PRIVATE FUND OFFERINGS: With General Solicitation Relaxation Comes New Scrutiny

 

SearchingWhile under the JOBS Act the capital formation process in private offerings may have gotten easier, the regulatory scrutiny may have gotten harder.

In a speech before the PLI Hedge Fund Management Conference in New York, Norm Champ, the SEC’s Director of the Division of Investment Management, addressed the increased oversight advisers to hedge funds relying on private offering exemptions can expect.  Of concern is  the adopted amendments to rules under the Securities Act of 1933 permitting general solicitation and general advertising in private securities offerings relying on Rule 144A or Rule 506 under the Securities Act and the rule’s  disqualifying of so-called “bad actors” who rely on its safe harbor.

In short, as to advertising, Rule 506 eliminates the prohibition on general solicitation and general advertising for some private fund offerings, with exceptions noted in the rule.  Generally, to find potential accredited investors, once the removal of the ban goes effective in the next few weeks, hedge fund will be able to use certain other methods of  solicitating and advertising.  With this comes the requirement that issuers take reasonable steps, defined by an objective assessment standard, to verify “accredited investor” status, to ensure that all purchasers of the securities are accredited investors.  Champ also stressed the importance of  advisers maintaining, reviewing and updating their policies and procedures to ensure, among other things, they are reasonably designed to prevent the use of fraudulent or misleading advertisements.

Other issues hedge funds will need to concern themselves with, related to  general solicitation, and  included in SEC proposals and related request for industry comment, include the following:

  • requiring issuers to file the Form D before a general solicitation begins and when an offering is completed to evaluate how general solicitation impacts investors in the private placement market, and expanding the information that issuers must include on Form D.
  • requiring private fund issuers  to include a legend in any written general solicitation materials disclosing that the securities being offered are not subject to the protections of the Investment Company Act of 1940.
  • requiring general solicitation materials containing performance data, to have additional disclosure explaining the context and limitations on the usefulness of such data.
  • extending to private funds Rule 156 of the Securities Act of 1933 guidance on when information in sales literature could be fraudulent or misleading under federal securities laws currently applicable to registerd funds.
  •  manner and content restrictions on private fund solicitation materials that include performance advertising specific to certain types of performance advertising, such as model or hypothetical performance.
  • using  an inter-Divisional group within the SEC to assess practices and developments in the Rule 506(c) market place, by looking at accredited investor verification practices used by issuers and other participants in these offerings, and studying risk characteristics that might identify potentially fraudulent behavior.
  • reviewing the definition of accredited investor as it relates to natural persons.

The “Bad Actor” Disqualification

As for the “bad actor” rule, the second amendment to Rule 506 implementing
Section 926 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, Champ warned of  serious regulatory consequences should the SEC make a  bad actor finding.  To avoid the finding, hedge  fund advisers should conduct appropriate due diligence when they hire employees, third-party solicitors, and when they screen investors.  Champ also reminded hedge funds that while disqualification applies only for triggering events that occur after the effective date of the rule, matters that existed before the effective date of the rule that would otherwise be disqualifying must be disclosed to investors.

Generally, an issuer cannot rely on the Rule 506 exemption from registration if the issuer or any other person covered by the rule is disqualified by a “triggering event,” including certain criminal convictions, certain SEC cease-and-desist orders and court injunctions and restraining orders.  Hedge funds are not the only potential “bad actors. ”  Others, Champ reminded, could  include  “the hedge fund’s general partner or managing member, its investment adviser and principals, significant shareholders holding voting interests, affiliated issuers and any placement agent or other compensated solicitor.”

Finally, from a risk perspective, how will the SEC determine which hedge funds engaged in general solicitation to examine and/or investigate?

