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Financial Services Law Insights and Observations


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  • SEC proposes rules for addressing conflicts of interest raised by predictive data analytics

    Agency Rule-Making & Guidance

    On July 26, the SEC issued proposed rules under the Securities Exchange Act of 1924 and the Investment Advisors Act of 1940 to address certain conflicts of interest associated with the use of predictive data analytics, including artificial intelligence (AI) and similar technologies, “that optimize for, predict, guide, forecast, or direct investment-related behaviors or outcomes.” The SEC explained that broker-dealers and investment advisors (collectively, “firms”) are increasingly using AI to improve efficiency and returns but cautioned that, due to the scalability of these technologies and the potential for firms to quickly reach a large audience, any resulting conflicts of interest could result in harm to investors that is more pronounced and on a broader scale than previously possible.

    Based on existing legal standards, the proposed rules generally would require a firm to identify and eliminate, or neutralize, the effects of conflicts of interest that result in the firm’s (or associated persons) interests being placed ahead of investors’ interests. Firms, however, would be permitted to employ tools that they believe would address such risks and that are specific to the particular technology being used. Firms that use covered technology for investor interactions would also be required to have written policies and procedures in place to ensure compliance with the proposed rules, the SEC said. These policies and procedures must include a process for evaluating the use of covered technology in investor interactions and addressing any conflicts of interest that may arise. Firms must also maintain books and records related to these requirements. Comments on the proposed rules are due 60 days after publication in the Federal Register.

    Agency Rule-Making & Guidance Federal Issues Securities SEC Third-Party Risk Management Artificial Intelligence Securities Exchange Act Investment Advisers Act

  • SEC proposes new protections for crypto assets


    On February 15, the SEC proposed new rules to enhance protections for customer assets, including cryptocurrency assets, managed by registered investment advisers. (See also SEC Fact Sheet here.) The proposed rules would implement measures under the Investment Advisers Act of 1940 to address how client assets are safeguarded, and would broaden the definition of “asset class” to ensure investment advisers are protecting not only their clients’ securities and funds but also “other positions held in a client’s account,” including crypto assets.

    Under the proposed rules, investment advisers would be required to, among other things, segregate such crypto assets into separate accounts for safekeeping, prevent commingling of assets with the adviser’s or another related persons’ assets, and place crypto assets with a qualified custodian such as a federal or state-chartered bank or savings association, a registered broker-dealer or futures commission merchant, or certain foreign financial institutions. Foreign financial institutions would have to adhere to enhanced requirements to serve as a qualified custodian.

    In a statement accompanying the release of the proposed rules, SEC Chairman Gary Gensler stated that “advisers who trade an investor’s assets cannot circumvent the custody rule and the safeguards it provides.” Gensler added that the proposal would impose several recordkeeping requirements, and require, for the first time, that advisers and qualified custodians enter into written agreements to help guarantee that customer assets are being protected.

    Comments on the proposed rules are due 60 days after publication in the Federal Register.

    Securities Agency Rule-Making & Guidance Digital Assets Cryptocurrency Investment Advisers Act

  • SEC proposes new requirements for advisors that outsource services to third parties


    On October 26, the SEC proposed new oversight requirements for outsourced investment advisory services. The proposed rule, issued under the Investment Advisers Act of 1940, would prohibit registered investment advisers from outsourcing certain services and functions without conducting due diligence prior to engaging a third-party service provider. The proposed rule would apply to advisors that outsource certain “covered functions,” including services or functions necessary for providing advisory services in compliance with federal securities laws that—if not performed or negligently performed—would result in material harm to clients. Under the proposed rule, advisors would also be required to periodically monitor a third party’s performance and reassess whether it is appropriate to continue to outsource its services and functions. Additionally, the SEC is proposing corresponding amendments so that it may collect “census-type information” about third-party service providers, as well as amendments that would require advisors to maintain books and records related to the proposed rule’s oversight obligations.

    SEC Chairman Gary Gensler released a statement supporting the proposed amendments. “[T]hese rules, if adopted, would better protect investors by requiring that investment advisers take steps to continue to meet their fiduciary and other legal obligations regardless of whether they are providing services in-house or through outsourcing, whether through third parties or affiliates,” Gensler said, explaining that the increased use of third-party service providers “has led staff to make several recommendations to ensure advisers that use them continue to meet their obligations to the investing public. When an investment adviser outsources work to third parties, it may lower the adviser’s costs, but it does not change an adviser’s core obligations to its clients.”

    Commissioner Hester M. Peirce criticized the proposed rule, with Peirce claiming the proposal “may end up abrogating fiduciary duty and replacing it with [a] predefined approach to best interest—one not responsive to unique facts and circumstances.” She also expressed concerns related to the proposal’s potential impact on smaller advisors that may face disproportionate competitive challenges. Commissioner Mark T. Uyeda also dissented, expressing concerns over whether “there is any observable problem related to investment advisers’ oversight of service providers that necessitates the blanket imposition of specified oversight requirements.”

