Investment Management

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.

Posted on Thursday, August 17 2017 at 8:39 am by

DOL Proposes an Extension of the Fiduciary Rule Transition Period

By Paul Foley and John I. Sanders

When the DOL Fiduciary Rule became effective on June 9th, it marked the start of a transition period that was scheduled to end on January 1, 2018 (the “Transition Period”).[i]  During the Transition Period, compliance burdens under the Fiduciary Rule are relaxed.  For example, those seeking to rely on the Best Interest Contract Exemption (the “BIC Exemption”) will face less stringent requirements.[ii]  Also, the DOL stated that it would not bring enforcement actions during the Transition Period against “fiduciaries who are working diligently and in good faith to comply with the new rule and exemptions.”[iii]

Last week, the DOL submitted proposed amendments to the BIC Exemption and certain other exemptions to the Fiduciary Rule.[iv]  We learned of this development through a 2-page filing the DOL made in relation to ongoing litigation.[v]  Unfortunately, the filing provided little detail, and the full text of the proposed amendments will not be available to the public until the conclusion of an interagency review.[vi]  However, what seems apparent, based upon the title of the proposed amendments in the filing, is that the proposed amendments include an extension of the Transition Period from January 1, 2018 to July 1, 2019.[vii]

In the long term, we believe that the DOL’s proposed amendments foreshadow either significant modifications to or a full repeal of the Fiduciary Rule and its exemptions.  In the near term, we believe the extension of the Transition Period, coupled with the temporary non-enforcement policy, provides fiduciaries with a reason to breathe easier.

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] Department of Labor, Conflict of Interest FAQs (Transition Period) (May 2017), available at https://www.dol.gov/sites/default/files/ebsa/about-ebsa/our-activities/resource-center/faqs/coi-transition-period-1.pdf.

[ii] Id.

[iii] Id.

[iv] Thrivent Financial for Lutherans v. Acosta, et al., No. 0:16-cv-03289 (D. Minn. Sept. 29, 2016), available at http://www.google.com/url?sa=t&rct=j&q=&esrc=s&source=web&cd=2&cad=rja&uact=8&ved=0ahUKEwjTqJP_utzVAhWI7CYKHdKTDrcQFggrMAE&url=http%3A%2F%2Fmedia.thinkadvisor.com%2Fthinkadvisor%2Farticle%2F2017%2F08%2F09%2Fthriventvdolnotice8-9-2017.pdf&usg=AFQjCNFWeSsTSR6C69Z17yHF1q1a7bkDpg.

[v] Id.

[vi] Id.

[vii] Id.

Posted on Monday, July 24 2017 at 2:41 pm by

Wyoming Mid-Sized Advisers Can No Longer Register with the SEC

By Paul Foley and John I. Sanders

Wyoming required investment advisers to register with the state for the first time on July 1, 2017.[i]  Wyoming’s decision primarily affects those Wyoming-based advisers with between $25 million and $100 million in assets under management (“Mid-Sized Advisers”).  Generally, Mid-Sized Advisers may not register with the SEC.[ii]  However, Wyoming-based Mid-Sized Advisers were required to register with the SEC pursuant to an exception to the general rule.[iii]  That exception requires a Mid-Sized Adviser to register with the SEC if its principal office or place of business is in a state that does not require it to register.[iv]  Wyoming’s lack of a registration requirement for Mid-Sized Advisers and the SEC’s exception made Wyoming a destination for Mid-Sized Advisers who wanted to tout SEC registration.[v]  Some Mid-Sized Advisers went as far as to fraudulently claim to be based in Wyoming so that they could boast SEC registration.[vi]  Wyoming’s decision to require investment advisers to register with the state means that Wyoming-based Mid-Sized Advisers (real and fictitious) are no longer permitted to register with the SEC.  Instead, they must register with Wyoming and comply with its new regulatory regime.[vii]  This continues a shift, which we first noted in 2011, of primary responsibility for the regulatory oversight of Mid-Sized Advisers to the states.[viii]

Please contact us if you have any questions about the new law or its potential impact on your investment advisory business.

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] Wyoming Secretary of State, FAQs (March 14, 2017), available at http://soswy.state.wy.us/Investing/Docs/investment_faq_final.pdf.

[ii] 15 USC 80b-3a (2017); see also SEC, Division of Investment Management: Frequently Asked Questions Regarding Mid-Sized Advisers, available at https://www.sec.gov/divisions/investment/midsizedadviserinfo.htm (providing additional commentary related to the effect of certain Dodd-Frank Act provisions on Mid-Sized Advisers).

[iii] Id.

[iv] Id.

