As everyone knows, back in the 1980s, broker-dealers fought hard for the ability to include in a customer agreement a clause mandating that all disputes be dealt with in the arbitration forum, rather than in court.  It was not an easy fight, as to require a customer to arbitrate means that certain rights that would otherwise be available in court – expanded discovery, additional motion practice, an actual judge presiding over the process rather than a volunteer whose skill set may or may not be appropriate or relevant, the right to appeal – are sacrificed in an effort to provide a system that is faster (Ha!) and cheaper (Ha Ha!).  But, the fight was won, and ever since, arbitration clauses are routine.

But not everyone is a fan.  Indeed, you may recall that buried in Dodd-Frank is a provision that gave the SEC the right to simply declare the end of mandatory arbitrations.  Armed with that power, the SEC basically did, um, nothing.  It conducted a study, or something.  But it’s been over ten years, and if anyone was breathlessly awaiting some action by the SEC on this hot, hot topic, they have long since expired from lack of oxygen.

I am wondering now, however, if that’s how things will remain.  Earlier this month, President Biden’s – first time I am typing those two words together! – nominee to head the SEC, Gary Gensler, was questioned by the U.S. Senate Banking Committee.  Including, notably, Elizabeth Warren, no fan of FINRA or of mandatory arbitration.  Check out this exchange she had with Mr. Gensler:

Senator Warren: Okay. And then finally, let me ask about the tilted roulette tables on Wall Street. If someone has been cheated by a broker dealer, hypothetically, for example, if Robinhood cheated individual investors, hypothetically, should that company be able to use forced arbitration clauses to avoid getting sued and held accountable?

Mr. Gensler: I think, Senator, that while arbitration has its place, I think it’s also important that investors, or in that case, customers have an avenue to redress their claims in the courts.

Senator Warren: Good. You know. As you know, the SEC has the power to require disclosures that will be helpful to the investing public-like climate risk disclosures and private equity practices. And Section 921 of the Dodd-Frank Act gives the SEC the authority to prohibit the use of forced arbitration by broker-dealers when it is “in the public interest and for the protection of investors.” In other words, the SEC has the tools to make the markets function better. So, if you are confirmed, Mr. Gensler, will you commit to picking up those tools and using them to make the markets more honest and more transparent?

Mr. Gensler: Senator, if confirmed, I look forward to looking at all of the authorities. Not just this one. But all of the authorities to help protect investors, promote the capital formation and the efficient markets that we talked about. And this is an important authority that was vested in the agency and looking at the economic analysis, working with fellow commissioners. I think we should look at all the authorities.

Senator Warren: I appreciate that. You know. Congress has given the tools to the SEC. We just need the SEC to pick up these tools and use them. The SEC has been asleep on the job for long enough. It’s time for the Commission to get off its behind and protect investors and consumers and I expect to see progress on all of these areas under your leadership.

My heavens, do you think Senator Warren tipped her hand regarding what she wants to see happen?  “Tilted roulette wheel.”  Jeez.

Clearly, she thinks that the current system of “forced arbitration” – even her use of “forced” vs. “mandatory” conjures up rather nasty images – does not hold BDs accountable, does not make the markets more honest, does not provide transparency, and, most important, does not protect investors and consumers.  But none of that was surprising.  She has maintained these views for a long time, and her frequent expression of her distaste for mandatory arbitration may be the principal reason that FINRA has displayed its long history of kowtowing to PIABA when it complains about the supposed unfairness of FINRA’s arbitral forum.

What IS surprising is Gensler’s answer, which I highlighted, in which he acknowledged that it’s important for investors to have the ability to go to court.  THAT is nothing we have heard coming out of the mouth of any Chairperson of the SEC since Dodd-Frank.  And while Mr. Gensler is hardly obligated if he is confirmed actually to do anything that he told the Banking Committee, you still have to take his comments seriously.

It will be very interesting to see what shakes out here.  Senator Warren is a powerful force in the Senate, more so now, under the Biden administration (which she, as well as other Democratic candidates, helped happen by gracefully bowing out of the race two days after the Super Tuesday results came in) than she had been.  Does President Biden owe it to her to look into this pet issue of hers?  Gensler’s answer certainly suggests that she will be taken seriously, at a minimum.

But, let me be clear about something: as I have undoubtedly said before, I am perfectly ok if I am required to defend my BD clients in court, rather than in a FINRA arbitration.  Indeed, that’s how I started my career, almost 40 years ago now, helping Chuck Murphy, my inimitable mentor, the partner for whom I principally worked, defend BDs in customer cases filed in federal court in the Northern District of Georgia.  (My first notable accomplishment as a baby attorney was winning a partial motion for directed verdict on a claim that my client had sold an unregistered security.  We lost the rest of the case, but, hey, I won my piece, despite not really knowing what I was doing.)  I am ready, willing and able to return to the court setting, if the SEC says that must happen.

I wonder, however, if the claimants’ bar can say the same thing.  Some of the Statements of Claim I receive likely could not survive a motion to dismiss for failure to state a claim.  (Of course, I can’t file that motion in arbitration, as the Code of  Arbitration Procedure doesn’t allow it.)  Some could not survive a motion to dismiss based on the statute of limitations (an argument that makes arbitration panels really uncomfortable, for some reason).  Some could not survive a motion on the pleadings.  Some could not survive a motion for summary judgment.  Some might even subject the lawyer who signed it to sanctions under Rule 11, given how far removed some of these things are from the truth.  I acknowledge that court will cost my clients more, and will take longer.  But, if it means that justice is really served, that the playing field is truly level, and I can go into battle armed with the various procedural devices that don’t exist in arbitration, then I would be all in.

My friend and former colleague, Brian Rubin, publishes annually his analysis of FINRA Enforcement cases, spotting trends in terms of the number and types of matters it brings, the sanctions meted out, etc.  It is an excellent tool, and eagerly anticipated by lots of us who practice in this industry.  One of the hard parts of his analysis is his effort to figure out how respondents who elected to take their case to hearing, as opposed to settling, fared.  That is, did they end up getting harsher or more lenient sanctions as a result of rejecting FINRA’s offer and going to hearing.  (It’s a labor intensive analysis, inasmuch as FINRA’s (rejected) settlement offer is not public information, so Brian has to call lawyers and cajole them to share that information on an anonymous basis.)

Something that Brian’s study typically reveals is a fact well known to lawyers who defend Enforcement cases, but which is surprising to everyone else: respondents often – certainly not all the time, or even most of the time – actually do better – in terms of sanctions[1] – by going to hearing.  The so-called “hearing discount.”  Which is a bit counter-intuitive since in most settings, settlements result in more benign sanctions (because by settling, the respondent is saving the other side from having to prepare the complaint and then prepare for and attend the hearing, all of which takes a lot of time and effort).

With that introduction behind me, let me get to the point: last week, Brian himself got a result in a case that demonstrated, once again, the phenomenon of the hearing discount – in this case, the ultimate discount: a finding of no liability and, therefore, no sanctions whatsoever.  Granted, it was not a short or easy road to get to that result, as the case took a long time – seven years – and a tortured route, as follows:

If you wanted, you could stop reading here and feel good about having learned a lesson from poor Mr. Tysk’s travails, namely, if you have the gumption and the money to fight, fight, fight, you just may, someday, prevail.  Or you can simply relish the notion of FINRA taking it on the chin from the SEC, hardly an everyday occurrence.  But, if you take the time to read through these decisions, particularly the last one, there are a few more points very worthy of discussion.

Before I do that, I have to give (or try to give, anyway) a brief synopsis of this procedurally complicated case.

