Announcements and analysis of key fintech, regulatory and compliance issues as they unfold.
Statement by SEC Chair Gary Gensler on Current Market Events
Statement by SEC Chair Gary Gensler on Current Market Events
Chair Gary Gensler
March 12, 2023
“In times of increased volatility and uncertainty, we at the SEC are particularly focused on monitoring for market stability and identifying and prosecuting any form of misconduct that might threaten investors, capital formation, or the markets more broadly. Without speaking to any individual entity or person, we will investigate and bring enforcement actions if we find violations of the federal securities laws.”
Ref: https://www.sec.gov/news/statement/3-12
SEC 2023 Examination Priorities
The Securities and Exchange Commission’s Division of Examinations announced its 2023 examination priorities. The Division publishes its examination priorities annually to provide insights into its risk-based approach, including the areas it believes present potential risks to investors and the integrity of the U.S. capital markets.
The following are a selection of the Division’s 2023 priorities:
-New Investment Adviser and Investment Company Rules
-RIAs to Private Funds
-Retail Investors and Working Families
-Environmental, Social, and Governance (ESG)
-Information Security and Operational Resiliency
-Emerging Technologies and Crypto-Assets
See full release below:
Ref: https://www.sec.gov/news/press-release/2023-24
Ref: https://www.sec.gov/files/2023-exam-priorities.pdf
SEC Rule 17a-4 Rule Amendment – Books and Records
The SEC approved a rule amendment that is now effective and impacts SEA Rule 17a-4(f) as well as certain aspects of the broker-dealer’s recordkeeping requirements, including but not limited to recordkeeping services provided by third-parties.
Broker-dealers that rely on third-party vendors need to request an updated 17a-4 Undertaking Letter from the vendor and received it by the compliance date of May 3, 2023 at the latest. Once the new 17a-4 Undertaking Letter is obtain, the Undertaking Letter will need to be filed with the Designated Examining Authority (DEA) (e.g., FINRA, etc.).
Funding Portals may note that Reg CF Rule 404’s Undertaking Letter requirement did not change as part of this rule amendment.
There are additional changes to the rule, including in regards to electronic books and records maintenance, such as instead of a sole ‘write once, read many’ (‘‘WORM’’) format requirement there is now also an alternative whereby “…a broker-dealer will need to use an electronic recordkeeping system that maintains and preserves electronic records in a manner that permits the recreation of an original record if it is modified or deleted.” (aka “audit-trail alternative”)
Fact Sheet: https://www.sec.gov/files/34-96034-fact-sheet.pdf
Final Rule: https://www.govinfo.gov/content/pkg/FR-2022-11-03/pdf/2022-22670.pdf
M&A / Mergers and Acquisition Brokers – Amendment to Section 15(b) of the Exchange Act
On December 23, 2022, the House of Representatives passed H.R. 2617, the “Consolidated Appropriations Act of 2023″. Title V of this Act amends Section 15(b) of the Securities Exchange Act of 1934 to add new subsection (13). This new section provides an exemption from broker-dealer registration for certain investment banking activities (E.g. An “M&A broker”). Contact us for more information.
Ref: SEC M&A Brokers No-Action Letter (January 31, 2014, amended February 4, 2014) – https://www.sec.gov/divisions/marketreg/mr-noaction/2014/ma-brokers-013114.pdf
Ref: North American Securities Administrators Association (NASAA) Model Rule – https://www.nasaa.org/wp-content/uploads/2011/07/MA-Broker-Model-Rule-adopted-Sept-29-2015-corrected.pdf
Ref: https://www.congress.gov/bill/117th-congress/house-bill/2617
Ref: https://www.govinfo.gov/content/pkg/BILLS-117hr2617enr/pdf/BILLS-117hr2617enr.pdf
FINRA 2023 Report on Exam and Risk Monitoring Program
FINRA has published its 2023 Report on FINRA’s Examination and Risk Monitoring Program to provide insights from FINRA’s oversight programs to member firms. The FINRA release states the following: https://www.finra.org/media-center/newsreleases/2023/finra-publishes-2023-report-exam-and-risk-monitoring-program
New Topics Covered in the Report:
Manipulative Trading. The report’s findings include inadequate written supervisory procedures, non-specific surveillance thresholds and surveillance deficiencies.
