LPL may be the biggest BD in the country, with 21,500 reps operating out of almost 13,000 branch offices.  Heaven knows how much money it brings in every year, but, goodness, it must be a lot.  And good thing, too, given how much the firm keeps paying to FINRA in fines for its serial, repeated, and egregious supervisory failures.

A week or so week ago, LPL kept its string of massive supervisory fines intact with a $6.5 million AWC.  I will get to the details, of course, but, for starters, let’s take note of the following:

  • In the “Relevant Disciplinary History” section of the AWC, FINRA identified three prior AWCs, dating back only five years, with fines totaling almost $12 million
  • For some reason, however, FINRA left out of that section another supervisory AWC, from 2013, in which LPL paid a $7.5 million fine for its failure to retain (and review) emails…which sort of sounds like the very problem that is the subject of the latest AWC
  • According to the firm’s BrokerCheck report, and as I pointed out in a blog post from a year ago, LPL “has 253 total disclosures, of which 175 are regulatory events, perhaps 20 or more of which involved a supervisory violation”
  • No individuals were named in this AWC, or in any of the three prior AWCs that FINRA mentions in the new AWC, or in the 2013 AWC that FINRA omitted (and without going through all of the 20 or so other supervisory cases, I would venture to speculate that no individual was named in them, either, although I am happy to be proven wrong by anyone with the inclination to review all those cases).

I am guessing that given these initial observations (well, and, perhaps, the title of this piece), you can deduce what I am thinking:  if you happen to be a firm that is big enough, with enough money, to pay FINRA millions and millions of dollars, year after year, for repeated supervisory violations, a firm whose CEO maybe sat on the FINRA Board of Governors not too long ago, you can happily remain in business no matter how pervasive the problems seem to be, and no one in management will be held personally accountable.  This is not conjecture.  This is fact.  All you have to do is read LPL’s BrokerCheck report, read the AWCs, and you will see for yourself the kinds of violations the firm has committed, the amount of fines it has paid, and who has NOT been named as respondents.

Can it be any wonder that small firms see this AWC and gnash their collective teeth in anger over the disparate treatment they receive?  Just look at my most recent blog post, about a FINRA AWC for Worden Capital Management for supervisory failures.  Guess who was also named as a respondent, as a result of the conclusion that he was personally responsible for the unreasonable WSPs?  That’s right, Jaime Worden, the firm’s owner and CEO.  Neither Mr. Worden or his firm had any relevant disciplinary history leading up to that AWC, quite unlike LPL, yet FINRA was comfortable naming him along with the BD.  And that is just one example.  The list goes on, and on, and on.[1]

Well, with that off my chest, let’s talk a look at LPL’s latest supervisory cluster.  There are actually three components to the firm’s failure to meet its regulatory obligations: record retention, fingerprinting and screening of associated persons, and supervision of consolidated reports.  I will take them one at a time.

Regarding record retention, for over five years – a time period that, incidentally, overlaps with prior AWCs – from January 2014 to September 2019, LPL failed “to retain electronic records in the required format, preserve certain electronic records, and notify FINRA prior to employing electronic storage media.”  That failure “affected at least 87 million records and led to the permanent deletion of over 1.5 million customer communications maintained by a third-party data vendor,” including “mutual fund switch letters, 36-Month Letters, and wire transfer confirmations.”  This bit about the third-party vendor is my favorite part of the AWC:

In August 2017, after FINRA requested certain customer letters that LPL could not locate, LPL contacted Vendor A in an attempt to locate them. Vendor A informed LPL that about 500,000 customer communications, including the letters, had been deleted because Vendor A placed them in a temporary storage location from which records were automatically deleted after one year. Subsequently, LPL did not take reasonable steps to verify that Vendor A migrated the other documents remaining in the temporary storage location to an appropriate location. Therefore, on October 26, 2018, Vendor A discovered that the migration did not occur and that approximately one million additional LPL customer communications had been deleted.

Whoops.  In addition, LPL also “failed to send account notices that are required to be sent to customers at 36-month intervals for each account in which a suitability determination had been made.”  This one impacted over one million customers.

Regarding the fingerprint problem, from January 2014 through the present, LPL failed to obtain fingerprints for more than 7,000 non-registered associated persons.  Because these associated persons were not fingerprinted, LPL did not screen them to determine whether any individual was subject to a statutory disqualification.  As part of the remediation efforts that the firm commenced, it determined that approximately 5,000 of the individuals were no longer associated with LPL, so it could not obtain their fingerprints or determine if they were subject to statutory disqualification.  5,000!

Of course, the AWC also provides that LPL actually did get the fingerprints for one guy, properly sent them to FINRA for review, and received a notice back that he was SD’d, which should have resulted in either (1) him being terminated, (2) the firm filing a BDW, or (3) the firm filing an MC-400.  LPL, however, boldly chose a fourth option: do nothing, and let the guy continue to work there for 2 ½ years.  I wish my small firm clients got that choice!

The final aspect of LPL’s supervisory failures relates to consolidated reports, “a document that combines information about most or all of a customer’s financial holdings, including assets held away from the firm.”  FINRA has previously expressed its concerns about the use of consolidated reports in Reg Notice 10-19.  I don’t want to get into the weeds here, but the concern was, basically, that consolidated reports create “the potential for communicating inaccurate, confusing, or misleading information to customers” because a BD may not “test or otherwise validate data” for assets that appear on such reports that are held away from the BD.

LPL got in trouble with FINRA in 2015 for not reasonably supervising consolidated reports, and so it told its RRs who wanted to use such reports that they could use only “LPL proprietary systems or specific, approved third-party vendors.”  Good move…but not good enough.  For five years, LPL still messed up in a number of ways:

  • While a copy of a finalized consolidated report was sent automatically to LPL to review and validate the information, RRs could also generate draft reports, which were not sent to LPL or reviewed by the firm. LPL does not know how many draft consolidated reports – including drafts containing manually-added values – its RRs sent to customers.
  • Although LPL’s WSPs required the firm to “review and validate” all manually entered valuations for “securities-related assets,” including retirement or brokerage accounts held away from LPL, private placements, or variable annuities, in practice, LPL only reviewed manually-entered assets if the RRs specifically characterized the assets as “securities-related.” If the RR said the manually-added assets was not a security, LPL didn’t review it.
  • Two of LPL’s vendors gave customers direct access to their consolidated reports without LPL’s knowledge or review. Although LPL could not quantify the problem, the AWC states that “at least 9,000 customers accessed one of the third-party vendors’ portals in one year alone.”
  • Three of LPL’s approved third-party vendors provided RRs the option of receiving consolidated reports directly, which the firm failed to supervise entirely.
  • Two of the approved vendors allowed RRs to export consolidated reports to Microsoft Excel files, after which the RRs could manually alter the reports. LPL was unaware of this, and therefore did not receive, much less review, those reports or any exported Excel files.
  • Finally, one approved third-party vendor enabled RRs to direct that emails be sent to customers that contained hyperlinks to consolidated reports. LPL was unaware that the vendor provided this service and therefore did not review any consolidated reports that its representatives disseminated in this manner.

