Custody | FATCA | FINRA Rule Changes

Regulatory Update May 2017

  • FINRA Provides Regulatory Support to Firms When Addressing Financial Exploitation of Specified Adults:  Effective February 5, 2018, new FINRA Rule 2165 will allow firms to exercise discretion in placing a temporary hold on disbursements of funds and/or securities from the account(s) of “Specified Adults,” while the firm conducts an internal investigation into the facts and circumstances that led to a reasonable belief of financial exploitation of the client.   Acting in compliance with Rule 2165 will provide firms and their associated persons with a safe harbor from FINRA Rules 2010, 2150, and 11870.   The Rule aids not just senior investors but also adults who are believed to have a mental or physical impairment that prevents them from protecting their own interests. For more details, see our blog post.
  • One Custodian’s response to SEC’s No-Action Letter on Standing Letters of Authorization:  After the SEC issued the No-Action Letter on February 21, 2017 to the Investment Advisor Association, (the “IAA Letter”), Charles Schwab & Co., Inc. (“Schwab”) sent out a communication to advisors stating that it is changing its policies and procedures to allow advisors to comply with the conditions set forth in the letter. On its website, Schwab told registered investment advisers that:

“We have already begun making the necessary changes to our forms and systems that will help you meet these requirements and provide you with options, allowing you to choose how—and if—you want to manage ‘first-party’ wires. We hope to complete the necessary work to our systems and processes by the fall of 2017. At that time, your clients will be able to grant you the following choice of authorizations when it comes to ‘first-party’ money movement:

    • Trading and disbursement authorization for checks and journals only;
    • Trading and disbursement standing authorization for checks, journals and wires where no destination account number(s) are supplied in advance.
    • Standing ‘first-party’ wire authorization where destination account number(s) and new signatures are obtained in advance.

Additional materials provided by Schwab include Schwab SEC No-Action Letter FAQs and a document discussing the SEC ‘no-action’ relief conditions and how Schwab can help advisers satisfy them.

Hopefully other custodians are following Schwab’s lead.

  • FATCA/CRS – Notification and Reporting Deadlines: In order to provide sufficient time to all Cayman Financial Institutions to file notification and reports, the Department of International Tax Corporation (“DITC”) aligned the deadlines for U.S. FATCA and CRS (Common Reporting Standard) for this year:
    • The notification deadline for FATCA and CRS is now June 30, 2017 (previously April 30, 2017)
    • The reporting deadline for FATCA and CRS is now July 31, 2017.

Lessons Learned From Recent SEC, FINRA and Massachusetts Cases:

$2.3 Million Restitution on Share Class Sales:  In an Letter of Acceptance, Waiver and Consent (“AWC”), FINRA commended broker dealer Legend Equities Corporation for its “extraordinary cooperation” in self- reporting inappropriate mutual fund share class sales.  Because Legend initiated an investigation, “promptly” established a plan of remediation, “promptly” self- reported the issue, “promptly” took action to correct the violations and employed corrective measures prior to detection and intervention by a regulator, FINRA waived a fine against the firm.  Instead Legend paid out $2.3 million in restitution to customers who were sold incorrect mutual fund share classes over an 8-year period.  FINRA cited in the AWC that Legend relied too heavily on the financial advisors to determine the appropriate share class for the client, did not have appropriate policies, procedures and training in place for advisors to make the correct share class determination, and did not have a control system in place to detect the violations.  The result: failure to supervise.  The big lesson here is that it’s never too late to correct your mistakes and have transparency with the regulator.  Legend’s openness and action plan mitigated its bottom line losses.

SEC Cracks Down on “Fake News”:  The SEC recently brought 27 enforcement actions against individuals and businesses that wrote articles promoting certain stocks. According to the SEC’s press release, public companies hired promoters to generate publicity for their stocks, which in turn hired writers to post bullish articles about the companies on the internet under the guise of impartiality. The SEC found that the promoters used various deceptive practices, including using different pseudonyms to publish multiple articles promoting the same stock, misrepresenting their experience and expertise, and falsely stating that no compensation had been received from the companies being promoted.  The SEC filed fraud charges against many of the companies, communications firms, CEO’s, firm individuals and writers.  Settlements have been reached with the majority of those charged.  The settlements include disgorgement or penalties ranging from $2,200 to $3 million depending on the severity or frequency of the actions.

