Broker- Dealer Law Corner

Broker- Dealer Law Corner

FINRA’s Exam Guidance Is A Big Yawn

Posted in Compliance, Enforcement, FINRA, Supervision

As promised, FINRA has released its first Report outlining common findings from its examinations, in an effort to help member firms comply with the rules and, presumably, avoid problems that other firms encountered.  A noble idea, especially for an entity not exactly known (at least lately) for its proactive measures to assist BDs with their ongoing compliance struggles.  Alas, it’s not clear that much was accomplished.  I was hoping to read something new and noteworthy, but, by and large, we got the same old same old, i.e., the same stuff we see in the annual Exam Priorities letter.  I suppose that this may not be FINRA’s fault, however.  Indeed, it may simply be a function of the fact that no matter what FINRA does to announce the sorts of misbehavior it finds problematic, member firms and their associated persons just continue to repeat the same errors we have always seen.

Take, for example, the part of the Report that deals with OBAs and PSTs, identified as a continuing issue. Well, these have been an issue for firms for, gee, forever.  The rules governing OBAs and PSTs are largely the same as they have been for decades (granted, with some slight modifications found in the Supplemental Material to Rule 3270, requiring an analysis of proposed OBAs to ensure there is no likelihood of confusion).  Yet, not a month goes by without multiple OBA/PST cases being included in the list of finalized Enforcement cases.  How many times do reps need to hear that they need to provide notice of OBAs to their firms?  How many times do firms need to hear that the receipt of selling compensation renders a transaction a PST?  How many times does FINRA need to remind members that their supervisory obligations include not just performing an analysis but memorializing it, as well?

There is a section on AML violations that is similarly full of old news. It starts off with the admonition that “[s]ome firms failed to establish and implement risk-based policies and procedures to detect and report suspicious transactions.”  Granted, it goes into somewhat more detail, but not much, really, not enough to provide true guidance in avoiding problems when the examiners come to visit.  So, what’s the point of the Report?

Truly, the best way to learn what really gripes FINRA is to review the Enforcement actions it files. Helpfully, FINRA makes available on-line all the complaints, the settlements, and the adjudicated decisions.  There is no better view into FINRA’s collective mind – a scary place, indeed – than these documents.  Every compliance issue noted in the Report just released has already been the subject of Enforcement actions, and discussed in much greater detail than in the Report.  Every argument respondents have conjured up to defend themselves against charges of rule violations – including all the usual suspects, like “FINRA examined me three times before this and never said anything about this,” or “no customers complained so what’s the big deal,” or “I’m just a small firm and can’t afford to do all the things you say I should be doing” – are outlined in these cases and addressed (and, unfortunately, but typically, dismissed).  You really want to learn about the problems that firms have encountered selling UITs?  Read the cases FINRA has already brought, not the Report.

With all this said, I don’t want to be too much of a Debbie Downer. I encourage FINRA to be more transparent about its attitude towards enforcement of the rules, and to provide as much advance notice of the standards to which it will hold member firms as possible.  Perhaps this Report is a start; at a minimum, even while not particularly useful, it represents an effort by Robert Cook to honor promises he’s made to members to fix what’s broken at FINRA – which is a long list, to be sure.  As I have said before, his words, while interesting, are not nearly as telling as his actions, and, for the most part, I continue to wait to see action.

FINRA Examiners Are Like A Box Of Chocolates . . .

Posted in Examination, examiners, FINRA, ODA

Michael discusses the differences in examiners — and, potentially — examination results from District Office to District Office.  Remember, however, that such differences aren’t supposed to exist!  That’s why the Office of Disciplinary Affairs exists.  I suppose the question is whether the ODA is doing its appointed task of achieving consistency throughout FINRA. – Alan

My view of FINRA examiners is akin to Forrest Gump’s view on life: FINRA examiners are like a box of chocolates. You never know what you’re gonna get. FINRA examiners vary widely in age, experience, and exuberance. If you get the wrong chocolate from the wrong box, these disparities can adversely impact not only the amount of time and money spent on an exam, but also the results of the exam. While you might not be able to select a new chocolate from a different box, you may be able to make your selected chocolate more palatable.

From Which Box Did Your Chocolate Come?

While most companies with offices throughout the country strive to produce a consistent product, not all of them can accomplish this challenging feat. For example, a chain restaurant at one location may serve better food, offer better service, and provide a better overall experience than the same chain restaurant at another location – no matter how hard the corporate office pursues homogeneity. The different management and staff at each location all impact the overall product. The same is true of FINRA and its 14 district offices.

Certain conduct being reviewed by one FINRA office may be resolved early and informally, while similar conduct being reviewed by another FINRA office may result in multiple 8210 letters, OTRs, and a referral to Enforcement. Because FINRA does not publish information regarding exams resolved through informal disciplinary action, there is no way to measure such discrepancies among its offices. FINRA, however, does publish the results of exams resolved through formal disciplinary action. A review of those statistics reveals consistent and significant differences in the number of formal actions brought by its district offices. It is reasonable to conclude that these differences are attributable, in part, to cultural differences among the offices. Some offices are simply more aggressive than others. Knowing the reputation of the office with which you are dealing can impact how you handle your exam if issues arise.

