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FMG Law Blog Line

Posts Tagged ‘SEC’

Duties of Care and Loyalty Coming to Investments Near You

Posted on: June 28th, 2019

By: Matthew Jones

The approval of Regulation Best Interest by the Securities and Exchange Commission last month continues to spark debate and controversy, and the future of the Rule remains uncertain.  The Rule’s implementation was set for June 30, 2020. However, on June 27, 2019, the United States House of Representatives passed a bill that would strip the SEC of its ability to implement the Regulation Best Interest package. The bill would prohibit the SEC from spending funds for Regulation Best Interest and the other items included in the Regulation. It is unclear whether the bill will pass both the Senate and White House, but the initial reaction is that the President will likely be advised to veto the bill.

Perhaps anticipating this potential obstacle, last week, Massachusetts released its own proposed fiduciary rule and is accepting comments until July 26, 2019. Its proposed rule requires that advice must be provided in the best interest of the customers without regard to the interests of the broker-dealer, advisory firm, or its personnel. The proposed standard permits the payment of transaction-based fees if the fee is reasonable, is the best of the reasonably available fee options, and the “care” obligation is complied with. This proposal applies to recommendations, advice, and the selection of account types. The stated goal of this standard is to protect the public interest and investors alike. This idea is nothing new, as the SEC’s Regulation Best Interest was designed to address and prevent similar issues. However, Massachusetts points out that the SEC Regulation fails to establish a strong and uniform fiduciary standard and fails to define the term “best interest.”

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

The SEC Seeks to Enhance the Quality and Transparency of Investors’ Relationships; Approves the Regulation Best Interest Rule

Posted on: June 17th, 2019

By: Joseph Suarez

On June 5, 2019, the U.S. Securities and Exchange Commission (“SEC”) approved its Best Interest Rule (the “Rule”) package requiring broker-dealers, and investment advisors, to act in their retail clients’ “best interests.” The SEC states the Rule, “will impose a materially heightened standard of conduct for broker-dealers when serving retail clients.” Broker-dealers must begin complying with the new rule, and broker-dealers and investment advisers must prepare, deliver to retail investors, and file a “relationship summary” by June 30, 2020.

The Rule is designed to enhance investor protections while preserving retail investor access and choice in: (1) the type of professional with whom they work, (2) the services they receive, and (3) how they pay for these services. In order to satisfy the new best interest standard of care, a broker-dealer who makes recommendations to a retail customer must fulfill four obligations: 1) a “disclosure obligation”; 2) a “duty of care” obligation; 3) a “conflicts of interest” obligation; and, 4) a “compliance obligation.” The duty of care obligation requires a broker-dealer to exercise reasonable “diligence, care and skill” when making investment recommendations. This obligation is similar to FINRA’s suitability rules. In order to satisfy the best interest obligation, a broker-dealer must understand and communicate the “risk, rewards and costs of any recommendation;” have a reasonable basis to believe that the recommendation is in the best interest of the customer; and refrain from making “excessive” recommendations, given the customer’s investment profile.

Regardless of whether a retail investor chooses a broker-dealer or an investment adviser, the retail investor will be entitled to a recommendation (if (s)he chooses a broker-dealer) or advice (if (s)he uses an investment adviser) that is in the retail investor’s best interest and that does not place the interests of the firm or the financial professional ahead of the retail investor’s interests. Nonetheless, the Rule’s perceived uncertainty is cause for division. The SEC claims the Rule is designed to enhance the quality and transparency of retail investors’ relationships with broker-dealers and advisors. Proponents say the Rule will elevate the standard for what is considered an investor’s best interest, specifically, that broker-dealers will need to make substantial changes to enhance investor protection. Opponents argue the Rule is too vague and retains a muddled standard that will not change any practices in the brokerage industry.

Given the current uncertainty, the question becomes: will the Rule cause more litigation? Given the near immediate scrutiny, the answer may be in the affirmative. The Plaintiff’s Bar will likely argue that the Rule now provides customers with a higher standard of care than the suitability standard in furtherance of asserting claims against broker-dealers. In any event, the Rule’s lack of clarity will surely stir debate over the next year before its implementation.

