BD Law Blog - by Georgia Securities Lawyer Joel Beck

Review of October 2011 U4-Related Cases

A post looking at U4-related enforcement cases reported by FINRA for October 2011 is now online at U4review.com.  We continue to see these types of cases by the regulator because they are easy to investigate and prove.  The regulator also continues to be aggressive when it comes to imposing sanctions, as well as the imposition of findings of willfulness, which invokes a statutory disqualification (learn more about the SD and willfulness issue here at BDLawBlog and at U4review.com.  

FINRA Fines Collection Efforts Hampered: What It Means to You.

This past week, there has been some musings and grumblings about a recent court decision that rebuffed FINRA's efforts to collect disciplinary fines imposed against folks through lawsuits and collections efforts.  The court decision involving John Fiero, formerly of Fiero Brothers, Inc., may now bring to a close a long saga of FINRA's (formerly NASD Regulation and NASD) efforts to collect a $1 Million fine that was imposed against Fiero after a disciplinary case brought by NASD.  In a nutshell, the Second Circuit Court of Appeals ruled that FINRA did not have the power to bring suit against folks to collect fines.  Finding that no rules or federal laws provided this avenue for collection of fines, the Court found in Fiero's favor.  You can read more about the story in this Investment News article.  

So what does this mean for the average registered rep.?  Not much.  If you are working in the industry and are fined through the disciplinary process, you will either pay the fine or likely lose your ability to work in the industry.  Nothing has changed there.  If you remain registered, and don't pay the fine, FINRA will seek to revoke your registration and if they do, you'll wind up out of the industry for failing to pay.  If you are out of the industry at the time a fine is handed down, the odds are that the fine would not be due and payable unless and until you seek to re-enter the industry.  If that's the case, then you don't have to pay and FINRA doesn't come after you seeking payment, until you attempt to be associated or registered with a broker-dealer.  

This court decision does not address the issue of FINRA orders to pay restitution to customers.  It seems that much of the analysis for this issue is the same as the fine issue, but the court did not address this. Should FINRA pursue collection of restitution orders via a lawsuit, we'll find out the answer to that question.  

Do You Need to Update Outside Business Activity Disclosure Forms?

As Fall temperatures start to come this way, many firms will be gearing up for annual compliance meetings with their brokers as 2011 begins to draw to a close.  At these annual meetings, firms often have brokers complete their annual compliance questionnaires, as well as to make sure that brokers have provided disclosure of outside business activities, U4 amendments, etc.  

Compliance folks putting these forms together should remember that last December, FINRA Rule 3270 took effect, replacing former NASD Rule 3030 relating to outside business activities.  The new rule is more expansive, and it imposes some supervisory obligations on the broker-dealer as well.  For more info. on the new rule, see this post on implications for brokers, and this one for implications for firms.   In light of this rule change, firms will likely wish to update their disclosure forms to capture the expanded scope of the rule.  

Operations Professionals: FINRA's New Registration Regime Set to Take Effect

FINRA has announced that it's new registration rule and requirements for Operations Professionals, Rule 1230(b)(6), becomes effective on October 17, 2011.  See Regulatory Notice 11-33 for the effective dates and other information material to this new rule.  

All persons who meet the definition of an "operations professional" by virtue of one or more of three roles, having to do with a laundry list of certain broker-dealer functions, will be required to be registered as an operations professional.  Those who have previously, and recently, been registered in certain other registration categories, can be registered with the new qualification without taking an exam.  But, those who do not meet this exam waiver requirement must take the new qualifications exam, the series 99.  

It is important to note that there is an opt-in requirement.  This means that folks who are otherwise eligible to be registered as an OpsProf without the exam, will not automatically be registered in that capacity unless they opt-in.  It is also important to note that FINRA is establishing certain dates and deadlines for firms to identify its OpsProfs, apply for the registration, and become registered in such capacity over a one-year transition period.  Also note that the new registration comes with continuing education requirements.

Both compliance folks and business leaders at firms will need to review and understand this new rule and formulate a plan to determine what folks must become registered, and put in place appropriate mechanisms to ensure compliance with the rule.  Going forward, new hires must also be evaluated to determine whether they must be registered as an OpsProf as well.  And importantly, firms must recognize that OpsProf have to also be assigned to designated supervisors as well.

We saw from the research analyst registration regime implementation that FINRA (NASD at the time) took regisstration issues seriously.  I believe that we can expect that FINRA will focus a part of future exams of broker-dealers on whether the firm has complied with the new registration requirements.  

