Investment Management

Posted on Monday, November 27 2017 at 5:46 pm by

Another Shoe Drops: UBS Withdraws from the Broker Protocol

By Paul Foley, John I. Sanders, and Lauren Henderson

Only one month after Morgan Stanley withdrew from the Protocol for Broker Recruiting (the “Protocol”), a second major brokerage firm has announced its intention to withdraw effective December 1st. UBS says it is withdrawing as part of a strategy to focus on retaining its current brokers instead of recruiting brokers from competitors. [i] Still, many observers believe Morgan Stanley’s and UBS’s withdrawals are meant “to stanch the flow of brokers and client assets.”[ii] This flow, of course, has quickened in recent years as advisers have left traditional, large brokerage firms to form independent advisory firms.[iii]

When Morgan Stanley withdrew from the Protocol, many speculated as to whether the Protocol would survive.[iv] Such speculation has only increased as sources have confirmed that Morgan Stanley’s withdrawal was the catalyst for UBS’s departure.[v] We expect more firms are currently considering how to respond to two of the largest brokerage firms withdrawing from the Protocol, and we would not be surprised to see similar announcements before year-end.

If you have questions about the recent withdrawals from the Protocol or general questions about the complexities that arise in establishing an independent advisory firm, please feel free to contact us directly.

Paul Foley is a partner with Kilpatrick Townsend & Stockton’s Winston-Salem and New York offices. John I. Sanders and Lauren Henderson are associates based in the firm’s Winston-Salem office.

[i] Lisa Beilfuss, UBS to Pull Out of Pact on Broker Recruiting, WALL ST. J., Nov. 27, 2017, available at https://www.wsj.com/articles/ubs-to-pull-out-of-pact-on-broker-recruiting-1511799020 .

[ii] Id.

[iii] Neil Weinberg, Broker Protocol Reduced to a Sell Game, OnWallSteet, Oct. 18, 2016, available at https://www.onwallstreet.com/news/broker-protocol-reduced-to-a-shell-game.

[iv] Lisa Beilfuss, Morgan Stanley to Exit Accord on Broker Recruiting, WALL ST. J., Oct. 30, 2017, available at https://www.wsj.com/articles/morgan-stanley-to-exit-accord-on-broker-recruiting-1509380038

[v] Beilfuss, supra note 2.

Posted on Friday, November 17 2017 at 8:38 am by

SEC Announces Enforcement Results, Sets New Priorities

By Paul Foley, John I. Sanders, and Lauren Henderson

On November 15, 2017, the SEC announced the results of its enforcement actions for fiscal year 2017 and stated its enforcement priorities for fiscal year 2018.

During fiscal year 2017, the SEC brought 754 enforcement actions, returned $1.07 billion to harmed investors, and obtained judgments and orders totaling $3.789 billion in disgorgement and penalties.[i] Of the 754 enforcement actions, 446 were standalone cases.[ii] Investment advisory issues, securities offerings, and issuer reporting each accounted for 20% of the standalone cases, roughly in line with fiscal year 2016 results.[iii]

In the current fiscal year, the following five core principles will guide the SEC’s enforcement actions:[iv]

  • Focus on Main Street (i.e., unsophisticated) investors
  • Focus on individual accountability (as opposed to organizational accountability)
  • Keep pace with technological change
  • Impose sanctions that most effectively further enforcement goals
  • Assess the allocation of resources

Both the enforcement results for the recently completed fiscal year and the stated priorities for the current fiscal year reflect Chairman Clayton’s oft-articulated dedication to the SEC’s mandates: protect investors, maintain fair and efficient markets, facilitate capital formation.

If you have any questions about the SEC enforcement actions or enforcement priorities, please feel free to contact us directly.

Paul Foley is a partner with Kilpatrick Townsend & Stockton’s Winston-Salem and New York offices. John I. Sanders and Lauren Henderson are associates based in the firm’s Winston-Salem office.

[i] SEC, SEC Enforcement Division Issues Report on Priorities and FY 2017 Results (Nov. 15, 2017), available at https://www.sec.gov/news/press-release/2017-210.

