BD Law Blog - by Georgia Securities Lawyer Joel Beck

Do you know your customers? Do you know their concerns?

FINRA today released the findings of a national survey of investors completed in June 2007.  The survey gives some insight into the concerns and desires of investors in today's markets, and, if you're in marketing and management of a B-D, or otherwise want to understand your clients, it is worth a quick read.  Here is the press release announcing the survey, that contains a PDF link to the executive summary made available to the public.

Some of the highlights:

78% of respondents were somewhat anxious or very anxious about losing money on investments (29% of the respondents fell into the "very anxious" category).

73% of respondents were somewhat anxious or very anxious about saving enough for retirement.

71% of respondents were somewhat anxious or very anxious about outliving retirement savings. 

67% of respondents were somewhat anxious or very anxious about being defrauded.

80%+ of respondents expressed a high degree of interest in investor education information that would be offered free and unbiased.

Educate? No, let's litigate!

I read an article at Investment News this morning about independent broker-dealers seeking guidance from the SEC on issues relating to Regulation SP.  In other words, these firms are trying to understand how to recruit representatives and grow their business without violating any of the industry rules and regulations.  According to the article, the Financial Services Institute has been kicking this problem around with the SEC in the hopes of getting guidance to help the industry, and the SEC is apparently working on the matter.  That's good.  What I find troubling is that (should the facts in the article be true), knowing this is a problem for independent firms, the SEC initiates an administrative disciplinary action against NEXT Financial, rather than work to help firms comply with their regulations.  See my earlier post for details of that action. 

If a firm violates the industry rules and regulations, they ought to pay the consequences.  I don't know the details of this case, but I've always had the belief - even as a regulator - that education should come first, before enforcement.  That's my $0.02 for the day.   

SEC Files Regulation S-P Case Against B-D

Last Friday, the SEC announced the initiation of administrative proceedings against NEXT Financial Group, Inc., a Houston, Texas brokerage firm.  The allegations against the firm relate to alleged willful violations of Regulation S-P in that it is alleged that the firm disclosed nonpublic personal information about customers to non-affiliated third parties without letting clients opt out from such disclosure.  More interesting, at least to me, is an allegation that the firm allowed brokers to take non-public client information to other firms when they left NEXT, and by "willfully aid[ing] and abet[ting] and caus[ing] other broker-dealer's violations of Regulation S-P by encouraging, and in many cases facilitating newly employed registered representatives to bring their customers' personal nonpublic information, such as social security numbers, account numbers, passprt numbers, drivers license numbers, dates of birth and customer financial information to NEXT without proper notice to the customer and a reasonable opportunity to opt out of such disclosure."  The oder instituting proceedings can be found here.

At this point, these are just allegations and the firm will have an opportunity to respond to the allegations and to have a hearing before an SEC administrative law judge.  But, this will be a case we'll want to follow.  Regulation S-P has been a somewhat hot-topic with the regulators in the past year or two.          

Avoiding Complaints and Compliance Issues - Part V - Firing Clients

Are you ready to fire some clients?  Maybe one or two?  A handful?  More?  Continuing our series on avoiding complaints and compliance issues, I ask you to consider this:  can you significantly reduce your exposure to having a complaint or compliance issue by trimming your "bad" clients from your book? 

What am I talking about, you may ask.  Let me try to explain.  You probably have a couple of clients that cost you more than they're worth.  Maybe the cost is In time spent on the phone or in-person, in dealing with their gripes and complaints about this or that.  Maybe their cost to you is something else.  Maybe they are just a pain in the rear to deal with.  Bottom line, the business they generate for you is small - small commissions, no referrals of prospective clients, etc., and your relationship with them has not really developed into a good one, or worse, it has degenerated from a positive relationship into a bad one.   If you weren't dealing with  these "bad" clients, what would you do - devote more time to the good clients, devote more time to growing your book of business, devote more time to your son's little league team,  your golf swing, etc.  And what would your relative happiness at work do - would it improve?