B/D's Beware: New Rule 4530 In Effect

Earlier this month, FINRA Rule 4530 became effective, replacing former NASD Rule 3070.  We can expect that compliance with the more stringent reporting requirements of this new rule will be examined closely, beginning immediately.  

Rule 4530 requires broker-dealers to report to FINRA the existence of certain criminal charges, indictments, arbitrations and litigation, regulatory findings, certain customer complaints, etc. against individual representatives and/or the firm, as well as to report quarterly statistical and summary information on complaints.  Going farther than the old Rule 3070, the new rule also requires firms to self-report certain violations stating, "Each member shall promptly report to FINRA, but in any event not later than 30 calendar days, after the member has concluded or reasonably should have concluded that an associated person of the member or the member itself has violated any securities-, insurance-, commodities-, financial- or investment-related laws, rules, regulations or standards of conduct of any domestic or foreign regulatory body or self-regulatory organization."

To help firm's with understanding the meaning of the new rule, FINRA recently released Regulatory Notice 11-32.  This is a must read for all legal and compliance folks who work in the area of reporting, as well as in registration/reporting, and those who develop and update the firm's WSPs.  Among other things, the notice gives guidance on interpreting the reporting requirements for self-reporting violations as well as dealing with situations when a broker is also affiliated with other companies such as insurance, mortgage, or banking.  Compliance folks should recognize that FINRA is interpreting a customer complaint very broadly in the context of complaints that don't directly to the broker-dealer, but to another financial services entity.  The Notice also highlights the need for firms to review their procedures for ensuring compliance with the rule.  Beyond that, I would also recommend that firms consider conducting training on the new rule for the appropriate folks, as we know that this rule will likely soon become the focus of enforcement actions. 

FINRA Enforcement Actions June 2011: Red Flags and Rule 3012 Problem

I spent some time reviewing the reported disciplinary actions for June 2011 to see what I could spot in terms of types of cases FINRA is focusing on, as well as the sanctions being imposed for various violations. As to cases against individuals, there were a lot of conversion or theft of funds cases, including one broker (Akins, 2011027093001, page 12) who was found to have misappropriated $1.1 Million from her broker-dealer firm by creating false entries in the firm's books and records ranging in amounts from $250 to $50,000 that caused the firm to pay her the money to which she was not entitled. Also, as to brokers, there were the usual selling away and undisclosed outside business activity cases.

As to the cases against firms (and firms and individuals), the cases that captured my attention related to a firm's failure to follow up on red flags.  In one case, a firm was fined $35,00 and censured, and a principal was fined $7,500 and suspended as a principal for 30 days for, among other things, not following up on red flags relating to a supervision of a branch manager.  It seems that FINRA asserts that had the firm and principal followed up, the firm could have discovered that the branch manager was involved in undisclosed OBAs  as well as in private securities transactions wherein he raised more than $1.5 million from folks, including customers of the firm.  (PAA/Long, 2008011640602, page 2).

In another supervision case, a firm was censured and fined $50,000 after findings were made that it failed to have a supervisory system in place reasonably designed to prevent one of it's brokers misconduct.  Specifically, the broker apparently forged customer signatures on documents submitted to the firm, among other things.  An employee of the firm became aware of the potential forgeries, but failed to follow up and investigate in a timely manner.  It seems the firm ultimately changed its procedures and identified that this matter had not been investigated, then conducted an investigation. (Ameriprise, 2008013648002, page 3).

Finally, in a third case relating to red flags, FINRA fined a principal $5,000 and suspended him in principal capacities for six months based on findings that he failed to take reasonable steps to follow up on red flags that "should have alerted him to a representative's violations."  FINRA noted that the representative that was supervised by the principal engaged in excessive short-term trading in a client account, effected trades in the account while it maintained a negative balance, and forged the client's signature on a LOA to transfer funds out of the account.  (Oftring, 2009019996501, page 27).

Finally, another case is noteworthy.  Here, FINRA fined a principal $15,000 and suspended him in principal capacities for 30 business days, based on findings that the principal, who was the VP of Compliance for his firm, failed to supervise certain aspects of the firm's business.  FINRA alleged that he failed to establish adequate procedures to ensure that the firm did not charge excessive commission of certain transactions, failed to adequately supervise the firm's communications with the public, and failed to adequately supervise the firm's compliance with reporting on Rule 3070 reports and Forms U5, among other things.  FINRA also found that he failed to comply with NASD Rules 3012 and 3013, noting that for one year, his 3012 report was not adequate because it did not contain a rationale for the areas that would be tested, failed to detail the manner of testing, and didn't provide a summary of the findings. Moreover, FINRA found that the 3012 report failed to detect repest violations.