  • At Mr. Tysk’s recommendation, his biggest customer made a $2 million annuity investment.
  • That customer later lodged a complaint against him with his BD, Ameriprise, alleging that the recommendation was unsuitable
  • Ameriprise embarked on an internal review to assess the merits of the customer’s complaint.
  • Based on a review of Mr. Tysk’s paper files, Ameriprise concluded the complaint was meritless.
  • In addition to his paper files, Mr. Tysk also maintained an electronic file – ACT! – that he used “to document client interactions, including a chronological record of client meetings, notes, and to-dos.”
  • After Ameriprise’s review, Mr. Tysk concluded that his electronic notes relating to the complaining customer “were not as complete as he would have liked them to be. As his biggest client, Tysk was in contact with him much more frequently than his other clients and did not make notes of each interaction at the time the interaction occurred.  Consequently, Tysk’s ACT! notes for his biggest client were much sparser than for nearly all of his other clients.”
  • So, relying on his memory and his papers, Mr. Tysk added approximately 70 supplements to his notes for this customer, most of which were new entries.
  • The added notes were accurate.
  • The supplements accurately reflect the fact that they were added at a later date, and Mr. Tysk never represented that the notes were made contemporaneously with the events they described.
  • Neither Ameriprise nor Mr. Tysk relied on the notes to establish the suitability of his annuity recommendation.
  • A few months later, the customer filed an arbitration against Mr. Tysk and Ameriprise alleging that the annuity was unsuitable
  • During discovery, a hard copy of Mr. Tysk’s ACT! notes was produced to claimant, which reflected that they had been supplemented at a later date.
  • The ACT! notes played no pertinent role at the arbitration hearing.
  • The Panel issued an Award in favor of Mr. Tysk’s client on the issue .
  • More important, the Panel faulted Mr. Tysk for altering his ACT! notes, and made a disciplinary referral.
  • FINRA then brought an Enforcement action against Mr. Tysk, alleging two things:
    • First, that Mr. Tysk violated FINRA Rule 2010 and NASD Rule 2110 by “alter[ing] his customer contact notes after receiving” the complaint letter “to bolster his defense of the customer’s claim . . . in violation of his firm’s policies”
    • Second, that Mr. Tysk violated IM-12000 of the FINRA Code of Arbitration and FINRA Rule 2010 by not notifying his client or Ameriprise of the edits to his ACT! notes when he “responded to discovery requests for his notes and when he responded to subsequent requests for edits to his notes.”

You already know how the story eventually played out.  But, how did the SEC come to the conclusion that FINRA erred – twice – in finding Mr. Tysk liable?

It started with an analysis of FINRA Rule 2010.  You know this one, it’s the general rule that FINRA cites when there’s no specific rule governing the conduct at issue, and requires that members and associated persons “observe high standards of commercial honor and just and equitable principles of trade.”  The SEC correctly noted that “[a]ssociated persons violate these rules (where the alleged violation is not premised on the violation of another FINRA rule) if they act unethically or in bad faith.”  The SEC defined “unethical conduct” as that which is “not in conformity with moral norms or standards of professional conduct,” and “bad faith” as “dishonesty of belief or purpose.”

Applying those definitions, the SEC concluded that FINRA failed to prove its case.  While FINRA had found that Mr. Tysk acted unethically by “deliberately creat[ing] misleading evidence,” i.e., that he created “the false impression that he wrote contemporaneous notes of his conversations” with his biggest client when in fact those notes were written many months later,” the SEC disagreed, finding that “the record does not show that Tysk attempted to create a false impression as to the date he created the [supplements to the] notes, either affirmatively or by implication.”   Moreover, the SEC observed that FINRA hadn’t even bothered to attempt to prove that Mr. Tysk added his supplements in some effort to “bolster his defense.”

Which brings us to the SEC’s next point, the one with, perhaps, the biggest ramifications for respondents everywhere.  Remember, FINRA alleged that Mr. Tysk violated 2010 because his actions violated Ameriprise’s policies by supplementing his ACT! notes during the firm’s pending exam.[2]  Specific to that allegation, the SEC stated that it did not need to decide whether or not Mr. Tysk violated Ameriprise policies “because even if he did so FINRA failed to establish he thereby violated FINRA Rule 2010 and NASD Rule 2110.  A violation of a firm policy does not necessarily mean that a registered representative has also violated these rules.”

This is HUGE.  There are maybe, what, a million Enforcement cases that FINRA has brought where the allegation was simply that the respondent violated some firm policy, and, therefore, Rule 2010?  Based on the SEC’s reasoning here, it is evident that going forward, FINRA is actually going to have to do some work in such cases.  It is actually going to have to prove that the respondent somehow acted unethically or in bad faith, not merely that a firm policy was violated. And this, I venture to say, will not always be possible for FINRA to pull off.

Back to the SEC decision.  In reversing FINRA’s ruling on the second charge, the SEC made two important observations.  First, Mr. Tysk was asked in discovery in the arbitration to produce the pre-supplemented versions of his ACT! notes, but he could not do so, despite the fact that the fancy-schmancy forensic computer expert FINRA engaged was somehow able to do that.  The SEC was unimpressed by that showing:  “Tysk’s discovery obligations – under both FINRA Rule 12506(b) and IM-12000 – extended only to documents in his possession or control.  He was under no obligation to create new documents.”  This is as true in arbitrations as it is in FINRA exams: Rule 8210 allows FINRA to request the production of documents, but it does not give FINRA the power to compel you to create one.  So bear that in mind the next time you receive a request asking you to create a spreadsheet.

Second, the SEC wrote that “FINRA’s decision suggests that if Tysk could not produce documents showing edits to his ACT! notes he was nevertheless required to provide additional explanation of those edits during discovery.  But FINRA has not shown that Tysk was required by the arbitration rules or by Rule 2010 to include an explanation of the ACT! notes that he produced, particularly here where the document disclosed on its face that it had been edited in May 2008, and Tysk took no other action to state or imply that the notes were created contemporaneously.”  As the case that the SEC cites for this proposition provides, it is not bad faith not to “spontaneously volunteer information” that was not requested.  I suggest you bear this mind not only when responding to discovery in arbitration, but also when responding to questions from FINRA during exams.

A final thing worth noting is what FINRA did NOT charge Mr. Tysk with: a violation of the books-and-records rule.  There are likely a couple of reasons for this.  First, broker notes are not included in the long list of documents in SEC Rules 17a-3 and -4 that a BD has to make and preserve.  These are optional, and what you do with them is largely up to you.  Second, Mr. Tysk did not make the mistake of altering documents after they were requested by FINRA during an exam.  Do that and FINRA will write you up no matter what the document at issue happens to be.  All you have to do is look, for instance, at this AWC, which FINRA issued three days before the SEC’s Tysk decision.[3]

I apologize for the length of this post, but there was a lot to work with, and a lot of lessons to glean.  Not everyone has the luxury of being able to pay counsel to wage a seven-year fight with FINRA, I get that.  But, at least this one time, it was worth it for Mr. Tysk.


[1] The reason I highlight this point is because taking a case to hearing vs. settling can be a hugely expensive decision in terms of attorneys’fees.  Thus, even if a respondent does end up with lesser sanctions after going to hearing, it could cost hundreds of thousands of dollars in legal expenses.  That is why it is usually a difficult decision to reject a settlement offer, even in a case with good facts, because, as I tell my clients, all you are buying, ultimately, is the right to read the Panel’s decision, not the right to dictate how it reads.

[2] Oddly, although Ameriprise issued a lukewarm reprimand to Mr. Tysk, according to the SEC decision, the firm determined that Mr. Tysk’s “addition to his ACT! notes did not violate any section of [Ameriprise]’s policies and procedures” or any “specific provision of the Code of Conduct.”  Moreover, Ameriprise did not find that Mr. Tysk had “engaged in any wrongdoing.”  Just one more example of FINRA knowing more than its members.

[3] I hate to dredge up old memories, but FINRA knows this lesson very well, after being sanctioned by the SEC back in 2011 for supplying the SEC with altered or misleading documents three times in an eight-year period.  Here is that Order, in case you wanted to relive this one.