It is next to impossible in most instances to have your exam transferred from one office to another office. This does not mean that you are without recourse. Knowing and delicately appealing your case to the voices of reason within the office, and, if necessary, delicately appealing your case to those outside the office are both viable options. Do you run the risk of stepping on toes if you appeal up the ladder? Of course you do, but less than you think. FINRA is a very hierarchical organization. Appeals of this nature are commonplace, and are almost invariably heard by the higher-ups. Needless to say, be certain that you have a story to tell about the facts of your situation and/or concrete evidence that your situation is being handled differently than similar situations. You can cry wolf only so many times.

Which Chocolate Did You Get?

I know a number of people who have been FINRA examiners and exam managers for ten-plus years. Most of them are not going anywhere. These “lifers” generally are not looking to rock the boat that they’ve rowed for a number of years, and that they plan to row into retirement. I also know a number of people whose first foray into the workforce was as a FINRA examiner. Generally speaking, these are the examiners with which you need to concern yourself. The key to dealing with younger, less experienced examiners is ascertaining their motivation. Are they simply not understanding and appreciating activity because of a lack of experience or are they bucking for a promotion, looking to use your exam as a means of self-promotion? Unfortunately, there are too many examiners who fall into the latter category because of how the system is set up. I am unaware of any accolades awarded to examiners who close the most exams without pursuing formal action. On the other hand, I know of plenty of kudos bestowed upon, and monetary awards and promotions provided to, those who develop formal actions.

The younger, less experienced examiner may not have a sufficient understanding of how the industry works, and he may mistakenly misinterpret innocuous conduct as nefarious conduct. If that is the case, it is worth the time and energy to educate this examiner to hopefully avoid having the exam spiral out of control. Further, the examiner may appreciate your efforts and openness, and give you the benefit of the doubt on other matters. Unfortunately, I expect that we will see more inexperienced examiners in the coming years. Due to budget constraints, FINRA has cut back on its training program for new examiners. Budget constraints also may lead FINRA to hire more inexperienced examiners who generally are cheaper than their experienced counterparts.

The best way to deal with the overly aggressive examiner typically is to climb the ladder. And you should climb higher than just his manager, who likely does not want to discourage his exuberance – however misplaced it may be. Do not be overly concerned with stepping on this examiner’s toes or the backlash that may follow, as there likely is little that you can do to change his view of the matter, or to prevent him from scorching the earth to build a case against you. Frame your case around the facts of your situation – not the actions of the overly aggressive examiner. FINRA management will defend attacks on its own, but it also likely will know the source of your discontent, as your situation probably is not the first time that this examiner has been accused of going too far.

SEC Decrees That Its ALJs Are Constitutional. Now What?

Posted in Disciplinary Process, SEC

After spending the last few years ferociously denying that there was any constitutional issue with the manner in which SEC Administrative Law Judges (ALJs) were appointed to their position, this morning, the SEC announced that it had “ratified” the prior appointment of each of its ALJs – Murray, Foelak, Elliot, Grimes and Patil.   You can read the SEC order here.  

For anyone who is or was the subject of an administrative proceeding before the SEC, this is a big deal.  Why?  The history of this issue is pretty extensive, and we have offered several prior blog posts on itMost succinctly, the issue is this:  The Constitution sets forth how inferior officers can be appointed.  The SEC ALJs were not appointed using that process.  Respondents in SEC actions have, lately, filed appeals challenging the constitutionality of the proceedings because the ALJs were not properly appointed.  One of those cases has requested certiori by the United States Supreme Court. 

In today’s order, the SEC formally appointed the five ALJs listed above.  That means, that as of today, the five judges are appointed in compliance with the Constitution.  The SEC, it appears form this order, takes the position that this cures any potential issues relating to Constitutionality.  Specifically, the Commission says  that ratification of the judges’ appointments is made with the intent  to “put to rest any claim that administrative proceedings pending before, or presided over by, Commission administrative law judges violate the Appointments Clause [of the United States Constitution].”  The SEC also outright  admits in today’s Order that its action was prompted by the Amicus Brief filed by the Solicitor General of the United States (filed yesterday), urging the United States Supreme Court to consider and resolve the Appointment Clause issue.

What does this mean?  Well, that depends.  If you have not yet, but will in the future, be called to defend yourself in an administrative proceeding before an SEC ALJ, this means your judge has been properly appointed (and you will not have a claim, on appeal, for vacatur of a decision based on the Appointments Clause). 

If you are currently the subject of an ALJ administrative proceeding where the initial decision has not yet been rendered, your judge must re-review the entire record, allow the parties to submit new evidence, re-examine all prior judicial rulings, and issue an order regarding the same.  Your deadlines are tolled until your judge issues this order.

If you have already been before the ALJ and he or she has issued an initial decision and your case is now pending before the SEC, your initial decision is remanded.  Your ALJ must reconsider the record, including all evidentiary decisions and rulings, allow the parties to submit new evidence, review the initial decision, and issue an order reversing or ratifying the same.

