Thanks to Blaine not only for attending this conference, but for actually listening, so he could share with you the insights he gleaned from the local securities regulators here in Chicago. – Alan

While much of the broker-dealer world has been trying to figure out how to protect the financial welfare of their customers, in addition to watching Netflix and searching in vain for Lysol wipes online, our trusty securities regulators have been hard at work figuring out just how to regulate in the new circumstances brought on by the pandemic.  I know this, because senior officials from the SEC, FINRA and Illinois Securities Department said as much as during a recent (virtual) meeting of the Securities Law Committee of the Chicago Bar Association.  Industry members might be wondering exactly how their interactions with regulators might change or stay the same in the future as a result of Covid, and the Panel’s comments might provide some, albeit limited, insight.

While the regulators did not verbalize it in so many words, their overarching theme seemed to be that bad apples are figuring out ways to get rich by taking advantage of the pervasive fear and corresponding hope that people are feeling as a result of the pandemic.  The SEC wants to stop those bad apples by focusing on areas such as insider trading, non-public information (who exactly is in your Zoom meeting?) and corporations putting out false or misleading information, especially as it relates to potential treatments or, even vaccinations.  In response to false or unrealistically optimistic information, the SEC has halted trading for certain corporations and instituted at least one fraud case with more expected.

Purported treatments and cures are also keeping FINRA up at night, and if you are a broker dealer, they might give you pause too.  The reason is that FINRA indicated selling away has become a concern with brokers trying to make a quick dollar on private offerings or unregistered securities for corporations that supposedly have a miracle drug or cure.  Selling away is, of course, an age old problem associated with supervising brokers, and with most if not all of them working from home these days, the task just got more difficult for firms.

But it is not just supervision that is more difficult with so much of the work force at home.  As FINRA pointed out, technological intrusions, aka hacking, are likely to become more prevalent since individual brokers are unlikely to have robust computer security at home.  FINRA is concerned that many firms, but especially the smaller ones, might lack the financial means to implement stronger measures for all their home bound employees, which could have serious financial consequences for the customers and firms alike.  If you are not sure how your brokers are connecting from home, and if those connections are truly secure, you might want to look into it because odds are that FINRA will be doing just that the next time it conducts an exam.

Speaking of which, industry professionals will, no doubt, be delighted to hear that FINRA’s ability to conduct exams has not been impacted to any great extent.  While on-site exams have been postponed, most of the examinations these days consist of the Staff reviewing large amounts of electronic data, which can be safely transmitted via the internet.  Thus, firms should be prepared to proceed if they have exams scheduled in the not too distant future.

Another area that industry participants should be prepared for are “virtual” interviews by the respective enforcement agencies.  The SEC indicated that they have had success conducting interviews on one platform ( e.g., WebEx) and allowing the industry professional and his or her lawyer to confer on another platform (like FaceTime or Zoom).  Moreover, as FINRA explained, its investigations are all predicated on the ability to conduct OTRs, so it has not and will not cease conducting them.  In fact, the FINRA representative indicated that the SRO has taken over 80 remote OTRs since the start of the pandemic with very few problems (although, he admitted, in most cases, they have reduced the number of exhibits used during the OTRs, for the sake of simplicity).

So what does the future hold?  The FINRA official mentioned that there has been an uptick in arbitration filings due, in large part, to some of the wild swings that have permeated the market.  However, in a statement that was music to the ears of this lawyer, he conceded that it was not clear there would be a corresponding increase in enforcement cases, since customers losing money on account of a market correction does not necessarily mean their investments were unsuitable or their accounts poorly supervised.

Finally, lest the reader think that EVERYTHING has changed as a result of the pandemic, you can take solace in the fact that the regulators all indicated that a priority going forward will be protecting senior investors.  Their focus on the wellbeing of seniors, which has always been paramount, seems magnified because older investors, who are now quarantined, tend to prefer face to face meetings and are now being forced to rely on unfamiliar technology such as virtual meetings.  The fear is that unscrupulous brokers can take advantage of that unfamiliarity or, more simply, that seniors might have more difficulty comprehending their options over a Zoom call and end up with unsuitable investments.

So there you have it; the collective focus of the regulators seems relatively unchanged since the onset of the pandemic, but the ways that they are implementing their supervision and enforcement have changed and will continue to change as events dictate.




Last year, I wrote a piece called “Wedbush Learns That It’s Not Enough Just To Spot Red Flags.”  As the title suggests, it analyzed an SEC decision in which Wedbush was sanctioned because it failed in several respects to follow up on certain red flags it saw that were indicative of potential misconduct.

I am now following another SEC case, this one involving a CCO of a broker-dealer, that highlights a similar, but slightly different, theme.  In this case, the lesson is that it’s not just the red flags you see (but fail to investigate properly) that can burn you, but also the red flags you miss entirely but “should have” seen.

This started out as a FINRA Enforcement case.  In December 2015, Thaddeus North, CCO for Southridge Investment Group, LLC, was found liable by a FINRA hearing panel for, among things, failing to report to FINRA (under Rule 3070) that one of the firm’s associated persons was “involved in a variety of business activities with a statutorily disqualified person.”  Here are the pertinent facts:

  • Southridge had an RR, we will call her Ms. A
  • Before joining Southridge, Ms. A had worked with another RR – Mr. B – at another firm
  • After Ms. A joined Southridge, Mr. B had a little problem reporting a tax lien on his Form U-4 in a timely manner, and because that failure was deemed to be willful, he became statutorily disqualified
  • Southridge contemplated hiring Mr. B, but when Mr. North learned that he was SD’d, that was aborted, and Mr. B left the securities industry
  • In July 2009, and without disclosing it to Southridge, Ms. A entered into a Services Agreement with Mr. B’s entity, pursuant to which she would pay him for referrals, advice and training
  • From August 2009 through September 2011, Ms. A received and paid at least 42 invoices from Mr. B’s entity totaling $605,365 for various services
  • Although Mr. North didn’t know about the Services Agreement when it was executed by Ms. A in July 2009, eight months later, in March 2010, he learned about it when FINRA, after having been provided invoices to Ms. A from Mr. B’s entity, asked for any agreements relating to it, and Ms. A gave him a copy
  • Mr. North looked at the Services Agreement
  • The Services Agreement does not disclose Mr. B’s name, only the name of his entity; indeed, while Ms. A signed it, there is not even a signature block for Mr. B or his entity
  • Mr. North was not familiar with Mr. B’s entity, and did not know that Mr. B was connected with it
  • Mr. North did not question Ms. A about the agreement, did not investigate the relationship between her and the mystery entity with which she had entered into the Services Agreement, and he made no attempt to learn the details about that entity

Based on the evidence, the panel concluded that

at a minimum, North should have known of these relationships by March 2010, after seeing the Services Agreement and the invoices issued by [Mr. B’s entity] under that agreement.  At that point, when North learned that [Ms. A] and [Mr. B’s entity] had a business relationship, he knew nothing about [Mr. B’s entity], including the identity of anyone connected with it.  As the Firm’s CCO and the person responsible for Rule 3070 reporting, North should have followed-up by seeking all relevant details of [Ms. A’s] relationship with [Mr. B’s entity], as well as inquiring about the identity of the person or persons behind it.  Significantly, the Services Agreement was only executed by [Ms. A] and not by anyone on behalf of [Mr. B’s entity]. By itself, this peculiarity — which hid the identity of persons connected with [Mr. B’s entity] – was a red flag that should have caused North to inquire further. Had he done so and asked [Ms. A] who she was dealing with at [Mr. B’s entity], North likely would have learned of [Mr. B’s] connection to [Mr. B’s entity] and his ongoing relationship with King.

