BD Law Blog - by Georgia Securities Lawyer Joel Beck

Are Your Firm's Auditors PCAOB Registered?

FINRA's Information Notice earlier this year reminds firms that even non-public broker-dealers must utilize auditors that are registered with the Public Company Accounting Oversight Board (PCAOB) beginning in fiscal year 2009.  Previously, the SEC had exempted non-public company's from this requirement, but such exemption expired in 2008.  Going forward, firm's financial statements must be audited by a PCAOB registered auditor.

Is Your 2009 Compliance Program Plan Planned?

February 2009 is here already.  Soon, we'll be commenting on how its already December 2009 and the year is almost over.  Before that happens, lets make sure to plan, and execute, your 2009 compliance plan.

As compliance officers and principals should know, each firm must implement an annual compliance plan, to include a continuing education needs assessment, continuing education program, an annual compliance meeting, as well as periodic inspections of OSJs (Office of Supervisory Jurisdiction), branch and non-branch locations.  Go ahead now and get those required action steps planned and on the calendar to ensure sufficient time to perform all necessary assessments and inspections.  And, be sure to contact Joel Beck at The Beck Law Firm if you need a speaker for your annual compliance meeting to discuss current legal and compliance news, disciplinary actions and tips to avoid complaints and arbitrations. 

More on Recent FINRA Enforcement Cases - Supervision and Conversion of Funds

I posted yesterday about my review of FINRA's January published disciplinary actions and the quarterly review of actions.  Two more cases there caught my eye. 

Supervision.  The first one involved a former principal in Arizona.  He was suspended as a principal for one year and fined $15,000 after FINRA found that he failed to properly supervise a broker  and to review trades for suitability.  FINRA explains that the broker made unsuitable recommendations in inverse floaters to public customers who were inexperienced investors with conservative investment objectives.  As a result of the unsuitable recommendations, the customers lost millions of dollars, FINRA says.  (FINRA Case No. 2006005546006).  From the case number beginning with 2006, we know that the exam that led to this action was initiated in 2006, so the conduct is not very recent.  But, especially given the current economic times, supervisors should take note of this. 

Whenever a broker or customer wants to use non-traditional investments, supervision must be stepped up.  Supervisors must be diligent to ensure that any recommendations by the broker are suitable, that the customer is informed about the risks involved and reasonably understands them.  When investors want to trade in securities not suited for them, perhaps its time to fire the client or to, at the least, document that the firm and brokers are not making such recommendations.  Remember, not only are there regulatory ramifications for failing to supervise, but investors often point to deficient supervision in their arbitration claims as well.

Conversion.  The quarterly summary highlighted a conversion case that is just pathetic.  Here's what it says:

FINRA settled a matter that involved a registered representative who
misappropriated $50 from a customer. The customer had earned a
$50 credit by referring two new customers to the representative’s
employer bank. The representative obtained the $50 from the bank
but never deposited the funds into the customer’s account. Instead,
the representative kept the money for himself.
FINRA concluded that this conduct violated NASD Rule 2110 (ethical

standards) and, as a result, barred the representative in all capacities.

What was this dude thinking?  As a former enforcement lawyer, I've handled my share of conversion cases, some large, some small, and some with some pretty complicated cover-ups, but I've never seen one for just $50.  Wow.

FINRA Releases January 2009 Disciplinary Information - Improper Loans on the Rise

FINRA recently released its monthly summary of disciplinary actions for January 2009.  There are many of the routine cases involving private securities transactions, outside business activities, omissions on Forms U-4, improper use of discretion, and forgery.  I noticed an increase in cases involving brokers making or receiving loans to/from customers.   There were 4 cases involving loans with customers reported for this one month. 

Brokers should beware of not only FINRA's Rule on loans with customers, NASD Rule 2370, but also their own firm's procedures on borrowing from or lending to customers.  Under Rule 2370, a broker may not borrow from, or lend to, a customer unless his or her firm's procedures authorize such loan.  in some cases as set forth in the Rule, the broker must have the lending arrangement pre-approved by the firm.  Of course, some firms outright prohibit such loans, and breaking the firm's policy could also be grounds for disciplinary action under NASD Rule 2110.   Regardless of whether its allowed, its not necessarily the best idea, and brokers should consider the consequences of undertaking such an agreement carefully. 

E*Trade Sanctioned for AML Issues (Again)

As I noted back in July 2008, the SEC settled charges against E*Trade Clearing and E*Trade Securities for AML (anti-money laundering) violations.  In that action, the SEC found that E*Trade failed to comply with rules requiring securities firms to verify the identities of their customers and to document their procedures with complying with AML rule and regulations.  More specifically, the SEC found that, from October 2003 to June 2005, E*Trade failed to verify the identity of over 65,000 customers, in violation of the USA PATRIOT act and SEC rules.  Without admitting or denying anything, E*Trade settled the charges, and was to pay a $1 Million fine.  The SEC noted that E*Trade personnel discovered, and then rediscovered, the deficiency in their CIP (customer identification program) but failed to take any corrective actions for nearly 2 years.

Now, FINRA has extracted their pound of flesh from E*Trade as well for AML issues.  In a press release from FINRA on January 2, 2009, FINRA announced that it is fining E*Trade $1 million for an inadequate AML program.  According to FINRA's release, the two E*Trade units were sanctioned "for failing to establish and implement anti-money laundering (AML) policies and procedures that could reasonably be expected to detect and cause the reporting of suspicious securities transactions" during the period from January 2003 to May 2007.  (Note that this period overlaps the period from the SEC matter).

