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SEC Answers Questions on Share Class Initiative, Creates Mock ICO; DOL Agrees to Continue Non-Enforcement Policy, and FINRA Helps BDs with Tips on Heightened Supervision: Regulatory Update June 2018

For Investment Advisers:  SEC Actions

  • SEC issues FAQs on Share Class Disclosure Initiative:  I meant what I said and I said what I meant:  Back on February 12, 2018, the SEC Division of Enforcement announced the Share Class Selection Disclosure Initiative (see our blog post for more details), to encourage advisers to self-report failure to disclose the receipt of 12b-1 fees from clients, and to promptly return money to harmed clients. In return for turning themselves in, the Enforcement Division has agreed to recommend “favorable settlement terms.” The deadline to self-report is June 12, 2018.  In response to numerous questions, the Division of Enforcement provided these FAQs, which could be summarized briefly in the words of Horton the elephant, “I meant what said and I said what I meant.”  Advisers have to self-report in order to take advantage of the settlement terms, the settlement terms will not vary from those set forth in the Announcement, the offer only applies to advisers that meet the definition of a “Self-Reporting Adviser” and the SEC makes no promises about other potential consequences arising from self-reporting.  Contributed by Jaqueline M. Hummel, Partner and Managing Director


  •  Your Tax Dollars at Work:  SEC Creates HoweyCoins to Teach Investors about ICO Scams!  Kudos to the team at the SEC that created the “HoweyCoin” website for its creativity, including the tongue-in-cheek reference to the SEC v. Howey, which provided the definition of a “security” still being used today (“a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party”).  The site was created as a mock initial coin offering (ICO) using the buzzwords (HODL), celebrity endorsements and promises of high returns.  It even includes an 8-page long “whitepaper”, which seems to be a hallmark of every cryptocurrency offering (coincidentally, bitcoin’s founder Satoshi Nakamoto’s white paper was only 8-pages long).  Once you click on a “buy coins now” button, you are taken to an SEC website that identifies all the red flags in the fake site to help investors spot scams.  According to its press release, the “SEC was able to build the HoweyCoins website in-house in very little time, which demonstrates just how easy it is for someone to create a scam opportunity.”   Contributed by Jaqueline M. Hummel, Partner and Managing Director


  • SEC Launches Public Database Identifying Individuals with SEC Disciplinary History  “Nowhere to run to, baby…” and less places for advisers with disciplinary histories to hide as the SEC launched its SEC Action Lookup for Individuals (SALI) online database in early May.  Intended to help main street investors research advisers, SALI can be used to search for any registered or unregistered individual and the results will include if the individual settled or contested the enforcement action.  At launch, SALI includes actions entered between October 1, 2014 and March 31, 2018, but the SEC indicated that it will periodically refresh the database with more current information and backfill the database over time with older actions.  Keep in mind that the database includes individuals only, and that it excludes individuals whose cases are pending or against whom no judgment or order has been issued.  A Google search for the name of an individual with “SEC” added will return a similar result to SALI.  That said, the launch of SALI reflects a concerted effort by the SEC to improve transparency and provide direct access to disciplinary information for investors.  Contributed by Cari A. Hopfensperger, Compliance Consultant

 For Investment Advisers and Broker Dealers: DOL Actions

  • DOL says it won’t go after Violations of Fiduciary Rule:  The Department of Labor (“DOL”) issued Field Assistance Bulletin 2018-02, stating financial institutions should be allowed to continue to rely upon the temporary enforcement policy set forth in the Fiduciary Rule pending the department’s issuance of additional guidance, expected to be issued “in the future.”  The question some financial professionals may be asking is who cares?  If the Fiduciary Rule is dead, why should I be worried about DOL enforcement?  Unfortunately, this relief is necessary since the Best Interest Contract Exemption (“BICE”) was also struck down along with the Fiduciary Rule.  By complying with BICE, advisers providing advice to retirement plan investors could receive commissions, also known as variable compensation. It is unclear whether firms that complied with BICE and received commissions and other forms of variable compensation would be guilty of engaging in prohibited transactions that apply to fiduciaries under ERISA and the Internal Revenue Code.  Basically, the DOL and the IRS acknowledged that there is a lot of uncertainty about what comes next.  Given that many financial institutions had already committed significant time and resources to comply with the Fiduciary Rule and BICE, the DOL said that as long as investment advice fiduciaries are working diligently and in good faith to comply with the impartial conduct standards (required to comply with BICE), the DOL and IRS will not pursue them for violating the prohibited transaction rules under ERISA and the Internal Revenue Code.   Contributed by Jaqueline M. Hummel, Partner and Managing Director

