Broker- Dealer Law Corner

Broker- Dealer Law Corner

What Else Is New? FINRA Skates Despite “Massive” Failure To Produce Documents

Posted in Discovery, Enforcement, FINRA, Rule 8210, Rule 9251, Uncategorized

Let’s play pretend.  Can you imagine what FINRA would do to a respondent broker-dealer in an Enforcement action that announced on Day Five of the hearing – i.e., during the “final phase” of the hearing – that – whoops! – it had forgotten to produce certain documents that it should have produced eight months before the hearing even started? Documents that would potentially prove FINRA’s case?  And then, after being given a week to determine exactly how many documents it forgot to produce, the respondent announced that, in fact, it was, um, 30,000 emails?  That the failure was the result of an “apparent miscommunication?”  And that in addition to those emails there were another few hundred more that also hadn’t been produced because they were “inadvertently omitted” from an earlier production?

I am speculating, if course, but it’s not difficult to imagine that there would be a permanent bar involved.  Rule 8210, which gives FINRA the power to compel the production of documents and information, is powerful.  The failure to abide by the rule routinely results in permanent bars.  FINRA takes very seriously its right to require member firms and their associated persons to produce whatever documents it feels are necessary to conduct an exam.  Apparently, however, when the shoe is on the other foot, when it is FINRA that fails to produce required documents, a simple apology is good enough to resolve the problem.

How do I know?  Yesterday, FINRA issued an Order in an Enforcement case denying a motion to dismiss that Respondent Stephen Larson filed stemming from FINRA’s “massive” – to quote the Hearing Officer – failure to produce required documents.  These were documents that FINRA should have produced eight months before the hearing.  And there were, as my hypothetical suggests, 30,000 emails, including potentially exculpatory documents.  According to the Hearing Officer, however, this was no big deal.

He started his analysis of whether to sanction FINRA – which could, theoretically, have included a dismissal of the Complaint – by considering FINRA Rule 9251, which “requires Enforcement to make available to a respondent for inspection and copying all documents (subject to various exemptions) prepared or obtained by FINRA staff in connection with the investigation that led to the disciplinary proceeding.”  This sounds an awful lot like the flip-side of Rule 8210, which requires a respondent to produce the equivalent documents to FINRA.  It, too, is a serious, powerful rule.  As the Hearing Officer stated, “[i]t is essential that Enforcement exercise diligence in complying with this obligation, as rule-compliant document production by Enforcement is fundamental to a fair disciplinary proceeding.” He also observed that “under the Code of Procedure’s regulatory scheme, a respondent typically relies substantially on Enforcement’s good faith and diligence in producing documents; in most cases, a respondent will never know what documents Enforcement has withheld.”[1]


Given this, is not surprising that the Hearing Officer called FINRA’s document debacle “disconcerting,” explaining that

  • FINRA utterly blew its Rule 9251 obligations;
  • It violated the terms of the Case Management and Scheduling Order;
  • It missed the production deadline by a whopping eight months;
  • It didn’t acknowledge the production failure until the hearing was nearly over;
  • The volume of missing documents was “staggering”;
  • The production failure “did not result from a single cause, but from a combination of miscommunications, misunderstandings, and other errors”; and
  • The missing documents were potentially exculpatory, but, at a minimum, were relevant to Mr. Larson’s defense.

Despite all this, the Hearing Officer took no action against FINRA.  Nothing.  No dismissal.  No sanction.  Why?  Because he basically concluded that FINRA didn’t intend to screw up, and that it was all an innocent mistake:  “Enforcement [did not] engage in willful misconduct, bad faith, or . . . otherwise act contemptuously.”  Guess what?  When respondents make this same argument in the defense of an 8210 claim, they are laughed off by FINRA.

The Hearing Officer also noted that “Enforcement admitted it made a mistake in not producing the omitted documents,” and deemed this admission to be important to his ruling.  I can assure you, as a respondents’ counsel, FINRA could care less if my client is willing to admit that a “massive,” eight-month-late production was a “mistake.”  The sanction would undoubtedly be harsh; after all, intent is not an element that FINRA needs to prove in an 8210 case.  It would be unheard of to suggest that there would be no ramifications for a respondent who mistakenly failed to produce 30,000 emails, as was the case here for FINRA.

The Hearing Officer also put a lot of stock in the fact that he granted a four-month continuance in the hearing to allow Mr. Larson to review the late-produced documents, asserting that somehow this “eliminated, or at least substantially mitigated” any prejudice to Mr. Larson.  At best, this is an arguable point, not nearly the dispositive issue it is made out to be.  Prejudice is in the eyes of the beholder, and I doubt Mr. Larson would concur that he was not prejudiced by this delay in the hearing.

If anyone ever has any doubt that the deck is stacked against you in a FINRA Enforcement case, or that FINRA rules only work to the detriment of the members, just read this Order.  FINRA completely blew its deadlines by months, omitted tens of thousands of documents that should have been produced, and yet, because it was a mistake and not intentional, and because it admitted its mistake, the Hearing Officer essentially concluded “no harm, no foul.”  Respectfully, I humbly suggest that if the roles had been reversed, Mr. Larson would never have received the same treatment.  And there are dozens and dozens of former reps who have been barred for 8210 violations involving way fewer documents, way less delay, with an equal lack of intent, who will attest to this.

[1] I blogged – here – about the unfairness of Rule 9251 – that a respondent is essentially forced to rely on representations by FINRA that it has produced all the required documents – a couple of years ago.

