Securities Compliance Sentinel - Analysis of Cutting Edge Securities Industry Issues

The Financial Industry Regulatory Authority (FINRA) recently announced that it expects to send a proposal to the SEC to make it easier for registered representatives to clear their record of black marks.  Up until now, the process for expungement has been drawn out and extremely limited in application.

The primary issue FINRA is attempting to address are the adverse marks of customer claims that are only brought against the firm.  As currently framed, a registered person's U-4 must be marked even if not a party, but named in the body of the complaint.  I suspect that FINRA is looking to change this aspect of the reporting requirement.

This practical proposal would address those unfair situations where the registered person sold an investment that the firm promoted as safe, which later turned out to be untrue; i.e. auction rate securities.  In other words, the registered person should not be punished for selling the product his or her firm recommended.

The proposal is sure to meet opposition from groups who represent claimants in arbitrations.  Nevertheless, I believe that the proposal will gain some traction because it fairly balances the interests of registered persons unfairly having their record marked and, at the same time, reporting of those who are named parties in claims.

My partner, Ernest Badway, recently blogged about the dangers of a lawyer referring a client to a rogue stockbroker.  The question for the broker-dealer/investment advisors is how do you uncover rogue brokers or prevent them from infecting your firm.

In all of the years that I have defended broker-dealers and investment advisors in cases involving rogue brokers, I have found that the answer to this question is much like the search for Bigfoot; everyone thinks it exists but cannot see to find it.  So what is a firm to do?

The most fundamental thing a firm can do to prevent/uncover rogue brokers is to foster a culture of compliance.  Firms with such a culture will go a long way to establishing itself as an entity to which rogue brokers need not apply. 

Rogue brokers tend to thrive in those environments where compliance and supervision are not up to snuff.  A firm that promotes a culture of compliance will also encourage other brokers to report up the supervisory chain when they see conduct that one can characterize as "rogue". 

Another useful tool for firms to employ is a regular review of your brokers, coupled with occasional surprise reviews.  Regular reviews are good because they emphasize that the firm is watching its brokers.

Surprise reviews are, in some ways, even better because the truly rogue broker may be able to cover their tracks before a regularly scheduled review.  The surprise inspection takes away this potential luxury.  Also, the firm should let its brokers know that they are subject to no notice surprise inspections.

Unfortunately, some rogue brokers are so good that they may fly under the radar even at firms that promote the culture of compliance; I have seen it happen.  But put the odds in your favor.  Keep tabs on your brokers through regular and surprise inspections, and maybe you will find Bigfoot.

FINRA announced that it is seeking proposed rule changes to make it easier for investors to use BrokerCheck.  See http://www.finra.org/Investors/ToolsCalculators/BrokerCheck/.

These proposed amendments to FINRA Rule 2267, Investor Education and Protection, would require member firms to include a BrokerCheck reference on their websites and those of any associated person.  Additionally, FINRA Rule 8312, BrokerCheck Disclosure, would be amended to allow the public permanent access to BrokerCheck information on state or foreign settled cases against associated persons as well as permit various data downloads.

Essentially, FINRA wants to ensure that BrokerCheck remains a key resource for investors.

Recently, a Texas appellate court upheld a common law prohibition against a former registered rep who had moved firms.

The court indicated that this departing broker had a common law obligation to maintain confidential information from his prior employer.  See Institutional Securities Corporation, et al. v. Vernon J. Hood, III (December 12, 2012), http://judicialview.com/State-Cases/texas/Employment/Institutional-Securities-Corporation-v-Hood/22/568743.  In this case, the broker had downloaded information and also obtained other documents in preparation for sending information to his customers.  The court found that he was not permitted to do such a thing and could not use a broker/client data.  This was interesting because the broker had actually been fired and escorted out of the building.  The broker had previously downloaded this information.

Although the broker did not have a restrictive covenant or non-compete, the court imposed one upon him and indicated that the broker could face disciplinary action from FINRA.  This decision is problematic for those brokers moving from firm to firm.