Fixed Income – Fair Pricing. Among the findings are incorrect determination of prevailing market price, outdated mark-up/mark-down grids, failure to consider the impact of mark-up on yield to maturity and unreasonable supervision.
Fractional Shares. Reporting failures and inadequate supervisory systems and procedures are among the findings.
Regulation SHO. This section includes findings on non-bona fide market making and impermissible reuse of locates.
Additionally, the report introduces a new Financial Crimes section, consisting of three topics — Cybersecurity and Technological Governance; Anti-Money Laundering, Fraud and Sanctions; and Manipulative Trading. This highlights FINRA’s increased focus on protecting investors and safeguarding market integrity against these ongoing threats.
Other Key Topics Include:
Cybersecurity. Cybersecurity threats continue to be one of the most significant risks facing many customers and firms. The frequency, sophistication and variety of attacks continue to increase. The report discusses FINRA’s significant focus on cybersecurity, including the establishment of the Cyber and Analytics Unit to enhance the ability to proactively address the increasingly sophisticated cyber threat landscape, the impact of cyber-enabled fraud activity including on investors in the crypto-asset market, and FINRA’s increased outreach to firms to make them aware of cybersecurity threats.
Complex Products. As discussed in the report, FINRA will continue to review firms’ communications and disclosures to customers relating to complex products. FINRA will also review customer account activity to assess whether firms’ recommendations regarding these products are in the best interest of retail customers given their investment profiles and the potential risks, rewards and costs associated with the recommendations.
Regulation Best Interest (Reg BI) and Form CRS. To provide firms with more information regarding these regulations, the report sets forth updated observations of FINRA’s review of firms’ compliance with Reg BI and Form CRS. These include observations relating to firms’ identifying and addressing conflicts of interest; disclosing to retail customers all material facts related to conflicts of interest; establishing and enforcing adequate written supervisory procedures; and filing, delivering and tracking an accurate Form CRS.
Mobile Apps. As the use of mobile apps becomes increasingly widespread, the risks posed by them become more significant. The report discusses FINRA’s observations of potential issues with some mobile apps, including apps that do not adequately distinguish between products and services of the broker-dealer and those of affiliates or third parties (such as transactions involving crypto assets). It also touches on mobile apps’ disclosures and explanations of higher-risk products or services, such as certain options and margin lending activities.
Reg CF & JOBS Act Inflation Adjustments 2022
Reg CF rules have been updated to reflect the change in inflation, which became effective last night upon publishing in the Federal Register. The amendments increase certain of these thresholds, including the following:
SEC Rule 100: Offering Maximum and Investment Limits
• Threshold for assessing investor’s annual income or net worth to determine investment limits (Rules 100(a)(2)(i) and 100(a)(2)(ii))
OLD = $107, 000; NEW = $124, 000
• Lower threshold of Regulation Crowdfunding securities permitted to be sold to an investor if annual income or net worth is less than $124,000 (Rule 100(a)(2)(i))
OLD = $2,200; NEW = $2,500
• Maximum amount that can be sold to an investor under Regulation Crowdfunding in a 12-month period (Rule 100(a)(2)(ii))
OLD = $107, 000; NEW = $124, 000
SEC Rule 201(t): Issuer Financial Statement Requirements
• 201(t)(1): OLD = $107, 000; NEW = $124, 000
• 201(t)(2): OLD = $535,000; NEW = $618, 000
• 201(t)(3): OLD = $1,070,000; NEW = $1,235,000
Please refer to SEC documentation when making updates.
References:
Fact Sheets: https://www.sec.gov/files/33-11098-fact-sheet.pdf
Federal Register: https://www.federalregister.gov/documents/2022/09/20/2022-19867/inflation-adjustments-under-titles-i-and-iii-of-the-jobs-act
FINRA Funding Portals Enforcement Actions
On May 4, 2022, FINRA announced that it has fined two FINRA-registered funding portals a combined $1.75 million for failing to comply with securities laws and rules designed to protect crowdfunding investors.
The FINRA Press Release emphasizes the Funding Portal’s supervisory role in the Issuer’s offering of securities to investors. The FINRA Press Release and respective enforcement actions are linked below and include topics related to communications with the public, prohibition on solicitations, issuer and offering page communication supervision, general supervision and supervisory systems, escrow activities and more.
