On March 9, 2020, the Financial Industry Regulatory Authority (FINRA) updated its guidance for broker-dealers’ pandemic-related business continuity plans (BCPs) and issued regulatory guidance and relief from some of their obligations in response to the novel coronavirus (COVID-19) global pandemic. FINRA made clear that Regulatory Notice 20-08 imposes no new rules or obligations on members and applies only to members’ obligations under FINRA’s rules and regulations and not those of other securities regulators. Acknowledging the evolving nature of the crisis, FINRA also invited members to consult with the organization to address additional compliance challenges as they arise, noting that additional regulatory guidance and relief may be provided at a later date. Finally, FINRA indicated that Regulatory Notice 20-08 will remain effective until a subsequent notice of cessation is published.
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SEC Files First Suit Against Alleged Unregistered Broker-Dealer Operating in Digital Asset Markets
On September 18, 2019, the Securities and Exchange Commission (“SEC”) filed its first civil suit alleging violations of broker-dealer registration requirements in U.S. digital asset markets. In a case filed in the U.S. District Court for the Central District of California, the SEC alleged that Defendants ICOBox and its founder, Nikolay Evdokimov, illegally conducted an unregistered public securities offering for their 2017 initial coin offering (“ICO”), and have operated an unregistered brokerage service facilitating the launch of ICOs in digital asset securities since 2017.
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SEC Adopts Regulation Best Interest and Investment Adviser Conduct Guidance
On June 5, 2019, the Securities and Exchange Commission (“SEC”) finalized Regulation Best Interest (“Reg BI” or the “Final Rule”) under the Securities Exchange Act of 1934 (“Exchange Act”) to establish a new “best interest” standard of conduct for broker-dealers when making a recommendation of any transaction or investment strategy involving securities to a retail
FINRA Publishes AML Red Flags to Help Broker-Dealers Satisfy Suspicious Activity Monitoring and Reporting Requirements
On May 6, 2019, the Financial Industry Regulatory Authority (“FINRA”) issued Regulatory Notice 19-18, addressing members’[1] anti-money laundering (“AML”) compliance programs. This notice focused extensively on members’ monitoring for suspicious activities and subsequent suspicious activity report (“SAR”) filing obligations, providing 97 examples of “money laundering red flags” to securities industry market participants. Where applicable to a members’ business operations, FINRA encouraged broker-dealers to take a “risk-based approach” to AML compliance and incorporate these red flags into their AML programs, even though the organization noted that merely doing so will not satisfy all obligations. Where any red flags are detected, FINRA encouraged firms to consider whether “additional investigation, customer due diligence measures or a SAR filing may be warranted.”
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FINRA Proposes Rules Targeting Firms With History of Misconduct
On May 2, 2019, FINRA proposed new rules to designate “high-risk” firms and strengthen its ability to impose additional obligations on those firms.[1]
- Proposed Rule 4111 would authorize FINRA to designate “Restricted Firms” based on the number of event disclosures made by the firm and its registered persons. Restricted Firms would be subject to limitations on their operations and could be required to maintain restricted deposits that could only be withdrawn with FINRA’s consent.
- Proposed Rule 9559 would create an expedited appeals process, including a process for challenging a designation as a Restricted Firm and any obligations imposed.
FINRA expects that only a small number of large firms (500 or more registered representatives) would be affected by the proposed rules, and that only zero to two would have been impacted in any given year had the rules been effective from 2013-2018.[2]
Early signals from FINRA about this rulemaking generated concern that the standards would be overly subjective, leading to uncertainty in application. We believe, however, that the proposed rules on balance reflect a reasonable, and largely objective, approach given FINRA’s stated goal to “impose tailored obligations” on those firms that “present heightened risk of harm to investors.”[3]
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SEC Brings First Enforcement Action Against a Digital Assets Trading Platform for Failure to Register as a Securities Exchange
On November 8, the Securities and Exchange Commission (“SEC”) imposed a cease-and-desist order against Zachary Coburn for causing his former company, EtherDelta, to operate as an unregistered securities exchange in violation of Section 5 of the Securities Exchange Act of 1934 (“Exchange Act”). Notably, EtherDelta, a trading platform specializing in digital assets known as Ether and ERC20 tokens,[1] was not operated like a traditional exchange with centralized operations, as there was no ongoing, active management of the platform’s order taking and execution functions. Instead, EtherDelta was “decentralized,” in that it connected buyers and sellers through a pre-established smart contract protocol upon which all operational decisions were carried out.
