective of NASAA’s new Task Force is to “proactively identify” and “disrupt, discourage and deter” investment fraud and unregistered regulated activities within member jurisdictions. NASAA structured the new Task Force on its successful “Operation Cryptosweep” model. (As Bates previously reported, those efforts led to the opening of more than 330 inquiries and investigations and brought more than 85 enforcement actions relating to ICOs and cryptocurrencies.) Preliminary steps include reviewing some 200,000 coronavirus-related internet domain names linked to the pandemic and identifying those that pose a threat to investors. NASAA states that the Task Force will use “online investigative techniques to identify websites and social media posts.” According to Joseph P. Borg, NASAA Enforcement Section Chair and Director of the Alabama Securities Commission, “fraudsters are ramping up as a result of this crisis … Our goal is to get and stay ahead of the curve.”

NASAA COVID-19 Scam Alert, State Resources and Examinations

Creation of the Task Force comes on the heels of NASAA publishing an investor scam alert, an online resource guide and a corresponding site update that provides useful state-by-state information detailing regulatory relief and current regulatory operations for state government offices. In a statement issued by NASAA, President Gerold said that across jurisdictions, examinations of firms are continuing but have “shifted from on-site to remote, or are being deferred when necessary,” and he also noted that “nearly all states are providing regulatory relief to licensees/registrants adversely impacted by COVID-19.”

FINRA Alerts Investors and Firms to Pandemic-Related Fraud

In twin publications—one for investors and one for firms—FINRA highlights the risks fraudsters present when seeking to prey on investor vulnerabilities exacerbated by COVID-19. In the publications, FINRA urges that stakeholders remain vigilant against attacks. FINRA’s communications warn against four specific scams: fraudulent account openings and money transfers, imposter scams, IT help desk scams, and email compromise schemes.

FINRA also warns that fraudsters can use stolen or synthetic customer identity information to gain access to an account, and once in control can transfer or divert funds from a customer’s account to the fraudster’s account or rapidly remove stolen funds from the brokerage account. For investors, FINRA recommends monitoring accounts for suspicious activity, which may occur in smaller, less detectable money transfers. For firms, FINRA advises managing the risk by strengthening (i) Customer Identification Programs, (ii) opening and ongoing account monitoring, (iii) account verification (and placing restrictions on fund transfers); (iv) clearing firm collaboration, and (v) suspicious activity report processes.

FINRA also cautions that fraudsters can claim to be brokers and can create a fake online presence. For investors, FINRA recommends independent verification of a firm’s contact information, keeping account information private, refusing callers who seek remote access to personal computer or devices, and use of BrokerCheck. For firms, FINRA advises specific staff training and practices as a 2019 FINRA Notice describes on imposter websites.

FINRA additionally warns that fraudsters may claim to represent a financial firm’s IT Help Desk in order to steal personal customer information. For investors, FINRA recommends verification before providing personal or password information, opening links, or downloading attachments (if by email). For firms, FINRA advises additional training, reporting of suspicious calls or activity, and to contact the official IT Help Desk to “confirm the veracity of the original communication.”

In the publications, FINRA further highlights scams involving those authorized to execute legitimate funds transfers. Schemes involve fraudsters posing as firm leaders requesting one or more fund transfers, for example, related to accounts payable invoices. For investors, FINRA recommends confirmation of any requested fund transfers via telephone and viewing any deviations from standard payment practices as red flags. For firms, FINRA advises alerting staff authorized to disburse funds to monitor for red flags and confirm requests via telephone before acting on them. FINRA also advises that firms consider including email “banners” for any communication coming from outside the firm.

Conclusion

NASAA and FINRA’s pandemic-related efforts make clear that the regulators are continually working to address significant issues and impacts of the pandemic to warn and protect both investors and the industry. Bates will continue to keep you apprised of future developments.


The current crisis presents many challenges. Bates practice leaders, consultants, and experts can help.

Please do not hesitate to reach out.

Julie Johnstone, Managing Director, Retail Securities Litigation 

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

Edward Longridge, Managing Director, Bates AML and Financial Crimes 

Robert Lavigne, Managing Director, Bates Compliance

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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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05-14-20

AML Compliance Report: FinCEN Says Hold the Line, FFIEC Updates Exam Manual

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At a time when regulators are emphasizing their understanding of, and flexibility concerning, the difficulties facing financial firms as a result of COVID-19, the Financial Crimes Enforcement Network (FinCEN) and the umbrella Federal Financial Institutions Examination Council (FFIEC) are demanding robust compliance with Bank Secrecy Act/ Anti-Money laundering (BSA/AML) requirements. Since Bates’ last report in which FinCEN highlighted warnings about bad actors finding opportunities created by the volatility and fear in the markets, the Network issued additional compliance information to its previous alert, and FFIEC published a long-anticipated update to its BSA/AML Examination Manual. Here are some of the details.

FinCEN Says Hold the Line

Last month, FinCEN issued its second Notice within a month concerning compliance with BSA/AML obligations during the pandemic. While it “appreciate[s]” the challenges financial firms are confronting as a result of the coronavirus, FinCEN reminded the firms that such compliance is “crucial to protecting our national security” and that the agency “expects financial institutions to … diligently adhere to their BSA obligations.”

Beyond that overarching message, FinCEN urged that financial firms stay the course in developing their risk-based compliance programs. In addition, FinCEN provided specific direction for making it easier to support pandemic-related programs and offered other tweaks for easing some compliance challenges.

First, FinCEN advised that loans disbursed to existing customers under the Paycheck Protection Program (PPP) of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) do not require re-verification under existing BSA requirements unless flagged by the institution under its risk-based approach. (Existing customers already undergo verification with BSA requirements.) In addition, FinCEN made note of previously limited relief from beneficial ownership requirements for non–PPP-related loans under certain circumstances. (See the Small Business Administration FAQs on beneficial ownership obligations under the CARES Act that FinCEN published on April 13, 2020.)

Second, FinCEN advised that it suspended implementation of a recent rule change scheduled to take effect on April 6, 2020, concerning the use of Currency Transaction Reports forms involving sole proprietorships and entities operating under a “doing business as” (DBA) name. FinCEN stated that financial firms reported difficulty in meeting the implementation timetable.

Third, FinCEN announced a new online contact mechanism for firms to convey COVID-19–related BSA compliance issues. FinCEN also reminded firms to contact “their functional regulator(s) or other BSA examining authority as soon as practicable” concerning BSA compliance concerns.

The Office of the Comptroller of the Currency (OCC) followed up the FinCEN Notice with a Bulletin of its own. OCC offered full support for FinCEN’s risk-based approach to BSA compliance, and actions described earlier, as a reasonable response to pandemic-related concerns. OCC stated that it will take into consideration “the actions taken by banks to protect and assist employees, customers, and others in response to the COVID-19 pandemic, including any reasonable delays in BSA report filings, beneficial ownership verification or re-verification requirements, and other risk management processes” when evaluating a firm’s compliance program. Presumably, that would apply to penalties for violations as well.

FFIEC Updates Examinations Manual

On April 15, 2020, FFIEC, the council of federal and state regulators that includes the Federal Reserve Board of Governors, the Federal Deposit Insurance Corporation, OCC, the National Credit Union Administration, the Consumer Financial Protection Bureau, and the State Liaison Committee, announced updates to its manual on BSA/AML compliance examinations. The publication is the instruction manual examiners use for overseeing compliance by financial institutions with regulatory requirements and supervision.

In its joint interagency statement, FFIEC explained that the latest revisions enhance the risk-focused approach to BSA/AML supervision. The regulators were keen on ensuring that evaluations of BSA/AML compliance programs are based on an institution’s risk profile for money laundering, terrorist financing, and other illicit financial activities. The revisions were also meant to clarify language that “distinguishes between mandatory regulatory requirements and supervisory expectations set forth in guidance.” That said, FFIEC stated that the revisions do not add new requirements. 

Specifically, the revisions concern (i) risk profile supervision, testing, and analysis; (ii) adequacy of a compliance program (with sections on internal controls, independent testing, and training, among others); and (iii) adequacy of the risk assessment process, including, bank-related risk categories and risk analysis. The new revisions emphasize the built-in flexibility over the design of BSA/AML compliance programs, risk assessments methods, and formats. In addition, the instructions relay to examiners that risk assessment updates do not have to be regular but rather should be aligned and reflect any changes to a bank’s risk profile.

Conclusion

Despite its second notice providing BSA/AML compliance guidance to financial firms during COVID-19, FinCEN is not offering much relief. If anything, the agency is doubling down on its direction to financial firms that they protect against the increased risks presented by bad actors during this time (i.e., the first Notice imploring that firms continue aggressively monitoring and filing SARs reports), and has offered various tweaks for speeding up the PPP application process or postponing implementation of beneficial owner rules (the second Notice). When placed in context, FinCEN appears to be demanding that financial institutions up their game at a time when those very institutions are dealing with staff and resource constraints including staff operating under quarantine conditions.

FFIEC’s Examination Manual remains the most definitive source for regulators to measure the adequacy of BMA/AML compliance. The revisions recommend a detailed review to ensure that a firm is implementing its risk-based approach in full. Put another way, significant penalties may hang in the balance.

In addressing these issues, Edward Longridge, Managing Director of Bates AML & Financial Crimes, points out that “[d]uring these challenging times with Coronavirus, the regulatory establishment is requiring increased efforts of BSA/AML managers over their programs, particularly related to COVID-19 scams and other types of fraudulent and money laundering activity. The expectation is for BSA/AML programs to step up to meet the challenge posed by bad actors.”

Bates will continue to monitor developments and keep you apprised.

 

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

Bates AML and Financial Crimes

Bates Compliance

Regulatory and Internal Investigations

Retail Litigation and Consulting

Institutional and Complex Litigation

Consulting and Expert Testimony

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05-11-20

Welcome Our New Bates Experts

Bates Group is proud to welcome our newest experts and consultants: 

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Kathy D. Ireland

ERISA, Investment Advisers Act, Codes of Ethics

Kathy D. Ireland is a Bates Group consultant specializing in ERISA and investment adviser issues, including codes of ethics and fiduciary matters. Prior to establishing her own consulting practice, Ms. Ireland served as Counsel for Federal Government Affairs at Ameriprise Financial in Washington, D.C. From 2011 to 2017 she represented SEC-registered investment advisers at the U.S. Department of Labor as well as the SEC as Associate General Counsel of the Investment Adviser Association. Prior to joining the IAA, she was an independent consultant focusing on ERISA and securities issues. Ms. Ireland is an attorney, earning her J.D. from the College of William and Mary and an LL.M. in Labor Law from the George Washington University National Law Center.

Full Bio

 

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Philip Lieberman, CPCO, CLU

Property and Casualty Insurance

Philip Lieberman is a Bates affiliate expert with a broad range of experience in the insurance industry. During his 50-year career, he has served as an expert witness in more than 140 case matters, representing both plaintiffs and defendants. He has also been deposed and cross-examined and has authored reports and served on arbitration panels. Following the sale of his agency to a national bank, Mr. Lieberman taught insurance under the auspices of the American Institute for Property & Liability Underwriters, Inc. and the Independent Agents and Brokers of New Jersey. Mr. Lieberman holds the Chartered Property Casualty Underwriter (CPCU) and Chartered Life Underwriter (CLU) designations.

Full Bio

 

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Jennifer Luce

Accounting, Media, Publishing

Jennifer Luce is a Bates affiliate expert based in New York. She is a CPA with an MBA and has nearly a decade of public accounting and media industry experience. Ms. Luce held various financial and accounting roles at AOL Time Warner, and prior to that worked in public accounting. She has served in financial analyst and managerial positions and is now using her finance and accounting skills to provide forensic accounting and litigation consulting services in disputes involving companies, government entities and law and accounting firms, financial statement analysis, and complex liability and damage analyses. A keen eye for detail, complex analytical proficiency and communication skills are the keys to her success. Ms. Luce graduated from Clarkson University with a BS in accounting. She then attended Boston University and earned her MBA. 

Full Bio

 

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Mike Steinmetz

Cybersecurity

Bates Group expert Mike Steinmetz has more than 40 years of federal, state, and private sector experience. As Rhode Island’s first State Cybersecurity Officer, he delivered the first cyber-risk assessment of state government and authored the state’s first cybersecurity strategy. As Rhode Island’s Homeland Security Advisor, he completed a complex risk analysis of physical, technological, and other risks to the state’s critical infrastructure. Mr. Steinmetz’s private sector work includes positions with Northrop Grumman, where he delivered the company’s first international cyberstrategy initiative. He later transitioned into international energy and power, addressing digital risk and security for National Grid plc, serving concurrently as National Grid’s Global Director, Governance Risk and Compliance, the Global Director for Strategy, Planning and Budget and as the interim Acting U.S. Chief Information Security Officer.

Mr. Steinmetz is an Oxford University Martin School Associate and serves on the Board of Boston College’s Woods College for Advancing Studies, Masters of Cybersecurity Policy and Governance. He is also Senior Advisor to the Cityforum in London, frequently chairing or speaking at its annual Cybersecurity Masterclass. A decorated combat pilot, Mr. Steinmetz is a graduate of the Peabody Institute of the Johns Hopkins University and a distinguished graduate of the National Defense University.

Full Bio

Need an Consulting or Testifying Expert? Please visit our Expert Search to view our online roster of Bates experts and consultants or call us at 503-670-7772.

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05-08-20

CLE Webinar: Senior and Vulnerable Investor Protection and Potential Claims in the COVID-19 World

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Join our panel of nationally recognized leaders for a conversation about what vulnerable and senior financial investor issues and litigation claims may look like going forward, recent cases and regulatory updates, and resources to assist firms in preventing exploitation.

Faculty:

Joseph “Joe” Thomas, co-host, nationally recognized expert witness and Bates Group director

Amy Bard, Esq., co-host, Senior Issues Expert, Bates Group

Melissa Acayan, Esq., Director, Senior Compliance Counsel, Raymond James

Marin Gibson, Managing Director and Associate General Counsel, SIFMA

Ronald Long, Head of Aging Client Services, Wells Fargo

 

CLE credit pending approval.

 

When: May 14, 2020 1:00 PM Eastern/10:00 AM Pacific

Program Length: 1 hour

 

Registration is required to attend this Zoom webinar.

Click Here to Register

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05-08-20

Webinar: Preserving and Growing your IBD/RIA Business in the Time of COVID-19

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Please join moderator Lilian Morvay, Principal and Founder of Independent Broker Dealer Consortium, LLC (“IBDC”) and Bates Expert, along with panelists David Baugh, Partner - Kaufman Dolowich & Voluck; Brian Nally, Partner - Reminger; Brian Cavanaugh, Director Corporate Risk & Brokering Financial Institutions - Willis, Towers Watson, Robert “Bob” Reidy, Alternative Products Testifying Expert - Bates Group; and Judith Knudsen, VP and Deputy General Counsel - Avantax Wealth Management; as they discuss the effects that Covid-19 may have on claims against BDs/RIAs, insurance concerns and considerations and opportunities to expand your businesses. Hosted by Bates Group and IBDC.

  • Creating an effective Communication Plan
  • What IBDs/RIAs Can Do To Mitigate Risk
  • Potential Effects on Financial Services Claims
  • Professional Liability and Cybersecurity Insurance Considerations

When: May 12, 2020 3:00 pm Eastern/12:00 pm Pacific

Registration is required to view this Zoom webinar.

