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Bates Research  |  01-24-23

FINRA 2023 Exam and Risk Monitoring Report with Bates Chart and Summary – Prioritizing the Priorities

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In its 2023 annual report on examinations and risk monitoring, FINRA provides its latest overview of firm compliance obligations. Divided into five discrete topical categories—financial crimes (a new breakout category this year), firm operations, communications and sales, market integrity, and financial management—FINRA’s priorities are further delineated into numerous subcategories. The Annual Report includes findings and observations from the recent oversight activities of FINRA’s Member Supervision, Market Regulation, and Enforcement programs, and:

  • Identifies the relevant rule(s);
  • Highlights key considerations for member firms’ compliance programs;[1]
  • Summarizes noteworthy findings or observations from recent oversight activities;
  • Outlines effective practices that FINRA observed through its oversight activities; and
  • Provides additional resources that may be helpful to member firms in reviewing their supervisory procedures and controls, and fulfilling their compliance obligations.

As always, FINRA encourages member firms to use the Annual Report (and its other published resources) to, among other things, (i) assess the applicability of the provided information to a firm’s business model; (ii) incorporate relevant topics into firm risk assessments; (iii) identify gaps in existing compliance programs; and (iv) improve training. The 24 substantive subcategories offer up important guidance. In this article, Bates summarizes FINRA’s 2023 Annual Report priorities. Our annual chart offers insight into how newly observed risks have added to and affected those priorities year over year.

The Annual Report identifies FINRA’s top examination priorities for member firms:

  • Adherence to their obligations pursuant to Regulation Best Interest and Form CRS[2]

  • Compliance with best execution obligations and disclosure regulations on order handling in certain stocks and listed options
  • Current regulatory obligations regarding complex products and options communications, and disclosure (including on crypto asset products) and supervisory controls related to the opening of options accounts;
  • Cybersecurity risk management (FINRA stated that it has specialized teams devoted to reviewing firm controls, conducting investigations of cyber-related fraud, and examining crypto-asset activity.) At the recent New York SIFMA C&L Society luncheon on the FINRA 2023 Priorities—featuring CEO Robert Cook and Member Supervision Head Greg Ruppert—it was relayed that firms should consider where they are using technology that it did not use before, including services offered via Application Programming Interface (APIs) and outside of the firm. Members should also review the Division of Examination’s alert on identity theft and FINRA’s Regulatory Notice 22-29 on ransomware. FINRA also emphasized that cybersecurity is not just the C.I.S.O.’s responsibility.
  • Obligations as to mobile apps, specifically whether firms adequately disclose or distinguish “between products and services of the broker-dealer and those of affiliates or other third parties”
  • Compliance with Consolidated Audit Trail reporting requirements including “timely submission of reportable events and corrections, reporting complete and accurate CAT records, and effectively supervising third-party vendors.”
 

[1] FINRA’s considerations are intended to serve as a possible starting point in considering a firm’s compliance program related to a topic. Firms should review relevant rules to understand the full scope of their obligations.

[2] In an upcoming article, Bates will take a deeper look at FINRA’s observations from its compliance reviews on each of the core duties under the two-year-old rule, including addressing the care in handling recommendations, conflicts of interest, required disclosure of material facts to retail clients, establishment of supervisory policies and procedures, and matters regarding Form CRS preparation.


Top Areas of FINRA Focus for 2023

See highlights of FINRA’s continuing and emerging concerns on our annual comparison chart below, which keeps track of articulated priorities from year to year. (Items highlighted in gold are new for 2023; summary continues after chart.)

FINRA 2023 Exam and Risk Monitoring Report with Bates Chart and Summary – Prioritizing the Priorities
FINRA 2023 Exam and Risk Monitoring Report with Bates Chart and Summary – Prioritizing the Priorities
FINRA 2023 Exam and Risk Monitoring Report with Bates Chart and Summary – Prioritizing the Priorities
FINRA 2023 Exam and Risk Monitoring Report with Bates Chart and Summary – Prioritizing the Priorities
FINRA 2023 Exam and Risk Monitoring Report with Bates Chart and Summary – Prioritizing the Priorities

© 2023 Bates Group LLC
Source: 2023 Report on FINRA’s Examination and Risk Monitoring Program
(Compiled by Alex Russell, Managing Director, White Collar, Regulatory and Internal Investigations)

New Format and New Topics

The Annual Report lists member firm compliance obligations by topic now under five categories. Financial crimes, the newest category, incorporates previous sub-topics (e.g., cybersecurity and technology governance under SEC Regulation S-P) concerning compliance policies and procedures to safeguard customer records and information, as well as FINRA rules on business continuity planning and supervision.

This new category also incorporates “anti-money laundering, fraud and sanctions” obligations concerning policies and procedures required under FINRA rules (e.g., detection, suspicious activity reporting, testing, training, and customer due diligence) for compliance under the Bank Secrecy Act (BSA) and its implementing regulations (e.g., maintaining a Customer Identification Program (CIP); verifying the identity of legal entity customers; etc.). The Report notes that member firms should stay apprised of progress being made to implement the Anti-Money Laundering Act of 2020.

A new sub-topic for FINRA, under the category financial crimes, focuses on manipulative trading, which implicates rules on impermissible trading practices (e.g., use of deceptive devices, publication of transactions and quotations, order entry and execution practices.) The new sub-topic also emphasizes supervisory obligations to ensure a process for the review of securities transactions “reasonably designed to identify trades that may violate the Exchange Act, SEC rules or FINRA rules prohibiting insider trading and manipulative and deceptive devices.”

At the SIFMA luncheon, FINRA’s Ruppert discussed manipulative trading and what prompted the change. He shared that there is an increase in wash sales and front running activity. He suggested that member firms look at manipulative trading from the perspective of behavioral analytics, starting with alerts and complaints and looking for commonalities in the data, including, for example, common phone numbers, IP addresses, and branches used. He emphasized the importance of "stepping up controls, investigative work, SARs, risk monitoring, and reach-outs to FINRA.”

The remaining new sub-topics fall under the general category of market integrity and include FINRA rules on (i) fixed income and fair pricing that apply to transactions (including fixed income and municipals) generally requiring that a dealer charging a mark-up or mark-down do so based on the prevailing market price; (ii) reporting and order handling of fractional shares; and (iii) short sale and closeout requirement exceptions for bona fide market making activity.

Conclusion

FINRA’s Annual Report provides important guidance for compliance officers. This latest Annual Report reinforces the reach and depth of FINRA’s rules and brings to light practices member firms can consider for maintaining effective compliance programs.

Last year, Bates recommended that member firm compliance reviews shift from an annual review to ongoing reviews.  In that light, this year’s Annual Report illustrates FINRA’s continuing efforts to guide compliance officers in navigating the expanding set of rules. As new developments arise, Bates will keep you apprised.

Contact us to discuss how we can assist with your FINRA Compliance and Regulatory Investigations and Enforcement Matters

Staff Contacts:

FINRA 2023 Exam and Risk Monitoring Report with Bates Chart and Summary – Prioritizing the Priorities

David Birnbaum

Managing Director, Business Development and Strategy

dbirnbaum@batesgroup.com

917-273-2682

FINRA 2023 Exam and Risk Monitoring Report with Bates Chart and Summary – Prioritizing the Priorities

Hank Sanchez

Managing Director, Bates Compliance

hsanchez@batesgroup.com

504-450-9632 

FINRA 2023 Exam and Risk Monitoring Report with Bates Chart and Summary – Prioritizing the Priorities

Alex Russell

Managing Director, White Collar, Regulatory and Internal Investigations

arussell@batesgroup.com

971-250-4353

FINRA 2023 Exam and Risk Monitoring Report with Bates Chart and Summary – Prioritizing the Priorities

Rhonda Davis

Managing Director, Bates Compliance

rdavis@batesgroup.com

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Bates News  |  01-24-23

New Cryptoasset Certification from ACAMS and Bates Group

We’re excited to share that Brandi Reynolds (Managing Director, Practice Lead) and John Ashley (Senior Consultant) of Bates' MSB, FinTech and Crypto team (pictured below) have combined their expertise with other AML, cryptoasset and law enforcement professionals to create an innovative new certification for financial crimes in the crypto space. Introducing the “Certified Cryptoasset Anti-Financial Crime (AFC) Specialist" Certification (CCAS) from ACAMS.

New Cryptoasset Certification from ACAMS and Bates Group

With the CCAS certification, individuals and entire cryptoasset compliance functions can step up their game in financial crime prevention and demonstrate their abilities to manage risk and comply with regulations surrounding financial crime in the rapidly evolving crypto space.

CCAS is made up of three interactive ACAMS certification courses covering AML foundations, cryptoasset and blockchain, and risk management in the crypto space, and includes e-learning courses, an electronic study guide, flash cards, review questions, and a practice exam. There are even optional Live Online classes to help professionals prepare for the exam.

 

Interested in getting CCAS certified? Check out the course and sign up here:

New Cryptoasset Certification from ACAMS and Bates Group

Learn more about how we can help strengthen your cryptoasset AML and compliance program:

Bates assists firms and counsel throughout their legal, regulatory, compliance and AML matters. Our experienced staff and consultants offer a suite of AML and Compliance consulting services to established and start-up companies in banking, broker-dealer, RIA, Fintech, virtual assets/cryptocurrency, Money Services Businesses (MSBs), and Non-Banking Financial Institutions (NBFIs). Our MSB and AML Team supports clients with their BSA/AML/OFAC Program Development, Risk Management, Training, Advisory Services, and Independent Reviews. We also provide practical guidance for obtaining and maintaining money transmitter licenses, identifying state requirements, coordinating with state regulators, submitting state reports, identifying risk, detecting suspicious or unusual activity, and preventing exposure associated with money laundering and terrorist financing.

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Events  |  01-23-23

Brandi Reynolds Speaking on Cryptocurrency Webinar - Jan. 24, 2023

TODAY: Join Bates Managing Director Brandi Reynolds (Practice Leader-MSB, FinTech & Crypto), speaking on the "State of Cryptocurrency As We Head Into The New Year" webinar at the ACAMS Colorado Chapter January 2023 Virtual Event.

Brandi Reynolds Speaking on Cryptocurrency Webinar - Jan. 24, 2023

Tuesday, January 24, 2023

Online, 12 p.m. MST, 2 p.m. EST

One ACAMS Credit

Program Details and Registration

Compliance and Regulatory Alerts  |  01-19-23

Louisiana Puts in Place New Virtual Currency Business Activity License

Louisiana Puts in Place New Virtual Currency Business Activity License
Image © [Виталий Сова] /Adobe Stock

Businesses that are interested in engaging in virtual currency activities in Louisiana must now take steps to file for a license from the state. The new Virtual Currency Business Activity License is designed to protect consumers, investors, and other stakeholders from fraudulent and deceptive business practices related to cryptocurrency activities by requiring licensees to meet certain qualifications and maintain specific records of their activities.

To obtain a license, applicants must demonstrate they have sufficient financial resources and management capabilities to properly and lawfully conduct the business activities; provide proof of a bond or other form of security; ensure the company abides by all applicable laws regarding data protection, consumer protection, anti-money laundering (AML) and countering terrorism financing (CTF); and provide ongoing reports of all transactions, including those conducted with external parties. Furthermore, businesses must also have an actively functioning website with help desk services available as well as a mailing address where customers can send any customer inquiries or complaints.

With the July 2023 deadline fast approaching, businesses should file for their Virtual Currency Business Activity License as soon as possible in order to remain compliant with Louisiana regulations.

How Bates Helps:

Bates assists clients in obtaining state virtual currency and money transmitter licenses, as well as with compliance following licensure and the start of operations. Contact us today to discuss your needs with a Bates Compliance licensing specialist.

View the New License Checklist

Learn More:

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Virtual Assets & Cryptocurrency

Bates News  |  01-18-23

Human Trafficking Prevention Month - January 2023

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January is National Human Trafficking Prevention Month, dedicated since 2010 to raising awareness about human trafficking and educating the public about how to identify and prevent it. This crime is facilitated by human smugglers, who victimize vulnerable individuals, often by making false promises related to immigration or employment.

The Financial Crimes Enforcement Network (FinCEN) issued a recent alert reminding financial institutions of the critical role they play in helping to fight human smuggling and human trafficking by identifying suspicious behavior and sharing crucial intelligence with law enforcement officials. The alert provides red flag indicators to help financial institutions better identify transactions potentially related to human smuggling and reminds financial institutions of their Bank Secrecy Act (BSA) reporting obligations.

Read the FinCEN Alert

About Bates:

Bates cares about this issue. We are committed to working with your firm to develop strong AML and compliance programs for banks, broker-dealers, money services business and digital asset firms, including virtual and cryptocurrency firms. Learn more about how we can help strengthen your AML and compliance program at the following links below:

 

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Events  |  01-17-23

Bates Sponsors the NYSBA Annual Meeting 2023 and WILS Symposium, Jan 18-24, 2023

Bates Group is a proud Bronze sponsor of the New York State Bar Association Women In Law Section (WILS) 19th Annual Edith I. Spivack Symposium and Kay Crawford Murray Memorial Award Luncheon. This two-day event will be held Thursday, January 19 and Friday, January 20, 2023, during the NYSBA Annual Meeting.

Agenda

Thursday, January 19, 2023

9:00 AM – 4:15 PM — 19th Annual Edith I. Spivack Symposium - "The Perpetual Geder Pay Gap: How Unequal Pay Negatively Impacts Women, Society, and the Profession"

  • This program is elegible for 6.0 MCLE Credits (3.5 Credits Areas of Professional Practice; 2.0 Credits Ethics and Professionalism; 0.5 Credit Diversity Inclusion and Elimination of Bias)

1:00 PM – 2:15 PM — Luncheon and presentation of Kay Crawford Murray Memorial Award - honoring an outstanding attorney who recognizes the value of diversity and mentoring in the legal profession

4:15 PM – 5:30 PM — Networking and cocktail reception

Friday, January 20, 2023

10:30 AM – 11:45 AM — Reception

NYSBA Annual Meeting Info & Registration

Bates Research  |  01-13-23

New York Sets Guidance for Approval of Virtual Currency Activities

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All New York banking organizations—and all New York licensed branches and agencies of foreign banking organizations (“Covered Institutions”)—must get approval from the New York State Department of Financial Services (“NYDFS”) prior to engaging in virtual currency-related activity. The NYDFS clarified its expectations on that requirement in the form of an industry guidance letter dated December 15, 2022. A few weeks earlier, NYDFS proposed a rule on costs related to supervision and examinations and how they will be assessed on virtual currency businesses. Here are the highlights.

Virtual Currency Activity

In its guidance, NYDFS reaffirms the definition of virtual currency contained in the 2015 statutory definition and explains its regulatory interest in protecting state residents. In short, entities that engage in “the direct or indirect offering or performance of any other product, service, or activity involving virtual currency that may raise safety and soundness concerns for the Covered Institution or that may expose New York customers of the Covered Institution or other users of the product or service to risk of harm” must get approval from the regulator.

By “virtual currency business activity,” the NYDFS is referring to conduct involving (i) receiving or transmitting virtual currency (with certain exceptions, i.e. for non-financial purposes or a nominal amount); (ii) holding or custodying virtual currency on someone’s behalf; (iii) buying and selling virtual currency; and/or (iv) providing virtual currency exchange services. NYDFS offers examples of activities that fall within this definition. They include a broad range of activity such as providing digital wallet services, lending activities backed by virtual currency assets, helping customers to participate on a virtual currency exchange, holding virtual currencies on a customer’s behalf, any stablecoin services, and traditional banking services that may utilize public blockchain technology.  

The guidance applies to covered institutions wanting to initiate virtual currency activity as well as to institutions wanting to add any new or significantly different virtual currency-related activity, even an activity that may involve a third party. (NYDFS recommends that institutions who want to add to their existing virtual currency activity notify their NYDFS point of contact to “enable the Department to review and seek additional information or clarification, and impose any supervisory requirements, if needed.”)

Submissions: Required Information

Covered institutions must provide a written submission of proposed activity that would allow the regulator to make a “comprehensive assessment” that the activity would be “appropriate for a covered institution to undertake.” The submission must be provided to NYDFS 90 days prior to engaging in the activity.

NYDFS laid out the types of information it expects in any submission. These include:

  1. A comprehensive business plan – NYDFS lists eight elements: (i) the legal entities that will be used; (ii) information on the operating model and technology; (iii) information about the use of any third-party service providers; (iv) costs and revenue targets; (v) the target customer base and fees; (vi) information on the expected impact on users; (vii) a formal project plan (e.g. budgets, schedules, staffing, etc.); and (viii) a comprehensive risk assessment and monitoring framework (see below).
  2. A risk management framework – NYDFS wants institutions to submit information “to identify, measure, monitor, and control all risks arising from the activity (e.g., risks as to operations, credit, market, capital liquidity, cyber security, technology, third party provider, strategic, legal and reputation).
  3. A governance framework – NYDFS wants to see all materials related to internal board/management approvals of the proposed virtual currency activity; all the designations for oversight; explanations on how the risks would be integrated into the institution’s overall governance framework; and all related controls and compliance processes.
  4. A customer protection approach – NYDFS wants to see policies and procedures, sample agreements with users (whether by the institution or a third-party provider), disclosures, and a representative sample of marketing materials.
  5. A financial analysis – NYDFS wants submissions to include an explanation describing any anticipated impact the new virtual currency activity may have on the entity’s capital and liquidity position.
  6. A legal and regulatory analysis – NYDFS wants to see the legal analysis underlying the internal approval process for the activity, including the reasoning that would permit the activity and attendant legal risks.

Bates offers services in State Licensing Acquisition and Maintenance

Paying for it All

On December 1, 2022, NYDFS announced a proposed regulation establishing how supervisory and examination costs will be assessed on virtual currency businesses. If approved, virtual currency institutions will be billed five times per year: quarterly and with an adjusted bill at end of the fiscal year. Licensed firms would have to pay within 30 days; dually-registered institutions under both state banking regulations and cryptocurrency regulations will be billed separately. Superintendent of Financial Services Adrienne A. Harris commented, “the ability to collect supervisory costs will help the Department continue protecting consumers and ensuring the safety and soundness of this industry.”  

Conclusion

While there is considerable overlap across the categories of information that NYDFS wants institutions to submit, doing so may not be a simple task, and approval is not assured. As applied to virtual currency businesses, NYDFS approvals and licensure have far-reaching impact. As designed, this state process is sure to be the subject of broader debate over the future of virtual currencies. Meanwhile, the proposed rules on assessments and costs related to supervision and examinations are more than mere housekeeping; they indicate that the state agency is gearing up to take a hard look on virtual currency activity in 2023 and beyond. Bates will keep you apprised.

About Bates' MSB and Virtual Assets Services

Bates Group’s MSB, FinTech, and Virtual Assets practice offers guidance and services for Money Services Businesses and financial institutions, fintech and cryptocurrency firms. Our subject matter experts work directly with firms and counsel to design and implement policies and programs and to ensure they are AML-compliant. Our MSB and AML Teams help obtain and maintain Money Transmitter Licenses nationwide, also engaging with clients for BSA/AML/OFAC Program Development, Risk Management, Training, Advisory Services, and Independent Reviews.

 

Contact Bates today to learn how we can support your Virtual Currency compliance and state licensing acquisition and maintenance needs.

New York Sets Guidance for Approval of Virtual Currency Activities

Matt Summers

Director

msummers@batesgroup.com

864.775.9419

Bates Research  |  01-11-23

What Banks Should Consider When Accepting Crypto Customers

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Banks are quickly realizing that it’s time to embrace crypto customers. With the rise of digital banking, more people are choosing to store their funds in cryptocurrencies, and banks need to be able to accept these customers as part of their services. However, there are some important considerations that banks should make as they begin to accept cryptocurrency customers.

Knowledge of the Regulatory Landscape

The regulatory landscape surrounding cryptocurrencies is constantly changing. Banks need to stay abreast of all changes in order to remain compliant with regulations and protect themselves from potential fines or other penalties. Knowing what regulations apply, how they affect the bank’s operations, and how they could potentially change in the future will help banks ensure that they are operating within legal boundaries when dealing with crypto customers. Knowing, for instance, which cryptocurrency companies are required to be registered as money services businesses and/or money transmitters, is crucial to complying with current regulations.

Various regulatory guidance is already in place, such as the Financial Crimes Enforcement Network (FinCEN)’s 2013 guidance and the 2019 FinCEN advisory on illicit convertible virtual currencies (CVC).

Risk Management Strategies

Banks need to have a thorough understanding of the risks associated with crypto customers and develop strategies for managing them effectively. This includes understanding the customer’s risk profile and developing policies for onboarding crypto customers that take into account their individual needs and goals. Banks should also create procedures for monitoring customer accounts in order to mitigate risk related to money laundering, fraud, or other suspicious activity.

Bates Services for MSBs, FinTech and Crypto

Customer Education

As cryptocurrencies gain more traction with the public, banks need to provide education on how cryptocurrencies work so that customers can make informed decisions about their investments and transactions. This includes educating customers on topics such as wallet security and storage options, transaction fees, trading platforms, and potential risks associated with investing in cryptocurrencies. Providing this type of education can help banks establish trust and credibility with their crypto customers while also helping them navigate the complex world of digital currencies safely and securely. 

Conclusion

As banks continue to accept crypto customers into their services, it’s essential that they consider all aspects of managing this new clientele , including knowledge of the relevant regulatory landscape, risk management strategies, and customer education initiatives. Taking these steps will help banks ensure compliance with applicable regulations while providing a secure environment for conducting business with cryptocurrency holders. Ultimately, this will help build trust between banks and their crypto clients so that everyone can benefit from this new type of banking relationship.

How Bates Helps:

Bates works with banks and crypto companies to provide Anti-Money Laundering (AML) and compliance solutions in the banking and cryptocurrency space. Our consultants have a wealth of experience in the cryptocurrency industry and assist crypto companies in navigating the complex world of obtaining and maintaining banking relationships. We will work with you to develop a tailored solution that meets your specific needs and helps you obtain and maintain the banking relationship you need to succeed.

Contact Bates today to learn more about how we can support your banking and crypto firm needs.

About the Author:

What Banks Should Consider When Accepting Crypto Customers

Brandi Reynolds, CAMS-Audit

Managing Director, BSA/AML Compliance, FinTech & Virtual Assets

breynolds@batesgroup.com
864.809.7718

Compliance and Regulatory Alerts  |  01-10-23

FINRA Publishes 2023 Report on Exam and Risk Monitoring Program

FINRA has announced the publication of the 2023 Report on FINRA's Examination and Risk Monitoring Program. The comprehensive report from FINRA’s regulatory operations covers 24 topics addressing issues that "remain perennially important, with updates to reflect evolving risks, industry trends and findings from FINRA’s recent oversight activities." Four of those topics are new for the 2023 report — Manipulative TradingFixed Income – Fair Pricing; Fractional Shares; and Regulation SHO.

Additionally, the report introduces a new Financial Crimes section, consisting of three topics — Cybersecurity and Technological Governance; Anti-Money Laundering, Fraud and Sanctions; and Manipulative Trading — highlighting FINRA’s increased focus on protecting investors and safeguarding market integrity against these ongoing threats. Other key topics include: Cybersecurity, Complex Products, Reg BI and Form CRS, and Mobile Apps.

Stay tuned for our annual commentary, coming soon, on FINRA’s 2023 objectives and how they may impact your legal, regulatory and compliance matters.

Bates Research  |  01-04-23

Are You Doing Enough to Supervise Your Options Accounts?

The likely answer is “no,” based on the latest FINRA targeted sweep. Beginning in August 2021, FINRA examined firms to assess the sufficiency of their practices and controls over options accounts. FINRA recently issued an update based on the results, including new guidance on what they want you to consider in order to enhance your supervision and revise your compliance programs. The guidance takes the form of questions to consider for firms offering options trading to ensure they are aware of their regulatory obligations. Here’s an overview.

Three Key Areas

The targeted exams were directed at retail firms and other diversified firms that offer their clients options trading. FINRA focused on three key areas: options trading approvals, relevant disclosures, and trading supervision. For each, FINRA identifies the relevant rules and poses questions to prompt firms to consider how to tailor a program to their own business.

Options Trading Approvals

FINRA identified different approaches firms might take to approve options accounts: manual review, automated review, or a combination of the two. Regardless of the approach, FINRA will examine how a firm approves an options account subject to its Know Your Customer (KYC), Options, Margin, and Customer Account Information rules. These rules require due diligence procedures for option account approval. FINRA questions would prompt a firm to review for options account application completeness, accuracy, consistency with available customer information, and updates to profiles to ensure the customer remains eligible to trade. FINRA asks firms to consider (i) minimum approval criteria, (ii) eligibility at different options trading levels, (iii) red flags warnings, (iv) compliance with Regulation Best Interest, and (v) other systems and controls to address errors and options trading application rejections or resubmissions.

Disclosures

FINRA identified all the disclosures obligations associated with options accounts and trading, including those required under FINRA rules on public communications, options communications, and other disclosure rules (including margin statements or other options information). FINRA questions prompt firms to review their entire communications approach to customers. Questions center on (i) disclosure of risk in promoting options products and services; (ii) representations regarding potential losses; on disclosure material at account opening (and any supplemental material on complex options strategies (as necessary); (iii) requests to increase options trading levels; and (iv) disclosure consistent with Regulation Best Interest compliance.

Trading Supervision

FINRA urged firms to ensure their options trading and account opening procedures processes, systems and controls align with their overall risk profile under FINRA rules on supervision and options. FINRA questions prompt firms to consider (i) the adequacy of their review processes (is there a specialized review group for options trading?); (ii) the frequency of their reviews (e.g., on options trading activity, trading levels, and eligibility); (iii) the sufficiency of their monitoring and surveillance; and (iv) the adequacy of review and response concerning trading restrictions and red flags.

Conclusion

After a targeted sweep, FINRA’s guidance on supervision over options trading should be taken as more of a warning than a general update. Internal consideration of this guidance demonstrates both responsiveness and good faith as to regulatory priorities should FINRA come knocking. Bates will keep you apprised.

How Bates Helps:

Bates has the experts and consultants to support your options supervision needs. We help you address FINRA’s questions and concerns with the assistance of our experienced former Administrative Managers, Branch Office Managers, and Central Business Review Professionals who will work with your option trading review processes, the frequency of your reviews, the sufficiency of your monitoring and surveillance, and, very importantly, the response to trading restrictions, red flags, and alerts.

In addition to providing options policy & procedure and supervision services, Bates experts also frequently consult and testify in litigation/arbitration matters involving options trading.

Search Bates Options Experts

For regulatory, compliance, or litigation questions, please contact:

Are You Doing Enough to Supervise Your Options Accounts?

Hank Sanchez

Managing Director, Bates Compliance

hsanchez@batesgroup.com

504-450-9632 

Are You Doing Enough to Supervise Your Options Accounts?

Julie Johnstone

Managing Director, Practice Leader - Securities and Financial Services Litigation & Consulting

jjohnstone@batesgroup.com

971-250-4319

Are You Doing Enough to Supervise Your Options Accounts?

David Birnbaum

Managing Director, Business Development and Strategy

dbirnbaum@batesgroup.com

917-273-2682

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Bates News  |  12-21-22

Bates Group Managing Director Brandi Reynolds Featured in CrossTech Magazine

Bates Group Managing Director Brandi Reynolds Featured in CrossTech Magazine

Bates Group's Brandi Reynolds, CAMS-Audit, CCI, CCCE (Managing Director, BSA/AML Compliance, MSBs, FinTech, and Virtual Assets), is featured in the latest issue of CrossTech Magazine, the magazine of the cross-border payments industry. Inside, read about Brandi's experience as an industry leader and learn about the Independent Review, Licensing Support, Compliance Consulting, Training, and other services offered by Brandi and her Bates team.

Read Online Now!

About Bates:

Bates Group's MSB, FinTech, and Cryptocurrency team provides a full suite of Bank Secrecy Act, Anti-Money Laundering, and Office of Foreign Assets Control (BSA/AML/OFAC) compliance consulting services, state money transmitter licensing acquisition and maintenance support, independent reviews, and corporate compliance training.

Learn More

Compliance and Regulatory Alerts  |  12-16-22

SEC Exams Division Warns Firms Against Lax Compliance on Rules to Prevent Identity Theft

The SEC Division of Examinations (“Division”) issued a risk alert for registered broker-dealers and investment advisers  that offer or maintain “covered accounts” in order to better protect retail customers from identity theft. The alert was issued because recent firm examinations revealed practices “inconsistent” with Regulation S-ID, (“Identity Theft Red Flag Rules”) which could subject retail investors to identity theft and financial loss. Several weeks earlier, the SEC Office of Investor Education and Advocacy (“Office”) issued a risk alert to inform investors how to handle investment accounts if they become victims of identity theft or a data breach. Here’s an overview.

Deficiencies in Regulation S-ID Compliance

Under the SEC rule, if a firm holds a covered account (i.e. an account that a financial institution maintains, primarily for personal, family, or household purposes), it must have a compliance program that can “detect, prevent, and mitigate identity theft.” The rule also provides guidelines to assist entities in the formation of the programs necessary to satisfy the obligation.

These guidelines require firms to develop a program to assess whether the rule is applicable by determining whether the firm offers or maintains covered accounts. If it does, firms must have a written program tailored to the size of the firm and the scope of its activities. The firm must have policies and procedures, updated periodically, that are reasonably capable of identifying, detecting, and responding to known red flags concerning identity theft. And finally, firms must administer and oversee the program elements to ensure the protection of investor’s personal information. Such administration must include Board participation, Board and senior management supervision, adequate training and oversight on related third-party service providers.

In its examinations, the Division observed numerous deficiencies in implementing each of these requirements. The Division cited examples where firms failed to identify covered accounts (including online accounts), failed to adequately assess risks related to covered accounts or failed to document those assessments, and failed to periodically update these accounts, all of which affected the firm’s ability to develop red-flag controls.

In addition, the Division found compliance programs that were not appropriately tailored to the firm’s business or were missing essential program elements. These program deficiencies included failures to identify red flags; failures to detect and respond to red flags and failures to update identified red flags—in one case after changing methods for opening and accessing accounts. Another specific case involved a firm that had undergone a business reorganization but had failed to incorporate new covered accounts into the existing compliance program. On matters of governance and program administration, the Division cited multiple types of reporting failures to the Board and senior management, inadequate training, and failures to monitor and control third-party service providers as to identity theft. 

Investor Instructions after Identity Theft or Data Breach

The Investor Office alert was an update to a July 2021 publication on ways to safeguard personal financial information. Information at risk included social security numbers, account numbers, phone numbers, and account passwords. The alert focused on what to do after such private data was compromised.

The Office recommended several immediate steps for investors to take, including contacting the financial institution, changing online account passwords, closing compromised accounts, activating multi-factor authentication (if available), and monitoring investment accounts for suspicious activity. The Office also recommended placing a credit freeze or fraud alert with the national credit bureaus and to consider creating an identity theft report which could help with debt collectors and business accounts. The Office described the process for submitting a theft report, which involves filling out an FTC online complaint form, drafting an FTC identity theft affidavit, and then contacting local authorities with the affidavit. 

Conclusion

At year’s end, the SEC Divisions are accumulating data from their exams and reports and sharing their findings and assorted guidance. These alerts, however, highlight areas broker dealers and investment advisers should note, given the likelihood they will be targeted in an examination. Combatting identity theft remains a high priority. Bates will keep you apprised.

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Bates Research  |  12-13-22

SEC to IAs: Take ESG Compliance Very Seriously

The SEC recently held a National Seminar on compliance for investment advisers and investment company senior officers. Of the many important panels in the day-long program, one was devoted to the SEC’s expectations on investment adviser compliance with ESG requirements. The panel included representatives from the Divisions of Examinations, Investment Management and Enforcement, as well as a Chief Compliance Officer of a sustainable investing asset management company. A week later on November 22, 2022, the SEC announced a $4 million dollar settlement with a large investment adviser for ESG-related compliance failures. In the Order, the SEC found that the firm (i) failed to timely “adopt written policies and procedures governing how … [they]… evaluated ESG factors as part of the investment process until some time after the strategy was introduced;” and (ii) failed to consistently follow its own written policies and procedures once adopted prior to February 2020.  

Here we look at the takeaways from the seminar, which covered SEC exam concerns, an ESG disclosure proposal update, recent enforcement activity, and a CCO’s advice on ESG compliance.

SEC Seminar on ESG Compliance Obligations

Moderator Cindy Eson, Associate Regional Director for the Division of Examinations, began the panel discussion by describing the state of the ESG investment adviser market. She said that advisers are responding to increasing demand from investors by offering products and services that incorporate ESG strategies in their investment decisions. She highlighted current estimates on the size of the market saying that over 800 ESG funds with three trillion dollars in investable assets are currently in play. But she also underscored the many political controversies permeating every aspect of the field and the uncertainty that follows. By example, she shared that a significant number of Senators have written to law firms that handle ESG matters notifying them that they should prepare for congressional investigations. In another instance, she pointed to a lawmaker who issued requests for information from six investor research firms about how they calculate issuers’ ESG scores.

Examination Observations

Andy Sohrn, Manager, SEC Division of Examinations, highlighted several observations on ESG compliance raised in recent examinations. He acknowledged the compliance challenges that result from the lack of a standard definition for ESG but focused on the practical steps advisers should be considering as they incorporate ESG factors (negative screening or filtering, positive screening, socially responsible investing strategies, integration of ESG into traditional analysis, issuer engagement, impact investing and proxy voting) into their policies, processes and practices. In anticipation of exams, Mr. Sohrn focused on three recommendations.

1 - Specificity in Disclosure and Marketing

First, he highlighted the importance of specificity in disclosures and marketing. He said the lack of a definition of ESG makes the need for specificity in disclosure critical and described how a simple ESG claim like“we exclude fossil fuel companies from our portfolio” can run afoul of an examination without greater specificity; (e.g., did the disclosure specify traditional oil and gas companies only? companies that may have subsidiaries in the industry? companies that are also consumers of fossil fuels?) He said that examinations revealed examples of the use of negative screens for ESG that were based on a politically divisive issue which should have been a material consideration but was not disclosed; and an instance where an adviser told fund investors that a company scored highly on each ESG rating, but failed reveal that the scores were provided by a third party which blended composite scores and contained no breakdowns for how the companies scored in each of the categories. 

2 - Reliance on Third-Party Data Providers

Second, Mr. Sohrn highlighted the added risk to ESG investment advisers from reliance on third-party data providers. He suggested that advisers understand fully the information a third-party data provider can give, what the advisers need from such a data provider to actually implement their ESG strategy, and what the adviser must disclose to its investors about that reliance. He reminded advisers that different data providers can come to different conclusions and recommendations regarding companies and, also, that there can be gaps in the data which can affect their recommendations and their disclosure obligations.

3 – Branding and ESG Strategy

Third, Mr. Sohrn highlighted that firms that rebrand existing funds or strategies into ESG funds or strategies ensure that the new name fairly and accurately represents the funders ESG strategy. He cautioned that sometimes “the marketing people get ahead of the portfolio management people and compliance people.” He concluded with a general warning that the more that ESG is integral to a firm’s business—the more it is advertised or marketed as part of the firm’s strategy—the more risk there is, and the more likely it is that examiners would expect a firm to have policies and procedures to address that risk.

Status Update on SEC ESG Disclosure Proposal

Sara Cortes, Senior Special Counsel, SEC Division of Investment Management, offered the latest on the SEC’s proposal to require “registered investment advisers, certain advisers exempt from registration, registered investment companies, and business development companies” to disclose information on ESG investment practices and strategies in fund registration statements, prospectuses, annual reports, and adviser brochures. (See previous Bates post). Ms. Cortes described the rulemaking as clarifying how much disclosure is necessary in various categories. She said that concerns raised in received comments include: (i) that some of the categories intended for regulatory purposes could be used by firms for marketing purposes, (ii) that a number of the rules were highly prescriptive, and (iii) that smaller advisers could be asked to bear unacceptably high compliance costs. In closing, she said that the proposed ESG rules reaffirmed existing obligations under the Compliance rule.

Enforcement Observations

Kimberly Frederick, Assistant Director, SEC Division of Enforcement (Asset Management Unit) emphasized that ESG compliance enforcement remain focused on broader regulatory requirements of materiality and disclosure. She described how the SEC built a special climate and ESG Task Force in March 2021, which currently has two dozen staff selected for their experience in financial reporting, issuer disclosure, investment adviser matters. She said the Task Force “proactively” works to identify ESG compliance and related misconduct and uses big data and other tools to analyze disclosure and compliance matters relating to investment advisers’ and funds’ ESG strategies.

Ms. Frederick described notable SEC ESG cases, including (i) a 2020 action against Fiat Chrysler for making materially misleading statements about the emissions from their vehicles which resulted in a $9.5 million fine; (ii) a 2022 case involving a NY robo-adviser that marketed itself as providing services that complied with Sharia law (The firm did not have written policies and procedures setting forth how it would do so and agreed to pay a $300,000 penalty and to hire an independent compliance consultant.); and (iii) an enforcement action against an adviser for representing that all holdings in a mutual fund had undergone an ESG review, even though that was not the case, resulting in a $1.5 million penalty.

Ms. Frederick reiterated that these cases were all about materiality and disclosure and said the takeaway is simple: “Say what you mean, and mean what you say.” She concluded that “if an adviser is marketing itself as having an ESG-driven or influenced investment process, it must make sure its marketing materials are not misleading, and it has to adopt policies and procedures reasonably designed to match its investing.”

A CCO Point of View: Consistency Matters

Several direct observations came from John Boese, Chief Compliance Officer at Impax Asset Management LLC. He remarked that an exam covering ESG was like a “routine exam on steroids,” and that his recent experience was that the exam was “as much of a fact-finding mission as it was an exam.” He asserted that the SEC is looking to see whether “you’re saying it,” and if you are, then “if you are doing it,” and further, “if you are consistent in all your filings and marketing and disclosures.” On ESG best practices, he suggested: “don’t create compliance traps in your prospectuses; don’t say things that you are not going to be able to do. You have to make sure that your prospectus is consistent with your website which is consistent with your ADVs and with your marketing.”

He also recommended (i) that compliance be an ad hoc member of every department in your organization; (ii) that firms create specific policies and procedures around ESG; and that (iii) compliance professionals be able to test those procedures, “not only for a firm’s own protection, but for compliance’s as well.”  

Policies and Procedures: Recent ESG Settlement

These observations were on display in a matter announced a week after the seminar. The SEC Order stated that the investment adviser “had several policies and procedures failures involving the ESG research its investment teams used to select and monitor securities.” Specifically, the SEC found that, for a time, “the company failed to have any written policies and procedures for ESG research in one product,” and “failed to follow its own policies and procedures” once they were established. These alleged failures included internal requirements for employees to complete questionnaires on companies to be included in ESG investment portfolios prior to their selection. In its settlement, the adviser agreed to a cease-and-desist order, a censure, and a $4 million penalty.

Conclusion

As the market for ESG investing grows, attention to compliance around related materiality and disclosure will intensify. Meanwhile, the SEC’s ESG disclosure proposal keeps winding its way through the rulemaking process. Notwithstanding the controversies surrounding ESG investing, and the political uncertainties hovering over it, the SEC has organized itself for sustained attention to investment adviser compliance. Both the panelists and the recent enforcement settlement make that clear. Bates will keep you apprised.  

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Events  |  12-12-22

Fraud Trends & Predictions for 2023: Webinar with Unit21 - Thursday, December 15, 2022

Today’s financial fraudsters are more well-funded, technologically savvy, and agile than they've ever been before. So how are the top risk & compliance teams preparing for fraud in 2023?

In this webinar, join Bates Group Senior BSA/AML/OFAC Compliance Consultant John Ashley along with industry-leading voices from Unit21, Chainalysis, and Helix for their insights into the biggest fraud trends for 2022 and their predictions for where fraud is headed in 2023. Sign up today to reserve your spot!

Date: Thursday, December 15th, 2022

Time: 10 a.m. PT / 1 p.m. ET

Topics:

  • How 2022 was unique as compared to 2021 and 2020 (as a “post-pandemic” year)
  • The main fraud trends that played out in 2022 and why these trends occurred
  • What to look out for in 2023 (and beyond) regarding fraud
  • Tips for successfully managing fraud risk in an ever-changing landscape

Webinar Details and Registration

Fraud Trends & Predictions for 2023: Webinar with Unit21 - Thursday, December 15, 2022

Bates Research  |  12-02-22

SEC FY2022 Enforcement Division Report: Regulator Raises Penalties to Increase Deterrence

In its annual report of legal actions taken in Fiscal Year 2022 (ending September 30, 2022), the SEC noted its “robust enforcement” efforts to “impose penalties designed to deter future violations, establish accountability from major institutions, and order tailored undertakings that provide potential roadmaps for compliance by other firms.” The SEC underscored these key messages by highlighting (i) aggregate metrics on the agency’s enforcement efforts; (ii) the expanded use of enforcement tools brought to bear (namely, data analytics and whistleblowers); (iii) the resolutions of specific high-profile cases involving disclosure and gatekeeping activities; and (iv) enforcement successes in categories of cases involving evolving risk.