Please feel free to reach out with any questions, comments or concerns that these materials may create. Happy to help in any way that I can.
FINRA Press Release
https://www.finra.org/media-center/newsreleases/2022/finra-fines-for-crowdfunding-rule-violations
Wefunder Enforcement Acton
https://www.finra.org/sites/default/files/2022-05/Wefunder-2021071940801.pdf
Primary Rule Violations Cited:
FINRA Rule 200(a) – .. shall observe high standards of commercial honor and just and equitable principles of trade.
Reg CF Rule 402(a) – Conditional safe harbor.
Reg CF Rule 301(a) – Measures to reduce risk of fraud.
Reg CF Rule 303(e) – Maintenance and transmission of funds.
StartEngine Enforcement Action
https://www.finra.org/sites/default/files/2022-05/StartEngine-matter.pdf
Primary Rule Violations Cited:
FINRA Rule 200(c) – Communications with the Public
FINRA Rule 300(a) – Supervisory System
FINRA Rule 200(a) – .. shall observe high standards of commercial honor and just and equitable principles of trade.
Regulatory Update: FINRA’s 2022 Examination Filings Report – Funding Portals
For the first time FINRA has included examination and risk monitoring findings for Funding Portals in their 2022 Annual Examination and Risk Monitoring Program Report.
You may review the Funding Portal finding here and below:
https://www.finra.org/rules-guidance/guidance/reports/2022-finras-examination-and-risk-monitoring-program/funding-portal-crowdfunding
Exam Findings:
Failure to Obtain Attestation – Not obtaining the attestation required by Regulation Crowdfunding Rule 404 when using a third-party vendor to store the required records.
Missing Disclosures – Offerings on the platform do not contain all required disclosures as codified in Regulation Crowdfunding, in particular:
names of officers and directors of the issuer, and the positions held by these individuals for the past three years;
descriptions of the purpose and intended use of proceeds, the process to complete the offering transaction or cancel an investment commitment, the ownership and capital structure, the material terms of any indebtedness of the issuer; and
financial statements, as required by Regulation Crowdfunding Rule 201(t).
Failure to Report Customer Complaints – Not reporting written customer complaints, as required by FINRA Funding Portal Rule 300(c).
Untimely Required Filings – Not making required filings in a timely manner—such as filing the funding portal’s Statement of Gross Revenue by the deadline of March 1—and not filing updates or changes to contact information within 30 days of the change.
Not Filing CMAs – Funding portals effecting changes in ownership without obtaining prior approval from FINRA, as required by Funding Portal Rule 110(a)(4).
Effective Practices:
Compliance Resources – Developing annual compliance questionnaires to verify the accuracy of associated persons’ disclosures, including follow-up questions (such as whether they have ever filed for bankruptcy, have any pending lawsuits, are subject to an unsatisfied judgments or liens or received any written customer complaints), as well as compliance checklists and schedules to confirm that required obligations are being met in a timely manner, such as providing all issuer disclosure requirements of Regulation Crowdfunding Rule 201.
Supervision – Implementing supervisory review procedures tailored to funding portal communications requirements that, for example, clearly define permissible and prohibited communications and identify whether any contemplated structural or organizational changes necessitate the filing of a CMA.
Related Considerations:
What steps is your firm taking to confirm all required issuer information, pursuant to Regulation Crowdfunding Rules 201 and 203(a), is publicly available on your firm’s platform?
Does your firm plan to undergo or has it already undergone an operational or structural change that impacts the capitalization of the firm, pursuant to Funding Portal Rule 110(a)(4)? Has your firm reviewed the membership rules to confirm a Continuing Membership Application (CMA) is not required?
Regulatory Update: 2022 Report on FINRA’s Examination and Risk Monitoring Program
FINRA has issued its 2022 Examination and Risk Monitoring Program Report
The 2022 Report on FINRA’s Examination and Risk Monitoring Program (the Report) provides firms with information that may help inform their compliance programs. For each topical area covered, the Report identifies the relevant rule(s), highlights key considerations for member firms’ compliance programs1, summarizes noteworthy findings from recent examinations, outlines effective practices that FINRA observed during its oversight, and provides additional resources that may be helpful to member firms in reviewing their supervisory procedures and controls and fulfilling their compliance obligations.
