BD Law Blog - by Georgia Securities Lawyer Joel Beck

FINRA December 2011 Disciplinary Actions: Registration Issues, CE Problems, and Escheatment Procedures

FINRA has published their notice of disciplinary actions for December 2011.  In cases involving firms, there were a few cases relating to alleged failures to complete an annual certification of compliance and supervisory processes to senior management at firms, as well as failing to test and verify supervisory controls and procedures.  Firms should be aware of the requirements for these certifications.  It is apparent that the examiners are reviewing for compliance in this area during examinations of broker-dealers.  

One case that caught my eye involved a national broker-dealer that submitted an AWC agreeing to be fined $350,000 and censured.  This was based on findings that the firm failed to establish, maintain and enforce adequate WSPs for its escheatment group in regards to addressing abandoned accounts (accounts where the account statements were returned as undeliverable, for example).  FINRA found that the deficient procedures allowed an operations manager to convert approximately $850,000 from retail client accounts, and let the manager avoid detection by the firm (Case 2009020630701).

As always, there were a number of actions against individuals.  We see the typical selling away cases, as well as several cases involving improper borrowing of funds from customers, and some conversation cases.  There were also several cases against supervisors relating to supervision of private offerings, as well as supervision of excessive or unsuitable trades.  Supervisors are increasingly on the regulator's radar and must be aware of, and respond to, red flags in these areas.  

A few cases against individuals also caught my eye.  First, there were a couple of cases against brokers who were found to have let a manager in their firm complete their required firm element continuing education program.  These brokers were fined $5,000 and suspended for 30 days. (2009019276103 and 2009019276102),  In another case, an individual was fined $7,500 and suspended for 20 business days based on findings that the individual sold $1.3 million in private placement offerings without required registration, as the individual had not passed the Series 7 exam (or, according to FINRA, any other FINRA qualifications exam) until a later date. (2010022715604).  

Proposed FINRA Rule On Social Media Supervision Modified

FINRA has sought to have the SEC approve proposed FINRA Rule 2210 relating to communications with the public (similar to NASD Rule 2210 dealing with the same subject).  In a letter to the SEC dated December 22, 2011, FINRA responded to comment letters on the proposed rule, as well as other proposed rules.  As it relates to social media use and other online electronic communications (not email), FINRA has explained that it believes that participation in online forums occur in real-time, and that it is not practical to require pre-use approval of such postings by a principal.  Nevertheless, these communications must still be supervised by firms.  Addressing concerns as to whether they are correspondence or public appearances, FINRA has explained that participation in an interactive electronic forum would fall under the "retail communication" category of communication and would be supervised by broker-dealers in the same manner as required for supervising correspondence.  Recognizing the difficulties of supervision in these areas if pre-use filing was required, FINRA has amended proposed FINRA Rule 2210(c)(7) to add an exclusion from filing for such communications posted online in interactive forums.  FINRA makes clear, however, that the exemption from filing would not apply if any other filing requirement arises under federal law or pursuant to SEC rules.  (See pages 10-12 in the letter at the link above).  

SEC and FINRA Issue Risk Alert/Regulatory Notice on Branch Office Inspections

Last week, the SEC and FINRA issued a joint Risk Alert/Regulatory Notice on broker-dealer branch office inspections.  The notice/alert is aimed at providing broker-dealers with guidance to consider with respect to the firm's branch office (and other office locations) inspection program.  The alert/notice highlights best practices observed by the regulators, as well as highlighting deficient practices that may lead to issues with the integrity of a firm's inspection program.  

Among other things, the regulators encourage firms to utilize a risk-based approach to "help drive the frequency, intensity and focus of branch office inspections," further encouraging that such risk analysis be made on an ongoing basis, and to move away from a model that simply relies on examiners checking a box, where that box and the inspection program has not been somewhat tailored for the firm, and for that office.   The notice/alert also provides further guidance in the way of previously issued notices and interpretations relating to the applicable supervision rules.

