Current Developments in Securities Law and Regulatory Matters

Posted on April 18th, 2017 at 12:56 PM
Current Developments in Securities Law and Regulatory Matters
  1. Introduction

            The purpose of this article is to cover the current developments in securities law and regulatory matters. More specifically, we will begin by discussing the most significant model rules recently adopted and proposed by the North American Securities Administrators Association (NASAA).  Second, we will walk through the Securities and Exchange Commission’s (SEC) 2016 Examination Priority Letter in order to gain an understanding of the Commission’s top initiatives. Third, we will discuss the Financial Industry Regulatory Authority’s (FINRA) 2016 Regulatory and Examination Priorities Letter. We will wrap up this article by discussing the Dodd-Frank Wall Street and Consumer Protection Act and the Department of Labor Fiduciary Duty Rule. More specifically, we will discuss how the election of Donald Trump could alter the foundation of these regulatory acts. This article will try to cover what we believe are the most pressing issues as move forward into 2017.

      II. NASSA State Law Development


         A. Model Rule Adopted



            The most significant model rule adopted by NASAA was the model legislation entitled, “An Act to Protect Vulnerable Adults from Financial Exploitation,” for the purpose of making it easier to help detect and prevent financial exploitation of vulnerable adults.[1]

            The purpose of this model rule is help limit fraud involving clients by mandating that a qualified individual report to a state securities regulator or state adult protective services agency when he or she detects the occurrence of financial fraud.[2]  A “qualified individual” is defined by NASAA as a broker-dealer agent or investment adviser representative who serves in a supervisory, compliance, or legal capacity for broker-dealers and investment advisers or any independent contractors that may be fulfilling any of those roles.[3] Significantly, this model rule would actually provide immunity from administrative or civil liability for “qualified individuals” if they choose to report to the state securities regulator or adult protective services agencies.[4] However, this model rule only applies to adults over 65 years of age and for individuals who qualify for protection under a state adult protective services statute.[5]

                     B. Model Rule Proposed


            NASAA has requested a public comment on proposed amendments to its Statement of Policy Regarding Real Estate Investment Trusts (REIT Guidelines). First and foremost, the proposal would add a uniform concentration limit of 10 percent of an individual’s liquid net worth in investment REITS and non-traded REITS. [6] NASAA defines liquid net worth as cash, cash equivalents, and readily marketable securities.[7]

            In addition, the proposal requires a separate suitability and concentration limit analysis.  This means that solely adhering to the concentration limit does not automatically satisfy the independently required suitability determination under the Guidelines, existing administrative rules, or the rules of a self-regulatory organization. [8] Thus, suitability and concentration standards are required to be met separately according to this proposed rule and the rule would require all prospectuses to spell out this distinction.[9]                                                                                           Finally, the proposal requires any person selling shares on behalf of a REIT must keep records for six years regarding the information obtained from shareholders to ensure compliance within the concentration limit.[10] NASAA believes that the recordkeeping requirement will ensure compliance within the concentration limits because it will keep firms accountable.[11]

      C. Top Investor Threats

            Separate from the adopted and proposed rules, NASAA has also provided a list of top investor threats in order to guide investors in the upcoming years.


            NASAA recommends verifying that a professional selling securities is licensed in some capacity in the securities industry. It is imperative that investors understand that when an individual sell securities without a license it is a red flag in almost every circumstance. [12]


            Purchasing a promissory note can be risky because they are usually marketed exclusively to sophisticated or corporate investors with the resources to research the companies issuing the notes thoroughly and to determine whether the issuers have the capacity to pay the promised interest and principal.[13] It is necessary for average investors to understand that, in most circumstances, promissory notes with a nine months or less duration do not require registration with the SEC or the state where the note is sold.[14] According to regulators, notes with short term duration are more likely than not to end up being fraudulent.[15] NASAA believes that the average investor should understand that short-term promissory notes involve a high degree of risk.


            The complicated operations of oil and gas investments cause difficultly for an average investor to determine if fraud is occurring.  For instance, there is a high probability that the actual partnership of an oil and gas investment firm is located in one state, the actual physical operation of the field is in a second state, and the investment offering is in a state other than the initial two states.[16] Therefore, the process for an average investor in following the line of money and the actions of all parties involved can be extremely difficult to monitor.


            As illustrated above, NASAA is taking action in trying to regulate REITs because of the risks involved. NASAA indentifies non-traded real estate investment trusts as the most risky real estate investments. These investments often carry high risk because non-traded REITs are sold directly to investors and are not traded on exchanges (conventional REITs are sold on exchanges).[17] The fact that non-traded REITS are not traded on exchanges allows these investments to become even more risky and have limited liquidity, causing them to become unsuitable for the average investor. [18]


            NASAA warns average investors to keep an eye out for Ponzi schemes. Ponzi schemes occur when an investor pays early with money raised from later investors and the fraud is only visible until the money runs dry.[19] Bernie Madoff made the Ponzi scheme famous during the 2008 financial meltdown and although most Ponzi schemes do not get as much media attention as this particular fraud, they occur more often than the average investor might believe.

