Look, I get that nobody’s perfect. We all make mistakes, it’s just human nature. I told my kids when they were growing up the same thing I tell my associates: it’s ok to make mistakes, it’s just not ok to repeat them. Sadly, my broker-dealer clients live in a heavily regulated environment, so when they find themselves in a pickle, it is typically not enough just to tell an examiner, “Oops, I made a mistake.” The fact is, when dealing with FINRA, as well as the SEC and the states, there are no free bites at the apple, no do-overs. Every action a broker-dealer takes, every decision it makes, no matter how well intended, is subject to being second-guessed, and could ultimately serve as the basis for regulatory action. As a result, BDs – at least diligent BDs – learn that it is in their best interest to be über careful with what they say in documents and what they say to the public, to minimize the chance that it comes back to haunt them.

FINRA, on the other hand, sometimes displays the opposite attitude, seemingly indifferent to the quality and content of its communications. If my clients were to act as cavalierly as FINRA does in this regard, they would undoubtedly be called on the carpet for it. That is why is so galling that when confronted with its errors, FINRA just shrugs it off.

How about an example? I received an envelope in the mail addressed to me, on behalf of a broker-client. In the envelope was a Letter of Caution. That was no surprise, as I had been negotiating with FINRA, and so I expected to receive it. What was surprising was that the Letter of Caution in the envelope was not addressed to my client, but, rather, to another broker-dealer. I guess they got mixed up somehow. Of course, that meant that someone else undoubtedly received my client’s LOC. Letters of Caution are informal dispositions, and are not reported on Form U-4 or Form BD; they are private and confidential. Yet, because of FINRA’s error, I learned of another BD’s LOC, and someone else learned of mine. Imagine what FINRA would do if a BD sent non-public, confidential customer information to the wrong recipient, even if it was sent accidentally. It wouldn’t result in the death penalty, but merely saying “Oops, sorry” would likely not suffice, either.

Here’s another. Recently, I completed long and hard-fought negotiations with FINRA and ended up with an AWC that my client and I could finally live with. A critical component of the settlement was that my client would not have to pay either a fine or restitution. Although it did have to make a payment under the terms of the AWC, it was not characterized as a fine or restitution. When FINRA reported the AWC in the monthly list of disciplinary actions, however, it still somehow managed to describe the payment as restitution, which was totally contrary to the terms of the AWC.

When I brought this to FINRA’s attention, it was fixed right away. But, when I asked that FINRA go beyond that, and expressly include a recitation on the FINRA website that the initial description of the AWC had been wrong, and that it was being amended, FINRA balked, insisting that “the correction speaks for itself.” Helpfully, however, it was suggested to me that I follow up with the Ombudsman if I had any concerns about the staff’s intent! (No offense to anyone in the Ombudsman’s Office – I know people who work there and they are very kind and nice – but complaining to the Ombudsman is as pointless an endeavor as I have ever encountered.)

Again, can you imagine FINRA’s reaction if a broker-dealer made a mistake of this magnitude? I appreciate the fact that FINRA doesn’t operate according to the myriad rules that govern the conduct of broker-dealers and registered reps, so, for instance, it need not satisfy the minutia contained in the Communications with the Public rule. But, FINRA is most certainly regulated – by the SEC. It has a statutory mandate to fulfill, and if it doesn’t meet that standard, it is subject to being disciplined itself. While FINRA manages to get on the SEC’s radar screen from time-to-time, historically, the discipline is modest. In October 2011, for instance, FINRA settled with the SEC to resolve charges that it had altered documents it provided to the SEC – the third time it had done so in an eight-year period! – and yet no fine was assessed. Do you sincerely believe that FINRA would act in such a benign manner if some broker-dealer did the same thing with documents it provided to FINRA?

I do not predict a sudden moratorium on Enforcement cases as FINRA contemplates this post. All I am saying is that one of two things should happen, perhaps both. First, FINRA needs to come to understand that not every error a broker-dealer commits – particularly the unintentional kind – dictates that a formal disciplinary action ensue, or that hefty fines be meted out. Second, FINRA needs to hold itself to the same lofty standards to which it holds BDs and RRs. That will not stop FINRA from committing mistakes, but they would be much easier to swallow knowing that they happened despite tight controls and procedures. At least then, it might even be forgivable. Now, however, FINRA’s failure to own up to its own occasional errors, or at least to take them seriously, makes FINRA’s take-no-prisoners attitude towards broker-dealers that much more difficult to accept.