In short, using a “should have known” standard, the hearing panel concluded that Mr. North missed the red flag waving in his face.

On appeal, the NAC affirmed the findings, and the hearing panel’s analysis.  It held that

North should have learned about [Ms. A’s] relationship with [Mr. B] shortly after March 2010, after seeing the . . . [S]ervice [A]greement and the invoices that Southridge produced to FINRA in March 2010. Although the [S]ervice [A]greement and invoices did not reference [Mr. B], North should have sought additional details about [Ms. A’s] business dealings with [Mr. B’s entity], in particular because of certain existing red flags.  First, the monthly invoices submitted by [Mr. B’s entity] were for considerable amounts with little description about the services being provided.  Among other things, the invoices generally referenced “consultations,” ”phone consultations,” various “trainings,” and ”introductions” to various people. From July 2009 to February 2010, the . . . invoices totaled $151,800, and included monthly invoices for significant amounts (e.g., $39,800 and $32,500).  Second, the [S]ervices [A]greement, under which the invoices were issued, was vague. It was one page, and it only was executed by [Ms. A] . . . . No one executed the agreement on behalf of [Mr. B’s entity], and it did not identify anyone associated with the company. Had North investigated and inquired further about [Mr. B’s entity], he would have discovered the connection to Mr. B and his ongoing relationship with [Ms. A].

Next, Mr. North appealed to the SEC.  Perhaps not surprisingly, the SEC sustained the NAC’s findings:  “We agree with the NAC that these facts should have led North to inquire about that relationship [between Ms. A and Mr. B’s entity].  Accordingly, North violated NASD Rule 3070 and FINRA Rule 2010 because he did not report [Ms. A’s] and [Mr. B’s] relationship to FINRA although he should have known about it.”

Now Mr. North has appealed the SEC decision to the D.C. Circuit Court of Appeals, where it is pending.  That particular court may not be so quick to rubber-stamp the SEC’s views.  And I say this from personal experience, as counsel – along with my partner, Heidi VonderHeide – in the noteworthy Robare case.  There, the D.C. Circuit agreed with us that because my clients only acted negligently, they could not have also acted willfully.  It is certainly possible that the D.C. Circuit will look very hard at the SEC’s position here, as stated in its appellate brief, which is that the mere failure to satisfy one’s duty to “inquire” when presented with red flags somehow equates to “should have known.”  As my friend and former colleague Brian Rubin so accurately put it in his own thoughtful take on Mr. North’s travails, “FINRA presented no evidence showing that if North had followed up, he would have (or even ‘likely’ would have) learned about the relationship [between Ms. A and Mr B].  The most FINRA established is that North ‘could possibly have’ learned about the relationship, and that does not appear to be sufficient grounds to charge anyone.”

That’s the thing about those pesky red flags.  They can get you into hot water any which way.  You can see them, and fail to respond, for whatever reason.  You can see them, and choose not to respond (because you don’t think they are, in fact, red flags[1]).  You can see them, but not respond vigorously, or quickly, enough.  And you can simply not see them at all.  Mr. North was sort of all over the place.  He sort of saw the red flag, but didn’t recognize it to be a red flag, and so didn’t respond particularly well (by failing to ask enough questions).  The regulators have concluded – rightly or wrongly – that had he done so, he would have learned of the problematic relationship and reported it.

I can’t say that is true or not.  But, what I can say – and this, at last, is the takeaway from this blog post – is that this is something that no one should ever leave up to the regulators to decide.  FINRA sees the failure to ask questions as the failure to act.  If Mr. North had just asked a few questions – if he had asked Ms. A to explain about the Services Agreement (and memorialized his efforts, of course) – he likely would not have gotten into trouble, even if Ms. A ducked his questions and he never actually learned that she had entered into an agreement with the SD’d Mr. B.

In other words, Mr. North’s problem wasn’t that he didn’t know something, it’s that he didn’t try hard enough to know it.  Even when confronted with a host of facts suggesting there was an issue.

As a defense counsel, I would always prefer to defend someone who saw the red flags, and followed up on them, regardless of the conclusion he or she reached.  It wouldn’t matter to me if my client concluded that, following a robust investigation, there may have been smoke, but ultimately no fire.  Provided the investigation was, in fact, robust, that case can be defended all day, every day.  But Mr. North, alas, didn’t follow up.  And notwithstanding the result Heidi and I got in the Robare case, I have my doubts that the D.C. Circuit will see this any differently than FINRA or the SEC.  Don’t let yourself suffer the consequences as Mr. North has.  Be prepared to demonstrate not only that you didn’t know something, but, despite your best faith efforts, no one could reasonably argue that you should have known it.


[1] Let me share one anecdote here, from a FINRA Enforcement case that Heidi handled.  The FINRA examiner was on the witness stand, and he testified about something he admitted probably wasn’t a red flag, but felt it was at least a “yellow flag,” and that those also needed attention.  That certainly suggests that it is never safe simply to conclude that something isn’t a red flag, given FINRA’s demonstrated willingness to characterize anything as such.

I may have said this before in another post, but in my opinion, whether a baseball umpire is good or bad is not a matter of whether he has a low strikezone, a high strikezone, or a wide one.  What matters is that whatever that umpire deems to be a strike vs. a ball is consistent from inning to inning, pitcher to pitcher, game to game.  Because that provides predictability.  When a pitcher and batter know what to expect, they can react accordingly.  It is no different with regulators.  If you know what they want from you, and how they will react, then compliance becomes an easier world to manage.

With these prefatory words in mind, I want to commend Jessica Hopper, the head of FINRA Enforcement, for actually doing what she says she wants to do (not necessarily a common event with securities regulators).  Here is what I mean.

In a recent FINRA podcast called “FINRA Enforcement: Protecting Investors and Markets in Good Times and Bad,” Jessica was the principal guest, and she spent a half-hour or so talking about her priorities for her department.  Happily, FINRA published the transcript of that podcast, so you don’t have to listen to it.  And according to the transcript, Jessica stated that her “first priority is obtaining restitution for harmed customers. When a customer has been financially harmed through whatever misconduct we identify, we want to get the money back to them quickly.”  Consistent with that, last week, in a webcast by SIFMA that I attended, she repeated the very same, very clear sentiment.