If your case has already resulted in an initial decision and a Commission order affirming that decision your decision is…..?  The SEC seems to think this settles the issue, and the Order is silent on such cases (including the many cases on appeal to circuits across the United States).  I’m confident that the petitioners in those appeals will disagree.  I’d wager they will argue that the SEC’s action today, formally appointing the judges in accordance with the Constitution, will be viewed as an admission, by the Government, that it did not properly appoint these ALJs at the start. 

That leaves us with the big questions:  What is the retroactive effect here?  If the petitioners are correct that prior ALJ proceedings were held before an unconstitutionally appointed tribunal, how can that constitutionality be rectified? Does this ratification have any effect on decisions unconstitutionally rendered by prior judges (who are not subject to this ratification Order)? Will the Supreme Court see this as rectification of the issue (mooting the need to hear the case) or an admission by the SEC that it failed to honor the Appointments Clause?

We shall see.  Until then, we anxiously wait to see whether SCOTUS grants cert and then, if they do, the ruling.  While we wait, ALJs have until February 16, 2018 to ratify or otherwise revise their initial decisions and/or prior rulings.  It will be interesting to see what, if any, revisions they make.

 

First Shot Fired In PIABA’s War On The Securities Industry

Posted in FINRA, PIABA

A week or so ago, I highlighted in a post the acceptance speech of PIABA’s incoming president, Andrew Stoltmann, in which he announced his intent to wage “war” on the securities industry. Bluster aside, Andrew has been true to his word.  His opening volley is an attack on the public governors who sit on FINRA’s Board, alleging that some of them have ties to the industry that raise significant conflicts of interest, compromising their ability to serve as public governors.  Indeed, PIABA has published a flashy report – co-authored by a real professor! – that analyzes the data and concludes that FINRA is not meeting its goal of investor protection.

The thing is, I don’t know if PIABA is right about this; frankly, I don’t really care if it’s right. I don’t care if the public members of the FINRA Board do, in fact, have ties to the securities industry.  And that’s because I have had an issue with the composition of FINRA’s Board for a very long time.  Remember, it was not that long ago that FINRA – which, after all, is a “self regulatory organization” – was run by – wait for it – actual members of the securities industry.  Indeed, up until 1996, NASD’s Board was principally and overwhelmingly comprised of people associated with broker-dealers.  While there might have been the occasional public member, there was no requirement that there be any, and they played a minor role.

In 1995, however, Senator Rudman and his Congressional Committee issued their Report scrutinizing NASD’s work, and suggested, among other things, some wholesale changes to the Board.  Then, shortly after that, the SEC issued its infamous 21a Report of NASD, concluding that the regulator had some serious issues, issues that derived from overly cozy relationships between NASD staff and the industry committee members (but only in New York, at the District 10 District Business Conduct Committee, and in DC, at the Market Surveillance Committee). In its effort to appease the SEC and avoid the imposition of any real sanctions, NASD basically capitulated and voluntarily agreed to adopt the Rudman Report’s recommendations regarding the composition of its Board, which included ensuring at least an equal number of public members.

Here’s what occurred to me at the time, and what still bothers me: how can NASD/FINRA truly consider itself to be a self-regulatory organization if the people that run it are not from the very industry it regulates? Many FINRA rules have reasonableness standards.  But, we are not talking reasonableness in the general sense of the word; we are talking what is reasonable for a broker-dealer to do.  Only someone with industry experience is truly capable of making this judgment effectively.  Maybe public governors could have some role in an oversight capacity, to ensure that FINRA is doing its job correctly.  But, to allow public governors to be able to dictate the standards to which FINRA holds its member firms, to decide the direction that FINRA takes its strategic initiatives, well, that is not self-regulation.

The other point to make is that PIABA is nothing if not predictable. Given its druthers, PIABA would remove anyone from FINRA who actually knows anything about the securities industry.  Remember, PIABA is the reason that there is no longer a requirement that there be an industry member on arbitration panels.  It argued to FINRA that somehow, having someone on the panel who knows something about securities created an unlevel playing field, tilted in favor of the respondents.  Naturally, FINRA folded in the face of this pressure (notwithstanding the fact that likely not a single member firm agreed with the argument), concerned that if it did not, Congress would find additional reasons to question the validity of pre-dispute agreements that compel customers to arbitrate their disputes, rather than going to court, which would end FINRA’s virtual monopoly on securities disputes.  So, now I have the pleasure of arguing cases – regardless of their complexity – to panelists who may not know a stock from a bond.

And that is exactly how PIABA wants it. PIABA doesn’t care about the law; it cares about the ability of its members to make panelists feel badly for claimants.  That’s why most arbitrations end up being fights about “fairness,” not about the application of actual statutes or regulations; in PIABA’s world, it is always unfair that a customer incurs a loss, no matter that investments inherently have risks, no matter how robust the risk disclosures may be, no matter the documents that claimant may have signed.

If PIABA is able to remove from the FINRA Board any public member who has the slightest degree of association with the securities industry, imagine the customer-friendly rules that PIABA lobbyists could work towards. Things are bad enough now for broker-dealers: too many rules, too much money to comply, too much Enforcement actions.  The last thing they need is a bunch of Board members who come to the table with the view that any investor who loses money has, necessarily, been the victim of broker misconduct.

 

 

No Bar For Submitting False Expense Reports?

