Jay Clayton

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.

Looking Out for Main Street: SEC Focuses on Retail, Cybersecurity and Cryptocurrency

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The Commissioners and senior officials of the Securities and Exchange Commission (“SEC” or “Commission”) addressed the public on February 23-24 at the annual “SEC Speaks” conference in Washington, D.C. Throughout the conference, many speakers referred to the new energy that SEC Chairman Jay Clayton had brought to the Commission since his confirmation in May 2017. The speakers also seemed relieved that the SEC was finally operating with a full set of commissioners since the recent additions of Robert J. Jackson, Jr. and Hester M. Peirce. Clayton’s address introduced the main refrain of the conference: that the SEC under his leadership is focused on the long-term interests of Main Street investors. Other oft-repeated themes included the challenges presented by cybersecurity and the fast-paced developments in cryptocurrency and blockchain. To address these shifts in focus, the Enforcement division plans to add more resources to the retail, cybersecurity and cryptocurrency spaces.

Following are the key litigation and enforcement takeaways.

Main Street Investors

Commissioner Kara Stein picked up on Clayton’s Main Street investors focus when she asked whether increasingly complex and esoteric investments, such as product strategies and structures that utilize derivatives, were appropriate for retail investors. She explained that it was not a question whether the financial industry could develop and sell these products, but whether it should. She said it was not clear that financial professionals fully understood the products they were selling, and that even if brokers and advisers made disclosures regarding the potential outcomes and risks to investors, complete disclosures might not even be possible due to the products’ complexity. Both SEC and FINRA Enforcement have brought actions related to the sales practices of inverse and leveraged ETFs, as well as the purchase and sale of complex products. Stein opined that gatekeepers needed to remember the real people behind every account number when they were advising clients on how to handle these types of products.

Steven Peikin, Co-Director of the Division of Enforcement, described the SEC’s Share Class Selection Disclosure Initiative as one way in which Enforcement was trying to help Main Street investors. The Initiative was created to address the problem of investment advisers putting their clients into higher fee share classes when no fee or lower fee classes were available. The SEC is incentivizing advisers to self-report this issue by promising not to impose any penalties, and only requiring them to disgorge their profits to investors. Peikin encouraged investment advisers to take advantage of this opportunity, indicating that if the Commission learned that an adviser had engaged in this conduct and did not self-report, it would be subject to significant penalties. The Chief of the SEC’s Broker-Dealer Task Force shared that AML programs and SAR-filing obligations are also a priority for the Enforcement division and OCIE exams. READ MORE →

The SEC Enforcement Division 2017 Annual Report: Continued Focus on Individual Wrongdoers and Enhanced Protections for the “Main Street” Investor

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Almost a year into the new administration, the U.S. Securities and Exchange Commission’s Division of Enforcement released its annual report last week, providing a recap of the SEC’s enforcement results over the past 12 months, as well as some insight into its direction for the coming year. Overall, the report suggests that the SEC will increase its focus on addressing harm to “Main Street” investors and that pursuing individuals will continue to be the rule, not the exception.

During fiscal year 2017, the SEC pursued 754 enforcement actions, 446 of which were “stand-alone” actions (as opposed to “follow-on” actions which seek to bar executives from practicing before the Commission or to deregister public companies). This represents a drop from the prior year in which the SEC pursued 784 enforcement actions, 464 of which were stand-alone actions. The bulk of the Division’s 446 stand-alone actions in FY 2017 focused on issuer advisory issues, issuer reporting, auditing and accounting, securities offerings, and insider trading—all areas that saw a relatively similar number of cases in FY 2016. Actions involving public finance abuse represented the only significant decrease in the number of cases versus the prior year. In FY 2016, the SEC brought nearly 100 public finance abuse actions compared to fewer than 20 in FY 2017. READ MORE →

SEC Chairman Testifies About SEC’s Direction and 2016 Cyberattack

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On September 26, 2017, SEC Chairman Jay Clayton testified before the Senate’s Banking, Housing and Urban Affairs Committee regarding the direction of the SEC under his Chairmanship. He also took the opportunity to address the 2016 cyberattack on EDGAR, the agency’s electronic filing system.

As in his first public speech as SEC Chair, in July 2017, Chairman Clayton’s testimony reveals his focus on issues related to cybersecurity, capital formation, and enforcement actions addressing traditional forms of fraud and misconduct. His testimony further reveals his position that regulations should be retroactively evaluated and relaxed as necessary, in order to account for the direct and indirect costs of compliance.

Below are key highlights of Chairman Clayton’s testimony:

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What to Watch for From the New SEC Chairman

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Last Thursday, Jay Clayton was officially sworn in as the new Chairman of the Securities and Exchange Commission.  As the new Chairman takes office, here are a few things we’re keeping an eye on:

Will Chairman Clayton take a position on the recently introduced bipartisan bill that would increase civil monetary penalties in SEC enforcement actions?  The “Stronger Enforcement of Civil Penalties Act of 2017” would significantly increase civil monetary penalties in enforcement actions to as much as $1 million per violation for individuals and $10 million per violation for entities, or three times the money gained in the violation or lost by the victims.  The current maximum civil monetary penalties are $181,071 and $905,353 per violation for individuals and entities, respectively.

Will the new Chairman preserve the directive reportedly issued by former Acting Chairman Michael Piwowar to re-centralize authority to issue formal orders of investigation?  In 2009, the SEC adopted a rule that delegated authority to issue formal orders initiating investigations to the Director of Enforcement, who then “sub-delegated” it to regional and associate directors and unit chiefs within the Enforcement Division.  In February, Piwowar reportedly revoked the “sub-delegated” authority, ordering it re-centralized exclusively with the Director of Enforcement.

Will enforcement actions against public companies increase or decrease after hitting their highest level since 2009 last year?  A recent report issued by the NYU Pollack Center for Law & Business and Cornerstone Research found that the 92 actions the SEC brought against public companies and their subsidiaries in 2016 is more than double the level of enforcement activity from just three years prior. READ MORE →