This blog identifies and discusses new and developing regulatory issues that impact investment advisers, broker-dealers, corporations and individuals who either work in the securities industry or who are impacted by its regulations.
The SEC and FINRA have reached a settlement with Goldman Sachs regarding the bank’s failure to supervise its employees participation in the firm’s “trading huddles.” As a result, Goldman will pay $11 million in fines to both the SEC and FINRA. Goldman consented to the fines without admitting or denying the findings. Read more here.
Does the CFP Board’s recent creation of the position and appointment of a new director of investigations create yet another level of securities enforcement scrutiny for financial planners? On the surface, it sure looks like it.
A recent Advisor One article entitled ”CFP Board’s Keller Says New ‘Top Cop” Will Beef Up Investigations” quotes CFP Board CEO Kevin Keller stating that the reason for the position was not because of an increase in the number of compliance cases or violations of CFP rules but to “to build our capacity to achieve our mission of benefiting the public.”
Translation. What this means is that given its membership growth expect number of enforcement cases to rise. More recently, the Board’s enforcement efforts have focused on bringing cases against members who have had bankruptcies or who have disclosures in FINRA or SEC matters that involve claims of misrepresentation or fraud. Also, the number of cases the CFP Board opened in 2011 (1,569 cases) increased from the 1,472 cases opened in 2010. Although most CFP investigations do not result in enforcement actions, expect a continued increase in the number of investigations with the new appointment.
A recent article in AdvisorOne entitled “DOL Cracks Down on Retirement Plan Advisors For Fiduciary Negligence,” quoting Andy Larson of the Retirement Learning Center, focuses on the large number of civil, and some criminal, enforcement actions bought by the Employee Benefit Security Administration (EBSA) against advisers for fiduciary negligence.
According to Larson, in addition to recognizing that the DOL has jurisdiction over them, advisers must ensure they have a “strong documentable fiduciary process.” From the plan sponsor’s side, Larson recommends that “the plan sponsor should be asking advisors what they can do to help my plan comply with the DOL rules” to minimize the DOL liability for their employers.
The article cites a white paper published by the Columbia Management Learning Center warning plan sponsors of their fiduciary duty to comply with the DOL regulations and that the probability that the DOL could audit their plan is increasing. To emphasize this point the paper notes, that during 2010, the DOL audited more than 3,100 plans finding that 73% of them were required to restore losses to the plan or take another type of corrective action to correct plan deficiencies.
Merrill Lynch’s settlement with FINRA reminds broker-dealers and reps that they can’t use contractual arrangements to deny arbitrating disputes between them arising out of their business activities……
In paying retention bonuses of $2.8 billion to 5000 of its registered representatives in January 2009, Merrill Lynch structured them as loans and required reps to agree to terms that required that any disputes regarding repayment of the notes be litigated in New York state court.
Later in that year, after a number of registered representatives left the firm without repaying the amounts due under the loan, Merrill Lynch filed over 90 actions in New York state court to collect amounts due under the promissory notes.
In agreeing with Merrill Lynch to a censure and fine of $1,000,000, FINRA rejected that arrangement and determined that Merrill’s restrictions violated FINRA Rule 13200. The rule requires that disputes between member firms and associated persons be arbitrated if they arise out of the business activities of the member or associated person. Further, under the Code of Arbitration Procedure (IM 13000) the failure of a broker-dealer to submit a dispute to arbitration “may be deemed conduct inconsistent with just and equitable principles of trade and a violation of Rule 2010.”
FINRA found that Merrill Lynch structured the loan program to make it appear that the bonuses came from Merrill Lynch International Finance, Inc. (“MLIFI”), a non-registered affiliate, rather than from Merrill Lynch’s parent company where the funds for the program actually came from. Doing it this way, Merrill Lynch pursued repayment of any bonuses in the name of MLIFI in expedited hearings in New York state courts to circumvent Merrill Lynch’s requirement to arbitrate disputes with its associated persons.
FINRA also n
oted that Merrill had chosen a state which greatly limits the ability of defendants to assert counterclaims in such actions. Brad Bennett, FINRA’s Chief of Enforcement, said, “Merrill Lynch specifically designed this bonus program to bypass FINRA’s rule requiring firms to arbitrate disputes with employees, and purposefully filed expedited collection actions in New York State courts and denied those registered representatives a forum to assert counterclaims.”
Without admitting or denying FINRA’s allegations, Merrill Lynch consented to the censure and fine.
The SEC’s Office of the Whistleblower posting of its Notices of Covered Action (“Notice”) should serve as a reminder to investment advisers and broker-dealers of the importance of developing a strong culture of compliance, including having policies and procedures designed to prevent and detect violations of law. The SEC’s whistleblower rules govern how the SEC goes about awarding whistleblowers money for providing tips about possible federal securities and commodities law violations that lead to successful enforcement actions. Under the SEC’s whistleblower program, eligible whistleblowers are entitled to an award of between 10% and 30% of the monetary sanctions the SEC collects in actions that it brings and related actions brought by other regulatory and law enforcement authorities.
