Broker- Dealer Law Corner

Broker- Dealer Law Corner

What Not To Wear (Or Do) At Your FINRA OTR

Posted in Disciplinary Process, Enforcement, FINRA, OTR

I apologize for not posting anything recently, but, sadly, I was embroiled in a two-week arbitration that occupied most of my recent attention.  I am home, however, and back in the saddle.  In the meantime, here’s a post from Blaine Doyle, author of the classiest post ever in this blog, something about ancient Greece.  I think.  Or maybe it was King Arthur.  Something memorable.  Anyway, here is Blaine passing along comments from some FINRA lawyers about how nice they’ve become and how they won’t be filing Enforcement actions willy nilly.  Another piece of classic fiction, perhaps?  –  Alan

I recently sat in on a panel of senior attorneys from FINRA Enforcement and while they did not actually discuss wardrobe selection, they did give some insight into the OTR process and Enforcement cases in general.  Here is a taste of what they had to say.

With limited staff and resources, the attorneys emphasized that the number of Enforcement cases being brought is actually down over the last few years.  Part of that is a function of a strong economy, but they also bluntly said that certain issues that in the past would have prompted an Enforcement action are now being let go by FINRA.  An example would be a firm that is dually registered as an RIA and broker-dealer.  If the issue is with the supervision of the I/A accounts and not the brokerage accounts, FINRA is less likely to bring a case now than it was just a few years back.  This is partly based on jurisdictional issues (FINRA does not have it on IAs; either the SEC does or the state) and partly based on allocation of resources.   Another example where FINRA is, today, less likely to institute an action would be failure to review broker emails where the action was corrected and no customers were harmed.

So what kind of actions will lead to an Enforcement case?   Basically, the opposite of what it is (supposedly) willing to let go, i.e., cases that feature 1) customer harm 2) ongoing violations and 3) recidivism.   Odds are if you have any of these issues, you are getting an Enforcement action from FINRA filed against you.  In an interesting note, one of the attorneys who used to be a partner at a big firm opined that there is too much review prior to the initiation of an Enforcement action.  In other words, the person/firm is brought up for votes before all kinds of committees and groups and the process can be a bit of a bureaucratic nightmare even in instances where it is readily apparent that violations were committed.

This is all putting the cart before the horse however, as an OTR will occur prior to the initiation of an Enforcement case.  Before filing an Enforcement case, FINRA will try to conduct complete discovery, so it can gather facts.  Part of this is requesting documents through 8210 requests and part of this is interviewing people “On The Record” during an OTR.  The FINRA staff didn’t say anything earth shattering about OTRs and lots of some of their comments, like “tell the truth,” seemed obvious enough that a third grader would know it.  But these comments had a little bit more nuance once they explained what they meant.  In this instance, what they meant was that you are not doing anyone any favors if you keep a defense hidden or don’t disclose it during your OTR.  They said this actually happens quite frequently and that in certain instances, they have decided to bring an Enforcement action only to have a cogent explanation/defense brought to their attention subsequent to the filing of the Enforcement action.  It was pretty clear that this really annoys FINRA, and since agitating FINRA is usually bad for business, it is best to put your cards on the table early on and to try to avoid the Enforcement action altogether.

This leads to another point, which I swear they actually said, namely, that a person facing an OTR needs to hire a lawyer.  A firm might have a great CCO and great staff but those individuals might not know what the FINRA attorneys are looking for or how to ease their concerns.  They emphasized that communication is greatly improved when there are attorneys involved as they tend to look at things with a more clinical view.  Some lawyers, including our own Alan Wolper and Michael Gross, used to be NASD/FINRA attorneys and they have even further insight as they used to sit on the other side of the table and speak fluent regulator.  The bottom line is that nobody likes to pay for lawyers but the FINRA attorneys made clear that the expense can help resolve issues early on and probably save money in the long term.

On the flip side, FINRA does not like when people plead the 5th Amendment in an attempt to avoid testimony.  As you are likely aware, because it is not part of the government, FINRA does not recognize the 5th Amendment; thus, attempts to hide behind it will likely lead to a permanent bar (for violating Rule 8210).  That said, if a person has a legitimate fear that their testimony could lead to criminal sanctions, they encouraged the interviewee’s attorney to reach out to the Staff beforehand so that they can evaluate the pleadings on a case by case basis.  In other words, don’t just show up and plead the 5th or try to hide behind it if you don’t have a legitimate criminal issue, unless you plan on getting barred.

