SEC | Solomon Exam Prep

Exam Alert: SEC clarifies supervisory liabilities of legal and compliance personnel

On September 30, 2013, the Division of Trading and Markets of the SEC put out an FAQ detailing when legal and compliance personnel would or would not be held responsible for failing to supervise a broker-dealer employee that commits a violation. Legal and compliance personnel are not, by default, considered supervisors, so they are not held responsible unless their position places them in a supervisory role. This can be determined by considering whether the personnel has the “requisite degree of responsibility, ability or authority to affect the conduct of another employee.” The Division lists several questions that can be used to ascertain whether the personnel has such responsibility, ability, or authority, but key elements are:

whether the company is structured in such a way that the personnel is clearly designated with responsibility,
whether the personnel can hire, reward, punish, or fire the employee, and
whether the personnel knew or should have known that he or she was responsible for preventing the violation.

Source: Frequently Asked Questions about Liability of Compliance and Legal Personnel at Broker-Dealers under Sections 15(b)(4) and 15(b)(6) of the Exchange Act

Further reading: United States: When Legal Or Compliance Personnel May Be Subject To Failure To Supervise Liability Under The Securities Laws

This alert applies to the Series 24, Series 26, Series 62, and Series 82.

Exam Alert: SEC changes broker-dealer financial responsibility rules

On October 21, 2013, the SEC will put into effect amendments to its financial responsibility rules for broker-dealers. These amendments include changes to the customer protection rule, net capital rule, books and records rules, and notification rule. Continue reading

On October 21, 2013, the SEC will put into effect amendments to its financial responsibility rules for broker-dealers. These amendments include the following changes:

Customer Protection Rule (Rule 15c-3-3)

-Carrying broker-deals that maintain customer securities and funds will be required to maintain a new segregated reserve account for broker-dealer accounts.

-The reserve requirement to protect customer cash will exclude cash deposits at affiliated banks and limit cash held at non-affiliated banks to no more than 15% of the bank’s equity capital.

-The rule will require disclosure, notice, and affirmative consent from the customer when their cash is “swept” to a money market or bank deposit product.

Net Capital Rule (Rule 15c3-1)

-The rule will require a broker-dealer to include liabilities assumed by a third party in the broker-dealer’s net worth if the third party is reliant on the broker-dealer to pay the liabilities.

-The rule will require a broker-dealer to count as a liability any contributed capital that may be withdrawn by an investor. Contributed capital that is withdrawn within a year of contribution must also be treated as a liability, unless the broker-dealer receives written permission for the withdrawal from its designated examining authority.

-Broker-dealers will be required to deduct from net capital the excess of any deductible amount over the amount permitted by SRO rules.

-Insolvent broker-dealers will be required to cease conducting a securities business.

Books and Records Rules (Rules 17a-3 and 17a-4)

-Large broker-dealers will be required to document their risk management controls.

Notification Rule (Rule 17a-11)

-The rule will establish new notification requirements for when a broker-dealer’s repurchase and securities lending activities exceed a certain threshold. Alternatively, a broker-dealer may instead report such activity monthly to its designated examining authority.

Source: SEC Release 2013-140: SEC Adopts Amendments to Financial Responsibility Rules for Broker-Dealers

This alert applies to the Series 24, Series 26, Series 7, Series 99, Series 82, Series 79, and Series 55.

Study Question of the Week: October 2, 2013 Edition

This week’s study question from the Solomon Online Exam Simulator question database is now available. Relevant to the Series 24 and Series 79. –ANSWER POSTED– Continue reading

This week’s study question from the Solomon Online Exam Simulator question database is now available.

Question (Relevant to the Series 24 and Series 79):

An issuer of publicly offered securities must file:

Answers:

A. Five copies of the preliminary prospectus with the SEC no later than the date that it is first sent to investors

B. Ten copies of the preliminary prospectus with the SEC no later than the date that it is first sent to investors

C. Five copies of the preliminary prospectus with the SEC at least 10 days prior to the date that it is first sent to investors

D. Ten copies of the preliminary prospectus with the SEC at least 10 days prior to the date that it is first sent to investors

Correct Answer: A

Rationale: An issuer of publicly offered securities must file five copies of the preliminary prospectus with the SEC no later than the date that it is first sent to investors.

Weekly study questions are from Solomon’s industry-leading Online Exam Simulator.

Exam Alert: SEC requires financial institutions to implement identity theft programs

On April 10, 2013, the SEC announced that it and the CFTC were implementing rules to require broker-dealers, mutual funds, investment advisers, and certain other entities to adopt programs to prevent identity theft. Continue reading

The programs should be designed to identify relevant red flags, and to detect and respond to such red flags. The programs must also be updated periodically. Staff should receive adequate training. Financial institutions must exercise appropriate and effective oversight of service provider arrangements.

