spying.jpgIn a prior post, I discussed the traps that people fall into when it comes to email.  One of the areas of greatest concern for me when I defend brokers and investment advisors are the emails that are generated immediately after a complaint (particularly an informal one) is received.

It goes without question that the broker/advisor will be upset when a customer makes a complaint.  That is, however, no reason to lose your discipline when reporting to compliance/legal about the complaint.

For one, never bad mouth or editorialize about a complaining customer.  Fight the natural reaction of wanting to call the complainant a pain, crazy, an idiot or anything in the pejorative.  Those emails may be subject to discovery and will be used against you to demonstrate that you did not have the customer’s best interests in mind.

Once a complaint is made, email about the customer should only be used to forward information, without additional comment.  Any debriefing about the customer should be in person or on the phone between you and your compliance/legal team.

If email is necessary to explain what happened, that email should be forwarded to someone in your legal team, which can improve your ability to assert the attorney-client privilege or work product to avoid producing that email in discovery.  If you do not have a legal team, you should avoid creating these types of emails as they may not be protected from discovery.


Dealing with customer complaints can be an arduous process.  Do not make a worse with loose emails after a complaint is received.


            * Photo from freedigitalphotos.net

idea.jpgThe recent news regarding members of the government and military should hammer home the importance behind a robust email review.  At the same time, these incidents reflect the importance of thinking before you press send.

Over the last decade that I have been coaching financial advisors on risk avoidance techniques, issues surrounding email use have become more prevalent.  Email is a great time-saver, but has resulted in many of you becoming intellectually lazy about the substance of your emails.

The most important thing to remember about email is that the “e” does not stand for electronic.  Rather, in my view, it stands for both “ever-lasting” and “exhibit”.

In other words, email will always remain in computer space, only to be recovered by a skilled technician.  Deletions are only temporary.  Think about the substance of your email before you send it because that email will always be available for the world to read.

Also, do not put anything in an email that you would not want blown up as an exhibit in a trial.  If you look at a draft email and think it may be a bit out of line, think how a judge, jury or arbitration panel will think when they look at that email on a wide screen or enlarged poster board at trial.  It is not a pretty sight when it is your email.

By the same token, these recent events should serve as an impetus for firms to revisit their systemic email review.  Think about the trigger words that your systems uses to flag emails.  Revise those triggers over time to focus on ever-changing issues.  What may be an area of focus this year, may not be the next.

Email can be a great tool or a terrible curse.  Only you can decide which it will be by your actions.  Think before you hit send.


* Photo from freedigitalphotos.net

The SEC’s Office of Compliance Inspections and Examinations (“OCIE”) issued a release directed to newly registered investment advisers (“RIAs”).  The release was a “hello” to these RIAs to make them aware of the National Exam Program (“NEP”) and explain the Presence Exams Initiative (“PEI”).  An RIA is “newly registered” if it registered with the SEC after the Dodd-Frank Act became effective.

The OCIE has indicated that the NEP staff will contact the RIA if it is to be examined.  The “focused, risk-based examinations” of RIAs will be conducted over the next 2 years, and will consider engagement, examination and reporting.  The engagement phase is essentially, an outreach program to inform RIAs about their obligations under the Investment Advisers Act of 1940, including, but not limited to, the SEC’s policies.

            The examination phase is the actual on-site review conducted by a NEP Staff member that will review one or more higher-risk areas of the RIAs’ business and operations.  The OCIE Staff may consider, among other things:

l      Marketing, marketing materials, and the solicitation of investors.

l      Portfolio management and the portfolio decision-making policies.

l      Conflicts of interest, concerning investment, fee and expense allocation, sources of revenues and transactions with related parties.

l      Safety of client assets, loss or theft prevention programs for client and assets, and a review of independent private fund audits.

l      Valuation, policies and procedures, illiquid or difficult to value instruments, fair valuation, calculating management and performance fees, and expense allocations.

Initially, the Staff will report their finding to the SEC and the public, focusing on common practices, industry trends and significant issues. 

RIAs (and fund managers) should be prepared to answer all SEC Staff inquiries concerning valuation methodology, marketing materials, and custody of assets, among others.  Thus, RIAs must start now preparing for these exams, and ensuring proper books and records. 

confusion.jpgSo the initial shock of uncovering a fraud has subsided.  What do you do now?  Here are some steps to consider.

 First, preserve all relevant records in both hard and soft form.  You may want one to hire an outside vendor that specializes in electronic discovery.  These technicians possess special skills and resources that will advance this effort, and, at the same time, provide an audit trail that the firm can share with inquiring regulators. 

Second, decide who is conducting the investigation.  The supervisor of the target should not conduct the investigation.  If the supervisor was involved, having him conduct the investigation is a sure fire way not to learn what happened.

Third, consider hiring an outside legal team, other than the law firm that typically handles you work, to assist with the investigation.  By doing so, you may better preserve the attorney-client privileged and have a more objective investigation.

Fourth, interview the fraudster and anyone who worked with him.  You may be able to determine the scope of the problem and the participants.  You should also speak with impacted customers as they too may be a source of useful information.

Fifth, assuming you concluded there was improper conduct, terminate the employees who participated in the fraud and, where applicable, accurately describe the reason for termination in the Form U-5. 

Sixth, depending upon the improper conduct and its scope, report the person to law enforcement and make regulatory disclosures, where appropriate.

