Editor’s letter

Journal of Investment Compliance

ISSN: 1528-5812

Article publication date: 28 October 2014



Davis, H. (2014), "Editor’s letter", Journal of Investment Compliance, Vol. 15 No. 4. https://doi.org/10.1108/JOIC-09-2014-0046



Emerald Group Publishing Limited

Editor’s letter

Article Type: Editor’s letter From: Journal of Investment Compliance, Volume 15, Issue 4

Dan Nathan and Libby Greismann explain that as cyber threats and breaches become more commonplace, the SEC has emphasized the “compelling need for stronger partnerships between the government and private sector” to examine and strengthen cybersecurity practices. The SEC’s March 26 Cybersecurity Roundtable and subsequent Risk Alert were the first steps in what is likely to be a crackdown on broker-dealers’ cybersecurity readiness plans and practices. Firms would do well to identify aspects of their cybersecurity policies and procedures that do not conform to the SEC’s expectations, and to adjust where necessary, in order to demonstrate a good faith effort should the firm be examined or audited.

Brian House, Pam Johnston, and Courtney Worcester discuss the first enforcement matter brought by the SEC for retaliation against a whistleblower under the Dodd-Frank Wall Street Reform and Consumer Protection Act. Prior to this, although the SEC had repeatedly warned that it had the authority to bring such actions, it had not followed through. Having broken the ice, the SEC is likely to bring additional actions. Companies need to have a plan in place for how to deal with a whistleblower once allegations are made and this case illustrates the difficulty that a company will have in balancing two competing interests: isolating or limiting a whistleblower’s ability to disclose additional information while at the same time trying to maintain the status quo with the employee so as not be accused of retaliation.

Domenick Pugliese, Michael Rosella and David Hearth explain a guidance update recently issued by the USA Securities and Exchange Commission (SEC) Division of Investment Management that furthers the SEC’s goal of clear and concise, user-friendly disclosure by focusing on certain specified requirements of Form N-1A and the rules under the Securities Act of 1933. They discuss five areas where the SEC staff had been providing significant numbers of comments related to mutual fund disclosure after the adoption of the amendments to Form N-1A in 2009: summarizing a fund’s principal strategies and risks clearly and concisely, using plain English and avoiding overly technical terms, including only required or permitted information in the summary section, not including non-principal investment strategies and risks in a prospectus, and avoiding cross-references to the shareholder reports or the Statement of Additional Information (SAI) required by Form N1-A.

Richard Kerr summarizes a speech in which Norm Champ, Director of the SEC’s Division of Investment Management discussed the rise of open-ended mutual funds pursuing alternative investment strategies that have historically been the province of private funds; risks associated with valuation, liquidity, leverage and disclosure that are common to all alternative mutual funds; and a fund board’s obligation to review and approve the fund’s compliance program, to make sure the adviser is providing the board with sufficient and appropriate information to execute its statutory and fiduciary obligations, to implement policies and procedures to monitor for conflicts of interest, and to make sure the fund is named appropriately in light of its particular investment strategies and risks.

Hartmut Renz, Ingrid Kalisch, Sandra Pfister, Stuart Axford, and George Williams, Jr. explain the practices that the European Securities and Markets Authority (ESMA) recommends for investment firms and national competent authorities to implement when it comes to structured retail products (SRPs), in order to ensure sound product governance arrangements and the consistency of supervisory practices needed for adequate investor protection across the European Union. Examples of SRPs might include mortgage-backed securities and other securitized debt instruments. A guiding principle is to recommend investment instruments that are appropriate for a particular investor and do not have complexities or risk profiles that the investor cannot understand. Following the Markets in Financial Instruments Directive (MiFID) 1 in 2004, which was designed to foster investor protection throughout Europe, ESMA is now focusing on structured retail products and complex products, and encouraging national regulatory bodies to focus their work on investor protection, product governance processes in investment firms, and occasions requiring product interventions by regulators. ESMA’s approach is building a bridge between MiFID 1 and MiFID 2, which should be implemented by the end of 2016. MiFID 2 is developing a product governance process for investment firms and a product intervention process for regulators.

Winston Penhall and Jacqui Hatfield explain practical marketing implications of the EU Alternative Investment Fund Managers Directive (AIFMD) for USA fund managers that are not regulated in the EU and want to access EU investors. A non EU alternative investment fund (AIF) manager must register separately with the regulator of each EU member state under its national private placement regime for each AIF to be marketed in that country and comply with various reporting, disclosure and other requirements of the AIFMD.