Thanks to Heidi for today’s post. – Alan

Today, the SEC put out its 2021 Exam Priorities, available here.   It is about 40 pages long and covers a lot of topics.  While I encourage everyone to read through the document, here are the primary focus items for 2021:

Overarching Themes / Focal Points:

  • Regulation Best Interest and Form CRS: Primary focus of 2021 exams based on its prominence in the letter and all the recent guidance we’ve seen.  Make sure to review the recent (December 2020) statement the SEC put out on what, specifically, it will be looking at during these exams.  That statement is located here.
  • Compliance Culture. Importance of a top-down approach to compliance, starting with Firm CCOs who are knowledgeable and empowered to make necessary changes.
  • Fees and compensation. Whether its looking at the reasonableness of a fee, whether the fee creates a conflict of interest, whether a fee is properly disclosed, or how the fee is calculated (for advisory fees), there are now a tremendous number of issues (and potential charges) that flow from fees.  If you understand how you are compensated, ensure fees are imposed properly, properly identify where that compensation creates a potential conflict, and properly disclose that conflict, you will have covered most of the areas on this year’s priority list.  Remember this is any compensation – not only compensation paid by clients.

Specific Points of Interest during Exams:

  • Best Interest Recommendations. The SEC will be looking at whether and how firms make best interest recommendations.  This will be more than just reviewing policies and paperwork – they will be conducting enhanced transaction testing to test those procedures.
  • RIA Fiduciary duties. This one is evergreen.  The SEC will be looking at whether RIA advice is in client’s best interest and whether there has been a full disclosure of conflicts of interest.  Continued focus on fees, costs, and undisclosed compensation that could result in a conflict of interest between a firm and its clients (note: its unimportant whether the conflict ever manifested or had any impact – the potential is enough to require disclosure).
    • Sustainable Investing/Socially Motivated Trading. The SEC devotes a separate section to investment strategies focused on “socially responsible” investment strategies. It’s really a subpoint of the fiduciary obligation.  If you offer investment strategies with these focuses, you need to make sure your disclosures, recommendations, and supervision of the same are accurate.
  • Form CRS and related disclosures. Broker dealers now have a similar obligation to disclose fees and potential conflicts.  BDs should be thinking hard about compensation or benefits they receive that has the potential to lead to conflicted advice.  Here, we can learn lessons from the disclosure cases brought previously against IAs.
  • Specific retail investors: Recommendations made to seniors, teachers, military personnel and “individuals saving for retirement” get special focus.  The last one on this list is a doozy.
  • Account type recs. Especially if it’s a rollover.
  • Complex products. They will be looking for best-interest grounds for the sale and, if the product is only for accredited investors, making sure customers are properly accredited under the new definition of the term.
  • Mutual Funds and ETFs. The SEC is looking for proper risk disclosures (especially with more risky options) and examining recommendations in funds that provide “incentives” to firms and their professionals.
  • Fixed Income. The Pandemic has stressed many municipal entities.  So, SEC is looking for proper risk disclosures re: muni issuer as well as whether the trades themselves show proper mark-ups/down, pricing, and achieve best execution.
  • Microcaps.  Another evergreen item. You know what they are looking for here.
  • Safeguarding customer info. Protection from hacks, email phishing, ransomware, etc. and protecting for your customer’ info whether held by you or a vendor. Especially now, as much of the country is working remotely. The SEC will be looking at how information security is handled in the new work-from-home setting.
  • Business Continuity. This has long been a focus, getting a lot of attention when Hurricane Sandy hit New York.  The pandemic only reinforced the importance of being able to respond to unexpected natural events.
  • Financial technology. Robo advisors, new software, mobile apps, digital assets.
  • AML.  Again, you’ve seen this one before.  Long-standing focus.
  • Fund examinations. The SEC will review funds’ compliance programs and governance, focusing on disclosures (including website language).
  • How RIAs treat private funds.  With a focus on funds that have experienced issues (liquidity, withdrawal freezes) or which have a high concentration of structured investments.  And, as always, surrounding disclosures

Thanks to Blaine for not only attending this panel session, but for summarizing it for us! – Alan 

Recently, the Roaring Kitty (aka Keith Gill) and his brethren made headlines with their trading (most notably in GameStop) and the impact it had on certain hedge funds and banks.  The interest on this saga seems to be universal with folks wanting to know whether or not these trader/customers were doing anything wrong and if there were any possible ramifications.  Thus, it seemed particularly timely when the Chicago Bar Association announced that it would be hosting a panel made up of SEC and FINRA personnel to discuss the topic of market manipulation (which was one of the theoretical transgressions of the traders that has been bandied about).  Before you get too excited, however, the regulators prefaced their comments by indicating they would not be discussing any current trading activity or active investigations, which would almost certainly cover GameStop, etc.  Still, as always, it is nice to learn what regulators are thinking before you end up sitting across the table from them trying to explain away your own actions.  With that in mind, here are the highlights of the discussion.

The regulators generally described manipulation as an action taken to interfere with the market in its natural state, which frequently means an act that artificially changes the price of a security or product.  Sounds amorphous, right?  Luckily, one of the regulators from the SEC outlined some of the things he looks for:

1) The trading makes no sense – e.g. orders on both sides of the market or other circumstances where even the traders themselves have no bona fide explanation for the purchases and sales.

2) Notice of illegality or rules violations – this does not necessarily mean that the SEC or FINRA are knocking on your door, it could be the BD telling the trader to stop a certain type of trade, shutting down accounts because of the trading activity or, simply, questioning the trading.  In other words, if the trader’s broker-dealer has been sniffing around, regulators are probably going to assume the trader was on notice that something might be afoot and will not look kindly upon an ignorance plea.  In theory, this should help weed out any type of mistaken or innocent acts.

3)  Hiding actions – this one seems obvious and includes opening up accounts in the names of friends, family and other entities to disperse trades and other furtive activity that indicate the trader knew or at least had reason to believe his or her actions might be wrong.

So how do these bad acts manifest themselves in the everyday market? The regulators mentioned a host of illicit activities including but not limited to spoofing, wash trades, banging the close and a healthy discussion of “pump and dumps.” A pump and dump classically occurs when a person or group of persons obtains control over a company that has a low value (sometimes known as a penny stock company).  That person might hide their control by putting their shares in the name of family members and or other entities (which would hit on Regulator’s #3, above).  After that they promote the company, either doing it themselves or by paying others to do so in chat rooms or other mediums, using false information about the future prospects of the company.  After innocent investors purchase the stock, and drive its price up, the owner dumps his or her shares and the innocent investors are left holding the bag.

These types of schemes were of particular concern last year when different companies marketed potential “miracle” cures for COVID that unsuspecting investors might have tried to jump on to make a quick dollar.  These schemes are often found in companies doing business in whatever is the fad of the day (COVID, Marijuana, etc.).  As the moderator pointed out, this fact pattern is basically the plot to the industry favorite film Boiler Room, which is worth a watch for industry wonks.

As mentioned above, the regulators promised to avoid current events (read GameStop) in favor of resolved matters. Still, it creeped into the conversation, at least tangentially.  The moderator, while not mentioning Game Stop, asked why the public should care if investors are doing something (whether manipulation or not) that ends up harming a Wall Street bank.  Notably, the question is not if there is some type of violation, but, instead, why people should care.  The answer was that it does not only impact those banks or hedge funds but interferes with market liquidity and, potentially, the average investor (especially older ones) if one of the securities at issue happens to be in average Joe’s 401K or his personal trading account.  Theoretically, that makes perfect sense, but if the average investor saw his stock in GameStop temporarily rise and then fall back down, he might not have suffered too much harm.  The real damages was done to those shorting stocks, but it is, of course, not clear how many 401Ks or elderly investors are shorting companies on a regular basis.  It will be interesting to see where the regulators, ultimately, shake out on the issue.