III. SEC Reports & Summary Activity (2016 Examination Priority Letter)

            The SEC publishes an Examination Priority Letter every year in order to update industry professionals. We will cover the most pertinent issues addressed by the SEC in its 2016 letter.

         A. Protection of Retail Investors

            Protecting retail investors and retirement savers remains a priority in 2016, and it will likely continue to be a focus in the foreseeable future.

  1. ReTIRE

             ReTIRE was launched last year in order to focus on registered advisers and brokers who offer investors retirement accounts. This initiative most importantly includes the examination of the reasonable basis for recommendations made to investors. The examination also includes a requirement for reviewing conflicts of interest, supervision and compliance controls, and marketing and disclosure practice with regard to the sale of investment products by advisers and brokers to retirees. [20]


            The SEC plans to examine ETFs more intensely for compliance violations under the Securities Exchange Act of 1934 and the Investment Company Act of 1940. [21] The SEC will focus on the sale and trading risks/strategies involved with ETFs, as well as excessive portfolio concentration, suitability, and adequacy of risk disclosure.[22]


            The SEC will continue to investigate fee arrangements such as asset-based fees, hourly fees, wrap fees, commissions that are offered by advisers and brokers. [23] More specifically, the SEC will also focus on the recommendations of the account types, which not only include fees charged but also services provided and disclosure made about arrangements.[24] The SEC will review different account types to determine if they are in the best interest of the investor at the inception of the arrangement. [25]


            As more baby boomers decide to retire, variable annuities are becoming more popular within the general population. The SEC believes it is vital that they continue to assess the suitability, adequacy of disclosure and the supervision of sales regarding exchange recommendations and product classes. [26]

       B. Systemic Risk Oversight

            Systemic risk oversight is the act of maintaining fair, orderly, and efficient markets.[27] In 2016, the SEC goals were not only to protect investors and facilitate capital but oversee systemic risk.     


            The SEC plans to examine illiquid fixed income securities more extensively, specifically the ones that are packaged by advisers in mutual funds, ETFs, and private funds.[28] The SEC plans on paying even closer attention to new registered broker-dealers whom have been expanding liquidity providers in the marketplace.[29] In order to examine and catch illiquid fixed income securities that are being sold in the marketplace, the examinations will include a review of various controls in these firms’ expanded business areas, such as controls over market risk management, valuation, liquidity management, trading activity, and regulatory capital.[30]


            The SEC wants to enhance its use of data analytics through the use of new technologies and risk-based initiatives.[31]

            Data analytics is an important tool in identifying firms and individuals whom have a specific track record after they have been disciplined or barred from a broker-dealer.[32] Analyzing data can also help the SEC discover activities that indicate that a broker or investment adviser might be engaged in or aiding and abetting pump-and-dump schemes or market manipulation.[33]

            The SEC’s pursuit in collecting as much data as possible will help the SEC develop patterns to detect fraud in the future. More specifically, data collection and analytics will help the SEC focus on detecting the promotion of new, complex, and high risk products and related sales practice issues in order to help identify potential suitability issues and potential breaches of fiduciary obligations.[34]

     IV. 2016 FINRA Priorities

            FINRA addresses three broad issue in its 2016 Regulatory and Examination Priorities Letter; culture, conflicts of interest and ethics; supervision, risk management and controls; and liquidity.

          A. Culture, Conflicts of Interest and Ethics

            In 2016, firm culture has been an important factor to determine how a firm conducts its business and manages its internal conflicts of interest and ethics.[35] FINRA believes that firm culture is important to monitor because it will inform and evaluate how it affects compliance and risk management practices throughout the firm. [36]

            FINRA assesses five indicators of a firm’s culture in order to determine a pattern of behavior that can lend itself to spotting compliance risks in the future: 

  1. Whether control functions are valued;
  2. Whether policy or control breaches are tolerated;                                                                           
  3. Whether the organization proactively seeks to identify risk and compliance events;              
  4. Whether supervisors are effective role models of firm culture;                                                            
  5. And whether sub-cultures conform to overall corporate culture are identified and addressed.[37]

            There is no doubt that a firm’s culture is a gateway to into the strength of its supervisory system and its internal policies that can help mitigate conflicts. Therefore, it is imperative that firms take culture seriously.

