BOSTON MUTUAL FUND DISTRIBUTOR ROUNDTABLE April 9, 2019 SPEAKERS - - PowerPoint PPT Presentation

April 9, 2019

BOSTON MUTUAL FUND DISTRIBUTOR ROUNDTABLE

SPEAKERS

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Thomas Grygiel Principal Consultant ACA Compliance Group Amy Shelton Chief Compliance Officer American Century Investment Services Inc. Michael J. Mahoney Chief Compliance Officer John Hancock Funds & John Hancock Distributors Tamara Salmon Senior Associate Counsel ICI Richard F. Kerr Partner K&L Gates

• C. Todd Gibson

Partner K&LGates

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

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Recent Marketing Developments

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
• f 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

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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

• f hypothetical back tested performance in communications used with retail

investors does not comply with FINRA Rule 2210(d).”

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Update on SEC’s Share-Class Disclosure Initiative

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

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Increases in Attempted Frauds/Senior Exploitation

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

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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

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State Escheatment

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

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Regulatory Enforcement Actions

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

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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.

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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

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Examination Priorities

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

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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)

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Distribution Compliance Challenges

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

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CONTACT

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Thomas Grygiel ACA Compliance Group | Principal Consultant tgrygiel@acacompliancegroup.com Richard F. Kerr K&L Gates | Partner rkerr@klgates.com

• C. Todd Gibson

K&L Gates | Partner todd.gibson@klgates.com Michael J. Mahoney John Hancock Funds & John Hancock Distributors | Chief Compliance Officer mmahoney@jhancock.com Tamara Salmon ICI | Senior Associate Counsel tamara@ici.org Amy Shelton American Century Investment Services | Chief Compliance Officer amy_shelton@americancentury.com