One way, he notes, is that registration and reporting reforms related to Dodd-Frank, over the past few years, including, the adoption of amendments to Form ADV and the creation of Form PF allows the SEC to cull more  information about individual hedge fund’s practices.  Another way, is the  Division of Investment Management establishment of a Risk and Examinations Office (“REO”) staffed with analysts with strong quantitative backgrounds, along with examiners, lawyers and accountants who will  conduct quantitative and qualitative financial analysis of the investment management industry, including private funds, advisers, types of funds, strategies and make up of a fund.

SEC Risk Alert: Business Continuity and Disaster Recovery Planning

The SEC has issued a new Risk Alert stemming from its observations of  the  business continuity and disaster recovery planning practices of  a number of  investment advisers.  The alert follows an National Examination Program (“NEP”) review of the plans of approximately 40 investment advisers following  Hurricane Sandy.  The SEC says the goal is to encourage investment advisers to review their business continuity and disaster recorvery plans (“BCPs”) to improve responses and recovery times for threats that might disrupt market operations.

Certain weakenesses observed, and that advisers would do well to heed,  include the following areas:

  • Preparation for widespread disruption. Some advisers whose BCPs did not adequately address and anticipate widespread events experienced more interruptions in their key business operations and inconsistent communications with clients and employees.
  • Planning for alternative locations.  Some advisers who switched to back-up sites or systems reported that the buildings where they usually conduct their business were closed for days.  At least, one adviser reported its building was closed for several weeks.  Other problems included extended outages of power, phone systems, and internet service and lack of geographically diverse office operations.
  • Preparedness of key vendors.  Some advisers failed to even evaluate the BCPs of their service providers or keep a list of vendor’s contact information.  Some advisers did not acquire or critically review service providers’ Statement on Standards for Attestation Engagements No. 16 reports. 
  • Telecommunications services and technology.  Some advisers failed to hire service providers to make sure back-up servers functioned properly, relying solely on self-maintenance, which led to more interruptions in their operations.
  • Communication plans.  Poor planning, inconsistencies and weak deployment in how to contact employees during a crisis.  Some plans did not identify which employees would execute and implement  various parts of the BCP.
  • Reviewing and testing.  Inadequate testing of operations and systems relative to size and nature of  advisory businesses.  Some problems here were based on adviser failures to conduct certain critical tests based on costs and other disincentives.  

The risk alert also encourages advisers to consider those best practices and lessons learned that were described in the Joint Review of Business Continuity and Disaster Recovery of Firms by the Commission’s National Examination Program, the Commodity Futures Trading Commission’s Division of Swap Dealers and Intermediary Oversight and the Financial Industry Regulatory Authority on August 16, 2013.  They are  available at http://www.sec.gov/about/offices/ocie/jointobservations-bcps08072013.pdf

While the alert serves as a friendly reminder, to avoid a potential enforcement action, the advice covered should be reviewed, and where appropriate, implemented.  The days of  preparing a boilerplate disaster recovery handbook to be left to collect dust on an adviser’s bookshelf have long passed.

SEC Risk Alert: Options Trading That Evades Short-Sale Rule Requirements

risk managementShort sale activity continues to be a significant focus of the SEC, particularly when it involves short sales without delivery, or “failures to deliver.”

The SEC’s Office of Compliance Inspections and Examinations (OCIE) has now  issued a new Risk Alert raised by its examination staff’s observation that some options trading strategies are being used to evade the short-sale rule, Rule 10b-21.  The alert addresses the need for customers, broker-dealers and clearing firms to be aware of options trading activity that could be used to avoid complying with the close-out requirements of Reg SHO.

Under the rule,  it is fraudulent to sell an equity security if it deceives a person participating in the transaction about the seller’s  intention or ability to deliver the security by settlement date.  Rule 10b-21 covers such situations where a seller deceives a broker-dealer, participant of a registered clearing agency, or a purchaser about its intention to deliver securities by settlement date, and the seller then fails to deliver securities by settlement date.  The violative activity would include broker-dealers (including market makers) acting for their own accounts.  Broker-dealers could also be held liable for aiding and abetting a customer’s fraud under Rule 10b-21.

