BD Law Blog - by Georgia Securities Lawyer Joel Beck

Sometimes it Still Pays to Fight the Regulators

Keeping up his annual report on securities regulatory litigation before FINRA and the SEC, Sutherland attorney Brian Rubin, a former colleague of mine  at NASD (n/k/a FINRA), together with Jae Yoon, recently released their study on whether it pays to take on the regulators.  As always, the study concludes that sometimes it does.  Importantly, the study finds that, generally, respondents can do better both on certain liability issues as well as on the issue of sanctions, when they are represented by counsel.  For those respondents considering whether to settle or litigate, and/or considering whether to go it alone or to hire experienced counsel to represent them, this study is worth a quick read.  

SEC Approved Changes to Composition of FINRA Arbitration Panels

On January 31, 2011, the SEC approved a rule change proposal, changing, potentially, the composition of arbitration panels in customer disputes.  Under the new rule, which is effective now for all cases in which arbitrator lists have not been sent to the parties, the parties can choose to have an all public panel by eliminating the industry member (or in FINRA terms, the non-public panelist).  Historically, three member arbitration panels were composed of two public arbitrators (without ties to the securities industry) and one industry or non-public panelist (often a broker, a principal, compliance official or attorney working in the financial services area).  For more, see FINRA's press release on this matter, as well as a Notice of Parties.  

When Supervising, Following Up Can be Critical

This week, the SEC announced an action it took against broker-dealer World Group Securities, Inc. According to the SEC order, World Group failed "to enforce a reasonable system of supervisory policies and procedures to prevent and detect fraudulent conduct by certain registered representatives and to maintain a guideline ratio of registered representatives to supervisors in its Ponoma, California branch office..."  The issues occurred during the period of early 2006 to May 2007.  The SEC noted that the firm failed to require the branch office to maintain enough supervisors to adequately supervise the branch.

Digging deeper in the SEC release, it seems that certain brokers in that branch were recommending that customers use home equity pto purchase VUL policies.  The recommendations were unsuitable, according to the SEC.   It also appears that World Group had policies in place that prohibited brokers from recommending a client take out a home equity loan to purchase securities. 

What the SEC took issue with was the firm's failure to follow up on the need to put in place additional supervisors at the office.  The release notes that in 2005, the branch manager supervised about 62 brokers.  In or about April 2006, the branch had 185 registered or pending brokers, with only three supervisors.  The number of brokers grew to 225 registered and pending folks, still with only three supervisors.  The firm learned of the increase in reps, and sought to have the branch manager add additional supervisors, but that manager did not do so in a timely fashion.  The release explains that in January 2007, the firm put the manager on a improvement plan, requiring him to increase supervisors by five, and to get the ratio of brokers to supervisors to 40:1 initially, and then to get it down to 20:1.  But the manager failed to do this.  In May 2007, the firm replaced the manager. As a result of this action, which the firm settled without admitting or denying anything, the firm will be fined $200,000 and be censured.  Further, the firm has agreed to retain an outside vendor to provide suitability training to all of the firm's brokers each year for two years on the suitability of VUL policies, and suitability issues relating to using home equity to purchase securities. 

I think that the lesson for firms here is simple:  When you spot an issue relating to supervision of brokers, you must seek to put in place the appropriate corrective measures or adjustments, AND must then follow up to ensure that things are being done correctly and timely.

SEC Proposes New Rules for Investment Advisors, Hedge Funds, Etc.

The SEC announced today that it is proposing new rules relating to registered investment advisors.  In addition, the proposed rules would require registration of hedge funds and other private funds.  And, as expected, the SEC's registration requirements for RIAs will change, with the SEC overseeing RIAs with assets over $100 Million.  Those current SEC registered advisors with assets between $25 Million and $100 Million will, for the most part, likely be required to become state registered RIAs.  According to the SEC's release, this change will result in about 4100 RIAs moving from SEC oversight to state oversight.  The Commission will be accepting public comments on the proposals following their publishing in the Federal Register. 

Arbitration Discovery Problems Result in Disciplinary Action for NY Firm

FINRA's National Adjudicatory Council (NAC) recently issued a decision finding that New York based firm Westrock Advisors, Inc. violated FINRA Rules by failing to produce discoverable documents to an arbitration claimant as requested, and failed to abide by an arbitration panel order regarding same.  The case was appealed to the NAC following an Office of Hearing Officers panel decision in which the firm was found to have violated the rules and was ordered to be censured and fined $35,000.  Westrock appealed the case to the NAC. On appeal, the NAC increased the sanctions to a censure and a fine of $50,000, and assessed appeal costs to Westrock.

Firms should understand that their conduct in arbitration proceedings can give rise to the initiation of regulatory examinations and, when deemed appropriate by the regulators, lead to the imposition of disciplinary actions against the firm. 

 

Sugarland Dispute Underscores Need for Written Agreements

Typically, I pontificate and ramble about on securities compliance and regulatory matters, and don't discuss many business law issues here at BDLawBlog.com.  But, for the owners and principals of a B-D or RIA, business law issues can be just as important, if not more so, in certain situations. 