Just a week ago, I ran a post about FINRA’s Sanction Guidelines, suggesting that they appear to have no relevance anymore, given the vast disparity between fines that FINRA is actually imposing in settled cases, on the one hand, and the supposed maximum fines described in the Sanction Guidelines, on the other. In an excellent example of fortuitous timing, just yesterday, FINRA released its new and improved version of the Sanction Guidelines (presumably not in response to my blog post). They make very interesting reading, as does the Regulatory Notice FINRA issued to announce the new Guidelines (which, by the way, are “effective immediately,” so bad news to anyone in the midst of negotiations with Enforcement over a settlement, as the price tag just jumped).

The principal purpose of the revisions was to ratchet up the available sanctions, both monetary and non-monetary, for some of the more heinous rule violations, such as fraud, misrepresentations and material omissions of fact, as well one rather less scandalous violation, unsuitable recommendations. That was hardly a surprise, and not particularly controversial, given the generally accepted view that at least the fraud-related violations are “bad,” as reflected by the heavy-handed manner with which FINRA has historically dealt with them. In addition, FINRA upped the high-end of the range of fines for each rule violation included in the Sanction Guidelines by indexing them to the Consumer Price Index, going all the way back to June 1998. Thus, for instance, the high-end of the range for the guideline for violating the supervisory rule by having deficient supervisory procedures – which I highlighted last week in the blog post – moved up from $25,000 to $37,000. Yikes, inflation!

What was more interesting to me, however, was what didn’t change, and that is the fact that FINRA sanctions are still intended to be remedial, not punitive. FINRA had the chance to excise that language from the Sanction Guidelines, obviously, but chose not to do so. So, in the “Overview” section, FINRA still employs the phrase “appropriate remedial sanctions,” and, in General Principle No. 1, still recites that “Adjudicators should . . . ensur[e] that the sanctions imposed are remedial and designed to deter future misconduct, but are not punitive.”[1]

That hardly means, however, that the fact I observed last week – namely, that FINRA routinely imposes monetary sanctions that represent a multiple of 200 or more over the supposed high-end of the ranges specified in the Sanction Guidelines – will now stop. To the contrary, I predict that FINRA will be emboldened by the new revisions, and argue that they constitute support for ever higher fines. Frankly, I disagree with that conclusion.

Revised General Principle No. 1 has new language that clearly suggests to me that absent certain extraordinary circumstances that would trigger a fine in an amount that exceeds the high-end of a particular range by an outrageous amount, such lofty monetary sanctions should not be routine at all:

Sanctions should be more than a cost of doing business. Sanctions should be a meaningful deterrent and reflect the seriousness of the misconduct at issue. To meet this standard, certain cases may necessitate the imposition of sanctions in excess of the upper sanction guideline. For example, when the violations at issue in a particular case have widespread impact, result in significant ill-gotten gains, or result from reckless or intentional actions, Adjudicators should assess sanctions that exceed the recommended range of the guidelines.

“Widespread impact.” “Significant ill-gotten gains.” “Result from reckless or intentional actions.” While the list of these factors is preceded by the words “for example,” so they are certainly not exclusive, it is now clear what sort of circumstances should result in fines that “exceed the recommended range of the guidelines.” Happily, these circumstances are not present in all cases, or even nearly all cases. Given that, instead of resulting in a fresh avalanche of bloated fines, as (sadly) I predict will actually happen, the revisions to the Sanction Guidelines should actually result in fewer cases with fines higher than the stated high-end of the ranges. I look forward to making that argument to some FINRA Enforcement attorney; I will let you know how it goes.

Unfortunately, I imagine what will happen is that what is true today will remain true, and that is that the Sanction Guidelines, with their adorable ranges of fines, will, generally speaking, continue to be ignored by FINRA in the context of settlement negotiations. The only place, in my experience, where the fine ranges have any real application is in front of a hearing panel, because the panelists – two of whom are from the industry, representing what I have repeatedly termed the “last bastion of self regulation” – actually seem to care that the NAC bothered to impose a high-end to each range, and therefore do not easily deign to exceed it.

And that explains why, as my friend and former colleague, Brian Rubin, who does an annual arithmetic comparison of fines imposed by FINRA in settlements versus fines imposed after going to hearing, regularly reports (revealing a secret that is hardly a secret to anyone that truly practices in this area), in a surprising number of cases, one can actually do better by going to hearing than by settling. Which is pretty weird, when you think about it, given the shout-out that FINRA gives in the Overview to the Sanction Guidelines to “the broadly recognized principle that settled cases generally result in lower sanctions than fully litigated cases to provide incentives to settle.” Perhaps the solution is to encourage FINRA Enforcement lawyers to find a nice, comfy chair and curl up with the Sanction Guidelines this weekend, and reacquaint themselves with its contents, which the NAC worked so hard to prepare.

