CFP Board Announces New Sanction Guidelines

The Board of Directors of Certified Financial Planner Board of Standards, Inc. (CFP Board)  has announced, effective August 27, 2012,  the adoption and  implementation of  new Sanction Guidelines.

Typically, the CFP Board’s enforcement process involves them investigating incidents of alleged unethical behavior using  procedures established by the CFP Board’s Disciplinary Rules and ProceduresWhen violations are found, the CFP Board can impose discipline ranging from a private letter of censure or public admonition to suspension or revocation of the right to use the CFP®  mark. 

In the past, the differences in punishment meted out for those violating CFP’s rules haven’t always represented a model of consistency.  Presumably, the new guidelines will  assist the Disciplinary and Ethics Commission (DEC), the group that conducts disciplinary hearings under the  CFP Board’s rules,  in doing just that.  Similar to FINRA’s approach, the CFP Board’s sanction guidelines includes a chart featuring recommended sanctions for violations that cover everything from bankruptcy, to borrowing money from a client to unauthorized use of  the CFP®  mark.  The chart also includes a column or category entitled “Policy Notes” or factors that the DEC, and if appealed, may also be used by the Appeals Committee of the Board of Directors which considers appeals of DEC decisions.



Big Firms Fare Better in SEC Enforcement Actions

So says a study conducted by Berkeley Law School professor, Stavros Gadinis.  The article appears in The Business Lawyer, published in the May 2012 issue  (Volume 67, Number 3)  by the American Bar Association. The study covers SEC enforcement actions against investment banks and brokerage houses during a period just before the 2007-2008 economic crisis (the dataset covers 2005, 2006, and the first four months of 2007); and the data suggests that defendants in smaller firms fared far worse in SEC enforcement actions.  According to Professor Gadinis, there are three dimensions to the data.

The first is that when the SEC action involved big firm misconduct, the preferred choice was corporate responsibility as opposed to individual liability.  In short, this sounds,  in part, like some of the criticism heaped on the Bush and Obama Justice Department for failing to bring criminal cases against some individual senior officers in the banking industry responsible for the financial debacle.  Often in these SEC actions, neither the individual who actually participated in the violative conduct nor high-level supervisors were subject to additional sanctions.

Even though both legal venues are open to them, a second factor involves the SEC’s more likely decision to bring adminstrative proceedings against big firms instead of court proceedings.  Hence, the study found that financial professionals subjected to court proceedings resulted in stiffer sanctions, including higher penalties and even bans from the securities industry.

Concomitantly, with administrative proceedings, a third factor arises.  For the same violation and comparable levels of harm to investors, the study found that big firms and their employees were less likely to be banned from the securities industry, even after controlling for violation type and harm to investors.

Skepticism over the legal and public policy implications of not holding individuals liable for violations noted in the Gadinis article (and as we discussed in our January 2, 2012 post) has been raised some courts like Judge Jed Rakoff’s criticism and rejection of the SEC’s settlements with Citi Bank and Bank of America.

To be fair, the article makes clear that “[w]hile… [these theories] seek to explain the SEC’s enforcement strategy… they do not purport to represent an exhaustive list of potential explanations of the [SEC’s] motives.”  Instead, the data raises and addresses major issues about the future implications of the SEC’s activities in recent years.

Merrill Lynch: FINRA’s Arbitration Mandate In Industry Disputes

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 noted 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 Deutsche Bank Arbitration Award: The Costs of Ignoring Internal “Coverage” Fights

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, Claimantvs. 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.


Client Records, You Can’t Always Take Them with You When you Go

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.”


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.



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.

After Citigroup, Will Settling SEC Enforcement Actions become Harder? SEC Press Release

The Securities and Exchange Commission’s Director of Enforcement, Robert Khuzami, today, issued a press release regarding a New York federal district court’s recent rejection of an SEC’s settlement with Citigroup.  Khuzami announced that the SEC is appealing the lower court’s ruling to the U.S. Court of Appeals for the Second Circuit.

In the Citigroup case, U.S. District Judge Jed Rakoff refused to accept a settlement between the SEC and Citigroup in a case involving the bank’s sale of mortgage-backed securities that cost investors almost $700 million in losses while the bank garnered profit of about $160 million.  Rakoff ruled that  the underlying allegations were ‘unsupported by any proven or acknowledged facts,’ and rejected a $285 million settlement between the SEC and Citigroup.  The SEC claimed that the settlement reasonably reflected the relief it would likely have gotten had it won at trial.

Khuzami’s press release argues that Rakoff has created a “new standard” that is “at odds with decades of court decisions that have upheld similar settlements by federal and state agencies across the country. ”  He is correct that courts have routinely approved SEC settlements in which a defendant does not admit or expressly deny liability, thus providing incentives for both the SEC and defendants.  However, Citigroup’s failure to acknowledge wrongdoing is actually what bothered Judge Rakoff.  Rakoff concluded that the settlement “is neither fair, nor reasonable, nor adequate, nor in the public interest.”

In a period when the public has become ever more skeptical about the fairness of financial bailouts and deals between governmental agencies and banks, Judge Rakoff’s decision appears to channel that same skepticism.  Might this be the beginning of the end of the SEC’s practice and policy of settling cases with defendants without requiring the defendant to admit to liability of some kind, even if modest?  For at least one judge, that appears to be the case.  And, if it is the beginning of a trend, this could mean more trials and fewer settlements.  If so, the danger of changing the SEC’s settlement approach to these cases could prove time consuming and expensive not just for the SEC and defendants but also for federal judges like Judge Rakoff.


FINRA Sanctions Eight More Firms.  FINRA’S  recent announcement that it had sanctioned eight more firms and 10 individuals, and ordered restitution totaling more than $3.2 million, for selling interests in private placement offerings without having a reasonable basis for recommending the securities is yet another warning to firms that fail to conduct adequate due diligence on alternative investment products.

NASD Conduct Rule 2310 requires member firms, when making a recommendation to a customer to purchase or sell a security, to have reasonable grounds to believe that the recommendation is suitable for the customer.  What this means, under FINRA rules, is that member firms who sell alternative investments such as Regulation D offerings must be able to demonstrate that they have an understanding of the potential risks and rewards of the security.  That demonstration must go beyond simply reading prospectuses, private placement memoranda, and other scripts passed along from issuers or participants in the offering process.

The eight firms and their reps FINRA snctioned sold interests in several high-risk private placements, including those issued by Provident Royalties, LLC, Medical Capital Holdings, Inc. and DBSI, Inc., which ultimately failed, causing significant investor losses.  The oft-forgotten message FINRA makes with these cases is that firms have at least two continuing responsibilities with alternative securities offerings.  The first is that member firms need first to document for themselves, and convey to their clients, an understanding of the inherent risks of private offerings; and the second is, after doing so, ask themselves whether these products are suitable for their customers.  Failing to conduct adequate due diligence makes this impossible to do since a selling firm may have no reasonable grounds to believe that the Regulation D offfering is suitable for any customer.

As with these cases, FINRA has shown no reservation in imposing supervisory liability , under Rule 3010, on principals of these firms for failing to conduct meaningful due diligence prior to approving such offerings for sale to customers.