Don’t Let The Revolving Door Hit You In The Butt

Posted in FINRA, Rule 9141, SEC

There has been a lot of talk, especially given the relatively recent change in the Executive Branch in Washington, about the problem with the “revolving door,” a concept so wide in scope that it actually has its own Wikipedia page.  It is defined to be the “movement of personnel between roles as legislators and regulators and the industries affected by the legislation and regulation.” It happens all the time in broker-dealer world, especially with FINRA and the SEC, where lawyers move back and forth between private practice and the regulator.

The examples are rampant.  Look no further than the current and former Chairmen of the SEC, Jay Clayton and Mary Jo White.  Both came from law firms before taking the reins at the SEC, and Ms. White is now back in the defense business again.  Mary Schapiro, former head of FINRA and then the SEC, is now a consultant to the industry.  Heck, look at me, I started in private practice, worked at NASD for a decade or so, and then returned to my current defense work 13 years ago.  Of course, unlike those others, I was never an officer of NASD, so my career path back to private practice is a bit less interesting, and my thoughts on things of much less import.

FINRA passed a rule about it a few years, even if it is rather a bit tepid in its scope, prompting immediate criticism. Conduct Rule 9141(c), subtitled the “One Year Revolving Door Restriction,” provides that “[n]o former officer of FINRA shall, within a period of one year immediately after termination of employment with FINRA, make an appearance before an adjudicator on behalf of any other person under the Rule 9000 Series.”

The problem with the concept of the revolving door is that it is, basically, unseemly. It is just amazing to listen to some former senior ranking officer of a securities regulator stake out a position that, prior to going through the revolving door, would never have been uttered aloud.  Judge for yourself.  The latest issue of Investment Advisor contains a column featuring comments from Brad Bennett, who recently rejoined Baker Botts after departing from his former job as head of FINRA’s Enforcement Department, a position proudly featured (and rightly so) in his firm bio.  According to the article, when asked about the regulatory burdens that broker-dealers face, Mr. Bennett said these burdens “have not been reduced. It is difficult to comply with the broad array of compliance responsibilities if a broker-dealer does not have scale. . . .  There is no doubt that the regulatory burden is more manageable from a business perspective if you are an investment advisor.”

I am unfamiliar with any remarks that Mr. Bennett – or any other FINRA officer – ever made (at least while still employed by FINRA) (a) admitting that it is hard for broker-dealers to comply with regulations, and (b) suggesting that small firms might be better off leaving FINRA and becoming investment advisors (thus, removing themselves from FINRA’s jurisdiction). The funny part about this is that Mr. Bennett is telling the truth.  I imagine that my clients and I are in practically universal agreement with his new (at least newly voiced0 viewpoint on regulation and compliance.  The problem is, as I suggested, where was this sentiment while he ran Enforcement?  Where was the concession that compliance these days is hard, hard, hard?  Where was the sympathetic ear to pleas of mercy when there was no evidence of intent, no customer harm?  Where was anything other than the heavy hand of Enforcement?  It simply wasn’t there.

I have no doubt that Mr. Bennett, and Ms. White, and Ms. Schapiro, and all the other former officers of FINRA and the SEC are doing just great in their new gigs, and that clients will continue to flock to them to provide the sort of access to their former colleagues at the highest levels of FINRA and the SEC that can often work wonders in resolving thorny problems. And, truly, I wish them all the best.  But, that does not change the fact that the revolving door problem exists as much as it ever has, and that whatever rules or policies have been implemented to address the problem have been ineffective.

Open The Pod Bay Doors: Computers Are Here To Take Your Job

Posted in Compliance, FINRA, Fintech

I read recently that in the not-too-distant future, the practice of law by actual human beings will become a rarity, as computers will take over those jobs, because they will be able to do the work better, cheaper and faster.  Speaking as a lawyer, I find that to be a somewhat troubling prospect.  I mean, this is what puts food on my table and all.  So, given a choice, I would clearly vote “no” on this.

Well, yesterday, I read that all of you compliance personnel will eventually be joining me on the unemployment line. IBM announced that Watson, its super-amazing Super Computer, is now providing Watson Financial Services.  Now you, too, can be replaced by a machine that does your job better and faster.  (I don’t know about cheaper!)  According to IBM, Watson can “[t]ransform your regulatory compliance and surveillance programs by deploying cognitive capabilities that drive the identification and understanding of regulatory requirements, improve your efficiency at addressing compliance requirements, while reducing the risk of misconduct.”

Holy cats, that sounds good. It is all too common in my experience that one of my clients get into difficulty with a regulator (and sometimes with a customer, as well) not because the firm had a lousy supervisory system or deficient written supervisory procedures, but due to good old human error.  Someone appropriately delegated some supervisory function forgets to do it.  Or does it but fails to document it.  Then you get, essentially, what HAL 9000 said in 2001: A Space Odyssey:  “I know I’ve made some very poor decisions recently, but I can give you my complete assurance that my work will be back to normal.  I’ve still got the greatest enthusiasm and confidence in the mission.”  No matter how well intended, and even in the absence of any demonstrable customer harm, human errors like this routinely result is regulatory scrutiny, and possible disciplinary action.

If there is a computer out there that can reduce, or, better, eliminate the possibility of errors like this, I am all in favor it.

The harder question concerns the other kind of thing that gets broker and broker-dealers in trouble: the exercise of subjective judgment. Most FINRA rules (but hardly all) have a reasonableness standard, including most notably the supervision rules.  To be in compliance, all one needs to be able to demonstrate is that he or she acted reasonably.  That means, necessarily, that while errors may not be encouraged, or welcomed, they can be tolerated, at least to a degree.