[1] Curiously, FINRA does not even mention the word “remedial” anywhere in Regulatory Notice 15-15, and even seems to go out of its way to avoid it. Consider the language used in the following sentence, which is largely lifted directly from the Overview section and General Principle No. 1, and notice what adjective has been omitted: “[T]he central idea contained in the Sanction Guidelines is that adjudicators start with a range of appropriate sanctions for a particular violation and consider aggravating and mitigating factors in order to arrive at an appropriate sanction for the particular circumstances.” Seems to me that the correct phrase FINRA should have used is “appropriately remedial sanction.”

Surprise!  In a rare occurrence, recently a CFTC Judgment Officer awarded a broker its attorneys’ fees for “frivolous and vexatious” litigation brought in “bad faith” by a customer in a Reparations proceeding. Azubueze Jiagbogu v. TradeStation Securities, Inc., [Current Transfer Binder] COMM. FUT. L. REP. (CCH) ¶ 33,430 (CFTC Mar. 9, 2015). The customer’s conduct was egregious, failing to comply with discovery even when a rule to show cause issued and failing “to substantiate his thin complaint.”

For those who do not know, there is a customer-dispute forum at the CFTC created by the Commodity Exchange Act and subsidized by taxpayers that is unlike any forum available at any other federal administrative agency or self-regulatory organization. With a click of a mouse, and as little as $50, a customer can file a pro se complaint for money damages against his broker by completing a form on CFTC.gov. (CFTC Division of Enforcement reviews these complaints to supplement its own surveillance activities.)  As a government program, it is presumably subject to due process requirements; but, its name, “Reparations,” reveals the true bias: its purpose is to give money back to customers.

In Reparations, the CFTC has adopted the “American Rule” as to awards of attorneys’ fees.  In theory, fees will be awarded evenly against a customer or a broker if the account agreement provides for it or if a party filed or litigated a Reparations complaint in bad faith. In practice, however, awards of attorneys’ fees to brokers are rare for three reasons. First, not surprisingly, Judgment Officers rarely find customers engaged in bad faith litigation, unlike in Jiagbogu. Second, when they do, the Commission often reverses the order on appeal. Third, except in connection with a counterclaim to collect a debit, the CFTC will not enforce an attorneys’ fees provision in an account agreement even though Reparations Rule 12.19 allows brokers to file any counterclaim that “arises out of the transaction or occurrence or series of transactions or occurrences set forth in the complaint.”

Through its decisions, the CFTC has narrowed this broad counterclaim rule so that the only counterclaim cognizeable in Reparations is to collect a debit.  Absent misbehavior by the customer, therefore, the only time brokers are awarded attorneys’ fees is when they defeat the customer’s claim, prevail on the debit counterclaim, and the account agreement provides for an award of attorney’s fees. A former ALJ at the CFTC fairly summarized the situation as follows: “[W]hile a mere favorable outcome is sufficient to award attorney’s fees to a prevailing [customer], neither a finding of bad faith nor a finding that there is an enforceable fee-shifting provision is sufficient to award attorney’s fees to a prevailing [broker].” Connolly v. Cotter, [2011-12 Transfer Binder] COMM. FUT. L. REP. (CCH) ¶ 31,980 (Levine, ALJ Jun., 23, 2011).

As to attorneys’ fees, the Reparations program is not at all a level playing field.  At the heart of the problem is the CFTC’s decision in Bianco v. Cytrade Financial, LLC, [2007-09 Transfer Binder] COMM. FUT. L. REP. ¶ 30,933 (CFTC Sept. 30, 2008), in which the CFTC held it would not enforce a fee-shifting provision in an account agreement except in connection with an award on a debit.  Besides not being even-handed, the Bianco decision is contrary to Congressional intent and Supreme Court law.  See CFTC v. Shore, 478 U.S. 833 (1986).  The time has come for the CFTC to overrule Bianco and level the playing field.

In a recent blog post, I wrote about the challenge a rapidly deteriorating change in mental capacity can cause BDs and RRs alike.  Often, we are asked to speak to groups and firms, and this subject is a popular one.   In my view, there are a couple of reasons for this development.

First, FINRA has provided an indication that it expects members to be focused on this issue.

The National Senior Investor Initiative Report stated:

FINRA Rule 1250(b) requires firms to have a training plan that is appropriate for all business activities. Senior investors represent a large percentage of the investing population, and training employees on sensitive senior matters is an important step in detecting elder financial abuse, detecting potential diminished capacity, and understanding the needs of senior investors.   Staff found that most firms incorporate training specific to senior issues into their training plans.

