Does the CFP Board’s Enhanced Enforcement Efforts Mean More Discipline?

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.  

 

 

 

DOL Enforcement and ERISA Plan Advisers

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.

Finally, The SEC Provides More Formal Guidance on Adviser Use of Social Media

The SEC’s National Examination 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.

 

 

A Resolution for Advisers and CCOs: The (New Year’s) Annual Review

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:

  • Portfolio management processes, including allocation of investment opportunities among clients and consistency of portfolios with clients’ investment objectives, disclosures by the adviser, and applicable regulatory restrictions;
  • Trading practices, including procedures by which the adviser satisfies its best execution obligation, uses client brokerage to obtain research and other services (“soft dollar arrangements”), and allocates aggregated trades among clients;
  • Proprietary trading of the adviser and personal trading activities of supervised persons;
  • The accuracy of disclosures made to investors, clients, and regulators, including account statements and advertisements;
  • Safeguarding of client assets from conversion or inappropriate use by advisory personnel;
  • The accurate creation of required records and their maintenance in a manner that secures them from unauthorized alteration or use and protects them from untimely destruction;
  • Marketing advisory services, including the use of solicitors;
  • Processes to value client holdings and assess fees based on those valuations;
  • Safeguards for the privacy protection of client records and information; and
  • Business continuity plans.

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?

 

 

 

The SEC Citigroup Settlement Saga May Mean Longer Investigations

As a follow up to our post of December 15, where we asked whether settling enforcement actions might become harder after Judge Jed Rakoff rejected the recent settlement between the SEC and Citigroup, one thing is clear, it will certainly be harder for the SEC to settle cases before federal judges like Rakoff who may be troubled by settlements in which a defendant is allowed to neither admit nor deny liability when accused of securities fraud.

The Washingon Post story on Judge Rakoff’s order accusing the SEC of misleading him and the federal appeals court, by among other things, failing to give him notice of the SEC’s emergency request to the appeals court to stop the judge from rejecting the Citigroup settlement, may have gotten for the SEC the opposite kind of attention it wanted when it first announced what it thought was a great settlement.  If Rakoff turns out to be right, this new and unwanted attention may come from federal judges who may begin to question more thoroughly both the SEC’s motives and tactics in settling such cases.  For the SEC, this could mean having to conduct longer investigations with an eye toward expecting to have a long trial, or, alternatively, foregoing court actions and opting for administrative actions.  In the future, to avoid federal judges questioning such settlements, the SEC may decide its easier to take the latter route.

What FINRA’s Investor Protection Efforts Will Mean for Broker-Dealers and Reps in 2012

On December 16, Financial Industry Regulatory Authority (FINRA)  issued a Press Release highlighting its regulatory accomplishments during 2011.  FINRA makes clear its goal is two-fold:  protecting investors and bringing transparency to financial markets.  The release demonstrates for senior management, risk management and compliance managers the additional arsenal FINRA is employing to beef up its oversight of broker-dealers and their registered reps.  So far, for reps and their firms, this has meant a significant increase in the number of disciplinary actions this year.  The release identifies  some of the newer tools and sources FINRA has used and will continue to employ to protect investors.

What’s been different about 2011 and what will firms and reps experience more of in 2012?  The press release sheds light on some measures FINRA will be employing, including:

  • Using its Office of Fraud Detection and Market Intelligence (OFDMI) to refer matters involving potential fraudulent conduct to federal and state regulators and law enforcement agencies.  FINRA referred more than 600 matters this year.
  • Reconfiguring its exam program to be more risk-based and ensuring exam teams are more focused on those areas critical to investor safety; including identifying high-risk firms, branch offices, brokers, activities and products through broader data collection.
  • Developing, through its Market Regulation Department, cross-market surveillance patterns that monitors all FINRA, NYSE and NASDAQ markets (80 percent of equity markets) with plans to launch these patterns in 2012.  Earlier, FINRA expanded the Order Audit Trail System (OATS) to include all NMS securities to create a uniform order audit trail to serve as a foundation for the cross-market surveillance program.
  • Expanding the Trade Reporting and Compliance Engine (TRACE) to include securitized products.  The effect was to add more than 1.2 million asset- and mortgaged-backed securities to the current 70,000 TRACE-eligible securities; and introduced securitized products benchmark pricing and aggregated data reports on FINRA’s website.
  • Continuing to push rule proposals that include Back Office Registration, Suitability and Debt Research Conflicts of Interest.
  • Enhancing its examination program by taking a more risk-based approach to focus on areas posing greatest risk to investors.  With this, FINRA has increased the number of its staff in district offices responsible for having a deeper understanding of specific firms, including increased real-time monitoring of business and financial changes.
  • Placing greater emphasis on branch-level activity by increasing the number of branch exams that focus exams at the point-of-sale.
  • For 2012, developing comprehensive cross-market surveillance patterns that will examine trading activity across all markets, including FINRA, NYSE and NASDAQ equity markets, at one time (which account for 80 percent of equity volumee time), rather than having multiple patterns survey each market separately.  This is suppose to help FINRA identify problematic trading more quickly.
  • Finally, FINRA implemented a rule for firms and reps involved in FINRA arbitrations allowing investors to choose all-public panels in customer cases involving three arbitrators.