Seemingly-- according to FINRA-- broker-dealers are failing in their due diligence efforts relating to knowing their clients, and, as required by FINRA Rule 2090.

Over the last year or so, the most FINRA rule has been FINRA's know-your-customer rule or Rule 2090.  As many know, FINRA Rule 2090 was modeled after the old NYSE Rule 405(1), requiring broker-dealers to use reasonable diligence in opening and maintaining customer accounts.  Broker-dealers are required to "know the essential facts concerning every customer," so that they may 

• service the customers' accounts;
• make appropriate decisions regarding special handling for the account;
• have appropriate authority from the customer; and
• follow all applicable laws, regulations, and rules.

This Rule must be followed by the broker-dealer at the beginning, during and, if necessary, the end of every customer relationship regadless of the type of account.

FINRA has also developed suitablity rules for transactions found in FINRA Rule 2111.  These rules require the broker-dealer or registered representative to have a reasonable belief when recommending a transaction or investment strategy or associated person "have a reasonable basis to believe that a recommended transaction or investment strategy.  Initially, the security or securities must be suitable for the customer, and based upon the information obtained from the process outlined abobe.  FINRA believes that there will be many factors involved depending upon, among other things, complexity and risk and broker-dealer and registered representative familiarity and knowledge.  FINRA Rule 2111 also requires that the broker-dealer and registered representative know much about a customer's investment profile, including, among other things, age; other investments; financial predicament and needs; tax status; investment objectives, experience, time horizon; liquidity requirements; tolerance for risk; as well as any other customer specific information disclosed to the broker-dealer and registered representative.  Finally, analysis of this information is critical to determine quantitative suitability if there is actual or assumed discretion over the customer's account.

Essentially, broker-dealers and their registered representatives are now on notice that they must know their customers or risk violating FINRA's rules.

Despite past false starts and losses, the SEC has announced that it will continue to bring actions against individuals and control persons.

Many believe that such a focus by the SEC will lead to more litigation.  Further, an individual's ability to defend these actions has been severely limited since the passage of the Dodd-Frank Act.  The Dodd-Frank Act, now, allows the SEC to merely prove as the standard reckless conduct when alleging aiding and abetting violations in stark contrast to the previous standard of proving actual knowledge of the fraud being committed by another party.  Additionally, given the SEC’s recent court injunction setbacks and settlement problems with federal judges, it is possible the SEC may use its administrative courts more, especially since the remedies in both forums are nearly identical.  One exception to this switch may be, however, insider trading.

In short, if you are an individual or control person in the securities industry, there is no escape: the SEC is watching you.

In our hyper-fast world, financial advisors, like many in the service sector, have become lazy.  Let me be clear, I think financial advisors are working harder than ever to service their clients in these challenging times for which they should be commended.

The laziness to which I refer is that I see financial advisors taking too many shortcuts in the race to secure clients and open accounts.  In particular, financial advisors have all too often taken the easy way out when it comes to account and investment opening forms.

For example, I have seen incomplete accredited investor questionnaires and account opening documents that do not have the tolerance for risk or investment objectives completed.  By failing to take the time to complete these forms, you expose yourself to unnecessary risk.

One of my partners tells a story about a line his high school football coach used to say when a player questioned being criticized; the coach would always respond, “The film don’t lie.”  Similarly, account/investment opening documents do not lie.

When I defend financial advisors, the very first thing I look for are these documents.  Completed documents, signed by the client are a sure fire step in the right direction when it comes to formulating the defense. 

Although there are times when the completed forms do not match reality, having completed forms, signed by the client, make your defense much easier.  In other words, having these forms places the burden on the complaining investor to overcome the presumption that the forms (and the investments) were consistent with the client’s desires expressed in those completed documents.

The converse is also true.  Incomplete forms may give rise to a presumption that the financial advisor was not looking out for his clients’ best interests.  Don’t be one of those advisors.  Take your time and protect yourself; make sure all forms are completed and signed by your clients.