Posted in Disciplinary Process, Enforcement, FINRA, Sanctions

Here is a post from Michael about a recent settlement involving the submission of false expense reports.  The issue isn’t the misconduct, but, rather, the rather tepid sanctions imposed.  Do I sense the pendulum starting to swing back? – Alan

It is no secret that FINRA’s Department of Enforcement is attempting to maintain a lower profile these days, due to the pro-business, anti-regulation sentiment emanating from the White House. This year, the number of disciplinary actions brought, and the amount of fines levied, by FINRA have declined substantially. The number of press releases that FINRA has issued promoting its disciplinary actions this year likewise has declined substantially (25 in 2016 vs. 12 in 2017 so far). This strategy appears to be working, as I am unaware of any late night tweets about FINRA being sent from 1600 Pennsylvania Avenue.

I just read a recent AWC that may (or may not) be the product of this new politically-motivated, but nonetheless welcome, strategy. But first a little context: It has been standard operating procedure that if a rep submits personal expenses as business expenses to his firm for reimbursement, then FINRA will seek to bar that rep, irrespective of the dollar amount involved. Period. No room for negotiation. Indeed, some call this stealing. The argument for the bar being that if the rep tried to pull a fast one on his firm, then he may try to do something similar with his customers’ funds, and therefore, is unfit to be in the securities industry.

FINRA chose to depart from its standard operating procedure for Sandy Galuppo, a former Merrill Lynch rep who allegedly had $1.4 billion in client assets.[1] According to BrokerCheck, Merrill terminated Mr. Galuppo for “conduct including improper submission of personal expenses for reimbursement, resulting in management’s loss of confidence.” According to his AWC with FINRA, Mr. Galuppo “submitted dozens of business expense reimbursement requests that he knew or was reckless in not knowing were not compliant with the Firm’s reimbursement policies.” The AWC further found that “[Mr.] Galuppo’s expense reimbursement requests sometimes described meals with his team members as meals with clients, or personal meals as business meals. In other instances [Mr.] Galuppo also provided his subordinates inaccurate information about the reported attendees at meals,” including a $430 alleged client meal that only he and another Merrill employee enjoyed. Conspicuously absent from the AWC is any mention of the dollar amount of personal expenses for which Mr. Galuppo improperly sought reimbursement. Instead of imposing the standard sanction for this misconduct (i.e., a bar), FINRA allowed Mr. Galuppo to serve a one-year suspension, and to pay a $10,000 fine if he joins another firm. This is a very surprising result not only because of FINRA’s prior and consistent treatment of such misconduct, but also because of the number of instances in which Mr. Galuppo submitted false expense reports.

Hopefully, this newfound leniency is not a one-off result, and it carries over to other matters that do not result in customer harm or impact the integrity of the markets – the two tenets of FINRA’s mission statement. In any event, Mr. Galuppo fared quite well under the circumstances. I certainly will be watching to see if others who submit false expense reports for reimbursement, but who do not have a $1.4 billion book of business or work at a large firm, are afforded the same favorable treatment as Mr. Galuppo.

[1] http://www.investmentnews.com/article/20161128/FREE/161129954/merrill-fires-another-star-broker-this-time-over-expense-account.

 

 

PIABA’s New President Is A Nice Guy, Sure, But He’s Hardly Your Friend

Posted in Arbitration, FINRA, PIABA

I have stated more than once in these posts that among claimants’ counsel, I have perhaps the greatest respect for Andrew Stoltmann, a fellow Chicagoan. I am not saying that I ever agree with anything he has to say, because I don’t, but he is a gentleman, he acts ethically, he is fun to listen to, and his zealous approach to the representation of this clients is legitimate, not feigned, as it is with too many claimants’ lawyers.

But you should know, if you aren’t already aware, that Andrew was just voted in as PIABA’s president, and he is taking no prisoners.

Here is the acceptance speech Andrew made to his fellow PIABA members last week.  If you do nothing else, skip to the 9:18 mark, just to hear him announce, rather remarkably, his “declaration of war on the securities industry.”  If there is anyone out there who thinks customer arbitrations are fun and games, think again.  PIABA is out for blood.  In its world, there is no middle ground: if you are a BD, or work for a BD, you are the enemy, and it will work to take you down.  As they say, to be forewarned is to be forearmed, so take this “declaration” seriously.

Just so you don’t have to listen to the rest of Andrew’s speech – but you should, since if you’ve never heard him pontificate, here is a wonderful opportunity to do so – here are the issues that he identified for PIABA this coming year under his reign:

  • Unpaid arbitration awards: PIABA believes that it is a national crisis that, according to its statistics, 25% of arbitration awards go unpaid. I have written about this before, so I won’t repeat myself, but, in short, I fear this issue is more about PIABA members getting paid than anything else.
  • Adding less educated people to arbitration panels: PIABA apparently believes that FINRA’s standards for allowing people to serve as arbitrators are too strict, and should be relaxed so, say, someone with only a high school education can serve. Well, this is hardly surprising. Remember, PIABA was the group that was responsible for FINRA’s decision to make the industry member of the hearing panel an option, rather than a requirement. For PIABA, the less informed a panelist is about the securities industry and how it works, the less likely the facts will matter to him or her, and the more likely they will be swayed by sympathy and empathy, tools that PIABA lawyers often wield with great skill.
  • Fighting to keep the Fiduciary Rule alive: PIABA is concerned that under the current administration, the Fiduciary Rule will never be implemented, and it wants to prevent that from happening. Again, it is easy to see why, since it is way, way easier to articulate a vague claim for a breach of a fiduciary duty than it is to prove that a particular rule or regulation has been violated.
  • Expungement: PIABA believes that it is too easy and common to obtain expungement, and wants to change that. First of all, I do not agree that it is easy to get expungement. FINRA arbitrators are well aware that FINRA considers expungement to be an “extraordinary remedy,” and appropriately put applicants through the wringer to establish that expungement is correct. Beyond that, it is rather ironic that while complaining about the supposed ease of obtaining expungement, once claimants’ lawyers have their settlements in hand, only very, very rarely do they deign to participate in the expungement portion of the hearing. For the most part, they don’t bother, and, frankly, why should they? They already got their money.
  • Non-attorney representatives: Unless state law prohibits it, a claimant in a FINRA arbitration may be represented by a non-lawyer. PIABA is against this, ostensibly in the interest of seeing that claimants have proper, competent representatives. I wonder, however, if it is simply more about eliminating a source of competition for potential clients? I mean, if PIABA truly cared about the quality of FINRA arbitrations and the fairness of such proceedings, it wouldn’t fight so hard to keep educated, trained people off the panels.

 

 

FINRA In The News, And Not In A Good Way

Posted in FINRA

It has been said that there’s no such thing as bad publicity, but I wonder if FINRA feels that way after having been featured in a number of less-than-favorable, or at least curious, media stories over the last couple of weeks.

First, two weeks ago, Bruce Kelly of Investment News ran a story with this headline:  “Finra Wants To Help The Small Broker-Dealer.”  I figured it was a prank, or maybe Bruce had lost a friendly bet to someone and now had to pay up, like when a Chicago Bears fan has to wear a Green Bay Packers jersey for a day in order not to welsh on a bet with his buddy.  Indeed, one of my clients forwarded the story to me and told me that the headline was so absurd he initially thought he had found the article on The Onion, rather than Investment News.

I am confident that I don’t have to explain why this idea is so funny. FINRA wanting to help small BDs?  Please.  Are we talking about the same small BDs that FINRA is rapidly driving out of business through endless regulatory exams with their countless requests for documents and information and OTRs, thereby driving up the cost of compliance to levels that are impossible to maintain?  Or maybe with its Enforcement actions, which small firms, unlike the wirehouses, are unable simply to resolve by stroking a six- or seven-figure check?

Given what I know to be the truth about what’s happening to small firms, it came as no surprise that only a week after Bruce’s article on FINRA’s supposed desire to help those firms, Investment News published another one, based on statistics released by FINRA, called “Finra’s stats reveal an industry in decline.”  That article was not funny or absurd, but chillingly accurate.  The number of BDs is down, and continues to drop.  Same with the number of branches.  Same with the number of reps.  Really, the only thing that isn’t down is FINRA’s operating budget.

Which leads us to the next two stories. The first dates back to last month, reporting on Robert Cook’s testimony before the House Committee on Financial Services, specifically the Subcommittee on Capital Markets, Securities, and Investment.  Not sure how well that went for Mr. Cook.  Consider this quote by Bill Huizenga (R-MI), the Chairman of the Subcommittee:  “As the primary regulatory authority for broker-dealers, FINRA plays an integral role in ensuring that capital markets are fair and efficient while protecting investors and other market participants. However, critics have noted that for the last decade, FINRA has engaged in mission creep and transformed itself from a traditional SRO into a quasi-governmental regulator more akin to a fifth branch of government, or a ‘deputy SEC.’” According to the Committee’s website, one of two key takeaways from that testimony was this:  “Congress must make sure that FINRA, as a self-regulatory organization (SRO), remains accountable and transparent to those it regulates while being flexible to react and respond to changes in the market.”

The second story, from earlier this week, follows up on that takeaway regarding transparency: “SEC Nominees Jackson And Peirce Blast Finra’s Transparency During Hearing.”  The article captures the highlights of the meeting of the Senate Banking Committee, held to consider the nominations of Robert Jackson and Hester Peirce to the SEC, but you can watch it yourself (start at one hour into the recording for the good stuff), if you are so inclined.  Here is what Ms. Peirce had to say about FINRA, small BDs, and transparency in response to a question posed by Senator Rounds on behalf of the Committee:

“I do think that FINRA needs to be reviewed.”

“I worry about transparency, too.  I’ve heard from small firms that have concerns about their ability to be heard by FINRA.”

“We’re seeing the number of small firms drop pretty dramatically and so one has to ask, is that related to the fact that the regulatory burden is not properly calibrated.”

“We want to make sure the communications between FINRA and its regulated entities is such that when someone sees something bad happening in the industry, they can go to FINRA without being scared that that’s going to train FINRA’s attention on a firm that’s fully compliant and doing things well.”

“I worry that the atmosphere now is one of . . . you keep your head low and you do your thing and you’re not even willing to raise issues when you see real fraud happening.”

