Category Archives: Enforcement

The Custody Rule Clarified (Again)

In a recent Risk Alert, the staff of the Office of Compliance Examinations and Inspections (“OCIE”) of the Securities and  Exchange Commission (“SEC”) observed that one of the most frequent deficiencies identified in OCIE examinations was the failure of investment advisers to recognize that they might be deemed to have custody of client assets for purposes of Rule 206(4)-2
(“Custody Rule”) under the Investment Advisers Act of 1940 (“Advisers Act”). On February 21, the staff of the SEC’s Division of Investment Management provided additional guidance under the Custody Rule that addressed three situations where there have been significant questions as to whether an investment adviser has custody of client assets:

  • when the adviser has limited authority to transfer client assets pursuant to a standing letter of instruction or other similar asset transfer authorization arrangement (“SLOA”) established by a client with a qualified custodian;
  • when an agreement between the client and its custodian appears to provide the adviser with access to client assets—even if the investment adviser is not a party to such agreement; and
  • when the adviser has the authority to move money between the client’s own accounts (“first-person transfers”).

Read More Here.

Additional contributor to this post:

Gregory T. Larkin,  gtlarkin@debevoise.com

Combating Disruptive Electronic Trading: Expedited Cease and Desist Proceedings by FINRA

The Financial Industry Regulatory Authority, Inc. (“FINRA”) recently filed an immediately effective proposal with the Securities and Exchange Commission (“SEC”) to adopt new rules aimed at certain abusive forms of electronic trading.  The proposed rules prohibit two specific types of disruptive quoting and trading activity, and permit FINRA to bring expedited cease and desist proceedings against violations, even if there is no showing of improper intent.  The proposal was published by the SEC on November 21, and will become operative on December 15 (see SR-FINRA-2016-043, available here).

Continue reading Combating Disruptive Electronic Trading: Expedited Cease and Desist Proceedings by FINRA

Ensuring Adequate Cybersecurity Procedures and Systems

On November 14, 2016, FINRA fined a registered broker-dealer $650,000 for failing to safeguard confidential customer data against foreign hackers.  Confidential customer information was stored on the firm’s electronic system without adequate protection from cyber hackers, which resulted in the exposure of confidential information for approximately 5,400 firm customers.  Although there was no evidence that the exposure of this customer information resulted in any distinct customer harm, FINRA insisted that the firm’s cybersecurity procedures and systems were inadequate.  The firm’s prior disciplinary history (similar fine in 2011) was also an important factor in FINRA’s decision to levy this $650,000 punishment.

Beware the Binary Option Trading Contract

On November 10, 2016, the SEC announced charges against an Israeli-based firm related to its sale of binary option trading.  The SEC fined the firm more than $1.7 million for failing to register the binary options as securities, failing to register as a broker-dealer for its sales of binary options to U.S. investors, and for misleading investors in its disclosures related to the risks associated with binary option trading.

In connection with this enforcement action, the SEC also issued an “Investor Alert” on the same day, warning potential investors that many binary option trading contracts are not properly registered with the SEC and may be associated with fraudulent investment schemes.

The Death Knell for L-Share Variable Annuities?

On November 2, 2016, FINRA announced fines against eight firms, totaling $6.2 million, related to supervisory failures for sales of L-share variable annuities.  FINRA has been focused on L-share variable annuity sales, because they are often sold with long-term minimum income riders, which may be incompatible with the higher up-front fees and shorter surrender periods normally associated with the L-share class.  Rather than claim that these products were unsuitable for certain investors, FINRA’s enforcement action alleges that firms did not have adequate supervisory systems in place to monitor the L-share variable annuity sales.  Moreover, many of the eight fined firms did not have supervisory systems reasonably designed to identify “red flags” related to the L-share variable annuity sales (e.g., the “red flag” of L-shares sold to senior investors with long-term riders).

Industry experts anticipate further FINRA enforcement actions related to the sale of L-share variable annuities, and many firms have gradually been eliminating L-share classes from their fund lineups in response to this recent regulatory scrutiny.