Investment Management

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 Wednesday, July 26 2017 at 8:58 am by

Six Ways to Improve Cybersecurity Policies and Procedures

By Paul Foley and John I. Sanders

The SEC has declared cybersecurity to be an examination priority for financial institutions (i.e., broker-dealers, investment advisers, and registered investment companies) in each of the past four years.[1]  While the SEC’s comments in these examination priority releases are helpful for financial institutions, we believe that the SEC may have provided more useful guidance concerning cybersecurity practices through investor bulletins designed to help investors avoid online fraud.[2]  This guidance reveals helpful insights into the SEC’s evolving approach to cybersecurity.  Accordingly, based on the SEC’s most recently issued guidance to investors, we identify six ways financial institutions could improve their cybersecurity policies and procedures below.[3]

1. Passwords. The SEC has recommended that investors choose a strong password (e., one that includes symbols, numbers, and both capital and lowercase letters) for online access, keep their password secure, and change it regularly.[4]  Consistent with this recommendation, financial institutions may want to consider requiring clients to choose strong passwords and change them regularly.

2.  Biometric Safeguards. The SEC has recommended that investors contact their financial institutions to determine whether they offer biometric safeguards (g., fingerprinting, facial and voice recognition, and retina scans) for mobile device access.[5]  Although biometric safeguards are not currently a standard security feature, financial institutions may want to consider ways they can add biometric safeguards as a feature of mobile device access for their clients.

3.  Public Computers. The SEC has recommended that investors avoid using public computers to access investment accounts.[6]  When an investor does use a public computer, the SEC recommends investors take the following precautions:  disable password saving; delete files, caches, and cookies; and log out of accounts completely when finished.[7]  Financial institutions could help investors follow the SEC’s helpful, but often forgotten, advice by, for example, requiring them to proactively check a box to enable password saving on each new device and automatically logging users out of their online accounts after relatively short periods of inactivity.

4.  Secure Websites. The SEC has recommended that investors not log in to an account unless the relevant financial institution’s website has a secure “https” address.[8]  Many financial institutions have a secure website already, but those that do not may want to consider implementing one.

5.  Links. The SEC has recommended that clients never click on links sent to them by financial institutions with which they do not have a relationship, and to confirm the legitimacy of links sent to them by their financial institutions by calling or emailing the purported sender.[9]  In response to this advice, financial institutions may want to use links judiciously, and ensure that those who will receive calls and emails from clients know what links have been sent to which clients and under what circumstances.  Without such knowledge, financial institution employees may be unable to confirm or deny the legitimacy of the link, undermining client confidence in the financial institution’s cybersecurity policies and procedures.

6.  Review Account Statements. The SEC has recommended that investors regularly review statements and trade confirmations for suspicious activity and contact their financial institution with a written complaint if there is suspicious activity.[10]  In response, financial institutions may want to evaluate their security procedures with respect to redemptions and distributions.  Adopting reliable technological innovations can help prevent suspicious activity and create a business advantage (g., using biometric safeguards or two-factor authentication may be more reliable and less time-consuming than requiring signature guarantees).

Please contact us if you have any questions about this article or the SEC’s cybersecurity guidance.

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] SEC, Examination Priorities for 2014 (Jan. 9, 2014), available at http://www.sec.gov/about/offices/ocie/national-examination-program-priorities-2014.pdf; SEC, Examination Priorities for 2015 (Jan. 13, 2015), available at http://www.sec.gov/about/offices/ocie/national-examination-program-priorities-2015.pdf; SEC, Examination Priorities for 2016 (Jan. 11, 2016), available at http://www.sec.gov/about/offices/ocie/national-examination-program-priorities-2016.pdf;  SEC, Examination Priorities for 2017 (Jan. 12, 2017), available at https://www.sec.gov/about/offices/ocie/national-examination-program-priorities-2017.pdf.

[2] SEC, Cybersecurity, the SEC and You (last visited July 25, 2017), available at https://www.sec.gov/spotlight/cybersecurity (containing a library of resources of both investors and securities industry professionals related to cybersecurity).