The rules will become effective 30 days after publication in the Federal Register. The compliance date for the rules will be six months after their effective date.

Source: SEC Release 2013-57: SEC Adopts Rules to Help Protect Investors from Identity Theft

This alert applies to Series 24, Series 26, Series 65, Series 66, and Series 99.

Exam Alert: SEC clarifies standards for filing social media communications by investment companies

On March 15, 2013, the SEC issued guidance for investment companies regarding their communications over social media. Noting that investment companies have been filing certain communications unnecessarily, the SEC describes which types of communications should or should not be filed, providing examples of each. Continue reading

Communications that should be filed include:

-Discussion of the specific elements of the performance of a fund

-Promotion of the performance of a fund

-Communication initiated by the issuer that talks about the merits of the fund

Communications that do not need to be filed include:

-Mention of an investment company that does not address the investment merits of the fund

-Talking about performance with no mention of any specific element of a fund’s return

-Factual introductory statements that include a link to the fund’s prospectus

-Factual responses to queries that do not address the investment merits of a fund

To see examples of what needs to be filed and what does not, check out the SEC guidance.

For further analysis of the SEC release, along with a general discussion of the intersection of regulation and social media, check out the blog post by Augie Ray at http://www.experiencetheblog.com/2013/03/regulators-to-financial-service-stop.html. Mr. Ray, an ex-Forrester analyst (source), asserts that regulators are encouraging firms to make more active use of social media, and that this guidance is part of that trend.

Source: SEC Release 2013-40: SEC Issues Guidance Update on Social Media Filings by Investment Companies

This alert applies primarily to the Series 6, Series 7, and Series 26. It may also be relevant to the Series 24, Series 62, Series 82, Series 99.

Exam Alert: SEC requires broker-dealers to search for lost holders of securities

On December 21, 2012, the SEC approved new rules that require broker-dealers to conduct searches for holders of securities with whom they have lost contact. The new rules also requires “paying agents” (certain issuers, broker-dealers, transfer agents, and other entities) to notify certain persons in writing when the paying agent has sent the person a check that has not been negotiated. Continue reading

On December 21, 2012, the SEC approved new rules that require broker-dealers to conduct searches for holders of securities with whom they have lost contact. Currently, transfer agents are required to conduct such searches – the rule will expand the requirement to broker-dealers.

The new rules also requires “paying agents” (certain issuers, broker-dealers, transfer agents, and other entities) to notify certain persons in writing when the paying agent has sent the person a check that has not been negotiated. This notification is not required if the value of the check is less than $25.

The new rules will become effective 60 days after the date of publication of the release in the Federal Register.

Source: SEC Release 2012-277: SEC Approves New Rules Regarding Lost Holders of Securities

This alert applies to the Series 6, Series 7, Series 24, Series 26, Series 62, and Series 99.

Exam alert: SEC issues risk alert on “Pay-to-Play” practices

On August 31, 2012, the SEC issued a risk alert regarding compliance with MSRB rules. Specifically, the alert looks at failures to comply with Rule G-37, which prohibits a firm from doing business with a municipal issuer if a municipal finance professional of the firm donated money to an official of that issuer within the past two years. Continue reading

The alert identifies good practices implemented by brokers to ensure compliance with the rule. These practices include training programs for municipal finance professionals, self-certification of compliance with the rule, surveillance of unreported political contributions, and restriction on political contributions (when permitted by state or local law).

Source: SEC Issues Risk Alert on “Pay-to-Play” Prohibitions Under MSRB Rules (SEC Release 2012-173)

This alert applies to the Series 24, Series 7, and Series 99.

Exam Alert: SEC and CFTC define “swap,” “security-based swap,” and “mixed swap”

Effective October 12, 2012, the SEC and CFTC will put into effect rules that specify whether a given product counts as a “swap,” “security-based swap,” “mixed swap,” or none of the above. The new rules also require market participants to keep the same books and records for “security-based swap agreements” as would be required for swaps. Continue reading

The CFTC regulates swaps, the SEC regulates security-based swaps, and both agencies regulate mixed swaps. The CFTC regulates security-based swap agreements, but the SEC has antifraud authority over those products.

