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Posts Tagged ‘SEC’

DOL Fiduciary Rule Suffers a Slow Death

Posted on: May 15th, 2018

By: Ted Peters

In 2016, the U.S. Department of Labor (“DOL”) promulgated a set of rules and regulations now infamously referred to as the “Fiduciary Rule.”  After multiple criticism and legal challenges, the Fifth Circuit Court of Appeal struck down the Fiduciary Rule effective May 7, 2018.  Surprising many, the DOL elected not to challenge the Fifth Circuit ruling.  Even more surprising, however, was the bulletin issued by the DOL on the effective date of the court’s order.

The court’s ruling, which was not opposed by the DOL, left many unanswered questions.  Enter the DOL’s field bulletin.  Rather than admitting the total defeat of the Fiduciary Rule, however, the DOL seeks to maintain the status quo.  Specifically, the DOL announced that pending further guidance, advisors will not be penalized for either complying with the Fiduciary Rule, or ignoring it in favor of pre-existing standards.  Unfortunately, this announcement leaves the single most important question unanswered – what is the standard to which advisors will be held?  With the U.S. Securities and Exchange Commission working on its own set of rules, and the wait-and-see approach embraced by the DOL notwithstanding, only time will tell.

If you have questions or would like more information, please contact Ted Peters at [email protected].

New FINRA Proposals for High Risk Brokers

Posted on: May 4th, 2018

By: Theodore C. Peters

On April 30, 2018, FINRA published Regulatory Notice 18-16, captioned “High-Risk Brokers,” which seeks comment on proposed rule amendments that would place further restrictions on not only high-risk brokers, but also the member firms that employ them.  FINRA warns that such brokers “may present heightened risk of harm to investors, and any misconduct by them also may undermine confidence in the securities markets as a whole.”

This Notice, among others, stems from the increasing pressure upon FINRA to deal with problem brokers.  According to the Notice, the amendments would serve to “strengthen existing controls.”  More specifically, the amendment would affect the Rule 9200 Series (Disciplinary Proceedings) and the Rule 9300 Series (Review of Disciplinary Proceedings by National Adjudicatory Council and FINRA Board; Application for SEC Review), and would allow a hearing panel “to impose conditions or restrictions on the activities of member firms and brokers while a disciplinary matter is on appeal to the National Adjudicatory Council (“NAC”), and to require member firms to adopt heightened supervision procedures for brokers during the period the appeal is pending.”

The proposal would also impact the Rule 9520 Series (Eligibility Proceedings) to mandate that member firms adopt heightened supervision procedures for brokers during the period a statutory disqualification (“SD”) eligibility request is under review. Further, Rule 8312 (FINRA BrokerCheck Disclosures) would require disclosure of the status of a member firm as a “taping firm” under Rule 3170 (Tape Recording of Registered Persons by Certain Firms).

Lastly, the NASD Rule 1010 Series (Membership Proceeding)(MAP Rules) would be amended to place additional limits on member firms by requiring firms to first submit a written letter to FINRA’s Department of Member Regulation through the MAP Group (the Membership Application Program Group), requesting a “materiality consultation” when a natural person who has been the subject of, within the prior five years, one or more final criminal actions or two or more specific risk events, seeks to become an owner, control person, principal or registered person of an existing member firm.  “Specific risk events” generally mean “final, adjudicated disclosure events disclosed on a person’s or firm’s Uniform Registration Forms.”

Separately, FINRA also published Regulatory Notice 18-15, which reiterates the existing obligation of member firms to adopt and implement heightened supervisory procedures under Rule 3110 (Supervision) that are specifically tailored for high-risk brokers.  Unlike Notice 18-16 which seeks comment on proposed rule amendments, Notice 18-15 intends to “reiterate the supervisory obligations of member firms regarding associated persons with a history of past misconduct that may pose a risk to investors,” and to provide guidance for member firms in implementing effective heightened supervisory procedures for such persons.

If you have questions or would like more information, please contact Ted Peters at [email protected].

