This post follows up on our earlier “primer” and flash alert on the Consumer Financial Protection Bureau’s proposed rule (the proposal) to implement the Fair Debt Collection Practices Act, which the CFPB released with a Fact Sheet and a Table of Contents to the proposal. Below, we describe key details of the proposal, and provide further information from stakeholders and the CFPB that has become available since the proposal’s publication.

McGuireWoods also will host a free webinar on the proposal in the coming weeks; a date will be announced soon.

Comments on all aspects of the proposal are due 90 days after it appears in the Federal Register, which should be any day now.

I. Summary of Key Points

  • The proposal would apply only to “debt collectors” as defined by the FDCPA. Importantly, owners of debt — even debt in default when purchased — would continue to fall outside the branch of the “debt collector” definition that covers those who regularly collect debts “owed or due, to another.” As a practical matter, this means that the only “first-party” collectors (i.e., collectors who own the debt) who would generally be regulated as “debt collectors” would continue to be those who operate a “business the principal purpose of which is the collection of debts.”
  • Nonetheless, many of the proposal’s requirements regarding what is unfair, deceptive or abusive under the FDCPA likely would be viewed as informing the UDAAP/UDAP analysis that applies to every person collecting consumer debts.
  • The proposal would regulate communications by debt collectors in several key ways. In particular, it would:
    • cap at seven the number of telephone calls that debt collectors may place to consumers within a seven-day window about a particular debt;
    • impose a waiting period of seven days after a debt collector has a telephone conversation with a person about a particular debt;
    • permit unlimited electronic communications about a debt, but require a debt collector to include in any e-mail, text message or other electronic communication a clear and conspicuous statement describing a way for the consumer to “opt out” from receiving any further messages through that particular medium;
    • prohibit communications about a debt via a workplace email addresses (with exceptions) and through public-facing social media platforms; and
    • create an exception to communications limits and requirements for messages satisfying the definition of a new term, “limited content message.”
  • The proposal would standardize the “debt-validation” disclosures to consumers long required by § 809 of the FDCPA.

Continue Reading The CFPB’s Debt-Collection Proposal: Key Details and Webinar

A federal district court recently refused to dismiss a complaint alleging that a real estate marketing company operated its “co-marketing program” among real-estate agents and mortgage lenders in a manner that violated the anti-kickback provision of the Real Estate Settlement Procedures Act (“RESPA”). In particular, the court concluded that plaintiffs in the case had plausibly alleged that:

  • lenders paid into the co-marketing program more, and sometimes much more, than the reasonable market value of their share (versus their partner agents’ share) of joint costs for leads and advertising services actually provided; and
  • the excess amount paid was in fact a benefit to the real estate agents in exchange for the agents’ agreement to refer customers to the lenders.

2019 WL 1755293 (W.D. Wa. Apr. 19, 2019).

The court reached the first conclusion, regarding whether lenders paid more than reasonable market value, in part by relying on allegations about what lenders paid the real estate marketing company for similar services that did not involve participating real estate agents. More generally, the court relied on confidential witness statements from former employees of the company put forward by plaintiffs, including allegations in those statements and in separate employment-discrimination lawsuits against the company, that the company ignored or retaliated against employee whistle-blowers who reported that illegal referral payments were being made through the co-marketing program.

The court does appear to have made one legal error, though it likely did not affect the holding that plaintiffs had plausibly alleged payments by the lenders in exchange for referrals by the agents. The court viewed as RESPA “referrals” not only alleged attempts by the real estate agents to influence customers to select the participating lender, but also instances in which agents only passed to lenders the name and contact information of customers that had chosen to have such information go only to the agent. 2019 WL 1755293, at *4-5. While providing a lender with a lead in spite of the customer’s wishes may be problematic for other reasons, doing so is not a “referral” under RESPA, which instead requires that the referring party either (i) affirmatively influence the selection by the customer of a provider, or (ii) require the customer to use that provider. (12 C.F.R. § 1024.14(f).) The mere purchase of leads, or prospects, that the purchaser may then contact on its own has long been viewed as permissible under RESPA, at least where the seller of the leads does not endorse the purchaser or its product or services.