Once a case concludes (whether it be through dismissal, settlement or administrative action), they mentioned that there will be a much larger focus on getting restitution for aggrieved investors instead of collecting fines for FINRA.  There has also been a greater emphasis on putting details of violations into consent decrees/AWCs, so that people who care to look can actually figure out what went on and why FINRA fined the firm in the first place.  Perhaps more importantly to industry folk, it appears that FINRA is actually going to let people know when and if an investigation is closed.  For many years FINRA staff had no obligation to let an individual know if an investigation was formally closed without an Enforcement case being brought.  At times, staff would let an attorney know, informally, that they probably would not be hearing from them on the issue again, but, in other instances, it was prolonged and deafening silence.  This albatross was tough on the business of the brokerage houses, not to mention the collective blood pressures of those running the firms.  According to the FINRA attorneys, the new policy is to let firms and individuals know if their investigation has concluded, especially in those instances where the CRD/ Form U-4 of the target was marked as a result of the investigation (like occurs after a Wells Notice).  This is a welcome change and should help clear the names of innocent firms/brokers.

That about sums it up, but since we did promise you fashion advice for an OTR, here goes: dress down but in a respectful manner. For instance, if you have a $5,000 suit and a $200 suit, go with the cheaper one.  Regulators don’t love flashy investment professionals but do like people that show respect for the investigatory process.



Expungement: Already An “Extraordinary Measure,” FINRA Now Seeks To Make It Even Less Accessible

Posted in Arbitration, Expungement, FINRA

Expungement is a funny thing, and here’s why: for years, claimants’ counsel have complained loudly to FINRA that expungement was being granted too frequently, that legitimate customer complaints were disappearing from CRD, resulting in an unfair, sanitized representation of brokers’ records that put unsuspecting customers at risk.  As Andrew Stoltmann, PIABA’s president, put it so colorfully in a recent quote, because of expungement, “retail mom and pop investors walk unsuspectingly into the arms of a financial predator all under the nose of FINRA.”

Yikes, that sounds bad. But, let’s get to the truth of things.  In reality, and completely opposite from what PIABA is telling FINRA and the media about rampant grants of expungement and the dangers that supposedly creates, by and large, claimants – and their counsel – have historically shown that they could care less about expungement.

In the old days, parties to an arbitration were allowed simply to bake into a settlement agreement a stipulation to having the complaint expunged. PIABA didn’t like that, I guess.  But, unless I am really, really mistaken, any claimant that was truly unhappy with such a stipulation had the right simply to say no, and not agree to the settlement.  The choice was always claimant’s to make.

The same was true in the next era of expungement history, namely, settlements that did not contain a stipulation to expungement, but, instead, a clause that recited the claimant’s agreement not to oppose a request by respondent for expungement. Again, claimants always had the right simply not to agree to settle if there was such a clause involved and they found it to be offensive. I don’t know about you, but I never had a settlement fall apart based on a claimant’s refusal to agree to such a clause.  Nevertheless, PIABA flexed its impressive lobbying muscle and convinced FINRA that, shockingly, respondents were the problem, not claimants, and these agreements were also nixed.

So, for PIABA, it came down to this: rather than advising their clients that they could simply choose not to settle if they were unhappy about stipulating to expungement, or agreeing not to oppose expungement – which would, of course, result in no settlement (and, more importantly, no contingent fee being collected by claimant’s counsel) – PIABA took a different approach.  Not just an easier approach but the one that allowed its members to collect their fees on settlements:  it conducted its study and used it to bully FINRA into changing the rules.  As a result, FINRA has declared that expungement is an “extraordinary measure,” and it is a violation of FINRA’s disciplinary rules for a respondent to condition a settlement on claimant’s agreement not to oppose expungement.