[3] SEC, Updated Investor Bulletin:  Protecting Your Online Investment Accounts from Fraud (April 26, 2017), available at https://investor.gov/additional-resources/news-alerts/alerts-bulletins/updated-investor-bulletin-protecting-your-online.

[4] Id.

[5] Id.

[6] Id.

[7] Id.

[8] Id.

[9] Id.

[10] 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 Friday, July 14 2017 at 12:01 pm by

Broker-Dealers and Investment Advisers Exempted from CFPB’s Arbitration Agreement Rule

By Paul Foley and John I. Sanders

The Consumer Financial Protection Bureau (the “CFPB”) issued a final rule on July 10, 2017 that has received widespread attention.[1]  The rule, promulgated pursuant to section 1028(b) of the Dodd-Frank Act, generally regulates “arbitration agreements in contracts for specified consumer financial products and services.”[2]  More specifically, the rule prohibits the use of arbitration agreements by providers of certain financial products and services “to bar the consumer from filing or participating in a class action.”[3]  Despite the apparent wide sweep of the rule, it includes important exemptions for broker-dealers and investment advisers.

First, the rule expressly exempts from its prohibitions “broker-dealers and investment advisers, as well as their employees, agents, and contractors, to the extent regulated by the SEC.”[4]  Also, the rule exempts those “regulated by a State securities commissioner as a broker-dealer or investment adviser.”[5]  As a result of these exemptions, the use of arbitration agreements by broker-dealers and investment advisers will continue to be regulated by the SEC and state regulators.  So far, the SEC has not exercised its authority under section 921 of the Dodd-Frank Act to restrict the use of arbitration agreements as the CFPB has done, and there is no indication it will do so soon.[6]

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] See e.g., Megan Leonhardt, Money Magazine, CFPB Just Issued a New Rule That Would Protect Consumers From Predatory Fine Print (July 11, 2017), available at http://time.com/money/4852123/cfpb-mandatory-arbitration-rule/; Maria LaMagna, MarketWatch, CFPB Announces Rule That Could Help Consumers Sue Financial Firms for Millions (July 11, 2017), available at http://time.com/money/4852123/cfpb-mandatory-arbitration-rule/; and Jessica Silver-Greenberg and Michael Corkery, The New York Times, U.S. Agency Moves to Allow Class-Action Lawsuits Against Financial Firms (July 10, 2017), available at https://www.nytimes.com/2017/07/10/business/dealbook/class-action-lawsuits-finance-banks.html.

[2] CFPB, Final Rule: Arbitration Agreements (July 10, 2017), available at https://www.consumerfinance.gov/policy-compliance/rulemaking/final-rules/arbitration-agreements/ (hereinafter “Arbitration Rule”).

[3] Id. at p. 1.

[4] Id. at p. 478.

[5] Id. at p. 479.

[6] 15 U.S.C. 78o(o) (authorizing the SEC to regulate broker-dealer arbitration agreements) and 15 U.S.C. 80b-5(f) (authorizing the SEC to regulate investment adviser arbitration agreements).

Posted on Tuesday, June 6 2017 at 12:13 pm by

Kokesh v. SEC:  The U.S. Supreme Court Limits SEC Disgorgement Powers

By Paul Foley and John I. Sanders

Since the 1970s, courts have regularly ordered disgorgement of ill-gotten gains in SEC enforcement proceedings.[1]  According to the SEC, this was done as a means to both “deprive . . . defendants of their profits in order to remove any monetary reward for violating” securities laws and “protect the investing public by providing an effective deterrent to future violations.”[2]  Disgorgement has been one of the SEC’s most powerful tools in recent years.[3]  Yesterday, the Supreme Court issued an opinion that significantly limits the SEC’s ability to disgorge ill-gotten gains.[4]

The question before the Supreme Court in Kokesh v. SEC was whether disgorgement, as it has been used by the SEC, constitutes a “penalty.”[5]  Under federal law, a 5-year statute of limitations applies to any “action, suit or proceeding for the enforcement of any civil fine, penalty, or forfeiture, pecuniary or otherwise.”[6]  The SEC has long argued that disgorgement does not constitute a “penalty” and, therefore, is not subject to a 5-year statute of limitations.  The Supreme Court unanimously rejected the SEC’s position by holding that disgorgement constitutes a “penalty.”[7]  As a result, the SEC will be precluded from collecting ill-gotten gains obtained by the defendant more than five years before the date on which the SEC files its complaint.[8]

In the Kokesh case, the Supreme Court’s decision means that the defendant may retain $29.9 million of the $34.9 million of allegedly ill-gotten gains because that amount was received outside of the 5-year state of limitations.[9]  The Kokesh decision is also likely to have a significant long-term impact on SEC enforcement proceedings by reducing the leverage the SEC can apply while negotiating settlements.

