Tag Archives: SEC (Securities and Exchange Commission)

SEC Adopts Rule to Disqualify Felons and other “Bad Actors” from Using Rule 506 of Regulation D in Connection with Private Placement Offerings.

 Bad-Boys, Bad-Boys What You Going to Do?

In lieu of doing a public offering of securities, companies issuing securities can rely on an exemption from registration.  Regulation D is one of those exemptions. In 2010, Congress passed the Dodd-Frank Act.  That law specifically ordered the SEC to prohibit felons and other bad actors from utilizing Rule 506 of Reg. D to issue securities pursuant to the before-mentioned “safe harbor.”

Persons who are subject to the ban include promoters, directors, investment managers or those owning more than twenty percent (20%) of the issuer’s securities. The “bad boy” behavior that would prevent one from using Rule 506 of Reg D includes:

i)                   criminal convictions;

ii)                 injunctions and restraining orders related to securities;

iii)              final orders from other securities regulators, banking regulators and the CFTC;

iv)               SEC disciplinary orders, SEC “cease and desist” orders, and SEC “stop orders;”

v)                 suspension or expulsion of broker-dealers (B-Ds) or registered representatives from the NASD, FINRA, NYSE; and

vi)                U.S. Postal Service “false representation orders.”

The length of time for the bar on events listed above is either within five (5) or ten (10) years.

While the disqualification events listed above would have to occur after the effective date of the amended Rule 506, matters previously existing and that would otherwise fall under the rule, are subject to mandatory disclosure to investors. The amended Rule 506 becomes effective in mid-September.


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Do Registered Investment Advisors Dare Roll the Dice with the Securities and Exchange Commission and Its Office of Compliance, Investigation and Enforcement?

An Analysis of the SEC’s Examination Priorities for 2013 in light of “the odds.”

In fiscal 2012 the Securities and Exchange Commission (“SEC”) had less than 150 enforcement actions against registered investment advisers (“RIAs”), of which there are now more than 11,000 subject to SEC jurisdiction. In addition, there are almost 2,000 new advisors that have had to register due to legal changes brought about by Dodd-Frank. Those include hedge funds, venture capital funds and those involving private equity. Annually, the SEC examines approximately only eight percent (8%) of RIAs per year.

The SEC released its examination priorities for 2013 with respect to registered investment advisors. We have narrowed them down to highlight and share some of the items we feel are most likely to impact firms. Those who wish to review the entire release may do so at the SEC’s website or contact the author.


One issue the SEC will address in 2013 examinations is conflicts of interest. The SEC will examine RIA’s policies, procedures and systems in an effort to determine whether they recognize, mitigate and disclose conflicts of interest present in the investment advisors’ business.


A)    Custody of Assets

Safety of assets remains a top priority for the SEC. In doing calculations of recent examination deficiencies, failure to comply with the Custody Rule (Investment Advisers Act Rule 206(4)-2) was present in over one third of the firms according to Office of Compliance, Examinations and Enforcement (“OCIE”). The SEC will be reviewing firm policies and procedures as well as books and records to determine whether firms are:

1)      Appropriately recognizing situations in which RIAs have “custody” as defined in the Custody Rule;

2)      Complying with the Custody Rule’s “surprise exam” requirement;

3)      Satisfying the Custody Rule’s “qualified custodian” provision; and

4)      Following the terms of the exception to the independent verification

requirements for pooled investment vehicles.

B)     Marketing/Performance

This is always a high risk area of concern because of the ultra competitive nature of money management. The SEC and OCIE will be reviewing instances of aberrational performance for signs of weak valuation procedures or fraudulent activity.  The SEC and OCIE’s staff will focus on the accuracy of advertised performance, including without limitation, back tested and hypothetical performance, methodologies and assumptions made and related disclosures. As always, the SEC will look at compliance with record keeping requirements by RIAs.

In conclusion, despite the odds, it makes little sense to roll the dice with an investment advisor’s fate because an adverse examination, investigation or enforcement from the SEC/OCIE could prove to be fatal to RIAs and/or their investment advisor representatives (“IARs”).

