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5 Major Takeaways from SEC’s New Investor Protection Rule – Thought Leaders

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5 Major Takeaways from SEC's New Investor Protection Rule - Thought Leaders

It seems that the controversies surrounding SEC’s newly adopted Regulation Best Interest rule (Reg BI), would continue to take center stage, even though it goes into effect next summer. The regulation is the culmination of a decade-long process that started in 2010, immediately after the great recession. The Dodd-Frank Act passed that same year authorized the SEC under section 913 to enact a fiduciary standard and best of interest rule to govern broker-dealers and investment advisors when engaging with private investors.

In the aftermath of the introduction of Reg BI, stakeholders, state regulators, investment advisers and broker-dealers have weighed in on various factors that could undermine or aid its effectiveness.

5 Key Takeaways 

  1. Brokers Dealers required to adhere to new “best interest” standard
  2. Sets up U.S. Department of Labor (DOL) to synchronize rule-making (later this year)
  3. Big win for broker dealers  → even bigger for financial services
  4. The New Common Reporting Standards (CRS) Says Broker = Advisor → confusion between  broker vs fiduciary advisor
  5. Reverse focus on protecting brokerage role than consumer = more confusion 

However, before we highlight these takeaways, let’s first take a look at the substance of the fiduciary standard clarification rule.

The Takeaways from SEC’s Regulation Best Interest Rule

SEC intends to subject broker-dealers, who currently are only required to meet suitability standards, under fiduciary standards.

On one hand, fiduciary standards presently govern the relationship between financial advisors and their clients. And it expects the former to only offer services that are in the best interest of the latter. On the other hand, suitability standards require brokers to ascertain that the investment they recommend suits their clients.

In essence, the rule looks to extend the fiduciary rule on broker-dealers who are increasingly taking up the roles of financial advisors, when their primary duty is to sell an investment product for a stipulated commission. Under the suitability standard, it is legal for a broker to recommend an investment product that avails him a good commission, so long the product is suitable to the customer.

While this is a given, it also presents a conflict of interest. It’s possible that there are cheaper investment products with similar features to the one the broker recommends, but with a less attractive commission. This conflict of interest is what the Reg BI looks to eliminate, as it requires brokers to place the client’s interest above theirs.

To do this, the rule would enforce brokers to explicitly disclose important information such as incentives and commissions that could influence their recommendations. More so, it would, to an extent, ban industry practices, like incentives in the form of vacations, that could spur brokers to betray the interests of their clients.

Knowing fully well that brokers could find a way around this requirement by disclosing conflict of interests with technical terms or in a voluminous document, the SEC also introduced another requirement that could counter such practices. The requirement states that brokers must outline conflict of interests and their compensation structure in plain English and in a concise manner on a document called form CRS.

Also, brokers would document the history of legal or disciplinary actions taken against the firm offering the investment product or its financial professionals. Another vital feature of the rule is Care Obligation. This requirement entails that financial advisors to make sure that they diligently and carefully ensure that their recommendations are in the best interest of their clients.

The last requirement is the Conflict of interest obligation. It requires the management and mitigation of commissions that could represent a financial conflict of interest.

Dissecting the Implications of The Regulation Best Interest Rule

As expected, critics left and right have dissected SEC’s Reg BI, and the prominent argument that many have brought up is the fogginess of the rule. For one, some critics have condemned SEC’s reluctance to clearly define what it means by “Best interest”, the actions that would suggest that an investment advisor is not compliant, and how to mitigate financial conflict of interest.

Chances are that broker-dealers would look to find a way around this rule, at least until SEC starts enforcing disciplinary actions against non-compliant investment advisors. Besides, Reg BI does not seem to have enforcement muscle. It is unlikely that non-compliance would lead to class action lawsuits and litigations.

Furthermore, there is an outcry that SEC’s rule has done nothing to clarify to investors the roles of Investment advisors and broker-dealers. Note that a majority of brokers-dealers are registered with the SEC. Technically, this means that they could assume the roles of Registered Investment Advisors (RIA), and yet, they are not fiduciaries.

More concerning is the fact that the Form CRS requirement would do little to change the status quo. This notion stems from the fact that studies showed that consumers found it difficult to understand the contents of CRS forms.