To begin, however, let’s put aside any discussion of whether this priority is correct or not.  I mean, one could make a pretty compelling argument that the appropriate venue for aggrieved customers to get their money back is the arbitration process (administered by FINRA Dispute Resolution Services, its relatively new name), not an Enforcement action.  Indeed, FINRA’s own website says that filing an arbitration – rather than a complaint with Enforcement – is the way to go “if you want to recover . . . money”:

Dispute Resolution is not the same as filing an investor complaint.  Some investors are confused about the differences between resolving monetary disputes through arbitration or mediation, and filing an investor complaint.  These are unrelated.  If you want to make FINRA aware of any potentially fraudulent or suspicious activities by brokerage firms or brokers, then the best course of action is to use FINRA’s Investor Complaint Center.

However, if you want to recover damages, such as money or securities, filing an arbitration or mediation case offers you a way to seek damages. Importantly, investors can file an investor complaint and file for arbitration; investors are not limited to one or the other option.

But, as I said, that’s not the point here, for this blog, anyway.  The point is that Jessica says she is all about getting customers their money back.  To show that she means what she says – and make no mistake, that’s a commendable quality, as it provides the predictability I mentioned above – check out this AWC just published last week involving SunTrust Investment Services, out of Atlanta, my old stomping ground.  According to the AWC, for three years, from January 2015 until January 2018, the firm

failed to establish, maintain and enforce a supervisory system, including written supervisory procedures (“WSPs”) that were reasonably designed to ensure compliance with FINRA Rule 2111 in relation to solicited sales of non-traditional exchange traded funds (“NTETFs”) by its registered representatives.  These supervisory failures resulted in losses during the Relevant Period of $584,466.

What, exactly, did SunTrust do wrong?  It boils down to a few things:

  • While its WSPs recognized that NT-ETFs “c[ould] be inefficient and problematic long-term investments” and required the positions be monitored by the representative, supervising principal and the Central Supervision Group (CSG), the firm lacked reasonable procedures or guidance to representatives or supervisors regarding how to determine whether an NTETF was suitable for customers given the unique features and risks of those products.
  • The Firm did not have any systems in place, such as an alert or exception report, to assist in monitoring the holding periods for NT-ETFs.
  • No one at the Firm conducted a customer-specific suitability analysis for NT-ETF positions held for periods longer than one day, nor did the WSPs require such an analysis.
  • Although SunTrust required its representatives to complete an online training course prior to recommending transactions involving NT-ETFs, the training did not describe how to monitor ongoing holding periods and the related impact on suitability.

As a result of these various failures, 95 customer accounts held positions in NT-ETFs for extended periods of time.

Where this AWC gets interesting, however, is in the sanctions.  FINRA only fined the firm $50,000, but, significantly, that seems to because SunTrust paid back to the affected customer accounts whatever they lost as a result of the supervisory failures.  Indeed, the AWC imposed a restitution obligation of $584,466.13, but noted that even before the AWC was finalized, the firm had already “voluntarily paid restitution [of] $445,836.27 to 30 customers that it identified through its own investigation based on a broad-based methodology prior to the opening of an Enforcement investigation.”

So, there you go.  Jessica tells the world that what she cares about is restitution.  And, bam!, here is an AWC with a big firm, with serious supervisory lapses over an extended period of time, and a not-insignificant disciplinary history, but with a relatively modest fine. Wait, you say.  Fifty-Thousand isn’t modest!  Ah, but I said “relatively modest.”  And by that, I mean it is modest compared to the fines that SunTrust has previously paid.  According to BrokerCheck, in 2017, the firm paid the SEC a civil monetary penalty of $1.1 million.  In 2014, it paid FINRA a fine of $80,000.  In 2011, it paid FINRA a fine of $400,000.  In 2010, it paid FINRA a $900,000 fine.  In 2008, it paid FINRA a $700,000 fine.  And way back in 2006, it paid FINRA a $150,000 fine.  As you can see, $50,000 is, in dramatic fact, a drop in the bucket compared to what SunTrust is used to paying.

Now, the AWC does not specifically state that the fine was deliberately minimized because of the restitution, but it does say that “[i]n determining the appropriate sanctions,” FINRA took the restitution into consideration.  Reading between the lines here, I’d say it’s pretty easy to deduce that Jessica’s stated desire to obtain restitution must have had a real, demonstrable impact on the fine imposed on SunTrust.  Now that you know that, now that you know the voluntary payment of restitution can result in a dramatically smaller fine, you would be silly to ignore this.

As I said, kudos to Jessica for actually walking the walk.  I would much prefer to deal with a regulator whose word means something than someone whose goals are mere lip service.

Update 5/28/2020:  FINRA released another AWC today that reinforces the conclusion that I reached in this post.  Stifel, Nicolaus signed an AWC for supervisory failures relating to the sale of UITs (dating waaaay back to 2012!).  In addition to a $1.75 million fine, Stifel also agreed to pay almost $1.9 million in restitution — plus over four years of interest! — to customers who purchased UITs from the firm.  Unlike SunTrust, there is no indication in the AWC that Stifel paid any restitution voluntarily, prior to the settlement.  Indeed, the AWC requires that when Stifel writes its checks out to the affected customers, they be notified that “the payment is being made pursuant to a settlement with FINRA and as a term of this AWC.”  In other words, with a gun to its head, held by FINRA.  In any event, that could explain why the fine is so high, and certainly so much more than SunTrust agreed to pay.  Finally, if you have any doubts that the restitution component of the sanctions is what makes FINRA happiest, consider the Press Release that FINRA issued to announce the AWC.  In it, Jessica is quoted, as follows: ““Firms must have an adequate supervisory system in place to detect potentially unsuitable UIT rollovers, and also provide customers with accurate information so they can make informed decisions about those rollover recommendations. We are pleased that customers will receive restitution for sales charges incurred as a result of the recommendations.”  Note that she specifically touted the restitution, and makes no mention of the fine, despite the fact it is nearly $2 million. 

Update 6/2/2020:  FINRA released another AWC today, with more of the same.  This time, the case involved an individual, who was found to have made unsuitable recommendations.  Notably, while FINRA agreed to waive the fine that would otherwise have been imposed (due to the respondent’s inability to pay it), it still required him to pay restitution to the customer of $50,000.  So, no money to pay the fine, but enough to pay the customer back.  

I am fairly certain that at least every once in a while, you appreciate hearing from someone a bit less snarky than me.  If so, then you’re in luck!  Please enjoy this post from my partner, and my co-leader of Ulmer’s Financial Services practice group, Fran Goins, about FINRA’s response to COVID-19. – Alan


Online fraud is a bigger business than ever in the current pandemic environment. Far from “self-isolating,” fraudsters are seeing online work as an opportunity to take advantage of firms and their customers, using stolen personal information to set up phony accounts and divert funds from customers. FINRA has not remained silent, publishing an Information Notice addressed to firms on March 26, 2020 and Regulatory Notice 20-13 on May 5, 2020, following up with new a FAQ for investors on May 11, 2020.