There are tons of events that occur every single day that call for the exercise of some subjective determination. For example, does this penny stock trade constitute a “red flag” for AML purposes?  Is this structured product suitable for that particular customer?  Would the addition of this business line constitute a material change requiring the filing of a 1017?  Is this letter from the customer a “complaint” that requires disclosure on the RR’s Form U-4.  You get the picture.  Some clients do a very good job of making good, reasoned judgments, based on all pertinent facts and circumstances.  But, sadly, some don’t.  And even if they think they do, they do a poor job of memorializing the analysis and the reasons on which the ultimate conclusion was based.

What I don’t know is whether a computer, no matter how Super it may be, can really be relied upon to make, or even help make, the sort of subjective decisions that compliance and supervisory personnel face every day. But, I feel like as a lawyer, I make a million judgment calls a day, and if a computer is eventually going to take my job away because it can make those calls better than me, then I suppose it is possible that the same is true of anyone who works in the area of securities regulation and compliance.

This is clearly a very interesting development, and merits our attention going forward to see if, indeed, IBM has created a better mousetrap. I suppose that it is only fitting that the press release came the same week that Robert Cook announced FINRA’s Innovation Outreach Initiative, a program that, according to the press release, will “foster an ongoing dialogue with the securities industry that will help FINRA better understand financial technology (fintech) innovations and their impact on the industry.”  The impact that technological innovations will have on the securities industry is obvious; it is just a matter of how much and when, not if.

As long as this doesn’t turn into HAL 9000, or Skynet, or Nomad.  If that happens, please beam me up.

Rogue Brokers: The Numbers Do Not Tell The Whole Story

Posted in FINRA, Registered Representative, Rogue rep

Not too long ago, I blogged a couple of times about the amount of attention that is suddenly being paid to the number of registered representatives with disciplinary histories working for FINRA member firms, i.e., the so-called recidivists (who used to be called “rogue reps”).  Among the complaints I voiced was the fact that while FINRA is, and has always been, well aware of this fact, it is seemingly acting as if this is somehow a newsflash, something just discovered that needs to be dealt with right away!

Well, today I ran across a fascinating article in Reuters that not only backs up my argument, but does so based on its own analysis of empirical data drawn directly from BrokerCheck.

What Reuters did was identify particular 12 disclosure events (of the 23 they say potentially appear in Brokercheck) – supposedly the 12 “most serious” disclosures – and then see how many RRs at each FINRA member firm have such disclosures on their CRD records. I cannot imagine the amount of work that this endeavor took, since, as the article points out, it is not possible to run a “bulk” search in BrokerCheck, but I am thankful for the coders that managed to pull it off.

According to their results, and assuming that they are correct, there are a lot of broker-dealers out there with a lot of RRs with disclosures, all still merrily working in the industry. Indeed, based on its study of BDs with 20 or more RRs with disclosures made between 2000 and 2015, Reuters found a total of 48 firms that had 30% or more of their RRs with at least one of the 12 disclosures; at 14 of those firms over 50% of the RRs had disclosures.

Now, I am not saying that each of those 48 firms should be branded a “bad” firm; indeed, several are my clients, and I will be the first one to attest that they are not at all bad, and that hiring an RR with a mark on his record is not something should, in isolation, invite regulatory scrutiny. The current law permits individuals with disclosure histories to continue to work in the industry, and broker-dealers are free to hire them.

That underscores the point I made in my earlier blog posts: FINRA knows who these firms are. Not surprisingly, because FINRA owns the database that Reuters examined, FINRA is already well aware of its contents, including those firms that hire a high percentage of RRs with disclosures.  Interestingly, FINRA admitted as much to Reuters.  The article quotes Susan Axelrod, FINRA’s executive vice president of regulatory operations, as having said, “Let’s just say those are not new names to us,” when confronted with a list of the firms identified by Reuters.

But, armed with that knowledge, FINRA still, largely, has does nothing that changes the fact that having a disclosure event, even multiple disclosures, simply does not prevent someone from working for a broker-dealer. At a speech he gave this very week, Robert Cook, FINRA’s CEO, addressed this subject:

We are also asked why firms or individuals with a regulatory history are allowed to remain in the industry in the first place. On the one hand, I share the desire to be aggressive in this space and to address recidivist misconduct promptly—and we need to make sure we are doing all we can.  On the other hand, like other regulators, FINRA does not—and should not—have unfettered discretion. Formal action to bar or suspend a broker requires satisfying procedural safeguards established by federal law and FINRA rules to prevent enforcement overreach by regulators (including FINRA) and to protect the rights of brokers to engage in business unless proven guilty of serious misconduct. Those safeguards include the right to defend oneself before a hearing panel and the right to appeal to FINRA’s National Adjudicatory Council, the SEC, and ultimately the federal courts.

In addition, federal law and regulations define the types of misconduct that presumptively disqualify a broker from associating with a firm, and also govern the standards and procedures FINRA must follow when a broker who was found to have engaged in such misconduct applies to re-enter the industry. These requirements, which are complex and beyond what I can address today, impose significant constraints on FINRA.   I do not mean to profess that we are perfect—we must continually work to improve our programs within these constraints to protect investors, while doing so in a manner that is transparent and fair to those involved.  A critical factor in ensuring that we are meeting this objective is the comprehensive SEC oversight that occurs with respect to our regulatory programs, including the standards and processes governing our examination, enforcement, sanctions, and adjudication activities.