 For Broker Dealers:  FINRA Actions

  • FINRA Cautions Firms Regarding Unpriced Customer Orders: In March, FINRA released Regulatory Notice 18-11 which provides guidance to firms when recommending and entering unpriced customer orders for “direct listings” at the opening on its first day of trading.   A “direct listing” is an initial listing of shares by an issuer that is not accompanied by a concurrent underwriting.  In such cases, a public market has not been established and a prior public market price does not exist.  Secondary market prices may vary greatly from the opening price, resulting in market orders being filled at prices detrimental to the client.  To mitigate this risk, FINRA recommends that firms consider the appropriateness of limit orders for direct listings.


  • Broker-Dealer Heightened Supervision Procedures: FINRA Notice 18-15 provides guidance on implementing effective heightened supervisory procedures for associated persons with a history of past misconduct.  FINRA encourages firms to adopt the practices that are outlined in the Notice to strengthen their existing supervisory procedures, as appropriate.


For Municipal Advisors and Brokers

  • GASB Accounting Fees Assessed: MSRB member firms who reported municipal securities trades to the MSRB during the first calendar quarter should have received their Governmental Accounting Standards Board (“GASB”) quarterly assessment, payable through WebCRD E-Bill.  Member firms with de minimis assessments (less than $25) will not receive an invoice.  If a firm elects to pass these fees onto its municipal customers, it must ensure proper disclosure of the fees, including, if applicable, the fact that the fee is an estimate and that the firm will most likely may pay more or less than the fee charged to the customer.

Lessons Learned from Recent SEC and FINRA Cases:

Inflated Valuations Stay in the SEC’s Cross Hairs:   The SEC brought a complaint against Premium Point Investments LP (“Premium Point”), Anilesh Ahuja aka Neil Ahuja, Amin Majidi and Jeremy Shor, for a scheme to pump up their funds’ poor performance by using a “friendly” broker to provide inflated mortgage-backed security quotes.  In turn, the firm promised to direct trades to the broker.  The defendants also used an imputed mid-point valuation that was not based on the individual security, but on a broad sector of securities price ranges, which resulted in further inflating the bond prices. The SEC alleges that the scheme ran from September 2015 through March 2016, when performance of the firm’s funds began to deteriorate.  The result of the inflated valuations allowed the firm to charge higher management and performance fees.  The curious thing about this case is that Premium Point disclosed the imputed price procedures in their Valuation Policy, however when a big institutional client said it would not invest with the firm because of this policy, Premium Point removed the procedure from the policy but continued the practice.

It’s a little surprising that the institutional client invested with them after calling them out. The old saying “trust but verify” is especially critical in these situations. In April 2016, the auditor for Premium Point’s funds became concerned about the overvalued securities and pressured Premium Point to restate the funds’ net asset value (NAV) from 2015 on.  In one case a fund was overvalued by $40 million dollars. Ultimately, Premium Point was unable to obtain audited financials and did not obtain annual surprise audits.  Not surprisingly, Premium Point was hit with a laundry list of fraud charges and aiding and abetting violations of the Investment Advisers Act.  Contributed by Heather D. Augustine, Senior Compliance Consultant

Firm Blows Up after Junior Trader Blows Whistle on Valuation Process:  It sounds like the basis for a John Grisham novel.  A junior trader at a hedge fund is asked to get fake quotes from friendly brokers to help the firm pump up the value of its portfolios. He participates in the scheme for a while, but either gets cold feet or decides he can make more as a whistleblower than as a junior trader.  So, he contacts the SEC and, in exchange for immunity, agrees to work as a confidential informant for the FBI.

This is the true story of Visium Asset Management, LP (“Visium”).  Unfortunately for Visium, the initial investigation strayed far afield, and led to revelations that not only were portfolio managers at Visium inflating the price of securities, they were also trading on inside information.  The fallout from this nefarious activity included an SEC enforcement action against three of the hedge fund managers and their source of inside information, the SEC filing charges against another inside tipster, an SEC settlement with Visium’s CFO on charges that he failed to adequately supervise the misbehaving portfolio managers. Not only that, but Visium agreed to pay more than $4.7 million plus interest in illegal profits and an additional $4.7 million in penalties.  And for the piece de resistance, the Firm went out of business.  Perhaps most tragically, one of the portfolio managers, Sanjay Valvani, committed suicide shortly after his indictment.