[ii] Id.

[iii] Id.

[iv] Id.

Posted on Thursday, November 9 2017 at 11:10 am by

Four Key Takeaways for Investment Advisers from Chairman Clayton’s PLI Address

By Paul Foley and John I. Sanders

On November 8, 2017, SEC Chairman Jay Clayton gave the keynote address at the Practicing Law Institute’s 49th Annual Institute on Securities Regulation.[i] Chairman Clayton’s remarks shed considerable light on the SEC’s priorities in the near-term. We believe there are four key takeaways from the address for investment advisers:

  • The SEC will deemphasize formal rulemaking and focus instead on enforcement actions that will improve “transparency in our securities markets”;[ii]
  • The SEC will scrutinize whether investment advisers’ proxy voting decisions are maximizing value for their clients;[iii]
  • The SEC will prioritize enforcement actions related to “complex, obscure, or hidden fees and expenses that can harm investors” (e.g., investing client assets in a mutual fund share class that charges a 12b-1 fee when a lower-cost share class of the same fund is available);[iv] and
  • The SEC will help investors track bad actors by creating a website with a searchable database of “individuals who have been barred or suspended as a result of federal securities law violations.”[v]

Chairman Clayton is clearly signaling to investment advisers that the SEC, in the near-term, will focus its energy on whether they are making complete and accurate disclosures to their clients.

If you have questions about Chairman Clayton’s keynote address or the regulations that govern investment advisers generally, please feel free to contact us.

Paul Foley is a partner with Kilpatrick Townsend & Stockton’s Winston-Salem and New York offices. John I. Sanders is an associate based in the firm’s Winston-Salem office.

[i] SEC Chairman Jay Clayton, Remarks at the PLI 49th Annual Institute on Securities Regulation – New York, N.Y. (Nov. 8 2017), available at https://www.sec.gov/news/speech/speech-clayton-2017-11-08.

[ii] Id.

[iii] Id.

[iv] Id.

[v] Id.

Posted on Wednesday, November 1 2017 at 8:46 am by

Morgan Stanley’s Withdrawal from the Broker Protocol Shocks the Industry

By Paul Foley, John I. Sanders, and Lauren Henderson

In 2004, the Protocol for Broker Recruiting (the “Protocol”) was established with the goal of furthering “client interest of privacy and freedom of choice in connection with the movement of their Registered Representatives between firms.”[1] The Protocol defined what information a registered representative could take when moving between signatory firms, how that information could be used, and when it could be used.[2] The Protocol has provided brokers and registered representatives important clarity for the past 13 years, which has cut down significantly on litigation associated with moves from one signatory firm to another, including from brokers to investment advisers.

In a letter dated October 24th, Morgan Stanley, one of the largest employers of registered representatives, announced its withdrawal from the Protocol.[3] According to Morgan Stanley, the Protocol is “replete with opportunities for gamesmanship and loopholes” and is “no longer sustainable.”[4] In particular, Morgan Stanley has been frustrated by the ability of talented advisers to take advantage of the Protocol’s terms to establish independent registered investment advisers (“RIAs”) and solicit the clients they served while employed by Morgan Stanley.[5] Still, the firm’s withdrawal is the most significant in the history of the Protocol. Since 2004, more than 1,600 firms have become signatories, and only 100 have withdrawn.[6]

Following Morgan Stanley’s announcement, speculation as to its significance for the investment advisory industry has been rampant. Some are asking whether “Morgan Stanley’s exit from the protocol will usher in its end.”[7] Supporting that speculation is the silence of Morgan Stanley’s largest competitors in response to the withdrawal.[8]

Some large firms may determine that they are able to derive a competitive advantage in recruiting by remaining signatories of the Protocol. However, large firms that decide to withdraw from the Protocol, will likely be forced to offer top talent some of the same post-termination rights found in the Protocol and will experience significantly greater litigation cost. Those rights can be inserted into employment contracts. Alternatively, firms could increase financial incentives to compensate top advisers for the loss of those rights. Either way, this course of action will increase the cost and complexity of maintaining a talented team of advisers.

