The SEC’s Office of Compliance Inspections and Examinations has issued an open letter to all FINRA member broker-dealers instructing them to make all Suspicious Activity Reports and related documentation available to FINRA during examinations.  The letter implements changes to the Bank Secrecy Act.  FINRA, in turn, must keep such information confidential.  Required information includes Suspicious Activity Reports, supporting documentation, and “any information that would reveal the existence of a SAR or any decision to not file a SAR.”

The staff of the Division of Investment Management has issued answers to certain questions arising under the new family office rule, which exempts single family offices from adviser registration.  Significantly, the responses make clear that merely serving as a family office does not trigger adviser registration so long as the office only provides non-advisory services such as tax filings, accounting, and housekeeping.  The responses also state that same-sex domestic partners and opposite sex partners that live together would be considered “spousal equivalents” for purposes of the rule.  The responses also address control issues and investments by key employees.

FINRA has issued a Regulatory Notice advising firms to implement a heightened supervisory system when recommending complex products.  FINRA defines a “complex product” as any product “with multiple features that affect its investment returns differently under various scenarios.”  FINRA provides a non-exclusive list of complex products: asset-backed securities, unlisted REITs, any product with an embedded derivative component (i.e. reference to another asset), structured notes, investments tied to the performance of other markets, principal-protected notes, and leveraged or inverse ETFs.  Recommended supervisory procedures include a more robust product approval process, an ongoing review to determine if the products performed as anticipated, extensive training of registered representatives, and limiting sales to customers that would qualify for options trading. 

The SEC has commenced an enforcement proceeding against the portfolio manager of a mutual fund for failing to inform the Valuation Committee of certain events that affected the valuation of an underlying security.  As a result, the SEC charges that the fund overstated its NAV, which allowed the fund’s adviser to receive inflated advisory fees.  The SEC alleges that the portfolio manager was informed by the trustee for the underlying security (a CDO in subprime mortgages) that an event of default occurred and that, as a result of acceleration declared by senior security-holders, the fund would not receive future coupon payments.  The respondent failed to inform her firm’s Valuation Committee even though the firm’s policies and procedures required portfolio managers to review all prices on a daily basis and notify the Valuation Committee of prices not representing fair value.  Once the Valuation Committee became aware of the valuation impairment, it wrote down the security, which led to a run on the fund and its ultimate liquidation.  The SEC alleges direct violations of the Adviser Act’s anti-fraud rules as well as aiding and abetting. 

A large mutual fund sponsor agreed to pay a $300,000 fine for failing to follow its own fair valuation procedures.  The SEC alleges that the respondent utilized broker and third party pricing service quotes for certain non-agency mbs securities in contravention of its own procedures.  According to the SEC, the firm’s procedures required the Fair Value Committee to make a fair value determination when broker quotes differed from transaction prices.  The SEC charges that the firm continued to use broker quotes for nearly a month, even though the broker quotes were not accurate or stale.  As a result, the Fund’s NAV was misstated for several weeks.

FINRA has indicated that investment-related information provided pursuant to ERISA Rule 404a-5 need not be filed with FINRA.   The Rule, which was adopted by the Department of Labor in October 2011, requires the disclosure to participants of certain plan and investment-related information including fund performance information.  FINRA has agreed that such materials need not be filed or comply with the otherwise applicable content rules (2210 and 2211) if such material complies with the content standards of the Rule.  However, FINRA does warn that firms must continue to file such materials if they contain other product promotional materials that fall outside the Rule.  FINRA’s position is consistent with a recent SEC no-action letter under Rule 482.

FINRA fined a large broker-dealer $1.75 Million for inadequate compliance procedures involving short sales.  According to FINRA, the broker-dealer released millions of short sale orders to the market without having reasonable grounds to believe that the securities could be borrowed and delivered.  FINRA charges that the firm did not have adequate technological and supervisory procedures necessary to comply with Regulation SHO, which requires firms to obtain and document “locate” information for short sales.  FINRA uncovered the problem during an investigation.

OUR TAKE: Eliminating the general solicitation and advertising restrictions would end the requirement that firms have some sort of pre-existing relationship with potential investors.  It is unclear whether the Committee intends its recommendations to apply to funds as well as operating companies.  It is even less clear whether the SEC will heed the Committee’s recommendations.

The SEC has upheld a FINRA action against a registered representative charged with unlawful taking of client information when switching broker-dealers.  FINRA found that the respondent violated his “duty to observe high standards of commercial honor and just and equitable principles of trade” (Conduct Rule 2110) by downloading customer information for use at his new firm.  FINRA charged that the taking of the information violated his old firm’s policies as well as Regulation S-P.  SEC rejected several arguments made by the respondent: (i) the 2004 “Protocol for Broker Recruiting” did not give rights to an individual representative to take confidential client information; (ii) his lack of knowledge or bad intent was not relevant nor was lack of any client harm, and (iii) he had no property right to the client data.  The SEC also indicated that focusing on his own self-interest without regard to his client’s rights violated Rule 2110.