In response to pandemic-engendered business issues, FINRA had already updated its Business Continuity Planning FAQ on March 24, 2020 to confirm that members and their associated persons were permitted to use remote offices or telework arrangements during the COVID-19 pandemic. The FAQ noted, however, that members who chose to utilize such arrangements would be expected to maintain appropriate supervisory systems and documentation.

The follow-up Information Notice titled, “Measures to Consider as Firms Respond to the Coronavirus Pandemic (COVID-19),” flags measures that firms should employ when having to close offices and work offsite in the wake of state stay-at-home orders. It addresses basic protective measures for associated persons and firms dealing with the new work arrangements. Associated persons are encouraged to update security on office and home networks, update software and operating systems on home computers and mobile devices, learn to recognize common phishing and business email scams, and understand the firm’s incident response plan, including who to call in the case of a breach. Firms are encouraged to beef up network security controls to provide staff with a secure connection to the work environment and review who needs to access sensitive systems and data, provide training to staff regarding potential scams and attacks, and provide well trained IT personnel to support staff working remotely.

In May, FINRA issued an additional set of COVID-19 updates and guidance to firms and investors. Regulatory Notice 20-13, addressed to firms, notes the “heightened threat of frauds and scams” that firms and their customers may be exposed to during the pandemic. These include: (1) fraudulent account openings and money transfers; (2) firm imposter scams; (3) IT Help Desk scams; and (4) business email compromise schemes. While none of these scams are new, the use of stolen or synthetic customer information and phishing emails to trick firms and their customers is even more prevalent in the current environment. The Notice suggests detailed, specific measures that firms should take to avoid becoming victims of such scams, including:

  • Using enhanced customer identification programs;
  • Monitoring for fraud during account opening;
  • Using careful bank account verification procedures and restrictions on fund transfers;
  • Continuing to monitor after accounts are opened;
  • Collaborating with clearing firms to handle ACH transactions;
  • Filing appropriate SARS reports;
  • Assessing compliance programs;
  • Safeguarding customer “records and information” pursuant to Reg S-P; and
  • Training staff to recognize scams such as firm imposter, IT Help Desk, and business email compromise schemes.

FINRA’s most recent guidance addressed to investors is titled, “Fraud & Your Investment Accounts During the COVID-19 Pandemic.” It largely tracks the Notice to firms, but also contains “Investor Tips” urging investors to review and monitor their accounts and credit reports to flag unusual or unauthorized transactions; safeguard credentials and control account access; verify the identity of anyone who contacts them purportedly on behalf of their firm through independent means; learn to recognize “red flags” that may indicate a business email compromise; and report any suspicious activity to FINRA, the SEC, the FBI, and local authorities.

Scammers and hackers take advantage of any unusual event to up their game, and nothing is more unusual than the current pandemic environment. FINRA’s comments and suggestions point out the dangers of remaining complacent. Firms, members, and investors should take heed.

I hope that, by now, everyone understands and appreciates just how freakishly sensitive the regulators are to misconduct involving the wrongful sharing of confidential information.  If you don’t, however, FINRA was kind enough to publish two settlements in the last few weeks that work well to drive this concept home.  And both share an interesting characteristic:  they do not involve the bread-and-butter factual scenario that one typically sees: an RR who leaves BD A and moves to BD B takes with him his customer information to facilitate his ability to move his customers to BD B along with him.  Rather, both settlements have unique and interesting facts, which makes them suitable fodder for this blog.

The first settlement was an AWC back in April, involving Kestra Investment Services, out of Texas.  According to the AWC, Kestra has 678 branch offices and just under 2,000 registered representatives, and is growing.  To help with that growth, for about a year-and-a-half, “Kestra contracted with a third-party vendor to provide assistance to recruited registered representatives who had agreed to join Kestra.”  As part of that assistance, “Kestra worked with the vendor to create a template spreadsheet to collect information about recruited representatives’ customers, including their nonpublic personal information.”  That information pretty much screams “confidential”:

  • social security numbers
  • driver’s license numbers
  • birth dates
  • account numbers
  • annual incomes
  • net worth

The AWC recites that “[i]n certain instances, Kestra employees worked with recruited representatives to complete the spreadsheet while the representatives were still registered through their prior broker-dealers.”  What does “worked with” mean?  Apparently, “Kestra employees arranged and participated in conference calls between the vendor and the recruited representatives, and provided recruited representatives with guidance about how to complete the spreadsheet.”

Notably, however, “Kestra employees . . . did not receive copies of the spreadsheet or have access to the nonpublic personal information provided to the vendor. Once a recruited representative became registered through Kestra, the vendor used the spreadsheet to automatically pre-populate new account forms, which the vendor sent to customers who agreed to open Kestra accounts.”

So let’s recap.  Kestra helped RRs who it was recruiting make their transition to Kestra smoother by introducing them to a third-party vendor who gathered and organized the confidential information of their customers, so when they arrived at Kestra they could quickly and easily get new account forms completed and signed, allowing assets to be transferred to Kestra from whatever BD the RR had been registered with.  But, Kestra itself did not see that information.

So what, then, did Kestra do wrong?  It didn’t violate Reg S-P since it didn’t share the confidential information.  Well, we know that, as the AWC points out, “[a] registered representative who discloses nonpublic personal information about a customer and causes his or her broker-dealer to violate Regulation S-P violates FINRA Rule 2010.”  But, turns out that “a firm that causes another broker-dealer to violate Regulation S-P violates FINRA Rule 2010.”  Ah.  Here, Kestra didn’t violate Reg S-P, but it caused other BDs to do so.  Kind of like aiding and abetting.  Specifically,

  • “Kestra failed to take any steps to inquire whether the recruited representatives or their broker-dealers at the time had notified customers about the disclosure of their nonpublic personal information”;
  • “Kestra [failed to] take any steps to inquire whether customers had been given an opportunity to opt-out of having their information disclosed”; and
  • “Kestra also failed to provide any guidance to the recruited representatives concerning the disclosure of customers’ nonpublic personal information to the vendor.”

Given these failures, FINRA found that “Kestra’s arrangement with the third-party vendor resulted in 68 recruited representatives taking nonpublic personal customer information from their broker-dealers and disclosing it to the vendor during the Relevant Period. In so doing, Kestra caused the other broker-dealers to violate Regulation S-P.  By virtue of the foregoing, Kestra violated FINRA Rule 2010.”