I read this morning in the Fulton County Daily Report that the Sugarland lawsuit is set to go to trial next week in Atlanta.  For those who don't listen to the occasional country song, Sugarland is (now) a vocal duo fronted by Mr. Kristian Bush and Ms. Jennifer Nettles.  They can sing and play the tunes.  Earlier this week, they were awarded the CMA (Country Music Awards) award for Vocal Duo of the Year for 2010.  But, the ritz and glimmer of this week's honor will fade quickly as the duo goes to federal court next week squaring off against their former band mate, Ms. Kristin Hall.  The dispute essentially comes down to whether the three have a partnership agreement, and if so, to what Hall is entitled, after she left the group.  For some background on the story, click here.  The litigants' problems in this situation essentially stem from the failure to plan, and to put those plans in writing in the form of a solid, written agreement setting forth their business arrangements, its terms, and how they'll deal with things when it is time to part ways. 

So what does this have to do with the broker-dealer and RIA world?  Glad you asked.  And here's the answer:

Broker-Go-Round. Be Careful When You Get Off.

According to a recent article in Investment News, over 7,000 brokers have left the bog firms in  18 months.  The article focuses on the period from January 2009 through this past June, and explains that many of these brokers are going to independent firms or shifting to work for registered investment advisers. 

It is easy to understand the frustration that some brokers might have now,  Some are seeing declining payouts, changes in their company (due to mergers, acquisitions, etc.), the inability to sell a wide range of products, to name a few.  But, brokers considering making a change should consider many issues before jumping the fence for greener pastures. Some time ago, I posted on items to consider before changing firms.  It made sense then, and it still does today.

At a recent conference I attended, a speaker quoted statistics or estimates of the dollar volume of outstanding forgivable loans or retention bonuses that brokers have not yet fully satisfied or had forgiven.  The amount was staggering.  With declines in revenues and an increasingly competitive environment, broker-dealer firms are pursuing  brokers to collect on these loans when the broker leaves.  FINRA arbitration has helped the firms in these situations by providing a streamlined arbitration process in many of these cases.  Before you consider jumping ship, you might want to invest in a consultation with experienced counsel to help guide you through the change. 

RIAs: Does your Language Match?

Registered Investment Advisers (RIAs) should be aware of the recent changes enacted that will modify disclosures and language on the Form ADV.  RIAs should begin to consider those changes, and prepare to ensure that their disclosures are consistent from part I to part II, as well as consistent with their fee agreements or contracts with clients.  Expect both the states and the SEC to review these documents for consistency whenever an examination of a RIA is conducted.  Forewarned is forearmed. 

Change Brewing for Arbitration

FINRA today announced that it will file a proposed rule change with the SEC next month to give investors the ability to have an all public arbitration panel to hear claims in arbitration cases before FINRA Dispute Resolution.  Historically, panels consisting of three persons included two from the public roster and one who was a "non-public" or "industry" arbitrator who held some ties to the industry.  Under the new proposal, which follows a short pilot program involving a limited number of broker-dealers, investors would have the ability to demand that their case be heard by three panelists (if the case calls for three) from the public roster.  Investors-rights groups have been calling on FINRA (and formerly NASD) to make this change for a long period of time.  I do not expect that the SEC will object to passing the proposal, but it might be interesting to see some comments filed when the SEC publishes the rule for comment. 

FINRA Enforcement Pursuing Brokers Who Sold Universal Leases from Resort Holdings

In the past two weeks, I've received a few calls from brokers who have received "Wells" letters and proposed AWCs from FINRA Enforcement, relating to the brokers' alleged involvement with sales of universal leases offered years ago by Resort Holdings and Yucatan Holdings.  In short, it appears that, several years ago, many brokers across the country became involved in selling the purported universal leases offered by Resort Holdings and affiliated companies, headed by Michael Kelly.  The leases were explained to be timeshares or similar, that would provide investors with a generous rate or return.  The reality was that the investments were fraudulent, and now the SEC and many state regulators have taken securities fraud action against the companies and principals. 

Now, FINRA is preparing to take disciplinary action against many brokers who had participated in the sale of these products, or otherwise were involved in the program.  Enforcement is seeking sanctions against brokers for violation of Rules 3040 (selling away, private securities transactions) and 3030 (outside business activities).  The brokers I've spoken with have informed me that FINRA is seeking harsh sanctions of lengthy suspensions and significant fines, including disgorgement of commissions received. 

Brokers who are facing action for their involvement in Resort Holdings products should understand their options, and understand that they do not have to accept FINRA's proposed settlement terms. Rather, they can seek to negotiate more favorable settlement terms, can dispute the charges at a hearing, or can go to a hearing to seek more favorable sanctions.  The disciplinary process is covered quite extensively in my e-book, A Stockbroker's Guide to Regulatory Investigations, that can be downloaded free online.  Brokers facing decisions about how to proceed with a pending action against them, might consider consulting with experienced securities counsel about their situation.