Annual Metrics

The numbers bear out just how robust SEC enforcement efforts have been. Representing a 9% increase year-over-year, the SEC filed 760 actions in 2022, including 462 new "stand alone" securities law cases, 129 cases involving compliance filing delinquencies, and 169 administrative proceedings against individuals that follow from criminal convictions or civil orders. In an addendum to the announcement, the SEC broke down these figures by percentage, revealing, for example, that 17% of filed cases were brought against broker dealers and 23% of filed cases were brought against investment advisers or companies.  In the aggregate, the SEC ordered payment in these cases (including civil awards, disgorgement and interest) totaling $6.4 billion, a significant increase over the $3.9 billion in 2021. The SEC figures also show an increase in the aggregate amount of money distributed to harmed investors ($937 million in FY 2022 vs. $521 million in FY 2021, but still shy of a high of $1.197 billion in 2019).

Data Analytics, Cooperation, and Whistleblowers

To underscore the message of its expanded strategic use of multiple resources to go after misconduct, the SEC described how it leveraged “the entire enforcement toolkit,” referring to the use of data analytics, “cooperators,” and whistleblowers.

On big data, the SEC used sophisticated techniques to “review and triage[ ] more than 38,500 tips, complaints, and referrals of possible securities law violations submitted by the public, self-regulatory organizations, and others.” The agency cited a wide range of cases using evidence derived from this method, including “hacking to trade,” “pump and dump” schemes, and “insider trading,” among others. On cooperation, the SEC highlighted cases in which the company “tangibly” helped with an agency investigation or by providing evidence. (The agency emphasized how it takes into account such cooperation when ordering remedies.) On whistleblowers, the SEC pronounced that their use is “an integral part of the enforcement program.” In 2022, the agency said it processed 12,300 tips and gave out $229 million over 103 awards. The agency also cited cases that emphasized its efforts to safeguard whistleblower anonymity and protect against retaliation.

Visit Bates Regulatory and Internal Investigations Practice

Categories of Enforcement Action

In its recap, the SEC distinguished several categories of cases. Among them: financial fraud and issuer disclosure along with so-called “gatekeeper” actions involving auditors, lawyers and transfer agents. Emphasizing personal accountability, the agency cited cases where it pursued issuers and employees who misled investors by making material and inaccurate disclosures, as well as going after “auditors and their professionals” for failures that led to improper disclosures, or other misbehavior.

As to broker-dealers and investment advisers, the SEC highlighted recent enforcement activity around Regulation Best Interest (Reg BI), special purpose acquisition companies (SPACs) and against institutions involving the “misuse of complex products and strategies.” The agency broke down the cases undertaken during the year, tackling a range of evolving risk. By category, the SEC highlighted enforcement actions involving:

  1. cryptocurrency (including registration violations, fraud, and insider trading); of note, the SEC said it had doubled the number of positions to its Crypto Assets and Cyber Unit to boost investigations of potential misconduct.
  2. cybersecurity (primarily compliance violations on recordkeeping and protecting personal information); the SEC emphasized the importance of ensuring that firms keep up with “technological developments” and its effect on business practices.
  3. complex products (concerning inadequate training of advisors, misleading communications and fraudulent schemes); the SEC pursued cases of fraud involving both complex products and strategies.
  4. environment, social and governance (ESG) issues (related to misleading disclosures and breaches of fiduciary duty); the SEC was careful to demonstrate how its efforts were tied to “time-tested principles concerning materiality, accuracy of disclosures, and fiduciary duty, as codified in federal statutes, regulations, and case law”.
  5. private funds (concerning conflicts of interest, fees and expenses, custody violations, and protection of nonpublic information); the SEC highlighted the growth in assets managed by private funds as the agency went after private fund advisors and associated individuals.
  6. public finance (including cases for disclosure violations and misleading statements, registration rule violations, and pay-to-play violations); the SEC noted cases against broker dealers, investment advisers and – for the first time – underwriters (for registration violations).
  7. market abuses (focusing on insider trading, market manipulation, and other illegal trading practices); the SEC underscored that its efforts served to defend both market integrity and victimized investors.
  8. Foreign Corrupt Practices Act (FCPA) violations (including misrepresentations to investors); these cases were brought against US issuers that committed bribery and other prohibited practices abroad. 

Conclusion

The aggregate metrics on the agency’s enforcement efforts, the emphasis on expanding the use of data analytics, cooperation agreements and whistleblowers, and the attention paid to compliance gatekeepers represent amplified messaging intended to alert both legislators and market participants. Most striking in the report are references to how the SEC “recalibrated penalties for certain violations, including prophylactic remedies, and required admissions where appropriate.” The agency stated that it increased these penalties to “deter future misconduct and enhance public accountability,” citing examples of orders (i) imposing additional billions of dollars in penalties for recordkeeping violations; (ii) requiring “undertakings” (including “retention of compliance consultants”) to ensure compliance policies and procedures and internal controls; (iii) requiring that gatekeeping (such as auditing) firms keep up with their continuing education courses; and (iv) requiring admissions of fault. These remedies go beyond proportional penalties for compliance or rule violations; they—like the report in general—reflect a very intentional message that “the fines were not just a cost of doing business,” thus once again raises the stakes. Bates will keep you apprised.

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SEC FY2022 Enforcement Division Report: Regulator Raises Penalties to Increase Deterrence

Alex Russell

Managing Director, White Collar, Regulatory and Internal Investigations

arussell@batesgroup.com

971-250-4353

SEC FY2022 Enforcement Division Report: Regulator Raises Penalties to Increase Deterrence

Julie Johnstone

Managing Director, Practice Leader - Securities and Financial Services Litigation & Consulting

jjohnstone@batesgroup.com

971-250-4319

SEC FY2022 Enforcement Division Report: Regulator Raises Penalties to Increase Deterrence

Brandi Reynolds

Managing Director, BSA/AML Compliance, FinTech & Virtual Assets

breynolds@batesgroup.com

864.809.7718

SEC FY2022 Enforcement Division Report: Regulator Raises Penalties to Increase Deterrence

Hank Sanchez

Managing Director, Bates Compliance

hsanchez@batesgroup.com

504-450-9632 

Events  |  11-30-22

Bates CEO Jennifer Stout is Featured Speaker at the FSDA-SIFMA C&L Forum in St. Petersburg

Register today to join FSDA President and Bates Group CEO Jennifer Stout at the in-person FSDA-SIFMA C&L Forum and networking event in St. Petersburg, Florida. Featuring welcome remarks from Jonathan N. Santelli, Executive Vice President and General Counsel, Raymond James Financial; panels on developments in privacy law and ESG in financial services (see below); a fireside chat with Jennifer Stout moderated by SIFMA EVP/GC Saima Ahmed; and closing remarks by SIFMA’s Ira Hammerman.

Hosted by the SIFMA C&L Society and FSDA and sponsored by Raymond James. CLE credit is available for this live program.

December 7, 2022

8:00am - 12:00pm EST

Raymond James | St. Petersburg, FL

Registration and Details

Featured Panels:

Developments in Privacy Law

Moderator: Ellyn Angelotti Kamke, Assistant General Counsel, Corporate Transactions and Financial Operations, Raymond James Financial

Panelists:

  • Olga Greenberg, Partner, Eversheds Sutherland
  • Jarod Koopman, Executive Director, Cyber and Forensic Services, IRS-Criminal Investigation
  • Rob Patchett, Global Chief Privacy Officer and I.T. Chief Compliance Officer, Raymond James Financial

 

Fireside Chat

Moderator: Saima Ahmed, Executive Vice President and General Counsel, SIFMA

Speaker: Jennifer Stout, President, FSDA and CEO, Bates Group

 

The Evolution and Explosion of Environmental, Social, Governance (ESG) Issues in Financial Services

Moderator: Samantha Trebesch, Head of Sustainable Investing, Raymond James Private Client Group

Panelists:

Events  |  11-28-22

Webinar: Reg BI Compliance What You Need to Know to Stay Ahead

As financial firms are starting to face the first round of enforcement actions from regulators under Regulation Best Interest (Reg BI), the “grace period” that followed the rule’s implementation data has come to an end.

The SEC has announced that Reg BI will be a high priority for Examinations and Enforcement in 2023, and firms need to have the right people, processes, and technology in place in order to remain compliant.

Join Bates Group and NICE Actimize for our upcoming webinar: “Reg BI Compliance: What You Need to Know to Stay Ahead.” Featuring Rhonda Davis, JD, CAMS, CFE, Managing Director, Bates Compliance; Jan Folena, Partner, Stradley Ronon (formerly with the SEC); Anand Maheshwari, Senior Product Manager, Suitability Surveillance, NICE Actimize; and moderated by Ozzie Berrios, Suitability Compliance Regulatory Expert, NICE Actimize. Register today for this complimentary event.

Date: Friday, December 9, 2022

Time: 1 p.m. ET/10 a.m. PT.

Webinar Details and Registration

Bates Research  |  11-21-22

On Our Radar: Crypto Regulatory and Enforcement Roundup

Regulatory and enforcement activity has been brisk since nine federal agencies issued a “Comprehensive Framework for Responsible Development of Digital Assets” in response to President Biden’s Executive Order to collaborate on a “whole of government approach.” As previously described, the Framework has done little to affect what federal agencies were already doing: asserting their jurisdictions, monitoring investor-related and market risks, and aggressively applying and enforcing rules on illicit finance and compliance violations.

The intensity is up. There are many voices across the spectrum competing for attention – a consequence of many factors, among them (i) the current and dramatic volatility in the digital asset markets that included losses estimated at $2 trillion in market value over the last year, (ii) the unfolding bankruptcy of crypto exchange FTX, (iii) state actors (both legislators and regulators) seeking to fill the void created by the lengthy federal deliberative process, and (iv) a national election, which has implications for both administrative and legislative developments on crypto. 

The following topics are some of the latest regulatory and enforcement developments on our radar right now.

FSOC Reports on Crypto Risk and Regulation

In an October Report on digital asset financial stability risks and regulation, the Financial Stability Oversight Council (“FSOC”) identified gaps in the regulation of crypto asset activities. The FSOC membership includes the heads of Treasury, the Federal Reserve, OCC, CFPB, SEC, and CFTC as well as advisors that include a designated state insurance commissioner, a designated state banking supervisor, and a designated state securities commissioner. In the report, FSOC recognized that the existing regulatory system covers large parts of the crypto asset ecosystem, but then identified three gaps in that regulation.

First, the report found that “crypto-asset businesses do not have a consistent or comprehensive regulatory framework and can engage in regulatory arbitrage.” The Council stated that some of the businesses have affiliates or subsidiaries that may operate under different regulatory frameworks. The identified risk was that no one regulator would have visibility into the risks across the entire business. Second, FSOC found that “the spot markets for crypto-assets that are not securities are subject to limited direct federal regulation;” and would not be subject to regulations to “ensure orderly and transparent trading [or] prevent conflicts of interest and market manipulation.”

Third, FSOC questioned whether “vertically integrated market structures can or should be accommodated under existing law.” FSOC stated its concern that retail investors could be exposed to risky practices used by such trading platforms (for example, “automated liquidation”).

In an effort to address the gaps, the Council made recommendations to (i) enact legislation that would strengthen member agencies rulemaking authority over the spot market for crypto assets that are not securities; (ii) address regulatory arbitrage (including legislation on stable coins) and provide agencies with the authority to oversee the activities of all crypto asset entities; and (iii) bolster member agencies capacities related to crypto asset data and expertise. 

CFPB Reviews Consumer Crypto Complaints 

In a November report, the CFPB analyzed more than 8,300 consumer complaints for crypto assets covering the period between 2018 through 2022. The CFPB described how crypto is increasingly marketed to consumers and incorporated in financial products such as credit cards, debit cards, prepaid cards (offering crypto “rewards”) and various other product offerings on crypto payment platforms. The CFPB said that the rate of complaints increased over those years with the greatest number coming from California. The agency reported that crypto complaints and fraud reports have increased at other federal agencies, citing the SEC, which received 23,000 tips, complaints, and referrals since 2019 and the FTC, which reported a sixty-fold increase over the amount of crypto asset losses since 2018.

The CFPB found fraud (more than 50 percent of all complaints) to be the top issue, with a large number related to scams inducing consumers to turn over account access. Schemes cited include: romance scams (accounting for the highest individual reported losses), “pig butchering” (fraudsters posing as financial successes and “coaching victims through setting up crypto asset accounts,” and scams involving social media influencers that lure in victims. The CFPB also highlighted transaction issues that made up about 25 percent of the complaints. Schemes cited included: “SIM swap” hacking, which allows fraudsters “to intercept SMS messages to exploit two-factor authentication,” phishing attacks, and other social engineering hacks. The CFPB highlighted complaints against platform exchanges, as well with customers raising account access issues, liquidation policy issues, customer service issues, and unexpected fees and other costs. 

Treasury Requests Comment on Digital Asset Illicit Finance 

In late September, the Treasury Department asked for input on digital-asset-related illicit finance risks as part of its response to the Executive Order and Framework (previously mentioned). Among the subjects included in the Request for Comment were general questions on a broad range of topics, including the scope of illicit financing risks associated with digital assets; how technological innovation might present new risks or mitigate existing ones; how to “more effectively deter, detect, and disrupt the misuse of digital assets;” the relevancy of existing AML/CFT regulatory obligations or additional alternative obligations that  should be imposed; and how to improve state-state and state-federal coordination for AML/CFT regulation and supervision. SIFMA, in a notable response, argued that banks and broker-dealers have the experience and know-how to effectively monitor the use of digital assets and that they are in the best position to take advantage of new technologies to manage illicit financing risks. SIFMA highlighted that AML regulations over money transfer transactions are effectuated by these intermediaries and with some modification can apply to all digital transactions. SIFMA cited emerging distributed ledger technologies as potentially helping manage illicit finance risks through tracking customer and transaction data.

Enforcement Activity Ramps Up

Federal agencies have zoomed in on pursuing enforcement actions involving crypto assets. The CFTC issued its annual enforcement results that highlighted 18 actions involving digital assets, [which] represents “more than 20% of all actions filed during FY 2022.” The CFTC-cited examples where that it charged (i) a digital asset exchange with illegally offering futures transactions on its unregistered platform, with attempting to manipulate the price of its native token and for failing to implement a Customer Identification and Anti-Money Laundering program; (ii) a registered entity with making false or misleading statements of material facts during an evaluation of the potential self-certification of a bitcoin futures contract; (iii) an unregistered software company for illegally offering leveraged and margined retail commodity transactions in digital assets and for failing to adopt a customer identification program as part of a Bank Secrecy Act (BSA) compliance program.

The SEC issued its own enforcement report which noted developments in the crypto asset securities space. The report stated that in May, 2022, the SEC doubled the size of the staff dedicated to a group it renamed the Crypto Assets and Cyber Unit. The SEC highlighted three cases – the first against a lending platform for failing to register a retail crypto product. This type of case continues to reflect the agency’s ongoing contention that crypto assets are securities under the legal Howey test. A recent decision handed down by a U.S. District Court determined that tokens sold by digital asset company LBRY were securities requiring registration with SEC because the offerings of LBC tokens led investors to have “a reasonable expectation of profits derived from the entrepreneurial or managerial efforts of others.” The SEC Report also highlighted an enforcement action against individuals in a fraudulent crypto-ponzi scheme, and an insider-trading case against individuals touting crypto assets about to be offered on a crypto trading platform.

In addition, FINRA recently announced a targeted examination on crypto assets. In letters sent to targeted firms, FINRA stated that it will be examining retail communications concerning a firm or its affiliates’ crypto assets, or services involving a transaction or a holding of a crypto asset. The examinations will focus on the period July 1, 2022 through September 30, 2022.

Notable Recent Crypto Enforcement Actions: Virtual Currency Exchange

The Treasury’s Office of Foreign Assets Control (“OFAC”) and FinCEN settled actions against Bittrex, Inc., a virtual currency exchange based in Bellevue, Washington. The cases represented the largest actions against a virtual currency company and the first parallel enforcement action by OFAC and FinCEN. The agencies found “willful violations” of sanctions compliance programs and BSA/AML risk-based compliance control requirements, including SARs reporting and transaction monitoring failures. Bittrex agreed to settle with OFAC its potential civil liability for 116,421 violations of sanctions programs for $24,280,829.20. It agreed to settle with FinCEN for $29,280,829.20 for violations of the BSA and FinCEN’s implementing regulations.

Virtual Currency Mixer

Back in August, OFAC sanctioned Tornado Cash, a virtual currency mixer that was accused of laundering more than $7 billion worth of virtual currency since 2019. The virtual currency mixer is a decentralized technology (“DeFi”) protocol designed to increase the privacy of its users and operated through smart contracts on the Ethereum blockchain. OFAC alleged that the protocol facilitated illegal and anonymous transactions “by obfuscating their origin, destination, and counterparties, with no attempt to determine their origin.” According to OFAC, the company “repeatedly failed to impose effective controls designed to stop it from laundering funds for malicious cyber actors on a regular basis and without basic measures to address its risks.”

The decision to designate the protocol remains controversial.  On October 12, 2022, Coin Center, a non-profit advocacy group focusing on cryptocurrency and decentralized technologies, sued the Treasury Department and OFAC over sanctioning Tornado Cash, claiming that the decision to do so was unlawful, was arbitrary and capricious, and that it violated the constitutional right to privacy. Coin Center argued that OFAC did not have the authority to sanction “an idea, a tool or a technology.”

Conclusion

In lieu of a comprehensive plan across all government sectors on digital assets, policy debates are playing out through regulatory and enforcement activity. The President’s efforts to create such a plan are made ever more difficult by the current market conditions including the recent bankruptcy of the FT crypto exchange, the speed of technological developments, and the hardening of the positions of the agencies – each elbowing the other for a share of the oversight (as the FSOC risk report suggests.)

The nine individual reports that make up the Framework served to articulate the core issues and national interests at stake. The recent activity highlighted above – the reports, Treasury’s request for information, the enforcement determinations – activity that does not even cover state or federal legislative efforts (more on that to come) – are generating momentum that serves the status quo. Such evidence, whether it’s the latest tallying of consumer complaints or the jurisprudence being developed in the name of investor protection or national security or combatting illicit finance, will be of continued use in bolstering or tweaking existing positions. All of it may or may not be affected by the results of the election. In the interim, Bates will continue to monitor developments. 
 

Bates Group has been a trusted partner to our non-banking financial institutions and financial services clients and their counsel for over 40 years, delivering superior quality and results on a cost-effective basis. With a full professional staff and a roster of over 175 financial industry and regulatory compliance experts, Bates offers services in AML and compliance, regulatory enforcement and internal investigations, litigation consultation and testimony, forensic accounting, damages, and big data consulting.

Bates Group's MSB, FinTech and Cryptocurrency team provides a full suite of Bank Secrecy Act, Anti-Money Laundering and Office of Foreign Assets Control (BSA/AML/OFAC) compliance consulting services, state money transmitter licensing acquisition and maintenance support, independent reviews, and corporate compliance training.

Contact Bates

To learn more about our services or to talk to one of our professionals, reach out to us directly today at contact@batesgroup.com.
 

Bates News, Compliance and Regulatory Alerts  |  11-16-22

Are Your Firm’s Policies and Procedures Working as Intended for Rights of Reinstatement?

FINRA has remained focused on ensuring that eligible customers received Rights of Reinstatement (“ROR”)[1] benefits where appropriate. Just recently, we were retained by another large firm looking to leverage the depth of our experience gained through many engagements assisting our clients with Rights of Reinstatement issues since the targeted examination announcement in 2020.

FINRA continues to scrutinize firms’ policies and procedures through examination and enforcement to ensure they are working as intended, and that investors are receiving the benefits they are due. FINRA also expects remediation in any instances where the policies or procedures did not work as intended.

We encourage firms to continue to review the effectiveness of and update their rights of reinstatement related procedures considering this ongoing regulatory focus and make updates to policy or remediation where necessary. Firms should be tracking mutual fund transaction activity and verifying that clients received the benefit of the ROR, as well as considering mutual fund trading in the context of their obligations under Reg BI.

 

[1] ROR allows a customer to redeem or sell shares in the fund and reinvest some or all of the proceeds and receive a waiver of the sales load or a rebate on the CDSC paid on the sale, within a specified period of time (for example, 90 days), in the same share class of that fund or another fund within the same fund family subject to certain terms and conditions. The terms and conditions vary among funds. See previous Bates alert.

 

If you are facing a FINRA inquiry or other action, contact Bates today.

How Bates Helps:

Regulatory Investigations and Enforcement

Bates Group supports firms subject to an inquiry or examination related to ROR by importing the firm’s mutual fund trading activity into our programmatic analysis environment, reviewing for ROR-eligible trading activity, and identifying records evidencing that the ROR benefit that we identified as due (whether a front load waiver or CDSC rebate) were handled contemporaneously via various record sources. Any remaining missed benefits are then quantified and summarized at the investor or account level. Bates will also provide insight into how FINRA has responded to various issues in prior ROR matters, assisting with any requests for additional information or support, until a result is agreed upon. Bates will then prepare a repayment file, including calculating prejudgment interest, for the firm to use.

Contact Bates and let us put our experience to work for your firm:

Are Your Firm’s Policies and Procedures Working as Intended for Rights of Reinstatement?

Alex Russell

Managing Director, White Collar, Regulatory and Internal Investigations

arussell@batesgroup.com

971-250-4353

Are Your Firm’s Policies and Procedures Working as Intended for Rights of Reinstatement?

David Birnbaum

Managing Director, Business Development and Strategy

dbirnbaum@batesgroup.com

917-273-2682

Bates Research  |  11-16-22

The New Federal Digital Asset Framework: Where Are We Now?

Image © [OlegKachura] /Adobe Stock

Since President Biden issued an Executive Order in March 2002 directing agencies to collaborate on a “whole of government approach” for ensuring the responsible development of digital assets, the market has been anticipating the release of the broader framework. As we noted in a previous post, the Executive Order was well received, in large measure because it laid out a high-level set of unobjectionable goals. Among them: consumer and investor protection, financial inclusion, mitigation of illicit finance and national security risks; consideration of a U.S. central bank digital currency ("CBDC"); and the promotion of technological innovation prioritizing “privacy, security, combating illicit exploitation, and reducing negative climate impacts.”

The Framework, issued on September 16, 2022, remains a high-level mix of broad directives by nine separate federal agencies which support these goals. Here are the highlights.

Illicit Finance

The Framework reinforces the current U.S. role in anti-money laundering in the “digital asset ecosystem” while acknowledging that “digital assets have facilitated the rise of ransomware cybercriminals; narcotics sales and money laundering for drug trafficking organizations; and the funding of activities of rogue regimes.”

The Framework would strengthen U.S. efforts to mitigate these risks by proposing that the President consider legislation amending the Bank Secrecy Act. The Framework names a few of these proposed amendments including (i) “anti-tip-off statutes, (ii) a law against, and increased penalties for, unlicensed money transmitting to apply explicitly to digital asset service providers—including digital asset exchanges and nonfungible token (NFT) platforms,” and (iii) allowing the Department of Justice “to prosecute digital asset crimes in any jurisdiction where a victim of those crimes is found.” The Framework commits Treasury to complete an illicit finance risk assessment on decentralized finance by the end of February 2023 and on non-fungible tokens by the end of July 2023. Further, Treasury committed to greater outreach to stakeholders (including through a Request for Comment) to encourage more feedback on combatting “anti-money laundering, terrorist financing; hacks that result in losses of funds; and fragilities, common practices, and fast-changing technology that may present vulnerabilities for misuse.”

U.S. Central Bank Digital Currency

The Framework continues the ongoing debate about the whether the Federal Reserve should issue a Central Bank Digital Currency (CBDC) and how. The Framework reiterates the potential advantages of a US CBDC including “enabling access for a broad set of consumers,” fostering “economic growth and stability, protect[ing] against cyber and operational risks, safeguard[ing] the privacy of sensitive data, and minimiz[ing] risks of illicit financial transactions.”  The Framework moves forward with recommendations for additional research and development and “experimentation and evaluation.” In the Framework, Treasury committed to lead an interagency working group to further consider the implications of a US CBDC.

Protecting Investors

Strengthening disclosure and more aggressive and collaborative investigations and enforcement, particularly by the SEC, CFTC, and CFPB to combat fraud and scams are the primary recommendations to protect investors in cryptocurrencies. The Framework also encourages the FTC and CFPB to increase their efforts to monitor consumer complaints and share the data. Beyond that, the Framework recommends that regulators issue more guidance on emerging risks, and for the Financial Literacy Education Commission (FLEC) to lead efforts to raise public awareness of these risks.  

Innovation

The regulators agreed to “foster” innovation in the digital asset market by committing to (i) offer regulatory guidance and assistance to technology entrepreneurs (through programs like tech sprints and Innovation hours), (ii) “kickstart fundamental research on topics such as next-generation cryptography, transaction programmability, cybersecurity and privacy protections, and ways to mitigate the environmental impacts of digital assets,” and (iii) work to inform, educate and train “diverse groups of stakeholders on safe and responsible digital asset use.” In addition, the DoE and EPA committed to track the environmental impacts of digital asset use, developing performance standards and “providing local authorities with the tools, resources, and expertise to mitigate environmental harms.” The Commerce Department offered to host stakeholder forums to allow for discussion on new federal regulation, standards, technical assistance and research. 

Access to Financial Services

Without much detail, the Framework states that the President will consider “agency recommendations to create a federal framework to regulate nonbank payment providers.” Otherwise, the emphasis was placed on the development of instant payment systems including the coming launch of “FedNow,” a Federal Reserve Board effort to “enable financial institutions of every size, and in every community across the U.S., to provide safe and efficient instant payment services in real time.” The expectation is that payment providers would offer innovative technologies that will help to expand access. The Framework also encouraged more research in “technical and socio-technical disciplines and behavioral economics” to encourage accessibility.  

Financial Stability                            

The Framework highlights that the Treasury Department will continue to help financial institutions “identify and mitigate cyber vulnerabilities,” share data, develop analytical tools, and collaborate with other agencies on tracking and analyzing digital asset market strategic risk.

Global Competitiveness

The Framework highlights the current work being done in international bodies (e.g., G7, G20, OECD, FSB, FATF, and the International Organization for Standardization) by the United States with respect to policies and regulation for digital assets. The Framework emphasizes the importance of U.S. values, namely “data privacy, free and efficient markets, financial stability, consumer protection, robust law enforcement, and environmental sustainability,” to the dialogue. The Framework states that the U.S., through the Departments of State, Treasury, and USAID, will further these values and offer technical assistance to help build out global “digital asset infrastructure and services.” 

Conclusion

The Framework for regulating digital assets is very broad and reaffirms, in large part, what the agencies are already doing in the space. In that sense, the emphasis on more aggressive enforcement of existing rules is worth noting. Meanwhile, the new “whole of government approach” takes nothing off the table nor does it centralize oversight. In this regard, it does not provide the kind of direction that market participants have long called for.

Kicking the can further down the road, of course, presents its own risks. But perhaps—given current market conditions—the Framework prevented additional deleterious effects that more definitive directives might have provoked. That said, taking nothing off the table continues a pattern that does little to address longer-term digital asset development and the lack of regulatory certainty. The main takeaways are: more regulatory scrutiny based on existing rules and holdings, more uncertainty regarding future federal and state legislative mandates that are proceeding apace (notwithstanding this deliberative federal effort), and more potential enforcement jeopardy for firms. 

Bates will continue to keep you apprised.

About Bates' MSB and Virtual Asset Services

Bates Group’s MSB, FinTech, and Virtual Assets practice offers guidance and services for Money Services Businesses and Non-Banking Financial institutions, fintech and cryptocurrency firms. Our crypto subject matter experts work directly with firms and counsel to design and implement policies to ensure they are AML-compliant. Our MSB and AML Teams help obtain and maintain Money Transmitter Licensing, and they also engage clients with BSA/AML/OFAC Program Development, Risk Management, Training, Advisory Services, and Independent Reviews.

For More Information, Please Contact:

The New Federal Digital Asset Framework: Where Are We Now?

Brandi Reynolds

Managing Director, BSA/AML Compliance, FinTech & Virtual Assets

breynolds@batesgroup.com

864.809.7718

The New Federal Digital Asset Framework: Where Are We Now?

Rob Ayers

Business Development and Consulting Expert

rayers@batesgroup.com

Events  |  11-14-22

Bates Cybersecurity Expert Patrick Cox to Speak at Greensfelder Securities Symposium Nov. 16

Join Bates at the 2022 Securities Industry Symposium, on Wednesday, November 16, 2022. Sponsored by Greensfelder, Hemker & Gale, P.C. and the Bar Association of Metropolitan St. Louis.

The Symposium is an afternoon of highly informative discussions and networking opportunities with other securities professionals and will include interviews of Missouri Securities Commissioner Douglas Jacoby, NASAA President and Iowa Deputy Administrator for Securities Andrew Hartnett, and Gregory Markovich, FINRA Senior Director of its Cyber Enabled Fraud group, as well panels on current events for dual registrants and cybersecurity, which includes Bates Cybersecurity Expert Patrick Cox (pictured).

The symposium is accredited for 4.6 MO CLE hours.

Event Details and Registration

Events  |  11-10-22

Bates Is Proud To Sponsor CrossTech World 2022, November 15-17

Bates Group is a proud sponsor of CrossTech World 2022 (formerly IMTC), November 15-17, 2022, at the Seminole Hard Rock Hotel & Casino in Miami, FL. Join our Bates MSB, FinTech & Virtual Assets team members Brandi Reynolds, Rob Ayers, Catherine Snyder, and Erin Dobbins (pictured above, L-R) for three days of compliance courses, trading workshops, panels, round tables, and networking for international financial services companies and service providers.

Bates Is Proud To Sponsor CrossTech World 2022, November 15-17

Don't miss the Crypto Investment & Trading Workshop "Using Crypto in Payment Companies: Crypto Basics Regulatory & Compliance," with Bates Managing Director Brandi Reynolds, on Tuesday, November 15 from 9:15-10:00 a.m. Brandi will also appear on the Compliance Officers' Discussion Forum: Regulatory Updates as moderator on Wednesday, November 16 from 11:45 a.m.-12:30 p.m., and later as a panelist on the Compliance Officers' Discussion Forum: Crypto Trends from 12:30-1:15 p.m. 

Bates Is Proud To Sponsor CrossTech World 2022, November 15-17

Also representing Bates at the conference is Rob Ayers, Business Development and Consulting Expert for MSBs and FinTech. He will be participating in the moderation of the Payment Track 2 Roundtable "Partnerships in the Banking Industry - Rails and Networks" on Wednesday, November 16 from 4:30-5:15 p.m.

MSB, FinTech, and Virtual Assets Support

Bates Group offers consulting and other services to established and start-up companies in the areas of banking, financial technology (FinTech), virtual assets and cryptocurrency, traditional Money Services Businesses (MSBs), and Non-Banking Financial Institutions (NBFIs). Our MSB, FinTech & Cryptocurrency team provides a full suite of Bank Secrecy Act, Anti-Money Laundering and Office of Foreign Assets Control (BSA/AML/OFAC) compliance consulting services, state money transmitter licensing acquisition and maintenance support, independent reviews, and corporate compliance training.

Visit Our MSB Practice Page

About CrossTech World 2022

CrossTech World (formerly IMTC) is the signature event of the Cross Border Transfers & Payments Industry. The conference brings together international financial services companies from around the world, as well as new sectors that are changing the face of the industry, including Remittance Service Providers (RSP), money transfer companies (MTO), money services business (MSB), mobile money operators (MMO), payment institutions, bill payment companies, Telcos, digital wallets, foreign exchange firms (Forex), and providers of products and services to the industry.

Conference Details and Registration

 |  11-10-22

FinCEN Beneficial Ownership Information Reporting & Overview: Are MSBs Required to Report? Here’s What You Need to Know.

Image © [Jarretera] /Adobe Stock

What is the rule?

The Beneficial Ownership Information (BOI) Reporting Rule establishes requirements for business entities—such as corporations or limited liability companies—who are created or registered in the U.S. to disclose information regarding their beneficial ownership to FinCEN.

Who must comply?

Generally, the rule applies to any domestic (registered in the U.S.) or foreign (incorporated abroad but registered to do business in any jurisdiction in the U.S.) company. A good rule of thumb is that the rule applies to any company who has filed a registration document with a state Secretary of State, Department of Corporations, or similar government agency.

Are there exemptions?

Yes – the rule follows the Corporate Transparency Act of 2020 and lists 23 types of entities which are exempt from reporting requirements, as they are already subject to substantial oversight at the federal or state level. Examples include banks, credit unions, insurance companies, any money services transmitting business and money services business (MSB) registered with FinCen, and entities registered with the Securities and Exchange Commission.

What is a beneficial owner?

FinCEN defines a beneficial owner as any individual who (either directly or indirectly):

  1. Exercises substantial control over a reporting company or
  2. Owns or controls at least 25% of the company

How do businesses comply?

Reporting companies must identify themselves to FinCEN and report the following information for each of their beneficial owners:

  1. Name
  2. Date of Birth
  3. Address
  4. Photo ID information and a copy of the ID

Beneficial owners may also opt to provide this information directly to FinCEN. If they do so, they will be issued a “FinCEN identifier” which reporting companies may submit to FinCEN in lieu of submitting the required beneficial ownership for that individual.

FinCEN will continue to publish guidance and instructions on how reports are to be filed and on how businesses can comply between now and the effective date of the rule.

When must business be compliant?

The rule becomes effective on January 1st, 2024. Reporting companies will have one year to file their initial reports. Reporting companies created after the effective date will have to comply 30 days after their creation or registration.

Source: Federal Register 87-189

About the Author:

FinCEN Beneficial Ownership Information Reporting & Overview: Are MSBs Required to Report? Here’s What You Need to Know.

John Ashley (CIPP/US, CCRS, CRCMP) is a Senior Consultant in Bates Group's Money Services, Fintech and Digital Assets Compliance and AML Practice. He can be reached at jashley@batesgroup.com.

About Bates:

Bates Group's MSB, FinTech and Cryptocurrency team provides a full suite of Bank Secrecy Act, Anti-Money Laundering and Office of Foreign Assets Control (BSA/AML/OFAC) compliance consulting services, state money transmitter licensing acquisition and maintenance support, independent reviews, and corporate compliance training.

Visit The MSB Practice Page

Events  |  11-09-22

Bates Sponsors NAWL General Counsel Institute November 9-11

Bates is a proud Networking sponsor of the 18th annual National Association of Women Lawyers (NAWL) General Counsel Institute, November 9-11, 2022, in New York City.

Now in its eighteenth year, GCI is a multi-day program of networking, education, and inspiration designed for senior in-house women counsel. Sessions with the general counsel of major corporations and other inspirational speakers foster frank, collegial discussions about career advancement, while workshops on key topics with leading experts provide opportunities to refine skills and expertise. GCI provides a unique environment to connect with other women counsel, share the highs and lows of in-house life, and build legal and leadership skills.

Conference Details and Registration

Connect with Bates Managing Director Jennifer Cunningham at the conference to discuss your securities litigation and arbitration needs, or reach out now to schedule a time to meet:

Bates Sponsors NAWL General Counsel Institute November 9-11

Jennifer Cunningham

Managing Director

jcunningham@batesgroup.com

302.521.0952

Compliance and Regulatory Alerts  |  11-07-22

Newly Proposed SEC Rule Would Impose New Requirements on IAs to Oversee Outsourced Providers

Under a proposed new rule, the SEC would require investment advisers to conduct due diligence and monitor “covered services” outsourced to third-party providers. The proposal would also amend Form ADV to include recordkeeping requirements as to the outsourcing of these "covered functions." The Commission said it recognizes that investment advisers are increasingly relying on outsourced sources to perform many functions in support of advisory services and, as a result, “more needs to be done to protect investors.” A Fact Sheet accompanying the proposal helps to break it down. Here’s what you need to know.

“Covered Functions”

The proposed new rule defines “covered functions” as those (i) necessary to the provision of advisory services and to comply with the securities laws, and (ii) that might cause a material negative impact on an adviser’s clients “if not performed or performed negligently.” Covered services may include, for example, third parties that provide portfolio management services, models related to investment advice, indexes, and trading services or software. (The proposal makes exceptions for “clerical, ministerial, utility, and general office functions or services.”)  

Due Diligence

Under the due diligence obligation in the proposed rule, the adviser must determine that the service provider would be appropriate to perform the covered function. Due diligence considerations include: the nature and scope of the covered function; potential risks and how to mitigate them; whether the service provider has the “competence, capacity, and resources necessary” to provide the service; any material subcontracting arrangements; any compliance coordination with the service provider; and issues that may arise in the event of a termination by the provider concerning the covered function. Ongoing due diligence would require that the adviser monitor the provider’s performance and keep books and records of these preliminary and ongoing oversight efforts.

Third-Party Record Keepers

The proposed rule adds special requirements when the service being provided is for advisor recordkeeping. Under this circumstance, the adviser must “obtain reasonable assurances” (i) that the service provider’s systems and processes satisfy the advisers’ obligation as to the recordkeeping rule; (ii) that the recordkeeping rule itself is being complied with (that the records are being created); (iii) that access to electronic records are provided; and (iv) that records are continually available even if the relationship with the provider ceases.

The proposal is open for comment for 60 days.

How Bates Helps

Bates supports firms navigating compliance with SEC rules. We work with your firm to address investment adviser concerns and to support efforts to conform to oversight, monitoring, recordkeeping and disclosure requirements. Our compliance team includes senior compliance staff and former regulators with expertise in the development of policies, procedures, supervisory and compliance processes, and best practices to enhance compliance and supervisory systems.

Visit Bates Compliance to Learn More

Events  |  11-05-22

Bates Sponsors 4th Annual Raymond James Valor Golf Outing

Image © [thaninee] /Adobe Stock

Bates is proud to be a sponsor of the 4th annual Raymond James Valor golf outing on November 5, 2022.

Valor, the Veterans' Inclusion Network at Raymond James, sponsors this annual golf tournament and raffle to benefit local veterans and their families.

Event Details and Registration

Bates Research  |  11-01-22

State Securities Regulators Report on 2021 Enforcement Trends:  Digital Assets Investigations, Increase in Promissory Note Enforcement, Concerns About Metaverse Fraud

image: Alabama Securities Commission - Joseph P. Borg, Director

NASAA, the North American Securities Administrators Association, published their 2022 Enforcement Report detailing data collected from 48 jurisdictions in 2021. This annual publication serves several purposes. Primarily, it is an attempt to aggregate the efforts undertaken by state regulators to protect the public from fraud. NASAA reports that in 2021, its members collectively investigated 7,029 cases (new and ongoing), engaged in 196 criminal complaints, filed 80 civil cases, and handled 1,284 administrative actions.

A second purpose of the report is to highlight emerging trends in specific types of cases. As Joseph Borg (NASAA 2021-2022 Enforcement Section Chair, pictured) states in his introduction, the report flags concerns about complex theft and misapplication, real estate and energy scams, cryptocurrency, non-fungible tokens, and metaverse schemes. Attention to these developments serves to reinforce the message that NASAA members are alert to increasingly sophisticated efforts by bad actors to take advantage of new technology. Third, the report repeatedly reminds their audience that NASAA members are on the front lines in fighting efforts to defraud investors and does so aggressively even as it navigates socio-economic challenges (like the pandemic).

The focus of the report—as in years past—is on aggregated metrics on investigations and enforcement actions. Here are the highlights.

State Licensing and Compliance

NASAA focused on metrics concerning licensure, including application denials, conditional approvals, suspensions, revocations, and barring professionals from conducting business in the state. As a tool used by securities regulators to “prevent bad actors from entering the industry” and to control those engaging in misconduct, NASAA reports that in 2021, 232 applicants were denied licenses, 278 applicants received conditional approvals, 26 professionals had their licenses suspended, 50 had licenses revoked and 61 individuals were barred from doing business in their respective states. These numbers all represented significant increases from the prior year. The report added that some 4,880 individuals withdrew their applications for licenses, many as a result of being presented with evidence from investigations or to avoid an enforcement action. This, too, represented an increase year-over-year and suggests a kind of deterrence that the regulators have created based on their effective licensing “gatekeeping” efforts.  

Compliance cases involving licensed broker-dealers (678 investigations and 140 enforcement actions) and licensed investment advisers (478 investigations and 267 enforcement actions) encompassed the full range of oversight including on supervision, suitability, unauthorized and excessive trading, cybersecurity, and books and records.  