Lessons to Learn:

FINRA Unveils Template for New Account Applications

On October 21, 2008, FINRA issued an Information Notice announcing its distribution of a model new account application template for brokerage firms as a resource for firms designing or updating their form.  The template is written in plain English, seeks the information firms need to comply with the USA PATRIOT Act and other regulatory requirements, as well as seeking suitability information in a "plain English" manner.  FINRA also states that it highlights key disclosures for investors, as well as incorporates certain related investor education material into the document.  Say goodbye to the term "investment objective" and hello to the concept of "I plan to use this account for..."   The template appears to be well put together, seeks to obtain the necessary information, and very investor friendly.  It is also customizable for firms that conduct business in different ways and offer different products.  Its important to note that use of this template is optional, and is not required.  Though not required, firms may wish to review their forms and compare them to this, to see if they are seeking the appropriate amount of information from their clients in an understandable manner, as having the information can only assist supervisors and compliance folks in carrying out their supervisory and compliance responsibilities. 

FINRA To Roll Out New Rules Soon

FINRA announced this week that it will soon start the process of announcing effective dates for the new FINRA rules as it seeks to consolidate the rulebooks from NASD and NYSE.  As specified in an Information Notice issued October 6, 2008, FINRA will issue a Regulatory Notice later this month announcing the effective dates of the rules approved by the SEC in the past two months.  Then, in December, it will do the same, and the process will continue with Notices every two months or so until complete.  The Notices will also contain links to online rule conversion charts, helping firms see how the new rules relate to the older NASD or NYSE rules that will be replaced.

As the new rules roll out, compliance folks will need to ensure that they are keeping abreast of the effective dates, as well as of any changes in the rules.  Among other things, written supervisory procedures and compliance manuals, and other documents that reference the old rules will need to be updated.  And, based on any changes in the rules, certain processes might need to be changed as well. 

SEC Sanctions LPL Financial for Regulation S-P Violation

The SEC announced on September 11, 2008, that it sanctioned LPL Financial for violations of Regulation S-P.  Regulation S-P requires that firms implement reasonably adequate policies and procedures to safeguard customer information.  According to the SEC's press release announcing the action, LPL failed to safeguard customer information, leaving the personal information of 10,000 customers vulnerable to identity theft, "following a series of hacking incidents involving LPL's online trading platform."  LPL settled the SEC's charges without admitting or denying anything, and agreed to pay a fine of $275,000.

The SEC noted that the firm conducted an internal audit in mid-2006.  That audit identified inadequate controls relating to guarding customer information and noted, according to the SEC, that there was a risk of hacking.  The hacking incidents began around July 2007, and, at that time, the SEC alleges that LPL had not implemented increased security measures despite actual awareness of the risks.

As we've noted before, Regulation S-P continues to be a regulatory hot topic.  Be sure that your firm reviews and examines its own procedures and policies in this area.  If weaknesses are discovered, take action and fix them.

SEC Chairman Sets Goals for Summer

In a speech June 12th in Washington DC to the Chartered Financial Analyst Institute Conference on Next Generation Asset Management, SEC Chairman Christopher Cox informed audience members  on upcoming issues and items to be addressed by the SEC this summer.  He stated that he expected the commission to soon consider rules on equity-indexed annuities and when those are traded as securities.  The SEC is working closely with NASAA (the North American Securities Administrators Association) and their state securities counterparts on this issue, he said.  Further, Chairman Cox noted that we can expect quick action on a proposal for new interpretive guidance on soft dollars, and to expect the SEC to consider, this summer, among other things:  a final principal trading rule for both broker-dealers and investment advisers, new interpretive guidance for both broker-dealers and investment advisers, as well as the adoption of amendments to Regulation S-P relating to account intrusions.   

Undercover NFA Examiners Find Violations

The National Futures Association barred Los Angeles based member Jaguar Trading from NFA membership and suspended its sole principal, Jonathan Berman, from NFA membership for 1 year based upon allegations of misleading sales solicitations. 

According to the NFA's press release, the NFA filed a Complaint against Jaguar and Berman in December 2007, and following the submission of an offer of settlement by the firm and Berman, a hearing panel issued a decision.  The Decision states that the "complaint alleged that Jaguar and Berman made misleading sales solicitations to NFA Compliance staff members, posing as a (sic) prospective customers, which exaggerated the profit potential of trading options, downplayed the risk of loss, failed to disclose that the vast majority of jaguar and Berman's customers lost money, contrary to Berman's rosy profit claims, and suggested that well-known current events and weather trends would move the markets higher, without disclosing that such information has already been factored into the markets." 

Pursuant to the terms of the settlement, if Berman becomes an NFA member or associate following the suspension, he will pay a $5,000 fine, as well as be required to tape-record all conversations between him and existing or potential clients for 6 months, retain the tapes for 1 year, and make them available to the NFA upon request.  Further, if he becomes a principal of an NFA member, then the tape-recording requirement shall apply to the entire firm, including all other associated persons, though in any event, all tape recording requirements will expire at the end of 2011.

I can't recall of other cases where SRO examiners posed undercover in an examination of this type, can you?