Posts by: Danielle Van Wert

SEC Proposes a “Best Interest” Standard for Broker-Dealers

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On April 18, 2018, the Securities and Exchange Commission proposed a set of rules and interpretations regarding the standard of conduct that broker-dealers owe to their investing customers, and reaffirming and clarifying the standard of conduct owed to customers by investment advisers.

The SEC’s proposal is the newest development in an ongoing effort to clearly define and determine the standards to which financial professionals are held. In 2010, the Dodd-Frank Act delegated authority to the SEC to propose a uniform fiduciary standard across all retail investment professionals. Rather than wait for the SEC to do so, however, in 2016 the Department of Labor (DOL) promulgated its own fiduciary rule. As previously discussed here, the U.S. Court of Appeals for the Fifth Circuit recently struck down the DOL rule.

According to SEC Chairman Jay Clayton, the Commission’s recent proposal is the outcome of extensive consideration and is intended to enhance investor protection by applying consistent standards of conduct to investment advisers and broker-dealers. The SEC’s proposal, spanning over 1,000 pages, has three main components:

Regulation Best Interest: First and foremost, the SEC proposal includes a new standard of conduct for broker-dealers that would be enacted through a set of regulations entitled, “Regulation Best Interest.” Although the term “Best Interest” is not defined in the proposal, the regulations would require a broker-dealer to act in the best interest of its retail customers when making investment recommendations, and prohibit it from putting its own financial interests first. To discharge this duty, a broker-dealer must comply with three specific obligations:

(1) Disclosure obligation – a broker-dealer must disclose key facts about its relationship with its customers, including material conflicts of interest.

(2) Care obligation – a broker-dealer must exercise reasonable diligence, care, skill and prudence to understand any recommended product, and have a reasonable basis to believe that a product and series of transactions are in the customer’s best interest.

(3) Conflict of interest obligation – a broker-dealer must establish, maintain and enforce policies and procedures to identify, disclose and mitigate or eliminate conflicts of interest.

Guidance for Investment Advisers: In addition to enhancing the standard of conduct for broker-dealers, the SEC reaffirmed its view that investment advisers owe their clients fiduciary duties. The SEC’s proposal seeks to gather, summarize and reaffirm existing guidance in one place.

Form CRS: The Commission also proposed a new disclosure document, Form CRS (Client or Customer Relationship Summary), which would provide retail investors with information regarding the nature of their relationship with their investment professional. The proposed Form CRS would be a standardized, short-form disclosure highlighting services offered, legal standards of conduct, possible customer fees, and certain conflicts of interest. In addition, the proposal limits a broker-dealer’s ability to identify itself as an “adviser” unless it is registered with the SEC as an investment adviser, so as not to cause confusion among investors.

Takeaways

In the wake of the controversy launched by Dodd-Frank and the DOL rule, and on the heels of the Fifth Circuit’s rejection of that rule, the SEC has taken a bold step in the direction of increased regulation of broker-dealers. The SEC’s proposal will undoubtedly impact the way broker-dealers make recommendations to their customers, although to what extent may depend on whether broker-dealers were already adapting to the DOL rule before it was overturned by the Fifth Circuit. The SEC will seek public comment on its proposal over the next 90 days, giving interested parties time to dig into the extensive materials. Indeed, several Commissioners acknowledged that questions about the applicable standards remain, suggesting that changes to the proposal will be forthcoming.

SEC’s OCIE Announces 2018 Areas of Focus

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On February 7, 2018 the SEC’s Office of Compliance Inspections and Examinations (OCIE) announced its 2018 National Exam Priorities. The priorities, formulated with input from the Chairman, Commissioners, SEC Staff and fellow regulators, are mostly unchanged from years past (New Year, Similar Priorities: SEC Announces 2017 OCIE Areas of Focus, Orrick.com). However, the publication itself is presented in a more formal wrapper that begins with a lengthy message from OCIE’s leadership team describing the Office’s role and guiding principles, including that they are risk-based, data-driven and transparent, and that they embrace innovation and new technology.

2018 Priorities

OCIE’s principal 2018 priority, not surprisingly, appears to be the protection of retail investors, including seniors and those saving for retirement. OCIE specifically stated that it will focus on the disclosure of investment fees and other compensation received by financial professionals; electronic investment advisors – sometimes known as “robo-advisors”; wrap fee programs in which investors are charged a single fee for bundled services; and never-before-examined investment advisors. As to the latter, OCIE indicated that in the most recent fiscal year, it examined approximately 15 percent of all investment advisors, up from 8 percent five years before. It remains to be seen whether that increasing trend will continue.

