SEC Enforcement Division: 2019 Fiscal Year Report

Last week, the Securities and Exchange Commission’s Division of Enforcement issued its annual report for 2019. Based on, and in keeping with its stated five core principles, that includes: (1) focus on the Main Street investor, (2) focus on individual accountability, (3) keep pace with technological change, (4) impose remedies that most effectively further enforcement goals, and (5) constantly assess the allocation of resources, the SEC brought a mixture of 862 enforcement actions, including 526 standalone actions. In total, the SEC obtained judgments and orders totaling more than $4.3 billion in disgorgement and penalties.

The majority of the SEC’s 526 standalone cases in 2019 concerned investment advisory and investment company issues (36%). Securities offerings (21%), and issuer reporting/accounting and auditing (17%) matters, actions against broker-dealers (7%), insider trading (6%), and market manipulation (6%), as well as other areas such as FCPA (3%) and Public Finance (3%) made up the rest.

A copy of the 2019 Annual Report is available here.

Top Compliance Observations of Investment Companies From OCIE’s MMF and Target Date Fund Initiatives

The Office of Compliance Inspections and Examinations (OCIE) has issued a Risk Alert providing investment companies, investors, among others, information on the most cited deficiencies found in 300 fund exams of registered investment companies. The Risk Alert also includes observations from national examination initiatives focused on money market and target date funds. While many of the funds weren’t cited for all the deficiencies referenced, the most noted weaknesses concerned:

The Fund Compliance Rule. Staff observed funds’ failures to adopt and implement policies and procedures reasonably designed to prevent violations of the federal securities laws, including policies and procedures “that provide for the oversight of compliance for each investment adviser, principal underwriter, administrator, and transfer agent of the fund (collectively, “service providers”).” Observations included:

● Compliance programs that did not take into account the nature of funds’ business activities; didn’t consider specific risks, method of pricing of securities; advertisements and sales literature problems; 
● Policies and procedures not followed or enforced i.e. funds’ policies and procedures related to the fair valuations determined by the valuation committee where certain funds failed to follow or enforce policies and procedures; 

● Inadequate service provider oversight i.e. failure to provide  ongoing monitoring or due diligence of providers’ services relating to pricing of portfolio securities and fund shares; 
● Annual reviews either not performed or did not addressed the adequacy of the funds’ policies and procedures; Certain funds conducted annual reviews of their policies and procedures that failed to address the adequacy of the funds’ policies and procedures;

Disclosure to Investors. Staff observed funds that provided incomplete or potentially materially misleading information in their prospectuses, statements of information, or shareholder reports when compared to the funds’ actual activities that the staff observed during examinations (i.e. service provider fees, change in investment strategy). 

Section 15(c) Process. Staff observed some funds’ failure to request and evaluate information reasonably necessary for the board to evaluate the terms of the adviser’s contract, including shareholder reports that failed to discuss adequately the material factors that informed the board’s approval of an advisory contract; failure to implement, follow or enforce code of ethics, or failed to comply with their own approval and reporting obligations.  

Certain National Examination Initiatives – Money Market Funds (MMFs) and Target Date Funds (TDFs)

As for observations from the national examination initiatives focused on money market funds and target date funds, the staff observed instances of deficiencies or weaknesses related to MMFs’ portfolio management practices, compliance programs, and disclosures. 

In examining over 30 TDFs, including both “to” and “through” funds, the staff observed instances of deficiencies or weaknesses related to TDFs’ disclosures and compliance programs, including:(i) incomplete and potentially misleading disclosures in  prospectuses and advertisements; and (ii) incomplete or missing policies and procedures related to monitoring asset allocations, advertising and sales literature, and glide path deviations.

A copy of the Risk Alert can be found here

 

A CLEARER FINRA 2019 Exam Findings and Observations

At the request of member firms (according to FINRA), FINRA  has now released its 2019 Reports on Examination Findings summarizing key findings from member exams. Different from earlier reports (2017 and 2018), this time around, FINRA says it wanted to make clearer the distinction between exam findings (violations of SEC, FINRA rules) and observations (suggestions for improving control environment).

FINRA’s stated goals are to identify issues and advise members of effective practices that can address deficient compliance programs in areas covering sales practice and supervision, firm operations, market integrity, and financial management. While the list contains many of the usual deficiencies, it also includes specific and noteworthy observations about how to strengthen compliance in these areas, including

supervision and document requirements

Suitability Rule violations

Digital Communication Use

Anti-Money Laundering (AML)

Uniform Transfers and Grants to Minors Accounts

Cybersecurity

Business Continuity Plans

Fixed Income Mark-up Disclosure

Best Execution

Direct Market Access Controls

Short sales

Liquidity and Credit Risk Management

Segregation of Client Assets

Net Capital Calculations

A link to the report can be found here.

RISK ALERT: ADVISER BEST EXECUTION PRACTICES

The SEC National Exam Program has issued a new Risk Alert addressing some of the most common deficiencies associated with advisers’ best execution obligations identified by OCIE staff.  In addressing the deficiencies, the alert reminds advisers of existing requirement that in determining best execution an adviser must seek to obtain the execution of transactions for clients in such a manner that the client’s total cost in each transaction is the most favorable under the circumstances. “[T]he  determinative factor [in an adviser’s best execution analysis] is not the lowest possible commission cost but whether the transaction represents the best qualitative execution for the managed account.” The SEC has brought enforcement actions against advisers who fail to meet this standard.