State Investigations and Enforcement on Products and Schemes

NASAA reported that the top products and schemes subject to state investigation and enforcement in 2021 concerned digital assets, internet and social media, promissory notes, real estate, stocks and equities, and Ponzi schemes.

The regulators said investigations related to suspect securities linked to digital assets increased by 70% year over year. They stated that “the importance and sheer volume of the work cannot be understated.” NASAA reported that state regulators opened 215 investigations of illegal or fraudulent securities offerings related to digital assets and initiated 89 enforcement actions for “misconduct involving products incorporating digital assets.” NASAA said that scams tied to cryptocurrencies and digital assets are the top threat to investors in 2022.

NASAA also reaffirmed the significant trend of bad actors’ increasing use of the internet and social media to market harmful products. The regulators said they opened 127 investigations of suspect securities offerings marketed through the internet and social media and 106 enforcement actions against promoters that use the internet and social media to market their scams.

On enforcement actions related to promissory notes, the report stated that these cases reflect attempts to take advantage of investors seeking safer investments as promissory notes purport to provide stability in a volatile marketplace. The state regulators said that “there were more enforcement actions involving promissory notes than any other products – and it was not even close.” Notably, the regulators warned that schemes incorporating promissory notes represented “a top threat to retail investors for 2023.”

As to concerns about the metaverse, cryptocurrency and non-fungible tokens, NASAA’s report was more future-oriented than a presentation of 2021 data. The report highlights the concern that “bad actors may be able to use the new technology to more effectively conceal their identities, launder money, market and sell illegal goods and impersonate trustworthy parties.” The report states that “fraudsters are now leveraging widespread interest in the metaverse to promote illegal securities offerings and deceive retail investors.”

Elder Financial Exploitation

Referring to the adoption of the NASAA Model Act to Protect Vulnerable Adults from Financial Exploitation (some form of which is law in 33 jurisdictions), NASAA said that 1428 reports were received by financial professionals, of which 356 investigations were opened and 54 enforcement cases were initiated. These were marked increases year over year attesting to the success of the Model Act. On suspected senior financial fraud, NASAA members reported fielding 1,320 tips and complaints (beyond those from financial professionals), opening 605 investigations and filing 304 enforcement actions. These ranged “from traditional sales of unregistered securities to an increasing number of illegal promotions tied to precious metals, frauds perpetrated through social media and the internet, romance scams and other schemes designed to exploit older investors.”

Conclusion

The bottom-line aggregate numbers on state investigations and enforcement actions leave an impression. NASAA’s annual enforcement report positions itself as one moment in a continuum (past, present, and future) of state efforts to protect state constituents. However, the report best serves as a reminder to firms of the reach of state regulators into every aspect of their license to do business and their relationship with clients. The warnings on current and future threats from the metaverse and digital assets tied to securities are less of a snapshot reflecting 2021 data and more an assertion of state regulator jurisdiction over new products, new markets and new marketplaces. The aggregate numbers—$312,097,734 in restitution and $145,567,334 in fines and penalties—are too big to ignore. By publishing this data, NASAA’s message couldn’t be clearer.

About Bates

Bates Group is a trusted partner to our financial services clients, counsel, and non-banking financial institutions, delivering superior quality and results on a cost-effective basis. We provide solutions for your legal, regulatory, AML, and compliance matters. With a full professional staff and a roster of over 175 financial industry and regulatory compliance experts, Bates offers services in AML and compliance, regulatory enforcement and internal investigations, litigation consultation and testimony, forensic accounting, damages, and big data consulting.

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Bates Research  |  10-21-22

Preparing for an Independent Review of a Money Services Business’s (MSB) AML Program

Money services businesses (“MSBs”) are required to conduct independent reviews to ensure their anti-money-laundering (“AML”) programs comply with Bank Secrecy Act (“BSA”) requirements. Under the BSA, MSBs must develop programs that identify and assess AML risks associated with their products, services, customers, and geographic locations and must take reasonable steps to manage them. Longstanding FinCEN guidance makes clear that the purpose of the reviews is to monitor the adequacy of these programs, especially in light of the recent expansion of BSA regulatory obligations under the Anti-Money Laundering Act of 2020. In this article, Bates offers tips to guide MSB firms in preparing for a review, including key review elements, timing, and selecting the right reviewer. 

What are the key elements for an independent review?

Independent reviews are concerned with assessing whether anti-money laundering risks for MSBs are being addressed. Policies, procedures, internal controls, recordkeeping, reporting, and training are all elements of an independent review. The reviewer must conduct tests to ensure that internal controls and transactional systems are working as intended and to identify weaknesses and potential fixes. To be thorough, the review must cover all actions taken by the compliance team on AML-related risk, on each of the above elements, and also on supervision of program controls and transactional systems.

When should independent reviews take place?

As formalized risk assessments are not required for MSBs, there is no mandated frequency for conducting independent reviews, but they must be periodic and appropriate to the level of risk. As these assessments change, the review period might change. “Given the changes to FinCEN regulations, MSBs should be proactively working on their programs and putting in place the oversight necessary to ensure compliance,” recommends  Brandi Reynolds, Bates AML & Compliance Managing Director and head of Bates Group’s MSB, Fintech and Virtual Asset practice.

Who should conduct  the independent review?

The independent review must include an unbiased assessment of each element of an MSB’s AML program. Under current guidance, a formal audit by a certified public accountant or third-party consultant is not necessarily required, but independence and thoroughness are key. (Remember, an internal assessment cannot be performed by an AML compliance officer, nor can it be someone who reports to the compliance officer.) Brandi points out that “the need for independence and the increasing complexity of AML regulatory obligations means that persons with the requisite knowledge and experience must oversee or conduct these reviews, in order for them to be considered adequate.”

Conclusion

Independent reviews on AML risk are becoming more important, not only to ensure compliance with current regulation and the documentation of all efforts undertaken, but also to uncover systemic weaknesses and to provide corrective recommendations for management. “In a changing AML regulatory environment, MSBs should be ensuring that their independent review framework is up to the task. These reviews are a critical tool in the regulator’s examinations,” said Brandi.

Our AML Independent Review Services

Bates Group  offers comprehensive independent review services that ensure your business will achieve AML compliance. Our reviewers are experienced in risk assessment and will thoroughly analyze policies, procedures,and processes. Components of your AML compliance program that we can review and analyze include: 

  • Recordkeeping requirements under the BSA;
  • Verification of policies, procedures, and processes in light of the BSA record retention requirements;
  • Training initiatives;
  • Compliance with USA PATRIOT Act sections 314(a) and 314(b), if necessary;
  • FFIEC expanded procedures, if needed for your company;
  • Suspicious activity monitoring and reporting (SARS);
  • Remote deposit capture
  • Customer identification requirements;
  • AML Independent Reviews;
  • Cash shipments, when appropriate;
  • Funds transfer recordkeeping
  • Monetary instrument sales recordkeeping

Our AML compliance independent review professionals manage even the most complex of review processes. We will thoroughly analyze your AML compliance program and accurately document our findings in a compliant manner. We know how much is on the line for your business when establishing a compliant AML program.

Contact Bates

To learn more about our services for independent reviews or to talk to one of our professionals about our company’s reputation or commitment to our clients, reach out to us directly today at contact@batesgroup.com.

Preparing for an Independent Review of a Money Services Business’s (MSB) AML Program

Brandi Reynolds

Managing Director, BSA/AML Compliance, FinTech & Virtual Assets

breynolds@batesgroup.com

864.809.7718

Events  |  10-18-22

MSBA Webinar: Money Services Business Best Practices + Your Crypto Company

Join us for a new webinar "Money Services Business Best Practices + Your Crypto Company" on October 18, 2022, at 1 p.m. ET. Presented by the Money Services Business Association (MSBA), this complimentary webinar presents key elements crypto companies should consider for their AML program:

  • Building an Effective AML program 
  • Know your Customer/Transactor 
  • Reporting and Monitoring (Chapter V) 
  • Compliance Certifications (Chapter VIII)

Register Here

Bates Senior MSB Consultant John Ashley, CIPP/US, CCRS, CRCMP (pictured) will be speaking on the panel, along with BitAML President Joseph Ciccolo.

MSBA Webinar: Money Services Business Best Practices + Your Crypto Company

John Ashley

Senior Consultant

jashley@batesgroup.com

Events  |  10-17-22

Visit the Bates Booth at NSCP 2022

Bates Compliance is a proud exhibitor at this year's NSCP National Conference, October 17-19, 2022, at the Gaylord National Hotel and Conference Center in National Harbor, MD. Visit us at Booth #25 to meet with Bates representatives, learn more about our broad range of compliance and AML services, and pick up some goodies!

We can assist with:

  • New Marketing Rule implementation
  • Reg BI Client Relationship Summary (“Form CRS”)
  • Policies and Procedures and Code of Ethics Manuals
  • ESG policy development and disclosures
  • BSA/AML Compliance
  • Compliance Program Review
  • Gap Analysis / Risk Assessment
  • Rule 206 (4) -7 Annual Review
  • Business Continuity and Disaster Recovery Plans
  • Trade Blotter Analysis
  • SEC Examination Preparation and Assistance
  • Custody Review
  • IARD Account Administrator and Annual Amendment Filing
  • Amendments to Form ADV
  • Due Diligence Review
  • Cyber guidance
  • FinTech and Virtual Assets
  • Ongoing Consulting Assistance as Needed

Visit the Bates Booth at NSCP 2022

Don't miss Bates Managing Director Hank Sanchez, Esq. (pictured) speaking on panel 10b: "Preparation for Disasters and Other Unexpected Events," on Wednesday 10/19 at 10:15 AM.

Not attending the NSCP conference this year? Please reach out to us to discuss your compliance needs at contact@batesgroup.com or call 503-670-7772.

Events  |  10-11-22

Bates MSB Consulting Expert Rob Ayers in London at the IAMTN Summit 2022

Bates Group Money Services Business (MSB) and money transmitter expert Rob Ayers will be representing Bates in London at the 2022 International Association of Money Transfer Networks (IAMTN) Annual Summit. October 11-12, 2022.

This event will welcome financial services firms, payment processors, and fintech innovators from all over the world to discuss innovations that are changing cross-border payments, remittance digitalisation patterns by regions, and technologies such as open-banking and blockchain.

Bates MSB Consulting Expert Rob Ayers in London at the IAMTN Summit 2022

Rob will be moderating several panels throughout this 2-day event, including:

  • Remittance digitalisation patterns - What can each market learn from the other?
  • Blockchain as a new infrastructure for cross-border payments?
  • Increasing customer expectations
  • An investor's outlook on the remittance industry

Conference Details and Registration

Events  |  10-10-22

Get BSA/AML Compliance Training at the INFiN MoneyTrends 2022 Conference, Oct. 10-13

Bates Group is proud to be a part of INFiN MoneyTrends 2022, October 10-13 in Austin, Texas. This 4-day event for Non-Bank Financial Institutions will offer networking, workshops and panels exploring the current state of the industry including FinTech, PayTech, LendTech and RegTech solutions.

Get BSA/AML Compliance Training at the INFiN MoneyTrends 2022 Conference, Oct. 10-13 Get BSA/AML Compliance Training at the INFiN MoneyTrends 2022 Conference, Oct. 10-13

Learn from Bates AML leaders Connie Fenchel and Brandi Reynolds (pictured) as they break down key anti-money laundering and compliance topics and review regulatory requirements and best practices. (Breakout Session V - Wednesday, 10/12 2:30-3:30 PM

In assisting MSBs to fulfill their compliance obligations, Western Union and Bates are also teaming up to offer conference attendees an intensive BSA/AML Compliance Training Session on Tuesday, October 11th. This two-hour session will highlight a variety of topics including best practices for maintaining your bank account, transaction monitoring, cybersecurity, risk assessment of information systems, federal and state legislative developments, the obligations of chief information security officers (CISOs), access privileges, and reporting requirements. We will also provide key tips for prevention, detection, and responding to cyberattacks. Certificate of Compliance issued for successful completion of this course. (Separate registration required - space is limited!)

Conference Details & Registration

Bates Research  |  10-07-22

FinCEN Publishes Final Beneficial Ownership Rule

Image © [Dzmitry] /Adobe Stock

On September 30, 2022, FinCEN published a final rule and related Fact Sheet on the reporting requirements for beneficial ownership information (“BOI”). This is the first of three sets of rules intended to implement the Corporate Transparency Act, contained in the Anti-Money Laundering Act (“AMLA”) which became law on January 1, 2021. The new reporting rule, as described below, requires reporting companies to submit accurate reports to FinCEN on beneficial ownership. In future rulemakings, FinCEN will address (i) access and safeguards on reported BOI and (ii) revisions to the Customer Due Diligence (“CDD”) Rule affected by this new reporting rule.

The new BOI reporting rule is intended to “help combat money laundering, terrorist financing, corruption, tax fraud, and other illicit activity.” It covers who must file, what must be reported, and when. It goes into effect on January 1, 2024. Until then, FinCEN will be developing reporting forms and other guidance to help companies with their reporting compliance (including, for example, a Small Entity reporting guide). Here are some of the highlights of the new reporting rule.

Who does it apply to?

The rule applies to domestic and foreign reporting companies, including corporations, limited liability companies, partnerships, and legal arrangements like trusts and other entities, created in or registered to do business in the United States. (Note: FinCEN stated that it estimates the rule will apply to tens of millions of entities and that more than “two million corporations and limited liability companies are being created under the laws of the states each year.”)

Who is a Beneficial Owner under the rule?

The rule requires information about the beneficial owners of these companies, that is, the person(s) who ultimately own or control a company. Beneficial owners are those who directly or indirectly exercise “substantial control,” or own (or control) at least 25 percent of the ownership interests over the company. The rule provides guidance and examples on the term “substantial control.” Reporting companies are required to identify two categories of individuals: (i) the beneficial owners of the entity and (ii) those who filed applications “with specified governmental authorities (e.g. state or foreign authorities) to create the entity or register it to do business.”

What must every BOI Report include?

The rule requires the identification of the reporting company and four pieces of information about the beneficial owner. These include the beneficial owner’s (i) name, (ii) birthdate, (iii) address, and (iv) “an identifying number and issuing jurisdiction from an acceptable identification document” (with a copy of the document). A reporting company may seek an identifying number directly from FinCEN.

Additional Deadlines

FinCEN stated that reporting companies in existence before the effective date will have one year (until January 1, 2025) to file their reports. Any company created after the effective date will have to file a report within 30 days of registering. Also, reporting companies have 30 days to update or correct information in a previously filed report. That period begins on the date when the company becomes aware of any inaccuracy.

Conclusion

The January 1, 2024, effective date—and the filing deadline a year later—provide a long lead for companies to comply with the new requirements. In the interim, companies should anticipate that additional regulations (on safeguarding BOI and on the CDD rule) as well as upcoming guidance and finalization of forms will impact the compliance processes necessary to implement the rule. FinCEN estimated that it would likely “cost the majority of reporting companies only $85.14 to prepare and submit an initial BOI report.” Bates will keep you apprised.

About Bates

Bates Group has been a trusted partner to our non-banking financial institutions and financial services clients and their counsel for over 40 years, delivering superior quality and results on a cost-effective basis. We provide solutions for your legal, regulatory, AML, and compliance matters. With a full professional staff and a roster of over 175 financial industry and regulatory compliance experts, Bates offers services in AML and compliance, regulatory enforcement and internal investigations, litigation consultation and testimony, forensic accounting, damages, and big data consulting.

Bates Compliance delivers guidance and tailored compliance consulting solutions to our broker-dealer, investment adviser and hybrid firm clients on an as-needed or ongoing basis. Our compliance team includes senior compliance staff and former regulators with expertise in the development of policies, procedures, supervisory and compliance processes, and best practices to enhance compliance and supervisory systems. 

Events  |  10-05-22

Join Bates at the South Carolina Bitcoin Blockchain Conference, Oct. 5-7, 2022

Bates Group is a proud sponsor of the South Carolina Bitcoin Blockchain Conference, October 5-7, 2022, in Charleston, SC. The conference will focus on Economic Development, Education, and Policy Guidance. Bates Managing Director Brandi Reynolds will be there as a panelist and moderator.

Join Bates at the South Carolina Bitcoin Blockchain Conference, Oct. 5-7, 2022

The conference features speakers from South Carolina and across the nation, workshops, hardware and art showcases, and a Q&A session with SEC Commissioner Hester Peirce, SC State Treasurer Curtis Loftis, and SC State Senator Tom Davis. On October 6th in the Blockchain Hall, hear Bates Managing Director Brandi Reynolds on the compliance & regulatory overview panel "Bitcoin and Digital Assets Regulation By Enforcement" and later as moderator of the "Women in Bitcoin" panel in the Bitcoin Hall.

Conference Details & Registration

Bates Research  |  10-04-22

How to Prepare for a Regulatory Examination: Bates’ Guide to Getting Ahead of Regulatory Exams

Each year, the SEC and FINRA release Exam and Risk Monitoring Reports highlighting continuing and emerging concerns for the year. These agency communications serve as a potential notice of subjects scrutinized for future examinations. We often hear the question, “How should I (or my team) best prepare for a regulatory examination?” We’ve got the answers.

In this guide, Bates Compliance Managing Director Linda Shirkey and Senior Consultant Shelley Dragon walk you through the exam process. Here, they break down what you need to know (including the various stages of an exam—before, during, and after), including: anticipation and preparation, first contact, document production, interviews, and findings.

 

Preparation Before the Exam

In anticipation of an examination, we recommend five ways to prepare:

1) Review your Form ADV filings, Client Agreements and Manual. Make sure that you are doing what you say you are doing. Specifically, are your representations and actions in sync?

2) Review your Manual for recent regulatory changes. This is a particularly important exercise in light of the SEC’s annual examination report. (Note: there has been significant scrutiny by the SEC on Form CRS recently. See Bates alert on recent enforcement actions.)

3) Review a recent SEC/State document request list with your team. Create a “roadmap” for preparing those documents and a presentation on the Firm to give the examiners.

4) Review your last findings letter/annual review report. Have the findings been remediated?

5) Consider conducting a fee audit. High on every regulator’s priority list, related to multiple rules, are conflicts, compensation, and funding arrangements. Do your fees match your agreements? Are all fees disclosed?

 

First Contact

Your first contact with a regulator begins with a short phone interview regarding the firm’s business and confirming information provided by the firm on Form ADV. Also covered are logistics: confirming the CCO’s email for sending a document request list; the scope of and nature of the exam (focused, limited, remote); scheduling issues (when documents are due); interview/onsite dates; and an introduction of the lead examiner and their contact information.  

Document Production

In general, the more organized the document production, the more relaxed the examiners are as the examination proceeds. We suggest a few tips to help you respond effectively. Foremost, be sure to understand what is being requested in terms of types of documents and time frames. Call the examiner for clarity, if needed. Establish a clear production process, e.g., designate the internal team, limit control over calls, select one person to manage the effort, determine who will produce what and how, and plan for regular check-ins with the team. Also important is to determine what outside help may be warranted—particularly related to data gathering and analytics—and engage them. Check, as early in the process as possible, that the data being produced is responsive to the requests and inform counsel or subject matter consultants if material issues start to show up. If red flags do appear, begin remediation immediately. For any other unusual data, prepare an explanation. Keep track of what was produced to the SEC and for which document request.  

Interviews – Before, During, and After

It is important to prepare and practice for interviews—be able to present an overview of the firm, read and reread the firm’s Form ADV and compliance manual, and prepare staff (in particular, the full senior management team). This means practicing interview skills—like how to answer the likeliest or most feared question or issue—and offering coaching on interviewing techniques.

The Chief Compliance Officer (“CCO”) should attend all interviews and should ensure that examiner concerns are addressed through regular outreach. On the first day, the CEO should give the firm presentation, introduce senior staff, and ensure that scheduling needs are coordinated. Documents requested during interviews should be tracked and timely produced. 

After the interviews, there may be follow-up questions or more document requests. The CCO and document manager should follow through (and allow for more interviews if warranted). If material items were identified during the onsite or interviews, begin remediation (if not already underway), possibly by correcting the manual, changing procedures, revising the Form ADV and/or client agreements, or by conducting staff training.

Findings and Next Steps

The lead examiner will call and read the findings letter. This is not a negotiation. The findings letter will follow that call, and the firm will be given a deadline to respond (usually about three weeks.) Every request for a change must be responded to in the order it was requested, even if the response is to “respectfully disagree.” Any changes made in response to the findings should be appended to the response letter.

Internal follow-up should include a review to ensure that all changes were implemented and then tested in six-month intervals to make certain the changes made are still in place.

Conclusion

Regulators expect that firms undertake a comprehensive review of their exam findings, observations and recommendations. Knowing and anticipating the process will help you better prepare and get through the exam successfully.

To learn more about how Bates Compliance services can help your firm, please contact:

How to Prepare for a Regulatory Examination: Bates’ Guide to Getting Ahead of Regulatory Exams

Linda Shirkey

Managing Director

lshirkey@batesgroup.com

How to Prepare for a Regulatory Examination: Bates’ Guide to Getting Ahead of Regulatory Exams

Shelley Dragon

Senior Consultant

sdragon@batesgroup.com

How to Prepare for a Regulatory Examination: Bates’ Guide to Getting Ahead of Regulatory Exams

Rory O'Connor

Director of Business Development

roconnor@batesgroup.com

860-671-7270

How to Prepare for a Regulatory Examination: Bates’ Guide to Getting Ahead of Regulatory Exams

Hank Sanchez

Managing Director, Bates Compliance

hsanchez@batesgroup.com

504-450-9632 

Compliance and Regulatory Alerts  |  10-04-22

With Nov. 4 Deadline Approaching, SEC Announces New Marketing Rule Exam Initiatives and Areas of Review

In a new Risk Alert issued by the Division of Examinations, the SEC reminded investment advisers to review their written policies and procedures on the new marketing rule before the November 4, 2022 compliance deadline. This was not an idle suggestion. Staff stated that they will be conducting “a number of specific national initiatives” to ensure compliance with the new rule. They warned that after that deadline, advisers will not be able to rely on conformance with the old advertising and cash solicitation rules.

As discussed in Bates’ previous post on compliance preparation for the marketing rule, there’s a lot to review, because the new marketing rule consolidates previous SEC guidance, no-action letters and exam findings on questions concerning recommendations, testimonials, and the presentation of performance metrics. Here’s the latest on what the SEC wants you to know.

Key Areas for Review

The SEC stated that it will focus on four areas: (i) policies and procedures, (ii) the “substantiation requirement,” (iii) the “performance advertising” requirement and related prohibitions, and (iv) books and records requirements.  

Policies and Procedures: Staff expects firms to have “objective and testable means, reasonably designed to prevent violations of the final rule in the advertisements the adviser disseminates.” They suggested policies and procedures for conducting an internal pre-review and approval of advertisements, reviewing samples of advertisements based on risk, and pre-approving advertising templates.

Substantiation Requirement: Staff expects advisers to “have a reasonable basis for believing they will be able to substantiate upon demand” – through a contemporaneous record demonstrating that basis – material statements of fact in advertisements. They also noted that failure to provide such substantiation would create the presumption that “the adviser did not have a reasonable basis for its belief.”

Performance advertising: Staff said they will review a firm’s representations and prohibitions communicating performance. They referenced prohibitions on (i) gross performance (in the absence of net performance); (ii) performance results that do not refer to specific time periods; (iii) statements suggesting the SEC “approved or reviewed any performance results”; (iv) performance results from a subset of portfolios within an advertised offering with substantially similar investment policies, objectives, and strategies; (v) performance results “of a subset of investments extracted from a portfolio,” under certain conditions; (vi) hypothetical performance; (vii) and predecessor performance, under most conditions.

Books and recordkeeping: Staff said they will review marketing rule and amended books and record requirements that advisers make and keep certain records, “such as records of all advertisements they disseminate, including certain internal working papers, performance related information, and documentation for oral advertisements, testimonials, and endorsements.” They will also review Form ADV submissions for the information on marketing practices now required under the rule.

Conclusion

This alert serves mainly to remind advisers of the upcoming compliance deadline and the broad oversight, recordkeeping, and disclosure requirements under the rule. The SEC stated that it “encourages advisers to reflect upon their own practices, policies, and procedures and to implement any appropriate modifications to their training, supervisory, oversight, and compliance programs.” Upon engaging in that reflection, let us know if we can help.

How Bates Helps:

Bates supports firms navigating and implementing the SEC’s New Marketing Rule. We work with your firm to address investment adviser concerns and to support efforts to conform to oversight, recordkeeping and disclosure requirements under the new rule. Our compliance team includes senior compliance staff and former regulators with expertise in the development of policies, procedures, supervisory and compliance processes, and best practices to enhance compliance and supervisory systems.

Visit Bates Compliance to learn more.

Bates Research  |  09-19-22

Seeking to Integrate Reg BI Standards, NASAA Proposes Revisions to REITs and Other Guidelines

Image © [SasinParaksa] /Adobe Stock

At summer’s end, the North American Securities Administrators Association, Inc. (“NASAA”) reminded financial professionals that state regulators remain a force to be reckoned with in an increasingly complex financial marketplace. Describing a need to protect elderly investors from unsuitable products, a need to protect average investors from the risks of confusing contract terms and misleading marketing communications, and to address ongoing and persistent complaints of fraud, NASAA proposed revisions to its Guidelines on Real Estate Investment Trusts (“REITs”). The regulation of publicly offered REITs that do not list their securities on a stock exchange (“non-traded REITs”) is not preempted by federal law and remains subject to substantive state securities law and state registration requirements. The proposed guidelines will be closely watched for the potential to add additional stringent requirements to existing federal regulations on financial professionals and complex products. 

Proposed Revisions

On July 12, 2022, NASAA requested public comment on amending its 2007 policy on REITs. The comment deadline on the proposal closed on September 12, 2022. The revisions have been in the works for several years—the latest set focuses on four updates.

The first proposed change would revise the standards of conduct applied to financial professionals that recommend or offer non-traded REITs to retail investors. These revisions would update the guidelines for brokers by enhancing the suitability standard to match the SEC’s Regulation Best Interest (“Reg BI”) standard. The guidelines keep the suitability section as “applicable when recommendations are made to non-retail customers.” NASAA recognized that REIT programs have been offered through investment advisers, “although still somewhat less popularly than through brokers.” The new guidelines would specifically prohibit indemnification to associated persons, investment advisers, or investment adviser representatives for violations of federal or state laws.

The second proposed change would adjust the net income and net worth required for investors. These adjustments are based on inflation, but the proposal requires REIT investors to have either (a) the combination of a minimum annual gross income of $95,000 and a minimum net worth of $95,000 or (b) a minimum net worth of $340,000.

The third proposed change would set a standardized concentration limit which would prohibit a total investment in the issuer that exceeds 10% of the investor’s liquid (cash, cash equivalents, and marketable securities) net worth. The new guidelines would impose the 10 percent concentration limit on the issuer, its affiliates, and other non-traded direct participation programs. NASAA stated that the concentration limit “accomplishes the goal of diversification to reduce the risk of loss from a single investment or single investment type.”

The fourth proposed change would prohibit REIT sponsors from making distributions from gross proceed distributions. (Within the REIT industry, NASAA states, it is relatively common—albeit “controversial”—for sponsors to market REITs as income-producing, and then to use investor proceeds from such offerings to fund cash distributions.) NASAA argues that the practice is potentially confusing and deceptive for investors, because “these are not liquidating distributions, but rather are distributions performed while simultaneously raising capital in the non-traded REITs offering to create the phantom ‘yield’ that was promised.”

Find a Bates REITs Expert

Impact on Other Guidelines

The proposed revisions to the REIT guidelines have implications for other NASAA guidelines under development. NASAA stated it is engaged in updates to its “Omnibus Guidelines, Asset-Backed Securities, Commodity Pools, Equipment Leasing, Mortgage Programs and Real Estate Programs (other than REITs),” as well as a “proposal for inaugural guidelines applicable to business development companies.” Integrating the Reg. BI standard into the guidelines while keeping the suitability standard present familiar compliance challenges. NASAA’s first report on Reg BI compliance raised many concerns. Should the proposed REIT requirements concerning concentration limits, net worth and income be imposed on other products regulated by states, compliance on recommendations could get exceedingly complicated.

The proposed guidelines have a long way to go before they are complete and face another long process before states adopt them. Bates will keep you apprised.

How Bates Can Help:

Bates Group’s experts offer consulting and testifying expert testimony. including for REITs, Reg BI and suitability. Find your expert today with our online Expert Search, or visit our Financial Securities Litigation & Consulting and Damages and Analysis services to support your net case ..

Contact us at contact@batesgroup.com or call 503-670-7772 to learn how we can support your team and your clients.

Bates Research  |  09-09-22

Private Funds: New Reporting Proposals from Regulators

Image © [Aspi13] /Adobe Stock

As the size of the private funds market has grown, regulators have been increasingly concerned about the risk posed to investors. In its 2022 annual Report, the SEC Examinations Division prioritized focusing on the “heightened risk to investors, registrants and the markets” of investing through private funds (see previous Bates coverage). In the Report, the Division estimated that 35% of registered investment advisers manage about $18 trillion in private hedge funds, private equity funds, and real estate funds. The sheer size of the market—and the state of the current disclosure framework covering it—has motivated regulators from both the SEC and CFTC to propose additional rule amendments to increase the regulatory oversight of private fund advisers and the funds they advise.

On August 10, 2022, the agencies jointly proposed to amend Form PF, a form they originally adopted in 2011, for reporting confidential information by SEC-registered investment advisers, as well as those registered with the CFTC as a Commodity Pool Operator (“CPO”) or Commodities Trading Adviser (“CTA”). The information collected on Form PF is intended to provide the Financial Stability Oversight Council (“FSOC”), an agency of the Treasury Department established by the Dodd-Frank Wall Street Reform and Consumer Protection Act, the necessary insight needed to assess systemic financial risks from private fund activity. The proposal, at 300 pages, is directed toward enhancing the FSOC’s abilities and to “bolster” the SEC’s regulatory oversight. Here are the highlights.

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

Bates Compliance

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

MSB, FinTech and Cryptocurrency

Regulatory and Internal Investigations

Retail Litigation and Consulting

Institutional and Complex Litigation

Bates News  |  09-07-22

Bates Welcomes New Experts and Consultants

Bates Welcomes New Experts and Consultants

Erin Baskett, CPA, CGMA

Brokerage, Investment Advisory, Cryptocurrency Consulting

Erin Baskett is a Bates Consulting and Testifying Expert and the founder and CEO of Sine Qua Non Global (SQN-Global.com). She is a financial, compliance, and operational executive with significant experience in accounting, auditing, business consulting, capital markets, and financial services, with a solid knowledge of U.S. GAAP, tax, IFRS, FINRA and SEC rules in companies with both domestic and international presence. Erin holds multiple certifications, including Certified Public Accountant (CPA), Chartered Global Management Accountant (CGMA), and Certified Human Resources Specialist (CHRS), and regulatory licenses.

Full Bio

Bates Welcomes New Experts and Consultants

Patrick Cox

Fintech and Cybersecurity, Employment Matters, Broker-Dealer Sales Practice

Patrick Cox is a Bates Testifying and Consulting Expert based in San Diego, California, with extensive experience in Retail Securities, Investigations, Cybersecurity, Privacy, and Compliance. Prior to joining Bates, Patrick was Executive Vice President and General Counsel for Advice, Litigation and Regulatory Strategy with LPL Financial, where he was responsible for all litigation, regulatory, and legal advice matters for the firm’s business units. He and his team also conducted internal investigations for the firm’s integrity hotline and other matters. Patrick was an ex-officio member of the firm’s Risk Oversight Committee for many years and provided ongoing advice to members of the Management Committee with reports to the Board of Directors on special issues. 

Patrick spent 20 years representing Morgan Stanley, Ameriprise Financial, and LPL Financial and their employees, and he handled hundreds of matters ranging from wrongful termination, raiding and recruiting, retail arbitrations, class actions, shareholder actions and internal investigations. He also worked on many due diligence and acquisition issues, both at LPL and Ameriprise. Prior to working in-house at Morgan Stanley, Patrick served as a civil litigator, an Adjunct Associate Professor at Fordham University School of Law, a law clerk at the U.S. Court of International Trade, and an Assistant District Attorney in Manhattan. An experienced executive and advocate, he received his Juris Doctor from Fordham and his Bachelor of Arts in English from Loyola Marymount University.

Full Bio

Bates Welcomes New Experts and Consultants

Frederick Egler

Operational Risk Management, Insurance/Reinsurance, Banking

Frederick Egler is a Bates Testifying Expert specializing in risk, compliance, and litigation management responsibility for all divisions of diversified financial services organizations. He has been responsible for claim and contingency resolution as well as risk mitigation measures, including development, implementation, and evaluation of risk identification and assessment programs, policies and procedures, internal controls, and appropriate financial disclosure and accounting treatment for a wide variety of risk events and contingencies. Frederick is is also available for consultation on insurance and reinsurance underwriting and claims management, including structure and management of captive insurers, creation and maintenance of enterprise insurance programs as part of overall risk mitigation strategy, and issues relating to coverage and claims management.

Full Bio

Bates Welcomes New Experts and Consultants

Brian Warshaw

Broker-Dealer Operations, Introducing Firm Operations, Transaction Processing

Brian Warshaw is a Bates Testifying Expert who started his career over 41 years ago as a Branch Operations Manager with Merrill Lynch. Brian’s career allowed him extensive experience in branch and core home office service and operations throughout the US and overseas markets. His in-depth knowledge of the rules, regulations and the practical application of them created a career growing executive responsibilities culminating in his last position in Rockefeller Capital Management (RCM) as head of Wealth Management Operations. Under Brian’s direction, Rockefeller (an UHNW-focused company that clears through National Financial Services) went from $15 billion AUM to $100 billion over 3 years.

At Merrill Lynch, Brian created a Branch Operations Manager training program (used worldwide), managed the sale of Merrill Lynch International Wealth Business to Bank Julius Baer (migrating $300 billion in assets), and managed all financial transaction processing through the Merrill Lynch core books and record systems. He was directly responsible for the margin department, tax reporting, cash management processing, trading, securities pricing, and fraud control, among other oversight. In his last full year at Merrill Lynch, Brian’s areas were audited 147 times with no violations found.  

Brian is a Past President of the SIFMA Credit and Margin Section, a former member of the FINRA Margin Committee, acted as an Arbitration and Legal Matter Subject Matter Expert on behalf of Merrill Lynch and FINRA and held FINRA Series 99, 7, 24 and 28 licenses.

Full Bio

Bates News, Bates Research  |  09-02-22

2022 Summer Roundup – What You Missed, What Is Happening This Fall

Bates In the News:

Bates Welcomes Paul Lambert, Former Bank of America Chicago Market President and Merrill Lynch Midwest Division Executive, as a Strategic Advisor and Consulting Expert - Bates Group

We've Moved! Bates Relocates to Lincoln Center in Portland - Bates Group

Bates Group Expands its National MSB, FinTech, and Cryptocurrency Practice - Bates Group

Bates Welcomes New Consulting and Testifying Experts – June 2022 - Bates Group

Bates Managing Director Julie Johnstone Quoted in InvestmentNews Article on Reg BI and FINRA Arbitration - Bates Group

Bates Managing Director Brandi Reynolds Quoted on the Pending Regulatory Framework for Crypto and Virtual Assets - Bates Group

See All Bates News & Events

Bates Industry Articles and Alerts:

August

July

June

Bonus Track:

Here's a fun song to get you moving and grooving with that summer feeling.

Join us this Fall!

  • September 7thACAMS Chapter Meeting: Cryptocurrency from A to Z webinar – Brandi Reynolds, Managing Director, AML & Compliance, is speaking.
  • September 13th - Southeast Women in Finance (SWIFs) Virtual Lunch and Learn, Fireside Chat: Crypto in the News – Brandi Reynolds is speaking.
  • September 19th - SIFMA C&L Regional Seminar, Charlotte, NC – Meet up with Bates Leaders and Experts.
  • September 19-22nd - MTRA Annual Conference, Fort Worth, TX – Meet Bates AML Expert and Strategic Advisor Connie Fenchel.
  • September 30th - FSDA Industry Outreach Program , Boca Raton, FL – Join Jennifer Stout, Bates CEO and FSDA President. Bates is a diamond sponsor.
  • October 5-7th - South Carolina Blockchain Conference , Charleston, SC – Brandi Reynolds is speaking.
  • October 17-19th - NSCP National Conference, National Harbor, MD – Managing Director Hank Sanchez is speaking. Visit the Bates Compliance Booth # 25 and connect with Director Rory O’Connor.
  • October 10th - IAMTN Summit 2022, London, UK – Bates Advisor and Consultant Rob Ayers is speaking.
  • October 10-13th - InFin Money Trends 2022, Austin, TX – Brandi Reynolds and Connie Fenchel are presenting.
  • November 3-6 - NAWL General Counsel Institute, New York City, NY – Join Bates Managing Director Jennifer Cunningham and Bates Expert Sheila Murphy. Bates is a sponsor.

Need Assistance?

For additional information and practice support, please Contact Us today and follow the links below to Bates Group’s Practice Area pages. Our team is always delighted to take your calls at 503-772-6770.

Consulting and Expert Testimony

Securities and Financial Services Litigation

Data Analyses and Analytics

Bates Compliance

MSBs, FinTech, and Virtual Assets

Regulatory and Internal Investigations

Bates AML and Financial Crimes

Forensic Accounting and Economic Damages

Annuity, Insurance, and Actuarial Services

Bates News  |  08-31-22

Bates Welcomes Paul Lambert, Former Bank of America Chicago Market President and Merrill Lynch Midwest Division Executive, as a Strategic Advisor and Consulting Expert

Continuing to grow and expand its national reach, Bates Group welcomes Paul Lambert as a Strategic Advisor and Consulting Expert. A 30-year financial services veteran at Bank of America Merrill Lynch, Paul was most recently Bank of America Chicago Market President and Merrill Lynch Midwest Division Executive, overseeing 14 Midwestern states with 2,500 advisers across 110 offices. In those positions, Paul successfully shaped strategy, served clients across the entire company, improved revenue and financial performance, fostered a well-supervised business that prided itself on strong compliance, and drove record employee engagement. At Bates, Paul will be working with senior leadership to expand our client engagement across the business.

Paul also served as a Regional Managing Director, leading Merrill’s ultra-high net worth business in the Midwest, and as Director of the Merrill Lynch New York Capital Complex, based in Albany, New York, where he earned special recognition as one of the Capital Region’s “Best Places to Work” in 2005 and 2006, as well as the 2007 Capital Region Human Resources Association “Spectrum Award” for promoting diversity and inclusiveness in the workplace. Paul has also held many national strategy, leadership, and coaching roles.

Paul joined Merrill Lynch in 1992 as a Financial Advisor in the Rochester, New York office where he founded and grew a wealth management business to a team of six associates working with more than 400 HNW clients and $200 million in assets. He maintains FINRA Series 3, 7, 8, 31, 63, and 65 licenses and is also a Certified Investment Management Analyst (CIMA) and Chartered Retirement Planning Consultant (CRPC).

Outside of financial services, Paul has served on the Board of Trustees for the Art Institute of Chicago, Chicago Community Trust, Civic Committee of the Commercial Club of Chicago, and Albany Medical Center. He also helped develop and launch We Rise Together, an initiative to promote an equitable and just recovery post-pandemic.

“We are looking forward to working with Paul, a highly accomplished executive and industry leader whose insights and decades of exceptional success will benefit Bates clients across the board,” said Bates Group CEO Jennifer Stout.

Read Paul's Full Bio Here.

Bates Research  |  08-30-22

On the Radar with FINRA: Remote Offices, Expungements, Customer Account Transfers, Digital Signature Forgeries

Image © [Andriy Blokhin] /Adobe Stock

FINRA remained active this summer with a series of important proposed rule changes and risk-related compliance reminders. Here’s a summary to keep you up to date.

Recent Proposed Rule Changes

Remote Offices: FINRA has been methodically moving toward allowing the use of remote offices on a permanent basis. Previously, Bates described a recent proposal to FINRA Rule 3110 (“Supervision”) to allow a home office to be considered a non-branch “residential supervisory location.” (The proposal was published in the Federal Register on August 2, 2022, and the deadline for comments was August 23, 2022.)

On August 9, 2022, FINRA published a new proposal to create a pilot program allowing broker-dealers to conduct remote annual office inspections. The new proposal amends FINRA rules on supervision to set up a pilot which would effectively extend previously granted COVID relief from the requirement of on-site inspections. (That relief is due to expire by the end of the year.) FINRA limited participation in the pilot program by excluding high-risk firms. Another limitation in the proposal requires firms to conduct a risk assessment for each office designated for remote inspection and to have related written supervisory procedures for that assessment. The comment deadline is September 6, 2022.

