Promising Results from Groundbreaking FinCrime Data Sharing Project Between Seven UK Banks and the National Crime Agency
In 2024, the National Crime Agency (the “NCA”), which is the UK’s lead agency against organized crime; human, weapon and drug trafficking; cybercrime; and economic crime, announced its “groundbreaking” data sharing partnership with seven UK banks, namely Barclays, Lloyds, Metro Bank, NatWest, Santander, Starling Bank, and TSB.[1]
This new public-private partnership (“PPP”) was the largest of its kind anywhere in the world and the initial results of the project suggest it is revolutionizing the fight against financial crime.
Joint Analysis of Transactional Data that is Indicative of Potential Criminality
The project involved the seven banks voluntarily sharing customer and transactional data with the NCA with the aim of tackling criminality and kleptocracy, and preventing the flow of “dirty money” through the UK’s financial system. AML subject matter experts from the seven banks were then seconded to the NCA to work directly alongside the NCA’s own analysts in the scrutiny of banking data that is suggestive of criminal behavior, with the dual goals of identifying bad actors that are exploiting and misusing the financial system while ensuring that legitimate customers are left alone.
Promising Results
PPPs can be vastly effective in tackling the complexities of financial crime. Principally, this is because they help to bridge gaps in intelligence and enable more holistic or collaborative analytics. In the UK’s case, the NCA has reported that since the project went live in 2024, eight new criminal networks already have been confirmed. In addition, a further three suspicious networks have been identified and referred to the NCA’s intelligence division for further examination, while new leads have been uncovered related to 10 of the agency’s largest ongoing investigations. In sum, data sharing of this sort appears to be materially augmenting the ability of law enforcement to detect and disrupt criminality. The likely result will be the reduction of the financial crime risks that all banks have to manage on a daily basis and a consequential decrease in their “compliance costs.”
Data Protection Considerations
The major concern about data sharing initiatives of this sort relates to privacy, and banks have long been wary of sharing customer data with third parties for fear of contravening applicable data protection laws. On this, Andrew Searle, the Director of the NCA’s National Economic Crime Centre, has said, “the NCA and its banking partners have designed the [project’s] data sharing principles to ensure that only account data with multiple clear indicators of economic crime is included.” [2] Additionally, the banks have included in their terms and conditions the ability to share information without notification where the purpose of doing so is the fulfillment of the legal obligation to detect and prevent financial crime. Finally, the Financial Conduct Authority (the “FCA”), which regulates the UK’s financial services industry, is observing the project and providing an additional layer of oversight that has helped appease concern regarding inadvertent violations of data protection law.
Additional Considerations
A similar initiative has now been launched in Singapore: a digital platform called “COSMIC” (the “Collaborative Sharing of Money Laundering/Terrorism Financing (ML/TF) Information and Cases”) that allows six Singaporean banks, namely Citibank, Development Bank of Singapore (DBS), HSBC, Oversea-Chinese Banking Corporation (OCBC), Standard Chartered, and United Overseas Bank, to share information on customers exhibiting multiple red flags indicators of financial crime concern.[3] The major difference between the UK project and the Singaporean project is that the former is being led by the NCA, or UK law enforcement, while the latter, COSMIC, is a purely private sector initiative.
Given the promising results of the UK project and Singapore’s launch of COSMIC, we expect that other countries will follow suit in terms of facilitating the sharing of intelligence related to suspected money laundering, terrorism financing, and proliferation financing, whether it be via the PPP model or among only private sector participants. Either way, fostering true collaboration between multiple interested parties likely is going to be crucial in the effort to stay ahead of sophisticated criminals and emergent threats.
For that reason, it is incumbent upon public sector actors, from the perspective of preventing financial crime, to actively facilitate information sharing initiatives, for example by updating laws or supervisory instruments as necessary; making use of regulatory sandboxes and pilot programs; highlighting typologies or data types that would benefit from sharing; deploying secure platforms for sharing and oversight; promoting regular dialogue between data protection and AML/CFT authorities; and more.
Finally, banks around the world should remember that, even if currently they are not able to pool data with other stakeholders, for example because of applicable data protection laws or other jurisdiction-specific fundamental rights, they still need to do everything possible to mine the volumes of customer and transactional data that they already possess and/or can obtain from their correspondents, as well as the huge quantity of open source intelligence that is readily available online, for compliance purposes. This means not just performing real-time, list-based screening, but investing in additional headcount, advanced analytical solutions and experienced external counsel to conduct proactive investigations of post-transactional data, looking for suspicious typologies, actors, networks or other activities. Ever-increasing amounts of customer and transactional data need not be overwhelming; on the contrary, if viewed as a resource rather than a burden and if leveraged appropriately, they represent a material opportunity to better detect and prevent criminal activity, and to protect legitimate consumers.
FOOTNOTES
[1]Ground breaking public private partnership launched to identify criminality using banking data
[2] Ibid.