Now, by rule, all expungement requests must go to hearing. And, as a matter of FINRA protocol, the complaining customer must be advised of the respondent’s request to expunge their complaint, and the hearing particulars, i.e., date, place and time, and invited to participate.  Well, guess what?  Claimants don’t show up.  They can simply pick up the phone, if they don’t want to appear in person, but they don’t even do that.  Nor, of course, do their lawyers.  Once claimants receive their settlement money, they lose any interest in their case, to the extent they ever had any true interest in the first place in anything other than collecting some money.

I realize I am painting with a broad brush, but what I have described is the universal experience for respondents’ counsel. I am not saying that expungement is never contested – indeed, when expungement is dealt with in a case that doesn’t settle, and the hearing panel rules on expungement at the same time as it deals with the underlying issues of liability and damages, it is fair to say that expungement can be hotly contested.  But, in cases that settle (and, statistically speaking, the vast majority of arbitrations settle) – which means that the only aspect of the case that goes to hearing is the request for expungement – claimants and their counsel just don’t choose to participate.

So, we all agree that PIABA’s professed resistance to expungement is at odds with reality, right? Well, it’s only going to get worse.  The comment period just closed on FINRA’s proposed tweaks to the expungement process, none of which serves to make it easier to obtain.  Among other things, the proposed rule changes:

  • Limit to one year the time within which a request for expungement must be filed (vs. the six years that the Code of Arbitration provides claimants to file their statements of claim);
  • Require a unanimous decision by the hearing panel (while a claimant’s claim only requires a majority decision);
  • Add as an additional prerequisite finding, i.e., in addition to the three potential bases for expungement outlined in Rule 2080, a determination that “the customer dispute information has no investor protection or regulatory value” (putting aside the fact that this standard is vague, undefined and utterly subjective, how could a claim that is subject to expungement because it is “false” or “factually impossible” or “clearly erroneous” – the Rule 2080 standards – possibly have any “investor protection or regulatory value?”); and
  • Require that the panelists (1) complete enhanced training; (2) be lawyers; and (3) have five years’ experience in either litigation, federal or state securities regulation, administrative law, service as a securities regulator, or service as a judge (as opposed to customer claims, which require none of these things of their panelists)

It is utterly unsurprising that FINRA received a lot of comments to the proposed rules, with the industry firmly lining up against them. Given FINRA’s historical penchant for doing whatever PIABA advocates, however, I, for one, would not expect those comments to be taken seriously.

A Sordid Story From The Trenches Of FINRA Arbitration

Posted in Arbitration, FINRA

I have used this forum before on occasion to complain about the vagaries of the FINRA arbitration process, and, in particular, the perspective of a respondent’s counsel that the game often seems to be rigged in favor of claimants. Let me give you an example that just occurred in the last two days.  And let me just say this: it is insulting to the letter “F” that the words “FINRA” and “fairness” both start with it.

My story concerns the scheduling of hearings. While FINRA provides a vague “guideline” regarding the length of time it is supposed to take from the filing of a Statement of Claim to the final hearing, for the most part, the actual scheduling of that hearing is a matter of agreement between the parties.  Most times, the parties are able to work out a date that is suitable for everyone, even if that date is well after when FINRA’s guideline suggests it should be.  From time to time, however, the scheduling of the hearing becomes a long, drawn-out, weird and ugly battle.

The case in question was initially scheduled for a hearing in April 2017 in San Juan. I had to request a continuance, as my daughter was born two months prematurely, so my wife and I had to spend 40 days in the NICU with her until we could take her home.  Claimants’ counsel graciously agreed, under the circumstances, to postpone.  The hearing was then re-set for July 2017, reflecting only a modest delay.  In June, however, FINRA notified us that one of the three arbitrators developed a scheduling conflict and could not do the hearing in July.  Rather than proceeding with two arbitrators, or having a replacement arbitrator appointed, either of which could have happened if time was truly of the essence, Claimants’ counsel elected, instead, to postpone the hearing in order to keep the conflicted arbitrator.  So, the hearing was postponed, a second time, with our consent, to some yet-to-be-determined date later in 2017.