Expungement: On July 29, 2022, FINRA proposed amendments to the Code of Arbitration Procedure to change the process for the expungement of customer dispute information. The 300-page proposal recounts the history of FINRA’s expungement rules and explains how the new amendments would balance the interests of (i) state and federal securities regulators—to have accurate and relevant information; (ii) investors—to have access “to accurate and meaningful information about associated persons with whom they may entrust their money”; (iii) broker-dealer firms—to have information for employment decisions; and (iv) the brokerage community—to have “a fair process to address inaccurate customer dispute information.”

The new rules would impose additional requirements for expunging customer dispute information. Among them: a “straight-in request” must be decided by a randomly selected three-person panel of experienced public arbitrators with enhanced expungement training, a request must provide notification to state securities regulators who can participate in the hearing, and a request must include a requirement for unanimous agreement of the panel to issue an award containing expungement relief. The proposal would also update procedures for requesting expungement of customer dispute information during simplified arbitrations. (The proposal was published in the Federal Register on August 15, 2022 and the deadline for comments is September 6, 2022.)

Compliance and Risk Reminders

Customer Account Transfer Contracts: On August 8, 2022, FINRA reminded members of their obligations on customer account transfer contracts (FINRA Rule 11870) between broker-dealer firms. Customer account assets move between broker-dealers through a system established for such account transfers (“ACATS”). In the Notice, FINRA reminded members to (i) expedite and coordinate their activities when a customer gives authorized instructions to transfer securities account assets; (ii) not remove an asset from the ACATS system unless it is a “nontransferable asset” (i.e., “an asset that is a product of a third party – e.g., mutual fund/money market fund – with which the receiving member does not maintain the relationship or arrangement necessary to receive/carry the asset for the customer's account”; and (iii) for a receiving member who removes a nontransferable asset using the new “receiver-delete” function in the ACATS system (i.e., a function that a receiving member may use “to designate an asset as a nontransferable asset and remove it from the list of assets to be transferred,” to provide the customer with a list of the nontransferable assets and a request in writing including instructions from the customer with respect to the disposition of the assets. FINRA stated that member obligations “do not end with the designation of an asset as nontransferable” when using the receiver-delete function. FINRA also stated that members must remember to request, in writing, instructions for the disposition of nontransferable assets, and “to expedite and coordinate their response to customer instructions with respect to the transfer of customer account assets.”

Digital Signature Forgery and Falsification: FINRA reminded firms that allow digital signatures “to have adequate controls to detect instances of signature forgery or falsification.” Many of the issues raised concern registered representatives and associated persons attempting to manipulate third-party digital platforms to forge or falsify customer signatures. To help mitigate the risks for firms, FINRA’s Notice details current regulatory obligations, and highlights digital signature scenarios reported to FINRA.

FINRA identified regulatory obligations under FINRA Rule 2010 (“standards of commercial honor and just and equitable principles of trade”), FINRA Rule 4511 (“books and records”), and FINRA Rule 3110 (“Supervision”), describing how signature forgery or falsification violates each. Signature forgery and falsification scenarios were identified in account opening documents and updates, account activity letters, discretionary trading authorizations, wire instructions and internal firm documents related to the review of customer transactions. To combat the problem, FINRA suggested that firms be attentive to potential signature forgery or falsification issues during customer inquiries or complaint investigations, digital signature audit trail reviews, e-mail correspondence reviews, administrative staff inquiries, and customer authentication supervision reviews.

Conclusion

Proposed rules on remote offices and expungement reflect efforts to make processes and procedures current in a changing marketplace. The updates address a broad set of stakeholders and attempt to take advantage of new technological tools. The FINRA compliance Notices demonstrate a recognition that firm’s need to constantly review obligation and procedure to remain in compliance with the consequences of constantly changing market and regulatory conditions. Bates will keep you apprised.

Learn More:

Email us at contact@batesgroup.com or call 503-670-7772 to speak with a Bates representative about how we can help you with your FINRA case, ongoing compliance, or project compliance needs.

About Bates:

The Consultants and Experts at Bates stand ready to support clients with their FINRA matters. Bates Compliance delivers guidance and tailored compliance consulting solutions to our broker-dealer, investment adviser and hybrid firm clients on an as-needed or ongoing basis. Our compliance team includes senior compliance staff and former regulators with expertise in the development of policies, procedures, supervisory and compliance processes, and best practices to enhance compliance and supervisory systems. Our Securities and Financial Services Litigation practice provides retail and institutional litigation consulting and data-driven analytic support and solutions for BDs, RIAs, banks and insurance companies. Our quantitative analysis and qualitative case strategy, advice, and expert testimony cover the full spectrum of investment activity, employment, and regulatory matters.

Bates Research  |  08-25-22

New Developments for New York BitLicense Holders and Applicants

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In 2015, the New York Superintendent of Financial Services came up with a response to the growing popularity of Bitcoin and other cryptocurrencies. The idea was a new charter based on the historic template for bank and trust charters. Called BitLicense, it came with many of the trappings of a bank or trust charter, including:

  • Mandatory minimum capital
  • Periodic examination by State examiners 
  • Periodic reporting to the Superintendent
  • Required policies and procedures (e.g., anti-money laundering, risk management and disaster recovery)
  • Controls on new product and service offerings
  • Regulation of changes in control

Similar to a bank charter, the procedure to obtain the license included fees payable to the State and a long application. The application included complete personal financial disclosure required of individuals associated with the proposed entity. Fees to professionals (lawyers, economists, or other advisors) have been estimated by outside observers to total $100,000 or more.

Also like a bank charter, the BitLicense process is daunting. Despite the challenge and expense, 20 firms signed up for one immediately, though not all of them completed the process. As of late 2021, according to industry newsletter CoinDesk, there were 25 firms authorized to operate under the regulation, including 6 that chose a limited purpose trust option license. Notably, the CoinDesk list shows there were no new licenses approved through September of 2021. Another news article published in May, 2022 cites 22 firms as license holders.

The list of license holders is revealing. The group includes Square, the payments company established by Twitter founder Jack Dorsey. Others on the list intend to use the BitLicense for options trading, and several licensees are providing services as fintechs in the payment services area.

The six firms that have received a limited purpose trust license appear to be interested primarily in providing custody services. Fidelity is the best-known name of the group, adding crypto custody to its array of other financial and investment services. One other, Paxos, is an issuer of cryptocurrency.

A Cloudy Future

The current inflation-riddled environment is a problem for any new business. For a crypto-based business, the difficulties have been magnified by serious declines in the value of cryptocurrencies. For example, Bitcoin has fallen from over $68,000 in November 2021 to around $20,000 in late June 2022. Terra, an issuer of “stablecoins” based on the U.S. Dollar, failed to hold its value at $1.00. A successor, Luna, has also failed to the point of being virtually worthless. CoinBase, the leading cryptocurrency exchange, may be the subject of a short squeeze that threatens its existence.

All of this is resulting in major financial pain to owners of crypto, issuers of crypto and of crypto-backed assets (such as ETFs), and companies serving the crypto industry, like the BitLicense holders. This last group can expect New York examiners—among other regulators—to peer into their books and records and to demand corrective action to respond to any noted deficiencies.

The FDIC is not likely to be involved, so any failure will pose only a minimal threat to the banking system. There is a significant threat to the BitLicense holders, however, because New York examiners will follow examination procedures based largely on those created by the FDIC. The corrective action might include a demand for additional capital, civil money penalties, management changes and closure of the institution.

Bates Offers AML and Compliance Services for Cryptocurrency and Virtual Asset Firms

New Developments

In mid-May 2022, Adrienne Harris, superintendent of New York's Department of Financial Services, announced that she was speeding up the BitLicense process. The Superintendent reported that her office had revised processes and approved three licenses this year compared to only one in 2021. (The previous process had taken years from application to approval.) There was not a statement on the length or other aspects of the revised process.

What to think about BitLicense?

The BitLicense has been controversial from the start. Proponents argue that it brings some order to a chaotic market. They also argue that it brings important consumer protections to an inherently risky endeavor. Opponents see it as just more regulatory overreach while noting that the BitLicense erodes some of the anonymity that has been a compelling selling point for crypto assets. Notwithstanding these opinions, New York continues to move forward in issuing BitLicenses. While there are only a few BitLicenses active, the State has granted more of them in the last 8 years than it has commercial banking licenses. For those seeking a BitLicense, new regulatory and process revisions are a welcomed start.

About the Author

New Developments for New York BitLicense Holders and Applicants

Paul Nelson is a Consulting Expert at Bates Group with more than 45 years of involvement with the regulatory and legal compliance issues facing banks and nonbank financial services providers. His five years as a Senior Attorney and Acting Regional Counsel with the Comptroller of the Currency formed the basis of his education in the principles of bank regulation as practiced in the U.S.

Paul has also served as a General Counsel of the U.S. House Banking Committee and as a registered lobbyist in private practice. In his long history in financial services regulation, Paul has represented clients in courts, before both federal and state financial regulatory agencies, the U.S. Congress, the NASD (now FINRA), and arbitration panels.

Bates News  |  08-24-22

We’ve Moved! Bates Relocates to Lincoln Center in Portland

Bates Group has recently relocated our corporate headquarters from Lake Oswego to Portland. Our new address is:

2 Lincoln Center

10220 SW Greenburg Road, Suite 200

Portland, OR 97223

Phone: (503) 670-7772

Please remember to update your contact information and records to reflect our new main office address. We will continue to provide the same industry-leading services as we settle into our new location!

Bates Research  |  08-23-22

Is Past Really Prologue When It Comes to Your Mutual Fund Share Class Selection, Conflicts, and Disclosures?

Is Past Really Prologue When It Comes to Your Mutual Fund Share Class Selection, Conflicts, and Disclosures?

Did Shakespeare get it right? Let us help you put the past in the past.

“What’s past is prologue.” This line from Shakespeare’s “The Tempest,” written over 400 years ago, has come to mean that history can provide context for events happening today.

About four (not 400) years ago, we reported on a discussion forum on SEC examination and enforcement initiatives where the OCIE Director expressed concern that their warnings related to appropriate share class recommendations and other related forms of compensation were not being heeded despite numerous enforcement actions, settlements, and repeated statements that mutual fund share class selection, conflicts, and disclosure were an important regulatory priority.

  • Recently, FINRA Enforcement concluded a matter involving a major financial services firm with a large fine, finding that clients purchased Class C mutual funds when Class A shares were available at substantially lower costs. Jessica Hopper, EVP & Head of FINRA’s Department of Enforcement reminded and encouraged firms to “proactively detect, fix, and remediate these types of supervisory issues.”

 

  •  A few months ago, the SEC settled charges against a registered investment adviser (“RIA”) for a breach of fiduciary duty to its advisory clients as a result of investing wrap fee clients in higher cost mutual fund share classes then were otherwise available while failing to disclose conflicts of interest associated with those investment recommendations. The SEC concluded that the RIA breached it duty of care, including its duty to seek best execution, by causing wrap fee clients to invest in fund share classes that charged 12b-1 fees when share classes of the same funds presented a more favorable value to clients.

These are just two examples of this type of regulatory action—there are more. So, is past inevitably prologue, or can we truly leave it in the past?

Yes, William Shakespeare, the past can still be prologue, but Bates can help clients put the past in the past.

How Bates Helps:

We have provided consulting support to clients and counsel on over 70 share class and related matters involving fees and other forms of compensation generated by investor mutual fund holdings including revenue sharing, missed rights of reinstatement benefits, annual expense ratios, the 12b-1 subcomponent of those same annual expense ratios, and avoided transaction costs, just to name a few. 

  • Bates was retained on behalf of dozens of financial institutions in evaluating whether to self-report under the SEC’s Share Class Disclosure Initiative, as well as by those who reported, and by many who did not report and subsequently found themselves defending investigations and enforcement actions.  
  • We have worked with clearing firms to gather required data, conducted a thorough evaluation of instances in which a lower cost share class was available and the client qualified for that lower cost share class, calculated the difference in fees charged, identified exceptions in the population where disclosures were sufficient or another factor justified the share class selected, and provided final reporting numbers for client use with the SEC (after discussion with counsel).  
  • We also assisted clients by providing metrics and reporting that contextualized the behavior of specific FAs, branches, account types, and other key indicators.  
  • We were also retained by dozens of financial institutions in evaluating whether to self-report under FINRA’s 529 Plan Share Class Initiative, those who reported, and those pursued by FINRA after the close of the Initiative.  
  • We worked with plan sponsors to gather required data, identified C-share activity where the beneficiary was less than 12 years of age, evaluated breakpoints and expense ratios offered by the share classes at issue (A and C) to determine the breakeven point wherein C-share investors were potentially harmed, and calculated that harm based on the expense ratio differential. We identified exceptions in the population where the rationale for the C-share purchase was sufficient, and after discussion with counsel provided final reporting numbers for use with FINRA.

Our Team Is Here To Support You

In service of these projects, Bates employs a team of programmers who combine subject matter expertise with the ability to process and analyze large amounts of data. Bates has also developed proprietary databases related to historical mutual fund information, including fee rates, etc., which are necessary to support an accurate review of potential harm. And, where necessary, our team of former Supervisors will review suitability determinations made for thousands of individual clients. Bates’ experience allows our clients and their counsel to be confident that they have isolated only those investors who may have incurred harm, and the amount of that harm. That process includes getting the right data and setting it up correctly, identifying ways to reduce the at-issue population, quantifying any available offsets to the damages, reviewing the subject transactions for suitability, and providing final reporting.

Let us help you put the past in the past. Contact us today to learn more: 

Is Past Really Prologue When It Comes to Your Mutual Fund Share Class Selection, Conflicts, and Disclosures?

David Birnbaum, Managing Director

dbirnbaum@batesgroup.com or  917-273-2682

Is Past Really Prologue When It Comes to Your Mutual Fund Share Class Selection, Conflicts, and Disclosures?

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

arussell@batesgroup.com or  971-250-4353

Bates Research  |  08-18-22

SEC Staff Offers Additional Guidance on BD and IA Conflicts of Interest

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On August 3, 2022, SEC staff issued new guidance addressing conflicts of interest under the Regulation Best Interest (“Reg BI”) standard for broker-dealers and the fiduciary standard for investment advisers. While the staff bulletin states clearly that the guidance is intended only to be a reflection of internal views on the subject, its tone, comprehensiveness (replete with numerous examples), and even its pragmatic question-and-answer format warrant careful attention. From the outset, the bulletin advises broker-dealers and investment advisers to “review their business models and relationships with investors to address conflicts of interest specific to them.” That would entail thoroughly reviewing a firm’s practices and procedures on all things that might create a conflict of interest, and then making adjustments consistent with this guidance. Here’s an overview.

Core Principles under Reg BI and the Fiduciary Standard

The guidance reaffirms the basic principles that underlie the different standards required of broker-dealers and investment advisers. The SEC defines a “conflict of interest” under both standards as “an interest that might incline a broker dealer or investment adviser – consciously or unconsciously – to make a recommendation or render advice which is not disinterested.”  

Under Reg BI, broker-dealers owe four duties to retail clients: disclosure, care, conflicts of interest and compliance. (For a detailed discussion of Reg BI requirements and firm compliance, see Bates’ White Paper). The bulletin reiterates that the duties on conflicts of interest under Reg BI require that broker-dealers who make recommendations to retail clients have written policies and procedures reasonably designed to (1) identify and disclose, or eliminate, all conflicts of interest; 2) identify and mitigate conflicts by associated persons; (3) identify and disclose securities investment strategies that may place the interest of the broker-dealer ahead of the interest of the retail customer; and (4) identify and eliminate certain “sales contests, sales quotas, bonuses, and non-cash compensation.” These requirements to identify, mitigate and eliminate conflicts exist under the other Reg. BI duties (compliance and disclosure) as well as in the care obligation, which requires a broker dealer to have “a reasonable basis to believe that each recommendation or series of recommendations made is in the best interest of the particular retail customer and does not place their financial or other interests ahead of the interest of the retail customer.”

For investment advisers, the bulletin reaffirms the core obligations under the fiduciary standard, including the duties of loyalty and care. Under the former, staff describe the obligation to eliminate conflicts of interest and make full and fair disclosures so that clients can give informed consent. Under the latter, they reiterate that investment recommendations must be in the client’s best interest, grounded in a “reasonable understanding of the client’s objectives." Also emphasized is the importance of written policies and procedures and recordkeeping, without which “it would be difficult for an investment adviser to demonstrate how it complies with its fiduciary obligations.”

New Guidance on Conflicts of Interest

The new bulletin includes an examination of the practical issues arising from these duties. This guidance is organized around (i) identifying conflicts, (ii) eliminating conflicts, (iii) mitigating conflicts and (iv) disclosing conflicts. While the guidance differentiates obligations under the two standards where applicable, the focus is directly on how to achieve these four compliance objectives.

Identifying Conflicts: Have An Ongoing Process and Procedure

The SEC acknowledges that all broker-dealers and investment advisers “have at least some conflicts of interest with their retail investors,” but that the “nature and extent” of these conflicts varies, often related to a firm’s business model. The bulletin lists various examples of conflicts stemming from arrangements on compensation, revenue or other benefits to the firm or its affiliates.

The bulletin emphasizes the importance of having ongoing processes and procedures to identify conflicts. The expectation is that broker-dealers develop, maintain, and periodically review policies and procedures to identify conflicts on an ongoing basis. Investment advisers must also identify “other compliance factors creating risk exposure for the firm and its clients in light of the firm’s particular operations.” They also note that disclosure of a conflict alone is not enough to satisfy the best interest or fiduciary obligations.

Eliminating Conflicts:

Broker-dealers and investment advisers may have to eliminate a conflict if it prevents them acting in the best interest of the retail investor. As to broker-dealers, Reg BI explicitly requires written policies and procedures “reasonably designed to identify and eliminate any sales contests, sales quotas, bonuses, and non-cash compensation that are based on the sales of specific securities or specific types of securities within a limited period of time.” Investment advisers are warned that, if the “nature and extent” of the conflict makes it difficult for the adviser to provide full and fair disclosure, and if the conflict cannot be mitigated, the adviser should eliminate the conflict or refrain from providing the advice or recommendation. Based on several examples, the bulletin concludes that if a particular practice incentivizes a “financial professional[] to place the firm’s or the financial professional’s interest ahead of the retail investor’s interest, the firm may need to revise its incentive program to reduce or eliminate the conflict.

Mitigating Conflicts:

A detailed section of the guidance deals with how a firm should mitigate a conflict of interest, primarily dealing with compensation, financial incentives, and other benefits, followed by a list of factors that should be considered when mitigating a conflict. Among those are (i) the extent to which a firm’s revenues vary based on the type of account, products, and services recommended; (ii) the extent to which incentives may encourage financial professionals to recommend products that are more profitable for them or the firm; and (iii) the payment structure for financial professionals. As a result, the bulletin reiterates that firms should consider whether their compensation programs could incentivize financial professionals to make recommendations that place their interests ahead of the interests of their retail investors. The SEC is persistent in reminding firms that conflicts must be addressed at the firm level as well as at the associated person level (as required by Reg BI).

The guidance repeatedly asserts that it is important to periodically review and test policies and procedures to “ensure the on-going adequacy and effectiveness of a compliance program.” That requires documenting the ways in which the firm mitigates conflicts of interest.

Disclosing Conflicts: Use “Plain English”

The SEC warns that disclosures should not be a “check the box” exercise, rather, that disclosures “should be specific to each conflict, in ‘plain English,’ and tailored to, among other things, firms’ business models, compensation structures, and products offered at different firms.” For broker-dealers, the bulletin emphasizes full and fair disclosure of all material facts that might “incline the firm or its financial professional to make a recommendation or provide advice that is not disinterested.” Investment advisers must “make full and fair disclosure of all conflicts of interest which might incline an investment adviser–consciously or unconsciously–to render advice which is not disinterested such that a client can provide informed consent to the conflict” (emphasis added). In cases where the conflict is “difficult to disclose comprehensibly,” staff states that the firm should address it through mitigation or elimination.

Get the Latest on Reg Bi and Form CRS

Facts to Disclose in Various Conflict Scenarios: Recommendations

Compensation Arrangements:

Firms should disclose facts about (i) the nature and extent of the conflict; (ii) how the conflict could affect the recommendation; (iii) the source and scale of compensation; (iv) how the firm is compensated (e.g., revenue sharing, cash sweep); and (v) the costs and fees to be incurred by the investor as a result.

Proprietary Product Recommendations:

The SEC recommends disclosure as to whether the firm or an affiliate manages, issues, or sponsors the product, as well as any additional fees and compensation related to that product or incentives to sell the product, among others. In cases where conflicts arise from compensation received from third parties, staff recommends (i) disclosure of the existence and effects of third-party incentives, (including if the offering is from a limited product menu based on preferred providers, see below); (ii) any agreements with a clearing broker for products offered on their platform; (iii) agreements to maintain assets with a specific custodian; and (iv) arrangements where the firm is compensated through revenue sharing or product fees.

Managed Accounts and Wrap Fee Programs:

On conflicts arising from separately managed account and wrap fee programs, the bulletin recommends disclosing any compensation from program sponsors or affiliates, any higher costs to the investor for participating in the program, and any material facts on how the account is managed, including manager’s financial incentives, (e.g., incentives to invest assets in share classes that provide higher compensation to the firm.)

Policies and Procedures

The guidance cautions firms to be continuously and periodically monitoring for conflicts of interest as well as testing the adequacy and effectiveness of their policies and procedures. In this regard, they emphasized, it is especially important for a firm to “document[] the measures it takes to address and monitor conflicts of interest.”

Guidance on Product Menus

The bulletin devotes a section of its conflict of interest guidance to firms that make recommendations based on a product menu. A product menu may limit offerings to, for example, proprietary products, a specific asset class, or to products that involve revenue sharing or third-party arrangements (see above). The recommendation is for firms to

consider establishing product review processes for these menus. Such processes would, among other things, (i) identify and mitigate conflicts associated with products offered through them; (ii) evaluate the use of “preferred lists”; (iii) establish training requirements for financial professionals as to certain products; and (iv) establish periodic product reviews. The SEC notes that broker-dealers “must identify and disclose any material limitations placed on the securities or investment strategies that may be recommended to a retail customer and any conflicts of interest associated with such limitations.” Further, the guidance states that a dual registrant “should disclose any circumstances under which its advice will be limited to a menu of certain products offered through its affiliated broker-dealer or affiliated investment adviser.”

Conclusion

A staff bulletin of this nature should be seen as a roadmap for firms to prepare for examinations. It argues that “identifying and addressing conflicts should not be merely a ‘check-the-box’ exercise, but a robust, ongoing process that is tailored to each conflict.” The conflicts guidance shows how complex a challenge that can be. Carefully addressing each duty as applied to a broker-dealer or investment adviser business model as prescribed by these recommendations affords the best possibility to withstand SEC scrutiny. Bates will keep you apprised.

Learn More About Our Practices

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Bates News  |  08-15-22

Bates Managing Director Julie Johnstone Quoted in InvestmentNews Article on Reg BI and FINRA Arbitration

Bates Managing Director Julie Johnstone was quoted in a recent InvestmentNews Article on the increase of Reg BI Customer Cases in FINRA Arbitration. Bates Group's prior reporting on the matter was also recognized in the article.

Read the Full Article at InvestmentNews

Bates News  |  08-15-22

Bates Managing Director Brandi Reynolds Quoted on the Pending Regulatory Framework for Crypto and Virtual Assets

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Bates Managing Director Brandi Reynolds (CAMS-Audit) is quoted in a new ACAMS Insights article discussing efforts to develop a federal regulatory framework for crypto and virtual assets. The article, published August 12, 2022, looks at proposed legislation in the U.S. Senate and House aimed at "preventing the use of cryptocurrency in illicit finance" and "developing 'principles-based guidance' on how anti-money laundering, sanctions and cybersecurity rules apply to cryptocurrency," among other goals.

Read the Full Article at ACAMS Insights: "Is Crypto a Security, Commodity or Means of Payment? All Three, Say Lawmakers"

Bates Group’s MSB, FinTech and Cryptocurrency practice offers guidance and services for fintech and cryptocurrency firms. Our subject matter experts work directly with firms and counsel to design and implement policies to ensure they are AML-compliant. Our MSB and AML Teams also implement, manage, and maintain Money Transmitter Licensing processes and engage clients with BSA/AML/OFAC Program Development, Risk Management, Training, Advisory Services, and Independent Reviews.

Bates Research  |  08-02-22

The SEC Marketing Rule - What You Need to Know

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The mandatory compliance deadline for the SEC marketing rule—which replaced the former Advertising Rule and the Cash Solicitation Rule—is November 4, 2022. Advisers should be reviewing, revising, and preparing to implement procedures and policies to prevent potential violations. There’s still time, but there’s also a lot to consider, as the rule consolidates previous SEC guidance, no-action letters and exam findings on questions concerning recommendations, testimonials, and the presentation of performance metrics. Here’s what you need to know.

Scope

The marketing rule is grounded in a new definition for “advertising” and covers any direct or indirect communication by an investment adviser offering services to prospective clients or new services to current clients. Seven prohibitions apply to advertisements under this definition: (i) untrue statements or omissions of material facts; (ii) untrue or misleading implication or inference; (iii) unsubstantiated material statement of fact; (iv) description of benefits without a “fair and balanced” discussion of risk; (v) “unfair or unbalanced” reference to specific advice; (vi) “unfair and unbalanced” performance (or time periods); and (vii) otherwise misleading statements.

Compliance Changes

The core message of the new marketing rule is that advisers must lock down their documentation and reporting processes. Claims related to performance and services must be able to be substantiated, and advisers are on notice that they will need to be able to back up those claims with documentation on demand. Experts say that advisers who can’t substantiate a claim will be presumed not to have a reasonable basis for making it.

The rule is written to be broadly applied. The SEC highlighted that they are concerned with, among other things: communications of hypothetical performance; reliability of performance communications; offers to expand a financial relationship; communications related to cross sales; information on investment strategies; and, in general, any adviser/intermediary/third party distributed material conveyed to the investor. The SEC also makes clear what few items the rule does not cover. These communications include extemporaneous or unprepared remarks, routine communications such as account statements or transaction reports, even white papers—or other content that does not contain any offer—that would be contained in a required notice or filing.

View Our Webinar: Deconstructing the SEC’s New Marketing (and Solicitor) Rule

Preparing for the Compliance Deadline

Advisers that are currently evaluating the processes and procedures necessary for full compliance with the marketing rule should be assessing their own advertising practices as defined under the rule. As mentioned, those communications include the way in which a firm communicates performance (i.e., related, extracted, hypothetical and predecessor performance) and the compliance requirements that apply to each, as well as the metrics the firm uses to communicate performance (e.g., gross and net numbers and/or 1-, 5-, and 10-year time intervals) to ensure consistency and not be misleading. The SEC will home in on these as they assess whether an adviser is offering “full and balanced disclosure” to investors.

Advisers should also be preparing marketing rule compliance processes and procedures if they utilize testimonials and endorsements in advertising. Testimonials are given by a current client or investor, endorsements are given by a party who is not a current client or investor (e.g., a service provider or family member). The SEC will be taking a close look at potential conflicts to paid quoters, particularly when payment involves waiving fees or other compensation. Conflicts must be prominently disclosed by explaining the terms of the compensation arrangements. (Testimonials or endorsements by broker-dealers have differing disclosure requirements depending on whether the intended audience is retail or not.) Compliance training will be required to ensure that advisers are aware of their obligation to gather testimonials or endorsements by service providers or outside parties, and to understand the rules around direct and indirect compensation to those providing them.

Disclosures and satisfying set criteria are required under the marketing rule before third-party ratings can be used in an advertisement. Use of third-party ratings raises concerns about the use of a fair and balanced methodology and on the need to substantiate claims. As a result, required disclosures should include the date of the rating, the period covered, the identity of the third party that created and tabulated the ranking, and if an advisor was paid directly or indirectly to participate.

When an adviser provides material to intermediaries for distribution, participates in its creation, uses the material in communications, and highlights, prioritizes, or deletes portions of the material, the material is considered advertising under the definition of the rule. These “affirmative actions” require significant compliance preparation, including employee training on, for example, what they’re allowed to do on social media. (Note: it is not considered advertising if modifications to the material were made by third parties, if unedited commentary was merely posted on an adviser’s website, or if procedures prohibiting employees to conduct business via social media are in place.)

Conclusion

The new marketing rule imposes significant oversight, recordkeeping, and disclosure requirements on investment advisers. It applies to all communication media (including e-mail blasts and social media posts). The November 4, 2022, implementation deadline is fast approaching, and the rule requires substantial changes to compliance processes and procedures that were previously designed for the former Advertising Rule and the Cash Solicitation Rule. The long lead time for compliance preparation is coming to an end. The SEC expects advisers to be ready—are you? Bates can help.

How Bates Helps

Bates supports firms navigating and implementing the SEC’s New Marketing Rule. We work with your firm to address investment adviser concerns and to support efforts to conform oversight, recordkeeping and disclosure requirements under the new rule. Our compliance team includes senior compliance staff and former regulators with expertise in the development of policies, procedures, supervisory and compliance processes, and best practices to enhance compliance and supervisory systems.

Visit Bates Compliance to learn more.

Contact

The SEC Marketing Rule - What You Need to Know
Linda Shirkey

Linda A. Shirkey

Managing Director
lshirkey@batesgroup.com

Bates Research  |  07-28-22

FINRA Proposes Updates to Supervisory Rule on Home Offices

FINRA has filed with the SEC proposed changes to FINRA Rule 3110 to add new Supplementary Material 3110.19 (Residential Supervisory Location). The changes allow a home office to be considered a non-branch “residential supervisory location” under certain conditions. As detailed in numerous Bates’ posts (see, e.g., here and here), the pandemic moved regulators to issue relief from strict regulatory requirements to firms in order to allow employees to work from home, including the use of new technology and communications to permit remote supervision. By this proposal, FINRA is adapting to a new, post-pandemic “blended workforce” model, one in which employees work at both conventional offices and in their private residences—and which FINRA acknowledges is likely to “endure.” Further, FINRA noted that “technological advances in surveillance and monitoring capabilities” have enabled such greater “workplace flexibility.” The proposal, therefore, is considered a reassessment of “the manner in which firms may effectively and efficiently carry out their supervisory responsibilities considering evolving business models and practices, advances in technology, and regulatory benefits.”

The proposed amendment—to classify some private residences as non-branch locations, subject to specific limitations—“aligns” the classification of non-branch locations with certain exclusions, which, according to FINRA “will not result in a loss of the important regulatory information that the rules were designed, in part, to provide regarding the locations or associated persons.”

Bates Offers Supervision and Compliance Support - Learn More

Under the proposal, “residential supervisory locations” would be subject to several limitations. Among them are: (i) that only one associated person can conduct business at the location; (ii) that the location is not held out to the public as an office (and that the associated person cannot meet with clients or prospects there); (iii) that no customer funds or securities are handled there; (iv) that the associated person is assigned to a specific branch office; (v) that all electronic communications are made through the member’s electronic system; and (vii) that books and records must be maintained.  

The proposed rule also elaborates on what makes a non-branch office ineligible to be designated a “residential supervisory location.” These factors generally concern member firms that are considered “restricted firms” or “taping firms,” or associated persons who are subject to mandatory heightened supervision, statutory disqualification, or otherwise subject to an investigation, proceeding, complaint or other action for failure to supervise another person that is subject to their supervision.

FINRA pointed out that once a home office has been designated a “residential supervisory location,” inspections would be required on a regular periodic schedule (likely once every three years, as opposed to annually), as is required of other supervisory branch offices.

Bates will keep you apprised as the proposal goes through rulemaking.

About Bates Compliance

Bates Compliance delivers guidance and tailored compliance consulting solutions to our broker-dealer, investment adviser and hybrid firm clients on an as-needed or ongoing basis. We also offer remote branch office inspections - Learn More.

Contact Bates Today

FINRA Proposes Updates to Supervisory Rule on Home Offices

Hank Sanchez, Managing Director

hsanchez@batesgroup.com or  504-450-9632

FINRA Proposes Updates to Supervisory Rule on Home Offices

David Birnbaum, Managing Director

dbirnbaum@batesgroup.com or  917-273-2682

Events  |  07-26-22

Bates Sponsors BitCoin Spartanburg Meetup - July 26, 2022 - Hosted by SCETA

Join Bates Group and the South Carolina Emerging Tech Association for a drink & evening of all things crypto! Whether you're brand new to crypto or are a seasoned trader, everyone is welcome! Meet members of Bates' MSB and learn more about our crypto and AML services.

Date: July 26, 2022

Time: 5:00 pm ET

Location: RJ Rockers Brewing Co., Spartanburg, SC 

Co-sponsored by Bates Group, Voyager, and Bitrefill.

View the PDF Flyer

Events  |  07-13-22

Upcoming Webinar - Best Practices for U.S. Money Services Businesses - Hosted by Bates Group and MSBA

Upcoming Webinar - Best Practices for U.S. Money Services Businesses - Hosted by Bates Group and MSBA

Bates Group and MSBA celebrate the return of MSBA's Summer Lunch & Learn Series this Wednesday, July 13, 2022 at 1:00 p.m. ET.

Upcoming Webinar - Best Practices for U.S. Money Services Businesses - Hosted by Bates Group and MSBA

John Ashley, CIPP/US, CRCMP (pictured), a Senior Consultant with Bates' MSB, FinTech and Cryptocurrency practice, joins other compliance experts to address takeaways and applications from Chapters 1-6 of The Best Practices for US MSBs.

Topics will include: 

  • Defining MSBs 
  • Building an Effective AML Program
  • Knowing your Customer/Transactor, Agent and Counterparts
  • Reporting & Information Sharing

Event Details and Registration

There will be a second session on Wednesday, July 27, 2022.

About Bates

Bates Group’s MSB, FinTech and Cryptocurrency practice offers guidance and services for fintech and cryptocurrency firms. Our subject matter experts work directly with firms and counsel to design and implement policies to ensure they are AML-compliant. Our MSB and AML Teams also implement, manage, and maintain Money Transmitter Licensing processes and engage clients with BSA/AML/OFAC Program Development, Risk Management, Training, Advisory Services, and Independent Reviews.

Events  |  07-13-22

Brandi Reynolds to speak on AML Virtual Panel: Identifying Crypto Risks and Red Flags Through Transaction Monitoring

Brandi Reynolds to speak on AML Virtual Panel: Identifying Crypto Risks and Red Flags Through Transaction Monitoring

Cryptoassets have become an increasingly visible feature of the financial services landscape - with many financial institutions beginning to offer crypto products and services. The deepening intersection between crypto and traditional finance also presents risks: banks and other financial institutions are increasingly likely to face exposure to crypto-related financial crime activity. Even banks that do not handle crypto directly can be impacted by these risks and require strategies to identify and mitigate them.

Bates Group Managing Director Brandi Reynolds, CAMS-Audit will join this expert panel (pictured above) to discuss how financial institutions can identify crypto-related financial crime risks and how to respond.

Date: Wednesday, July 13, 2022

Time: 11:00 a.m. ET

Presented by: Elliptic

Register Now for this Complimentary Webinar

Learning Objectives:

  • Key crypto financial crime typologies and red flags impacting the banking sector
  • Regulatory expectations for crypto-related financial crime risk management
  • How to leverage transaction monitoring and blockchain analytics capabilities to detect crypto risks

About Bates

Bates Group’s MSB, FinTech and Cryptocurrency practice offers guidance and services for fintech and cryptocurrency firms. Our subject matter experts work directly with firms and counsel to design and implement policies to ensure they are AML-compliant. Our MSB and AML Teams also implement, manage, and maintain Money Transmitter Licensing processes and engage clients with BSA/AML/OFAC Program Development, Risk Management, Training, Advisory Services, and Independent Reviews.

Bates Research  |  07-07-22

Reg BI Makes FINRA’s Dispute Resolution Stats List and Other Notable Arbitration Developments

An inevitable—if somewhat subtle—milestone was reached this month for Regulation Best Interest. Posted on FINRA’s monthly dispute resolution statistics page are numbers related to the top 15 security types in customer arbitrations, and coming in at number 14 (through May 2022) was Reg BI. Other recent developments in dispute resolution include movement on rule proposals concerning accelerating processes for elderly claimants, and amendments to align the arbitration code with a new federal law on sexual assault and harassment. Further, FINRA committed to producing a plan to enhance the transparency of the arbitrator selection process, based on recommendations of an independent counsel report. Also notable, the SEC issued a new primer on arbitration and mediation. Here are the highlights to note:

Regulation Best Interest

According to the most recent FINRA Dispute Resolution statistics, thirty-seven cases related to Regulation Best Interest were reported through May 2022, meaning that Reg BI has now entered the list of the top 15 customer arbitration controversy types. This may represent a growing awareness of the SEC rule and is the first tranche of actionable claims since the final regulation went into effect on June 30, 2020. (See our charts below for the top 15 controversy and security types in customer arbitrations.)

Reg BI Makes FINRA’s Dispute Resolution Stats List and Other Notable Arbitration Developments
Reg BI Makes FINRA’s Dispute Resolution Stats List and Other Notable Arbitration Developments
© 2022 Bates Group LLC. Source: https://www.finra.org/arbitration-mediation/dispute-resolution-statistics

Also of note is FINRA’s comment on the continued pace of virtual hearings: “Since the postponement of in-person hearings, and as of May 31, 850 arbitration cases have conducted one or more hearings via Zoom (356 customer cases and 494 industry cases).”

FINRA Proposal on Arbitration and the Elderly

The comment period has now ended for FINRA’s proposed rule to speed up arbitration for seriously ill or elderly claimants. FINRA had proposed amendments to the Code of Arbitration Procedure to accelerate certain case processing deadlines. (See previous Bates’ post). Under the proposed rule, certain elderly claimants can request a determination to shorten the time it takes to complete steps throughout the arbitration. Comments were less than enthusiastic.

SIFMA responded that the proposed rules were unnecessary, given the flexibility of the current program and additional guidance that may be issued under it. SIFMA stated that the proposed rules were not warranted by a showing of investor harm to seniors or seriously ill parties. Further, SIFMA argued that (i) the proposed standard for granting accelerated arbitration proceedings was insufficient to prevent abuse; and that (ii) some of the proposed deadlines were “too short and would undermine the fairness of the process.”

The North American Securities Administrators Association (“NASAA”) supported accelerating the processing of arbitration proceedings, stating that “the proposal poses little risk for claimants if properly administered by FINRA’s dispute resolution staff.” However, NASAA reiterated its opposition to mandatory arbitration clauses in retail customer contracts, and argued that FINRA should discontinue its longstanding policy of allowing them. In particularly pointed language, NASAA stated: “The fact that the U.S. Supreme Court has upheld the validity of mandatory predispute arbitration agreements, even in contracts of adhesion, does not mean that permitting their use is good public policy. It is not, and NASAA encourages FINRA to fundamentally revisit its views on this issue.”

SEC Investor Bulletin on Arbitration and Mediation

In an investor bulletin issued on June 14, 2022, the SEC Office of Investor Education and Advocacy provided a tutorial on arbitration processes involving a customer dispute with a broker-dealer. The bulletin provides basic information on dispute resolution including describing the differences between arbitration and litigation, the requirements for simplified arbitration at FINRA, arbitrator selection, associated processes and awards, the use by numerous exchanges of FINRA’s dispute resolution forum, and fees. The bulletin also covers a series of specific questions including on filing claims, payment of settlements, choosing representation, and the decision to choose mediation.

Learn how Bates’ damages analyses and schedules can help you win your next case

FINRA Proposal on Arbitration and Sexual Assault and Harassment

On March 3, 2022, the federal “Ending Forced Arbitration of Sexual Assault and Sexual Harassment Act of 2021” became law. The Act gives individuals who claim sexual assault or sexual harassment the ability to reject a predispute arbitration agreement and bring their claims directly to court. Under the Act, courts would determine whether the Act applies and whether the predispute arbitration agreement is enforceable. (Parties may still agree to arbitration after a claim has been asserted.)

On May 13, 2022, FINRA proposed rule changes to conform the FINRA Code of Arbitration for Industry Disputes to the new law. In the relevant section, the proposed amendments provide “that a party alleging a sexual assault or sexual harassment claim that has agreed to arbitrate before the dispute arose may elect post-dispute not to arbitrate the claim under the Code.” Consistent with the Act, the proposal provides that the claim may be arbitrated if the parties agreed to arbitrate it after the dispute arose. Additional amendments to the Code would conform the procedural rules imposed in statutory discrimination arbitrations to sexual assault and/or sexual harassment arbitrations.

FINRA to Produce Plan to Modify Arbitrator Selection Process

On June 29, FINRA published an independent counsel’s report, requested by FINRA’s Audit Committee of the Board of Governors, related to a case involving the arbitrator selection process. The report includes a series of recommendations to better “reflect the neutrality of the dispute resolution services forum [“DRS”] and to further promote uniformity and consistency among the different DRS regions.”