[v] See Danielle Andrus, ThinkAdvisor, Wyoming to Begin Registering RIAs (July 13, 2016), available at http://www.thinkadvisor.com/2016/07/13/wyoming-to-begin-registering-rias; see also Christine Idzelis, Investment News, Wyoming poised to scrutinize its RIA industry for the first time (July 6, 2016), available at http://www.investmentnews.com/article/20160706/FREE/160709978/wyoming-poised-to-scrutinize-its-ria-industry-for-the-first-time.

[vi] See In re Matter of New Line Capital, LLC and David A Nagler, IA-4017 (February 4, 2015), available at https://www.sec.gov/litigation/admin/2015/ia-4017.pdf; and In the matter of Wyoming Investment Services, LLC and Criag M. Scariot, IA-4014 (February 4, 2015), available at https://www.sec.gov/litigation/admin/2015/ia-4014.pdf.

[vii] Wyoming Secretary of State, Proposed Rules, available at http://soswy.state.wy.us/Investing/Docs/WyomingProposedRulesforIA.pdf.

[viii] Paul Foley, Kilpatrick Townsend & Stockton, LLP Investment Management Blog, Deadline for Meeting the New Investment Adviser Regulatory Requirements Under the Dodd-Frank Act is Quickly Approaching (Sept. 20, 2011), available at http://www.kilpatricktownsend.com/en/Knowledge_Center/Alerts_and_Podcasts/Legal_Alerts/2011/09/Deadline_for_Meeting_the_New_Investment_Adviser_Regulatory_Requirements.aspx.

Posted on Thursday, May 25 2017 at 9:32 pm by

DOL Puts Advisers on Notice:  Fiduciary Rule Will Be Effective June 9th

By Paul Foley and John I. Sanders

On March 2, 2017, the DOL extended the applicability date of the Conflict of Interest Rule (the “Fiduciary Rule”) from April 10, 2017 to June 9, 2017.[1]  This week, with the extension drawing to a close, Secretary of Labor Alexander Acosta has reported that the DOL “found no principled legal basis” to delay the applicability date beyond June 9.[2]  It is now a near-certainty that the Fiduciary Rule will “go live” on that date.

Despite DOL statements about a “transition period” and a “phased approach to implementation,” the heart of the Fiduciary Rule will be effective in just two weeks.[3]  Most importantly, “investment advice providers to retirement savers will become fiduciaries.”[4]  As fiduciaries, they must provide impartial advice in the customer’s best interest and cannot accept payments creating conflicts of interest (i.e., commissions and 12b-1 fees) unless they qualify for an exemption.[5]  Among exemptions, the Best Interest Contract Exemption is especially enticing before more stringent requirements for its use go into effect on January 1, 2018.[6]  Until January 1, 2018, the only conditions for the BIC Exemption are:  (i) investment advice is in the “best interest” of the retirement investor, meaning that it is both prudent and the advice is based on the interest of the investor rather than the adviser; (ii) no more than reasonable compensation is charged; and (iii) no misleading statements are made about the transaction, compensation or conflicts of interest.[7]  After January 1, 2018, an actual contract with particular terms will be required.[8]

For many investment advisers (as opposed to broker-dealers and their registered representatives), the impending applicability of the Fiduciary Rule is not a significant concern.  The DOL has stated that a fee based on assets under management (i.e., flat asset based fees or traditional wrap fee arrangements)  typically would not raise any issues under the Fiduciary Rule.[9]  However, for investment advisers not currently employing such fee arrangements, the Fiduciary Rule likely will require changes.[10]

In an effort to calm would-be fiduciaries that will not be able to meet the June 9th deadline for compliance with the Fiduciary Rule, the DOL issued a temporary enforcement policy on May 22nd stating that it would not take any enforcement action against “fiduciaries who are working diligently and in good faith to comply with the new rule and exemptions” until January 1, 2018.[11]  The DOL also promised an enforcement approach prior to January 1, 2018 “marked by an emphasis on compliance assistance (rather than citing violations and imposing penalties).”[12]  This policy only applies to DOL enforcement actions.  Investors may still bring private actions (i.e., fraud or breach of contract claims) against those who breach their fiduciary duties, and the IRS may still impose excise taxes or seek civil penalties.[13]

With applicability of the Fiduciary Rule just two weeks away, all investment advisers should assess its applicability to them and prepare accordingly.  At a minimum, this means working with compliance staff and legal counsel to determine whether all advice given to retirement investors is:  (i) in the client’s best interest (which investment advisers, as fiduciaries should already be doing), (ii) is impartial, and (iii) does not generate payments to the investment adviser giving rise to a conflict of interest.