For more information, please contact Joseph Suarez at [email protected].

Protecting Seniors From Investment Exploitation – One Year Later

Posted on: June 3rd, 2019

By: Ryan Baggs

One year after the passage of the Senior Safe Act (the “Act”) the SEC, FINRA, and NASAA continue to emphasize the importance of “covered financial institutions” (“CFIs” or “CFI”) providing adequate training to all relevant employees for the protection of investors over the age of 65. If an employee undergoes proper training and reports a violation of the act in “good faith” and “with reasonable care” she/he will be immune from suit or issues related to the reporting. What’s even more of an incentive to CFIs, such as a large broker-dealer, is that if the broker-dealer properly trains and educates all of its representatives and a representative later reports a violation of the Act, the broker-dealer itself, not just the representative, will be immune from that suit. Each organization involved, as can be seen by the numerous articles and reminders regarding the Act’s one year anniversary, is eagerly dedicated to encouraging training and education related to the immunity benefits behind the Act.  As noted by FINRA President and CEO Robert Cook: “The Senior Safe Act seeks to empower financial professionals to detect and report cases of suspected abuse of senior investors and we believe it is important to broaden awareness and understanding of the Act throughout the securities industry.” (finra.org May 23, 2019 news release).

The goals of the SEC, FINRA, and NASAA are extremely important and beneficial to the industry in general; however, with all well-meaning intentions, there always exists the possibility of abuse. What is uncertain because of the brief history of the Act is exactly what “good faith” and “with reasonable care” mean or will mean in the future. Are there ways a CFI or representative will be able to manipulate the Act to avoid liability or litigation? Almost undoubtedly, but how is remained to be seen. But overall, despite the possibility of some abuse at some point, the purpose of the Act and dedication to protecting seniors from investment and elder abuse is an admirable step in the industry.

For more information, please contact Ryan Baggs at [email protected].

SEC Issues Risk Alert Regarding Broker-Dealers and Investment Advisers’ Privacy Practices and Compliance with Regulation S-P

Posted on: April 22nd, 2019

By: Jennifer Lee

On April 16, 2019, the U.S. Securities and Exchange Commission (“SEC”) issued a Risk Alert summarizing the findings from the examinations of broker-dealers and investment advisers’ privacy practices and compliance with Regulation S-P.

Regulation S-P, 17 C.F.R. § 248.30, was enacted to protect the privacy of customers and their information. It has three major components:

  1. Firms are required to provide their customers with a copy of their privacy policies and procedures at the initial outset of the relationship and also on an annual basis.
  2. Firms are prohibited from sharing customers’ nonpublic information with unaffiliated third parties unless the customer is given prior notice regarding such practices.
  3. Firms must inform customers that they have a right to opt-out of the firm’s data sharing practices with unaffiliated third-parties and provide a method in which customers can opt-out.

During the examinations, which spanned over the course of the past two years, the Office of Compliance Inspections and Examinations (“OCIE”) found common deficiencies in firms’ compliance with Regulation S-P. The OCIE found that some firms did not provide customers with the initial and/or annual privacy policies and procedures. In other instances, the privacy policies and procedures were inadequate to satisfy the requirements under Regulation S-P. For example, the policies and procedures failed to identify the precautions taken to ensure the integrity of customers’ information.

Even when firms gave the required notices and had satisfactory written policies and procedures on the books, the OCIE often found that such policies and procedures were not actually being implemented and firms’ practices diverged from the written policies and procedures. Customers’ personally identifiable information (“PII”) were sent via unencrypted emails and left in unsecured physical locations, firm employees had customer information on unsecured personal devices, and outside vendors were not vetted on their cybersecurity and privacy practices.

These findings are unsurprising because often when a new set of privacy or cybersecurity regulations is introduced, companies will invest an incredible amount of time and resources to develop policies and procedures that comply with the new requirements. Usually, most of this work is done by the COO or Chief Information Security Officer (“CISO”). However, it does not and cannot stop there as most enforcement actions and customer actions are brought based on the firm’s failure to implement its policies and procedures.

