In a very interesting webcast, the FINRA staff discusses how FINRA rules are made and reviewed. See http://www.finra.org/industry/podcasts/how-finra-rules-get-made-and-reviewed. Although it will not reach the level of Schoolhouse Rock (as the FINRA staff seemingly hopes it will), it is an excellent discussion of the process, and should be considered by all those in the securities industry, or, at the very least, those regulated by FINRA.
A chief compliance officer (“CCO”) for a registered investment adviser (“RIA”) found himself barred from any compliance or supervisory role in the future because he willfully refused to fix a number of compliance issues. See https://www.sec.gov/litigation/admin/2017/34-82397.pdf.
The RIA had conducted a review that uncovered numerous compliance problems. Despite having notice of the results of this review, the CCO simply ignored it, and did not address any of the problems, including, among other things, the failure to retain emails, electronic information, or protect customer information. The CCO also failed to update the compliance manual or conduct an annual review.
Such a step by the SEC is in keeping with its belief that CCOs are on the front lines of ensuring that the public are protected. Here, it seems that the CCO ignored those responsibilities, and was punished severely.
Most FINRA arbitration awards are unanimous. However, once in a while, we have an interesting set of facts that results in a dissent, and, in the almost unheard of cases, we have an outright attack on the entire FINRA Dispute Resolution system as well as the FINRA staff itself. Such was the case in Hasko v. Morgan Stanley Smith Barney LLC, et al. See Hasko v. Morgan Stanley Smith Barney LLC, et al., FINRA Dispute Resolution Arbitration Number 15-03434 (August 10, 2018).
The Hasko case started out like many other expungement cases handled by FINRA arbitration panels, but, somewhere between the hearing and the resulting award, the tracks fell off the case, and the FINRA staff was being accused of “egregious misconduct” by one of its own arbitrators. The dissenting arbitrator in question took great umbrage with the FINRA staff’s refusal to change the language in a CRD (that the unanimous arbitration panel found defamatory) unless a court of competent jurisdiction confirmed the FINRA arbitration award. Apparently, despite FINRA rules not requiring such a court award confirmation where no customer information was at issue, the FINRA staff refused to budge. Consequently, the dissenting arbitrator wrote a detailed and scathing opinion excoriating the FINRA staff’s conduct for seeking to force a “rule change” by making the arbitration panel agree to court confirmation. Accordingly, in the dissent, the arbitrator specifically outlined all of the reasons why a court would not have jurisdiction to confirm, but, if it were to chose to confirm the award, the court should assess against FINRA “all attorney’s fees and expenses, court costs and other related expenses for both parties, or either party as the case may be, and of those of any other persons, if any, compelled by the court to appear or give testimony, for FINRA’s actions in connection with this dispute as set forth above.” The arbitrator’s vitriol was not sated because the arbitrator went onto request that: “[a]s the court deems appropriate it should also charge FINRA with a penalty for any action it deems ethically improper or otherwise egregious in conduct.”
There is really only one word for this arbitration award…. WOW! In short, arbitrators do not normally “bite the hand that fees them,” but, in the Hasko matter, this particular panelist felt the need to simply unload on a system that placed an undue burden on one party in an intra-industry action. Although one appreciates the panelist’s willingness to look at the actual underlying FINRA rule and not slavishly accept some bureaucratic directive, I believe there is more to this story.
Simply stated, the FINRA staff is not the great evil the panelist makes them out to be. Before the criticism of this statement begins, let me state for the record that I am by no means a FINRA apologist, and FINRA and its staff certainly do not need my defense. Nonetheless, FINRA and its staff are working under some harsh and glaring eyes, that is, the public customer claimant’s bar, who view any expungement case as nothing short of a Watergate cover-up. This unending and misguided glare has caused the overly cautious approach so despised by the dissenting arbitrator.
In sum, the FINRA arbitrator should be lauded for taking on this issue, but we hope other arbitration panels lay the blame on the appropriate party and not take out their frustrations on people merely trying to avoid more unwarranted criticism of the CRD process.