Key Takeaways

  • Lenders and other companies involved in real estate transactions should regularly review and monitor their provision and receipt of fees and other benefits in connection with the transactions, to ensure that those benefits are not being provided in exchange for referrals of customers.
  • Review and monitoring should include periodic determinations that even where benefits are provided in exchange for advertising, lead generation or other goods or services, those benefits approximate the reasonable market value for the goods or services. Providers of settlement services must assess in particular whether more than market value is provided, in which case the excess may be a disguised payment for referrals. This value standard sometimes also is described as whether payments are reasonably related to the value of the goods or services.
  • Determining fair market value can be challenging, but some good faith attempt must be made. In this case, there was an allegedly very easy comparison to be made, between the lenders’ co-marketing payments and lenders’ payments for services not involving real-estate agents.
  • Charges that a company received but ignored whistle-blower reports about illegal activity have a profound influence on courts. Companies must continue to take such reports seriously, to conduct a reasonable review or investigation, and to document the results.
  • Employees must be properly trained to understand RESPA’s anti-kickback, including the reasonable market value standard.

See below for more details on this case.

The Lawsuit

Although RESPA is at the core of the case, the case is in fact a typical securities class action. Plaintiffs allege that the company’s representatives made materially misleading public statements (with scienter), which in turn caused plaintiffs to purchase stock at a price that was artificially inflated by the statements. When the truth of the statements were called into question, plaintiffs allege, the resulting drop in the stock price caused them losses. RESPA’s anti-kickback provision is at issue because the allegedly false statements were that the real estate marketing company operated its co-marketing program in compliance with RESPA, when in fact the company allegedly operated it in a manner that violated RESPA. The company’s statements about RESPA compliance were called into question as a result of disclosures about a CFPB investigation of the company.

The threshold issue in the lawsuit, therefore, is whether the defendants’ statements of RESPA compliance were true; that is, whether the real estate marketing company’s operation of its co-marketing program did, in fact, comply with RESPA. In an earlier opinion, the court found that plaintiffs had not adequately alleged a RESPA violation, but gave them leave to re-plead with more particular allegations. Plaintiffs then did so, setting up the court’s decision in the later decision.

The Co-Marketing Program

The real estate marketing company launched a co-marketing program in 2013 that allowed a participating lender to pay a portion of a participating real estate agent’s advertising costs directly to the company in exchange for appearing on the agent’s listings on the company’s website and receiving from the company at least a portion of the leads it would send to the agent. How many of the agent’s leads would also go to the lender would depend on whether the user “opted out” from her information going to both parties.

 CFBP Investigation and This Lawsuit

Beginning in 2015, the real estate marketing company received inquiries from the CFPB regarding its co-marketing program. In February 2017, the company received a Notice and Opportunity to Respond and Advise letter from the CFPB, stating the CFPB was considering whether to recommend legal action against the company for violation of RESPA’s anti-kickback provision. In May 2017, the company publicly disclosed the CFPB’s investigation, but executives allegedly stated to investors that the co-marketing program complied with RESPA.

In August 2017, the company publicly disclosed that the CFPB had concluded its investigation, but wanted to discuss settlement or pursue further action. The company’s stock price fell as a result of that last disclosure. Shortly thereafter, investors filed a class action suit against the company and two executives, alleging that the investors purchased shares before the last disclosure at a price that was inflated by the executives materially misleading statements about RESPA compliance. Ultimately, in June 2018, the company reported that the CFPB determined not to take any enforcement action.

