The Sutherland Asbill firm recently released its report regarding FINRA enforcement actions. In all, the report reflects that enforcement actions and fines decreased over the past year. So what does this all mean?
According to the firm, this could be a reflection of the larger financial crisis cases having worked their way through the system. One statistic that particularly caught my attention, however, was the decrease in the number of suitability cases; according to the report, a 38% drop.
Does this mean that FINRA is less focused on suitability cases? Not in the least.
According to FINRA, suitability remains one of its primary exam priorities in 2014. FINRA has stated that it is particularly focused on suitability when it comes to more complex products. FINRA is also focusing on those situations where there is a financial incentive for the recommendation of a particular investment. Examinations will focus on how material risks are being disclosed.
Don’t take the statistics lightly when it comes to suitability. Make sure your registered representatives are doing their job when making recommendations, especially when it comes to sophisticated and incentive-based products. Otherwise, you may contribute to an increase in suitability statistics next year.
* photo from freedigitalfotos.net
Usually, we spend a fair amount of time advising our American broker-dealer clients, who do business overseas, that they have to follow the rules of those countries as well. However, the “shoe” may sometimes be on the other “foot.” See http://www.sec.gov/litigation/admin/2014/34-71593.pdf.
Recently, a foreign broker-dealer was forced to pay a 9 figure judgment to resolve an action brought by the SEC. This foreign broker-dealer solicited and serviced thousands of American clients and made 8 figures in annual revenue over a 5 year period. However, a slight detail was ignored. The foreign broker-dealer never bothered to register as an American broker-dealer or investment adviser.
Sadly, some will never learn especially in this case where it seemed the foreign br0ker-dealer could have easily become registered. In any event, this is a good example of what happens when you believe you can avoid the rules if you do not speak the “language.”
We keep saying it, and we will keep saying it, cyber-security issues will not go away.
Now, FINRA has notified its member firms that it will begin assessment examinations regarding controls, procedures, approaches and management of cyber-security threats. See http://www.finra.org/Industry/Regulation/Guidance/TargetedExaminationLetters/P443219. In particular, FINRA examiners will review business continuity plans, service provider arrangements, other third party vendor agreements, reporting lines, cyber-attacks and responses, training, and insurance. FINRA will use this information to assess its member firms potential response to these issus as well as their infrastructure.
Seriously, member firms need to take this risk seriously and ensure that core systems are protected.
Recently, the SEC’s Division of Trading and Markets Staff issued no action relief allowing those persons and entities specializing in mergers and acquistions (“M&A Broker”) to avoid broker-dealer registration. See http://www.sec.gov/divisions/marketreg/mr-noaction/2014/ma-brokers-013114.pdf.
The staff defined a M&A Broker as “a person engaged in the business of effecting securities transactions solely in connection with the transfer of ownership and control of a privately-held company … through the purchase, sale, exchange, issuance, repurchase, or redemption of, or a business combination involving, securities or assets of the company, to a buyer that will actively operate the company… .” Id. However, the Staff did not permit unfettered non-registration for M&A Brokers. Instead, the Staff limited the work these people and entities could perform to instances where the M&A Broker was not able to: (1) bind a party to any transaction; (2) hold funds or securities as part of the transaction; (3) participate in a public offering; and (4) participate unless the buyer, ultimately, owned a private company. As is typical, the Staff said the no-action letter only applied to the described transaction, however, it does shed light on the Staff’s thinking in this area.
In short, this no-action letter may prove to be a major opening into avoiding broker-dealer registration. However, we caution our readers that it may be sometime before the effects are all played out, and please keep in mind that the Staff is notorious for providing inconsistent positions in subsequent no-action letters.
Suspicious Activity Reports (SARs) have been a useful tool for financial institutions to report financial fraud while, at the same time, prohibiting the reporting institution from disclosing the existence of a SARs in response to a third-party request. In 2010, the Financial Crimes Enforcement Network (FinCEN), amended this regulation to extend the prohibition against disclosure to futures commission merchants (FCMs) and introducing brokers (IBs). The amendments permitted FCMs and IBs to make a SAR and related information available to any SRO that examines the FCM or IB.
The CFTC has recently tweaked the playing field. FCMs and IBs that are subject to examination by the National Futures Association are now requested to make all SARs, information revealing the existence of a SAR, and supporting documentation available to the NFA upon request.
Just as important, the CFTC cautioned the NFA and its officers, directors employees and agents that they are prohibited from revealing the existence of a SAR, except as required to fulfill its self-regulatory duties upon the request of the CFTC. If the NFA wants to disclose the existence of a SAR or related information to a third party, it must first seek the authorization of the CFTC.
If you are an FCM or IB and you make a SAR, you are still obligated to keep the existence of the SAR a secret. When faced with a request for a SAR (or even the existence of one) make sure you know who is requesting it. Always look before you leap when it comes to protecting the secrecy of a SAR.
* Photo from freedigitalphotos.com
A frequent tool for settlement was to make a stipulated award that included expungement of the registered representative’s U-4 a condition of settlement. FINRA recently announced that it is “developing rule changes that would prohibit the practice of conditioning settlements on an investor’s agreement not to oppose expungement.”