We are regularly approached by both our RIA (and BD too) clients, who inquire, usually around election time, how they should make political contributions. Our advice is usually do not make the political contribution and you can blame your lawyer!
However, those persons, ignoring that advice, should be concerned that the SEC, recently, fined an investment adviser for violating the Investment Advisers Act of 1940’s pay-to-play rule prohibiting an RIA from accepting compensation for 2 years following a political contribution to an official that may influence, who obtains an investment contract. See https://www.sec.gov/litigation/admin/2018/ia-4960.pdf. Although in this case the significant investment in the RIA’s managed fund preceded the campaign contribution, it simply did not matter. The RIA could no longer do business with the entity once the campaign contribution was made, it was simply strict liability.
Thus, we are always reluctant to recommend that a client should make a political contribution since it could cost the RIA business.
Securities attorneys routinely are asked by people in the securities industry a form of this question: “how do I get rid of the marks on my license.” Typically, registered representatives are talking about the fact of life in the securities industry where every time some customer makes a claim, regardless of how baseless it may be, it will end up on the person’s CRD record. Once there, it is nearly impossible to expunge.
Nonetheless, FINRA has developed over the years a process whereby a registered representative may bring an arbitration proceeding to request expungement of these items. Such an expungement is, unfortunately, very difficult to obtain for many reasons, among others, the cost, high standards of review, and the fact there may be objections from a number of sources. However, some registered representatives have not been dissuaded.
In particular, a recent FINRA arbitration panel ruled in favor of a registered representative, and expunged his record. See https://www.finra.org/sites/default/files/aao_documents/17-01429.pdf. In the Molinari matter, the registered representative was seeking expungement for some very old claims. The customers and settlement agreements were not available given the age of the claims, and he no longer was working at the broker-dealer where the complaints were first registered. To ensure the registered representative had at least an opportunity to be heard, the FINRA arbitration panel permitted the proceeding to move forward with the named respondent being that of the registered representative’s current firm. The panel then reviewed the claims, and the registered representative’s involvement in said claims. After hearing the evidence, the panel found that the claims should be expunged from the registered representative’s CRD records.
In short, with the arbitration panel’s willingness to look at the actual substance of the matter and not some formulaic process, it accomplished the ultimate goal of ensuring an accurate CRD system. We hope other arbitration panels follow suit.
FINRA, recently, announced a major overhaul of its Central Registration Depository (“CRD”). The first step will be a new WebCRD interface, effective June 30, 2018. More changes will come over time with FINRA claiming all changes will be made sometime in 2021.
The CRD is the central licensing and registration system that the SEC, FINRA, and the states use to monitor securities firms. Securities firms use the CRD system to register, make form filings, and maintain records for associated persons, among other things. It also assists the public as well because it serves as the basis for FINRA’s BrokerCheck. Essentially, the changes to WebCRD will make it easier for firms, when filing various forms, to obtain feedback in nearly real time about issues relating to those filings.
In sum, FINRA is finally updating an overworked and inefficient system. However, hopefully, the changes will actually be worthwhile and of assistance to CRD users.
Today, the United States Supreme Court sent shock waves through the securities industry as well as the United States Securities and Exchange Commission’s (“SEC”) enforcement program when it held that SEC administrative law judges (“ALJ”) are “inferior officers,” and must be chosen pursuant to the appointments clause of the United States Constitution. That is, the President with the advise and consent of the United States Senate may appoint “all other Officers of the United States, whose Appointments are not herein otherwise provided for, and which shall be established by Law: but the Congress may by Law vest the Appointment of such inferior Officers, as they think proper, in the President alone, in the Courts of Law, or in the Heads of Departments.” See United States Constitution Article 2, Section 2, Clause 2. Although this decision was centered on an appeal involving an SEC ALJ, it may also effect other federal agencies that use in-house judges.
Initially, the case involved a former investment adviser who was sanctioned by an SEC ALJ. See Lucia v. SEC, https://www.supremecourt.gov/opinions/17pdf/17-130_4f14.pdf. The United States Court of Appeals for the District of Columbia had held that SEC ALJs were not subject to the appointments clause; however, the United States Court of Appeals for the 10th Circuit had found differently. Justice Elena Kagan authored the opinion and found that the SEC’s ALJs were very similar to tax court trial judges where the Supreme Court had previously found those judges to be inferior officers subject to the appointments clause.