The more likely scenario is that Morgan Stanley’s withdrawal (and any similar firm’s withdrawal) is likely to hasten, not slow, the flow of advisers from the traditional, large brokerage firms to independent advisory firms. That flow has been so great in recent years that assets under management at registered investment advisers doubled between 2007 and 2015.[9] The most significant change for advisers employed by firms that withdraw from the Protocol is that they will need more sophisticated legal counsel to handle the process of establishing and transitioning to an independent advisory firm.

If you have questions about Morgan Stanley’s withdrawal from the Protocol or general questions about the complexities that arise in establishing an independent advisory firm, please feel free to contact us directly.

Paul Foley is a partner with Kilpatrick Townsend & Stockton’s Winston-Salem and New York offices. John I. Sanders and Lauren Henderson are associates based in the firm’s Winston-Salem office.

[1] Protocol for Broker Recruiting, available at http://www.bressler.com/DE0ED6/assets/files/Documents/Copy_of_Broker_Protocol.pdf.

[2] Id.

[3] Lisa Beilfuss, Morgan Stanley to Exit Accord on Broker Recruiting, WALL ST. J.,Oct. 30, 2017, available at https://www.wsj.com/articles/morgan-stanley-to-exit-accord-on-broker-recruiting-1509380038.

[4] Id.

[5] Neil Weinberg, Broker Protocol Reduced to a Sell Game, OnWallSteet, Oct. 18, 2016, available at https://www.onwallstreet.com/news/broker-protocol-reduced-to-a-shell-game.

[6] Beilfuss, supra note 3.

[7] Id.

[8] Id.

[9] Weinberg, supra note 5.

Posted on Monday, October 30 2017 at 8:39 am by

Advisers Trading in Europe or Advising E.U. Clients Must Prepare for MiFID II

By Paul Foley, John I. Sanders, and Lauren Henderson

On January 3, 2018, the European Commission’s sweeping reform, the Markets in Financial Instruments Directive II (“MiFID II”), will become effective. MiFID II applies to firms providing investment services or performing investment activities in the European Union (the “E.U.”).[1] E.U. investment advisers, naturally, will be among those effected. However, U.S. investment advisers who transact in European financial markets or offer investment advice to E.U. citizens through separately managed accounts (“SMAs”), pooled products (e.g., hedge funds), or indirectly through sub-advisory arrangements may be effected as follows:

  • Trading Equities and Derivatives: Under MiFID II, equity trading must occur on regulated markets, multilateral trading facilities, systematic internalisers, or equivalent third country venues.[2] Accordingly, over-the-counter trading of European equities may be severely restricted and the cost of trading certain securities may increase substantially. In addition, derivatives are subject to new reporting requirements and national regulators are empowered to set position limits for certain derivatives.[3]
  • Marketing Separately Managed Accounts: Each U.S. investment adviser must review licensing requirements in each jurisdiction where an E.U. client or potential client resides to determine whether the adviser must establish a branch or obtain a license to do business in the jurisdiction.[4]
  • Marketing Pooled Products: U.S. investment advisers that offer alternative investment funds (“AIFs”) will be governed by the Alternative Investment Fund Managers Directive (“AIFMD”) and jurisdiction-specific private placement rules, not MiFID II, when engaging in marketing activities for an AIF.[5] Likewise, U.S. investment advisers offering Undertakings for Collective Investment in Transferable Securities (“UCITSs”) are not directly subject to MiFID II when marketing a UCITS to E.U. clients, but will be indirectly impacted by MiFID II’s investor protection regime.[6]
  • Providing Sub-Advisory Services to E.U. Firms: E.U. firms subject to MiFID II may attempt to delegate compliance obligations to U.S. investment advisers serving as their sub-advisors. Among compliance obligations likely to be passed to the U.S. sub-advisor are those related to transparency and reporting.[7]

We invite you to contact us directly if you have any questions about the application of MiFID II to U.S. investment advisers.