Yahoo Fined $35M for Delay in Disclosing 2014 Cyberattack

Posted on: April 30th, 2018

By: Theodore C. Peters

On April 24, 2018, the U.S. Securities and Exchange Commission hit Altaba, Inc. (formerly known as Yahoo) with a $35 million fine.  The penalty stems from Yahoo’s failure to disclose a 2014 cyberattack until 2016, even though it knew of the breach within days after it occurred.

In its order, the SEC said that Yahoo’s information security team was promptly advised that Russian hackers had acquired highly sensitive information that Yahoo itself referred to as its “crown jewels,” namely Yahoo usernames, email addresses, telephone numbers, dates of birth, hashed passwords, and security questions and answers for hundreds of millions of accounts.  Despite such knowledge, however, Yahoo waited until September 2016, on the eve of a pending sale to Verizon Communications, Inc., before it officially disclosed the breach.

Yahoo’s disclosure of the breach resulted in an immediate 3 percent decline (estimated at $1.3B) of Yahoo’s share price, and caused Verizon to renegotiate the purchase price, lowering it by $350M (representing a 7.5% discount).  Before publicly acknowledging the breach, Yahoo released annual and quarterly reports that the SEC concluded were “materially misleading” insofar as “they claimed the company only faced the risk of potential future data breaches that might expose the company to loss of its users’ personal information…”(emphasis added).

Yahoo later amended its risk factor disclosures and MD&A (Yahoo management’s discussion of financial condition and results of operations) to reflect the 2014 breach in its subsequent public filings.  On October 9, 2016, Yahoo acknowledged that the breach occurred in 2014.  Yahoo also corrected prior public disclosures for 2014 and 2015, which indicated that Yahoo’s disclosure controls and procedures were effective.  The amended filings stated that such controls and procedures were not effective.

As part of its agreement with the SEC, Altaba neither confirmed nor denied the statements in the order.  Whether further action will be taken against any of the Yahoo executives who were employed at the time of the 2014 cyberattack remains to be seen.  Altaba must pay the $35M penalty.

Separately, a U.S. District Court Judge, for the Northern District of California, held off on sentencing of a 23-year-old Canadian “international hacker-for-hire,” Karim Baratov. At an April 24, 2018 sentencing hearing, Judge Vince Chhabria told federal prosecutors that he was concerned that Baratov could potentially face a tougher sentence solely based upon the fact that among Baratov’s clients were certain Russian nationals who committed the 2014 Yahoo cyberattack, even though there was no evidence that Baratov himself was involved in the Yahoo breach.  Prosecutors sought a near eight year term of imprisonment.  During the sentencing hearing, Judge Chhabria stated that he had “multiple concerns” about the sentence and noted that other hackers engaged in similar conduct had received lesser sentences.  Further briefing was ordered on the issue of what national sentencing ranges are for hackers convicted in federal court.

If you have questions or would like more information, please contact Ted Peters at [email protected].

SEC Fiduciary Rules Proceeds on Split Vote

Posted on: April 19th, 2018

By: Theodore C. Peters

The Securities and Exchange Commission (“SEC”) conducted a public hearing on April 18, 2018 to address a series of SEC proposals governing securities professionals.  Recall that the Department of Labor previously sought to promulgate a “fiduciary rule” which encountered numerous legal hurdles and ultimately was struck down by the Fifth Circuit.  Concurrently, over the last 11 months, the SEC has been working on its own set of rules to provide the securities industry with more clarity concerning advice standards.  After a two hour hearing, the SEC Commissioners split over whether to proceed with the next step in the rule making process.  Chairman Jay Clayton and Commissioners Michael S. Piwowar, Robert J. Jackson Jr. and Hester M. Peirce voted in favor of the proposals; Commissioner Kara M. Stein vociferously rejected the proposals.