The lesson is an easy, but important one:  you not only have to be careful about violating Reg S-P yourself, but, in addition, you must take pains not to cause anyone else to violate it.  It is not enough to say, Hey, well I didn’t look at any of those social security numbers, it was my vendor.  Might be a good time to check your own hiring policies, to see whether you have facilitated someone else’s Reg S-P violation.

The second AWC did not involve Reg S-P, but was still all about protecting confidential information.  It was submitted by Brandon Rolle, a research analyst who’s been in the industry for about five years.  The facts are short and sweet:

  • Rolle was a research analyst who researched certain sectors and companies.
  • His BD at the time, Longbow Securities, “would ultimately publish research reports to institutional customers who paid a fee for access to the reports.”
  • While associated with Longbow, Rolle sent himself five emails using his personal e-mail address “to evade detection by the firm.”
  • Attached to those emails were 31 documents “that contained confidential and/or proprietary information obtained from Longbow’s computer system. The documents included financial models, industry channel contact information, research reports, and surveys for the companies that Rolle researched and analyzed at Longbow.”
  • Rolle quit Longbow shortly after emailing himself those documents. He then joined another BD and “used the information he had taken from Longbow to assist him in carrying out his duties as an analyst for his new firm.”

So, if Reg S-P wasn’t the issue, what was?  According to the AWC, by emailing himself confidential and proprietary information, Rolle violated two things:

  • “provisions in Longbow’s employee handbook and compliance manual,” as well as
  • “a confidentiality agreement executed by Rolle when hired at Longbow.”

Here’s what’s interesting about Rolle’s AWC:  since when does FINRA care about an RR breaching a confidentiality agreement?  I am pretty sure that 99% of independent contractor reps have a confidentiality provision baked into their rep agreements, and violations, or alleged violations, of such provisions are often the subject of arbitrations.  But FINRA does not usually involve itself in such “business” disputes.  Indeed, as most compliance people know, at least those who deal with registrations, disputes between a BD and a terminated RR are explicitly deemed to be private, non-disclosable matters.

The instructions to Form U-5 say this about “internal review” disclosures:  “Generally, the Internal Review Disclosure question in Question 7B and the Internal Review Reporting Page (DRP U5) are used to report matters relating to compliance, not matters of a competitive nature. Responses should not include situations involving employment related disputes between the firm and the individual.”  Based on that instruction, I have always counseled my BD clients NOT to mark-up someone’s U-5 if the termination is related to an employment dispute.  And I, for one, would absolutely consider the breach by an RR of a confidentiality provision to be an employment dispute – provided that it does not involve confidential customer information.

And, finally, along the same lines, since when does FINRA care about the violation by an RR of a provision of an employee handbook?  A firm is entitled to include all sorts of restrictions and rules in its own handbook.  Say, a dress code provision.  Are you telling me that if an RR shows up to work in shorts and flip-flops that FINRA is going to label that a 2010 violation?  Ok, that’s an extreme example.  But, what if it’s something less silly?  What if an RR’s adult child has an account, and the RR lends money to his child?  That is not against FINRA rules, but some BDs prohibit any and all loans to and from customers, even family members.  Is FINRA saying here that it is willing to bring an Enforcement action to, well, enforce a firm’s policies?  If that is the case, then we are clearly in new territory.  Dangerous territory, at that.


Let’s take a step back from Covid-19 news, for a moment, which, rightfully, has dominated the news and everyone’s collective conscience, and focus on something that has been pervasive in the broker-dealer world for much, much longer than this virus, and which has taken its own toll on the industry in terms of dollars – in both fines imposed by regulators and awards handed down by arbitration panels – and suspensions and bars:  unsuitable recommendations.

Last week, FINRA announced that it had accepted a Letter of Acceptance, Waiver and Consent – an AWC – from Moloney Securities.  It was not accompanied by any fanfare.  I don’t recall reading any articles about it in any of the industry magazines.  But, it merits some attention here for the various lessons it imparts about how easy it is to find oneself the focus of regulatory scrutiny in a suitability case.

First, an observation: none of this should be news to anyone even half awake.  Seemingly every stinkin’ year – including this year – FINRA includes “suitability” in its annual list of “hot topics” as something on which it will be focusing its exams.  Month after month, when FINRA publishes the disciplinary actions it took over the preceding 30 days, there are tons of suitability cases included in the mix.  Yet, violations continue to occur, at an alarming rate.  No flattening of the curve here.

Ok, what happened with Moloney?  According to the AWC – which, as I am sure you know, includes findings that Moloney neither admits nor denies, but which it “accepts” – during the pertinent time period – January 2013 through April 2015 – the firm committed two supervisory violations: it failed

to establish and maintain a supervisory system reasonably designed to: (1) achieve compliance with FINRA’s suitability rule with respect to qualitative suitability and concentration in high-risk products; and (2) achieve compliance with applicable NASD and FINRA Rules pertaining to the detection and prevention of a form of manipulative trading known as marking-the-close.

I am going to focus on the first of these two violations.  But, before I do, take a second to appreciate just how OLD this misconduct is!  The pertinent time period started over seven years ago, and had ended over five years ago!  The books and records at issue were already long past the required retention period!  You think the wheels of justice grind juuuuuust a bit slowly at FINRA?  You think that maybe FINRA won’t sniff out something just because it happened during President Obama’s second inauguration? Think again.

But I digress.  Moloney’s problems related principally to two things: qualitative suitability and concentration in high-risk products.  Per the firm’s written procedures, its Regional Managers were “responsible for conducting a daily review of all trades executed by the registered representatives assigned to them (approximately 50 registered representatives per Regional Manager during the Relevant Period).”  FINRA had no issue with that.  But, it is one thing to delegate supervisory responsibility to others.  If you are going to do that, you actually have to ensure that the individuals to whom the responsibility has been delegated know what they are doing, and have the proper tools at hand to do their jobs.  Neither of those things happened here.

The AWC recites that Moloney’s written supervisory procedures “contained a cursory discussion of monitoring for qualitative suitability, including procedures related to speculative, low priced securities, and no discussion of concentration in high-risk products.”  Given this, you can see why it ultimately became a firm problem, not a problem for the Regional Managers.  They were obliged to do what the firm’s WSPs dictated; but if the WSPs were deficient, their efforts to supervise would undoubtedly have left considerable room for problems to occur.

So, takeaway no. 1: review your WSPs for suitability and make sure that they do more than simply repeat verbatim the language from Rule 2111.  Make sure they outline exactly how/when a supervisor is to review a particular trade for suitability.  And, just as important, make sure they also outline how a supervisor should also review any particular trade in the context of previous trades, to look for patterns (which could, potentially, result in over-concentration in a certain security or class of securities).

The AWC then provides that “the Firm did not provide any training to its Regional Managers on reviewing the suitability of recommendations in such products, nor did the firm issue any instructional materials or alerts, such as compliance bulletins, addressing these issues.”

