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Regulatory Update for February 2017

  • SEC Exam priorities for 2017: The SEC’s Office of Compliance Inspections and Examinations (OCIE) released its 2017 examination priorities, including some golden oldies from 2016 and a few new twists.  OCIE has three main themes: protecting retail investors, scrutinizing advice provided to elderly and retiring investors, and assessing market-wide risks.  For advisers serving retail investors, the staff will focus on reviewing advice provided through automated platforms (“robo-advisers”), wrap fee programs, share class selection, and sales practices and disclosures for ETFs.  Never-before examined investment advisers and advisers that employ representatives with tarnished track records will also be in the spotlight.  Advisers with multiple branch offices should expect to receive increased scrutiny.  OCIE will continue the ReTIRE initiative, and review firms’ interactions with elderly investors to ensure they are meeting their fiduciary obligations. To assess market-wide risks, the SEC will enhance oversight of FINRA and continue its cybersecurity initiative.  Private funds and their conflicts of interest are a continuing priority.  Compliance officers should review these priorities and update their compliance programs accordingly.
  • DOL issued 2nd set of FAQs defining “Investment Advice”: The DOL released its second set of FAQs on January 17, discussing 35 questions in 17 pages, to provide further clarifications on its new Fiduciary Rule.  The FAQs cover investment recommendations, investment education, general communications, transactions with independent fiduciaries with financial expertise, marketing platforms for individual account plans, and providing assistance in selection and monitoring investment alternatives.  For more information, check out this link.
  • The High Price Associated with Excessive Trading: Brokers Gregory T. Dean and Donald J. Fowler will soon pay the price for fraudulently recommending an unsuitable, high-cost trading strategy to multiple investors involving excessive trading which resulted in substantial commissions and fees.  According to the SEC’s Press Release dated January 9, 2017, Dean and Fowler failed to conduct the due diligence necessary to determine if the questionable trading strategy could result in any profit for customers.  The strategy involved the purchase of a stock followed by the sale of the stock within a week or two, with no consideration of price movement.  Twenty-seven customers suffered “substantial losses” as a result of the unsuitable strategy while the brokers earned generous commissions.  The Director of the SEC’s New York Regional Office and Co-Chair of the Enforcement Division’s Broker Dealer Task Force reinforced that the SEC is focused on punishing brokers who fraudulently benefit at the expense of their customers.    On the same day as the Complaint was filed in Manhattan federal court, the SEC issued an Investor Alert encouraging investors to review their confirmations and statements for unauthorized trading, churning and excessive fees in their brokerage accounts.  Brokers beware and compliance officers take note.
  •  CFTC Adopts Amended Position Limit Aggregation Rules The U.S. Commodity Futures Trading Commission (the “CFTC”) has issued amended aggregation rules for determining compliance with speculative position limits established by the CFTC in futures contracts and options thereon. If your firm trades futures contracts and options on certain agricultural commodities (i.e., wheat, soybean, cotton, etc.), check out this summary

Lessons Learned from Recent SEC Actions:

PE Firm Censured for Failing to Disclose Investment in Service Provider:  The SEC lays out the importance of accurate disclosure of conflicts of interest regardless of financial profitability or similarity in name in this order.  Familial business partnerships and relationships are material conflicts of interest when business dealings are intertwined.  In this case, it was the use and investment in a third-party IT service provider by principals of the firm which also included a familial relationship.  Executive management assumed the investors understood the relationship with the IT service provider since the name of the IT firm was similar to the firm’s name, and reaped no profits from the service provider.  The SEC disagreed, and imposed a fine of $50,000.  As compliance professionals, it’s often an awkward conversation discussing familiar conflicts of interest with executive management, but as illustrated in this order, it’s a requirement to keep your firm compliant.  It’s crucial to revisit business relationships regularly to uncover, disclose and re-evaluate conflicts of interests.

Why is fee testing critical to your advisory business? Because it can save you $13 million in penalties plus client reimbursement.  Recently a large adviser was fined for incorrect fee billing, custody, and books & records violations related to a merger and acquisition and subsequent fee billing system conversion. During the merger the new firm never properly tested client fees against the client’s investment advisory agreement. Later, the bad fee schedules were then copied over to a new billing system.  If they had done proper fee testing initially, they would have identified the incorrect fees being charged as well as the fact they couldn’t produce the investment advisory agreement verifying the fees.  In addition, the firm was cited for custody failures because they did not provide the independent auditor an accurate account listing of the advisory accounts where they maintained custody.  This ultimately led to an insufficent sample size. It is critical that compliance professionals are included in merger and acquisition teams for initial due diligence as well as represented on test script development teams to insure that compliance issues are identified, tested and addressed by computer programmers and operations personnel when systems are integrated and converted.

