Archives: Compliance and Supervision

Over the years that I have defended broker-dealers and investment advisors on customer-initiated claims, I have seen many things that would make any compliance officer cringe. One spine tingling (not in the good way) type of conduct is when an advisor engages his/her client when the client makes an informal complaint, instead of routing the complaint to compliance/supervision.whistle

So why is engagement against the rules of engagement? The most important reason is that engagement (aka arguing) may only make a simple customer service issues into a formal complaint. Rather than engage, my experience suggests that it is better to get the complaint (assuming it is in writing) to the proper person in compliance/supervision.

Dealing with an oral complaint is a little trickier because you are put on the spot. Nevertheless, the best course, as hard as it may be, is to try to defuse the situation by expressing that you understand the issue that is being raised, you will look into the issue and, finally, will respond further as soon as possible.

By defusing instead of engaging, you give all sides the opportunity to let cooler heads prevail. Many times a customer service issue can be easily addressed by taking a little time to consider the issues and formulate a response/course of action instead of blurting out the first thing that comes to mind; that is invariably the worst thing to say.

If you get a complaint; don’t jump to respond. Use your resources and formulate a well-reasoned response. Sometimes the client is wrong, but arguing with the client gets you nowhere except guaranteeing litigation.

When faced with a customer complaining through a letter or email, it is human nature to try to appease the customer with a conciliatory response or no response at all. I have seen this “human nature” all too often when defending brokers and advisor from customer complaints.

In almost all instances, the complaining customer now claims that the conciliatory comment or non-response is the functional equivalent of an admission by the broker/advisor that he/she did something wrong. In turn, the broker denies that he/she made any admissions by being conciliatory or silent. While I generally agree with the advisors, it is always an issue that must be overcome.whistleblower

So what should an advisor do when confronted with a nasty/accusatory email/letter? Most important, forward the communication to the person/persons who are designated in your company to handle customer complaints regardless if you “think” this person is just blowing smoke.

Someone should always respond to such a communications. The responding communication does not have to be the functional equivalent of beating up baby seals with a bat. Instead, it should be nice, but be firm at the same time.

If a client claims that you misrepresented an investment that you recommended, the response should remind the client in detail what was discussed, and why the investment falls within the client’s overall investment objectives, goals and tolerance for risk. Ideally, prior written communications on the subject will be sent back to the customer as part of this “reminder.”

Although nothing will ultimately keep a client from suing you if he/she is really inclined to do so, avoid potentially making it worse by not responding or being too conciliatory to a complaining email/letter. The last thing you want to have do is explain away the poor response (or absence of any response) to an arbitrator or jury who may not really understand you were just trying to be nice.

Back in April, the Securities and Exchange Commission sought public comments on modernizing certain business and financial disclosure requirements in Regulation S-K.  In their Concept Release, the SEC noted that some investors and interest groups have “expressed a desire for greater disclosure of a variety of public policy and sustainability matters, stating that these matters are of increasing significance to voting and investment decisions.”

48936020 - man pointing at the brown picture of oil industry components and green eco energy arranged in circle, earth in the centre, concept of environmentIn response to the SEC’s request for comment, numerous environmental groups pressed the SEC to require disclosure of environmental, social, and governance risks in companies’ public filings.  According to Law360’s Juan Carlos Rodriguez, last week the Sierra Club, Greenpeace, Friends of the Earth and several other groups urged the SEC to create uniform environmental, social, and governance (“ESG”) disclosure requirements for companies, which would enable investors to identify companies that reflect their values.

However, as Rodriguez noted in his article, there were others who cautioned the SEC against going too far with ESG disclosures.  For example, the American Fuel & Petrochemical Manufacturers advised the SEC that “Such supplemental discussion beyond the bounds of mandated disclosure enriches the public discussion of ESG issues, but may not be material and should not be conflated with disclosures made pursuant to Regulation S-K according to the longstanding principles of financial relevance and materiality upon which the securities markets rely.”

The takeaway here is that the SEC will likely begin to require ESG disclosures from companies in their public filings.  Rodriguez explained that the SEC’s investor advisory committee has noticed a “significant and growing” number of investors who rely on sustainability and other public policy disclosures to better understand a company’s long-term risk profile.  Thus, while it is unclear what those ESG disclosure requirements will be, it is likely that some additional regulations and disclosures will be forthcoming, so plan accordingly.

To read more, please visit: http://www.law360.com/environmental/articles/820522

If you thought the SEC and FINRA were serious about elder issues, welcome to the Alabama, Indiana and Vermont. Each has focused on elder abuse issues.

These states will have mandatory reporting to state officials in instances involving the disabled or those over 65 years of age. They will also allow advisors to cease disbursing funds from clients and providing advisors with immunity associated with doing so. So what does this all mean?

For one, states are starting to run on the coattails of federal regulators who have made elder issues an examination priority in recent years. In addition, such state laws should be a wake-up call for brokerage and advisory firms who service elder clients.money and calculator

The actions of these states should force you to ask yourself; what is my firm doing to prevent, detect and report elder abuse. Although a FINRA proposed rule does not require reporting, its goal is the same because it would allow advisors to designate a third-party to who they can inform of suspected problems.

In the absence of reporting requirements, firms should consider having clients aged 65 or above designate a trusted family member or friend when the advisor suspects that the client may be the subject of some abusive conduct. At that point, you may have a group approach to address suspected abuse.

Firms may also want to consider requiring these elder clients to designate a trusted family member or friend to receive copies of account statements. This way, someone who is “independent” can check an account for irregular activity as well.

Whether you are required to address elder abuse or not, firms should make sure that they are taking special care with their elder clients. Federal regulators and now states are focused on the issue. Are you doing anything to make sure your firm does not get into an elder abuse nightmare?

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.

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.

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.

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.

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.

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