Initially, I must say, the Report’s reference to FINRA Rule 1250 is a bit troubling. The requirement that a firm must have a training program has been a long standing requirement. The implication, however, that if the firm has senior investors and the training program does not specifically instruct on senior issues, the firm risks a Rule 1250 violation is something altogether different. Using this catch-all, FINRA appears to be expanding the scope of the Rule. Putting to the side a clause related to research analysts, Rule 1250 identifies only three matters that must be part of the firm’s training program: 1) general investment features and associated risk factors; 2) suitability and sales practice considerations; and 3) applicable regulatory requirements. Absent from that list are any specifics. Instead, the Rule describes broad categories and subjects of training. It certainly does not describe any specific requirement to provide training on senior issues.

Nonetheless, FINRA is provided some guidance on what it expects and it is perilous to ignore it.

The other reason firms are focused on the mental capacity of senior investors is the difficulty the subject presents. Compliance officers and RRs are not trained clinical psychologists. Identifying the signs of diminished capacity is a challenge and the risk associated with missing those signs is significant. One day, your 77-year-old client, a retired CFO of a Fortune 1000 company, is as sharp as a tack. His complex investment portfolio, which might not be suitable for the average run-of-the-mill investor, is reasonable for him because he understands the risk and it is consistent with his investment objectives. Then, the next time you meet with him, perhaps just a few months later, something is off. He seems confused about his account and his investments. Now what?

If you are a RR, how can you prepare for the possibility? If you are a Compliance Officer, what can you do when your RR reports to you that the mental capacity of the investor suddenly changed?

In my view, a firm’s options become much more limited after the change in mental capacity. As a result, firms should develop procedures for working with senior investors that focus on the front end. These procedures can include the following:

  • Updating account documentation on an annual basis rather than every three years. This update should include having the senior investor sign the confirmation rather than via a negative consent letter.
  • Updating the new account form to include a line item for a durable power of attorney designee.   Require that senior investors initial that box even if they have not yet made such designation. Either way, it’s an introduction to what can be a touchy subject.
  • RRs should invite their senior investors to bring other family members to their meetings. Including family members will go a long way to foreclosing arbitrations initiated by those family members later on when and if the portfolio value declines.
  • Document and take copious notes of your meetings with senior investors. These records will help defend any customer complaint or FINRA inquiry.

Finally, the firm should understand that the type of products it recommends to senior investors could invite additional regulatory scrutiny. As the National Senior Investor Initiative Report stated:

Mutual funds, variable annuities, and equities were most often purchased by senior investor. More complex securities such as UITs, REITs, alternative investments, and structured products were also purchased by seniors, but such purchases were less frequent. Due to the wide-ranging nature of these investment products, it is critical that senior investors are fully informed of the features of any securities they are purchasing, including the potential return and associated risks.

As the firm and its associated persons recommend products that FINRA considers complex (putting to the side that a UIT or REIT is not particularly complex anyway), the firm should make sure that it is clear on the paperwork that the senior investor understands the risks and features of those investments.   There is nothing wrong with incorporating an additional one-page, plain-language disclosure form that the senior investor must sign before the investment is made. That additional documentation can help insulate you should a regulator review and analyze the transaction. It will also give someone like me a strong piece of evidence I can use to defend an arbitration brought by a son or daughter based on trades made by mom or dad.

I read with interest the press release FINRA issued this week announcing an $11.7 million settlement with LPL, principally over what FINRA characterized as “widespread supervisory failures.” There were two things most noteworthy to me.[1] The first, interestingly, is not the size of the monetary sanctions (a $10 million fine plus $1.7 million in restitution), but, rather, the opposite, i.e., that such inflated sanctions have become so commonplace that they are no longer remarkable. (Take a quick look at the fines that FINRA has trumpeted in its press releases in just the last few months: $1.4 million; $3.75 million; $3 million; $43.5 million; $15 million.) The second, and the point of today’s post, is something that has become increasingly evident over recent years, and that is the almost utter lack of relevance of FINRA’s Sanction Guidelines.