Takeaway no. 2:  it is not enough even to have robust WSPs.  Your policies must be augmented by periodic training sessions, and supplemented by alerts and compliance bulletins as subsequent developments – like the publication of a relevant Enforcement action, like this one, for instance, or a Regulatory Notice – dictate.  Proper supervision is a marriage of written rules and policies – WSPs, compliance manuals – and execution of those rules and policies by appropriately qualified and trained people.  A failure of either component is sure to attract FINRA’s attention.

Next, the AWC states that

Moloney Regional Managers responsible for daily reviews of all trades executed by registered representatives reviewed equity transactions almost exclusively through the same electronic surveillance system provided by its clearing firm. The electronic surveillance system provided to and utilized by Moloney during the Relevant Period, however, was not equipped to reasonably surveil for concentration in high-risk products or qualitative suitability. While Moloney generally instructed Regional Managers to review transactions for potential suitability concerns, the Firm did not provide reasonable guidance, written procedures or training programs to address how to conduct those reviews.

This was clearly a bitter pill for Moloney to swallow, to have to accept a finding that even though it paid for and utilized its clearing firm’s electronic surveillance system, that was still deemed to be unreasonable by FINRA.  How do I know Moloney was bitter?  Well, the firm elected to append to the AWC a Statement of Corrective Action.  Every individual and BD that submits an AWC is offered the right to submit such a Statement.  Most don’t, likely for a couple of reasons.[1]  But Moloney did here, and in that Statement, it wrote that it had “[u]pgraded its trade surveillance system from the Standard version of ProtegentTM Surveillance (ProSurv), an application provided by its clearing firm, RBC Correspondent Services (RBC), and apparently used by roughly 90% of RBC’s 200+ correspondent firms during the Relevant Period, to the more robust and expensive Enhanced ProtegentTM Surveillance system.”  You can see what Moloney is saying here: c’mon, FINRA, 90% of RBC’s introducing firms used the same system we did, yet you are coming after us?  And, you are making us – not the other 90% — shell out more money for the “more robust” system?  What is fair about that?

Takeaway no. 3:  there is no safe harbor simply because you use what your clearing firm offers.  You must independently review whatever electronic surveillance system is available to you to determine whether it actually does a reasonable job.  Here, despite the fact the Regional Managers used RBC’s system, it apparently did not pick up concentration problems.  Specifically, the AWC includes a finding that “Moloney registered representative JM recommended that five senior customers, with investment objectives that included ‘balanced growth’ and ‘preservation of principle [sic] /income,’ purchase risky oil and gas limited partnerships and oil and gas exchange traded funds,” causing these customers to become concentrated in these products.  But, “Moloney’s electronic surveillance system . . . did not flag the transactions for concentration issues, nor was the concentration questioned or reviewed by anyone at the Firm.”

The last takeaway is to take serious note of the fact that the specific customers who FINRA singled out in the AWC as examples of people who suffered as a result of Moloney’s supervisory failure are all seniors.  Rightly or wrongly, FINRA places special emphasis on senior investors, and is constantly touting what a wonderful job it does of protecting them.  If you have any senior investors, and heaven forbid they engage in an investment strategy other than buying and holding blue chip stocks (or, even better, buying CDs), you had better be prepared to answer questions about how you allowed that to happen.

As I said at the outset, this is a routine, vanilla AWC, one that you could easily miss even if you make it a practice of reviewing FINRA enforcement actions for the lessons they teach.  But, as you can see, it is actually chockful of practical knowledge that likely has relevance to your own business.  So, maybe there is one more takeaway: spend a few minutes every week, and read – carefully – what FINRA does to other firms and RRs.  Those decisions and settlements paint a very vivid picture of what FINRA is focusing on.


[1] First, what’s the point?  From my experience, seems unlikely that the Statement has much, if any, impact on whether the AWC will be accepted.  Given that, why spend the time, money and energy to prepare it?  Second, why provide a potential roadmap to attorneys for your customers who may want to file arbitrations that allege supervisory failures?  While the Statement may not be deemed to be admissible (because it reflects subsequent remedial measures), you just never know how an arbitration panel will rule.

If you are a regular reader of this blog, you know that one of my pet peeves with FINRA is its unrelenting zeal to bar people, permanently, from the securities industry.  Seemingly without much regard for the actual conduct at issue, or for the existence of mitigating circumstances.  It is literally a running joke in my office: after every call with the Department of Enforcement about settlement, the lawyer who handles the calls has others guess what FINRA insists it needs from the respondent to settle.  The reason this is a joke – or at least what passes for humor in our world – is that nearly 100% of the time, what FINRA wants is…wait for it…a bar.  It doesn’t matter who our client is, or what they supposedly did wrong, or whether a customer was harmed, or whether they are still in the industry, or whether they have been working for two or 20 years in the industry with a clean record: if you guess “permanent bar,” you win!

Now, FINRA bridles at such accusations.  FINRA management often touts just how fair and reasonable they are.  Robert Cook, the head of FINRA, Jessica Hopper, the head of Enforcement (and before her Susan Schroeder): they all talk (or talked) about their even-handed approach to disciplinary actions, and how the sanctions meted out are tailored carefully to the offense at issue.  That sounds good, but just doesn’t comport with reality.  What FINRA likes to do, and wants to do, is bar people.

You don’t have to take my word for it.  At the end of March, FINRA published a blog post entitled “Working on the Front Lines of Investor Protection – Barring Bad Actors from the Industry.”  Read it.  It is a one-page self-congratulatory puff piece in which FINRA openly brags about how many people it has barred:  “In the last two years alone, FINRA barred more than 730 brokers from the brokerage industry – an average of one per day – for a vast range of misconduct.”  Wow!  One per day!  Imagine how happy FINRA must be that 2020 is a leap year!

And make no mistake, FINRA is downright excited about its statistics.  The post ends with this statement:  “Thus, we are particularly proud that, in numerous instances, FINRA staff were able to bar a bad actor from the industry within just a few weeks of the discovery of the underlying misconduct, saving investors and the markets from further harm.”  FINRA is “proud” not just of the fact that it bars one person per day, but that it goes after those bars so quickly.

I just don’t get this as a source of “pride.”  When I worked for the NASD 20 years ago as a regional attorney prosecuting enforcement actions, what made me proud is not the particular sanctions I was able to get, but, rather, the fact that I never once lost a case that I brought.  That meant that I had properly evaluated the facts uncovered during the exam, correctly concluded that a rule had been violated, and accurately assessed my ability to prove the allegations to the satisfaction of the hearing panel.  Indeed, my bonus at the time wasn’t impacted in the slightest by the magnitude of the sanctions awarded in my cases; more importantly, my receipt of a bonus hinged on me not losing a case as a result of my failure to meet my burden of proof.

