Compliance and Supervision

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.Core Values

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.

Ask yourself:

  • 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.Core Values

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 has recently issued an Investor Alert regarding commentary provided about investors from what appear to be independent sources. It turns out, many of those independent sources are not independent at all. Instead, they are paid shills.

The SEC has instituted enforcement actions against such companies for generating deceptive articles on investment websites. Among other things, these companies:

  1. Failed to disclose that they received payment even though companies had paid them directly or indirectly.
  2. Used different pseudonyms to publish multiple articles the promoted the same stock.

    24752961 - grunge rubber stamp with text disclosure,vector illustration
    24752961 – grunge rubber stamp with text disclosure,vector illustration
  3. Falsified their credentials; misrepresenting themselves as accountants or a fund manager, for example.

So where does that leave firms that rely upon commentaries for the sale of stock. For one, if you pay for it, you had better disclose that you paid for it. If you did no pay for it, do a little digging to make sure that the commenter is legitimate. If not, stay away lest the SEC pay a visit.

 

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.Core Values

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.

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:

  1. The ability to check on an investment professional.
  2. Self-education about various products.
  3. To learn about online tools to make investing a simpler process.
  4. To learn how to avoid investment fraud.
  5. To stay current with SEC resources.
  6. To start researching public companies.
  7. To consider fees associated with investing.
  8. To gain an understanding of how the market works.
  9. To plan for retirement.
  10. To find SEC contact information.Core Values

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.

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.

Money and calculator
Copyright: denikin / 123RF Stock Photo

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.

The SEC recently issued regulatory guidance for robo-advisors. This guidance focuses on what robo-advisors must do to meet their disclosure obligations.

Among other things, the SEC has recommended robust disclosures in the following areas:

  1. The use of algorithms, overrides, third parties, fees and client information.
  2. The limits on use of the robo-advisor model to ensure adequate disclosures.
  3. Adequate and clear investment questionnaires to ensure suitability of investments.

Robo-advisors are a growing trend. Thus, it is only logical that the SEC would provide such guidance. Now that the SEC has spoken, it is on you to ensure that you take the message to heart; or learn the hard way.

The SEC recently released its findings relating to exams of investment advisers.  https://www.sec.gov/ocie/Article/risk-alert-5-most-frequent-ia-compliance-topics.pdf.

In particular, the SEC’s Office of Compliance Inspections and Examinations (“OCIE”) found weak compliance programs; insufficient or late filings; custody rule violations; Code of Ethics problems; and the often used books and records issues. OCIE, in fact, criticized the use of non-particularized, “off-the-shelf” manuals, nearly non-existent annual reviews, and plain and simple failure to implement or follow procedures.  Form ADV and Form PF filings also included inaccurate information or were late.  Investment advisers were also found to not have the requisite knowledge to follow the custody rule, its requirements, persons responsible, or adequate and readily available books and records.

Finally, RIAs should consider this release a warning shot.  That is, the SEC staff will most likely continue to focus on these issues during its future exams.