Fintech ch. 3

SEC act of 1934

-established the Federal Securities and Exchange Commission and governs broker dealers

payment for order flows

-the compensation and benefit a brokerage firm receives for directing orders to different parties for trade execution. -Allows brokers to exploit the diff between bid and ask price to buy and sell those orders

1a) yes, She's a person, recommend investment in security, for econ benefit (part of her services) 1b) Yes, they are an entirety that recs investments in securities for compensation in the form of fees

1a) Liz is a real estate egan who sells homes of retirees. As part of her services, she often recs that her clients invest their sales proceeds into exchange traded funds (type of investment fund that is traded on a stock exchange) Should liz register as an investment adviser? 1b) Do robo-advisors meet the elements?

Keith Gill case

Aka Roaring Kitty -Picked Gamestop as undervalued stock -Founding father of gamestop squeeze -Promoted GS stocks and gathered momentum -Prob: ppl made money but many lost -SEC fraud Action against Gill -Misrep himself as amateur investor on Reddits'wall Street Bets form when he was a licensed investment adviser -Profited from GS rise by artificially inflating price of stock

FINRA Rule 2111

Broker dealer must hv reasonable basis to blv that transaction is suitable for customer based on info obtained via reasonable diligence to ascertain customer's investment profile

It's business model is designed to do so but by providing links to articles and news updates, it can argued that RB provides investment advice via notifications and popular lists

Does robinhood avoid reg BI standards?

Finra v. Robinhood (2019)

Duty of best execution violation -Robinhood fined 1.25 mill for lack of care in routing orders -RB routed its customers to four HFT broker dealers -Best execution requires broker dealers to complete order by order rvw of execution quality -RB didn't consider exec. Quality factors such as PI that firm could obtain from alt. markets -Instead they focused on quality of pre-existing routing destinations (all of which paid RB for that order flow)

SEC v. Capital gain research

Facts: investment adviser would buy shares b4 recommending that his client buy same shares and then sell them off for a profit (order anticipation) Holding: SEC could obtain an injunction compelling registered investment adviser to disclose the practice Reasoning: Court held that investment advisers act created fiduciary responsibilities for regulated investment advisers vis-a-vis their clients

Investment advisers don't hv to register with finra but broker dealers do

In terms of registration, what is a major difference btwn investment advisers and broker dealers?

Investment Advisers Act of 1940

Legislation governing who must register with the SEC as an investment adviser. -created in New Deal Era

yes, she's violating fiduciary duty by not disclosing this info to clients

Liz registers with SEC as investment adviser and rcvs comp from funds she recs but doesn't charge clients for her advice. Since she blvs investing in these funds is in best interest of clients, she doesn't disclose compensation she receives from fund. Could she face an enforcement action from the SEC?

1a) No, there's an exemption for private fund managers 1b) He needs to register with SEC within 90 days of hitting the 150 mill mark

Neal has been hired by a private hedge fund to provide long term investment advice. The fund has 125 mill in assets. 1a) Does neal need to register with SEC? 1b)

duty of best execution

Obligates brokers to exercise reasonable care in obtaining most advantageous terms for customer whether it be with an affiliate or another firm

Yes, they are an entity that recs security investments for econ. benefit

Rich is an app allowing users to link savings account and provide advice on how they can allocate savings into mutual funds, etc based on financial goals. They don't charge for service but do sell user data per terms of user agreement. Should they register as an investment adviser?

They are comitting fraud

Robo Strategy is registered as investment adviser. They claim to invest client funds in stable growth funds bt actually invest in higher risk investment vehicles and pocketing the difference. What's the problem with this strategy?

Disclose material facts and gain informed consent

Robostrategy is registered with SEC as an investment adviser/ It operates an app that provides advice for .25% of the value of assets under management/ company that owns robostrategy also owns large stakes in several of funds that they rec. What can Robostrategy do to avoid getting in trouble with SEC?

Compliance officer, compliance program

Rule 206 (4)-7 requires investment adviser to appoint a (blank) to oversee a (blank) program

-Follow 80/20 PI standard -Rvw each order individually -Follow best execution: Disclose PFOF as source of rev

Tradeit executes buy AND sell orders that are placed by users on its application on the NYSE. It doesn't charge a fee to its customers but earns the majority of its rev from payment for order flow. What steps should they take to ensure compliance with its duty of best execution?

Register with SEC and Finra as a brokerdealer

Tradeit executes buy and sell orders that are placed by users on it app on the nYSE. With whom would Tradeit need to register and as at?

Depends on business model -If it conducts recs of stock, subject to RBI

Tradeit is an app that allows users to place orders and sell stocks. Are they subject to regulation best interest?

true

True or false: roboadvisers charge less for their services than trad. investmen t advisors

Etrade Acorns Webull Betterment Wealth front

What are examples of dual registrant companies?

ellevest and folio investing

What are examples of investment advisor only companies?

robinhood

What are examples of just broker deal companies?