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05-07-20

Bates Group Welcomes New Managing Director Steven Engel

Bates Group Welcomes New Managing Director Steven Engel

Bates is proud to welcome Steven Engel as a new Managing Director on the Bates Compliance team. Steven brings to Bates a background in Risk and Regulatory Advisory. He was previously with BNY Mellon Corporation where he served as a Senior Principal in the Program Management Office. Prior to BNY Mellon, he was Director of Financial Services Risk and Regulatory Consulting at a Big Four consulting firm, serving institutional and retail clients in a national practice. At Bates, Steven will be working directly with clients to support their risk and compliance activities and solutions.

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04-30-20

FINRA Carries On: Focuses on High-Risk Brokers, Broker Beneficiaries, Arb Postponement & Reg BI

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While the COVID-19 pandemic continues to create unusual and difficult challenges for the financial service industry, FINRA continues to move forward with regulatory matters that warrant attention. In this article, Bates reviews recent FINRA developments on high-risk brokers, proposed limitations on brokers acting as beneficiaries, executors or trustees for senior investors, additional COVID-19-related hearing postponements, a recent arbitration proposal related to claims against inactive members and further remarks on Regulation Best Interest (Reg BI).

FINRA Proposes to Hold Firms More Accountable for Bad Actors

On April 14, 2020, FINRA proposed a host of new rules that would strengthen oversight over member firms’ supervision of high-risk brokers. The proposed rules include (i) disciplinary changes that would allow a hearing officer to impose “conditions or restrictions” on firms and require heightened supervisory procedures during an appeal to the National Adjudicatory Council, (ii) changes that would require firms to adopt heightened supervisory procedures for statutorily disqualified brokers during an eligibility review; (iii) changes that would allow disclosure that a firm is subject to the "Taping Rule" through FINRA’s BrokerCheck system; and (iv) changes under membership application and registration rules that would require firms to engage in additional obligations before hiring any person who has final criminal matters or specified risk events during the previous five years to become an owner, control person, principal or registered person of the firm. 

FINRA Highlights Senior Investor Protection Proposal on Brokers Acting as Beneficiaries, Executors and Trustees

In one of her first statements since formally becoming Executive Vice President and Head of FINRA Enforcement on January 17, 2020, Jessica Hopper highlighted an increasingly frequent pattern of brokers who are appointed beneficiaries, executors or trustees on behalf of vulnerable senior clients. She pointed out the risks and potential conflicts of interest associated with these arrangements and noted that investigations into the details often present challenges, particularly in cases where the client has a mental impairment or has died.

Ms. Hopper’s statement is significant, in large measure because she calls attention to a recent FINRA 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. As part of a firm’s review under the proposed rule, the member firm would be expected to reasonably assess the risks of the arrangement and would have to supervise compliance with any conditions placed upon the approval. (Note: the proposed rule would not apply where the customer is a member of the registered person’s “immediate family,”  which is defined to include “parents, grandparents, mother-in-law or father-in-law, spouse or domestic partner, brother or sister, brother-in-law or sister-in-law, son-in law or daughter-in-law, children, grandchildren, cousin, aunt or uncle, or niece or nephew, and any other person whom the registered person financially supports, directly or indirectly, to a material extent. The term includes step and adoptive relationships.”)  

Not all respondents agree with FINRA’s proposed approach. The North American Securities Administrators Association (NASAA) commented with a recommendation for a stricter standard that would (i) prohibit outright any registered persons from “being named as a beneficiary or appointed to a position of trust by a customer, unless the customer is an immediate family member” (and even then, only under certain conditions), and (ii) implement heightened supervision of all such accounts.

Ms. Hopper emphasized that FINRA will act aggressively to sanction brokers that procure such an appointment through unethical means. While the comment period ended on January 10, 2020, the rule has yet to be adopted, and there is no indication when this will occur. However, a few days after her statement appeared on the agency blog, a FINRA podcast celebrating the five-year anniversary of its Securities Helpline for Seniors covered notable “trends and themes,” including the proposed new rule. It is clearly top of mind.

FINRA Extends Postponement of Arbitration and Mediation Proceedings

On March 17, 2020, Bates reported that FINRA administratively postponed all in-person arbitration and mediation proceedings scheduled through May 1, 2020. On April 20, 2020, FINRA extended that postponement through July 3, 2020. FINRA reminded all parties that “case deadlines will continue to apply and must be timely met unless the parties jointly agree otherwise.” In addition, FINRA announced that it is waiving postponement fees if the parties stipulate to “adjourn in-person hearing dates” between July 6 and September 4, 2020. Written notices are required. Those interested in virtual hearing services were encouraged to contact FINRA case administrators.

FINRA Expands Procedural Options for Claims against Inactive Members

On April 9, 2020, FINRA amended its arbitration rules to “expand the options available to customers” when a firm or associated person becomes inactive during a pending arbitration, or before a claim is filed. Under the new procedures, which go into effect on June 29, 2020, if a member firm or an associated person becomes inactive during a pending arbitration, FINRA will notify the customer claimant of the status change. Within 60 days of receiving notice that a member firm’s or an associated person’s status has been changed to inactive, a customer may withdraw the claim, add a claim or new party or postpone a scheduled hearing. The customer still retains the option to request a default proceeding against an inactive member or associated person.

FINRA Endorses OCIE’s Reg BI and Form CRS Approach

On April 8, 2020, FINRA issued a statement backing up the approach the SEC Office of Compliance Inspections and Examinations (OCIE) will take following the compliance date of June 30, 2020. (See Bates coverage on the OCIE alert here.) FINRA said that, like the SEC, it too will focus on whether firms have made a good-faith and reasonable effort at compliance with Reg BI and Form CRS. As a reminder, FINRA is also seeking to modify its suitability rule to better conform to the new Reg. BI standards. The proposed amendments clarify that pre-existing FINRA rules would not apply to broker-dealer recommendations for retail customers under Reg BI. (See additional Bates coverage.)

Like the assurances given by the OCIE, FINRA emphasized that it would work “with firms and the SEC on issues that may arise in the course of examinations for compliance.”

Conclusion

During this transition period between what was and what will be the “new normal,” FINRA continues on course. The proposal to protect senior investors in cases involving appointed beneficiaries, executors and trustees should be carefully watched, as it is unlikely that so much concentrated attention is coincidental. Similarly, the proposal to impose and strengthen accountability for firm supervision of bad actors communicates that this subject remains a top compliance priority. FINRA’s messaging on Reg BI is part of a continuing effort to harmonize its position with the SEC. FINRA’s long-anticipated amendments to the arbitration rules are necessary to shut down loopholes in this increasingly important aspect of the FINRA agenda. Bates will continue to monitor further developments.


For FINRA arbitration and litigation matters, please note 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

If you are a Bates client and your case is postponed, please be in touch to discuss interim case support needs. Contact Julie Johnstone, Managing Director, Retail Litigation at jjohnstone@batesgroup.com.

 

For Reg BI and Form CRS support, please visit our Reg BI service page or contact Robert Lavigne, Managing Director, Bates Compliance, at rlavigne@batesgroup.com or Rory O’Connor, Director at roconnor@batesgroup.com to discuss your current needs one-on-one. (Note: Bates has developed a Training and CLE page for on-demand Reg BI webinars and Reg BI training for your company. Join our Form CRS Countdown Webinar today, 4/30 at 12 pm ET/9 am PT.)

 

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

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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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04-21-20

Coronavirus and the Approaching Business Interruption Insurance Storm

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These are uncertain times for insurers. In a report issued on March 31, 2020, Congressional Research Service (“CRS”) staff noted the likelihood that loss of income from mandatory or voluntary closures, supply chain disruptions, and reduced demand due to social distancing measures may induce businesses of all sizes to seek compensation from insurers.” That was clearly an understatement. Early estimates from the American Property Casualty Insurance Association (“APCIA”) are that some 30 million small businesses claims may be filed. This would be more than ten times greater than the highest number of claims “ever handled by the industry in one year.” In statement released by the APCIA, David A. Sampson, President and CEO of APCIA, offered preliminary estimates of closure losses for small businesses, which have increased to $255 billion to $431 billion per month. “Continuity losses for small businesses are approximately 43 to 72 times the monthly commercial property insurance premiums,” Mr. Sampson said.

Insurance market participants are sounding alarms about a wave of state and federal legislation that would shift onto insurers a significant portion of the burden to compensate businesses from the massive losses resulting from pandemic-related shutdowns. Bates takes a look at these legislative moves, early legal action taken by policyholders seeking coverage for business interruption losses as a consequence of the coronavirus (COVID-19), and the reaction by the insurance industry.  

Types of Business Interruption Insurance Coverage

The CRS report describes various kinds of insurance that cover specific losses due to certain business interruptions. The issues facing insurers are (1) whether the terms of these policies can be potentially stretched to include losses of the kind that may result from government-mandated (“Civil Authority”) pandemic closures, and (2) what might happen if federal or state authorities retroactively require coverage under these policies for COVID-19 claims.  

Commercial property insurance has been a target for legislators mainly because most businesses carry it in some form. Generally, these policies require that the insured suffer a loss of income due to direct physical loss or damage to covered property. Assessments of these losses are fact-specific and subject to significant challenge in court. Christine Davis, Bates Managing Director of Forensic Accounting and a commercial damages testifying expert, explains that “to measure business interruption loss requires taking a number of meticulous steps, including understanding the experience of business before the incident, analyzing the business’s financial records and historical performance, estimating the profits lost during the indemnity period, and gathering the proper documentation that supports the loss calculation.”

That said, many of these policies explicitly exclude losses due to viruses and bacteria - modifications to policies made as a result of unexpected losses suffered during the SARs epidemic. According to the CRS, insurance policies of special relevance include: (1) business interruption insurance (which covers business losses directly or indirectly caused by a covered peril or, in some cases, caused by all risks); (2) business income insurance (which covers sustained loss of income due to a suspension of business operations arising out of a covered risk); (3) contingent business interruption insurance (which covers business losses based on destruction of property owned by others); and (4) civil authority coverage (which covers business interruption losses when a civil authority restricts access to a business premises.)

State governments are aware of the limitations included in many of these policies and are responding to constituent concerns with basic FAQs and other general guidance (see, e.g. this dedicated web page by the New York Department of Financial Services (“NYDFS”); and, more broadly, this database resource provided by NAIC offering State Bulletins and Alerts Regarding Coronavirus). The scope of the problem, however, is so great that these early steps may be seen, in hindsight, as mere placeholders before the real battle over coverage began. 

Federal and State Legislators Seek Coverage for COVID-19 

The real battle includes legislative efforts to compel the industry to cover COVID-19 claims. The first attempt was outlined in a March 18, 2020 letter by a bipartisan group of U.S. House members to four leading insurance trade associations and their response to it. In the letter, the representatives urged the associations “to work with your member companies and brokers to recognize financial loss due to COVID-19 as part of policyholders’ business interruption coverage.”  Similar letters have since been sent  to insurers from state representatives.  

The implicit threat behind these inquiries is that either the federal government or the states will force insurers to cover COVID-19 related claims. The intention is clear and the concerns are real, warned Sheila Murphy, an insurance consultant and expert with Bates Group: “the government is seeking to expand or shift this risk, but insurers have not priced it into their premiums.” In various forms, state legislative bills have now been introduced in New JerseyOhio, MassachusettsNew YorkLouisiana, Pennsylvania, and South Carolina. Though there are differences among the bills, in general they require insurers to retroactively include the coronavirus as a “covered peril” under business interruption policies. In the interim, various state agencies have adopted emergency regulations requiring that property and casualty insurers provide relief to consumers and small businesses with extensions for the payment of premiums and fees under these policies, (see, e.g. NYDFS Emergency Action). 

The U.S. House Financial Services Committee, meanwhile, is considering a draft Pandemic Risk Insurance Act (“PRIA”) patterned after the Terrorism Risk Insurance Act (TRIA). According to Maxine Waters, U.S. House Financial Services Committee Chair, PRIA would “create a reinsurance program similar to [TRIA] for pandemics, by capping the total insurance losses that insurance companies would face.” Recent reports suggest that  PRIA “would be triggered when industry losses exceed the $250 million threshold and aggregate losses would be capped at $500 billion in a calendar year for both insurers and the government.” Further, the bill reportedly states that participating insurers will be charged an annual premium for reinsurance coverage, “based on the actuarial cost of providing such reinsurance coverage, including costs of administering the program.” Insurers, in turn, would agree to provide coverage for insured losses that does not “differ materially from the terms, amounts and other coverage limitations applicable to losses arising from events other than public health emergencies.”  

Other legislative proposals include establishing a compensation fund – currently referred to as the “Federal Business Interruption and Workers' Protection Recovery Fund." Lilian A. Morvay, Bates Insurance expert and consultant , describes such a solution as similar to the 9-11 Victims Compensation Fund or the National Flood Insurance Program. Shestates: “clearly, the pandemic and the losses it is leaving in its wake are unprecedented. In the interest of supporting businesses without bankrupting the insurance industry, this solution would backstop insurers that provide monetary relief to businesses that suffered economic losses.” Under the proposal, insiders say, businesses would “submit claims to their insurers as if business interruption resulting from coronavirus were covered. Insurers would then adjust those claims as normal and determine the appropriate claims payment, which would be funded by the government.”   

Industry Response 

The industry response to the bipartisan letter and state and federal actions has been forceful. Collectively, the insurers are leaving no doubt that they will fight attempts by state and federal legislators (and in court) to force payment for income losses from COVID-19 that their policies were never designed to cover. 

In their letter in responding to House members, the associations asserted that “the proposed retroactive application legislation would fundamentally change the agreed-upon transfer of prospective risk-of-loss exposure to coverage for a known and presently occurring loss, something the parties did not agree to, the insurer did not rate for, and the policyholder did not pay for.”  Following up, the association leadership said that while insurers stand ready to help, “if policymakers force insurers to pay for losses that are not covered under existing insurance policies, the stability of the sector could be impacted.” Siding with the trade associations, the National Association of Insurance Commissioners (“NAIC”) issued their own statement asserting: “while the U.S. insurance sector remains strong, if insurance companies are required to cover such claims, such an action would create substantial solvency risks for the sector, significantly undermine the ability of insurers to pay other types of claims, and potentially exacerbate the negative financial and economic impacts the country is currently experiencing.”  

Conclusion 

In the days to come, there will be a fair amount of reporting on state lawsuits filed by policyholders attempting to challenge existing terms of business interruption policies (see, e.g. herehere and here). For now, these coverage claims may be raised against insurers, agents, and brokers, and are handled on a normal case-by-case basis.

Insurers must brace themselves for these cases. That said, the real concern for insurance industry leadership is the momentum building for state and federal intervention in the sector to address this extraordinary challenge. Only some agreement on a collaborative framework between the industry and the government to respond to the national need could possibly result in a way forward. Absent that, the legal battle will be epic. Bates will keep you apprised.  

