Section 911 of the Dodd-Frank Act established the Investor Advisory Committee to advise the SEC on regulatory priorities, the regulation of securities products, trading strategies, fee structures, the effectiveness of disclosure, and on initiatives to protect investor interests and to promote investor confidence and the integrity of the securities marketplace. On November 22, 2013, the Committee issued a recommendation to extend the fiduciary duty to broker-dealers.
The Committee preliminarily stated its conclusion: that personalized investment advice to retail customers should be governed by a fiduciary duty, regardless of whether that advice is provided by an investment adviser or a broker-dealer. In approaching this issue, the Committee noted that the SEC's goal should be to eliminate the regulatory gap that allows broker-dealers to offer investment advice without beings subject to the same fiduciary duty as other investment advisers. However, the Committee noted that the SEC should not eliminate the ability of broker-dealers to offer transaction-specific advice compensated through transaction-based payments.
The Committee made two specific recommendations for action by the SEC. First, the Committee recommended that the SEC should conduct a rulemaking to impose a fiduciary duty on broker-dealers when they provide personalized investment advice to retail investors. Second, as a part of its rulemaking, the SEC should adopt a uniform, plain English disclosure document to be provided to customers and potential customers of broker-dealers and investment advisers that covers basic information about the nature of services offered, fees and compensation, conflicts of interest, and disciplinary record.
In the stated "Supporting Rationale" for its recommendation that the SEC should engage in rulemaking to impose a fiduciary duty on broker-dealers when they provide personal investment advice, the Commission noted that in arriving at this decision they took into account a broad consensus among widely disparate groups that broker-dealers and investment advisers should be subject to a uniform fiduciary standard. The Committee also noted that these various stakeholder groups generally agree that the fiduciary duty should not apply to all brokerage services, but only to those services that fall within a reasonable definition of personalized investment advice to retail customers.
The Committee also addressed some of the limited opposition that exists. First, some argue that broker-dealers are already extensively regulated under existing law and self-regulatory organization rules. The Committee believed, however, that while the existing regulatory scheme may adequately regulate broker-dealers when they act as salespeople, it does not offer adequate investor protection when they offer advisory services, since under the suitability standard they generally remain free to put their own interests ahead of those of their customers. Second, some argue that regulation is not needed because investors are capable of choosing for themselves whether they prefer to work with a broker-dealer operating under a suitability standard or an investment adviser who is a fiduciary. However, the Committee found that various studies had indicated that investors do not distinguish between broker-dealers and investment advisers, do not know that broker-dealers and investment advisers are subject to different legal standards, do not understand the difference between suitability standard and a fiduciary duty, and expect broker-dealers and investment advisers alike to act in their best interests when giving advice and making recommendations.
The Committee noted that the SEC has a range of options available to it in order to implement this regulatory goal. These include the rulemaking authority under Section 913(g) of the Dodd-Frank Wall Street Reform and Consumer Protection Act, as well as existing authority under the Investment Advisers Act to regulate non-incidental advice by broker-dealers.
The Committee's second recommendation was that the Commission should adopt a uniform, plain English disclosure document to be provided to customers and potential customers of broker-dealers and investment advisers. The Committee believed that improved disclosure was necessary to help investors select a financial professional. Relevant topics could include what services are provided, how the broker-dealer or investment adviser is compensated, and what conflicts of interest exist.
The Committee's recommendation is another step towards the establishment of a fiduciary duty standard for broker-dealers. This position has already been applauded by the NASAA, which in a statement supporting the recommendation said that: "A fiduciary standard for broker-dealers will guarantee that all financial professionals providing investment advice will act in the best interests of their clients, and in turn, enhance investor confidence in the financial services industry and securities markets."
Monday, November 25, 2013
Section 911 of the Dodd-Frank Act established the Investor Advisory Committee to advise the SEC on regulatory priorities, the regulation of securities products, trading strategies, fee structures, the effectiveness of disclosure, and on initiatives to protect investor interests and to promote investor confidence and the integrity of the securities marketplace. On November 22, 2013, the Committee issued a recommendation to extend the fiduciary duty to broker-dealers.
Tuesday, October 15, 2013
Wednesday, April 13, 2011
On April 7, 2011, the SEC charged three former brokerage executives for failing to protect confidential information about their customers in violation of Regulation S-P. Regulation S-P prohibits any broker or dealer, any investment company, or any investment adviser registered with the SEC under the Investment Advisers Act of 1940 from disclosing any nonpublic personal information about a consumer to a non-affiliated third party. "Nonpublic personal information" can include, among other things, the fact that an individual is or has been one of your customers or has obtained a financial product or service from you.
The SEC found that while GunnAllen Financial, Inc., was winding down its business operations last year, its former president and former national sales manager violated customer privacy rules by improperly transferring customer records to another firm. The SEC also found that the former chief compliance officer failed to ensure that the firm's policies and procedures were reasonably designed to safeguard confidential customer information.
