BD Law Blog - by Georgia Securities Lawyer Joel Beck

Court Holds FINRA (f/k/a NASD) is Immune From Suit

This week a federal court judge in New York dismissed a lawsuit by two broker-dealers against NASD (now FINRA) relating to NASD communications with member firms in advance of the merger of NASD and NYSE Regulation.  Investment News journalist Dan Jamieson reported the judge as stating that "SROs and their officers are absolutely immune from private damages suits challenging official conduct performed within the scope of their regulatory functions." 

The plaintiffs argued that the situation at issue was not a regulatory function of the NASD, but was a business governance matter.  That seems like a logical position to take, and it looks to me like my colleague Mark Astarita (author of seclaw.com) agrees as well, although the Court rejected that argument, siding with FINRA that the functions were regulatory in nature.    And I think we both agree that it is interesting, to say the least, that NASD (now FINRA) can claim that it is not a governmental entity when it suits them (such as when investigating firms and stockbrokers and not providing them with protections of the 5th amendment right against self-incrimination), and then claim that it is essentially a quasi-governmental or governmental organization or actor when it is in their interest (when faced with lawsuits and seeking immunity).  

Most of the time the courts don't let you have it both ways.  At some point, such treatment much stop. 

FINRA Details 2010 Exam Priorities

In an annual letter to member firms, the FINRA departments of Member Regulation, Market Regulation and Enforcement outlined some of their 2010 examination priorities, as well as updated firms on other news and events.  The letter is worth a read by all compliance staff and higher level managers, if not all principals.  While many of the items are not new, its a good reminder of what the regulators believe are still the "hot button" items, and what things they'll certainly be reviewing during examinations of broker-dealers. 

Making the 2010 list are: fraud detection ( ensuring adequate procedures and controls for preventing fraud); information barriers (prevention of insider trading and misuse of other information); variable annuities (particularly recommendations to switch from one to another); protection of customer information/ firm's internal IT security; anti-money laundering; business continuity planning; and branch office supervision.  Several other areas focusing on trading issues as well as valuation made the list as well.

Forewarned is forearmed.

Have you Prepared your 2010 Compliance Plan Yet?

February will be over before we know it.  And I suspect that soon we'll be looking back wondering how 2010 came to an end so quick.  With that in mind, Compliance Officers should make sure that they are preparing their compliance plan for 2010 before its too late.  In addition to ensuring that WSPS remain current and are followed, CCOs and staff need to focus on he firm's annual compliance meeting, continuing education (firm and regulatory elements as needed), AML training, new representative and employee compliance-oriented training, etc.  Plan now, get things on the calendar, and work the plan. 

Firms that need a speaker for their annual compliance meeting or other broker meetings, can contact Joel Beck of The Beck Law Firm, LLC.  As a former NASD enforcement lawyer, and now in private practice, Joel can share with your representatives the "Dumb Things Brokers Do" along with practical, real-world ways to minimize complaints, regulatory actions and arbitration claims, while reinforcing the need to follow the firm's compliance guidelines and policies.  To book Joel for a speaking event, contact him at 678-344-5342 today. 

Georgia Supreme Court recognizes "Holder" claims, and Fiduciary duties

On February 8, 2010, the Supreme Court of Georgia issued its opinion in Holmes e al. v. Grubman et al., a case brought by a group of former WorldCom, Inc. shareholders against Salomon Smith Barney & Co (Citigroup Global Markets, Inc.) and its financial analyst Jack Grubman.  This case was brought in federal court and was later appealed.  During the appeal process, the United States Court of Appeals for the Second Circuit certified three questions to the Supreme Court of Georgia.  The three questions related to 1) whether Georgia common law recognizes holder claims (holder claims relate to advice given to hold onto a security (to refrain from selling it) with such advice based on some type of misrepresentation or omission of material fact), 2) a question relating to adequacy of pleaded fraud under Georgia law based on claims for misrepresentations or omissions of material facts in connection with the purchase of a security, and 3) does a brokerage firm owe a fiduciary duty to account holders of non-discretionary brokerage accounts. 

The Court held that Georgia does recognize holder claims, adding that such a claim requires the"typical fraud context to be one in which the parties knew each other and the alleged misrepresentations occurred through direct communication."   In addition, the Court noted that there must be specific reliance on the defendant's misrepresentation.  The Court also stated that holder claims could be considered in negligent misrepresentation cases (as opposed to fraud cases). 

With respect to the third question, the fiduciary question, the Court agreed with federal precedent that a broker has limited fiduciary duties to customers who have non-discretionary account, with such duties requiring the broker to place trades only after receiving authorization from the client, and the duty to not misrepresent facts that are material to the transaction.  The Court found, however, that the fiduciary duties extend further. finding that "The broker will generally have a heightened duty, even to the holder of a non-discretionary account, when recommending an investment which the holder has previously rejected or as to which the broker has a conflict of interest."

SEC Approves New Money Market Rules

At the end of January, the SEC approved new rules relating to money market funds in response to the recent financial crisis, including the Reserve Primary Fund's breaking the buck in September 2008.

According to the SEC's release, the new rules, which are not yet final and have not been made available to the pubic, will focus on a few areas:

    * Improved liquidity:  the rules will have both daily and weekly liquidity requirements for the funds, with rules regarding maturities as well as restrictions from investing in illiquid securities.