I don’t mean to single LPL out here, but when confronted with this AWC, the big firm vs. small firm problem was too much to ignore.  LPL’s supervisory issues are serious.  Despite repeated representations to FINRA that the firm was prepared to do whatever it takes to remedy the problem and avoid a recurrence, that seems simply not to be true.  Either LPL is, in fact, not taking its supervisory obligations seriously (because it knows it can afford to write the next multi-million-dollar check to FINRA), or it is simply too big, with too many RRs, to reasonably supervise them all despite its best efforts.  Either way, one needs to ask whether this should be permitted to continue as it has for all these years.


[1] It is worth contrasting this, at least in a footnote, to other regulators.  I read just last week that the OCC, the Office of the Comptroller of the Currency, fined the former GC of Wells Fargo $3.5 million “for his role in Wells Fargo Bank, N.A.’s systemic sales practices misconduct.”  Mr. Strother was the SIXTH individual manager named by the OCC for some responsibility for the scandal involving the creation of millions of fake bank accounts.

I apologize for taking so long between posts, but, to be fair, there’s been a lot going on in the past week or so that has captured my attention!  I wish everyone a happy and SAFE new year! – Alan

While undoubtedly FINRA will be issuing its annual “examination priorities” letter any day now, that is hardly the best way to figure out exactly what FINRA is paying attention to now (as that letter kind of reads the same, year after year).  Rather, it is much more effective to read the results of the latest Enforcement actions.  That will really tell you the kinds of cases that FINRA is bringing, the kinds of respondents it is naming, and the sort of sanctions it is meting out.

There have a bunch of interesting cases of late, and I intend to get to them all eventually, but I thought I would start with this AWC from New Year’s Eve, a churning mess involving Worden Capital Management and its owner, Jamie Worden.  I realize that I just posted a piece about churning in November, but this case merits its own attention.

According to the summary, for about a 4-and-1/2-year period, the firm and Mr. Worden

failed to establish, maintain, and enforce a supervisory system, including written supervisory procedures (WSPs), reasonably designed to achieve compliance with FINRA’s suitability rule as it pertains to excessive trading.  As a result, WCM registered representatives made unsuitable recommendations and excessively traded customer accounts, causing customers to incur more than $1.2 million in commissions.

Let’s explore what happened.

First of all, you should know that the bulk of the firm’s business consisted of “registered representatives recommending active short-term trading to retail customers with speculative investment objectives.”  Given that, and given the fact that Rule 3110 mandates that a firm’s WSPs must be specifically tailored to the kinds of business that it actually conducts, it seems pretty dang clear that the suitability section of WCM’s WSPs should have contained a pretty hefty portion devoted to the supervision of churning, a/k/a quantitative unsuitability.

Well, not so much.  Turns out that the WSPs were, in fact, pretty skimpy where it mattered.

First, while the WSPs appropriately noted “that factors such as the turnover rate, the cost-to-equity ratio, and in-and-out trading might be indicative of a suitability violation,” they “did not define those terms.”  Second, and worse, the WSPs “also failed to explain what actions to take when supervisors and principals observed such activity.”  Finally, “although branch managers were responsible for supervising trading activity at their assigned branches, the WSPs were silent on how they should perform that supervision.”

In other words, the WSPs not only failed to describe what supervisors should have been looking for, they also failed to detail how the supervisors should have been conducting such reviews, or what to do if they actually found a problem.  0 for 3.

The AWC goes on to describe the ways that WCM did attempt to keep any eye out for churning, but, as you will see, they were so patently insufficient that FINRA found that they “were individually and collectively unreasonable.”

The principal unreasonable thing that the firm did was not provide its supervisors with the proper tools they needed to perform their job.  WCM supplied its branch managers daily trade blotters.  But, because the blotters “were not designed to flag excessive activity,” they didn’t contain the typical data one needs to spot churning.  Some branch managers were alert enough to independently calculate the cost-to-equity ratios – which, according to the AWC, “revealed high levels of trading activity in customer accounts” – but they failed to take reasonable steps to address what they discovered.

Apparently, WCM also used a Monthly Active Account Report, which “flagged customer accounts meeting certain thresholds such as high commission-to-equity ratios, high volume of trades, and losses greater than 20% of an account’s equity during the month.”  Wow, sounds great, right?  Indeed, the report “routinely flagged dozens of customer accounts each month.”  Even better, the report is doing what it was designed to do!

Sadly, even a good report is useless if you ignore it, or don’t understand it.

Here, Mr. Worden delegated a guy to review the report, but, alas, Mr. Worden failed to train him how to read it.  As a result, the poor delegate “could not define or calculate a cost-to-equity ratio or turnover rate.”  Thus, even though the report generated “high cost-to-equity ratios and turnover rates to identify potentially violative conduct,” that data was meaningless to the supervisor, who “wrongly assumed all active trading was suitable for customers with a speculative investment objective.”

Take, for example, the March 2017 Monthly Report.  It flagged 91 accounts, approximately 10% of all firm accounts that traded during that month.  Those accounts – which appeared on the report multiple times – “should have attracted scrutiny because the accounts had (1) annualized cost-to-equity ratios and turnover rates well above the traditional guideposts of 20% and 6, respectively, (2) large numbers of transactions and high commissions, and (3) substantial losses.”  Unfortunately, there was no such scrutiny.

Finally, it is particularly instructive to note that the AWC takes the delegate to task for the activity letter (or happiness, or comfort letter, as some refer to it) that he sent to flagged customers.  Rather than telling them in clear terms that their accounts were potentially being churned, his letter “merely stated that the firm ‘trust[ed]’ customers were receiving ‘trade confirmations and monthly statements on a timely basis and are reviewing them for accuracy.’”  This comports with the advice that I have been giving for decades, that it is actually worse to send a BS activity letter than not to send anything.  If you are going to notify a customer that his or her account has exceeded one or more objective criteria consistent with excessive trading, you need actually to spell out the numbers.  While such a letter is, obviously, more likely to induce the recipient to conclude his account has been mishandled,[1] at least you will get some credit with the regulator (and, perhaps, an arbitration panel) when it comes to the supervisory aspect of the case.

Compounding his problem, Mr. Worden also failed to ensure that his delegate was actually conducting the review.  And, in a triumvirate of supervisory failures, “although Worden had access to the Monthly Reports and occasionally reviewed the reports [himself], he never acted on the dozens of accounts that routinely were flagged because he believed active trading was suitable for speculative customers.”  Indeed, to the contrary, Mr. Worden “rejected the CCO’s recommendation that at least four representatives be disciplined for unsuitable recommendations.”