According to the SEC's orders, GunnAllen's former president authorized the former national sales manager to take information from more than 16,000 GunnAllen accounts to his new employer. The former sales manager downloaded customer names and addresses, account numbers, and asset values to a portable thumb drive, and provided the records to his new employer after resigning from GunnAllen. The SEC found that the record transfer violated Regulation S-P because account holders were only informed about it after the fact.
Without admitting or denying the SEC's findings, the individuals consented to the entry of an SEC order that censures them and requires them to cease and desist from committing or causing any violations or future violations of the provisions charged. The order also imposed financial penalties against them. This is the first time that the SEC has assessed financial penalties against individuals charged solely with violations of Regulation S-P.
A copy of the SEC's press release can be found here.
Friday, March 18, 2011
This month, the Financial Industry Regulatory Authority (FINRA) reprimanded First Clearing, LLC, a St. Louis-based brokerage firm, for insufficient anti-money laundering (AML) protections in FINRA Case #2008012791101.
First Clearing consented to the described sanctions, without admitting or denying the findings, submitting the firm to $400,000 in fines. The AML inadequacies focused on the firm’s practice of only reviewing transactions regarding a limited amount of potentially suspicious activity. FINRA findings stated that “the firm generated many exception reports and alerts dealing with potentially suspicious securities transactions and money movements in customer accounts that were introduced by unaffiliated broker-dealers to the firm.” However, a majority of these exception reports were not reviewed. As a result, FINRA concluded that First Clearing did not have an adequate program for detecting, reviewing, and reporting suspicious activities as required by the Suspicious Activities Report (SAR) reporting provisions of 31 U.S.C. 5318(g) and NASD Rule 3011(a).
Previously in March 2009, FINRA levied fines against First Clearing for the firm’s failure to provide the required notifications to customers over a five-year period ending in 2008.
Thursday, January 27, 2011
Friday, October 22, 2010
On October 20, 2010, FINRA issued Regulatory Notice 10-51 regarding sales practice obligations for commodity futures-linked securities. FINRA notes that in recent years, securities that offer exposure to commodities have become increasingly popular to retail investors - presumably due to a low correlation with other asset classes and enhanced portfolio diversification. FINRA notes that commodity futures-linked securities can be an effective tool for gaining exposure to this asset class that in some cases can be difficult for investors to access.
FINRA recognizes, however, that in some cases the performance of the commodity futures-linked security can deviate significantly from the performance of the referenced commodity. This deviation can produce unexpected results for investors who are not familiar with futures markets, or who mistakenly believe that commodity futures-linked securities are designed to track commodity spot prices (i.e., the immediate delivery value of the commodity).
Therefore, FINRA issued Regulatory Notice 10-51 to remind firms that offer commodity futures-linked securities that they must ensure that communications with the public about these securities are fair and balanced, that recommendations to customers are suitable, and that their registered representatives adequately understand and are able to inform their customers about these securities before they recommend them. FINRA notes that under NASD Rule 2210, firms must ensure that all communications with the public are fair and balanced, and provide a sound basis for evaluating the facts about any particular security or type of security, industry or service.
FINRA states that firms should not suggest that a commodity-futures linked security offers direct exposure to the commodity's spot price, overstate the degree of correlation between the the spot price and the commodity-futures linked security, or understate the risks inherent in investing in commodity futures. Firms should also not overstate the hedging value value of commodity futures-linked products, or commodities generally, for, by example, implying that their performance is always negatively correlated with equities or other asset classes. That a prospectus may convey such information does not excuse the firm's duty to ensure that its communications regarding the product are fair, balanced and not misleading.
Moreover, FINRA notes that NASD Rule 2310 requires that, before recommending the purchase, sale or exchange or a security, a firm must have a reasonable basis for believing that the transaction is suitable for the customer. For commodity futures-linked securities, the registered representative and retail customer should discuss, among other things:
- The commodity, basket of commodities or commodities index that a given product tracks;
- The product's goals, strategy and structure;
- That commodities prices, and the performance of commodity futures-linked securities, can be volatile;
- That the use of futures contracts can affect the performance of the product as compared to the performance of the underlying commodity or index;
- The product's methodology, including its strategy, if any, for managing roll yield and other factors that may affect performance; and
- The product's tax implications. (Commodity pools have different tax implications than mutual funds or exchange-traded notes.)
Tuesday, October 12, 2010
The North American Securities Administrators Association (NASAA) identified the top compliance deficiencies and offered a series of recommended best practices for broker-dealers to consider in order to improve their compliance practices and procedures. The securities examiners from 30 states provided information to compile the report. These examinations took place between January 1, 2010, and June 30, 2010.
The examinations focused on number of different areas: Sales Practices, Supervision, Operations, Books & Records, and Registration/Licensing. From the 290 examinations reported, 567 deficiencies were found. The greatest number of deficiencies (33 percent or 185 deficiencies) involved books and records, followed by sales practices (29 percent or 164 deficiencies), supervision (20 percent or 115 deficiencies), registration and licensing (10 percent or 56 deficiencies), and operations (8 percent or 47 deficiencies). The top five deficiencies were: 1)failure to follow written supervisory policies and procedures (57 instances), 2) advertising and sales literature (46 instances), 3) variable product suitability (38 instances), 4) maintenance of customer account information (37 instances), and 5) suitability (34 instances).