             B. Supervision, Risk Management and Controls

            The rules implemented by FINRA can help guide firms in maintaining a system of supervisory control. In 2015, FINRA launched an examination of the incentive structures and conflicts of interest with regard to firms’ retail brokerage business.[38] Moving forward, FINRA plans on finishing the examination in order to draw conclusions on how a firm’s conflict mitigation processes regarding compensation plans for registered representatives effect the success of a firm’s compliance department.[39]  In addition, FINRA will continue to examine firms’ approaches to mitigating conflicts of interest that arise through the sale of products, or products for which a firm receives third-party payments and how that effects the success of a firm’s compliance department. [40]

            C. Outside Business Activities (OBAs)

            Evaluating a firm’s procedure to review OBAs is required under FINRA regulations. In fact, one of the most common examination findings is that a firm has not adequately reviewed a registered representative’s OBAs.[41] FINRA stresses to member firms that OBAs should be made aware of and mitigated to absolve any future issues. FINRA states that firms should review all OBA notifications and determine whether the proposed activities might interfere with or whether customers have been harmed due to these activities.[42]

            D. Similarities Between the SEC Examination Letter & FINRA 2016 Priorities

            Both the SEC and FINRA have put forth many similar initiatives. Some of the more important priorities include the following.


            Liquidity risks have long been an area of interest for both the SEC and FINRA because failures to manage liquidity have contributed to both individual firm failures and systemic crises.[43] Both the SEC and FINRA plan to review the adequacy of firms’ contingency funding plans in light of their business models to limit failures to manage liquidity.

            In addition, both the SEC and FINRA will focus their attention on high-frequency trading because given the number trades during a given period or just simple market event could create liquidity challenges for HFT firms. [44]  


            The SEC and FINRA will focus on suitability and concentration of investments by paying close attention to how firms monitor for excessive concentrations. Moreover, the SEC and FINRA will also examine suitability determinations by looking at how it recommends transactions and investment strategies.[45] In all, this means that the SEC and FINRA will assess whether registered representatives adequately consider factors of credit risk, duration and leverage as relevant to specific fixed-income, complex and alternative products.[46]



            In our aging country, the SEC and FINRA are focusing more of their attention in protecting seniors and vulnerable investors from fraud, sales practice abuse and financial exploitation. The scope of both the SEC and FINRA’s focus is derived from suitability and concentration concerns as well as recommendations regarding higher-cost products that may drive unsuitable recommendations and affect product performance to the detriment of the investor. [47]

    V. The State of Dodd Frank and the DOL Fiduciary Rule

            Last year, professionals in the securities industry were bracing for the continuing implementation of the Dodd Frank Wall Street Reform and Consumer Protection Act and the eventual enactment of the Department of Labor Fiduciary Rule in 2017. However, with the election of Donald Trump, these two financial regulatory reform acts will become at the very least watered down law.

            A. Dodd Frank

            With regard to the continuing implementation of Dodd Frank, before Donald Trump was elected, the SEC asserted that it was going to try to “finalize proposals made in 2015 for the remaining executive compensation rulemakings required by the Dodd-Frank Act, including disclosure of whether a company allows executives to hedge the company’s stock, disclosure of pay versus performance measures of executive compensation, and new disclosures and rules for clawing back incentive compensation erroneously awarded.” [48] However, after Donald Trump is sworn in as President of the Untied Stated, finalizing these proposal will most likely not be a priority.  

            In addition, the SEC security-based swap rules required by Title VII of the Dodd-Frank Act were in the process of being finalized in 2017.[49]  Similar to the other initiatives in Dodd Frank, with the election of Donald Trump, the new appointed head of the SEC will likely put the rules governing security-based swap’s business conduct and their requirements for capital, margin and asset segregation in jeopardy.[50]

              B. DOL Fiduciary Rule

             The Department of Labor’s Fiduciary Duty Rule has been intensely debated over how the rule will play out in practice. The Department Labor enacted the rule in order to protect and educate retirement plan investors.[51] The DOL believes that these investors face important choices in savings for retirement in their IRAs and employee benefit plans.[52] The DOL plans on addressing these problems associated with conflicts of interest, by balancing the need to better protect retirement savings while minimizing disruptions to the many good practices and good advice that the industry provides.[53] The DOL believes that this rule would impose basic standards of professional conduct that are intended to address an annual loss of billions of dollars over the years to ordinary retirement investors as a result of conflicted advice.[54]  The DOL has also enclosed a regulatory analysis which compares and contrasts the losses in monetary value from conflicted advice and the gains that will result from the implementation of the rule.[55]

            Furthermore, it is important to define who is a fiduciary investment adviser for the purpose of the rule.  For instance, although the rule would allow certain broker-dealers, insurance agents and others that act as investment advice fiduciaries to continue to receive a variety of common forms of compensation, this group of securities professionals must still adhere to standards aimed at ensuring that their advice is impartial and in the best interest of their customers.[56] According to the DOL, firms and advisers will be required to make prudent investment recommendations without regard for their own interests, or the interests of those other than the customer, charge only reasonable compensation, and make no misrepresentations to their customers regarding recommended investments. [57]