Again, while not mentioning GameStop, there was talk about how broker-dealers can protect themselves if, by chance, their customers are engaged in some type of market manipulation.  According to the FINRA representative, foreign nationals going through broker-dealers (especially those who offer direct to market access) have been an ongoing problem.  While FINRA, at least, would not be able to touch those unregistered foreign individuals (true of unregistered domestic individuals, as well),[1] the broker-dealer could find itself with a failure to supervise case pending against it.  The lesson is that broker-dealers need to be vigilant in ensuring (or at least taking reasonable steps to try to ensure) that its customers are not manipulating the market and to make sure they are keeping accurate tabs on who exactly is opening accounts with the firm.  In other words, and as always, vigilance is the key to avoiding entanglements with regulators whether pertaining to manipulation or any other issues that broker-dealer personnel face.


[1] The Roaring Kitty, of course, presents a different circumstance since he is currently registered.

I get the fact that anyone silly enough to work for a broker-dealer knowingly chooses to live in a fishbowl.  Thanks to BrokerCheck, you can very easily learn more about a registered representative than you can about, say, a doctor, a teacher, a lawyer, you name it, all through a couple of mouse clicks.  But, this is no secret, as I said.  It is the price one pays to work in the securities industry, and I suppose that if one feels strongly enough about not having to disclose a baseless, frivolous complaint from a customer, or an unpaid tax lien, or a personal criminal history, then, arguably, one should find a different profession, where such things do not have to be shared with the public at large.

My problem is not, therefore, with BrokerCheck per se (although I remain convinced that FINRA’s ongoing and vigorous – but largely vain – efforts every year to increase the public’s awareness of BrokerCheck just go to show that no one actually cares very much about it).  Rather, my problem is the use that claimant’s counsel make of the information available in BrokerCheck, particularly reported arbitrations, disciplinary actions taken by regulators, and even customer complaints that remain pending, or were even dismissed.  In short, they take that information – which, in theory, is designed to enable investors to check out prospective brokers, to decide whether to trust them with their investments – and turn it into advertisements, soliciting customers to engage them to file arbitrations in an effort to recover alleged losses.

Just in case you don’t know what I’m referring to, let me walk you through how it works.  And believe me, there are probably hundreds, or even thousands, of examples.

The lawyers start by taking advantage of the search algorithms buried beneath the surface of Google, acquiring and utilizing website domains designed to pop up in response to searches for lawyers who handle customer cases.  Sort of like (which, remarkably, seems to be available).  When you click on that link, you are directed to the law firm’s actual website.  There are likely dozens of these domain names.  Some are specific to particular products, so if a customer invested in a certain investment that has not performed to expectations, the thought is that they will be directed to these websites.

Once you get to the actual website of the law firm, there, you will be presented with page after page of things that read like press releases, with headlines announcing that the law firm is “investigating” – that is the verb most often used, for some reason, even though, in fact, there is no such investigation – some person or some firm that was obligated to disclose in his or her Form U-4 (or Form BD, in the case of a BD) a complaint, an arbitration settlement or award, or a regulatory matter.  The body of these “press releases” then simply parrot the language found in BrokerCheck, leading to the big finish, which is a blunt, no-nonsense solicitation: If You, Too, Have Done Business With This Guy (or This Firm), Hire US So We Can Go After Him And Accuse Him Of The Same Thing.

These are, of course, advertisements, and the lawyers who publish them are typically very careful not to say anything that is false (since to do could be defamatory).  Thus, for instance, if they run one of the press-release-sounding ads to take advantage of the disclosure of the filing of a regulatory complaint – which, of course, contains nothing but unproven allegations – they will be sure to bury the word “alleged” in there, somewhere, so they cannot be accused of actually stating that someone committed securities fraud.

Because these ads do no more than repeat (albeit in fancy, formal sounding language) information that is otherwise available to the public via BrokerCheck, there is basically nothing that you can do to stop it.  Assuming that the lawyer has not said anything actually false, requests or demands to take these “press releases” down from the website are met with laughter, or worse.  (What could be worse?  I have had claimants’ lawyers retaliate against clients who insisted that I at least try to get their names removed from these websites by actually increasing their efforts to solicit business against such clients.)

It is very frustrating, and sad, for me to have, basically, the same conversation, over and over again, with different clients.  Yes, it sucks that when you Google your name, the first three pages of results are simply lawyers hoping to sue you.  Yes, it is frustrating that there is nothing to do about that.  Yes, it would be nice if FINRA cared even in the slightest about this issue.  Sorry.  Sorry.  Sorry.

What made me think about this issue today is what happened recently regarding GPB.  GPB is an investment that hasn’t done too well.  In the least shocking development ever, that has resulted in a TON of arbitrations against BDs and registered reps, all alleging that they failed to figure out that GPB was operating some sort of fraud.  Every claimant’s counsel in the world probably has some “investigation” regarding the sale of GPB on their website.  Yet, these arbitrations came in the absence of any actions being taken by regulators, in the absence of any findings that GPB was, in fact, a fraud.  Well, that has changed.  Two weeks ago, the SEC, along with seven states, filed civil actions against GPB, and the DOJ filed a criminal case against three individuals associated with GPB, alleging – ALLEGING, not actually FINDING – that GPB was operating a “Ponzi-like scheme.”

And you know what this will mean: the websites of every claimant’s counsel will be updated immediately to disclose this development, and encourage investors to hire them…not to sue GPB, but, rather, to sue the poor BDs and RRs who sold them GPB.  I have looked, and, not surprisingly, the updates have already been made by most.

But what is very interesting is that the claimant’s lawyers point to the SEC, state and DOJ complaints as evidence of wrongdoing that investors should take into consideration, but they do not bother to state that according to the allegations in these complaints, the BDs who sold GPB were ALSO VICTIMS OF GPB’S ALLEGED FRAUD!  That is, the U.S. Government has taken the position in the formal pleadings that it has filed that GPB defrauded not just the investors, but the BDs, as well, by providing them with due diligence materials that contained false information.  The complaints do not state, or even suggest, that the BDs should have been able to figure out that the information GPB supplied was false.

Yet…the claimant’s lawyers ignore this allegation completely, talk simply about the fraud, the fraud, THE FRAUD.

So, to conclude my little rant, here is my wish list – and I call them wishes because I am well aware that none of these things will ever happen:

  • FINRA does something to prevent lawyers from using information in BrokerCheck simply to advertise for new clients
  • State Bar Associations do something to prevent lawyers from using the same information in advertisements to solicit new clients
  • FINRA tweaks BrokerCheck so that mere complaints, i.e., complaints that have not resulted in anything being done, are not disclosed
  • Complaints that are dismissed, or withdrawn, should be automatically expunged from an RR’s CRD record
  • In the same sense that communications by BDs with the public must be “fair and balanced,” ads placed by lawyers should tell the whole story. So, for instance, ads referencing the GPB complaints should have to explicitly disclose that there is nothing in those complaints that could serve as evidence of wrongdoing by a BD.

I truly feel badly for those among my clients who find themselves the victims of these advertising campaigns.  This is not why BrokerCheck was created, not at all.  Yet, FINRA sits back and lets this happen.  So, I guess you guys get a two-fer here: a reason to dislike both FINRA and lawyers.


I just read this article – admittedly authored by lawyers, Ethan Brecher and Ana Montoya, whose website provides that one of their three principal areas of practice is representing investors “who have been defrauded by their securities brokers”[1] – that advocates for a new FINRA rule designed “to limit wasteful post-arbitration appeals by brokerage firms.”  And I just had to respond.  Because I am soooo tired of claimant’s counsel complaining about the supposed advantages held by broker-dealers in arbitrations that result in the so-called “unlevel playing field.”

According to Mr. Brecher and Ms. Montoya,

Brokerage firms, with vast financial resources and the home court advantage at FINRA, have little to complain about when they lose an arbitration.  Generally, arbitrators reach fair and equitable results and give all parties a full opportunity to be heard.  Many brokerage firms, however, pursue sour grapes appeals when they lose against less financially resourced employees and customers, resulting in a man-bites-dog situation.

