Financial Industry Trends

 

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 announced fraud charges, and sought an emergency asset freeze against a pastor who was accused of exploiting church members, retirees, and laid-off autoworkers. Apparently, he mislead these people by purportedly selling them on a successful real estate business.

The pastor cloaked his fraud in faith-based rhetoric, including references to the bible and suggestions that he was praying for investors. As a result, his defrauded investors thought that he was more trustworthy than a banker, investing nearly $7 million in this scheme.

Money and calculator
Copyright: denikin / 123RF Stock Photo

The message here is that fraud lurks everywhere and that affinity schemes are alive and well. Unfortunately, for those defrauded, they had access to public information that may have helped them avoid the fraud.

Neither the pastor nor his investment firm were registered with the SEC. A simple check on the SEC’s investor web side would have revealed no records for the pastor or his firm.

Undoubtedly, he would have still gotten some of those who checked, but look before you leap into an investment. Be wary of those who are focused on a particular group as a source of investing funds; it may be an affinity fraud.

 

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.

24752961 - grunge rubber stamp with text disclosure,vector illustration
24752961 – grunge rubber stamp with text disclosure,vector illustration

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.

Many people see the green of cannabis as a way to the pot of gold at the end of the rainbow. If you are going to invest in a legal (at a state level) cannabis business, you need to make sure that you know what you purchase.

Whistleblowers
Copyright: lightwise / 123RF Stock Photo

The SEC recently charged a company and its founder with promoting “record” revenue numbers to investors and touting itself as a leader in the cannabis industry, all the while it generated certain of its earnings from sham transactions through a secret corporate affiliate. The company and its principal agreed to settle the charges, with the principal agreeing to pay $12 million in disgorgement and penalties and accepting a bar from serving as an officer or director of a public company or participating in any penny stocks.

So what do these events tell us? First, there are potential big rewards through investing in this burgeoning industry. Second, there are people looking to take advantage of your desire for large profits.

Investing in these businesses is fine, but make sure your eyes are wide open. Ask question, perform due diligence, and ask more questions. You don’t want to see your investment go up in smoke.

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 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.