Header graphic for print

Securities Compliance Sentinel

Analysis of cutting-edge securities industry issues

So You Think That You Really Know Your Customer

Posted in Arbitration, Compliance and Supervision, Registered Representatives

If the recent National Senior Investor Initiative of the SEC and FINRA taught us anything, it was the tremendous importance to know your customers. This takes on more significance when you are working with seniors.money.jpg

You may ask why does “knowing your customer” take on any more significance for these clients. For one, an investor’s goals, objectives and tolerance for risk may change over time. What may have been suitable when your client was in her thirties may not when the same client is in her 60s.

By the same token, as our society grays, there may be more issues with cognitive impairment. Getting in front of your clients as they age will then take on an even bigger significance, especially if you detect cognitive issues.

Best practices would suggest that you have a face-to-face meeting with your clients at least once a year. At those meetings, you should undertake that know your customer analysis as if the client was new to the firm. Although this may seem like needless work, there is a benefit.

First, any time you are in front of your client you have the opportunity to generate new business. Second, it shows your clients, particularly as they age, that you have a vested interest in them as people, than just AUM. Third, it provides you with a possible risk avoidance tool. The more you know, the less likely you will be faced with a suitability claim in the future.

Take the time every year to make sure you still know your customer. Otherwise, place yourself at risk of being a target in the future. The choice is yours.

* photo from freedigitalphotos.net

So What Does The SEC Think About Cybersecurity

Posted in Breach of Fiduciary Duty, Broker-Dealer Regulation, Compliance and Supervision, Cyber-Security, FINRA Compliance, Investment Adviser Regulation, Investment Company Regulation, SEC Compliance

At the end of last month, the SEC provided a guidance update on cybersecurity for registered investment companies and registered investment advisors. This guidance is equally instructive for broker-dealers and registered representatives.
Cyber threats are numerous and ever changing with technology. The SEC provided the guidance to highlight the importance of having a robust cybersecurity program because the failure to do so is just too risky for you and your clients.robber.jpg

The SEC identified a number of things that firms can do to make sure that they have an adequate cybersecurity program. These include, among others, the following:

  1. Periodic assessments of (1) the nature, sensitivity and location of information the firm collects; (2) internal/external threats; (3) current security processes and controls; (4) the potential impact of a compromise; and (5) the effectiveness of firm governance over cybersecurity.
  2. Creation of a cybersecurity strategy designed to prevent, detect and respond to the threats associated with cybersecurity.
  3. Implementation through written policies and procedures and training to provide guidance from the top to the bottom of the corporate tree concerning threats, measures designed to prevent and detect and to respond to such threats.

Teenagers playing on their computer are not the only threat to infiltrate a firm’s systems. Organized crime and foreign nations are engaged in this industry as well. Assess your cybersecurity systems on a regular basis throughout the year consistent with the SEC’s guidance, and don’t be a victim.

* photo from freedigitalphotos.net

What The Heck Is A Senior Designation

Posted in Broker-Dealer Regulation, Compliance and Supervision, Conflicts of Interest, FINRA Compliance, FINRA Enforcement

That is one of the questions FINRA sought to answer in its recent National Seminar Investor Initiative. FINRA confirmed that many representatives use such designations, but some of them are bogus or no better than a certificate you find as a prize in a cereal box.

The problem is that some representatives use these bogus designations to pray on seniors. Some seniors, unfortunately, get lulled into believing the “senior” alphabet soup next to their broker’s name really means the person has some special skills when it comes to helping seniors.

This is not to suggest that there are not real senior designations or people particularly skilled to help seniors. Instead, it is a caution to firms that retain such individuals.fraud.jpg

To address the senior designation issue, firms have a few possible options:

  1. Prohibit the use of senior designations.
  2. Require that senior designations have a verified curriculum, a continuing education element, and accreditation from a recognized independent organization.
  3. Mandate supervisory approval prior to the use of such designations.

If you decide to let your representatives use senior designations that are properly accredited, the use of such designations have to be properly supervised. If you do not supervise this activity, you – like an unknowing senior – may become the victim of a fraud.

* photo from freedigitalphotos.net

Why Reverse Churning Does Not Create Cream From Butter.