This Opinion Denying the Motion to Dismiss

In denying defendants’ motion to dismiss the complaint that plaintiffs had amended, the Court concluded that:

  • The new complaint pled facts sufficient to allow the Court to infer that the real estate marketing company designed its co-marketing program to allow agents to provide referrals to lenders in violation of RESPA, and that such referrals were occurring. The pertinent facts contained in the complaint included:
    • Two anonymous-witnesses statements, made by prior employees of the company. In essence, the statements reported that there was an understanding and practice among the company, the agents, and the lenders that lenders were paying for agents’ referrals of customers.
  • The allegations were sufficient to infer that the company designed the co-marketing program to allow lenders to pay more than fair market value for their share of marketing services. The pertinent alleged facts included:
    • Several indications that the co-marketing program’s prices were more expensive for lenders than comparable programs with the company not involving real-estate agents.
    • An anonymous witness statement by a former employee of the company describing how in practice lenders were able to make payments of up to 90% of co-marketing costs, which was corroborated by allegations in a wrongful termination suit filed in 2015.

On April 29, the New York Department of Financial Services (NY DFS)—the state’s principal banking and insurance regulator—announced that it is creating a new Consumer Protection and Financial Enforcement (CPFE) division. The new division, described by commentators as a state-level version of the Consumer Financial Protection Bureau (CFPB), or “mini CFPB,” will have responsibility for consumer financial enforcement and have oversight over consumer financial services institutions within the state. The NY DFS’s announcement highlighted that the agency’s new CPFE division will be particularly focused on review and response to cybersecurity events and the development of supervisory, regulatory, and enforcement policy and direction in the area of financial crimes.

New York’s creation of the new CPFE division, which will combine prior divisions within the DFS, comes as New York’s and other states’ representatives have raised concerns about the direction of the CFPB in Washington, D.C. State-level regulatory agencies can be expected to be aggressive enforcers in light of perceived laxer enforcement at the federal level. NY DFS’s announcement that the CPFE division will focus on cybersecurity events also reflects the New York regulator’s continued focus on this space following its promulgation in 2017 of rules governing cybersecurity standards for financial institutions.

As we anticipated last week, today the CFPB issued its much anticipated proposal to adopt the first substantive regulations to govern the activity of debt collectors under the Fair Debt Collection Practices Act (FDCPA) since that law’s passage in 1977 (Proposal).

The Proposal, which runs over 530 pages, would among other things:

  1. set limits on the number of calls that debt collectors may place to reach consumers on a weekly basis;
  2. clarify how collectors may communicate lawfully using newer technologies, such as voicemails, emails and text messages; and
  3. require debt collectors to provide more information to consumers to assist consumers in identifying debts and responding to collection attempts.

In the coming days, McGuireWoods will be publishing additional analysis of key issues in the Proposal. An overview of the scope of the proposed rule is also available in a CFPB-published “Fast Facts” document.

As we explained in our Primer last week, the rules ultimately adopted under this Proposal likely will impact not only “debt collectors” as the FDCPA defines that term, but also others involved in collections activity. FDCPA rules may affect others by influencing not only how UDAAP and UDAP requirements apply to all collections activity, but also how state debt collection law is interpreted, because such laws often apply to collectors who are not covered by the FDCPA.

Written comments on the Proposal are due 90 days after its publication in the Federal Register, which will occur within the next few weeks. Under that timeline, comments would likely be due in August of this year.

On May 2, 2019, the U.S. District Court for the Southern District of New York denied the Office of the Comptroller of the Currency’s (OCC) motion to dismiss a complaint brought against it by the Maria T. Vullo, superintendent of the New York State Department of Financial Services (DFS).  The complaint had challenged the OCC’s authority to provide its special-purpose charter to fintech companies under the National Bank Act (NBA).  Click here and here for our prior coverage on this lawsuit.