Then came the hurricanes, and the devastation they wrought on San Juan, and FINRA administratively stayed all hearings in Puerto Rico through early December. That required my colleagues and me to find room in our nearly completely full 2018 calendar for this case.  We offered July and September, but Claimants’ counsel refused.  Instead, they argued to the Panel that the hearing should take place in March, during a two-week period when we already had two other hearings scheduled.  Claimants’ counsel argued that this case should have priority, as the principal Claimant was ill.  While sympathetic to Claimant’s situation, we pointed out that (1) our expert witness – who’s been with the case since it was filed and wrote a report – was unavailable, and (2) we were unsure whether our chief fact witness, the RR who handled the account, was available.  We also pointed out that Claimants’ counsel had hardly been pushing the case, which kind of belied the sudden need for a prompt hearing.

The Panel ignored our arguments, and issued an Order that those other two cases would be stayed, so that this case could proceed, notwithstanding our witness issues.

The good news – at least temporarily – was that the Director of the FINRA Dispute Resolution office administering the case recognized the problem, and the Order was withdrawn when I pointed out to him that the Panel had no authority to direct that two other cases be stayed over my objection. Stupid me, I presumed that with the benefit of a little time to regroup, the Panel would reissue its Order and set the hearing in July or September, as we had offered.  Nope.  Today, we received the amended Order requiring me to try this case over two weeks in March, on the very same days that I am already scheduled to try two other cases.  I still have no expert witness, and I still don’t know if my registered rep is available.  And while I have to believe those other two panels will yield to this one’s Order, it is possible they won’t, my client and I will somehow have to be in two places at once.

The point is pretty obvious: in its zeal to accommodate the Claimants, the Panel completely disregarded the prejudice that its decision to hear the case sooner rather than later has caused my client.  I mean, the Panel is apparently content to make me defend a case without an expert and possibly without my most important fact witness.  How can that possibly be considered fair?

Look, I will dutifully file a motion for reconsideration, and I will complain, again, to the Director about this situation the Panel has created for my client and me. But, based on experience, I wouldn’t bet on my chances of changing anyone’s mind.  Why?  Because I’m just the respondent, and no one cares about the respondent.  I can tell you with absolute candor, no editorializing, no hyperbole, that decisions like this, Claimant-favorable procedural/administrative decisions, are issued every day.  Remarkably, though, and completely contrary to experience, PIABA will still argue that the playing field is tilted in favor of respondents.  Even worse, FINRA will listen.


Help! FINRA Is Calling My Customers

Posted in Disciplinary Process, Discovery, Examination, FINRA, Rule 8210

Here is a really interesting post from Michael regarding those potentially uncomfortable moments when FINRA calls non-complaining customers.  Because FINRA is not the government, it has no subpoena power over these people, and so needs them to cooperate voluntarily.  The problem is that FINRA does an awful job of informing non-complaining customers that they are not obliged to cooperate, and, in fact, often takes full advantage of the misapprehension in customers’ mind that they have no option but to respond to questions.  What to do about that?  While I agree you should never instruct, or even encourage, a customer to blow off a call from FINRA, I do think it’s fair to educate customers about their right to do so, and then let them decide.  – Alan


FINRA has many weapons in its investigative arsenal. It can issue overly broad and unduly burdensome discovery requests that gobble up resources. It can seek to take testimony from so many reps at a firm that it may just be cheaper to pay the piper than your lawyer. It can conduct unannounced visits at an inconvenient time. These armaments – all of which stem from FINRA Rule 8210 – can result in significant expenses. FINRA’s biggest weapon, which, surprisingly, does not stem from Rule 8210, can adversely affect both expenses, through new customer complaints and arbitrations, and revenue, through lost customers and future commissions and fees. I am, of course, talking about calls to non-complaining customers. (Yes, FINRA really makes these calls, and no, you probably do not have a viable tortious interference claim if your customers receive a call.)

FINRA’s Reasons And Method For Calling

Calls to non-complaining customers certainly do not occur in every sales practice exam, but they are not entirely uncommon. FINRA generally reserves these calls: (1) to determine if a possible sales practice or other issue involving one customer is a systemic issue involving multiple customers; (2) to determine if a possible written or other supervisory deficiency resulted in customer harm; or (3) to learn more regarding potentially troubling information about a customer, firm, rep, or security. Before cold calling a customer, a FINRA examiner may send a letter to the customer advising who FINRA is, and asking the customer to call him to discuss her account. The examiner, like a good salesman, then may use the letter to kick-off the call.