Based on their observations, they advocate for a new rule “that broker-dealers be required to pay liquidated damages equal to double the damages awarded in arbitration to the prevailing employee or customer if the firm loses an appeal from an adverse arbitration award.”

Where should I start?

How about the brokerage firms’ “vast financial resources.”  I wonder who they had in mind when they wrote that?  Granted, there are, of course, lots of big broker-dealers with lots of money.  But, they are hardly the only firms that get named as respondents in customer (or industry) arbitrations.  Indeed, most cases are filed against small firms, whose financial resources are anything but “vast.”  And many of those firms rely on insurance coverage to pay the cost of defense, coverage that has finite limits (not to mention deductibles – sometimes very high deductibles – that alone can bankrupt a firm).  Moreover, this ignores the fact that customers don’t always just sue their BD; often, they name their advisor, too.  And rare is the registered rep who has “vast financial resources.”  (Even when an RR is not named, if he works for an independent contractor model firm, the likelihood is that he has signed an indemnification agreement, obligating him to reimburse the BD for its “losses,” which include the firm’s self-insured retention.  That can be considerable, to say the least.  I have one client now whose deductible is $150,000.  PER CASE!)

Ok, moving on to BDs’ supposed “home court advantage at FINRA.”  Frankly, I have no idea what they are referring to, although this phrase has been used forever (but, sadly, successfully, by claimants’ counsel, who have managed over the years to gaslight FINRA into believing it).  Anyone who deals with FINRA customer arbitrations knows well that as a result of changes that have been implemented over the years – at the behest of PIABA and claimant’s counsel – FINRA has bent over backwards to avoid any argument that somehow its forum favors firms over customers.  Just consider, most notably, the drastic limitations imposed on pre-hearing, dispositive Motions to Dismiss, and the elimination – at the claimant’s option! – of the Industry member of the hearing panel.  To suggest that there is a home court advantage for respondents is to ignore this reality.

Mr. Brecher attempts to support his argument by citing FINRA Dispute Resolution statistics that show that in cases that actually go to hearing, the hearing panel only occasionally awards the claimant money.[2]  Which must mean that there is a problem with the system itself, right, that it is skewed in favor of respondents?  Well, no.  As I have stated time and time again, it is no surprise that respondents win the vast majority of cases that go to hearing, and that’s for the simple reason that we settle cases that we reasonably think we have some chance of losing.  According to FINRA statistics, in 2020, only 13% of all cases that were closed came after a hearing (or a decision on the papers).  Respondents’ counsel are clever enough not to risk taking a case with bad (or arguably bad) facts to hearing.  Thus, it makes perfect sense that claimants don’t usually receive money at a hearing.  This does not mean the playing field is not level.

There are other problems with the proposal.  To begin, the law already provides a remedy if a lawyer files a frivolous appeal.  According to Rule 38 of the Federal Rules of Appellate Procedure, “[i]f a court of appeals determines that an appeal is frivolous, it may, after a separately filed motion or notice from the court and reasonable opportunity to respond, award just damages and single or double costs to the appellee.”  That is already a big enough club for any ethical lawyer to deal with.  Besides, note that Mr. Brecher’s proposal doesn’t make any distinction between a “frivolous” appeal and an appeal that is merely unsuccessful.  According to his article, any time an appeal fails, the respondent would owe the claimant not just “costs,” as per the Federal Rule, but double the “damages,” with no consideration of whether the appeal was frivolous.  Such a powerful, preemptive procedural maneuver exists nowhere else, to my knowledge.

Also, it is sort of predictable that Mr. Brecher’s proposal is strictly a one-way street.  That is, there is no reciprocal treatment suggested for when a claimant who loses at hearing files an appeal and loses there, too.  Apparently, that either never happens, or, when it does, it is somehow ok, and respondents should just suck it up.  I can tell you from personal experience that it does, in fact, happen.  Claimants who receive a 0 from an arbitration panel sometimes decide to file a motion to vacate, and my clients are stuck defending them, no matter how spurious the arguments they contain.  At a minimum, putting aside all the other issues I have with Mr. Brecher’s proposal, shouldn’t it cut both ways?  Maybe have a rule that says if a losing claimant files a motion to vacate that is denied, then the claimant must pay the respondent’s legal fees, at least the fees incurred in connection with the defense of the appeal (but maybe, too, the fees incurred defending the hearing)?  Fair is fair, after all.

Look, I don’t know Mr. Brecher and have never litigated with him, and I have no issue with him personally.  All I am saying is that it gets old hearing complaints about how FINRA arbitration is supposedly unfair to claimants[3] when, in my experience, it is respondents who can make the much better argument.  Most of the time – the vast majority of the time – FINRA arbitrations do work.  Or, to the extent there is some unfairness, it impacts both sides equally.  But, in short, there is absolutely no evidence that I have ever seen, statistical or anecdotal, that would lead me to conclude that the playing field tilts in respondents’ favor.


[1] With that said, I looked at every arbitration award in a case that Mr. Brecher has handled – at least those that appear on FINRA’s website – and in not one did he represent an investor.  Rather, every case was on behalf of someone who worked for a BD and was either going after his/her firm for damages, or was the subject of a claim by the BD for damages.  The point is: Mr. Brecher likely knows a lot about industry cases, but, perhaps, not as much about customer cases.

[2] Mr. Brecher says 40% of the time a customer gets an awrrd, but the statistics I looked at – the ones to which the hyperlink here will send you – show that in 2020, claimants only got some money in 34% of cases that went to hearing.

[3] This is what I said on this issue back in 2017, which I think sums it up pretty well: “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.”

I have always found it enlightening – and a bit scary – to talk to my clients about FINRA Rule 2210, the advertising (or “communications with the public”) rule, to see what they know about it.  It’s a long, dense rule, so I’m not talking about knowledge of its more esoteric components; I’m talking about something way more basic, namely, what communications does it apply to.  All too often, my clients are surprised to learn that by the very definitions in the rule itself, 2210 is NOT restricted to communications relating to securities.  Just a week or so ago, in an AWC, FINRA made this abundantly clear.

Let’s back up and review some basics.  According to 2210(a), there are three types of communications: correspondence, retail communications and institutional communications. All are defined.  Notably, none of the definitions makes any mention of the need to pertain to a security.  “Correspondence” is “any written (including electronic) communication that is distributed or made available to 25 or fewer retail investors within any 30 calendar-day period.”  “Retail communications” are simply correspondence sent to more than 25 retail investors in a 30-day period.  And “institutional communications” “means any written (including electronic) communication that is distributed or made available only to institutional investors.”  Lest you think that FINRA tried to sneak in a requirement that securities be involved through its definitions of the terms “retail investor” and “institutional investor,” you would be wrong.  A retail investor is simply “any person other than an institutional investor, regardless of whether the person has an account with a member.”  That definition has nothing to do with securities.  The same is true of how FINRA defines an institutional investor.

Similarly, in 2210(d), the portion of the rule that governs the content of communications with the public, there is also no requirement that the communications be about securities.  In short, the content standards merely require that communications

  • “must be fair and balanced”
  • may not “omit any material fact or qualification if the omission, in light of the context of the material presented, would cause the communications to be misleading
  • cannot be “false, exaggerated, unwarranted, promissory or misleading”
  • cannot contain “any untrue statement of a material fact or is otherwise false or misleading.”[1]

Because of this, I have always told my registered rep clients that, strictly speaking, the advertising rule applies if they were to place an ad in the newspaper to sell their car.  I am not saying that FINRA would bring a case if it concluded that the ad was not “fair and balanced,” but it remains that it could.[2]

Which brings us to the AWC.  In July 2017, Michael Pellegrino mailed an ad “promoting [a] short-term, high yield contract to approximately 80 retail investors.”  Notably, the ad itself “stated that the product was not a security.”  Even more notable, the AWC never finds that it was, in fact, a security.  But, that’s because of what I have just been saying: it doesn’t matter, it’s still a violation if it doesn’t meet the content standards.