In addition to addressing, with examples, trading strategies that could be used to circumvent Reg SHO requirements, and other helpful ways that OCIE has observed that some firms have used to effectively detect and prevent violation of the rule, the alert provides summary guidance covering (a) Reg SHO Close-out Requirement; (b) Reg SHO Locate Requirement; (c) Rule 10b-21; (d) Key Trading Terms and Concepts; and (d) Option Activity Related to Hard to Borrow and/or Threshold Securities.

ACHIEVING “BEST EXECUTION” AND RECENT SEC ENFORCEMENT

Two SEC enforcement cases last week demonstrate (i) how using affiliated brokerage on an agency or principal basis raises potential conflicts of interest  when dealing with ” best execution” concerns , and (ii) the importance of having robust best execution policies and procedures and then following them.  In both cases, the SEC sanctioned investment advisers for not heeding these concerns in failing to seek best execution on client trades placed through in-house brokerage divisions.

While the duty of an adviser or fund to seek best execution may not expressly be stated in the federal securities laws, to the extent they are typical, these cases tend to follow a pattern:  An SEC best execution enforcement action might involve the SEC’s examination staff first finding that a firm failed to disclose compensation on client brokerage, failed to adequately its brokerage practices or failed to properly disclose to clients the adviser’s best execution policies and procedures.  The two recent cases are no exception.

In the first case against A.R. Schmeidler & Co. (ARS), a dually registered investment adviser and a broker-dealer, the SEC found that ARS failed to reevaluate whether it was providing best execution for its advisory clients when it negotiated more favorable terms with its clearing firm.  This resulted in ARS retaining a greater share of the commissions it received from clients, a best execution violation.  The SEC found that the firm also failed to implement policies and procedures reasonably designed to prevent the best execution violations.  To settle the SEC charges, ARS agreed to pay disgorgement of $757,876.88, prejudgment interest of $78,688.57, and a penalty of $175,000.  The firm also must engage an independent compliance consultant, and had to consent to a censure and cease-and-desist order.

The second case involved a CEO who also served as Chief Compliance Officer officer, Goelzer, and his Indianapolis-based dually registered firm Goelzer Investment Management (GIM).  The SEC found that GIM made misrepresentations in its Form ADV about the process of selecting itself as broker for advisory clients.  The SEC found that GIM failed to seek best execution for its clients by neglecting to conduct the comparative analysis of brokerage options described in its Form ADV, and recommended itself as broker for its advisory clients without evaluating other introducing-broker options as the firm represented it would.  Goelzer and GIM agreed to pay nearly $500,000 to settle the charges that included GIM paying disgorgement of $309,994, prejudgment interest of $53,799, and a penalty of $100,000.  The firm was also required to comply with certain undertakings, including the continued use of a compliance consultant and the separation of its chief compliance officer position from the firm’s business function.  Goelzer agreed to pay a $35,000 penalty, and Goelzer and GIM consented to censures and cease-and-desist orders.

What are some of the lessons for advisers and funds engaged in managing potential conflicts related to best execution?

While the SEC provides no specific definition of “best execution,” it has said that managers should seek to execute securities transactions for clients in such a manner that the client’s total cost or net proceeds in each transaction is most favorable under the circumstances. The determinative factor is not necessarily the lowest commission cost, but whether the transaction represents the best qualitative execution for the managed account.  So what  should advisers learn from these cases?    

  • Recognize the importance of having strong written policies and procedures that provide guidance concerning the quality of trade execution while, at the same time, attending client investment objectives and constraints.
  • Make sure that disclosures in Form ADV and elsewhere include information about trading and actual and potential trading conflicts of interest.
  • Document compliance with best execution policies and procedures and disclosures to clients.
  • Consider setting up a brokerage or trade management committee to review trade placement and best execution. The committee should address such topics as broker trading cost and execution, brokerage expertise and infrastructure and the broker’s willingness to explore alternative trading options.
  • Test for best execution, including possibly hiring a third party service provider to periodically assess the broker’s capacity to evaluate which competing markets, market makers, or electronic communication networks (ECNs) offer the most favorable terms of execution, the speed of execution, and the likelihood that the trade will be executed.   