If you bother to read the 24-page AWC that LPL signed, you will see that it is chockfull of a variety of rule violations. In fact, there are seven enumerated sections in the “Facts and Violative Conduct” portion of the AWC, and many of those have subsections, resulting in a grand total of 17 separately described rule violations. But, there is one rule that is clearly the most prevalent. Of those 17 descriptions, fully 14 of them include a violation of NASD Rule 3010, i.e., the supervision rule. In FINRA’s Sanction Guidelines, there are two specific Guidelines that are pertinent to supervisory violations, “Deficient Written Supervisory Procedures,” and “Failure to Supervise.” Interestingly enough, the suggested range of appropriate monetary sanctions for the former is $1,000 – $25,000, and, for the latter, $5,000 – $50,000.” The question is: how does FINRA get from $25,000 or $50,000 – the high end of these ranges – to $10 million?

I acknowledge, of course, that the Sanction Guidelines are just that, merely guidelines, and are not absolutes. As FINRA expressly cautions in the Overview to the Sanction Guidelines,

These guidelines do not prescribe fixed sanctions for particular violations. Rather, they provide direction for Adjudicators in imposing sanctions consistently and fairly. The guidelines recommend ranges for sanctions and suggest factors that Adjudicators may consider in determining, for each case, where within the range the sanctions should fall or whether sanctions should be above or below the recommended range. These guidelines are not intended to be absolute. Based on the facts and circumstances presented in each case, adjudicators may impose sanctions that fall outside the ranges recommended and may consider aggravating and mitigating factors in addition to those listed in these guidelines.

I “get” the notion that “aggravating circumstances” can cause the fine in a given case to go beyond the range identified by the NAC. But, at the same time, I can only wonder how relevant is a supposed maximum of $25,000 or $50,000 fine when, as is the case with the LPL settlement, it can be exceeded by a multiple of 200 or 400. The suggested range of fines that the NAC published in the Sanction Guidelines is rendered completely meaningless if FINRA has the ability to impose a monetary sanction 400 times higher than what the NAC deemed to be the upper end of the appropriate range. It can be a frustrating experience, when negotiating a settlement with FINRA, to cite the Sanction Guidelines as support for a fine within the stated range, only to have the Enforcement lawyer ignore them, and, instead, cite some prior settled case with an exorbitant fine, many, many times the “maximum” fine listed in the Sanction Guidelines.

The real problem respondents face is that FINRA increasingly ignores the General Principle that “[d]isciplinary sanctions are remedial in nature,” that “that the sanctions imposed are not punitive but are sufficiently remedial to achieve deterrence.” Instead, FINRA relies heavily on the NAC’s statement that “[w]hen applying these principles and crafting appropriate remedial sanctions, Adjudicators also should consider firm size.” “Firm size” is explained in a footnote as follows: “Factors to consider in connection with assessing firm size are: the firm’s financial resources; the nature of the firm’s business; the number of individuals associated with the firm; the level of trading activity at the firm; other entities that the firm controls, is controlled by, or is under common control with; and the firm’s contractual relationships (such as introducing broker/clearing firm relationships).” Focusing on the first phrase – the firm’s “financial resources” – FINRA essentially pegs the fines it metes out to a respondent’s ability to pay. Thus, the greater a firm’s financial resources, i.e., the greater the ability to pay a fine, the larger the fine.

To me, this is practically the dictionary definition of punitive damages, which are damages meant to punish. We are all familiar with the obvious notion that punitive damages have to be large enough to cause pain, financial pain, to the respondent. Accordingly, for FINRA to ratchet up its monetary sanctions, in derogation of the guidelines and fine ranges published by the NAC, based on “firm size,” is to render the Sanction Guidelines, and the principles that they are meant to embody, particularly the notion that sanctions are designed to be remedial and not punitive, nothing more than a quaint reminder of the days when “disciplinary proceedings [were] remedial actions conducted in a businessman’s forum.”

[1] Well, maybe there is a third observation to make. The violations cited in the AWC occurred from 2007 – 2014. One can only wonder how many examinations LPL endured over that time period, and why FINRA either failed to detect any issues sooner, or failed to bring an Enforcement case sooner. Neither is recognized as a defense, but, as a matter of equity, these lapses should have had some impact on the size of the sanctions.

Obviously, given the name of this blog, the focus is on broker-dealers, but we also have a robust practice advising RIAs and investment management companies.  In that vein, a group of attorneys working in our Cleveland office published a Client Alert today that discusses a recent Investment Management Guidance Update published by the SEC.

The Alert begins by saying:

On April 28, 2015, the SEC Division of Investment Management issued an Investment Management Guidance Update identifying cybersecurity as an important concern for investment companies and registered advisers. To prevent, detect, and respond to cybersecurity threats, the SEC recommends that these entities conduct periodic risk assessments, design a cybersecurity strategy intended to prevent, detect, and respond to threats, and implement that strategy.

The rest of the Alert can be read here.