The Problems With The Calls

There are multiple problems with FINRA’s calls to non-complaining customers. First, because FINRA is not conducting a customer satisfaction survey, the call, in and of itself, may cause customers to believe there is a problem with their accounts. This is the case even if the examiner appropriately acquits himself by making appropriate disclosures, and by asking only open-ended questions designed to elicit an understanding of a situation, as opposed to asking leading and other questions that imply there is a problem.

Second, examiners are not always entirely candid during calls with customers – most of whom are unfamiliar with FINRA. When a customer receives a call from someone who knows her name and phone number, where she maintains an account, what investments she has made, and who recommended those investments, the customer may reasonably presume the caller works for the government. Many people, of course, believe it to be their patriotic duty to help the government. Examiners may perpetuate this reasonable misunderstanding by not telling customers that:

  • FINRA is not part of the government;
  • FINRA cannot compel a customer to speak with it;
  • It is the customer’s choice to speak or not speak with FINRA; and
  • There are no repercussions if the customer chooses not to speak with FINRA.

Indeed, these omissions are a bit reminiscent of the following phrase from Rule 10b-5(b): “to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading.”

Third, there are instances where FINRA examiners have crossed the line during calls with customers. Some examiners become personally invested in exams. They believe that misconduct has occurred, and that they simply need to make enough calls, or push hard enough during calls to elicit the desired statements. Instead of attempting to gather information about what was or was not said, these examiners are aggressively trying to convince a customer that she has been harmed, and she therefore should cooperate with FINRA in an effort to right a supposed wrong, and to ensure the same thing does not happen to others. Examples of this type of inappropriate conduct include: leading questions implying the customer has been wronged, without providing all of the pertinent facts; any question implying FINRA can recover investment losses for the customer; and any question implying the customer should hire an attorney.

How To Handle The Calls

While there are certain things that can be done to attempt to address the impact of calls to non-complaining customers, there is one thing that should never be done: You should not do anything to attempt, or even give the appearance of attempting, to impede FINRA’s inquiry. Such conduct could lead to a new inquiry, and even bigger problems. You should thoroughly document all calls with customers who have spoken with FINRA. These notes can be extremely helpful if the situation escalates. You should be sure to address any questions or concerns that the customers have after speaking with FINRA. You also should consider using your own carefully worded script to advise customers who have been contacted by FINRA about the exam, who FINRA is, their rights, and how you will continue to provide the best possible service. If you have concerns about what an examiner said in a letter or call, or the number of customers being contacted, you should promptly raise your concerns with FINRA management. While FINRA management may not put an immediate end to the letters and calls, they may put in place safeguards to better ensure future communications with customers are more appropriately handled, or they may even limit the number of future letters and calls.

In sum, addressing FINRA’s calls to non-complaining customers is a dicey situation that needs to be handled with care, no matter how angry you may be.



Posted in Administrative Proceedings, SEC

On January 12, 2018, the U.S. Supreme Court agreed to review the constitutionality of the SEC’s appointment of its in-house administrative law judges (“ALJs” for short).

As we’ve discussed previously on the blog, a trip to SCOTUS seemed inevitable after the 10th Circuit handed down its decision in Bandimere, concluding that the SEC ALJs were “inferior officers” who had to be appointed in compliance with the Appointments Clause of the Constitution.  That decision directly conflicted with an earlier decision handed down by the D.C. Circuit (Lucia), which made the opposite finding.

SCOTUS’s ruling will have an immediate impact on those who are or have been the subject of an ALJ proceeding. In November, the SEC attempted to head off this issue in cases that were still pending before the ALJ or on appeal from the ALJ to the SEC.  First, the SEC complied with the Constitution and formally appointed the ALJs.  Simultaneously, it issued an order remanding all cases back to the (now Constitutionally appointed) ALJs, asking those judges to review the evidence and either modify or ratify their prior rulings.  That process is still underway.