Today, it seems that FINRA operates quite differently.  Given the frequency with which FINRA seeks permanent bars, and its public, prideful trumpeting of its numerical success in obtaining bars, it is hard to argue that it really doesn’t matter to FINRA whether it gets a bar or not.  To FINRA, getting a bar provides bragging rights, I suppose.  I am not sure who FINRA is trying to impress.  The investing public?  The SEC?  The media?  I will tell you one group that is not impressed, and that is the group that consists of FINRA member firms and their associated persons.  To them, this is not a game, not a joke, and not a matter of flaunting the statistical equivalent of sticking an enemy’s head on a pike.  All they want is to be treated fairly and reasonably, and I don’t think that’s too much to ask.  Sadly, that doesn’t make good headlines, so don’t waste your time looking for another blog post from FINRA touting the number of, say, Cautionary Action Letters it issues.

I read with interest earlier this week that a judge in Texas conducted a one-day bench trial via Zoom, apparently representing the first time this has happened.  I understand that hearings, i.e., matters that involve arguments of counsel, rather than the introduction of evidence through the examination of live witnesses, are often done over the phone or by video, and that has been the case since long before the coronoavirus hit.  Such remote arguments are not necessarily as effective as being right in front of a judge or a panel, but they work ok; well enough that they are widely accepted.  Indeed, even the United States Supreme Court has announced that rather than simply suspending oral arguments, as it has historically done in circumstances that dictate against holding sessions in open court, it will, starting in May, entertain oral arguments via remote access.

But, a trial is different than a hearing.  In a trial, the factfinder is called upon to make a credibility determination for each testifying witness, and that determination is based not just on what the witness actually says, but how the witness says it, and how he or she acts on the witness stand, including the slew of non-verbal communications that we tend to pick up on subconsciously.  Given that, I wondered how the judge in Texas felt that he was able to be fair to the parties before him.

And understand, this is not merely an academic exercise for me and my clients.  For just in this past week, I have learned of both a FINRA arbitration panel and a FINRA Hearing Officer in a pending Enforcement matter who have raised the prospect of conducting a final evidentiary hearing by Zoom, rather than waiting to do it in person.  And, frankly, I find that a bit scary.

Let’s start with arbitration.  As you all likely know by now, FINRA has determined to administratively stay all in-person arbitration hearings through July 3.  But, that is not the end of the story.  In that same release, FINRA also made the following statement:

Finally, FINRA Dispute Resolution offers virtual hearing services (via Zoom and teleconference) to parties in all cases by joint agreement or by panel order.  These services provide high-quality, secure, user-friendly options for conducting video and telephonic hearings and sharing documents remotely.  Staff is available to schedule virtual hearings and provide technical support. Parties that are interested in exploring this option are encouraged to contact their Case Administrator for details.

Focus, for a second, on the language that I have highlighted.  This says that a Zoom hearing can happen not only when the parties jointly agree to do so, but, as well, “by panel order.”  In other words, FINRA has told panelists that they have the power simply to insist that in-person hearings may happen via Zoom, presumably even over the parties’ objections.  Has any panel taken that grant of authority seriously?  Well, at least one I know of has.  It has issued a directive that states that in light of this language from FINRA,

the Panel is now considering the implementation of a Virtual Hearing to be conducted May 18-22, 2020 and Orders the parties to continue to prepare for a final hearing during those scheduled dates until further advised. At such time all issues are resolved to be able to move forward with the final hearing the parties will be notified.

Note that this directive does not say that the hearing will happen as long as the parties all agree to proceed.  It doesn’t even invite input from the parties.  It just says that this hearing is happening as long “all issues are resolved,” whatever those issues may be.  I concede that arbitration panels have considerable power, but I wonder whether that power is sufficiently broad to compel parties to conduct an entire final hearing by Zoom, even, theoretically, over their objections.[1]

As for Enforcement, FINRA has issued a similar decree as in arbitrations:  “The Office of Hearing Officers (OHO) has postponed hearings of Disciplinary Proceedings scheduled through July 3, 2020 with the exception of pending Expedited Proceedings, as they are not conducted in person.”  I have a case that is scheduled to go to hearing in June, so I presume that this general postponement means the hearing is off.  But, not necessarily.  The Hearing Officer assigned to the case correctly observed that it may be a looong time before anyone is truly comfortable traveling to a hearing, sitting in a small, confined conference room all day/every day for a week or more with ten or 15 other people, staying in a hotel, dining at restaurants every day.  Given that, who knows just how long it may be until this in-person hearing can safely be scheduled.  (And I say “in-person” here because FINRA Rules, specifically, Rule 9261(b) provide that “[i]f a hearing is held, a Party shall be entitled to be heard in person, by counsel, or by the Party’s representative.”)

So, the Hearing Officer has suggested – but not dictated – that, perhaps, it may make sense to keep the case on the calendar in June and do it using Zoom.  Otherwise, this case may not get heard for many, many months.  I am not sure how this will be resolved; indeed, as I said, the Hearing Officer is merely mulling over the idea of a Zoom hearing.  But the longer these Shelter In Place orders continue, and the longer it takes for life to return to “normal,” the more hard-pressed FINRA may become to get its hearing calendar moving, even if that means exploring options to traditional in-person hearings.

And let’s be clear: as cool as Zoom is, it never functions completely smoothly.  Sometimes it doesn’t even come close to smooth.  Maybe you’ve been in a Zoom meeting like this one.  The report of the Texas bench trial I mentioned at the beginning of this post (from Law360) includes this comment:

Throughout the trial there were sporadic interruptions involving Zoom, most notably the several times the court reporter told the parties she could no longer hear what they were saying.  At one point message notifications could be heard coming from Black’s [one the attorneys] computer, which he attributed to his “family group chat” before turning the sounds off.

The point is, even a relatively simple meeting is rendered awfully difficult when its participants are forced to do it over a computer.  The question is whether it is so difficult that it would render it unfair to a respondent forced to defend him- or herself using such technology, and unfair to the point of depriving the respondent of due process.  I, for one, simply cannot see how it can work.

Just want to provide an update on this:  Wunderlich Securities lost an arbitration in which the final session of the hearing was held via Zoom, with the consent of all parties.  Wunderlich has now filed a Petition to Vacate the Award with the U.S. District Court for the Southern District of New York.  You can read that here.  While Wunderlich raises a number of troubling issues involving the panel’s conduct during the entirety of the hearing, the Petition does specifically complain about the session that was done via Zoom.  According to the Petition,”the Panel was inattentive [during the Zoom session], with Arbitrator Finard looking at other screens, typing, and eating during the course of the presentation. Arbitrator Gross even blocked her screen during the hearing,preventing the parties from confirming that she was even participating. And at one point during closing arguments for WSI and Mr. Wunderlich, Chairman Hollyer walked away from his screen.”  I will report when I learn the outcome of the Petition.

[1] It is worth noting that in arbitration hearings, the occasional witness is permitted to testify remotely, by phone or video.  But, this is only done by motion, and the other party has the right to lodge objections to the proposal.  Moreover, it is typically reserved only for “minor” witnesses, whose testimony will be short and limited to a discrete topic or two.

