Monday, July 09, 2018

SEC Investor Advocate’s 2019 objectives include broker-dealer standards of conduct, Kokesh concerns

By Amanda Maine, J.D.

The SEC’s Office of the Investor Advocate (OIA) has submitted a report on its objectives for fiscal year 2019, which begins on October 1, 2018. The report expects the Commission to examine the impact on investors from proposed changes in the standards of conduct for broker-dealers, updates to its transfer agent and ETF rules, and enhancements to disclosures by mutual funds and variable annuities. The report also states that the SEC is considering possible approaches to help restore its ability to impose disgorgement orders after five years in the wake of the Kokesh decision, which may require legislative intervention.

OIA will continue to support the SEC’s efforts to modernize the SEC’s disclosure requirements in FY 2019, according to the report. OIA said that making disclosure more effective can be a win for both investors and for companies, although it stressed it would remain vigilant to guard against reducing disclosures that are important to investors. In an effort to stem the falling rate of initial public offerings, OIA recognizes that early efforts toward that goal are centered on reducing compliance burdens and advises that it has engaged in investor outreach about rulemaking on disclosure obligations. OIA also recommends using a holistic approach for creating a “healthy ecosystem” for small public companies.

Regarding equity market structure, the report states that in FY 2019, OIA will examine the elements of its transaction fee pilot for National Market System (NMS) stocks to determine whether it can provide the SEC with useful data for evaluating equity market structure reforms, including considering whether lowering these fees on a permanent basis will improve market quality for investors. In addition, the SEC will hold two more roundtables on equity market structure on the topics of access to markets and market data and regulatory approaches to addressing retail fraud.

The SEC’s Fixed Income Market Structure Advisory Committee (FIMSAC) adopted a recommendation for a pilot program to study the effects on the market of changing the reporting regime for block-size trades in corporate bonds by introducing a delay for larger trades. OIA will continue to monitor FIMSAC’s discussions and recommendations in FY 2019, the report advises. Other issues relevant to fixed income market structure OIA will review include rulemakings impacting municipal securities and corporate bond investors.

OIA expressed its appreciation to the Commission for its work on the standards of conduct for broker-dealers and investment advisers, including proposed Regulation Best Interest, proposed Form CRS (client relationship summary), and restrictions on broker-dealers using certain titles. However, while the proposed rulemakings reflect some of OIA’s views, they do not represent its strongest policy preferences, OIA explains. OIA recommends that broker-dealers be required to mitigate—and not merely disclose—material conflicts for situations where the broker-dealer cannot form a reasonable basis for believing that the disclosure does address those conflicts. In addition, the proposed prohibition on labeling should not be limited to “adviser” and “advisor,” but should be expanded to the use of any label implying an ongoing relationship of trust with an investor.

OIA supports the SEC’s efforts to allow ETFs satisfying certain conditions to operate without having to obtain an exemptive order; however, it will examine more closely the treatment of leveraged and inverse ETFs that have sought or obtained exemptive relief. OIA also supports the development of a summary prospectus for variable annuities, recommending one based on the mutual fund summary prospectus. In addition, OIA anticipates considering whether proposed changes to transfer agent regulations would benefit retail investors.

The report also addressed the Supreme Court’s holding in SEC v. Kokesh, which barred the Commission from obtaining disgorgement beyond the five-year statute of limitations under 28 USC §2462. OIA notes that the co-directors of the Division of Enforcement have testified that the decision has already had a significant impact because many complex securities frauds take significant time to uncover and investigate, especially where the fraud schemes are well-concealed and not discovered until after many years, which limits the amount of funds that can be returned to investors who were tricked early in an ongoing scheme. According to the report, following Kokesh, the Enforcement Division had to forego over $800 million in disgorgement.

Describing the impact on retail investors of the Kokesh decision as “troubling,” the report observes that Enforcement Co-Director Steve Peikin has testified that the Division would like to work with legislators to either design a proposal consistent with the ruling or to respond to any legislation that Congress may introduce. OIA intends to work with the Division and others to explore how to protect retail investors in the wake of Kokesh, according to the report.