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Securities Compliance Sentinel

Analysis of cutting-edge securities industry issues

So what’s your firm’s culture

Posted in Broker-Dealer Regulation, Compliance and Supervision, Financial Industry Trends, FINRA Compliance, FINRA Enforcement

If you cannot answer this question, you may have an issue when you have your next FINRA exam. After all, firm culture is a FINRA exam priority. Does your firm have a culture of compliance?

This question only leads to another; what is a culture of compliance. For one, this is something that has to resonate from the top down. If senior management ascribes to uphold firm compliance, that should promote the “culture of compliance.”CEO tree

For example, does senior leadership enforce the firm’s written supervisory processes and procedures? In doing so, does senior management hold everyone accountable the same way, or are exceptions made for the “big producers”. If exceptions are made, you are not promoting a culture of compliance.

Does senior management ensure that there is adequate training of all personnel? There should be a robust and mandatory training program to account for changes to the rules and to make your personnel aware of risks and how to avoid them; one of the biggest being data security.

These are only two of many considerations for assessing whether there is a culture of compliance. The key in it all is leadership from the top. After all, people cannot follow a leader who does not lead. Be a leader.

Huge Customer Protection Rule Fine Brings Back Memories

Posted in Broker-Dealer Regulation, SEC Enforcement

My friend and a legend in the securities regulatory field, Edwin Nordlinger, who served as Deputy Regional Director in the SEC’s New York office for years, was one of the nation’s premier experts on the SEC’s net capital and customer protection rules.  He taught hundreds of SEC staff members and others about these rules over the years.  However, when Ed would begin one of these lectures, he would always introduce himself by saying: “Hello, I am Ed Nordlinger from New York, where you do not go to jail for killing people, but you will go to jail if you violate the net capital or customer protection rules.”  Well, Ed, you continue to be right on point about these rules and their impact.

The SEC’s net capital rule, SEC Exchange Act Rule 15c3-1, requires firms to maintain certain capital so that the firms will be able to meet their financial obligations to customers and other creditors.  Similarly, SEC Exchange Act Rule 15c3-3, the customer protection rule, requires a firm that clears transactions to maintain certain reserve amounts to protect customers in the event of a firm failure.

Recently, the SEC found a firm to have violated the customer protection rule, and settled the matter with the firm whereby the firm agreed to pay a fine of $358 million and a total amount of $415 million.  https://www.sec.gov/news/pressrelease/2016-128.html.  Further, the SEC also charged the firm’s regulatory reporting officer and financial operations principal for aiding and abetting the violations by misleading regulators about the real reason behind certain transactions that caused the violations.  In particular, the SEC claimed that the firm used synthetic securities transactions solely to reduce the reserve calculation and release capital.  The firm also apparently used non-qualifying bank accounts that could be subject to bankruptcy if the firm were to fail.

The real kicker, however, is the SEC’s announcement that it plans to undertake a targeted sweep of firms to find potential violations by other firms of the customer protection rules.  Of course, the SEC also encouraged firms to self-report any potential violations of the customer protection rule.

In short, Ed, after all these years, you are still right.  Firms need to seriously undertake compliance with these rules, or there will be significant consequences.  Accordingly, although the rules may seem technical with no fraud or customer losses, the SEC plans major activity to ensure compliance.

What to do about a stupid client

Posted in Books and Records, Compliance and Supervision, Financial Industry Trends, FINRA Compliance, Public Customer Arbitrations, Registered Representatives, SEC Compliance, Securities Litigation

Anyone in a professional service business, like being a stock broker, have been faced with a client who decides to make a stupid decision. But the issue we all face is when that decision results in the client losing money; who is to be held accountable.whistleblower

Fortunately, the law does not require you to stop a client from making a stupid decision with their investments. As long as a broker-dealer’s advice was suitable and the investment advisor’s advice is in keeping with the fiduciary duty, you should not be held accountable.

But this does not mean a client who has now lost money won’t try to hold you accountable for letting them make a stupid business decision. So how do you protect yourself?