[3] MAS Launches COSMIC Platform to Strengthen the Financial System’s Defence Against Money Laundering and Terrorism Financing
Court Holds That Contingent Remainder Beneficiary Has Standing To Sue Trustee For Breach Of Fiduciary Duty
In In re Est., the court of appeals dealt with whether a contingent beneficiary can file claims against a trustee. No. 02-23-00104-CV, 2024 Tex. App. LEXIS 1878 (Tex. App.—Fort Worth March 14, 2024, no pet.). The court held that contingent beneficiaries do have standing:
We conclude that James is within the class of persons authorized to sue the Trustees. First, we reject the assertion that a trustee can never be sued by a contingent beneficiary… Texas also allows a contingent or vested beneficiary to sue a trustee for breach of fiduciary duty. See Tex. Prop. Code Ann. §§ 111.004 (defining “beneficiary” and “interested person”), 115.011(a) (authorizing any “interested person” to bring suit relating to trust administration); Berry, 646 S.W.3d at 527-28 (applying Texas Property Code Sections 111.004, 115.001, and 115.011 in analysis of whether contingent trust beneficiary was authorized by statute to bring her breach-of-fiduciary-duty claims and concluding that she was). Even at the time that Mary Sue transferred the money, James had a contingent interest in the Trust subject only to Claude’s power of appointment. See Berry, 646 S.W.3d at 529. Second, and more importantly, in this case regardless of whether the applicable laws or the terms of the Trust would have restricted James’s ability to sue the Trustees while Claude was alive, by the time that he did sue, his interest was no longer contingent. James now unquestionably has a right to at least a share of the Trust’s assets, and he contends that Mary Sue’s improper action reduced those assets. Accordingly, James was within the class of persons authorized to bring his claims. See Ala. Code §§ 19-3B-101, 19-3B-1001-02; Tex. Prop. Code Ann. §§ 111.004, 115.011(a); Berry, 646 S.W.3d at 527.
…
In their reply brief, the Trustees argue that Section 115.011 does not authorize James to bring his suit because although that provision allows an “interested person” such as a beneficiary to bring claims under Section 115.001, a claim under Section 115.001 does not include tort claims, and thus Section 115.011 does not authorize James to sue for breach of fiduciary duty. The Trustees do not, however, discuss Berry, in which the Texas Supreme Court applied Sections 115.001 and 115.011 in its analysis of whether a contingent trust beneficiary was within the class of persons authorized to sue the trustee for breach of fiduciary duty. Berry, 646 S.W.3d at 527-30. We therefore disagree that those Property Code sections have no relevance to an analysis of who may sue a trustee for breach of fiduciary duty. Thus, even applying Texas law, we conclude that James was authorized to bring his breach-of-fiduciary-duty claims. We reject the Trustees’ challenge to James’s standing and capacity.
Id.
Europe: Proposed UK and EU Rules on More Research Cost Re-Bundling Move Closer
In the United Kingdom, the FCA has proposed to give fund managers (including UCITS Mancos and full-scope UK AIFMs) an option to use fund assets to pay jointly for execution and research (so-called ‘bundled’ payments). The existing options of paying for research from manager funds or operating a customer-financed research payment account would remain. Final rules are expected in the first half of 2025. This follows the introduction on 1 August 2024 of a similar option for separate account managers as discussed here.
Fund managers opting for joint payments will be subject to ‘guardrails’ like those for firms managing segregated mandates. The guardrails are intended to ensure client protection by (for example) requiring appropriate disclosure to clients and seeking to ensure that research spend achieves value for money for each relevant fund client. Managers of FCA authorised retail funds opting for joint payments would need to treat the matter as a ‘significant change’ requiring both prior FCA approval, and that unitholders are given at least 60 days’ prior written notice.
One reason why firms may wish to consider using the joint payment option is so that they can obtain research from US broker-dealers who may be unable to accept unbundled payments for research.
In the European Union, changes to MIFID under the Listing Act Directive are being implemented in EU member states by 5 June 2026. These will give MiFID investment firms (incl. separate account managers) an option to make joint payments for execution and research. Conditions will apply, including an obligation to assess the quality, usability and value of research used, but the current limitation to the effect that this option does not apply to research concerning issuers with a market capitalisation of over €1 billion is being removed.
“Oops, I Was a Broker!?” SEC Cracks Down on Investment Adviser Representatives Acting as Unregistered Brokers
On 14 January 2025, the Securities and Exchange Commission (SEC) announced settled charges against three investment adviser representatives for acting as unregistered brokers in the sale of membership interests in certain limited liability companies (i.e., Funds) that each purportedly owned shares of private issuers that had prospects of becoming publicly traded. The SEC separately announced settled charges against an advisory firm in a related action involving improperly managing conflicts of interests and the use of liability waivers.
The settled charges against investment adviser representatives highlight the SEC’s continued drive to hold unregistered brokers accountable – especially those who facilitate the sale of pre-IPO investments to retail investors. Recently, in September 2024, the SEC had settled charges against various market participants for unregistered broker activity.
The individuals subject to the SEC’s orders were investment adviser representatives but, according to the orders, had provided investors with marketing materials and advised investors on the supposed merits of the investments. Although the individuals were each affiliated with a registered investment adviser, the SEC alleged that their actions constituted brokerage services distinct from investment advisory services. Among other facts, most investors were not pre-existing investment advisory clients. In addition, the adviser did not charge a management fee for the value of the investments into the Funds. Instead, the individuals received transaction-based compensation.
The SEC charged all three individuals with failures to register as brokers and provided for nearly US$540,000 in collective disgorgement, prejudgment interest, and civil penalties.
Ten Minute Interview: Family Investments [Video]
Brian Lucareli, director of Foley Private Client Services (PCS) and co-chair of the Family Offices group, sits down with Kay Gordon, partner, and member of our Fund Formation and Investment Management practice group, for a 10-minute interview to discuss family investments. During this session, Kay explained which are the structures utilized for family investments, the benefits of using external, as opposed to internal, management, and what are some of the legal considerations for retaining internal and/or external managers.
Regulatory Update and Recent SEC Actions January 2025
Recent SEC Administration Changes
SEC Chair Gensler to Depart Agency on January 20
The Securities and Exchange Commission (the “SEC”) announced, on November 21, 2024, that its Chair, Gary Gensler, will step down. Chair Gensler’s resignation from the SEC will be effective at 12:00 pm EST on January 20, 2025. On December 4, 2024, President-elect Trump stated his intention to nominate Paul Atkins as the Chair of the SEC. Mr. Atkins served as a Commissioner from 2002 to 2008 and on the SEC staff in the 1990s.
