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Securities Compliance Sentinel

Analysis of cutting-edge securities industry issues

What Is Big Brother Focused On In 2015

Posted in Broker-Dealer Regulation, Investment Adviser Regulation, Investment Company Regulation, Registered Representatives, SEC Compliance, SEC Enforcement

It is that time of year again.  The SEC Office of Compliance and Inspection (OCIE) has announced its examination priorities for 2015.  Knowing what these priorities are will help firms gauge their compliance and supervision efforts over the next year.

For firms that are in the retail sector, OCIE has identified particular areas of interest.  These areas include the following: OCIE will focus on firm recommendations when there is a variety of fee arrangements and account structures at the firm.

  1. OCIE is focusing on whether the arrangements and the fees charged are in the best interest of the client.
  2. OCIE is looking into the use of improper or misleading sales practices when recommending the movement of retirement assets from employee-sponsored defined contribution plans into other investments, especially those with higher fees.confusion.jpg
  3. OCIE is looking into the suitability of investing retirement assets into complex or structured products, including due diligence, and disclosures made to the investor.
  4. OCIE is looking into the supervision of branch offices, including using data analytics to identify branch offices that may be deviating from firm compliance.
  5. OCIE is continuing its focus on investment companies that are offering alternative investments.
  6. OCIE is looking into whether mutual funds with significant exposure to interest rates increases have implemented compliance policies, procedures and sufficient controls to ensure its disclosures are not misleading and that the investment profile is consistent with the disclosures.

Now that you know the SEC’s focus for the year ahead, ask yourself whether your firm is doing what it needs to do to answer the above issues with a positive response.  If no such response is forthcoming, you need to revisit what you are doing and act accordingly, lest you be a firm OCIE focuses upon.

* Photo from freedigitalphotos.net

Why You Need To Think Twice About That New Hire

Posted in Broker-Dealer Registration, Broker-Dealer Regulation, Compliance and Supervision, FINRA Compliance, FINRA CRD, FINRA Enforcement

Starting July 1, member firms are required to have written procedures to verify the accuracy and completeness of the information in a registered representative’s U-4 within 30 days of the U-4 being filed with FINRA.  The question that arises is whether the expense of this new type of “investigation” is worth it.pointing.jpg

In short, member firms will have to do more than a simple internet search of a potential hire, particularly if the firm finds something on the new hire.  For example, what do you do if the new hire was sued in the past?

Under this new requirement, it is fair to say that you will have to do more than just look at a docket.  Instead, it is likely that, in order to comply, you will have to review documents filed in the case to see if there were allegations against the new hire such as for fraud or other things that would present cause for concern.

This heightened analysis will certainly take time and money to complete.  If you are hiring a big producer, then the analysis is probably only a minor inconvenience, but what about if the new hire is not a big producer?  How much is enough?

Undoubtedly, firms will likely need to have bright line tests for when they will keep reviewing, as opposed to declining to hire a person with a complicated past.  There will certainly be a market for other firms to conduct this analysis for you.  Either way, member firms have to do more than a passing glance at a new hire’s U-4.

There is likely going to be a fair amount of question regarding how much is enough of a review.  Nevertheless, get your written procedures in place and have a game plan for how you will review the veracity of a new hire’s U-4.  Otherwise, you face the risk of suit for negligent hiring and the wrath of your regulator.

* Photo by freedigitalphotos.net

Whistleblower Tips Continue to Rise in 2014

Posted in Compliance and Supervision, Dodd-Frank, Financial Industry Trends, FINRA Compliance, FINRA Enforcement, SEC Compliance, SEC Enforcement, Uncategorized

The number of whistleblower tips to the Securities and Exchange Commission (SEC) continues to rise, according to the SEC’s 2014 Annual Report to Congress on the Dodd-Frank Whistleblower Program.  In the November 17, 2014 report, Sean X. McKessy, Chief, Office of the Whistleblower, notes that his office received 3,620 whistleblower tips in Fiscal Year 2014, which is more than a 20% increase from two years prior.  Indeed, the SEC’s Office of the Whistleblower received 3,001 tips in the 2012 fiscal year and 3,238 in the 2013 fiscal year, so the 2014 number (which is almost 400 tips greater than the previous year) also represents a larger leap forward year-over-year.