To reduce the risk of enforcement and customer actions, firms must ensure that the policies and procedures in its books are put into practice. This requires buy-in from everyone at the executive level—from the CEO to the CMO—and cooperation from multiple departments in the firm that may not necessarily work closely with each other on a regular basis. In addition, firms should shift their perspective on compliance with Regulation S-P and other privacy or cybersecurity regulation. It is not a one-off event. Instead, it should be seen as an active and on-going process that requires constant training and monitoring.

If you have any questions regarding your firm’s compliance with Regulation S-P or other privacy and cybersecurity regulations, please contact Jennifer Lee at [email protected]glaw.com.

SEC Holds Public Forum as Part of Increasing Efforts to Regulate Digital Assets, Cryptocurrency Exchanges, and ICOs

Posted on: March 28th, 2019

By: Jennifer Lee

The Securities and Exchange Commission will be hosting a public forum on distributed ledger technology and digital assets in Washington DC on May 31, 2019. This is a part of the SEC’s increasing efforts to regulate cryptocurrency exchanges and initial coin offerings (ICOs) that have been proliferating unchecked until very recently.

Since digital assets are still an emerging concept, regulators, such as the SEC and the Financial Crimes Enforcement Network (FinCEN), a bureau of the U.S. Department of Treasury, have been struggling to figure out how the existing regulatory framework applies to cryptocurrencies, exchanges, and ICOs. However, as established financial institutions, such as Fidelity, begin to enter the digital asset space, the SEC has ramped up its efforts to ensure that companies are aware of and are in compliance with all applicable laws and regulations. Depending on the nature of the services provided, companies may be subject to the Securities Exchange Act of 1934, Bank Secrecy Act, and states’ money transmitter licensing statutes.

The push for more oversight over cryptocurrencies comes at the heels of high-profile scandals involving cryptocurrency exchanges and ICOs that left consumers and investors alike with nothing but questions after losing their fiat and digital currencies.

The very first incident involved Mt. Gox, a bitcoin exchange based in Tokyo, Japan that operated between 2010 and 2014. Cryptocurrency exchanges allow its users to exchange fiat currency (e.g., U.S. Dollars) into cryptocurrency and provide digital wallets for users to store their cryptocurrency. At its heyday, it was handling over 70% of all bitcoin transactions worldwide. However, it ran into a host of problems in 2013 continuing on to 2014 until it stopped operations and filed for bankruptcy. During the litigation that ensued, it was revealed that Mt. Gox somehow lost approximately 750,000 of its customers’ bitcoins, valued at around $473 million at that time.

More recently, in February 2019, the cryptocurrency exchange QuadrigaCX announced that it was missing approximately $145 million in digital assets. Its executives, consumers, and law enforcement are in a frenzy to determine what happened to the missing digital assets as the only person who had access was QuadrigaCX’s founder Gerry Cotten, who had passed away the month prior.

These incidents are not limited to cryptocurrency exchanges, especially as ICOs have become more popular in recent years. ICOs are similar to IPOs in the sense that investors can buy a stake in a particular cryptocurrency (referred to as a token), but unlike IPOs, a token’s value is not tied to the value or performance of an underlying company. In November 2018, the SEC settled charges against professional boxer Floyd Mayweather Jr. and singer/producer DJ Khaled for failing to disclose payments they received for promoting investments in ICOs. This suggests that despite the decentralized nature of cryptocurrencies and ICOs, the SEC has assumed jurisdiction over the space and its players.

Accordingly, broker-dealers and investment advisory firms looking to get involved in the digital asset space, including operating cryptocurrency exchanges, providing trading platforms for cryptocurrencies, or facilitating ICOs, must ensure that they are in compliance with all existing laws and regulations that govern traditional financial transactions and investments.

For more information or to inquire about the firm’s services related to digital currencies, please contact Jennifer Lee at [email protected].