SEC Announced Departure of Trading and Markets Division Director
The SEC, on December 9, 2024, announced that Haoxiang Zhu, Director of the Division of Trading and Markets, would depart the agency effective December 10, 2024. David Saltiel, a Deputy Director who also heads the Division of Trading and Markets Office of Analytics and Research, will serve as Acting Director. Mr. Saltiel served as the Division of Trading and Markets Acting Director for several months in 2021.
SEC Announces Departure of Corporation Finance Division Director
The SEC, on December 13, 2024, announced that Erik Gerding, Director of the Division of Corporate Finance, would depart the agency effective December 31, 2024. Cicely LaMothe is now the Acting Director. Ms. LaMothe previously served as the Deputy Director, Disclosure Operations for the Division of Corporation Finance. Before joining the SEC, Ms. LaMothe worked in the private sector for six years, including as the financial reporting manager for a public company and as a senior associate with a national accounting firm.
SEC Rulemaking
SEC Adopts Rule Amendments and New Rule Addressing Wind-Down Planning of Covered Clearing Agencies
The SEC, on October 25, 2024, announced the adoption of rule amendments and a new rule to improve the resilience and recovery and wind-down planning of covered clearing agencies. The rule amendments establish new requirements regarding a covered clearing agency’s collection of intraday margin, as well as its reliance on substantive inputs to its risk-based margin model. The new rule requires a covered clearing agency to specify nine elements for its recovery and wind-down plan that address: (1) the identification and use of scenarios, triggers, tools, staffing, and service providers; (2) timing and implementation of the plans; and (3) testing and board approval of the plans.
SEC Modernizes Submission of Certain Forms, Filings, and Materials Under the Securities Exchange Act of 1934
The SEC, on December 16, 2024, adopted amendments to require the electronic filing, submission, or posting of certain forms, filings, and other submissions that national securities exchanges, national securities associations, clearing agencies, broker-dealers, security-based swap dealers, and major security-based swap participants make with the SEC. Prior to the adoption of these amendments, registrants filed with, or otherwise submitted to, the SEC many of the forms, filings, or other materials in paper form. Under the amendments, registrants will make these filings and submissions electronically using the SEC’s EDGAR system, in structured data format where appropriate, or by posting them online.
SEC Adopts Rule Amendment to Broker-Dealer Customer Protection Rule
The SEC, on December 20, 2024, adopted amendments to Rule 15c3-3 (the “Customer Protection Rule”) to require certain broker-dealers to increase the frequency with which they perform computations of the net cash they owe customers and other broker-dealers from weekly to daily. The amendments will become effective 60 days after the date of publication of the adopting release in the Federal Register. Broker-dealers that exceed the $500 million threshold using each of the 12 filed month-end FOCUS Reports from July 31, 2024, through June 30, 2025, must comply with the daily computations no later than December 31, 2025.
SEC Enforcement Actions and Other Cases
SEC Charges Market Makers and Nine Individuals in Crackdown on Manipulation of Crypto Assets Offered and Sold as Securities
The SEC, on October 9, 2024, announced fraud charges against three companies purporting to be market makers and nine individuals for engaging in schemes to manipulate the markets for various crypto assets. The SEC alleges that the companies provided “market-manipulation-as-a-service” which included generating artificial trading volume through trading practices that served no economic purpose and that they used algorithms (or bots) that, at times, generated “quadrillions” of transactions and billions of dollars of artificial trading volume each day.
SEC Charges Investment Adviser and Owner for Making False and Misleading Statements About Use of Artificial Intelligence
The SEC, on October 10, 2024, announced charges against an investment adviser (the “Adviser”) and two individuals, an owner and a director of the Adviser, with making false and misleading claims about the Adviser’s purported use of artificial intelligence (“AI”) to perform automated trading for client accounts and numerous other material misrepresentations. The SEC’s order states that the two individuals raised nearly $4 million from 45 investors for the growth of the Adviser that was falsely described as having an AI-driven platform. The Adviser and individuals were charged with fraudulent conduct in the offer or sale of securities under the Securities Act of 1933 and the Securities Exchange Act of 1934, and the Adviser was charged with fraudulent conduct by an investment adviser under the Investment Advisers Act of 1940, as amended.
SEC Charges Advisory Firm with Failing to Adhere to Own Investment Criteria for ESG-Marketed Funds
The SEC, on October 21, 2024, charged a New York-based investment adviser (the “Adviser”) with making misstatements and for compliance failures relating to the execution of the investment strategy of three exchange-traded funds (“ETFs”) that were marketed as incorporating environmental, social, and governance (“ESG”) factors. According to the SEC’s order, the Adviser represented in the prospectuses for the ETFs and to the board of trustees overseeing the ETFs, that the ETFs would not invest in companies involving certain products or activities, such as fossil fuels and tobacco. Further, the SEC order states that the Adviser used data from third-party vendors that did not screen out all companies involved in fossil fuel and tobacco-related activities. The SEC’s order further finds that the Adviser did not have any policies and procedures over the screening process to exclude such companies. The Adviser consented to the entry of the SEC’s order finding that the firm violated the antifraud provisions of the Investment Advisers Act of 1940 and the Investment Company Act of 1940 and the Compliance Rule of the Investment Advisers Act.