 

To learn more about Bates Group’s Insurance & Actuarial Services, including expert consultation and testimony, regulatory and analytics support, annuities, business interruption, D&O insurance, property & casualty, and life insurance, please contact:

Greg Faucher, Managing Consultant, Insurance and Actuarial Practice Leader - gafucher@batesgroup.com

Andrew Daniel, Director, Securities Litigation Expert and Consultant - adaniel@batesgroup.com

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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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04-03-20

Reg BI: SEC Keeps June 30th Deadline, FINRA Seeks to Amend Suitability Rule

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image: Kristina - stock.adobe.com

Over the past few weeks the coronavirus pandemic has overtaken the nation’s financial agenda and diverted the attention of financial regulators who are struggling to keep up and address urgent market needs. With recent actions to provide temporary delays from certain compliance deadlines and other relief, regulators have worked hard to accommodate the practical difficulties of operating under business contingency plans. These actions have left some firms curious as to whether the rollout of Regulation Best Interest (“Reg BI”) may be affected. Well, the wait is over, and SEC Chair Clayton has finally weighed in. Meanwhile, FINRA has pushed forward amendments to its rules on suitability and non-cash compensation “to provide clarity on which standard applies and to address inconsistencies with Reg BI.” And the SEC has filed a brief in the Second Circuit Court of Appeals arguing for rejection of state petitions for review of the Reg BI final rule. Here’s what you need to know.

The Reg BI Compliance Deadline Will Not Be Delayed 

After reported consideration of requests by broker-dealer advocacy groups like the Financial Services Institute (FSI), SEC Chair Jay Clayton issued a statement saying that the June 30, 2020 compliance date will not be moved. He explained that the agency has been engaged extensively with market participants as well as with FINRA on the implementation of Reg BI and Form CRS, and that “firms with account relationships comprising a substantial majority of retail investor assets have made considerable progress in (1) adjusting their business practices, (2) supplementing and modifying their policies and procedures, and (3) otherwise aligning their operations and preparing for the requirements of Reg BI and the obligation to file and begin delivering Form CRS.” 

That said, Chair Clayton did note that if a firm “is unable to make certain filings or meet other requirements because of disruptions caused by COVID-19” the firm should “engage with us.” He stated that “the Commission and the staff will take the firm-specific effects of such unforeseen circumstances (and related operational constraints and resource needs) into account in our examination and enforcement efforts.” 

Chair Clayton relayed that, following the compliance date, “SEC examiners will be focusing on whether firms have made a good faith effort to implement policies and procedures necessary to comply with Reg BI, while also providing an opportunity to work with firms on compliance and other questions.”  

He also mentioned that the SEC Office of Compliance Inspections and Examinations “will be issuing two Risk Alerts providing broker-dealers with specific information about the scope and content for (i) initial examinations of Reg BI and (ii) Form CRS.” In a nutshell, Chair Clayton was clear: game on.

FINRA Proposes Modifications to Suitability Rules

In its March 12, 2020 rule proposal, FINRA seeks to clarify its existing suitability and non-cash compensation rules in the context of Reg BI. The amendments apply to 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).

First, the proposed amendments clarify that these pre-existing FINRA rules would not apply to broker-dealer recommendations for retail customers under Reg BI. Though it may be clear, as FINRA explained, that any broker-dealer in compliance with Reg BI would meet the suitability standard under Rule 2111, FINRA opted to propose to formally limit the application of Rule 2111 to “reduce the potential for confusion.” In so doing, the amendments make explicit that the higher Reg BI standards apply to broker-dealer recommendations for retail customers.

FINRA explained that it is not eliminating the suitability rule altogether. Rather, it is drawing a distinction between Reg BI’s applicability to “retail customers” and the suitability rule’s continuing applicability to “entities and institutions (e.g. pension funds), and natural persons who will not use recommendations primarily for personal, family, or household purposes (e.g. small business owners and charitable trusts.”)

Second, the self-regulatory organization is removing the "element of control from the quantitative suitability obligation," thus removing the requirement that a broker-dealer must exercise control over an account. This is one of the three prongs of the suitability rule (along with “reasonable basis suitability” and “customer-specific suitability”). This change is consistent with considerations contained in Reg BI, which replaces the suitability rule with four “enhanced” obligations: disclosure, care, conflict of interest and compliance.

Third, FINRA is proposing to apply Reg BI’s conflict of interest limitations on sales contests, sales quotas, bonuses and non-cash compensation to its existing rules governing non-cash compensation. The proposed amendments state that going forward, FINRA rule provisions will not permit non-cash compensations arrangements that conflict with Reg BI.

Comments on the FINRA proposal must be submitted by April 15, 2020. Notably, the effective date will be the compliance date of Reg BI.

SEC Defends Reg BI in Court

Back on September 9, 2019, attorneys general of seven states and the District of Columbia sued the SEC, challenging the issuance of Reg BI on numerous grounds. As Bates described previously, the petitioners asserted, in part, that Reg BI is invalid because the SEC exceeded its statutory authority and acted in an arbitrary and capricious manner by issuing the rule. (These are similar arguments as those that were raised in 2018 successfully challenging the Department of Labor’s Fiduciary Duty Rule.) The petitioners asked the Court to vacate and set aside the rule, and to permanently prevent the SEC from “implementing, applying, or taking any action” under it.

On March 3, 2020, the SEC filed a brief responding to these arguments and defending the agency’s issuance of Reg BI. The SEC asserted that the AG’s argument that the agency exceeded its authority in issuing Reg BI “disregards the text of Dodd Frank, which gave the Commission express, but discretionary, power to adopt a rule imposing a standard of care for broker-dealers.” The SEC also defended the process against arbitrary and capricious claims arguing that the “Commission assessed multiple viewpoints and promulgated a standard of conduct tailored to broker-dealers that will enhance protections for investors against potential harms caused by conflicts of interest while preserving investors’ ability to choose the type of relationship and fee arrangement that best suits them.” (Brief at pp.16-17).

The SEC also defended against a claim that retail consumers will be more “confused” by the different standards for broker dealers and investment advisers created by Reg BI. The SEC said that such a claim is unsupported by any evidence.

Finally, the SEC argued that the state AGs are making “only policy arguments” about what they want to see (a uniform fiduciary duty rule for both investment advisers and brokers) rather than what Congress directed the SEC to do (“evaluate multiple alternatives”). The SEC argued that it did exactly what Congress intended when it gave “the Commission broad authority to balance investor protection with access to services.”

Conclusion

Following SEC Chair Clayton’s statement, firms must now set aside any hope for a Reg BI reprieve through a temporary order of relief. FINRA’s proposed amendments leave little doubt that Reg BI will likely be the controlling standard on recommendations to retail customers. That said, as Bates noted previously, getting past the compliance deadline—and a possible Second Circuit decision—does not end the conversation. There is still the conflicting fiduciary regulation promulgated by states like Massachusetts to contend with. But, the momentum toward an end game continues and firms must continue to stay the Reg BI course.


Bates Group’s Compliance team helps firms implement Reg BI and navigate compliance concerning investor and consumer protection standards. To learn more about Reg BI compliance consulting support for your firm, please visit our Reg BI service page or contact Robert Lavigne, Managing Director, Bates Compliance, at rlavigne@batesgroup.com.

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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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03-26-20

Enforcement Warnings in the Age of the Coronavirus

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As regulators struggle to adjust to the stress that the coronavirus pandemic is placing on the markets, fraudsters are viewing it as an opportunity. That is one clear and consistent warning emanating from federal enforcement agencies over the past month. Last week, Bates described early compliance guidance, regulatory assistance and relief offered by various financial agencies to address some of the difficulties that firms are having, like, for example, fulfilling their reporting and recordkeeping obligations under newly activated business contingency plans. This week we take a look at the latest enforcement warnings and guidance from financial regulators, who are sounding alarms over the added threats that exist in the current volatile environment.

FinCEN Says File your SARs!

On March 16, 2020, the Financial Crimes Enforcement Network (FinCEN) warned financial firms to be alert to malicious or fraudulent transactions. FinCEN requested that institutions affected by the pandemic notify them “as soon as practicable” about any potential delay in filing suspicious activity reports (SARs) as required under the Bank Secrecy Act (BSA). Increasingly, regulatory enforcement strategies rely on these filings (see e.g., Bates’ recent article on senior financial exploitation), and FinCEN is emphasizing the importance of continued compliance and the filing of these reports.

Look Out for Scams

Since the outbreak of the pandemic, FinCEN has noted emerging trends related to imposter scams (impersonations of government officials to steal personal financial information), investment scams (promotions of companies claiming the ability to detect, prevent or cure the virus), and product scams (fraudulent marketing that make false health claims concerning unapproved products). These have yet to result in enforcement actions, but that may only be a matter of time. In any case, tracking these trends requires regulatory reliance on SARs reports which makes continued filings imperative.   

Likening the coronavirus to a natural disaster, FinCEN recommends financial institutions review its 2017 Advisory, which describes other types of potential fraud that FinCEN has reason to believe will possibly occur in the days ahead (i.e. benefits and charities fraud and cyber-related fraud).  FinCEN also notes that it received reports of potential insider trading – a subject highlighted by the widely reported news that two U.S. Senators sold millions of dollars of stock holdings shortly after private government briefings and just prior to the recent market downturn.

SEC on Heightened Alert for Insider Trading

The subject of trading on inside information has been top of mind for the Co-Directors of the SEC’s Division of Enforcement. In a statement issued on March 23, 2020, Stephanie Avakian and Steven Peikin reminded market participants of the importance of following corporate controls to ensure market integrity. Specifically, they noted the significant COVID-19 relief the Commission provided to firms, which allowed for certain delayed submission of earnings reports and certain required SEC disclosure filings. (For more on this SEC March 4, 2020 compliance relief, see here). The Co-Directors warned that this scenario can lead to more people having access to “material nonpublic information” and emphasized the importance of complying with “obligations to keep this information confidential.” This includes maintaining “disclosure controls and procedures, insider trading prohibitions, codes of ethics, and Regulation FD [Fair Disclosure] and selective disclosure prohibitions,” which protect against the “improper dissemination and use of material nonpublic information.” The Co-Directors made clear that these warnings applied to all registrants including broker-dealers and investment advisers. The expressed concern about more insiders holding material non-public information for longer periods of time should be a warning to firms that the SEC will be looking even closer at the effectiveness of existing controls. 

Other Federal Agency Messages

Consistent with the Co-Directors’ statement and FinCEN’s release, other SEC Offices have communicated additional messages that impact enforcement and institutional concerns. For example, the Office of Compliance Inspections and Examinations (OCIE) announced that a firm’s “reliance on [the SEC’s COVID-19] regulatory relief will not be a risk factor utilized in determining whether OCIE commences an examination.” This assurance shows that OCIE will not use these temporary measures to add to a firm’s compliance stress.

As early as February 4, 2020, the SEC Office of Investor Education and Advocacy (OIEA) warned investors about fraud involving claims that a company’s products or services will be used to help stop the coronavirus outbreak. The OIEA also raised issues around “so-called research reports” that make predictions that contain a specific stock target price and “pump and dump” schemes that involve microcap stocks. While these are familiar scams that firms were already alerted to in the OIEA’s Examination Priorities Report (see previous coverage), firms should take note of the enhanced attention the SEC is paying to them given the extreme circumstances afforded fraudsters in the current environment.

Similarly, in an advisory issued on March 18, 2020, the CFTC Office of Customer Education and Outreach (OCEO) warned against fraudsters seeking to profit from coronavirus-related market volatility. The Office urged investors to protect themselves “by learning to recognize common mental biases” and common fraud tactics including (i) promises of oversized returns, (ii) pressure to act “before market conditions change,” (iii) phony credentials, (iv) bogus testimonials, and (v) scams that involve some free gift in exchange for private information.

Conclusion

Financial regulators do not yet know what the new normal will look like.  They warn that bad actors are probing new opportunities created by the volatility and the fear in the markets brought on by the COVID-19. Enforcement officials are also trying to adapt to the temporary loosening of certain compliance reporting and disclosure obligations provided to help market participants cope with their contingent capabilities. As the SEC Co-Directors make clear, relaxing compliance for some of these requirements may create new opportunities for mischief and fraud – particularly as they relate to potential for dissemination of material non-public information. On both counts, regulator guidance emphasizes vigilance and communication. But the landscape is changing quickly. Bates will keep you apprised.

 

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

Bates AML and Financial Crimes

Bates Compliance

Regulatory and Internal Investigations

Retail Litigation and Consulting

Institutional and Complex Litigation

Consulting and Expert Testimony

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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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03-19-20

Financial Regulatory Guidance, Assistance and Relief Roundup

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The volume and urgency of general coronavirus news can seem overwhelming. For financial professionals, separating the facts from the hype is important. Since our last post, financial regulators have pushed out reminders about ongoing compliance obligations, deadline extensions, various general investor “tips” and notifications as to how, for example, the agencies are coping with their own organizational issues. (Note: they remain “fully operational and committed” to their respective missions.)

The challenge for financial firms and investors is to keep on top of the latest communications, understand what is actionable and what is not, and ensure that compliance and supervision processes are in place to manage the crisis. Bates continues to monitor it all. Here’s a recap of the latest compliance guidance, regulatory assistance and relief offered by the SEC, FINRA, NFA and MSRB. (Next, we will look at the latest enforcement warnings and guidance from other financial regulators.)

SEC Gets Practical

 
SEC Offers Compliance and Disclosure Reminders

In late January, SEC Chair Jay Clayton reminded issuers that the coronavirus and its impacts may be material to investment decisions and to make sure that they pay attention to proper disclosures. A few weeks later, SEC leadership, together with the Public Company Accounting Oversight Board, advised market participants to ensure that their financial reports and auditing processes were in order so that they could reflect unforeseen circumstances consistent with their obligations. That joint statement also offered assurance that the agency would grant relief from filing deadlines (i) beyond the control of the issuer, and (ii) in cases where filings cannot be completed on time or with the appropriate level of review and attention. These statements were general reminders, but were issued in the context of agency concerns about companies that had operations and subsidiaries doing business in China. 

SEC Offers Compliance Filing Flexibility

In the past few weeks, the SEC’s posture became significantly more concrete. With the growing realization that the coronavirus had the potential to make it more difficult to gather required information, on March 4, 2020, the SEC issued an Order granting 45 days’ conditional relief from compliance filing obligations to companies that may be challenged in assembling and providing required reports to trading markets, shareholders and the SEC (particularly to companies operating in affected areas like China). The SEC again reminded companies to provide investors with any insight that may be considered a material development and to take the necessary steps to avoid selective disclosures. (See related Alert concerning SEC communications extending the filing and delivery of the Form ADV due to COVID-19)

SEC Offers Board and Shareholder Compliance Relief

On March 13, 2020, the SEC issued two Orders (see here and here) effectively providing relief for funds and investment advisers whose operations may be affected by the coronavirus “due to restrictions on large gatherings, travel and access to facilities, the potential limited availability of personnel and similar disruptions.” Under the Orders, the SEC is expressly granting permission for boards of directors of registered management investment companies and business development companies to fulfill their obligations “by any means of communication that allows all directors participating to hear each other simultaneously during the meeting;” (i.e. virtual board meetings.) The formal relief comes on the heels of the SEC Division of Investment Management's March 4th, 2020 statement that the agency “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.”

SEC Offers Warnings on Coronavirus Fraud

The SEC Office of Investor Education and Advocacy issued an alert to warn investors about fraud involving claims that a company’s products or services will be used to help stop the coronavirus outbreak. (Bates will cover enforcement issues in more detail in our next post.) In particular, the Office noted that investors should be wary of “so-called research reports” that make predictions that contain a specific target price and of any “pump and dump” schemes that involve microcap stocks.

 

SEC, FINRA, MSRB and NFA Cover Business Continuity

In a March 3rd, 2020 statement, the SEC Division of Investment Management advised investment advisers and funds “to evaluate their business continuity plans (“BCPs”) and valuation procedures, among other relevant policies, procedures and systems.” This recommendation was underscored the next day by the derivatives self-regulatory organization National Futures Association (“NFA”), and a week later by FINRA, which detailed the essential elements of such a plan under prescribed rules.