All investment advisers must -Avoid defrauding clients or potential clients -Avoid selling securities to a client or purchasing securities from a client -Avoid engaging in any fraudulent, deceptive, manipulative action, practice or course of business

What are the SEC's anti-fraud obligations?

Investment advisor, dual registrant, broker dealer

What are the business models in fintechspace?

1) investment advisers and broker dealers are required to disclose cyber risks and incidents in periodic reporting 2) Investment advisors are required to Ensure that cybersecurity policies and procedures are backed w/ functioning compliance programs

What are the cyber security requirements for broker dealers?

1) Must register with SEC and FINRA 2)Subject to SEC Act of 1934 3)Subject to oversigh by SEC and FINRA

What are the implications of being a broker dealer?

1) Prohibits ads for containing üntrue statements of material fact which are false/misleading 2) Limits use of testimonials of past performance, graphs/models and promises of free podructs or reports 3) Requires investment advisors to include adequate disclosures of the impact of material market conditions when using past performance

What are the specific advertising restrictions on investment advisers?

SEC v. capital gains rsrch

What case established fiduciary duty for investment adviser?

Betterment

What was first investment robo adviser?

Includes customer's age, other investments, financial situation, tac status, investment objectives, investment experience, investment time horizon, liquidity needs, risk tolerance, etc.

What's included in an investment profile?

yes, violates best interest

When users on Tradeit place a sell order, it recs a replacement stock. The stock rec is based on stock that will pay most commission. Is this a prob?

Engaging in fraudulent, deceptive and manipulative action, practice or course of business

Which anti fraud obligations did Gill violate?

Investment advisers who act solely as an adviser to private funds and have assets under management of less than 150 mill

Who qualifies for the private fund registration exemption under the IAA?

most robo advisors are DUALLY registered as investment advisors and broker dealers

Why are the rules for investment advisors and broker dealers relevant for robo advisors?

As just a broker dealer, you are NOT subject to fiduciary duty -If they avoid making recs, they only hv duty of best execution

Why would a company want to operate as a broker dealer (as opposed to a dual registrant)?

1a) register with SEC and FINRA as broker deal 1b) best execution 1c) Vet ur wholesalers to ensure that clients get best execution (not just using pre-existing routes like RB)

Your friends make an app that allows traders to buy and sell stocks. You have designed an app to be easy to use like a game. Users don't pay so u make money from high frequency trading payment flow orders. You want to sell the app for at least 1 billion. 1a) What is the first thing u must do? 1b) What duty must u fulfill? 1c) How can you ensure the best execution is filled?

Use regulation best interest: -Must disclose writings fees -Disclose conflicts of interest (getting paid comission) -Exercise reasonable diligence that rec is suitable for client

Your team is struggling to make money and your fund manager offers to pay you large coisions if you recommend for your clients to invest in his funds. What do you need to do?

dealer

any person engaged in business of buying and selling securities for such person's own account through broker or otherwise

broker

any person engaged in business of effecting transactions in securities on behalf of others

brokerdealer

firm engaged in business of trading securities for own account on behalf of customers

Regulation Best Interest

requires firms to -disclose all material facts relating to conflicts of interest when making a recommendation -must exercise reasonable diligence and care when evaluating recs and deciding whether it's best interest of client -must establish and enforce reasonably designed policies that ID material conflicts of interest related to both rec and financial incentives of the BD

Rule 206(4)-7: Compliance programs

requires investment advisors to : 1) Implement written policies and procedures "reasonably designed to prevent, detect and connect violations of IAA 2) Rvw policies annually to determine effectiveness 3) Appoint COO

1) duty to dislose material facts relating to investment 2) due to gain informed consent and provide info on material conflicts 3) duty to make reasonable inquiry to ensure that advice gvn is suitable for clients 4) duty to complete best execution of client transaction where investment advisor has a responsibility to select broker dealers to execute client trades

what are the 4 fiduciary duties?

1) Protect society from negative consequences of the failure of financial product providers 2) Protect consumers from being exploited due to lack of knowledge and dependence on product providers

what are the main goals of regulation?

When a broker dealer is making a rec to a retail customer (individual customer) NOT institutional investor

when is best interest triggered?