The bottom line comes down to this. First, data simply do not tell the whole story.  Just because a firm has a number of RRs with “dings” on their record is not a reason in and of itself to conclude, or even suggest, that the firm represents a particular threat to the investing public.  FINRA correctly recognizes this.  Second, FINRA’s hands are tied when it comes to its ability to address quickly those firms that it does determine to be bad.  In FINRA world, as elsewhere, people (and firms) are presumed to be innocent.  FINRA has the burden to prove misconduct, and that is not always easy, or quick, to accomplish.

Finally, regardless of whatever significance you ascribe to the data the Reuters analyzed, FINRA should quit acting like the sky is falling. This is, as I have said, old news.  Perhaps it is new to Senator Elizabeth Warren, but rather than scrambling to do something – anything – to appease her and others in Congress critical of the job FINRA is doing, FINRA ought instead to educate them about the rules, the regulations, the laws that govern broker-dealers, none of which permit the sort of mass, summary revocations that the politicians seem to be contemplating.  It is time for FINRA to stand up for its members – the overwhelming majority of whom are, in fact, good – and defend them for a change, instead of rushing to jump on the recidivist bandwagon.

The Financial Choice Act — Much Ado About Nothing

Posted in Dodd Frank

While most of DC was watching the Comey hearing, the House of Representatives passed the Financial CHOICE Act, which would significantly alter the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act. Dodd-Frank created the Consumer Financial Protection Bureau (CFPB).

The Financial CHOICE Act passed the House with a vote of 233 to 186; a vote straight down party lines with the exception of one Republican who voted against the bill. However, there is little chance of the bill surviving a Democratic filibuster in the Senate. To survive a filibuster, it takes 60 votes to proceed to a vote on a bill. Currently, the GOP has 52 seats in the Senate, which would require 8 Democratic Senators to vote with the GOP. Rather than face these numbers, the Senate will likely draft a companion bill, with the same intent to reform Dodd-Frank.

As passed in the House, the CHOICE Act seeks to reform the Dodd-Frank Act, but does not completely change the consumer protection landscape. Instead, the Financial Choice Act seeks to limit regulations aimed at supervising financial institutions. Specifically the CHOICE Act looks to provide an alternative to banks who maintain higher levels of capital, thus avoiding additional regulations. The Dodd-Frank Act supervised financial institutions, with particular focus on banks deemed “Too Big to Fail” and non-bank financial institutions who were deemed as “systematically important.” Further, it would ease some of the regulations that currently apply to smaller financial institutions, such as credit unions and community banks. The CHOICE Act would also repeal the Volcker Rule and the Fiduciary Rule, which would require retirement advisors to put their clients’ interests before their own.

As passed by the House, the CHOICE Act also restructures the CFPB from a bureau to a consumer law enforcement agency, subject to the congressional appropriations process. This change would also permit the President to fire the head of the CFPB at any time and without reason. The constitutionality of a bureau with a director who can only be removed for cause was one of the key issues in the PHH Case, which was argued to the U.S. Court of Appeals for the D.C. Circuit on May 24th. If the director of the CFPB or a consumer law enforcement agency can be removed without cause, the director would follow the policies and priorities of the President, which could change every election cycle.

Until the Senate drafts and votes on a companion bill or votes on the CHOICE Act, Dodd-Frank and all its regulations remain. With the current makeup of the Senate, it remains risky to attempt to predict the outcome of reform efforts.

FINRA Provides The Blueprint For Monitoring Outside Business Activities

Posted in Disciplinary Process, Disclosure, Enforcement, FINRA, Outside business activities

Outside business activities are in the news. In Reg Notice 17-20, FINRA announced that it was seeking comments in an effort to learn whether or not the existing rules governing OBAs are effective.  (The comment period is open until late June, so if you have strong feelings on the subject, now is the time to speak up!)  It’s an interesting question, but, in my long experience, the effectiveness of the rules will always be dubious for the simple reason that it is impossible to prevent undisclosed outside business activities, or, worse, undisclosed private securities transactions.  It doesn’t matter how many times a firm asks its reps to make those disclosures, how dire the potential consequences for not making those disclosures, how many Enforcement cases FINRA brings, or how simple the rule is to understand, the fact is, reps have been failing to disclose OBAs since, well, forever.

I can understand why, however. In some (rare) instances, it is because somehow, despite being peppered with constant requests to disclose, beginning with the initial hiring process, a rep may fail to appreciate that something he is doing away from the firm actually constitutes an OBA.  In most cases, however, a failure to disclose is as result of the fact that the rep simply doesn’t want his firm to know what he’s doing.

Given that OBAs are impossible to prevent, it is especially frustrating when FINRA concludes – and it happens often enough – that not only did a rep violate the OBA rule, but the broker-dealer with which the rep is associated is also guilty, specifically for not having done enough to detect the undisclosed OBA. The operative question is, what is enough?

Today, in a FINRA Enforcement decision issued by a hearing panel against Jim Seol,[1] FINRA was kind enough to answer that question. While Mr. Seol was permanently barred for not disclosing his extensive outside business activities, his broker-dealer – Ameriprise Financial Services, Inc. – was not only not named as a co-respondent, but was essentially commended for the scope of the efforts it took to try to get Mr. Seol to disclose his OBAs.  The hearing panel concluded that because Mr. Seol failed to disclose his OBAs after being subjected to everything Ameriprise did, his failure had to be intentional, thus meriting the bar.