FINRA’s intent is that the Report be an up-to-date, evolving resource or library of information for firms. To that end, the Report builds on the structure and content in the 2021 Report by adding new topics (e.g., Disclosure of Order Routing Information, Funding Portals) denoted NEW FOR 2022 and new material (e.g., new exam findings, effective practices) to existing sections where appropriate. (New material in existing sections is in bold type.)
https://www.finra.org/rules-guidance/guidance/reports/2022-finras-examination-and-risk-monitoring-program
Regulatory Update: SEC Observations Regarding Implementation of Reg BI’s Form CRS Disclosures
The SEC Staff issued observations and findings related to Regulation BI and Form CRS Disclosures, which include the following topics. You may review the full SEC release here: https://www.sec.gov/news/statement/staff-statement-form-crs-disclosures-121721
Use of Technical Language, Including Disclaimers.
Omission of Required Information.
Reliance on Proposed, Rather than Final Instructions.
Lack of Specific References to More Detailed Information.
Shortcomings in Descriptions of Relationships and Services; Fees, Costs, Conflicts, and Standard of Conduct.
Modification and/or Supplementation of the Disciplinary History Disclosure.
Issues with Prominently Displaying Relationship Summary on Firm Website.
Issues with Description of Affiliate Relationships.
Poor Design.
Use of Marketing Language.
Boilerplate.
The following are important FORM CRS resources:
OFAC sanctions virtual currency exchange and updates ransomware advisory
The U.S. Department of the Treasury’s Office of Foreign Assets Control (OFAC) is issuing this updated advisory to highlight the sanctions risks associated with ransomware payments in connection with malicious cyber-enabled activities and the proactive steps companies can take to mitigate such risks, including actions that OFAC would consider to be “mitigating factors” in any related enforcement action.
Demand for ransomware payments has increased during the COVID-19 pandemic as cyber actors target online systems that U.S. persons rely on to continue conducting business. Companies that facilitate ransomware payments to cyber actors on behalf of victims, including
financial institutions, cyber insurance firms, and companies involved in digital forensics and incident response, not only encourage future ransomware payment demands but also may risk violating OFAC regulations. The U.S. government strongly discourages all private companies and citizens from paying ransom or extortion demands and recommends focusing on strengthening defensive and resilience measures to prevent and protect against ransomware attacks.
Read more here:
https://home.treasury.gov/system/files/126/ofac_ransomware_advisory.pdf
https://home.treasury.gov/policy-issues/financial-sanctions/recent-actions/20210921
Regulatory Update: SEC’s First-Ever Enforcement Actions Regarding Duties of Municipal Advisors
The SEC has charged a Muni Advisory firm and its two principals with violating numerous duties under MSRB Rule G-42.
The allegations include, among other things, the following:
Violation of fiduciary duties and engaged in unregistered municipal advisory activities;
Engaging in municipal advisory activities when not registered with the SEC or the MSRB;
Prohibited fee-splitting arrangement with their former employer;
Engaging in muni underwriting and muni advisory for same client;
Lack of conflict of interest disclosures regarding fee-splitting arrangement and relationship with the underwriting firm;
Excessive fees charged to client for underwriting and advisory services.
Please see the SEC compliant and release for additional details, which include allegations that the Principals violation Sections 15B(a)(5) and 15B(c)(1) of the Securities Exchange Act of 1934 (“Exchange
Act”) and MSRB Rules G-17 and G-42. Additionally, the allegations that the Firm violated Section 15B(a)(1) of the Exchange Act and MSRB Rule A-12, and the Principals aided and abetted the Firm’s violations of Sections 15B(a)(1) and 15B(c)(1) of the Exchange Act and MSRB Rule A-12.
Ref: SEC Compliant – https://www.sec.gov/litigation/complaints/2021/comp-pr2021-188.pdf
Ref: SEC Release – https://www.sec.gov/news/press-release/2021-188?utm_medium=email&utm_source=govdelivery
Ref: SEC Order – https://www.sec.gov/litigation/admin/2021/34-93105.pdf
Regulatory Update: SEC’s First Case Involving Regulation Crowdfunding
The SEC filed its first Complaint regarding Reg CF and has charged the Funding Portal, Issuer and related Individuals for fraudulent offerings. The allegations include, among other things, the following:
Related to the Issuer:
fraudulent and unregistered crowdfunding offerings through two cannabis and hemp companies;
misuse of offering proceeds and diverting investor funds for personal use rather than using the funds for the purposes disclosed to investors;
false and misleading representations and omissions to investors.