The new Notice provides a list of actions in which the SEC obtained a final judgment or order, by itself, or together with other prior judgments or orders in the same action that were issued after July 21, 2010, and that resulted in monetary sanctions over a $1 million. The Notice gives individuals 90 calendar days to apply for an award. The Notice covers a diverse group of SEC enforcement actions, including whistleblowing on (i) improper advisory fees charged to a registered fund (ii) ”pump- and- dump” schemes (iii) unlawful tipping of information about clinical trials (iv) fraud related to unregistered boiler-room offerings (v) violation of Reg SHO recordkeeping requirements and (vi) inaccurate books and records of securities transactions, just to name a few.
No group is immune. The Notice lists SEC whistleblower actions against large investment banks, investment advisers, including hedge funds and advisers to registered funds, as well as a number of broker-dealers and individuals. Investment advisers and broker-dealers ought to study the list, if for no other reason than to learn what kinds of violations whistleblowers are reporting. However, one hopes that the larger purpose would be for firms to review the list with an eye toward correcting policies and procedures to prevent wrongdoing and misconduct and to encourage employees to report violations internally when they occur.
FINRA has now provided regulatory guidance 
to member firms about how its advertising rules (NASD Rules 2210 and 2211) would apply to information they provide to participant-directed individual account plan participants under a U.S. Department of Labor rule. The DOL rule, Rule 404a-5, was designed to ensure that plan participants are provided with sufficient information about the plan and designated investment options alternatives under ERISA. The DOL rule requires the disclosure of certain plan and investment-related information, including performance information, to participants.
The FINRA guidance follows the SEC’s issuance, in October 2011, of a letter to the DOL in which the SEC’s staff agreed to treat information provided by a plan administrator to plan participants that complies with the DOL rule requirements as if it were a communication that complies with the requirements of Rule 482 under the Securities Act. The SEC does not require that such information be filed under Rule 497 of the Securities Act and Section 24(b) of the Investment Company Act with the SEC or FINRA. The SEC letter mentioned that FINRA staff intended to interpret applicable FINRA rules consistent with the SEC letter.
FINRA now says that if a firm provides information to plan participants that complies with the DOL rule requirements, it will treat the information as if it were a communication satisfying the content and filing requirements of NASD Rules 2210 and 2211. Thus, firms would not be required to file the information with FINRA under NASD Rule 2210(c), nor would the information be subject to the content requirements of NASD Rule 2210.
However, FINRA warns, to the extent a firm includes in an advertisement or item of sales literature content promoting a product or service of the firm, in addition to what is required by the DOL rule, the non-required content will be subject to NASD Rules 2210 and 2211.
Financial service firms may want to pay more careful attention to internal politics and turf battles involving issues like which adviser or rep gets credit or compensation for a particular client relationship or allegations of ”book poaching” and other territorial “coverage” disputes.
The FINRA arbitration in Stephen Colavito, Claimant, vs. Deutsche Bank Securities, Inc.,Respondent (FINRA Arbitration 10-01557, December 27, 2011) looks like a good example of the financial costs when management fails to deal with simmering internal battles about who gets paid for a particular client relationship or territory. A FINRA panel awarded $3.6 million to, the claimant, a former Deutsche Bank unit managing director. What sticks out is that the award included a punitive damage award of nearly $1.7 million to a managing director, in the firm’s Atlanta office, for an employment dispute involving internal coverage. The punitive damage award in the case is certainly not common in FINRA arbitrations. Generally, punitive damages may be considered in these kind of cases when statutes, rules, or arbitration provisions in contracts, permit doing so for egregious behavior. Historically, FINRA arbitration panels have not often granted such awards without clear and convincing evidence of oppressive conduct or wrongful acts done maliciously, wantonly or with indifference to some obligation.
The arbitrators found that another Deutsche Bank managing director’s conduct was ”reprehensible” when he “systematically blocked” the claimant from conducting business with institutional clients (both broker/dealer and non-broker/dealer) without regard to whether some clients were “covered” by the claimant/managing director’s division.
Despite the SEC’s adoption of Regulation S-P back in 2000, some reps still mistakenly believe that client accounts belong to them and that they are free to take them, including any information about the client, when they depart one firm for another. And whether by bringing improper recruiting practices or misuse of client information enforcement cases, FINRA and the SEC keep reminding reps and their firms that this is not the case.
Under Regulation S-P, any information given by consumers or customers to broker-dealers to obtain a product or service is generally considered to be nonpublic financial information. The regulation mandates that financial firms safeguard customer confidential information and prevent its release to unaffiliated third parties without the customer’s authorization.
In a recent case, the SEC announced that it sustained FINRA’s sanctioning of a former Banc of America Investment Services, Inc. (“BAIS”) rep fining him $10,000 and suspended him from FINRA membership for ten business days for having downloaded confidential nonpublic information about approximately 36,000 customers and providing that information to a competing firm that he joined. In rejecting the rep’s claim that the FINRA sanctions for his violations were excessive or oppressive, the SEC found that FINRA’s fine and sanction were not excessive or oppressive, and that the rep’s conduct was unethical, and violated NASD Conduct Rule 2110. (Rel. 34-66113; File No. 3-14195).