Noting that the cryptocurrency and initial coin offering (ICO) markets “present a number of risks for retail investors,” OCIE included them as a priority for the first time. Examiners will focus on whether financial professionals maintain adequate controls and safeguards over the assets, as well the disclosure of investment risks.

Other 2018 priorities are compliance and risks in critical market infrastructure; cybersecurity protections, which OCIE states are critical to the operation of our markets; and anti-money laundering programs. In addition, OCIE has prioritized its examinations of FINRA and MSRB to ensure that those entities continue to operate effectively as self-regulatory organizations subject to the SEC’s oversight. READ MORE →

SEC Updates Revenue Recognition Guidance for Bill-and-Hold Arrangements

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Last Friday, the SEC issued two releases regarding guidance on revenue recognition, along with a related Staff Accounting Bulletin. These releases are notable for all SEC registrants, as they update prior revenue recognition guidance.

First, the SEC updated its guidance for criteria to be met in order to recognize revenue when delivery has not occurred, i.e., bill-and-hold arrangements. The SEC’s guidance now follows that of the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 606, Revenues from Contracts with Customers. Per ASC Topic 606, revenue may be recognized when or as the entity satisfies a performance obligation by transferring a promised good or service to a customer, and a good or service is transferred when the customer obtains control of that good or service. In the context of bill-and-hold arrangements, ASC Topic 606 provides specific guidance that certain indicators must be met to show that control has been transferred, including: (i) a substantive reason for such an arrangement where the customer has declined to exercise its right to take physical possession of that product; (ii) the product must be identified separately as belonging to the customer; (iii) the product currently must be ready for physical transfer to the customer; and (iv) the entity cannot have the ability to use the product or direct it to another customer. Until a registrant adopts ASC Topic 606, however, it should continue to follow the older guidance for revenue recognition. In conjunction with the SEC’s release, the SEC’s Office of the Chief Accountant and Division of Corporate Finance also released a bulletin that brings existing SEC staff guidance into conformity with ASC Topic 606.

The SEC also published new guidance with respect to accounting for sales of vaccines and bioterror countermeasures to the Federal Government for placement into the pediatric vaccine stockpile or the strategic national stockpile. In light of the updated ASC Topic 606 referenced above, the SEC states that vaccine manufacturers should now recognize revenue and provide disclosures when vaccines are placed into Federal Government stockpile programs because control of the enumerated vaccines (i.e., childhood disease, influenza and others) will have been transferred to the customer.

2016 Could Be Peak SEC

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2016 was a high-water mark for SEC enforcement activity; however, with the uncertainties associated with the new administration’s enforcement regime, we could be seeing a downturn going forward. According to a recent report issued by the NYU Pollack Center for Law & Business and Cornerstone Research, the SEC’s 2016 fiscal year (spanning October 1, 2015 – September 30, 2016) saw the highest number of enforcement actions brought against public companies and their subsidiaries since 2009, the year the Pollack Center and Cornerstone Research first began tracking information on such actions.  The 92 actions brought against public companies and their subsidiaries last year is more than double the level of enforcement activity from just three years ago and represents the latest in a continuing upward trend of enforcement actions.  Also consistent with recent trends, the vast majority of these actions have been brought as administrative enforcement proceedings before SEC ALJs, rather than civil actions in federal court.

The SEC continues to focus most heavily on issuers’ reporting and disclosure obligations, which comprised more than a quarter of the enforcement actions initiated last year. The SEC has consistently emphasized issuer disclosures as an area of enforcement priority and its pattern of activity has, to date, backed that up.  Last year also brought enhanced focus on investment advisors and investment companies, with the SEC initiating more actions against those defendants in 2016 than in the previous three years combined.  Allegations of foreign corrupt practices and actions against companies making initial or secondary securities offerings also resulted in an increased rate of enforcement activity over prior periods.

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The Call for a Statutory Insider Trading Law

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Judge Jed S. Rakoff (S.D.N.Y.) recently made headlines after urging lawyers to draft and advocate for a more straightforward insider trading statute to replace judicially-created insider trading law. During his keynote speech at the New York City Bar’s annual Securities Litigation & Enforcement Institute, Judge Rakoff explained that the law has become overly-complicated since courts were forced to define insider trading by shoehorning the concept into the fraud provisions of the Securities Exchange Act of 1934. As a result, increasingly suspect theories have been developed to address potential insider trading in an expanding variety of scenarios.

In promoting a statutory solution for insider trading law, Judge Rakoff pointed to the Europe Union (“EU”) as an example. He explained that the EU defined insider trading by statute in simple and broad terms, and avoided relying on the framework of fraud.  Considering Judge Rakoff’s influence and expertise in securities law, inquiry into the EU’s approach to insider trading is warranted.

