Compliance and Supervision

The Office of Compliance Inspections and Examinations (or OCIE) recently issued a Risk Alert that identified the five most frequent compliance topics that arising from OCIE examinations. These compliance topics include the following:

  1. Deficient compliance programs,
  2. Late or insufficient filings,
  3. Violations of the custody rule,
  4. Code of Ethics compliance deficiencies, and
  5. Books and records.

Among other things, OCIE noted that it continues to see untailored “off-the-shelf” manuals, deficient or non-existent annual reviews, as well as the systemic failure to follow procedures. So what does this all mean?Core Values

It would certainly appear from OCIE’s analysis that firms continue to take the easy way out when it comes to compliance. There is nothing per se wrong with an “off-the-shelf” compliance manual. The impropriety comes when the firm does nothing to modify that manual to conform to its business model. Not conforming a compliance manual to your individual circumstances is no different from not having a manual.

Equally problematic are the lack of meaningful annual reviews. Any annual review must be meaningful to have any regulatory significance. A meaningful review can look differently from firm to firm, but there are a few components were noting.

First, everyone at the firm must participate in the review process. Compliance comes from the tone at the top. Second, the firm should employ a checklist of required elements, and those that may be firm specific. Third, correct any deficiencies found through this process.

Compliance is not easy. But don’t take the easy way out. Having a robust compliance program takes hard work. Do it now, or pay the SEC later.

Like it has in the past, FINRA is sharply focused on examining brokers with a disciplinary past, including the identification and examination of such brokers being placed at the top of its 2017 exam priorities. Does this mean that firms cannot hire brokers with a past?

The short answer is no, but the longer is a bit more involved. A FINRA examination team is going to be conducting a quantitative analysis to review the broker’s test scores, number of prior employers and disciplinary history.Core Values

When FINRA finds such brokers, it will contact the employing firm’s compliance department to ensure that they know of this history. FINRA will also inquire about the type of supervision being used for the individuals. So what does this mean?

For one, you can hire individuals with a past, but you must do so with caution. That caution would necessarily entail placing such a broker on some form of heightened supervision for at least a period of time. At the end of that time, you can then consider removing or downgrading that supervision, assuming that the broker does not have any additional issues.

The key to remember is that FINRA’s goal is to protect the markets and the consumers who hire brokers who may have a past. Hiring brokers with a history and protecting consumers are not mutually exclusive. However, make sure you take special care in the decision to hire and then supervise such individuals because FINRA is watching.

In its never-ending effort to thwart senior investor fraud, FINRA recently proposed a new rule to the SEC. This proposal would require member firms to obtain the name of a trusted contact person for the customer’s account. The new rule would also allow firms to place temporary holds on the disbursement of funds or securities when there is a reasonable belief of exploitation, and notify the trusted contact of such a hold.

This proposed rule is consistent with the advice I have been giving clients over the years as senior issues became more and more prevalent. So what does the potential formalized rule mean for the business?Conference Room

It should come as a relief to firms to have this type of safeguard. It is a difficult situation to say the least when a firm is uneasy with what a family member may be doing with a senior client of the firm. This rule change will give you somewhat of an out.

The key for having this proposal work is for the right selection of the trusted contact person. Assuming such a person can be identified, I think that it is a good idea for that person to be designated as a fiduciary to the client on the account applications and the account coded so that this trusted person receives regular account statements regarding the senior account.

By doing this, you as a firm have a separate set of eyes on the account activity by someone who may know the family/personal dynamics better that you. Having that person designated as a fiduciary on the account documents also should lend you some protection in the event that the trusted person is not so trustworthy.

Either way, this new rule should be embraced a positive step to protect both firm and clients.

Consistent with the ongoing guidance/requirements from the SEC and FINRA, all firms must have and enforce data security policies and procedures.  Even the best policies and procedures may, however, not protect the firm in every instance.  So what do you do if there is a breach?19196909_s

One of the most important things to determine is what law governs.  In other words, if you have clients in all 50 states, it is possible that there are 50 different data breach laws that may be implicated.  Fox Rothschild LLP has a free app, Data Breach 411, which provides an overview of state data breach laws.

Knowing what you need to know is imperative when assessing a data breach.

 

 

In the hectic world of financial services, registered representatives and investment adviser representatives are always looking to increase their assets under management. At what cost? Are there situations where you would be better off just saying no to accepting that one additional client?

In my many years of defending representatives and advisers from customer complaints, the unqualified answer is yes; there are situations when you are better off just saying no. Any good risk avoidance program will provide for the proper screening/selection of prospective clients. I have addressed this very issue in a risk avoidance handbook.whistle

The key to this screening process is being able to sniff out the types of clients that you do not want to accept. For example, are you the fourth adviser that this client has come to in the last four years? Does the client profile not fit your personal/company investment philosophy? Does the client have unrealistic expectations on what she is expecting you to deliver?

If the answer to any of these questions is in the affirmative, there should be a huge stoplight in front of you flashing red. Any client who fits any of these descriptions is also the client most likely to bring a claim against an adviser.

So before you take on any client with a little money, be cautious. Are there red flags coming into the relationship? If so, just say no.

On Monday, September 12, 2016, the SEC’s Office of Compliance Inspections and Examinations (“OCIE”) announced that a “Supervision Initiative” will take place across the country.

OCIE staff will conduct focused RIA examinations of firms employing or contracting with supervised persons, who have a disciplinary history.  OCIE plans to evaluate the effectiveness of RIA compliance programs, supervisory oversight practices, and disclosures to clients and prospective clients, concentrating on the potential risk disclosures arising from financial arrangements initiated by supervised persons with a disciplinary history.  OCIE’s justification for this targeted examination is its belief that firms, who hire those with disciplinary histories, are more likely to have future disciplinary issues arising from these individuals’ conduct.

Frankly, this announcement should come as no surprise to anyone.  The SEC has made it abundantly clear over the years it does not like people who have disciplinary histories working for regulated entities.  However, the SEC always seems to fail to consider that, for a significant part of the securities industry, disciplinary histories have become the norm given the ease where people may make complaints against registered persons, and how expensive and difficult the regulators have made fighting unfounded allegations.  Numerous registered persons have had to make the difficult choice of agreeing to resolve disciplinary charges simply because the price of fighting them would be too great.

Conveniently, the SEC ignores this fact and instead will seek to further stigmatize many hard working and honest members of the securities community.

That is the question that the SEC has essentially posed for registered investment advisers in a National Exam Program Risk Alert. In doing so, the SEC has stated that it will be “examining compliance oversight and controls of registered investment advisers that have employed or employ individuals with a history of disciplinary events . . . .”

The SEC will essentially be examining the investment advisers business and compliance practices, particularly focused on higher risk individuals. Does this mean that you should not hire or retain someone who may have a disciplinary past?Core Values

Of course, not. Instead, this alert should be telling you that such people, if you do decide to hire (or retain) them, should come under some form of heightened supervision for a period of time, if not forever. But be forewarned that the SEC is going to check up on you by reviewing certain information, including the following:

  1. Your compliance program , including the practices surrounding the hiring and ongoing reporting obligations of investment adviser representatives.
  2. The firm’s disclosures (i.e., Form ADV) that it makes to its customers to ensure that they are accurate.
  3. The conflict of interest that the firm discloses.
  4. The firm’s marketing.

By reviewing these areas, the SEC believes that it can better understand how firms are handling and representing advisers with a past to their customers. If you decide to hire or retain such advisers, you should focus on what you are saying to the public about them through your words and actions before you are in the SEC doghouse following an examination.

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