Posted in Arbitration, Broker-Dealer Regulation, Compliance and Supervision, Financial Industry Trends, FINRA Compliance, FINRA Enforcement, Public Customer Arbitrations, Registered Representatives

For years, firms have been using wrap products to charge an annual fee based upon the value of assets under management regardless of the number of trades, as opposed to fees per trade. In other words, wrap accounts were an effective tool to avoid churning claims because the customer theoretically could trade daily and only be charged an annual fee. These accounts are, however, giving way to a new type of customer complaint and regulatory oversight.

The new claim is known as reverse churning. In that situation, the client is placed into a wrap account, but trades very infrequently. As a result, the client winds up paying more in wrap fees than she would have with a straight brokerage, pay per trade account. idea.jpg

You can avoid these types of claims and potential regulatory headache by doing some simple due diligence when the account is opened and over the life of the account. As part of the “know your customer” intake process, you need to make proper inquiry to get a sense from your new client how frequently that client may want to execute trades in the account.

If your prospective client is looking for an active trading strategy, then the wrap account is probably the right way to go, and vice versa. It is equally important to review your accounts on a regular basis, at least annually, to see if the account activity justifies the fee structure. If the fees are out of whack when judged against the trading volume, then recommend a change in a formal written communication.

Unfortunately, reverse churning does not change butter into cream. To avoid what it can create, do your due diligence during your initial and subsequent know your customer analysis. Make sure your client is in the right type of account and avoid the stomach upset associated with a churn.

* photo from freedigitalphotos.net

Fox’s Frank Razzano Publishes New Securities Article in Securities Regulation Law Journal

Posted in Securities Litigation

Our partner, Frank C. Razzano, has recently published an article, entitled “What Lies Ahead: Halliburton v. Erica P. John Fund, Inc.,” in the Securities Regulation Law Journal (Spring 2015).  It is a great article discussing a recent United Supreme Court decision dealing with class actions.  Kindly let us know if you would like a copy for your review. 


The DOL Proposes A Fiduciary Duty Rule; Is This The Beginning Of The End

Posted in Uncategorized

The Department of Labor delivered on a longstanding but controversial promise when it recently proposed a fiduciary duty rule for all brokers who work with retirement accounts. The primary purpose of the proposed rule is avoidance of conflicts of interest.

If the proposed rule becomes final in its current form, it will have the following impact:money.jpg

  1. Anyone who is paid for providing individual advice to a plan sponsor, a participant in a retirement plan or an IRA for consideration of investments will be a fiduciary.
  2. It will continue to be acceptable for a plan sponsor and providers to continue educating investors in workplace plans and IRAs without being considered a fiduciary.
  3. Any fiduciary adviser must provide investment advice that is impartial and in the best interests of the client.
  4. Under what is called the “best interest contract exemption”, firms and individual advisers operating in conformity with the exemption can receive commissions and revenue sharing, but have to act in the clients’ best interests, and disclose potential conflicts and hidden fees.

This rule is a long way from becoming final, and, for that matter, may never become final. Nevertheless, the trend is set. Maybe the SEC will be next. . . .

* Photo from freedigitalphotos.net

So Who Wants To Give A Vendor Access To Your IT Systems

Posted in Books and Records, Cyber-Security, Federal and State Criminal Activities, Financial Industry Trends, FINRA Compliance, FINRA Enforcement

At one time or another, member firms will likely need the services of an outside vendor. This may be particularly true for smaller member firms. Outside vendors have their place, but FINRA’s Report on Cybersecurity Practices details that level of vigilance needed when it comes contracting with vendors who have access to your IT systems.

The first thing that firms must do to protect themselves is to perform due diligence on the prospective vendor. When it comes to cybersecurity in particular, FINRA has noted that vendors should have a number of controls in place when it comes to, among other things, limits on data access by vendor employees, virus protection, and encryption of data while at rest and in transit to name a few. The key for firms is to make sure that these controls are covered in your vendor contract.robber.jpg

FINRA noted that a number of firms that were reviewed had language in their contracts that included provisions on the following subject areas:

  1. Non-disclosure agreements/confidentiality agreements.
  2. Data storage, retention and delivery.
  3. Breach notification policies.
  4. Right to audit clauses.
  5. Vendor employee access limitations.
  6. Use of subcontractors.
  7. Vendor obligations upon contract interpretation.