As for sanctions, as ugly as these supervisory problems appear to have been, and despite the fact the AWC also includes violations of two other rules, one relating to a plan by Mr. Worden and the firm to interfere with 288 customers’ efforts to transfer their accounts from WCM to another BD, and another involving the firm’s failure to timely disclose customer arbitrations on Forms U-4 and U-5, they don’t appear to be too bad.  Sure, there’s the hefty restitution piece – to the tune of $1.2 million – that we have come to expect to see under Jessica Hopper’s reign as head of Enforcement – but Mr. Worden got slapped with a mere $15,000 fine, a measly three-week suspension in all capacities, and a three-month supervisory suspension.  The firm got a $350,000 fine.  Not cheap, but not horrible, under the circumstances.

What are the lessons we can glean from this New Year’s Eve settlement?

  • Make sure your WSPs are specific to your business.
  • Make sure the principals to whom you delegate supervisory responsibilities are properly qualified, by training and/or pertinent experience, to do the job.
  • After you delegate supervisory responsibilities, take steps – demonstrable, provable steps – to follow up and ensure that they are, in fact, doing what they are supposed to be doing.
  • Provide your delegates with the tools to do their job. Spring for the exception reports that your clearing firm offers.
  • Don’t play games with your customers. If you are going to go to the trouble of sending them a letter about their account activity, make it meaningful.
  • If you do something wrong, and it costs your clients money, pay it back to them. Do it before FINRA makes you.

[1] As proof of this point, the AWC recites that “WCM briefly implemented a more detailed active account letter that reflected, among other things, the amount of commissions paid by the customer and the number of transactions,” but “the firm ceased using this letter after one month because it caused customers to express concerns about their accounts.”  Ha!

Happy Holidays, everyone!  Since you’re all just sitting home with plenty of time on your hands, it is the perfect opportunity to enjoy this post from my colleague Denise Fesdjian, about the SEC’s new marketing rule for RIAs. – Alan

“The SEC score(s) one for the digital age.” These are the words of SEC Commissioner Heist, though, not my own. After a nearly year-long comment period, the SEC announced last week that it was replacing its former advertising and cash solicitation rules with a single, streamlined merged marketing rule. The former advertising rule has not been updated since 1961, back in the Mad Men era of advertising. Recognizing that social media and other digital communications play a significant role in current advertising practices, the SEC agreed that investment advisers can now use such methods as social media, third-party ratings, and testimonials for their marketing.

At first, the expanded marketing rule sounds promising for investment advisers looking to take advantage of the Amazon age of online reviews and ratings. While some industry leaders applaud the long-awaited rule update, the SEC does not shy away from the fact that its new marketing rule is meant to serve the agency’s real raison d’être: investor protection. Indeed, the SEC makes it clear throughout the final rule that since marketing practices have a higher risk of being fraudulent, the rule’s real purpose is to ensure investor protection, rather than to “score one for the digital age.”

To further its regulatory goal within the new rule, the SEC imposes a set of seven “principles-based” prohibitions (which largely mirror the anti-fraud provisions of the Advisers Act) that apply to all advertisements under the rule. The SEC also sets out three types of regulated marketing practices under the rule: (1) testimonials and endorsements; (2) third-party ratings; and (3) performance advertising, which are all subject to stringent disclosures and other requirements.

To better understand the magnitude of the new marketing rule, I rely on what the SEC has to say about it: “we estimate that all investment advisers will disseminate at least one communication that meets the rule’s definition of ‘advertisement’ and therefore be subject to the requirements of the marketing rule.” The SEC’s near-guarantee that “100 percent of investment advisers” will communicate to an investor in a way that invokes the new marketing rule speaks volumes as to its breadth.

In addition to the rule’s broad application and onerous disclosure requirements, the SEC also updated related requirements under its Form ADV and books and records rules, adding a higher compliance burden on firms. For instance, the new recordkeeping requirement now applies to all advertisements (instead of only to those made to ten persons or more under the old rule).

The final rule also includes an oversight and compliance provision that requires an investment adviser to have a reasonable basis for complying with certain elements of the rule to “address the accuracy of disclosures made to investors.” Collectively, these oversight activities, recordkeeping obligations, and disclosure requirements come at a cost, and not just to investment advisers, but also to the very investors the SEC seeks to protect. As the SEC admits, “although the direct costs of advertisements would be borne by the investment adviser, it is possible that some portion of the costs of advertisements will be indirectly borne by investors. As a result, investments in advertisements may result in higher fees for investors.” And since the SEC expects that “100 percent” of investment advisers will engage in some activity regulated by the new rule, it is likely that nearly every investor will bear the costs of compliance with this rule.

The SEC provides an 18-month grace period for firms to adapt to these new changes once the rule goes into effect. It will be interesting to see how investment advisers will avail themselves of the new marketing rule considering the cumbersome restrictions imposed on them. While I was initially idealistic about the new marketing rule, it seems that the SEC’s attempt to modernize advertising practices falls short of the millennial style of digital advertising I was hoping for.

Not too long ago, I posted a blog complaining that FINRA’s Nominating Committee had basically abdicated its responsibility to identify suitable candidates for certain seats on FINRA’s Board.  Perhaps not surprisingly, I never heard – from anyone, but least of all FINRA itself – why the Nominating Committee had punted.  But, I put my head down and went on with my life, such as it is these days, content merely – as my law school professors would say – to have spotted the issue.

Until yesterday.  Yesterday I got my weekly email from FINRA announcing the results of elections to fill seats on certain Regional Committees, the Small Firm Advisory Committee (SFAC), and the National Adjudicatory Council (NAC).  The email had a link to the December 15 Election Notice, so, cleverly, I checked that out.

According to that Notice, in five of FINRA’s Districts, specifically, District 1 (San Francisco), District 3 (Denver), District 5 (New Orleans), District 6 (Dallas), and District 10 (New York) – there were still empty seats after the election.  Seats for which, according to the Notice, “appointees [were] being identified.”  Huh?  That is really odd.  Helpfully, there was a footnote in the Notice, and it explained that “[i]ndividuals are being identified for appointment to the Regional Committee seats for which no individuals self-nominated.”  In other words, no one wanted the job.

In addition, the Notice reported that while someone appeared to have won election for the Midwest Region seat on the SFAC, in fact, that was not the case; indeed, there was no election.  According to a footnote, “[n]ormally, the SFAC Midwest seat is an elected position; however, since no candidates came forward to run for election for this seat, FINRA filled this vacancy by appointment.”

Finally, in two of the so-called elections – for the two Large Firm NAC Member seats and the one Small Firm NAC member seat – while (yay) there were actual nominees for those seats, the races “were uncontested,” so FINRA didn’t bother actually to mail ballots to anyone and simply appointed the nominees.

I don’t know about you, but I find all of this extremely concerning.  Not just for FINRA, but for the industry, and its future.  What does it mean when no one is interested enough to bother to serve on a FINRA committee?  It was NEVER like this back in the day.  There was always a surplus of qualified candidates eager to serve on the committees; indeed, it was often a challenge for the nominating committee to winnow down the candidates to a manageable number.  Not anymore, apparently.

