Global asset management quarterly - North America

Quarterly SEC developments roundup

Author: Steven Howard

US Supreme Court to decide whether the SEC’s judges are constitutionally appointed

On April 23, 2018, the US Supreme Court will hear oral arguments in the Lucia v. SEC case to determine whether the SEC’s administrative law judges (ALJs) are constitutionally appointed.  There is a “circuit split” between the 10th Circuit and the D.C. Circuit which has led to the Supreme Court’s review. It is widely expected that the Supreme Court will agree with the 10th Circuit’s decision in Bandimere v. SEC and hold that the SEC’s ALJs are not constitutionally appointed.  However, there is considerable speculation about what remedy, if any, the Supreme Court will grant to defendants whose cases are currently pending before ALJs who have not been constitutionally appointed by the SEC Commissioners. The ultimate outcome of the Supreme Court’s decision may have broad implications not only for the SEC and its 5 ALJs, but also for the other 1,926 ALJs in the 36 other federal agencies that decide more than 700,000 cases each year.

The 5th Circuit Court vacates the highly controversial Fiduciary Rule

On March 15, 2018, the US Court of Appeals for the 5th Circuit vacated the Department of Labor’s (DOL) highly controversial Fiduciary Rule. The 5th Circuit Court held that the DOL exceeded its rulemaking authority under the Administrative Procedure Act when it adopted the Rule in 2017. The Court stated that the magnitude of the legal change that is contemplated by the DOL’s Fiduciary Rule requires an act of Congress. Circuit Court cases are binding only within each circuit. The D.C. Circuit has a similar pending case which may increase the likelihood of eventual US Supreme Court review.

In response to the 5th Circuit’s decision, the DOL announced that it will not enforce the Fiduciary Rule pending further review. However, the DOL did not withdraw the Rule.

Meanwhile, SEC Chairman Clayton has stated that one of his top regulatory priorities is consideration of an SEC enacted Fiduciary Rule.

SEC awards a record breaking $83 million to whistleblowers

On March 19, 2018, the SEC awarded a record $83 million to three whistleblowers tied to a 2016 settlement with Bank of America’s Merrill Lynch for misuse of customers’ funds. Merrill Lynch entered into a $415 million settlement agreement with the SEC for holding up to $58 billion a day in a clearing account rather than holding the customer cash in a reserve account. The SEC also said that Merrill Lynch engaged in complex options trading to artificially reduce the amount of the reserve cash it is required to hold for customers. The SEC has awarded more than $262 million to 53 whistleblowers since it began issuing awards in 2012.

Theranos CEO Elizabeth Holmes settles massive fraud case with the SEC

On March 14, 2018, Theranos Inc. and its CEO Elizabeth Holmes agreed to settle massive fraud charges for deceiving investors with exaggerated statements about the company’s blood testing capabilities. Theranos was once hailed as a Silicon Valey star with a $9 billion valuation based on false claims that it could diagnose 200 medical conditions from a single drop of blood. Theranos raised more than $750 million from investors based on these false claims.  Holmes agreed to give up control of Theranos, pay a $500,000 fine and not serve as an officer or director of a public company for 10 years.

SEC adopts cybersecurity policy and guidance

On February 21, 2018, the SEC approved a statement and interpretive guidance to assist public companies in preparing disclosures about cybersecurity risks and incidents. The SEC guidance focuses on the need for public companies to review their controls and procedures for dealing with cyberattacks.

SEC continues to actively pursue fraudulent cryptocurrency schemes

On April 6, 2018, the SEC obtained a court order freezing more than $27 million in trading proceeds from an allegedly illegal distribution and sale of restricted stock in Longfin Corp., a purported cryptocurrency company and three of its officers.

On April 2, 2018, the SEC charged two co-founders of CentraTech Inc., a purported financial services start-up, with orchestrating a fraudulent initial coin offering that raised more than $32 million. The defendants have also been criminally charged.

On February 21, 2018, the SEC charged BitFinder and its founder for operating an unregistered securities exchange and defrauding users of that exchange.

On February 16, 2018, the SEC suspended trading in three companies, Cherubim Interests Ins., PDX Partners Inc., and Victura Construction Group Inc. for questionable statements the companies made regarding the acquisition of cryptocurrency and blockchain technologies.

On January 30, 2018, the SEC obtained a court order halting an alleged fraudulent initial coin offering by AriseBank which claimed to be the world’s first “decentralized bank.”