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] SEC v. Texas Gulf Sulphur Co., 312 F. Supp. 77, 91 (SDNY 1970), aff ’d in part and rev’d in part, 446 F. 2d 1301 (CA2 1971).

[2] Id. at 92.

[3] SEC, SEC Announces Enforcement Results for FY 2016 (Oct. 11, 2016), available at https://www.sec.gov/news/pressrelease/2016-212.html (illustrating that the SEC has obtained more than $4 billion in disgorgements and penalties in each of the three most recent fiscal years).

[4] Kokesh v. SEC, available at www.supremecourt.gov.

[5] Id. (“This case presents the question whether [28 U.S.C.] §2462 applies to claims for disgorgement imposed as a sanction for violating a federal securities law.”).

[6] 28 U.S.C. §2462 (2017).

[7] Kokesh v. SEC, supra note 4, available at www.supremecourt.gov.  (“SEC disgorgement thus bears all the hallmarks of a penalty: It is imposed as a consequence of violating a public law and it is intended to deter, not to compensate.”).

[8] Id.

[9] Id.

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 10:38 am by

General Solicitations of Certain Regulation D “Private” Securities Offerings:  SEC Affirms Zero-Tolerance Policy.

By Paul Foley and John I. Sanders

On March 29, 2017, the Securities and Exchange Commission (the “SEC”) issued a noteworthy opinion in In re KCD Financial Inc.,[i] a review of a FINRA disciplinary action.[ii]  While the opinion affirmed FINRA’s disciplinary action,[iii] it also affirmed the SEC’s zero-tolerance policy regarding general solicitations made in the course of certain Regulation D offerings.  Those relying on or contemplating relying on Regulation D exemptions from registration should review the SEC’s opinion.

Factual Background

KCD Financial, Inc. (“KCD”) is an independent broker-dealer.[iv]  In 2011, KCD signed an agreement with one of its affiliates (“Westmount”) under which it would solicit accredited investors for a particular private fund (the “Fund”) sponsored by Westmount.[v]  Westmount did not plan to register the offering.  Westmount instead planned to rely on a Rule 506(b) exemption from registration.[vi]

Prior to KCD selling any interest in the Fund, Westmount issued a press release describing the Fund.[vii]  Two Dallas newspapers published articles based on the press release and made the articles available on their respective public websites.[viii]  One of those newspaper articles was then posted on a public website belonging to a Westmount affiliate.[ix]  Westmount’s outside counsel informed Westmount that the newspaper articles constituted general solicitations, which are prohibited in Rule 506(b) offerings.[x]

After KCD and Westmount officers were told that the articles were general solicitations prohibited under Rule 506(b), they did not end the offering, register the securities, or seek to rely on an alternative exemption.  Instead, KCD’s CCO and Westmount’s Vice President of Capital Markets instructed the representatives to sell interests in the Fund only to (i) those with an existing relationship to KCD or Westmount and (ii) accredited investors who had not learned of the offering through the general solicitations.[xi]  Under those guidelines, at least one person was refused an opportunity to purchase interests in the Fund.[xii]

During a FINRA examination of KCD, the examiner found that the newspaper article about the offering had not been removed from a Westmount-affiliated website.[xiii]  Subsequently, FINRA filed a complaint against KCD alleging that the firm’s registered representatives sold securities that were unregistered and not qualified for an exemption from registration, thereby violating FINRA Rule 2010.[xiv]  FINRA also alleged that KCD failed to reasonably supervise the offering, thereby violating FINRA Rule 3010.[xv]  FINRA’s Hearing Panel found that KCD violated those rules.[xvi]  FINRA censured KCD and imposed a fine of $73,000.[xvii]  The National Adjudicatory Counsel affirmed FINRA’s decision.[xviii]  KCD then requested an SEC review.[xix]