I think the obvious and easy answer to my question is simply that no one wants to waste their time doing something that is pointless.  Or thankless.  Or will do nothing other than cause you frustration and aggravation.  FINRA is, of course, a self-regulatory organization, meaning that, by statute, it exists at the pleasure of the industry members whom it regulates.  But, no one really believes that anymore.  No one believes that FINRA is truly interested in serving its member firms.  To the contrary, the commonly held view is that FINRA doesn’t much care for its members, particularly small firms (who still comprise a majority of FINRA’s membership).  And it demonstrates this in the often heavy-handed manner in which it runs its Enforcement program.  Or by passing onerous and complex rules that are difficult and expensive to comply with, especially by small firms.  Or by listening more closely to the concerns of lawyers whose job it is to sue broker-dealers than to BDs themselves.

What this means, in short, is that industry members know that their voices are not being heard by FINRA management, so what’s the point?   And that’s a terrible shame.  I have encouraged many people over the years to volunteer to serve on FINRA committees, particularly a national committee like the NAC.  And the reason I do so is that I believe that change needs to come from within FINRA, from the industry people who sit on committees, and can provide real-world perspectives to the non-industry people on those same committees.  If industry people have concluded that it doesn’t really matter what they think, or what they say, because FINRA is simply going to do what FINRA is going to do, then the future is bleak indeed.

There is a little corner of the FINRA world that most people never have the need or desire to visit, and that’s the not-so-quaint village of statutory disqualification.  SD, for short.  I have written about this sad place many times, mostly about those poor souls who manage to end up here through confusion, or, too often, reliance on bad legal advice, and who discover – too late – that it is impossible to leave.  Like the Roach Motel, where “roaches check in, but they can’t check out.”  Or Gilead, for you Handmaid’s Tale fans.  Or, in the spirit of the Season, the Island of Misfit Toys.  Safely navigating away from SD can be a procedural nightmare, as the rules are complex and hardly intuitive.

But all trips to SD start with the same event: a determination by FINRA staff that you are, in fact, statutorily disqualified.  It comes in a letter addressed to your BD.  It recites, basically, that because you are SD’d, the BD has a few weeks within which to choose one of three options, none of which is particularly attractive:

  • Fire you
  • File a Form BDW (because a BD is not permitted to associate with an individual who’s SD’d; to do so renders the firm SD’d, too, thus necessitating the withdrawl from FINRA membership)
  • File an MC-400 (to seek permission to remain a FINRA member firm notwithstanding the fact that you are SD’d)

If your firm agrees to file the MC-400, there is long, complicated, expensive process that ensues.  FINRA staff have the authority to approve, but not reject, an MC-400 application.  So, in a best case scenario, some months after the MC-400 is filed you learn that it’s been accepted, and you can avoid being fired.  If, on the other hand, FINRA staff is disinclined to approve the application, they will notify the BD, providing it the opportunity to withdraw the application.  Most firms opt for this.  If it is not withdrawn, then the process culminates in an evidentiary hearing before a two-person hearing panel representing the NAC’s SD Subcommittee.

Once that first letter is received, there is nothing to stop the SD train from rumbling down the tracks to its eventual (but yet undetermined) destination.  This is true even in those circumstances where there is some question whether or not FINRA is correct that there has been an SD trigger.  Indeed, sometimes it is not so clear.  Take one case I had, as an example.  The SD statute states that any felony conviction results in an SD.  But, what happens if a convicted felon manages, under state law, to have the conviction expunged?  The fact is, in some states, the result is that the conviction goes away completely, as if it never happened in the first place.  In other states, however, it only goes away partially.  This can result in a debate over whether or not someone who obtains an expungement of their criminal record is truly SD’d.

The problem is, as the rule is presently structured, apart from attempting to engage in a dialogue with the people that run the SD program at FINRA (who, by the way, are really nice and normal and seem truly to care about getting the right result), there is no formal, official mechanism to immediately challenge the determination that you are SD’d.  Rather, the only way to go about doing that is to go through the full-blown MC-400 process and try to convince the hearing panel that FINRA staff erred.  That is expensive and time-consuming, and incredibly inefficient.

Well, wonder of wonders, it seems that FINRA management has recognized this.  I was excited to learn that at its December Board meeting, FINRA approved a “Proposal to Establish a Process to Appeal Staff Statutory Disqualification Determinations.”  Specifically,

[t]he Board approved the filing with the SEC proposed amendments to the FINRA Rule 9000 Series to establish a process to appeal statutory disqualification determinations made by FINRA staff.  The new process would provide individuals with the ability to challenge a FINRA decision that the person is subject to a statutory disqualification, without needing the support of a firm to do so.

There are two important things to observe here.

First, as noted, it is encouraging to see that FINRA has acknowledged that there is a hole in its current process, a hole that forces individuals who want to contest the threshold determination that they are SD’d to go through the entire MC-400 process.  This is the very sort of hole in the Rule 8210 process I have been complaining about for years, i.e., that in order to challenge the validity of an 8210 request for documents and information, one must become a respondent in an Enforcement complaint, and take the matter to a hearing (with the knowledge that an adverse outcome results in a permanent bar).  I am pleased anytime FINRA tries to make improvements to its administrative scheme that same time and money.

Second, note the last sentence: under the proposal, if you are SD’d, you can file the application yourself.  That saves you from the always-awkward, mostly unsuccessful conversation with management of the BD in which you try to convince them to file the MC-400 on your behalf (because, under the current rule, if the BD declines to file the MC-400, you are out of luck).  As I said earlier, a BD only has three options when you’re SD’d, and only one of them – firing you – is free and easy.  By ceding some control over the situation to the SD’d (or apparently SD’d) individual, the proposal helps reduce the pressure on the BD to take that easy way out.

I like to think that I am evenhanded in my critiques of FINRA, that is, while I am quick to point out problems and errors, when FINRA manages to get something right, I am perfectly willing to give it the credit it deserves.  That is the case here.  I get that for most people, and I mean the overwhelming majority of people registered with FINRA firms, this proposal will have zero impact on their lives.  But for the few unlucky people who, as I said, find themselves trapped in SD through mistake or inadvertence, the new mechanism could be a Godsend.  I only hope that FINRA considers doing something similar with Rule 8210.

We have frequently blogged here about the degree of attention that regulators pay to Chief Compliance Officers, and whether it is proper that they sometimes are named individually in Enforcement actions.  And we are hardly the only ones who see this issue.  The New York City Bar back in February – I know, that seems like a lifetime ago, as it was before COVID-19 really impacted us all – published a Report On Chief Compliance Officer Liability In The Financial Sector that explored the subject in great detail.  It concluded that “Compliance officers can function as effective gatekeepers only if they are given the information and tools necessary to carefully police the boundary between culpable and permissible conduct—and do so without bearing a disproportionate risk of liability for others’ misconduct.”

Interestingly, that Report noted at the time that there was some reason for hope, citing remarks made by Peter Driscoll, the Director of the SEC’s Office of Compliance Inspections and Examinations (“OCIE”), at a spring 2019 conference.  There, he announced that OCIE was embarking on a “pilot initiative to hold regional roundtables with CCOs in select locations” designed “to encourage productive dialogue with the compliance community and ‘search for ways to strengthen the role of the CCO, improve the culture of compliance, and deliver on the shared goal of investor protection.’”