In the long awaited ruling, the court focused on the dual-banking system, in which state and national banks are chartered and regulated at different levels, to find that DFS properly demonstrated a “substantial risk that harm will occur,” to establish Article III standing. The court reasoned that since New York already provides a comprehensive regulatory system for nearly 600 non-depository fintechs, those regulations “are all at risk of becoming null and void,” by the OCC’s special-purpose charter.  Judge Marrero noted that fintechs may leave New York altogether, which will force DFS to incur costs now to avoid such harm.  According the court, the OCC focused exclusively on constitutional ripeness and did not address some the arguments presented by DFS concerning harm to its sovereignty and state interests. On this basis, the court found that DFS established standing to pursue its statutory and constitutional challenges against the OCC.

The court also disagreed with the OCC’s arguments that the claims are untimely.  The court focused on the ‘reopening doctrine,’ a long-standing principle permitting a court to review recent regulatory action based on prior agency interpretations.  The court noted that this doctrine “likely defeats [the] OCC’s statute of limitations defense,” and focused on the OCC’s failure to respond to the DFS’s arguments about the application of the doctrine.  On this basis, the court held the OCC did not meet its burden proof to assert the affirmative defense of timeliness, but expressly noted that the OCC may re-raise this defense later in the proceedings.

In addressing whether DFS can state a claim, the court held that the term “business of banking,” contrary to the OCC’s interpretation, “unambiguously requires receiving deposits[.]” The OCC had argued that the term “business of banking” was ambiguous and a reasonable interpretation would provide the  OCC with chartering authority for nonbanks that do not accept deposits. The court held that the OCC’s reading is “not so much an ‘interpretation’ as ‘a fundamental revision’ of the NBA.” According to the court, the special-purpose charter would enable a “dramatic disruption of federal-state relationships” which “lends weight to the argument” that the OCC’s authority “exceeds what Congress may have contemplated in passing the NBA.” On this basis, the court held that “only depository institutions are eligible to receive national bank charters from [the] OCC,” and denied the OCC’s motion to dismiss with respect to Counts I and II, both of which challenged the OCC’s authority under the NBA.  The court, however, dismissed DFS’s claim for a violation of the Tenth Amendment.


As soon as next week, the Consumer Financial Protection Bureau (CFPB) is expected to propose the first substantive regulations under the Fair Debt Collection Practices Act (FDCPA) since the law’s enactment in 1977. This rulemaking has the potential to substantially clarify and modernize many of the FDCPA’s requirements, with important implications not only for debt collection agencies and others who fit the law’s narrow definitions of “debt collector,” but for any entity engaged in the collection or sale of consumer debts.

Interest among industry and consumer-group stakeholders likely will be intense: An earlier agency notice about possible subjects for FDCPA rulemaking drew over 23,000 written comments to the CFPB, and a concrete proposal like the one forthcoming could generate many more. That level of interest is not surprising, given that debt collection activities consistently have ranked either first or second on the list of areas generating the highest number of consumer complaints to the Bureau. According to some press reports, the proposal may be released Wednesday, May 8, in connection with a CFPB Town Hall hosted by Director Kraninger.

Given the likely implications and widespread interest in the proposal, this alert serves as a primer on the anticipated rulemaking, both by placing it in context through a brief summary of its background, and by focusing on topics that the proposal is likely to cover.

Continue Reading Primer on the CFPB’s Imminent Fair Debt Collection Practices Act Rule Proposal

On Wednesday, Consumer Financial Protection Bureau (CFPB) Director Kathy Kraninger delivered her first policy speech since succeeding Mick Mulvaney as head of the CFPB in December. Forecasting the Bureau’s agenda over the coming months, Kraninger promised that, among other things, the Bureau will publish within weeks proposed rules to implement the Fair Debt Collection Practices Act (FDCPA) and will convene a “symposium” on “clarifying the meaning of abusive acts or practices under Section 1031 of the Dodd-Frank Act.” Kraninger also focused her remarks on the four “tools” given by Congress to the Bureau to carry its mission – education, regulation, supervision, and enforcement.