The best way to protection yourself is to send the client a letter or email at the time that the client makes the bad decision. The communication should detail why you think it is a bad decision and the potential ramifications associated with that decision.

At a minimum, you should make a note in your file, either electronic or in hard copy, that the client made the bad decision and that you (presumably) advised against it.

The law should protect you from stupid clients, but make sure you protect yourself. Contemporaneous communication to the client and notation to the file may save you millions of dollars in the future.

It Is All About The Disclosures

Posted in Breach of Fiduciary Duty, Conflicts of Interest, Financial Industry Trends, SEC Compliance, SEC Enforcement

Core ValuesThe SEC recently commenced an enforcement action against an investment advisory firm and its principal in connection with the failure to disclose material conflicts of interest in connection with new mutual funds that the firm recently created and managed. The SEC is seeking disgorgement and an injunction against the firm and its principal.

Clients of the firm paid a fee for investment advice. Initially, the clients were invested in an ETF program. The firm subsequently created its own mutual funds that it managed for a fee.
Without disclosing that it would be paid both an investment advisory fee and fees for managing the mutual funds, the firm moved its clients into the mutual funds, which mirrored the investments in the ETF program. So why did the SEC take issue with this?

For one, the firm did not disclose the conflict of interest associated with this new strategy. The conflict of interest is that the firm is going to be paid two fees for an investment program that was the same as the prior program for which clients were only charged one fee.

Interestingly, the SEC in its complaint does not contend that the charging of two fees is per se improper. Instead, the issue is the fact that the firm did not disclose the conflict to its client before shifting the investment program. So what does this mean?

It all comes down to disclosure. If you disclose all conflicts of interest in sufficient detail, you may be able to avoid these types of enforcement issues.

To be a broker-dealer or not to be; that is the SEC’s question

Posted in Broker-Dealer Registration, Broker-Dealer Regulation, Compliance and Supervision, Financial Industry Trends, SEC Compliance, SEC Enforcement

The SEC recently announced that an equity advisory firm and its owner agreed to pay more than $3.1 million to resolve charges that they improperly engaged in brokerage activity, as well as charging fees without registering as a broker-dealer.  In other words, the firm acted like a broker-dealer but never bothered to register as one.

The SEC’s investigation demonstrated that the firm performed brokerage services in-house, instead of using investment banks or broker-dealers to handle the acquisition and sale of portfolio companies for a pair of equity funds they advised.  Interestingly, the firm disclosed to its customers that it would provide brokerage services and charge customers a fee for doing so.

The problem is that the firm provided those services itself even though it was not registered to do so.  This action should serve as warning, particularly for firms who may be engaged in Reg. D offerings.

money and calculatorIf part of the offering you find yourself engaged in the sale of securities, you better be registered as a broker-dealer to be doing so.  Alternatively, you could have retained the services of a broker-dealer to sell interests in the fund.  The law is clear; you need to do one of the two.

Another point of interest is that the SEC uncovered this improper conduct through an ordinary examination of the investment advisory firm.  In other words, there was no customer complaining that it suffered any harm.  So what lessons are to be learned?

For one, only broker-dealers can engage in brokerage services.  Second, the SEC in its exam process is looking for such activity and going after it.  Don’t make the same mistake; register as a broker-dealer or retain one to provide those services for you.

Why a bad broker is not like fine wine

Posted in Broker-Dealer Regulation, Compliance and Supervision, Financial Industry Trends, FINRA Compliance, FINRA CRD, FINRA Enforcement, Registered Representatives

Unfortunately, a bad broker does not take on the same attributes as a fine wine. Bad brokers do rarely improve with time.

At least this was the recent message of Robert Ketchum, head of FINRA. But should all brokers who have any pings on their record be foreclosed from the industry? Certainly not, but what should you do?Core Values

The question is tougher when the broker coming to you with some knocks on his record has been a historically high producer for his prior member firm. Surely, there must be more to the story.
In my experience, there usually is more to the story. Just because someone has some marks does not mean he/she is not worthy to be with your firm. But be careful.