Heidi is my go-to destination for all things Reg BI.  Here’s a quick, but really helpful, update from her. –  Alan


This week OCIE issued twin alerts relating to the upcoming implementation of Reg BI.  A lot of the statements are nothing new – brief repetitions of the Regulation, the four obligations, etc.  None of that should be new information for firms at this point.

What is new (and useful) is that in one of the two Alerts, OCIE appended a list of documents it will likely request when it begins conducting Reg BI examinations (and it intends to conduct those exams within a year of the June compliance deadline).

In some respects, the document request list is not surprising in that it is focused on disclosure documents, disclosure procedures, and the way fees are charged/disclosed/supervised.  In other respects, its quite novel.  The SEC is, essentially, telling firms – well in advance – the information it will be asking to see and the questions it intends to ask during the exam.  Firms will want to make sure these items have been reviewed and addressed, obviously, but they should also be prepared to explain or defend how the firm approached these issues.  Remember, the SEC is looking for “reasonableness” and, as a result, the effort and attention to detail that went into compliance is going to be important.

The second alert focused on Form CRS, specifically – not only on the content and form, but also how it was delivered to both new and existing clients.  Be mindful of the recordkeeping requirements as to transmission data.

The uncertainty and interruptions caused by the spreading pandemic have only added to the anxiety surrounding the June compliance deadline but, for now, the SEC seems intent to hold to the schedule it established last year.  If you are looking to assess your readiness – not only for implementation but for the exams that will follow – see how completely you can address each of the “mock” requests contained in these two Alerts.

Forced to sit at home under government-ordered decree, and having finished binge-watching Season 3 of Ozark and Season 4 of Money Heist on Netflix, what’s left to do except prey upon scared investors – particularly seniors – who have been watching the markets not so much fly as plummet?  With (perhaps) that very thought in mind, on Thursday last week, the SEC’s Investor Advisory Committee hosted a conference call – nice social distancing! – with other regulators to discuss what sales practice issues have already arisen, and what issues might soon be expected, once the dust from the coronavirus settles.  Frankly, if you didn’t already have enough to be scared about, if you work in the securities industry, this list might just put you over the edge.

Microcap fraud.  Scammers love to take advantage of people’s fears.  The fear of dying prematurely, unaccompanied by loved ones, especially when combined with the simultaneous fear of losing all of one’s money, can be pretty motivating.  To that end, the SEC has warned investors that there are lots of companies out on the internet touting their supposed COVID-19 cures, treatments and even vaccines, designed to induce people to invest in them now.  NOW!![1]  As most amateur epidemiologists, like myself, well know, there is yet no known cure or treatment or vaccine for this virus.  Given that hard fact, these companies have a decent chance of being scams, pump-and-dump schemes designed to enrich the few insiders who already own shares.  FINRA, too, has issued its own warning on this subject.  And inasmuch as the CARES Act allows retirees to withdraw up to $100,000 from their retirement accounts without incurring a penalty, it is easy to see why suddenly cash-heavy seniors may be particularly targeted.

Non-scam private placements.  A private offering does not need to be a scam, of course, to present sales practice issues.  There are real companies promoting private offerings related to COVID-19, e.g,, vaccines, personal protective equipment – that, as NASAA has pointed out, use the same techniques as a pump-and-dump scheme.  Because these private offerings are not subject to review by federal or state securities regulators, however, they present their own unique risks.  They can have high up-front sales costs, they may have limited liquidity opportunities, they may be difficult to price, and, most obvious, the prospects for actual success may be quite limited.  There is nothing inherently wrong with a private placement, contrary to what regulators seem to suggest; but they do require a healthy amount of due diligence.

Use of margin.  Margin can be a very useful tool; especially in a rising market.  But, in a market like we’ve seen over the last few weeks, one that drops very quickly and very dramatically, owning securities purchased on margin can be devastating.  The market losses are magnified, and can cause forced sell-outs, resulting in massive realized losses.  Not surprisingly, therefore, the regulators have warned that complaints about margin may be around the corner.  Sadly, I have to agree.

Operational issues.  Another problem created by extremely fast moving markets is simply the crush of investors trying to place orders, or just contact their brokers.  According to FINRA, it has already received complaints from customers who experienced problems trying to trade, because phones were not answered and/or because of internet connectivity.  Undoubtedly, some of these investors will eventually complain that they incurred losses that could have been avoided or mitigated had their orders – or should we say supposed orders – been entered in a timely fashion.   And this cuts both ways.  In some cases, the complaint will be that a sell order could not be placed, period.  In others, it will be that the sell order was timely placed, but the order was not timely filled, and by the time it was filled, the market had dropped even further.  And in others, there will be complaints from sellers who supposedly tried to cancel their sell orders but could not, incurring losses as a result.

Precious metals fraud.  It is no secret that when the securities market tanks, some investors move their cash to gold and silver, tried and true investments that are touted as being recession/depression/inflation/deflation proof.  Fraudsters are well aware of this phenomenon, and take advantage of it.  I am not saying gold is a bad investment, or a good one; what I am saying is that because there will be a demand for this stuff, invariably, and sadly, some of the available investments will not be legitimate.

Good, old-fashioned suitability claims.  Beyond these fancy-schmancy issues that are unique to the particularly peculiar times in which we all now live, there are the bread-and-butter claims that investors have been raising since time immemorial:  suitability.  Or, more accurately: unsuitability.  With the benefit of hindsight, investors who lose money in this market chaos can be counted on to argue that they are the victims of unsuitable recommendations made long ago, and rather than blaming the market, or the virus, or the government, for their predicaments, they will straight-facedly blame their brokers.  They will argue that, somehow, their brokers should have known what would happen, and, therefore, never should have recommended that they buy – and you can fill in the blank with whatever stock you want, e.g., American Airlines, Carnival Cruise Lines, etc.  These claims ought to be pretty defensible, but it not always easy, and never cheap, to defend even bogus claims.

It is hard enough dealing with this terrible virus, and the disruption it has created in all of our lives.  It makes it worse to understand, however, that fraudsters are out there trying to take advantage of people who are already anxious and afraid.  And, on behalf of brokers, it is also distressing to know that claimants’ counsel are sitting in their quarantines, licking their collective chops, thinking of the arbitrations they will invariably be filing.

[1] You want proof of the regulators’ interest in this subject?  On Friday last week, the SEC filed two orders temporarily halting trading for No Borders Inc., a dental supply company, and Sandy Steele Unlimited Inc.  Regarding No Borders, the SEC was concerned about a representation the company made that it had an agreement to bring its “COVID-19 specimen collection kits” to the U.S.  As for Sandy Steele, apparently, “unknown sources” have sent emails to prospective investors claiming that the company has the capability to manufacture protective masks “that are in high demand due to the COVID-19 crisis.”