On March 4, 2020, the NFA reminded its members to review their BCPs to ensure that they can adequately address risks associated with the coronavirus to “clearing firms, telecommunications networks, third party providers, internal departments, mail or email services, utilities, etc.,” and to “assess the risks a pandemic poses to those relationships, and understand how a pandemic may materially impact their businesses.”  The NFA also urged firms to make sure they had up-to-date contact information for key employees.

With far more specificity, on March 9, 2020, FINRA issued a broad Regulatory Notice covering member obligations under FINRA Rule 4370 which requires: (i) members to create, maintain and review procedures to address an emergency or significant business disruption, (ii) that the BCPs be reasonably designed to enable the member to meet its existing obligations to customers, and (iii) that the BCPs take into consideration existing relationships with other broker-dealers and counter-parties. In the Notice, FINRA reminded firms to consider whether their BCPs “are sufficiently flexible to address a wide range of possible effects in the event of a pandemic in the United States.” Considerations include staff absenteeism, travel or transportation limitations, risks associated with remote offices and telework arrangements, cybersecurity and technology interruptions or slowdowns.

The landscape is shifting dramatically. FINRA will continue to make interpretive and no-action decisions quickly in the coming days. For detailed updates, FINRA has set up a dedicated Coronavirus related web page to provide information on rule compliance extensions, notices and other guidance for member firms, investors and other stakeholders. The site is an important reference as FINRA continues to respond to a range of concerns (e.g. from broad investor alerts to member applications and mediation and arbitration postponements).

Supervision and Control Issues under BCPs

FINRA urged member firms to review supervisory control policies and procedures under their BCPs to ensure effective communications with customers and to support customer access to funds and securities during the crisis. These supervisory concerns are highlighted because of branch office rule limitations and as a result of the rush to alternative and telework arrangements. Notably, FINRA informed member firms that it is temporarily suspending requirements to update Form U4 information for registered persons who are temporarily relocated; and to submit branch office applications on Form BR for temporary office locations or space-sharing arrangements.

Similarly, on March 16, 2020, NFA told its members that they would allow associated persons to temporarily work from home under their business contingency plans, provided that the firm (i) institutes adequate supervisory methods, (ii) meets its recordkeeping requirements and (iii) "ensure[s] that these procedures are documented."

MSRB addressed the same issues concerning remote supervision in a March 10th, 2020 Notice on the “Application of Supervisory Requirements in Light of Coronavirus.” The Notice covered MSRB rules that require broker-dealers and municipal advisors to implement a system to supervise municipal advisory activities, and asserts that under the rules, firms may incorporate remote supervision using technological resources.

 

Conclusion

As the coronavirus takes its course, regulators will be getting more and more specific with their compliance guidance, regulatory assistance and relief. Bates will continue to monitor and summarize these regulatory developments.


We know that the current crisis is a challenging time for you, your families and your businesses. Our practice leaders, consultants and experts are available to answer your questions and be a source of knowledge to in-house and outside counsel, and our clients’ compliance, risk, supervision, audit and business teams to help them through this period. Please do not hesitate to reach out to us for any reason.

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03-18-20

What We Have Learned From Previous Market Downturns and Corrections

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Dear Clients and Friends:

Over the course of the last 40 years we’ve seen plenty of ups and downs in the markets. Along the way, Bates Group has helped our clients sort through the complexities and fallout of each financial upheaval—and the inevitable litigation and regulatory investigations that follow—by providing clear and accurate analyses, reporting, and expertise.

This was true from the 1987 stock market crash through the limited partnership litigation in the early 1990s, the bond market crash in 1994, the Asian financial crisis in 1997, the Russian default in 1998, the bursting of the “technology bubble” at the turn of the century, the credit crisis that began in late 2007, and now the markets’ reaction to the COVID-19 pandemic.

Each of these events caused investors to re-evaluate the way in which they think about the markets and investing. During the turmoil that followed, previously existing models and paradigms were challenged, and Bates Group helped to provide insight into these challenges by carefully separating fact from fiction and reducing critical issues to their core, while guiding our clients in support of their regulatory compliance.

We know that the current crisis is a challenging time for you, your families and your businesses. Our practice leaders, consultants and experts are available to answer your questions and be a source of knowledge to in-house and outside counsel, and our clients’ compliance, risk, supervision, audit and business teams to help them through this period. Please do not hesitate to reach out to us for any reason.

If there is one thing we have learned over the course of 40 years as experts and consultants, it is that market corrections happen, and rebounds will eventually follow. While we do not have a crystal ball to tell us when this will occur, based on our experience, we know that market participants will react and we will continue to be there to offer our consultation and industry expertise to help you through it. 

Wishing You All the Best,

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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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03-16-20

UPDATE: NSCP Regulatory Interchange with the SEC, DOL & FINRA: July 24, 2020 in Denver, CO.

UPDATE: NSCP Regulatory Interchange with the SEC, DOL & FINRA: July 24, 2020 in Denver, CO.
Linda Shirkey

UPDATE: The NSCP Regulatory Interchange with the SEC, DOL & FINRA has been moved to July 24, 2020 in Denver, CO. Bates Compliance Managing Director Linda Shirkey will be facilitating a discussion at this half-day conference for Investment Advisors, Private Fund and Broker-Dealer Industry Professionals. 

Details at the NSCP Event Page

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03-12-20

Regulators Are Gaining Traction in the Fight Against Elder Financial Exploitation

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Bates Group has been tracking regulatory and enforcement developments on senior financial exploitation. Two recent publications and recent sweeping enforcement actions suggest that the phenomenon is becoming better understood and addressed. The Financial Crimes Enforcement Network (FinCEN) published a strategic analysis after reviewing Suspicious Activity Reports (SARs) filings over a six-year period. The North American Securities Administrators Association (NASAA) issued a statement and a legislative update based, in part, on an enforcement analysis showing that the Model Act to Protect Vulnerable Adults is gaining traction. And the Department of Justice, FBI and Postal Inspector jointly announced the results of “the largest coordinated sweep of elder fraud cases in history.” Here’s a closer look.

FinCEN Analyzes SARs Filings on Senior Financial Exploitation

In December 2019, FinCEN analyzed SARs filed from October 2013 through August 2019 concerning senior financial exploitation. The analysis also reviewed a statistically random sample of SAR narratives contained in these filings between 2013 and 2017. Suspicious activity reported in elder financial exploitation SARs amounted to $21.8 billion during the six-year period, with the number of SAR filings peaking at 7,500 per month by August 2019. FinCEN also found that the total dollar amounts at issue increased annually. In 2014, the total amount reported was $2.2 billion—by August 2019, the amount surpassed $5 billion.

According to the report, “MSBs and depository institutions accounted for the majority of the filings and of the increase, while casino, insurance company, securities and futures, and ‘other’ filers’ reporting trended upward, but accounted for substantially fewer filings per month. Depository institution and securities and futures SARs saw a steady upward filing trend, while MSB SAR filings trended down in 2018 and early 2019.“

The amount reported on a per-SAR basis fluctuated over time. By year, the highest average amount was $70,809 in 2015, and the lowest average amount per SAR was $40,790 in 2017. Breaking these numbers out, however, FinCEN noted that when accounting for type of activity, the average amounts reported for theft (primarily from depository institutions and brokerage firms) were more than double that for scams (mostly from money services businesses.)  For theft, the average per SAR filing was $50,084 with the median amount $15,964. For scams, the average was $25,432, and the median was $6,105. Citing Census Bureau data, FinCEN asserts that these losses reflect as much as 28 percent of the median net worth of households aged 65 or over. 

Distinctions between theft and scams are important as well from the point of view of proposed legislative remedies. Scams (in particular, romance, emergency/persons in need, and prize/lottery scams,) are often characterized by instances where the victim does not know the perpetrator. Fraud and theft, on the other hand, implicates family members (46% of the cases) and non-family member caregivers (20% of the cases). Further, victims of theft often suffer from some cognitive decline or other incapacitation, making the crime even more egregious. FinCEN’s findings clarify the broad spectrum of abuse captured under the term “financial exploitation” and suggest effective responses using a variety of tools.

NASAA Highlights Success of Model Act

In a press release accompanying a 2020 legislative text and commentary on NASAA’s Model Act to Protect Vulnerable Adults From Financial Exploitation, NASAA President Christopher W. Gerold touted the success of the organization’s ongoing effort. He asserted that the Model Act is “on course to become operative in a majority of states” in 2020 and that the success of these measures will result in “additional reporting leading to more enforcement actions and greater protections for seniors and other vulnerable adults.” (Note: New Jersey enacted the “Safeguarding Against Financial Exploitation Act," a statute based on NASAA’s Model Act, on January 13, 2020.)

As described previously, the Model Act (i) “offers broker-dealer and investment adviser firms qualified immunity for delaying disbursements when the firm reasonably believed financial exploitation would result,” and (ii) requires mandatory reporting by an agent or representative upon reasonable belief of senior financial exploitation. NASAA reports that 25 jurisdictions have now enacted some form of the legislation.

Referring to its enforcement report issued last year and covering data from 2018, NASAA asserted that 14 jurisdictions received 426 reports from broker-dealers and investment advisers regarding the potential financial exploitation of a vulnerable adult. Further, these notifications led to 81 investigations which resulted in 57 delayed disbursements and 32 enforcement actions. Finally, NASAA reports that the states that have enacted the Model Act have seen a “drastic increase” in the number of reports of potential financial exploitation.

For detailed consideration of sections of the Model Act, the accompanying legislative commentary for 2020 is an important read. In it, NASAA describes the intention behind many of the definitional terms used in the Act and offers important legislative history and synopses of public comment. Further, NASAA stated that a designated committee “will undertake a review of the implementation and efficacy of the Model Act in the 25 states where the law has been adopted,” in order to “gather information about how effective the laws have been in protecting vulnerable adults from financial exploitation.” These feedback mechanisms are very important to measure the success against the intentions behind the Model Act.

Federal Enforcement Action

On March 3, 2020, the Attorney General, FBI Director and Chief Postal Inspector announced the results of a coordinated enforcement effort that targeted elder fraud schemes. This year, the agencies racked up impressive prosecutions of more than 400 defendants who allegedly caused more than a billion dollars in damages. Unlike last year’s sweep, which focused on technical support scams and mass mail fraud, this year’s enforcement efforts targeted the “threat posed by foreign-based fraud schemes that victimize seniors in large numbers.” Attorney General Barr explained that reduction of transnational fraud schemes on older Americans has become a Justice Department priority. The agencies highlighted going after the “money mule network that facilitates foreign-based elder fraud” and said that actions were taken against over 600 money mules nationwide in an effort to stop the flow of money from seniors to perpetrators.

In addition, FBI Director Christopher Wray commended the work of the Transnational Elder Fraud Strike Force. Established in June 2019, the Strike Force has been meeting with “industry, victim groups, and law enforcement at the federal, state, and local levels to identify the most harmful schemes victimizing American seniors and to bolster preventive measures against further losses,” said Director Wray. 

In the joint announcement, the Justice Department noted additional resources are being made available on senior fraud, including (i) an interactive map showing state-by-state prosecution and educational efforts and (ii) information on a new National Elder Fraud Hotline, for reporting suspected fraud. The latter is to be staffed by case managers who can refer callers to appropriate agencies and services (including the FBI for internet-related scams and the Federal Trade Commission for consumer complaints).

Conclusion

FinCEN and NASAA’s latest efforts to document and analyze their initiatives on elder financial exploitation are important in the ongoing efforts to understand the scope of the problem. FinCEN’s review of available data from SARs filings reinforces prevailing notions that seniors may face an “increased threat to their financial security by both domestic and foreign actors.” NASAA’s updated legislative commentary of key definitions and clauses within the Model Act allows states that have already enacted similar laws—and those that are contemplating enacting such laws—to have the benefit of the latest reasoning based on the latest data. The most recent law enforcement sweep (as evidenced by the interactive map) shows how data sharing, interagency coordination and federal-state collaboration is having an impact.


Learn how to protect your company and its most vulnerable investors with Bates Investor Risk Assessment. For more information concerning financial issues related to vulnerable and senior investors, senior investor expert witnesses, financial crimes, damages analysis, and compliance solutions, please contact Bates Group today.

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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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02-28-20

Massachusetts Adopts New Fiduciary Rule; SEC Releases Reg BI FAQs;  NAIC Approves Annuity Regulation

Massachusetts Adopts New Fiduciary Rule; SEC Releases Reg BI FAQs;  NAIC Approves Annuity Regulation

As the June 30, 2020, date for compliance with the Regulation Best Interest (“Reg BI”) draws near, federal and state regulators are increasingly vocal in warning market participants about how they should treat client investors. Fortunately, the regulators have provided a constant flow of guidance and resources designed to help firms prepare. Unfortunately, however, a chance still exists that geography will affect compliance. In this article, we look at the latest developments by state regulators to push a more stringent fiduciary standard, new SEC staff considerations on Reg BI questions, and important developments in the National Association of Insurance Commissioners (“NAIC”) model regulation on conflict of interest rules for insurance agents and representatives selling annuity products.

Massachusetts Adopts Fiduciary Rule

On February 21, 2020, the Massachusetts Securities Division (“the Division”) of the Office of the Secretary of the Commonwealth officially adopted its proposed “Amendments to Standard of Conduct Applicable to Broker-Dealers and Agents.” The final regulation, effective March 6, 2020, and enforceable starting September 1, 2020, applies a fiduciary conduct standard to broker-dealers when dealing with customers. (Note: the Division adopted amendments concerning disclosure obligations for investment advisers effective back in June of 2019. Enforceable as of January 1, 2020, the amendments require that investment advisers registered in Massachusetts provide clients and prospective clients with a one-page, stand-alone Table of Fees for Services.)

The final regulations were revised to “make clear that the existing suitability standard still applies to any relationships or transactions expressly excluded from the fiduciary standard.” As a previous Bates post describes, the revised version adds “language expanding a potential breach of fiduciary duties to commodity and insurance products;” establishes a presumption that a fiduciary duty exists simply by the title used by an advisor; and requires that an advisor go beyond disclosure or mitigation of a conflict of interest by requiring efforts to actually avoid such conflicts.

Based on comments received, the standards were adopted despite significant pushback, even from Massachusetts Governor Charles Baker (see here). Broker-dealers and agents registered in Massachusetts that fail to comply with the newly adopted fiduciary standard will be deemed in violation of their obligation of “utmost care and loyalty” and considered to be operating a “dishonest or unethical practice” under Massachusetts law.

SEC Issues New FAQs on Reg BI Compliance

On February 11, 2020, SEC staff modified their Frequently Asked Questions (“FAQs”) documents on Reg BI and CRS Forms. Though staff member answers are not official “rules, regulations or SEC statements” and “have no legal force or effect,” compliance professionals should not ignore them. The documents are available on the SEC website. The Reg BI FAQs cover by category the following: Retail Customer, Recommendation, Disclosure Obligation, Care Obligation, Conflict of Interest Obligation and Compliance Obligation. The CRS FAQs cover Retail Investor, Relationship Summary Format, Delivery Requirements, Amendments to the Relationship Summary, Disciplinary History, and Plain English; and Fair Disclosure.