Now that the Supreme Court has opened this door with the finding ALJs are inferior officers, the SEC’s ALJ’s will have to be appointed pursuant to the appointments clause in the future, and it calls into question what, if anything, will happen to the ALJs at other federal agencies. Further, there will be the question of prior SEC cases, the Supreme Court stated that not every appointments clause violation requires a new hearing. However, time will tell.
Additionally, although Justice Kagan specifically said it was not being addressed in this case, we may also shortly see that, since the SEC’s ALJs are now considered inferior officers subject to the appointments clause, they may also now be subject to removal by the SEC Chairman for good cause. Such a result may provide significant power to the president to fire such ALJs at will, maybe even in a Tweet. As for Mr. Lucia, well, he now gets a re-trial before either the full SEC or a new ALJ appointed pursuant to the appointments clause, who will determine if his “Buckets of Money” program is real or made-up.
In short, the Supreme Court has upended how the SEC does business. Of course, we will follow how the SEC responds.
Recently, the SEC’s Director of Corporation Finance provided long overdue insight on cryptocurrencies. In particular, he indicated that Bitcoins, Etherium, and other such coins functioning on certain decentralized platforms are not securities. Our partner, Kristen Howell, authored a fascinating and informative alert on this topic. See https://www.foxrothschild.com/publications/sec-bitcoin-is-not-governed-by-securities-laws/. We commend it to anyone interested in this area.
Essentially, the SEC Staff has taken the position that, various cryptocurrencies operating from a central control group, who target passive investors, will be engaging in a securities offering while less centralization focusing in on purchasing goods or services will be less likely to be considered a security. The SEC Staff also suggested that those interested in this field should consider seeking formal interpretive or no-action letter guidance so as to avoid the potential pitfalls. The SEC Staff also indicated that securities registration may end up being required if there is a central group/promoter offering an increase in value; raising excess funds that are more than necessary for the actual network; having purchasers looking for a greater return than the current value; and a directed sales effort.
Thus, it is critical to seek out legal counsel before engaging in cryptocurrency networks and offerings.
For those interested in a description of the DOJ’s new corporate resolution policy, we strongly urge you to review our partner, Matt Lee’s, recent posting on this topic. See https://www.foxrothschild.com/white-collar-compliance-defense/publications/the-justice-departments-new-corporate-resolution-policy-an-end-to-piling-on/.
In rapid succession, the SEC has issued warnings and announced sanctions against registered investment advisers for fee and expense practices, false statements regarding assets under management, and misleading performance data. No one should be surprised that the SEC is actively seeking to uncover transgressions in the RIA field.
Initially, the SEC’s Office of Compliance Inspections and Examinations issued a Risk Alert outlining a variety of RIA failures concerning the proper calculation and disclosure of fees and expenses. See https://www.sec.gov/ocie/announcement/risk-alert-advisory-fee-expense-compliance. In particular, the alert detailed a series of failures that OCIE found in its examinations of RIAs, among other things, RIAs failed to properly value assets, overbill, use incorrect fees or time periods.
Similarly, the SEC also sanctioned a principal of a closed RIA for falsely stating it was subject to SEC registration. See https://www.sec.gov/litigation/admin/2018/ia-4875.pdf. Although we believe it admirable for someone to want to achieve SEC RIA registration status, you want to be accurate when you make this claim. Apparently, this individual was not, and lying to the SEC will always incur its wrath.
Finally (and this is a pet peeve with us), the SEC also sanctioned a RIA for using misleading performance data. See https://www.sec.gov/litigation/admin/2018/ia-4885.pdf. The RIA was caught using hypothetical back-tested performance data– a pretty big no-no. We are constantly advising RIA clients of the pitfalls in using any type of performance data, and this case illustrates how closely the SEC will look at its use.
In sum, RIAs have to be careful the SEC is watching.