While responding to many of the criticisms leveled against Reg BI, SEC’s chairman, Jay Clayton stated that “differing views were expressed regarding whether the standard should be more principles-based or more prescriptive — and in particular, whether to provide a detailed, specific, situation-by-situation definition of ‘best interest’ in the rule text.” 

As such, after careful consideration, the agency concluded that the principle-based approach adopted for the rule “is a common and effective approach to addressing issues of duty under law, particularly where the facts and circumstances of individual relationships can vary widely and change over time, including as a result of innovation,”

Judging from the details of Reg BI discussed above, there is no doubt that the rule has elements of the fiduciary rule that the Obama administration proposed through the Department of labor. The difference is that the latter was looking to classify all investment professionals as fiduciaries. In other words, a client could decide to sue his investment advisor or broker once he notices any discrepancies that would suggest that his interests were not best served by the actions of his investment manager.

Recall that this rule hit a roadblock under the present administration, as the securities industry challenged its viability in court. And while DOL has also indicated that it is pushing for a new fiduciary rule, there is no guarantee that its future proposal would have the same grit as the previous one. This assertion is probable, considering the likelihood that Eugene Scalia, the attorney that led the case against DOL’s previous fiduciary rule, would emerge as the new Labor Secretary.

Also, it is important to note that the Certified Financial Planner Board of Standards plans on enforcing an ethics code that would entail that its 84,000 members adhere to fiduciary standards, irrespective of the regulatory frameworks that govern them. Interestingly enough, this code’s implementation date coincides with that of Reg BI’s.

More importantly, some states are contemplating on taking matters into their own hands by imposing separate fiduciary rules that would correct the apparent flaws of Reg BI. For instance, New Jersey’s security bureau has released a rule proposal that explicitly classifies brokers- dealers as fiduciaries. Other states that have taken a similar path are Nevada and Massachusetts.

In response to this development, SEC’s chairman, Jay Clayton, stated that “I and many others believe a patchwork approach to the regulation of the vast market for retail investment advice will increase costs, limit choice for retail investors and make oversight and enforcement more difficult. I am hopeful that our regulatory colleagues will continue to work with us to minimize inconsistencies and maximize the effectiveness of our collective efforts.”

However, regardless of the loopholes of Reg BI, and the controversies that spurred responses from state regulators, I believe that the SEC’s proposal is a step in the right direction in order to protect investors. 

For investors, it is a matter of asking the right questions: 

  1. Who pays your broker’s commission?
  2. How much he gets paid for encouraging you to buy an investment product. 
  3. Are you a fiduciary?
  4. How does a broker apply investor protection rules? 

 

The information provided here is personal opinion and provides only a subjective opinion of the rules and regulatory guidance provided by the SEC. It should not be read as legal or compliance advice. Consult with your compliance professional for further details.

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Constantin is a venture partner at BitBull Capital, CBO at ABOTMI, and has been a cryptocurrency investor since 2012. He has 10+ years experience in corporate leadership, technology and finance. He contributes to the digital asset space, sharing and value economies.

Regulation

Bank of China Moves to Regulate STO

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Bank of China to Create STO Regulations

This month, executives from the bank of China unveiled some major announcements regarding the future of blockchain technology in the country. Apparently, the Bank of China will now create its own centralized cryptocurrency. Additionally, the bank intends to roll out a robust security token protocol in the coming weeks.

In the past, Chinese officials have been very critical of cryptocurrencies. The country famously banned exchanges back in 2017. Also, Chinese officials have been hard on miners in the country despite the fact that the Chinese government operates some of the largest mining facilities in the world.

Pivot Towards Blockchain – Bank of China

Now it appears as if Chinese officials got the memo that blockchain technology is here to stay. At the recent Finance Technology Summit in Beijing, the Chief Scientist of the Bank of China, Weimin Guo described the country’s new strategy moving forward.

Chief Scientist of the Bank of China - Weimin Guo

Chief Scientist of the Bank of China – Weimin Guo

National Digital Currency

China now intends to release its own cryptocurrency called China’s Digital Currency Electronic Payment (DCEP). This cryptocurrency will serve as the only national digital currency of the country. Interestingly, the token will be a stablecoin pegged to the Chinese RenMinBi (RMB).

