Financial Industry Trends

Nearly a year ago, FINRA adopted Rule 2165 (Financial Exploitation of Specified Adults) and amended Rule 4512 (Customer Account Information). This new rule and amended rule were ways to address the myriad of issues dealing with senior clients.

With nearly a year gone by, FINRA has now published responses to frequently asked questions involving Rules 2165 and 4512. The responses to the FAQs are broken down into the following categories.

  1. Placement of temporary holds.
  2. Extensions of temporary holds.
  3. Trusted contact.
  4. Disclosure.

For anyone who has any senior clients, a review of these FAQs is necessary because they reflect FINRA’s ongoing focus of senior clients. Reviewing the FAQs will only take a few minutes, defending yourself in a lawsuit brought by a senior will take years. How would you rather spend your time?

The SEC recently put out an Investor Bulletin on wrap fees. Although this guidance is steered toward consumers, there are lessons to be learned by firms who offer such programs.

The SEC specifically posed the question of what does the fee cover. Included in that list of possibilities are:

  1. Investment advice.
  2. Brokerage costs.

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  3. Administrative expenses.
  4. Other fees and expenses like those associated with mutual funds.
  5. Third party service provider costs and trading away.

So what can a firm take away from this bulletin? For one, now is as good a time as any to make sure that your wrap fee disclosures are complete and up to date.

In the first instance, do you even have written disclosures that you can provide customers? If you do, do they detail the services being provided and the fees being charged. If the answer to either question is no, you have work to do.

In Notice to Members 17-38, FINRA has put out for comment a change to Rule 3110 that would allow the remote inspection of certain “qualifying offices” as that term is defined by FINRA. In its Notice to Members, FINRA highlighted the point that technology and a changing industry mandate reconsideration of requiring mandatory, in-person inspections.

A “qualified office” is an office that meets the following conditions:

  1. A location where there are no more than three associated persons that conduct business for the firm.
  2. A location that is not held out to the public as an office of the firm.
  3. The associated person at that location conducts business for the firm solely through the firm’s authorized electronic systems.
  4. All required books and records are maintained by the firm other than at the location.
  5. No customer funds or securities are handled at the location.
  6. The location is either (i) not required to be annually inspected; (ii) designated as an OSJ solely because of supervisory activities described in Rule 3110(f)(1)(D) through (G); or (iii) designated as a branch office solely because of supervisory activities described in Rule 3110(f)(2)(B).
  7. No registered person at the location has a disciplinary history and no associated person at the location is subject to statutory disqualification.

Although there are a number of conditions to satisfy the exception to in-person branch office inspections, this proposed change is a start in the right direction. Compliance and supervision take substantial overhead, and the proposed change is just an acknowledgement of reality that inspections can be performed without the need of boots on the ground. Time will tell if this rule change happens.

The SEC recently announced an enforcement initiative that will target retail investor harm. The agency’s task force will use data analytics to find widespread problems regarding fee disclosures and unsuitable investment recommendations. In addition to data analytics, the SEC will rely upon tips, complaints and referrals that come into the SEC.

This heightened analysis of the retail investor market should be a wake-up call to firms who service the retail investor space. There are a few questions that you should be asking as you move forward:

  1. Do I have a rigid supervisory system to make sure clients are receiving suitable investment advice for the fee being paid?
  2. If my firm does not have a robust supervisory system over retail investment advice, what is the firm doing to develop and deploy such a system?
  3. What does you supervisory system provide if it finds unsuitable investment recommendations?

There are certainly additional questions that firms can ask themselves, but the point is made. What are you doing to make sure the SEC does not have an issue with the retail investment advice that you are giving to your clients? If you cannot answer that question, you had better go back to the drawing board.

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.