Lessons learned from this case:  First, portfolio managers should treat junior traders with respect, especially if you count on them to participate in illegal activity.  Second, the SEC views information gathered from government sources the same way as inside information about corporations.  In this case, the portfolio managers used former government officials to obtain confidential information from friends and former colleagues in government agencies.  The information was then parlayed into various market bets, reaping Visium and its hedge funds substantial gains. Contributed by Jaqueline M. Hummel, Partner and Managing Director

FINRA Charges Recidivists with Bigger Fines:  On May 8th, Fifth Third Securities, Inc. (“Fifth Third”) submitted a Letter of Acceptance, Waiver and Consent (“AWC”) to FINRA, in which the firm was fined $4 million and required to pay approximately $2 million in restitution.  FINRA noted in the AWC that in determining the fine for Fifth Third, it specifically considered the firm’s recidivist activities, its failure to comply with a prior regulatory action, the harm to the customers resulting from the Firm’s violations, and the extent and duration of the activities.  Fifth Third has a history of issues resulting from inadequate sales and supervisory procedures related to variable annuities.  FINRA found that the firm failed to comply with the terms of a 2009 AWC (which resulted from significant deficiencies in its VA business), made material misstatements and omissions of material facts in connection with variable annuity exchanges, failed to have a reasonable basis to recommend or approve the exchanges, and failed to reasonably supervise the exchanges.   My recommendation is to add the following to your To-Do List:  (1) review your policies and procedures regarding the sale and supervision of variable annuities; and (2) review to ensure your firm has implemented the corrections necessary to comply with prior regulatory findings.  Failing to fix deficiencies cited in prior exams can result in more zeroes being added to the amount of your fine.    Contributed by A. Rochelle Truzzi, Senior Compliance Consultant

Worth Reading:

 Private Fund Advisor Wins — Mostly — in Battle with SEC:  Check out this summary of a private firm’s fight with the SEC on valuation by Doug Cornelius.

6 big questions about the SEC advice rule:  Greg Iacurci of InvestmentNews discusses some of the more confusing aspects to the new “Best Interest” standard.

Companies use ‘nudges’ to promote ethical behavior: Learn more about how some companies are offering subtle reminders to their employees to think about ethics when making business decisions.

Filing Deadlines and To Do List for June


  •  Distribute Audited Financial Statements for Private Funds for Funds of Funds: Private fund investment advisers should have their funds audited by an independent, PCAOB-registered accountant and deliver the audited financial statements to the funds’ investors within 120 days of the end of the funds’ fiscal year. The deadline for private funds that are fund of funds is within 180 days of the funds’ fiscal year end. That’s June 29, 2018 for funds with December 31 year-end.


  • Rule 17a-5 Monthly and Fifth FOCUS Part II/IIA Filings:  For period ending May 31, 2018. For firms required to submit monthly FOCUS filings and those firms whose fiscal year-end is a date other than a calendar quarter. Due June 25, 2018. 
  • Supplemental Inventory Schedule (“SIS”): For the month ending May 31, 2018. The SIS must be filed by a firm that is required to file FOCUS Report Part II, FOCUS Report Part IIA or FOGS Report Part I, with inventory positions as of the end of the reporting period, unless the firm has (1) a minimum dollar net capital or liquid capital requirement of less than $100,000; or (2) inventory positions consisting only of money market mutual funds.  A firm with inventory positions consisting only of money market mutual funds must affirmatively indicate through the eFOCUS system that no SIS filing is required for the reporting period. Due June 28, 2018.
  • Annual Audit Reports for Fiscal Year-End April 30, 2018:  FINRA requires that member firms submit their annual audit reports in electronic form.  Firms must also file the report at the regional office of the SEC in which the firm has its principal place of business and the SEC’s principal office in Washington, DC.   Firms registered in Arizona, Hawaii, Louisiana, or New Hampshire may have additional filing requirements. Due June 29, 2018.
  • SIPC-7 Assessment: For firms with a Fiscal Year-End of April 30, 2018.  SIPC members are required to file the SIPC-7 General Assessment Reconciliation Form together with the assessment owed (less any assessment paid with the SIPC-6) within 60 days after the Fiscal Year-End. Due June 29, 2018.

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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.