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Securities Compliance Sentinel

Analysis of cutting-edge securities industry issues

Is the SEC that good? SEC Wins Every Administrative Case

Posted in Dodd-Frank, SEC Enforcement, Securities Litigation

In what is sure to add more “fuel to the fire,” it was recently reported that the SEC has won every case brought in its administrative courts over the last year.  The SEC has not been so successful with its federal court cases, winning 61% of those cases over that same period.

Of course, regular blog readers know that the Dodd-Frank Act expanded the SEC’s powers to permit it to bring more cases in its administrative courts.  These SEC proceedings restrict discovery, testimony and evidence while federal court proceedings permit the full panoply of discovery as well as the protections afforded when appearing before a federal judge.   One should also keep in mind that the SEC appoints the administrative law judges while federal judges are appointed by the President and confirmed by the United States Senate.

Ultimately, it is the SEC that makes the call on where the case is brought, however, these statistics are telling.  If you are the respondent in a SEC administrative action, your chances of success are minimal as opposed to being a defendant in federal court.  Accordingly, it may be worthwhile to start thinking settlement if you find yourself in a SEC administrative court.

Forget Including A Bar Of Whistleblower Tips In Settlement Agreements

Posted in Broker-Dealer Regulation, FINRA Compliance, FINRA Enforcement, Public Customer Arbitrations, Registered Representatives, Uncategorized, Whistleblowers

FINRA recently warned that firms could face disciplinary action if they enter into settlement agreements that bar customers or former employees from reporting wrongdoing at the firm.  Although FINRA recognized that confidentiality provisions were acceptable, it noted that they have to be written in such a way to authorize the individual to contact FINRA or another regulator to report improper activity. 

Similarly, FINRA announced that any confidentiality stipulation that at arbitration panel enters in a case would not apply to sending information to regulators about the firm.  The timing of this announcement coincided with the SEC approving a FINRA rule change that allows arbitrators to make a referral to enforcement before the end of a case.  This was certainly not coincidence. 

So what is the take away from these policies?  For one, it could embolden whistleblowers to reach a resolution with a member firm, only to then report the firm to FINRA or another regulatory body.   

In the end, this may result in more litigation and enforcement proceedings.  It may also result in more FINRA arbitrations being tried to award.  In other words, the firm may as well try to get exonerated by a panel if the claimant could just report the firm to FINRA regardless of a settlement. 

The other side of this coin is FINRA’s push for transparency.  By restricting these agreements and allowing arbitrators to report firms to enforcement during arbitration, FINRA is stepping up its oversight of member firms. confusion.jpg

The cynic in me says that the lawyers will be the one that will ultimately benefit from these policies because firms may be forced to litigate claims to a conclusion and fight more enforcement matters.   

One unfortunate outcropping of these policies may also be frivolous reports to FINRA to use as settlement leverage.   Compounding that issue, making a whistleblower report is at least entitled to a qualified privilege such that firms may have little recourse for a whistleblower that makes a bogus report. 

So what should firms do?  The key is leadership from the top that promotes a culture of compliance.  This may be cliché, but solid firm leadership that has a no-nonsense approach to compliance and supervision will stand in a better position than firms that deal with compliance and supervision on an ad hoc basis. 

Life for member firms and registered representatives is becoming more challenging, and FINRA is not making it any easier.  Nonetheless, you should take a hard look at yourself.  Are you doing enough to create a culture of compliance to avoid the sting of whistleblowers?

* photo from freedigitalphotos.net

Personal Email For Firm Business – Don’t Do That

Posted in Books and Records, Broker-Dealer Regulation, FINRA Compliance, FINRA Enforcement, Social Media

As firm clients demand more and more access to their registered representatives, member firms must do more to make sure that their brokers do not run afoul of the firm communication written supervisory procedures.  One firm recently failed that test, resulting in a FINRA fine and censure. 

In that matter, FINRA found that the member firm allowed representatives to use personal email for firm business, including client communication.  Making that matter worse, the firm was aware of the practice and allowed storage of email communications on personal computers, exposing those emails to alteration and deletion.

The first question you should have is where compliance was and supervision regarding the pre-approval of client communications was.  The firm did have such WSPs requiring pre-approval of client communications, but lacked access to the personal computers to perform this supervisory task.  FINRA took issue with this type of supervision; more like the lack of supervision. 

This case is the perfect of example of the question, why have WSPs if the firm is not going to enforce them.  Client communications represent a hotbed of issues for large to small firms.  Allowing representatives to use personal email for client communications is not one of the better decisions a firm can make. 

The key to supervision is to be able to supervise.  This firm, by allowing the use of personal email accounts without meaningful supervision, set itself up for failure and sanction. 

