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Frail, Ineffective OCIE Statement About Complex Financial Products
November 23, 2020
With the recent announced departure of SEC Chair Jay Clayton and the likely inauguration of Joe Biden as President, Wall Street will face uncertainty in 2021 when it comes to regulation. What's the agenda? What's the focus? Perhaps sensing that change is in the air -- perhaps itching to get things going in a different direction -- on November 16, 2020, the SEC's Office of Compliance Inspections and Examinations ("OCIE") issued a Statement about complex products/strategies. BrokeAndBroker.com publishes the full-text of the OCIE Statement below (please see our publisher Bill Singer's "Comment" following the quoted material. It's quite the rant!!):
Bill Singer's CommentStatement on Recent Enforcement Matters Involving "VIX-Related" and Other Complex Exchange Traded Products (ETPs) from the SEC Office of Compliance Inspections and Examinations (Statement from Office of Compliance Inspections and Examinations Staff / November 16, 2020)https://www.sec.gov/news/public-statement/ocie-vix-matters-2020-11-16It is critically important for registered investment advisers and broker-dealers to implement robust and effective policies and procedures reasonably designed to prevent violations of the federal securities laws, which includes ensuring that their financial professionals understand the risks and purposes of the products they advise on and/or recommend to firm clients and customers.[1] Moreover, firms must ensure that their financial professionals, including independent contractors acting on their behalf, actually follow in practice those firm policies and procedures.The recent settled charges by the Commission reflect examples of failures in design and/or implementation by firms of robust and effective policies and procedures, and highlight the importance of investment advisers and broker-dealers ensuring that the recommendations they make to their retail clients or customers comply with their legal obligations.[2] These matters reflect instances where financial professionals recommended complex investment products to retail clients and customers that were intended for short-term use, but were not used as designed causing financial harm to their clients and customers. The VIX-related exchange-traded products (ETPs) recommended in these matters generally disclosed in their prospectuses and supplements that they were intended as short-term investments and that risks heightened when holding these products for longer periods.[3]Complex products and investment strategies are continually evolving in terms of their construction and risks. A compliance program that is not dynamic, but is instead based on product features, such as leverage or inverse correlation, is more susceptible (as is the case with these firms) to fail to maintain appropriate controls on the products available to their financial professionals. OCIE routinely observes firms that have dynamic compliance programs with policies and procedures and practices for onboarding new products, including complex products. These policies and procedures and related practices often include, at the firm level, an assessment as to whether and how the product should be used by clients and customers and the training and monitoring of financial professionals necessary for the firm to meet its legal obligations. OCIE has observed that this assessment, often done by a committee, typically calls for the active involvement of senior managers, and includes participation from compliance, legal, risk, marketing, portfolio management and/or operations.Firms that offer their financial professionals access to a full scope of products on a platform made available by the firm's clearing or executing broker should review the design and implementation of their policies and procedures so that product analysis is not solely left to each financial professional. Specifically, OCIE has observed firms that provide financial professionals with the training and tools such that the financial professional is familiar with the product to discharge the firm's and his or her own legal obligations. For example, in the case of both existing products and new products, firms should consider which products are complex, suitable only for sophisticated investors, not suitable for investors who plan to hold them for longer than one trading session or not suitable for longer-term investment, so that the firm can take appropriate steps concerning financial professional access, training, and/or compliance monitoring and review.As part of its examinations, OCIE often does, and will continue to, review for the inappropriate use of complex investment products and evaluate the robustness and effectiveness of related supervisory policies and procedures. OCIE will also evaluate compliance with Regulation Best Interest and an investment adviser's federal fiduciary duty. Under these standards, a financial professional recommending a complex or risky product should apply heightened scrutiny to understand the terms, features and risks of the product and whether such product fits within the client or customer's risk tolerance and specific-trading objective, and whether it would require daily monitoring by the investor or the financial professional.[4] A recommendation by a firm's financial professionals is a recommendation of the firm. Accordingly, in order to fulfill their legal obligations, it is critically important for firms to implement policies and procedures reasonably designed so that their financial professionals: (1) understand the risks and purpose of the products they recommend to firm clients and customers; (2) apply the necessary heightened scrutiny; (3) only recommend products in compliance with legal standards; and (4) monitor the investment daily, as applicable.