As a former regulator doing preventive compliance seminars across the Southeast, my colleagues and I often advised brokers that it was OK to fire clients, and that it could be a good thing to help keep them out of trouble.  A recent post over at Church Marketing Sucks talked about a church that grew because it asked people that weren't really committed to its vision to leave.  500 folks left and opened up quite a few pew seats for new people.  But the church grew.  Read that post here. 

Does church marketing relate to a broker's business?  In a way, I think it does.  I'm not suggesting that you go out there and fire clients willy-nilly.  No, I'm suggesting that you carefully consider your definition of an ideal client, and consider that against those clients in your book.  Maybe you need to make some changes.  Maybe you don't.  But think about it seriously, and think about which ones in your book are the type that will cause you to have some complaints and compliance issues to deal with.  Either improve those relationships, or think seriously about terminating that relationship.   

Anyone willing to share their experiences in firing a client?  Anyone have a thought or comment?  Let's discuss.

Stupid Ways to Ruin a Reputation

In a release issued yesterday, the SEC announced findings and sanctions against a Washington, D.C.-based registered investment adviser (an "RIA").   It's an interesting case that again shows that it doesn't pay to screw your clients.  Here, a broker-dealer also operated an RIA.  When a client contacted the B/D and needed advisory services, brokers referred the client to their own RIA.  The RIA and client entered into an advisory agreement and the B/D served as the custodian of the assets and provided trade execution services.  Clients of the RIA who were not referred by the B/D sometimes used other custodians, and sometimes used the B/D.  Those non-referred clients using the B/D paid significantly less in commissions for trades than the "referred clients."  These discounted commissions were not made available to the referred clients. 

The SEC found that the RIA "willfully" (meaning intentionally) violated Section 206(2) of the Investment Advisers act (a section that prohibits conduct by an adviser that constitutes a fraud or deceit) by failing to disclose to their referred clients that they could use another custodian for assets, failing to disclose their conflict of interest, and failing to review the accounts for best execution.   The SEC also made findings of violation relating to books and records charges.  The RIA will disgorge their excess profits, plus pay an additional penalty.  Read the SEC release here. 

I don't know anything about this particular B/D or its affiliated RIA, and can't recall ever having heard of them before.  But I do know that this action by the SEC will certainly damage their reputation with the investing public and their community.  And that damage will cost much more than the fines being paid to the SEC, I'd bet.   

Follow up on Misreps. and Omissions

I stumbled across David Macchia's website and his blog today.  I read his interview, posted on August 9th, with an executive from Lincoln Financial, and was intrigued by some of her comments regarding the state of products being sold in today's marketplace.  Particularly interesting was her comments to the effect that she believed that the industry (insurance industry, apparently) has made their products (including various annuity types) much more complex than customers - and advisers -  can "swallow."   To me, this speaks volumes, and goes to my comments earlier this week about the exposures to misrepresentations and omissions violations by brokers who don't fully understand the product they are recommending to a client.

A Culture of Compliance?

An interesting article featured at Investment News  this week reported on the results of a survey of traders.  The survey, the report says, found that over 90% of traders would not divulge insider information on a $10 Million deal if there was a 50% chance they would be arrested.  But, 58% of traders responding said that they would participate in insider trading if they knew there was no chance that they could be arrested.  Interesting commentary, some might say.  By the way, I'd guess that most of the folks who are convicted of insider trading never thought that they'd get caught. 

So what are you doing at your firm to instill a culture of compliance?  What are you doing to try to ensure that compliance is taken seriously, for the protection of the firm and brokers - even when folks think the potential of being caught is slim to none?  Something to think about.

H-E-D-G-E by Merle Hazard

On a lighter note here, if you've got a moment, take a look at this great clip  on Youtube, about the decline of a hedge fund. 

Avoiding Complaints and Compliance Issues Part IV - Misrepresentations and Omissions

Continuing our series on this topic, let me highlight another area in which brokers tend to get in trouble: making material misrepresentations and omitting to disclose material information.  Typically, these cases involve brokers who commit fraud - acting with some amount of intent to misrepresent or omit to disclose information about a security they are recommending to a client.  Often, those cases involve a broker recommending a questionable and speculative security, such as a penny stock, to a client.  Examples of the violation may include: failing to disclose the financial condition of the company, failing to disclose the risks associated with the security, failing to disclose investment banking relationships between the issuer and the broker-dealer, and misrepresenting the financial condition of the issuer.