    Securities Agency Rule-Making & Guidance Third-Party Investment Advisers Act

  • SEC files charges against crypto-asset seminar operation


    On September 19, the SEC filed a complaint against a two individuals and the companies they controlled (collectively, “defendants”) in the U.S. District Court for the Southern District of Texas for allegedly operating an on-going fraudulent and unregistered crypto-asset offering targeting Latino investors. According to the SEC, the defendants allegedly raised more than $12 million from over 5,000 investors who paid for seminars to learn how to build wealth through crypto-asset trading. However, the SEC claimed that one of the individual defendants—who founded the company and actually had no education or training in investments or crypto assets—used the seminars to solicit investors to give their money to the company and then supposedly used the funds to conduct crypto asset and foreign exchange trading. In total, the SEC alleged the individual defendants made roughly $2.7 million in Ponzi payments, diverting nearly $8 million for their own personal use. The complaint charges the defendants with violating, or aiding and abetting violations of, the antifraud provisions of the Securities Act of 1933, the Securities Exchange Act of 1934, and the Securities Act. The company’s founder is also charged with violating the Investment Advisers Act of 1940. The complaint seeks a permanent injunction against the defendants, civil penalties, disgorgement of ill-gotten gains with prejudgment interest, and bars. The SEC stated in its announcement that, at the Commission’s request, the court issued a temporary restraining order to stop the offering, in addition to temporary orders freezing assets and granting additional emergency relief.

    Securities Courts Digital Assets SEC Enforcement Cryptocurrency Fraud Securities Act Securities Exchange Act Investment Advisers Act

  • SEC files charges in undisclosed transactions case


    On August 30, the SEC filed a complaint against two North Carolina-based executives, and their Malta-based registered investment adviser company (collectively, “defendants”) in the U.S. District Court for the Middle District of North Carolina for allegedly engaging in a fraudulent scheme involving undisclosed transactions. According to the SEC, the defendants “repeatedly recommended and entered into transactions that were not disclosed to and were not in the best interests of their clients.” Specifically, one of the executives allegedly “acquired 100% ownership of four North Carolina insurance companies [] and a reinsurance trust, which gave him control over hundreds of millions of dollars in premiums from their policyholders.” The complaint further stated that “[a]lthough the funds were supposed to be used to pay the policyholders’ insurance claims, [the executive] treated the funds as his own assets and used the money for any purpose he decided was in his best interest.” The SEC found that the executive allegedly conducted the schemes through “complex” investment structures and affiliate companies and allegedly used the proceeds to pay himself or to divert the funds to his other businesses. The complaint also noted that the defendants “breached their fiduciary duties to their advisory clients by engaging in numerous undisclosed related-party transactions and by misappropriating over $57 million in client funds” and over $21.4 million in advisory fees generated in connection with these schemes. The SEC’s complaint alleged violations of anti-fraud provisions of the Investment Advisers Act of 1940. The complaint seeks a permanent injunction against the defendants, disgorgement of ill-gotten gains, penalties, bars, and other equitable relief.

    Securities SEC Enforcement Transactions Investment Advisers Act Courts

  • SEC settles allegations regarding robo-adviser service


    On June 13, the SEC announced a settlement with three subsidiaries of a financial services holding company (collectively, “respondents”) regarding their robo-adviser service. The order, which the respondents consented to without admitting or denying the findings, imposes a civil money penalty of $135 million and a total of $52 million in disgorgement. The order also provides that the respondents must cease and desist from committing or causing any future violations of the antifraud provisions in the Investment Advisers Act.

    Securities Enforcement Cease and Desist Investment Advisers Act Robo-Advisor Service

  • SEC levies $18 million fine for mishandling MNPI


    On November 19, the SEC announced that an investment company affiliate of a global consulting firm agreed to pay $18 million to settle alleged compliance failures. The affiliate provided investment services to current and former partners and employees of the consulting firm. The SEC alleged that the affiliate failed to maintain adequate policies and procedures to prevent firm partners from misusing material nonpublic information (MNPI) gained from consulting clients to make investment decisions. The SEC alleged that the affiliate invested hundreds of millions of dollars in companies that the firm was advising. According to the SEC, certain firm partners oversaw these investments and had access to MNPI, such as financial results, planned bankruptcy filings, mergers and acquisitions, among other things, as a result of the consulting work they did for the firm.

    According to the cease-and-desist order, allowing active firm partners, “individuals who had access to MNPI about issuers in which [affiliate] funds were invested, to oversee and monitor [the affiliate’s] investment decisions presented an ongoing risk of misuse of MNPI.” The SEC claimed that the affiliate allegedly violated Sections 204A and 206(4) of the Investment Advisers Act of 1940 (related to the prevention and misuse of MNPI and prohibited investment adviser transactions), as well as Rule 206(4)-7 (concerning compliance policies and procedures). Without admitting or denying the findings, the affiliate consented to the entry of the cease-and-desist order, a censure, and the $18 million penalty.

    Securities SEC Enforcement Compliance Investment Advisers Act

  • SEC takes emergency action against investor fraud scheme


    On August 13, the SEC announced it obtained a temporary restraining order through an emergency action filed against an individual and his two entities, which allegedly induced dozens of consumers to invest by falsely claiming that their funds would be used to acquire real estate and to make commercial loans. According to the SEC, the individual misappropriated the vast majority of the investors' funds to pay for his residences, cover credit cards bills, and make student loan payments. The complaint also alleges that the individual hid the fraud from investors by providing investors with false valuations, among other things. The SEC’s complaint alleges violations of the antifraud provisions of the Securities Act of 1933, the Securities Exchange Act of 1934, the Investment Advisers Act of 1940, and seeks a permanent injunction against the defendants enjoining them from future violations, disgorgement of all ill-gotten gains, and civil penalties, among other things.

    Securities SEC Enforcement Investigations Securities Act Securities Exchange Act Investment Advisers Act

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