The following brief updates exemplify trends and areas of current focus of relevant regulatory authorities:

SEC 2016 Examination Priorities

The National Examination Program, which is administered by the SEC’s Office of Compliance Inspections and Examinations (“OCIE”), recently published its Examination Priorities for 2016 (the “2016 Exam Priorities”). In the 2016 Exam Priorities, OCIE listed the following priorities that are worthy of note: 

  • ReTIRE. OCIE will continue its “Retirement-Targeted Industry Reviews and Examinations Initiative,” launched in June 2015, which focuses on the services offered by investment advisers and broker-dealers to retirement account investors. 
  • Cybersecurity. OCIE will continue to examine broker-dealers’ and investment advisers’ cybersecurity compliance and controls in 2016. 
  • Liquidity Controls. Reflecting the SEC’s concerns related to the changes in fixed-income markets over the past several years, OCIE will examine advisers to mutual funds, ETFs, and private funds that have exposure to potentially illiquid fixed-income securities.
  • Variable Annuities. As part of its focus on retirement products and services, OCIE will review the suitability of sales of variable annuities to investors, as well as the adequacy of disclosure and the supervision of such sales.
  • Using Data Analytics to Identify Signals of Potential Illegal Activity. OCIE noted that it will be leveraging its capabilities in the area of data analytics in connection with several initiatives, including the detection of the promotion of new, complex, and high risk products and related sales practice issues to identify potential suitability issues and potential breaches of fiduciary obligations.

FINRA 2016 Examinations Priorities Letter

On January 5, 2016, FINRA issued its 2016 Regulatory and Examination Priorities Letter (the “FINRA 2016 Priorities”). The FINRA 2016 Priorities cover many topics and themes, including:

  • Culture, Conflicts of Interest and Ethics. FINRA will formalize its assessment of firm culture by focusing on certain indicators of a firm’s culture, including the value placed on control functions within the firm, the firm’s tolerance of policy or control breaches and the firm’s efforts to identify risk and compliance events proactively.
  • Supervision, Risk Management and Controls. FINRA will focus on four areas where it has observed repeated concerns that affect a firm’s business conduct and the integrity of the markets: management of conflicts of interest, technology (including cybersecurity, technology management, and data quality and governance), outsourcing (including a review of a firm’s due diligence and risk assessment of service providers) and anti-money laundering controls.

Other topics discussed in the FINRA 2016 Priorities include liquidity, sales practices (including sales discounts and waivers), financial and operational controls, and market integrity.

CFTC Approves Final Rules Imposing Minimum Margin Requirements on Uncleared Swaps

On December 16, 2015, the CFTC approved final rules that will impose mandatory minimum margin requirements on uncleared swaps entered into by registered swap dealers or major swap participants that are not subject to regulation by U.S. banking regulators (the Federal Reserve Board, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the Farm Credit Administration or the Federal Housing Finance Agency (collectively, the “Prudential Regulators”). The rules are substantially similar to the rules adopted by the Prudential Regulators in October 2015, which apply to uncleared swaps and security-based swaps entered into by registered swap dealers, security-based swap dealers, security-based swap participants and major security-based swap participants that are subject to regulation by the Prudential Regulators, and are described in our earlier Alert. While neither the CFTC rules nor the Prudential Regulator rules will apply directly to buy-side entities, both sets of rules are expected to have a material impact on buy-side entities due to their impact on registered swap dealers and security-based swap dealers, which are typically the counterparties to buy-side entities’ derivatives transactions. Both sets of rules will impose minimum margin requirements on derivatives transactions and may increase the amount of margin buy-side entities are required to provide. Both sets of rules also will likely require margin to be delivered by buy-side entities more quickly than is current market practice, and will also effectively require changes to typical derivatives documentation, including the ISDA Credit Support Annex. We understand that ISDA is developing a market-side protocol that parties can use to make those changes. 

The compliance dates for the CFTC rules are identical to the compliance dates for the Prudential Regulator rules. While the compliance dates phase in beginning on September 1, 2016, we expect that the rules will affect transactions of most buy-side entities beginning on March 1, 2017 (for variation margin requirements) and September 1, 2020 (for initial margin requirements). For more information, please see our earlier Alert.

Broker-Dealer to Pay $13.75 Million for Mutual Fund Sales Deficiencies

On December 29, 2015, FINRA ordered Barclays Capital, Inc. (“BCI”) to pay approximately $13.75 million for alleged deficiencies in its supervisory systems and procedures that resulted in thousands of unsuitable mutual fund transactions for its retail brokerage customers. A “mutual fund switch” involves one or more mutual fund redemption transactions coupled with one or more related mutual fund purchase transactions. According to the settlement order, BCI’s compliance procedures incorrectly defined a mutual fund switch. As a result, BCI failed to review thousands of mutual fund switches for suitability and failed to ensure that the required disclosures of the costs associated with these switches were sent to customers. Separately, according to FINRA, BCI also “failed to have a supervisory system reasonably designed to ensure that mutual fund purchases were properly aggregated or householded so that customers were provided with available [breakpoint] discounts.” Without admitting or denying FINRA’s findings, BCI agreed to pay $13.75 million to settle the enforcement action which was comprised of over $10 million in restitution (including interest) to affected clients and a $3.75 million fine. This enforcement proceeding is one of several recent FINRA cases that have resulted in large settlement payments by broker-dealers for failure to ensure that clients receive available mutual fund breakpoint discounts.

PCAOB Adopts New Rules Regarding Disclosure of Audit Participants

In December 2015, the Public Company Accounting Oversight Board (“PCAOB”) adopted new rules that, subject to approval by the SEC, will require accounting firms to file a new PCAOB Form AP disclosing information about the persons who participated in an audit, including the name of the engagement partner for the audit and the names of other firms participating in the audit. For audits of mutual funds, Form AP permits one Form AP to be filed in cases where multiple audit opinions are included in the same auditor’s report. If multiple audit opinions included on the same auditor’s report involved different engagement partners, a separate Form AP would need to be filed for each engagement partner, covering the audit opinions for the funds for which he or she served as engagement partner. The PCAOB believes that, by requiring disclosure of information about the engagement partner and the other accounting firms that participated in the audit in Form AP, and allowing firms to voluntarily report this information in the auditor’s report, the new rules will promote the objectives of enhancing transparency and accountability for the audit.