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New Year, Similar Priorities: SEC Announces 2017 OCIE Areas of Focus

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On January 12, 2017 the SEC announced its Office of Compliance Inspections and Examinations (OCIE) priorities for the year, including areas of focus for Retail Investors, Senior Investors and Retirement Investments, Market-wide risks, FINRA oversight, and cybersecurity.  These priorities reflect an extension of previous years’ commitments, in particular with regard to focus on the retirement industry and cybersecurity.  The “Regulation Systems Compliance and Integrity” (Regulation SCI) adopted by the SEC in November 2014 will also be a continued focus.

Once again, protection of retail investors is of primary concern for the OCIE. Among the detailed areas of focus are examining risks related to electronic investment advice, “wrap fee” programs where investors are charged a single fee for bundled advisory and brokerage services, and “Never-before examined” Investment advisers, an initiative that was started in 2014 to engage with newly-registered advisers that had never-before been examined.  Examination of Exchange-Traded funds (ETFs) and continuation of the ReTIRE initiative are two carryovers from 2016 priorities .  The OCIE previously identified ETFs, which are sometimes seen as alternatives to mutual funds, for examination related to compliance with the Securities Exchange Act of 1934 and the Investment Company Act of 1940. ReTIRE, launched in June 2015, places particular focus on those SEC-registered investment advisers and broker dealers who offer retirement-oriented investment services to retail investors, including examining whether there is a reasonable basis for the recommendations made.  This year, the SEC will expand ReTIRE to include “assessing controls surrounding cross-transactions, particularly with respect to fixed income securities.”

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The Whistle Blows Again: SEC Pays Second Largest Whistleblower Bounty Award

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whistleblower

On June 9, 2016, the Securities and Exchange Commission (‘SEC”) awarded the second largest whistleblower bounty – $17 million – granted under the Dodd-Frank whistleblower rules to date.  Previously, the highest whistleblower awards were a $30 million award in September 2014 and a $14 million award in October 2013.  The $17 million award comes on the heels of $26 million in whistleblower awards given to five anonymous individuals over the last month alone.  These awards serve as a warning to companies that the SEC takes its whistleblower program seriously and will continue to encourage and reward company insiders for coming forward with information that leads to successful enforcement actions.  As Sean X. McKessy, Chief of the SEC’s Office of the Whistleblower – a department created by the SEC to give whistleblowers a place to submit their tips – said, “[W]e hope these substantial awards encourage other individuals with knowledge of potential federal securities law violations to make the right choice to come forward and report the wrongdoing to the SEC.”

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Regulation S-K Concept Release: Will the SEC Reform the Norm for Corporate Disclosures?

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On April 13, 2016, the SEC published a concept release discussing and seeking public comment on modernizing certain business and financial disclosures required by Regulation S-K, which lays out reporting requirements for various public company SEC filings.   The release focuses on whether the disclosure requirements – many of which have seen little change in decades – continue to elicit the information that investors need for investment and voting decisions, and whether any of the relevant rules have become outdated or unnecessary.  It also seeks input on how registrants can most effectively present material information, including how the Commission can assist with improving the readability and navigability of SEC filings.  As SEC Chair Mary Jo White explained in an April 13, 2016 statement regarding the release, “[w]e want to make sure that [the Commission’s disclosure] rules are facilitating both timely, material disclosure by companies and shareholders’ access to that information.  And we want to make sure that our requirements are as efficient as they can be.”

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Second Circuit Applies Omnicare to Affirm Dismissal of Securities Fraud Actions

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On March 4, 2016, the Second Circuit affirmed the dismissal of two related securities actions against Sanofi Pharmaceuticals, its predecessor Genzyme Corporation, and three company executives (collectively, “Sanofi”).  In doing so, the Second Circuit offered its first substantial interpretation of the Supreme Court’s March 2015 decision in Omnicare, Inc. v. Laborers District Council Construction Industry Pension Fund, 135 S. Ct. 1318 (2015), which addresses how plaintiffs can allege securities claims based on statements of opinion.

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New Year, New Priorities for the SEC’s Office of Compliance Inspections and Examinations

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On January 11, 2016, the SEC announced its Office of Compliance Inspections and Examinations (OCIE) priorities for the year .   The announcement included several new areas of focus, including liquidity controls, public pension advisers, exchange-traded funds (ETFs), product promotion, and variable annuities.   Hedge fund and mutual fund managers, private equity firms, and broker-dealers – in particular those that deal with retirement investments – would be wise to take note of these new areas of interest.  As in past years, enforcement actions in these areas are likely to follow.

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