Mr. Jackson echoed her concerns about transparency, although he was more focused on how well FINRA has publicized the number of registered reps who are still working in the industry despite multiple disclosures on their records.

Is it any wonder that small BDs are an endangered species? Even potential SEC Commissioners whose nominations have yet to be approved are already well aware that FINRA doesn’t listen to such firms, that it is out of touch with small BDs, who are literally afraid of being regulated out of business by FINRA.  All this despite Mr. Cook’s “listening tour” and his “FINRA 360” initiative.  I remain hopeful that something will change, that there will come a time when I run across a headline like Bruce’s that touts FINRA’s support of small BDs and not laugh out loud.  But, clearly, we are not there yet.  FINRA has a long way to go to gain the trust and confidence of the small member firms that it regulates, and it will take actions, not words, to make that happen.

This Case Could Mean An End To Bars And Suspensions…Maybe

Posted in Disciplinary Process, Enforcement, FINRA, Sanctions, SEC

Bear with me here as I relate the tale of John Saad and his tortuous path through the FINRA Enforcement process and, ultimately, the court system. It is worth following me on this journey, as the upshot of the story is that FINRA, which is so quick to want to bar every respondent it sees, may have to change its ways.

Mr. Saad was barred by FINRA for misappropriating his employer’s funds on two occasions. He accomplished this by submitting false expense reports.  Mr. Saad appealed to the SEC, which affirmed FINRA’s decision.  From there, he then appealed to the U.S. Circuit Court of Appeals for the D.C. Circuit, what has been characterized as the nation’s second highest court.  The Circuit Court remanded the case back to the SEC because the Commission’s analysis of the FINRA decision “failed to address potentially mitigating factors, such as Saad’s termination by his employer and Saad’s personal and professional stress.”  The Court “left open the question whether the lifetime bar was an ‘excessive or oppressive’ sanction, noting that the Commission had an obligation on remand to ensure that its sanction was remedial rather than punitive.”

The SEC, in turn, remanded the case back to FINRA, specifically to the NAC, to reconsider the imposition of a bar on Mr. Saad, particularly in light of certain claimed mitigating evidence that he cited, namely, the fact that he was disciplined – i.e., terminated – by his BD before the regulators detected the issue, and that he was under personal and professional stress, which may have led to his poor decisions.

The NAC concluded that while prior discipline by a BD “may be mitigating,” in this case, it was not. It also found that Mr. Saad’s stress levels were not mitigating, either.  Accordingly, the NAC concluded, again, that he deserved to be barred, and the SEC agreed, concluding that the bar was “remedial, not punitive,” and “necessary to protect FINRA members, their customers, and other securities industry participant[s].”

Mr. Saad appealed, again to the Circuit Court, arguing that the SEC “failed to give his mitigating evidence sufficient heed.” The Court disagreed:

  • Getting fired by his BD for his misconduct “carried little weight” because Mr. Saad repeatedly lied to his BD about what he had done in an effort to mislead.
  • His claims of “stress” were uncompelling because his conduct “was not a momentary or impulsive action driven by stress, but instead involved ‘deceptive conduct demonstrate[ing] a high degree of intentionality over a long period of time.’”
  • It did not matter that Mr. Saad misappropriated firm funds, rather than customer funds, since the “threat [to the integrity of the securities industry] remains the same whether the victim is a trusting employer or trusting client.”
  • Mr. Saad’s otherwise clean disciplinary record was irrelevant, as “individuals in a profession that depends critically on public trust and honesty are already expected to have a clean record, so it is not something for which they get extra credit.”

But…and here, finally, is the point of this blog post…the Court remanded the case back to the SEC – again – to answer the question whether the permanent bar imposed on Mr. Saad was “impermissibly punitive” in light of the Supreme Court’s recent decision in Kokesh.  As students of the industry are undoubtedly aware, in Kokesh, the Supreme Court ruled that disgorgement paid by a respondent to the Government as a sanction imposed by the SEC was a “penalty,” and therefore subject to a five-year statute of limitations, overturning a line of cases that had concluded that disgorgement was remedial and not punitive.

The Supreme Court’s reasoning was logical:

  • Disgorged money paid to the Government does not go to victims;
  • Disgorged money also is not limited to the amount of harm to victims;
  • Both of these would need to be true for the sanction to be “truly remedial rather than punitive.”

As the concurring opinion[1] pointed out, the courts’ “use of the term ‘remedial’ to describe expulsions or suspensions finds its roots in a single, unexplained sentence in a 77-year old Second Circuit case.”  But that conclusion does not make sense in light of the bullet points above.  As the court put it,

Like other punitive sanctions, expulsion and suspension may deter others from and will necessarily deter and prevent the wrongdoer from further wrongdoing. Expulsion and suspension may thereby protect the investing public.  But expulsion and suspension do not provide a remedy to the victim.  Under any common understanding of the term ‘remedial,’ expulsion and suspension of a securities broker are not remedial.  Rather, expulsion and suspension are punitive. . . .  Like disgorgement paid to the Government, expulsion or suspension of a securities broker does not provide anything to the victims to make them whole or to remedy their losses.  Therefore, in light of the Supreme Court’s analysis in Kokesh, expulsion or suspension of a securities broker is a penalty, not a remedy.