Developers hope that the integration of blockchain and cryptographic technology will streamline the outdated financial practices currently in use. Blockchain tech brings some serious advantages to the table. For one, the tech eliminates the frictions seen in traditional payment systems.

Shade on Bitcoin

After acknowledging the huge benefits gained from blockchain technology, Guo stated that Bitcoin had failed its purpose to provide a safe haven from the traditional market manipulations. He stated that Bitcoin’s launch was poorly timed and its primary goal to disrupt the global economy was “impossible.”

Strict Regulations – Bank of China

While China loosens its blockchain leash, it’s obvious the country wants to keep the technology in check. For example, all STOs are to operate within a strict “regulatory sandbox mechanism” at first. Basically, the country wants to promote innovation with new technology but desires a measured integration to maintain complete control over the sector.

It’s no surprise that China feels the pressure from blockchain adoption. At one time, China controlled a large majority of the crypto market. Since that time, the country continually targeted crypto investors and traders.

Additionally, regulators expressed concern about major tech firms such as Facebook issuing a cryptocurrency. Not surprisingly, regulators only want currency creation to originate from a national bank or government agency.

China’s Big Hope

Chinese regulators now believe that the DCEP has the potential to evolve into a leading global currency. Bank officials seek to integrate the currency into the main economy as soon as possible. This integration will span the scope of the Chinese economic sector from retail all the way to major investment firms.

China Inches Back into the Game

It’s interesting to see how Chinese regulators continue to embrace blockchain technology. China has always been on edge over the emergence of cryptocurrencies, but as it stands today, the country has to embrace the technology or fall to the wayside against the growing competition.

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Regulation

VNX Exchange Hopes to Get in Front of Upcoming AMLD5 Legislation with Sumsub Collaboration

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VNX Exchange Hopes to Get in Front of Upcoming AMLD5 Legislation with Sumsub Collaboration

Tech Provider

Recently launched platform, VNX Exchange, and compliance expert, Sumsub, have announced a new collaboration. This will see Sumsub provide the necessary technology, which will allow VNX Exchange to ensure compliance with European laws surrounding AML/KYC.

This move is a proactive one, being taken by VNX Exchange. They have indicated that they chose to collaborate with Sumsub, as they possess the ability to remain compliant with the upcoming AMLD5 European legislation.

AML/KYC Importance

Anti-Money-Laundering and Know-Your-Client are important compliance mechanisms used world-over. While their implementation may vary depending on regions, the purpose of each remain the same.

These compliance measures are what allow for regulatory bodies to keep nefarious activity in check. This is done by, first, knowing who they are dealing with. This part is taken care of through KYC checks, which gather information such as legal names, place of residence, passport info, and etcetera. Next, AML puts roadblocks in place, designed to prevent the origins of money from being clouded.

Unfortunately, blockchain based endeavours (including digital securities), remain synonymous with nefarious activity, to date. Much of this stems from past markets that saw the ICOs boom and bust. The entire point of digital securities, however, is to offer the benefits of tokenization, through a regulatory compliant and legal manner. For this to be achieved, and to dispel pre-existing notions (warranted or not) surrounding blockchain based endeavours, AML and KYC remain of utmost importance.

Rival Providers

As indicated above, compliance measures surrounding AML and KYC are of the utmost importance within the digital securities sector. Many companies have recognized this, and are in the midst of developing their own solutions for the issue at hand. The following companies are but a few of those leading the way.

Commentary

Upon announcing their collaboration, representatives from each, Sumsub and VNX Exchange, took the time to comment. The following is what each had to say on the matter.

Alexander Tkachenko, CEO of VNX Exchange, stated,

“VNX Exchange is very serious about all aspects related to compliance and investor protection. For these purposes, we are leveraging the benefits and advantages of innovative compliance systems provided by Sumsub to create a seamless client experience and open access to the new class of liquid digital assets backed by venture capital investments.”