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

[1] Department of Labor,  Conflict of Interest Rule – Retirement Investment Advice; Proposed Rule; Extension of Applicability Date (March 1, 2017), available at https://www.dol.gov/agencies/ebsa/laws-and-regulations/rules-and-regulations/completed-rulemaking/1210-AB32-2.

[2] Id.

[3] Department of Labor, Conflict of Interest FAQs (Transition Period) (May 2017), available at https://www.dol.gov/sites/default/files/ebsa/about-ebsa/our-activities/resource-center/faqs/coi-transition-period.pdf.

[4] Id.

[5] Id.

[6] Id.

[7] Id.

[8] Id.

[9] Conflict of Interest Rule, 81 Fed. Reg. 20946, 20992 (April 8, 2016) (to be codified at 29 CFR Parts 2509, 2510, and 2550) (The DOL has stated that if an investment adviser using a flat fee or wrap fee compensation model makes recommendations that would generate additional compensation for the adviser (e.g., adviser recommends rolling an IRA into an annuity that will generate fees for the adviser), then the adviser would need to rely on an exception.)

[10] Id.

[11] Department of Labor, Conflict of Interest FAQs (Transition Period) (May 2017), available at https://www.dol.gov/sites/default/files/ebsa/about-ebsa/our-activities/resource-center/faqs/coi-transition-period.pdf .

[12] Id.

[13] Conflict of Interest Rule, 81 Fed. Reg. 20946, 20653 (April 8, 2016) (to be codified at 29 CFR Parts 2509, 2510, and 2550).

Posted on Monday, May 8 2017 at 9:59 am by

SEC Amends Crowdfunding Rules

By Paul Foley and John I. Sanders

Under the Jumpstart our Business Startups Acts of 2012 (the “JOBS Act”), the Securities and Exchange Commission (the “SEC”) adopted rules allowing for securities-based crowdfunding in 2015.[i]  The JOBS Act required the SEC to adjust dollar limits placed on the amount that could be invested or raised through securities-based crowdfunding at least every five years to account for inflation.[ii]  On April 5, 2017, the SEC issued a final rule adjusting those limits for the first time.[iii]  We encourage those interested in issuing securities through a securities-based crowdfunding offering to review the final rule and call us with any questions you may have.

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

[i] SEC, Release No. 33-9974 (Oct. 9, 2015), available at https://www.sec.gov/rules/final/2015/33-9974.pdf.

[ii] Id. at 15.

[iii] SEC, Release No.33-10332 (April 5, 2017), available at https://www.sec.gov/rules/final/2017/33-10332.pdf.

Posted on Wednesday, April 19 2017 at 8:48 am by

SEC Issues Guidance to Robo-Advisers

Robo-advisers are a fast-growing segment of the investment advisory industry.  In fact, they now account for an estimated $71.5 billion in assets under management.[1]  In response to their explosive growth, the SEC has made robo-advisers an examination priority[2] and has issued regulatory guidance to them.[3]  The SEC’s guidance is summarized below.

  • Disclosures to potential clients should explain the: (i) robo-adviser’s business model and how it differs from traditional investment adviser models; and (ii) limitations in the scope of the robo-adviser’s services.[4]  The robo-adviser should also consider whether its delivery of the disclosures is clear and conspicuous enough to be effective in the context of the relationship, which may be entirely web-based.[5]
  • Questionnaires used to gather client information should be designed to obtain sufficient information to support the robo-adviser’s suitability obligation.[6] Where the client can select investments other than those the adviser recommends, the robo-adviser should provide commentary supporting its recommendations.[7]
  • Internal compliance programs should address the unique aspects of the robo-adviser business model, including limited human interaction and heightened cybersecurity risks.[8]

Advisers who have replaced or supplemented their advisory services with robo-adviser technology in recent years may have questions after reviewing the SEC’s guidance.  Please feel free to contact us with any questions you may have.

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

 

[1] Daisy Maxey, Spotlight on Robo Advisers’ Returns, Wall Street Journal (Nov. 1, 2016), https://www.wsj.com/articles/spotlight-on-robo-advisers-returns-1478018429.

[2] SEC, National Exam Program Examination Priorities for 2017 (Jan. 13, 2017), www.sec.gov/about/offices/ocie/national-examination-program-priorities-2017.pdf.

[3] SEC, IM Guidance Update No. 2017-02 (Feb. 2017), www.sec.gov/im-guidance-2017-02.pdf.

[4] Id.

[5] Id.

[6] Id.

[7] Id.

[8] Id.