The concurring opinion was quick to point out that it did not mean “to suggest that FINRA lacks power to impose punitive sanctions such as expulsions or suspensions.” But, the unanswered question, the one that was remanded back to the SEC, “is whether the lifetime expulsion of Saad – what our prior opinion in this case called the ‘securities industry equivalent of capital punishment” . . . – was a permissible and appropriate penalty under the relevant statutes and regulations.”

What will this mean going forward? According to the concurring opinion, FINRA and the SEC

will have to explain why such penalties are appropriate under the facts of each case. FINRA and the SEC will no longer be able to simply wave the ‘remedial card’ and thereby evade meaningful judicial review of harsh sanctions they impose on specific defendants.  Rather, FINRA and the SEC will have to reasonably explain in each individual case why an expulsion or a suspension serves the purposes of punishment and is not excessive or oppressive.  Over time, a fairer, more equitable, and less arbitrary system of FINRA and SEC sanctions should ensue.

There is no guarantee that Mr. Saad’s case will change anything, but it is nice to dream of a world where FINRA and the SEC will actually have to justify suspending and barring people. A “fairer” and “more equitable” system, wow, sounds too good to be true.

[1] It is worth noting that in addition to the concurring opinion, one Judge authored a lengthy and thoughtful “dubitante” opinion, i.e., one that expresses “deep doubts” about the majority’s decision to remand the case back to the SEC.  Even though it is not a true dissenting opinion, the Judge nevertheless went along with the majority.

FINRA’s Heavy Hand Questioned…By FINRA

Posted in Defenses, Disciplinary Process, Enforcement, FINRA, Rule 2010

I am on the record, many times, with my belief that, at least in theory, FINRA should never lose any Enforcement cases it files. This is for the simple reason that if FINRA has any genuine doubts about its ability to prevail in front of a hearing panel, due to the quality of the evidence that’s been gathered, it doesn’t have to file a complaint; rather, it can just settle the case cheaply and/or charge respondent with a more benign rule violation.  Given this dynamic, it is easy to understand why FINRA generally does not lose Enforcement cases.  Sometimes, however, it does.  These occasional decisions typically provide some lesson to be learned in how to defend a FINRA complaint; and, if they don’t, at least they provide the opportunity to celebrate a respondent’s victory.

Last week, Stanley Clayton Niekras, a former registered rep, managed to beat FINRA in a one-count complaint that accused him of making material misrepresentations in violation of Rule 2010. Essentially, the case boiled down to an accusation that Mr. Niekras took advantage of a strong relationship he had with a wealthy, senior couple to induce them to pay him for financial planning services that he had rendered to them. The couple themselves, it seems, had no issues with Mr. Niekras. Their adult children, however, viewed things rather differently. One of the children eventually filed a written complaint with FINRA about Mr. Niekras, and that ultimately led to the issuance of the Enforcement action.

According to the decision, the adult children told FINRA that their parents were too old to provide any meaningful assistance, and affirmatively prevented the examiner assigned to investigate the complaint from contacting the parents. Thus, everything FINRA ever learned before filing the Enforcement complaint came from the adult children and Mr. Niekras, but not from the two people who were the “victims” of the alleged misrepresentations.

That carried through to the hearing itself. At the outset of the hearing, in the opening statement, the Enforcement lawyer announced that while the case was indeed about the two parents, they were “94 and 95 years old, and, unfortunately, they will not be appearing at this hearing.” Enforcement reassured the Hearing Panel, however, it would hear from the adult daughter, who would “testify about conversations she had with her father.” As the decision put it, this “suggest[ed] that, but for their advanced years, the [parents] would have testified and Enforcement would not have needed to offer evidence through a surrogate.”

Turns out that FINRA’s suggestion was way, way off. The decision contains a very detailed discussion of the parents’ mental and physical condition, too detailed to recount here, but, it came down to this finding by the hearing panel: “[T]he record does not reflect that they suffered from mental or physical health problems preventing them from having provided evidence, in some form, at least during the investigation.” Notably, FINRA didn’t even bother to get the parents to sign Declarations in lieu of providing testimony. I am not saying that I advocate the use of such – indeed, when confronted with Declarations instead of live witnesses, I routinely argue as to the unfairness, given the inability to cross-examine the declarant. But, from FINRA’s perspective, arguably a Declaration is better than nothing. The hearing panel observed, however, that while the adult daughter “testified that it would have been emotionally difficult and painful for her parents to have provided a written statement or declaration, she did not point to any physical or mental infirmity that would have prevented them from doing so.”

This led to my favorite part of the decision, which recounts what happened on the night before the last day of the hearing. Apparently, Mr. Niekras and his attorney “drove unannounced to the [parents’] home and met with [the huband] for about an hour.” According to Mr. Niekras, the husband was “very sharp . . . sharp as a tack.” The decision continues:

Mr. Niekras claimed that when he asked [the husband] to testify, [the husband] told him he was unaware of this proceeding, but “would do anything he could to help,” including testifying, because Niekras had been loyal to him and had never cheated him or presented him with a bill. [The husband] and Niekras arranged for Niekras to pick up [the husband] the next day to take him to the hearing. But when Niekras and his counsel arrived at the [parents’] home the next morning, [the adult daughter and one adult son] were there and [the adult daughter] told him not to get out of his vehicle, so he left.

