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.

Recent Regulatory Actions Against Broker-Dealers

Variable Annuity Exchanges:  $Six Million is the Costs for Failing to Consider and Accurately Describe their Costs and Benefits

Fifth Third Securities, Inc. Action

For the second time, the FINRA has sanctioned Fifth  Third related to its sale of variable annuities.  This time, Fifth Third failed to ensure that its reps obtained and assessed accurate information when recommending VA exchanges.  FINRA also found that the firm’s reps and principals were not adequately trained in how to conduct a comparative analysis of the material features of its VAs, causing the firm to misstate the costs and benefits of exchanges, thus making the exchange appear more beneficial to its customers.  To make matters worse, the firm’s principals approved approximately 92 percent of the exchange applications submitted for review. FINRA reviewed a sample of VA exchanges Fifth Third approved from 2013 through 2015, and found  that Fifth Third misstated or omitted at least one material fact relating to the costs or benefits of the VA exchange in approximately 77 percent of the sample.

FINRA fined Fifth Third Securities, Inc. $4 million and required restitution to customers of approximately $2 million.  So what went wrong?  FINRA found Fifth Third’s practices included

  •  overstating the total fees for existing VA or misstating fees associated with various additional optional benefits, known as riders;
  • failing to disclose that existing VAs had an accrued living benefit value, or understating that a customer would forfeit a living benefit value, upon executing an exchange; and
  • representing that a proposed VA had a living benefit rider when it did not.

Compared to FINRA’s fine against MetLife Securities, Inc., ($20 million and order to pay $5 million to eligible customers,  for similar behavior, around the same time two years ago) Fifth Third fared better.  Do these firms believe that such fines (which could have easily been avoided) are simply a cost of doing business? Or maybe Fifth Third believes for namesake that, next time, a “third” time violation may be just the charm.

Recent Regulatory Actions Against Advisers

SEC v. Visium Asset Management LP

Visium has agreed to settle charges related to asset mismarking and insider trading by its managed hedge funds and portfolio managers who inflated the value of securities held by hedge funds it advised causing the funds to falsely inflate returns, overstate aggregate net asset value, and pay excess fees. Based on confidential information from a former FDA official working as a paid consultant to Visium, certain Visium portfolio managers traded in the securities of pharmaceutical companies in advance of two generic drug approvals by the U.S. Food and Drug Administration. Among other violations, the SEC found that Visium failed to enforce its own valuation and insider trading policies and procedures that might have prevented mispricing and the insider trading.

SEC and FINRA To Hold 2014 Regional Outreach to Broker-Dealers

Broker-dealers are reminded, beginning this  spring, the SEC’s Office of Compliance Inspections and Examinations (OCIE), and the SEC’s Division of Trading and Markets, is partnering with FINRA to sponsor regional compliance outreach programs for broker-dealers. The programs will take place in Denver, Los Angeles, Chicago, Miami, Philadelphia, and New York.  Registration is open to all broker-dealer risk, audit, legal, and compliance professionals. Continue reading “SEC and FINRA To Hold 2014 Regional Outreach to Broker-Dealers”

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?”

An Outline of The SEC’s 2014 Examination Priorities

Last week I wrote about FINRA’s 2014 exam priorities. This week, the SEC announced its 2014 examination priorities covering a number of topics important to investment advisers, investment companies, broker-dealers, clearing agencies, exchanges and other self-regulatory organizations, hedge funds, private equity funds, and transfer agents.

While the SEC makes clear the list is not exhaustive, areas that firms will see heightened scrutiny include fraud detection and prevention, corporate governance and enterprise risk management, technology controls. Included also are issues concerning the growing relationship between broker-dealers and investment advisers, new rules and regulations, and retirement investments and rollovers. Continue reading “An Outline of The SEC’s 2014 Examination Priorities”