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.

 

 

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.

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.

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.

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

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

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

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

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

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

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

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

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

 

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

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

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

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

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

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

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

 

 

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

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

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

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

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

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

 

 

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

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

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

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

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

 

 

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

The Supreme Court’s reasoning was logical:

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

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

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

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

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

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

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

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