            * Photo from freedigitalphotos.net

The late great comedian, George Carlin, was made famous by his routine, “The Seven Dirty Words You Can Never Say On Televisions”.  Likewise, fraudsters do not want compliance personnel to ever mention the 13 common dirty traits that may uncover a fraud.

Although not as funny as George Carlin, focusing on these traits may be the key to a firm’s survival.  In no order of significance, you should look for people who do the following:

1.         Never takes a vacation;

2.         Live beyond their means;

3.         Too much debt relative to income (creditors calling the place of employment);

4.         Possess an attitude that they are above the system;

5.         Suspicious of having others check their work;

6.         Extreme behavior changes to either extreme (depression and euphoria);

7.         Set unrealistic personal goals;

8.         Unexplained spike in production;

9.         Spouse loses a job;

10.       Divorce (i.e., a property distribution);

11.       Drug or alcohol abuse;

12.       High number of elderly clients (or any other affinity group concentration); and

13.       Consistently offering new product lines for investing.

So what does the list of 13 suspect behaviors mean for member firms and investment advisers?  You must do all you can to know your personnel as well as you need to know your customers before making an investment recommendation.

The better you know your team, the better prepared you will be to notice any of these ugly traits.  You will notice erratic behavior or behavior that is simply out of the norm.

Certainly everyone going through a divorce or an alcohol problem are not fraudsters, but traits in combination may be the sign of trouble.  Do more due diligence over your personnel when any of these traits arise.

Protect yourself and the firm.  There are fraudsters under every rock.  You just need to identify those rocks needing to be turned over. 

*Photo from Freedigitalphotos.net

Brokers may finally see the light at the end of the expungement tunnel.  Over the last month, registered representatives have received some surprisingly good news relating to their CRD licensing records. 

In August 2012, the United States District Court for the Northern District of California granted a motion by E-Trade Securities LLC to expunge an employee’s CRD records relating to an investor dispute where he had no involvement.  The court stated that there is a FINRA Rule 2080, relating to the expungement of information from the CRD system, provides that a court of competent jurisdiction may direct and order such an expungement, providing that FINRA may participate in the judicial proceeding.  Nonetheless, the court found that there was no substantive legal standard to determine if such a challenge was or was not appropriate.  As a result, the court adopted the standard for expungement that SEC guidance provided, as well as, from case law, Reinking v. FINRA, Western District of Texas, #A-11-CA-813 (Dec. 1, 2011). 

Applying these standards, the court found that the broker’s case easily meets the regulatory purpose standard found in Reinking case some of the allegations were false in that there was no regulatory value in keeping the records active.  As such, the court determined that the records should be expunged from this broker’s record.  See Bridge v. E-Trade Securities LLC, et al., N.D. Cal. No. C-11-2521 E.M.C. (Aug. 7, 2012). 

Additionally, in another California case, this time at the state court level, a California Appeals Court held that a court could erase past public disclosure reports for a broker that were old or irrelevant since it unfairly hurt his livelihood.  The appeals court, thus, allowed the lower court to possibly invoke unusually broad authority to erase details on this broker’s record involving more than a dozen arbitration cases.  The court determined that this was simply the fair thing to do, and that the court did not have to follow any rigorous standards imposed by FINRA.  See Lickiss v. Financial Industry Regulatory Authority, __ Cal. Rptr. 3d __, 2012 WL 3605785 (August 23, 2012).  Although this was a victory for the broker, in that he could proceed with his case, his case must now proceed before the trial court to determine if this information should, in fact, be expunged.  As a result, at least in California, brokers now have the opportunity to ask a Judge to rule that such disclosures on CRD licensing records are simply not fair. 

Intriguingly, Reuters also reports that the number of broker requests for expungement to date nearly matches the total number filed last year.  This is indicative of the overall trend by brokers to clean their records. 

In sum, these two cases represent a watershed for brokers seeking to clean up their CRD disclosures.  Although some commentators are suggesting that this may open up the flood gates and possibly provide for other states to follow suit, we believe that the more appropriate approach would be for FINRA to propose new rules and regulations to streamline the process so that such information would be removed from the public disclosure files, especially when it is old and irrelevant.