The SEC maintains their growing whistleblower operation by incentivizing whistleblowers with an award that can range from 10%-30% of the SEC’s recovery.  According to SEC counsel (at a 2014 Securities Litigation & Regulatory Update CLE in Philadelphia) the whistleblower will even get credit for any information gathered from a company’s internal investigations, although the date that the whistleblower informs the SEC is the date that is used to start the clock on the whistleblower’s award.whistle

Not to be outdone, FINRA also has an Office of the Whistleblower, which, created in 2009, actually predates the SEC’s 2010 Office of the Whistleblower that was established under Dodd-Frank.  However, unlike the SEC, FINRA does not financially incentivize whistleblowers.  Thus, according to FINRA’s counsel, it only receives approximately 1,000 whistleblower tips per year, with between 200-300 referrals.

Counsel for the SEC and FINRA (at the 2014 CLE noted supra) agreed that self-reporting is considered a mitigating factor that is taken into consideration for fine determination.  However, both the SEC and FINRA cautioned that self-reporting will not preempt a fine for wrongdoing, as both agencies can still impose hefty fines even where a company self-reports a violation.

The takeaway here is that whistleblowers continue to be a growing source of information for the SEC and FINRA to begin investigations and enforcement actions.  As the SEC continues to incentivize whisleblowers and publicize large awards, the number of tips they receive is expected to continue to increase annually.  Moreover, while there is some incentive for companies to self-report, the risk of being hit with a large fine still looms large.  Additionally, as we noted earlier this year, the SEC discourages incentivizing whistleblowers to keep complaints in-house.  Thus, if faced with a possible violation, it is important for companies and in-house counsel to engage experienced outside counsel as early as possible to investigate and advise on the proper response and path forward.

My Client Is Ignoring Me, Now What

Posted in Arbitration, Breach of Fiduciary Duty, Compliance and Supervision, FINRA Compliance

Anyone who is in a service industry frequently faces this question.  It is what you do in response that makes the difference between being a target for a lawsuit and moving on to greener pastures.bankinchains.jpg

The most important thing is not to ignore the fact that your client has ignored your advice.  A client ignoring your advice could have a material impact on the investment advice you gave.

For example, if you have prepared a financial plan with certain assumptions such as cash flow, a customer who alters the cash flow could impact the overall plan.  So what do you do?

The critical thing to do is to document the fact that the customer has ignored your advice and detail the ramifications for doing so.  Using the example above, you should write a letter or email to the client explaining the advice you gave (including whatever assumptions it was built upon) and detail the impact to the overall financial plan.

This is no guarantee that the client will not complain at some later date, but you have a paper trail.  You documented the advice that you gave the disregard of that advice, and the impact for doing so.  The only other question is whether to fire the client.

* Photo from freedigitalphotos.net

Reverse-Flash: SEC and FINRA Looking to Slow High-Speed Traders?

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

High-frequency trading is the latest craze hitting the market.  Popularized by Michael Lewis’s Flash Boys, high-frequency or high-speed trading involves the use of sophisticated technological tools and computer algorithms to rapidly trade securities.  According to Bloomberg BusinessWeek, high-frequency trading has been “blamed for making stock exchanges less transparent and markets more volatile [and] has disrupted the process of trading stocks that determines the value of public companies.”  Yet, I was recently told by counsel for the Securities and Exchange Commission and FINRA (at a 2014 Securities Litigation & Regulatory Update CLE in Philadelphia) that there is “nothing inherently bad” about high-frequency trading.  That said, these agencies are still looking for ways to safeguard investors.

