Opening Session/Firm Culture/CCO Liability. If you are reading this blog, then you, like me, have been probably eagerly waiting for the start of SIFMA’s annual Compliance and Legal conference not just for the jumbo shrimp at the reception, but also to learn some insights from the regulators about their concerns and intentions. If you attended the opening session of the conference this morning, “Current Enforcement Issues Panel,” then you are probably still waiting for those insights, at least from FINRA. During the entire 65-minute opening session, FINRA’s Executive Vice President of Enforcement, Brad Bennett, uttered a grand total of six sentences. He was asked zero questions by the moderator and was given the floor for three whole minutes at the end of the session. His preparation must have been grueling.
Besides the brevity of his remarks, the substance of Mr. Bennett’s six sentences was also curious. His first comment was that the Series 7 exam needs to be more difficult. The implication, I suppose, is that a more challenging Series 7 exam will help keep less intelligent individuals from becoming registered persons, which FINRA must think is good, because, presumably, intelligent people will commit fewer sales practice violations. The problem is, while the Series 7 exam may or may not be a measure of intellect or knowledge, it is certainly not a measure of honesty. So, even if the goal is hiring more intelligent, or at least more knowledgeable, brokers, this hardly protects customers. A smart broker does not equate to an honest one; indeed, some devastating frauds have been incredibly sophisticated, perpetrated by financial geniuses.
The second thing that Mr. Bennett said was that FINRA will NOT be using its new culture survey as a feeder for eventual Enforcement actions. Laughter ensued. A breakout session later in the day on “Compliance for Small and Regional Firms” offered two theories for the culture survey. First, FINRA may be encouraging firms to cull outlier brokers or branches that don’t fit within their self-described culture. In other words, once a broker-dealer defines its culture, it can more easily identify those reps who don’t fit that culture and then either figure out how to integrate them better, or cut ties with them.
The second theory about why FINRA is focusing on culture – the one which received near universal head nods from the audience – is that FINRA is, in fact, going to bring Enforcement actions based on poor firm culture, or where it identifies registered persons who do not seem to be adhering to firm culture. In other words, nobody believed what Mr. Bennett had said 30 minutes earlier. The prevailing theory suggests that FINRA may bring an action against the firm or individual for a Rule 2010 violation (FINRA’s favorite rule, besides 8210), based on “just and equitable principles of trade.”
As for the SEC, its Director of Enforcement, Andrew Ceresney, was asked about the “targeting” of CCOs. The moderator framed the question to Mr. Ceresney by asking if the SEC was going after CCOs for “wholesale failure to carry out policy and procedure.” Mr. Ceresney interrupted the question and said the SEC wasn’t looking to enforce conduct that is considered a wholesale failure to carry out policy and procedure but, instead, conduct that is a “wholesale failure to carry out responsibility.” Hmmm. I am not certain I understand this distinction, but, one could very well make the argument that notwithstanding the repeated statements that the SEC is NOT targeting CCOs, the message is that the SEC is focused both on a CCO’s strict compliance with WSPs and its enumerated responsibilities, as well as other, unspecified responsibilities that CCOs routinely assume. If so, that’s a scary prospect.
Fiduciary Duty. One of the biggest attractions was the panel on the Fiduciary Duty Rules. As everyone likely already knows, the proposed Department of Labor rules will be released by the OMB within weeks and, unless Congress manages to kill them, they will become effective in early 2017. What does this mean? Owners of 401ks and IRAs will be able to hold their advisors liable as fiduciaries, assuming that some recommendation is made (and the standard of what is a recommendation may be very easily satisfied). Even simple solicitations to rollover your 401k to an IRA could create a fiduciary duty. Even saying “you should open an IRA with my firm” during a cold call could make the securities professional a fiduciary. TV ads directed to the general public that say, “follow the green line” to retirement security may create a fiduciary duty. The panel believed that among the unintended consequences of this change in the law will be that employees/investors will have less information available to them and fewer products to choose from.
Let’s take a step back. Remember the days when many employees had a professionally managed pension as a benefit of their employment? Employers got out of these expensive plans because Congress created 401ks and IRAs. As a result, employees became managers of their own retirement funds. But – and I acknowledge I am painting with a very broad brush – the average American is relatively incapable of managing his own retirement funds. Indeed, most Americans are so inept at managing their financial affairs that they have not saved anywhere near enough to maintain the same lifestyle to which they were accustomed, and a significant number of people have not saved any money for retirement. With this new Fiduciary Duty Rule, the DOL is shifting the cost of employers guaranteeing their workers a decent retirement and the cost of the financial incompetency of employees onto the financial securities industry, which will end up bearing the financial burden of baby-boomer retirement.
Municipal Securities: Not a subject for everyone, but, very important to those who sell munis, obviously. A few things of note were said. First, FINRA said it would be focusing on late trade reporting, concentration and new issue pricing. Second, the panel went into some detail about the new best execution rule going into effect on March 21. They advised that firms should look wide and document their search for bonds in different places to ensure that customers get the best price. Interestingly, it was suggested that putting out lots of bids, looking for the best price, can have the unintended consequence of masking illiquidity. Third, with regard to “Extended Settlement,” the panel discussed FINRA Rule 4210 and said that FINRA seems to view purchases not settled by T+6 to be purchases on credit…which is problematic because it would then require margin. Finally, the panel revealed what is already clear to those of us who work with muni firms, which is the regulators’ renewed focus on enforcing the minimum denomination rule. Cases in that area were few and far between for years, but not anymore.
We are looking forward to Day 2!