In recent days, industry and investor advocates have been fighting over the general solicitation and advertising exemptions in private placements that went into effect with the JOBS Act.

Further, these advocates are also discussing the definition of the accredited investor standard.  Investor groups are looking to tighten these standards while industry advocates are seeking flexibility.  This dispute has led to the Securities Industry and Financial Markets Association weighing in on the matter, and informing the SEC that it should not impose a higher burden other than the current requirements of Rule 506 and the reasonable belief standard.  Other groups have also asked the SEC to develop a flexible and principles-based standard when it comes to an interpretation. 

Additionally, other disputes have arisen over the question of the JOBS Act's impact on foreign issuers operating in the United States.  Some are suggesting that those companies may or may not be subject to US jurisdiction.  There is no particularized fault line going one way or another at this time as to how that would work.

In short, the JOBS Act continues to be a quagmire with no easy solutions or answers. 

Within thirty days after a registered representative leaves a member-firm, the member-firm must file a U-5 with FINRA stating the reasons for the departure.  Those instances where the registered representative leaves on her own accord without any controversy are easy. 

The challenge you face is when the reasons for departure are not so clean.  In those instances, you may be faced with a dilemma regarding what to state because an adverse statement on a U-5 may make a registered representative unemployable. 

Depending upon where you are situated in the country, U-5 reporting may be absolutely protected speech (meaning you cannot be sued for its content) or speech entitled to a qualified privilege (meaning you can be sued under certain circumstances).  Regardless of what law applies, you should exercise caution when completing a U-5. 

The most important thing when completing the U-5 is to make sure that you accurately detail the reason for termination, but do so without editorializing about the former associated person.  The last thing you want to do is create a scenario where the former associated person sues you for some improper remark.

At the same time, you must have a description that states the reasons for departure.  If the detail is vague, another member firm may look past the U-5 and associate with a registered representative who should be out of the industry.  In that case, you may be buying yourself only temporary piece or mind; the subsequent member firm and/or FINRA may have an issue with you for an incomplete description.

The completion of a U-5 can be tricky business, but it is best to err on the side of caution and include a clear, succinct and accurate description of the reasons for termination.  If you have done your homework on the front end when you decided to separate from the registered representative, then you should not be concerned about that person or another member firm looking back at you in the future.

Our partner, Josh Horn, was recently quoted on the rise of FINRA enforcment proceedings.  Great analysis from Josh.  Here is the link:  http://www.foxrothschild.com/newspubs/newspubsArticle.aspx?id=15032386143

On July 9, FINRA Rules 2090 and 2111 go into effect.  In Rule 2090, FINRA has defined what a member firm/registered representative must do to know their customers.  In addition, Rule 2111 defines suitability when it comes to investment recommendations.  For what this means for you as a practical matter, I have written the attached guidebook.  http://www.foxrothschild.com/uploadedFiles/attorneys/eBook_aGuideToAnswerThatAgeOldQuestion.pdf

Recently, an investor advocacy group petitioned the SEC to prohibit brokerage firms, who offer wraparound accounts, to also provide investment advice through both a duly registered BD and investment adviser. 

This group claims that terminating this practice would resolve a very troubling regulatory issue.  The group also petitioned the SEC to ban mandatory arbitration accounts for individual retirement accounts and allow for a private right of action by investors in a court.  In any event, this group claims that its petition and potential subsequent SEC action were necessary because FINRA has refused to take any action to resolve this problem.

The groupl claims that FINRA refuse to enforce any fiduciary standard for investment advice relating to wrap accounts.  This group believes that such a "non-practice" violates the U.S. Court of Appeals for the District of Columbia Circuit's decision in 2007 in a case entitled Financial Planning Association v. SEC.  The group believes that the D.C. Circuit stated that the SEC exceeded its authority in promulgating a rule exempting from regulation broker-dealers who also provided investment advice to client fee based accounts. 