SEC Review

KCD admitted that the Fund interests it offered were not registered, but argued that offers were made pursuant to Rule 506(b).[xx]  The SEC rejected KCD’s contention,[xxi] finding that where a party relying on the Rule 506(b) exemption makes a general solicitation, the exemption then is unavailable “regardless of the number of accredited investors or the knowledge and experience of the purchasers who were not accredited investors.”[xxii]  In this context, whether purchasers were accredited or had prior relationships with KCD and Westmount was “irrelevant to whether or not the newspaper articles constituted a general solicitation” and precluded reliance on Rule 506(b).[xxiii]

KCD also argued, assuming the newspaper articles constituted general solicitations, it could still rely on a Rule 506(b) exemption because “KCD did not generally solicit any of the actual investors in the [Westmount] Fund.”[xxiv]  This argument confused the notion of what is prohibited under Rule 506(b).  It is making an offer by general solicitation which precludes reliance on a Rule 506(b) exemption.[xxv]  Whether a sale results directly from the general solicitation is irrelevant.[xxvi]

Practical Implications

The SEC’s opinion affirms its view that exemptions from registration in securities offerings are narrowly construed and must be adhered to strictly.[xxvii]  Where, as here, the exemption prohibits a general solicitation, any general solicitation forever forfeits the issuer’s ability to rely on the exemption in making the offering (i.e., the toothpaste cannot go back into the tube).

Those making exempt offerings in reliance on Rule 504,[xxviii] Rule 505,[xxix] and Rule 506(b)[xxx] should review their sales practices in light of the KCD opinion.  In reviewing practices, issuers should look beyond the obvious means of making a general solicitation (e.g., a press release that is published by a widely-circulated newspaper).  Websites and social media accounts of those participating in the offerings are equally capable of precluding use of a valuable registration exemption.

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

[i] In re KCD Financial, Inc., SEC Release No. 34-80340 (March 29, 2017), available at www.sec.gov/litigation/opinions/2017/34-80340.pdf (hereinafter, SEC Opinion).

[ii] In re KCD Financial, Inc., FINRA Complaint No. 2011025851501 (Aug. 3, 2016), available at http:www.finra.com (hereinafter, FINRA Opinion).

[iii] SEC Opinion, supra note 1, at p. 1.

[iv] Id., at p. 2.

[v] Id.

[vi] Id.

[vii] Id, at p. 3.

[viii] Id.

[ix] Id. at p. 4.

[x] Id.

[xi] Id.

[xii] Id.

[xiii] Id.

[xiv] Id.

[xv] Id.

[xvi] FINRA Opinion, supra note 2, at p. 4.

[xvii] Id.

[xviii] Id.

[xix] Id.

[xx] SEC Opinion, supra note 1, at 2.

[xxi] Id.

[xxii] Id. at 7.

[xxiii] Id. at 9.

[xxiv] Id at 10.

[xxv] Id.

[xxvi] Id. at 11

[xxvii] Id. at 7.

[xxviii] 17 CFR 230.504 (2017).

[xxix] 17 CFR 230.505 (2017).

[xxx] 17 CFR 230.506(b) (2017).

Posted on , 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, December 16 2016 at 11:51 am by

7 Securities Law and Regulatory Changes Likely to be Considered During the Trump Administration

By Paul Foley and John Sanders

On November 8, 2016, political power in United States shifted in an unexpected and unprecedented way.  As of January 20, 2017, Republicans will hold the White House and both Houses of Congress.[1]  President-elect Donald Trump will also have the opportunity to appoint two SEC Commissioners and a new Chair.[2]  He and his party will have the ability to reshape securities law and regulation.  As this was unanticipated, there was little discussion before the election as to what it would mean for securities law and regulation.  We believe the following seven issues are likely to be part of the discussion in the weeks and months ahead.