            With regard to the DOL Fiduciary Rule, according to Richard Ketchum, the chairman and CEO of FINRA, he “completely agrees with DOL that those broker-dealer conflicts are real and they need to be addressed, and that firms have failed in managing their conflicts on too many occasions.”[58] While Ketchum noted that FINRA “disagrees in details” with the DOL’s proposed fiduciary rule, he has “tried to provide constructive comments that identified potential changes.”[59]

            However, like the Dodd Frank, the DOL Fiduciary Rule is also in jeopardy of actually becoming implemented once the Trump administration has settled into Washington. President-Elect Trump never has specifically addressed the rule but there is no doubt that there are members of his inner-circle that believe the rule should be gutted.

    VI. Conclusion

            NASAA, the SEC and FINRA work with the hope that securities industry professionals, especially advisers and brokers, consider the broad issues and the targeted topics addressed in their respective annual updates. It is vital that everyone pay close attention to information that comes from NASAA, the SEC and FINRA and utilize the information as part of all firms’ risk management in order to better protect investors, the markets and the firms themselves.


[1] "NASAA Members Adopt Model Act to Protect Seniors and Vulnerable Adults - NASAA." NASAA. Page 1. 17 Feb. 2016. Web.

[2] Id. at 1. 

[3] Id. at 1.

[4] Id. at 1.

[5] Id. at 1.

[6] Notice of Request for Public Comment Regarding a Proposed Amendment to the NASAA Statement of Policy Regarding Real Estate Investment Trusts - NASAA." NASAA. Page 1. 27 July 2016. Web

[7] Id. at 1

[8] Id. at 1.

[9] Id. at 1.

[10] Id. at 1.

[11] Id. at 1.

[12] "Top Investor Threats - NASAA." NASAA. Page 1. 03 Oct. 2016. Web.

[13] Id. at 1.

[14] Id. at 1.

[15] Id. at 1.

[16] Id. at 1.

[17] Id. at 1.

[18] "Top Investor Threats - NASAA." NASAA. Page 1. 03 Oct. 2016. Web.

[19] Id. at 1.

[20] Office of Compliance Inspections and Examinations, U.S. Securities and Exchange Commission. "Examination Priorities for 2016."National Exam Program Examination Priorities for 2016. Page 2. 2016. Web.

[21] Id. at 2.

[22] Id. at 2.

[23] Id. at 2.

[24] Id. at 2. 

[25] Id. at 2.

[26] Office of Compliance Inspections and Examinations, U.S. Securities and Exchange Commission. "Examination Priorities for 2016." National Exam Program Examination Priorities for 2016. Page 3. 2016. Web.

[27] Id. at 3.

[28] Id. at 3.

[29] Id. at 3. 

[30] Id. at 3.

[31] Id. at 3.

[32] Office of Compliance Inspections and Examinations, U.S. Securities and Exchange Commission. "Examination Priorities For 2016." National Exam Program Examination Priorities for 2016. Page 3. 2016. Web.

[33] Id. at 4.

[34] Id. at 4.

[35] Financial Industry Regulatory Authority: 1-12. 2016 Regulatory and Examination Priorities Letter. Page 1. 5 Jan. 2016. Web.

[36] Id. at 1.

[37] Id. at 1.

[38] Id. at 2.

[39] Id. at 2.

[40] Id. at 2.

[41]  Financial Industry Regulatory Authority: 1-12. 2016 Regulatory and Examination Priorities Letter. Page 9. 5 Jan. 2016. Web.

[42] Id. at 9.

[43]  Financial Industry Regulatory Authority (2011): 1-12. 2016 Regulatory and Examination Priorities Letter. 5 Jan. 2016. Page 5.Web.

[44] Id. at 5.

[45] Id. at 6.

[46] Id. at 6.

[47] Id. at 6.

[48] "Speech." | Chairman's Address at SEC Speaks - "Beyond Disclosure at the SEC in 2016" 19 Feb. 2016. Page 1.Web.

[49] Id. at 1.

[50] Id. at 1.

[51] "UNITED STATES DEPARTMENT OF LABOR." FAQs: Conflicts of Interest Rulemaking — Protect Your Savings — U.S. Department of Labor. Page 1. Web.

[52] Id. at 1.

[53] Id. at 1.

[54] Id. at 1.

[55] Id. at 1.

[56] Id. at 1.

[57]  "UNITED STATES DEPARTMENT OF LABOR." FAQs: Conflicts of Interest Rulemaking — Protect Your Savings — U.S. Department of Labor. Page 1. Web.

[58] "FINRA's Top Exam Priorities for 2016." Investment News & Analysis for Financial Advisors. 05 Jan. 2016. Web.

[59] Id. at 1.

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