    *Credit quality: the rules will place restrictions on a fund's ability to purchase lower credit quality securities.

    * "Know Your Investor" Procedures: The rules will require fund manager's to hold liquid securities to meet expected or foreseeable redemptions.  That will require funds to identify investors "whose redemption requests may pose risks for funds." 

In addition to these, the rules will cover other areas, including certain required disclosures to publish holdings to the fund's website.  

The rules become effective 60 days after publication in the Federal Register.  Compliance with some rules may be phased in over time. 

AML Again the Subject of Regulatory Action

This week, FINRA announced two recent disciplinary actions against firms related to anti-money laundering (AML) rule violations.  These cases are remarkable for a few things: the scope of the alleged failures, and the size of the sanctions. 

According to the press release, FINRA fined Pension Financial Services, a clearing firm, $450,000.  The allegations were based on alleged failures to "establish and implement an adequate [AML] program to detect and trigger reporting of suspicious transactions," as required by the BSA and FINRA rules.  FINRA also fined Pinnacle Capital Markets $300,000 for the same basic violations.

The press release notes that the issues uncovered at Penson occurred from October 2003 to May 2008.  From the wording of the release, it may be that the deficiencies were caused by the firm's failure to devote sufficient resources to the AML compliance program.  The issues with Pinnacle, occurred from January 2006 t September 2009, involved the firm failing to have procedures to verify the identities of foreign sub-account holders. 

AML has been a regulatory hot-topic since the rules were established.  Firms should by now recognize that this will continue to be a focus of regulatory scrutiny, and that it is in their best interests to evaluate and modify as needed, its AML program to ensure compliance with the rules.  The stakes for failing to do so are increasing.

FINRA Webinar on Social Media Issues

Following up on the last post, FINRA has announced a webinar on "Compliance Considerations for Social Networking Sites."  The live webinar took place today, and is already over (it apparently was originally scheduled for mid-March).  But, it can be accessed online here.  I haven't seen it yet, and therefore can't comment on it, but I can say this:  you can expect, given FINRA's recent Regulatory Notice on supervision of social media use, that this topic will be explored by the regulators and made part of regulatory examinations beginning in the near future.  Forewarned is forearmed.

FINRA Issues Regulatory Notice Regarding Social Media Supervision

Yesterday, FINRA issued guidance to firms regarding supervisory obligation relating to social media sites.  The notice, Regulatory Notice 10-06, provides information clarifying a broker-dealer's obligation to supervise the use of social media sites by the firm, as well as the business use of such sites by individual representatives.  Social media sites and activities addressed by FINRA in this guidance includes things such as blogs as well as sites like LinkedIn, Facebook, Twitter and others.  The notice can be found here: Regulatory Notice 10-06.

Firms should use the issuance of this guidance as an opportunity to make sure that they have developed adequate supervisory procedures for its own social media communications, as well as for the business uses of social media of its brokers/registered representatives.  Firms must consider that supervisory procedures must address not only how these technologies can be used, but also the recordkeeping and retention requirement that might be involved depending on the type of "communication" made through social media.  Firms and brokers who blog should also carefully study FINRA's opinion in Question 4 of the Notice regarding its treatment of blogs as advertisements.

While the use of social media is not new,the consideration of the impact of such technology and the regulation of it is relatively new to the regulators.  (As an aside, to get a better glimpse of how media has changed over the years, check out this video prepared by XPlane in partnership with The Economist).  I expect that for the next several years, regulatory examinations will include reviewing a broker-dealer's procedures and systems for ensuring that they are properly supervising the use of this medium. 

Dealing with a FINRA Investigation, Part V- Disciplinary Actions - formal vs. informal

Continuing the series on dealing with a FINRA disciplinary action, this post provides an overview of the types of disciplinary action (formal vs. informal) taken by the regulator.

After the examiners have completed their exam, a supervisor of examiners reviews the exam report and makes a recommendation to do one of three things: to file the exam without action, to pursue informal action, or to pursue formal disciplinary action. 

Most Popular Posts for 2009? All things U4.

It seems that, more than any other topic, folks searching the internet through the major search engines in 2009 came to BDLawBlog.com seeking information on the Form U4.  Unfortunately, there is a certain mystique to the form.  I think this may be in part to misunderstandings by many about the requirements of the Form U4, as well as a lack of understanding of the significance of this regulatory filing.  Ultimately, the U4 is a straightforward document, but it must be read in conjunction with its instructions, and the definitions in those instructions.  And, importantly, registered folks must familiarize themselves with the information required to be disclosed on the U4, and make sure to timely amend the disclosures when appropriate.

If you have questions about the U4, here are a few resources for you.  To begin with, check out the other U4 related posts here at BDLawBlog.com.  Be sure the read the several part primer on the U4, as well as the post about the little known lifetime bar.  Yeah, its not stuff you'll talk about over dinner or drinks, but if you are a registered representative, this one document can have a significant impact on your ability to continue to work in your chosen field.

FINRA's site contains the current version of the Form U4, and the instructions for the U4 (a separate document) here.  

FINRA's site also details the statutory disqualification process and answers questions about statutory disqualifications (some disqualifications arise as a result of improperly completed U4s).  Find that information here.