At issue were three proposals: (1) a rule to establish a standard of conduct for broker-dealers and their associated persons when making a recommendation of any securities transaction or investment strategy involving securities to a retail customer; (2) a rule requiring registered broker-dealers and registered investment advisers to provide a brief relationship summary to retail investors; and (3) a formal SEC interpretation of the standard of conduct applicable to investment advisers.  Various SEC staffers introduced each of the proposals with candid remarks, tacitly admitting that there was room for improvement with respect to each component of the proposal package.

The so-called “Regulation Best Interest” would mandate that broker-dealers and their registered representatives who make recommendations to a retail customer act in the best interest of the customer at the time the recommendation is made, without putting the financial or other interest of the broker-dealer ahead of the retail customer.  To comply with this obligation, a broker-dealer would need to do three things: (1) disclose key facts about the relationship (including material conflicts of interest); (2) exercise reasonable diligence/care/skill to i) understand the product, ii) have a reasonable basis to believe that the product is in the customer’s best interest, and iii) have a reasonable basis to believe that a series of transactions is in the customer’s best interest; and (3) establish/maintain/enforce policies and procedures designed to identify and disclose and then mitigate or eliminate material conflicts of interest.

The Form CRS (customer relationship summary) rule would require investment advisers and broker-dealers (and their associated persons) to provide retail investors with a short-form (4 pages maximum) disclosure summary that would identify key differences in the principal types of services offered, the legal standards of conduct that apply to each, applicable fees and conflicts of interest.

In connection with the proposal regarding a Commission interpretation of the standard of conduct for investment advisers, the SEC seeks a Commission-sanctioned interpretation as to the duty owed by an investment adviser to his/her clients.  The proposed interpretation reaffirms, and in some cases clarifies, certain aspects of the fiduciary duty owed by an investment adviser.

Republican Commissioner Michael Piwowar candidly admitted that the failed DOL Fiduciary Rule was “terrible,” “horrible,” and “very bad.”  He expressed greater faith in the SEC proposals, though he said that the proposals could be improved in several respects.  He stated that the proposed Regulation Best Interest represented a “solid building block,” but noted that there was much room for improvement.  As for the proposed Form CRS template, Piwower suggested that it was “as comprehensible as Herman Melville’s Moby Dick.”  Despite having misgivings as to all three proposals, he voted in favor of them.

Democratic Commissioner Robert Jackson, who admitted being an advocate of the DOL Fiduciary Rule, also professed to have concerns over the proposals.  He stated that the standard set forth in Regulation Best Interest was too ambiguous and he feared that such ambiguity would be used by lawyers to defend transgressing brokers.  As for the proposal concerning mitigation of conflicts of interest, Jackson stated that “some conflicts should simply be banned outright.”  Despite his concerns, Jackson stated that he was “reluctantly voting to open the proposals for comment.”

Republican Commissioner Hester Peirce concurred with many of the prior comments concerning clarity (or the lack thereof) of the proposals.  She stated that “disclosure should be the centerpiece of reform,” and that she was in favor of requiring brokers to provide more details in connection with their disclosures of services offered and fees charged. Peirce believes that the proposed Regulation Best Interest was mislabeled, stating that it would be more accurate to call it a “suitability-plus” standard.  Lack of clarity in the proposal leads to increased cost of compliance, Peirce said, and suggests an “impossible standard” to satisfy which could lead to a decline in the number of registered broker-dealers. Commissioner Peirce stated that the proposals were an “excellent start toward reform,” and voted in favor of them.

Democratic Commissioner Kara Stein blasted the proposals as too weak.  She said the Commission had the opportunity to propose meaningful proposals, but failed to do so.  Critically, Stein said the Regulation Best Interest provided broker-dealers with a safe harbor and did nothing to require that they put customers’ interests first.  Noting that the proposed regulation lacked any definition of “best interest,” Stein said the proposal might mislead investors and might as well be called “Regulation Status Quo,” because it simply reaffirms that broker-dealers are required to meet their suitability obligations.  Not surprisingly, Commissioner Stein voted against the proposals.