Among several scenarios, the latest answers clarify (i) the applicability of Reg BI obligations and CRS Form requirements for accredited investors, (ii) whether CRS forms must be sent or resent to customers if the type of account changes, and (iii) issues concerning state and federal registrations.

NAIC Approves Model Regulations

On February 13, 2020, NAIC announced approval of final revisions to the Suitability in Annuity Transactions Model Regulations. Bates has been following the NAIC deliberations to revise standards and procedures for providing recommendations to consumers on transactions involving annuity products. In general, the model regulation requires that an agent demonstrate in writing a recommendation is in the consumer’s best interest and must identify, manage, and disclose material conflicts of interest. In our previous post, we note that NAIC’s Life Insurance and Annuities Committee approved final revisions (i) that spell out that any producer of such products must satisfy obligations of care, disclosure, conflict of interest, and documentation, (ii) that the model regulation does not require a fiduciary relationship between the producer and the customer, and (iii) that the model regulation provides a safe harbor for producers that comply with the Reg BI. For compliance purposes, the revised model also enhances supervision regime. NAIC President Ray Farmer stated that “nearly every state has adopted the model, which has been protecting consumers for 15 years. I encourage my colleagues to work with their state legislatures to pass these updates to provide even stronger protection” for consumers purchasing annuities.

CONCLUSION

There are no surprises among the developments. Processes undertaken by various authorities are leading to different, but anticipated results; some that can coexist (i.e., SEC and NAIC) and some that may ultimately be a bit more challenging for firms (Massachusetts fiduciary duty standards and Reg BI).

Despite the request Kenneth Bentsen Jr., president and chief executive of SIFMA for Massachusetts, issued, to “delay action for at least 18 months and then assess whether any further steps are necessary,” the Division appears to have done the opposite, setting an effective date almost 2 months earlier than the Reg BI compliance date. The stage is set for a possible legal battle about whether state or national standards will prevail.

The NAIC’s Reg BI-friendly model regulation for annuity products appears to accommodate some of the differences between the states and the federal agencies.

Firms have little choice but to prepare for Reg BI and should consider their own business practices in light of the detail offered by the SEC FAQs. For broker-dealers whose customers are in Massachusetts, the March 6th effective date for the regulation is fast approaching. For all, the Reg BI June 30 compliance date is just around the corner.


Bates Group’s Compliance team helps firms through the implementation phase of Reg BI and navigating compliance concerning investor and consumer protection standards. To learn more about Reg BI compliance consulting support for your firm, please visit our Reg BI service page or contact Robert Lavigne, Managing Director, Bates Compliance, at rlavigne@batesgroup.com.

For information about Bates Group’s Insurance and Actuarial practice services, please contact Bates Managing Consultant, Greg Faucher.

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02-27-20

Visit Bates Compliance at the 2020 IAA Compliance Conference, March 5-6

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Visit Bates Compliance at Booth #10 at the 2020 IAA Investment Advisor Compliance Conference to discuss your compliance needs and solutions on March 5-6  in Washington, D.C. Hear Bates Compliance Managing Director Robert Lavigne on the panel “Vendor Due Diligence: One Approach Does Not Fit All.”  Learn about different strategies for conducting due diligence, who is typically involved in the process, identifying vendor risks, differences in initial and ongoing processes, important contract provisions, supervision considerations when outsourcing, and SEC guidance on how an adviser should assess third-party service providers. The 2020 IAA Compliance conference will cover a wide range of topics, including preparing for new Form CRS; strategies for managing an SEC exam; data privacy; cybersecurity; technology; trading and best execution; ethics; and much more. Continuing Education Credit will be available.

Full Conference Agenda and Registration Details

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02-26-20

Reg BI Webinar March 4, 2020 from Bates Compliance and NICE Actimize

Reg BI Webinar March 4, 2020 from Bates Compliance and NICE Actimize

Robert “Bob” Lavigne, Bates Compliance Practice Leader, will be participating in a joint webinar co-hosted with NICE Actimize entitled “Reg BI Countdown: Strategies to Ensure Compliance,” Wednesday, March 4, 2020 at 11:00 AM EST. The panel of regulatory compliance and technology experts will discuss new tools, technology, and process changes to help your firm comply with SEC Regulation Best Interest. 1 Hour

Now Available on Demand

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02-20-20

FINRA Talks Dispute Resolution - Offers Tips and Advice to Counsel and Arbitrators

On February 3, 2020, the New York County Lawyers Association hosted its “21st Annual FINRA Listens and Speaks” panel. The panel members discussed recent statistics, proposed regulations, and tips for counsel and arbitrators on the agency’s dispute resolution efforts. Katherine Bayer, Northeast Regional Director of FINRA’s Dispute Resolution Office, and Arthur Baumgartner, Senior Case Administrator, FINRA Dispute Resolution, delved into details of the inner workings of the Office and responded to comments from moderator and arbitrator Martin Feinberg. Bates takes a closer look at what you need to know.

Recent Statistics

FINRA’s case load has been on the decline for a number of years. In 2019, 3,757 new claims were filed – a decrease of 13 percent from 2018. Customer cases made up 63 percent of the filings and intra-industry cases made up the remaining 37 percent. On average, cases took 14.2 months to conclude – no change from the prior year. However, cases that went through to hearing averaged 16.9 months (slightly longer than the year before), and cases decided on the pleadings alone – with no hearing – averaged 5.8 months, which was a decline from the previous year.

A new category of “special proceeding” cases focusing on small claims were resolved in an average of 7 months. The 1-day telephonic hearings using a single arbitrator went into effect a year and half ago. In 2019, 46 customer cases were decided under the special proceedings. Director Bayer stated that she believes that it is likely the number of these cases will increase as they become better known.

In 2019, 16 percent of the cases closed by award, a low figure and one trending downward. Each year since 2016, the number of cases closed by award went down. Cases closed by settlements and through mediations of customer cases, however, represented 74 percent of the cases adjudicated, which has increased year over year. Mediation case filings also went up last year, with 592 new mediation cases filed (up from 16 percent from the prior year). Director Bayer noted that cases from San Juan, Puerto Rico comprised of more than a third of the mediation case filings. Mr. Feinberg noted that this statistic was the result of the filings from disputes on Puerto Rico bonds.

Rule and Proposed Rule Changes

Director Bayer highlighted a number of recent rule and proposed rule changes affecting FINRA dispute resolution. Those include:

  • New rules extending the time for non-parties to object to an Order of Subpoena or Order of Production of Documents (to 15 days upon receipt from 10 days upon service).
  • Proposed changes to member application program (MAP rules) related to pending arbitration claims and awards. The proposed rule change would create a rebuttable presumption that an application for new membership should be denied if the applicant is subject to a pending arbitration claim. The presumption can be overcome by a demonstration of the ability to satisfy an unpaid claim, unpaid award, or unpaid settlement.
  • The above proposed rule also applies to an existing member seeking a specified change in ownership or control of business operations. Resolution would require a “materiality consultation” – to ensure that the member seeking the change can satisfy an unpaid claim or award. Director Bayer noted that the issue addresses when a firm sells its assets to another firm, and the new firm declines any liability for previously unpaid claims or awards. The rule also requires that an applicant notify any pending arbitration claim before a decision on an application. Comments were completed on January 21, 2020. FINRA is expected to act on it soon.
  • Proposed changes placing restrictions on non-attorney representatives (NARs) practicing in a FINRA dispute resolution. Law school clinics, family members, and non-compensated friends are not subject to the restrictions in the proposed rules. FINRA will file a formal amendment with the SEC sometime soon. Director Bayer also clarified that under FINRA rules, an out-of-state lawyer can practice in a FINRA dispute resolution proceeding subject to state law restrictions. Mr. Feinberg noted that the original reasoning behind NARs concerned fully qualified, non-lawyer union representatives representing individuals in a labor dispute.
  • Proposed changes to amend the Code of Arbitration Procedures to expand a customer’s option to withdraw an arbitration claim and file in court in situations where the member firm becomes inactive before a claim is filed, or during a pending arbitration claim. The current rule states that a customer is not required to arbitrate a dispute involving a terminated member. The proposed rule allows a customer to amend pleadings, postpone hearings, and receive refunds of filing fees. Staff is in the process of reviewing comments.
  • Proposed rule change to the Code of Arbitration Procedures to increase various arbitrator fees and honoraria. To cover the fees, the proposed rule would increase member surcharges in case processing under certain circumstances. The proposed amendments are to be filed soon with the SEC.

Director Bayer also announced the inclusion of case-specific contact information to be delivered at the time the Notice of Panel is announced. The contact sheet includes names of the case administrator, case coordinator (who handles scheduling), and a case specialist (who handles the case when its first is filed, when the answer is filed, and, in general, the motions docket).

Tips for Counsel:

  • Director Bayer emphasized the importance of, the improvements to, and the expectations for arbitrators to utilize the FINRA arbitration portal. Director Bayer encouraged arbitrators to trust the portal for documents sent and received that will automatically provide a confirmation in the submissions folder. She stated that it speeds up the process, prompts required disclosures (and disclosure updates), and creates automated processes that generate required notices to parties and updates relevant arbitrator disclosures in other cases.
  • Send Submission Agreement with your Answer. Arbitrator Feinberg stated, “distributing an Answer without a Submission Agreement can do great harm to the parties later on after the case closes and if claimant wants to vacate an award.”
  • Provide copies of Settlement Agreements to FINRA – they are relevant in expungement proceedings.
  • “No action” letters (e.g., from an investigation) should not be submitted as evidence in customer arbitration cases.

Tips for Arbitrators:

  • Complete and execute the Arbitrator Oath on the portal – it starts the disclosure process.
  • Make disclosures early and throughout the life of the case. Director Bayer stated that “everything is out there these days.” If you are not sure, it is best to disclose.
  • Avoid withdrawals. Withdrawals are very disruptive to the parties. Director Bayer explained that FINRA staff track withdrawals and patterns emerge, particularly close to hearing dates, FINRA may remove the arbitrator from the roster.
  • In ruling on motions that include fees (e.g., adjournments), arbitrators should be deciding at the time of the decision who should be responsible for the fee or on any waivers of fees. Director Bayer stated that deferments on assessment of fees may cause problems at the end of the case.
  • Rulings on motions (e.g., a Motion to Compel) should not be made before an initial pre-hearing conference (even though the arbitrator may have the authority to do so after the filing of the Oath).
  • Avoid ex parte communications, or any interaction – no matter how innocent – that may be interpreted as bias.

Diversifying Arbitrator Panels

Director Bayer reported that her Office is beginning to see results of outreach efforts to find diverse candidates to serve as arbitrators. She said an outside firm conducts a voluntary confidential demographic survey of the arbitration population. The results are then published on the FINRA website. In the 2019 survey results published in January, significant increases occurred in the diversity of the new arbitrator roster: 39 percent were women, 19 percent African American, 6 percent Latino, 3 percent Asian, and 4 percent LGBT.

Conclusion

The “FINRA Listens and Speaks” panel is an important outreach effort to communicate current thinking on arbitration processes and procedures. The decline in case filings is noteworthy given the longevity of the strong markets. FINRA’s efforts to diversify its arbitrator roster is laudable. FINRA distinguishes itself as one of the few forums in the country that has made progress in addressing and tracking the issue. Director Bayer and Administrator Baumgartner’s tips for practitioners and arbitrators demonstrate a continuing commitment to improve and clarify FINRA’s adjudicatory process. Their repeated admonitions to “trust the portal” should not be ignored. 

Learn more about Bates Group’s Litigation Services, including expert testimony, damages analysis, and our Arbitrator Evaluator™ selection tool.

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02-12-20

New OCIE Report Offers Best Practices for Firms to Enhance Cyber Preparedness and Resiliency

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A few weeks ago, Bates reviewed the SEC Office of Compliance Inspections and Examinations ("OCIE") recently issued 2020 examinations priorities. That report reminded registered entities to address potential vulnerabilities in compliance programs and practices in order to minimize retail investor and market risks. On the heels of that report, OCIE has issued a new report on “Cybersecurity and Resiliency Observations” to reemphasize that cybersecurity is a top examination priority and that registered entities should be assessing their practices and procedures to ensure adequate compliance. Bates Research takes a closer look at what OCIE wants you to know.

Increasing Threats, Serious Consequences

The OCIE issued its new cybersecurity observations report based on concerns about (i) increasingly aggressive and sophisticated “cyber threat actors,” (ii) increasing firm reliance on technology, and (iii) the rising potential for negative consequences to investors, market participants and the financial markets. Based on 2019 examinations, the report offers best practices on a wide range of cybersecurity controls and operations.

Support from the Top: Governance and Risk Management

OCIE asserts that effective governance and risk management programs (i) demonstrate strong and engaged leadership, (ii) effectively assess and prioritize cybersecurity risk, (iii) have written policies and procedures to address that risk, and (iv) have practices that implement and enforce those policies.

Specifically, OCIE recognized programs that demonstrate appropriate board- and senior-level engagement, including those in which senior leaders demonstrate their commitment “to improving their organization’s cyber posture through working with others to understand, prioritize, communicate, and mitigate cybersecurity risks.”

OCIE highlighted risk assessment methodologies tailored to an organization’s business model and wants firms to consider a wide spectrum of vulnerabilities from “remote or traveling employees” to “geopolitical risks.” Firms should expect that the OCIE will examine for policies and procedures that (i) establish adequate testing and monitoring, informed by cyber threat intelligence; (ii) respond to such testing and monitoring with continuous updates and (iii) provide updated information to stakeholders and to regulators.

Access Rights and Controls

Firms should also expect that the OCIE will examine to ensure that a firm has appropriate controls in place to limit access to sensitive client information. This means an organization’s systems should demonstrate that managers (i) understand the location of client information, (ii) restrict access to that data only to authorized users; and (iii) take steps to prevent and monitor for unauthorized access.

OCIE said it observed firm strategies in which managers limited access during “onboarding, transfers, and terminations;” implemented “separation of duties for user access approvals” and created periodic recertification procedures, among others. Similarly, OCIE identified best practices for access monitoring, including procedures for logins, user name and password changes, hardware and software changes and for the investigation of system anomalies.

Data Loss Prevention

OCIE said that firms should ensure the protection of sensitive data from unauthorized users. OCIE highlighted “capabilities” used by firms to (i) scan for vulnerabilities in internal and external systems (including applicable third party providers,) (ii) “control, monitor, and inspect network traffic,” (iii) “detect threats on endpoints” (e.g. maintaining system logs and applications for aggregation and analysis), (iv) “patch” software and hardware from virus and malware threats, (v) maintain inventories of all hardware and software, (vi) secure data and systems through encryption and network segmentation, (vii) identify and block the transmission of suspicious behaviors and (viii) secure legacy systems and equipment.

Mobile Security

OCIE highlighted firm strategies to secure mobile devices and mobile applications. These include establishing clear policies and procedures and requiring the use of mobile device management (MDM) technology applications for authorized users. OCIE also noted firm best practices that “prevent printing, copying, pasting, or saving information to personally owned computers, smartphones or tablets as well as sufficient employee training on mobile device policies.

Resiliency and Incident Response

OCIE expects firms to have incident response plans that include “timely detection and disclosure of material information” in the event of a cyber incident. Specifically, OCIE noted effective programs that incorporate: (i) scenario planning (e.g. denial of service or ransomware); (ii) systems for regulatory and suspicious activity reporting (SARs) and compliance; (iii) adequate notifications concerning data breaches to customers, clients and employees; (iv) staff preparedness plans and (v) incident response testing.