Among the recommendations are (i) ongoing and mandatory staff training; (ii) manual reviews for conflicts of interest (which would require amendments to FINRA rules); (iii) ensuring that FINRA rules and the dispute resolution manual are consistent with publicly available documents; (iv) requiring written explanations, upon request, whenever there is a causal challenge to the selection or removal of an arbitrator; (v) a procedural review of the algorithms used “to determine if FINRA’s current technology is still the most effective means in creating random, computer-generated arbitrator lists for the arbitrator participants;” and (vi) other updates to the dispute resolution manual to clarify staff roles and procedures. In a separate statement, the FINRA Board of Governors said it has “directed FINRA management to implement the recommendations contained in the report… and that FINRA management agrees with the recommendations and has committed to deliver a plan for implementation to the Board.” The Board also directed the Audit Committee to “monitor management’s progress in implementing these recommendations going forward.”

Conclusion

Perhaps the most interesting aspect of the SEC investor bulletin is its straightforward list of all the exchanges that are using FINRA’s forum to resolve disputes arising between customers and the members of the exchanges. That so much of the securities industry relies so heavily on the FINRA forum underscores the importance of staying current on amendments to the Arbitration Code. The proposal on accelerating processes for elderly claimants, and the amendments to conform the Arbitration Code to the new law on sexual assault and harassment are important developments. Similarly, FINRA’s commitment to changes in the rules, polices and procedures with respect to the arbitrator selection process must be closely watched.

The FINRA dispute resolution statistics page offers a glimpse of the kinds of disputes that have the greatest frequency and currency. That Reg BI has cracked the top fifteen customer dispute types should be widely noted. Bates will continue to keep you apprised.

Bates stands ready to support clients with their FINRA arbitration matters. Our Securities and Financial Services Litigation practice provides retail and institutional litigation consulting and data-driven analytic support and solutions for broker-dealer, RIAs, banks and insurance companies. Our quantitative analysis and qualitative case strategy, advice, and expert testimony cover the full spectrum of investment activity. We work closely with our clients to examine the issues, markets, industry, regulatory context, historical analogy, and other experts’ work product to develop thoughtful, precise, and dispassionate analysis and testimony based on experience and judgment. Bates also offers Arbitrator Evaluator™ – your source for FINRA arbitrator selection.

For more information about our services, please visit:

Securities Arbitration and Litigation Services 

Damages Analyses and Data Analytics

Arbitrator Evaluator™ - Arbitrator Ranking and Selection Tool

Expert Consulting and Testimony

Find a Senior Investor Expert

Complimentary "ABCs of Financial Schedules" CLE training for your team - Contact us to schedule.

Contact

Reg BI Makes FINRA’s Dispute Resolution Stats List and Other Notable Arbitration Developments

Julie R. Johnstone, Managing Director, Securities & Financial Services Litigation

971-250-4319
jjohnstone@batesgroup.com

Reg BI Makes FINRA’s Dispute Resolution Stats List and Other Notable Arbitration Developments

Andrew Daniel, Director, Securities & Financial Services Litigation

971-250-4347
adaniel@batesgroup.com

Bates News  |  07-05-22

Bates Group Expands its National MSB, FinTech, and Cryptocurrency Practice

Bates Group Expands its National MSB, FinTech, and Cryptocurrency Practice

“Connie Fenchel is one of the nation’s leading AML/MSB experts,” said Brandi Reynolds, Bates Group’s MSB, FinTech, and Cryptocurrency Practice Leader. “With over 45 years of law enforcement and financial services-related experience, Connie is an industry trailblazer who brings her unparalleled knowledge, regulatory and compliance experience, and industry know-how to Bates.”

Connie joins Bates as a Strategic Advisor with more than four decades of government and private sector experience in law enforcement, financial crimes, regulatory compliance, anti-money laundering (AML), and sanctions. She is a former Deputy Director in the Financial Crimes Enforcement Network (FinCEN) of the U.S. Department of the Treasury. Before working at FinCEN, Connie had a lengthy career with the U.S. Customs Service in several senior-level positions. Upon retirement from government, she established AML Experts, Inc., an independent consulting firm assisting banks and non-banks in complying with AML laws and regulations. Full Bio

Bates Group Expands its National MSB, FinTech, and Cryptocurrency Practice

Catherine Snyder joins Bates as a Program Director for the MSB practice, bringing her unique expertise at the intersection of information technology, process development, and system implementation. In this new role, she manages the group’s business development, information technology, and all business support including people, process, and systems implementations. Prior to joining Bates, Catherine served as Head of Digital Products for Monex Inc. since 2018. Full Bio

Bates Group Expands its National MSB, FinTech, and Cryptocurrency Practice

Experienced as a regulator and AML compliance professional, Justin Vick joins Bates' MSB practice as a Senior Consultant. In this role, he provides support for diagnostic assessments of BSA/AML/OFAC compliance programs, MSB licensing, independent reviews, risk assessments, and ongoing support for compliance matters and training. Prior to Bates, Justin previously served as Senior Compliance Manager at CEX.IO Corporation, and he was a Senior Financial Examiner with the Washington State Department of Financial Institutions for 11 years. Full Bio

About Bates

Bates Group’s MSB, FinTech and Cryptocurrency practice offers guidance and services for fintech and cryptocurrency firms. Our subject matter experts work directly with firms and counsel to design and implement policies to ensure they are AML-compliant. Our MSB and AML Teams also implement, manage, and maintain Money Transmitter Licensing processes and engage clients with BSA/AML/OFAC Program Development, Risk Management, Training, Advisory Services, and Independent Reviews.

 |  06-23-22

Fighting Elder Financial Exploitation: FinCEN Releases Behavioral and Financial Red Flags, NASAA Publishes Guidance on POAs, CFTC Releases Warnings

Image © [LIGHTFIELD STUDIOS] /Adobe Stock

Timed to coincide with World Elder Abuse Awareness Day on June 15, 2022, federal and state government officials issued proclamations, advisories, and new resources to help in the fight against senior financial abuse. Despite many government initiatives now in place to go after the perpetrators of elder financial abuse, the problem continues to grow. Taken together, these latest government alerts offer a snapshot of where things stand. Here’s a brief look at the most significant developments.  

FinCEN Highlights “EFE” Typologies and Red Flags

In an advisory alerting financial institutions of “rampant fraud and abuse targeting older adults,” the Financial Crimes Enforcement Network (FinCEN) highlighted new behavioral and financial red flags to help in the identification, prevention, and reporting of suspected elder financial exploitation (“EFE”).  FinCEN noted that in 2021, financial institutions submitted 72,000 suspicious activity reports (“SARs”)—nearly 10,000 more than the prior year—and cited CFPB estimates that EFE suspicious transactions grew from an estimated value of $2.6 billion in 2019 to $3.4 billion in 2020. Citing the Department of Justice, FinCEN stated that EFE affects at least 10 percent of older adults each year in the United States. And, citing the Federal Trade Commission, FinCEN stated that “older adults now account for 35 percent of the victims associated with filed fraud reports in cases when a consumer provided an age.”

FinCEN categorized EFE as either related to theft or to scams, the former concerning stolen “assets, funds, or income by a trusted person,” and the latter related to the wrongful transfer of senior assets to a stranger or imposter. Based on its analysis of SARs relating to elder theft, FinCEN found that family members were involved in assets stolen from older adults in 46 percent of the cases between 2013 and 2019. Regarding EFEs perpetrated by strangers, FinCEN identified the following prevalent “typographies”: government imposter scams, romance scams, emergency/person in need scams, lottery and sweepstakes scams, and tech and customer support scams. FinCEN offered case studies on each.

FinCEN reminded financial institutions that it is critical for “customer-facing staff to identify and consider [] behavioral red flags when conducting transactions involving their older customers,” and that the details should be incorporated in SARs filings. They listed twelve behavioral red flags in all. Among them are sudden and unusual changes in contact information, an unusual degree of fear or submissiveness by a client toward a caregiver, and unexplainable or unusual account activity. FinCEN listed an additional twelve financial red flags including sudden or frequent non-sufficient fund activity, customer purchases of large numbers of gift cards or prepaid access cards, and uncharacteristic attempts to wire large sums of money, among others.

The FinCEN advisory reminds financial institutions of their Bank Secrecy Act obligations, including SARs reporting, currency transaction reporting, reports of cash payments over $10,000 received in a trade or business, foreign bank and financial accounts reporting, and registration of money services business, among others. As FinCEN Acting Director Himamauli Das stated: “Financial institutions serve on the frontlines in protecting their older customers’ finances, and can play a critical role in helping to identify, prevent, and report suspected elder financial exploitation. Financial institutions’ vigilance matters. Their reporting matters.”

Searching for a Testifying Expert on Elder Issues? Start Here!

NASAA Publishes Primer and Guidance on Powers of Attorney

The state securities regulators’ association published two documents on the importance of the use of powers of attorney (“POAs”) in managing the financial affairs of seniors. The publications were developed by NASAA’s Senior Issues and Diminished Capacity Committee. The first, a primer for all investors, describes how to choose someone to become a POA, the right form, disclosure to key persons and how best to ensure “that the POA will serve its purpose in meeting your needs and expectations.”

The second document offers guidance to financial professionals. As stated: “a well-planned and well-communicated POA can ensure that the financial professional and client relationship is preserved during times of incapacity.” The guidance contains questions that financial professionals can use (i) to engage clients on the subject, (ii) on protective provisions to be considered for inclusion in the document, (iii) on preparations for the moment in time when the client may lose capacity, and (iv) on the obligations to the client when working with someone designated as the power of attorney. The guidance also reviews long-established NASAA guidance for financial professionals on suspected financial exploitation.

CFTC Warns Seniors to Take Precautions Against Investment Fraud

In a CFTC advisory, the agency restated that the reason fraudsters target seniors is “because they have typically acquired more assets through a lifetime of saving and investing.” The agency suggested that seniors are more vulnerable because they are more likely to have dealt with “major traumas and life events—such as severe changes in their health, the death of a loved one, divorce, retirement, financial setbacks, and isolation.” The CFTC highlighted the most frequent scams affecting these seniors, including fraud involving the sale of precious metals (particularly gold and silver as a hedge against economic challenges), fee scams, and romance scams.

The agency warns seniors to be wary of investment pitches made through “social media, dating apps, messaging apps, or through unsolicited email or telephone calls.” The agency also warns senior investors against discussing “trading or investing in digital assets, precious metals, over-the-counter foreign exchange (also called “forex” or “FX” trading), or other commodity derivative products.”

Further, the agency recommends that seniors (i) get a second opinion before making an investment decision, (ii) not share sensitive information online, (iii) check credentials and backgrounds and ensure that firms are registered with federal or state authorities, (iv) not trade in markets or products without understanding them, and (v) stay aware of current fraud trends.

Conclusion

World Elder Abuse Awareness Day, launched in 2006 by the International Network for the Prevention of Elder Abuse and the World Health Organization at the United Nations, is intended to raise “awareness of the cultural, social, economic and demographic processes affecting elder abuse and neglect.” This year, President Biden issued a proclamation officially recognizing June 15th as World Elder Abuse Awareness Day in the United States. He highlighted the administration’s “comprehensive, collaborative efforts to respond to elder abuse, neglect, and exploitation [through] initiatives to reform guardianship, support adult decision-making, crack down on scammers and fraudsters, and empower victims of exploitation.” As to elder financial exploitation, the regulatory advisories and newly released guidance show how aware we are of the problems of elder financial exploitation, but also how far away we are from getting it under control.  Bates will keep you apprised.

How Bates Helps

Learn how to protect your company and its most vulnerable investors. Visit us online for the following senior investor services: Bates Investor Risk Assessment (BIRA)senior and vulnerable investor expert witnessessecurities litigationdamages analysisfinancial crimes, and compliance solutions.

To speak with a Bates representative about your vulnerable or senior investor matter, please contact us at 503-670-7772 or email contact@batesgroup.com.

Events  |  06-15-22

Join Bates Group at the SIFMA C&L Luncheon, June 15th in NYC, featuring Raymond Dorado, Senior Deputy Superintendent - Banking Division, NYSDFS

Bates Group is proud to sponsor the upcoming June SIFMA C&L luncheon program featuring Raymond “Ray” Dorado, Senior Deputy Superintendent - Banking Division, New York State Department of Financial Services.

The SIFMA Compliance & Legal Society's monthly luncheon series presents opportunities to gain valuable insights and need-to-know updates from influential voices in the compliance and legal profession while connecting with colleagues new and old.

Program Details: Wednesday, June 15, 2022, at the Harvard Club in New York City, starting 12:30 p.m.

We hope to see you there!

Event Details and Registration

Bates Research  |  06-09-22

Regulatory and Legislative Action on SPACs Gaining Momentum: SEC Rule Proposal and Senate Legislation Introduced; Class Actions Growing

Image © [iQoncept] /Adobe Stock

It has been clear for some time that regulators are targeting special purpose acquisition companies (“SPACs”) for increased scrutiny, tighter rules, and aggressive enforcement. (See Bates White Paper.) The SEC has responded to the market phenomenon over the past few years by publishing guidance, issuing frequent warnings on the inherent risks of these structures, and ramping up its compliance investigations and enforcement actions (See previous Bates post). On March 30, 2022, the agency took the next step by proposing rules on SPACs. The amendments would enhance disclosure in SPAC initial public offerings (“IPOs”) and business combination transactions involving shell companies.

SPACs have been on the radar of legislators as well. In September, 2021, Senators Warren (D-Mass.), Sherrod Brown (D-Ohio), Tina Smith (D-Minn.), and Chris Van Hollen (D-Md.) sent letters to prominent SPAC “creators” seeking information about potential abuse by insiders who “are taking advantage of legislative and regulatory gaps at the expense of ordinary investors.” In November, Senator Warren asked the SEC to investigate potential securities violations (i.e. failures to provide material information and other filing omissions) related to one SPAC’s plan to merge with former President Trump’s Media and Technology Group. Based on these and other reported concerns, Senator Warren released a report in May titled: The SPAC Hack: How SPACs Tilt the Playing Field and Enrich Wall Street Insiders. The Report is intended to serve as the basis for her proposed legislation: the “SPAC Accountability Act of 2022.”

This regulatory and legislative activity comes amid poor overall SPAC performance and volatility. As a result of all this attention, the market for SPACs has recently soured. In this article, we review the proposed SEC regulation, Senator Warren’s SPAC report, the anticipated legislation, and current conditions.

SEC Proposal on SPACs, Shell Companies, and Projections

In a fact sheet, the SEC stated that the new rule on SPACs was needed due to (i) the “unprecedented surge in the number of initial public offerings,” (ii) “heightened investor protection concerns about various aspects of the SPAC structure,” (iii) the “increasing use of shell companies as mechanisms for private operating companies to become public companies,” and (iv) projections and forward-looking statements by private operating companies that may lack a reasonable basis. The proposed rules are intended, therefore, to provide additional investor protections in initial public offerings by SPACs and in de-SPAC transactions.

The 372-page rule proposal responds to concerns in several ways, first and foremost by requiring specialized disclosure on compensation paid to sponsors, conflicts of interest, sources of dilution, and business combination transactions. The proposal would amend financial statement requirements on transactions involving shell companies and includes new guidance on such disclosure. Further, the proposal would require additional disclosure in Commission filings on any use of projections of future economic performance.

The proposal also expands the definition of SPACs as “investment companies” under the Investment Company Act, thus ensuring agency oversight by “deem[ing] any business combination transaction involving a reporting shell company, including a SPAC, to involve a sale of securities to the reporting shell company’s shareholders.”

Under the proposal, a SPAC would have a safe harbor from registration as an investment company if it “fully complies with the rule’s conditions,” by (i) maintaining certain types of assets (cash items, government securities, and certain money market funds); (ii) “seek[ing] to complete a de-SPAC transaction after which the surviving entity will be primarily engaged in the business of the target company,” and (iii) agreeing to engage in a de-SPAC transaction within 18 months after its IPO and complete its de-SPAC transaction within 24 months.

The comment period closes on June 13, 2022.

Read the Bates summary on SPACS and how they work

Senator Warren’s SPAC Report

Senator Warren’s Report is an indictment on the use of SPACs as a vehicle to avoid the requirements placed on traditional IPOs. Her investigation consisted of a review of responses received from the Senators’ letters to SPAC creators, contributions from the SEC, and other public disclosures. The resultant Report “finds that the structure of SPACs routinely rewards serial SPAC creators and Wall Street backers while leaving retail investors at risk from SPACs’ convoluted structure and incentives for dilution, fraud, and abuse.”

Senator Warren draws several conclusions:

  1.  SPAC “sponsors’ incentives and outcomes do not align with retail investors;” the Report found that “from 2019 to 2021, SPAC sponsors received average returns of 958 percent, even as companies taken public by SPACs consistently underperformed the market and retail investors took losses.”
  2.  SPAC “shortcuts give institutional investors and Wall Street insiders opportunities that dilute shares for retail investors and put companies at risk;” the Report found that “institutional investors are given early access to information and discounted stock before retail investors can participate on the open market.” These “shortcuts” include the ability to participate - at a discounted rate - in private investment in public equity (so-called “PIPES,”) and access to redemption rights that can insulate institutional investors from any risk or long-term investment in the public company.
  3.  Financial institutions can charge excessive and hidden fees; the Report states that financial institutions charge fees that outstrip those of a traditional IPO, including an underwriter fee, a PIPES placement agent fee, and a financial advisor fee.
  4.  SPACs incentivize inadequate and fraudulent disclosures; the Report states that SPACs are “rife” with disclosures where companies “used inflated information about their financials, their future business, or even their underlying technology.”
  5.  SPACs allow rampant self-dealing at the expense of retail investors; the Report states that the flawed regulatory rules allow SPAC sponsors to “pay advisory fees to companies they are associated with, participat[e] in PIPEs and private investment rounds despite their clear insider knowledge, and even choos[e] their own companies as acquisition targets.”

The Report concluded that regulation and legislation is necessary to protect retail investors and the integrity of the markets. Senator Warren acknowledged that the SEC proposed rules would address many of the issues her office identified. She noted, among other things, that the proposed SEC amendments would cover “dilution of SPAC shares, inadequate disclosures, and the use of forward-looking statements to make overblown or even fraudulent projections.” She also highlighted that the SEC’s proposal would give teeth to enforcement, increasing the legal liabilities for involved parties in a de-SPAC transaction by expanding the definition of underwriters to anyone who acted as an underwriter for the initial SPAC offering. That said, the Senator recommended legislative action to strengthen the SEC’s authority to crack down on SPAC malfeasance.

Legislation on the Horizon

The Report previewed the senator’s anticipated legislation: the SPAC Accountability ACT of 2022. The bill would, purportedly, “close regulatory loopholes” (as to the current use of the existing safe harbor provisions) and “codify the [SEC’s] amended definitions [on ‘investment companies,’ ‘underwriters’ and ‘blank check’ companies] into law.” The intention of the bill, according to the Report, is to enhance investor disclosure, “to require SPAC sponsors and underwriters to have a greater stake in their merged companies’ futures,” and to impose “greater liability during the SPAC IPO and de-SPAC process.” The Report states that the expanded definition of “underwriter” would increase the liability of SPAC sponsors and financial institutions, and the bill would also require SPAC sponsors’ shares “to remain locked-up until the company has projected bringing in revenue in forward-looking statements.”

Conclusion

Regulatory and legislative attention to SPACs is a direct result of their proliferation. Senator Warren cited the numbers: “In 2019, 59 SPACs raised more than $13 billion… In 2021, there were 613 SPAC listings raising a total of $145 billion.” Federal civil actions also reflect the increase in attention. (e.g., Stanford Law School’s Class Action Clearinghouse is now tracking 63 filings since January 30, 2019. These are primarily cases where investors allege that they were misled by company statements.)

Beyond the historical data cited by the Report, the market has not been kind to SPACs during this recent period. The New York Times reported the following: “around 600 SPACs that went public in the past couple of years are still trying to complete deals … seven SPACs have folded since the beginning of the year ... 73 SPACs that were waiting to go public have shelved their plans … and a fund that tracks the performance of 400 SPACs is down 40 percent over the past year.” The Wall Street Journal reported that “about 90% of the companies that completed SPAC mergers during the boom that started in 2020 now trade below the SPAC’s initial listing price … some investors expect many SPACs to pursue low-quality companies to take public at improper valuations to stave off possible losses… and analysts say many SPACs won’t find mergers because there simply aren’t enough companies that will want to complete SPAC deals in time.”

Whether regulator warnings, guidance, enforcement actions (primarily related to disclosure and compliance failings) and now proposed rules and anticipated legislation protect retail investors and rectify problems on the use of SPACs as an investment vehicle is yet unknown. The market volatility may preempt the conversation. Bates will keep you apprised.

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


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

Julie Johnstone, Managing Director, Securities Litigation - jjohnstone@batesgroup.com

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

Hank Sanchez, Managing Director, Bates Compliance - hsanchez@batesgroup.com

Events  |  06-08-22

Meet Bates at the SIFMA C&L Regional: St Louis, June 8, 2022

Meet Bates Director Joe Thomas and Experts Clay Grumke and Jeff Jamieson (pictured, from L) in St. Louis at the SIFMA C&L Regional Seminar, June 8, 2022, at the Edward Jones Conference Center. Bates cybersecurity expert Paul Horn (pictured, R) will appear on the afternoon panel “Managing Cybersecurity and Data Risk in Today’s Technological Environment” at 1:30 p.m. CT.  Join us for in-person networking and a full day of programming with content including:

  • Key Regulatory Developments
  • Social Media
  • Washington Update
  • Cybersecurity
  • Crisis and Risk Management

Joe, Clay, Jeff, and Paul will be on hand to share ideas on the increasingly complex and changing regulatory and compliance arenas, and how Bates can assist your firm with Securities Litigation and Arbitration, Expert Witness Testimony and Consulting, Cybersecurity, Regulatory and Investigations, Compliance, Damages, and more.

Seminar Details and Registration

Bates News  |  06-07-22

Bates Welcomes New Consulting and Testifying Experts – June 2022

Joan Marie Asher, CIFD, IACCP

Hedge Funds, Private Equity, Alternative Investments

Joan Marie Asher is a Consulting Expert at Bates Group and the Founding Director of Paragon Fund Services, a boutique fractional service provider and advisory firm. Her career in financial services includes capital markets, hedge funds, broker dealers, and private equity, and she engages with numerous financial institutions, fund administrators, legal teams, vendors, and clients throughout the United States and abroad in various investment related activities.

Ms. Asher has more than 25 years of experience at several top-tier financial firms where she has successfully served in roles such as Chief Operating Officer, Chief Financial Officer, and Chief Compliance Officer. Her experience includes compliance and governance, risk management, operational due diligence, and the oversight of third-party service providers.

Ms. Asher is an Investment Advisor Certified Compliance Professional (IACCP) and one of only four women in the United States to hold a Certified Investment Fund Director (CIFD) designation, which is the premier qualification for investment fund directors. She also served as a subject matter expert to National Regulatory Services in reading, writing, and reviewing questions for the IACCP exam.

Full Bio

Jeffrey L. Baliban, MA Econ, CPA/ABV/CFF, CDBV

Business and Economic Damages, Business Valuation, Accounting

Jeffrey Baliban is a Bates Testifying Expert whose professional practice has, for more than 4 decades, focused on resolving complex commercial disputes by providing independent evaluation studies of economic impact on the various parties involved. He is often asked to render independent opinions on business damages, loss of profits, and business valuation, and he has provided expert witness testimony in various federal and state jurisdictions, as well as in arbitration.

Over the years, Mr. Baliban has directed many national and international projects in matters including (but not limited to) breach of contract and tort claims, intellectual property disputes, shareholder disputes, fair value measures, post-acquisition disputes, post-employment restriction claims, adversarial proceedings in bankruptcy, and solvency/fraudulent transfer analyses. In addition, he has considerable experience as a damages expert in property and casualty insurance matters.

Mr. Baliban has been a CPA since 1981 and has written and spoken widely on various accounting, economics, valuation, and damages issues.  He is currently an adjunct professor of statistics in the New York University School for Professional Studies’ MS in Integrated Marketing program.

Full Bio

Jeff Jamieson

Litigation, Regulatory, Internal Investigations

Jeff Jamieson is a Bates Consulting and Testifying Expert based in St. Louis, Missouri, who uses his expertise in Retail Securities, Regulatory Investigations, Compliance and Regulatory Reporting to serve our financial services clients and their counsel. He has extensive experience in litigation and regulatory matters, conducting internal investigations and regulatory reporting.

Since 1991, Mr. Jamieson has represented brokerage firms and their employees in litigation and arbitration cases and matters before federal and state regulators. He has arbitrated to award 35 cases before FINRA and the NYSE.

Before joining Bates, Mr. Jamieson was Senior Counsel for Wells Fargo Advisors, responding to regulatory matters and directing internal investigations for the Wealth and Investment Management Division. He has also testified as a fact witness on several occasions in arbitration cases brought against A.G. Edwards and Edward Jones related to internal investigations and Forms U4 and U5. Prior to his work in the securities industry, Mr. Jamieson was a Felony Staff Attorney for the St. Louis Circuit Attorney’s Office where he prosecuted criminal cases and tried 65 jury trials to verdict.

Full Bio

Bates News  |  06-02-22

Introducing Bates Group’s Wage and Hour Services for Public Agencies, Private Companies and their Counsel

Our experienced team supports:

The Public Sector

  • Bates Group’s wage and hour team works closely with cities, counties, regional 9-1-1 dispatch centers, and their attorneys to evaluate whether their compensation practices are compliant with the FLSA and/or provisions of employee contracts.
  • Our analysis helps ensure that counsel and clients have sufficient information to respond to employee grievances/complaints, prepare for labor negotiations, or prepare for litigation.
  • We are highly experienced in examining and analyzing timekeeping and payroll records for the purpose of evaluating potential FLSA wages due as well as wages due per employee/union contracts.

The Private Sector

  • We provide expert consulting and testifying services involving the calculation of potential unpaid wages and penalties related to overtime, meal and rest break violations, travel time, off-the-clock time, minimum wage violations, and expense reimbursement.
  • We have assisted attorneys in every stage of the litigation process related to wage and hour disputes for those arising under the California Labor Code, Fair Labor Standards Act, and PAGA.

We are proud of the positive feedback we have received from our clients and would like to share more about how our services could benefit your wage and hour matters.

Please visit our Wage and Hour services page online or reach out to us directly should you need assistance with a pending matter.

We welcome your referrals, too!

Contact:

Introducing Bates Group’s Wage and Hour Services for Public Agencies, Private Companies and their Counsel

Leonore Ralston, CFE, CAMS

Managing Consultant, Securities Litigation & Consulting
lralston@batesgroup.com

Introducing Bates Group’s Wage and Hour Services for Public Agencies, Private Companies and their Counsel

Learon Bird, JD, CFA

Managing Consultant, Securities Litigation & Consulting
lbird@batesgroup.com

Coming Up:

Join us for an upcoming CLE Webinar with the Oregon State Bar titled "Wage-and-Hour Disputes: Working with Consultants and Testifying Experts," featuring Bates Group's Learon Bird and Leonore Ralston. June 23, 2022 - Registration coming soon to our Webinars and CLE page!

Bates Research  |  06-01-22

Non-Fungible Tokens: a Beginner’s Perspective

by Managing Director Brandi Reynolds, CAMS-Audit and Consultant John Ashley, CIPP/US, CRCMP.

We've all heard of Non-Fungible Tokens (NFTs) by now, and when this term comes up in the news or a talk with friends, there is no shortage of opinions. But what actually is an NFT?

An NFT is a unique digital identifier that cannot be copied, substituted, or subdivided, that is recorded in a blockchain, and that is used to certify authenticity and ownership of a specific digital asset and specific rights relating to it. This digital asset is usually an image, audio, or video file. The NFT is not the asset itself, rather, it is a one-of-a-kind digital marker assigned to the asset as code stored within the blockchain. NFTs are themselves considered to be digital assets.

An NFT is linked to a digital identity which is then linked to an owner or owners. NFTs are used to create verifiable digital scarcity of a digital object as well as a verifiable digital ownership trail. As such, NFTs function like virtual versions of physical collectibles, such as paintings, books, or baseball cards. NFTs can also store more esoteric information, such as experiences. For example, an NFT could represent attending a particular concert or other event on a specific date and/or time. NFTs can also be used in conjunction with the trading of physical items as well. 

How Does It Work?

NFTs are stored on a blockchain, meaning they are individual tokens with additional information stored in them. As they have value, they can be bought and sold, and, like other types of art, their value is determined by market demand.

However, this does not mean that there is only one NFT for each digital asset on the market. In a similar way to artists issuing print runs of original pieces, NFT copies are still important parts of the blockchain, but they can’t substitute for the original.

The NFT links the owner to the original marker, and this makes the NFT “exclusive.”

Where Are They Sold?

Currently, NFTs can be purchased on a variety of digital platforms, and the choice depends on what you want to buy. Transactions can occur in cryptocurrency exchanges or in online marketplaces like OpenSea. Also, some physical-item auction houses have recently started offering NFTs.

What Are the Risks?

There are many risks associated with NFTs, one of the biggest being the volatility associated with NFTs. Prices are largely determined by uniqueness, creativity and scarcity. However, there is still significant uncertainty surrounding NFT price determination, as there are no universal standards in place. Additionally, fraud is a significant risk for the sale and purchase of NFTs. This can take the form of NFT projects which are set up as scams, or through the use of stolen or fraudulently acquired NFTs.

What Is Driving the NFT Market?

Digital scarcity: Back in the days when music was primarily bought and sold on vinyl, cassette, and CD, it was easy to prove you owned an official copy of a song or album. Now that most media is consumed online, it has become easier to copy and distribute content over the internet, often without any recognition for the original creator. Since NFTs are based on blockchain technology, an immutable record of ownership can be clearly identified.

Fair compensation for creators: The ability for Internet users to download, copy and distribute digital audio, video, and image content has meant that creators of original content often cannot fully reap the benefits of their work.

According to a report released on March 19, 2021, by DataProt, pirated videos are viewed more than 230 billion times per year, resulting in annual losses of between $40 billion and $97.1 billion. Although governments, regulators and distributors have attempted to put in place various strategies to stem piracy, their attempts have been unsuccessful and piracy activity continues. Unlike traditional distribution networks, blockchain technology has the potential to slow down this phenomenon. Creators can set commissions on all sales of their works and all transactions are recorded.

For example, the artist known as Beeple sold a piece titled “CROSSROAD” for $ 66,666.66 in October 2020, which then resold in 2021 for $ 6.6 million. Despite the change in ownership, Beeple earned a 10% commission on each sale and will continue to earn a commission each time the NFT is resold.

Bates Offers AML and Risk Management Services for Crypto and NFTs

The Possibilities Seem Endless

Well-known brands and major companies are also seeing the appeal of NFTs. Taco Bell, for examples, sold NFTs of GIFs and taco images, with many designs being purchased almost immediately after being announced. Each token contained a $500 gift card that the owner could spend in-store. Today, TacoCards are selling on the secondary market, some for over $3,000.

Even tweets on Twitter can fetch a high value as an NFT. Jack Dorsey, co-founder of Twitter, sold his first tweet for nearly $3 million. The possibilities seem endless, which stimulates creativity.

What the Future Holds

Regulatory uncertainty around NFTs and cryptocurrency in general creates a significant hurdle in the way of mass adoption.

Despite the uncertainties, Nadya Ivanova, Chief Operating Officer of BNP Paribas-affiliated research firm L’Atelier, sees “huge potential in the future of NFTs. A correction is inevitable, she said, but ultimately the market will continue to grow and "NFTs may become the underlying asset of the entire virtual economy, expanding far beyond just digital art and collectibles."

How Bates Group Helps

While there’s no specific guidance on whether non-fungible tokens (NFTs) constitute a virtual currency or other regulated activity, regulators and legislators are scrutinizing virtual currency and digital closely now. Most NFTs involve art or intellectual property. In 2021, FinCen specifically issued a notice concerning AML, the Arts & Antiquities Market and illicit activity under the AML Act. (Source: FinCEN Notice on Antiquities and Art (FIN-2021-NTC2)

Bates Managing Director Brandi Reynolds notes that "with the potential for money laundering and OFAC risks associated with NFT marketplaces, it is prudent for those operating in the space to have a risk-based AML program in place." Bates can create a best-in-class AML compliance program which will meet best practices, regulator and financial partner expectations, tailored specifically to your business model. We also design and implement controls to detect and prevent fraud, money laundering, and other forms of illegal activity.

Call or email Bates today to discuss how we can help protect your NFT firm or program.

Contact:

Brandi B. Reynolds, CAMS-Audit, Managing Director, AML & Compliance

breynolds@batesgroup.com | 864-809-7718

Compliance and Regulatory Alerts  |  05-31-22

SEC Proposes Amendments to ESG Disclosure Rules and Forms

The SEC last week issued a proposal to require “registered investment advisers, certain advisers exempt from registration, registered investment companies, and business development companies” to disclose information on environmental, social and governance (“ESG”) investment practices and strategies in fund registration statements, prospectuses, annual reports, and adviser brochures. In April of 2021, the SEC Division of Examinations issued a risk alert to review compliance deficiencies concerning ESG product and service offerings by investment advisers, registered investment companies, and funds. (See previous Bates post). Based in part on those findings, the newly proposed amendments are intended to make ESG disclosures more “consistent, comparable and reliable,” and “decision-useful” for investors. The 362-page proposal contains new disclosure requirements and would amend numerous Forms for funds (Forms S-6, N-1A, N-2, N-8B-2, N-CEN, and N-CSR) and advisers (Form ADV Part 1A, 2A - Items 8, 10 and 17, and 2A Appendix 1 - Items 4 and 6). The SEC also issued an accompanying Fact Sheet on the proposal.

The proposal acknowledges that (i) funds must currently “provide disclosures concerning material information on investment objectives, strategies, risks, and governance;” (ii) “management must provide a discussion of fund performance in the fund’s shareholder report;” and (iii) advisers must provide information about their advisory services describing methods of analysis and investment strategies, fees, conflicts, and personnel on Form ADV. The SEC asserts that ESG strategies differ in ways that “necessitate specific requirements and mandatory content to assist investors in understanding the fundamental characteristics of an ESG fund or an adviser’s ESG strategy.” The agency contends that “variation” concerning ESG investing (i.e., “the variety of perspectives concerning what ESG investing means, the issues or objectives it encompasses, and the ways to implement an ESG strategy”) and the “lack of a specific disclosure framework” increase the “risk of funds and advisers marketing or labelling themselves as ‘ESG,’ ‘green,’ or ‘sustainable’ in an effort to attract investors or clients, when the ESG-related features of their investment strategies may be limited.”

In a statement on the proposal, SEC Chair Gary Gensler said that “it can be very difficult to understand what some funds mean when they say they’re an ESG fund. There also is a risk that funds and investment advisers mislead investors by overstating their ESG focus.” He clarified that the proposal requires funds that say they consider ESG factors to put in their prospectus the factors they consider and the strategies they use. For certain funds, it would require disclosing relevant metrics of the portfolio including greenhouse gas emissions. Further, he highlighted that funds that use proxy voting as a means of implementing their ESG strategy “would be required to disclose information regarding their voting of proxies on particular ESG-related voting matters and information concerning their ESG engagement meetings.” Investment advisers would be required to disclose similar information regarding their ESG factors and strategies in their client brochures.

Additional Rules Proposed Affecting ESG

In a second proposal issued on May 25, 2022, the SEC offered amendments to its rule addressing “certain broad categories of investment company names that are likely to mislead investors about an investment company’s investments and risks.” The proposal on the so-called “Name Rule” would expand the requirement to hold at least 80 percent of a fund’s assets consistent with the focus of the fund’s name. The SEC stated that this requirement would apply “to any fund name with terms suggesting that the fund focuses on investments that have, or investments whose issuers have, particular characteristics,” such as “those indicating that the fund’s investment decisions incorporate one or more environmental, social, or governance (‘ESG’) factors.” Among other new obligations, the proposal would also require enhanced disclosure (on how it tracks investments), notice (to add electronic delivery), and additional recordkeeping requirements. 

The comment period for both proposals will run for 60 days after publication in the Federal Register.

Contact

For regulatory and compliance questions, please contact Managing Director Hank Sanchez (hsanchez@batesgroup.com). For litigation questions, please contact Managing Director Julie Johnstone (jjohnstone@batesgroup.com). 

If you would like more information concerning Bates Group's Practices and Services, please visit:

Regulatory and Internal Investigations

Bates Compliance

Retail Litigation and Consulting

Institutional and Complex Litigation

Consulting and Expert Testimony

Bates AML and Financial Crimes

Bates Research  |  05-26-22

SEC Chair Gensler Speaks: The Latest on the SEC’s Agenda

In a conversation with FINRA President Robert Cook at FINRA’s annual conference last week, SEC Chair Gary Gensler discussed his agency’s rulemaking agenda by explaining that the market is in the midst of a transformation that requires adjustments, modernizations and updates to existing regulations. President Cook covered a broad range of topics, probing where the SEC may be focusing its attention next. Chair Gensler responded by giving historical context, reciting congressional authorizations and legal reasoning, and providing examples of current events requiring urgent action concerning products and services across the market. He saved his comments on the implication of digital engagement practices on broker-dealer and adviser obligations until the next day, when he addressed an audience of State securities regulators (NASAA). Here are some of the highlights from both events.

FINRA President Robert Cook’s Discussion with Chair Gensler

FINRA President Cook peppered the SEC Chair with a number of questions covering the gamut of financial services industry concerns.

Digital Engagement Practices

Foreshadowing his address on digital engagement practices and the related compliance implications for brokers and advisers, Chair Gensler framed the agency’s efforts around digital engagement in light of “the transformative time in which we are living—[when] data analytics can predict so much of our choices as individuals.” While noting that the SEC has learned from many comments it received in response to an agency request on the subject earlier this year, and from “GameStop” and other market events, Mr. Gensler questioned whether retail investors were getting “the best advice, the best recommendations—where best interest is supposed to be best interest and best execution is supposed to be best execution.” He questioned whether the duty of care and the duty of loyalty to real standards can “stand the test in this new data analytics period.”

Complex Products

Referring to concerns about risks from complex exchange-traded products and derivatives that may be embedded in such products (e.g., leveraged or inverse ETFs), Mr. Gensler linked the question to whether the product is risk-appropriate for the retail investor. “Just think about it on a brokerage app,” he said, “It doesn’t just have to be one of those complex inverse products or a double-two-times leveraged product, but it’s also about options, or margin accounts—is that really appropriate for that investor?” In the institutional space, Mr. Gensler cited enforcement efforts against companies using derivatives inside of structured vehicles. As a result, Mr. Gensler said he directed staff to offer recommendations on sales practice appropriateness, valuations, and “making sure folks aren’t gaming the system and basically trying to mislead the public and its investors.”  

When challenged on the broad scope of these staff directives, Mr. Gensler asserted the necessity of updating the capital markets. “We can’t take anything for granted; technologies are changing so rapidly…we are living in a truly transformative age. I think every bit as transformative as the internet.” He argued that current marketing is now based on predictive data analytics. “All of that [data] is being souped up, which raises the question of how the platform is marketing to you—are they doing it in your best interest with your best execution of a trade, or is it about their revenues? And therein lies the challenge of our times.” Briefly referring to Reg BI, Mr. Gensler focused on the importance of the role of broker-dealers and investment advisers in instilling trust in the markets.

Fixed Income Market Transparency

Mr. Gensler framed questions on fixed income market transparency as part of the SEC’s goal to “driv[e] efficiency in the core product” within the “hundred-trillion-dollar capital market.” He directed staff to consider “the authorities Congress has given us and good economic analysis to help promote greater efficiency in the middle…better return for investors, better for issuers, [but] maybe a little less return for the market makers and the service providers in the middle.” He described how FINRA’s trade reporting system (TRACE) has led to greater economic efficiency in the market and how the transparency it provides promotes competition. He emphasized the importance of (i) greater transparency in post-trading; (ii) shortening the time frame to get the information out (“fifteen minutes [is] a lifetime now in markets”); (iii) greater transparency in terms of spread products “or what can be called corporate bonds that are priced as a spread to an underlying treasury curve;” and (iv) making available currently collected data to market participants “not just the official sector.”

In terms of pre-trade information, Mr. Gensler advocated for greater transparency and resiliency as to electronic platforms and alternative trading systems. He directed staff to “look for ways to promote greater pre-trade transparency for the corporate and municipal market.” He emphasized that the key to boosting competition and resiliency is “getting those platforms registered.” He also said that the SEC is working with the Treasury and Federal Reserve Board on clearing issues on both sides of the trade. He warned of the risk residing inside these platforms and explained: “What we know about clearing is, it’s not a silver bullet, it’s not without risk, but it significantly lowers risk in a system through netting—the math of netting—and through the collection of the margin both initial and variation, importantly the robust risk protocols one can put on the clearinghouse.”