Well, last week, Mr. Driscoll again offered remarks relating to CCOs that, once again, reveal not only that he feels their pain, but provide some solid guidance as to what the CCO job should look like and how CCOs should be treated by firm management.  And while he was discussing CCOs of RIAs, not BDs, I think both should pay heed to his words, as they apply equally to both.

He started with this summary observation:  A CCO “should be empowered with full responsibility and authority to develop, implement, and enforce appropriate policies and procedures for the firm.  And a CCO should have a position of sufficient seniority and authority within the organization to compel others to adhere to the compliance policies and procedures.”  He then went on, very helpfully, to illustrate what that general description means by detailing what the SEC does NOT like to see during an exam:

  • CCOs who are hired merely so the firm can “check the box,” but who are not supported or empowered by management;
  • CCOs who hold one or more roles in a firm and are, as a result, inattentive to their compliance responsibilities;
  • CCOs who are “too low in the organization to make meaningful change and have a substantive impact, such as a mid-level officer or placed under the CFO function”;
  • CCOs who “are expected to create policies and procedures, but are not given the resources to hire personnel or engage vendors to provide systems to implement those policies and procedures”;
  • When “a CCO is replaced because they challenge questionable activities or behavior”;
  • When “a CCO is trotted out for an examination or sits silently in the corner in compliance discussions, overshadowed by firm senior officers”;
  • When “a firm puts responsibility on the CCO for a failure of an employee or an officer to follow a firm policy or procedure.”

Then, he listed what the SEC LIKES to see in a CCO:

  • CCOs who “are routinely included in business planning and strategy discussions and brought into decision-making early-on, not for appearances, but for their meaningful input”;
  • CCOs with “access [to] and interaction with senior management, prominence in the firm, and when they are valued by senior management;”
  • Senior management who evidence “demonstrable actions, not just words, supporting the CCO and compliance.”

He concluded his remarks with some very powerful statements on what makes not just a good CCO, but a good firm, a firm that is truly interested in achieving – and demonstrating to its regulators – effective compliance.  If I was a CCO, I would print these things out and hand deliver them to firm management, and if all I got in return was a hearty laugh, I’d find somewhere else to work:

  • The CCO is not there to fill out irrelevant paperwork or serve as a scapegoat for the firm’s failings.
  • A firm’s compliance department should be fully integrated into the business of the adviser for it to be effective.
  • Compliance regarding conflicts of interest, disclosures to clients, calculation of fees and protection of client assets should not be done from the sidelines. The CCO needs a meaningful seat at the table.
  • Although the responsibilities and challenges are significant, the critical function of compliance should not all fall on the shoulders of CCOs.
  • Without the support of management, no CCO, no matter how diligent and capable, can be effective.
  • An effective CCO should have confidence that they can stand up for compliance and be supported.
  • Compensation and job security for CCOs should be commensurate with their significant responsibilities.
  • CCOs should not be made to feel that they are one “no” away from termination.
  • CCOs should not be made the target of every problem. The cause or blame for a compliance issue or failure typically does not sit only with the CCO and may not sit at all with the CCO.  In fact, we appreciate that often the CCO is the one responsible for identifying the problem and for fixing it.

So, let’s hear it for CCOs, as well as firms who rightfully value their CCOs.  Let’s not just look at them merely as a line – and a big one, at that – on the expense side of the ledger.  Let’s no longer brand them the “anti-sales department.”  And let’s agree that Ari Spyros on Billions is not a realistic portrayal.

As everyone is likely well aware, one of the principal changes that happened when FINRA retired the old suitability rule – NASD Rule 2310 – and replaced it with shiny new FINRA Rule 2111 back in 2012 was the broadening of the scope of the rule to encompass not just recommendations to buy or sell specific investments, but, as well, recommendations involving investment strategies (which could include a combination of securities and non-securities).  Despite that change, the overwhelming majority of suitability cases still focus on recommendations relating to specific investments.  Every once in a while, however, a case comes out that makes it abundantly clear that FINRA stands prepared to charge registered reps with making unsuitable strategy recommendations.  Richard Wesselt, who has been in the industry since 1992, learned this the hard way through an AWC that was published a week or so ago.

According to the facts of the case as recited in the AWC (which Mr. Wesselt accepted), Mr. Wesselt recommended an “unsuitable investment strategy to 78 customers.”  It was a three-step process, as follows:

Step 1: Mr. Wesselt recommended that the customers “liquidate their retirement savings, which they often held in qualified, tax-deferred accounts such as 401(k)s or IRAs.”  Hmm.  This already sounds troubling.

Step 2: Mr. Wesselt then recommended that the customers “purchase a variable annuity with funds liquidated from their retirement plans.”  Interestingly, Mr. Wesselt generally recommended that his customers “purchase an X, or bonus, share class variable annuity.”  According to the AWC, while such shares “add a cash bonus to the contract,” they also “typically have the longest surrender periods of any variable annuities offered in the marketplace and charge higher mortality and expense fees than other share classes.”  Mr. Wesselt also recommended that as part of the annuity purchase, the customers pay extra for “a guaranteed minimum withdrawal benefit rider, which allows lifetime withdrawals of a specified percentage once the customer reaches a specified age.”  By recommending both the X-share and the withdrawal rider, Mr. Wesselt managed to increase the customers’ fees for purchasing the variable annuity.  Getting worse, huh?

Step 3: Finally, after the variable annuity was issued, Mr. Wesselt recommended that his customers take early withdrawals, causing them not only to lose benefits they had paid for, but to incur surrender charges.  Many of withdrawals were large one-time withdrawals to purchase whole life insurance policies (notoriously expensive products that have super high commissions); others were used “to pay significant expenses, such as the purchase of a home or the settlement of a divorce.”  The purpose of the life insurance policy was to build cash value, part of what Mr. Wesselt dubbed “building your own bank” or, even more perplexing, “infinite banking.”

FINRA rightly takes the position that a variable annuity is a “complex” investment vehicle, with lots of moving parts.  Given that, it is essential that extra care be taken when recommending such products to ensure that customers understand how they work, how much they cost, how the RR is going to be compensated, etc.  Indeed, as you know, FINRA has a special suitability rule – Rule 2330 – just for annuities.[1]  Mr. Wesselt, sadly, seemed to go in the opposite direction, and hid vital disclosures from this customers, as he “typically had his customers sign blank or incomplete disclosure documents or had them sign those documents quickly in his presence.”  As a result of his sleight-of-hand, “his customers frequently did not understand the unique features and risks associated with these variable annuities and riders.”

No surprise, I suppose, that between the unsuitable recommendations and the paperwork trickery, FINRA had enough to permanently bar Mr. Wesselt.