Addressing education, Kraninger stated that “empowering consumers to help themselves, protect their own interests, and choose the financial products and services that best fit their needs is vital to preventing consumer harm and building financial well-being.” Focusing on improving consumer savings, Kraninger noted that in addition to the Bureau’s recently launched a “Start Small, Save Up” initiative, the Bureau will later this year launch a “savings boot camp” which will include a series of videos to educate consumers on good savings habits.

On regulation, Kraninger promised that the Bureau will focus on “articulating clear rules of the road for regulated entities that promote competition, increase transparency, and preserve fair markets for financial products and services.” Emphasizing that the “the best possible rules” come from the “the best possible process,” Kraninger promised that the Bureau will proceed “deliberately and transparently in its rulemakings.” Of particular, note, Kraninger stated that the Bureau will soon release proposed rules to implement the FDCPA, which was first enacted in 1977. Kraninger also promised that the Bureau would take seriously its “responsibility under the law to reduce unwarranted regulatory burden and to consider the impact of rulemaking on regulated entities and consumers.”

Turning to supervision, which she described as being “the heart of this agency,” Kraninger stated that the Bureau would be taking a “fresh look at the entire process” to ensure that the Bureau’s supervisory activities are used “as effectively and efficiently as possible to prevent consumer harm” and consistently across supervised entities. Kraninger emphasized the need for coordination among government entities that supervise financial institutions, noting that she recently assumed the chair of the Federal Financial Institutions Examination Council, a group of federal and state agencies that regulate financial institutions, and stated she planned to focus “on strengthening coordination and collaboration with our sister regulators who review the same or similar information at the same institutions, albeit for different reasons.”

Finally, Kraninger promised that the Bureau would continue to focus on enforcement in appropriate cases, stating her “emphatic” view that “enforcement is an essential tool Congress gave the Bureau – particularly because education, rulemaking, and supervision will not prevent every violation.” She spoke of the need to emphasize consumer education because enforcement actions cannot identify every bad actor. Ultimately, Kraninger said, “purposeful enforcement is about utilizing robust resources most effectively to focus on the right cases to reinforce clear rules of the road and prevent harm by making sure bad actors know they will be held to account.”

Kraninger also shared her thoughts on how the CFPB’s effectiveness should be measured – not by “outputs” such as the number of complaints handled, but instead by “how well we use all of our tools to prevent consumer harm.” To that end, she announced that the Bureau will convene a symposia series over the next year on a variety of topics relating to the Bureau’s mission, beginning with “clarifying the meaning of abusive acts or practices under Section 1031 of the Dodd-Frank Act” – clarity that financial institutions will welcome.


On Thursday, March 28, California Governor Gavin Newsom announced that Manuel “Manny” Alvarez, 38, has been appointed Commissioner of the California Department of Business Oversight (DBO). Alvarez is currently general counsel, chief compliance officer and corporate secretary at Affirm Inc., the point-of-sale lending platform founded by PayPal’s Max Levchin in 2012. Alvarez’s appointment requires California State Senate confirmation. See the Governor’s press release here.

The Supreme Court and the Third Circuit decided three cases in the last week relating to the interpretation and enforceability of arbitration agreements. We discuss them below.

Third Circuit Compels Arbitration of an E-Signed Enrollment Agreement

The Third Circuit compelled arbitration of an agreement signed electronically by a student taking online courses. In Dicent v. Kaplan University, Maria Dicent, who represented herself in the case, filed a complaint against Kaplan University for various causes of action. Kaplan moved to compel arbitration on the basis that Dicent electronically signed a packet containing both an enrollment agreement and an arbitration agreement. Dicent claimed that she was not aware of the arbitration agreement and that Kaplan “tricked” her by including it within the enrollment packet.