Paul Foley is a partner with Kilpatrick Townsend & Stockton’s Winston-Salem and New York offices. John I. Sanders and Lauren Henderson are associates based in the firm’s Winston-Salem office.

[1] Directive 2014/65/EU of the European Parliament and of the Council of 15 May 2014 on Markets in Financial Instruments and Amending Directive 2002/92/EC and Directive 2011/61/EU, 2014 O.J. (L 173) 349, 374.

[2] Id. at 409.

[3] Id. at 440, 444.

[4] Christopher D. Christian & Dick Frase, MiFID II: Key Considerations for US Asset Managers, 23 The Investment Lawyer. 1, 4 (May 2016).

[5] Id. at 5.

[6] Id.

[7] Id. at 4.

Posted on Friday, October 13 2017 at 11:35 am by

Regulation S-K Amendments Promise FAST Relief for Advisers and Funds

By Paul Foley, John I. Sanders, and Lauren Henderson

On October 11, 2017, the SEC issued a Proposed Rule to modernize and simplify disclosure requirements in Regulation S-K.[1] The Proposed Rule, authorized by the Fixing America’s Surface Transportation Act (the “FAST Act”), is intended to reduce the costs and burdens on registrants while still providing investors with disclosures that are user friendly, material, and free of unnecessary repetition.[2]

The Proposed Rule, if adopted, would amend rules and forms used by public companies, investment companies, and investment advisers.[3] The most notable provisions of the Proposed Rule include the following:

  • Eliminating risk factor examples from Item 503(c) of Regulation S-K because the examples do not apply to all registrants and may not actually correspond to the material risks of any particular registrant;[4]
  • Revising requirements related to descriptions of property owned by the registrant in Item 102 of Regulation S-K to emphasize materiality;[5]
  • Eliminating undertakings that are unnecessarily repetitious from securities registration statements;[6]
  • Changing exhibit filing requirements and allowing flexibility in discussing historical periods in the Management’s Discussion and Analysis;[7]
  • Permitting registrants to omit confidential information (e.g., personally identifiable information and material contract exhibits) from Item 601 without submitting a confidential treatment request;[8] and
  • Using hyperlinks in forms to help investors access documents incorporated by reference.[9]

The SEC will accept public comments on the Proposed Rule for sixty days before determining whether to issue a final rule or amend the proposal and seek additional public comment.[10] We are hopeful the Proposed Rule will be well-received by all stakeholders and be finalized relatively quickly.

We invite you to contact us directly if you have any questions about the SEC’s Proposed Rule or Regulation S-K generally.

Paul Foley is a partner with Kilpatrick Townsend & Stockton’s Winston-Salem and New York offices.  John I. Sanders and Lauren Henderson are associates based in the firm’s Winston-Salem office.

[1] SEC, SEC Proposes Rules to Implement FAST Act Mandate to Modernize and Simplify Disclosure (Oct. 11, 2017), available at https://www.sec.gov/news/press-release/2017-192.

[2] Id.

[3] Id.

[4] SEC, Proposed Rule: FAST Act Modernization and Simplification of Regulation S-K,

Release No. 33-10425; 34-81851; IA-4791; IC-32858, available at https://www.sec.gov/rules/proposed/2017/33-10425.pdf.

[5] Id.

[6] Id.

[7] Id.

[8] Id.

[9] Id.

[10] Id.

Posted on Friday, September 8 2017 at 9:48 am by

ERISA Group Offers Insights into DOL Proposal to Extend Fiduciary Rule Transition Period

Kilpatrick Townsend & Stockton’s ERISA Law practice group has a new article with valuable insights into the DOL’s Proposed Rule that would extend the Fiduciary Rule transition period.  We encourage those impacted by the Fiduciary Rule to read it here.