It should come as no shock that FINRA is taking the next step to do away with stipulated awards that include expungement as a condition to settlement when considered in the context of FINRA Rule 2080, which requires specific findings by an arbitral body before recommending expungement as part of an award. Whether this is a good idea will remain to be seen.
One unintended result may be an impetus to try arbitrations to award rather than settle. After all, if a registered representative cannot get an expungement without an award (based upon a factual record), then what is the point to settle in the first place.
Conversely, this change may force the claimant’s bar not to name registered representatives or refer to them specifically in statements of claim in order to avoid the expungement issue altogether and, in turn, promote settlement. Would that result be a bad thing?
Having represented respondents for the better part of my career, I can see a distinct possibility that more claims will be tried to an award because there may be little incentive to settle if expungement is not possible without a fully developed record. At some point, this additional cost would likely be passed on to the consumer. I suspect that this is not what FINRA intended.
Tis the season for the regulators to announce their examination priorities. No less than the SEC’s Office of Compliance Inspections and Examinations released its 2014 Examination Priorities for its National Examination Program (“NEP”).
In particular, the SEC identified several new issues for registered investment advisers, primarily for those RIAs, who are at least three years old and have never been examined; as well as continued presence exams for hedge and private equity managers; wrap fee programs; quantitative trading models; and disguised distribution payments. OCIE will also continue to examine for failure to comply with the custody rule; conflicts of interest, including, but not limited to, undisclosed compensation and allocation of investment opportunities, and performance marketing; alternative investment strategies for registered funds; money market fund stress testing; securities lending; senior management meetings concerning risk management; IT systems’ supervision; dual registrants and suitability; private placement solicitations; and IRA rollovers. OCIE stated that these priorities also apply to broker-dealers, clearing agencies, and transfer agents. See http://www.sec.gov/about/offices/ocie/national-examination-program-priorities-2014.pdf.
In short, given these priorities, it looks to be an interesting year for securities entities subject to the SEC’s jurisdiction.
A must read is the article in this quarter’ s The Neutral Corner, published by FINRA Dispute Resolution, and authored by John D. Nachmann, Esq., Deputy Chief Counsel, FINRA Registration and Disclosure. Mr. Nachmann’s article, “Limitations on the Types of Disclosure Events That May Be Expunged From the Central Registration Depository Through Arbitration,” provides a blueprint for those seeking expungement through arbitration. The article also offers a waring that, even if expungement is ordered, FINRA’s CRD may not be obligated to remove the material from the system. We encourage all those who are interested in expungement to read this informative article. See http://www.finra.org/web/groups/arbitrationmediation/@arbmed/@arbtors/documents/arbmed/p410646.pdf.
Now that 2014 is here, it is a good idea to understand what the Enforcement Division might focus on this year. In a recent article that appeared in the BNA, David Marder, a partner with Robins, Kaplan, Miller & Ciresi identified fifteen things to expect in the coming year.
The fifteen things he noted to expect include:
- Increased use of whistle-blowers;
- Increase requiring defendants admit guilt in settlements;
- Increasing the use of available technology;
- Increase the number of easier to prove cases;
- Push self-reporting of securities violations;
- Increased focus on microcaps;
- Continued focus on gatekeepers;
- An emphasis on financial reporting;
- Protection of market structure and integrity;
- Increase the activity of specialized SEC units;
- Continue attacking insider trading;
- Investigate misconduct at hedge funds, private equity funds and mutual funds;
- Increase the size of the trial unit to avoid losing at trial;
- To further leverage the exam program; and
- Increase administrative proceedings.
Although this certainly seems like a robust agenda, expect the SEC under the leadership of Chair Mary Jo White to pursue it with particular vigor.
It seems like the SEC has a lot to prove; in part, to justify it budget. The question is whether the industry is adequately prepared to deal with a bulked up and more aggressive SEC. Time will tell . . . .
Just yesterday, FINRA issued its annual regulatory and examinations priorities letter. In keeping with its tradition, FINRA’s list keeps getting longer with each passing year, and it does not seem that FINRA has deleted anything from prior years. Nonetheless, we will be discussing this letter in more detail in later posts but wanted to let everyone know that FINRA seems to be concerned with: complex product suitability; recidivist brokers; conflicts of interest; the suitability of recommendations to retail investors for complex products, including structured products with interest rate sensitivity; private REITS; frontier emerging market funds; MBS; long duration bond funds; wealth management practices and proprietary products; protection of customer data; IRA rollovers; IPOs; private placement solicitations and accredited investor status; AML; protecting senior investors; liquidity risk and firm stress-testing; net capital calculations; auditor independence; and municipal securities. FINRA also created a new enforcement group to prosecute cases against brokers with disciplinary histories, and to review member firm’s hiring and supervisory practices regarding brokers’ previous issues. See http://www.finra.org/web/groups/industry/@ip/@reg/@guide/documents/industry/p419710.pdf.