Welcome to the Regulatory Roundup. Each month, Eversheds Sutherland Investment Services attorneys review significant regulatory developments (including notable rulemakings and guidance from securities regulators) from the previous month that are of interest to retail broker-dealer and investment adviser firms.
SEC Division of Examinations Issues Risk Alert on the Division’s Examination and Selection Process for Broker-Dealers
On June 5, the SEC Division of Examinations (Division) published a Risk Alert outlining criteria for selecting broker-dealers to examine and highlighting key areas of focus during the examination process. The Risk Alert also outlines the specific types of information and documents that staff may initially request when examining a broker-dealer, along with a sample initial information request list.
The Risk Alert highlights several factors that the Division considers when selecting broker-dealers for examination. These factors include prior examination history, supervisory concerns, disciplinary history of associated individuals or affiliates, the firm’s customer base, the products and services offered, media reporting related to the firm and whether the firm holds customer cash and securities. Additionally, the Division may choose firms based on risk areas identified in its annual priorities letter.
When selecting examination focus areas, the Division considers the firm’s business model, associated risks and whether the firm has recently undergone examination by another regulator with specific focus areas. Additionally, the Division outlines the documents it will request during an examination, including the firm’s written policies and procedures, enabling Division staff to perform compliance testing across various areas.
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The Fifth Circuit Vacates the SEC’s Private Fund Adviser Rule
On June 5, the US Court of Appeals for the Fifth Circuit ruled that the SEC exceeded its statutory authority in promulgating new regulations that would have required private fund advisers to disclose information to investors about performance, fees, and conflicts of interest and restricted certain practices. The Court’s ruling is a victory for the private fund industry, which has viewed the rules as unduly burdensome and an improper extension of the SEC’s authority.
The Court focused on the SEC’s reliance on statutory authority found in Section 211(h) and Section 206(4) of the Investment Advisers Act of 1940, as amended (the Advisers Act). The Court first held that the SEC’s reliance on Section 211(h) to promulgate rules regarding private fund advisers was improper because Section 211(h) specifically applies to “retail investors.” Next, the Court found that the SEC failed to articulate a “close nexus” between the new rules and the anti-fraud purpose of Section 206(4).
As for next steps, if the SEC seeks to challenge the Court’s order, the most options it would pursue would be a rehearing from the full Fifth Circuit en banc or a petition to the Supreme Court for review. Beyond the private fund adviser ruleset, the Court’s decision could have implications for other rules on the SEC’s rulemaking agenda that rely on the same statutory authority.
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FINRA Issues Guidance Regarding Newly Designated Residential Supervisory Location Offices
On June 18, FINRA issued an alert to member firms advising them not to close or withdraw any existing Form BRs for locations designated as Residential Supervisory Locations (RSLs). This guidance stems from certain states that mandate branch offices to be “registered” or “notice filed” using Form BR but do not currently recognize the RSL office designation.
In its guidance, FINRA highlights that Form BR does not currently permit firms to “select or deselect” specific jurisdictions. This means that a firm cannot withdraw a Form BR for FINRA purposes while keeping it in place for states that do not recognize the RSL office designation. However, FINRA notes that it is actively collaborating with the states to enhance the CRD system functionality. This enhancement would allow member firms to “select or deselect” individual regulators/states for an office/location without affecting the registration status with other regulators/states.
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FINRA Advises Firms to Prepare for New Regulation S-P Requirements
FINRA’s Cyber and Analytics Unit issued a Cybersecurity Advisory highlighting the SEC’s recent amendments to Regulation S-P, which, among other things, will require broker-dealers, investment companies, registered investment advisers and transfer agents (“covered institutions”) to: (1) adopt an incident response program, and (2) notify affected individuals whose sensitive customer information was, or is reasonably likely to have been, accessed or used without authorization.
In the Advisory, FINRA recommends that member firms review the amendments to ensure that their cybersecurity programs are modified, as needed, to come into compliance by the applicable compliance date for their firms.