[5] In addition, the Chairman and the Directors of the Divisions of Investment Management, Corporation Finance and Trading and Markets recently addressed the application of Regulation Best Interest and the adviser's federal fiduciary duty in the context of complex products.[6]For further information regarding OCIE priorities and its examination approach to Regulation Best Interest, please visit https://www.sec.gov/ocie.[7] Firms are encouraged to familiarize themselves with the specific requirements of Regulation Best Interest by reviewing the Regulation Best Interest Adopting Release and the Small Entity Compliance Guide[8] and other materials available on the SEC's spotlight page.[9] Questions regarding Regulation Best Interest may be directed to: IABDQuestions@sec.gov.Finally, please know that OCIE is always interested in hearing more about new and emerging risk areas and products as well as how it can be more effective in its mission. OCIE's contact information can be found at: https://www.sec.gov/contact-information/sec-directory. Please engage with our staff. If you suspect or observe activity that may violate the federal securities laws or otherwise operates to harm investors, please notify SEC staff at https://www.sec.gov/tcr.= = = = =[1] This Statement represents the views of OCIE staff. It is not a rule, regulation, or statement of the Securities and Exchange Commission ("Commission"). The Commission has neither approved nor disapproved its content. This Statement, like all staff guidance, has no legal force or effect: it does not alter or amend applicable law, and it creates no new or additional obligations for any person.[2] See https://www.sec.gov/news/press-release/2020-282. See also Section 15(b)(4)(E) of the Securities and Exchange Act of 1934 ("Exchange Act") and Rule 206(4)-7 under the Investment Advisers Act of 1940.[3] These VIX-related ETPs are just one example of the many complex products and strategies available in the marketplace that financial professionals may recommend to investors that may not be intended as long-term investments. See https://www.investor.gov/introduction-investing/general-resources/news-alerts/alerts-bulletins/investor-alerts/sec-finra; see also https://www.investor.gov/introduction-investing/general-resources/news-alerts/alerts-bulletins/investor-bulletins-24; see also, https://www.investor.gov/introduction-investing/general-resources/news-alerts/alerts-bulletins/investor-bulletins-50.[4] On June 5, 2019, the Commission adopted Rule 15l-1 ("Regulation Best Interest") under the Exchange Act, which had a compliance date of June 30, 2020. Exchange Act Release No. 86031 (June 5, 2019) at https://www.sec.gov/rules/final/2019/34-86031.pdf. See Regulation Best Interest Adopting Release, pages 263-264; see also Commission Interpretation Regarding Standard of Conduct for Investment Advisers, Investment Advisers Act Release No. 5248 (June 5, 2019) ("Fiduciary Interpretation") at https://www.sec.gov/rules/interp/2019/ia-5248.pdf, p. 16.[5] Id.[6] See https://www.sec.gov/news/public-statement/clayton-blass-hinman-redfearn-complex-financial-products-2020-10-28.[7] See https://www.sec.gov/files/Risk%20Alert-%20Regulation%20Best%20Interest%20Exams.pdf.[8] See The Regulation Best Interest Adopting Release; see also, the Small Entity Compliance Guide is available at: https://www.sec.gov/info/smallbus/secg/regulation-best-interest.[9] See https://www.sec.gov/regulation-best-interest.
Oh for godsakes -- really?
After some 40 years on the Street, my bull-shit alarms went off as the OCIE Statement crossed onto my radar screen -- consider how this preamble triggered my crapola bells and whistles:
It is critically important for registered investment advisers and broker-dealers to implement robust and effective policies and procedures reasonably designed to prevent violations of the federal securities laws, which includes ensuring that their financial professionals understand the risks and purposes of the products they advise on and/or recommend to firm clients and customers.[1] Moreover, firms must ensure that their financial professionals, including independent contractors acting on their behalf, actually follow in practice those firm policies and procedures.
How uncanny that OCIE managed to publish the Statement on November 16, 2020, which was the same day when SEC Chair Clayton announced his resignation effective December 31, 2020. "SEC Chairman Jay Clayton Confirms Plans to Conclude Tenure at Year End" (SEC Release / November 16, 2020) https://www.sec.gov/news/press-release/2020-284. Fascinating timing, no? As to the breathless admonition in the very opening lines, c'mon, have you ever found that anything "critically important" was announced in a government document whose first sentence proclaimed that it was addressing something "critically important?" Sort of like how every major settlement is the biggest, largest, most fantabulous in the history of the world, until next week, when, go figure, another settlement is trumpeted as bigger, larger, and more fantabulous. So what, pray tell, was critically important in the OCIE Statement? As best that I can discern, registered investment advisers and broker-dealers are being warned that they must:
implement robust and effective policies and procedures reasonably designed to prevent violations of the federal securities laws, which includes ensuring that their financial professionals understand the risks and purposes of the products they advise on and/or recommend to firm clients and customers.[1] Moreover, firms must ensure that their financial professionals, including independent contractors acting on their behalf, actually follow in practice those firm policies and procedures.