 

Posted on Thursday, August 31 2017 at 5:45 pm by

DOL’s Proposed Rule Would Extend the Transition Period for Certain Fiduciary Rule Exemptions to July 2019

 By Paul Foley and John I. Sanders

Today, the text of a Department of Labor (the “DOL”) Proposed Rule we have been anticipating for several weeks was made available to the public.[i] The Proposed Rule would “extend the special transition period” for certain components of the Best Interest Contract Exemption (the “BIC Exemption”) and certain other exemptions to the Fiduciary Rule.[ii] Perhaps the most important aspect of the Proposed Rule is that it would maintain the current version of the BIC Exemption, which requires fiduciaries relying on it to merely “give prudent advice that is in retirement investors’ best interest, charge no more than reasonable compensation, and avoid misleading statements.”[iii] In making the proposal, the DOL stated that its purpose was to give the DOL “time to consider possible changes and alternatives” to the exemptions.[iv] If finalized, the Proposed Rule would extend the transition period of the effected exemptions to July 1, 2019.[v]

Please contact us if you have any questions about this article or the DOL Fiduciary Rule generally.

Paul Foley is a partner with Kilpatrick Townsend & Stockton’s Winston-Salem and New York offices.  John I. Sanders is an associate based in the firm’s Winston-Salem office.

[i] DOL, Notice of proposed amendments to PTE 2016-01, PTE 2016-02, and PTE 84-24, 82 Fed. Reg. 41365, available at https://www.federalregister.gov/documents/2017/08/31/2017-18520/extension-of-transition-period-and-delay-of-applicability-dates-best-interest-contract-exemption-pte.

[ii] Id.

[iii] Id. at 41367.

[iv] Id. at 41365.

[v] Id.

Posted on Friday, August 25 2017 at 9:51 am by

Second Circuit Clarifies its Post-Salman Position, Affirms Insider Trading Conviction

By Paul Foley and John I. Sanders

On August 23rd, the Second Circuit issued its much-anticipated opinion in U.S. v. Martoma, affirming the 2014 insider trading conviction of S.A.C. Capital Advisors portfolio manager Matthew Martoma.[1]  In doing so, it clarified an important point regarding what is required to convict a person who trades on a tip received from an insider.  We believe this decision will have an immediate impact on how hedge fund portfolio managers and other investment advisers interact with third party resources.

Section 10(b) of the Securities Exchange Act of 1934[2] and Rule 10b-5[3] promulgated thereunder prohibit insider trading.  The basic elements of insider trading are:  (i) engaging in a securities transaction, (ii) while in possession of material, non-public information, (iii) in violation of a duty to refrain from doing so.

Under the classic theory of insider trading, a corporate insider trades in shares of his employer while in possession of material, non-public information (e.g., advance notice of a merger).  In addition to the classic theory of insider trading, case law has extended the liability to persons who receive tips from insiders (i.e., individuals whose duty to refrain from trading is derived or inherited from the corporate insider’s duty).  Thus, not only may insiders be liable for insider trading, but those to whom they pass tips, either directly (tippees) or through others (remote tippees) may be liable if they trade on such tips.

The seminal case involving tippee liability is Dirks v. SEC.[4]  In Dirks, the U.S. Supreme Court held the following:

In determining whether a tippee is under an obligation to disclose or abstain, it is necessary to determine whether the insider’s “tip” constituted a breach of the insider’s fiduciary duty.  Whether disclosure is a breach of duty depends in large part on the personal benefit the insider receives as a result of the disclosure.  Absent an improper purpose, there is no breach of duty to stockholders.  And absent a breach by the insider, there is no derivative breach.[5]

The question of what constituted a “personal benefit” was left ill-defined until the Second Circuit gave it shape in U.S. v. Newman.[6]  Newman held that a tipper and tippee must have a “meaningfully close personal relationship” and that the insider information be divulged in exchange for “a potential gain of a pecuniary or similarly valuable nature” for the court to find the tipper had breached his fiduciary duty to the source.[7]  For a period of time after the Second Circuit issued its opinion in Newman, it seemed that Martoma’s conviction was likely to be overturned.