As a result of FINRA’s inaction, these dully registered wrap accounts are creating conflicts that are not being disclosed.  Further, this group claims that confusion exists in the industry, leaving retail retirement investors without any appropriate legal process for claims of breach of fiduciary duty under the Investment Advisers Act of 1940.

Although it is unlikely this petition will ever be acted upon, it is important to keep in mind that, in an election year, anything is possible, and, who knows, the SEC may consider appropriate action at some time in the future.

Colin O'Keefe at LXBN TV recently asked me a few questions about crowdfunding, the hype around it and what it might really look like.  At first glance, I look kind of pissed off - do I always scowl like that? - and more interested in something happening on the table.  But - despite appearances - I honestly enjoyed myself and appreciated the opportunity to discuss this exciting development. 

Looking at the interview again, I'm reminded of something my Dad likes to tell me:  "Jim, you have a face for radio." 

Again, the interview is here, and you can find my crowdfunding coverage here.  As the SEC starts to propose rules on crowdfunding, check back here for more detailed coverage on the latest developments.

Like many others, my interest in the JOBS Act really started with crowdfunding.  This is probably because securities law is an imposing tangle of archaic acts, byzantine regulations and repetitive rules.  (Securities lawyers commonly say things like “…Rule 506 under Regulation D, promulgated pursuant to Section 4(2) of the ’33 Act…” and expect you to understand/stay awake).  Crowdfunding, however, is the hip, internet-based, exciting new thing!  It’s like that Kickstarter thing your cousin, the “performance artist”, keeps posting about on Facebook!  Everyone is talking about crowdfunding, so it MUST be awesome, right?  Well, not so fast: a lot of media coverage and law blogs doesn't mean a law will live up to the hype (I admit my own guilt).   So, what impact will Crowdfunding really have once the SEC passes all its rules? 

I’m leaning towards not much.  First, they have 270 days to enact the rules, but as this guy explains quite well, you really shouldn’t bother writing that down in your calendar: the SEC will be late. More to the point, some think this will be the panacea to our economies ailments, while others expect it to pretty much license fraud.  Obama called this a “game changer” and I agree, but - to make a football analogy - this is more like a “two-point conversion” game changer than a “forward pass” game changer.  Most start ups will eschew crowdfunding for more traditional fund raising methods.

First, we need to ask: what kind of issuer will use crowdfunding?  Not the guys who are looking to ramp up an already humming business, they already have venture capitalist to turn to.  And remember that the JOBS Act also amended Reg A (allows a company to sell up to $50 Million in securities with minimal disclosures and no restrictions on advertising) and Sec. 12(g) of the ’34 Act (now companies can have up to 2000 investors without being forced to go public, and employees don’t count towards the limit).  One the SEC makes rules on these changes, a company can offer up to $50 Million in stock, advertising however it likes, using a Regulation A circular, provided that it keeps non-accredited investors under 500 and total number of investors under 2000.  $50 Million divided by 2000 investors is a mere $25,000 per investor – not an extravagant amount by any means, and this might deepen the venture capital markets.  For many more established or promising start ups, this will present a much more appealing opportunity.  The “start up” that already has a product and some employees probably won’t resort to crowdfunding.

Crowdfunding is limited to $1,000,000 dollars, gleaned from any number of investors.  Issuers (and the funding portals) are prohibited from advertising the offering, beyond director investors to the website (it will be interesting to see whether Facebook and Twitter links will be considered advertising or mere directing).  And if the issuer wants to raise over $500,000, it will need to release audited financial statements.  That means dropping a few grand on a CPA, on top of the whatever fees the funding portal will charge (and issuers would be remiss to do any of this without an attorney).  The transaction costs will be high.  If the issuer wants to raise somewhere between $100,000 and $500,000, then the financial statements need only be “reviewed”, which is slightly less pricey.  On top of those requirements (and the basics like names of officers and addresses), issuers will need to describe the purpose of the fundraising, a description of the ownership and capital structure of the issuer and file annual reports with the SEC, including financial statements.  And, do note, the SEC is empowered to make “any other requirements…for the protection of investors and in the public interest.”  That means that the SEC could make any of these requirements more onerous and costly.  Again, given that Mary Schapiro and Luis Aguilar have pooh-poohed the concept generally, expect the SEC to add some regulatory meat to the statutory bones.

