The Beck Law Firm, LLC Blog

Justice Department Revises Policies Related to Corporate Fraud Charging Issues

Today, the US Department of Justice announced changes to its policies relating to prosecuting corporate fraud.  The revisions were announced by Deputy Attorney General Mark R. Filip, and the revisions will likely come as a relief to the defense bar and inside counsel for corporations.

The changes basically relate to the manner in which credit for cooperation with the government will be assessed and rewarded by Justice.  For years, Justice has given credit for cooperation to corporations.  The amount of that credit, and whether the credit is given, has been often debated.  Many people argued that prosecutors required corporations to waive their attorney-client privilege or attorney-work product protections and provide information to the government in exchange for receiving "cooperation" credit. 

Now, under these new guidelines, credit for cooperation will not hinge on whether attorney-client privilege is waived. Instead, it will depend on disclosure of facts.  And, prosecutors are now forbidden from asking for protection and privilege waivers in most instances.  Justice will also no longer consider fees advanced for attorney's fees for employees and directors as evidence in evaluating whether the corporation was cooperating with the government.  Likewise, prosecutors may not inquire about the existence of joint-defense agreements.  Moreover, they cannot consider termination of employees as evidence of cooperation, but may review discipline of employees as evidence of the corporation taking remedial measures.  

According to Justice's press release, the changes are effective immediately.

Common Mistakes Stockbrokers Make, Part III - Undisclosed Outside Business Activities

As avid readers of BDLawBlog.com know, I'm posting a series on some of the violations that are most repeatedly found by the regulators, for which brokers are sanctioned.  Continuing this series of mistakes to avoid, today's topic is participating in undisclosed outside business activities.  Look through any monthly report of disciplinary actions, and you'll likely find several brokers who have been disciplined for not disclosed their involvement in an outside business activity.  Sanctions may typically  include a suspension, fine, and censure. 

FINRA Rule 3030 is the outside business activity rule.  It says:  "No person associated with a member in any registered capacity shall be employed by, or accept compensation from, any other person as a result of any business activity, other than a passive investment, outside the scope of his relationship with his employer firm, unless he has provided prompt written notice to the member. Such notice shall be in the form required by the member. Activities subject to the requirements of Rule 3040 shall be exempted from this requirement."

The Rule does not prohibit engaging in outside business activities.  The Rule requires that  brokers  provide their firms with written notice that they are involved in an outside business activity.  But what is an outside business activity?  It's easy to identify those when you are employed by another person or company such as at a retail store, restaurant, or some similar part-time job.  Many brokers, however, fail to recognize the existence of an outside business activity when they receive finder's fees, do consulting work on the side, prepare tax returns for clients for a fee, sell a product that's not a security or do something similar for money.  Under the rule, if you receive money for doing something away from your firm, its likely an outside business activity that requires disclosure.

But it may be a reportable activity even if you don't receive compensation.  Note that the rule defines an outside activity as being "employed."  If you start a new side business but have yet to pay yourself, that may result in you being considered as an employee of that business.  Even serving on the board of directors of a company, depending on the nature of the company, may result in your being considered as engaged in an outside business activity as one Hearing Officer noted in a Default Decision.

Also note that the Form U-4 requires brokers to disclose outside business activities in which they engage, along with additional information about that activity.

Finally, in addition to the regulatory requirements, most firms also have internal policies and procedures relating to Rule 3030.  Most firms will require the broker to obtain approval from the firm before participating in any activity.  Failing to follow the firm's policies and procedures may subject the broker to disciplinary action by the term, including termination.  

Recent FINRA Enforcement Cases

Some relatively recent disciplinary panel decisions have popped up on FINRA's website, and two caught my eye.

In one case (2006005565401) a principal at a firm was sanctioned "for approving the falsification of records" in violation of NASD Conduct Rule 2110.  The Hearing Panel sanctioned the principal with a 30 day suspension in all capacities, a six month principal capacities suspension, fine of $10,000 and an order that he take an ethics course.

The violation was not contested, but the hearing apparently was to determine sanctions.  The principal conceded that he approved an employee's suggestion to copy customer signatures on outdated new account forms onto the revised, current version of the firm, rather than to contact the customers and obtain genuine signatures on the new documents.  The forms had been revised by the clearing firm to provide better disclosure regarding the pre-dispute arbitration agreement.   When old firms were rejected by the clearing firm, and with the principal's approval, operations staff cut and pasted the clients' signatures (about 60 of them) onto new firms and submitted them to the clearing firm!

The Decision notes that the firm did not notify clients to obtain their signatures until after being contacted by the regulators.  The panel found that concealing the conduct was an aggravating factor, though they also found that the conduct was negligent and not reckless or intentional.  They described the principal's misconduct as a result of a hastily made decision while he was preoccupied with other work. 

It appears that principal won, at least with respect to the sanction war.  According to the Decision, Enforcement sought to have the principal suspended in all capacities for one year, suspended in principal capacities for 18 months, and fined at least $25,000.  The sanctions imposed by the panel were significantly less than Enforcement's requested sanctions.  Another case of the "litigation discount" that I've posted about a few times - where you just may be better off fighting unreasonable sanction demands by Enforcement. 

In another case (20070077587), a broker was barred from the industry after a hearing panel found that he converted firm funds and falsified expense reports submitted to the firm.  The case is an interesting read as its not the standard conversion case, but it also noted that the respondent claimed, as an affirmative defense, that his alleged misconduct was the result of psychological disorders and was not committed intentionally.  This is the first time I've seen a case where Enforcement retained a forensic psychiatrist to provide evidence such as an assessment of the broker's mental state at the time of the alleged misconduct, and to opine on the broker's psychologist's report that was apparently presented as evidence.

 

Common Mistakes Stockbrokers Make - Part II - Discretion

Following up the earlier post regarding commom mistakes brokers make part one - forgery, mistake number two involves improper use of discretion.  In FINRA's disciplinary actions reported for July 2008, improper use of discretion was the second most charged violation. 

What is discretion?  In the securities industry, it means that a client has authorized the broker to purchase or sell securities in the customer's account.  Discretion may be granted either orally or in writing, but, as discussed below, for brokers to avoid compliance issues and possible disciplinary action, the discretionary authority must be granted in writing, signed by the client.

FINRA Rule 2510 (formerly NASD Rule 2510) provides that no broker may exercise discretion in a client's account, unless the customer has provided such instructions in writing AND the account has been approved and accepted as a discretionary account by the broker's firm (the broker-dealer).  Note that the rule does not allow a broker to exercise discretion in a client account based upon oral authority given by the client.

Brokers often talk about "time and price discretion" but many don't understand the requirements for this principle.  Time and price discretion is not a blanket grant of discretion to the broker by the client, but applies only to to discretion regarding when (at what time) to effect a purchase or sale transaction, or to the price (or both) relating to a specified quantity of a specified security.  For example, if the broker and client discuss purchasing 500 shares of ABC Corp. and the client grants T&P to the broker, they broker may not then purchase 600 shares of XYZ Corp. for the client.  Pursuant to a rule amendment in January 2005, time and price discretion expires at the end of the business day the customer granted such discretion, absent written instructions from the client to the contrary. 

From time to time we see disciplinary actions against brokers involving improper use of discretion.  In many of these cases, the client had granted the broker discretionay authority orally, but it was never reduced to writing and the broker-dealer never approved and accepted the account as discretionary.  In other cases, we see brokers contend that they were using discretion, but the customers contend that no such authority was granted, and brokers may face charges of unauthorized trading.  Be smart, and don't risk your license by cutting this corner.  Before using discretion, get the authority in writing, and have it approved by the firm.