Further, Mr. Gensler said he was working with his colleagues on “over a dozen resiliency projects,” citing myriad risks, including “uncertainties from the geopolitical side—the unprovoked war in Eastern Europe, the COVID surge—and the uncertainties in the financial markets moving from a more accommodating toward a tightening stage.”  He said, “There’s a lot of uncertainty in our capital markets; these macroeconomic times are a reminder how important these resiliency projects are.”

Market Structure

Beyond promoting pre- and post-trade transparency and resilience, Mr. Gensler cited a list of other agency steps in the works to strengthen competition and efficiency across all parts of the market. He said that staff is taking a “holistic” approach to every element: payment for order flow, exchange rebates, access fees, and the minimum increment (tick size). “There’re a lot of pieces—the last time this was updated was 2005. Congress gave us broad authority in the seventies, during the early days of new technologies at NASDAQ. That led Congress to tell the SEC to promote competition. After 17 years, we think its time to put out a proposal.”

Cybersecurity and Risk Management Requirements on Broker-Dealers

Chair Gensler stated that cyber risk is a part of the reality of the economy today, calling it “an arms race [between] those who are operating the systems [and] those who want to disrupt the systems.” The list of those disrupters includes those who want to take commercial or proprietary information for economic gain, and those who want to steal intellectual property, whether they are State or private actors. Mr. Gensler cited a long list of SEC actions taken to enhance cybersecurity. He said that the SEC (i) is not the lead, but is active on “team CYBER;” (ii) has put out a proposal on cyber-hygiene for advisers and investment funds; (iii) is working on a similar proposal for broker dealers; (iv) extended a rule called Systems Compliance and Integrity (“Rule SCI”) concerning the biggest platforms, including stock exchanges and clearinghouses; (v) proposed similar rules for fixed income and alternative trading systems, and for issuers; and (vi) proposed disclosure requirements when there is a material incident. Mr. Gensler also noted his intention to update Regulation SP, a privacy notice requirement for customers in both the broker dealer and investment adviser space.

Crypto Assets

Mr. Gensler reminded the investing public that crypto markets are “a highly speculative asset class.” He warned that, with crypto, investors are not getting the disclosure they get with other asset purchases. He argued that such disclosure reflects a basic bargain: “You, the investing public, can make your choices as to the risk you take, but there’s supposed to be full and fair disclosure and people aren’t supposed to lie to you. That’s the basic bargain, and then you get to choose.”

He explained that many of crypto tokens fall within the securities laws but are not registered, and, therefore, are not living up to the basic bargain—to the detriment of the investor. Further, he warned investors: “don’t think you actually own your tokens when you go into your digital wallet or your crypto wallet and you transfer ownership to the platform. If the platform goes down, guess what, you just have a counterparty relationship with the platform, and get in line at bankruptcy court.” He also warned them that, unlike the equity markets, “when [these platforms] take your custody, when they take your tokens, they can use them, they can trade them…these platforms are often trading against you. They’re actually making markets against you.”

Mr. Gensler said that contrary to popular belief, there are really only a handful of platforms, and that “this crypto-asset space is not that decentralized.” He said that the focus of the SEC’s attention is on these platforms, and how to protect the public with “basic market integrity” activities to prevent front running, manipulation and fraud.

SEC Spotlight: New Cybersecurity Rules Heading Your Way

SEC Chair on Regulation Best Interest

A day after his conversation at the FINRA conference, Mr. Gensler addressed state securities regulators to talk about the dangers inherent in broker-dealers or investment advisers providing advice digitally through investment platforms (e.g., robo-advising, brokerage apps, and wealth management apps). He questioned whether these advisers could provide these services and still act in the best interests of their clients (and not place their own interests in front of their clients'). He questioned how, in the digital age, regulators can ensure that broker-dealers (through Reg BI) and advisers (through their fiduciary duty) “live up to their obligations and the trust that’s been placed in them.”

Mr. Gensler highlighted financial innovations that raise these questions, referring to the use of predictive data analytics, built upon artificial intelligence and machine learning. He “coupled” those innovations with the advent of “differential marketing, differential pricing, and individually tailored behavioral prompts…called digital engagement practices…which are increasingly shaping many parts of our economy.”

Mr. Gensler asserted that these digital engagement practices raise issues of (i) bias (through the use of data that is itself biased) and (ii) systemic risk (concerning known predictive data analytics vulnerabilities like “herding,” “interconnectedness,” and “concentration”). The Chair stated that the SEC must safeguard against these biases and vulnerabilities.

As to the impact on brokers and adviser obligations, Mr. Gensler is concerned that the use of these applications—“behavioral nudges” that narrowly target each consumer with specific marketing and pricing—raise questions about whether digital engagement practices optimize for the investor’s benefit or for the platform’s revenue or performance. “When do behavioral nudges take on attributes similar enough to advice or recommendations such that related investor protections are needed?” he asked.  

As a result of these concerns, Mr. Gensler directed staff to develop new guidance on conflicts of interest inherent in these questions. Specifically, Mr. Gensler wants additional guidance to ensure that (i) brokers comply with their best interest obligations and “eliminate the conflict, don’t give the advice, or find some other way to ensure that they don’t put their interests ahead of the retail investor’s interests;” (ii) brokers and advisers demonstrate meaningful consideration of reasonably available alternatives; and (iii) brokers and advisers really consider costs and risks in the investor’s best interests.

Conclusion

Chair Gensler’s ability to make the case for expansive rule revision in the capital markets is predicated on addressing the needs of this transformative time. His eye on the big picture, his fluency with historical detail and legislative history merge with his professorial ability to convey the gravity of the moment. His admonitions on the need to keep up with market and technological innovation is compelling. His answer to this need is a waterfall of rulemaking. His efforts to address, simultaneously, all compliance risks concerning many “incredibly complex issues” (Mr. Cook’s words), however, sparks concern over how much market participants can absorb. As the SEC continues to release new requirements for broker-dealers, Bates will keep you apprised.

About Bates:

Bates Group has been a trusted partner to financial services firms and counsel for 40 years, providing leading industry expertise, knowledge, and data-driven solutions for legal, regulatory and compliance matters. Our professional staff and over 175 industry experts offer services in regulatory and internal investigations; litigation consultation and expert testimony; ongoing and project-based compliance services for BD, IA and hybrid firms; AML and financial crimes support, including for Money Services Businesses, fintech and cryptocurrency; big data; forensic accounting; and damages consulting.

For additional information and assistance, please follow the links below to our Practice Area pages:

Regulatory and Internal Investigations

Data Analyses and Analytics

Bates Compliance

Consulting and Expert Testimony

MSB, FinTech and Cryptocurrency

Retail Litigation and Consulting

Institutional and Complex Litigation

AML and Financial Crimes

Insurance and Annuities

Bates News  |  05-25-22

Bates Group’s Brandi Reynolds, CAMS-Audit, quoted in Crypto AML Guide from ComplyAdvantage

Brandi Reynolds, Manging Director of Bates Group's MSB, FinTech and Cryptocurrency practice, is quoted in the recent "Guide to Anti-Money Laundering for Crypto Firms" from ComplyAdvantage.

Ms. Reynolds, a leader in AML Compliance, is also a contributor to the Guide, which is designed to serve as a practical, hands-on resource for financial compliance professionals working in the crypto industry.

She provides expert insight on effective AML controls, including transaction monitoring, and weighs in with details—and warnings—on an area of compliance that “is arguably where crypto firms and traditional banking diverge the most."

Download the Full Guide from ComplyAdvantage

Events  |  05-25-22

Join Bates at SIFMA’s Anti-Money Laundering & Financial Crimes Conference - Booth #14

Bates Group is a proud sponsor of SIFMA’s Anti-Money Laundering & Financial Crimes Conference, May 25-26, 2022 in New York City. 

Visit Bates at booth #14 and speak with our representatives about your AML, Compliance, BSA, Crypto and Digital Currency AML needs.

Join Bates at SIFMA’s Anti-Money Laundering & Financial Crimes Conference - Booth #14 Join Bates at SIFMA’s Anti-Money Laundering & Financial Crimes Conference - Booth #14 Join Bates at SIFMA’s Anti-Money Laundering & Financial Crimes Conference - Booth #14 Join Bates at SIFMA’s Anti-Money Laundering & Financial Crimes Conference - Booth #14

SIFMA’s Anti-Money Laundering & Financial Crimes Conference is the leading forum for professionals from the securities industry, regulatory agencies and law enforcement to discuss current legal and regulatory developments and priorities in the AML and financial crime space. Learn about regulatory and examination priorities and lessons learned from enforcement; participate in interactive financial crime case studies; and hear industry perspectives on the latest developments in the AML and financial crime space.

Conference Details and Registration

This event will be eligible for continuing education credits, including CAMS, CLE and CPE credits.

We look forward to seeing you there!

Events  |  05-16-22

Visit Bates at the 2022 FINRA Annual Conference, Booth #8, in person or virtually May 16-18, 2022. We’re a Proud Sponsor.

Bates Compliance is proud to return as a sponsor of the 2022 FINRA Annual Conference. Join us May 16th-18th, 2022, in Washington, D.C. to discuss the issues that matter most for the financial services industry and to exchange ideas on timely compliance and regulatory topics, including current trends in technology, cybersecurity, risk management and much more.

Talk with Bates Compliance leaders live at the conference, or connect with us virtually if you are not able to attend in person. We will be on hand at booth #8 to answer all your questions about our ongoing and project-based compliance solutions for BDs, RIAs and Hybrid firms. Hear about practical insights and best practices that can help you maintain a successful compliance program, enter our booth raffle, and pick up some great giveaways!

Conference Details and Registration

Events  |  05-16-22

Meet Bates Compliance Managing Director Hank Sanchez at the SIFMA 2022 Operations Conference & Exhibition, May 16-19, 2022

Meet Bates Compliance Managing Director Hank Sanchez (pictured) at the SIFMA 2022 Operations Conference & Exhibition, May 16-19, 2022 at the JW Marriott Desert Ridge, Phoenix. The SIFMA OPS conference gathers operations, technology and regulatory leaders from across the securities industry to discuss the most critical priorities.

Conference Details and Registration

Bates News  |  05-09-22

Bates Group Expands its MSB, Fintech and Cryptocurrency Practice with Michael Lindemann and Edel Gonzalez - Focusing on AML, Compliance, MSB and MTL & Renewals

Bates Group welcomes Michael Lindemann, Director and Certified Anti-Money Laundering Specialist, to Bates Group’s MSB, FinTech and Cryptocurrency Practice. Mr. Lindemann joins Bates with more than 15 years of experience as a Financial Services and Compliance professional. Prior to joining Bates, Mr. Lindemann served as Chief Compliance Officer for Monex USA (formerly Tempus), where he oversaw legal, AML and licensing, and was responsible for the creation and maintenance of all AML compliance manuals, policies, and procedures, as well as company AML and compliance policies. Prior to joining Bates, he served as a senior analyst for Citi, where he initiated, processed, concluded, and documented investigations aimed at mitigating corporate risk in accordance with Know Your Customer (KYC) and Enhanced Due Diligence (EDD), USA PATRIOT Act, and Bank Secrecy Act (BSA) requirements. He has also held analyst and manager positions at Regions Financial and Wells Fargo.

Read Full Bio

Bates also welcomes Edel Gonzalez, Senior Consultant, to our MSB, FinTech and Cryptocurrency Practice. As the Senior Licensing & Compliance Specialist, Mr. Gonzalez is responsible for supporting the licensing needs of its Money Services Business (MSB) clients, including obtaining and renewing MSB-related licenses, as well as other communication with state regulators.  Before joining Bates, Mr. Gonzalez served as Head of Compliance, Americas for PingPong Global Solutions, an online payment processing service provider. In this role, he oversaw all aspects of the Americas regulatory compliance, licensing, AML/CFT and Sanctions programs including SARs, regulatory reporting, licensing, audit and examinations. Prior to that, Mr. Gonzalez was Regulatory Compliance Manager and later Director of Regulatory Compliance for Skrill USA (Paysafe Group). There, he managed the Merchant Onboarding team and advised merchants on product and service offerings, guiding them through the onboarding process for digital wallets and payment processing services. He also oversaw state MSB and Money Transmitter Licenses (MTL) licensing and renewals and managed state regulatory examination requests. Mr. Gonzalez holds industry licenses and certifications in Cryptocurrency, GDPR Compliance, Anti-Money Laundering, and more.

Read Full Bio

About Bates MSB, FinTech and Cryptocurrency Services

Bates Group’s MSB, FinTech and Cryptocurrency practice offers guidance and services for Money Services Businesses and Non-Banking Financial institutions, fintech and cryptocurrency firms. Our crypto subject matter experts work directly with firms and counsel to design and implement policies to ensure they are AML-compliant. Our MSB and AML Teams help obtain and maintain Money Transmitter Licensing, and they also engage clients with BSA/AML/OFAC Program Development, Risk Management, Training, Advisory Services, and Independent Reviews.

For more information, please contact:

Brandi Reynolds, CAMS-Audit, Managing Director, breynolds@batesgroup.com or 864-590-8696

Rob Ayers, BD and Consulting Expert, rayers@batesgroup.com or 303-478-2962

Compliance and Regulatory Alerts  |  05-05-22

SEC Exams Division Warns Firms to Tighten Up Compliance on the Misuse of Material Non-Public Information

On April 26, 2022, the SEC Division of Examinations (“the Division”) urged investment advisers to revisit their compliance policies, practices, and procedures concerning the misuse of non-public information (“MNPI”). In the Risk Alert, the SEC (i) reviewed the applicable Investment Adviser Act rules and ethical code considerations and (ii) described compliance deficiencies observed by the Division during its recent examinations.

The General rule (204A) requires advisers to have and enforce reasonably tailored written policies to prevent MNPI. The Code of Ethics rule (204A-1) requires advisers to have a code of business conduct applicable to certain “supervised persons”—identified as “access persons” (e.g., those with access to non-public information regarding client transactions, fund holdings, securities recommendations and the like, including officers, directors and partners)—who must report their “personal securities transactions and holdings to the adviser’s chief compliance officer.”  

Deficiencies

The Division found compliance deficiencies related to both rules. Regarding the general rule, the Division highlighted process and procedure insufficiencies related to:

(i) “alternative data,” (i.e., information obtained through non-traditional means like big data transaction analysis, social media, internet search, mobile phone geolocation or from consumer apps);

(ii) “value-add investors,” (i.e., clients or fund investors that are corporate executives or financial professional investors who are likely to possess MNPI); and

(iii) “expert networks,” (i.e., professionals and consultants who are paid for specialized information and research).

In each case, the Division observed gaps in how firms might cover the increasing array of information that may lead to the rule violation.

With regard to the Code of Ethics rule, the Division found deficiencies concerning the identification of “access persons,” failures to ensure access persons obtained prior approval before personally investing (including as to beneficial ownership in IPOs), and other reporting failures on personal securities transactions and holdings. In each case, the Division found additional provisions that might be incorporated into a firm’s ethics rules to address personal trading by access persons. 

The Division recommended that advisers develop “restricted lists” of issuers and prohibit trading in securities of those issuers. The Division also recommended that advisers consider adopting a policy that would require clients be given investment opportunities before advisers or employees.

Conclusion

Compliance issues related to MNPI are challenging. Compliance departments need to consider how to cover an increasingly broad set of data and new sources of information that might be deemed material and non-public. And, they must apply those considerations to an increasingly large pool of access persons while continuously updating their ethics code.  

Learn more about Bates Group's services:

Regulatory and Internal Investigations

Bates Compliance

Consulting and Expert Testimony

MSB, FinTech and Cryptocurrency

Retail Litigation and Consulting

Institutional and Complex Litigation

AML and Financial Crimes

Upcoming Events:

May 5-6, 2022: Bates Compliance’s Rhonda Davis and Hank Sanchez to Speak at FMA’s 2022 Securities Compliance Virtual Seminar on “Crypto and Digital Assets - AML and BSA/OFAC Fraud Implications.”

May 16-18, 2022: Visit Bates at the 2022 FINRA Annual Conference, Booth #8, in person or virtually. We’re a Proud Sponsor.

May 16-19, 2022: Meet Bates Compliance Managing Director Hank Sanchez at the SIFMA 2022 Operations Conference & Exhibition.

May 25-26, 2022: Visit the Bates Booth at SIFMA’s 2022 Anti-Money Laundering & Financial Crimes Conference in NYC.

Events  |  05-05-22

Bates Compliance’s Rhonda Davis and Hank Sanchez to Speak at FMA’s 2022 Securities Compliance Virtual Seminar on “Crypto and Digital Assets - AML and BSA/OFAC Fraud Implications.”

Bates Compliance’s Rhonda Davis and Hank Sanchez to Speak at FMA’s 2022 Securities Compliance Virtual Seminar on “Crypto and Digital Assets - AML and BSA/OFAC Fraud Implications.” Bates Compliance’s Rhonda Davis and Hank Sanchez to Speak at FMA’s 2022 Securities Compliance Virtual Seminar on “Crypto and Digital Assets - AML and BSA/OFAC Fraud Implications.”

Bates Compliance Managing Directors Rhonda Davis and Hank Sanchez (pictured) will be speaking at the Financial Market Association's 2022 Securities Compliance Virtual Seminar, May 5-6, 2022. This 2-day virtual event focuses on current compliance topics, new rules or interpretations and regulatory initiatives for financial institutions and their affiliated broker dealers.

Rhonda and Hank will be on Friday's panel: Crypto and Digital Assets - AML and BSA/OFAC Fraud Implications. The speakers will address topics including the SEC proposal re: “communication protocol systems,” FinCEN rulemaking and KYC/CIP for cryptocurrency platforms that qualify as “financial institutions” under BSA , and Cryptocurrency-based funds 1933 Act vs. 1940 Act protections.

CLE credit is available.

Webinar Details and Registration

FMA is a non-profit 501(c)(6) educational association dedicated to providing the financial services industry with quality capital markets education, including: legislative and regulatory updates; securities dealer and public finance compliance; trading risk management; retail and institutional sales compliance; and fiduciary compliance.

Events  |  05-03-22

Bates is a Proud Sponsor of the 2022 SWIFS Spring Symposium, May 3, 2022

Bates is proud to sponsor the Southwest Women in Financial Services (SWIFS) 2022 Spring Symposium, May 3rd at Raymond James headquarters in St. Petersburg, FL. The agenda includes:

  • Keynote: Cori Flam Meltzer (CFM Mediation), "The XX Factor - How Gender Affects Your Workplace in Ways You Don't Realize"
  • Workshop: "What in the World is Metaverse?"
  • Panels: "Regulation Innovation - Evolving Securities Issues for a Digital World"; "How Do You Define Success?"
  • Member of the Year Award
  • Networking

Date: May 3, 2022

Time: 12:00 - 8:30 p.m.

Event Details

Bates Research  |  04-28-22

SEC Spotlight: New Cybersecurity Rules Heading Your Way

In a January 2022 speech before the Northwestern Pritzker School of Law’s Annual Securities Regulation Institute, SEC Chair Gary Gensler broadcast his intention to tackle an array of cybersecurity concerns. He listed four targets for revised regulatory policy: (i) SEC registrants; (ii) public companies; (iii) service providers that work with SEC registrants; and (iv) the SEC itself. To date, he has moved the ball forward on the first two of these targets, and his most recent announcements suggest more to come. Here is a quick summary of these proposed rules before we dive into the details:

  • On February 9, 2022, the SEC proposed rules on cybersecurity risk management for investment companies, registered investment advisers, and business development companies.
  • On March 9, 2022, the SEC proposed additional rules to enhance disclosures on cybersecurity risk management, strategy, governance, and cybersecurity incident reporting by public companies.
  • In an April 14, 2022 address before the Financial and Banking Information Infrastructure Committee (FBIIC), a chartered committee of the President’s Working Group on Financial Markets, and the Financial Services Sector Coordinating Council (FSSCC)—a group comprised of financial service providers and financial industry associations—the SEC Chair expounded on the agenda he laid out in January, reaffirming his comprehensive approach on cyber security and indicating next steps.

Here are the latest developments.

Regulatory Developments for SEC Registrants

The rules proposed on February 9, 2022, require registered investment advisers, registered investment funds, and business development companies to strengthen their cybersecurity practices by (i) adopting written plans on cybersecurity risks; (ii) disclosing cybersecurity incidents to the public; (iii) reporting incidents to the Commission; and (iv) adding recordkeeping obligations. (Note the SEC Fact Sheet accompanying the rule proposal.) The SEC rationale is that the rule, if adopted, will ensure that registrants “maintain critical operational capability during a significant cybersecurity incident;” will provide investors with more information; and will “create incentives to improve cyber hygiene.”  Mr. Gensler also stated that the required disclosures would offer more insight into intermediaries’ cyber risks.

Industry to SEC: Reconsider Proposals

Industry comments on the proposal (submitted by the April 11, 2022, deadline) were supportive of the goal but critical of the means. SIFMA asked the Commission to reconsider the proposal, characterizing it as an “overreach” and challenging the proposed rule’s reliance on the antifraud authority under the Advisers Act. SIFMA argued that the Commission “should assist institutions to enhance cybersecurity programs instead of drafting new rules that punish advisers if there is a perceived deficiency in security measures.” SIFMA made several recommendations on the rule proposal, among them dispensing with public disclosure of details relating to a cybersecurity incident or cyber risks and adopting a principles-based approach to cyber risk management, rather than a "one-size-fits-all" system. Notably, on March 31, 2022, SIFMA released its own cybersecurity recommendations on strengthening defenses against cyberattacks. The recommendations were based on a broad biennial cybersecurity exercise among financial institutions. Other industry associations contended that the proposed regulations were not proportionate to the actual threats to funds and advisers, were too burdensome, or suffered from a lack of reporting uniformity.

Just Around the Corner for Registrants

In his April 2022 speech, Chair Gensler broadcast other cybersecurity areas ripe for SEC review. First, he suggested that it was time to “freshen-up” Reg SCI (Regulation Systems Compliance and Integrity)—the rule currently covering exchanges, clearinghouses, alternative trading systems, and self-regulatory organizations, among others—to ensure that they have “sound technology programs, business continuity plans, testing protocols, data backups, and so on.” The Chair said he asked his staff to consider how to “broaden and deepen the rule,” possibly by expanding its coverage to include large market-makers and broker-dealers. Second, Mr. Gensler reported that he asked staff to offer recommendations to update Reg S-P—the rule that requires broker-dealers, investment companies, and investment advisers to safeguard customer records and information—perhaps by requiring breach notifications when a customer’s information is accessed without authorization. Finally, the SEC Chair asked staff for additional cybersecurity proposals specifically for broker-dealers along the lines of the February proposed rules for advisers.

Regulatory Developments for Public Companies

On March 9, 2022, the SEC proposed rules to enhance disclosures on cybersecurity risk management, strategy, governance, and cybersecurity incident reporting by public companies. The proposed rules would require (i) reporting about material cybersecurity incidents; (ii) periodic disclosures about a company’s policies and procedures on cybersecurity risks, on management implementation (including who’s responsible), on cybersecurity expertise and oversight at the board level; (iii) periodic updates about previously reported incidents; and (iv) disclosures in a specific format so that investors can better understand the risk management, strategy, and governance practices of the company. (Stay tuned for industry reaction due by May 9, 2022.)

Read about the SEC's 2022 Exam Priorities - with Bates' Annual Comparison Chart

Regulatory Developments for Service Providers Who Offer Operational Support

In his April 2022 address, Chair Gensler alluded to new cybersecurity regulations on financial service providers who offer operational support to registrants. These include providers of investor reporting systems, middle-office services, fund administration services, custody services, data analytics, trading and order management, and pricing and other data services. Mr. Gensler stated that he directed staff to make recommendations on the risks posed by these service providers, suggesting that new proposals might include notification requirements on (i) service providers that may cause or become aware of a cyber breach and (ii) registrants who may suffer customer data breaches as a result. An SEC proposed rule might parallel a new banking rule that went into effect on April 1, 2022, that requires bank service providers to notify as soon as possible their bank customers after determining that a "computer-security incident" occurred.

Regulatory Developments Turned Inward

In less-specific commentary on plans for regulatory reform of the SEC’s own cyber vulnerabilities, Chair Gensler reported that agency staff “continue to work to protect SEC data and information technology, as well as the industry data we need to carry out our mission,” noting only that staff will evaluate “our data footprint” and “improve our data collection processes.”  

Conclusion

In general, the SEC’s heightened focus on cybersecurity is consistent with repeated warnings of increased risk and examples of significant intrusions. The issue remains at the forefront of the regulators’ agenda. (See, e.g., our post on the SEC’s 2022 Examination Priorities, highlighting extra scrutiny on operational resiliency and cybersecurity.) FINRA, too, has been issuing regular alerts on a host of cybersecurity concerns. (See, e.g., a February 15, 2022 Alert and March 21, 2022 Alert regarding anticipated increases in risk resulting from Russia’s invasion of Ukraine; and an April 4, 2022 FINRA statement on mitigating recently found internet vulnerabilities that may affect its own software.)    

“Adopting a heightened posture,” as Jen Easterly, Director of the Cybersecurity and Infrastructure Security Agency (CISA) said last year, has consistently been supported by market participants. (Again, note SIFMA’s recent cybersecurity recommendations based on extensive outreach and engagement.) However, the promulgation of multiple and substantial SEC cyber rules on registrants and public companies in February and March 2022, and now the anticipated rules on brokers, financial service providers and others that Mr. Gensler spoke to in his April 2022 address, raises concern for some. Bates will continue to keep you apprised.

How Bates Helps:

Bates Compliance provides tailored solutions for financial institutions and investment advisers. Our compliance team includes senior compliance staff and former regulators, with expertise in the development of policies, procedures, supervisory and compliance processes, including in state and federal registration, supervision and oversight, recordkeeping and disclosure. Contact us today:

Hank Sanchez, Managing Director, hsanchez@batesgroup.com or 504-450-9632

Rory O'Connor, Director, roconnor@batesgroup.com or 860-671-7270

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

Bates Compliance

RIA Services

Broker-Dealer Services

Consulting and Expert Testimony

Regulatory and Internal Investigations

MSB, FinTech and Cryptocurrency

Retail Litigation and Consulting

Institutional and Complex Litigation

AML and Financial Crimes

Upcoming Events:

May 3, 2022: Bates is proud to sponsor the Southwest Women in Financial Services (SWIFS) 2022 Spring Symposium at Raymond James headquarters in St. Petersburg, FL.

May 5-6, 2022: Bates Compliance’s Rhonda Davis and Hank Sanchez to Speak at FMA’s 2022 Securities Compliance Virtual Seminar on “Crypto and Digital Assets - AML and BSA/OFAC Fraud Implications.”

May 16-18, 2022: Visit Bates at the 2022 FINRA Annual Conference, Booth #8, in person or virtually. We’re a Proud Sponsor.

May 16-19, 2022: Meet Bates Compliance Managing Director Hank Sanchez at the SIFMA 2022 Operations Conference & Exhibition

May 25-26, 2022: Visit the Bates Booth at SIFMA’s Anti-Money Laundering & Financial Crimes Conference

Bates Research  |  04-14-22

SEC 2022 Exam Priorities and Chart: Retail Investor Protection, Private Funds, ESG, Cybersecurity and Crypto-Assets Top this Year’s List

Image © [Kristina Blokhin] /Adobe Stock

SPECIAL REPORT - Including Bates' 2022 SEC Priorities Comparison Chart

In its annual priorities report, the SEC Examinations Division focused on areas of “heightened risk to investors, registrants and the markets.” The report details examination programs covering (i) investment advisers and investment companies, (ii) broker-dealers and exchanges, (iii) clearance and settlement, (iv) oversight of FINRA and the MSRB, and (v) system technology (“Reg SCI”) for securities exchanges, self-regulators and other market participants.

The priorities list serves as both a reflection of new and evolving threats, and as a reminder for firms to address compliance gaps or deficiencies the Division observed over the past fiscal year. This year, the Division highlighted priorities concerning retail investor protections, private funds, environmental, social and governance (“ESG”) investing, cybersecurity and crypto-assets. Bates tracks that evolution to help firms consider how best to prepare for upcoming exams and to better anticipate how their resources might be directed. Here’s a look at the Division’s perspective and their exam priorities for 2022.

Leadership Messaging

Division Acting Director Richard Best and Acting Deputy Director Joy Thomson opened their priorities discussion citing data points from the Division’s FY2021 examination record. They reported a 3% increase in examinations (3,040), the issuance of 2,100 deficiency letters, hundreds of outreach meetings, 190 referrals to the Division of Enforcement, and asserted that examinations in 2021 returned more than $45 million to investors. Leadership offered these results against the backdrop of high market volatility, the effects of the pandemic and challenging market trends (such as the fast growth in the number of RIAs—an increase of 20% over the last five years) which demanded greater regulator efforts to achieve consistent year-over-year market coverage.

In a separate section, Division leadership accentuated the positive by describing efforts to promote compliance engagement and acknowledging best practices. In particular, they focused on the importance of resiliency for an effective compliance program and how the most resilient programs: (i) are “inclusive,” and encourage “input across all business and operational lines;” (ii) are “flexible” with management processes that can adapt and ensure business continuity; and (iii) subject their policies and procedures to periodic review and testing.

The Division leadership also provided a link to a list of a variety of previously issued Risk Alerts on relevant subject matter.  

Highlighted Priorities for 2022

As can be seen in Bates’ 2022 Exam Priorities Comparison Chart below, the Division emphasized a series of existing priorities and added several new ones.

SEC 2022 Exam Priorities and Chart: Retail Investor Protection, Private Funds, ESG, Cybersecurity and Crypto-Assets Top this Year’s List
SEC 2022 Exam Priorities and Chart: Retail Investor Protection, Private Funds, ESG, Cybersecurity and Crypto-Assets Top this Year’s List
SEC 2022 Exam Priorities and Chart: Retail Investor Protection, Private Funds, ESG, Cybersecurity and Crypto-Assets Top this Year’s List

Legend

SEC 2022 Exam Priorities and Chart: Retail Investor Protection, Private Funds, ESG, Cybersecurity and Crypto-Assets Top this Year’s List
© 2022, Bates Group LLC
Source: U.S. SEC Division of Examinations 2022 Examination Priorities (Compiled by Alex Russell, Managing Director, White Collar, Regulatory and Internal Investigations)

Download this chart as a PDF

Protecting Retail Investors

Compliance with Regulation Best Interest (“Reg BI”) and the Advisory Act fiduciary standard remains a top priority and underscores every aspect of the priority list. The Division stated that examiners will review firm compliance with Reg BI and the fiduciary standard by concentrating on the following: “consideration of investment alternatives” (notably, about potential risks, rewards, and costs), management of conflicts of interest (particularly with respect to incentive practices in connection to certain products or services), trading (re: best execution), disclosures on Form ADV and Form CRS, account selection for brokerage, advisory, or wrap fee accounts, as well as account conversions and rollovers. For both broker-dealers and RIAs, examiners will focus on compliance program effectiveness, testing, and training.

Consistent with its past priorities, the Division emphasized that it would examine for recommendations and sales practices related to complex investments. This year it highlighted “SPACs, structured products, leveraged and inverse exchange traded products (ETPs), REITs, private placements, annuities, municipal and other fixed income securities, and microcap securities.” The Division noted that complex product recommendations, cost assessments, sales-based fees, and conflicts of interest may be subject to “enhanced examination.” Further, the report stated that examiners will evaluate the compensation structures for financial professionals and may focus on highly compensated financial professionals. For RIAs, examinations will focus on fees and expenses, revenue sharing or other compensation arrangements, complex products, and best execution. “Extra attention” will be paid to the use of “turnkey asset management platforms that provide technology, investment research, portfolio management and other outsourcing services.”

Private Funds

The Division reported that 35% of RIAs manage about $18 trillion in private hedge funds, private equity funds, and real estate funds. The size, complexity, and significant growth of this market has pushed the Division to prioritize examinations on practice and procedure, and to ensure compliance with an adviser’s fiduciary duty. These examinations will assess risks, focusing on fees and expenses, custody, fund audits, valuation, conflicts of interest, disclosures of investment risks, and controls around material nonpublic information. The Division stated it will also examine for: calculations and allocations on fees and expenses; the “potential preferential treatment of certain investors by RIAs;” disclosure and reporting requirements under the Custody Rule, as well as for cross trades, principal transactions, or distressed sales; and conflicts of interest concerning liquidity events. Portfolio strategies, risk management, and investment recommendations (e.g., around conflicts and disclosures on SPACs) will also be reviewed.

Environmental Social and Governance Investing (ESG)

The Division stated that there is a risk that portfolio management disclosures on environmental social and governance (“ESG”) investment strategies could involve “materially false and misleading statements or omissions, which can result in misinformed investors.” Due to concerns over the lack of standardization, multiple approaches to ESG portfolio investing, and failures “to address legal and compliance issues with new lines of business and products,” the Division prioritized (i) examining ESG advisory services and products for disclosure accuracy, (ii) review of proxy voting policies and procedures for consistency with ESG mandates; and (iii) examining for misrepresentations in performance advertising and marketing (and potential “greenwashing”).

Operational Resiliency and Cybersecurity

The Bates chart shows that last year’s focus on information security continues in 2022. The Division will examine firms to ensure that they are applying security controls to protect investor information, records, and assets and to prevent unauthorized account access. Specifically, examiners will review policies and practices on how the firm: (i) supervises vendors and service providers; (ii) addresses malicious email activities; (iii) responds to cyber incidents, (e.g., ransomware attacks); (iv) detects red flags concerning identity theft; and (v) manages operational risk (e.g., remote working employees). Further, the Division said it will review registrants’ business continuity and disaster recovery plans, considering climate risks and other disruptions to business operations.

CONTACT US TO DISCUSS YOUR SEC REGULATORY, COMPLIANCE AND AML NEEDS

Crypto-Assets and Emerging Technologies

Concerned about the risks associated with automated investment advice to clients (i.e., “robo-advisers”), the use of financial mobile apps, and increases in crypto-asset trading, the Division stated that examiners will review whether RIAs and broker dealers considered the risks these technologies may add to their compliance programs. As a result, examiners will target firms that offer new digital products and services (“e.g., fractional shares, ‘Finfluencers,’ or digital engagement practices”). Examiners will determine whether (i) operations and controls are in place that are consistent with disclosures and standards of conduct; (ii) algorithmic recommendations are consistent with investors’ strategies; and (iii) associated risks are addressed. Those trading in crypto-assets will be examined for adequate custody arrangements, as well as to assess whether they have met their respective standards of conduct. The Division added that it will also examine the trading of mutual funds and ETFs that may offer exposure to crypto-assets “to assess, among other things, compliance, liquidity, and operational controls around portfolio management and market risk.”

General Examination Issues

The remaining examination priorities mentioned in the Report are largely perennial. Under its program on investment advisers and investment companies, the Division will continue to examine marketing practices and whether investment advice and recommendations are consistent with the appropriate standards. Programs will be assessed for “custody and safety of client assets, valuation, portfolio management, brokerage and execution, conflicts of interest, and related disclosures,” among others. Registered funds will be examined for disclosure and accuracy of reporting, liquidity risk practices, and on the firms’ oversight of third-party service providers. The Division stated that it will prioritize examination of EFTs, money market funds, and business development companies as well as mutual funds that invest in private funds.

Under the broker-dealer and exchange program, the Division highlighted its focus on compliance with Reg BI regarding obligations in the offer, sale, and distribution of microcap securities. The Division stated that examinations will also address timely and accurate municipal issuer disclosure and trading activity in fixed-income securities (i.e., sales practices, best execution, markups/markdowns and commissions, and confirmation disclosure.) Further, the Division noted “the responsibility of broker-dealers who hold customer cash and securities to comply with the Customer Protection Rule and Net Capital Rule.” Examiners will determine compliance with requirements “for borrowing fully paid and excess margin securities from customers; and funding and liquidity risk management practices, with an eye toward the management of stress events.” 

Anti-Money Laundering

Consistent with last year’s report, the Division separated out the importance of compliance with anti-money laundering Bank Secrecy Act rules for broker-dealers and registered investment companies. The Division reiterated that examiners will continue to assess: (i) the adequacy of customer identification programs; (ii) SARs filing performance; and (iii) whether firms are conducting appropriate customer due diligence, beneficial ownership review, and adequate testing of their programs. These exams are also meant to ensure that firm policies are appropriately tailored to the characteristics of the firm and the products and services sold to their clients.

Conclusion

This year, several conclusions can be drawn from the new priorities list. First, the importance of the Reg BI standards to the risk-based approach is taking root, and this year’s emphasis on the Advisor’s Act fiduciary standard is significant. Reg BI has always been emphasized in the context of retail investor protection, but this year’s priorities show that the Division will not only hold advisers and brokers to their respective standards on established rules but will also integrate these standards on newly developing priorities. Preparation for this year’s examination priorities on private funds, ESG, cyber and crypto-assets is a continuation of an ongoing process that requires deeper consideration of firm activities against these standards. Second, the new priorities align with the SEC’s policy agenda on each of these matters. As proposed rules are being contemplated on climate disclosure, crypto-assets, cybersecurity, private funds (e.g., on SPACs), how the SEC examines firm’s compliance programs on these topics this year will matter—if only as prelude to future obligations. Finally, technology is multiplying the types of risks that firms need to cover to be in compliance. It is not yet clear, however, whether the regulatory framework adequately enables firms to assess and address all potential risks. As the chart shows, compliance regulation is expanding to cover more products, more risk and more innovation. It takes a lot to keep up—Bates will continue to keep you apprised.

To discuss support for these regulatory and compliance priorities, please contact:

Alex Russell, Managing Director, White Collar, Regulatory and Internal Investigations, at ARussell@batesgroup.com 

Hank Sanchez, Bates Compliance Managing Director, at HSanchez@batesgroup.com

Rory O’Connor, Bates Compliance Director, RIA Compliance, at ROconnor@batesgroup.com

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Compliance and Regulatory Alerts  |  04-12-22

SEC Proposes New Disclosure Rules on Climate Change

In a broad new rule proposal, the Securities and Exchange Commission would require both domestic and foreign registrants to provide climate-related information in their filings and periodic reports. The proposed rule would require disclosure of “climate-related risks that are reasonably likely to have a material impact on its business, results of operations, or financial condition.” A registrant would be required to first assess and then disclose its greenhouse gas emissions and other “climate-related financial metrics” in their audited financial statements. The proposed rule would also require a company’s board and management to provide information on its climate change risk management and risk mitigation processes. 

The SEC is proposing a gradual phase-in period for rule compliance considering a registrant’s filer status, and their ability to assess the risks and comply with climate-related financial metrics. The short comment deadline is May 20, 2022, or thirty days after publication of the rule in the Federal Register – whichever is longer.

How Bates Can Help:

Bates Compliance provides tailored compliance consulting solutions for financial services clients. Our compliance team includes senior compliance staff and former regulators with expertise in the development of policies, procedures, supervisory processes, and best practices to help enhance compliance and supervisory systems. Bates ESG consultants and experts can help your firm achieved ESG compliance.

Please contact Bates Compliance Managing Director Hank Sanchez and Insurance Managing Consultant Greg Faucher to learn more.

Compliance and Regulatory Alerts  |  04-07-22

FINRA Clarifies and Cautions Firms on Potential Supervisory Liability of Chief Compliance Officers

In a reminder to (i) firm management on their supervisory obligations under FINRA Rules, and (ii) Chief Compliance Officers (“CCOs”) on their potential liability within a firm’s supervisory system, FINRA distinguished between the two in a recent Notice and detailed how it would make liability determinations on an enforcement action against a CCO for a failure to reasonably supervise. This guidance on FINRA Rule 3110 (“Supervision”) is significant, as it gets to the entire workings of the regulator’s compliance framework. Indeed, FINRA clarifies its expectations on supervision by emphasizing the “vital” role of the CCO to help “protect investors and market integrity, as well as the member firm itself.” The Notice reviews the scope of the FINRA supervision rule, the role of the CCO, and how FINRA determines liability against a CCO when it is applicable under the rule. Here are some takeaways from the FINRA guidance. 

FINRA Rule on Supervision

In reviewing the scope of Rule 3110, FINRA highlights the difference between the firm’s management’s supervisory responsibility and a CCO’s responsibility. The Notice makes clear that the management is responsible for designating individuals for supervisory responsibility. This might be done expressly (i.e., through written procedures) or impliedly (i.e., ad hoc or based on exigencies). Accordingly, FINRA asserted that it will look to management and supervisors first, “to determine responsibility for a failure to reasonably supervise.”  