Normally, a start up gets going using the founder’s own funds, and the money he can beg, borrow or steal from his friends and family, and sometimes they find an “angel investor” – some wealthy person willing to give them a shot in the form of a few thousand dollars.  Crowdfunding will be popular among the start ups that can’t find this kind of “seed money”.  Younger entrepreneurs, whose friends are all also broke, are more likely to turn to crowdfunding.  In addition, crowdfunding will be huge for entrepreneurs living outside of seed-money friendly areas.  It will also help individuals with really solid ideas of how to return 20% on the dollar, which isn’t the sort of return that excites many angel investors (think pizza shop in a small town without so much as a Dominos).  And, to be frank, it will help the socially awkward types who can’t sell their vision face-to-face. 

Crowdfunding isn’t the democratization of equity investment; it’s the democratization of angel investment.  Most of us will still be unable to invest in the next Facebook or Google, because they’ll skip crowdfunding altogether.  I suspect most crowdfunding offerings will end up being for less than $100,000 (meaning the issuer only needs to provide self-certified financial statements and last year’s tax return, plus the other rules).  It will be for just enough to make a prototype or launch a beta version.  In other words, just enough to attract a venture capitalist.

For investors, crowdfunding means a lot of chances to lose some money.  Some will get to support the next must-have app for your phone, but more will probably invest in a bar or restaurant (an industry famous for failures), or with tech-geeks without a lick of business acumen.  I’m okay with this, to be honest.  Some will invest for philosophical reasons (support only small/local businesses), others will gamble (better here than a casino), but I think most will do it almost for fun (another venue for those who “dabble” or “play” in the stock market).  And there are limits on how much someone can lose.  The Act uses “income or net worth” in setting limits, which will allow some retirees with over $100,000 saved to potentially risk the greater of 10% or $20,000.  Potential for fraud is restricted by investment limits, the fact that issuers need to use a broker or a funding portal*, and that said fraudsters need to give the SEC their name, address, etc. (generally not a good criminal plan, giving the Feds your personal info).  More importantly, the Act requires brokers/funding portals to ask and receive answers from the investors, making sure they understand the risks.  I’m pretty sure that no other group of investors have to pass a quiz before they can invest.  That’s a lot of work for something that should be understood as allowing the Average Joe to invest $100 in a company a few times a year.

Crowdfunding will be good for the little guy start up.  Investors who decide to go into crowdfunding should do so understanding the risks, and should model themselves after angel investors, who often invest in a dozen companies in the hopes that one strikes it big. 

Crowdfunding will be fun and exciting, don’t get me wrong, and I intend to invest this way myself.  For some, it really will be a game changer, but only if the game is already really, really close. 

* This is really an aside: Funding portals and brokers acting as crowdfunding intermediaries will need to register with the SEC and register with an applicable self-regulatory organization.  There are already a few nascent organizations coming together to create a funding portal SRO.  Thus, these guys will face the type of serious and undoubtedly complex regulations not unlike those that broker-dealers already face.  In addition, if a funding portal wants to skip registration as a broker-dealer, it will need to be a member of a national securities association, which means a battery of tests and not-insignificant fees.  Most importantly, they will be exposed to all sorts of liabilities, which will make prudent portals wary of shady start-ups.  The net effect will mean that a crowdfunding boiler room will have a similiar likelihood of getting caught as any other, only for a lot less potential payout.

The new SEC Rule 13h-1, the large trader reporting rule, became effective. 

Starting on April 30, 2012, broker dealers will be required to maintain records of large trader trading, similar to records maintained relating to the electronic blue sheet system.  Further, supplemental information will also be required.

