FINRA has rulemaking authority. Nevertheless, the trend would appear to be that FINRA is making its rules through the enforcement process. Read this blog for insightful thoughts on this issue.
FINRA is currently reviewing its rules regarding outside business activities and private securities transactions. From time to time, FINRA reviews its rules and application of those rules to see if anything needs to be tweaked. Is there any significance to FINRA looking at these particular rules?
From my experience, some bad brokers have used the outside business activity disclosure process as the tool to cover their tracks while engaging in activity that the firm would otherwise want to know about. In some case, the undisclosed outside business turned out to be a Ponzi scheme.
The purpose of requiring outside business disclosures is for a firm to make sure that it and its clients know about any conflicts of interest that their brokers may have. For example, the firm would want to know if the broker had a real estate broker’s license because that business may compete with the time the broker can give to her securities investing clients.
FINRA exploring this area should be a message to firms that they need to ask critical questions about what they are doing regarding outside business disclosures.
- Are you doing enough to make sure you receive honest and complete disclosures?
- What, if any, ramifications are there for incomplete or untimely disclosures?
- Are you asking enough follow-up questions to understand the proposed outside business activity?
- What follow-up, if any, do you make with brokers who make disclosures?
If you cannot answer these questions, you need to do more homework or be exposed to the bad broker who may be in your midst.
One certainty in the brokerage world is that registered representatives often switch from one member firm to another. There is nothing wrong with the switch, but there is a word of caution to be shared.
Before you leave, make sure you only have in your possession, if anything, only those things that the firm you are leaving lets you keep. If you take something you are not allowed to have, you can rest assured that your former employer will come looking for you.
Similarly, you should determine whether the old or new firms are members of the broker-dealer protocol. If so, you should check the protocol for what you are allowed to take and what notice you have to give to your former employer about the information you are taking with you.
If one or neither firm is a member of the protocol, it still makes sense to follow the protocol. By doing so, you can demonstrate, if ever challenged, that you tried to do the right by following an objective standard that many in the industry have accepted.
Another thing you should verify is whether you are under contract with your old firm to delay your formal commencement with the new firm; otherwise known as a garden leave policy. If so, you had better follow it. If you opt not to follow it, you should expect a disgruntled former employer coming after you.
So change firms if you like. Just be certain you know what you are doing before you do it. A couple missteps here and there could get you in front of FINRA on an enforcement case.
The SEC recently announced that it charged a former broker with knowingly or recklessly trading unsuitable investment products for five customers and taking $170,000 for one of those customers. These charges follow a prior SEC Investor Alert warning about excessive trading and churning as well as another one focused on the risks associated with exchange-traded notes.
The broker must not have read those two alerts. According to the SEC, the broker enriched himself by systematically disregarding client investor profiles. He repeatedly traded in risky, unsuitable and volatile products like leveraged exchange-traded funds and exchange-traded notes.
This case provides a number of lessons that firms should take away. Specifically, the SEC publishes Investor Alerts for a reason. The SEC is doing your work for you by flagging an issue for investors, as well as firms.
The second thing that this case hammers home is that firms must be more diligent in their broker supervision. As part of the firm’s ordinary surveillance, it should have flagged the unsuitable sale of highly volatile products to relatively unsophisticated clients.
A valuable thumb rule to follow is that as the sophistication of the products increases so should the sophistication of the customer buying those products. Although this rule of thumb will not completely stop all bad brokers, it will go a long way toward flagging those brokers before they cause harm to your clients and liability for your firm.
In Notice to Members 17-13, FINRA announced changes to its sanction guidelines. In other words, FINRA has listed its new top hits that it is pursuing. Two items bear particular attention.
First, FINRA has introduced a “new principal consideration that examines whether a respondent has exercised undue influence over a customer.” This guideline reinforces FINRA heightened focus on senior investors and those who may be otherwise vulnerable, such as those with diminished capacity.
Second, FINRA has introduced a “guideline related to borrowing and lending arrangements between representatives and customers.” This guideline is particularly alarming in as much as it suggests that associated persons are actively engaging in such transactions even though firms uniformly ban them.
Notice to Members 17-13 is a strong guidepost for your supervision and compliance teams. The guidelines highlight growing problems in FINRA’s eyes. This is a cue that you should be ever vigilant for the same conduct. Otherwise, you may be the focus of the new sanction guideline that addresses systemic supervisory failures.
Contrary to what the title may suggest, I am not referring to students who are about to graduate from high school or college. Instead, this post is about that group of our society who all too often (based upon my years of defending broker-dealers) are claimants in FINRA arbitrations; senior investors.