The essential facts leading to the SEC’s decision were that FINRA found that the rep breached his duty of confidentiality when he “surreptitiously” downloaded BAIS’s customers’ confidential nonpublic information, including account numbers and net worth figures, and transmitted that information to his future branch manager at a competitor firm.
Quoting Regulation S-P, the SEC found that the rep’s conduct prevented BAIS from giving its customers proper notice and an opportunity to opt out of the disclosures, as required by Regulation S-P. The SEC held that the rep’s violation caused his new employer to improperly receive BAIS’s customers’ “nonpublic personal information.”
The SEC’s National Exa
mination Risk Alert issued yesterday through the Office of Compliance Inspections and Examination comes at an interesting time. Almost two years after FINRA issued specific guidance in its Notice to Members 10-6 defining the social media it sought toregulate and suggesting ways member firms should supervise use of social media, and on the same day the SEC’s Division of Enforcement issued an Order Instituting Administrative and Cease-and-Desist Proceedings in an enforcement action against an Illinois investment adviser, alleging, among other things, that the adviser used social media platforms, including LinkedIn, to offer to buy and sell fraudulent bank guarantees and medium term notes in exchange for transaction-based compensation, now comes a social media alert to investment advisers and their associated persons. Undoubtedly, the alert’s guidance is important, but the timing is a bit off. Adviser use of social media has been around for a while now. However, to their credit, the SEC has in many ways endorsed FINRA guidelines and, in the past, issued its own guidance with respect to website use.
In addition to those mentioned in the summary, what are the key takeaways from the alert?
1. Adopt and Periodically Review Social Media Procedures. If you decided to take a break from the guidance, including notices (for e.g. NTM 11-39, NTM 10-6, and other comments coming from FINRA and other regulators over the past two years that the SEC endorsed) and chose not to address the use of social media in your compliance policies and procedures, you should start addressing them. They need to comply with the federal securities laws, including the recordkeeping provisions of Section 204 of the Advisers Act of 1940, and Rule 204-2, thereunder;
2. The Social Media Policies and Procedures need to be Specific. Here one size doesn’t fit all. Just using your existing advertisement/electronic/client communication policies, won’t cut it. Advisers will need to specifically a address the types of social networking activity they will allow. This is also true for any third-party solicitor the firm employs. The alert provides a non-exhaustive list of factors that firms should use to identify conflicts and risk exposure to them and their clients. Those factors include: Usage Guidelines, Content Standards and their approval, Monitoring and its frequency, Firm resources, Criteria for participation in social media, Training, Possible Certification requirements for users, Personal/Professional and Enterprise-Wide Sites, and Security;
3. The Policies and Procedures Should Address Third-Party Postings. This is particularly true with third-party testimonials which are prohibited. Adviser will need to address whether they will limit third-party postings to authorized users and prohibit postings by the general public, and also determine what steps they might take to avoid having third-party postings attributed to the adviser; and
4. With Social Media, Advisers Have RecordKeeping Obligations. The alert reminds advisers of their recordkeeping obligations under Rule 204-2 of the Advisers Act of 1940 that would also apply to social media. What this also means is that before advisers allow use, they should determine whether they have the capacity to retain the required data, given the possible large volume of communications. They should be ready to make such information available to the SEC for inspection any required records generated by social media.
Pull out the compliance procedures and let the revisions and training begin.
It’s a New Year! And for advisers it’s again time for a new year’s resolution, only this kind of resolution is not voluntary. Like holidays, it comes once a year, and while the responsibility for it falls on the adviser, the obligation to ”administer” (or the commitment to follow our new year’s theme) falls on the Chief Compliance Officer - it’s called the Annual Compliance Review. Further, consider it the type of resolution made mandatory by Rule 206-4(7) of the Investment Advisers Act of 1940 known as the “Compliance Rule.”
This new year’s “resolution” requires advisers and their CCOs not simply to resolve that they will do better with compliance than last year, but requires them actually to adopt and implement written policies and procedures reasonably designed to prevent a violation of the federal securities laws, and to evaluate their adequacy and effectiveness.
With this in mind, as CCO what have you resolved to do this year? As the SEC’s Final Rule clearly mandated, will your annual review of 2011, at a minimum, address the adequacy of your policies and procedures in the following areas:
After considering those questions, among others, will advisers resolve in the new year to test 2011 to determine whether they have (i) met regulatory deadlines? (ii) conducted a risk assessment to determine any unique compliance risk exposure to its business?(iii) determined whether compliance procedures needed to be changed to better reflect the adviser’s business practices? (Obsolete procedures or programs that the firm cannot follow should be repealed) (iv) conducted adequate transactional, forensic or periodic tests of its procedures and programs in the areas mentioned in the Final Rule? (In both speeches and its own seminars, the SEC has made clear the importance of proper testing); and (v) adequately documented the annual review? The SEC examination staff will ask advisers for documentation of their annual compliance review. Further, Investment Advisers Act Rule 204-2(17)(ii) and Investment Company Act Rule 38a-1(d)(3) to preserve records documenting the annual review.
When looking back on your annual compliance review for 2011, what resolutions/changes or enhancements will you be making?