There are numerous sources to consult when thinking about and developing best execution policies.  A few advisers might want to consider include:  Trade Management Guidelines (Nov. 2002), available at www.dfainstitute.org/standards/ethics/tmg; See Interpretive Release Concerning the Scope of Section 28(e) of the Securities Exchange Act of 1934 and Related Matters, Exchange Act Release No. 23170 (Apr. 23, 1986) (“1986 Soft Dollar Release”); Lori Richards, Valuation, Trading, and Disclosure: The Compliance Imperative, Remarks at the 2001 Mutual Fund Compliance Conference of the Investment Company Institute (June 14, 2001), available at www.sec.gov/news/speech/spch499.htm.   

In statements following these cases, the SEC warned all investment advisers with affiliated broker-dealers that it would hold them accountable to ensure clients are obtaining the most beneficial terms reasonably available for their orders.

THE UPWARD TREND IN MUNCIPAL SECURITIES CASE ENFORCEMENT

upwards-trendThe past two weeks has seen the SEC’s continued ratchet upward the number of enforcement actions against municipal securities participants for disclosure violations.

These enforcement actions also continue to ensnare an array of players in municipal securities transactions, that include underlying obligors, their chief executive officers, national and regional investment banks, the heads of public finance departments at several investment banks, as well as individual investment bankers at various levels of seniority, issuers, issuer officials, financial advisers, attorneys and accountants.

The cases have involved everything from  tax or arbitration-driven fraud, pay-to-play and public corruption violations, public pension accounting and disclosure fraud, valuation/pricing issues, and most recently, more offering offering and disclosure fraud, involving misleading statements or omissions in offerings.

Two recent enforcement actions illustrate this trend.  The first, SEC v. City of Miami, Florida and Michael Boudreaux, an SEC complaint filed in federal court in Miami alleged that the City of Miami, through its then Budget Director, charged that beginning in 2008, the City and the budget director made materially false and misleading statements and omissions concerning certain interfund transfers in three 2009 bond offerings totaling $153.5 million, as well as in the City’s fiscal year 2007 and 2008 Comprehensive Annual Financial Reports.  The City puportedly transferred a total of approximately $37.5 million from its Capital Improvement Fund and a Special Revenue Fund to the General Fund in 2007 and 2008 in order to mask increasing deficits in the General Fund.

The complaint alleged that the City and the budget director failed to disclose to bondholders that the transferred funds included legally restricted dollars which, under Miami’s city code, was not permitted to be commingled with any other funds or revenues of the City.  The defendants  also failed to disclose that the funds transferred were allocated to specific capital projects which still needed those funds as of the fiscal year end or, in some instances, already spent that money.  The transfers enabled the City of Miami to meet or come close to meeting its own requirements relating to General Fund reserve levels.  According to the SEC, the results of the transfers, meant that the City’s bond offerings were all rated favorably by credit rating agencies.

The second and most recent case, In The Matter of  West Clark Community Schools, a settled administrative cease-and desist proceeding, involved the West Clark Community Schools, an Indiana school district.  In 2005, the West Clark Community Schools contractually, in accordance with SEC rules, undertook to annually disclose certain financial information, operating data and event notices in connection with a $52 million municipal bond offering.  In 2007, the school district, in connection with a $31 million municipal bond offering, stated in public bond offering documents that it had not failed, in the previous five years, to comply in all material respects with any prior disclosure undertakings. That statement, the SEC alleged, as well as a Certificate and Affidavit signed by the School District attesting that the offering documents did not contain any untrue statement of material fact, was materially false.  To the contrary, the SEC found that between at least 2005 and 2010 the School District never submitted any of its contractually required disclosures.

