Official Newsletter of Gordian Compliance Solutions, LLC.

REGULATORY UPDATES

Interim Status Update: 
Appeals Court Strikes Down Fiduciary Rule


On March 15, the U.S. Department of Labor (“DOL”) lost its legal battle to uphold the fiduciary rule in the 5th U.S. Circuit Court of Appeals.[1] The fiduciary rule would require all financial professionals who service individual retirement clients, including brokers and insurance agents, to provide advice that meets a heightened fiduciary (also known as “best interest”) standard instead of a suitability standard. Currently, the U.S. Securities and Exchange Commission (“SEC”) only holds investment advisors to a stricter fiduciary standard. In a 2-1 decision, the court vacated the rule and held that, among other arguments, the DOL overstepped its authority since the Employee Retirement Income Securities Act (“ERISA”) does not enable the agency to legally bind all financial service providers to a fiduciary standard.[2]
 
Much remains to be seen regarding the government’s next steps. The DOL has until April 30th to request a circuit court rehearing of the decision and until June 13th to petition the case to the Supreme Court. In the meantime, SEC Chairman Jay Clayton stated that the agency is prioritizing the creation of a harmonized standard that would bridge the current distinctions among financial professionals.[3] Clayton also stated that the SEC is open to working with the DOL in creating this new approach.[4]

 

[1] Chamber of Commerce of the U.S.A., et al. v. U.S. Dep’t of Labor, et al., No. 17-10238, slip op. 46 (5th Cir. Mar. 15, 2018)
[2] Id. at 35.
[3] Clayton: SEC Fiduciary Rule on Track Despite DOL Court Defeat, The National Law Journal (March 22, 2018)
[4] SEC Begins Working with DOL on Fiduciary Rule, FinancialPlanning (October 5, 2017)

Certified Financial Planner Board
Approves Expanded Fiduciary Standard

 
The Certified Financial Planner Board of Standards, Inc. (“CFP”) announced that Certified Financial Plannersä must uphold a fiduciary standard of conduct when providing clients with financial advice of any kind and not only financial planning services as originally required.[1] The expanded application of the fiduciary standard comes on the heels of the U.S. Department of Labor’s (“DOL”) recent legal push to apply a fiduciary standard industry-wide[2] and the U.S. Securities and Exchange Commission’s recent statement that a strengthened fiduciary policy is in the making.[3] The CFP has updated its code of ethics and standards of conduct to reflect these changes and outlines how the fiduciary duty needs to be communicated to clients and carried out by planners.  The new standard doesn’t become effective until October 1, 2019 to provide financial planners with sufficient time to integrate the new requirements.[4]
 

[1] Code of Ethics and Standards of Conduct, Certified Financial Planner Board of Standards, Inc. (March 2018; Effective Date: October 1, 2019)
[2] Chamber of Commerce of the U.S.A., et al. v. U.S. Dep’t of Labor, et al., No. 17-10238, slip op. 46 (5th Cir. Mar. 15, 2018)
[3] Clayton: SEC Fiduciary Rule on Track Despite DOL Court Defeat, The National Law Journal (March 22, 2018)
[4] Code of Ethics and Standards of Conduct, Certified Financial Planner Board of Standards, Inc. (March 2018; Effective Date: October 1, 2019)
NASAA Encourages Caution on Cryptocurrencies

The North American Securities Administrators Association (“NASAA”) issued a statement warning the public to be wary of cryptocurrency investments.[1] The U.S. Securities & Exchange Commission (“SEC”) affirmed NASAA’s position and further reminded investors of the risks involved.[2] NASAA stressed that cryptocurrencies are not backed by tangible assets and are subject to little or no regulation. A NASAA survey showed that 94% of regulators felt cryptocurrencies carried a “high risk of fraud” and they unanimously believed more regulation is needed.[3] NASAA has since deemed cryptocurrencies an emerging investor threat for 2018.
Enforcement Actions
 
SEC Cherry-Picking Enforcement Initiative

The SEC’s ongoing “Cherry-Picking” Enforcement Initiative continued into 2018 with the filing of two more enforcement actions. Since 2015, the SEC has utilized a data-driven approach to “identify instances where it appears an adviser is disproportionately allocating profitable trades to favored accounts.”[1]
 