What remains to be seen is whether this Constitutional band-aid will have the intended effect. If SCOTUS rules against the SEC, what will that mean for respondents in these still-pending cases? What will it mean for respondents, like the Petitioner in Lucia, whose case is final?

Equally interestingly, how far will this spread? The Constitutional issue raised here has called into question other in-house judges, including those who oversee cases brought before the Federal Energy Regulatory Commission and the Environmental Protection Agency.

Oral arguments in the case are expected to being as soon as April, with a decision predicted in late June. This should be interesting!


FINRA’S 2018 Exam Priorities Reflect Business As Usual

Posted in Annual Report, Cybersecurity, Disclosure, FINRA, Outside business activities

I would imagine that the point of FINRA releasing its list of exam priorities each year is to help firms who are actually going to be examined, by providing a glimpse into FINRA’s playbook so they can address, proactively, the issues they know FINRA will focus on. To be forewarned is to be forearmed, right?  It is a great theory.  Unfortunately, in practice, it has turned out, perhaps, not to be quite as useful as imagined, as the list basically stays the same from year to year, with some modest adjustments.  Such is the case with the 2018 Letter, released this week.

For instance, once again, we can see discussions on AML, OBAs, suitability, and best execution. These topics are covered seemingly every year, with nothing new really added to the mix.  The idea that FINRA is focusing on them during its exams can hardly be deemed newsworthy, so the utility of the exam priorities letter is questionable.  With that said, any firm stupid enough to ignore these annual warnings from FINRA gets what it deserves.

Even when there’s a supposed new topic, even that is somewhat illusory. For instance, FINRA mentions that it will be keeping a close eye on the sale of cryptocurrencies and initial coin offerings (as it should).  But, those are just the new, cool investment products du jour.  The fact is, FINRA has already spoken many times about its concerns regarding a firm’s obligations when it sells new products, particularly when those products are complex.  Again, it should not be news to any well-run BD that before it oks the sale of a new product, it must first undertake an extensive reasonable basis suitability analysis to ensure its efficacy.  That was true before, and remains true.  Thus, while the particular products the Letter highlights are, in fact, new, the guidance provided is the same old, same old.

But enough of the obvious, let’s look at those items in the Letter that are worth our attention. I will boil it down to a few easy-to-absorb bullet points:

  • FINRA does not like fraud. Of any variety. But, if you put a gun to FINRA’s head, it will admit that it particularly doesn’t like:
    • Microcap fraud,
    • Fraud perpetrated on seniors, and, most of all,
    • Microcap fraud perpetrated on seniors.
  • If you have a registered rep working for you with an extensive disciplinary history, or you are considering hiring such an individual, then it is clear that FINRA is expecting that you will have conducted some careful analysis of whether a heightened supervision plan is necessary. Indeed, I suspect that FINRA is approaching the point where, essentially, a rebuttable presumption exists that an HSP is necessary.
  • If you haven’t already designated someone to serve as your “Cyber” guy, whether in-house or outsourced, you need to do it. Now. While no one can 100% prevent cyber related issues, it won’t become a regulatory problem if you’ve got a robust plan in place.
  • FINRA will be focusing on disclosures to customers, principally in the context of risk disclosure (apparently, for instance, some firms are somehow inducing their customers to utilize margin without adequately disclosing the risks of using margin . . . which, frankly, I don’t really understand how that can happen given that Rule 2264 outlines – verbatim – the risk disclosures that must be made to margin customers).
  • Even though global warming is a myth, 2017 proved that every BD needs to have a real business continuity plan in place, heaven forbid a catastrophic storm hits and power disappears for an extended period of time. In that same vein, FINRA wants to be sure that firms have undertaken liquidity planning, which can become of paramount importance in times of “stress,” including stress caused by catastrophic storms. Truly, FINRA could care less if a BD is forced to go out of business, but, it does care if, in the process of going out of business, regardless of the reason, customers are impacted in a negative way.

Finally, a nice feature to this year’s edition of the Letter is a list of new rules that have already been approved but which are only going into effect this year. There is a handy reminder of things that BDs will need to implement in order to demonstrate compliance with these new rules.  While FINRA unofficially provides a little bit of a grace period to get new supervisory systems and procedures and new forms and documents in place, that is nothing that you can safely count on, so you should be prepared, once the examiners arrive at your door, to show that you’re aware of the rule changes and have implemented all necessary changes.



