BOSTON MUTUAL FUND DISTRIBUTOR ROUNDTABLE April 9, 2019
SPEAKERS C. Todd Gibson Thomas Grygiel Partner Principal Consultant K&LGates ACA Compliance Group Michael J. Mahoney Richard F. Kerr Chief Compliance Officer Partner John Hancock Funds & John K&L Gates Hancock Distributors Amy Shelton Tamara Salmon Chief Compliance Officer Senior Associate Counsel American Century Investment ICI Services Inc. 2
DISCUSSION TOPICS • Recent Marketing Developments – SEC Proposed Test-the-Waters Rule – FINRA Interpretative Letter related to use of Pre-Inception Index Performance • Update on the SEC’s Share-Class Selection Disclosure Initiative • Increases in Attempted Frauds/Senior Exploitation – FINRA Rule 2165 • State Escheatment Issues and the IRS Revenue Ruling • Regulatory Enforcement Actions and Examination Priorities – Notes from the field – Practical implications for the industry with the SEC’s use of analytics • Distribution Compliance Challenges 3
Recent Marketing Developments 4 4
SEC PROPOSED TEST THE WATERS RULE • Proposed Rule 163B under the Securities Act which would allow all issuers, including investment companies, to engage in test-the- waters communications with certain institutional investors • Communications could be made either prior to or following the date of filing of a registration statement related to such offering • Exception would be from Securities Act registration statement requirement (and not from the Investment Company Act) • Comments on the Proposed Rule are due April 29, 2019 19
PRE-INCEPTION INDEX PERFORMANCE • FINRA Interpretive Letter to Foreside (Jan. 31, 2019) – Permits pre-inception index performance (“PIP”), a form of backtesting to be used by passively managed open-end funds – Natural extension of the relief granted to Alps Fund Distributors in 2013 related to the use of PIP data in communications to exchange traded products – Only permitted in communication that is distributed or made available to Institutional Investors but does not include a member's internal communications – “...this letter does not affect FINRA's long standing position that the presentation of hypothetical back tested performance in communications used with retail investors does not comply with FINRA Rule 2210(d).” klgates.com 6
Update on SEC’s Share-Class Disclosure Initiative 7 7
SHARE-CLASS SELECTION DISCLOSURE INITIATIVE • On 2/12/2018 SEC Enforcement staff announced a “Share Class Disclosure Initiative” • Self-reporting program – Investment advisers that failed to disclose receipt of 12b-1 fees – Recommending that clients invest in, a 12b-1 fee-paying share class when a lower-cost share class of the same fund was available • Standardized settlement terms • Staff noted that mutual fund share class selection practices are priorities for both Enforcement and OCIE
2019 SETTLEMENTS • Settlements with 79 investment advisors who charged investors too much to buy mutual funds and failed to adequately disclose related conflicts of interest • Standardized Terms: – Combined the firms will repay investors $125 million – None of the firms will pay a fine – Each agreed to review and correct all relevant disclosure and evaluate “whether existing clients should be moved to an available lower-cost share class and move clients, as necessary”. • The SEC continues to evaluate additional self-reports
Increases in Attempted Frauds/Senior Exploitation 10 10
INCREASES IN ATTEMPTED FRAUDS/SENIOR EXPLOITATION Recurring priority in FINRA annual letter • Deficient Quantitative Suitability determination or related controls • Overconcentration in illiquid securities in client portfolios • Securities offered as cash alternative in a low interest rate environment • Inconsistent share class recommendations 11
INCREASES IN ATTEMPTED FRAUDS/SENIOR EXPLOITATION Requirements: • Effective February 5, 2018 FINRA Rule 4512 Trusted contact “Reasonable” efforts to obtain a trusted contact FINRA Rule 2165 Placing a hold on the disbursement of funds when suspected exploitation of a senior account Best practices 12