1. Dodd-Frank Act – Volcker Rule

The Volcker Rule, a 900-plus-page rule adopted in December 2013, was intended to limit proprietary trading by banks.[3]  Championed by former Federal Reserve Chairman Paul Volcker, the rule was a last-minute addition to the 2010 Dodd-Frank Act.  For years, it stalled as regulators and commentators tried to distinguish between speculation (deemed bad) from investment (deemed good).  Few believe that the regulators were successful in properly drawing this distinction.[4]  Making the rule more susceptible to criticism, many experts have determined the rule “would have done nothing to mitigate [the Great Recession,] the worst financial crisis since the Great Depression.”[5]

President-elect Trump’s nominee for Secretary of the Treasury has promised “strip back” elements of the Dodd-Frank Act, including the Volcker Rule.[6]  If the new administration is dedicated to repealing the Volcker Rule, something that isn’t quite clear,[7] repealing it won’t be easy.  Legislative action would likely require bipartisan support in the Senate.[8]  Eliminating the rule through agency rule making, like adopting the rule, would require coordination between multiple independent agencies,[9] an opportunity for public comment,[10] and time.[11]  The easier (but less permanent) solution is for the new President to appoint agency heads who will interpret the rule differently or deemphasize its enforcement.[12]  The discussion of whether, and how, to repeal the Volcker Rule should be followed closely.

2. Delegated Authority for Enforcement

In 2009, the SEC delegated authority to the Director of Enforcement to open formal orders of investigation of persons and entities.[13]  The Director of Enforcement then took the unprecedented step of sub-delegating authority to Regional Directors, Associate Directors, and Specialized Unit Chiefs.[14]  The delegation supports Chair White’s “broken windows” approach by which deficiencies and misconduct of every size and nature are addressed.[15]  This approach has resulted in a record number of enforcement proceedings.[16]  However, many commentators have raised concerns about the ease with which proceedings can be brought and subpoenas issued and whether enforcement is now less effective because it is uncoordinated.[17]  If the new administration wishes to end the delegation, it can appoint SEC Commissioners and a Chair that will withdraw the delegation with an order[18] not subject to the lengthy formal rule making process.[19]

3. Fiduciary Rule

The Department of Labor (the “DOL”) finalized the so-called “Fiduciary Rule” in April 2016 and announced it would go into effect in April 2017.[20]  According to the DOL, investors lose billions of dollars in fees each year because their advisors are not acting in their best interests.[21]  The goal of the Fiduciary Rule, therefore, is to “stop advisers from putting their own interests in earning high commissions and fees over clients’ interests in obtaining the best investments at the lowest prices.”[22]  However, the net effect of the rule is unclear.  Among the potential negative effects of the rule are investors losing access to competent advice,[23] skyrocketing costs for affected accounts,[24] decreases of 25 to 50% in annuities sales,[25] and unnecessary corporate restructuring.[26]

If lawsuits aimed at preventing the rule from going into effect fail, those who advocate repealing the rule will find the job challenging.  First, the rule isn’t within the reach of the Congressional Review Act[27] and isn’t likely to be suspended by the Secretary of Labor who oversaw its creation.[28]  That means a lengthy formal rule making process would be required to repeal the rule.[29]  It is uncertain whether this is an effort the investment advisory industry would welcome after spending the past year working toward compliance, which included spinning off business units[30] changing long-standing pricing models,[31] and jettisoning certain clients.[32]

4. Consolidated Audit Trail

In 2010, as the SEC and CFTC attempted to trace the root cause of the Flash Crash, it became abundantly clear that the financial market regulators were ill-equipped to police modern markets.  Out of this realization came the idea for the Consolidated Audit Trail (the “CAT”).[33]  CAT is conceptualized as a market-wide system that tracks equity and option trades.[34]  It would help in both investigations and monitoring.  Proving manipulation and fraud, as well as identifying systemic risk, should become easier with CAT in place.  However, despite years of work, “a fully baked, centralized trail is still years away.”[35]  Given the benefits of an operational CAT to each of the SEC’s mandates, including maintaining the investor confidence that drives investment into our public markets, getting it up and running may be a priority.  However, many commentators argue that CAT would be a hacker’s dream.[36]  The new administration will signal its where it stands on CAT with its appointment of SEC commissioners and Chair.