But here’s the real lesson of this settlement:  there are communications that don’t involve securities that FINRA could care less about, and there are communications that don’t involve securities that FINRA will care a great deal about.  Mr. Pellegrino’s mailing fell squarely into the latter category because while the product he was pushing may or may not have been a security as a matter of law, it sure as heck looked like one as a matter of fact.  That’s why FINRA takes pains in the AWC to point out the characteristics of the product and the mailing, to make it clear that whatever Mr. Pellegrino was selling, it walked and quacked like a security:

  • The mailing referenced Mr. Pellegrino’s BD, and noted that it was a member of FINRA.
  • In order to invest in the contract, investors had to sign a “Memorandum of Indebtedness” (MOI), whereby they agreed to provide funds for distribution at the issuer’s discretion.
  • Investors also had to sign a Statement of Understanding relating to the MOIs that referenced Mr. Pellegrino’s BD.
  • The issuer pooled investor monies and lent it as a “Merchant Cash Advance” to small businesses unable to borrow money through traditional avenues.
  • The investors entered into the MOIs with the expectation of investment returns based on a percentage of the merchants’ future revenues.

While this is not quite a full-blown Howey analysis, i.e., the test that a court historically would apply to a product to determine whether it is a security or not, it certainly borrows enough from the Howey test that it’s obvious that FINRA cared that, at a minimum, Mr. Pellegrino’s mailing sure resembled a security.  And that, in my view, is why FINRA brought the case.

So I wouldn’t worry too much about the ad you’re about to place on Craig’s List to sell your old couch, or the email you sent to everyone in your contact list sharing your opinion of Lupin, that new Netflix show, or the flyer you created to support your nomination for Condo Board.  Despite the fact that they are all theoretically subject to the content standards of the advertising rule, FINRA will not be troubled if, say, you under-disclosed the size and source of the stain on the couch cushion.  On the other hand, if you communicate in writing with people about something that involves an investment, you may not take much comfort from the fact that you could plausibly argue it is not a security.


[1] I should note that the word “security” does appear in the rule.  In 2210(d)(1)(A), it says that “[a]ll member communications must . . . provide a sound basis for evaluating the facts in regard to any particular security or type of security, industry, or service.”  But, as you can see, this by no means restricts the rule ONLY to securities.

[2] I learned this lesson, like, two decades ago as a lawyer with NASD’s Department of Enforcement.  I brought an advertising case involving a viatical settlement, which, at the time, was or wasn’t a security, depending on who you asked.  That is, the SEC said it was, but the DC Circuit Court of Appeals held to the contrary.  Acknowledging that split in authority, the NAC, in affirming the finding by the hearing panel that the respondent did, in fact, violate the rule, essentially said it didn’t care one way or the other because the rule covered the ad either way: “we find that the advertisement at issue is subject to the requirements of Conduct Rule 2210, which addresses, among other things, standards applicable to all member communications with the public.”

Thanks to Blaine for tackling FINRA’s annual list of things it is paying particular attention to in 2021. – Alan


The world has changed a lot in the last 12 months, but those in the securities industry can always rely on their trusty regulator, FINRA, to put out its annual priorities list to provide some semblance of consistency in the world.  In a break from the past, however, this year FINRA has combined two annual reports – the Report on Examination Findings and Observations, and the aforementioned Risk Monitoring and Examination Program Priorities Letter – into one new document (the “Report”).  The 46-page Report addresses 18 regulatory areas and organizes them into four categories (sadly, there is no mention of the ultra-recent GameStop saga).

Readers familiar with past priorities letters will recognize many of the issues raised in the current incarnation, and FINRA concedes that “many of the areas addressed in the publication represent ongoing core compliance responsibilities.”[1]  In other words, AML has always been a priority and continues to be a priority so nothing to see here.

Unfortunately, the subject that is likely to be of most interest, given the current state of affairs in the world, i.e., “Firms’ Practices During COVID-19,” is set off in blue because the “Report does not address exam findings, observations or effective practices specifically relating to how firms adjusted their operations during the pandemic.”[2]  Fortunately, FINRA promises, “those reviews are underway now and will be addressed in a future publication.”[3] If we are lucky, said results will issued before the entire country is vaccinated while the results are still relevant.[4]  Stay tuned to the BD Law Corner blog for timely updates in relation to COVID guidance.  With all of the above in mind, here are selected highlights from the new combined Report:[5]

Regulation Best Interest (“BI”)

Regulation BI replaces[6] the well-known and weathered suitability standard with one that requires broker-dealers and associated persons to make recommendations on transactions or investment strategies based on the best interests of their retail customers.  While the standard sounds simple, its implementation has caused heartburn in CCOs across the country as they struggled to understand how FINRA will interpret BI differently than suitability.  Unfortunately, CCOs will have to continue purchasing their extra-strength Tums.  Because, while the Report lists some rather obvious guidance, such as, “Has your firm provided adequate Reg BI training to its sales and supervisory staff,” it punts on the all-important question of what firms are being disciplined for and, more importantly, what FINRA will look at in the upcoming year.

FINRA’s posture is likely due to the fact that Reg BI is relatively new, in conjunction with the difficulties of regulating during a world-wide pandemic.  Notably, the Report does refer readers to a Roundtable that the SEC held on Reg BI that my colleague Heidi VonderHeide reviewed in another blog post.  Speaking of which, Ms. VonderHeide will be discussing the ins and outs of Reg BI in a webcast later this month that interested readers can register for here.

As was the case with its COVID guidance, FINRA promises to update the industry as information is gathered and priorities determined.  While we all hope COVID will soon be a distant memory, Reg BI is here to stay, so FINRA’s updates warrant further watching.


Another issue that is here to stay and promises, in fact, to increase in importance over the coming years is cybersecurity.  The Report notes increased occurrences of cybersecurity related issues, including system wide outages; email and account takeovers; fraudulent wire requests; imposter websites; and ransomware.  In addition, the Report indicated that data breaches remain an issue.   The pandemic has brought this already important issue to the forefront as brokerage personnel increasingly work remotely, increasing the importance of home internet security for each and every employee touching private company data.

The limitation on personal interactions between brokerage employees and their customers has only exacerbated the problem and ensured that most, if not all, exchange of customer paperwork takes place over the internet.  With such exchanges becoming the rule instead of the exception, FINRA has, not surprisingly, noted during its exams that firms have failed to encrypt customer personal information (which can be as simple as failing to encrypt and redact new account forms).  Firms also failed to limit access to customer information (along with other sensitive data) and failed to train personnel and maintain adequate branch policies, amongst others.  During compliance reviews, firms, naturally, tend to look within to figure out how they can improve internally.  While it is not necessarily intuitive, FINRA notes that firms must institute proper policies to ensure that their vendors are taking all steps that the firm, itself, is taking to ensure data safety.  This might be especially important for smaller firms that outsource their technological needs to vendors.  During past roundtables with Regulators at the Chicago Bar Association, those Regulators have indicated that a firm blaming its vendor is not a valid excuse if a data breach occurs and the Report seems to confirm as much.  The basic takeaway seems to be that internet technology is changing all of the time and the onus is on firms to keep pace in terms of protecting itself and its customers.

Communications with Public

As technology changes, the way that firms communicate with their customers has also changed.  Late last year, the SEC revolutionized its marketing rules for RIAs bringing them out of the 1960s and into the digital age (my colleague, Denise Fesdjian wrote about it here.) While FINRA did not do anything near as exciting as the SEC, it is worth noting the issues it uncovered as well as what infractions might focus on in the future.