On February 22, the SEC filed a complaint against brothers Joseph Bronson and John Engebretson of Strong Investment Management for cherry picking trades for client accounts.[2] The complaint alleges that for over four years, Bronson traded in the firm’s omnibus account and at the end of the day would allocate unprofitable trades to clients and profitable trades to his personal account. Engebretson was the chief compliance officer and is included in the complaint for failing to carry out the firm’s policies and procedures on trade allocation and for disregarding red flags. The SEC also alleges that Bronson and Engebretson falsely stated in the firm’s ADV that “all trades would be allocated according to pre-allocation statements and that the firm did not favor any account, including those of the firm’s personnel.”[3]
 
On March 8, the SEC announced this year’s second cherry-picking case against Robert Mark Magee, sole owner and employee of Texas-based investment advisor Valor Capital Asset Management LLC. After placing trades in the firm’s omnibus account, Magee “disproportionately allocated” profitable trades to his own accounts and unprofitable trades to his clients’ accounts. The SEC determined there was less than a one-in-one trillion chance that this disproportionate allocation was by chance.[4] As a result, Magee settled the case for over $715,000.
 
FINRA Fines Raymond James $2 Million Over Email Review Failures

The Financial Industry Regulatory Authority (“FINRA”) found that Raymond James Financial Services (“Raymond James”) failed to maintain reasonable procedures for reviewing email communications. The investigation revealed that millions of emails were not properly flagged through keyword searches and that inadequate resources and personnel were allocated to the review in light of the firm’s size and business model.[5] FINRA noted that instead of testing and updating the system to be as comprehensive as needed, the firm focused on eliminating “false positives” to reduce the number of emails under surveillance. Moreover, Raymond James excluded the emails of its 1,300 registered representatives who serviced customer brokerage accounts from the review process.[6] As a result, the firm was fined $2 million dollars and will conduct a risk-based retrospective review of past emails.
 
 
Merrill Lynch Fined $26 Million for Anti-Money Laundering Violations

The U.S. Securities and Exchange Commission[7] and the Financial Industry Regulatory Authority[8] fined Merrill Lynch $13 million dollars each for failing to implement anti-money laundering policies and procedures. The firm provided brokerage customers with a range of money transfer services yet didn’t monitor transfers or investigate suspicious activity. In addition, the firm failed to file Suspicious Activity Reports as required under Rule 17(a) of the Securities Exchange Act of 1934.
 
Accelerated Capital Group
 
The Financial Industry Regulatory Authority (“FINRA”) fined and barred the president of broker-dealer Accelerated Capital Group, Inc., Wayne Ivan Miiller, for failing to adequately supervise the firm’s Chief Compliance Officer (“CCO”).[9] The COO informed Miiller she was having difficulty analyzing both the trade blotter and registered mutual switch reports and was concerned that a registered representative she supervised had “excessively traded mutual fund “A” shares in customer accounts.”[10] Although a compliance consultant was retained for outside assistance, Miiller failed to ensure the CCO was able to competently monitor the registered representative’s trading actions on an ongoing basis. As a result, the registered representative continued the excessive “A” share trading and initiated an unsuitable “swing trading” strategy on these accounts as well. As a result, Miiller was suspended from participating in principal activities with any FINRA member for six months and fined $10,000.
 

[1] SEC Announces Cherry-Picking Charges Against Investment Manager, United States Securities and Exchange Commission (June 29, 2015)
[2] SEC Charges Orange County Investment Adviser and Senior Officers in Fraudulent “Cherry-Picking” Scheme, United States Securities and Exchange Commission (February 21, 2018)
[3] Id.
[4] Id.
[6] Id.
SEC 2018 Exam Priorities
 
The Securities and Exchange Commission’s (“SEC”) Office of Compliance Inspections and Examinations (“OCIE”) has released its 2018 examination priorities.[1] The report focuses on five areas: (1) Retail Investors; (2) Critical Market Infrastructure; (3) FINRA and MSRB; (4) Cybersecurity; and (5) Anti-Money Laundering. This article provides a summary of the report and highlights key areas for investment advisors and broker-dealers to focus on during the upcoming year.
 