“At a fundamental level, the federal securities laws enforce a straightforward proposition: investment advisers must do what they say and say what they do,” said Sanjay Wadhwa, Acting Director of the SEC’s Division of Enforcement. “When investment advisers represent that they will follow particular investment criteria, whether that is investing in, or refraining from investing in, companies involved in certain activities, they have to adhere to that criteria and appropriately disclose any limitations or exceptions to such criteria. By contrast, the funds at issue in today’s enforcement action made precisely the types of investments that investors would not have expected them to based on the Adviser’s disclosures.”
Directors of Money Market Fund Sued Over Share Class Conversion
Two shareholders (the “Shareholders”) filed a lawsuit alleging that the directors of a money market fund (the “Directors”) breached their fiduciary duty by failing to automatically move fund investors’ assets from higher cost share classes of the fund to lower-cost share classes. The Shareholders allege that the board of the money market fund allowed certain fund investors to continue paying higher fees as retail class shareholders rather than auto-converting their holdings to the cheaper, but otherwise identical premium class, even though their holdings were eligible for the “auto-conversion”. The complaint states that “[the Directors’] inaction demonstrates gross neglect or reckless disregard for the best interest of the class shareholders… Either the [Directors] have been recklessly uninformed of these massive overcharges that cause significant losses to the shareholders, or have known about the issue and inexcusably failed to take action to remedy it.” The Shareholders seek damages, restitution, disgorgement, and an injunction preventing the Directors from continuing to engage in the alleged conduct.
Two Entities Affiliated with Major Institutional Organization to Pay $151 Million to Resolve SEC Enforcement Actions
The SEC, on October 31, 2024, charged two affiliated and commonly-owned investment advisers (each an “Adviser” and together, the “Advisers”) in five separate enforcement actions for compliance failures including misleading disclosures to investors, breach of fiduciary duty, prohibited joint transactions and principal trades, and failures to make recommendations in the best interest of customers. The enforcement actions related to:
Conduit Private Funds – An Adviser made misleading statements regarding its ability to exercise discretion over when to sell and the number of shares to be sold, despite disclosures representing that it had no discretion.
Portfolio Management Program – An Adviser failed to fully and fairly disclose the financial incentive that the firm and some of its financial advisors had when they recommended the Adviser’s own Portfolio Management Program over third-party managed advisor programs offered by the Adviser.
Clone Mutual Funds – An Adviser recommended certain mutual fund products, Clone Mutual Funds, to its retail brokerage customers when materially less expensive ETF products that offered the same investment portfolios were available.
Joint Transactions – An Adviser engaged in $3.4 billion worth of prohibited joint transactions, which advantaged an affiliated foreign money market fund for which it served as the delegated portfolio manager over three U.S. money market mutual funds it advised.
Principal Trades – An Adviser engaged in or caused 65 prohibited principal trades with a combined notional value of approximately $8.2 billion. In order to conduct these transactions, according to the SEC’s order, a portfolio manager directed an unaffiliated broker-dealer to buy commercial paper or short-term fixed income securities from the Adviser which the other Adviser then purchased on behalf of one of its clients.
SEC Charges Adviser for Making Misleading Statements About ESG Integration
The SEC, on November 8, 2024, charged an investment adviser (the “Adviser”) with making misleading statements about the percentage of company-wide assets under management that integrated ESG factors. The Adviser stated in marketing materials that between 70 percent and 94 percent of its parent company’s assets under management were “ESG integrated.” However, in reality, these percentages included a substantial amount of assets that were held in passive ETFs that did not consider ESG factors. Furthermore, the SEC’s order found that the Adviser lacked any written policy defining ESG integration.
SEC Charges Three Broker-Dealers with Filing Deficient Suspicious Activity Reports
The SEC, on November 22, 2024, announced that three broker-dealers (the “Broker-Dealers”) agreed to settle charges relating to deficient suspicious activity reports (“SARs”) filed by the Broker Dealers. The SEC alleged that multiple SARs filed by the Broker-Dealers failed to include important, required information. SARs must contain “a clear, complete, and concise description of the activity, including what was unusual or irregular” that caused suspicion of the use of funds derived from illegal activity or activity that has no apparent lawful purposes. The SEC’s orders alleged that each Broker-Dealer filed multiple deficient SARs over a four-year period.
SEC Charges Former Chief Investment Officer with Fraud
The SEC, on November 25, 2024, charged the former co-chief investment officer (the “CIO”) of a registered investment adviser with engaging a multi-year scheme to allocate favorable trades to certain portfolios, while allocating unfavorable trades to other portfolios (also known as “cherry-picking”). The SEC’s complaint alleges that the CIO would place trades with brokers but wait until later in the day to allocate the trades among clients in the portfolios he managed. According to the complaint, the CIO’s delay in allocating the trades allowed him to allocate trades at first-day gains to favored portfolios and trades at first-day losses to disfavored portfolios.
SEC Charges Wealth Management Company for Policy Deficiencies Resulting in Failure to Prevent and Detect Financial Advisors’ Theft of Investor Funds
The SEC, on December 9, 2024, charged a wealth management company (the “Company”) with (1) failing to reasonably supervise four investment advisers and registered representatives (the “Financial Advisers”) who stole millions of dollars of advisory clients’ and brokerage customers’ funds and (2) failing to adopt policies and procedures reasonably designed to prevent and detect the theft. Specifically, the SEC found that the Company failed to adopt and implement policies designed to prevent the Financial Advisers from using two forms of unauthorized third-party disbursements, Automated Clearing House payments and certain patterns of cash wire transfers, to misappropriate funds from client accounts.