With New SEC Unit and Data Mining, Advisers Face Closer Scrutiny in 2012

With a renewed focus on analytics and more readily available data, expect the SEC’s scrutiny of investment advisers, including advisers to mutual funds, hedge funds, and private equity funds, to get  tougher.

In December, in a speech before the Consumer Federation of America’s Financial Services Conference, the SEC’s Director of Enforcement, Robert Khuzami, once again emphasized many of the organizational and structural changes that have already occurred and that will continue to impact the way investment advisers and mutual funds will be watched and regulated going forward.  Moreover, advisers may begin to feel the heat from these changes in a deeper, and for their investment adviser reps, and more personal way.  With changes to its organizational structure, the SEC created the Asset Management Specialized Unit to evaluate data and risk-based analytics.  One of the investigative practices the unit is implementing involves adopting a kind of early-warning framework to detect what Khuzami says is the kind of “retail fraud” that may foreshadow more serious problems within assets management and mutual funds.    

Utilizing a retail approach, what might the SEC’s enforcement division be looking at for potential signs of fraud?  Khuzami gives a few examples.  One involves the SEC scouring an adviser’s Form ADV to determine if they’ve lied about their educational achievements, their business affiliations, and their assets under management.  “For us, it’s advisers who lie about graduating Phi Beta Kappa, conceal their association in a past failed business venture, or inflate their assets under management who might well be the same persons who outright steal your money when the markets turn against them,” says Khuzami.

A second approach, for mutual funds, might involve the SEC reviewing databases in an effort to identify poor performance, when at the same time, the fund has relatively high fee arrangements, for them and their sub-advisers.  This, Khuzami says, may suggest excessive fee arrangements that can eat away at the mutual fund investment returns.  See More……

 

FINRA AND SEC GUIDANCE: EFFECTIVE RISK MANAGEMENT FOR BRANCH AUDITS

In its continual focus on the importance of effective risk management for broker-dealers (as well as investment advisers) the Securities and Exchange Commission’s Office of Compliance Inspections and Examinations and FINRA have issued a National Exam Risk Alert aimed at providing broker-dealer firms with information on developing effective policies and procedures for branch office inspections.  In addition to reminding firms of their supervisory obligations under FINRA’s supervision rule, the alert notes some common deficiencies found during SEC and FINRA examination of branch office audit practices and emphasizes the need for firms to adopt a comprehensive risk approach to compliance practices. 

The Alert, including FINRA’s Regulator Notice 11-54 , contains a number of best practices that Chief Compliance Officers and other compliance professionals of broker-dealers should consider incorporating as part of their mandated supervisory oversight of branch offices.  The Alert warns that some practices FINRA and SEC examiners have observed, including

  • firms utilizing generic examination procedures for all branch offices, regardless of business mix
  •  leveraging  novice or unseasoned branch office examiners who lack the experience or understanding of the business to challenge assumptions, and
  •  devoting minimal time to each exam and little, if any, resources to reviewing the effectiveness of the branch office exam program

will not be tolerated.  In short, the alert is a reminder that the SEC and FINRA view branch office inspections as integral to determining whether a firm’s culture of compliance eliminates risks to the firm and its clients or contributes to violations of the securities laws.

Will FINRA Become the New Regulator for Investment Advisers?

Yesterday, in front of the House Financial Services Capital Markets SubCommittee, Richard Ketchum, CEO of the Financial Industry Regulatory Authority (FINRA) testified that FINRA is prepared to assume the regulation of investment advisers. Ketchum noted that while the SEC oversees more than 11,000 investment advisers, but in 2010 conducted only 1,083 exams of those firms due to lack of resources. Noting two studies related to the regulation of broker-dealers and investment advisers that were completed by the SEC in January, Ketchum stated, “the average registered adviser could expect to be examined less than once every 11 years.” This means that “[w]hile the SEC examines only about 9 percent of investment advisers each year, 55 percent of broker-dealers are examined each year by the SEC and FINRA,” he said.

The SEC’s study on investment adviser exams concluded that, going forward, the Commission would not have sufficient capacity to conduct effective registered investment advisers examinations with adequate frequency. Further, the study found that enhanced examination responsibilities given the SEC under Dodd-Frank meant that an increase in agency examination staff “is unlikely to keep pace with the growth of registered investment advisers.”

Making the argument that if FINRA were to become the SRO for investment advisers, Ketchum pledged that FINRA would establish a separate entity with separate board and committee governance to oversee any adviser work, and would plan to hire additional staff with expertise and leadership in the adviser area. He argued that FINRA possessed the experience operating a nationwide program for examinations and had the ability to leverage existing technology and staff resources to support a similar program for investment advisers. See more…