But, what about Mr. Wesselt’s BD, The O.N. Equity Sales Company?  The AWC states that during the relevant period, Mr. Wesselt was one of the firm’s “top producers for variable annuity sales”; in fact, in 2016 he was the firm’s highest producer.  For the 78 customers alone who FINRA identified, Mr.  Wesselt earned $686,025 in commissions just on the sale of the variable annuities.  And that doesn’t include, I expect, the commissions he earned on the sale of the products in Step 1 of his plan, or the purchase of the whole life insurance in Step 3.  The point is, Mr. Wesselt should certainly have been the focus of a good bit of attention from the firm.  Yet, there is no indication that O.N. Equity noticed anything untoward.  (Similarly, there is no indication that the firm has been the subject of any action taken by FINRA, i.e., no Wells letter, no filed complaint and no settled case.)

And, look, I get two things.  First, I get that Mr. Wesselt made it appear that his clients actually signed all the necessary documents, but all that means is that as far as O.N. Equity knew the transactions were authorized; those signatures do not, however, establish that the transactions were suitable.  A customer cannot conclusively agree that a recommendation was suitable, as that is not something a customer is deemed capable of knowing.  That’s why Supplementary Material .02 to FINRA Rule 2111 explicitly states that “[a] member or associated person cannot disclaim any responsibilities under the suitability rule.”

Second, I get that the final step in the strategy – the purchase of the whole life insurance – did not take place at O.N. Equity, so the firm may not have known about it.  (I know this because O.N. Equity went to court to fight to keep complaints about the whole life insurance purchases out of four customer arbitrations that Mr. Wesselt’s conduct triggered.  According to the court’s decision determining that the insurance piece of the strategy was not subject to FINRA arbitration, “O.N. Equity is not in the business of selling life insurance, is not licensed to sell insurance, and does not appoint life insurance agents.”)  But, O.N. Equity certainly could have seen the early and sizable withdrawals from the recently purchased annuities across his customer accounts.

And when you look at the descriptions of what happened to the sample of Mr. Wesselt’s 78 customers described in the AWC, it makes you wonder how the firm could have missed these situations:

  • In 2014, Customer 1 was 43 years old, with “substantial daycare expenses” and a 401(k) worth $220,000. He had her liquidate the 401(k), and used the proceeds to buy an X-share variable annuity.  He then had her withdraw $225,000 from the annuity to buy whole life insurance (that amount included surrender fees of $11,998 and tax withholding of $71,564).  The early withdrawals also caused her to incur a tax penalty.  Now she can’t afford her life insurance premiums, and her annuity, which held most of her retirement savings, is worth less than $10,000.


  • Customer 3 was 59 years old in 2014 and nearing retirement. She approached Mr. Wesselt regarding the purchase of an apartment and assisting a child with student loan repayment.   Wesselt had her take $58,000 from her 401(k) and buy a variable annuity.  Six months later, he had her buy whole life insurance using her annual withdrawals from the annuity.  Each withdrawal was $16,840, which included $12,000 for the insurance premiums, $840 in surrender charges, and tax withholding of $4,000. Not surprisingly, because each withdrawal depleted the value of the annuity, this was sustainable for only three years.  By June 2017, the variable annuity had declined from its original value of $57,955 to $8,489.


  • Customer 4 was 52 years old when she met with Mr. Wesselt in 2016. She needed to pay $40,000 as part of a divorce settlement, and wanted to help a child pay off student loans.  The only money she had available was her 401(k).   Wesselt had her roll her 401(k) into an X-share VA worth $133,144. Within three days, he recommended that she withdraw $63,697, which included $40,000 for the divorce settlement.  A week later, he had her withdraw another $55,323 from the variable annuity in order to pay for a new whole life policy.  In other words, in one week, her new annuity declined by 85% to $19,764, she paid $8,180 in surrender charges, and she was assessed a tax penalty for taking the early withdrawals.

Anyway, I didn’t mean to get hung up on O.N. Equity, but it does make me wonder how the firm has stayed clean throughout this.  The reason I found the AWC worth discussing is that, unlike probably 99% of suitability cases, this one focuses solely on the notion of an unsuitable strategy.  So, if anyone tries to tell you that Rule 2111 really didn’t change anything from old, reliable Rule 2310, feel free to laugh in their face as you share Mr. Wesselt’s sad tale.

[1] Weirdly, Rule 2330 does NOT explicitly cover recommendations involving a “strategy,” as Rule 2111 does.  If you read Rule 2330, it only “applies to recommended purchases and exchanges of deferred variable annuities and recommended initial subaccount allocations,” i.e., actual transactions, not strategies.  Nevertheless, the AWC provides that Mr. Wesselt violated both Rule 2111 and Rule 2330(b).

As should be clear to readers of this Blog, I find that Enforcement actions often provide the best guidance in terms of what regulators deem to be unacceptable conduct, which is very useful when dealing with subjective standards like “reasonableness.”  This past week, FINRA published an AWC submitted by Coastal Equities, Inc. that offers a good lesson in the sort of red flags associated with unsuitable recommendations – particularly quantitatively unsuitable recommendations – to which every BD ought to be sensitive.

As in every AWC, the salient facts recited were deemed by Coastal to be accurate.  They relate to the recommendations made by a particular RR referred to as “SA,” who, according to a footnote, was barred by FINRA (for violating Rule 8210 for not appearing at his OTR, which was investigating his “recommendations of excessive and unsuitable trading, including his recommendations involving the use of margin”[1]):

  • During the pertinent time period, i.e., from September 2015 to July 2018, Coastal supervised the recommendations of its registered reps “primarily through the review of daily trade blotters.” Ok, no problem here, as lots of firms rely on the same tool.
  • The blotters showed each trade entered by each RR, as well as the turnover rate and the amount of commissions charged to each account for the preceding 12-month period. Wow, this sounds great!  This is clearly more info than many blotters provide.
  • In addition to that, from time-to-time, supervisors would calculate the cost-to-equity ratio for certain accounts. More points for Coastal!
  • In September 2016, Coastal, through daily trade blotter review by SA’s immediate supervisor, became aware that SA had recommended frequent transactions in preferred stock that resulted in significant losses in the account of one customer. Man, this is sounding great for Coastal.  I can’t imagine how it could’ve gone wrong!
  • That led SA’s supervisor to sample other customer accounts of SA. This is exactly the response you would want to see.
  • That revealed “additional accounts showing indicia of potential excessive trading.” Ok, that’s what the sample was designed to look for.
  • When asked about this trading, SA “claimed that the customers approved of his trading strategy.” Uh oh.  Everyone knows that the issue of suitability does not turn on the question whether the customer approved; indeed, it is irrelevant. This answer was not what you would want to hear.
  • Coastal accepted that explanation at face value and as a result took no further steps at that time. Well, here we go.  Now I see the problem. 