Seventh, implement a remedial plan of action to address any uncovered gaps.  As important as implementing this plan, you must see it through its course.

Any fraud can have a devastating impact on any firm.  If you conduct a proper and complete investigation, you may succeed in lessening the impact on the firm.


            * Photo from freedigitalphotos.net

In previous blogs, I have noted the importance of focusing on certain types of troublesome activity and the use of outside business disclosure forms to unravel or prevent fraud.

There are also a number of other techniques as part of the overall culture of compliance that you can use to prevent/uncover fraud.  In no particular order, these techniques include the following: 

  1.          Compliance testing;
  2.          Forensic testing;
  3.          Monitoring phone usage;
  4.          Monitoring internet usage;
  5.          Monitoring email usage;
  6.          Education and training;
  7.          Internal audit; and
  8.          Whistleblower hotline.

All broker-dealers and investment advisors should have clearly defined policies pertaining to monitoring the usage of the telephone and electronic media.  Having such policies may dissuade someone from using them for improper purposes.

robber.jpgLikewise, when circumstances warrant, you may need to use forensic testing or internal audits.  When conducting an internal audit, you should strongly consider employing outside counsel to spearhead that effort.

Although using outside counsel comes at an expense, not using one may have adverse consequences for maintaining the attorney-client privilege.  Also, you should strongly consider using a different firm than one under retainer.  By doing so, you can better promote the appearance of independence.

Depending upon the results of the review, you may need to make a disclosures to your regulator.  At a minimum, take action to address any gaps uncovered by the examination.

Finally, employing a whistleblower hotline is consistent with a culture of compliance.  It promotes the reporting of suspicious activity on a confidential basis. 

No system is full proof, but put the odds in your favor.  By doing more on the front end, you are in a better position to protect the firm from the bad acts of a few.

 * Photo from Freedigitalphotos.net

Recently, a registered investment adviser and its principal had to pay approximately $500,000 in disgorgement and penalties when they used an affiliated broker-dealer to charge clients higher commission rates.  See http://www.sec.gov/litigation/admin/2012/34-68118.pdf

The SEC found that the RIA and its principal, essentially, mislead their advisory clients by representing the clients were receiving a discount on commissions when the trades were placed through the affiliated BD.  In fact, the SEC stated these advisory clients paid higher rates than the BD charged the RIA, and the RIA and principal pocketed the difference.  The RIA did, however, disclose the potential conflict of interest in its Form ADV, but omitted any discussion on the compensation.  For good measure, the SEC also found the RIA failed to have any best execution review despite such a description contained in the Form ADV.

This enforcement action clearly portrays a more activist SEC on these issues so RIAs and their principals really need to be prepared by ensuring their Form ADVs are accuarate and disclose all conflict of interest information including fees and commissions.  Most likely, this will also be a particular concern during SEC RIA and BD exams, yet another potential hot point.

Last week, FINRA issued FINRA RN 12-45 laying out several items members should consider in the aftermath of Hurricane Sandy.

For example, FINRA suggested that member firms provide office space to those member firms affected by the Hurricane.  Further, member firms housed in temporary space would not need to make an application for a new branch location or have to update RRs’ Form U-4 forms.  FINRA did specifically require these firms to contact their FINRA regulatory coordinator as soon as possible.  FINRA also extended the deadlines for completion of CE requirements and qualification examinations for those people living in federally declared disaster areas.  These deadlines now will be extended to December 10, 2012.

Additionally, at the time of this writing, FINRA’s NYC offices are still closed, but that may change shortly.  As a result, member firms and RRs should check on any filed information to ensure FINRA has any materials filed by these member firms or RRs.  FINRA is also allowing member firms and individuals the opportunity to ask for more time to respond to investigations or make filings.  However, a request must be made, it will not be automatically be granted or extended.

Finally, we are all in this together, and, at Fox Rothschild, we are prepared to offer assistance where we can.

Ponzi schemes seem to be more and more common over the last few years.  Whether the ponzi scheme is a multibillion dollar scheme, or a smaller scheme involving several thousand dollars, they all share certain common characteristics.  The most common characteristic among ponzi schemes is that they tend to show their investors relatively consistent gains, even when the markets are extremely volatile.  For example, during the tech bubble burst in the early 2000s, Mr. Madoff reported steady gains of about 12% or so a year.  Most experienced and some inexperienced investors are probably consciously or subconsciously aware that those types of consistent gains, during a recession, should raise some eyebrows.  The reason Mr. Madoff could perpetrate his fraud for so long, however, is that investors let their greed blind them to common sense.  In essence, investors should remember that if an investment opportunity seems to good to be true, it probably is and investors should be cautious.

Another common characteristic is that many of the investors in a ponzi scheme tend to be from the same affinity groups, such as social, economic, religious or cultural.  In the Madoff scheme, nearly all of the investors were wealthy individuals or charities.  Many investors unknowingly invest in a ponzi scheme through the recommendation of a friend or relative.  As a result, investors often fail to do their normal due diligence because they are disarmed by their friend’s or relative’s glowing recommendation of the investment.  Investors should remember to do their normal due diligence before investing in a fund based on any recommendation.

There other common characteristics of ponzi schemes include complex or secretive investment strategies, issues with paperwork and difficulty receiving payments.  Although legitimate funds could, from time to time, share some of these characteristics, it is important that all investors follow the advice of a former president, “trust but verify”.