Lying to SEC, Clients and Defrauding Elderly Widows Creates Bad Karma:  John W. Rafal, founder of Essex Financial Services, agreed to pay more than $575,000 in fines and disgorgement to the SEC, and be permanently barred from the industry to settle charges that he defrauded a client, mislead SEC investigators, and lied to other clients about the SEC’s investigation.  The trouble started when Rafal made a deal with an attorney to pay him about $50,000 for referring the business of a wealthy widow to his firm, Essex Financial. The attorney was not registered as an investment adviser, so Rafal and the attorney agreed to make the payments look like legal fees.  When rumors started circulating about Rafal’s payment of illegal fees, he sent emails to firm clients falsely stating that the SEC had investigated the matter and issued a “no action letter.”  The SEC also nailed the attorney.  He settled, agreed to an industry bar and to pay disgorgement of $49,760, and fines of $37,500.

A few lessons to be learned.  First, whenever there is a whiff of fraud, expect regulators and law enforcement to pile on.   The state of Connecticut’s securities authorities initially investigated Mr. Rafal in 2014, leading to the SEC settlement and criminal charges by the U.S. Attorney General of Massachusetts. (For details, check out this article.)  Second lesson:  don’t assume that national recognition means a clean record.  Mr. Rafal was recognized by Barron’s number 7 on its Top 100 Independent Financial Advisors list as recently as 2014.  Third lesson:  Covering up wrongdoing always leads to greater punishment.

SEC Rebuffs Attempts to Stop Whistleblowers – Despite No Proof of Harm and Remediation Taken by Investment Firm.   The SEC fined BlackRock, Inc. $340,000 to settle charges that it improperly forced exiting employees to waive the ability to obtain whistleblower awards.  According to the SEC, more than 1,000 departing Blackrock employees signed separation agreements that included a waiver of “any right to recover of incentives for reporting misconduct” in order to receive separation payments.  Apparently the waiver provision was added in 2011 after the Whistleblower Rule (Rule 21F-17) was enacted.   The lesson from this case is that the SEC gets incredibly annoyed if any restrictions are placed on potential whistleblowers, and is willing to impose sanctions even where firms took action to correct the problem before regulators found it.

Worth Reading:

 Filing Deadlines and To Do List for February


  • Form 13F: Form 13F (institutional manager) quarterly filing for Q4 2016 is due within 45 days after the end of the calendar quarter, on February 14, 2017.
  • Form 13H: Form 13H (large trader) annual filing is due for advisers that already have a Form 13H filing obligation by February 14, 2017.
  • Form 13D & 13G: Annual amendments are due for advisers that have changes to disclosure information on previously filed 13D or 13G forms, on February 14, 2017.
  • IARD Fees: SEC-registered advisers and exempt reporting advisers are required to pay IARD fees before the submission of the Form ADV annual amendment (by March 31, 2017).


  •  Form PR should be filed with National Futures Association (“NFA”) for registered Commodity Trading Advisors by February 14, 2017, for the year ended December 31, 2016.
  • CFTC CPO-PQR Form (All Schedules): Large Commodity Pool Operator Form CPO-PQR is required to be filed with the NFA for Commodity Pool Operators by Mach 1, 2017.


  • Form PF for Large Hedge Fund Advisers must be filed within 60 days of each quarter end on the IARD system (March 1, 2017).
  • Initial Form PF: For Hedge Fund Advisers that have reached $1.5 billion regulatory assets under management (“RAUM”) attributable to hedge funds as of December 31, 2016 must make initial filing (the initial quarterly Form PF filing within 60 days of quarter end if an adviser’s hedge fund RAUM exceeds $1.5 billion as of the previous quarter end).  (March 1, 2017)


  •  Reaffirm YOUR CPO and CTA Exemptions: Firms that claim exemptions from Commodity Pool Operator (“CPO”) registration under CFTC Rule 4.5 or CTFC Rule 4.13(a)(3) (the “de minimis exemption”), or Rules 4.13(a)(1), 4.13(a)(2), 4.13(a)(5), and firms that claimed an exemption from Commodity Trading Adviser (“CTA”) registration pursuant to CFTC Rule 4.14(a)(8) must re-affirm those exemptions by March 1, 2017 or those exemptions will be automatically withdrawn.


  •  Form SHC – TIC SHC Survey: The U.S. Treasury’s TIC SHC Survey is a benchmark report and is filed every five years with the Federal Reserve Bank of New York. NOTE: U.S. investment managers that have previously determined themselves to be exempt from other TIC reports may be required to file the TIC SCH.  The report is mandatory in the following two circumstances:
    • Entity is contacted by the Federal Reserve Bank of New York
    • Entity exceeds the reporting threshold for either Schedule 2 or 3, regardless of whether they are contacted.
      • Schedule 2 threshold: fair value of reportable foreign securities held directly by the US resident reporter or by a foreign-resident custodian is at least $200 million
      • Schedule 3 threshold: fair value of reportable foreign securities held by a US custodian on the reporter’s behalf is a least $200 million

The help desk from the Federal Reserve of New York said that the notification has gone out – electronically – so advisers should check to see if they received any communication from the “Federal Reserve of New York.” Remember to check junk/clutter boxes to be sure.  Due date is March 31, 2017.

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.