Retail Investors, Including Senior and those Saving for Retirement

The OCIE is focused on protecting retail investors and ensuring that all fees, expenses, and other charges are properly disclosed to the client as well as any conflicts of interests that may exist. Business models receiving heightened scrutiny include those involving financial incentives and commissions, wrap fee programs, and automated robo-advisors.
 
Special focus will also be placed on “products and services directed at senior investors”[2] including internal controls of representatives, investment recommendations, and management of target fund dates. High-risk mutual funds and ETFs, such as those with low liquidity, valuation difficulties, or that track custom-built indexes are also a priority. Municipal advisors and underwriters will be reviewed according to the Municipal Securities Rulemaking Board (“MSRB”) rules and broker-dealers’ best execution policies for fixed income products will also be examined. Cryptocurrency sales and compliance procedures will be monitored, including controls to protect assets from theft and disclosing risks to investors.
 
Compliance Risks in Critical Market Infrastructure
 
The OCIE will examine third party service providers such as clearing agencies and transfer agents to ensure they are meeting required standards. Other entities that will be monitored include national securities exchanges as well as regulation systems compliance and integrity (SCI) entities.
 
FINRA and MSRB
 
The Financial Industry Regulatory Authority (“FINRA”) and the MSRB’s operational and regulatory policies and procedures will be reviewed to maintain FINRA’s examination standards for broker-dealers and municipal advisors as well as ensure MSRB’s regulation of municipal securities firms.
 
Cybersecurity
 
Cybersecurity continues to be prioritized given its implications across the industry. The OCIE’s cybersecurity concerns include “governance and risk assessment, access rights and controls, data loss prevention, vendor management, training, and incident response.”[3]
 
Anti-Money Laundering Programs
 
Examinations will also cover financial institutions’ anti-money laundering (AML) programs including performing customer identification and due diligence, timely and complete filings of suspicious activity reports, and independent testing of the AML program.
 
If you have any questions about how these exam priorities may apply to your firm, please contact your Gordian consultant.
 

[1] 2018 National Exam Program Examination Priorities, United States Securities & Exchange Commission (February 7, 2018)
[2] Id.
[3] Id.

BROKER-DEALER UPDATES

FINRA Protections for Senior Clients
 
On February 5, 2018, the Financial Industry Regulatory Authority (“FINRA”) Rule 2165, known as “Financial Exploitation of Specified Adults,” went into effect. This rule enables brokers to place a temporary hold on the disbursement of securities belonging to those age 65 or older and those under 65 who have a diminished capacity.[1] In order to place such a hold, a broker must reasonably believe that financial exploitation has occurred or will be attempted. Within two days of placing such a hold, a broker is required to inform the client about the situation.
 
Effective February 5, 2018, FINRA also updated Rule 4512, knowns as “Customer Account Information,” which requires brokers to make reasonable efforts to identify a trusted contact for adults specified in Rule 2165 and to inform the trusted contact about any financial holds.[2] Under this new provision, all new accounts must include a trusted contact and all existing accounts must be updated with a trusted contact. Though temporary holds are set to expire within 15 days they can be extended for an additional 10 days provided the broker’s internal review supports a reasonable belief of financial exploitation.[3]
 
In addition, some states[4] have passed legislation similar to the North American Securities Administrators Association (“NASAA”) elder-abuse rule.[5] This rule is similar to FINRA’s and also requires brokers to inform authorities of suspicious activity.
 
If you have any questions about how to comply with FINRA or state elder-abuse rules, please contact your Gordian consultant.

 

[4] States that have enacted legislation or regulations based on the NASAA Model Act to Protect Vulnerable Adults From Financial Exploitation include Alabama, Arkansas, Colorado, Indiana, Louisiana, Maryland, Mississippi, Montana, New Mexico, North Dakota, Oregon, Texas, and Vermont.
[5] NASAA Model Legislation or Regulation to Protect Vulnerable Adults from Financial Exploitation, North American Securities Administrators Association (January 22, 2016)
 
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