5. Pay Ratio Disclosures

The Dodd-Frank Act instructed the SEC to adopt a rule requiring each publicly traded company to disclose “the ratio of the compensation of its chief executive officer (CEO) to the median compensation of its employees.”[37]  The ratio would appear in registration statements, proxy and information statements, and annual reports that call for executive compensation disclosure.[38]  This seemingly simple calculation may “actually entail herculean bookkeeping for large, diverse companies.”[39]

The compliance date for the pay ration rule is January 1, 2017.[40]  Once the new Congress and SEC commissioners are in place, authorities should consider whether the rule serves any of the SEC’s three mandates: protect investors; maintain fair, orderly, and efficient markets; and facilitate capital formation.[41]  If the rule is deemed inappropriate under those mandates, Congress may amend the Dodd-Frank Act and instruct the SEC to engage in a formal rule making process aimed at repealing the rule.  If the rule is deemed appropriate, or the political will to repeal the rule is lacking, it may remain in place with the SEC allowing companies “substantial flexibility in determining the pay ratio.”[42]

6. Political Contributions Disclosures

In 2011, a group of college professors argued that the Supreme Court’s Citizens United[43] ruling necessitated an SEC rule requiring public companies to disclose their political expenditures.[44]  The SEC received more than 1 million public comments – a record.[45]  Yet, the SEC did not act.  Senator Elizabeth Warren, less than a month before the recent election, openly urged President Obama to remove SEC Chair Mary Jo White for refusing “to develop a political spending disclosure rule despite her clear authority to do so.”[46]  This was perhaps a bit unfair.  Not only was the SEC restricted by law from working on the rule at that time,[47] but the rule has faced tremendous opposition.[48]  Business groups and Republicans have long argued that “a company’s political contributions are not related to its financial performance and that the disclosures are unnecessary.”[49]  A Republican Congress or appointments to the SEC may find 2017 is an ideal time to revisit this issue.

7. Liquidity Risk Management

On October 13, 2016, the SEC announced that it had finalized a rule that would require open-ended investment companies to develop liquidity risk management programs and make additional disclosures related to liquidity.[50]  The rule, among other things, requires an investment company’s board of directors to adopt a formal plan for managing liquidity risk and make disclosures classifying fund investments into one of four categories according to liquidity.[51]  In a letter to the SEC supporting the rule, Senator Sherrod Brown cited several sources for the proposition that the fund industry was growing and offering investments in less-liquid assets.[52]  Tellingly, Senator Brown cited widely-available public sources such as Barron’s and Bloomberg articles.[53]  If the public has access to multiple news stories about liquidity risk, risk disclosures in regulatory filings, and lists of fund holdings online, it is fair to ask whether the rule carries a benefit to investors along with its cost.  If the determination is made the costs of this rule substantially outweigh the benefits, then the SEC may engage in a formal rule making process to repeal the rule.

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.

[1] Richard Cowan and Susan Cornwell, Republicans Defend Grip on U.S. Congress as Trump Wins Presidency, Reuters (Nov. 9, 2016), http://www.reuters.com/article/us-usa-election-congress-idUSKBN13317Z.

[2] Mark Shoeff Jr., Where Donald Trump Stands on Top Financial Adviser Issues, Investment News (Nov. 9, 2016), http://www.investmentnews.com/article/20161109/FREE/161109909/where-donald-trump-stands-on-top-financial-adviser-issues.

[3] SEC, Final Rule: Prohibitions and Restrictions on Proprietary Trading and Certain Interests In, and Relationships With, Hedge Funds and Private Equity Funds (Dec. 10, 2013), https://www.sec.gov/rules/final/2013/bhca-1.pdf.

[4] The Volcker Ambiguity, The Wall Street Journal (Dec. 11, 2013), http://online.wsj.com/news/articles/SB10001424052702304744304579250393935144268.

[5] Ben Steil, Beyond the Volcker Rule: A Better Approach to Financial Reform, Council on Foreign Relations (April 2012), http://www.cfr.org/financial-crises/beyond-volcker-rule-better-approach-financial-reform/p27894.

[6] Jacob M. Schlesinger, Trump Treasury Choice Steven Mnuchin Vows to ‘Strip Back’ Dodd-Frank, The Wall Street Journal (Nov. 30, 2016), http://www.wsj.com/articles/trump-treasury-choice-steven-mnuchin-vows-to-strip-back-dodd-frank-1480513188.