SEC Charges Two Broker-Dealers with Recordkeeping and Reporting Violations for Submitting Deficient Trading Data to SEC
The SEC, on December 20, 2024, announced settled charges against two broker-dealers (each a “Broker-Dealer” and together, the “Broker-Dealers”). According to the SEC’s order, the Broker Dealers made numerous blue sheet submissions to the SEC that contained various deficiencies, including inaccurate or missing information about securities transactions and the firms or customers involved in the transactions. The SEC found that, one of the Broker-Dealers made 15 types of errors, that caused nearly 11,200 blue sheet submissions to have missing or inaccurate data for at least 10.6 million total transactions, while the other Broker-Dealer made 10 types of errors that caused 3,700 blue sheet submissions to have misreported or missing data for nearly 400,000 transactions.
International Bank Subsidiary to Pay $4 Million for Untimely Filing of Suspicious Activity Reports
The SEC, on December 20, 2024, charged a registered broker-dealer (the “Broker-Dealer”) for failing to file certain SARs in a timely manner. According to the SEC’s order, the Broker-Dealer received requests in connection with law enforcement or regulatory investigations, or litigation that prompted it to conduct SARs investigations. The SEC’s order found that in certain instances, the Broker-Dealer failed to conduct or complete the investigations within a reasonable period of time.
SEC Files Settled Charges Against Multiple Entities for Failing to Timely File Form D in Connection with Securities Offering
The SEC, on December 20, 2024, announced charges against three companies (for this section only, the “Companies”) for failing to timely file Forms D for several unregistered securities offerings in violations of Rule 503 of Regulation D of the Securities Act of 1933. The SEC found that one of the Companies, a registered investment adviser that controls two private funds, failed to ensure that such private funds timely filed Forms D in connection with offerings involving the sale of membership interest in such private funds. The SEC found that two other Companies, both privately held companies, failed to timely file Forms D in connection with unregistered securities offerings for which the Companies engaged in certain communications that constituted general solicitations.
“Form D filings are crucial sources of information on private capital formation, and compliance with the requirement to make such filings in a timely manner is vital to the Commission’s efforts to promote investor protection while also facilitating capital formation, especially with respect to small businesses,” said Sanjay Wadhwa, Acting Director of the SEC’s Division of Enforcement. “Today’s orders find that the charged entities deprived the Commission and the marketplace of timely information concerning nearly $300 million of unregistered securities offerings.”
Shareholders File Derivative Complaint Against Independent Directors and Fund Management Alleging Breach of Fiduciary Duties
In December 2024, a derivative complaint was filed against the independent directors and fund management, alleging that their breach of fiduciary duties was responsible for the “astonishing collapse” of several funds. In December 2021, the board of directors (the “Board”) approved a plan of liquidation involving transferring nearly all the $300 million in assets of four closed-end feeder funds and a master fund, along with several private funds, for unlisted preferred units from the buying company (the “Buyer”). Ultimately, the units converted into common shares worth eight dollars each when the Buyer went public through a merger with a special purpose acquisition company. Since going public, the value of the shares has fallen to 81 cents, or less than a penny after accounting for a one-for-80 reverse stock split. According to the lawsuit, fund management and the Board did not inform the shareholders of the liquidation plan until weeks after it happened, and the liquidation plan was never submitted to shareholders for approval.
Other Industry Highlights
SEC Division of Examinations Announces its Examination Priorities for Fiscal Year 2025
The SEC Division of Examinations (the “Division”), on October 21, 2024, published its Fiscal Year 2025 Examination Priorities which highlights the practices, products, and services that the Division of Examinations believes present heightened risk to investors or the overall integrity of U.S. capital markets. The report indicated that the Division would focus on:
Investment Advisers – (1) adherence to fiduciary standards of conduct, (2) effectiveness of advisers’ compliance programs, and (3) examinations of advisers to private funds.
Investment Companies – (1) fund fees and expenses, and any waiver or reimbursements, (2) oversight of service providers (both affiliated and third-party), (3) portfolio management practices and disclosures, for consistency with claims about investment strategies or approaches and with fund filings and marketing materials, and (4) issues associated with market volatility.
The report also indicated that the Division is going to continue examining advisers and funds that have never been examined or those that have not been examined recently, with a particular focus on newly registered funds. The full report can be found here.
SEC Announced Enforcement Results for Fiscal Year 2024
The SEC announced that it filed a total of 583 enforcement actions in fiscal year 2024 while obtaining orders for $8.2 billion in financial remedies. The 583 enforcement actions represent a 26 percent decline in total enforcement actions compared to fiscal year 2023. Key areas of focus by the SEC included:
Off-channel communications. In fiscal year 2024, the SEC brought recordkeeping cases against more than 70 firms resulting in more than $600 million in civil penalties.
Marketing Rule (Rule 206(4)-1 under the Investment Advisers Act of 1940, as amended (the “Advisers Act”)) compliance. More than a dozen investment advisers were charged with non-compliance of the Advisers Act Marketing Rule including charges for advertising hypothetical performance to the general public without implementing policies and procedures reasonably designed to ensure hypothetical performance was relevant.
Misleading claims regarding AI. AI and other emerging technologies presented heightened investor risk from market participants using social media to exploit elevated investor interest in emerging investment products and strategies. These actions included multiple actions against advisers alleging the use AI in their investment processes.
SEC Risk Alert Highlights Examination Deficiencies Found in Core Focus Areas for Registered Investment Companies
The SEC’s Division of Examinations (the “Staff” or the “Division”) issued a risk alert (the “Alert”) regarding its review of certain core focus areas and associated document requests for registered investment companies (each a “Fund”, and collectively, the “Funds”). The Alert highlighted that examinations typically focus on whether Funds: (1) have adopted and implemented effective written policies and procedures to prevent violation of the federal securities laws and regulations, (2) provided clear and accurate disclosures that are consistent with their practices, and (3) promptly addressed compliance issues, when identified.