As a result, the SEC claimed that the school district violated Section 17(a)(2) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5(b) thereunder.  In a separate, but related, settled cease-and-desist proceeding, In the Matter of City Securities Corporation and Randy G. Ruhl, the SEC found that City Securities, the underwiter, and an vice president of City Securities’ municipal bond department conducted inadequate due diligence and, as a result, failed to form a reasonable basis for believing the truthfulness of material statements in an the school district’s  official statement, resulting in City Securities offering and selling municipal securities on the basis of a materially misleading disclosure document.

In addition to being censured, City Securities was ordered to pay disgorgement and civil penalties.  The vice president was barred from the securities industry with a right to reapply after one year and ordered to pay disgorgement and civil penalties.

In July 2012, the SEC  issued a comprehensive report with recommendations aimed at helping improve the structure and enhance disclosure provided to investors for a municipal securities market that has grown to $3.7 trillion in municipal debt outstanding from a level of $361 Billion in 1981.  To that, add potential enforcement actions from the MSRB, states, and other SROs, and there’s little doubt that the enforcement action trend will escalate.

FORM 13F: FILINGS DUE AUGUST 15

 

The August 15 deadline for investment advisers to make Form 13F filings to report equity security securities holdings of their managed accounts is approaching.  Form 13F must be filed within 45 days of the end of a calendar quarter.

As required by Section 13(f) of the Securities Exchange Act of 1934, and rule 13f-1, Institutional investment managers ( which includes investment advisers)  must file Form 13F with the SEC if they exercise investment discretion for accounts holding Section 13(f) securities.  Section 13(f) securities are defined in the rules as securities having an aggregate fair market vaule of at least $100 million on the last trading day of any month of any calendar year. 

What types of securities are Section 13F securities? The SEC has said that “[s]ection 13(f) securities generally include equity securities that trade on an exchange (including the Nasdaq National Market System), certain equity options and warrants, shares of closed-end investment companies, and certain convertible debt securities.  The shares of open-end investment companies (i.e., mutual funds) are not Section 13(f) securities.”  Advisers can find Section 13(f) securities on the Official List of Section 13(f) Securities.  An updated list of 13(f) securities is published on a quarterly basis.

Advisers can also find valuable information about the filing’s requirements in the Frequently Asked Questions About Form 13F.   

SEC ANNOUNCES REGIONAL COMPLIANCE OUTREACH SEMINARS

The SEC has announced its schedule for the  upcoming Compliance Outreach Program regional seminars to be held in Chicago, New York, Atlanta and San Francisco.   Investment adviser and investment company senior officers, including chief compliance officers (CCOs) are invited to register and attend.  The first meeting will occur in Chicago on August 28. 

 This years’ Compliance Outreach Program, which started off  in Boston in May, will likely include panel discussions with SEC staff from the Office of Compliance Inspections and Examinations (OCIE), Division of Investment Management, and Division of Enforcement’s Asset Management Unit.  Topics will vary depending on location. For example, the Chicago seminar will address traded and non-traded real estate investment trusts, investment companies with special emphasis on alternative investment funds and money market funds, and current enforcement actions in the investment management industry.  The New York seminar will focus more on newly registered investment advisers, dual registrants and to investment advisers affiliated broker-dealers, and will topics like the SEC’s examination process, priorities, risk surveillance, and examination selection process.   

 As we’ve alerted our audience in previous blogs, investment advisers should attend these meetings because “[t]he seminars highlight areas of focus for compliance professionals.  They provide an opportunity for the SEC staff to identify common issues found in related examinations or investigations and discuss industry practices, including how compliance professionals have addressed such matters.”

