The Beck Law Firm, LLC Blog

UPDATED: Enforcement Appeals. Was: FINRA Hearing Panel Decision Issued in Key Arbitration Case

Feb 21, 2013:  FINRA announced today that a Hearing Panel issued a Decision in the case of FINRA's Department of Enforcement v. Charles Schwab & Co., Inc.  In doing so, the Hearing Panel dismissed two of three causes of the action against Schwab, and found for Enforcement on the remaining cause.  The Panel imposed a fine of $500,000 and ordered that Schwab take specific corrective action.  The Panel Decision was issued today (2/21/13) and is not final.  It may be appealed by either party, or it may be called for review by FINRA's National Adjudicatory Council.  I don't know how the case will finally end, but the ending will be very significant to the industry and investors.  

The Hearing Panel Decision is about 49 pages long, and takes some time to go through.  Here's my attempt at a down and dirty summary based on a quick review (links to the press release and the decision itself are above, so you can access the documents yourself if you are interested):

FINRA Adopts Rule 5123 Relating to Private Placements

FINRA has adopted Rule 5123 concerning private placements, and has announced an effective date of December 3, 2012.

Under this new rule, each FINRA member broker-dealer that is selling in a private placement will file a copy of the PPM, term sheet or other offering document within 15 days of the date of the sale, or advse FINRA that no such materials were used. 

There are several exemptions under 5123(b), and business leaders and compliance folks should become familiar with the reporting requirements and the applicable exemptions.  Further, in advance of the effective date, firms need to consider whether their written supervisory procedures need to be amended to help achieve compliance with the rule.

FINRA's Regulatory Notice 12-40 announcing the SEC approval and effective date of the rule can be found here.

Settlement Discount? Not Necessarily So in FINRA and SEC Cases.

I've opined many times here on the blog that sometimes it pays to litigate, rather than settle.  What I mean by that is that in some cases before FINRA or the SEC, while a settlement might be quick, the end result is that the settlement imposes harsher sanctions than could reasonably be obtained after a formal hearing.  In other words, some cases have a "litigation discount" it seems, as opposed to a discount for settling that you might expect.  

Brian Rubin, a former colleague of mine at NASD, and Jae Yoon, both lawyers at Sutherland, recently published their most recent study on the question of settling or litigating.  Their article, Sutherland Study on Litigating Against the SEC and FINRA Shows It Sometimes Pays for Broker-Dealers and Registered Representatives to Take On The Regulators, reveals the results of a pretty intensive analysis.  If you are a rep. or a broker-dealer facing enforcement action by the regulators, I commend this article to you.  Some of the highlights of the study, in my view, are:

* FINRA respondents with a lawyer are significantly more successful than pro se respondents.  The study details that respondents with counsel succeeded in getting 18.8% of charges dismissed, while respondents without counsel had 0% success during the review period.  

* With respect to monetary sanctions, SEC and FINRA respondents were able to obtain lower sanctions against them, when compared to what the staff had sought, in nearly a third of the cases.

* With respect to suspensions from the industry, FINRA respondents were effective in reducing sanctions at hearing in approximately 50% of cases studied.  Importantly, the study notes, when FINRA staff sought a complete bar as a sanction, 75% of respondents convinced a Hearing Panel to impose a lesser sanction.

So what does all of this mean?  To me, it boils down to two things that folks facing a regulatory action need to understand.  First, having a lawyer experienced in securities regulatory cases is critical.  Second, sometimes you have to be willing to stand up and fight.  

Obviously, with respect to the decision of settling or litigating, other factors come into play including resources, publicity, etc.  The decision of whether to settle or litigate is a very important decision that must be made based on the particular facts of the case.  Many times, settling a case is the right thing to do.  But not always.  And sometimes it pays to fight.

 

 

 

Review of FINRA Disciplinary Actions - May 2012

I spent a few minutes reviewing the FINRA disciplinary actions reported for May 2012.  These are published each month online; you can find May's notice here.  As to cases against firms, there are the run of the mill trade reporting type violations that we see each month.  In addition, however, were several cases dealing with AML compliance and email retention.  There were also a few cases relating to sales of unregistered securities and private placement issues, including a case involving general solicitation in a private offering.  Two cases caught my eye, as firms were fined significantly ($100,000 and $350,000 plus restitution) in cases alleging a failure to supervise reasonably.  In each of these cases, it seems that the firm was alleged to have failed to respond appropriately to red flags, that the regulator seems to argue would have uncovered and stopped theft of client funds by a broker or stop other fraudulent activity by the broker.  If you're read BDLawBlog before, you know that supervision is always scrutinized, and wise principals know to focus on red flags, to respond to them, and to document their activity to help manage the risks of supervising.

In cases against individual brokers, we see the typical failure to respond, U4 violations, conversion of funds types cases that we see each month.  One broker case caught my eye:  a broker was fined $10,000 and suspended for a year, and required to take ethics training acceptable to FINRA, based on allegations that he improperly requested, or in some cases permitted, another individual at his broker-dealer to complete nineteen online courses and tests on his behalf.  It seems that these online courses were certification tests as well as continuing education courses and the like.  Over the past year or so, we're seen a rise in cases similar to this, and folks should know that, even if it is not a FINRA exam or continuing education session, the regulators take these things seriously  

Rule 2111 - The New Suitability Rule - Goes Into Effect July 9, 2012

FINRA Rule 2111, the new suitability rule, will become effective on July 9, 2012.  In advance of this, FINRA recently released additional guidance on the new rule, via Regulatory Notice 12-25 (FINRA previously has issued two other notices relating to the rule - see Notice 11-02 and 11-25).

As the new notice indicates, much of the obligations imposed on firms and representatives is not new, however, the new rule incorporates obligations that have been enforced via disciplinary cases and interpretive releases.  Specifically, the new rule requires that firms and brokers have a reasonable basis to believe that a security is suitable for some investor (reasonable basis suitability), then have a reasonable basis to believe it is suitable for that particular customer (customer specific suitability), and finally, the concept of quantitative suitability (the suitability of a series of recommended transactions) is written into the new rule.  In addition, to a discussion of these three items, the notice provides further guidance to firms and brokers regarding the new rule.

I recommend that all brokers and supervisors, including compliance folks, review this new notice.  It is safe to expect that once the new rule is implemented, regulators will review compliance with it, as well as the reasonableness of supervisory procedures and controls regarding complying with the rule, during routine and special exams at broker-dealers.   

 

RIAs Look Out! The Investment Adviser Oversight Act of 2012 Hits Congress.

Spencer Bachus (AL), the Chairman of the House Financial Services Committee, introduced legislation into the House on Wednesday, Apri 25, 2012, together with Rep. Carolyn McCarthy (NY) to change the regulatory structure for the retail investment advisory industry.  Under the bill, the short title of which is The Investment Adviser Oversight Act of 2012, registered investment advisors would be required to register with a newly created self-regulatory organization(s) called National Investment Adviser Associations (NIAAs) that would be registered and overseen by the SEC.  This proposal would result in an SRO regulatory system for RIAs very similar to the SRO oversight in the broker-dealer community, where FINRA serves as the predominant SRO for broker-dealers.  As many know, FINRA has been positioning itself to become the selected regulatory for the RIA industry.  At this point, the legislation has just been introduced.  It will be assigned to a committee for review first, and then may possibly work its way to the full House for consideration.  The proposed bill is here, and the Committee on Financial Services announcement can be found here.  

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.