[7] Emily Stephenson, Trump Calls for ‘21st century’ Glass-Steagall Banking Law, Reuters (Oct. 26, 2016), http://www.reuters.com/article/us-usa-election-trump-banks-idUSKCN12Q2WA.

[8] Ryan Tracy and John Carney, How to Kill the Volcker Rule? Don’t Enforce it, The Wall Street Journal (Nov. 28, 2016), http://www.wsj.com/articles/how-to-kill-the-volcker-rule-dont-enforce-it-1480329002.

[9] Id.

[10] 5 U.S.C. 553 (2016), available at https://www.law.cornell.edu/uscode/text/5/553 (Outlining the process for rule making, as defined in 5 U.S.C. 551 (2016)).

[11] Tracy and Carney, supra note 8.

[12] Id.

[13] SEC, Final Rule: Delegation of Authority to Director of Division of Enforcement (Aug. 5, 2009), https://www.sec.gov/rules/final/2009/34-60448.pdf.

[14] Bradley J. Bondi, A Questionable Delegation of Authority: Did the SEC Go Too Far When It Delegated Authority to the Division of Enforcement to Initiate an Investigation?, Center for Financial Stability (Sept. 20, 2016), http://centerforfinancialstability.org/wp/2016/09/20/a-questionable-delegation-of-authority-did-the-sec-go-too-far-when-it-delegated-authority-to-the-division-of-enforcement-to-initiate-an-investigation/

[15] Jean Eaglesham, SEC Breaks Record for Number of Enforcement Cases, The Wall Street Journal (Oct. 11, 2016), http://www.wsj.com/articles/sec-on-track-to-break-record-for-number-of-enforcement-cases-1476198436.

[16] Id.

[17] Bondi, supra note 14.

[18] 17 CFR 200.30-4 (2016), available at https://www.law.cornell.edu/cfr/text/17/200.30-4.

[19] 5 U.S.C. 553(a)(2) (2016), available at https://www.law.cornell.edu/uscode/text/5/553.

[20] Department of Labor, Final Rule: Conflict of Interest Rule (April 8, 2016), https://www.dol.gov/agencies/ebsa/laws-and-regulations/rules-and-regulations/completed-rulemaking/1210-AB32-2.

[21] Id.

[22] Liz Skinner, Figuring Out Fiduciary: Now Comes the Hard Part, Investment News (May 9, 2016), http://www.investmentnews.com/article/20160509/FEATURE/160509939/the-dol-fiduciary-rule-will-forever-change-financial-advice-and-the.

[23] Robert Litan & Hal Singer, Obama’s Big Idea for Small Savers: ‘Robo’ Financial Advice, The Wall Street Journal (July 21, 2015), http://www.wsj.com/articles/obamas-big-idea-for-small-savers-robo-financial-advice-1437521976.

[24] Jed Morowitz & Mason Braswell, Exclusive: Merrill to End Commission-Based Retirement Business on Retail Accounts, AdvisorHub (Oct. 6, 2016), http://advisorhub.com/exclusive-merrill-end-commission-based-retirement-business-retail-accounts/.

[25] Skinner, supra note 22.

[26] Christine Idzelis, Sale of AIG Advisor Group May Signal Wave of Mergers Ahead, Investment News (Jan. 29, 2016), http://www.investmentnews.com/article/20160129/FREE/160129906/sale-of-aig-advisor-group-may-signal-wave-of-mergers-ahead.

[27] 5 U.S.C. 801 (2016), available at https://www.law.cornell.edu/uscode/text/5/801.

[28] Aaron Back, Eliminating Obama’s Fiduciary Rule Easier Said Than Done, The Wall Street Journal (Dec. 5, 2016), http://www.wsj.com/articles/eliminating-obamas-fiduciary-rule-easier-said-than-done-1480976385.

[29] 5 U.S.C. 553 (2016), available at https://www.law.cornell.edu/uscode/text/5/553 (Outlining the process for rule making, as defined in 5 U.S.C. 551 (2016)).