I read today about a lawsuit that two registered persons, one of whom is a Chief Compliance Officer, filed against FINRA in federal court a couple of weeks ago. Mind you, lawsuits against FINRA are not particularly common, given the fact that FINRA has “absolute immunity” against monetary claims arising out of its regulatory activities. So, I am not saying that these plaintiffs will ultimately prevail, but their complaint did raise an interesting issue regarding Rule 8210, one of my favorite subjects.

In short, the lawsuit alleges that FINRA (as well as the third-party vendor that was hired to preserve the broker-dealer’s emails in accordance with SEC Rule 17a-4) is guilty of “spoliation,” i.e., tampering with or destroying the emails. What happened was, allegedly, FINRA issued 8210 letters for the firm’s emails, but insisted that the emails be produced in “a special format” – .pst, to be specific. The firm recognized that the vendor would likely be better at responding to the 8210 requests than its own internal people, so it had the vendor supply the emails. Somehow, allegedly, when FINRA subsequently used some of the emails as exhibits during OTRS, they had been altered in some fashion, including language added to the sender line, the substitution or insertion of inaccurate sender and receiver names, formatting and time differences, lost and incomplete content, etc.

I have no idea if these allegations have merit or not. But, what is interesting to me is the allegation that FINRA requested in its 8210 letter that the emails be produced in a particular format. It is pretty common to see 8210 requests that ask that documents be produced in a particular manner (e.g., emails in .pst format), or that data be produced in a certain way other than the manner in which it was originally created (e.g., on a searchable Excel spreadsheet). Here are some actual, verbatim examples of 8210 requests my clients have received:

  • “Provide a spreadsheet showing each time the computer was started-up and shut-down or logged on and logged off from October 1, 2012 to the present.”
  • “Produce a schedule of any customers that affected [sic] purchases from the firm’s inventory accounts during January 1, 2011 through December 31, 2013 (in excel format).”
  • “Provide a listing of all customers of the firm who held XXX as of June 30, 2013 who meet or exceed the below thresholds,” and then went on to list four particular criteria.

Where, exactly, does FINRA get the right to dictate the format in which documents are produced? Or that data be gathered from disparate sources and neatly collected for FINRA on a single document? Clearly, it does not appear anywhere in any of the pertinent rules.

Rule 8210 provides that FINRA has

the right to:

(1) require a member, person associated with a member, or any other person subject to FINRA’s jurisdiction to provide information orally, in writing, or electronically (if the requested information is, or is required to be, maintained in electronic form) and to testify at a location specified by FINRA staff, under oath or affirmation administered by a court reporter or a notary public if requested, with respect to any matter involved in the investigation, complaint, examination, or proceeding; and

(2) inspect and copy the books, records, and accounts of such member or person with respect to any matter involved in the investigation, complaint, examination, or proceeding that is in such member’s or person’s possession, custody or control.

Nowhere in this rule is FINRA given the power to dictate that documents be produced in any format other than the format in which they were created. Indeed, under subsection (1), the rule expressly limits FINRA’s ability to compel the production of electronic information only if the information “is, or is required to be, maintained in electronic format.” Yet, FINRA routinely ignores that language, and demands production in a certain way.

Moreover, the rule certainly does not give FINRA the power to require that firms prepare spreadsheets, or schedules, or lists. The rules that define the universe of documents a broker-dealer must create and preserve are SEC Rules 17a-3 and 17a-4 and FINRA Rule 4511. And I assure you, those rules do not require broker-dealers to create the sort of lists and schedules that FINRA often demands. Strictly read, Rule 8210 gives FINRA the right to “inspect and copy” documents; but, it does not empower FINRA to compel firms to “create” documents. Despite the clarity of that limitation, FINRA regularly ignores it, as demonstrated by the examples I have provided in FINRA requires the creation of some schedule or spreadsheet.

Finally, speaking of FINRA’s right to “inspect” documents, it is also clear that FINRA is not content merely to be provided the opportunity to view a BD’s books and records; rather, it generally requires that the particular requested documents be culled out and formally presented. Consider this real-life scenario: I had a broker-dealer client that sold its assets to one of its competitors and closed shop. It dutifully filed a Form BDW, as it was required to do. That form requires that someone be identified as the custodian of the firm’s books and records, and that the custodian certify that “that the broker-dealer’s books and records will be preserved and available for inspection as required by law.”