FINRA could have ended the AWC at this point and it would have been clear that there was a supervisory problem.  As I have said countless times, when confronted with red flags, you cannot simply pretend they do not exist; you must investigate them to see whether a problem exists and, if it does, address the problem.  Here, Coastal did everything exactly right . . . up until the moment it confronted SA, at which point it (1) asked him the wrong question, and then (2) blindly relied on his irrelevant answer.  The potential issue that the blotter review revealed was SA possibly churning his accounts, i.e., making quantitatively unsuitable recommendations.  But, rather than explore that, Coastal apparently satisfied itself that there was no problem because SA assured them that his customers “approved” his trading strategy.  In no world does that constitute a defense to a suitability claim, and Coastal had to have known that.

But, as is typical, it only gets worse.

As the AWC provides, after that observant supervisor picked up on SA’s red flags, “Coastal, through supervisory review of the daily trade blotter, was on notice of additional red flags that SA was recommending unsuitable and excessive trading in the accounts of four customers, and that that he was making unsuitable recommendations to purchase securities using margin in two of those customers’ accounts.”

In other words, Coastal compounded its problem.  Not only did it fail to understand the implications of the first situation it stumbled across, it now failed to appreciate all these other red flags madly waving in its face.

Who, exactly, were these four customers?  They were, in short, the embodiment of your worst case scenario:  all were seniors, all were retired, and all had a “moderate” risk tolerance.  There is no greater sin, in FINRA’s eyes, than messing with seniors.  Hard to argue with that, at least in this case, when you consider some of these ugly details:

  • Customer 1 was 75 years old. From October 2016 to July 2018, SA recommended more than 100 trades in his accounts, resulting in commissions totaling $84,525.
  • Customer 2 was a married couple living on a fixed income. From October 2016 to April 2017, SA recommended 65 trades in their account, including recommendations to purchase securities using margin. They paid $97,587 in commissions plus another $11,845 in margin interest.
  • Customer 3 was 91 years old, also on fixed income. According to his new account paperwork, his annual income and other investments were less than $50,000.  From October 2016 to July 2018, SA recommended 31 trades in his account, resulting in $61,657 in commissions and $580 in margin interest.
  • Customer 4 was 82 years old. From October 2016 to December 2017, SA recommended 39 trades resulting in $14,126 in commissions.

To be clear, there can no reasonable argument that the flags were not red, or that Coastal somehow could not plainly see them.  From October 2016, its daily trade blotter showed not only SA’s frequent trading but the “correspondingly high turnover rates and commissions in the accounts of Customers 1 through 4.”  Each had a turnover rate well over 6 and a cost-to-equity ratio in excess of 20%.  I am not saying that these numbers conclusively establish churning, but they do require investigation, which Coastal failed to do.

Finally, on top of that, beginning in August 2017, Coastal bolstered its daily blotter review with exception reports from its clearing firm, which included a report of accounts with turnover rates over 6 and a report for accounts with high margin-to-equity ratios.  The accounts of all four customers generated multiple turnover exceptions, and Customer 3’s account generated two margin exceptions.

Yet, even with these nifty exception reports, even in the face of all these red flags, from October 2016 through December 2017, no one at Coastal:

  • reviewed the accounts of Customers 1 through 4 to determine whether SA’s recommendations were suitable,
  • questioned SA about the trading in any of his customer’s accounts,
  • contacted any of SA’s customers, or
  • took any steps to reduce the commissions that SA was charging his customers or the frequency with which SA was recommending.

The AWC does show that, finally, in December 2017, the firm suggested that SA move some actively traded accounts from commission-based to fee-based accounts, and in February 2018, Coastal began sending activity letters to some of SA’s customers.  Despite this, however, SA “continued to recommend excessive trading and/or unsuitable use of margin to certain customers.”

Coastal stepped it up in April 2018 and sent SA a “letter of admonishment,” for what that’s worth, but, even then, SA did not sign it until June 2018.  SA finally quit in July.

There are so many things here that Coastal did wrong, or did too late, or did too half-assedly, that it is impossible to argue with the outcome.  So, as I said at the outset: use this as a lesson in what NOT to do.[2]






[1] About two minutes of Google research revealed this AWC for the RR, Sam Aziz.

[2] There is more point I want to make. At the beginning of the AWC, as it does in all AWCs, FINRA outlines the rule that the respondent violated.  Here, it was FINRA Rule 3110, the supervision rule.  But, strangely, the AWC does not include a simple recitation of the rule; instead it includes what I find to be a disturbingly inaccurate summary of the rule:  “FINRA Rule 3110 requires that a member firm take reasonable steps to: ensure that the activities of each registered representative comply with applicable securities laws, regulations, and FINRA rules, and FINRA rules.”  I want to be very clear about something:  Rule 3110 does not require that a firm’s supervisory system “ensure” that its reps abide by all applicable rules.  The word “ensure” appears in the rule exactly eight times, by my count, but never in the manner that FINRA uses it here.  Through its use of “ensure” here, FINRA has inaccurately elevated the core standard of “reasonableness” that underpins Rule 3110 to something rather higher.  Thanks to my buddy Richard Brodsky for sensitizing me to this issue.

Attentive readers will recall that a couple of weeks ago, I mentioned in a preface to great post from Chris about expungement becoming an endangered creature due to changes in FINRA rule that I was about to embark on a two-week FINRA Enforcement hearing, all done by Zoom, by consent.  I promised to provide some feedback, so here it is.

In short, despite the best and sincere efforts and intentions of the parties, their counsel, and the Hearing Officer, in a word, it simply failed.

It was not, however, a matter of the typical Zoom-related technical glitches, like someone inexplicably dropping off the feed, or someone’s video freezing.  We had a few of those, but, at the Hearing Officer’s instructions, everyone on the call was extremely attentive to any such occurrences, and when they happened, they were immediately brought to the Hearing Officer’s attention (unless she discovered the problem first herself), and she paused the proceeding to correct the glitch.  So, I have no complaints about that.

Sadly, my complaints are much more serious.

What happened was that at the close of the hearing on Day 2 (of what was supposed to be a 10-day hearing, remember), I posed a question to the Hearing Officer.  I told her that when a witness was testifying while a document was being displayed to the witness – which was about 90% of the time a witness was testifying – I could only see the document, and not the witness.  (For that matter, I couldn’t see anyone, that is, either the witness or the members of the hearing panel, so I also had no way of gauging the degree of attention being paid to the proceedings by the panelists.)  Maybe it was no big deal that I couldn’t see the witnesses.  But, given that it was the job of the hearing panel, perhaps its most important job, to make credibility calls about the testifying witnesses, based not only on what the witnesses said but, as well, on how they said it, i.e., their demeanor, it was a very big deal to ensure that each panelist was able to see the witnesses as they testified.  So, I asked if anyone else was having the same experience as me.

The Hearing Officer told me that, indeed, she could see both the witness and the exhibit.  Great.  The second panelist echoed that response, as he, too, could see both.  Excellent.  But…the third panelist said, nope, that, like me, he could only see the document and not the testifying witness.

Remember, this was after two full days of testimony, all from my clients, the respondents.  This meant that one-third of the hearing panel was, basically, deprived of the essential tools he needed to do his job.

Ah, but that’s not all!