Common adviser best execution deficiencies that were observed by the staff include:

failure to demonstrate periodic and systematic evaluation of the execution performance of broker-dealers used to execute client transactions.

failure to consider the full range and quality of a broker-dealer’s services in directing brokerage.

failure to seek or consider the quality and costs of services available from other broker-dealers.

advisers who failed to provide full disclosure of best execution practices.

•failure to provide full and fair disclosure in Form ADV of their soft dollar arrangements.

•advisers who did not “appear to make a reasonable allocation of the cost of a mixed use product or service according to its use or did not produce support, through documentation or otherwise, of the rationale for mixed use allocations.”

•advisers that appeared to fail to have adequate compliance policies and procedures or internal controls for best execution.

advisers who failed to follow their policies and procedures regarding best execution, including failing to seek comparisons from competing broker-dealers to test for pricing and execution, not allocating soft dollar expenses in accordance with their policies, and not conducting ongoing monitoring of execution price, research, and responsiveness of their broker-dealers.

Advisers should remember that as fiduciaries, they have a duty to obtain best execution in client transactions. The alert list several actions advisers may want to consider when cleaning up such deficiencies.  Actions that might be taken by advisers include, amending their best execution or soft dollar arrangements disclosures, revising compliance policies and procedures, and changing their practices regarding best execution or soft dollar arrangements.

The End of Not Opposing Expungements in Return For Settlement?

Thinking of conditioning the settlement of  a customer arbitration claim on the customer agreeing to expunge her complaint against you? Think again.  The FINRA is now awaiting the SEC’s approval of a FINRA rule proposal that would prohibit associated persons from conditioning settlements of customer disputes on, or otherwise compensating customers for, an agreement not to oppose a request to expunge information from an associated person’s Central Registration Depository (CRD) record. Continue reading “The End of Not Opposing Expungements in Return For Settlement?”

Cyber-Security: FINRA’s Targeted Examination Letter

The IPR Blog: FINRA's Targeted Examination LetterAs we posted earlier in outlining  FINRA’s  2014 Regulatory and Examination Priorities Letter, one focus included FINRA’s concern for the integrity of member firms’ policies, procedures and controls that are supposed to protect sensitive customer data.  In the letter, FINRA states that it will examine and conduct targeted investigations and followed up by issuing  a separate notice concerning  Targeted Examination Letters that some firms may get seeking information about how the firm addresses the issue of cyber-security threats, vulnerabilities, and management of related risks.  The cyber-security topics FINRA will examine or assess include a firm’s

Continue reading “Cyber-Security: FINRA’s Targeted Examination Letter”

Reminder: SEC National Compliance Outreach Program

Advisers are reminded the SEC’s annual compliance outreach program National Seminar will be held on January 30, 2014, at its headquarters in Washington, D.C. Investment adviser and investment company senior officers, including chief compliance officers (CCOs) are invited to register and attend.

This year’s agenda will likely include panel discussions with SEC staff from the Office of Compliance Inspections and Examinations (OCIE), Division of Investment Management, and Division of Enforcement’s Asset Management Unit and investment adviser personnel. The agenda’s topics will include SEC exam priorities in 2014, private fund advisers, registered investment companies, valuation, and the role of the CCO. Continue reading “Reminder: SEC National Compliance Outreach Program”

Compliance Risks With Leveraged and Inverse ETF Sales

FINRA has ordered Atlanta-based broker-dealer, J.P. Turner & Company, L.L.C. to pay $707,559 in restitution to 84 customers for sales of unsuitable leveraged and inverse exchange-traded funds (ETFs) and for excessive mutual fund switches.

FINRA’s action against J.P. Turner is another reminder of the need for broker-dealers to carefully scrutinize the suitability of such non-conventional investments products like inverse exchange-traded funds.

While FINRA mutual fund switch violation cases (a practice FINRA has addressed repeatedly) are more common, inverse ETFs sales practice violations case have not been as prominent, but should come as no less a surprise. Continue reading “Compliance Risks With Leveraged and Inverse ETF Sales”

NEW REGISTRATION RULES FOR MUNICIPAL ADVISORS

As they were required to do under the Dodd-Frank Act, the SEC announced that it has now voted to adopt permanent rules requiring municipal advisors to register.  Previously, and immediately after Dodd-Frank,  municipal advisors were placed under a temporary registration requirement, and following it, more than 1,100 municipal advisors registered with the SEC.

The permanent rule, the SEC says, will address the long concern about the fallout from losses suffered, in part, by municipalities purchasing complex derivatives products and relying on the advice from unregulated advisors — advisors, who municipalities may not have been aware, may have had conflicts of interest.   In addition to defining the term “municipal advisor,” and who is exempted from that definition, the rule  identifies when a person is considered to be providing “advice.”   For example, the SEC says, other than general giving information, a  person recommending to a municipal entity advice based on a particular need related to municipal financial products or related to the muncipalities’ issuance of municipal securities would be considered providing muncipal advice. 

The SEC’s Press Release states that the new rules will be effective 60 days after publication in the Federal Register.