Some findings have been virtually unchanged over the years, with the exception that they are now more likely to be found on the internet instead of in print, e.g. failing to balance promotional statements with prominent risk disclosures, while others deal with newer technology, i.e., the failure to retain email and other digital communication.  Once such technology that the Report sets off in blue (which apparently indicates that FINRA wants people to read it and, thus, will likely focus on it) is the emergence of new digital platforms with “Game-Like” features.”  FINRA cautions that these platforms, which are reaching a new segment of retail investors and, thus, providing important access to the marketplace, can also represent danger.  The message seems to be that firms can splash up their websites in order to appeal to new consumers but, in doing so, they are not relieved of any of their regulatory responsibilities.  Substance over form when it comes to the rules, in other words.

Above is just a smattering of what is available in the Report and I encourage anyone with an interest to review it in detail to learn about all of the topics not discussed here.



[3] Id. 

[4] See FINRA Regulatory Notice 20-16 for guidance on operating during the pandemic.

[5] For those wishing to read the report in its entirety, it is available at

[6] Technically, Regulation BI supplements the suitability standard but according to Regulatory Notice 20-18, “Reg  BI’s Care Obligation addresses the same conduct with respect to retail customers that is addressed by Rule 2111, but employs a best interest, rather than a suitability, standard, in addition to other key enhancements. Absent action by FINRA, a broker-dealer would be required to comply with both Reg BI and Rule 2111 regarding recommendations to retail customers. In such circumstances, compliance with Reg BI would result in compliance with Rule 2111 because a broker-dealer that meets the best interest standard would necessarily meet the suitability standard.”

In other words, you have to follow Reg BI and if you follow Reg BI, you are meeting suitability so Reg BI is the determinative consideration.

Almost three years ago, in Reg Notice 18-08, FINRA wisely (but, nevertheless, still a bit late to the party) proposed to revise its own prior guidance regarding the troublesome intersection between outside business activities and investment advisor business, guidance that FINRA itself acknowledged had “caused significant confusion and practical challenges.”  Specifically, in crusty old Notices to Members 94-44 and 96-33, issued over two decades ago, FINRA saddled the industry with nearly inscrutable attempts to delineate the scope of a BD’s supervisory obligations over the investment advisory activities conducted by its dually registered RRs away from their BD.  Although it took FINRA about 25 years to finally attempt to clean up the muddy playing field it had created, finally, it seemed, clarity was on the way.  Astutely noting one of those rare instances in which FINRA actually seemed to be acting in its members’ best interests, I blogged about that proposal and dutifully congratulated FINRA for “provid[ing] meaningful relief to firms who are now nearly crippled by the sheer amount of their compliance obligations.”

Boy, did I speak too soon.

Three years after it was issued, the proposal has never been approved.  Indeed, who knows where it is today.  In a July 2020 release, the SEC observed that FINRA’s review of the proposed rule change was still pending, but, since then, I have seen nothing.  Making matters much, much worse, FINRA continues to enforce 94-44 and 96-33, despite FINRA’s explicit acknowledgement of the terrible job those notices have done in establishing a clear standard of conduct.  Just ask Cetera.  Right before the new year, FINRA issued an AWC from Cetera with a $1 million fine for doing something that, had FINRA followed through on the proposal in Reg Notice 18-08, would have been ok.

Before I get on my soap box, let me break down the AWC.

First you need to understand the underlying dynamic.  Cetera – like hundreds of other firms – has RRs who are simultaneously registered with an outside RIA, where the RRs serve as IARRs.  These folks are referred to as “dually registered representatives” or DRRs.  Because what the DRRs do at the RIA constitutes a securities business, from the perspective of the BD, it is a private securities transaction, thereby triggering Rule 3280.  The issue this tees up is what role, if any, Cetera has to supervise the IA work that its dually registered RR/IARRs are conducting at the RIA (where, of course, they are already subject to the RIA’s supervision).

The NASD tried in 94-44 and 96-33 to account for that fact, i.e., that DRRs are already being supervised by their RIAs, by attempting to delineate a more narrow scope of the DRRs’ RIA activities that the BDs also have to supervise.  The problem is, this was very difficult to articulate.  So difficult that the securities industry has struggled with this problem for the past 25 years.

Consider this:

  • As the AWC notes, according to Rule 3280, when a BD approves a PST, the BD must “supervise the person’s participation in those transactions as if the transactions were executed on behalf of the firm.”
  • Consistent with that, 94-44 states that “these requirements apply ‘to all investment advisory activities conducted by [DRRs] that result in the purchase or sale of securities by the associated person’s advisory clients”
  • But, curiously, 94-44 also states that Rule 3280 is focused “primarily upon the RR/RIA’s participation in the execution of the transaction – meaning participation that goes beyond a mere recommendation. Article III, Section 40 [the precursor to Rule 3280], therefore, applies to any transaction in which the dually registered person participated in the execution of the trade.”
  • 96-33 similarly states: “Most notably, Notice to Members 94-44, clarifies” – sorry, I have to pause here to insert the laughter that the use of “clarifies” will undoubtedly trigger – “the analysis that members must follow to determine whether the activity of an RR/IA falls within the parameters of Section 40. Fundamental to this analysis is whether the RR/IA participates in the execution of a securities transaction such that his or her actions go beyond a mere recommendation, thereby triggering the recordkeeping and supervision requirements of Section 40.”

So…we’ve got this hard-and-fast standard in the rule – “all” PSTs must be supervised by the BD.  But, we’ve also got this squishy interpretation that says it is NOT all PSTs, only those where the DRR “participates in the execution.”  THIS is the gray area that NASD created, which it never remedied, but teasingly proposed to fix in Reg Notice 18-08, in which poor Cetera found itself.

What, exactly, did Cetera do?  According to the AWC, “[f]rom January 2011 through December 2018, [Cetera] failed to establish, maintain and enforce a supervisory system and written supervisory procedures reasonably designed to supervise certain private securities transactions conducted by their dually-registered representatives (DRRs) at unaffiliated or ‘outside’ registered investments advisors (RIAs).”  Why did Cetera get picked on FINRA?  That’s easy: the AWC provides that Cetera underwent three SEC exams between 2013 and 2017 in which findings were made about this issue, but the firm failed to take adequate remedial measures.  FINRA had no choice, it seems, but to reluctantly step in and enforce its own fuzzy standard, just to be able to look the SEC in the eye.  In other words, Cetera paid the price for FINRA waiting 25 years to try to fix a problem that it created…and then quietly pretending that it hadn’t.  And speaking of price…how the heck did this possibly become a $1 million problem?  For a firm that has NO relevant disciplinary history?  Seems to me like FINRA trying to show the SEC something.

Ok, back to my soap box.

So, why has FINRA failed to act on the 18-08 proposal?  Let’s say I have my theory.  To start, let’s take notice of the fact that the rule proposal garnered 51 comments.  That may not be the indoor record, but it’s a lot.  I have gone through them, so you can spare yourself that exercise.  Nearly without exception (for some reason, Raymond James didn’t seem to like the rule), the industry was strongly in favor of it.  Just as a for instance, Fortune Financial Services wrote that NTM 94-44 and 96-33 were “both confusing and difficult to implement without providing any meaningful investor protection.”  Foreside noted that implementation of the proposal “will dramatically save costs and reduce a firm’s administrative and regulatory burden.”  I could go on, but you get the point.

The rule proposal – from the perspective of FINRA’s members – was a fantastic idea.  And for good reason: it saves BDs from having to try and supervise activities which they have limited, if any, access to or ability to control,[1] yet without adding any regulatory risk – given that the activities of the IARRs away from the BDs are already subject to the supervision of the particular RIA with which they are associated, under the watchful regulatory eyes of either the states or the SEC (depending on the size of the RIA).  I mean, who needs FINRA to butt into the existing supervisory scheme of an RIA that seems to be working ok on its own?