Some may say this firm was lucky because there was no client harm.  I recently tried a case where the representative used a personal email account and made some statements that could be considered admissions.  Since the representative ignored firm policy, she and the firm were exposed to liability. spying.jpg

When it comes to client communications, you need a robust email review policy.  By having such a program, you may be able to uncover the more problematic issue of unauthorized use of personal email accounts.  Either way, firms need to really focus on client communications to avoid FINRA enforcement and civil liability. *


* photo from freedigitlphotos.net

The Uniform Fiduciary Duty Standard – It Seems Like Déjà vu All Over Again

Posted in Breach of Fiduciary Duty, Broker-Dealer Regulation, Dodd-Frank, FINRA Compliance, FINRA Enforcement

Although it has been many years since Yogi Berra uttered this famous line, it seems like he must have been thinking about the debate regarding the adoption of a uniform fiduciary duty standard.  All kidding aside, one SEC commissioner recently expressed his doubts regarding the SEC proposing such a rule for those who give retail investment advice. buyholdsell.jpg

From all accounts, there appears to be a split, along party lines, of the SEC Commissioners on the adoption of such a rule.  Some argue that a rule should be adopted because investors do not understand the difference between the duties of investment advisors and broker dealers. 

In my view, the confusion has been spawned by the ongoing debate.  For broker-dealers, separate confusion can also be found with FINRA arbitration panels, some of which do not know that broker-dealers do not have a fiduciary duty to their customers.  So where does this leave us? 

In my experience defending retail broker-dealers, I have found that most customers assume that there is such a duty on their brokers, only to be shocked to hear in closing argument that it does not exist.  Nevertheless, there is a take away from this improper assumption most customers make. 

While the debate rages, broker-dealers should be taking a harder look at the suitability of their investment recommendations.  By taking a harder look, not only do you satisfy your legal obligations, but also may also satisfy the “expectations” of your customers.  Doing that may help you avoid the likelihood of customer claims and, if you have one, a better suitability defense on top of that.


* photo from freedigitalphotos.net

So Who Wants To Hire A Registered Representative

Posted in Broker-Dealer Regulation, FINRA Compliance, FINRA CRD

If you answered in the affirmative, then you need to be aware of a recent FINRA proposal submitted to the SEC.  The proposal would require member firms to take a harder look when they vet new hires. 

About the rule, FINRA said that it “believes that the proposed rule change will streamline and clarify members’ obligations relating to background investigations, which will, in turn, improve members’ compliance efforts.”  Under the new rule, member firms will have to conduct a more stringent review, forcing firms to conduct a search of public records. 

So what should member firms do under this new rule?  For one, you cannot simply rely on the CRD for information about your potential hire.  Although this new rule may cause some strain for smaller firms, the new rule can be satisfied by some internet searches. pointing.jpg

For example, a simple Google search of a name turns up unbelievable things.  LinkedIn, Twitter and Facebook searches may also be useful tools.  Likewise, there are ways to search your local state and federal court systems to see if your new hire has either sued or been sued. 

There are also third-party services that you can use to perform these searches for you. 

After some initial learning curves, I believe that the net result of the rule should lead to firms having a more robust hiring process and, in turn, avoid hiring those registered representatives who may have a history that you would not want to bring to the firm.  Do your homework up front, and avoid problems later.

* photo from freedigitalphotos.net

Cyber-Security – What Do Enforcement Actions Tell You

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

In a recent NSCP Currents article, Giselle Casella addressed what every compliance office must know about cyber-security.  One of the more compelling lessons was what can be learned from enforcement actions dealing with cyber-security. 

Cyber-security enforcement actions fell into the following groupings: 

  1. Inadequate security policies and procedures;
  2. Failure to enforce policies and procedures;
  3. Failure to conduct periodic cyber-security assessments;
  4. Failure to respond to cyber-security deficiencies;
  5. Failure to protect company networks and client information;
  6. Failure to protect non-public personal information;
  7. Failure to have an adequate firewall or anti-virus software;
  8. Failure to have adequate user access protocols;
  9. Inadequate oversight of third-party vendors; and
  10. Failure to adequately respond to cyber-attacks.

 This list demonstrates that enforcement actions focus on every aspect of company life. idea.jpg

For example, these actions focus on written policies and procedures, their existence and adequacy.  Taking the next step, these enforcement actions demonstrate that there is a focus on follow through; it is great to have policies and procedures, but you must follow them. 

Likewise, what is the security architecture at the firm?  Does the firm have adequate systems and software to stave off cyber-attacks?  Do you have proper oversight of third-party vendors? 

Even if you have the best policies and procedures, you may still be subject to attack.  In those instances, you are going to be reviewed for the adequacy of the response. 

In order to avoid these enforcement actions, it is important for firms to take a granular approach from the ground up.  Are you WSPs adequate?  When was the last time the firm tested its system for outside attacks?  What is your response plan in the event of a breach?   

If you cannot readily answer these questions, you are not prepared.  Learn from the mistakes of others, and take preventative action to make certain that history does not repeat itself.

* Photo from freedigitalphotos.net

Guess Who Did Not Take A Summer Vacation

Posted in Dodd-Frank, Investment Adviser Regulation, SEC Compliance, SEC Enforcement

Now that summer has come to its unofficial end, it seems as though the SEC forgot to check its calendar back I May because it has been conducting exams at a breakneck pace as reported in the Investment News.  These exams have focused, in part, on those investment advisors who have never been examined. 

