We wanted to announce that Ernie Badway has taken over the authorship of Chapter 7, Proxy Regulation, in Lexis-Nexis Matthew Bender’s Federal Securities Exchange Act of 1934 treatise: https://store.lexisnexis.com/products/federal-securities-exchange-act-of-1934-skuusSku10509.  His work will be available on November 26, 2018, just in time for the holiday season!

Acknowledging the self-promotion aspect of this blog, we wanted to invite you to attend Josh Horn’s seminar at the NSCP National Conference in Atlanta.  Josh’s presentation is on Monday, October 29, 2018, at 1:55 p.m. and lasts 75 minutes.  Josh, along with Tanya Kerrigan, General Counsel & CCO, Boston Advisors, will be speaking on “Testing the Written Policies & Procedures Lab.”  We invite all to join Josh and Tanya for this very interesting program.

Conference information may be found here: https://www.omnihotels.com/hotels/atlanta-cnn-center/meetings/2018-nscp-national-conferences.

Just this week, a United States District Judge for the Eastern District of New York told a defendant in a criminal case that he was out luck with the claim there was no securities fraud because he was selling  digital tokens.  See United States v. Zaslavskiy, Case Number 1:17-cr-00647 (E.D.N.Y.).

The defendant tried to argue that the digital tokens were not securities.  The court was simply not buying what the defendant was now selling.  The case involved claims the defendant bilked investors in ICOs.  The court refused to say that the tokens were not securities at such an early stage in the case, and believed it was up to the jury to make that determination.

This decision highlights the very fact intensive nature of determining if the federal securities laws apply to these types of digital token fraud claims.  Essentially, the court was relying upon the United States Supreme Court’s SEC v.  W. J. Howey Co., 328 U.S. 293 (1946), test to delineate the respective position these tokens held within the ambit of the federal securities laws.  Ultimately, the court believed there was enough evidence to indicate it was a question of fact for the jury.

One of the big takeaways from this case is that courts, at least, initially, seem to be reluctant to claim crypto instruments are not securities.  It almost appears that, like everyone else, courts such as the one in the EDNY are looking for more guidance, and are reluctant to make any major pronouncements about the status of such items as digital tokens.

A year in the making, FINRA announced in late July 2018, that it had completed the reorganization of its enforcement program.  See the FINRA website.  Coupled with the consolidation was the creation of 2 new units: the Office of the Counsel to the Head of Enforcement and the Investigations Unit.  FINRA’s stated goal was to ensure consistency in its enforcement program while maintaining expertise in a number of areas.

In particular, over 150 attorneys will be placed in teams within groups.  These groups will be Main Enforcement, generalists, who will prosecute and investigate any disciplinary issue; Sales Practice Enforcement, specialists in sales practice investigations and prosecutions; and Market Regulation Enforcement, who will assist the Market Regulation staff in examinations and investigations as well as prosecuting any resulting offenders.

Not surprisingly, many of the changes FINRA appears to be implementing seem to mirror changes the SEC has made in the past.  It will be interesting to see if FINRA achieves its stated goals with this new structure.  However, we do not believe it will have much effect on how investigations and prosecutions will be conducted, that is, this seems more of an internal bureaucratic change as opposed to any goal of significantly increasing enforcement investigations and prosecutions.

In a very interesting webcast, the FINRA staff discusses how FINRA rules are made and reviewed.  See http://www.finra.org/industry/podcasts/how-finra-rules-get-made-and-reviewed.  Although it will not reach the level of Schoolhouse Rock (as the FINRA staff seemingly hopes it will), it is an excellent discussion of the process, and should be considered by all those in the securities industry, or, at the very least, those regulated by FINRA.

A chief compliance officer (“CCO”) for a registered investment adviser (“RIA”) found himself barred from any compliance or supervisory role in the future because he willfully refused to fix a number of compliance issues.  See https://www.sec.gov/litigation/admin/2017/34-82397.pdf. 

The RIA had conducted a review that uncovered numerous compliance problems.  Despite having notice of the results of this review, the CCO simply ignored it, and did not address any of the problems, including, among other things, the failure to retain emails, electronic information, or protect customer information.  The CCO also failed to update the compliance manual or conduct an annual review.

Such a step by the SEC is in keeping with its belief that CCOs are on the front lines of ensuring that the public are protected.  Here, it seems that the CCO ignored those responsibilities, and was punished severely.

Most FINRA arbitration awards are unanimous.  However, once in a while, we have an interesting set of facts that results in a dissent, and, in the almost unheard of cases, we have an outright attack on the entire FINRA Dispute Resolution system as well as the FINRA staff itself.  Such was the case in Hasko v. Morgan Stanley Smith Barney LLC, et al.  See Hasko v. Morgan Stanley Smith Barney LLC, et al., FINRA Dispute Resolution Arbitration Number 15-03434 (August 10, 2018).