Posted on Friday, January 27 2017 at 10:34 am by

Effects of the DOL Fiduciary Rule Reach Mutual Fund Industry

By Andrew Sachs and John I. Sanders

The Department of Labor finalized the so-called “Fiduciary Rule” in April 2016 and announced it would go into effect in April 2017.[i]  Since the finalization of the Fiduciary Rule, the annuities,[ii] brokerage,[iii] and advisory industries[iv] have all seen substantial changes to products or fee structures.  Now, the effects of the rule have reached the mutual fund industry as well, with the SEC’s recent approval of American Funds’ “Clean Shares” – shares stripped of any front-end load, deferred sales charge, or other asset-based fee for sales or distribution that are sold by brokers who set their own commissions in connection with such sales.[v]

On January 11th, the SEC issued a no-action letter to Capital Group, the parent company of American Funds.[vi]  The no-action letter stated that the SEC concurred with Capital Group’s view that Section 22(d) of the Investment Company Act of 1940 (the “Act”), which prohibits selling securities except at “a current public offering price described in the prospectus,” does not apply to brokers when acting as agent on behalf of its customers and charging customers commissions for effecting transactions in Clean Shares.[vii]

At least one publication predicts that thousands of mutual funds will create similar classes of shares.[viii]  We believe that the ability to replace the distribution fees typically charged by its mutual funds with commissions charged by the broker will give funds a new measure of flexibility to meet the demands of the Fiduciary Rule and competition generally.  For those wishing to more fully understand the costs and benefits of adopting a similar share class, we are here to help.

Andrew Sachs is a partner with Kilpatrick Townsend & Stockton’s Winston-Salem office. John I. Sanders is an associate in the firm’s Winston-Salem office.

 

[i] Department of Labor, Fact Sheet: Department of Labor Finalizes Rule to Address Conflicts of Interest in Retirement Advice, Saving Middle Class Families Billions of Dollars Every Year, https://www.dol.gov/agencies/ebsa/about-ebsa/our-activities/resource-center/fact-sheets/dol-final-rule-to-address-conflicts-of-interest.

[ii] Greg Iacurci, Insurers Developing Fee-Based Fixed-Index Annuities Post-DOL Fiduciary Rule, INVESTMENT NEWS (July 14, 2016), http://www.investmentnews.com/article/20160714/FREE/160719964/insurers-developing-fee-based-fixed-indexed-annuities-post-dol.

[iii] Katherine Chiglinsky and Margaret Collins, AIG CEO Blames Obama Retirement Rule for Broker-Dealer Exit, BLOOMBERG (Jan. 27, 2016), http://www.bloomberg.com/news/articles/2016-01-27/aig-broker-dealer-exit-fueled-by-obama-retirement-rule-ceo-says.

[iv] Darla Mercado, How the New “Fiduciary” Rule Will Actually Affect You, CNBC (Oct. 13, 2016), http://www.cnbc.com/2016/10/13/how-the-new-fiduciary-rule-will-actually-affect-you.html.

[v] John Waggoner, Brace for Thousands of New DOL Fiduciary-Friendly Mutual Fund Share Classes, INVESTMENT NEWS (Jan. 6, 2017), http://www.investmentnews.com/article/20170106/FREE/170109955/brace-for-thousands-of-new-dol-fiduciary-friendly-mutual-fund-share.

[vi] SEC, Response of the Office of Chief Counsel Division of Investment Management, available at https://www.sec.gov/divisions/investment/noaction/2017/capital-group-011117-22d.htm.

[vii] Id.

[viii] Waggoner, supra note 5.

Posted on Tuesday, January 17 2017 at 8:39 am by

SEC Announces 2017 Exam Priorities

By Paul Foley and John I. Sanders

Each year, the SEC’s Office of Compliance Inspections and Examinations (the “OCIE”) releases its priorities for the upcoming year.  For regulated entities such as investment companies and investment advisers, the release of the OCIE’s priorities is highly significant.  The reason, simply put, is that your regulator’s priorities must also be your own priorities.

Among the OEIC’s newly-released examination priorities for 2017 are the following:[i]

  • Never-Before Examined Investment Advisers
  • Cybersecurity compliance procedures and controls
  • Robo-advisors’ marketing, recommendation formulation, and security procedures
  • ETF exemptive relief compliance, sales practices, and risk disclosures
  • Elder abuse detection and prevention practices
  • Money market funds’ compliance with the newly effective rules
  • FINRA oversight

We agree with the OCIE Director who stated earlier this week that the release of examination priorities is an important opportunity for regulated entities to evaluate their own compliance programs and make the necessary enhancements prior to examinations.[ii]  Therefore, we encourage you to read the full text of the SEC announcement, consider your compliance programs in the prioritized areas, and contact us with any questions you may have.

 

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

[i] SEC, SEC Announces 2017 Examination Priorities (Jan. 13, 2017), https://www.sec.gov/news/pressrelease/2017-7.html.

[ii] Id.