Can FINRA Deliver On A Promise To Provide Meaningful Relief To Compliance Departments?

Posted in Compliance, FINRA, Outside business activities, Rule 3270

As I have discussed before, there are some rule violations that are going to happen no matter what FINRA says about them, no matter how many Enforcement cases it brings, and no matter what BDs do to “detect and prevent” such violations. A prime example of such is outside business activities, or OBAs.  The rule itself – new FINRA Rule 3270 and old NASD Rule 3030 – is straightforward:  before an RR can engage in an OBA, he has to notify his firm.  While the rule does not require that the RR obtain approval, in practice, nearly every firm’s internal procedures do require such.  In addition, under 3270, the firm is required to undertake an analysis of the proposed OBA to ensure that it would not confuse customers about whether they are dealing with the RR wearing his RR hat, or the RR wearing his OBA hat.  Once notice of a proposed OBA has been provided (and, if required, permission obtained), and the requisite “possibility of confusion” analysis conducted, the BD can wash its hands of the matter, since a BD has no obligation to supervise an RR’s OBA.

That’s it. Not much to it, really.  Yet, every year, there are tons of Enforcement cases devoted to OBAs, mostly against RRs who fail to notify their BDs of their OBAs, but, also against BDs who fail to take reasonable steps to ensure that their RRs are dutifully disclosing their OBAs, or BDs who erroneously treat a PST (private securities transaction) as an OBA.  Seems like a lot of regulatory and compliance energy spent on something that, relative to lots of other problems, doesn’t have too much of an impact on investor protection, market integrity, the supposed raison d’etre of FINRA’s existence.

Perhaps that is why at its December Board meeting, FINRA approved a proposal to consider “streamlining” the rules on OBAs, as well as PSTs. According to the FINRA website,

the Board approved the publication of a Regulatory Notice seeking comment on a proposal that would reduce unnecessary burdens while maintaining strong investor protections. The proposal would require registered persons to provide their member firms with prior written notice of a broad range of outside activities, and would impose on firms a duty to reasonably assess a narrower set of activities that are investment-related, allowing firms to focus on outside activities that are more likely to raise potential investor-protection concerns.  The proposal also would streamline the obligations by generally excluding from the rule a registered person’s personal investments and work performed on behalf of a firm’s affiliate, and it would eliminate supervisory obligations for non-broker-dealer outside activities, including investment advisory activities at an unaffiliated third-party adviser.

This does not mean that a rule change will inexorably follow, but, if I had to guess, the comments FINRA receives will be universally in favor of anything that makes life easier for BDs. If FINRA is serious that is willing to explicitly narrow the range of OBAs that firms are required to run through the “possibility of confusion” meter, if FINRA is willing to eliminate completely from consideration an RR’s personal investments, that would be a huge step in the right direction.

But, the biggest gift of all would be FINRA’s apparent willingness to carve out a need to consider or supervise work done for affiliates of the BD, “including investment advisory activities at an unaffiliated third-party adviser.” Why do I say this?  Because this particular issue has been the subject of such hand-wringing and angst over the years, due to FINRA’s inability ever to explain adequately what its expectations are regarding a BD’s responsibility to supervise the IA activities of its dually registered RR/IA reps who conduct their IA business away from the BD.  NASD tried back in 1994 Notice to Members 99-44 to outline just when a BD has the obligation to supervise its RRs’ IA business as PSTs.  Good luck figuring out that NTM.  I must have read it 100 times in the last 20+ years, and it still makes no sense.

NASD realized it had done a poor job in 94-44, so, two years later, in NTM 96-33, it tried a second time, this time in the form of Q&A, to explain what its expectations were.  Again, the attempt at clarification only muddied the waters worse.  Unfortunately, that represented the last effort by FINRA (apart from the occasional Enforcement action) to speak to this issue.  The result, as I said, has been confusion, uncertainty and anxiety among compliance personnel, who to this day are still unsure about what transactions done away from the firm by customers of their dually registered RR/IA reps must be supervised as PSTs and which need not be supervised (because they are merely OBAs).