As part of its ongoing effort to protect seniors, FINRA recently introduced Rule 2165 and amended Rule 4512. Both rules reflect a growing trend to provide greater protection to seniors.
Rule 2165 allows a member firm who reasonably believes that senior financial exploitation may be occurring to hold for up to 15 business days the disbursement of money or securities from a senior’s account. This rule gives a firm a safe harbor to take action when it reasonably suspects such exploitation. The firm can extend the hold an additional 10 days.
At the same time, FINRA amended Rule 4512 (providing for the firm to make a reasonable effort to obtain the name of a trusted contact person to place on a newly opened account) further defined the trusted person to be someone that the customer authorized the firm to contact and disclose information to in the event that there is possible financial exploitation. Importantly, the firm is only obligated to make a reasonable effort to obtain this information.
So what does all of this mean for the industry? For one, I do not think that FINRA has to paint you a picture to show you how serious it is taking financial exploitation of seniors. Considering the ongoing greying of the baby boomers, this focus will likely become even more heightened as the years pass.
The SEC recently published its latest investor bulletin. The SEC publishes these from time to time to bring awareness to the investing public on certain issues.
The current bulletin notes that the investor.gov web page provides a number of resources for the investing public, which include:
- The ability to check on an investment professional.
- Self-education about various products.
- To learn about online tools to make investing a simpler process.
- To learn how to avoid investment fraud.
- To stay current with SEC resources.
- To start researching public companies.
- To consider fees associated with investing.
- To gain an understanding of how the market works.
- To plan for retirement.
- To find SEC contact information.
For investment professionals, you should be asking yourself why the SEC has issued such guidance. I think that the easy answer requires you to look yourself in the mirror. Apparently, the SEC does not think you are doing a good enough job educating your clients.
The fact that the SEC thinks these are important areas of interest should be notice to you to make sure your own house is in order. Are you doing enough to educate your clients on most of these topics? If not, you may want to revisit your customer service before the SEC does it for you.
Last week, the Securities and Exchange Commission proposed Rule Amendments to Improve Municipal Securities Disclosures. According to the SEC, these rule amendments are intended to “improve investor protection and enhance transparency in the municipal securities market”. Rule 15c2-12 would be amended to add two new event notices:
– Incurrence of a financial obligation of the issuer or obligated person, if material, or agreement to covenants, events of default, remedies, priority rights, or other similar terms of a financial obligation of the issuer or obligated person, any of which affect security holders, if material; and
– Default, event of acceleration, termination event, modification of terms, or other similar events under the terms of the financial obligation of the issuer or obligated person, any of which reflect financial difficulties.
Currently, Rule 15c2-12 under the ’34 Act requires brokers, dealers, and municipal securities dealers that are acting as underwriters in primary offerings of municipal securities to reasonably determine, among other things, that the issuer or obligated person has agreed to provide to the Municipal Securities Rulemaking Board (MSRB) timely notice of certain events. The proposed amendments are aimed to “provide timely access to important information regarding certain financial obligations incurred by issuers and obligated persons that could impact such entities’ liquidity and overall creditworthiness.”
There is a 60 day comment period, so firms that are affected by these new rules and wish to comment should consult with counsel as to the most effective way to provide feedback to the SEC.
According to a recent report of the Eversheds Sutherland firm, 2016 was a banner year for FINRA-assessed fines. FINRA collected a record $176 million in 2016. So what gives?
The increase in fines was attributable to two things. First, a significant number of fines in the $1 million plus range. Second, of those fines, a fair number were in excess of $5 million.
Of particular note, the report shows that FINRA is seeking and obtaining very large fines even when there is limited or no measurable client harm. Historically, the lack of client harm was the siren call of a firm defending itself. In other words, no fine if there is no client harm.
So what does this all mean? For one, FINRA is pressing hard on enforcement even in the absence of client harm. It also reflects that FINRA is willing to go the distance so to speak to recoup the maximum fines possible.
I do not think that firms should anticipate FINRA taking 2017 off by any means. Now is as good a time as any to ensure that you have your compliance and supervision house in order. If not, break out the big checkbook. This one is going to hurt.
According to Bloomberg, Trump plans to order a review of Dodd-Frank, with an eye to significantly scale back the regulations. Trump also plans to do away with the “fiduciary rule”, which requires retirement account advisers to perform in the best interests of their clients.
This confirms Trump’s goal to loosen regulations in the financial services industry. While the Dodd-Frank review will not have an immediate impact, Trump’s order will stall the fiduciary rule from going into effect this April. Trump is likely to face significant opposition to his efforts to dismantle Dodd-Frank, but will likely succeed in scaling back at least some of its regulations.
We will continue to monitor developments in this area and provide further updates as they unfold.