FINRA clarified that CCOs act in an advisory—not supervisory—capacity, drawing a distinction between supervision and compliance. As a result, supervisory liability does not attach to a firm's CCO unless the firm “conferred upon the CCO” a supervisory role and, if so, only when the CCO “failed to discharge those responsibilities in a reasonable manner.” Therefore, FINRA would first consider, for example, whether the CCO is responsible for creating the firm's supervisory procedures or for enforcing the firm's supervisory compliance procedures (in order to establish that the CCO is operating in a management supervisory capacity) before there could be a determination on CCO liability.

Determinations of Liability

Once a CCO is identified as a designated supervisor, FINRA would determine whether to bring an enforcement action after an assessment of the CCO’s actions under a reasonableness standard, judged against factors for reviewing supervisors. Examples of actions that could lead to CCO liability include: awareness of and failure to address red flags or misconduct, failure to establish or enforce written procedures, and failures that lead to violative conduct that were likely to cause customer harm. Mitigating factors to CCO liability include insufficient support by the firm (i.e., staffing, budgets or training) and poorly defined or unduly burdensome supervisory responsibilities, among others. Such mitigating circumstances may result in a Cautionary Action Letter rather than a disciplinary action. FINRA noted that these determinations are made on a case-by-case basis.

Conclusion

As the number of rules expands, pressure is mounting on CCOs to ensure adequate compliance on the entire range of regulatory oversight. In the Notice, FINRA acknowledges the importance of the CCO role to the entire regulatory framework:

“CCOs and their compliance teams help design and implement compliance programs, help educate and train firm personnel, and work in tandem with senior business management and legal departments to foster compliance with regulatory requirements.”

By asserting that CCO liability for supervisory failures only “represent a small fraction of the enforcement actions involving supervision that FINRA brings each year,” and by drawing attention to other designated supervisors as potentially liable for such failures, FINRA appears to be trying to assure CCOs that they are not being exclusively targeted within the framework due to their title alone. Bates will continue to keep you apprised.

How Bates Helps

Bates Compliance provides tailored solutions for financial institutions and investment advisers. Our compliance team includes senior compliance staff and former regulators, with expertise in the development of policies, procedures, supervisory and compliance processes, including in supervision and oversight, recordkeeping, and disclosure.

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

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Bates Research  |  03-31-22

President Biden Issues Executive Order on Crypto Seeking “Whole-Of-Government Approach”

In a recent article assessing the regulatory horizon for cryptocurrency, Bates identified several areas of uncertainty which raised certain questions. Among them were whether the President would offer the kind of direction that would move federal agencies and legislators toward consensus on regulating the burgeoning crypto-marketplace; whether the resulting framework would encourage the development of—or place strict limitations—on stablecoins; whether proposed legislative solutions would be officially endorsed to empower various agencies with explicit regulatory and enforcement authority over digital assets; and whether the money laundering and national security implications of crypto would be integrated with other supervision within this new framework.   

We may now have answers to those questions in the form of an Executive Order and accompanying Fact Sheet on “ensuring responsible development of digital assets,” issued by President Biden on March 9, 2022. Here is a summary of the main points.  

The Executive Order

The Executive Order is described by the White House as a set of priorities for a “whole-of-government approach” to manage the risks from digital assets. In other words, it is not a framework itself, but rather a call to action for government agencies to collaborate on policy recommendations for legislation and regulation of the digital asset space. The Order (as clarified in the Fact Sheet) details six core U.S. goals and concerns:

  1. the protection of U.S. consumers, investors and businesses while promoting equitable economic growth;
  2. the protection of U.S. financial stability and mitigation of systemic risk;
  3. the mitigation of illicit finance and national security risks;
  4. the promotion of U.S. leadership in the global financial system, including the exploration of a U.S. Central Bank Digital Currency ("CBDC");
  5. the promotion of equitable access to safe and affordable financial services; and
  6. the promotion of technological advances while prioritizing “privacy, security, combating illicit exploitation, and reducing negative climate impacts.”

The Executive Order requires collaboration from many administrative agencies on reports, action plans, annexes, and recommendations consistent with these objectives. For example, to protect consumers, investors, and businesses, the Treasury Secretary, the Attorney General, and the White House Director of the Office of Science and Technology Policy et. al. are directed to produce three reports on the implications of digital assets to payment system infrastructures, law enforcement, and on energy and the environment. These reports are due by September 5, 2022.

To promote financial stability and mitigate systemic risks, the Treasury Secretary and the Financial Stability Oversight Council (whose members include the SEC, the OCC, the CFTC, the CFPB and the Federal Reserve Board Chair) must produce a report by October 5, 2022.

To limit illicit financial and national security risks, a host of agencies including Treasury, Homeland Security, Commerce, the Office of Management and Budget, and others must (i) submit an annex to the National Strategy for Combating Terrorist and Other Illicit Financing, (ii) submit a coordinated action plan, and (iii) notify all relevant agencies of legislative proposals or necessary rulemakings.

On the creation of a U.S. CBDC, a similar group was directed to prepare a “Digital Assets Report,” an assessment of the legislative changes that would be necessary, a technical evaluation (all of these by September 5, 2022), and corresponding legislative proposals to be prepared by the Attorney General, the Treasury Secretary, and the Federal Reserve Board Chair by October 5, 2022.

Let Bates Help You Navigate AML Compliance for Cryptocurrencies - Learn More

Toward a Comprehensive Framework

The Order encourages independent agencies mostly through the umbrella FSOC to report on digital asset stability risks and regulatory gaps and to deliver recommendations to address such risks. While the Executive Order serves as a high-level list of general priorities, these required submissions serve as a method through which a common framework may emerge. As Bates previously reported, the current regulatory vacuum has led many independent agency regulators (e.g., the SEC) to assert themselves in this area. The Executive Order is an attempt to bring the federal administrators into a “whole of government” approach, but it really applies only to a "whole of the federal government." It does not address the myriad State legislative initiatives or regulatory oversight rules on money transmitting licensure (see, e.g.New York DFS regulations).

Conclusion

The Executive Order has been positively received. In large measure, that is because it is a very high-level set of unobjectionable goals. It does provide a process that might lead to the kind of direction that market participants have long called for. The fact that the digital asset market has a three trillion-dollar capitalization, as highlighted in the Executive Order, speaks to how behind the curve the United State is in creating a unified framework.

Though it kicks the can down the road by forcing hard compromises at the administrative level, the Executive Order has made clear that cryptocurrencies are here to stay. That is, it has rendered the debate about whether to legitimize them—long the dominant question—moot. Further, it is clear from the Order that a U.S.-issued CBDC is on the way. 

As to the many reporting directives, reaching consensus is unlikely to be an easy task, particularly given that many of the agencies charged with the effort (independent or not) have already forged positions mostly by extending their interpretations of their authorities. And this is all before the legislative process even starts. So, for now, there is still little change in the regulatory environment. Bates will continue to keep you apprised.

About Bates MSB and Cryptocurrency Services

Bates Group’s MSB and FinTech practice offers guidance and services for Money Services Businesses and Non-Banking Financial institutions, fintech and cryptocurrency firms. Our crypto subject matter experts work directly with firms and counsel to design and implement policies to ensure they are AML-compliant. Our MSB and AML Teams help obtain and maintain Money Transmitter Licensing, and they also engage clients with BSA/AML/OFAC Program Development, Risk Management, Training, Advisory Services, and Independent Reviews.

For more information, please contact:

Brandi Reynolds, CAMS-Audit, Managing Director, breynolds@batesgroup.com | 864-590-8696

Rob Ayers, Consulting Expert, rayers@batesgroup.com | 303-478-2962

Compliance and Regulatory Alerts, Bates Research  |  03-30-22

SEC Division of Examinations Announces 2022 Examination Priorities

Image © [Kristina Blokhin] /Adobe Stock

The Securities and Exchange Commission’s Division of Examinations has just released its 2022 examination priorities report, focusing on Private Funds, ESG Investing, Standards of Conduct (including Regulation Best Interest, Fiduciary Duty, and Form CRS), Information Security and Operational Resiliency, and Emerging Technologies and Crypto-Assets. The Division publishes its examination priorities annually to provide insights into its risk-based approach, including the areas it believes present potential risks to investors and the integrity of the U.S. capital markets. You can read the press release here

Stay tuned for our annual commentary, coming soon, on the SEC's 2022 priorities and how they may impact your legal, regulatory and compliance matters.

Compliance and Regulatory Alerts  |  03-30-22

FINRA Proposes Rule to Speed Up Arbitration for Seriously Ill or Elderly Claimants

In an effort to ensure that seriously ill or are elderly claimants are able to “participate meaningfully” in FINRA arbitration proceedings, FINRA proposed amendments to the Code of Arbitration Procedure to accelerate certain case processing deadlines. Under the proposed rule, parties to the proceeding must request the expedited deadlines.

Under its existing program, FINRA can accelerate certain processes, such as arbitrator selection, scheduling, and executing the final awards, on a voluntary basis. Currently, FINRA does not provide for “shortened, rule-based processing deadlines for parties” or offer any related guidance. FINRA determined that its current program “has not resulted in meaningfully shortened case processing times.”

Under the proposed rule, claimants 75 years or older, or those who certify to a “medical diagnosis and prognosis” and reasonably believe that an “accelerated processing is necessary to prevent prejudicing their interest,” can request a determination by the Director of Dispute Resolution to shorten the time it takes to complete the arbitration. If approved, the timeframe for completion of the process, which includes discovery, motions, hearings, and the award, would be set at 10 months or less. Deadlines for each part of the process would be  reduced (e.g. time allowed for serving an answer reduced from 45 days to 30 days).

FINRA requested comments on all aspects of the proposal and prompted responses with specific questions for arbitrators concerning their practical experiences. Comments are due May 16, 2022.

How Bates Helps

Bates stands ready to support clients with their FINRA arbitration matters. For FINRA arbitration and litigation matters, please visit the following services:

Litigation Services and Damages Analyses

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Bates News  |  03-29-22

Podcast: Bates’ Brandi Reynolds Speaks on “How to Scale an AML/CFT Program for Crypto”

Podcast: Bates’ Brandi Reynolds Speaks on “How to Scale an AML/CFT Program for Crypto”

According to a recent report on the state of Financial Crime in 2022, 98% of firms say they are crypto native, offer crypto services, or are planning to do so in the future. With crypto services now reaching a mass audience, how do firms scale their compliance efforts?

Bates Managing Director Brandi Reynolds recently joined ComplyAdvantage for the latest episode of their Uncover podcast series to explore this question.

Hear Brandi’s insights how companies are scaling AML/CFT programs in the fast evolving crypto world.

Listen to Podcast Now

The Uncover podcast can also be found on Apple Podcasts and on Spotify.

Bates Research  |  03-22-22

Dispelling Five Common Misconceptions About Cryptocurrencies

by Brandi B. Reynolds, CAMS-Audit, Manging Director and Paul Nelson, Consulting Expert

As cryptocurrency becomes more mainstream, many people are looking to learn more, including bankers and regulators. Because of our work in this industry, we often hear many misconceptions about cryptocurrencies, so we have created this list to dispel some of those common myths. 

It is important to do so, because financial institutions are currently trying to determine how to integrate cryptocurrency into the traditional banking and investment worlds. To do that, financial institutions must understand the risk. 

Additionally, regulators continue to look for ways to create additional oversight of this developing industry. In this role, regulators are both altruistically trying to protect financial institutions from risk and self-interestedly trying to expand their regulatory reach. Therefore, it is of the utmost importance to have a clear understanding of the industry.

But why does it matter? Cryptocurrency could just be a fad that’s not here to stay, right? After all, Warren Buffett has compared cryptocurrencies to the 17th-century Dutch tulip craze[1]. Years later, Berkshire Hathaway bought $1 billion worth of stock in a digital bank that focuses on crypto.[2] He didn’t think he was buying 21st-century tulips.


Here are our top five misconceptions about cryptocurrencies:

 

1 - Cryptocurrency is Entirely Unregulated

While there are no controls over the creation of crypto and no requirement of capital support for it, cryptocurrency is currently regulated in the United States. Anti-money laundering and combatting the financing of terrorism (AML/CFT) regulations for cryptocurrency are either already in place or are in the process of rolling out in jurisdictions around the world.

The Financial Crimes Enforcement Network (FinCEN)—the bureau of the U.S. Department of the Treasury that collects and analyzes information about financial transactions—has many advisories and interpretive opinions on cryptocurrency. The FinCEN controls have an important effect on the creation, transfer, and recordkeeping of crypto.

Internationally, the Financial Action Task Force (FATF) issued recommendations for the regulation of virtual assets in 2019. FATF is the inter-governmental body that sets global standards relating to anti-money laundering and combating the financing of terrorism. These recommendations are now being implemented and applied around the world.

Licensing and registration also exist in many jurisdictions.

2 - All Cryptocurrency Transactions are Anonymous

This is simply not true. Cryptocurrency transactions are only anonymous to a certain extent. Many exchanges, brokers, etc. operate in countries that regulate financial transactions. The regulatory systems uniformly require that those exchanges and brokers must obtain information about those conducting transactions. Additionally, whenever someone trades crypto on any blockchain, the trader’s address will always be there, and that address is traceable. As such, the address enables transactions to be monitored for illicit activity.

It's also important to note that cryptocurrencies are not all the same. Bitcoin, for example, is pseudonymous rather than anonymous—it doesn’t disclose the user’s personal data during the transaction. However, there are ways of tracking identities across the blockchain.

Other cryptocurrencies provide much higher levels of anonymity. Monero and Dash are two coins that focus on privacy. Even so, when you use cryptocurrency on certain exchanges, as noted above, you often have to submit personal data, and many exchanges cooperate with governments in tracking fraudulent activity.

3 - Cryptocurrency Transactions are Fully Secure

This one comes close to being true. Crypto is complicated, beginning with the high computing power required to create a coin and including the requirement that all segments of a blockchain accept the coin as valid. Storage security is enhanced by the protections surrounding the wallet where a coin may be stored. The creation of crypto seems as close to fully secure as any electronic transaction can be.

The blockchain may be unhackable, but the path as the crypto enters the market is not so secure. If used to pay for goods, services, or ransom, crypto becomes a little less secure. Because the transaction will not go through any payment system, however, it’s still highly secure. From the point of view of a fraudster, the irreversibility of a crypto transaction is a security enhancement. Security still depends on the security of the system holding the crypto, whether it’s been obtained honestly or not.

In a well-publicized action in 2021, the US Department of Justice recovered several million dollars in Bitcoin from the hackers who attacked the Colonial Pipeline. The DOJ didn’t explain how they did it, but the recovery shows that crypto transactions aren’t always secure.

4 - Cryptocurrency Transactions are Primarily Used for Illicit Activity

This one is not new and is probably still on people’s minds from the time Silk Road was in operation. While cryptocurrency can be used for illicit activity, it is not used solely for that purpose. Criminals are early adopters of many new technologies, and their initial embrace of cryptocurrency has helped shape its overall reputation. News reports still sometimes note crypto’s association with criminal activity.

Although today more people understand that cryptocurrency is traceable, criminals still use it for the same reason people use crypto for legitimate purposes: it’s instantaneous, cross-border, and liquid. According to various research items, illicit activity accounts for a small percentage of cryptocurrency transactions compared to traditional payment networks.[3]

5 - Bitcoin is Equivalent to Cryptocurrency

This misconception is waning in importance. Five or six years ago when Bitcoin first hit the public’s imagination, many considered it to be all of cryptocurrency. At the time, it probably constituted a huge majority of the value held in crypto. It still represents around 60% of the assets in crypto.

As of January 2022, there were over 16,000 different crypto currencies—of which 9,300 are active—according to coinmarketcap.com, a cryptocurrency tracking service. Some of the cryptos have been designed to be used in specific types of transactions, while others have been designed to be easier to create than Bitcoin. Some peg their value to a dollar or another currency.   

The coins (or tokens) that make up the cryptocurrency universe are not uniform. They are not solely Bitcoin.


[1] https://cointelegraph.com/news/chief-economist-of-major-investment-firm-makes-tired-comparison-of-crypto-to-tulips

[2] https://fortune.com/2022/02/16/warren-buffett-invested-1-billion-crypto-bank/

[3] https://www.swift.com/sites/default/files/files/swift_bae_report_Follow-The%20Money.pdf

How Bates Helps

Bates advises financial institutions and other companies working in the unpredictable and fast-growing sector of cryptocurrency. We work with crypto traders, trading platforms, ATM operators, hedge funds, exchanges, crypto-cannabis companies and NFT-related businesses, among others. Our MSB and AML Teams offer services for BSA/AML/OFAC Compliance programs and Money Transmitter Licensing acquisition and maintenance. Our Crypto subject matter experts work directly with firms and counsel to design and implement policies to ensure they are AML-compliant. If you are looking to explore cryptocurrencies further, our team can help dispel the myths with custom training. We can also provide education on how to integrate cryptocurrencies and blockchain technology into your financial institution. 

Contact

For more information about Bates Group’s Cryptocurrency Services, please contact:

Brandi B. Reynolds, CAMS-Audit, Manging Director, MSB, FinTech and Cryptocurrency

breynolds@batesgroup.com | 864-809-7718

Visit Bates Group at Booth #703 the 2022 SIFMA C&L Annual Seminar, March 20-23, 2022 at Grande Lakes in Orlando. Learn about solutions for digital, virtual, and crypto AML and compliance.

Bates Research  |  03-17-22

Will a Current Lawsuit Redefine Cryptocurrency as Property for Tax Purposes?

A determined litigant is hoping to define, or redefine, a type of cryptocurrency through a lawsuit against the Internal Revenue Service. The cryptocurrency involved is Tezos, one of several cryptocurrencies that rely on “proof of stake” as the validation method for additions to a blockchain. This matter is significant, as Tezos has a unit value of about $4 and a market value of about $8 billion. Tezos is one of the currencies available for use in smart contracts—self executing contracts where the parties can verify performance without an intermediary.

Trust in Smart Contracts?

Smart contracts seem most useful in transactions along a blockchain. Like crypto itself, a smart contract is another piece of complex computer programming. In traditional contracts, elements of trust enter at most stages from concept through execution. For instance, a party to a contract must trust the initial intention of the other party to complete the transaction, the ability of that party to complete it, that the subject of the contract exists, and that the subject is as specified in the contract.

The verification process in blockchain, whether by proof of work or proof of stake, establishes or eliminates these elements of trust. There must be consensus for a transaction to be recognized on the blockchain. The irreversibility of a blockchain transaction may resolve the need to prove trust for completion. But smart contracts, and the blockchain features that underlie them, may require further development to be useful in general commerce. With certain transactions, there are too many legal requirements requiring written agreements to allow them. For example, a sale of real estate can’t be self-executing even if crypto is involved.

Is a New Crypto Token Income or Property for Tax Purposes?

The current litigation, Jarrett vs. United States of America, may have emerged as the result of a mistake. The plaintiff, Mr. Jarrett, participated in the Tezos blockchain and, in so doing, validated transactions through proof of stake. As a result, he produced 8,876 new Tezos tokens.  When he filed an IRS 1040 form in 2019, he and his wife reported $9,047 in other income attributable to the production of the new tokens. Later, the Jarretts filed an amended return and sought a refund of the $9,047.

The IRS resisted the refund, prompting the Jarretts to file suit in Federal District Court. The plaintiffs argue that there can be no income from this staking transaction until there is a sale. They liken the tokens to loaves of bread (conveniently, producers of Tezos are called “bakers”) arguing that income can only result from a sale. More specifically, they argue that the tokens are property under the tax code.

The IRS disagreed with that analysis, but after initial pleadings and motions, they proposed to settle the case by offering a full refund and interest. The agency was probably shocked when the Jarretts refused to accept the settlement offer. The Jarretts refused because the IRS would not concede that the Tezos tokens, and any other virtual currency, are property for purposes of the tax law. In its Answer to the Complaint, the government stated: “the United States denies that virtual currency is in all instances property for purposes of U.S. tax law.” Analysts note that if crypto isn’t property, what else could it be?

Is Crypto the New Phlogiston?

In 18th century science, phlogiston was postulated as an undetectable substance released during combustion and used to explain the oxidation process. Crypto could be like phlogiston in that it is a mysterious substance that is undetectable but converts one substance into another. Following the IRS's position, a court may find that the mysterious substance converts property into income. Most likely, if sense prevails, a court will find that crypto is not like phlogiston.

The Jarretts continue to litigate to resolve the definitional uncertainty. If their Tezos are not property, yet can produce taxable income immediately, smart contracts must take that into account. The elimination of uncertainty may require some form of government regulation. But resolution of the uncertainty will require answers to several questions that affect smart contracts and tokens, including transaction timing, taxation rates and—perhaps more challenging—valuations of the tokens involved.

About the Author

Bates Consulting Expert Paul Nelson has 45 years of experience with the regulatory and legal compliance issues facing banks and other financial services providers. Paul’s background includes five years as a Senior Attorney and Acting Regional Counsel with the Comptroller of the Currency and serving as a General Counsel of the U.S. House Banking Committee. His areas of expertise include Corporate Governance, Trusts, AML, Banking, and Nonbank Financial Services Providers Regulation, Legislation.

About Bates

Bates Group’s MSB, FinTech and Cryptocurrency practice offers guidance and services for Money Services Businesses and Non-Banking Financial institutions, fintech and cryptocurrency firms. Our crypto subject matter experts work directly with firms and counsel to design and implement policies to ensure they are AML-compliant. Our MSB and AML Teams help obtain and maintain Money Transmitter Licensing, and they also engage clients with BSA/AML/OFAC Program Development, Risk Management, Training, Advisory Services, and Independent Reviews. 

Visit Bates booth #703 at the 2022 SIFMA C&L Annual Seminar to learn more about our MSB, FinTech and Cryptocurrency services.

Bates Research  |  03-03-22

Navigating the Money Transmitter Licensing Process

Image © [Jess-Ivanova] /Adobe Stock

Determining if you are a money transmitter and then navigating the licensing requirements can be a daunting task. This guide is meant to ease the pain of that process with some helpful tips as well as great resources.

What is a Money Transmitter?

Essentially, anyone who operates a money services business (MSB) that moves money from one business to another or one person to another is a money transmitter. According to the Financial Crimes Enforcement Network (“FinCEN”), a money transmitter is anyone who transmits money over certain thresholds for others as a normal part of doing business. This may include individuals or business that:

  • Process traveler’s checks
  • Exchange or deal in currency, potentially including virtual currencies
  • Cashing checks
  • Process money orders
  • Transmit money in other ways

Money transmitters are a part of the broader category of MSBs.

What does the State Licensing process involve?

While registration with FinCEN is straightforward, state licensing requirements have been found to be extremely difficult to navigate. 

The details of the money transmitter license process vary from state to state. Below is a list of common requirements in many states:

  • Complete state’s license application(s)
  • Provide personal and business financial statements
  • Provide proof of meeting a given net worth requirement
  • Agree to a background check
  • Pay application and license fees
  • Provide business plan
  • Provide compliance program
  • Obtain surety bonds
  • Other state-specific requirements

Do virtual currency businesses need a license?

The short answer is maybe. The best way to know for certain is to obtain a legal analysis. State requirements vary, and one wrong mistake can result in conducting unlicensed money transition. 

The current regulatory framework relating to cryptocurrency is still a gray and rapidly evolving area for both regulators and businesses.

It can be difficult to determine if certain licensing requirements extend to virtual currency companies because laws have yet to be updated or are being created. Additionally, one aspect of the business may require a license but not another.

Additional Resources

Below is a list of helpful resources as you start your journey into money transmitter licensing or maintenance of your existing licenses.

How Bates Helps

Our consultants advise and assist clients throughout the application process.  Some areas in which we provide assistance include:

  • Developing a licensing strategy (including possible rollout plan)
  • Obtaining strategic partners such as:
    • Attorneys
    • Banking partners
    • Technology partners
    • Surety bond company, etc.
    • Registered agent
  • Assisting with state business registrations
  • Handle your application submission process
  • Coordinating critical requirements gathering such as fingerprints, financial disclosures
  • Preparing and/or revising business documents (i.e., business plan, flow of funds, etc.
  • Develop your anti-money laundering compliance program and applicable compliance related policies; and procedures such as Office of Foreign Assets Control (OFAC)
  • Act as liaison with state regulators
  • License maintenance

Contact

For more information about Bates Group’s Money Transmitter Licensing and Maintenance services, please contact:

Brandi B. Reynolds, CAMS-Audit, Manging Director, MSB, Fintech and Cryptocurrency

breynolds@batesgroup.com | 864-809-7718

Events  |  03-03-22

Join Bates at the 2022 IAA Compliance Conference, March 3-4, 2022 in Washington, D.C.

Bates Compliance is a proud sponsor of the 2022 IAA Compliance Conference, March 3-4, 2022, in Washington, D.C. This year's in-person conference will provide investment advisers with the most current information available on the changing regulatory landscape.

Join Bates at the 2022 IAA Compliance Conference, March 3-4, 2022 in Washington, D.C. Join Bates at the 2022 IAA Compliance Conference, March 3-4, 2022 in Washington, D.C. Join Bates at the 2022 IAA Compliance Conference, March 3-4, 2022 in Washington, D.C.

Visit our booth in the exhibit hall and connect with Bates leaders Jennifer Stout, Rory O'Connor, and Hank Sanchez (pictured, L-R) to hear about practical insights and best practices that can help you maintain a successful compliance program.

Join Bates at the 2022 IAA Compliance Conference, March 3-4, 2022 in Washington, D.C.

Hear Bates Compliance Managing Director Kurt Wachholz (pictured L) speak on the panel "Ethics for Advisers: Compliance with Fiduciary Standards - Part 2" on Friday, March 4 from 8-9 a.m. The panel will discuss the protection of material nonpublic information (MNPI) and prevention of insider trading, whistleblower policy issues and scenarios, and best practices for monitoring, testing, administering, and enforcing these policies. (CE credit available)

Conference Details and Registration

Compliance and Regulatory Alerts  |  02-28-22

SEC Targets More Firms for Form CRS Failings: Is Your Firm Next?

In a press release touting twelve additional enforcement actions against firms for failing to provide complete information on, file, or deliver client relationship summaries (Form CRS) to retail investors, the SEC announced settlements against six investment advisers and six broker-dealers. This is the second time the SEC chose to make such an enforcement announcement on Form CRS (the last was in late July 2021). The agency remarked that it has now settled 42 cases against financial firms for Form CRS violations. That message underscores the agency’s intention to hold firms accountable for making these disclosures. 

The recent cases follow compliance examinations which revealed the failings. The investment advisers settled alleged violations of Advisers Act Section 204 (“Reports”) and Adviser Act Rules 204-1 (“Amendments to Form ADV”) and 204-5 (“Delivery of Form CRS”). The broker-dealers settled alleged violations of Securities Exchange Act Section 17(a)(1) (“Records and Reports Rules and Regulations”) and Rule 17a-14 (“Preparation, filing and delivery of Form CRS”). The cases were settled without admitting or denying the findings, however, each firm agreed to be censured, to cease and desist from further violations and to pay civil penalties ranging from $10,000 to nearly $100,000.

The enforcement announcement follows the issuance of recent SEC guidance on Form CRS disclosure (see Bates post). That guidance reflected yet another effort by the agency to urge IAs and BDs to pay more attention to the Form if the relationship summary is to fulfill its intended purpose of providing meaningful accessible information upon which investors can make reasoned choices as to financial professionals.

How Bates Can Help

The Bates Compliance team helps BD, IA and hybrid firms meet their Form CRS and Reg. BI compliance obligations, including further defining conflicts, determining your disclosure approach and mitigating risk to your firm. We develop, review and update Form CRS and also support firms with Form CRS gap analyses, risk assessments, consistency reviews, and training. For a full list of services, visit our Reg BI and Form CRS resource page.

To learn more about Reg BI and Form CRS compliance consulting support, including how your firm can improve its compliance, please contact us directly:

Rhonda Davis, Managing Director, Bates Compliance – rdavis@batesgroup.com or 713-410-3978

Rory O'Connor, Director, Bates Compliance – roconnor@batesgroup.com or 860-671-7270

Hank Sanchez, Managing Director, Bates Compliance – hsanchez@batesgroup.com or 504-450-9632

Bates Research  |  02-24-22

FinCEN Roundup: Recent Developments, Rulemakings on Anti-Money Laundering

Image © [kentoh] /Adobe Stock

On January 1, 2021, the Anti-Money Laundering Act (“AMLA”), became law. The far-reaching legislation expanded the Bank Secrecy Act regulatory framework by, among other things, establishing a beneficial non-public ownership database and reporting requirements under AMLA’s Corporate Transparency Act (“CTA”); promoting technology and other innovation to support enforcement, particularly concerning suspicious activity reports (“SARs”); expanding enforcement authority over art, antiquities and real estate; and increasing penalties for AML violations. (See the Bates review of AMLA’s key concepts here.) The story of FinCEN’s regulatory efforts since the passage of AMLA is the story of the agency working to effectuate those mandates. In this post, Bates looks at where we are in that story with the following regulatory developments.

FinCEN’s Proposed Rule on Beneficial Ownership Reporting (and Reminder of an Upcoming Rule on Access to the Reports)

On April 1, 2021, FinCEN solicited public comment in an Advanced Notice of Proposed Rulemaking about AMLA directives for beneficial ownership. (See Bates article here.) On December 8, 2021, FinCEN published the proposed rulemaking along with a detailed fact sheet. The proposed rules implement the CTA requirement within AMLA “that a reporting company submit to FinCEN a report containing beneficial owner and company applicant information (“BOI”). The proposed rule defines: (1) who must file, (2) when they must file, and (3) what information they must provide. The proposal states that this information would enable “law enforcement, the intelligence community, and other key stakeholders” to “diminish the ability of malign actors to obfuscate their activities through the use of anonymous shell and front companies.”

The comment period on the proposed rulemaking closed this week (February 7, 2022). FinCEN reported receiving more than 230 comments.

Among the comments was a submission by two Senators instrumental in the passage of AMLA: Ron Wyden (D-OR), Chair of the Senate Finance Committee, and Sheldon Whitehouse (D-RI), Chair of the Finance Subcommittee on Taxation and Internal Revenue Service (“IRS”) Oversight. Their comments give a flavor of the complexities involved as FinCEN navigates the CTA provisions of AMLA. For example, the Senators applauded (1) “the proposal’s comprehensive and clear definitions for beneficial owner and applicant;” (2) how the rule covers “each individual who exerts substantial control, whether directly or indirectly, over an entity;” and (3) how it broadly defines “other similar entities” required to report BOI. The Senators expressed concerns, however, over a possible loophole about exemption language concerning “wholly owned” subsidiaries. The Senators suggested amending the proposal to clarify that the “exemption applies only to entities that are ‘wholly controlled or wholly owned’ by certain exempt entities and not to “any entity whose ownership interests are even partially owned by a criminal, kleptocrat, or terrorist, so long as some of such entity’s voting rights are controlled by certain other exempt entities.”

The regulatory processes on reporting and the database of beneficial ownership are far from complete. In announcing the close of the comment period on beneficial reporting, FinCEN reminded stakeholders that the reporting proposal is only the “first in a series of rulemakings” that FinCEN will undertake to implement the CTA. Later this year, another rulemaking is expected on access to the information reported. In their comments, the Senators also noted FinCEN’s efforts to revise customer due diligence requirements for financial institutions (the “CDD Rule”). The Senators encouraged FinCEN to “ensure that any new CDD rule (1) adopt the definition of beneficial owner included in the CTA, and (2) requires financial institutions to verify the beneficial ownership information of each legal entity customer, regardless of whether such entity is covered by the CTA’s definition of reporting company.”[1]

FinCEN’s Proposed Rule on SARs Sharing Pilot Program

On January 24, 2022, FinCEN proposed a new rule to establish a limited-duration pilot program for sharing SARs pursuant to the AMLA. The AMLA limited the pilot to 3 years after the law’s enactment date (i.e., January 1, 2024). The proposed program would allow a financial institution to share SARs with its foreign branches, subsidiaries, and affiliates. Such sharing would be (1) undertaken “under standards and requirements regarding data security and the confidentiality of personally identifiable information,” (2) limited by the requirements of federal and state law enforcement, and (3) with consideration for the concerns of the intelligence community. AMLA prohibits financial institutions with a foreign branch, subsidiary, or affiliate located in the People’s Republic of China, the Russian Federation, or any jurisdiction that is a state sponsor of terrorism from sharing SARs or related information. Comments are due by March 28, 2022.

 


[1] It should be noted that the SEC is also proposing to update its reporting rules on beneficial ownership. In a proposed rulemaking issued on February 10, 2022, the SEC proposed amendments to its regulations to (1) accelerate the filing deadlines for beneficial ownership reports from 10 days to 5 days and require that amendments be filed within 1 business day; (2) expand the application of its beneficial ownership reporting to certain derivative securities; (3) clarify the circumstances under which two or more persons have formed a “group” that would be subject to beneficial ownership reporting obligations; (4) provide new exemptions “to permit investors to communicate and consult with each other, jointly engage with issuers, and execute certain transactions without being subject to regulation as a group;” and (5) require beneficial ownership filings to use a structured, machine-readable data language. See also, the newly issued Fact Sheet accompanying the proposal.

CONTACT BATES AML AND FINANCIAL CRIMES TODAY FOR AML SERVICES AND AMLA SUPPORT

FinCEN’s Pre-Proposed Rule on Real Estate Transactions

On December 8, 2021, FinCEN issued an advanced notice of proposed rulemaking (“ANPR”) “to address the vulnerability of the U.S. real estate market to money laundering and other illicit activity.” Though the advanced notice is a precursor to an actual rulemaking, FinCEN makes clear that it is seeking input on proposing nationwide “recordkeeping and reporting requirements on certain persons participating in transactions involving non-financed purchases of real estate.” Under prior authority, FinCEN imposed specific Geographic Targeting Orders (see here, for example) requiring transaction reporting by title insurance companies.

The ANPR—which makes several references to the BSA framework as changed by the AMLA—seeks input on (1) persons who should be subject to the requirements, (2) the types of real estate transactions to be covered, (3) the reporting information required, and (4) reporting dollar-value thresholds. The close of the comment period was supposed to be February 7, 2022. Last week, however, FinCEN extended the comment deadline until February 21, 2022.

One to Watch: Potential Regulation on Money Laundering in the Art Market

Mandated by the AMLA, a study on the facilitation of money laundering and the financing of terrorism through the trade in works of high-value art was published on February 4, 2022. The Department of the Treasury found that “most art market participants, including some entities that provide financial services within the high-value art market, are not subject to anti-money laundering/countering the financing of terrorism (“AML/CFT”) obligations.”

The study found that the art market is particularly attractive to illicit actors because of “the high-dollar values of single transactions, the ease of transportability of works of art, the long-standing culture of privacy in the market (including private sales and transactions), and the increasing use of art as an investment or financial asset.” The study concludes with a number of regulatory recommendations for consideration, including potential “targeted recordkeeping and reporting requirements to support information collection and money laundering activity analyses” and the application of “comprehensive AML/CFT measures to certain art market participants” – though it did not recommend the latter at this time. This initiative could also impact the evolving NFT market.

Conclusion

FinCEN has taken significant regulatory steps to effectuate the AMLA and CTA mandates. The proposed reporting rules, the anticipated proposed rules on BOI report access (expected later this year), the SARs-sharing pilot, anticipated rules on non-financial real estate transactions, potential action on the art markets—all these have enormous compliance consequences for financial institutions. And those rules do not include what may result from FinCEN’s general Request for Information (“RFI”) issued in December that seeks input on ways to “streamline, modernize, and update” the entire AML/CFT regime post-AMLA. (Note: All comments are due by February 14, 2022). Bates will keep you apprised.

How Bates Helps

Bates AML and Financial Crimes helps its clients meet their AML/CFT obligations through experience, resources, and ongoing guidance. Bates is a practitioner-led firm, consisting of former Chief AML Officers and Chief Compliance Officers, former regulators and practicing attorneys, Risk Management Officers, as well as data and technology specialists to deliver exceptional results on a cost-effective basis.

Our AML and Financial Crimes services include:

  • AML gap assessments and audits
  • BSA/AML and OFAC risk assessments
  • AML program design and implementation
  • Customer risk model design, tuning, and implementation
  • KYC system design, testing, and implementation
  • AML transaction monitoring and sanctions system tuning, testing and new platform implementation or existing platform upgrades
  • Model validations
  • Coverage assessments
  • AML Compliance for Cryptocurrency
  • Money Transmitter Licensing
  • Artificial Intelligence and Big Data analytics support
  • Independent consulting review for AWC or other regulatory response
  • AML and Financial Crimes testimony
  • AML and Financial Crimes corporate training

For questions concerning our AML and Financial Crimes services, AMLA, and how it may impact your business and AML obligations, please reach out to us at Contact@Batesgroup.com

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

Bates AML and Financial Crimes

MSB, Fintech and Cryptocurrency

AML and Financial Crimes Corporate Training

Bates Compliance

Regulatory and Internal Investigations

Consulting and Expert Testimony

Retail Litigation and Consulting

Bates Research  |  02-18-22

FINRA Releases 2022 Exam and Risk Monitoring Report - Plus Bates’ Annual FINRA Chart

Image © [Andriy Blokhin] /Adobe Stock

At a recent event sponsored by Bates Group, FINRA CEO Robert Cook remarked that the “theme” of the self-regulator’s 2022 Examination and Risk Monitoring Program Report will remain the protection of retail investors. He noted that the surge in the number of retail investors entering the market in the last few years requires continuous vigilance as to compliance with the rules and regulation on new products and platforms drawing in these investors.

Issued on February 9th, the 2022 Report highlights several new areas of FINRA focus that back up this theme of protection of retail investors, including, for example, first-time attention to FINRA rules on trusted contacts, funding portals and crowdfunding offerings. The 2022 Report itself follows a new format initiated last year, a format intended to enable firms to refer to it continuously as a repository of compliance and supervisory information. The new structure—better organized for ease of use and replete with links, citations and additional references related to supervisory procedures and controls—still contains the same core elements as in previous years: relevant rules, related compliance considerations, notable exam findings, and observed best practices. But, as structured, the taxonomy is that of an online library, updated continuously and available immediately as an on-line reference for members. This year’s Report “denotes” new topics for 2022 and highlights areas of ongoing concern from 2021, while adding updated material and guidance to existing rules and regulations. Here Bates reviews those new topics and the selected highlights as we adapt our own annual summary Chart to better reflect the changing FINRA approach.

Top Areas of FINRA Focus for 2022

See highlights of FINRA’s continuing and emerging concerns on our 2022 FINRA chart below, which keeps track of articulated priorities from year to year. (Items highlighted in green are new for 2022).

FINRA Releases 2022 Exam and Risk Monitoring Report - Plus Bates’ Annual FINRA Chart
FINRA Releases 2022 Exam and Risk Monitoring Report - Plus Bates’ Annual FINRA Chart
FINRA Releases 2022 Exam and Risk Monitoring Report - Plus Bates’ Annual FINRA Chart
FINRA Releases 2022 Exam and Risk Monitoring Report - Plus Bates’ Annual FINRA Chart

© 2022, Bates Group LLC
Source: 2022 Report on FINRA’s Examination and Risk Monitoring Program (Compiled by Alex Russell, Managing Director, White Collar, Regulatory and Internal Investigations)

New in ‘22

The report lists member compliance obligations by topic under four categories: firm operations, communications and sales, market integrity, and financial management. As configured, each topic is not only linked to the section of the report directly, but can also be found in a slightly clearer form through the table of contents (published here). These topic pages are very helpful, and clearly break down for each obligation: the rule, related considerations, exam findings, effective practices, and additional resources. Also, various topic pages importantly delineate additional recent guidance or relevant related material on the obligation.

Under the category of firm operations, three new topic pages were added for 2022. The first is on “Trusted Contact Persons.” On this page, FINRA reviews a firm’s obligations to make a reasonable effort to obtain the name and contact information for a trusted contact person (aged 18 or older) for non-institutional customer accounts. The page offers guidance and exam findings on the circumstances in which firms and their associated persons are authorized to contact a trusted person and disclose information about the customer account. The second new topic under firm operations is on “Funding Portals and Crowdfunding Offerings.” This page reviews firm obligations (i) to register funding portals with the SEC, (ii) to become a member of FINRA, and (iii) additional requirements concerning corresponding notifications. The third new topic page concerns “Firm Short Positions and Fails-to-Receive in Municipal Securities.” Here, FINRA reviews the obligation on firms to develop and implement adequate controls and procedures for detecting, resolving and preventing adverse tax consequences on customers in certain instances when a firm effects sales to customers of municipal securities that are not under the firm’s possession or control—instances where a firm’s trading activity “inadvertently results in a short position or a firm fails to receive municipal securities it purchases to fulfill a customer’s order.”