Not just robust.
Not just effective.
But robust and effective policies and procedures.
OCIE's mandate is to conduct compliance inspections and examinations, hence its name and acronym. As such, given that OCIE's raison d'etre is compliance, I'm assuming that its Staff sort of visits RIAs and BDs and reviews those firms' policies and procedures and has a very precise and detailed checklist for what's a
- "robust" policy,
- an "effective" policy,
- a "robust" procedure, and
- an "effective" procedure.
Wow!!! Wall Street's policies and procedures should be so robust and effective that those charged with implementing them understand same.financial professionals understand the risks and purposes of the products they advise on and/or recommend to firm clients and customers.[1]
Lemme write that down so that I don't forget it.
What a revelation! Who knew, right?
By the way, did you read Footnote 1 of the OCIE Statement? Here it is for your edification:
Ummm . . . what the hell? The OCIE Statement is not a rule.[1] This Statement represents the views of OCIE staff. It is not a rule, regulation, or statement of the Securities and Exchange Commission ("Commission"). The Commission has neither approved nor disapproved its content. This Statement, like all staff guidance, has no legal force or effect: it does not alter or amend applicable law, and it creates no new or additional obligations for any person.
It's not a regulation.
It's not even an SEC Statement.
It has no legal force.
It has no legal effect.
It doesn't alter or amend jack.
It doesn't require you to do anything new or different.
As such, it's a waste of everyone's time and unduly imposes upon the industry's compliance professionals, who had to read through this nonsense rather than focus on their jobs.
Imagine that Moses came down from Mount Sinai and held aloft the Ten Commandments for all to read. Then imagine that there's a Footnote 1, which is carved in small print at the bottom of one of the tablets. That footnote discloses that the above Ten Commandments are not rules, not regulations, not something from God, have no legal, ethical, or moral force or effect. So . . . the Ten Commandments are like what -- suggestions, just some thoughts that were carved in stone for us to ruminate about? And while Moses was wasting his time atop the mount, someone from the tribe stole a couple of goats, graved an image, and was begetting with someone else's wife in one of the tents.
Without question, the OCIE Statement addresses an important problem: The manner in which complex ETPs are marketed to customers. Without question, far too many financial products are sold by those who have no idea as to what the product does or how/when it should be used. Without question, far too many financial professionals recommend far too many financial products without first having had any meaningful training about such products. Consequently, it's the blind leading the blind, and that is an horrific compliance regimen. But is this a new development? Is this something that warranted the issuance of the OCIE Statement on November 16, 2020? I think not. I know otherwise.
Wall Street's concern is making a buck. Pure and simple. Which explains why Wall Street is always in a rush to flood the markets with whatever crap is the fashion of the day in the hopes that the retail idiots will trade the shit out of the product, even if those who trade the product have no idea what it's really supposed to be used for. Ultimately, trading yields commissions, fees, and profits. The more the merrier. As a corollary to that dour pronouncement, Wall Street not only hopes to foist such crap upon the unwashed and uninitiated among the small fry retail traders but the industry could give a crap as to whether those who are recommending the product to retail traders have any idea what the product is or what it should and shouldn't be used for. Don't ask so many questions. Don't volunteer too much information. Keep it short and stupid. Sell. Sell. Sell. Driven by the profit motive, Wall Street can't be bothered with such concerns as meaningful disclosure or training. Those are luxuries. Which explains why on Wall Street, compliance is undertaken grudgingly.
I'm not going to continue, paragraph by paragraph, sentence by sentence, word by word, to pull apart the OCIE Statement. I will chalk it up to a well-intentioned but ultimately asinine exercise in impotent regulation.
If Wall Street's policies and procedures are not compliant with the SEC's rules and regulations, then OCIE should make the regulatory case, have the SEC file charges, and seek fines and remedial measures. Otherwise, puhlease, enough with the thought pieces. There are a lot of thieves, crooks, and fraudsters out there operating as RIAs and BDs. Put 'em out of business. Don't sit around writing about what's robust and what's effective and how the twain is unified into a compliant, regulatory whole of diverse policies and procedures. Get to work.