The OCIE also stated that resiliency plans should be based on assessed risks and business priorities, so the firm is in the best position to maintain its core business operations and systems in the event of an incident. This includes determining system and process substitutions during disruptions, maintaining back up data, and assessments of the “effects of business disruptions on both the institution’s stakeholders and other organizations.”

Vendor Management

OCIE highlighted firm best practices for vendor management. These include, among others, required due diligence during vendor selection, ongoing relationship monitoring, assessments of vendor services within the firm’s ongoing risk processes, and vendor protection of client information.

Employee Training

OCIE expects that firm employees undergo training about cyber risks to help “build a culture of cybersecurity readiness and operational resiliency.” OCIE observed firms that have robust policies, procedures, training guides and training programs that incorporate specific examples of threats (e.g. phishing emails) to help employees prevent breaches, and to identify and respond to suspicious behavior. OCIE recognized firms that continuously evaluate and update their training programs based on cyber threat intelligence.

Conclusion

The new OCIE report  emphasizes that cybersecurity remains a key SEC priority, particularly when it comes to customer data protection, disclosure and compliance (see previous Bates alert). Though OCIE offers these very specific observations on “cybersecurity preparedness and operational resiliency,” it says that there is no such thing as a “one-size-fits-all” cybersecurity program. However, in light of the fact that this very detailed template represents the second OCIE warning in a matter of weeks, it would be prudent for firms to review whether they are appropriately assessing, monitoring and managing their cybersecurity risk.

 

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

Bates Compliance

Regulatory and Internal Investigations

Retail Litigation and Consulting

Institutional and Complex Litigation

AML and Financial Crimes

Insurance and Actuarial Services

Consulting and Expert Testimony

 
Learn more about Bates Group’s Data Security

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02-11-20

Private Placement Alert: GPB Private Funds Under Scrutiny

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Bates Group is alerting counsel that we are seeing cases filed where firms sold private funds issued by GPB Capital Holdings LLC. It is alleged that firms selling these funds were negligent and failed to perform adequate due diligence when approving these funds for sale, misrepresented and omitted material information when recommending and/or selling these funds to their clients, had conflicting interests in selling the GPB Capital Funds, negligently supervised the sale of these funds and breached the fiduciary duty owed to their clients.

GPB Capital Funds include:
  • GPB HOLDINGS, LP;
  • GPB HOLDINGS II, LP;
  • GPB AUTOMOTIVE PORTFOLIO, LP;
  • GPB COLD STORAGE, LP;
  • GPB WASTE MANAGEMENT FUND, LP;
  • GPB HOLDINGS III, LP;
  • GPB HOLDINGS QUALIFIED, LP;
  • GPB NYC DEVELOPMENT, LP;

Bates Group Support:

Bates staff and experts have provided both consulting and testimony services in matters involving private placement funds. Bates experts have opined on the rules and regulations associated with public and private securities offerings,  the adequacy of disclosures in offering documents, the adequacy of due diligence undertaken by firms selling private funds, a determination of the product’s suitability for sale by the firm, a determination of the suitability of individual recommendations made, the adequacy of sales supervision, and an assessment of whether the firm and its representatives met their fiduciary obligations to accredited and retail investors.

Bates has also performed quantitative analyses examining the feasibility of investments at issue producing the expected or advertised returns, including calculating a probability-weighted expected value of return amongst other hypothetical scenarios.

Our experts have provided in-depth knowledge and analysis concerning trading strategies involving alternative investments and the role of these strategies within an overall investment objective, as well as the relative risks for the client in engaging in these types of strategies. We have also provided analysis and testimony in support of matters involving strategies employed to generate additional yield in a client’s portfolio, across a variety of investment products, as well as damages calculation and alternative damages calculation.

Specifically, Bates can assist in the following ways:
  • Examining the relationship between the general partner and the lead broker-dealers to assess if there was a conflict of interest in brokering, selling, and underwriting the funds.
  • Assessing whether the offerings were appropriately registered under the Securities Act of 1933 and Section 12(g) of the Securities Exchange Act of 1934.
  • Assessing the adequacy of disclosures in the private placement memorandum and other offering documents, including the adequacy of risk disclosure and whether there were any material misstatements and omissions.
  • Assessing the suitability of the products and the suitability of the recommendation.
  • Analyzing the trading in brokerage accounts to determine the P/(L) associated with investments in the funds at issue.
  • Contextualizing the fees and commissions that were charged in light of alternative products of a comparable nature and examining the likelihood of the investments at issue generating the expected or advertised returns.
  • Examining the changes in the investor’s portfolio risk and expected return when investments in the funds at issue are considered as part of an overall investment strategy; forecasting the probability of a loss and the probable size of a loss at the time of purchase.
 
Please contact us today if you have any questions or need assistance:
 

Andrew Daniel, Securities Litigation Expert and Director – adaniel@batesgroup.com

Alex Russell, Managing Director, Practice Leader, Regulatory Enforcement & Complex Litigation – arussell@batesgroup.com

Julie Johnstone, Managing Director, Practice Leader, Retail Litigation – jjohnstone@batesgroup.com

Peter Klouda, Securities Litigation Expert and Director, Retail Litigation – pklouda@batesgroup.com

 
Learn More About Bates Group’s Securities Litigation Practice

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02-06-20

Hank Sanchez to Speak at the Nashville Compliance Roundtable - Feb 13, 2020

Hank Sanchez to Speak at the Nashville Compliance Roundtable - Feb 13, 2020

Bates Managing Director and Expert Consultant Hank Sanchez will be speaking at the Nashville Compliance Roundtable on February 13, 2020, in Nashville Tennesee. The roundtable will cover the following topics: Reg BI, Form CRS, SEC and FINRA 2020 exam priorities, Cyber, Seniors, and the SECURE Act. Sponsored by TrustCore.

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02-05-20

Bates Managing Director Linda Shirkey To Facilitate Reg BI Compliance Workshop in Austin, TX

Bates Managing Director Linda Shirkey To Facilitate Reg BI Compliance Workshop in Austin, TX
Linda Shirkey

Bates Managing Director Linda Shirkey will be serving as a facilitator at a Regulation Best Interest (Reg BI) Compliance Workshop for FINRA-registered broker-dealers, SEC-registered investment advisers, and dual registrants on Tuesday, February 11, 2020, from 2:30 – 5 p.m. at the UT McCombs School of Business’ Center for Enterprise and Policy Analytics in Austin, Texas. The workshop will open with an overview of Form CRS content and distribution requirements, followed by small-group working sessions to help each attendee draft their own Form CRS. The workshop will be interactive, drawing on insights and best practices shared by the facilitators and by attendees, with the facilitators also hosting conversations about the identification, mitigation and disclosure of conflicts of interest within the framework of Regulation BI.

This two-day conference brings together current and former government officials, industry experts, and academic researchers to engage in a series of dialogues on how Reg BI will impact securities brokers and registered investment advisors.

Click Here for Conference Details and to Register

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02-05-20

U.S. Anti-Money Laundering Updates

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Photo by Pepi Stojanovski on Unsplash

 

The Treasury Department’s Office of Comptroller of the Currency (OCC) issued an Annual Report to Congress highlighting, among other things, the past year’s Bank Secrecy Act (BSA) and anti-money laundering (AML) efforts and setting out strategic priorities and policy initiatives for the new year. The Comptroller says he wants to reduce the burden of BSA and AML compliance, while protecting the financial system. Meanwhile, (i) financial institutions continue to watch the Senate Banking Committee to see if there will be movement on the ILLICIT CASH Act, a bill containing provisions on beneficial ownership that would have significant implications for AML/BSA compliance, (ii) the Association of Certified Financial Crime Specialists (ACFCS) shared some interesting AML 2019 enforcement data compiled by a number of private companies, and (iii) there were some unusual AML-related enforcement actions worth noting. Here’s a closer look.

OCC Report

The OCC Report states plainly that BSA/AML compliance risk remains high. In response to these risks, the OCC highlights three main points. First, it references two previously published joint bulletins (see here and here) that (i) encourage financial institutions to consider innovative approaches in meeting their BSA/AML compliance obligations, and (ii) “address instances in which banks may decide to enter into collaborative arrangements to share resources” to manage these obligations. (The latter provides examples of how “shared personnel, technology and other resources may be beneficial for certain financial institutions – e.g. Community Banks.) The new Report re-emphasizes these themes by acknowledging the global nature and the dynamic of the current technological environment. The Comptroller stated that as innovative solutions continue to evolve, particularly related to identifying suspicious activity and terrorist financing, his Office will focus on encouraging financial institutions to adopt them to manage compliance risks.

Second, the Comptroller reinforces the goal of working with other regulators to ensure that financial institution BSA/AML compliance risk management systems “be commensurate with the risk associated with a bank’s products, services, customers, and geographic footprint.” The Report references OCC’s participation in a Financial Crimes Enforcement Network (FinCEN) working group to improve the transparency of the regulator’s “risk-focused approach to BSA/AML supervision.” Regulators agreed to “tailor examination plans and procedures based on the unique risks of each bank, thereby allowing banks to allocate compliance resources commensurate with their risks.” In 2020, the Comptroller states, OCC will work with other agencies to update the Federal Financial Institutions Examination Council’s (FFIEC) BSA/AML Examination Manual . Notably, the OCC report comes on the heels of publication of the SEC’s Office of Compliance Inspections and Examinations (OCIE) annual report which stated that the OCIE will examine BSA/AML compliance in particular for customer identification programs and customer due diligence, beneficial ownership, and Suspicious Activity Report (SARs) compliance. (See Bates’ OCIE Priorities review here.)

Third, the Comptroller stated that the Office is committed to advocating for updating the “nearly 50-year-old BSA/AML regime.” Referencing 2019 testimony by the Deputy Comptroller, the Report asserts that regulations should be updated “to address rapidly evolving risks, including the inappropriate use of shell companies, and to make better use of technology to protect the financial system from illicit activity.”

ILLICIT CASH Act

OCC’s advocacy for updating the BSA/AML regime finds expression in the Improving Laundering Laws and Increasing Comprehensive Information Tracking of Criminal Activities in Shell Holdings Act (“ILLICIT CASH Act”), a bill which would strengthen the authority of FinCEN. (See previous Bates article here.)

As described in its legislative summary, the bill “comprehensively updates the BSA for the first time in decades and provides a coherent set of risk-based priorities in statute.” Specifically, the bill requires the reporting of beneficial ownership information for domestic shell companies and creates federal reporting requirements that mandate all beneficial ownership information be maintained in a comprehensive federal database, accessible by federal and local law enforcement. A similar bill, sponsored by Congresswoman Carolyn Maloney, titled the Corporate Transparency Act (“CTA”), passed the House of Representatives. To date, the ILLICIT CASH Act resides in the Senate Committee on Banking, Housing, and Urban Affairs, which last held a hearing on it on December fifth.

AML 2019 Enforcement

The Association of Certified Financial Crime Specialists (ACFCS) shared AML enforcement data for 2019. UK software company Encompass concluded that AML enforcement penalties totaled US $8.14 billion globally, nearly doubling the amount that was handed out in 2018. In the United States, they said, regulators assessed 25 penalties totaling $2.29 billion.

FinCEN and SARs

ACFCS also noted a widely reported plea deal by a former senior adviser at FinCEN. (See also here.) The United States Attorney for the Southern District of New York brought charges against the employee for “conspiring to unlawfully disclose Suspicious Activity Reports” to reporters concerning “among other things, Paul Manafort, Richard Gates, the Russian Embassy, Maria Butina, and Prevezon Alexander.” Under the BSA, disclosure of a SAR by a government employee is a felony.

Conclusion

The OCC remains committed to its collaborative approach to regulating for BSA/AML risk. It has embraced and encouraged adoption of innovation and technology as the solution, while working with its regulatory counterparts to require that financial institutions tailor their resources to their business models, products, services and customers. The OCC also seeks regulatory changes in the BSA/AML regime that will extend government reach, capture more data and boost their regtech approach. If passed, the ILLICIT CASH Act may serve that purpose. The consistent rise in AML enforcement cases and penalties may evidence the success of that approach. However, the FinCEN case suggests that even the best approach comes with unexpected consequences. Bates will keep you apprised.

To learn more about Bates Group’s AML and Financial Crimes services, please contact Edward Longridge at elongridge@batesgroup.com.


This week: Meet Bates AML Leaders at booth #8 at SIFMA's Anti-Money Laundering and Financial Crimes Conference, Wednesday and Thursday, February 5-6, 2020 in New York City. Hear Bates AML and Financial Crimes Managing Director Edward Longridge speak on the panel "Wherever You Go, There You Are: Money Laundering in an International Context," 12:55 - 1:55 p.m. on Thursday, February 6th.

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

Anti-Money Laundering and Financial Crimes

Bates Compliance Solutions

Regulatory and Internal Investigations

Retail Litigation and Consulting

Institutional and Complex Litigation

Consulting and Expert Testimony

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01-29-20

Meet and Hear from Bates AML Leaders at the 2020 SIFMA AML and Financial Crimes Conference

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Bates AML and Financial Crimes Managing Director Edward Longridge (pictured, top left),will be a panelist at SIFMA's Anti-Money Laundering and Financial Crimes Conference, February 5-6, 2020 in New York City. Mr. Longridge will be speaking on the panel "Wherever You Go, There You Are: Money Laundering in an International Context," 12:55 - 1:55 p.m. Thursday, February 6th, alongside panelists Sterling Daines, Managing Director - Credit Suisse, Alan Ketley, Managing Director - MUFG Securities America Inc., and Betty Santangelo, Of Counsel - Schulte, Roth & Zabel LLP. The panel will be moderated by Alan Williamson, Director of Financial Crime Compliance - Barclays.

Bates Group is proud to be a returning sponsor and exhibitor at the 2020 AML and Financial Crimes Conference, which brings together leaders from the securities industry, regulatory agencies and law enforcement to discuss the latest developments and priorities in the AML and financial crime space. Throughout the two-day program, attendees will hear directly from the industry’s regulators and network with policymakers and peer compliance professionals.

Visit Bates at booth #8 to meet Mr. Longridge and fellow Bates Group leaders Dennis Greenberg, Susan Harper and David Birnbaum (pictured, clockwise from top right), and to learn more about Bates AML and Financial Crimes solutions.

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About Bates AML and Financial Crimes

Bates AML and Financial Crimes offers a valuable combination of industry and technical consulting expertise, providing the highest possible value to our clients in the areas of AML and financial crimes, fraud investigations, forensic accounting, data analysis and expert witness consulting. Our Financial Crimes team is led by recognized experts in AML, financial crimes, fraud and forensic accounting with extensive experience in the broker dealer, banks and investment adviser field. We provide tailored solutions and support that covers the following areas: AML/FC program redesign and implementation, AML/OFAC risk assessments, AML/FC program gap assessments and audits, KYC risk model design, AML systems tuning and optimization, AML systems integration, transaction monitoring look-back and ongoing investigations, fraud investigations, forensic accounting, AML/FC policies and procedures reviews, advisory services for AML/FC rule implementation, regulatory response support, and white collar crime testimony support.

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01-28-20

Bates Group Welcomes New Managing Director Jennifer L. Cunningham

Bates Group Welcomes New Managing Director Jennifer L. Cunningham

Bates Group is proud to welcome new Managing Director Jennifer L. Cunningham. She is an accomplished and seasoned financial services industry professional, with over 20 years of experience working with financial advisors and customers in branch office management. Her areas of expertise include risk and supervision, customer complaints, FINRA arbitration and mediation matters, suitability, operations, sales support, Human Resources, customer communications and relations, project management and FINRA new member applications.