At the hearing, Mr. Niekras brought these developments out, and Enforcement basically corroborated them. And, in doing so, Enforcement counsel uttered these soon-to-be-famous lines:

I have not said this on the record before, but we were specifically requested not to call [the husband] to testify because the perception by his children is that it would not be good for him, good for his health. And, we respected that because that’s part of what we do as FINRA Enforcement lawyers. We don’t wave around a heavy hand like we may have if we were federal or state prosecutors.

NOW you see why I HAD to blog about this decision.

As to the merits of the case, turns out that without the parents’ testimony backing its allegations, FINRA had nothing but the adult children. And the hearing panel, to its credit, wasn’t buying what they had to say.  With regard to the adult daughter, in particular, the panel noted that she “impeded the investigation and Niekras’s defense by shielding the [parents] from contact with the parties,” and that “her objectivity was questionable” as “she was openly hostile toward Niekras.”  Not quite sure what’s so special about that last observation, as FINRA routinely trots out customers who are “openly hostile” to my clients, yet hearing panels have no problem believing them, but I suppose that’s an issue for another blog post.  The bigger problem was that the adult children were the only ones who testified for FINRA, but they were also the only reason that the parents themselves did not appear to testify.  As a result, the hearing panel chose not to believe the only witnesses that FINRA produced in support of the allegations.

Here is what I take from this case: FINRA Enforcement lawyers have to remember that just because they are presented with an exam report from Member Reg with a recommendation to proceed with a complaint, the evidence supporting that recommendation may not be there.  Enforcement owes it to prospective respondents everywhere actually to do its job, to conduct a real review of the exam report for sufficiency of evidence, not merely to rubber-stamp Member Reg’s opinion.  Had Enforcement done that here, it would have realized that it could not prove a misrepresentation case without the ability to produce as witnesses the only two people who actually heard the alleged misrepresentations, and Mr. Niekras would not have had to go through with this silly charade of a case.

The Equifax Breach May Be A Problem For More Than Just Equifax

Posted in Confidential customer information, Cybersecurity, FINRA

All of you who use Equifax to conduct a part of your CIP responsibilities, raise your hands. Ok, now, only to those of you whose hands are in the air:  how many of you have checked your firm’s incident response plan to determine the steps that need to be taken in the event of a breach of your customer confidentiality obligations?  I am betting that there are very few hands left in the air.  And that could be a problem for you.

There have been a lot of articles published about what to do as a consumer if you are among the 145 million Americans whose data got hacked from Equifax. But, lost in all the excitement is the fact that BDs who utilize Equifax to run checks on new customers to satisfy CIP obligations – and that may be a lot, given that FINRA essentially endorsed Equifax for that role in Notice to Member 02-21 – may have exposed those customers’ information to the hackers.  And, as a result of that, you could have a variety of reporting obligations which, if you fail to recognize them, could land you in regulatory hot water.

In the event that a BD experiences a breach, it is possible it could have no disclosures to make, or several, depending on where it is located and the nature of the information at issue. This is a function of the fact that disclosure obligations are imposed by state law, among other things.  Forty-eight states – all but Alabama and South Dakota – have statutes requiring that customers impacted by the revelation of PII, or personally identifiable information, must be notified.  Thus, whether or not a breach has occurred that requires notification, and, if it is required, the method of disclosure, the timing of the disclosure, and who receives the disclosure (not to mention the penalty for not making a required disclosure) will vary from state-to-state.  Do not presume that FINRA or the SEC will tell you what to do, or that they will give you a pass just because the size of this breach is so big and has been so widely reported.

In guidance that FINRA has previously supplied in connection with cybersecurity, specifically, the 2015 Report on Cybersecurity Practices, it was pointed out that notification of a breach could very well include “customers, regulators, law enforcement, intelligence agencies, [and] industry information-sharing bodies.”  This is because “[f]irms may have notification obligations pursuant to, for example, Regulation S-ID, state reporting requirements and FINRA rules,” in particular, FINRA Rule 4530(b). In addition, according to FINRA, even if a cybersecurity incident does not trigger a reporting obligation, firms are “urged” to report such an incident “to their regulatory coordinator,” and stressed that “the information must be accurate and not misleading.”

This all boils down to a point I made in a blog post earlier this week: handling potentially troublesome compliance issues at a FINRA member firm in 2017 is, basically, a do-it-yourself proposition. You simply cannot count on FINRA to provide useful guidance or assistance.  Indeed, what you can count on is FINRA pointing fingers at you if you don’t manage to do things correctly.  Here, the Equifax breach appears to have been the fault of Equifax, not any of the BDs who have contracted with it to provide services.  Yet, despite the absence of any fault, this breach may have nevertheless created significant regulatory implications for BDs across the country.

So, do your homework. Check your incident response plan – assuming that you have one.  If you don’t, now is as good a time as any to prepare one.  If you have reports to make, get them in as quickly as possible.  And paper up everything you do.  Remember: (1) Spot the red flag.  (2) Investigate the red flag.  (3) Document the fact that you did both.  And then keep your fingers crossed that whatever you do is enough to make FINRA happy.

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