According to the lower court, Kaplan supported its motion to compel with an affidavit explaining its e-signature verification process. To enroll in courses, students must log into an enrollment portal website. After clicking the “Electronically Sign” button, students enter personal identifying information on a verification page. An e-signature verification company compares the information with that in a confidential database. Upon positive verification of the student’s identity, the student and Kaplan receive a confirmation that the e-signature was successful. Kaplan’s records showed that Dicent’s enrollment packet, including the arbitration agreement, was accepted.

The Third Circuit explained that the first step in deciding whether to compel arbitration is to ask whether the parties have a valid agreement to arbitrate. In this case, the issue was whether Dicent assented to the agreement. Assent, the court explained, turns on ordinary state-law contract principles. The court observed that Pennsylvania, which the parties agreed governed the contract, recognizes e-signatures as a valid means to register legal assent.

The court held that there was no genuine issue of material fact as to whether Dicent assented to the arbitration agreement. Kaplan had presented evidence of her e-signature and Dicent conceded that she e-signed the enrollment packet. It concluded that the “most reasonable inference we can draw from the evidence presented is that Dicent simply did not read or review the Enrollment Packet PDF closely before she e-signed it, which will not save her from her obligation to arbitrate.”

A link to the opinion is here.

Justices Reject Judicially-Created Exception Limiting Enforcement of Arbitrability

 In Schein, Inc. v. Archer & White Sales, Inc., Justice Kavanaugh, writing for a unanimous Court, rejected the judicially-created “wholly groundless” exception to arbitrability.

Archer & White filed a complaint against Henry Schein, Inc. for various causes of action. Schein moved to compel arbitration on the basis that the parties’ contract required arbitration of “[a]ny dispute arising under or related to this Agreement.” Archer & White opposed the motion, arguing that it was “wholly groundless.” It pointed to the arbitration clause’s exception for “actions seeking injunctive relief” and argued that Schein sought injunctive relief in addition to damages.

The Court considered this question: does a court or an arbitrator decide whether a dispute falls within an exception to the parties’ arbitration clause? The arbitrator decides, the Court held; a court has no power to decide the arbitrability issue if the parties’ contract delegates that issue to an arbitrator. The Court concluded that the “wholly groundless” exception, adopted by some lower courts, was inconsistent with the Federal Arbitration Act’s text, which contains no such exception. It also contravened earlier cases, the Court said, that held courts cannot screen from arbitration cases that appear frivolous on the merits and that arbitrators may decide “gateway” questions of arbitrability.

A link to the opinion is here.

 Justices Uphold Statutory Exemption for Independent Contractor

In New Prime Inc. v. Oliveira, a unanimous opinion penned by Justice Gorsuch, the Supreme Court affirmed the First Circuit’s judgment that it lacked authority under the Federal Arbitration Act to enforce an arbitration agreement between an interstate trucking company and one of its drivers. The driver, purportedly an independent contractor, had argued that an exception to the Act for “contracts of employment” for transportation workers removed his agreement from the Act’s coverage.

The Supreme Court first considered whether a court or an arbitrator should decide whether the statutory exception applies. The court should decide, it held. The Court reasoned that the provisions of the Act empowering courts to stay litigation and compel obligation apply only if the Act applies, which requires an initial determination of whether the contract falls within the Act’s “contracts of employment” exception.

 The Court then turned to the term “contracts of employment.” Looking to its meaning in 1925, the year the Act was adopted, the Court concluded the term “meant nothing more than an agreement to perform work.” Dictionaries of that era, the Court said, did not distinguish between employees and independent contractors.

Although New Prime did not distinguish Schein, discussed above and decided only a week earlier, the key difference appears to be that Schein involved interpreting a contract whereas New Prime involved interpreting the statute, the source of the court’s authority to compel arbitration in the first place.

A link to the opinion is here.

With the SEC prioritizing protection of retail investors, investment advisers are facing increased scrutiny for misappropriation offenses. Adviser representatives are becoming more creative, making it harder for investment advisers to detect misappropriation. It may be easy for investment advisers to rely on software and automated-alerts to safeguard client assets, but the days of solely relying on software or even traditional confirmation letters are gone.