Best practices would certainly dictate including these areas in any contract with a vendor, especially those who have access to your IT systems. If your contracts do not cover these areas, it is time to revisit your vendor contracts and bring them up to date to account for cybersecurity.

* photo from freedigitalphotos.net

The SEC Cracks Down on Anti-Whistleblower Agreements

Posted in Compliance and Supervision, Financial Industry Trends, SEC Compliance, SEC Enforcement, Whistleblowers

Around this time last year, the Securities and Exchange Commission’s Office of the Whistleblower warned lawyers that they may be disciplined for drafting contracts to incentivize whistleblowers to not bring alleged company wrongdoing to the SEC’s attention.  It appears the SEC is beginning to make good on its threat.  Last week, the SEC resolved its first enforcement action against a company for allegedly using improperly restrictive language in confidentiality agreements with the potential to stifle whistleblowers.  That company agreed to pay a $130,000 penalty to reach a “no admissions” resolution with the SEC.

According to the SEC, the company required witnesses in certain internal investigations interviews to sign confidentiality statements with language warning that they could face discipline and even be fired if they discussed the matters with outside parties without the prior approval of the company’s legal department.  Since these investigations included allegations of possible securities law violations, the SEC asserted that these terms violated Rule 21F-17 (enacted under the Dodd-Frank Act), which prohibits companies from taking any action to impede whistleblowers from reporting possible securities violations to the SEC.

The SEC said there were no apparent instances in which the company actually prevented employees from communicating with the agency, but that such a “blanket prohibition” on discussing internal investigations with outsiders has a “a potential chilling effect on whistleblowers’ willingness to report illegal conduct to the SEC.”

In addition to paying the fine to the SEC, the company also amended its confidentiality agreements by adding language making clear that employees are free to report possible violations to the SEC and other federal agencies without company approval or fear of retaliation.

As we previously cautioned, general counsel and securities compliance attorneys should be careful when drafting employment contracts to avoid including language that could be interpreted to incentivize employees to keep potential securities fraud whistleblower complaints in-house or confidential, or in this case disincentivize whistleblowers from bringing those complaints to the SEC.  While the disclaimer described above should certainly be included in any employee confidentiality restrictions, the SEC has not stated that such a disclaimer would be a safe harbor for companies.  Thus, counsel may want to consider additional cautionary language or revisions to their employment agreements to avoid broad restrictions that could discourage potential whistleblowers from reporting violations to the SEC.

Is This A Preview of FINRA’s Approach to Rule 3110(e)

Posted in Broker-Dealer Regulation, Compliance and Supervision, FINRA Compliance, FINRA CRD, FINRA Enforcement, Raiding/Moving Firms, Registered Representatives

In a recent Acceptance, Waiver and Consent (“AWC”) a broker dealer was censured and fined for, among other things, the failure to conduct an adequate pre-hire investigation of a registered representative. The importance of this AWC is that it may signal FINRA’s mindset for what firms must do under Rule 3110(e).

Under Rule 3110(e), FINRA expects member firms to more of a background check than simply reviewing the new hire’s CRD, and requires firms to have written supervisory procedures specifically designed to verify the accuracy and completeness of the information on the applicant’s U-4. The AWC noted that the member firm only reviewed the new hire’s CRD, and did not conduct any more investigation of that information even though the CRD showed the following: reportable events, including criminal charges, a termination for cause and customer complaints of unauthorized trading.idea.jpg

Although the AWC pre-dates the “go-live” date for Rule 3110(e), it is instructive to member firms. The AWC echoes the fact that a firm will not be insulated if it limits its pre-hire review to the information that appears in the CRD of the potential new hire. Instead, the member firm must do more to get behind the information contained on the CRD for a more detailed understanding.

Rule 3110(e) becomes effective on July 1, 2015. Between now and then, firms should be reviewing their written supervisory procedures regarding pre-hire due diligence. Make sure you have procedures that go above and beyond the CRD, or be faced with possible consequences for the failure to do so.

* photo from freedigtalphotos.net