What did Ameriprise did here serves as excellent guidance to understanding just how far a broker-dealer needs to go to satisfy FINRA that its efforts to monitor OBAs are effective. Let’s look at them.

  • As one might expect, under Ameriprise policy, Mr. Seol was required to disclose and obtain prior approval from the firm before commencing any outside business activities, including any business ownership or business appointment, regardless of whether compensation was being received.
  • To that end, like most firms, Ameriprise had Mr. Seol execute an Annual Compliance Questionnaire asking about his OBA. Here, Mr. Seol failed to disclose his OBA in February 2012, February 2013, and February 2014.
  • Beginning in at least 2011, Mr. Seol’s supervisor at Ameriprise conducted annual site inspections of Mr. Seol’s office. These in-person site inspections included a detailed review of the operation, function, and management of Mr. Seol’s office.
  • During each site inspection, the supervisor conducted an extended interview with Mr. Seol to understand his business and any issues that may have impacted the operation of the branch.
  • During the interviews, the supervisor reviewed with Mr. Seol the annual attestations he
  • submitted to Ameriprise.
  • Among the attestations reviewed was Mr. Seol’s representation that he had no outside business activities.
  • The supervisor made sure Mr. Seol had “a good understanding” of what the question called for, and confirmed that the representation was accurate.
  • The supervisor “educate[d]” Mr. Seol, ensuring that he was “familiar with what needs to be disclosed – if you have any businesses, if you have any outside activities like being on a board.”
  • During the interview, the supervisor “would not only ask if he was involved in any kind of outside [activities],” he would also inquire as to “how [he] was making his money, what’s he doing, is he focusing in on his practice, has he been out of the office.
  • In addition to these annual visits by Mr. Seol’s supervisor, the firm’s compliance department also routinely inspected Mr. Seol’s branch office. In 2012, 2013, and again in 2014, a compliance inspector traveled to Mr. Seol’s office for an in-person review.
  • Importantly, some of these were unannounced, and included a detailed and careful review of all aspects of the operation and function of Mr. Seol’s office.
  • In her interviews with Mr. Seol, the compliance inspector confirmed that he had access to the firm’s compliance manual and was familiar with the firm’s policies.
  • The inspector confirmed that Mr. Seol understood that an outside business activity was required to be disclosed whether or not he was being compensated for that activity.
  • She explained that both Ameriprise policy and FINRA rules required him to disclose and obtain prior approval for all OBAs.
  • She also reminded Mr. Seol about his obligation to update his Form U4 to include any outside business activities.

Despite all that, Mr. Seol nevertheless falsely represented to Ameriprise that he had no outside business activities, over and over again.

Ameriprise deserves commendation for the amount of effort it expended in reminding Mr. Seol of his obligations regarding OBAs, and working to ensure that it gave him every opportunity to meet them. That effort was neither cheap, quick, nor easy.  But, that is the kind of supervision that FINRA expects to see from member firms.  I’d say that Ameriprise has provided a blueprint for everyone to follow to avoid being ensnared in an Enforcement action when an RR conceals an OBA. Ignore this lesson at your own peril.


[1] The decision is subject to being appealed by Mr. Seol.

How The Fiduciary Rule May Impact Outside Business Activities

Posted in annuities, Fiduciary duty, Fiduciary Rule, Fiduciary Standard

Because fixed annuities and fixed life insurance are not securities, many broker-dealers treat the sales of these products by their registered reps as outside business activities. In that event, there is no obligation by the BD to supervise those sales, and they can be run directly with the issuing company and not through the broker-dealer.  While this may mean the firm loses out on some[1] or all of the commissions the RRs earn on those sales, that fact is tempered by the elimination of a whole host of oversight obligations by the BD which would be time-consuming and expensive.  Perhaps even more important, by not having any supervisory obligations — obligations which could, at least theoretically, subject the firm to potential liability in the event a customer claimed he or she was damaged as a result of a firm’s failure to meet them — the firm minimizes its risks on fixed annuity sales.

Well, this approach may not be viable much longer. Among the requirements of the DOL’s new fiduciary rule – effective on January 1, 2018, not this Friday, happily (and assuming that the President doesn’t do something to delay, or simply eliminate, the institution of the rule) – if a firm wants to charge commissions on the sale of these products is the execution of a contract between the customers and a “financial institution.”  In that agreement, the financial institution must represent that it is a fiduciary, and that it is acting in the customer’s best interest, among other things.

Going forward, then, broker-dealers which up to now have allowed sales of these fixed products to be handled as OBAs may be forced to sign off as the “financial institution” if they want to continue to offer these products. The bad news?  They won’t be able to treat them as OBAs anymore, and will have to take on the many supervisory obligations relating to these sales that they formerly disclaimed.  The good news?  The BDs will be able to get paid for that supervisory work through a split of the commissions paid to the selling rep.

So, the question for broker-dealers is whether this additional revenue will be worth (1) the costs associated with these new supervisory efforts, and (2) the risk (of potential liability for not supervising adequately) these sales present. Frankly, there may not be any choice involved, if BDs want to continue selling these popular products and charging commissions for doing so.

An additional concern, although it is difficult to gauge how big of a deal it might be, is how the sales force may react if, going forward, they will now have to split commissions with the BD, commissions that, in most cases, they presently keep entirely for themselves. I imagine that most reps will have no problem sharing commissions if it means that they can rely on their BD to backstop their sales efforts, but I cannot say for sure that this will be the universal reaction.