At the same time, the SEC also issued an Investor Alert warning investors that “fraudsters may generate articles promoting a company’s stock to drive up the stock price and to profit at your expense.” The alert summarized the enforcement actions, and further warned investors that stock promoters may use social media, investment newsletters, online advertisements, email, chat rooms, mail, print media, television and radio.  The investor alert highlights to investors that even articles that appear to be unbiased may be part of an undisclosed paid stock promotion.  Investors should not make investments “solely on information published on an investment research website.”  Before making any investment, the SEC cautions investors to research the company thoroughly and verify the information provided.

It’s not a sales contest because “everyone is a winner”?  The Massachusetts Securities Division nailed Morgan Stanley Smith Barney for a failure to supervise and failure to follow up once inappropriate practices were discovered.

The facts in this case would make any compliance officer cringe. The compliance manual has a policy called “Prohibition Against Sales Contests”, yet a couple of masterminds decided to start an incentive program in early 2014 to encourage financial advisors in five Morgan Stanley branches in Massachusetts and Rhode Island to get clients to apply for lines of credit, secured by securities in their brokerage account.  The loans would be supplied by Morgan Stanley Private Bank.  The more lines of credit they opened, the more money the financial advisors would receive for “business development”, which could be used for client entertainment, seminars and marketing materials. And, like any sales organization, the financial advisors in these five branches egged each other on to open as many lines of credit as possible.  After almost a year, a mastermind at another branch asks whether he can start a similar program, using that familiar refrain – “others are doing it and it is not a contest b/c everyone is a winner.”  Fortunately, this individual actually asked a compliance officer whether such a contest is allowed under the Firm’s compliance manual.

Compliance takes one look at the program and says it’s clearly a sales contest and should immediately be stopped.   Now here is where things get a little hazy.  The risk officers responsible for telling the branches to stop didn’t want to send the message via email, believing it was better to have a conversation instead.  But it looks like there was a delay of about four months before the incentive program was actually halted, and that’s what really got the Massachusetts Division of Securities mad.  The risk officer testified that she told the manager responsible for the program to stop in January, but did not follow up.  And that appears to be the basis for this case – the fact that the program was continued for four months after it was discovered and deemed impermissible.  The Division found this to be a failure to “observe high standards of commercial honor and just and equitable principles of trade in the conduct of business.”  Additionally, the Division also found that Morgan Stanley failed to reasonably supervise its agents.

The obvious lesson is that once a policy violation is discovered, compliance and risk officers should follow up to ensure that the violation stops.

Worth Reading:

Filing Deadlines and To Do List for May


  • Form 13F:  Form 13F quarterly filing is due for Q1 2017 within 45 days after the end of the calendar quarter. Due date is May 15, 2017.
  • Form PF for Large Hedge Fund Advisers: Large hedge fund advisers must file Form PF within 60 days of each quarter end on the IARD system. Due date is May 30, 2017.
  • CFTC CPO-PQR Form:  Large Commodity Pool Operator Form CPO-PQR (March 31 quarter-end report) required to be filed with the NFA for Commodity Pool Operators. Due date is May 30, 2017.
  • CFTC Form CPO-PQR:  Small and Mid-Sized Commodity Pool Operators are required to file NFA Form CPO-PQR.   Due date is May 30, 2017.


  •  Form PF:  Initial Form PF filing is due within 120 days of fiscal year-end for private fund advisers that are not Large Hedge Fund Advisers or Large Liquidity Fund Advisers and manage more than $150 million in regulatory assets under management attributable to private funds as of December 31, 2016. The due date is May 1, 2017.
  • Form PF Annual Amendment:  Form PF Annual Amendment is due within 120 days of fiscal year-end for private fund advisers that are not Large Hedge Fund Advisers or Large Liquidity Fund Advisers and manage more than $150 million in regulatory assets under management attributable to private funds. The due date is May 1, 2017.

Hardin Compliance Consulting provides links to other publicly-available legal and compliance websites for your convenience. These links have been selected because we believe they provide valuable information and guidance.  The information in this e-newsletter is for general guidance only.  It does not constitute the provision of legal advice, tax advice, accounting services, or professional consulting of any kind.