Products that are not swaps or security-based swaps include:

-insurance that falls under 1) the grandfather provision, 2) the product safe harbor, or 3) the enumerated product safe harbor

-security forwards

-consumer transactions

-commercial transactions

Products that are considered swaps include:

-Title VII instruments on interest rates and other monetary rates

-Title VII instruments on rates or yields of U.S. Treasuries and certain other exempt securities

-Title VII instruments on futures (other than futures on foreign government debt securities)

-broad-based index credit default swaps that require cash settlement or auction settlement

Products that are considered security-based swaps include:

-Title VII instruments on yields of a non-exempt debt security, loan, or narrow-based security index

-Total Return Swaps on a single security, loan, or narrow-based security index

-Title VII instruments on security futures

Products that are considered mixed swaps include:

-Total Return Swaps that include interest-rate optionality or a non-securities component

-broad-based index credit default swaps that require mandatory physical settlement

Products that may be swaps or security-based swaps:

-Title VII instruments based on futures contracts on certain foreign government debt securities

-index credit default swaps

-foreign exchange forwards

-foreign exchange swaps

-foreign currency options (other than foreign currency options traded on a national securities exchange)

-non-deliverable forward contracts involving foreign exchange

-currency and cross-currency swaps

-forward rate agreements

-contracts for differences

-certain combinations and permutations of (or options on) swaps and security-based swaps

Market participants may request a determination from the SEC and the CFTC of whether a product is a swap, a security-based swap, or a mixed swap.

Sources:

SEC Approves Rules and Interpretations on Key Terms for Regulating Derivatives (SEC Release 2012-130)

Further Definition of “Swap,” “Security-Based Swap,” and “Security-Based Swap Agreement”; Mixed Swaps; Security-Based Swap Agreement Recordkeeping (Federal Register publication)

This alert applies to the Series 62, Series 79, Series 99, Series 7, Series 66, and Series 65.

Exam Alert: SEC adopts definitions for security-based swap rules

Under the Dodd-Frank Act, the SEC and CFTC (Commodity Futures Trading Commission) regulate the OTC swaps market. On April 18, 2012, the SEC adopted rules that provide definitions for terms used in the law, specifying who will be subject to regulation. Continue reading

The rules provide two categories of persons subject to SEC registration: “security-based swap dealers” and “major security-based swap participants.” In essence, a security-based dealer is a person that regularly trades security-based swaps for their own account. A de minimis exemption exists for dealers who traded up to $3 billion worth of credit default swaps over the past year and up to $150 million worth of other security-based swaps. Note that there is a different de minimis threshold of $25 million for security-based swaps involving “special entities,” including certain government agencies.

A major security-based swap participant is a person who maintains a “substantial position” in any of the major security-based swap categories, or whose outstanding security-based swaps create “substantial counterparty exposure.” Note that hedging positions are not counted towards the “substantial position” threshold if the person is not a “highly leveraged financial entity,” meaning a financial entity with a ratio of liabilities to equity in excess of 12-to-1. Two tests are provided for determining “substantial position,” and two thresholds are provided for “substantial counterparty exposure.” The specifics of these tests and thresholds may be found in the SEC release, along with background information, a plan to phase-in the de minimis rule, a safe harbor to avoid being considered a major participant, and other details.

The rule will become effective 60 days after publication in the Federal Register, though the deadline for registration will be given in SEC’s final rules for registration of dealers and major participants.

Source: SEC Release 2012-67

This exam alert applies to the Series 62, Series 79, Series 99, Series 65, and Series 66.

Exam Alert: SEC releases risk alert on unauthorized trading

On February 27, 2012, the SEC released a risk alert providing suggestions for techniques and controls a firm may use to help avoid conducting unauthorized trades. The alert has a large focus on supervisory procedures, but also addresses other ways in which firms can make it harder for employees to engage in unauthorized trading. The alert identifies alternative methods to more readily detect unusual trading activity and stresses the importance of a culture of openness and compliance. Continue reading

Suggestions for supervisory procedures include:

-Have more than one chain of control be responsible for monitoring the integrity of the business, i.e. don’t have all your compliance personnel report to the same person.

-Managers and supervisors should understand any complex products and strategies being employed by traders.

-Supervisors should engage in discussions with traders and portfolio managers and address positions that are unusual (given the strategies and/or client objectives involved).

-Make sure the payment structure for traders and supervisors encourages responsible risk-taking.

-Try to avoid having one person or desk fulfill multiple roles.

-Have an “open-door” policy that encourages traders to report unexpected losses promptly.

-Limit trader access to their appropriate portfolios – don’t let them keep access to ones that they are no longer authorized to trade in.

-Consider additional controls (several are listed in the alert).

Other suggestions include:

-When an employee transfers into the trading department, remove any prior system access he or she had.

-Have controls in place to confirm extended settlement trades and rollovers.

-Review delays and discrepancies in the customer trade confirmation process to check for unauthorized trading.

-Require mandatory vacations for traders with no remote access to accounts, then assign their portfolio(s) to a supervisor or experienced trader for the duration. Use this time to check for unusual activity.

-Have the audit and compliance departments review trading strategies, business performance, and risk profile.

-If the firm has multiple recordkeeping systems, try to integrate them.

-Test the controls put in place to discourage unauthorized trading.

-Maintain a corporate culture of honesty, integrity, accountability, and responsible risk-taking.

Source: SEC Release 2012-33

This exam alert applies to the Series 24, Series 26, Series 6, Series 7, Series 62, Series 79, Series 82, and Series 99.