On Sept. 25, 2018, the Security and Exchange Commission (SEC) charged a former adviser representative for misappropriating more than $1.6 million from primarily elderly clients over the span of 14 years. This comes after the SEC announced on Aug.15, 2018 that an investment adviser agreed to pay $4.5 million to settle charges that it failed to safeguard retail investors’ assets from theft after four adviser representatives misappropriated, in aggregate, $1 million. This Alert discusses the significance of the Order and what investment advisers can do to avoid similar offenses.

 Key Considerations

Under Section 206(4) of the Investment Advisers Act of 1940 (the Act), investment advisers are required to exercise the duty of undivided loyalty and utmost care to their clients. Specifically, Rule 206(4)-2, commonly referred to as the “custody rule,” requires investment advisers who have custody of its clients’ funds or securities to adopt and implement policies and procedures reasonably designed to prevent violations by the investment adviser and its supervised persons.

In the Order, the SEC’s primary concern with the investment adviser’s supervisory systems was whether the system effectively detected misappropriation and the breadth of its detection. According to the SEC, the investment adviser had a hybrid supervisory system with manual and automated reviews which combined a geographical field-based supervisory model and a centralized supervisory model. However, because of the volume of transactions processed daily, a technical error, and limitations in the supervisory system, the investment adviser was unable to detect misappropriation that the SEC believed it was capable of discovering. For example, one adviser transferred funds from his client’s account to an account he effectively controlled for his personal business. The investment adviser’s supervisory system did not account for “controlled accounts” because the investment adviser’s system used a “hot list” of addresses, which, at the time, did not include the adviser representative’s business addresses. Further, the investment adviser’s system was limited only to flagging “exact addresses” so variations as subtle as using avenue instead of ave. would not have identified fraudulent transfers from a client’s account.

Moreover, the SEC highlighted the importance of investment advisers ensuring that its heightened supervision unit adequately monitors recidivist adviser representatives. An adviser representative under heightened supervision for prior unauthorized trading was one of the five representatives that misappropriated $1 million between 2011 to 2014. With the lowest offender misappropriating $21,000 in funds, the SEC sent a clear message; it will not tolerate misappropriation of any retail investors’ funds, no matter how small. Despite reimbursing clients for the misappropriated funds, the investment adviser was still penalized.

This Order comes weeks after another investment adviser faced a multi-million dollar fine for failing to reasonably design policies and procedures to prevent its adviser representatives from misappropriating client funds. One adviser representative’s misappropriation of $7 million led the SEC to uncover that the investment adviser’s policies and procedures, while appearing robust, failed to detect or prevent the adviser representatives from misusing or misappropriating client funds through use of internal electronic forms. The investment adviser allowed for its clients to place verbal requests by phone or in-person for outgoing wire transfers and journals of up to $100,000 per day per account. Based on the adviser representative’s attestation on an electronic form and providing certain details, the requests were completed. However, the investment adviser failed to account for fabricated request made by the adviser representatives. The SEC suggested the investment adviser could have routinely called clients to verify the authenticity of the transfer request or require oral requests be followed-up with a letter of authorization from the client or any writing with the client’s signature.

Bottom Line

 Investment advisers should reevaluate their supervisory policies and procedures to ensure their systems are performing as intended. Accordingly, investment advisers should:

  1. Ensure if they are handling large volumes of transactions daily, their systems are capable of processing and reviewing the mass number of transactions;
  2. Increase personal client-contact, not merely sending a letter, but rather client callbacks, at random and based on risk, to verify fund transfers are approved; and
  3. Increase anti-fraud expenditures to guarantee that automated-fraud software systems can account for third-party transfers for “controlled accounts” of persons associated with the advisers.

Investment advisers should consider retaining a compliance consultant to access the reasonableness of their policies. As the recent SEC Orders illustrate, the cost of noncompliance is greater than the cost for failing to comply.