In the SEC’s view, EtherDelta met Exchange Act Rule 3b-16(a)’s definition of an exchange notwithstanding the lack of ongoing centralized management of order taking and execution. Robert Cohen, the Chief of the SEC’s Cyber Unit within the Division of Enforcement stated after the order’s release, “The focus is not on the label you put on something . . . The focus is on the function . . . whether it’s decentralized or not, whether it’s on a smart contract or not, what matters is it’s an exchange.” This functional approach echoes prior SEC guidance and enforcement actions in the digital asset securities markets in emphasizing that the Commission will look to the substance and not the form of a market participants’ operations in evaluating their effective compliance with U.S. securities laws.
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SEC Reforms Regulation ATS to Improve Trading Transparency
On July 18, 2018, the U.S. Securities and Exchange Commission (the “SEC” or “Commission”) voted to approve a final rule (the “Final Rule”) amending Regulation Alternative Trading System (“Regulation ATS”) to require alternative trading systems (“ATSs”) that trade national market system (“NMS”) stocks (“NMS Stock ATSs”) to file with the SEC new Form ATS-N to begin operations or, for currently operating ATSs, to continue operations. Form ATS-N will provide for enhanced disclosures regarding the ATS’s operations and relationship with its broker-dealer operator relative to current Form ATS and will be publicly available. Importantly, unlike under the November 2015 proposal (the “Proposed Rule”), the SEC would automatically deem the Form ATS-N submissions to be effective after the review period, unless the Commission found it to be ineffective.
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OCIE Risk Alert Focuses on “Best Execution” and Investment Advisers
On July 11, 2018, the Securities and Exchange Commission’s (“Commission”) Office of Compliance Inspections and Examinations (“OCIE”) published a risk alert describing common deficiencies that OCIE staff observed in recent examinations regarding advisers’ compliance with their obligation under the Investment Advisers Act of 1940 (the “Advisers Act”) to seek “best execution” of client transactions. This obligation is a specific component of advisers’ general fiduciary duties owed to clients and requires an adviser to execute transactions so that “the client’s total cost of proceeds in each transaction is the most favorable under the circumstances.” Though what constitutes “best execution” lacks a uniform definition, the staff continues to maintain the well-settled principle that an analysis of whether a broker-dealer provides best execution should be qualitative based on the nature of the broker-dealer’s services, and that the lowest price does not necessarily equate to best execution. The risk alert nonetheless clarifies and reiterates particular practices that the staff considers inconsistent with an adviser’s best execution obligation.
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SEC Settles With Private Funds For Rule 204(b)-1 Disclosure Violations
On June 1, 2018, the U.S. Securities and Exchange Commission (“SEC”) issued a press release announcing settlements for $75,000 each with 13 private fund advisors for violating their disclosure obligations under Rule 204(b)-1 under the Investment Advisers Act of 1940. Rule 204(b)-1, adopted to increase transparency in the U.S. financial system and identify risks to financial stability, implemented provisions of Title IV of the Dodd-Frank Act and requires that SEC-registered investment advisers with at least $150 million in private fund assets under management file Form PF with the SEC.
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SEC Proposes New Best Interest Standard for Broker-Dealers and “Clarification” of Existing Fiduciary Standard for Investment Advisers
On April 18, 2018, the Securities and Exchange Commission (“SEC”) proposed Regulation Best Interest under the Securities Exchange Act of 1934 to establish a new “best interest” standard of conduct for broker-dealers when making a recommendation of any transaction or investment strategy involving securities to a retail customer. The SEC also proposed an interpretation to