US AML laws on “beneficial ownership” fully effective beginning May 11

Author: Kathleen A. Scott

In May 2016, the Financial Crimes Enforcement Network (FinCEN), the U.S. agency tasked with issuing anti-money laundering (AML) regulations, issued final regulations requiring that certain categories of financial institutions identify the beneficial owners of their legal entity customers. The regulations were effective July 2016, but only applicable to accounts opened on or after May 11, 2018.

The regulations are limited to certain categories of financial institutions (“covered financial institutions”): banking organizations, securities broker-dealers, mutual funds, futures commission merchants and introducing brokers in commodities.

These covered financial institutions are required to maintain a written risk-based customer identification program (“CIP”) that, at a minimum, includes obtaining, verifying and retaining certain information regarding each new customer, whether the customer is a natural person or an entity. Persons exempt from the CIP procedures include governmental agencies and regulated financial institutions. The final regulations expand the CIP to now include identification of beneficial owners of certain legal entity customers.

In addition to the new beneficial owner requirement, FinCEN is requiring that these covered financial institutions incorporate into their required AML compliance programs “appropriate risk-based procedures for conducting ongoing customer due diligence” that must include at least (i) understanding the nature and purpose of customer relationships for the purpose of developing a customer risk profile and (ii) conducting ongoing monitoring to identify and report suspicious transactions, and on a risk basis, maintaining and updating customer information.

What does the regulation require?

Subject to certain exemptions, the covered financial institution must “establish and maintain written procedures that are reasonably designed to identify and verify” the beneficial owner(s) of each legal entity customer at the time a new account is opened, and obtain an executed form from the individual opening the account certifying to such beneficial ownership information. The information may be obtained through other means so long as the individual certifies, to the best of his or her knowledge, that the information is accurate. The covered financial institutions need to incorporate these written procedures into their AML compliance programs.

What is a “beneficial owner”?

A “beneficial owner” is defined as:

  • Each individual, if any, who, directly or indirectly, through any contract, arrangement, understanding, relationship or otherwise, owns 25% or more of the equity interests of a legal entity customer (“ownership” prong”); and
  • An executive officer or senior manager of the legal entity (Chief Executive Officer, Chief Financial Officer, President, Vice President, or Treasurer); or any other individual who regularly performs similar functions (“control” prong).

All individuals who meet the “ownership” prong of the definition would be subject to the new identification and verification requirements. Under the “control” prong of the definition, only one individual must be identified and verified. A covered financial institution may identify additional individuals as part of its customer due diligence if it deems it appropriate on the basis of risk.

What is a “legal entity customer”?

The legal entities subject to the regulations are corporations, limited liability companies, or other entities created by the filing of a public document with a state secretary of state or similar office, general partnerships, and any similar entities formed under the laws of a non-U.S. jurisdiction that open an account.

In addition to those persons already exempt from the definition of “customer” under the CIP regulations, such as regulated financial institutions, several additional categories of persons also would be exempt from the definition of a “legal entity customer,” such as public accounting firms and non-U.S. financial institutions established in jurisdictions where their regulators maintain beneficial ownership information regarding such financial institutions.

Certain types of legal entity customers that are pooled investment vehicles or nonprofit corporations need only provide information for the “control” prong of the beneficial owner requirement.

Are there any exemptions?

There are limited exemptions to the requirements, such as a legal entity customer that opens an account to finance the purchase of postage or insurance premiums, provided that such accounts cannot be used to make or receive payments from third parties.

Can one financial institution rely on another financial institution’s compliance with this regulation?

Yes, under conditions similar to those already in place that would allow the covered financial institution to rely on another financial institution’s CIP.

Shortly after publishing the final regulations, FinCEN issued an initial set of Frequently Asked Questions regarding the beneficial ownership requirements.

On April 3, 2018, FinCEN issued another set of Frequently Asked Questions providing more detailed guidance. Subjects include what to do in instances where legal entity customers have complex ownership structures, when to update beneficial ownership information already on file and clarifying the various exemptions from the rule for certain legal entity customers.

FinCEN also added a cautionary note to this guidance that if a covered financial institution has notice or a reasonable suspicion that a customer is evading or attempting to evade the beneficial ownership rule or other customer due diligence requirements, it should consider whether it should (i) not open an account, (ii) close an account or (iii) file a suspicious activity report.


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Steven Howard

Steven Howard

New York