Ms. Cunningham has held various broker-dealer management positions during her career. At UBS Financial Services, Inc. (UBS), headquartered in Weehawken, New Jersey, she was a Director, Senior Client Communications Manager, where she worked in the Marketing office, drafting and executing UBS’s customer communications. Ms. Cunningham was a Director, Complex Administrative Manager for UBS’s Park Avenue branch office in New York City, where she supervised branch office sales support personnel along with the operations and compliance teams.

Before joining UBS in 2013, Ms. Cunningham was a Vice President, Administrative Manager at the Merrill Lynch Fifth Avenue flagship office in New York City, where her responsibilities included various compliance supervisory reviews and approvals, customer complaints, heightened supervision, liaising with in-house and outside counsel on customer litigation, as well as serving as Merrill’s corporate representative for those matters.

Prior to joining Bates, Ms. Cunningham served as a Managing Director at another consulting firm, where she provided expertise in support of broker-dealer litigation and customer complaint matters, prepared FINRA broker-dealer New Member Applications, and served as lead project manager for specialized regulatory and compliance consulting retentions. Ms. Cunningham began her financial services career in the early 1990’s in Wilmington, Delaware. She became a FINRA licensed Sales Assistant in 1997 and has held FINRA Series 7, 9, 10, 31, 63 and Series 65 licenses.

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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:

Bates Compliance Solutions

Reg BI Services and Support

Broker-Dealer Compliance Services

RIA Compliance Services

Retail Litigation and Consulting

Regulatory Enforcement and Internal Investigations

Bates Investor Risk Assessment for Vulnerable and Senior Investors

Bates AML and Financial Crimes

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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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01-15-20

Bates Expert William Jannace Quoted in Investment News Article

Bates Expert William Jannace Quoted in Investment News Article

Bates Group Expert and Consultant William Jannace is quoted in a new article from Investment News. The article discusses FINRA's interest in brokerage bank sweep accounts at a time of low commissions for brokers.

Read the full article at Investment News.
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01-10-20

Bob Lavigne to Speak at the SIFMA Regulation Best Interest Vendor Forum

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Bates Compliance Managing Director Robert "Bob" Lavigne will be a featured speaker at the SIFMA Regulation Best Interest Vendor Forum, January 16, 2020, at the SIFMA Conference Center in New York, NY. Bob will be speaking on the topic of “Documentation of Best Interest and Supervision.”

Bates Compliance, the compliance consulting division of Bates Group LLC, is a proud Gold Sponsor of the SIFMA Regulation Best Interest Vendor Forum. This half-day session will provide attendees an overview of the implementation considerations, and the opportunity to interact with Bates Compliance and other consultants who are developing the products, tools and services to help firms with implementing and complying with the SEC's Reg BI and Form CRS.

Bates Compliance consultants helps firms implement the SEC's Reg BI. We help you navigate disclosure obligations, duty of care obligations and conflicts of interest obligations. We also assist firms with:

  • Developing the new Reg BI Client Relationship Summary (“CRS”) for retail investors;
  • Impact and readiness assessments;
  • Conflicts of interest inventory;
  • Conflicts of interest assessment;
  • Product shelf reviews;
  • New product approval processes;
  • Drafting new policies and procedures;
  • Data capture and recordkeeping; and
  • Special IA and BD compliance considerations.

Visit the Bates booth to meet Bob and learn more about Reg BI solutions from Bates Compliance.

 

About Bates Compliance

The Bates Compliance team of experienced compliance professionals provides comprehensive compliance consulting services for BD and RIA clients on an as-needed or ongoing basis.  Bates assists with supervision, compliance, risk assessments, WSPs, annual compliance reviews, mock exams, regulatory remediation and internal audits. We review and test firms’ programs, policies and procedures, recommending changes based on regulatory requirements and leading practices designed to supplement and enhance compliance and supervisory systems.

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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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01-09-20

Massachusetts State Fiduciary Rule and NAIC Annuity Standards Proposals Continue to Move Forward

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Photo by Ken Lund under CC BY-SA 2.0

Bates Group continues to track a host of issues affected by the adoption of Regulation Best Interest (“Reg BI”), the 2019 package of rules and interpretations from the SEC setting standards of conduct for broker-dealers and independent advisers. These include a variety of state responses to the federal regulation, as well as Reg BI impacts on issuers of other complex financial products sold through brokers and advisers, specifically, recommendations to consumers on transactions involving annuity products. Here are some of the latest developments.

Massachusetts Introduces Revised Fiduciary Regulation Proposal

In prior posts, Bates Group reviewed legal challenges to the new federal regulation from state attorneys general, state legislative and regulatory initiatives (see here and here) designed to provide an alternative regulatory framework to protect in-state investors, and the North American Securities Administrator Association (“NASAA”) cautious position toward both these state approaches.

Just before the new year, the Massachusetts Securities Division of the Office of the Secretary of the Commonwealth formally proposed a revised uniform fiduciary conduct standard for broker-dealers, agents, investment advisers and investment adviser representatives that provide financial advice to clients and client prospects in the state. In general, the regulation establishes a fiduciary duty and makes a violation of that duty a sanctionable "unethical or dishonest conduct or practice."

The revised proposal differs in several respects from the preliminary proposal issued last June. One legal analysis notes that, among other things, this new version adds “language expanding a potential breach of fiduciary duties to commodity and insurance products;” establishes the presumption that a fiduciary duty exists simply by the title used by an advisor; and requires an advisor to go beyond disclosure or mitigation of a conflict of interest by requiring efforts to actually avoid such conflicts. The proposed regulation also requires ongoing monitoring of accounts by registrants; bans sales contests, sales quotas, and other incentive programs; further clarifies duty of loyalty and care obligations, as well as existing suitability standards.

The breadth of the proposal has elicited strong reaction. Massachusetts Secretary William Galvin argues directly that Reg BI fails to provide investors the protection they need from harmful conflicts of interest and that his state proposal is the only way to truly strengthen investor protections. In response to the proposal,  Kenneth Bentsen Jr., president and chief executive of the Securities Industry and Financial Markets Association (“SIFMA”) in a public statement said, “We are very concerned that the proposal exceeds the state’s authority, will diminish investor access to advice, products and services and will increase investor costs. We respectfully suggest that you delay any decision making until after Reg BI is fully implemented and the SEC, FINRA, and the Division and other state regulators have the chance to examine firms for compliance.” SIFMA recommended that the Division delay action for at least 18 months and then assess whether any further steps are necessary.

Secretary Galvin’s move to introduce the revised state regulation sets in motion the formal process by which Massachusetts’s fiduciary rule may be finalized and adopted. In so doing, Massachusetts becomes the next state to reach this juncture, (New Jersey’s rule proposal was first,) setting the stage for an inevitable legal battle over whether state or a national standards will prevail.

NAIC Committee Approves Revisions to Annuity Standards

Bates has also been following the efforts of the National Association of Insurance Commissioners (“NAIC”) to revise standards and procedures for providing recommendations to consumers on transactions involving annuity products. As we previously covered, an NAIC Working Group has been attempting to develop a framework that would revise its “Suitability in Annuity Transactions Model Regulation with the federal Reg BI standards and accommodate 2019 New York regulations (Regulation 187) which require insurers to establish policies and procedures so that broker-dealers put the “best interest” of consumers ahead of their own.

On December 30, 2019, NAIC’s Life Insurance and Annuities Committee took an important step by approving revisions to the model regulation. In general, the revisions specify that the producer must satisfy obligations of care, disclosure, conflict of interest and documentation.

The regulators specifically pointed out that the model regulation does not require a fiduciary relationship between the producer and the customer and that it provides a safe harbor for producers that comply with the SEC’s Regulation Best Interest. (Notably, New York voted against it at Committee.) That said, the model regulation requires an agent to be able to demonstrate that a recommendation is in the consumer's best interest (the basis of which must be included in a written record), and must identify, manage and disclose material conflicts of interest. The model regulation now heads to the NAIC Executive Committee and Plenary for a final vote before the states may consider its adoption.

Conclusion

The Massachusetts and NAIC processes demonstrate the difficulty in reaching consensus around investor and consumer protection standards. The Massachusetts proposal will serve to build momentum for states to adopt fiduciary standards on broker-dealer recommendations to their clients. These state fiduciary rules, however, will face their test in court. No doubt the NAIC’s Reg BI-friendly model regulation for annuity products may possibly face similar state-by-state reactions and similar legal tests. Meanwhile, firms are left with heavy compliance burdens and lingering uncertainty.

 

Bates Group's Compliance team can help your firm through the implementation phase of Reg BI and navigating compliance concerning investor and consumer protection standards. To learn more about Reg BI compliance consulting support for your firm, please visit our Reg BI service page or contact Robert Lavigne, Managing Director, Bates Compliance, at rlavigne@batesgroup.com.

For information about Bates Group’s Insurance and Actuarial practice services, please contact Managing Consultant Greg Faucher.

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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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12-17-19

Bates Compliance at the FINRA 2019 Regulation Best Interest Conference

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Bates Compliance will be at FINRA’s Regulation Best Interest Conference, December 18, 2019 in Washington, D.C. This one-day event is designed to bring regulators, executives and industry practitioners together to learn more about Regulation Best Interest (Reg BI). Meet Bates Compliance Managing Director Bob Lavigne and Director Jill Ehret to learn more about Reg BI solutions from Bates Compliance.

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12-12-19

Banking Agencies Clarify SARs Requirements for Hemp, Possibly Paving the Way for Cannabis

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Photo by Matteo Paganelli on Unsplash
 

A key to understanding new Bank Secrecy Act (“BSA”) guidance on the “legal status of commercial growth and production of hemp” can be found in provisions of the Agriculture Improvement Act (the “Farm Bill”) signed into law in December of last year. As Bates has noted, bipartisan support for legalization of hemp agricultural products was driven in part by Senate Majority Leader Mitch McConnell (R-KY), who included the provisions into the legislation and pointed out that “the crop is being grown in 101 out of 120 counties in Kentucky.” That legislation distinguished and removed hemp (though not marijuana) as a controlled substance under law, and directed the USDA, together with the U.S. Attorney General, to regulate its production.

Interim rules, issued by the USDA in late October 2019 (to accommodate the 2020 planting season), established a federal licensing approval plan that allows state departments of agriculture and tribal governments to submit plans for monitoring and regulating hemp production. They also establish a federal plan for producers that do not have a USDA-approved plan in their state or territory. The regulations (i) require retention of information “on the land where hemp is produced,” (ii) testing hemp to ensure that certain chemicals (i.e. THC) do not exceed levels that, by law, would make them a controlled substance, (iii) procedures for disposal of hemp that violates those levels, and (iv) other licensing and registration requirements.

Regulatory Clarification under BSA

Given this context, the Federal Reserve Board, the FDIC, FinCEN, the OCC and the Conference of State Bank Supervisors issued a statement clarifying BSA obligations under these new USDA interim rules. (The interim period runs from October 31, 2019 until November 1, 2021.)

The guidance makes clear that banks are no longer obligated to file Suspicious Activity Reports (SARs) on customers that produce hemp, since hemp is no longer on the controlled substance list. However, the agencies also make clear that institutions must still comply with BSA requirements, and, therefore, financial institutions serving hemp producers must establish and maintain effective compliance programs that address the complexity and risks involved in the production of hemp. As with other regulated entities, this means compliance with customer identification, suspicious activity reporting, currency transaction reporting, and risk-based customer due diligence, including the collection of beneficial ownership information for legal entity customers. Consequently, these financial institutions must still file SARs based on suspicious activity.

Potential Impact of BSA Clarification

The agencies’ issuance of a clarifying statement on BSA obligations related to hemp production provisions under the Farm Bill and USDA interim rules, paves the way for similar regulatory adjustments should the Secure and Fair Enforcement Banking Act of 2019 ("SAFE Banking Act") become law.                                                                                           

As described in a previous Bates Research post, the SAFE Banking Act creates a safe harbor for depository institutions that provide banking services to state-licensed cannabis businesses. As with hemp before the Farm Bill, financial institutions must file SARs for cannabis firms, regardless of the legal status of cannabis under state law. Should the SAFE Act—which recently passed in the House of Representatives—become law, proceeds from cannabis businesses would not be considered proceeds from illegal activity. That would open the door to the same kind of regulatory adjustments as the newly clarified treatment for hemp production.

Similarly, should the "Marijuana Opportunity Reinvestment and Expungement Act of 2019" (“the MORE Act”)—which passed a vote out of the House Judiciary Committee—become law, cannabis would be removed from the list of federally controlled substances and could potentially be dealt with under the treatment now afforded hemp. (See Bates coverage of the MORE Act here.) Though the MORE Act and SAFE Banking Act have made progress in the House, time is running out for action on the bills by the Senate. Bates will continue to keep you apprised of developments in this area.

 

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

Ed will also be speaking at SIFMA's Anti-Money Laundering and Financial Crimes Conference, February 5-6, 2020 in New York, NY. Visit the Bates booth to meet Ed and discuss AML and Financial Crimes solutions for your firm.

 

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

Bates AML and Financial Crimes

Bates Compliance

Regulatory and Internal Investigations

Retail Litigation and Consulting

Institutional and Complex Litigation

Consulting and Expert Testimony

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12-05-19

Do The SEC Enforcement Directors’ 2019 Successes Preview Their 2020 Priorities?

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(photo: SEC Enforcement Division Co-Directors Stephanie Avakian and Steven Peikin)
 

Despite “significant headwinds,” including “adverse” holdings in Supreme Court cases and a significant disruption in Congressional funding in the beginning of the year, Co-Directors of the SEC Enforcement Division Stephanie Avakian and Steven Peikin announced that their efforts in FY 2019 have been successful. In a recently published Annual Report, the Directors described enforcement actions that held wrongdoers accountable, removed bad actors, stopped frauds and prevented losses. The report also highlighted that many of the enforcement actions resulted in harmed investors being made whole. According to the report, SEC enforcement in 2019 concentrated on two priorities: retail investor protection and combatting cyber threats. Here are some of the key observations.

Share Class Disclosure

The report highlighted “extraordinary results” from the agency’s Share Class Selection Disclosure Initiative, an effort intended to protect retail investors from failures by investment advisors to disclose conflicts of interest on different share class compensation schemes. (See here for our review of the latest alert on the SEC’s efforts concerning investment advisor compensation issues.)  According to the report, the SEC, to date, has ordered 95 investment advisor firms that self-reported their disclosure failures to return $135 million to impacted investors. While the Division of Enforcement did not impose civil penalties in these cases (part of the incentive to report under the initiative), participating firms were required to align their practices and disclosures going forward.

The division was very active in “standalone” cases to protect retail investors. The numbers detailed in the report reflect this priority.  Of the 862 enforcement actions brought in 2019, 526 were standalone actions brought in federal court or as administrative proceedings. (The others include “follow on” actions tied to other regulators or criminal authorities, and proceedings to deregister public companies that were delinquent in Commission filings.) The number of standalone cases breaks down as follows: investment advisory/investment company issues (constituting the greatest increase in enforcement actions at 36%), securities offerings (21%), issuer reporting/accounting and auditing matters (17%), broker-dealers issues (7%), insider trading (6%), and market manipulation (6%). Other areas include FCPA (3%) and Public Finance (3%). The charts below provide the numerical breakdown for comparison with FY 2018.