The Staff reviewed deficiency letters sent to Funds during the most recent four-year period and analyzed deficiencies and weakness related to the core areas of fund compliance programs, disclosures and filings, and governance practices. Below are some of the common deficiencies:
Fund Compliance Programs
Funds did not perform required oversight or reviews as stated in their policies and procedures or perform required assessments of the effectiveness of their compliance programs.
Funds did not adopt, implement, update, and/or enforce policies and procedures.
Policies and procedures were not tailored to the Funds’ business models or were incomplete, inaccurate, or inconsistent with actual practices.
Funds’ Codes of Ethics were not adopted, implemented, followed, enforced, or did not otherwise appear adequate.
Chief Compliance Officers did not provide requisite written annual compliance reports to Fund boards.
Fund Disclosures and Filings
Fund registration statements, fact sheets, annual reports, and semi-annual reports contained incomplete or outdated information or contained potentially misleading statements.
Sales literature, including websites, appeared to contain untrue statements or omissions of material fact.
Fund filings were not made or were not made on a timely basis.
Fund Governance Practices
Fund board approvals of advisory agreements appeared to be inconsistent with the requirements of the Investment Company Act of 1940, as amended, and/or the Funds’ written compliance procedures.
Fund boards did not receive certain information to effectively oversee Fund practices.
Fund boards did not perform required responsibilities.
Fund board minutes did not fully document board actions.
The full alert can be accessed here.
SEC’s Division of Investment Management’s Disclosure Review and Accounting Office Identifies Common Issues Found in Review of Tailored Shareholder Reports
As of July 24, 2024, open-end funds have been required to file more concise annual and semi-annual reports (“Tailored Shareholder Reports” or “TSRs”) that highlight information that the SEC deems “particularly important” to retail shareholders in assessing and monitoring their fund investments. After three months of TSR filings, on November 8, 2024, the Division of Investment Management’s Disclosure Review and Accounting Office (“DRAO”), which is responsible for reviewing TSR filings, published Accounting and Disclosure Information 2024-14 (the “ADI”) which flags common issues it has identified in its review of TSR filings and provides a reminder to funds of certain requirements.
Issues Regarding Expense Information
Annualizing expenses in dollars paid on a $10,000 investment in a semi-annual shareholder report, instead of reflecting the dollar costs over the period on a non-annualized basis.
Calculating expenses in dollars paid on a $10,000 investment by incorrectly multiplying the “Costs paid as a percentage of your investment” by $10,000, instead of multiplying the figure in the “Cost paid as a percentage of your investment” column by the average account value over the period based on an investment of $10,000 at the beginning of the period.
Presenting expenses in dollars paid on $10,000 investments to the nearest cent, when the figure must be rounded to the nearest dollar.
Funds might consider noting in their semi-annual reports that costs paid as a percentage of a $10,000 investment is an annualized figure.
Issues Regarding Management’s Discussion of Fund Performance
Disclosure by many ETFs of average annual total returns for the past one-, five-, and 10-year periods based on market value, instead of the ETF’s net asset value; additional disclosure of market value performance is not permitted to be included in the shareholder reports.
Failure by some funds to compare their performance to an appropriate broad-based securities market index both in their shareholder reports and in its prospectus.
Failure by some funds to include a statement to the effect that past performance is not a good predictor of the fund’s future performance, or to utilize text features to make the statement noticeable and prominent.
Other Issues
Including portfolio-level statistics, such as average maturity or average credit rating, under the heading “Graphical Representations of Holdings,” instead of under the heading “Fund Statistics.”
Disclosing holdings as a percentage without specifying the basis for the presentation of the information (i.e., net asset value, total investments, or total or net exposure).
Disclosing material fund changes while omitting the required cover page disclosure or including the cover page disclosure but failing to include any disclosure about the material fund changes.
Including broken links (to their websites) in their shareholder reports.
Including extraneous and sometimes lengthy disclosures such as disclaimers or risks that are not required or permitted.
For Inline XBRL structured data purposes, tagging all of their indexes as broad-based indexes instead of tagging their additional indexes with the separate tag intended for additional indexes.
For further information, the complete ADI may be accessed, here.
American Airlines Breaches Fiduciary Duty of Loyalty with BlackRock ESG Funds in 401(k) Plans
Whether, and the extent to which, a plan fiduciary can consider nonpecuniary environmental, social and governance (“ESG”) objectives in selecting plan investments has been a hot-button issue for many years, with the view on such practices tending to swing back-and-forth with each new administration.
In Spence v. American Airlines, Inc., 2024 WL 733640 (N.D. Tex. 2024), Plaintiff brought a class action suit against American Airlines and its Employee Benefits Committee (“EBC”) alleging breaches of fiduciary duties of loyalty and prudence resulting from the plan fiduciaries’ investment practices. Specifically, Plaintiff argued the plan fiduciaries mismanaged retirement plan assets when the plans’ investment manager, BlackRock Institutional Trust Company, Inc. (“BlackRock”), pursued non-financial and nonpecuniary ESG policy goals through proxy voting and shareholder activism. Plaintiff claimed that including BlackRock as an investment manager harmed the financial interests of plan participants and their beneficiaries due to BlackRock pursuing socio-political outcomes rather than exclusively chasing financial returns.
It is no coincidence that this suit was filed in the Northern District of Texas. That district, and the Fifth Circuit generally, has been a popular forum for those seeking to challenge federal regulations, and the Fifth Circuit recently remanded a suit challenging the DOL’s ESG-friendly regulation back to district court.