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With First Quarter in the books, what more do we know?
As you may recall, on January 13, 2013, FINRA came out with its letter listing its concerns. In counseling several clients and participating in a fair number of “On the Record” (“OTR”) interviews, this post will provide greater insight than simply relisting the priorities.

A) Suitability of Complex Products

Perhaps the prevalence of these products has to do with the extraordinary low interest rate environment that we find ourselves. FINRA believes that if you cannot effectively communicate the requisite information to them about such products upon request then you cannot hope to explain this to the customers. While that may not be the case, it certainly is a widely shared view at FINRA.

B) Exchanged Traded Funds and Products

Do you know the difference between an exchange traded fund (“ETF”) and an exchange traded note (“ETN”)? What about a commodity pool or grantor trust? You may not have cared before the collapse of Lehman Brothers, but now you should be able to explain the difference and the risk that certain products may not track the index that they are designed to follow.

C) Non-Traded REITs and Closed End Funds

On non-traded REITs, is the money paid from operations/investment or just return of principal? Are those stated prices accurate? For closed end funds, what sort of risk is taken on to juice returns and are distributions from investment return? All of the foregoing is fair game in an OTR!

D) Private Placements

FINRA now has Rule 5123; Securities Law and Compliance, previously covered this on December 12, 2012, and will be examining “due diligence procedures,” whether they are followed and documented and the disclosures of material risks of the offering. How are conflicts resolved between say investment banking and the end purchasers/customers?

E) The Not so “New” Suitability Rule and Customer Identification Procedures

This was covered in depth previously by Securities Law and Compliance in posts from February 10, 2013 and post from June 24, 2012.

My take away from the first quarter and the 2013 priority letter are:

  1. Can the registered representative fully explain the products features and risks? You sold the product to a customer so now you need to explain to FINRA how it works, and “no” you are generally not allowed to take the prospectus into this examination.
  2. Due diligence on private placements must be done even if one is not an underwriter and effective due diligence means asking questions and not simply accepting answers given.
  3. More and more suitability is being morphed into a test of understanding products’ features.

How do your firm’s practices, procedures and compliance program deal with the above insights and criteria? The time to act is now and not after FINRA shows up on your threshold unannounced and planning to stay for a several week “visit!”

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Are we set to expunge like its 1999? Do ancient CRD entries have “regulatory value?”

A California state appellate court, in Liss v. FINRA, recently held that the earlier trial court’s earlier decision — that FINRA’s Rule 2080 was the only path to expungement of material from the CRD — was wrongfully decided.  Importantly, the information in the CRD record need not be erroneous to seek expungement. It could be still true but arguably no longer relevant due to the amount of time between the events in question and the present day.

FINRA Rule 2080 requires the person seeking expungement to include FINRA as a party to any expungement case brought in state or federal court. FINRA’s Rule 2080 requires proving two additional items. First, the fact finder – court or arbitration panel – must make an affirmative finding. Courts routinely do this but arbitrators do not. Indeed, FINRA arbitration panels will not provide an explanation unless all parties unanimously agree by certain case milestones. Second, that finding must demonstrate one of the following occurred: (i) the claim, allegation or information is factually impossible or clearly erroneous; (ii) the registered person was not involved in the alleged investment-related sales practice violation, forgery, theft, misappropriation or conversion of funds; or (iii) the claim, allegation or information is false. Those are high hurdles for FINRA arbitration where discovery is more limited, no written opinion generally need be given and often no explanation for a decision is given.

In Liss v. FINRA, registered representative Mr. Liss requested the court use its inherent equitable powers to affect the expungement.  Equitable powers essentially means invoking the Court’s conscience to obtain relief aside from an award of money. In the case of expungement, the court must weigh the hardship to the individual with the protection afforded to society by the information being in the records.

Mr. Liss, believed the following factors warranted expungement.   All complaints on his CRD record were related to only one security. Every complaint was more than fifteen (15) years old, and he has had an unblemished record since the incidents in question. Importantly, Mr. Liss filed an affidavit that he suffered professional and financial hardship due to current and potential clients using the Internet to obtain his Broker Check history.

The Liss court latched onto something mentioned in the SEC Release approving FINRA Rule 2080: whether or not continued inclusion of the allegation(s) in the CRD have “regulatory value.”  That standard has been utilized by two other federal courts.