As the clock ticks down to the effective date of the fiduciary rule, firms large and small are going to have to take a very close look at their existing business model, including products that, like fixed annuities, aren’t even run through the firm. Regulators, historically, have been less than forgiving regarding compliance with new rules, no matter how significant a change they represent, when such rules have been the subject of intense public comment, as has clearly been the case with the fiduciary rule.  “I didn’t realize” simply won’t cut it as an excuse for failure to meet the new requirements.

[1] Even when these non-securities are sold as OBAs, BDs can still get paid for the efforts they make, even though those efforts are not, technically speaking, supervisory in nature.  But, the lion’s share of the sales commissions go to the selling reps.

Where’s The Beef? The SEC Complains That Filing A SAR Isn’t Enough If It Skimps On Details

Posted in AML, Compliance, Enforcement

Many of my clients chafe at the AML rule, given the cost of compliance and the even higher cost of defending an Enforcement action if the regulators conclude that red flags were somehow missed, or spotted but not dealt with adequately, or soon enough, or both, or spotting the red flags, responding to them, but not memorializing those efforts sufficiently.  In short, there are a lot of ways to trigger an AML problem.

A common source of annoyance is when firms find themselves having to defend a decision not to file a SAR, a Suspicious Activity Report. They insist that what FINRA, or the SEC, or FinCEN, deems to be a red flag consistent with money laundering is, in fact, something innocent, and not suspicious once you understand the underlying facts.  But, those can be difficult, and expensive, arguments to make, and even harder and more costly to win.  So, many firms simply say it’s easier not to fight City Hall, and just go ahead and file SARs even if they believe that nothing truly suspicious happened, with the thought being that you can’t get in trouble for filing a SAR, as opposed to what can happen if you don’t.

Well, not so fast. Today, the SEC filed an AML complaint in federal court against Alpine Securities Corp., and the problem is not that Alpine failed to file SARs in the face of suspicious activity, but that it did file SARs – hundreds of them – and left out the juicy parts.  According to the complaint,

Alpine filed hundreds of SARs that omitted material information that was in Alpine’s possession and was required to be reported pursuant to Alpine’s BSA Compliance Program, which incorporated FinCEN guidance, the SAR Form instructions, and the regulations implementing the BSA. Many SARs identified no suspicious activity at all.  Even when Alpine reported some suspicious activity in some of its SARs, it systematically omitted other known material information in such a way that the SARs deprived law enforcement, regulatory, and intelligence consumers, including the Commission, of valuable and timely intelligence and undermined the very purpose for which BSA obligations are imposed on financial institutions.

What did Alpine omit? According to the complaint,

  • Hundreds of instances in which its customer had prior or ongoing financial fraud charges;
  • Approximately 100 instances in which the issuer was previously a shell company, or had filed for bankruptcy, or frequently changed its business;
  • Approximately 100 instances in which the ticker being deposited was the subject on an ongoing promotional campaign;
  • Approximately 100 instances in which its customer was a foreign financial institution; and
  • Dozens of instances in which its customer was depositing millions or billions of shares of a security that had little or no previous trading activity, and dozens more instances in which the issuer could not be verified as an operating entity.

The lesson here is clear and unmistakable: it is not enough merely to file a SAR because it’s easier than not filing and then having to justify your decision not to file.  Rather, if you do file a SAR, you have to provide enough detail to make clear what, exactly, was suspicious.  In the complaint, the SEC was kind enough to cite to guidance that FinCEN has provided regarding the content of SARs:

FinCEN’s guidance to broker-dealers instructs SAR filers to “identify the five essential elements of information—who? what? when? where? and why?—of the suspicious activity being reported” and to include “a summary of the ‘red flags’ and suspicious patterns of activity that initiated the SAR.”  See FinCEN, Guidance on Preparing A Complete & Sufficient Suspicious Activity Report Narrative (November 2003) at pp. 3, 7.  FinCEN guidance also states that “SAR narratives should describe, as fully as possible, why the activity or transaction is unusual for the customer, taking into consideration the types of products and services offered by your industry and the nature and typical activities of similar customers. Explaining why the transaction is suspicious is critical.”  See FinCEN, Suggestions for Addressing Common Errors Noted in Suspicious Activity Reporting (October 10, 2007) at p. 2 (emphasis added).  FinCEN guidance regarding SARs further states: “In answering this question, a filer should describe why the transaction is unusual for the customer or why the activity created a red flag for the filer or triggered an alert within their system.” See FinCEN, The SAR Activity Review, Trends Tips & Issues, Issue 22 (October 2012) at p. 40 (emphasis added).

Thus, if you really believe that it’s easier to file a SAR than not doing so and risking having your decision-making process subjected to close scrutiny, then be sure your SARs contain the necessary information to make them meaningful. Otherwise, you may be worse off than if you hadn’t filed in the first place.

Does FINRA Give Credit For Self-Reporting Problems? It Says It Does, But….

Posted in Disciplinary Process, Enforcement, FINRA, Reg Notice 08-70, Sanctions, Settlements

I read a fascinating piece the other day in BankInvestmentConsultant about FINRA’s Enforcement program, specifically about the notion of broker-dealers self-reporting problems, and whether that was a smart thing to do.  Some of the quotes attributed to FINRA senior Enforcement management are really interesting, so I wanted to share them with you in the event you missed this article.