Registration information about the regional seminars is available at:

http://www.sec.gov/News/PressRelease/Detail/PressRelease/1370539720572#.Uef5kdK1Eec

 

Time For Quarterly Transaction Reports

FE_DA_Deadline_050613425x283A reminder to advisers,  the code of ethics you adopted probably requires quarterly reports to be prepared for all personal securities transactions made by access persons.  If it doesn’t there are two possible reasons (1) chances are you haven’t read it, or (2) you don’t have one — in which case you need to first read Rule 204A-1 of the Investment Advisers Act of 1940.

The Timing of Transaction Reports

Under Rule 204A-1(b)(2), these reports are due no later than 30 days after the close of the calendar quarter.   Access persons who would be submitting duplicate information contained in trade confirmations or account statements that an  adviser holds in its records (provided the adviser has received those confirmations or statements not later than 30 days after the close of the calendar quarter in which the transaction takes place) may be excused by their investment advisers from submitting transaction reports.

Who is an access person?

Rule 204A-1(e)(1) defines an access person as a supervised person who has access to nonpublic information regarding clients’ purchase or sale of securities, is involved in making securities recommendations to clients or who has access to such recommendations that are nonpublic.  Further, a supervised person who has access to nonpublic information regarding the portfolio holdings of affiliated mutual funds is also an access person, but only to the extent they make, participate in, or obtain information regarding, the purchase and sale of the fund’s securities, or if their functions relate to the making of any recommendations for such transactions.

This definition is broad enough to include, for example,

(i) portfolio management personnel and, in some organizations, client service representatives who communicate investment advice to clients;

(ii)  administrative, technical, and clerical personnel if their functions or duties give them access to nonpublic information;

(iii) organizations where  employees may have broad responsibilities, and fewer information barriers are in place  to prevent access to nonpublic information.  On the other hand, as the SEC has noted, organizations that keep strict controls on sensitive information may have fewer access persons; and

(iv) presumably if the firm’s primary business is providing investment advice, then all of its directors, officers and partners would be access persons.

When must access persons report personal securities transactions?

Under Rule 204A-1(b), each of an adviser’s access persons must report his securities holdings at the time that the person becomes an access person and at least once annually thereafter. Further, they must make to the adviser’s Chief Compliance Officer or other designated person a report at least once quarterly of all personal securities transactions in reportable securities.

What are “reportable securities”?

Rule 204A-1 treats all securities as reportable securities, but list five exceptions designed to exclude securities that appear to present little opportunity for the type of improper trading that the access person reports are designed to uncover. These include transactions and holdings in:

  • direct obligations of the Government of the United States.
  • money market instruments — bankers’ acceptances, bank certificates of deposit, commercial paper, repurchase agreements and other high quality short-term debt instruments.
  • shares of money market funds.
  • shares of other types of mutual funds, unless the adviser or a control affiliate acts as the investment adviser or principal underwriter for the fund.
  • units of a unit investment trust if the unit investment trust is invested exclusively in unaffiliated mutual funds.

There are other exceptions. For example, under Rule 204A-1, no reports are required for transactions effected under an automatic investment plan; No reports are required for securities held in accounts over which the access person has no direct or indirect influence or control; and finally, under Rule 204A-1(d), no report is required in the case of an advisory firm that has only one access person, so long as the firm maintains records of the holdings and transactions that rule 204A-1 would otherwise require be reported.

There are other requirements in Rule 204A-1, the Code of Ethics Rule, covering access persons transactions and holdings that advisers should review.  These includes such issues as pre-approval of certain investments, review of personal holdings and transaction reports, procedures to address personal trading and reporting of violations.

 

 

A Lesson From Ameriprise: Risk Mitigation With Third-Party Prospectus Delivery

Broker-dealers and other financial service firms using third-party service vendors, whether to reduce costs, enhance performance, and obtain access to specific expertise, and perform vital functions, sounds good in most instances.  But doing so is not without risks.