Under the category of market integrity, FINRA added a topic page on “Disclosure of Routing Information.” This page focuses on a broker-dealer’s obligations to disclose information on the handling of customers’ orders in NMS stocks and listed options. FINRA explained that it is concerned with ensuring that customers: “better understand how their firm routes and handles their orders; assess the quality of order handling services provided by their firm; and ascertain whether the firm is effectively managing potential conflicts of interest that may impact their firm’s routing decisions.”

Under the category of financial management, FINRA added a topic page on “Portfolio Margin and Intraday Trading.” FINRA reviews a firm’s obligation to monitor the risk of positions held in portfolio margin accounts “during a specified range of possible market movements according to a comprehensive written risk methodology.”

CONTACT US TO DISCUSS YOUR FINRA REGULATORY, COMPLIANCE AND AML NEEDS

“Selected Highlights”

In a section of the Report called “Selected Highlights,” FINRA lists big-picture subject areas that will continue to be prominent for the regulator in 2022. Given the public and industry attention to these topics (which have been regularly tracked by Bates), expect a possible pickup in enforcement actions related to them.

Among these topics include compliance with (i) Reg BI and Form CRS requirements; (ii) best execution obligations (particularly when it comes to order routing, commissions and conflicts of interest); (iii) obligations on the use of mobile applications for communications with customers (and a firms’ supervision of activity on those apps); (iv) obligations regarding SPAC transactions, including as to conflicts of interest, adequate due diligence, and disclosures; (v) obligations to protect sensitive customer and firm information through effective cybersecurity measures; and (vi) communications and disclosure obligations made in relation to complex products—particularly options, but also products like variable annuities. (Not included in these “selected topics,” but sure to be an issue going forward are obligations concerning communications on digital assets.) 

Conclusion

Each year the Report is published, FINRA emphasizes its expectation that member firms undertake a comprehensive review of the findings, observations and recommendations, and identify those areas that are applicable to their businesses. FINRA explains it wants member firms to incorporate the highlighted topics in their overall risk assessments and compliance program review and to evaluate their compliance programs and supervisory procedures to address these challenges. This year, the Report includes a helpful appendix containing a step-by-step outline on how to do that.

In its new form, the Report has gone from a once-a-year update of new priorities and exam findings within the context of market developments to an ongoing and curated compliance library. The result is that FINRA’s approach shifts member compliance review from an annual exercise to a perennial one. As new developments arise, Bates will keep you apprised.

Contact us to discuss how we can assist with your FINRA compliance:

David Birnbaum, Managing Director - dbirnbaum@batesgroup.com or (917) 273-2682

Hank Sanchez, Managing Director, Bates Compliance - hsanchez@batesgroup.com or (504) 450-9632 

Rory O'Connor, Director, Bates Compliance - roconnor@batesgroup.com or (860) 671-7270

 

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

Bates Compliance

Reg BI Services and Form CRS

Broker-Dealer Compliance

RIA Compliance

Retail Litigation and Consulting

Regulatory Enforcement and Internal Investigations

Bates Investor Risk Assessment for Vulnerable and Senior Investors

Bates AML and Financial Crimes

MSB, Fintech and Cryptocurrency

Bates News  |  02-17-22

Meet Our Consulting and Testifying Experts

Brooke J. Billick

Compliance, Investment Advisory

Brooke Billick is a Consulting Expert for Bates Group with more than 40 years of experience in the Financial Services Industry. His business areas of expertise include mutual funds, asset management, and broker-dealer activities in retail and institutional channels, as well as board governance. Prior to joining Bates, he spent 16 years with Artisan Partners Limited Partnership and Artisan Partners Funds as Chief Compliance Officer and Associate Counsel, responsible for developing, administering, and evaluating the effectiveness of written compliance programs and controls covering all operational areas.

Before Artisan Partners, Mr. Billick was a senior executive officer with M&I Marshall & Ilsley Bank’s trust and investment management operations, and he began his career in private practice, specializing in corporate and securities law serving securities brokerage firms, registered representatives, investment advisers, and public and privately held companies. He has significant examination and liaison experience with various regulatory bodies including the SEC, FINRA, OCC, Federal Reserve, DOL, and others. Over the past 16 years, Mr. Billick has served on key CCO committees with the Investment Company Institute and has presented at numerous ICI and industry conferences.

Full Bio

Jennifer Cunningham, CAMS, Managing Director

Broker-Dealer Supervision & Compliance, Suitability

Now Available as a Testifying Expert

Jennifer Cunningham is based in Edgewater, NJ, and is a Managing Director – CAMS for the Regulatory and Internal Investigations team at Bates Group, where she is responsible for working on regulatory and compliance projectsand supporting client case and project needs. She is a seasoned financial services professional with an extensive 20-plus years of experience working at large broker-dealer firms, such as Merrill Lynch and UBS in New York City.

Since Joining Bates in 2020, Ms. Cunningham has served as a Consulting Expert in matters involving broker-dealer compliance and supervision and is available as a Testifying Expert for related Securities Litigation and Compliance matters.

Some key areas of her expertise include broker-dealer front office management, compliance, supervision, operations, human resources, and customer communications. Ms. Cunningham’s former daily interactions with financial advisors and customers provide Bates Group clients with a unique perspective across a wide array of topics.

Full Bio

Bradley S. Goldfarb, CIMA

Suitability, Asset Allocation, Risk Assessment

Bradley “Brad” Goldfarb is a Bates Testifying Expert who started his career as a financial advisor in New York State. A pioneer in developing a fee-based practice, he began using professional money managers in 1989 and in 1996 earned the coveted Certified Investment Management Analyst (CIMA) designation through the Investments & Wealth Institute (previously IMCA).

Throughout his career, Mr. Goldfarb worked at some of the most respected Wall Street firms and appeared numerous times on radio and television discussing the merits of professional money management on a fee basis. Mr. Goldfarb holds a U.S. Trademark for his investment management process, Multidimensional Asset Planning (MAP), and in 2018 he completed the necessary coursework to be a non-public arbitrator for FINRA. As a published author, his book, “You’re Kidding, Right?” (based on behavioral finance and why investors lose money by relying on emotional decisions) was awarded a Bronze Medal by the Readers’ Favorite International Book Award Contest in the Non-Fiction, Retirement category.

Full Bio

Paul Nelson

Corporate Governance, Trusts, AML, Banking and Nonbank Financial Services Providers Regulation, Legislation

Paul Nelson is a Consulting Expert at Bates Group with more than 45 years of involvement with the regulatory and legal compliance issues facing banks and nonbank financial services providers. His five years as a Senior Attorney and Acting Regional Counsel with the Comptroller of the Currency formed the basis of his education in the principles of bank regulation as practiced in the U.S.  He has also served as a General Counsel of the U.S. House Banking Committee and as a registered lobbyist in private practice.

He has more than 10 years of experience with prominent consulting firms (PwC and the Promontory Group) serving trust companies and foreign bank clients. In addition to that experience, Mr. Nelson was Senior Vice President and Chief Compliance Officer for IBJ Whitehall Bank and Trust, a part of the Mizuho Group. For 11 years he was a Senior Vice President, Chief Compliance Officer, and Corporate Secretary of NewTower Trust in Bethesda, Maryland. Prior to Joining Bates, Mr. Nelson was a Director and Executive Officer with Reserve Trust Co. in Denver, Colorado. In his long history in financial services regulation, Paul has represented clients in courts, before both federal and state financial regulatory agencies, the U.S. Congress, the NASD (now FINRA), and arbitration panels. 

Full Bio

Laura Grillet-Aubert

Regulatory Exam Management, Investment Advisory, Fiduciary Compliance

Laura Grillet-Aubert is a Bates Consulting Expert with more than 30 years of experience in legal and compliance regulatory matters. Her career has included 6 years as a New York Stock Exchange Trial Counsel as well as Assistant General Counsel and Compliance Officer roles with top-tier bank holding companies/dual registrant financial entities.

Prior to joining Bates Group, Laura was an Executive Director and Compliance Officer with JPMorgan Chase. Her regulatory coverage experience includes positions at Citigroup and Goldman Sachs. She has served as Assistant General Counsel positions for PaineWebber (now UBS) covering regulatory investigations and inquiries, and she was Chairperson for the SIA (now SIFMA) Continuing Education Committee from 2006 to 2007.

Full Bio

Events  |  02-17-22

2022 Capital Markets Litigation and Regulatory Outlook CLE Webinar

Back by popular demand!

Jack McGuire, Esther Cho and Greg Kyle reunite for a new CLE Webinar to provide a capital markets update and discuss related litigation, regulatory and enforcement areas to keep an eye on in 2022. Bates Group Managing Director Alex Russell will be joining the panel to discuss Regulatory issues and updates.

Date: Thursday, February 17, 2022

Time: 1:00 p.m. Eastern / 10:00 a.m. Pacific

Program Length: 1 hour

Register Now for this CLE Webinar

Program Speakers (above, L to R):

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

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

Registration is required to attend this Zoom webinar.

Continuing legal education (CLE) Credit will be offered. Minimum continuing legal education (MCLE) credit is pending in CA and MO, giving reciprocal credit to NJ and FL. (NY credit is available through the approved jurisdiction rule.) A Multi-Jurisdiction Certificate of Attendance will be made available to participants requesting MCLE credit in all other jurisdictions. To be eligible to earn a CLE certificate, you must attend the entire webinar—credit for partial attendance will not be provided. If participating via telephone, you must enter your participant code (found in your registration confirmation email) to verify attendance.

Compliance and Regulatory Alerts  |  02-09-22

FINRA Releases 2022 Report on FINRA’s Examination and Risk Monitoring Program

Image © [Andriy Blokhin] /Adobe Stock

FINRA has announced the publication of the 2022 Report on FINRA's Examination and Risk Monitoring Program. The new Report builds on the structure and content in the 2021 Report by adding new topics and new material to existing sections where appropriate. It addresses 21 regulatory areas organized into four categories: Firm Operations, Communications and Sales, Market Integrity and Financial Management.

Stay tuned for our annual commentary, coming soon, on FINRA’s 2022 objectives and how they may impact your legal, regulatory and compliance matters.

Events of Interest:

Join us on February 17, 2022, when we discuss 2022 regulator priorities at the 2022 Capital Markets Litigation and Regulatory Outlook CLE Webinar.

Register for this Webinar

Bates Research  |  02-04-22

Crypto Regulation: Speed and Size of Evolving Market Creates Urgent Need for Framework

Whether crypto regulation is just around the corner or merely at the beginning of a long deliberative process remains an open question, but regulators and legislators recognize that the market for products and services tied to blockchain technology is increasingly complex and not waiting on them to propose a path forward. In 2021, the market for cryptocurrencies nearly tripled to more than $2 trillion.

In previous posts, Bates touched on broad warnings regarding current gaps in regulating crypto that could impact national security, anti-money laundering, cybersecurity (specifically as to ransomware), and investor protection. We have also described some of the legal challenges that prevent current regulators from simply absorbing some of these developing products and services into their existing authorities and SEC efforts to overcome those challenges.

Recent movement toward some framework over cryptocurrency seeks to balance the twin goals of supporting (or at least not stifling) innovation while reducing (or at least mitigating) risk. The speed and size of the complex and evolving market is creating urgency. States are also competing to see who can be the most crypto-friendly. It is now clear that all the players across the executive and legislative landscape are engaged. Here’s a brief update on the latest developments.

The White House

Recent reports suggest that the President will issue an Executive Order this month detailing a strategy that would (i) require agencies to formally assess the risks that cryptocurrencies present (with accompanying National Security Council memorandum); (ii) coordinate on overlapping regulatory issues among agencies; and (iii) address national security, competitiveness, money laundering (and other illicit use of virtual currency) concerns. (Notably, the Federal Trade Commission just published a “Consumer Protection Data Spotlight” alerting the public to a significant increase in “crypto-currency investment scams” that use social media.) The Executive Order is expected to build upon a report by the President’s Working Group (“PWG”) on stablecoins published in November, 2021. (For more on the PWG, see previous Bates article here.)

Congress

Legislators have been active as well, but seem to still be at the information-gathering stage. In December 2021, both the House Financial Services Committee and the Senate Banking Committee heard from experts on approaches to regulating cryptocurrencies in general and stablecoins in particular. At the House hearing, fundamental concerns on risk, regulatory clarity, fraud, money laundering, and competitiveness were raised. Witnesses acknowledged the importance of bringing crypto activities inside the regulated financial system but had divergent views on a host of issues, from whether to create one primary regulator to oversee digital assets and digital products, to the need to create a clear set of standards to enhance risk management and supervision. Witnesses were dubious of any immediate legislative faction, but emphasized the importance of legislative response, in part, due to concerns over issues of regulatory clarity raised repeatedly by SEC Chair Gary Gensler.

The Senate Committee hearing focused on the risks related to market integrity and investor protection from stablecoins, issues raised in the PWG report. Witnesses differed on the legislative recommendations in that report on how to guard against stablecoin runs and how to address concerns about payment system risks and concentration of economic power. The PWG had recommended that the Financial Stability Oversight Council (FSOC) take action to address these risks if Congress failed to enact legislation that would treat stablecoin issuers as insured depository institutions under the supervision of the Treasury.

This week, House Financial Services Committee Chair Maxine Waters (D-CA) announced that the Committee will hold a hearing on February 8, 2022, devoted to the PWG’s recommendations and titled “Digital Assets and the Future of Finance: The President’s Working Group on Financial Markets’ Report on Stablecoins.” The Senate Banking Committee also calendared a follow-up hearing scheduled for February 15, 2022, titled “Examining the President’s Working Group on Financial Markets Report on Stablecoins.”

Learn More: Watch Our On-Demand Webinar - Demystifying Cryptocurrency Law & Compliance

The Federal Reserve and Stablecoins

On January 31, 2022, the Federal Reserve weighed in with new research on stablecoins. The researchers examined the impact of the adoption of stablecoins on traditional banking and credit intermediation. The report found that the banking system can support both stablecoin issuance and maintain traditional forms of credit creation, and that dollar-pegged stablecoins, in particular, “can serve as a safe haven relative to other crypto-assets during times of market distress if they are perceived to be sufficiently collateralized.”

The report concludes that a wider stablecoin issuance, beyond that advocated by the PWG, which would limit stablecoin issuance to insured depository institutions, is preferable. The report warns that “the overall structure of the narrow bank approach to stablecoin reserves is potentially destabilizing for the banking system," and that “the narrow bank approach could lead to an expansion of the central bank’s balance sheet in order to accommodate the demand for reserve balances from stablecoin issuers." Further, the researchers argue that potential credit disruptions “could be mitigated by limits on stablecoin holdings and differential reserve interest rates.” Coming at this time, the Federal Reserve research should have a significant influence on the debate of legislating and regulating cryptocurrency.

States

By the end of 2021, at least 33 states had pending legislation covering some aspect of regulating virtual currency business activity within the state. In the most recent move gaining attention, newly proposed state legislation on virtual currency and operations in Wyoming and Arizona (see here and here) would allow those states to accept digital currency tax payments. Currently, only U.S. currency is acceptable for this purpose. The Arizona bill would permit payment in Bitcoin, and the Wyoming bill would accept additional cryptocurrencies, but only applicable to sales and use taxes. The proposed state legislation would be a direct challenge to central bank regulation over U.S. currency. In the context of creating a federal regulatory framework for cryptocurrencies, the use of these alternative currencies for official government purposes is a development that cannot be ignored.

Conclusion

The market is now watching to see how these developments play out—whether the President’s Executive Order will ultimately offer the kind of direction that can move federal agencies and legislators toward some kind of consensus—whether the new framework extends the position of the PWG toward tight limitations on stablecoins, or incorporates a more expansive approach suggested by the Federal Reserve research—whether state acceptance of Bitcoin for the payment of taxes and other official purposes opens a pandora’s box by leapfrogging federal legislative action—whether the lack of, or piecemeal, federal legislative action empowers the SEC to assert greater regulatory authority and enforcement power—and, on an even more fundamental level, whether any legislative solution to protect investors and stablecoin users and deter money laundering will encourage, accelerate or stifle the momentum toward the use of cryptocurrencies. Bates will continue to keep you apprised of these fast-moving developments.

About Bates MSB, Fintech and Cryptocurrency Services

Bates Group’s MSB, Fintech and Cryptocurrency practice advises financial institutions and other companies working in the unpredictable and fast-growing sector of crypto and virtual currency. We work with crypto traders, trading platforms, ATM operators, hedge funds, exchanges, crypto and cannabis companies, and others. Our compliance specialists seek to make it as simple as possible to design and implement AML-compliant policies that are up-to-date regarding cryptocurrency requirements, helping you understand these policies and how to identify noncompliance issues and risk.

Our MSB and AML Teams also implement, manage, and maintain Money Transmitter Licensing processes and engage clients with BSA/AML/OFAC Program Development, Risk Management, Training, Advisory Services, and Independent Reviews. We provide practical guidance for obtaining and maintaining money transmitter licenses, identifying state requirements, coordinating with state regulators, submitting state reports, identifying risk, detecting suspicious or unusual activity, and preventing exposure associated with money laundering and terrorist financing.

For more information about Bates Group’s MSB, Fintech and Cryptocurrency AML and Compliance Services, please contact:

Rob Ayers, Consulting Expert

rayers@batesgroup.com or 303-478-2962

 |  02-03-22

2022 Capital Markets Litigation and Regulatory Outlook CLE Webinar

Date: Thursday, February 17, 2022
Time: 1:00 p.m. Eastern / 10:00 a.m. Pacific
Program Length: 1 hour

Back by popular demand!

Jack McGuire, Esther Cho and Greg Kyle reunite for a new CLE Webinar to provide a capital markets update and discuss related litigation, regulatory and enforcement areas to keep an eye on in 2022. Bates Group Managing Director Alex Russell will be joining the panel to discuss Regulatory issues and updates.

Program Speakers (above, L to R):

  • 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
  • Alex Russell, Managing Director, White Collar, Regulatory and Internal Investigations, Bates Group

Registration is required to attend this Zoom webinar.

Continuing legal education (CLE) Credit will be offered. Minimum continuing legal education (MCLE) credit is pending in CA and MO, giving reciprocal credit to NJ and FL. (NY credit is available through the approved jurisdiction rule.) A Multi-Jurisdiction Certificate of Attendance will be made available to participants requesting MCLE credit in all other jurisdictions. To be eligible to earn a CLE certificate, you must attend the entire webinar—credit for partial attendance will not be provided. If participating via telephone, you must enter your participant code (found in your registration confirmation email) to verify attendance.

Register Me for this Webinar

Bates News  |  02-02-22

Celebrating Black History Month 2022

Bates proudly celebrates Black History Month this February. Connect with us on social media as we examine the rich legacy of Black Americans in the fields of Finance, Banking, and Investing.

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Bates Group on Twitter

Bates News  |  01-28-22

Bates Group Welcomes New Consulting Expert Rob Ayers

Bates Group is proud to welcome Rob Ayers as a Business Development and Consulting Expert. A payments and remittance veteran with more than 25 years in the industry, he has held positions with a variety of companies, from publicly traded firms and global businesses to startups and early-stage entities. During his career, Rob has served as an executive at licensed money transmitters, managed P&L for various regions around the world, run sales and marketing organizations, and worked both sides of mergers and acquisitions. At Bates, he represents the Money Services Business, Fintech and Cryptocurrency practice, supporting client engagement and new business outreach.

In 2016, Rob established Fintech-Advisors, focusing on supporting clients in the payments and remittance industries, both consumer and business-to-business. His many clients include “B2B” global payment firms, third-party payment processors, cryptocurrency firms, traditional money remittance firms, and others in the payments industry.

Read Rob's full bio here

Bates Research  |  01-24-22

Highlights from SIFMA’s “One-on-One” with FINRA CEO Robert Cook: Previewing the Regulator’s 2022 Priorities

In a SIFMA “One-on-One” virtual event sponsored by Bates Group, FINRA CEO Robert Cook sat down with SIFMA President Ken Bentson to discuss FINRA priorities for 2022. The conversation offered a first glimpse at the issues to be covered in the self-regulatory organization’s Annual Exam and Risk Monitoring Report, due out in the next few weeks. That report serves as an important guide for firms to ensure their policies, programs and practices are aligned with the latest guidance. Mr. Cook emphasized that the “theme” in 2022 will remain the protection of retail investors, due to the surge in the number of retail investors entering the market in the last few years. Here are some highlights from that conversation.

FINRA's 2022 Priorities

Enforcement

The “sweeps” (targeted exams) begun last year will continue, with a particular focus in 2022 on options account openings, SPACs, and influencers. On the latter, Mr. Cook stated that FINRA will be looking at how member firms engage with influencers on social media to promote products and whether they are complying with existing rules.

Proposed Rulemakings

Mr. Cook reported that firms should expect updates to rules on options accounts and other complex products. In response to a question on the scope of that update, Mr. Cook elaborated, saying that the current options account rules are obsolete. At the time they were adopted, he said, “you would probably not open an options account unless you were going through a registered representative, who would conduct reviews, dependent on the nature of your trading activity and your experience, and make determinations on the appropriateness of trading the option and what restrictions ought to apply.” He highlighted the tremendous technological innovation that has taken place since then, “making the markets more accessible to investors” and making the older rules – based on certain assumptions about how one would open an options account – inapplicable.

Cryptocurrency and Digital Assets

Mr. Cook also relayed that firms should expect a Notice soliciting comment on the sale of crypto assets, particularly as to advertising and disclosure requirements. He noted that FINRA would solicit comment not only on the rules as they exist today, but also how they might evolve in the changing environment to better protect investors. In response to a question posed by Mr. Bentsen on the scope of FINRA’s digital asset review, Mr. Cook said:

“[FINRA is] not looking to regulate or change the regulatory structure here – that is for Congress and other federal regulators to determine what are the rules of the road here – but our member firms are involved in the sale of digital assets – some securities, some non-securities – and when customers interface with one of our members and then buy a cryptocurrency or a digital asset, they need to comply with disclosure rules that currently apply.”

Describing the inquiry as more of an “early-stage concept release type of Notice,” Mr. Cook framed his answer as an investor protection issue, stating: “We want to take the opportunity to … see if there are additional enhanced requirements … [W]hen people buy a securities product and then buy a product that is not regulated, they may not know that they may be flipping out of one regulatory regime into another even though they are dealing with the same broker-dealer.”

New Regulations

FINRA will be “rolling out” the SEC-approved “High Risk Regime” (Rule 4111 - Restricted Firm Obligations), said Mr. Cook.  It will propose amendments to the regime as necessary (for example, a proposal to disclose on BrokerCheck the status of firms that are restricted). Further, Cook said to look out for a Notice in the next few weeks concerning the first evaluation of Rule 4111.

Retrospective Rule Review

FINRA continues to undertake a retrospective review of rules in a number of areas. Mr. Cook highlighted rules with respect to (i) borrowing and lending with customers; (ii) COVID and the evolving workplace; (iii) liquidity risk management practices; (iv) FINRA’s MAP (“Membership Application Program”) program, which allows for members to come in and apply or change their memberships; and (v) Regulation Best Interest (“Reg BI”). On the latter, Mr. Cook noted that FINRA would be taking a broader look at “how our rules may need to be reevaluated given that they were adopted before Reg BI.”

Resources and Education

Expect FINRA to offer firms more compliance resources and information to help them with their regulatory obligations this year. Specifically, he said that FINRA would offer more guidance related to cyber security, but also as to technology products that support compliance programs. He reported that FINRA would also be “adding a few features to facilitate digital interaction on our platform this year.” 

Bates Offers FINRA Registration and Compliance Solutions for Broker-Dealers

Pandemic-Related Examination and Arbitration Programs Going Forward

Mr. Cook offered several insights on post-pandemic practice, including on (i) FINRA’s examination program (“I expect we will adapt and form a risk-based approach on whether to go on site or not, though there will always be some in-person element”); (ii) FINRA arbitration (“We expect to continue to offer zoom hearings to parties as an option … We have created a Zoom taskforce”); (iii) FINRA workforce (“We will be adapting to hybrid environment – remote and in-person. Our philosophy is what we are calling ‘Presence with Purpose.’”)

Mr. Cook also weighed in on pandemic-accelerated developments concerning firm moves toward hybrid models and the future of branch inspections. He opined that these are complex questions requiring consideration by all stakeholders. He noted that the current rulebook was based on certain historical assumptions about brick-and-mortar offices and that stakeholders will need “to reassess the office construct and all the supervisory issues tied to that concept.” He stated: “our role is not to tell people how to organize their workforce. But our rules need to adapt to the evolution of different workplaces while still prioritizing investor protection.” He also noted that , “it’s more than just the inspection issue, we need to look at what functions are being performed at each location, what are the risks associated with those functions, and what are the registration supervision and inspection requirements that flow from those functions and risks.”

Arbitration and Expungement

In response to a question on the withdrawal of a comprehensive rulemaking on expungement requests, Mr. Cook stated that FINRA wants to work with stakeholders, including the state regulators, to reimagine how expungement decisions are made “to ensure we are striking the right balance among all the relevant interests.” He expects FINRA will issue a white paper “where we provide data and statistical analysis and discussion about what is happening today in the space and suggesting alternative approaches on handling expungement.” On a parallel track, he noted, FINRA will continue working on a revised package of amendments to the existing arbitration rules to give greater confidence that these expungements are only happening in accordance with circumstances identified in our rules.

Continuing Education and Testing

Mr. Cook highlighted three significant changes to FINRA’s continuing education program. They include: (i) the move to an annual regulatory element, rather than every 3 years, together with the requirement that registered representatives take courses for the license they hold, allowing for more timely and relevant training on significant regulatory developments; (ii) the extension of the regulatory and firm elements to all registered persons effective January 1, 2023; and (iii) the creation of a “Maintaining Qualification Program” which would allow previously registered persons to keep their qualifications active for up to 5 years after terminating registration, as long as they remain up-to-date with their continuing education requirements. That program begins on March 15, 2022. Starting Jan 31, 2021, representatives can notify FINRA about participating in this program (2 years retroactive).  

Mr. Cook also noted developments in online testing. He said that more than 100,000 exams were delivered this way. Here too, Mr. Cook, described the circumstances that necessitated the shift. While not anticipating any changes, he said that FINRA “needs to be thinking about maintaining our capacity and capability so we can maintain business continuity, if this [the pandemic or other exigency] happens again, so that we will be able to use it if we need to use it.”

Diversity, Equity, and Inclusion

FINRA is reviewing feedback on ways to improve diversity, equity and inclusion in the industry and referred to significant changes already underway. These include changes to the continuing qualifications program and the promotion of the SIE (“Securities Industry Essentials”) exam. He noted that FINRA dropped the requirement that an applicant needs to be affiliated with a firm to be able to sit for that exam. He cited recent data that over 300,000 signed up to take the test since the change, and that two-thirds of the test takers were not affiliated. He further noted outreach to broader communities, including through the SIFMA investor club and vouchers to take the SIE. He suggested that further changes are being considered.

Annual Report on Risk Monitoring

Mr. Cook previewed the annual report which will include an overview of relevant rule obligations, what to consider when firms are adjusting their compliance programs, FINRA’s recent examination findings and priorities, and effective practices that FINRA observed and wants firms to know as they apply this information to their business models.

Along with “carryover” areas of focus, he mentioned new priority areas for 2022, including: (i) the “Trusted Contact person” requirement, (ii) portfolio margining, (iii) intraday trading, and (iv) complex products and options. He also said that the report will update observations on firm practices regarding Reg BI and Form CRS, and compliance with best execution obligations given the many evolving changes in the market (including with advent of zero commissions). Finally, he reemphasized FINRA’s focus on liquidity risk management – “an essential element management responsibility” and an ongoing focus for risk monitoring and stress testing (given issues raised by certain events last year like Gamestop).

Conclusion

The conversation with Mr. Cook provides valuable insight on how FINRA is balancing the exigencies of the pandemic and rapid technology developments in the financial services industry. While the Annual report will be the ultimate guide, Mr. Cook’s list of subjects for target examinations and compliance priorities suggests a very busy year for both FINRA and the firms it regulates. In the coming weeks, we will be bringing you more coverage on FINRA and other regulators’ priorities as they are released, along with Bates Group's annual regulatory priorities chart.

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

Bates Compliance

Reg BI Services and Form CRS

Broker-Dealer Compliance

RIA Compliance

Retail Litigation and Consulting

Regulatory Enforcement and Internal Investigations

Bates Investor Risk Assessment for Vulnerable and Senior Investors

Bates AML and Financial Crimes

MSB, Fintech and Cryptocurrency

Events  |  01-20-22

Join Bates at the 2022 NYSBA Annual Meeting and Presidential Summit

Join Bates at the 2022 NYSBA Annual Meeting and Presidential Summit

Bates is proud to participate in the 2022 New York State Bar Association Annual Meeting and its marquee event, the Presidential Summit, on Thursday, January 20, 2022, from 2:00 – 5:00 p.m.

Led by NYSBA President T. Andrew Brown (pictured above, L), the Summit will focus on two of the leading social justice and civil rights matters of the day: a reevaluation of the #MeToo Movement, and the intersection of transgender rights and sports. NY State Attorney General Letitia James (pictured above, R) will deliver the keynote address.

Conference Details and Registration

Bates Group Managing Director Susan Harper will moderate the first panel, "A Reassessment Of #MeToo: At A Critical Juncture in State & National History, Where Do We Truly Stand?" at 2:20 p.m. We hope you can join us!

Join Bates at the 2022 NYSBA Annual Meeting and Presidential Summit

#MeToo Panelists (pictured above, L-R)

Susan L. Harper, Esq. – Managing Bates Group LLC (moderator), Founding and Past Chair of NYSBA’s Women in Law Section (Testified in the 2019 Joint New York State Senate and Assembly Public Hearing on Sexual Harassment in the Workplace.)

Taa R. Grays, Esq. – Vice President and Associate General Counsel, MetLife, Inc., NYSBA Secretary and Co-Chair of NYSBA’s Task Force on Racism, Social Equity and the Law

Debra S. Katz, Esq. – Founding Partner, Katz, Marshall & Banks (Representing high-profile cases including: Charlotte Bennett, a former aide to then Governor Andrew Cuomo in sexual harassment allegations and represented Dr. Christine Blasey Ford before the Senate Judiciary Committee in September 2018 when she testified about then-Supreme Court nominee Brett Kavanaugh.)

Kathryn Barcroft, Esq. – Partner, Chair Private Sector Employment Division, Solomon Law Firm, PLLC (Representing employees and employers in workplace matters and high-profile sexual harassment cases, and a sought-after media commentator on workplace sexual harassment and discrimination issues.)

Carrie Goldberg, Esq. – Founder, C.A. Goldberg, PLLC (A victims' rights attorney who’s brought groundbreaking civil rights and personal injury cases against schools, municipalities, Hollywood predators, and major tech companies. She is the author of the New York Times Editor’s Choice book Nobody’s Victims: Fighting Psychos, Stalkers, Pervs, & Trolls.)

Events  |  01-19-22

Virtual Event - Bates Group is the Proud Sponsor of SIFMA C&L Society’s “FINRA’s 2022 Priorities with CEO Robert Cook,” January 19 in NYC

Join The SIFMA Compliance & Legal Society for a discussion of FINRA’s 2022 priorities, featuring a one-on-one conversation between FINRA president and CEO Robert Cook and SIFMA president and CEO Kenneth E. Bentsen, Jr. (pictured above).

Bates Group is proud to sponsor this virtual event.

Date: January 19, 2022

Time: 3:30 PM - 4:15 PM ET

Register Now For This Event

Events  |  01-18-22

NYSBA Annual Meeting 2022 - Bates is Proud to Sponsor the Women In Law Section Symposium Jan. 18 & 25

Bates Group is a proud Bronze sponsor of the New York State Bar Association Women In Law Section (WILS) 18th Annual Edith I. Spivack Symposium. This two-day event will be held during the 2022 NYSBA Annual Meeting on January 18th and 25th. The theme for this year is "Women Leaders: Driving Change by Opening Doors and Raising Our Voices."

Day 1 (Tuesday, January 18, 2022) will feature a keynote address from Jennifer Wu, Esq. (Partner, Paul, Weiss, Rifkind, Wharton & Garrison LLP), a panel discussion on elevating and supporting women as leaders, and will conclude with the presentation of the Kay Crawford Murray Memorial Award honoring an outstanding attorney who recognizes the value of diversity and mentoring in the legal profession. 

Day 2 (Tuesday, January 25, 2022) will open with the presentation of the Ruth G. Shapiro Memorial Award and will feature panel discussions on combating sexual harassment and recognizing ethical blind spots. A virtual networking reception will follow the panel discussions.

Registration is now open.

Conference Details and Registration

About Bates:

Bates Group is a leading financial services consulting firm, providing end-to-end solutions on legal and compliance matters for financial services firms and their counsel. Our 165+ financial industry experts offer services in securities litigation consultation and testimony, regulatory and internal investigation matters, compliance solutions, AML and financial crimes prevention, MSB and fintech, forensic accounting, data analysis, and damages consulting.

Events  |  01-12-22

CLE Webinar January 12, 2022 - Demystifying Cryptocurrency Law & Compliance

Image © [REDPIXEL] /Adobe Stock

The cryptocurrency legal and compliance landscape is constantly changing, and there’s more scrutiny than ever before on the industry. Please join leading experts from McDermott Will & Emery and Bates Group for a discussion on the current virtual currency environment and what you need to know for your business as we kick off 2022.

Date: January 12, 2022

Time: 12:00 pm - 1:00 pm (EST)

Topics will include:

  • An overview of current cryptocurrency legislation
  • Point of View: the Financial Crimes Enforcement Network (FinCEN) and the Office of Foreign Assets Control (OFAC)
  • Enforcement updates

Register for this CLE Webinar

Continuing legal education (CLE) Credit will be offered. Minimum continuing legal education (MCLE) credit is pending in California, Illinois and New York. A Multi-Jurisdiction Certificate of Attendance will be made available to participants requesting MCLE credit in all other jurisdictions. To be eligible to earn a CLE certificate, you must attend the entire webinar. Credit for partial attendance will not be provided. You must join via the Zoom application – not by dialing in via telephone.

Speakers:

CLE Webinar January 12, 2022 - Demystifying Cryptocurrency Law & Compliance

Edward B. Diskant – McDermott Will & Emery, Partner (New York)

CLE Webinar January 12, 2022 - Demystifying Cryptocurrency Law & Compliance

Annemarie McAvoy – Bates Group, Affiliate Consultant and Expert, AML & Financial Crimes

CLE Webinar January 12, 2022 - Demystifying Cryptocurrency Law & Compliance

Brandi Reynolds – Bates Group, Managing Director, MSB & Cryptocurrency Compliance Practice

CLE Webinar January 12, 2022 - Demystifying Cryptocurrency Law & Compliance

Alexandra C. Scheibe – McDermott Will & Emery, Partner (New York)

Bates Research  |  01-06-22

SEC Issues New Guidance on Form CRS Disclosures

Image © [Kristina Blokhin] /Adobe Stock

In further guidance on compliance with the broker-dealer/investment adviser-mandated Client Relationship Summary Form (“Form CRS”), the SEC Standards of Conduct Implementation Committee (“the Committee”) evaluated “whether the relationship summary is fulfilling its intended purpose.” The Committee was made up of SEC staff from the Division of Trading and Markets, the Division of Investment Management, the Division of Examinations, and the Office of Investor Education and Advocacy.

Disclosure Details

The Committee statement provides significant detail on specific disclosure topics as well as the content, format and posting requirements for the Form. In its review, the Committee considered a “diverse cross-section” of firm filings and previous regulator engagements covering both SEC and FINRA observations on implementation (referring back to a 2020 roundtable—see Bates summary). Here is a list of the latest highlighted concerns and key takeaways.

Plain English – The Committee reasserted that the summary must be “concise and direct” to best communicate to retail investors with varied financial experience. Based on their observations, they added that this means (i) avoid unexplained legal jargon or business terms, (ii) no unpermitted disclosures and (iii) no disclaimers or hedging language (i.e. no footnotes).   

Required Information – Do not to omit or modify required information including headings, conversation starters and prescribed language, particularly as they relate to (i) conflicts of interest, (ii) investment authority, (iii) monitoring services, and (iv) disciplinary history.

Reliance on Final Instructions Only – Firms should confirm that their CRS disclosures comply with the SEC’s final adopted instructions and not previous or proposed instructions.

Cross References – Firms should  provide cross references and links to more detailed information describing the firm’s services, fees (e.g. schedules related to particular services), costs and conflicts disclosures. The Committee noted that hyperlinks to Form ADV Part 2A or Reg BI disclosure were acceptable, though warned that failure to facilitate access to those disclosures was not acceptable.

Substantive Disclosures – It was reiterated that firms should: only include required disclosures; not omit material facts in light of the circumstances; not be misleading; be responsive and relevant and not include “impermissible, extraneous, or unresponsive” information.

Specifically, it was relayed that firms must:

  • explain their monitoring practices on investments, including the frequency and any material limitations of that monitoring;
  • describe the services of an adviser who has discretionary investment authority (including material limitations and any circumstances that would impact this authority) and—for advisers who do not offer discretionary services—that the retail investor makes the ultimate investment decisions;
  • explain whether or not the firm offers limited investment advice on proprietary products and, if so, describe any limitations on these investment offerings;
  • summarize the principal fees and costs for services, including how frequently they are billed and any conflicts of interest;
  • describe any wrap fee program service offering including, in detail, related fees and costs;
  • describe the standard of conduct applicable to firm professionals (note: couching the applicable standard as an explanation to mitigate a conflict of interest is not permitted); and
  • summarize clearly how the firm’s financial professionals are paid, disclosing any potential conflicts of interest related to the firm’s compensation arrangements. (The Committee noted firms that provided “concrete examples to help investors understand the incentives associated with proprietary products, third party payments, revenue sharing, and principal trading.”)

Visit the Bates Reg BI and Form CRS Resource Page

Disciplinary History – Strict compliance must be adhered to when responding to questions on the disciplinary history of their financial professionals. Under the proper heading, the answer must be unambiguously yes or no, and the relationship summary must include the required conversation starters on the subject. Further, the Committee warned that firms do not have discretion to leave the disciplinary history answer blank or to omit reportable disciplinary history. In addition, they stated that firms must not add any language—including “qualitative or quantitative” language—that may minimize that history.

Websites – The Committee identified several issues for firms that post relationship summaries on websites. These include using features or links that pose difficulties for investors (i.e., that are hard or confusing to find, hyperlinks that are several clicks away from the homepage, small text, mistitling.) In short, relationship summaries posted on websites must be prominently displayed and formatted for easy investor access.

Affiliate Relationships – Firms should use clarity when describing their  relationship with affiliates. When a firm uses one relationship summary to describe affiliated relationships, it must display the brokerage and investment advisory information “with equal prominence, and clearly distinguish and facilitate comparison of the two types of services.” In all cases, firms must: (i) clearly state which firm offers which services or investment products; (ii) attribute disclosures to the particular firm providing the service, and (iii) describe fully the relationship between the firm and its affiliates.

Marketing Language and Boilerplate – The Committee emphasized that relationship summaries are not marketing material, and the information provided must be strictly factual, balanced and not contain sales “superlatives or similar descriptives.” Similarly, firms were reminded that the disclosures contained in the summaries must be tailored to the their “services, fees, relationships or conflicts” and not to use boilerplate language that may undermine an investor’s ability to understand the services offered or potential conflicts.

Design – Firms should design their relationship summaries to “help retail investors easily digest the information and enhance their understanding of the disclosures.” The Committee noted those firms that summarized information using graphs, charts and tables and those that used innovative approaches such as interactive features to enhance readability.

Conclusion

By issuing this additional guidance on the preparation of Form CRS, the SEC is communicating that firms need to pay more attention if the relationship summary is to fulfill its intended purpose of providing meaningful accessible information upon which investors can make reasoned choices as to financial professionals. As a practical matter, firms need to review the current version of their CRS to make sure that the highlighted issues are addressed for the new year.

How Bates Can Help

The Bates Compliance team helps BD, IA and hybrid firms meet their Form CRS and Reg. BI compliance obligations, including further defining conflicts, determining your disclosure approach and mitigating risk to your firm. We develop, review and update Form CRS and also support firms with Form CRS gap analyses, risk assessments, consistency reviews, and training. For a full list of services, visit our Reg. BI and Form CRS resource page.

To learn more about Reg BI and Form CRS compliance consulting support, including how your firm can improve its compliance, please contact us directly:

Rhonda Davis, Managing Director, Bates Compliance – rdavis@batesgroup.com or 713-410-3978

Rory O'Connor, Director, Bates Compliance – roconnor@batesgroup.com or 860-671-7270

Hank Sanchez, Managing Director, Bates Compliance – hsanchez@batesgroup.com or 504-450-9632

Contact Bates Group

Bates Group is with you every step of the way. Contact us today for more information on how our End-to-End Solutions can help your firm.