FINRA recently approved various proposed rule changes regarding high-frequency trading, aimed at increasing transparency.  Additionally, the government has prosecuted traders for using high-frequency trading technology to manipulate the market.  For example, in October, the SEC fined an investment company for manipulating the closing prices of securities with a flurry of last second trades before the market closed.  That same month, the U.S. Attorney’s office in Chicago indicted a trader for placing and then rapidly cancelling orders to manipulate perceived demand, a tactic that has become known as “spoofing”.

The takeaway here is that, while high-frequency trading is still permitted—so long as it complies with FINRA’s new guidance and is not intended to manipulate markets and exploit other investors—the regulatory and enforcement landscape is starting to change.  Thus, companies and in-house counsel should continue to monitor developments in how the government plans to handle high-frequency trading.

Who Wants To Speak With Me, Oh No

Posted in Breach of Fiduciary Duty, Compliance and Supervision, Conflicts of Interest, Registered Representatives

Anyone in a service industry has had that dreaded feeling.  You see your email or caller identification and realize it is “that” client trying to reach you.  The client I reference is that extremely difficult client that we all have.

The natural inclination for many of us is to not take the call or respond to the email.  From a risk avoidance perspective, this is the last thing that you want to do. money.jpg

Unfortunately, we are all going to have difficult clients from time to time.  It is how you deal with that client that will make the difference between having a difficult and demanding client or a customer complaint to defend.

My late father had a saying that I think applies here; kill them with kindness.  Yes, difficult clients will take your attention away from other clients, but you still must make sure you address even the concerns of these difficult clients.

One key when working with these clients is to document everything that you do.  You speak with the client, follow-up with a confirming email.  The client ignores your advice; follow-up with an email restating your advice and note the consequences for the client not following it.

There is no easy way to deal with difficult clients, but the key is never ignoring them.  That will only create an issue where there may be none.  Don’t be afraid to hold a hand from now and again.  It may make the difference from just having a difficult client or a customer complaint.

* photo from freedigitalphotos.net

I Just Got A Client, Now What

Posted in Public Customer Arbitrations, Registered Representatives, Securities Litigation

After the obvious, make and execute on investment recommendations, some are at a loss for what to do next.  From my perspective, it is the next step that may mean the difference from having a career without customer complaints to one with them. 

The key to survival in this competitive industry is to have a constant line of communication open with your customers.  For one, you should have at least one face to face meeting with each of your clients every year. 

The next thing you should do is to have some contact with your clients on at least a quarterly basis.  With all of the technology available, there is just no excuse not to be in contact with your customers.  Email, text or, for heaven’s sake, call your clients.  Any time you have contact, that may be an opportunity to get more assets under management. idea.jpg

Most importantly, when a client reaches out to you, get back to that client no later than 24 hours after the client contacts you.  It is easy to blow off those high maintenance clients, but those are also the ones most likely to make complaints. 

By simply returning calls or emails expeditiously, you can avoid small issues bubbling into a major issue, written complaint, or worse, a lawsuit. 

If you take away one thing form this post, remember you are in the customer service business.  Give service.  Get customers.  Don’t give service.  Get sued.  Choice is yours.

* Photo from freedigitalphotos.net

NFA Prohibits Funding of Retail Forex Accounts With Credit Cards

Posted in CFTC Compliance, NFA Enforcement

This week, the CFTC approved a NFA Interpretative Notice that prohibits a Member from accepting credit card payments from customers to fund retail forex accounts.  The NFA recently reviewed how customers fund their retail forex accounts and found that customers overwhelmingly funded their trading accounts using a credit card.  The NFA noted that credit cards permit easy access to borrowed funds and the highly volatile nature of the forex and futures markets create a significant risk of substantial loss in a short period of time.  The NFA cautioned that it is not prohibiting other forms of electronic funding so long as the funds come directly from a customer’s bank account.  Members will be permitted to accept debit card transactions assuming that Members are able to distinguish between a debit card and a credit card transaction.  Member firms must comply with the interpretative notice by January 31, 2015.