State Escheatment 13 13
STATE ESCHEATMENT • Summary of state escheatment laws • Recent trends in state escheatment efforts • IRS Revenue Ruling 2018-17 (Withholding and Reporting With Respect to Payments From IRAs to State Unclaimed Property Funds) • Fund industry efforts − Shareholder outreach − Closer monitoring of inactive accounts − ICI Abandoned Property Working Group 14
Regulatory Enforcement Actions 15 15
REGULATORY ENFORCEMENT ACTIONS • Conflicts of Interest – Share Class Selection Disclosure Initiative . SEC announced settlements with 79 investment advisers related to inadequate disclosures of conflicts of interest related to the sale of higher-cost mutual fund share classes – Merrill Lynch, Pierce, Fenner & Smith Incorporated, Advisers Act. Rel. No. 4989 (Aug. 20, 2018). • $8.9 settlement related to a failure to disclose conflict of interest in relation to its continuing relationship with a third-party manager offering products on Merrill platform • $575 million invested by Merrill retail clients • Decision-making process by internal committees put on hold in consideration of broader banking and other relationships with third-party manager 16
REGULATORY ENFORCEMENT ACTIONS • Cybersecurity – Voya Financial Advisors, Inc., Advisers Act. Rel. No. 5048 (Sep. 26, 2018). • $1 million settlement related to its failures in cybersecurity policies and procedures surrounding a cyber intrusion that compromised personal information of its customers • Resulted from Voya’s failure to adopt policies and procedures reasonably designed to comply with Regulation S-P, and failure to develop and implement a written Identity Theft Prevention Program under Regulation S-ID. 17
REGULATORY ENFORCEMENT ACTIONS • FINRA – Suitability – Thrivent Investment Management, Inc. (August 9, 2018) Citigroup Global Markets Inc. (September 7, 2018) • FINRA - Anti-Money Laundering – Seven Points Capital, LLC (August 3, 2018) – ICBCFS (May 11, 2018) • FINRA – Other – Failure to deliver prospectuses in connection with ETF sales – Failure to conduct due diligence on private placements 18
Examination Priorities 19 19
EXAMINATION PRIORITIES • Retail investor issues (focus on seniors and retirement savers) • Compliance and risk in registrants responsible for critical market infrastructure (e.g., transfer agents, clearing agencies) • FINRA and MSRB • [NEW FOR 2019] Digital assets (cryptocurrencies, tokens, ICOs) • Cybersecurity • AML 20
EXAMINATION PRIORITIES • OCIE Leadership Team Message: “ ….OCIE is increasingly leveraging technology and data analytics…to fulfill its mission.” • Digital Assets – Are digital currencies a “security” for federal securities law purposes?? – April 2, 2019: SEC’s “Strategic Hub for Innovation and Financial Technology” (FinHub) issues a Framework for Investment Contract Analysis of Digital Assets – TurnKey Jet, Inc. (SEC No-Action Letter, April 3, 2019) 21
Distribution Compliance Challenges 22 22
DISTRIBUTION COMPLIANCE CHALLENGES Distribution of investment products, including funds, presents many compliance challenges. Among these challenges are: • Fiduciary duty or suitability obligations (Regulation Best Interest) • Advertising of products in compliance with differing regulatory regimes • Suitability of investment products for investor • Selling Agreement Issues – Oversight of intermediaries – distribution in guise (still an issue) – Anti-money laundering 21
CONTACT C. Todd Gibson Thomas Grygiel K&L Gates | Partner ACA Compliance Group | Principal Consultant todd.gibson@klgates.com tgrygiel@acacompliancegroup.com Michael J. Mahoney Richard F. Kerr John Hancock Funds & John Hancock K&L Gates | Partner Distributors | Chief Compliance Officer rkerr@klgates.com mmahoney@jhancock.com Amy Shelton Tamara Salmon American Century Investment Services | ICI | Senior Associate Counsel Chief Compliance Officer tamara@ici.org amy_shelton@americancentury.com 24
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