Unfortunately for Martoma, the U.S. Supreme Court issued its opinion in U.S. v. Salman while Martoma’s appeal was pending.[8]  In Salman, the U.S. Supreme Court flatly rejected certain aspects of the Newman holding and called others into question.[9]  Accordingly, the Second Circuit held in Martoma that “Salman fundamentally altered the analysis underlying Newman’s ‘meaningfully close relationship’ requirement such that the ‘meaningfully close personal relationship’ requirement is no longer good law.”[10]

In Martoma, the court held that rather than looking at objective elements of the relationship between tipper and tippee, the proper inquiry is now whether the corporate insider divulged the relevant information with the expectation that the tippee would trade on it.[11]  This is “because such a disclosure is the functional equivalent of trading on the information himself and giving the cash gift to the recipient.”[12]

Please contact us if you have any questions about the Second Circuit’s opinion in Martoma or the law concerning insider trading generally.

Paul Foley is a partner with Kilpatrick Townsend & Stockton’s Winston-Salem and New York offices.  John I. Sanders is an associate based in the firm’s Winston-Salem office.

[1] U.S. v. Martoma, available at http://www.ca2.uscourts.gov/decisions/isysquery/71a89161-eec1-457e-b79b-a0d9503765c1/2/doc/14-3599_complete_opn.pdf#xml=http://www.ca2.uscourts.gov/decisions/isysquery/71a89161-eec1-457e-b79b-a0d9503765c1/2/hilite/.

[2] 15 U.S.C. 78j (2016).

[3] 17 CFR 270.10b-5 (2016).

[4] Dirks v. SEC, 463 U.S. 646 (1983).

[5] Id. at 647.

[6] U.S. v. Newman, 773 F.3d 438 (2d Cir. 2014).

[7] Id. at 452.

[8] Salman v. U.S., available at https://supreme.justia.com/cases/federal/us/580/15-628/opinion3.html.

[9] Id. at 10.

[10] U.S. v. Martoma, supra note 1, at 24.

[11] Id. at 25.

[12] Id.

Posted on Tuesday, August 22 2017 at 2:05 pm by

Adviser Settles with SEC over Insider Trading Controls for Political Intelligence Firms

By Paul Foley and John I. Sanders

Yesterday, the SEC announced a settlement under which Deerfield Management Company L.P. (“Deerfield”), a hedge fund adviser, agreed to pay more than $4.6 million.[i]  The SEC charged Deerfield with failing to “establish, maintain and enforce policies and procedures reasonably designed to prevent the illegal use of inside information”[ii] as required by Section 204A of the Investment Advisers Act of 1940 (the “Advisers Act”).[iii]

The SEC cited Deerfield for failing to tailor its policies and procedures “to address the specific risks presented by its business.”[iv]  In particular, Deerfield’s reliance on third-party political intelligence firms to provide insight into upcoming legislative and regulatory action created the risk that Deerfield would receive and illegally trade on inside information (e.g., a regulator’s unannounced decision to finalize a rule that would materially affect certain industries and publicly traded companies).[v]

The SEC’s settlement with Deerfield serves as a warning for advisers utilizing investment strategies dependent on obtaining or correctly predicting non-public information (e.g., unannounced mergers and acquisitions or the governmental approval of a pharmaceutical product), particularly those advisers partnering with third party consultants and analysts.  Such advisers should consider whether their current policies and procedures address the specific risks likely to arise under such strategies and partnerships.

Please contact us if you have any questions about the SEC’s recent settlement with Deerfield or an adviser’s obligations under the Advisers Act generally.

Paul Foley is a partner with Kilpatrick Townsend & Stockton’s Winston-Salem and New York offices.  John I. Sanders is an associate based in the firm’s Winston-Salem office.

[i] SEC, Hedge Fund Adviser Charged for Inadequate Controls to Prevent Insider Trading (Aug. 21, 2017), available at https://www.sec.gov/news/press-release/2017-146 (hereinafter SEC Release).

[ii] Id.

[iii] 15 USC 80b-4a (2017).

[iv] SEC Release, supra note 1.

[v] Id.