Lukas Prorokowski notes that the AIFMD makes fundamental changes to depository liability and managing counterparty risk by making a depository bank liable for any losses to investor assets, even those held within third-party custodians appointed by the depository. Depositories are having to scrutinize their prime broker relationships. Depositories will also need to calculate the probability of default of their sub-custodians and use complex credit models to calculate any capital requirements under the fourth Capital Requirements Directive (CRD IV). With these enhanced requirements and regulatory pressures, he sees a strong possibility that only the largest and strongest players will remain in the securities depository and custody business and many of the other marginal players will exit.

Veronica Rendon, John Freedman, and Adam Reinhardt address the Supreme Court’s June 2014 decision in Halliburton Co. v. Erica P. John Fund, Inc., a much anticipated decision reaffirming a key legal point that permits investors to pursue securities fraud claims on a class or collective basis. While the Supreme Court recognized in its 1988 Basic Inc. v. Levinson decision that investors could proceed collectively, that decision was controversial at the time and had been extensively challenged in the economic and academic literature, leading a number of Justices to suggest that Basic should be overturned. Accordingly, there was considerable speculation among the bar that the Supreme Court might be prepared to overturn Basic, which would have made it exceedingly difficult for investors to recover their losses on a collective basis. Contrary to this speculation, Halliburton affirmed the core holding of Basic, meaning that securities fraud class action suits may continue to be brought.

Terence Healy, Amy Greer, and Daniel Herbst note that for decades, the SEC maintained an internal policy of accepting settlements with defendants in enforcement actions without requiring defendants to admit the alleged wrongdoing known as the “neither admit nor deny policy.” In a high profile 2011 post-financial crisis opinion, USA District Court Judge Rakoff of the Southern District of New York rejected an SEC “neither admit nor deny” settlement agreement with Citigroup and called the policy into question. The opinion caused the SEC and other courts to reassess the policy and to begin requiring admissions of guilt in certain high-profile matters following the global economic crisis. An admission of guilt by a defendant creates significant risk of private civil liability or even criminal liability, and the opinion created an uncertain enforcement environment. The USA Court of Appeals for the Second Circuit recently restored some order in reversing the 2011 decision by Judge Rakoff and setting forth a more predictable framework for approving SEC settlements without admissions. The authors’ article describes the history of the no-admit policy, the opinion by Judge Rakoff, the Second Circuit decision, and its implication on enforcement actions.

Kristen Garry, Etienne Gelencsér, Eileen O’Pray, Naomi King, and Jeffrey Tate provide a timely and practical guide for non-USA funds that are in the process of evaluating their status under the USA Foreign Account Tax Compliance Act, commonly referred to as “FATCA,” and implementing new procedures to comply with FATCA. Although FATCA was enacted to reduce perceived tax evasion by USA persons holding assets through offshore accounts, it has the potential to affect a wide range of funds and investors, and non-USA funds will need to carefully evaluate their FATCA status to ensure that they are not subject to USA withholding tax. The article provides a general overview of the applicable rules and highlights some of the key aspects of FATCA compliance that may be relevant to non-USA funds.

Richard Kerr explains a FINRA enforcement action taken against a broker-dealer over (1) failure to waive mutual fund sales charges for certain eligible customers and (2) failure to establish, maintain, and enforce a supervisory system and written procedures reasonably designed to ensure eligible accounts received sales charge waivers as set forth in the mutual funds’ prospectuses. This settlement provides an important reminder for FINRA member broker-dealers of the need to ensure that eligible investors receive applicable sales charger waivers or are placed in the appropriate share class, and to establish, maintain, and enforce a supervisory system and written procedures reasonably designed to ensure eligible accounts received sales charge waivers as set forth in the mutual funds’ prospectuses.

Petter Gottschalk presents results from an empirical study of 21 investigation reports by fraud examiners who ae lawyers, auditors, and other professionals who investigate suspicions of financial crime by white-collar criminals. Having done several previous studies of police investigations into financial crime, he wanted in this study to find out how private investigators do it. Before making a comparison between police and private investigations, he wanted to establish some characteristics of fraud examination reports. That is the purpose of his article. Very little is known about actual fraud examination cases, since they are not published. Most known cases are from the USA, while this article is based on a sample of cases in Norway, which opens up an international perspective. Although it is too early to tell in his research, it seems to him that the quality of private fraud investigations varies even more than police investigations.

Henry Davis

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