For some Members, the new guidance will cause a substantial change in the way they accept customer funds and will add to the long list of regulatory compliance requirements.  Members that want to allow customers to fund their accounts using debit cards will likely have to retain a third party vendor to help in differentiating between debit card and credit card transactions.  Also, Members will have to ensure that they do not accept funds from electronic payment facilitators (i.e. Paypal) that commonly draw funds from a customer’s credit cards.  Certain customers may also ask why the NFA is no longer allowing them to get frequent flyer miles before they start forex and futures trading.

No Admit, No Deny – No Longer?

Posted in Compliance and Supervision, SEC Compliance, SEC Enforcement

Admissions by companies in enforcement actions brought by the Securities and Exchange Commission (SEC) can open the floodgates to follow-on private civil litigation.  Fortunately, the SEC has traditionally settled with companies on a “no admit, no deny” basis.  That has begun to change.

As you may recall, in 2011, U.S. District Judge Rakoff of the Southern District of New York refused to approve a “no admit, no deny” settlement between the SEC and Citigroup Global Markets, Inc.  See SEC. v. Citigroup Global Markets Inc., 827 F. Supp. 2d 328 (S.D.N.Y. 2011).  While that decision was recently overturned by the Second Circuit, see SEC v. Citigroup Global Mkts., Inc., 752 F.3d 285 (2d Cir. 2014), its effect lingers on.  According to the Second Circuit, district courts should still assess whether a SEC settlement is “fair and reasonable” and that the “public interest would not be disserved.”  Id.

In response, the SEC has begun pursuing admissions from companies under certain “limited” circumstances.  Recently, at a 2014 Securities Litigation & Regulatory Update CLE, SEC counsel offered insight into its new settlement admissions policy, suggesting that it would it would seek an admission, rather than the traditional ”no-admit no-deny” settlement, where the alleged securities violations were particularly egregious.  Counsel for the SEC then offered four “limited” circumstances that would warrant it requiring an admission at settlement:

1.  Where the violation placed investors at significant risk;

2.  Where the company’s actions hindered the SEC’s investigation;

3.  Where the SEC views there to be a deterrent effect to requiring an admission and wants to “send a message to the market”; and

4.  Where the SEC perceives a possible future threat.

Companies and in-house counsel should be mindful of these circumstances when dealing with an SEC enforcement action.  An admission of wrongdoing can lead to years of headaches from continuous private litigation, not to mention the significant financial costs of defending these civil cases.  Should you be faced with an SEC enforcement action, you should consider how your legal strategy can demonstrate that each of these circumstances does not apply to you, so that you can preserve the possibility of a “no admit, no deny” settlement.

You Don’t Really Want That Client, Do You

Posted in Books and Records, FINRA Compliance, Uncategorized

As we all look to our planning for the coming year, we are all looking for ways to increase our client base.  Although that is the goal, a mistake in client selection can significantly harm your business. 

In my experience defending brokers and member firms, it seems as though mistakes made during client selection and intake ultimately lead to claims.  How does this happen? 

In my view, we are more concerned about getting clients, and less concerned abot of they are the right clients.  There are a few red flags about potential clients that should steer you away from them. 

These potential problem clients are what I call:

  1. The free agent; these are clients that jump from one firm to another looking for better results.
  2. The client with unrealistic expectations.
  3. The client whose goals and objectives are inconsistent with your investing philosophy.buyholdsell.jpg

So how do you avoid these potential problems?  Detailed screening and know your customer analysis before commencement of the relationship is the best practice. 

Know that you will never satisfy the free agent, or the client who thinks that they are going to have a 25% ROI every year no matter what happened in the markets.  Likewise, do not try to pigeon hole a client into your approach because that approach may not be proper for that potential client.  In other words, if you are a long-term growth investor, having a customer with fixed income and liquidity needs, is a recipe for a lawsuit.

Dust off your investor questionnaires and client intake due diligence materials and use them when considering the retention of a new client.  Forgot to use them and only have yourself to blame when you get sued. *

Photo from freedigitalphotos.net