The Hasko case started out like many other expungement cases handled by FINRA arbitration panels, but, somewhere between the hearing and the resulting award, the tracks fell off the case, and the FINRA staff was being accused of “egregious misconduct” by one of its own arbitrators.  The dissenting arbitrator in question took great umbrage with the FINRA staff’s refusal to change the language in a CRD (that the unanimous arbitration panel found defamatory) unless a court of competent jurisdiction confirmed the FINRA arbitration award.  Apparently, despite FINRA rules not requiring such a court award confirmation where no customer information was at issue, the FINRA staff refused to budge.  Consequently, the dissenting arbitrator wrote a detailed and scathing opinion excoriating the FINRA staff’s conduct for seeking to force a “rule change” by making the arbitration panel agree to court confirmation.  Accordingly, in the dissent, the arbitrator specifically outlined all of the reasons why a court would not have jurisdiction to confirm, but, if it were to chose to confirm the award, the court should assess against FINRA “all attorney’s fees and expenses, court costs and other related expenses for both parties, or either party as the case may be, and of those of any other persons, if any, compelled by the court to appear or give testimony, for FINRA’s actions in connection with this dispute as set forth above.”  The arbitrator’s vitriol was not sated because the arbitrator went onto request that: “[a]s the court deems appropriate it should also charge FINRA with a penalty for any action it deems ethically improper or otherwise egregious in conduct.”

There is really only one word for this arbitration award…. WOW!  In short, arbitrators do not normally “bite the hand that fees them,” but, in the Hasko matter, this particular panelist felt the need to simply unload on a system that placed an undue burden on one party in an intra-industry action.  Although one appreciates the panelist’s willingness to look at the actual underlying FINRA rule and not slavishly accept some bureaucratic directive, I believe there is more to this story.

Simply stated, the FINRA staff is not the great evil the panelist makes them out to be.  Before the criticism of this statement begins, let me state for the record that I am by no means a FINRA apologist, and FINRA and its staff certainly do not need my defense.  Nonetheless, FINRA and its staff are working under some harsh and glaring eyes, that is, the public customer claimant’s bar, who view any expungement case as nothing short of a Watergate cover-up.  This unending and misguided glare has caused the overly cautious approach so despised by the dissenting arbitrator.

In sum, the FINRA arbitrator should be lauded for taking on this issue, but we hope other arbitration panels lay the blame on the appropriate party and not take out their frustrations on people merely trying to avoid more unwarranted criticism of the CRD process.

We are regularly approached by both our RIA (and BD too) clients, who inquire, usually around election time, how they should make political contributions. Our advice is usually do not make the political contribution and you can blame your lawyer!

However, those persons, ignoring that advice, should be concerned that the SEC, recently, fined an investment adviser for violating the Investment Advisers Act of 1940’s pay-to-play rule prohibiting an RIA from accepting compensation for 2 years following a political contribution to an official that may influence, who obtains an investment contract.  See https://www.sec.gov/litigation/admin/2018/ia-4960.pdf.  Although in this case the significant investment in the RIA’s managed fund preceded the campaign contribution, it simply did not matter. The RIA could no longer do business with the entity once the campaign contribution was made, it was simply strict liability.

Thus, we are always reluctant to recommend that a client should make a political contribution since it could cost the RIA business.

Securities attorneys routinely are asked by people in the securities industry a form of this question: “how do I get rid of the marks on my license.”  Typically, registered representatives are talking about the fact of life in the securities industry where every time some customer makes a claim, regardless of how baseless it may be, it will end up on the person’s CRD record.  Once there, it is nearly impossible to expunge.

Nonetheless, FINRA has developed over the years a process whereby a registered representative may bring an arbitration proceeding to request expungement of these items.  Such an expungement is, unfortunately, very difficult to obtain for many reasons, among others, the cost, high standards of review, and the fact there may be objections from a number of sources.  However, some registered representatives have not been dissuaded.

In particular, a recent FINRA arbitration panel ruled in favor of a registered representative, and expunged his record.  See https://www.finra.org/sites/default/files/aao_documents/17-01429.pdf.  In the Molinari matter, the registered representative was seeking expungement for some very old claims.  The customers and settlement agreements were not available given the age of the claims, and he no longer was working at the broker-dealer where the complaints were first registered.  To ensure the registered representative had at least an opportunity to be heard, the FINRA arbitration panel permitted the proceeding to move forward with the named respondent being that of the registered representative’s current firm.  The panel then reviewed the claims, and the registered representative’s involvement in said claims.  After hearing the evidence, the panel found that the claims should be expunged from the registered representative’s CRD records.

In short, with the arbitration panel’s willingness to look at the actual substance of the matter and not some formulaic process, it accomplished the ultimate goal of ensuring an accurate CRD system.  We hope other arbitration panels follow suit.

FINRA, recently, announced a major overhaul of its Central Registration Depository (“CRD”).  The first step will be a new WebCRD interface, effective June 30, 2018.  More changes will come over time with FINRA claiming all changes will be made sometime in 2021.

The CRD is the central licensing and registration system that the SEC, FINRA, and the states use to monitor securities firms.  Securities firms use the CRD system to register, make form filings, and maintain records for associated persons, among other things.  It also assists the public as well because it serves as the basis for FINRA’s BrokerCheck.  Essentially, the changes to WebCRD will make it easier for firms, when filing various forms, to obtain feedback in nearly real time about issues relating to those filings.

In sum, FINRA is finally updating an overworked and inefficient system.  However, hopefully, the changes will actually be worthwhile and of assistance to CRD users.