In January 2010, the SEC launched a formal program that outlined specific benefits available to individuals and firms who self-report, and self-remedy, problems.  Done correctly, such cooperation can result in fewer charges and lesser sanctions, sometimes dramatically less.  There are plenty of examples of cases where the respondent’s cooperation was explicitly cited – favorably cited – as the reason that sanctions were mitigated.

By comparison, FINRA has no such formal program. Instead, it issued fairly vague guidance, back in Regulatory Notice 08-70, that suggested “extraordinary cooperation,” examples of which were provided, could possibly influence “the sanctions [FINRA] will seek in the context of settlement discussions that precede the filing of a formal disciplinary action.”  Perhaps the vagueness is a function of the fact that FINRA Rule 4530 requires that firms promptly report when they have a problem, at least serious problems.[1]  Thus, there really is no question whether or not a firm should self-report, because there is no option not to do so.

But, clearly, there is a difference between, on the one hand, simply making a 4530 report and, on the other hand, going beyond that and doing the sorts of things that would get you cooperation credit from the SEC, or which FINRA has identified as being “extraordinary.” So, the real question is, is it in a firm’s best interest to exceed the simple 4530 requirements in an attempt to get some credit from FINRA?

According to the article in question, the answer is yes. The reporter there wrote, “FINRA’s enforcement officials are willing to cut a break for firms that demonstrate ‘extraordinary cooperation,’” citing comments from Jessica Hopper, a senior vice president with FINRA Enforcement. The reporter continued, saying FINRA “is urging firms to take the difficult but important step of informing the regulator when they detect serious compliance failures.”  Here is where it gets good.  “Doing so, [Ms. Hopper] said, not only fulfills a firm’s regulatory responsibilities, but it can also mean the difference between a slap on the wrist and a steep fine, should the infraction elevate to an enforcement case.”

This sounds amazing, admittedly. I just wish it was true.  But, the notion that FINRA would choose to slap a firm on the wrist rather than crush a firm with sanctions simply because the firm self-reports a “serious compliance failure” is incredible, i.e., not credible.  Granted, there have been a number of cases since 08-70 in which FINRA acknowledged that the respondent demonstrated “extraordinary cooperation,” resulting in some diminution of the sanction.  Indeed, in July and October 2015, FINRA historically imposed no fines on several firms in two very large group settlements involving mutual fund overcharges because the firms “were proactive in identifying and remediating instances where their customers did not receive applicable discounts.”  But, in those cases, the firms voluntarily paid their customers almost $50 million in restitution.  How many broker-dealers have the ability to do that, if that’s what’s considered “extraordinary cooperation?”  And, if that’s what it takes to get some serious cooperation credit, maybe it would be better simply to get fined.

Back to reality. My clients report to me an extreme reluctance to volunteer to FINRA any discovery of a problem, for fear that FINRA will reward them not with a slap on the wrist but, rather, a full-blown investigation, complete with serial 8210 letters and OTRs, culminating in an Enforcement action and big fines.  To the extent FINRA does give cooperation credit, no one actually expects to get it.  If FINRA truly wants its members to provide extraordinary cooperation, then it needs to do more than talk the talk; it has to do a much better job of making clear that cooperation will materially reduce the scope of an exam, and thus the time and expense of dealing with the exam; increase the likelihood that the exam will not get referred to Enforcement; and significantly reduce any sanctions that may be meted out should the exam go to Enforcement.  If FINRA cannot or will not do that, then it should not be surprised how few firms actually attempt to take advantage of cooperation credit.

The good news, perhaps, is that FINRA appears to have recognized this. The article again quotes Ms. Hopper: “”We’re taking a fresh look at credit for cooperation and how we are going to be handling it.  I don’t think there’s as much clarity as people would like on the credit for cooperation.”  No kidding.




[1] Subsection (b) of the Rule provides that “Each member shall promptly report to FINRA, but in any event not later than 30 calendar days, after the member has concluded or reasonably should have concluded that an associated person of the member or the member itself has violated any securities-, insurance-, commodities-, financial- or investment-related laws, rules, regulations or standards of conduct of any domestic or foreign regulatory body or self-regulatory organization.”  In the Supplementary Material, FINRA explains that it “expects a member to report only conduct that has widespread or potential widespread impact to the member, its customers or the markets, or conduct that arises from a material failure of the member’s systems, policies or practices involving numerous customers, multiple errors or significant dollar amounts. With respect to violative conduct by an associated person, FINRA expects a member to report only conduct that has widespread or potential widespread impact to the member, its customers or the markets, conduct that has a significant monetary result with respect to a member(s), customer(s) or market(s), or multiple instances of any violative conduct.”

Body-Slammed By FINRA, Twice In A Week

Posted in Arbitration, Disciplinary Process, Enforcement, FINRA, PIABA, Rule 9555, Statutory Disqualification

I sometimes (well, perhaps frequently) use this blog as a vehicle to complain about certain things that FINRA does, or about certain of its rules, that I feel are just unfair, plain and simple. To show you that I am not simply making this up, I experienced two such events this past week, which I will share with you, and I dare you to reach a contrary conclusion.

The first arose in connection with a customer arbitration. As every reader here likely knows, broker-dealers are compelled to arbitrate customer disputes.  This is both a matter of rule, but, more importantly, a matter of contract, as an arbitration clause is baked into the customer agreement.  Because arbitration is a matter of the parties’ mutual agreement, for the most part, the Code of Arbitration Procedure provides that as long as the claimant and the respondent agree on something, even if it is contrary to the rules, the panel is compelled to follow suit.  For instance, if the parties both want to extend the cut-off date for serving discovery, or move the 20-day exchange deadline to ten days, then the hearing panel has no choice and must accept these modifications.

