Month: February 2017

The Five Most Frequent Compliance Topics in SEC Exams

The SEC’s Office of Compliance Inspections and Examinations published a list of the five compliance topics most frequently identified in deficiency letters that were sent to SEC-registered investment advisers.

The five are actually the bulk of advisor compliance requirements. It’s the examples in the five topics that are the most useful indicators.

Compliance Rule

  • Compliance manuals are not reasonably tailored to the adviser’s business practices.
  • Annual reviews are not performed or did not address the adequacy of the adviser’s policies and procedures.
  • Adviser does not follow compliance policies and procedures.
  • Compliance manuals are not current.

Regulatory Filings

  • Inaccurate disclosures
  • Untimely amendments to Form ADVs
  • Incorrect and untimely Form PF filings
  • Incorrect and untimely Form D filings

Custody Rule

  • Advisers did not recognize that they may have custody due to online access to client accounts.
  • Advisers with custody obtained surprise examinations that do not meet the requirements of the Custody Rule.
  • Advisers did not recognize that they may have custody as a result of certain authority over client
    accounts.

Code of Ethics Rule

  • Access persons not identified
  • Codes of ethics missing required information
  • Untimely submission of transactions and holdings.
  • No description of code of ethics in Form ADVs

Books and Records Rule

  • Did not maintain all required records.
  • Books and records are inaccurate or not updated.
  • Inconsistent recordkeeping.

The only thing surprising about this publication is that conflicts are not mentioned.  I had assumed that undisclosed conflicts or improperly managed conflicts was the biggest problem found in SEC exams. This list makes it seem like ministerial missteps and sloppy paperwork are the most common problems.

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The SEC Is Making Room For A New Regulation

Although is questionable whether the Securities and Exchange Commission is subject to President Trump’s executive order calling for a reduction in the number of regulations, the SEC seems to be taking it to heart.

Last week, Congress started the push to roll back the Extraction Disclosure Rule. This week, the SEC is looking to roll back the pay ratio disclosure rule.

The SEC is short-handed. Acting SEC Chair Michael Piwowar asked SEC staff to reconsider implementation of the rule. The pay-ratio rule mandates companies to disclose median worker pay and compare it with CEO compensation. This product of Dodd-Frank is supposed to put pressure on corporate boards to slow pay increases for CEOs.

The argument against is that is a costly to implement and not valuable to shareholders.

Unlike the Extraction Disclosure Rule, the Pay Ratio Rule was not implemented in the window subject to the Congressional Review Act. The SEC cannot rely on Congress to repeal the rule for them.

For the SEC to make changes, it has to create a new rule-making process and open to comments on changing the rule. Repealing the rule would put the SEC at odds with the Congressional mandate in Dodd-Frank to create the rule. That seems an untenable position to take.

Since the SEC is currently subject to three vacancies, it’s unlikely that anything will happen until Jay Clayton is approved by the Senate as the new Chair. That would likely mean two votes in favor of killing or maiming the rule, to one likely opposed.

According to the President’s executive order, the SEC has identified two rules to be repealed. That means it can now roll out a new regulation. Wonder what it will be?

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Comeback

It’s tough thinking about compliance this morning after staying up to watch the greatest comeback in Super Bowl history by one of the greatest quarterbacks, orchestrated by one of the greatest coaches.

I reflect back humbly. I grew up with the red-uniformed Patsies. I remember the 1 and 2 win seasons. I remember the years of not being able to beat Miami in Miami.

At halftime of this game, I remembered the Patriots’ first Super Bowl when the team was steamrolled by the great ’85 Bears in what, at the time, was the most lopsided loss in Super Bowl history.

I remember the Patriots with one foot out the door to St. Louis and again with an aborted move to Hartford.

I know that the painting in Tom Brady’s attic will not hold back time forever, that Belichick will retire someday, and that Mr. Kraft will pass on the team to someone else to run. This dynasty will come to end some day.

But not today.

I’ll leave with a picture of my good friend holding the Lombardi Trophy last night.

Congress Disapproving The SEC Rule That Congress Made The SEC Make

Dodd-Frank made the Securities and Exchange Commission create a rule on the disclosure of payments by resource extraction issuers. The SEC finally got the rule out this fall. Now Congress is threatening to abolish the rule.

Section 1504 of the Dodd-Frank Act directed the Securities and Exchange Commission to

“issue final rules that require each resource extraction issuer to include in an annual report . . . information relating to any payment made by the resource extraction issuer, a subsidiary of the resource extraction issuer, or an entity under the control of the resource extraction issuer to a foreign government or the Federal Government for the purpose of the commercial development of oil, natural gas, or minerals..”

SEC finished the rule and finally adopted the Rules for Resource Extraction Issuers Under Dodd-Frank Act in September.

The strategy is not to pass a law removing section 1504. That would require getting the supermajority in the Senate to overcome the filibuster obstacle. That is hard and unlikely.

The plan is to use the Congressional Review Act to repeal the rule. That Act was part of Newt Gingrich’s Contract with America.

Under the law, Congress can stop a regulation passed within the last 60 legislative days. That counting is a bit fuzzy, but seems to stretch all the way back to the middle of June 2016.

I have little doubt that the rule will be rolled back. My question is whether this repeal counts towards the two repealed rules it takes to get a new one enacted under the Executive Order.

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The New Supreme Court Pick and Private Funds

Justice Scalia died last year and replacing his position has been held up by partisan politics ever since. President Trump has made his pick, federal appeals court judge Neil Gorsuch from the 10th Circuit, and the confirmation battle has begun.

Being very liberal on social issues, I’m disappointed that the Senate chose not consider President Obama’s pick for the vacancy. We’re now faced with a justice who is likely to cause an erosion of some of the liberal gains we have seen on social issues.

But Compliance Building is about compliance so I quickly looked for some of judge Gorsuch’s opinions involving the Securities and Exchange Commission or private funds. I didn’t find much.

In ACAP Financial v. US SEC (2015), Judge Gorsuch wrote the opinion upholding an SEC penalty levied against the appellants for failing to take sufficient steps to guard against the firm’s involvement in the unlawful trading of unregistered shares. I found the writing to be very clear and easy to read. It lacks the ponderous rhetoric of many court opinion.

The decision is an easy one to find in favor of the SEC, so it does not offer much insight. The appellants did not argue their liability, but merely disputed the remedy imposed. The remedy was one proscribed for “egregious” behavior and they argued that their behavior was not “egregious.” The judge goes on for ten pages shooting down the appellants’ arguments, none of which even come close.

Gorsuch’s 10th Circuit is responsible for the Bandimere decision that recently struck down the SEC’s current system of administrative law judges. That put the 10th Circuit in opposition to other appeals courts, setting up a potential clash at the Supreme Court. However, Judge Gorsuch was not one of the appellate judges on the Bandimere case.

Let me know if you find any other cases from Judge Gorsuch that are relevant to private funds, compliance or the SEC.

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