Firms should understand that this notice/alert does not propose or institute a new rule or requirement. Historically, firms have been required to inspect their offices, and they still are.  Firms should, however, understand that this issue is on the radar of the regulators, and that when a firm faces an examination by FINRA or the SEC, the adequacy of their office inspection program will likely be reviewed.  According to the SEC's release, the Risk Alerts are "intended to alert senior management, risk management and compliance managers in the securities industry to significant risks identified by the SEC's national examination staff so that industry members can more effectively address those risks."  The regulators appear to consider this a significant area; forewarned is forearmed.  

Resources:

FINRA's Regulatory Notice 11-54

SEC Announcement - 2011-250

 

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.  

New Discovery Guide and Document Production Lists for FINRA Customer Arbitrations Effective May 16, 2011

FINRA has announced, via Regulatory Notice 11-17, a newly revised Discovery Guide and Document Production Lists for customer arbitration cases.  The revised guide and lists becomes effective on May 16, 2011, and will apply to all customer cases filed on that date and after.  

This new version replaces the old guide, commonly referred to as 99-90, that was announced as NASD Notice to Members 99-90, that debuted in 1999.  99-90 contained 14 document production lists, some of which applied only to certain types of cases.  The revised guide provides for two lists of presumptively discoverable documents to be applied to all cases.  

FINRA Revises the Sanction Guidelines

FINRA recently announced, via Regulatory Notice 11-13, that it has revised the Sanction Guidelines.  According to FINRA's release, the new guidelines, which are now effective, made four main changes:

    * clarify the causation standard for when restitution can be ordered as a sanction;

    * recognize the a panel can order a respondent's ill-gotten gains to be paid to those injured by misconduct;

    * recognize that not every factor in the principal considerations has the potential to be both an aggravating factor and a mitigating factor; and

    * directs adjudicators to consider the sanctions imposed by other regulators for the same misconduct,when assessing sanctions in a FINRA matter.

The majority of these changes deal with FINRA's restitution policy.  Based on the Sanction Guidelines published in 2007,adjudicators were informed, "Adjudicators may order restitution when an identifiable person, member firm or other party has suffered a quantifiable loss as a result of respondent's misconduct, particularly where a respondent has benefited from the misconduct."  (See General Principles Applicable to All Sanction Determinations #5, March 2007).  Now, in the March 2011 revision, adjudicators are advised," Adjudicators may order restitution when an identifiable person, member firm or other party has suffered a quantifiable loss proximately caused by a respondent’s misconduct." (Id., March 2011 Ed.).  

In addition to this change, the revisions to the guidelines provide adjudicators with authority to have disgorgement of ill-gotten gains to be used to redress harms to customers rather than to be paid as a fine to FINRA.

 

Review of FINRA Actions for June 2010

I just finished reviewing the FINRA Disciplinary actions reported for June 2010.  I'm a little behind, but finally got to read through this batch of new cases.  As we see each month, there are the routine TRACE and OATS compliance cases brought by Market Regulation.  There are also a few U4 cases here and there as well.  But what somewhat surprised me was the number of conversion of funds/theft cases that FINRA brought, as well as the number of cases involving improper borrowing of funds from customers.  Must be a sign of the economy, as my non-scientific review seems to point to more of these cases than normal. 

There were also a number of selling away cases.  Regular readers now that selling away cases are routine, but in today's regulatory environment, those cases involving private offerings are under more intense scrutiny.  I believe that we can expect to see a continuing increase in selling away cases, especially those involving private placements, for the near future.  

Two cases stood out to me as noteworthy.  The first involved a firm that was censured and fined $55,000 pursuant to an AWC.  The firm was found to have improperly paid commissions to reps. in branch offices through non-registered entities.  The firm was also found not to have used the FTC national do-not-call list and also had some problems with telemarketing scripts and reports.  I think the unique aspect of this case relates to the payments of commissions.  Under the rules, firms may only pay sales commissions to registered entities.  That means to a registered representative or to another broker-dealer.  So, when the firm tries to pay commissions to a rep.'s LLC, there's gonna be a problem.  This is not a new rule or regulation, so it is unusual to see this type of basic violation. 