The selection of the arbitrators is also a matter of agreement between the parties. FINRA supplies a list of names of potential arbitrators, and the parties each strike those who they simply won’t accept, and rank the remaining names in order of preference.  FINRA then compares the two lists and creates the panel from the three remaining names with the highest rankings.  Thus, the parties dictate who hears their case.

Unless, as happened to me, one of the arbitrators decides to withdraw on the eve of the hearing. Then, FINRA can cram down on the parties anyone it wants to serve as replacement.

To be fair, that doesn’t always happen. Before FINRA picks the replacement, it gives the parties the ability to agree either to (1) proceed with only two arbitrators, or (2) delay the hearing, in which case FINRA will supply the parties a short list of names – three people – from which the parties will select the replacement through the strike-and-rank method.  But, if the parties cannot agree on either of these options, what happens is this: FINRA goes back to the original rankings that the parties submitted at the outset of the case, and starts calling those people, to see if anyone is willing, at the last minute, to jump on a plane.  In my case, the hearing was scheduled to start the Tuesday after Memorial Day, which would have required the substitute to fly out on Memorial Day, so, not surprisingly, FINRA struck out.  Most of the time, no one is available, or willing.

At that point, FINRA simply goes into its giant database of arbitrators, and starts calling anyone who might have nothing on their to-do list for the following week and is actually willing to go hear a case. When FINRA finds someone – and assuming there is no conflict – then, BOOM, that person is appointed to your case.  And the parties have nothing to say about it.  It doesn’t matter how horrible that person may be, you’re stuck with him, or her.

My case was a good one, and we felt we had a good chance of prevailing at the hearing, based on the facts, on the law, and, of course, on the three panelists sitting on the case. When we analyzed the case to calculate the likelihood of winning, and what that meant in terms of a reasonable settlement value, we carefully considered the quality of the arbitrators.  And they were good.  But, when one dropped out five days before the hearing, FINRA ended up appointing as substitute an attorney, who just happened to be a PIABA member, and who just happened to have an award history that was full of big awards for claimants, sometimes with punitive damages included.  He was the type of arbitrator that I would have stricken immediately…had I been given the chance.  But, FINRA gave me no such chance.  As a result, we ended up paying to settle, because we concluded that there was simply no way we could get a fair hearing from this substitute arbitrator that FINRA stuck me with.

It is not easy to explain to a client that this case we were all prepared to try – plane tickets purchased, hotel rooms rented, boxes of documents shipped – had changed dramatically for the worse, at the 11th hour, because of a FINRA procedure over which we had zero control.  THAT is not fair.

The second episode concerns statutory disqualification, one of my favorite subjects for this blog. When an individual becomes statutorily disqualified, the broker-dealer with which he is registered receives a letter from RAD, Registration and Disclosure, advising the firm of the fact that the person is SD’d.  Because associating with an SD’d individual would, in turn, also render the firm SD’d, the firm is given a couple of weeks to make one of three choices: it can terminate the SD’d person, it can file a Form BDW (and withdraw from membership), or, alternatively, it can file an MC-400.  An MC-400 is the application that the firm files seeking permission to remain a member of FINRA notwithstanding the fact that is associating with an SD’d person.  Importantly, while the MC-400 application process is pending, the SD’d person is free to continue to work at the BD.[1]  If the MC-400 is ultimately denied, then, at that point, the firm has to terminate the SD’d person or BDW.

Got it? So, I had a client that had one of its partial owners become SD’d as a result of the fact he got barred, through an AWC.  We knew when he signed the AWC he would become SD’d, but we also knew we could file an MC-400, which would allow him to remain associated with the firm, as a partial owner, while he worked to sell his ownership interest.

So we filed the MC-400. But then, things went weird.  Even though filing the MC-400 allows the SD’d person to remain associated with the broker-dealer, FINRA initiated an “Expedited Proceeding” under Rule 9555.  In short, what that rule says is that FINRA can summarily revoke a firm’s registration within 14 days if it does something which renders it unqualified to be a member.  Here, FINRA alleged that my client was unqualified because it was associating with an SD’d person.


The firm dutifully filed the MC-400, right? So, the SD’d person could continue to associate with the firm while the MC-400 application was pending, right?  Apparently, FINRA decided that is not the case.  Despite the fact that my client did exactly what RAD said it could do to remain a member when it was apprised that the partial owner was SD’d, another arm of FINRA, specifically, Member Reg at the District level, has apparently concluded that it was somehow not enough for my client to rely on that instruction it received from RAD.

Heads, FINRA wins; tails, my client loses. Even when you follow FINRA’s instructions, you can find yourself booted from the industry.  That seems fair…where?  Not in this country.

In politics now, we are at the point where it is impossible to shock people anymore. Insult women with a graphic reference on Entertainment Tonight?  No problem.  Mock a reporter with a disability.  No problem.  Body slam a reporter on the eve of the election?  No problem.  Sadly, I am at the same point with FINRA.  Its actions are past the point of being able to shock or surprise me anymore.  But, as I said at the outset, tell me if you think I am overreacting.

[1] How do we know, apart from experience?  FINRA tells us on its website: “If a person is currently associated with a FINRA member at the time the disqualifying event occurs, the person may be permitted to continue to work in certain circumstances, provided the employer member promptly files a written application with FINRA seeking permission to continue that person’s employment with the member firm.”