Well, guess who didn’t like the rule proposal?  Yes, that’s right, PIABA condemned it, dramatically claiming that FINRA was “contemplating the evisceration of crucial protections that have been in place for decades to safeguard investors against investment schemes!”  Ironically, and in apparent total disregard for the mess that 94-44 and 96-33 actually created, PIABA insisted that adoption of the proposed new rule “would create mass confusion for brokerage firms and registered representatives.”  That’s funny stuff.

So, there you go.  On one side, you have the industry almost entirely lined up in support of the proposed rule. On the other side, you have PIABA arguing that the rule would be bad.  Given that dynamic, who do you think FINRA is going to listen to?  You don’t have to guess, of course.  FINRA’s three-year-and-counting failure to follow through on its eminently reasonable rule proposal tells you all you need to know.  And, as I stated earlier, it’s not just FINRA’s failure to follow through on the rule proposal that is so aggravating, it’s the fact that FINRA has the temerity to nick Cetera for $1 million for failing to meet the needless and fuzzy standards that FINRA attempted to articulate in 94-44 and 96-33.



[1] As an example of this, the AWC points out that for years, Cetera did not receive “transaction data for its DRRs’ outside securities . . . and, thus, did not have the information necessary to reasonably supervise its outside RIA transactions. And even after [Cetera] began receiving transaction data, it did not receive the customer-specific account information to satisfy its supervisory obligations including, but not limited to, a suitability review.”

FYI, in February, Ulmer & Berne will be hosting a series of webinars on the following: FINRA Expungement: Rule Changes and Updates on Tuesday, February 9 2:00 PM EST; SEC Update: Reg BI, Enforcement Activity, and the Willfulness Standard on Thursday, February 11, 2021 at 2:00 PM EST; Data Protection & Cybersecurity Challenges for Financial Institutions in 2021 on Wednesday, February 17, 2021 at 2:00 PM EST; and FINRA 2021: What to Expect on Wednesday, February 24, 2021 at 2:00 PM EST.  (I will be co-presenting this last one, fair warning.)  If you are interested in attending any or all of them, here is the unique registration link you can use:

A long time ago, long before there existed any whistleblower statutes, I had a client – a CCO of a broker-dealer – who discovered some pretty funky trading at his firm.  As he tells the story, when he went to see his boss (who was the owner of the firm) to report his troubling discovery, the owner sidled out from behind his desk, and casually unbuttoned his suitcoat, deliberately revealing the handgun he had strapped to his belt, and told my guy, basically, that he must be mistaken about those trades.  My client took the not-so-subtle hint and bid a hasty adieu and said not another word.  But, from that day forward until the day he was able to find a new job, he carefully documented every trade that made him queasy.  When he finally left, he took with him all that trade data and presented it, wrapped in a bow, to the SEC.  Fast forward: the SEC, as well as the DOJ, brought actions against the owner, and my client was the hero (and star witness).

Cool, true story.  But the same underlying issue for CCOs (and all supervisors, I suppose) still exists today:  what do you do when you come across a situation that raises serious compliance concerns, but which firm management appears to condone?

The answer, according to an SEC settlement from a week ago, is SPEAK UP.  Here are the pertinent facts,[1] as I have pieced them together:

  • Michael Sztrom has been in the securities industry since 1998.
  • In 2015, he tried to associate with Advanced Practice Advisors (“APA”), an RIA.
  • Unfortunately, he couldn’t, due to an open FINRA investigation into his activities at his prior firm, which caused Schwab, APA’s clearing firm, to bar Michael from its platform.
  • Unable to service his clients, Michael had his son, David – a newly minted IARR whose “only prior advisory experience was assisting Michael for five months at [Michael’s prior firm] by performing administrative tasks, such as processing forms and taking notes at meetings – join APA.
  • Michael told APA that he “would serve in the limited role of financial planner to the clients who moved to APA,” but would not serve as their investment advisor.

Well, as you may have guessed, Michael didn’t honor that promise.  Rather, “he continued to provide investment advice to the clients who had followed him from his prior firm to APA and who were supposed to be advised by his son.”  Indeed, there was no formal agreement for Michael to serve as a financial planner to his former advisory clients, he never charged any client to prepare a financial plan, and never actually prepared any such plan.  (Easy to see why the SEC called this supposed financial planner role a “sham.”)

But this isn’t about Michael and David (although you ought to take note that the SEC has filed a complaint against the son and his undisclosed-advisor father); this is about the CCO – the hero of this story but whose name, sadly, is never revealed – and his boss, Paul Spitzer.

Turns out, rather unsurprisingly, if you ask me, that Mr. Spitzer either knew or should have known what Michael was up to.  As the SEC points out, Mr. Spitzer knew

that the father and son shared office space and telephone lines, that all of the APA clients the son worked with had come from his father, and that the son lacked any significant experience and was just learning the business. In addition, Spitzer would often correspond directly with the father, rather than with the Adviser Representative, about things such as advisory fees.

Despite this, Mr. Spitzer did not require that David “maintain separate office space from his father or take other precautionary measures, such as implementing an ethical screen to prevent the Adviser Representative from sharing confidential client information with his father.”

Six months after David joined APA, enter our hero, the new CCO.  He saw that Michael, who was not formally associated with APA, worked in the same office with David, allowing him to access APA client information and advise APA clients.  Moreover, the new CCO was concerned that APA clients might not know that Michael was not formally associated with APA, was not permitted access to APA information and systems, and could not advise clients under APA’s aegis.  He apparently told his boss, Mr. Spitzer, but none of this managed to sway Mr. Spitzer.

And then it got worse.  Schwab called Mr. Spitzer to report that Michael had called and “impersonated his son on at least 38 occasions.”[2]  In recorded calls, some of which David participated in (albeit silently), Michael

identified himself by his son’s name and as a representative of APA, and discussed block trading, warrants trade allocation, and rebalancing APA client accounts. He also asked APA’s clearing broker how to execute a trade for a client and repeatedly provided the clearing broker with the master account number for APA.

When the CCO learned about this, he went to his boss – again – and recommended that Mr. Spitzer fire David.  Mr. Spitzer refused.  Instead, he simply imposed a heightened supervision plan on David, and even though Michael didn’t work for APA, he made Michael sign it, too.  Even then, however, the SEC found that APA and Mr. Spitzer “failed to enforce several of the requirements set forth in that agreement.”

When the dust settled, the SEC brought actions against Mr. Spitzer, APA, Michael and David, but, more to the point of this blog post, NOT against the CCO.  Why not?  Because he (or she?) appears to have brought his concerns about Michael to his boss immediately – i.e., he spotted the red flag – and made recommendations for action to be taken.  (Given that the CCO only made a recommendation to fire David, we can safely presume that he lacked the authority actually to take that action.)  Even though Mr. Spitzer shot down that idea, it gave the CCO the protection he needed when the regulators subsequently came knocking.

Only one thing to add: the importance of documentation.  To become the hero of the story, the CCO here, like my client many years ago, had to have the documents to back up what he told the SEC happened.  When he discovered the odd situation with David and Michael, I am willing to bet he memorialized his findings.  When he recommended that the firm let David go, I bet there’s an email, at a minimum, that corroborates this.  The lesson is clear: no matter that it’s obviously a CYA moment, it is critical to take the steps necessary to protect yourself, and this typically means creating a document.  An email is good, especially because they are automatically preserved.  A memo to the file.  An entry on a calendar.  Frankly, anything is better than nothing.  Remember: no matter how credible you think you are, no matter how clean your record, no matter how long you’ve been in the industry, in the eyes of a regulator, you didn’t do anything unless there’s a document that proves you did.

[1] The facts that I lifted from the settlement can safely be called facts; those that come from the SEC complaint should be understood to be mere allegations, for now.

[2] To Schwab’s credit, when it “discovered Michael’s deception, it immediately terminated David’s access to its platform and gave all of the APA clients 90 days to either find an investment adviser other than APA or move their brokerage accounts to another brokerage firm.”