This new large trader rule could implicate investment advisers, banks, broker dealers, insurance companies and foreign entities.  All may be required to self-identify by filing a Form 13H with the SEC, and provide unique information to the SEC.  Broker dealers will also be required to maintain information relating to these trading records supplemented with the time of order, execution and the trader’s ID number if the SEC so requests.  Broker dealers will also be required to file a Form 13H if they are large traders.

Although the definition of a large trader is enunciated in the rule, there is some factual assessment that goes into it.  That is, it relates to any person, who directly or indirectly, exercises investment discretion over one or more accounts through NMS securities and registered broker dealers in a certain activity level.  The large trader must file an initial Form 13H promptly after it crosses the trading thresholds, and it has been considered that promptly means within ten days.  There are also annual filings that must be done within 45 days after each calendar year.  Confidentiality was also critical in assessing this information, and the SEC expects firms to realize that it will maintain the confidentiality of said information.  However, it may have an obligation to disclose it to Congress, other federal agencies and pursuant to a federal court order. 

Accordingly, firms should be aware that these issues may arise, and should be ready to file and maintain the appropriate records.

FINRA recently announced that, in the first quarter, it will issue a risk control assessment survey to all member firms.  Although this is a voluntary program, member firms should strongly consider their participation.  Your efforts on the front-end may alleviate the work you would otherwise perform during an examination.

The purpose of the survey is for FINRA to better understand member firm business models, the risks attendant with those models and the controls intended to manage those risks.  According to FINRA, responses to this survey will afford it the ability to conduct more focused examinations.  In other words, the program will give examiners a better understanding of your firm before arriving on site and allow the examiners to streamline the examination.

According to FINRA, firms who do not participate will not suffer negative consequences.  However, those non-participating firms should expect FINRA to spend more time during an examination.  FINRA plans to conduct this survey on an annual basis; the content will change as new risks emerge and as priorities evolve.

Even though answering the survey will take time to complete, streamlining the examination process is a laudable goal.  If the time spent on completing the survey results in a more focused and shorter examination, it seems to me that the decision to participate in the survey should be a forgone conclusion.

BrokerCheck is a publicly available tool that FINRA offers for the public to learn about member-firms and their registered representatives.  Over the years, the information available to the public has expanded.  The fallout from the financial crisis has resulted in more and more information being made available to the public, with additional categories of information being made available by July 2012.  Now, FINRA is seeking public comment for the release of reasons for termination and scores from industry qualifying examinations, but there is a potential unappreciated downside to the release of this information.

 Making information available to the public about a registered representative’s reason for termination can be seen as another way to smoke out those individuals who should not be in the industry in the first place.  This disclosure will provide the public greater protection against rogue brokers fleeing one firm for another.

 One commentator has noted that there is a downside from the dissemination of all this information; namely, identity theft.  The more and more personal information that becomes available, the more likely for there to be identity theft.  In light of the SEC’s recent alert on investment scams through social media, FINRA may be inadvertently helping the promulgation of such scams.

 In the end, I suspect that the reasons for termination and test scores will become available through BrokerCheck.  As such, member-firms and registered representatives will have to be even more diligent to ensure that they are not subject to the improper use of this information.  One potential tool is the frequents internet searching of the names of registered representatives to test for improper use, but this will come at a cost in time and resources.  Similarly, FINRA will have to critically review instances of purported financial fraud to ensure that the perpetrator is who the public thinks she or he is.  Otherwise, BrokerCheck will become a tool for fraudsters as opposed to protecting the public.

The GAO has indicated to the SEC that it should consider the codification of the analyst conflict pact it entered into with other regulators in 2003.

As many recall, in 2003, a group of regulators, including the SEC, struck a deal with a number of Wall Street firms concerning their equity research analyst's conduct.  These firms agreed to pay $1.4 billion in penalties and disgorgement.  The GAO is now recommending that the SEC codify this pact (although at the time, the NASD and NYSE finalized rules relating to this pact), in the SEC’s rules and regulations. 