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(source: U.S. SEC)
 

Furthermore, the division reported a total of $3.248 billion in disgorgement of ill-gotten gains, with additional penalties of $1.101 billion.  This represents, in aggregate, a $404 million (10%) increase year-over-year.

The SEC also noted recent retail investor protection efforts under its Retail Strategy Task Force (“RSTF”). The RSTF is comprised of enforcement personnel from around the country and works with SEC staff employing data-driven analytics to help identify financial market practices that can harm retail investors. It also supports retail investor advocacy and outreach. The report underscored new initiatives to educate teachers, veterans and active duty military personnel on the basics of savings and investment, fees and expenses, retirement programs, and “the red flags of investment fraud.”

Cyber Enforcement Activity and Digital Assets

As part of its cybersecurity focus, the division counted victories in investigating “violations involving distributed ledger technology, cyber intrusions, and hacking to obtain material, nonpublic information.” Specifically, the division described its increasingly sophisticated capability and developing approach to distributed ledger accountability and misconduct. The division said that recent settlements with issuers of digital assets (ICOs) helped to establish registration and reporting frameworks for future resolutions. The commission also brought actions against third parties for violating securities laws regarding the offer, sale and promotion of digital asset securities. Legally, the SEC stated that its enforcement actions in this space “send the clear message that, if a product is a security, regardless of the label attached to it, those who issue, promote, or provide a platform for buying and selling that security must comply with the investor protection requirements of the federal securities laws.”

Market Integrity Issues

Among its broad efforts on cybersecurity the commission conducted investigations of public companies and regulated exchanges for potential violations of system compliance rules intended to ensure the security of the technology infrastructure of U.S. securities markets. The SEC said that in the last few years, it initiated investigations associated with accounting rule irregularities that pointed to such violations and concluded that “having sufficient internal accounting controls plays an important role in an issuer’s risk management approach to external cyber-related threats.” Further, the SEC described actions it took against financial institutions for improper conduct that undermined market integrity in connection with the “pre-release” of American Depository Receipts (ADRs).

Reporting and Trading

The SEC emphasized its developing use of analytics to identify trade-related impropriety. According to the report, for example, the identification of the overseas hackers who accessed the SEC’s EDGAR system to steal nonpublic information for use in illegal trading “showcased” the agency’s expanding capabilities to identify patterns in the suspicious activity. Central to this approach is the importance of accurate financial and other disclosures—“the bedrock of our capital markets”—critical to the detection, remediation and punishment of misconduct by individuals and corporations. The report went on to list a number of cases that focused on financial statement integrity, the accuracy of issuer disclosures, and the demonstrable willingness by the agency to punish significant corporate wrongdoing.

Additional Context

The Co-Directors lauded the efforts of the division, but noted that they were also limited by decisions from the Supreme Court, notably the 2017 holding in Kokesh v. SEC, which “continues to impact adversely the Commission’s ability to return funds to investors injured by long running frauds.” In that case, the court found that disgorgement constitutes a “penalty,” and is therefore subject to the five-year statute of limitations. As a result, the SEC cannot seek that remedy for ill-gotten gains older than five years. The Division calculated that the ruling forced it “to forego approximately $1.1 billion” and added that it does not include the impact Kokesh has had on SEC resource allocations, which were redirected toward cases with greater potential for recovery.

The Co-Directors also noted the impact of Lucia v. SEC, a 2018 decision that found the way the agency appointed Administrative Law Judges violated the “appointments clause” of the U.S. Constitution. The ruling forced a stay, and approximately 200 administrative proceedings were reassigned. Though many of the matters resolved without the need to have a rehearing, there were others that required a full rehearing before new ALJs and the co-directors said they anticipate additional rehearings in the next fiscal year.

Conclusion

It is clear that the Division of Enforcement has been aggressive this year, despite continued limitations on resources, evolving standards for retail investors and significant legal and cyber-regulatory developments. The Co-Directors provide a clear picture of the management challenges as well as the importance and reliance on data analytics to keep up with the changes. The SEC is likely to issue its Examination priorities soon, and it will be interesting to see if the enforcement trends identified in this report will be reflected in those priorities. Bates Research will continue to keep you apprised.

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11-21-19

SEC Zeroes in on Investment Adviser Compensation Conflicts

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(photo credit: U.S. SEC under CCPL 2.0)
 

On October 18th, 2019, more than a year after the launch of the SEC Share Class Disclosure Initiative and targeted enforcement activity, the SEC Division of Investment Management issued information clarifying conflicts of interest raised by different types of investment adviser compensation. In a new set of FAQs, SEC staff reviewed general conflicts of interest disclosure requirements and offered insight on the “material facts” that need to be disclosed concerning mutual fund share classes and an adviser’s receipt of revenue-sharing payments. Here’s a closer look.

Why It’s Important

In a recent regulatory alert, we highlighted recent actions targeting investment advisers by the SEC Enforcement Division. The noted actions were aimed at potential conflicts of interest that arose from revenue-sharing payments and other forms of representative compensation or cost offsets. In general, the actions test whether investment advisers are adequately disclosing potential conflicts of interest consistent with the fiduciary obligations owed to their clients.

These enforcement efforts follow on the heels of the Share Class Disclosure Initiative, an undertaking intended to encourage firms to self-report past violations relating to certain mutual fund share class selection conflicts, and to promptly return money to harmed clients. As Bates has cautioned, the enforcement activity sends firms a strong message to make sure that disclosure concerning revenue-sharing arrangements and other forms of compensation are consistent with SEC interpretations.

New FAQs

The new FAQs cover (i) general compensation disclosure obligations for investment advisers related to recommended investments, (ii) “material facts” that advisers should disclose concerning mutual fund share classes,” and (iii) disclosure requirements related to an adviser’s receipt of revenue-sharing payments. The FAQs also make clear that any amendments to share class or revenue-sharing arrangements made in annual updates are required to be highlighted on Form ADV.

General Compensation Disclosure

The FAQs restate the overarching principles that advisers must disclose financial incentives when recommending investments that are tied to compensation, and that the nature of the compensation affects the disclosure. Staff noted that conflicts are “especially pronounced” when certain share classes of the same funds that do not bear these fees are available.

The FAQs also describe more detailed disclosure obligations required under Form ADV, including the provision of “sufficiently specific facts” to enable clients to give informed consent. This includes “‘information not specifically required by’ the Form or more detail than the Form otherwise requires.”

Importantly, staff made clear (i) that merely reporting that the adviser “may” have a conflict is not adequate disclosure “if the conflict actually exists,” and (ii) that “an adviser should consider these disclosure obligations with respect to both recommendations to purchase and recommendations to continue holding an investment.”

Material Facts on Mutual Fund Share Classes

According to SEC staff, when recommending a mutual fund share class which is tied directly or indirectly to compensation, material facts include the existence and effect of different financial incentives that may lead to conflicts (e.g. those arising from shared incentives between the adviser and a clearing broker, various limitations on share class transactions within a fund, or adviser practices concerning transactions after the initial recommendations). It is also material to disclose how the adviser addresses the conflict, (e.g. on practices related to differences between share classes with different compensation structures for 12b-1 and transaction fees; or whether the adviser “has a practice of offsetting or rebating some or all of the additional costs to which a client is subject.”) The FAQs make clear that these examples are not comprehensive but rather should serve the broader message that all compensation arrangements are on the table.

Material Facts on Revenue-Sharing Payments

An investment adviser is required to disclose any arrangement they may have with anyone who provides an economic benefit for providing investment advice or other advisory services for clients. Under Form ADV, the adviser is obligated to “describe the arrangement, explain the conflicts of interest, and describe how it addresses the conflicts of interest.” The FAQs highlight examples of arrangements in which there are financial incentives provided to the adviser or shared between the adviser and clearing brokers, custodians, funds’ advisers or other service providers. SEC staff warns that such disclosures “should be concise and in plain English.”

Bates Experts Reflect

While the FAQs state explicitly that the interpretations provided do not alter or amend applicable law nor create any new or additional obligations for advisers, the SEC is clearly sending a message that the agency will continue its focus on disclosure and adviser compensation.

Bates Group Securities Litigation & Regulatory Enforcement Managing Director Alex Russell highlights several aspects of the new FAQs. He notes the SEC staff’s expansive view of adviser compensation (e.g. to include areas where a firm saved costs as well as earned fees) and the application of these staff interpretations to investments more broadly. He points out staff’s expectation as to the ongoing nature of the disclosure obligation “beyond point of sale,” underscoring the FAQ warning that “an adviser should consider these disclosure obligations with respect to both recommendations to purchase and recommendations to continue holding an investment.”

Bates Group Managing Director of Compliance Robert Lavigne urges firms to work on the language of their disclosures to ensure not only that they are “concise, direct, appropriate to the level of financial sophistication of the adviser’s clients and written in plain English,” but that they also be explicit and specific (hence, the admonition against the use of the word “may” when a conflict of interests exists). Getting this right will require a deep dive into advisers’ policies and practices as firms can no longer rely on longer disclosures or references to “potential conflicts” to withstand examination or enforcement scrutiny.


About Bates:

Bates Group stands ready to support firms to ensure that their revenue sharing arrangements and other forms of compensation are consistent with SEC interpretations. Bates is actively engaged in providing assistance to firms responding to enforcement inquiries, 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 

Robert Lavigne, Managing Director, Bates Compliance

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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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11-12-19

Bates Welcomes Our Newest Experts and Consultants

Bates Group is proud to introduce our newest experts and consultants. Follow the links below to view their full bios, or visit our Expert Search to view the entire Bates roster of experts and consultants.

 

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Gontran de Quillacq

Equity Derivatives and Structured Products, Options and Futures, Quantitative Investment Research, Portfolio Management

Gontran de Quillacq is a Bates Group Consultant and Expert in the areas of equity derivatives and structured products, options and futures, equity finance, Delta One, proprietary trading, statistical arbitrage, quantitative investment research, and portfolio management.

Mr. de Quillacq traded derivatives for two decades at top-tier banks of the London Square Mile and Wall Street. As a portfolio manager, he researched and managed investment strategies, delivered both in hedge fund and in structured note formats. He selected portfolio managers and strategies for top hedge funds and asset managers. In 2017, Mr. de Quillacq co-founded a quantitative activity deploying the latest machine learning techniques in global long/short equities. He is a quantitative researcher and portfolio manager for an asset management firm deploying volatility arbitrage strategies and has held FINRA Series 7, 63, and 55 licenses.

Full Bio

 

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Caryn Miller

Compliance, Legal, Retail BD/RIA, Mutual Funds

Caryn Miller is a Bates Compliance consultant based in New York City and Los Angeles. Ms. Miller joined Bates Group after nearly 22 years at Bank of America Merrill Lynch that were divided almost equally between positions in Legal and Compliance. Her previous roles—spanning 20 years—included legal positions with the U.S. Securities and Exchange Commission, Division of Investment Management (New York), another dual registrant broker-dealer/investment adviser, and two major New York law firms. She is an accomplished financial services specialist with extensive experience in the retail broker-dealer/investment advisory and mutual fund fields.

Full Bio

 

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Michael Dorsey

Market Regulation, Asset Management and Corporate Compliance

Mike Dorsey is a Bates Group Consultant and Expert in Market Regulation, Asset Management and Corporate Compliance. Throughout his professional career, Mr. Dorsey has advised executives of broker-dealers and investment advisers on legal and regulatory aspects of their businesses, including fixed-income trading and securities lending, financial and operational matters, and alternative trading systems. For 8 years, he held various positions of increasing responsibility in the Division of Market Regulation at the SEC and has since held a variety of positions in the securities and asset management industries. Mr. Dorsey holds FINRA Series 7 and 24 licenses.

Full Bio

 

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Amy Ott, CPA

Tax Examinations, Tax Litigation Support

Amy Ott is a Bates Group Expert and Certified Public Accountant located in Central Oregon. She has 20 years' experience as an independent Tax Consultant. Her focus has been tax controversy (tax examinations and litigation support) for income tax and property tax at the federal and state levels. Ms. Ott also has extensive experience with Research and Development and Orphan Drug Tax credits, including computations for tax provisions and returns, and audit defense.

Full Bio

 

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Mark Filler, CPA

Tax, Damages, Commercial Disputes, Business Valuation per Divorces and Shareholder Disagreements

Mark Filler is a Bates Group Consultant and Certified Public Accountant. His experience has been entirely with small firms, with a focus on helping small business entrepreneurs solve their tax and business problems. Over the past 25 years, Mr. Filler has focused on providing consulting and expert witness assistance to clients and counsel in commercial disputes, with particular emphasis on business valuations pursuant to divorces and shareholder disagreements. Mr. Filler has been retained by lawyers and claims professionals to calculate damage assessments and business interruption losses, to assist in arson and embezzlement investigations, to provide testimony in accountants’ malpractice lawsuits, and to measure damages for lost profits in personal injury cases as well as wrongful discharge and death cases, among others.  Mr. Filler has worked on over 1,300 cases and has provided testimony over 120 times at depositions and in State and Federal Court.

Full Bio

 

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Tali Taft, CPA, CIA, CFE

Governance, Risk, Internal Audit, Fraud, Compliance

Natalie "Tali" Taft is a Bates Group Consultant and Expert in Governance, Risk, Internal Audit, Fraud, and Compliance with more than 27 years of financial services industry experience. She is an experienced financial services executive leader, a negotiator with federal examiners, and is recognized as an IIA All-Star Conference speaker and keynote speaker and master of ceremonies. The foundation of Ms. Taft’s career was built during her 18 years as an Internal Auditor, and she maintains multiple certifications in her field. Ms. Taft served over 5 years as a Senior VP at Santander Consumer USA, managing the Enterprise Risk Management department. Before joining Santander, she served as the CCO for Think Finance where she oversaw a robust financial services regulatory department. Ms. Taft has also held Internal Audit management positions with GM Financial and Bank One.

Full Bio

 

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Paul Horn, C|CISO, CISSP, CRISC, CISM, GCIH

Cybersecurity

Paul Horn is a Bates Group Consultant and seasoned Cybersecurity Expert with 20 years of experience based in Prosper, Texas.  Mr. Horn previously served as the Chief Information Security Officer for an independent Broker-Dealer with billions of dollars in assets under management and thousands of Advisors spread across the United States.  He has been a part of several FINRA and SEC Cybersecurity sweeps and examinations and maintains a deep understanding of the regulatory requirements associated within financial institutions as well as prioritizing risk remediation activities. Mr. Horn has a Master's of Science in Management with a concentration in Information Systems Security and a Bachelor’s of Science in Business Administration in Information Technology from Colorado Technical University as well as several industry certifications. He also on a variety of Advisory Boards for information security-related topics and shows a deep dedication to the information security community by mentoring other security professionals.

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Debra Vaughan

RIA Compliance Supervision, Sales Supervision and Suitability, Branch Management

Debra Vaughan is a Bates Compliance Expert and Consultant based in Florida. She is an accomplished and seasoned professional with proven success in sales support, operations, compliance oversight, trading, risk, and management. Before joining Bates, Ms. Vaughan was an Executive Director for more than a decade with Morgan Stanley Chicago PWM with overall responsibility for all of the Administrative and Risk functions. She was also responsible for ensuring compliance with legal and regulatory requirements within each jurisdiction. Ms. Vaughan began her career with Goldman Sachs in Chicago, and also served as an Investment Associate at Lehman Brothers.

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