Given this, you can, perhaps, sense my excitement over the prospect of a rule change that eliminates the confusion created by 94-44 and 96-33, and clearly delineates the trades subject to supervision by the BD and those which may safely be ignored. I certainly hope that FINRA follows through on this promise, and provides meaningful relief to firms who are now nearly crippled by the sheer amount of their compliance obligations.



Will FINRA’s 8210 Madness Ever Stop?

Posted in Enforcement, FINRA, Rule 8210

Once again, Rule 8210 has me frustrated. And angry.  Well, not the rule itself, but the aggressive manner in which FINRA continues to wield it, and how its scope is interpreted by hearing panels called upon to consider cases involving what seem to me, at least, to be troublesome uses of Rule 8210.

Let’s start by making a pretty obvious observation: Rule 8210 is not the equivalent of a search warrant. FINRA does not have the right to march into your office, slap an 8210 request on your desk, and then simply start rummaging through your drawers and file cabinets, looking for documents pertinent to its exam.  Only law enforcement gets to do that, and even then they have to go to court – where, theoretically, some semblance of due process exists – to obtain permission to conduct such a search.  Yet, when it comes to its own members and their documents, particularly electronic documents, i.e., documents maintained on a computer hard drive, FINRA takes the attitude that it is entitled to conduct the equivalent of a search warrant.  And that is simply wrong.

Here’s the situation: let’s say that you’re the owner of a small BD, and you have a single laptop computer.  On that laptop, you keep all the emails, documents, spreadsheets, whatever, that are related to the operation of the BD.  All documents which FINRA is absolutely entitled to review.  But, in addition, you also keep on the same computer all your personal stuff, i.e., pictures, personal emails, stuff wholly unrelated to the BD.  All documents FINRA is clearly not entitled to review.  Yet, according to FINRA, if you do maintain your documents like this, then, guess what?  FINRA does get to look at your photos, your personal emails, etc.  Here’s how FINRA put it last week in an Enforcement decision:

FINRA member firms and their associated persons . . . are on notice that FINRA may request the production of Firm materials, whether stored electronically or on hard copy. A firm or an associated person who nevertheless elects to commingle personal or unrelated business materials with member firm materials, whether stored electronically or in hard copy, does so at its own risk.

This is a staggering statement. Remember, if you choose to keep your personal documents and your BD documents in the same desk drawer in your office, that does not mean FINRA simply gets to open that drawer and rifle through everything that’s in it, regardless of whether it pertains to the BD.  Before you produce the contents of that drawer, you can pull out your personal files so FINRA does not see them, and no examiner can do anything to prevent you from doing that.  Yet, this statement suggests otherwise.  It states that FINRA can somehow compel you to produce personal documents, whether in hard copy or in electronic format, if they happen to be “commingled” with firm documents.  That, apparently, is the “risk” that is being referred to here.

This is, simply, wrong. The requirement to respond to a request for production of documents pursuant to Rule 8210 does not depend on where the documents may be located.  Rather, according to the language of the rule itself, it depends merely on whether the documents in question (1) are in your possession, custody or control, and (2) relate to the subject matter of the exam.  The mere fact that a firm document may be “commingled” with a personal document that has nothing to do with the exam does not magically render the personal document subject to FINRA’s review.  FINRA is not entitled to the unrelated personal documents, no matter where they are located.  The idea that somehow physical proximity to a firm document creates a “risk” that FINRA will insist on its supposed right to see something it is clearly not allowed to see is a scenario not at all contemplated by Rule 8210.

Abuse of Rule 8210 by FINRA examiners happens everyday. That’s bad enough.  But, when hearing panels encourage that sort of activity by issuing pronouncements condoning it, even though it is clearly against the rules, enough is enough.  Member firms must continue to speak out against FINRA’s increasingly aggressive use of Rule 8210, to challenge FINRA’s efforts to expand the scope of its jurisdiction to cover areas that are properly subject to the jurisdiction of other regulators.  Otherwise, BDs run the “risk” that not only will FINRA force you to produce, among other things, those personal emails with your spouse that happen to reside on your laptop’s hard drive, but that the contents will be reviewed and held against you in an Enforcement action.

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.