You may recall at the beginning of the year that the SEC made it an exam priority to focus on investment advisors who, for one reason or another, have never been subject to an examination.  The SEC has targeted about 1,000 of those entities, which should represent about a quarter of the 15% of all investments advisors who have never been examined. 

What should be the take away from the SEC’s focus on investment advisors being examined for the first time? buyholdsell.jpg

For one, it is a clear message that you should jump start the review of your operation.  Are your WSPs up to date?  Have you reviewed your policies and procedures regarding AML, custody of client funds, use of social media, and avoidance of insider trading? 

If the answer to any of these questions is no, now is the time to take preventative action and revisit these, among other issues, to make sure that your house is in order.  Either you do it now, or have the SEC do it for you later.   The decision is yours.

* photo from freedigitalphotos.net


Posted in Investment Adviser Regulation, No-Action Relief, SEC Enforcement

The SEC Division of Investment Management determined that a solictor may receive a fee for the soliciation of clients for registered investment advisers notwithstanding a Commission administrative order against her.  See Matter of Stephanie Hibler, https://www.sec.gov/litigation/opinions/2013/34-70140.pdf.

In deciding to allow the solicitor to receive cash solicitation fees, the SEC staff noted in its response letter that the Commission vacated the portion of the order barring her from being associated with an investment adviser.  The staff also noted that she will conduct any cash solicitation arrangement entered into with any registered investment adviser in compliance with the terms of Investment Advisers Act of 1940 Rule 206(4)-3, except for the investment adviser’s payment of cash solicitation fees.  Finally, the staff considered the fact that she has complied with the terms of the order and will continue to do so, except for those portions vacated by the Commission.

This decision seems to primarily rely upon the fact that the Commission had previously lifted the bar in place.  Thus, we should not all go crazy thinking the SEC is opening the floodgates for barred securities professionals to re-enter the business.

What are Knowledgeable Employees?

Posted in Hedge and Private Equity Funds, Investment Adviser Regulation, Open-Ended Mutual Funds

The SEC’s Division of Investment Management issued updated guidance regarding the definition of “knowledgeable employees” under Rule 3c-5 of the Investment Company Act of 1940.  See Managed Funds Ass’n, SEC No-Action Letter, avail. 2/6/14, https://www.managedfunds.org/wp-content/uploads/2014/02/Staff-Response-to-MFA-3c-5-Letter-Final-Outgoing-2-6-14-no-sigs.pdf

The SEC staff explained that “private funds” include private equity funds, hedge funds, and other pooled investment vehicles, excluded from the definition of an “investment company.”  Investment Company Act Rule 3c-5 permits a knowledgeable employee of a private fund – “covered fund”- or a knowledgeable employee of an affiliated person managing the investments of a covered fund – “affiliated management person”- to invest in a covered fund, without being subject to certain conditions under Investment Company Act Section 3 that otherwise apply.

The SEC staff clarified the definition of a knowledgeable employee by analyzing the various categories of the term under Rule 3c-5.  The staff confirmed that it will not recommend enforcement action against covered funds if they treat certain employees of covered separate accounts as knowledgeable employees.  The staff further explained that other employees may also qualify as knowledgeable employees, depending on the facts and circumstances.

The letter recommended that investment managers maintain a written record of employees that have been “permitted to invest in a Covered Fund as knowledgeable employees” and should be able to explain why a particular employee qualifies as a knowledgeable employee.

This guidance provides a road map for those employees acting in this type of fund sphere.

Cash Solicitations Allowed Despite Court Bar

Posted in Hedge and Private Equity Funds, Investment Adviser Regulation

The SEC’s Division of Investment Management said it will not object if an investment adviser pays a cash fee for the solicitation of advisory clients, although a federal district court injunctive order precluded it.  RBS Sec. Inc., SEC No-Action Letter, avail. 11/26/13, http://www.sec.gov/divisions/investment/noaction/2013/rbssecurities-11252013-section 206.htm.

In granting relief, the staff noted especially that the firm otherwise will conduct any such cash solicitation arrangement in compliance with Investment Advisers Act of 1940 Rule 206(4)-3.  Rule 206(4)-3 prohibits an investment adviser from paying a cash fee to any solicitor subject to a court injunction related to the purchase or sale of a security.  The staff especially noted counsel’s representations that:

  • It will conduct any cash solicitation arrangement with an investment adviser registered or required to be registered under Section 203 of the act in compliance with the terms of Rule 206(4)-3, except for the investment adviser’s payment of cash solicitation fees to it;
  • The judgment does not bar or suspend it from acting in any capacity under the federal securities laws;
  • It will comply with the terms of the judgment; and
  • For 10 years from the date the judgment was entered, it and any investment adviser with which it has a solicitation arrangement will disclose the judgment to each person whom it solicits at least 48 hours before the person enters into an advisory contract, or at the time the person enters into such a contract, provided the person may terminate the contract without penalty within five business days.

In short, the SEC has opened the door on these cash solicitations.