[30] Greg Iacurci, Insurance Based Broker-Dealers Plan to Use BICE Under DOL Fiduciary Rule, Investment News (July 7, 2016), http://www.investmentnews.com/article/20160707/FREE/160709959/insurance-based-broker-dealers-plan-to-use-bice-under-dol-fiduciary.

[31] Id.

[32] Andrew Welsch, Raymond James follows Morgan’s Lead in Keeping Commissions Under Fiduciary, OnWallStreet (Oct. 27, 2016), http://www.onwallstreet.com/news/raymond-james-follows-morgans-lead-in-keeping-commissions-under-dol; See also Robert Powell, New Rules Force Financial Advisers to do What’s Best for their Clients, USA Today (April 6, 2016), http://www.usatoday.com/story/money/columnist/powell/2016/04/06/investors-new-fiduciary-rule-protection/82661384/.

[33] SEC, Final Rule: Consolidated Trail (July 18, 2012), https://www.sec.gov/rules/final/2012/34-67457.pdf.

[34] Nick Fera, What New Developments in the Consolidated Audit Trail Spell for Broker-Dealer Compliance, The Street (June 13, 2016), https://www.thestreet.com/story/13604582/1/what-new-developments-in-the-consolidated-audit-trail-spell-for-broker-dealer-compliance.html.

[35] Id.

[36] Dave Michaels, SEC Approves Consolidated Audit Trail to Detect Market Manipulation, Wall Street Journal (Nov. 15, 2016), http://www.wsj.com/articles/sec-to-vote-on-consolidated-audit-trail-to-detect-market-manipulation-1479240411.

[37] SEC, SEC Adopts Rule for Pay Ratio Disclosure (Aug. 5, 2015), https://www.sec.gov/news/pressrelease/2015-160.html.

[38] Id.

[39] Richard Levick, The Pay Ratio Rule:  Businesses Face Unprecedented Executive Pay Disclosure Burden (Feb. 9, 2016), http://www.forbes.com/sites/richardlevick/2016/02/09/the-pay-ratio-rule-businesses-face-unprecedented-executive-pay-disclosure-burden/#a044585cf077.

[40] SEC, Final Rule: Pay Ratio Disclosure (Aug. 5, 2015),  https://www.sec.gov/news/pressrelease/2015-160.html.

[41] SEC, What We Do, https://www.sec.gov/about/whatwedo.shtml.

[42] SEC, SEC Adopts Rule for Pay Ratio Disclosure (Aug. 5, 2015), https://www.sec.gov/news/pressrelease/2015-160.html.

[43] Citizens United v. Federal Election Com’n, 558 U.S. 310 (2010).

[44] Committee of Corporate Political Spending, Rulemaking Petition to SEC (Aug 3, 2011), available at https://www.sec.gov/rules/petitions/2011/petn4-637.pdf.

[45] Ranee Merle and Jim Tankersley, Elizabeth Warren Urges President Obama to Remove the Head of the SEC, The Washington Post (Oct. 14, 2016), https://www.washingtonpost.com/news/wonk/wp/2016/10/14/elizabeth-warren-asks-president-obama-to-remove-the-head-of-the-sec/.

[46] Id.

[47] Pub. L. No. 114-113, 129 Stat. 3030 (2016), available at https://www.congress.gov/bill/114th-congress/house-bill/2029/text (stating that no funds made available under the Consolidated Appropriations Act would “be used by the [SEC] to finalize, issue, or implement any rule, regulation, or order regarding the disclosure of political contributions.”)

[48] Andrew Ackerman, Elizabeth Warren to Obama: Fire SEC Chief Mary Jo White, The Wall Street Journal,  (Oct. 14, 2016), http://www.wsj.com/articles/elizabeth-warren-to-obama-fire-sec-chief-mary-jo-white-1476439200.

[49] Merle and Tankersley, supra note 45.

[50] SEC, Final Rule: Investment Company Liquidity Risk Management Programs (Oct. 13, 2016), https://www.sec.gov/rules/final/2016/33-10233.pdf.

[51] Id.

[52] Letter from U.S. Senator Sherrod Brown to SEC Chair Mary Jo White (July 6, 2016), available at https://www.sec.gov/comments/s7-24-15/s72415-247.pdf.

[53] Id.

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