But importantly, good, honest brokers can get in trouble in this area too.  Take an example - broker learns of a new product and a few of its key features, and recommends that product to a client without following up and learning about all of the features and pitfalls associated with the product.  In making the recommendation, the broker may make incorrect assumptions about the product, and answer a client's questions based on those incorrect assumptions.  The client considers the recommendation, the information provided by the broker, and purchases the product.  Down the road the client learns the truth about the product, or maybe the product tanks or doesn't perform as expected, and the client files a complaint against the broker.  The broker gets a U-4 disclosure, faces an internal investigation by the firm, might have an arbitration claim to defend, and a regulatory inquiry from the SROs and states. 

The good news is that this situation is avoidable, for the most part.  Make sure that you know the products you are recommending, and don't make assumptions about it.  Read the sales literature, the prospectuses, and fully understand the product.  If you don't understand it, odds are good that you can't explain it correctly to your client.  And, don't forget to disclose the bad with the good. 

Got another topic you'd like us to address?  Let us know - and stay tuned.

Avoiding Complaints and Compliance Issues. Part III- Forgery

FINRA recently released its summary of disciplinary actions published for August 2007 here.   I took a quick read through these.  Nothing particularly exciting, mostly routine stuff, but I continue to be amazed at the trouble brokers get themselves into, oftentimes when they are trying to provide good customer service or help their customer.  Continuing the series on avoiding customer complaints and compliance issues,let's tackle one of these preventable issues today: forgery.

Forgery, as generally defined by the regulators, is signing another person's name to a document.  Period.  Many FINRA (NASD) cases note that forgery occurs when the signing of the other person's name occurs without permission, but other cases also find violations of Conduct Rule 2110 even when the customer gave the broker permission to sign the customer's name to the form or document.  So whether its the legally correct definition or not, brokers are well-advised to define forgery as the act of signing another's name to a document, with or without permission. 

And you'd be surprised (maybe) at the number of times this happens.  In this month's report, seven individuals were sanctioned for forgery.  The sanctions ranged anywhere from a 60-day suspension and a fine, up to a bar from the industry.  Even on the low-end, these sanctions are severe - a 60-day sit down can destroy a career.

So why do brokers do this?  I don't have any knowledge about these particular cases, but my past experience as an Enforcement attorney tells me that brokers commit forgery for essentially three reasons: 1) what they define as "customer service" issues, 2) fear of looking incompetent, and 3) laziness. 

The "customer service" cases often involve a broker signing a form for a customer because the customer can't make it back to the firm to complete it, are out of town and can't be reached, the broker is trying to expedite an account matter, etc.   In other instances, brokers have a client sign numerous forms, but might forget to have the client sign one particular form, or have the client sign an outdated version of a form.  Perhaps because its a new client, or there have been issues impacting the relationship in the past, the broker is reluctant to have the customer come back in and sign another form, or do it in the mail.  So, to avoid looking incompetent, the broker might forge the client's signature.  Finally, there have been a few cases where the broker just admitted that it was too much work to have the clients sign the correct forms (generally in cases involving the broker changing firms and transferring client accounts to the new firms). 

Regardless of the reason, forging a client's name is not a good idea.  Putting aside the regulatory problems, most customers get upset when they learn their signature has been forged, and many of these customers will complain to the firm.  Many firms will immediately terminate brokers who forge documents.  In addition, the brokers may be on the hook to reverse or write-off those affected transactions - especially if the involved security has declined in value since the forged document.  And finally, arbitrators typically don't cast a favorable light on brokers who forge documents, including disclosure documents. 

So add this one to the list of ways to avoid complaints and compliance issues:  Never sign a customer's name to anything.

Comments?  Anyone want to comment on how prevalent forgery is in the industry?  Post anonymously if you'd like, and lets start a discussion.