Quarterly SEC developments roundup

Robert Jackson and Hester Peirce were sworn into office as Securities and Exchange Commission (SEC) Commissioners on January 11, 2018 joining Chairman Jay Clayton and Commissioners Stein and Piwowar. Robert Jackson was most recently a New York University Law Professor, and Hester Peirce was a Senior Research Fellow at George Mason University. With their installations, the SEC which has five Commissioners is now complete.

On December 11, 2017, the SEC announced that it issued an order to Munchee Inc., a block-chain based food review service, halting its $15 million initial coin offering (ICO) before any tokens were delivered to investors. The SEC found that Munchee’s conduct constituted an offering of unregistered securities.

The SEC halted an ICO on December 4, 2017 by PlexCorps for claiming investment returns of 1,354% in less than 29 days. To date, the SEC has not promulgated or adopted any regulations concerning ICOs or distributed ledger technologies (DLT). The SEC issued an Investor Bulletin in July 2017 that discussed potential investor risks that may arise from participating in initial coin offerings.

The SEC organized a Cyber Unit in September 2017 that focuses on misconduct involving distributed ledger technology and ICOs, the spread of false information through electronic and social media, brokerage account takeovers, hacking to obtain non-public information and threats to trading platforms. The SEC has also formed a DLT Working Group that focuses on emerging applications of DLT in financial services.

On November 30, 2017, the SEC announced awards of more than $16 million to two whistleblowers. The SEC has issued a total of $175 million in whistleblower awards since its first award in 2012, and more than $1 billion in financial remedies since the start of the program.

On November 30, 2017, the SEC ratified its prior appointments of its administrative law judges, reversing its many-decades long position that its judges did not require approval by the Commissioners. The SEC approval of its administrative law judges is important because it now throws into doubt thousands of decisions made by its judges prior to their ratification by the Commissioners.

On January 16, 2018, the US Supreme Court agreed to resolve a circuit split over whether the hiring of SEC administrative law judges violates the US Constitution’s appointments clause. The SEC has reversed its historical position and now takes the position that its judges are “officers of the United States,” not mere employees, and, therefore, must be approved by the SEC Commissioners under delegated executive authority from the US President.

An appellate case in the Tenth Circuit agrees with the SEC’s new position that its judges are officers, and the D.C. Circuit disagrees with that position in Lucia v. SEC. The Supreme Court will resolve the ‘split in the Circuit Courts.’

There is a likelihood that the Supreme Court will resolve the case in the SEC’s favor, and in doing so, throw into doubt the legitimacy of thousands of decisions made by hundreds of administrative law judges who, like the SEC judges, have not been approved by the US President or a government official who was appointed by the President.

On October 26, 2017, the SEC issued three no-action letters designed to provide market participants with greater certainty regarding their US regulated activities as they engage in efforts to comply with the European Union’s Markets in Financial Instruments Directive (MiFID II). The no-action letters provide a path for market participants to comply with the research requirements of MiFID II in a manner that is consistent with the US securities laws.  More specifically and subject to certain conditions, broker-dealers may receive research payments from money managers in hard dollars or from advisory clients’ research payment accounts; money managers may continue to aggregate orders for mutual funds and other clients; and, money managers may continue to rely on an existing safe harbor when paying broker-dealers for research and brokerage.

The temporary no-action relief facilitates compliance with the new MiFID II research provisions while respecting the existing U.S. regulatory structure.

On September 14, 2017, the SEC issued an order in connection with the settlement of an enforcement proceeding against SunTrust Investment Services, Inc. (“Adviser”), a dually-registered investment adviser and broker-dealer, in connection with its alleged: (i) failure to seek best execution for client transactions in mutual fund shares; (ii) failure to fully and adequately disclose conflicts of interest related to the Adviser’s mutual fund share class selection process; and (iii) deficiencies in related compliance policies and procedures.

This order concerned clients who held either discretionary or non-discretionary wrap fee investment accounts managed by the Adviser. The order states that from December 2011 to June 2015, the Adviser, on behalf of these clients, purchased, recommended or held Class A or other mutual fund shares that charged a Rule 12b-1 fee, when less-expensive institutional class shares of the same mutual funds were available. Further, the order states that while the Adviser disclosed in its Form ADV Part 2A that it “may receive 12b-1 fees” as a result of investments in certain mutual funds in its advisory program and that such fees may present a conflict of interest, the Adviser failed to disclose that many of the Adviser’s recommended mutual funds offered a variety of share classes, including some that did not charge 12b-1 fees. In addition, the order states that the Adviser failed to disclose to affected clients that an Adviser representative could purchase, hold, or recommend - and in certain instances did purchase, hold, or recommend - mutual fund investments in share classes that paid 12b-1 fees to the Adviser. The order indicates that the Adviser ultimately shared these fees with its representatives as compensation, even though such clients were eligible to invest in share classes of the same mutual funds that did not charge such fees and were less expensive.

The order states that the Adviser’s failure to make “adequate disclosures concerning its [representatives’] share class selections was misleading to investors in light of [the Adviser] investing its clients in more expensive mutual fund share classes when lower-cost options of the same funds were available.” The order further states that the practice of investing clients in mutual fund share classes with 12b-1 fees rather than lower-fee share classes was also inconsistent with the Adviser’s duty to seek best execution for its clients.

Based on these findings, the SEC alleged that the Adviser violated various provisions of the Investment Advisers Act of 1940, including Section 206(2) (an antifraud provision), Section 206(4) and Rule 206(4)-7 thereunder (requiring written policies and procedures reasonably designed to prevent Advisers Act and rule violations), and Section 207 (making an untrue statement in SEC filings). Without admitting or denying the SEC’s findings, the Adviser agreed to pay a civil penalty of $1.1 million and about $40,000 in disgorgement and pre-judgment interest.

On October 4, 2017, SEC Chairman Jay Clayton stated that it is a priority of the SEC to promulgate and adopt a rule that defines the fiduciary duty of broker-dealers for all investor assets, including assets under the Employee and Retirement Income Security Acts of 1975. With the effectiveness of the US Department of Labor’s Fiduciary Rule postponed until July 1, 2019, the SEC has 18 months to promulgate and adopt its version of a fiduciary standard.  How the SEC and Department of Labor will harmonize two different fiduciary standards, is an open question at this point.