Defendants Breached the Fiduciary Duty of Loyalty.
The district court in American Airlines concluded that the plan fiduciaries breached their duty of loyalty by failing to act solely in the retirement plan’s best financial interest when the plan fiduciaries allowed their corporate interests to influence management and investment of plan assets. The court found it apparent that the plan fiduciaries failed to question BlackRock’s ESG activities, either because the plan sponsor’s corporate objectives were aligned with BlackRock’s ESG objectives or because the plan fiduciaries were afraid to question a large shareholder (or both).
The court took note of the following factors that showed the various corporate ties to BlackRock that were inappropriately leveraged to influence management of the plan:
BlackRock was one of American Airline’s largest shareholders.
BlackRock managed billions of dollars in plan assets at a time that it owned 5% of American Airline’s stock.
BlackRock financed roughly $400 million of American Airline’s corporate debt when American Airlines was experiencing financial difficulty.
Defendants Did Not Breach the Fiduciary Duty of Prudence.
Despite finding that the plan fiduciaries breached the duty of loyalty, the court found that their investment monitoring practices were consistent with prevailing industry practices and that the plan fiduciaries acted in a manner similar to other fiduciaries in the industry. Accordingly, the court did not find that the plan fiduciaries breached the duty of prudence when using BlackRock as an investment manager.
Recommended Actions
This case marks the largest victory for opponents of ESG investing to date and could spark a new wave of class action litigation against retirement plans. American Airlines demonstrates the need for employee benefit committees or plan sponsors to closely monitor and perform risk assessments when investing—or relying on others to invest—employee retirement assets toward ESG objectives, as well as to monitor an investment manager’s proxy voting and ESG policy goals.
Drilling Down into Venture Capital Financing in Artificial Intelligence
It should come as no surprise that venture capital (VC) investors are drilling down into startups building businesses with Artificial Intelligence (AI) at the core. New data from PitchBook actually shows that AI startups make up 22% of first-time VC financing. They note that $7 billion of first-time funding raised by startups in 2024 went to AI & machine learning (ML) startups (this is according to their data through Q3 of 2024).
Crunchbase data also showed that in Q3 of 2024, AI-related startups raised $19 billion in funding, accounting for 28% of all venture dollars for that quarter. They importantly point out that this excludes the $6.6 billion round raised by OpenAI, which was announced after Q3 closed. With this unprecedented level of investment in the AI vertical, there is increasing concern that i) some startups might be using AI as more of a buzzword to raise capital rather than truly focusing on this area, and/or ii) there are bubbles in certain sub-verticals.
PitchBook analysts also note that with limited funding available for startups, integrating AI into their offerings is crucial for founders to secure investment. However, this also makes it harder to distinguish which startups are genuinely engaging in meaningful AI work. For investors, the challenge lies in sifting through the AI “noise” to identify those startups that are truly transformative and focusing on key areas within the sector, which will be vital as we move into 2025.
A recent article in Forbes examined the themes that early-stage investors were targeting for the new year. When looking at investment in AI startups, these included the use of AI to help pharmaceutical companies optimize clinical trials, AI in fintech and personal finance, AI applications in healthcare to improve the patient to caregiver experience, and AI-driven vertical software that will disrupt incumbents.
According to the Financial Times (FT), this boom in AI investment comes at a time when the industry still has an “immense overhang of investments from venture’s Zirp era” (Zirp referring to the zero interest rate policy environment that existed between 2009 and 2022). This has led to approximately $2.5 trillion trapped in private unicorns, and we have not really seen what exit events or IPOs will materialize and what exit valuations will return to investors. Will investors get their capital back and see the returns they hope for? Only time will tell, but investors do not seem ready to slow down their investment in AI startups any time soon. As the FT says, this could be a pivotal year for the fate of VC investment in AI. We will all be watching closely.
What the Future May Hold for the Consumer Financial Protection Bureau’s Open Banking Rule
Will the Consumer Financial Protection Bureau’s (CFPB) recently promulgated open banking rule survive under the new Congress and incoming presidential administration? Two upcoming proceedings may hold the answer.
On 22 October 2024, the CFPB finalized a rule to govern personal financial data rights, known colloquially as the open banking rule.1 In promulgating the open banking rule, the CFPB relied on Section 1033 of the Dodd-Frank Act for authority. In general, the open banking rule requires banks to establish electronic facilities for the reliable and accurate transmission of consumer data to authorized third parties at the consumer’s request and for a specified purpose and time period. Under the new Congress and incoming presidential administration, the rule may face two significant challenges to its existence in the coming months.
The first challenge may occur rapidly now that the 119th Congress is in session. Under the Congressional Review Act (CRA), Congress may disapprove of any rule finalized by the CFPB within the last six months of the outgoing presidential administration. To do so, both the Senate and the House must pass an identical joint resolution of disapproval. All votes under the CRA are simple majority votes, and under most circumstances, the resolution is not subject to filibuster in the Senate. Whether Congress will reject the open banking rule remains to be seen. To disapprove of a rule under the CRA, Congress must act within a 60-day period that commences in mid-January. This review period overlaps with the first weeks of the new administration when the Senate is typically focused on confirming the president’s cabinet nominees. The CFPB also issued a flurry of rules in the final months of the outgoing administration, so the new Congress may need to pick and choose which ones to consider jettisoning during the short CRA review window.