What's the bottom line?  It's simple:  If you identify red flags, follow up on them, or be prepared to pay the price.

Making the Invisible Visible. FINRA announces new disciplinary actions database.

For many years, brokers who had been sanctioned by FINRA (f/k/a NASD), rarely received publicity on any settled or litigated disciplinary action against them.  The action would be reported in mice type that month in the WSJ, and would appear in the monthly Notice to Members or Regulatory Notice.  Later, came the online BrokerCheck report that would disclose a brief summary of the action to the few folks who might check it.  But, even if a client or prospect got that report, they generally  did not see the underlying settlement  or panel decision documents that went into further detail, unless they actually contacted the right department at FINRA to obtain a copy.

FINRA has just changed the game.  Yesterday, the regulatory organization announced the Disciplinary Actions Database, a searchable database that will let folks search for and obtain copies of disciplinary actions, free of charge.  In addition, BrokerCheck reports will also now contain links to these documents in this new database, as will the monthly (beginning in mid-June) Regulatory Notice announcements of actions.  The database can be found online here.  

FINRA To Delay Effective Date of New Suitability and Know Your Customer Rules (Rule 2090 and 2111)

Last week FINRA filed a request with the SEC to delay the implementation date of new FINRA Rule 2090, the know your customer rule, and FINRA Rule 2111, the new suitability rule.  The SEC approved the request, and now these new rules will become effecitve on July 9, 2012, instead of the original implementation date of October 7, 2011.

 

FINRA Sanctions UBS for Issues with Sales of PPNs

FINRA announced today that it has sanctioned UBS Financial Services for sales practice issues relating to sales of Lehman-issued PPNS (principal protection notes).  According to its press release, FINRA explained that it fined UBS $2.5 Million and ordered it to pay $8.25 million in restitution for "omissions and statements made that effectively misled some investors regarding the "principal protection" feature of 100% Principal-Protection Notes Lehman Brothers Holdings, nc. issued prior to its September 2008 bankruptcy filing."  As with all FINRA settlements, UBS did not admit or deny the charges.

FINRA made findings that the firm failed to adequately emphasize (thats FINRA's word) that the protection feature was subject to credit risk, and that the firm did not adequately analyze suitability of the notes to certain customers, and failed to establish an adequate supervisory system for sale of these notes, among other findings.  The press release also explained, "FINRA found that some of UBS' financial advisors did not understand the product, including the limitations of the "protection" feature.  Consequently, certain financial advisors communicated incorrect information to their customers."  

Joel's thoughts:  This case is another example of product-based enforcement cases, somewhat similar to the very recent FINRA and SEC cases brought against firms for inadequate due diligence in private offerings. When selling non-traditional products (such as publicly traded stocks, bonds and mutual funds) firms must ensure that they have completed sufficient due diligence to understand the product and its features, that they effectively communicate information about the product to its sales reps., and that they put in place appropriate mechanisms to supervise the sale of the products.  Recent disciplinary actions show that the failure to do so can be costly.   

 

FINRA and SEC Bring Cases Regarding Due Diligence on Failed Offerings

Yesterday, FINRA announced actions against two firms and seven individuals in connection with allegations of sales of private placement offerings without conducting adequate due diligence.  The cases related to the private placement offerings of Medcap, Provident Royalties and DBSI.   Also, on April 6th, the SEC announced actions against against firm and its former president, and another principal of that firm (which was a settled action) relating to due diligence regarding Provident.  The gist of all of the FINRA cases is the allegation that the firms, through their principals, failed to have reasonable grounds to believe that the offerings were suitable for any of their customers inasmuch as they had not conducted effective due diligence of the offerings.  The SEC's allegations essentially allege that by not engaging in adequate due diligence, the respondents violated Section 17(a) of the Securities Act and 10(b) of the Exchange Act.  The unsettled allegations represent simply that, allegations by the SEC.  The Respondents have an opportunity to submit an answer and to defend the case, and no final decision has yet been reached in these unsettled cases with regards to liability or sanctions.

Given the number of firms involved in sales of Provident, Medcap and DBSI, I anticipate that we'll see other cases brought by FINRA and/or the SEC.