The SEC responded through its Director of Trading and Markets Division, who indicated that the SEC Staff believes this recommendation makes sense, and will plan accordingly. 

We wanted to make everyone aware of a great resource published by Fox Rothschild's Securities Industry and Labor & Employment practice groups.  It is called the National Survey on Restrictive Covenants.  You can access a copy by entering or clicking on the following link:  http://emarketing.foxrothschild.com/reaction/RSGenPage.asp?RSID=3H1FlS0GKN33lpQjC7nN5rf9QYXnH3iRCz_uLuiWHMc.  This survey is a quick reference for in-house counsel and human resource professionals.

For anyone reading this post, you appreciate the value of social media.  It looks as though FINRA is finally prepared to do so as well.

FINRA recently proposed changes to its rules governing communications with investors.  In doing so, FINRA has proposed easing its requirements of pre-approval for a broker-dealer's use of social media.  Chief among the proposed changes would be the authorization of registered representatives communicating with clients via social media without a supervisor's prior approval.  Without pre-approval, a registered representative could engage in interactive , real-time communications with customers via a social media site.

Assuming this proposal is adopted, this is a positive step for FINFRA.  Nevertheless, I think that broker-dealers and registered representatives still must be wary of using social media to communicate in real-time with their clients.  First, the member firm will surely still be required to maintain copies of these communications consistent with its record retention obligations.  Keeping track of the potential volume of such communications creates a record-keeping nightmare.  Second, broker-dealers should consider restricting their registered representatives from making investment recommendations through interactive social media because of suitability concerns.  The risk of an investment recommendation being disseminated via social media is that anyone accessing that source could argue that it was an investment recommendation made by the firm and pursue a claim against the firm in the event of a loss. 

In my experience defening member firms and registered representatives, the types of claims asserted are only limited by the creativity of the lawyers.   Do not be a victim.  If FINRA specifically endorses inter-active communciations via social media without pre-approval, be certain that you have meaningful policies, procedures and protocols to maintain proper records and avoid open-ended recommendations to the public.

Thought you might be interested in a recent podcast I did concerning my securities law practice.  http://web.me.com/cordpar/Client_Development_Tips/Law_Consulting_Coaching_Podcast/Entries/2011/10/28_Developing_a_Securities%2C_White_Collar_and_Complex_Litigation_Practice.html

In January 2001, the Securities and Exchange Commission (“SEC”) recommended the implementation of a uniform fiduciary duty standard for broker-dealers and registered investment advisors. Significant debate has followed regarding the potential parameters and scope of such a duty. Recently, the Securities Industry and Financial Markets Association (“SIFMA”), a lobbying group for large broker-dealers, proposed a framework for a uniform fiduciary duty.

Although SIFMA reiterated its support for such a standard, it also recommended against applying the fiduciary duty found in the Investment Adviser Act of 1940 to broker-dealers, stating that it would adversely impact “choice, product access and affordability of customer services”. Among other things, SIFMA proposed a new fiduciary duty for broker-dealers to accommodate broker-dealer conduct that would otherwise be in violation of the 40 Act.

In doing so, SIFMA recommended that, in its rulemaking, the SEC “provide the necessary rule-based guidance regarding when the fiduciary duty begins and ends and what disclosures and consents, if any, are necessary to satisfy the duty where a broker-dealer gives “advice involving principal trading, structured products, hybrid accounts, complex investment strategies, concentrated positions, and receipt of commissions and differential loads for different products.” To implement this standard, SIFMA proposed that it be articulated in the initial customer agreement. SIFMA also recommended that the fiduciary duty apply on an account-by-account basis.

By implementing a new fiduciary duty standard unique to broker-dealers, SIFMA believes that the SEC will properly take into account the distinctions in the law between registered investment advisers and broker-dealers while taking customer service into account. It remains to be seen if SEC heeds this call to action, or if the SEC simply rubbers stamps the 40 Act fiduciary duty standard to broker dealers.