Jacob Sever, Cofounder of Sumsub, stated,

“AMLD5 is soon to gain full power and influence among all financial entities in Europe with reinforced AML demands. With many clients based in Luxemburg, such as JobToday, Wecan Group, etc., we see the demand for compliance and anti-fraud measures, and know how to ensure them. VNX is a serious and mature project, with founders and management from traditional well-respected foundations, so we are happy to provide them with a high-level solution, optimising compliance under the Luxembourg regulations.”

Sumsub

Founded in 2015, Sumsub is a tech provider operating out of London, U.K. Above all, services offered by Sumsub revolve around compliance. This includes KYC/AML, investor onboarding, and more.

CEO, Andrey Severyukhin, currently oversees company operations.

VNX Exchange

Founded in 2018, VNX Exchange operates out of Luxembourg. The team at VNX Exchange has recently announced the launch of their digital securities issuance platform, along with their inaugural STO.

CEO, Alexander Tkachenko, currently oversees company operations.

In Other News

Both, VNX Exchange and Sumsub, have found themselves in our headlines in the past. Now their past work has brought them together, as they work with one another moving forward. The following articles touch on past events pertaining to each company.

VNX Exchange Launches, Calling Luxembourg Home

Sum&Substance Introduced to Polymath ‘Service Provider Marketplace’

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Regulation

Gladius Fails to Pay SEC Fines

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Gladius Dissolves

The blockchain-based cybersecurity firm, Gladius announced that the company dissolved this week. Unfortunately for Gladius token holders, the company chose to ignore the $12.7 million settlement payment the SEC imposed earlier in the year. Now, Gladius token holders are left holding the bag.

In what seems to be a growing trend, another SEC charged ICO dissolved before repaying investors.  In this instance, Gladius received $12.7 in fines after self-reporting to the SEC in February. Understandably, the SEC showed some leniency towards the firm for their decision to self-report.

A Lenient Approach

As part of the SEC settlement, regulators didn’t impose any additional penalties on the firm. However, they did make the company executives agree to compensate investors fully. Also, the company was to register the tokens as securities. Gladius agreed to the terms but asked for multiple extensions on the repayment date. Rather than repaying investors, the company chose to dissolve.

Gladius Founder Max Niebylski

Gladius Founder Max Niebylski

News of the Dissolution

Investors first received the bad news via a November 22 telegram post. In the post, the company’s co-founder and chief technology officer, Alex Godwin described the decision. He explained that  the firm “ceased operations effective immediately.” He also stated that the firm “no longer has funds to continue operations.”

Rektiers

As you could imagine, investors are furious over the turn of events. Investors feel as if the SEC’s approach lacked enforcement. Investors have even formed a Telegram chat group called the Gladius Rektiers to organize another strategy to reclaim lost funds.

Gladius

Gladius entered the market in April 2017. The firm planned to utilize a combination of blockchain-based technologies to protect users. Specifically, the firm employed decentralized CDN and DDoS protection on the Ethereum Blockchain. Additionally, Gladius platform users could rent out unused bandwidth and computational power.

Gladius Website

Gladius Website

Interestingly, Gladius executives did decide to leave their open-source code available on GitHub. The team even welcomed developers to further their protocol on their now deceased website’s homepage.

Dipping on the Bill

While the Gladius dissolution is bad news, it joins a host of other SEC charged ICOs who skipped out on their deadlines. For example, AirFox missed an October deadline this year. Airfox entered the market as a mobile banking solution before the SEC charged the firm with selling unregistered securities.

Additionally, Paragon Coin missed its investor repayment deadline. As part of Paragon Coin’s SEC settlement, the company agreed to offer to repay investors and pay $250,000 in fines.  For their cooperation, the SEC withheld fraud charges. Also, the company agreed to register their tokens as securities and adhere to all relevant regulations moving forward.

The Paragon Coin saga received premier coverage as it involved a well-known beauty pageant winner and the rapper – The Game. Currently, the Paragon Coin website tells investors that want a refund to submit before November. Notably, their SEC repayment settlement date already pasted back in July.

The Gladius Saga Continues

The decision to dissolve prior to adhering to the SEC’s demands could prove to be a costly one for Gladius. For now, investors are culminating their outrage to organize their next maneuver. Many expect to see additional charges in some shape or form against the company’s owners as regulators decide how to handle the news and investor outcry.

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