The firm’s former president identified himself as custodian, had the documents boxed up, placed in storage, filed a Form U-5 for himself, and happily moved on to his new business (which had nothing to do with securities). Sure enough, months later, FINRA sent him an 8210 request – remember, FINRA retains jurisdiction for two years after the U-5 is filed – seeking particular documents from the defunct BD. We offered FINRA the unfettered right to review the contents of all the stored boxes, for as long as it desired, but we were rebuffed, and instructed that we had to conduct the search for the examiner, or else face a possible 8210 charge. We explained that no one worked for the BD anymore, so there was no one around to go through the boxes and find the specific documents FINRA requested; alas, FINRA did not find that explanation compelling, and insisted that we figure out a way to get them ourselves.

The scope of Rule 8210 is certainly broad, but it is not limitless. Unfortunately, FINRA often disregards its limits. And given the potentially huge price to pay for ignoring an 8210 request, FINRA typically gets what it wants, even when it acts in a manner not countenanced by the rule. As I have said before, there needs to be a mechanism created whereby 8210 requests can be challenged other than through the Enforcement process, so overly broad requests can be examined without the threat of being barred or expelled in the event the challenge is unsuccessful.

Before I became a District Director for NASD, I was an attorney with its Department of Enforcement. In those days, I would occasionally take someone “on the record,” but only when it was clear that a formal disciplinary action, i.e., a complaint, would be forthcoming. The purpose of the OTR was principally to memorialize and set in stone the testimony of the prospective respondent, thus enabling me to use the transcript to impeach him at the hearing, should he be silly enough to change his story from what he swore to at the OTR. We didn’t take too many people’s testimony, maybe ten in the course of a year.

Now, things are different. Now, as defense counsel, it seems that I am in FINRA OTRs constantly. This is because OTRs have somehow become an integral part of the routine exam process for FINRA. Even in exams that, happily, never become formal actions, FINRA regularly summons witnesses to appear and give sworn testimony. Sometimes lots of witnesses. A single exam may entail multiple people appearing before FINRA over a period of several days or weeks, requiring repeated trips to whatever location FINRA dictates.[1] And, unlike federal (and some state) courts, where depositions are limited by rule to a set number of hours (barring an agreement by the parties or an order from the judge extending the time limit), FINRA OTRs can continue for as long as the examiners desire. OTRs extending more than one day are, sadly, all too common.

I have lost track of the number of OTRs I have defended over the years, but it is somewhere in the hundreds. Having a lawyer with you at an OTR may not change the ultimate outcome of the exam, but it most certainly keeps things honest and ensures that the record created will be fair and orderly. Knowing this, and because testifying at an OTR can be a frightening experience for both the uninitiated as well as the seasoned witness, given that FINRA always trots out a lawyer to assist in the interrogation, most sensible people, particularly those who can afford to do so, bring counsel with them to an OTR. Some bring more than one (something, absent very unique circumstances, I have never quite understood; one lawyer should be plenty).

News flash: like most lawyers, unsurprisingly, I do not work for free. It is not inexpensive to pay counsel to travel to, prepare for, and appear at an OTR. Multiply that by several OTRs, and the cost to a broker-dealer just to get through an examination – and remember, this is all before a complaint is filed, or before the decision to issue a complaint is even made – can become exorbitant. When you couple OTRs with the need for counsel to assist with the responses to serial 8210 requests for documents and information, the amount of legal resources necessary to get through a FINRA exam adds up quickly and dramatically.

News flash two: FINRA doesn’t care. The financial impact that OTRs have on a firm, or worse, an individual, causes FINRA not the slightest concern. If FINRA determines that your testimony is necessary, there is little if anything that can be done to derail that process, regardless of cost. But, by and large, FINRA seems blind to any questions of economy when it comes to OTRs. It is increasingly common to have gangs of FINRA examiners and attorneys appear at OTRs. My indoor record for the number of FINRA people at an OTR is seven – it happened a few years ago in an exam out of the Dallas District Office.[2] If FINRA doesn’t care how much it spends on its own resources to conduct an OTR, it sure isn’t going to care about how much the OTR costs the witness.

The point is, FINRA should care about this. When deciding whether to conduct OTRs, and where and when to do so, FINRA ought to consider how these decisions impact its members and their associated persons. Like it or not, the subjects of FINRA exams are deemed innocent unless and until either they agree they’re not, in the form of a settlement, or a hearing panel concludes that FINRA has met its burden of proving they’ve violated some rule. By forcing member firms to spend thousands and thousands of dollars to hire counsel simply to defend OTRs, which are conducted during the examination phase, FINRA is, in essence, exacting a financial penalty from prospective respondents before the formal disciplinary process even commences, assuming it will ever commence. That is simply not consistent with one of the “General Principles” behind the FINRA Enforcement process, which, according to the Sanction Guidelines, is supposed to be remedial, not punitive.