FINRA’s recent disciplinary action against Ameriprise, tagging it with a censure and fine of $525,000, is a reminder of inherent risks when firms fail to monitor outsourced service work to third parties.  In settling with Ameriprise (through an Acceptance Waiver and Consent, FINRA Case # 2011029100301) FINRA found that Ameriprise, in approximately 580,000 transactions, failed to timely deliver mutual fund prospectuses to its customers within three business days of their purchases.  FINRA also found Ameriprise to have failed to establish and maintain adequate supervisory systems and written supervisory procedures that should have reasonably monitored and ensured the timely delivery of mutual fund prospectuses — a requirement of Section 5(b)(2) of the Securities Act of 1933.

As FINRA noted, Rule 10b-10, promulgated under Section 10(b) of the Securities Exchange Act of 1934, requires a broker-dealer to provide to the customer, in writing, certain information “at or before completion of such transaction” and that transactions are complete when they settle.  Rule 15c6-l(a) provides that securities transactions settle in three business days, unless otherwise specified.  Consequently, a broker-dealer must deliver a prospectus to a customer who has purchased a mutual fund no later than three business days after the transaction.

What are the compliance takeaways from the Ameriprise action?  How does a firm avoid or mitigate legal, reputational and operational risks to its business when dealing with outside vendors?

First, firms should make sure they hire qualified vendors and that such relationship are structured to avoid operational problems. Expectations on both sides need to be clearly articulated.  Second,  monitor frequently and document that the outsourced activity is being properly managed.*  Appropriate oversight ensures that the third-party program is meeting its regulatory purpose.  Third, document and make sure that the third-party has adequate internal controls.  Finally, make sure that the vendor has a contingency plan in the event of a disruption, and make sure that you do the same.

In the end, while day-to-day management of a service like sending the prospectus can, in some instances, be transferred to a third party, ultimate responsibility for any compliance requirement cannot be delegated and remains with the financial service firm.

*Outsourcing Financial Services Activities: Industry Practices to Mitigate Risks, Federal Reserve Bank of New York, October 1999, p. 5, available online.; Outsourcing By Financial Services Firms, Broker-Dealer Regulation (Second Edition) Practicing Law Institute, C.E. Kirsch.

FINRA’s Targeted Examination Letter on Social Media Use

wallpapers-red-bull-s-eye-target-psdgraphics-x-1June 2013,  has seen FINRA publish another targeted examination letter — this time aimed at members and associated persons use of social media.  FINRA uses these letters, primarily, to educate member firms about how it uses targeted exams, known as sweeps, to gather insights on member regulatory responses on emerging issues, and carry out investigations.

Relying on FINRA Rule 2210(c)(6) which subjects member firms’  communications (including electronic)  to periodic spot-check procedures, FINRA’s Advertising Regulation Department is asking firms and their associated persons for information about how they use social media (e.g., Facebook, Twitter, LinkedIn, blogs).  Questions and information requests include:

  • how a firm’s social media (e.g., Facebook, Twitter, LinkedIn, blogs) platform is being used as part of its business purpose; 
  • URL information for all social media sites the firm uses; date of first use, and the identity of those who post or update content;
  • how a firm’s associated persons are using social media;
  • a firm’s written supervisory procedures covering the production, approval and distribution of social media communications;
  • what measures firms adopt to monitor compliance with social media policies (e.g., training meetings, annual certification, technology);
  • a list of a firm’s top 20 producing registered representatives (based on commissioned sales) who used social media for business purposes to interact with retail investors, including the type media they use, their name, CRD number, and dollar amount of sales made and commissions earned during a specific period.

FINRA says its  selection of firms for the targeted exam is based on a number of factors, including the “level and nature of business activity in a particular area, customer complaints and regulatory history, and prior examination findings.”

The letter demonstrates the attention broker-dealer’s should pay to both adopting policies and procedures and supervising interactive electronic communications to ensure that content requirements of FINRA’s communications rules are not violated.  In doing so, members should review FINRA’s Regulatory Notices 07-59, 10-06,  11-39 and FINRA Conduct Rules 2210 and 3010.