After informing us that he couldn’t see the testifying witness 90% of the time, the third panelist also volunteered the fact that he had not been able to hear the second witness very well, either.

Mind you, that witness’s testimony, i.e., my client’s testimony, had occupied much of the second hearing day.  Which meant that for all intents and purposes, the hearing panelist could neither see nor hear (at least not very well) hours of testimony from one of the two respondents.  I know justice is blind, but this, well, this is not what anyone had in mind.

Perhaps not surprisingly, when we resumed the hearing on Day 3, the Hearing Officer announced that due to the problems that my inquiry had revealed at the close of Day 2, she was adjourning the hearing, and that there would be a do-over.  That is, we would pretend the first two day had not happened, i.e., no opening statements, no testimony, no nothing, and we would start all over again at some point in the future, from the beginning, when the hearing panel could both see and hear the witnesses.

From a fairness-of-the-hearing standpoint, I think that the Hearing Office had no choice but to make that decision.  There was simply no way to adequately remedy the problem.  I mean, I suppose that the third hearing panelist could be provided with a transcript of the hearing to read the testimony he was not able to hear, but there is simply no way to make up for the fact that he had been deprived of his ability to eyeball the witnesses while they testified.

From a fairness-to-my-clients perspective, however, consider the costs, both out-of-pocket as well as emotional, of having to start over again.  Consider, too, that when this hearing restarts, Enforcement will have had the benefit of hearing my opening statement, and seeing my nifty PowerPoint slide deck, and seeing how my clients performed on the witness stand.  There is nothing that FINRA can do to compensate for that.

The only positive development is that this little snafu provided an opening to settle the case on terms that heretofore FINRA refused to find agreeable.  In other words, for the first time, FINRA agreed to drop its insistence that – guess what? – both my clients be permanently barred.

The irony of this experience is that it happened despite pretty good diligence by the Hearing Officer, not because of inattentiveness.  The lesson is that you can take absolutely nothing for granted in a virtual hearing, and must constantly take steps to ensure that everything is proceeding according to plan.  While there is no good excuse for the third hearing panelist not to have complained sooner that he could not hear the witness’s testimony, there is also not much excuse for FINRA to have set up a system in the first place that apparently did not permit that panelist to see the witness while a document was being displayed, and for not checking on that before I happened to bring it up when I did.  It should not be my job to ensure that the hearing – from a straight technological, administrative angle – is fair.



On October 26, the SEC hosted a roundtable discussion during which the SEC and FINRA shared some of their observations about how firms are doing implementing Regulation Best Interest.  If you missed the live presentation, it was recorded and is available here.

The discussion covered a lot of topics and, in some instances, simply directed firms to the FAQs and guidance released to date.  But, in a few instances, there were glimpses of what the regulators liked and what troubled them as they conducted these reviews.   Here are a few of the highlights where we learned what pleased and displeased the regulators:

Reg BI training.  The regulators are seeing a lot of firms sharing documents with their reps that explain what Reg BI is, what their procedural changes and requirements are, etc.

The Regulators are pleased with firms that:

  • Added a “live” (electronic, of course, given the pandemic) training element.
  • Included in their training specific guidance for reps on how they fulfil the various obligations owed under the regulation. So, for example, instead of merely repeating the requirement reps must act in the customers’ best interest when recommending a specific account type, the regulators were pleased by firms who go on to train reps on how to perform that analysis (and how to memorialize it).
  • Conduct ongoing testing to ensure that the rep’s understanding of his or her obligations has “stuck.”
  • Write up reps who do not complete their training on time.

The Regulators are displeased with firms that:

  • Had not started training or started it long after Reg BI’s implementation date.
  • Merely distributed rule updates as training.

Care Obligation.  The care obligation requires reasonable diligence and care when making a recommendation including knowledge of risks, rewards, costs, and that the rep has a reasonable basis to believe that the recommendation is in the customers’ best interest.  This analysis specifically requires that the rep consider “reasonably available alternatives” to the product or strategy the rep intends to recommend.

The Regulators are pleased with firms that:

  • Had developed tools to assess “alternative” recommendations.
  • Conducted up front review of certain products prior to making them available.
  • Evaluate their existing customer records and the manner in which they collect customer information to ensure they are properly collecting and preserving information about the customers’ risk, experience, etc.
  • Requiring reps to include comments around each recommendation so that supervisors can review compliance with care obligation. (The regulators acknowledged that there was no requirement to document this process, but recommended firms do so, especially if it involves an unusual product or if the recommendation seems to be a poor fit for the customer, in case the regulators come in and ask about it).

The Regulators are displeased with firms that:

  • Had procedures that failed to distinguish between the Rule 2111 suitability and the best interest standard OR had simply added Reg BI language to existing procedures without “harmonizing” Reg BI and the Suitability Rule.
  • Required reps to certify that they had performed the care analysis, but did not require the reps to explain what the analysis was.

Form CRS.  The Regulators pushed firms to review the guidance and FAQs they had published about Form CRS and its requirements.

The Regulators are pleased with firms that:

  • Avoided legalese and disclaimers. The document should be in plain English.  (I think one of the Panelists suggested that it should be written for a person who reads at an 8th grade reading level, but I’m not sure I caught that correctly and there was no rewind button!)
  • Used charts, graphics, and exciting fonts to highlight items.
  • Made sure conversation starters were visible.
  • Did not “overload” the pages in dense text and, instead, used white space to draw the reader’s attention.
  • (for dual registrants) used side by side columns or boxes to illustrate the differences between brokerage and IA accounts.
  • Clearly described how and when fees were imposed.
  • Explained whether the firm monitors customer accounts and, if so, the frequency.

The Regulators are displeased with firms that:

  • Modified the conversation starters.
  • Used Form CRS as marketing material instead of a disclosure document.
  • Used Form CRS to explain how conflicts would be mitigated or to suggest they were rare/minimal by using words like “may.” (The Commission believes this downplays the conflicts, whereas the purpose of Form CRS is to highlight them).
  • Failed to disclose disciplinary history or incorrectly said no history existed when it did.
  • Provided “extraneous” language explaining disciplinary history.
  • Failed to state “yes” or “no” in response to the disciplinary history question or otherwise provided a vague response.
  • Provided only vague cost and fee descriptions and no discussion on how they are imposed.
  • Failed to provide a WRAP fee disclosure.
  • Modified the required headings.
  • Missed required sections of Form CRS.
  • Missed required headers.
  • Missed required conversation starters.
  • Failed to deliver the Form CRS.
  • Failed to record delivery (meaning delivery could not be verified).

Towards the end of the program, FINRA suggested that it may not necessarily agree with some of the firms that had concluded they were not required to file Form CRS at all.  FINRA seemed surprised by the number of firms that reached this conclusion.

I encourage everyone to find the archived program and watch it.  A lot of the information will be repetitive for anyone who has read the Rule, Form CRS and followed the subsequent guidance.  But it is interesting to hear about what other firms are doing (good or bad) and see which areas the regulators are most focused on – at least for the moment.