Related to the Funding Portal:
failed to address red flags related to criminal history;
failed to reduce the risk of fraud to investors.
Alleged violations included the following rules and regulations:
Section 10(b) of the Exchange Act [15 U.S.C. § 78j(b)]
Rule 10b-5 thereunder [17 C.F.R. 240.10b-5]
Sections 5(a) and (c) of the Securities Act [15 U.S.C. §§ 77e(a) and (c)]
Section 17(a) of the Securities Act
Section 4A(a)(5) of the Securities Act and Rules 301(c)(2) Thereunder [15 U.S.C. § 77d–1(a)(5) and 17 C.F.R. 17 C.F.R. § 227.301(c)(2)]
Ref: SEC Compliant – https://www.sec.gov/litigation/complaints/2021/comp-pr2021-182.pdf
SEC Red Flag Resources:
Regulatory Update: FINRA Reminds Firms of their Supervisory Obligations Related to Outsourcing to Third-Party Vendors
Regulatory Notice 21-29
FINRA Reminds Firms of their Supervisory Obligations Related to Outsourcing to Third-Party Vendors
“Member firms are increasingly using third-party vendors to perform a wide range of core business and regulatory oversight functions. FINRA is publishing this Notice to remind member firms of their obligation to establish and maintain a supervisory system, including written supervisory procedures (WSPs), for any activities or functions performed by third-party vendors, including any sub-vendors (collectively, Vendors) that are reasonably designed to achieve compliance with applicable securities laws and regulations and with applicable FINRA rules. This Notice reiterates applicable regulatory obligations; summarizes recent trends in examination findings, observations and disciplinary actions; and provides questions member firms may consider when evaluating their systems, procedures and controls relating to Vendor management.”
Read further here: Ref: https://www.finra.org/rules-guidance/notices/21-29
Regulatory Update: SEC Risk Alert – Fixed Income Principal and Cross Trades – Examination Initiative
Observations Regarding Fixed Income Principal and Cross Trades by Investment Advisers from an Examination Initiative
On September 4, 2019, the Division of Examinations (the “Division”) published a Risk Alert highlighting the most common compliance issues observed by the staff related to principal and agency cross trades under the Investment Advisers Act of 1940 (“Principal Transactions Risk Alert”). In this follow-up Risk Alert, the Division supplements the staff’s observations made in the Principal Transactions Risk Alert by providing greater detail on certain compliance issues. These observations are derived from an examination initiative that focused on SEC-registered investment advisers that engaged in cross trades, principal trades, or both, involving fixed income securities. The Division encourages advisers to review their written policies and procedures regarding principal and cross trades, including the implementation of those policies and procedures, to ensure that they are consistent with the Advisers Act and the rules thereunder.
View the Risk Alert: Observations Regarding Fixed Income Principal and Cross Trades by Investment Advisers from an Examination Initiative
Read the Risk Alert here: https://www.sec.gov/files/fixed-income-principal-and-cross-trades-risk-alert.pdf
Regulatory Update: SEC Risk Alert – Investment Advisers Managing Client Accounts That Participate In Wrap Fee Programs
Observations from Examinations of Investment Advisers Managing Client Accounts That Participate In Wrap Fee Programs
The Division of Examinations (“The Division”) focused on wrap fee programs because of the continued growth of investor assets participating in such programs and the conflicts and disclosure practices observed during previous examinations. This Risk Alert discusses the most frequently cited deficiencies and other staff observations from the Division’s Wrap Fee Initiative examinations. In sharing the information in this Risk Alert, the Division encourages advisers that recommend wrap fee programs to consider and adopt policies and procedures to address those risks, conflicts, and challenges.