Why is the Liss decision so important? It demonstrates that this court believes that FINRA’s requirements in Rule 2080 are not the exclusive way to get materials erased from the CRD system despite FINRA’s arguments to the contrary. While the Liss decision is helpful to those seeking expungement, the downside to court based expungement includes its expense and the lack of privacy.

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Eight Things You Need to Know about FINRA’s New Suitability Rule – 2111

 Securities Law and Compliance Blog

Upcoming Effective Date of FINRA’s Amended Suitability Rule

Back in 2011, FINRA announced its new Suitability Rule.  The effective date is approximately fifteen (15) days away on July 9, 2012.  Some highlights of the new rule are provided below:

Suitability under amended FINRA Rule 2111: 

1)      Like its predecessor, the suitability rule is applicable only to those transactions which are “recommended” by the broker-dealer (BD) or registered representative (“RR”);

2)      The representative and/or broker-dealer must have a reasonable basis to believe that a recommended transaction or investment strategy involving a security or securities is suitable for the customer, based on the information obtained through the reasonable diligence to ascertain the customer’s investment profile;

3)      The new rule explicitly applies to investment strategies and hold recommendations involving a security or securities. FINRA defines “strategy” broadly.

4)      Expressly, the new rule delineates the following to information to be used in determining suitability: (i) age, (ii) investment experience, (iii) risk tolerance, (iv) liquidity needs, (v) investment time horizon, (vi) tax status; and (vii) investment objectives.

5)      The rule defines three types of suitability which must be understood and abided by:  (i) Reasonable product; (ii) Customer specific; and (iii) Numerical or quantitative suitability, i.e., that the number of recommended transactions is not excessive;

6)      Broker-dealers and registered representatives are allowed an exemption to its “Reasonable-basis” suitability obligation for the purposes of an institutional customer (defined under NASD Rule 3110 (c)(4)) when the BD or RR has basis to believe the customer is capable of evaluating investment risks independently, and when the institutional customer “affirmatively acknowledges that it is exercising independent judgment.”  Such an acknowledgment will not, however, release the firm from its other suitability obligations;

7)      Customer-specific and Quantitative-suitability are always applicable whether the client be to institutional or retail; and

8)      In determining whether a communication is a “recommendation” for purposes of the rule, FINRA considers the content, the context and presentation; the more tailored to a particular customer or customers, the more likely it is to be considered a recommendation by the broker-dealer or representative; A series of actions which may not be considered a recommendation individually may still amount to a recommendation when taken in the aggregate.

May Law, PC is a securities and commodities boutique firm that has a an extensive knowledge of FINRA related rules and assists registered broker-dealers (BDs) and associated persons (APs) in responding to FINRA investigations, disciplinary matters and routine “on the record” interviews (OTRs).  The firm also assists broker-dealers draft and revise compliance, supervisory manuals and written supervisory procedures. The firm’s website is located at www.maylawpc.net, and the main number is 847-675-1052. Andrew May has been practicing law for 16 years and can be contacted at amay@maylawpc.net.

© 2012 May Law, PC

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Amended SEC rule changes to whom advisers can charge incentive fees to

New Requirement for Performance Fees.

Under the New Rule, performance based fees, i.e., a percentage of the capital gain, can be charged generally to if the client has at least $1M in assets under management with the advisor; or the client has net worth of $2M, excluding the value of the client’s primary residence.

Grandfathered Clients.

Essentially, if the contract was legal when entered then it is still legal. Under the prior version of the rule the amount under management with the advisor was $750,000 and the net worth requirement was $1,500,000. In addition, the equity in one’s home was counted as part of the client’s net worth. Such equity is no longer counted! Different rules may apply to new owners of an existing client including individual members of a private investment fund.  Please direct your specific inquiries to author listed below.

Other wrinkles.

Debt secured by the primary residence are generally not counted in the client’s net worth calculations. The exception to this rule is that any increase in the amount of debt sixty (60) days before the advisory contract is entered into is to be included as a liability. Moreover, debt on the primary residence in excess of its fair market value must be included as a liability. Given the diminished value of housing, this may be a significant exception to the rule.

The effective date for the new rule is May 22, 2012.

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