The second challenge to the open banking rule is playing out in a lawsuit filed by a Kentucky-based national bank and the Bank Policy Institute in federal court in Lexington, Kentucky. In their amended complaint, the plaintiffs allege that the open banking rule exceeds the congressional grant of rulemaking authority in at least six ways, which include the following:
The rule purports to regulate the provision of data to third parties, but the statute only permits rulemaking with respect to banks’ obligations to “make available to a consumer, upon request, information in the control or possession of the [bank] concerning the consumer financial product or service that the consumer obtained” from the bank.2
The rule increases risk to consumers by forcing banks to make available information enabling third parties to initiate payment from a consumer’s account and tasks banks with ensuring that unsupervised third parties can be trusted with the data they receive.
The rule seeks to outsource the task of establishing standards for compliance to private entities.
The rule imposes vague and confusing performance standards for the developer interfaces that data providers are required to establish.
The rule would require compliance before any of the standard-setting bodies are convened, much less able to promulgate standards for compliance.
The rule prevents data providers from recouping any of the substantial costs that compliance with the rule will impose.3
The CFPB filed an answer to the amended complaint on 27 December 2024, and the court directed the parties to confer regarding a case schedule. The incoming CFPB director will have wide latitude to use the lawsuit to determine the fate of the rule. The new director could, for example, consent to an injunction that would prevent the rule from taking effect. Whether the open banking rule will meet this fate remains to be seen. The proposed rule drew bipartisan support, including from former US Representative Patrick McHenry, the then-chair of the House Financial Services Committee. And the final rule, though controversial in many respects, appears to have avoided the ire of at least some members of the incoming administration.
Regardless of what happens to the rule, open banking is likely here to stay. Data providers have already established private, though largely unregulated, facilities for the electronic sharing of consumer data. Consumers and market participants who take issue with the manner in which data is shared, or allegedly misused, have several legal remedies available to them, regardless of whether open banking is regulated by the CFPB.
While it is impossible to predict the ultimate fate of the open banking rule, this much is likely certain: it will meet its destiny sooner rather than later. the firm will continue to provide updates on the fate of the rule.
Footnotes
1 12 C.F.R. pt. 1033.
2 12 U.S.C. § 5533(a) (emphases added).
3 See Am. Compl. ¶¶ 12-18, Forcht Bank, N.A., et al. v. CFPB, No, 5:24-cv-00304-DCR (E.D.K.Y.).
European Regulatory Timeline 2025
Following the turn of the new year, our UK Regulatory specialists have examined the key regulatory developments in 2025 impacting a range of UK and European firms within the financial services sector. The key dates have been distilled by the Proskauer team in an easy to read timeline with our commentary.
Download the 2025 European Regulatory Timeline
Michael Singh and Sulaiman I. Malik also contributed to this article.
Nasdaq Rule Change Lengthens Reverse Stock Split Notice Period
Last November, Nasdaq proposed a rule change that would lengthen the notification period for companies conducting reverse stock splits from five business days to 10 calendar days. The rule change became effective immediately and will become operative on January 30.
In November 2023, the US Securities and Exchange Commission approved new listing requirements for Nasdaq, including Rule 5250(e)(7). Rule 5250(e)(7) currently requires a company conducting a reverse stock split to notify Nasdaq of the stock split by submitting a Company Event Notification Form no later than 12:00 PM, ET five business days prior to the proposed market effective date of the reverse stock split.
However, Rule 10b-17(a)(2) and (b) of the Securities Exchange Act of 1934, as amended, requires that a company notify the Financial Industry Regulatory Authority no later than 10 calendar days prior to the date of record to participate in a reverse stock split, unless that notice is compliant with the procedures of a national securities exchange whose requirements are “substantially comparable” with the 10-day requirement.
Because Nasdaq’s five-business-day requirement may not be considered “substantially comparable” to the 10-calendar-day requirement under Rule 10b-17, Nasdaq has proposed the modified rule (to 10 calendar days) in order to conform to the requirements of Rule 10b-17. Nasdaq also submitted a modified Company Event Notification Form that will reflect the new notice requirement.
Takeaways
Beginning January 30, companies seeking to effectuate reverse stock splits will be required to provide 10 calendar days’ notice by submitting a Company Event Notification Form.
The Company Event Notification Form will continue to require disclosure of information such as the effective date of the split, the split ratio, confirmation of Depository Trust Company eligibility of the post-split Committee on Uniform Securities Identification Procedures number, and dates of board and shareholder approval.
Failure to provide timely notice could result in a halt in stock trading.
Nasdaq is not proposing any changes to the two-day public disclosure requirement outlined in Rule 5250(b)(4).
CHASE: JP Morgan Chase Allowed to Pursue Debt Against TCPA Litigant via Counterclaim
This lady named Gina Henry allegedly owed Chase Bank some money. It made collection calls to her and Henry sued for TCPA violations.
Chase countersued Henry for the debt owed and Henry moved to dismiss the claim.
In Henry v. JP Morgan Chase, 2025 WL 91179 (N.D. Cal. Jan 14, 2025) the court denied this effort and allowed the bank to chase Henry for the debt.
Reasoning that the claim for the debt is related to the same operative facts as the phone calls at issue in the TCPA claim– the calls were made to collect the debt after all– the Court had little trouble concluding the two claims should proceed in one suit.
The Court also rejected the idea that allowing counterclaims might dissuade TCPA suits– Chase is free to sue Henry for the debt in state court regardless. So doing it all in one place will be easier for Henry in the Court’s view.
TCPA suits against debt collectors and servicers are at an all time low right now as Plaintiff lawyers focus their energies on origination and marketing callers. Still it is important to keep in mind that an occasional debt collection TCPA suit might still be filed–especially if prerecorded calls or RVM is used– and when they are pursuing the debt in a counterclaim is a splendid idea.
Nice work Chase.