View the Risk Alert: Observations from Examinations of Investment Advisers Managing Client Accounts That Participate In Wrap Fee Programs
Read more here: https://www.sec.gov/files/wrap-fee-programs-risk-alert_0.pdf
Regulatory Update: SEC Risk Alert – Environmental, Social, and Governance (“ESG”) Investing
The SEC Division of Examinations has issues a Risk Alert – SEC Risk Alert – Environmental, Social, and Governance (“ESG”) Investing:
“The Risk Alert provides observations of deficiencies and internal control weaknesses from examinations of investment advisers and funds regarding ESG investing. It also provides observations of effective practices from such examinations. The Risk Alert is intended to highlight risk areas and assist firms in developing and enhancing their compliance practices. In addition, the staff seeks to provide transparency regarding the Division’s focus areas during examinations on this topic observed that firms approach ESG investing in various ways. In making investment decisions, some advisers and funds consider ESG factors alongside many other factors, such as macroeconomic trends or company-specific factors like a price-to-earnings ratio, to seek to enhance performance and manage investment risks. Others focus on ESG practices because they believe investments with favorable ESG profiles may provide higher returns or result in better ESG-related outcomes.”
View it here: https://www.sec.gov/files/esg-risk-alert.pdf
Regulatory Update: FINRA Supervision Frequently Asked Questions (FAQ)
FINRA has updated it’s FAQs on supervision. It has added the following Q&A:
https://www.finra.org/rules-guidance/key-topics/supervision/faq?utm_source=MM&utm_medium=email&utm_campaign=O%5FWeekly%5FUpdate%5F040721%5FFINAL#3-7
“7. How can member firms change the date on which their Rule 3130 annual certification is due?”
“8. What is the difference between the FINRA Rule 3120 report and the FINRA Rule 3130 report? Updated”
“10. What are the timetables for the FINRA Rules 3120 and 3130 reports and the Rule 3130 certification? Updated”
Visit here for the answers:
https://www.finra.org/rules-guidance/key-topics/supervision/faq?utm_source=MM&utm_medium=email&utm_campaign=O%5FWeekly%5FUpdate%5F040721%5FFINAL#3-7
Regulatory Update: SEC Broker-Dealer Risk Alert Regarding AML Suspicious Activity Monitoring and Reporting
The SEC’s Division of Examinations (“EXAMS”) has issued a Risk Alert regarding their compliance findings related to anti-money laundering (“AML”) requirements. In sharing its observations from these examinations of broker-dealers, EXAMS is seeking to remind firms of their obligations under AML rules and regulations and to assist broker-dealers in reviewing and enhancing their AML programs, in particular their monitoring for and reporting of suspicious activity to law enforcement and financial regulators. Mutual funds also may benefit from the examination observations discussed here. The Risk Alert states the following and notes the following areas that need enhancement at broker-dealers.
AML Policies and Procedures and Internal Controls
Suspicious Activity Monitoring and Reporting
The Bank Secrecy Act (“BSA”) and implementing regulations establish the basic framework for AML obligations imposed on financial institutions.2 The Financial Crimes Enforcement Network (“FinCEN”), a bureau of the Department of Treasury, adopted the “AML Program Rule” and the “SAR Rule” to implement AML programs and suspicious activity monitoring and reporting requirements for broker-dealers Rule 17a-8 under the Securities Exchange Act of 1934 (“Exchange Act”) requires broker-dealers to comply with the reporting, recordkeeping, and record retention requirements of the BSA, including those regarding Suspicious Activity Reports (“SARs”).
See the full alert here: https://www.sec.gov/files/aml-risk-alert.pdf
Regulatory Update: SEC Reg CF and NEW Form C Filing FAQ
In light of the Reg CF rule amendment that became effective on March 15, 2021, the SEC released an Announcement regarding new Form C guidance in an FAQ format. Below is a link to the SEC Announcement and referenced Reg CF Rule Amendment. The FAQ guidance addresses the following questions:
Is a crowdfunding vehicle required to file its own Form C, separate from the Form C filed by the crowdfunding issuer?
Does the crowdfunding vehicle need to have its own filer identification number (called a “Central Index Key” or “CIK” number) and EDGAR access codes?
What information about the crowdfunding vehicle is required to be provided in the XML-based portion of the Form C?
The crowdfunding vehicle and its principal executive officer or officers, its principal financial officer, its controller or principal accounting officer and at least a majority of the board of directors or persons performing similar functions are required to sign the Form C. How should those signatures be provided?
SEC Announcement here: https://www.sec.gov/corpfin/announcement/staff-guidance-edgar-filing-form-c
Regulation Crowdfunding Amendment: Release No. 33-10884 https://www.sec.gov/rules/final/2020/33-10884.pdf
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