The other case involved a broker who was suspended for 20 business days and fined $10,000.  FINRA made findings that the broker exercised discretion in a client account without written authority from the client and without having the firm approve the account as discretionary.  The notice also reported that the broker attempted to settle an anticipated customer complaint without his firm's knowledge, by giving checks totaling $20,000 to his client.  The client never cashed the checks, but took the complaint to the firm.  My regular readers will also know that you can't settle a client complaint away from the broker-dealer.  When those who do get caught, it never turns out well. 

Registration Soon to be Required for Operations Professionals?

Last month FINRA issued Regulatory Notice 10-25, seeking comments on a proposal to implement a requirement for operations supervisors and other designated folks to be registered as "Operations Professionals" under a new registration category, testing requirement and continued education requirement.  The new category primarily relates to back-office functions, and in particular, those persons who supervise activities in the back-office area.  The proposal carves out certain exemptions from taking the new test for those who are or have recently been registered in certain other categories. 

The comment period expires 7/12/10, and the link above will take you to the notice, which includes instructions for submitting comments on the proposal. 

FINRA Reminds Firms of Requirements for Sales of Private Placements

FINRA reminded firms today of their requirements for completing due diligence and suitability reviews when participating in sales of private placements, through Regulatory Notice 10-22 and a press release announcing the issuance of the notice.  A quick read through of the notice doesn't seem to find that FINRA is attempting to impose new requirements on firms; rather, the notice apparently seeks to pull together other pieces of guidance and also articulates a broker-dealer's responsibilities under current federal securities laws and industry rules, including the obligation to conduct reasonable due diligence, to document such investigation, and to make appropriate suitability determinations in the sale of private offerings, including both reasonable-basis and customer-specific suitability determinations. 

If your firm participates in private offerings, then supervisors and brokers and bankers should be aware of the contents of this notice.  While the requirements are not new, based on recent enforcement actions by various regulators, including FINRA, private placements remain a hot button issue that will continue to be scrutinized by the regulators.

Review of Recent FINRA Disciplinary Actions - March 2010

FINRA has released its monthly report of disciplinary actions reported for March 2010.  They can be found online here.  In this month's report, we see many of the standard or routine violations: OATS and trade reporting compliance, conversion of funds, U4 omissions, and a few cases involving improper borrowing of customer funds (to be addressed in another post later this week).  There were three cases that caught my eye, relating to responding to red flags. 

In a case against a firm (Case No. 2006006836301), FINRA censured a broker-dealer and fined it $65,000 for not adequately responding to red flags generated by its exception report systems relating to potentially improper sales practices, including excessive trading and unsuitable transactions.  The report noted that the firm failed to have in place, and to enforce, adequate written supervisory procedures that provided guidance to supervisors and compliance folks for review of transactions for suitability and excessive trading.

Two cases against two individuals appear to arise from the same regulatory examination given the case numbers (Case Nos. 2005000346105 and 200500346106).  Here, two principals were each fined $15,000, suspended for one year in principal capacities, and were each required to re-qualify by examination (retake the test) before being a principal again.  The report for the first case noted that FINRA made findings that representatives in the principal's office became subject to active account reviews and compliance reviews when customer accounts sustained losses due to "voluminous stock and options transactions."  The report further explained that, despite being made aware of red flags indicating excessive and unsuitable trading, the supervisor "failed to take reasonable supervisory steps to respond to the "red flags"  with a view to preventing the unsuitable and excessive trading and did not adequately investigate the representatives' options trading."  The second case noted that the principal didn't respond to the red flags and instead relied on the "representatives' unsubstantiated and false claims." 

So what's the lesson here?  Have systems in place to identify the red flags.  Then have systems in place to tell your supervisors how to respond to them.  And, if you're a supervisor, you must take reasonable steps to investigate those red flags that present themselves to you.  Having the best exception reports doesn't help if they are not used.  Failure to supervise reasonably can be a costly endeavor.