Chairman Jay Clayton acknowledged his fellow Commissioners’ comments and stated that “much work” was still needed before the proposals could be adopted as final rules.  Calling for a vote, Commissioners Piwower, Jackson, Peirce and Clayton voted in favor; Commission Stein voted against.  With majority approval, the SEC’s rule package will now be submitted for a 90-day public comment period.

If you have questions or would like more information, please contact Ted Peters at [email protected].

Has Fiduciary Rule Suffered a Fatal Blow?

Posted on: April 4th, 2018

By: Theodore C. Peters

The Employee Retirement Income Security Act of 1974 (“ERISA”) defined a “fiduciary” as someone who provides investment advice for a fee.  The following year, the U.S. Department of Labor (“DOL”) promulgated regulations that provided a five-part test for assessing whether someone was a fiduciary as defined by ERISA.  Seeking to implement a uniform fiduciary rule for all retail investment accounts, the DOL issued the Fiduciary Rule on April 6, 2016.  The Fiduciary Rule re-defined who is an “investment advice fiduciary” under ERISA and heightened the fiduciary duty to a “best interest” standard for those clients with ERISA plans and IRAs.  Previously, brokers were bound only to make “suitable” recommendations.  The Fiduciary Rule also created a “Best Interest Contract Exemption” that permitted financial advisors to avoid penalties stemming from prohibited transactions so long as they contractually affirmed their fiduciary status.

Several industry groups brought suit against the DOL, opposing implementation of the Fiduciary Rule.  In 2017, the United States District Court for the Northern District of Texas, in an 81-page ruling, ruled in favor of the DOL.  Chief Judge Barbara M.G. Lynn concluded that the DOL had not exceeded its authority and had not created a private right of action for clients. On March 15, 2018, in Chamber of Commerce v. United States Department of Labor, the Court of Appeals for the Fifth Circuit invalidated the Fiduciary Rule in a 2-1 decision.

In reversing the lower court, the Court addressed a simple but critical issue: whether the DOL exceeded its rulemaking authority by expanding the definition of “investment advice fiduciary.” The Court concluded that the new definition was in conflict with ERISA and the Internal Revenue Code because it was inconsistent with the common meaning of “fiduciary.”  The Court noted that the DOL arbitrarily and improperly sought to broaden the scope of its authority through the concept of investment “advice,” that included products sold by financial salespersons and even insurance agents. Further, the Court criticized the best interest contract exemption, which permitted brokers to receive compensation for investment products they recommend (thereby creating potential conflicts), provided they agree by contract to act in the investor’s “best interests.”

By vacating the Fiduciary Rule under the Administrative Procedures Act, the Fifth Circuit effectively voided the entire rule nationwide.  The DOL could possibly request a hearing en banc before the entire Fifth Circuit, or alternatively, petition for a writ of certiorari to the United State Supreme Court.  Or perhaps, the DOL will take no action at all, in which case the Fiduciary Rule will presumably die on the vine, and the five-step test enunciated in 1975 would be resurrected. Of note, however, mere days before the Fifth Circuit’s decision, the Tenth Circuit ruled in favor of the DOL in the context of a more limited challenge to the Fiduciary Rule highlighting a split between federal circuits – which may in turn spur the DOL to seek Supreme Court review.

Regardless of what action the DOL takes, the Securities Exchange Commission (“SEC”) is likely to seek to implement its own rules.  Commencing in October 2017, the SEC began reviewing the DOL’s Fiduciary Rule with a goal of introducing its own new rule governing investment advice.   SEC Chairman Jay Clayton testified before the Senate Banking Committee that the drafting of an SEC rule that harmonizes with the DOL’s Fiduciary Rule was a priority.  Despite the Fifth Circuit ruling, the SEC’s resolve appears to remain steadfast.  During a Q&A session at the SIFMA compliance conference just days after the ruling, Jay Clayton said “I’m not sitting on this… [and] as far as I’m concerned, we’re moving forward.”

If you have questions or would like more information, please contact Ted Peters at [email protected].