Anyone coming to your firm with any pings on their U-4 should be brought on under heightened supervision. This way you can personally assess this person and test the reasons why this person has been pinged in the past. Maybe the registered representative was just the victim of circumstance in the past.

Either way, if you are going to bring someone on with a checkered past, you better be willing to take the time to watch over this person. After all, by bringing them to your firm, you have assumed responsibility for them. Take caution on the front end or be ready to pay the price later.

SEC Announces Third Largest Whistleblower Award

Posted in Compliance and Supervision, SEC Compliance, SEC Enforcement, Whistleblowers

Business Insurance reported late last week that the Securities and Exchange Commission will award $5-6 million to a whistleblower who provided information on securities violations that would have been “nearly impossible” for the SEC to detect on its own.  Such an award would be the third larges award ever granted to a whistleblower by the SEC.  This also comes on the heels of a $3.5 million whistleblower award from the week before.  whistleblower

The takeaway is that the SEC continues to heavily incentivize company insiders to report possible securities violations.  It is critical to have internal controls and monitoring to catch these problems before a whistleblower runs into the SEC.  Self-reporting can drastically reduce exposure to damages and fines, but if you do not have proper compliance checks in place, you may never even catch the problem yourself.  Routine internal investigations and a rigorous compliance and monitoring system will go a long way to preventing and spotting securities issues early, and thereafter managing and mitigating the fallout.

So you think you want to invest in medical marijuana

Posted in Financial Industry Trends, Private Placements

By most recent estimates, the medical marijuana business is generating at least $4.5 billion a year in revenue. Naturally, many people want to cultivate their own opportunities in this ever growing business.

Now that Pennsylvania has become the latest state to authorize medical marijuana, many people will look to invest in this industry. Some businesses in this industry may try to raise capital by having a Reg. D offering. Before investing in such an opportunity, it is important to read the “fine print” in any statutory or regulatory scheme on the subject. money and calculator

Pennsylvania, for example, will require a criminal history record check (through the State Police and FBI) “of the principals [and] financial backers . . . .” The stated purpose of such a check is to determine the “fitness and suitability” of the principals and financial backers to serve in those capacities. The criminal background check does not apply, however, to an owner of securities of a publicly traded company as long as the owner of securities is not “substantially involved” in the operations of the business.

So what does this all mean? For those of you looking for investors, you should do your own legwork on all potential investors in your venture. For those of you looking to invest in this smoldering industry, you need not apply if you have a criminal background, especially one involving the sale of controlled substances.

There are many opportunities in this industry. But ownership or financial backing of such a business in Pennsylvania comes at a price. Before you buy in, make sure you are willing to pay the price.

Take Away From The NSCP New York Regional Conference

Posted in Breach of Fiduciary Duty, Broker-Dealer Regulation, Compliance and Supervision, Cyber-Security, Financial Industry Trends, FINRA Compliance, FINRA Enforcement, Investment Adviser Regulation, Public Customer Arbitrations, Registered Representatives, SEC Compliance, SEC Enforcement, Securities Litigation

It was great speaking at the May 17 New York NSCP regional conference on risk issues facing firms where Ernie Badway and I discussed cyber-security, risk issues, regulatory matters, issues involving elder clients and ways compliance personnel can protect themselves.  For those of you who could not make the conference, these topics are frequently discussed in our various publications.  Feel free to access them here and use them as you see fit.  Core Values

NSCP Spring Conference in New York

Posted in Breach of Fiduciary Duty, Broker-Dealer Regulation, Compliance and Supervision, Cyber-Security, Financial Industry Trends, FINRA Compliance

On Tuesday, May 17, Ernie Badway and I are the keynote speakers at the NSCP Spring Conference in New York, entitled “Juggling Compliance Risks — Maintaining the Balance“. BoardAmong other things, Ernie and I will be speaking about cybersecurity, risk avoidance techniques, government regulations, elder client issues and compliance.  We hope to see you at the conference.