[1] Under Rule 8210, FINRA has the right to compel a witness to appear anywhere, at any time, for an OTR. While the FINRA office located closest to the witness is often the venue selected, and sometimes FINRA will actually travel to where the witness happens to live, or conduct the OTR by video, that is hardly always the case. For example, for exams being conducted by FINRA Enforcement or Market Regulation out of Rockville, the OTRs will be set in that bucolic location, regardless of where the witness resides or works. Similarly, most of the time, FINRA will work with me to schedule the OTR on a date that works well for all concerned. On occasion, however, I have had to fight hard to move the OTR to a date that would not cause my client extreme inconvenience.

[2] FINRA explained this by saying the OTR was to intended cover both the exam of the BD, as well as a related branch office exam, and different examiners were involved in each. Regardless, it was just my client and me on one side of the table, and the seven FINRA people – a combination of examiners and lawyers – on the other.

Over the last few months and years, securities regulators have repeatedly emphasized the special care and attention senior investors[1] should be afforded by broker-dealers and their associated persons. As part of that focus, on April 15, 2015, FINRA and the SEC Staff published their National Senior Investor Initiative Report. The report highlighted recent industry trends extrapolated from “44 examinations of broker-dealers in 2013 that focused on how firms conduct business with senior investors as they prepare for and enter retirement.”

A few days later, FINRA issued a press release announcing the launch of the toll-free “FINRA Securities Helpline for Seniors.” The main goal of the helpline is to “provide older investors with a supportive place to get assistance from knowledgeable FINRA staff related to concerns they have with their brokerage accounts and investments.” A few of us have joked here that the phone number should be 1-800-ENFORCEMENT.

Let me say this at the outset. There is nothing wrong with FINRA looking out for senior investors. It’s admirable.

But it is also low hanging fruit for the regulator. For the most part, there is nothing inherently unique about a senior investor. To begin with, any recommendation made to a senior investor must still be suitable for him/her (i.e., taking into account the investment objective, risk tolerance, financial situation and needs, etc.). Sure, their time horizon, liquidity needs and financial situation are likely to be different than a 30-year-old investor, but FINRA Rule 2111 – the “regular” suitability rule – already captures the duties owed to all investors. (There’s no special suitability rule for senior investors yet!) In addition, any risks associated with the recommendation must be properly and adequately disclosed.

Further, many other, much younger, unsuspecting investors lose money as a result of unsuitable recommendations or unscrupulous sales practices every day. Routinely, we read about FINRA Enforcement actions and/or arbitrations against broker-dealers and their associated persons for such transactions. Those with wealth are always at risk, even much younger professional athletes.

There is one circumstance, however, that I think is unique to senior investors – a rapidly deteriorating change in mental capacity. That unfortunate occurrence creates challenges to the industry that I’ll talk more about that in my next post.

[1] It is interesting that neither the SEC nor FINRA have ever defined exactly when an investor actually becomes a “senior.”

As those who know me well are already too aware, rarely does a day go by without some action by a securities regulator that causes me to whine and complain endlessly about a crazy rule or the manner in which it has been applied to my clients, who are, by and large, broker-dealers and the individuals associated with BDs. That’s what 32 years in the securities litigation field will do to a person, especially someone on the defense side, who spends all day fighting enforcement complaints from regulators, or arbitrations brought by former customers. So, when it was suggested to me that I could share these thoughts with others through the magic of the Internet, I figured, why not? That led to the creation of this blog, Ulmer & Berne’s BD Law Corner.

Then, I cleverly realized that there are other lawyers here, also with vast securities experience and serious credentials, whose views on broker-dealer issues would be of interest to anyone who might enjoy my own musings. I say with no small degree of pride that Ulmer & Berne has one of the best groups of broker-dealer lawyers anywhere, no matter how big our competitors may be, no matter in what city they may be located. Accordingly, I invited five of my talented colleagues, with over 100 years of cumulative experience, to share responsibility for the content of this blog with me, so readers will have the opportunity not just to take advantage of our deep pool of securities capabilities, but to hear different voices, with different takes on things that impact broker-dealers.

I invite you, therefore, to subscribe to our blog, and receive email notifications when new content is added, or, if you prefer, simply to follow it through whatever method makes the most sense for you, whether Facebook, Twitter, etc. Either way, I invite your feedback and your questions, to let us know if you agree or disagree with our views, to engage in a dialogue, perhaps, or even if just to let us know you enjoy what we are doing.

Alan Wolper

Partner

Wolper