True

(T/F) If a fund starts at less than that amount and rises, must fill up that amount (150 mill is threshold)

true

(T/F): The duty of best exec applies to investment advisers and broker dealers

False- most are still managed by institutions

(T/F): the majority of assets under management in US are now managed by robo advisers

SEC v. Hedgeable (2012)

-1st robo advisor action -Cease and desist order -Robo index comparison was misleading (only included less than 4% of their clients) -Hedgeable composite was incorrect and firm had insufficient documentation -Fined 80k

Charles Schwab case

-Charles Schwab advertised "no fee" for its robo-advisory services -Charles Schwab earns more income on cash deposits -Had incentive to allocate more of clients' investments to cash -Breach of fiduciary duty: gvn 200 mill charge

SEC v. Emperor (2021)

-Consent order with civil penalties -Emperor used misleading marketing materials and performance data that stated it had "outperformed market for past 11 years" when its model had been operating for less than 2 years -also emperor hired bloggers for referrals without disclosing payments

SEC v. Robinhood (2020)

-SEC said Duty of best execution requires brokers to act in customer's best interest when executing trades -Robinhood failed to disclose PFOF as source of rev -Brokers are supposed to use 80% of rev for price improvement for investor BUT RB did OPPOSITE(80% was rev and 20% used for PI) -SEC issued consent order for 65 mill.

Making same recs violates. suitability standard.They must ensure that they past suitability standard

Hometrade is app that helps sellers sell homes and also recs investment strategies and has thus registered with SEC as an investment adviser. Hometrade makes same recs to every seller. What is the problem with a business plan?

Executing trade w/o providing advice on how to execute it

How can a Broker Dealer avoid reg. BI standards?

1) Application gathers objective info (age, income assets) 2) Gathers subjective info (what would you do in a market downturn-usually good time to buy but risk adverse ppl won't) 3) Calculates a risk tolerance number based on this input to choose an investment porfolio

How do robo advisors work?

Securities act of 1934 applies and then the co. must register with the SEC and FINRA as a Broker-Dealer

If an app is a broker dealer what framework applies?

Investment Adviser Act applies and the co. must register with SEC as an Investment Adviser

If an app is an investment adviser, what framework applies?

False: RGBI only applies to recs for retail client

True or False: Regulation best interest applies anytime a broker dealer makes a rec on a securities transaction whereas the suitability rule only applies when broker dealer makes a rec on a sec transaction to retail investor

-Algothorimic functions used to manage client's account -Assumptions used to create algorithm -Limitations of algorithm to assess optimal securities for client -Assessment of risks associated with using the algorithm -Involvement of third party in developing or constructing algorithm -Human involvement in managing algorithm

What are the disclosure obligation specific to roboadvisors?

1) Must register with SEC 2) Owe fiduciary duties to clients 3) Subject to SEC reg

What are the implications of being labeled an investment adviser?

Hedgeable and Emperor

What cases involved Robo adviser disclosure violations?

Broad interpretation Any receipt of econ. Benefit suffices Fees need not be separate from other fees charged

What does "for the purpose of compensation" mean in context to investment advisors?

Making a rec about accounts that potentially contain securities (IRA, ROTH, 401k, edu accnts) Recs to buy or sell certain securities

What does "making a rec" apply to?

-Need not be sole or even primary activity -SEC's jurisdiction applies to securities ONLY

What does "providing advice on securities'' mean in the context of investment advisors?

Requires adviser to execute transactions for each client in such a manner that client's total cost or proceeds are the most favorable under the circumstances

What does best execution mean?

1) Disclose: Conflicts of interest 2) Legal or penalizing events relevant to evaluating adviser's integrity 3) Fees: -Whether adviser charges fee higher than other advisers fr similar services -Whether adviser receives any benefits from 3rd parties -Whether transactional costs or commission fees will be charged to client

What does it mean to disclose material facts?

someone who Provide transaction specific advice and has compensation per transaction (commission based)

What is a broker dealer?

An automated computer program used to offer investment advice and related services

What is a robo advisor?

any person or entity that for the purposes of compensation is engaged in the business of providing advice, making recs, issuing reports, or furnishing analysis on securities

What is an investment advisor?

-Requires adviser to make reasonable inquiry gather enough data to effectively provide personalized and appropriate advice -Questionnaires cannot be over generalized, ambiguous, misleading or designed to fit client into tool's predetermined options

What is suitable advice?

-In SEC case RB fined for failure to disclose conflict of interest (rev from PFOF) while in FINRA they're fined for lack of care (quality of pre-existing routes)

What is the difference btwn the SEC's case against robinhood v. Finra's case?

must File form ADV with SEC -Provides general info about nature and size of business -Discloses conflicts

What is the registration process like for Investment advisors?

Still very small b/c most assets held by institutional investors who prefer trad. Investment advisors but slowly gaining more market share with individual investors

What percentage of the market do roboadvisors have?

-Lower cost solutions to early investors -Lower threshold for investing (as little as $0)

What promises do robo advisers typically offer?

1) duty of best execution 2) Suitability standard 3) regulation best interest

What rules apply to broker dealers?