Based on the examinations project, the NASAA produced a list of best practices:
- Develop effective standards and criteria for determining suitability.
- Ensure that exception reports are generated when necessary and that “red flags” are documented and resolved in a timely manner. If the BD elects to electronically recreate an exception report, the BD must not only be able to recreate the report but also document how the exception was resolved.
- Develop, update and enforce written supervisory procedures. BDs should also ensure that staffing and expertise are commensurate with the size of the BD and type(s) of business engaged in by the firm.
- Develop a branch audit program that includes a meaningful audit plan, unannounced visits, a means to convey audit results and a follow-up plan for requesting that the branch take corrective action.
- Firms must ensure that adequate procedures are in place to prohibit and detect unauthorized private securities transactions (selling away). If this activity is permitted, the firm’s written supervisory procedures should be adequate to monitor this activity on an ongoing basis.
- Outside business activity requests from registered representatives must be received and reviewed by the firm prior to the activity. The firm and its registered representatives are obligated to report the outside business activity on the representative’s Form U-4. The firm should have a supervisory procedure in place to address its approval/denial process.
- Advertisements and sales literature must be balanced, make full and fair disclosure, and be approved, as necessary, prior to use.
- Seminar notices/advertisements, seminars and seminar materials utilized must be approved by the BD prior to use and the seminar being held. Additionally, any guest speakers and their materials must also be reviewed and approved prior to the seminar. In instances where registered representatives routinely conduct seminars, a supervisory representative of the firm should randomly attend the seminar for compliance purposes.
- Correspondence, both electronic and hard copy, must be effectively monitored by the BD including a system of capturing and maintaining e-mails sent by registered representatives from websites and Internet Service Providers outside the firm.
- Upon receipt of a complaint, the firms must acknowledge receipt, update the registered representative’s Form U-4, if required, and conduct and document a thorough review of the customer’s allegations. In situations where the firm discovers wrongdoing, the firm should redress customer harm. Failure to do so may result in enhanced penalties under NASAA guidelines.
Friday, June 25, 2010
On June 24, 2010, lawmakers from the House and Senate working to merge two versions of the financial-regulation overhaul into a single bill agreed to let the SEC impose a fiduciary duty on brokers once the regulator completes a six-month review. House lawmakers had earlier proposed implementing stiffer rules without a study period, prompting opposition from senators led by Tim Johnson, a South Dakota Democrat.
Johnson proposed language that could have, among other things, maintained the study requirement. However, Johnson's proposal made it even more difficult for the SEC to act on its findings by allowing the SEC to set new rules regarding the fiduciary duty standard only if the agency concluded after its study that regulatory gaps between certain brokers and investment advisors could not be addressed through other approaches.
A fiduciary duty would obligate brokers to act in the best interest of their clients and to disclose all conflicts of interest. Brokers now only have to ensure a product is suitable before marketing it to a customer. As discussed in an earlier blog post, the expansion of the fiduciary duty has met resistance from the broker-dealer and insurance industries whose sales practices would be subject to the new fiduciary duty standard. Whereas consumer advocates have said the fiduciary obligation is needed because investors can be misled into buying products they don’t understand and are often confused by the titles used by financial advisers.
However, the debate is not over just yet, even if federal lawmakers pass the legislation. Once the job of conducting the study and making the rules goes to the SEC, the debate over the details of just how the new rules will apply will likely continue.
A copy of the Businessweek article discussing this development can be found here, and an article from Financial Advisor Magazine can be found here.
Tuesday, May 25, 2010
On May 20, 2010, the U.S. Senate passed its version of the financial reform bill. The U.S. House of Representatives passed its financial reform legislation earlier this year. The two bills have varying degrees of regulation and differences on how to regulate. One such difference involves mandatory arbitration provisions included in brokerage firm and investment advisory contracts. Currently, most brokerage or investment advisory firms require customers sign a contract in order to open an account. The contract usually requires all claims arising out of or related to the contract to be submitted to arbitration. These mandatory arbitration provisions often specify the arbitral venue and the arbitration rules that will apply.
According to Senate Bill 3217, the Securities and Exchange Commission (“SEC”) would be given the authority to determine the permissibility of mandatory arbitration provisions to govern the arbitrability of securities claims. The Senate specifically gives the SEC the option to reaffirm, prohibit, or impose certain conditions on the use of mandatory arbitration provision in broker-dealer and investment advisor agreements.
On the other hand, the House legislation does not give the SEC the authority to reaffirm current practices regarding mandatory arbitration. Rather, HR 4173 only permits the SEC to restrict or prohibit the use of mandatory arbitration provisions in such contracts. Therefore, without the ability to reaffirm the status quo, it would seem that mandatory arbitration provisions included in brokerage and advisory contracts would no longer restrict a defrauded investor from choosing to seek redress in a judicial forum. Further, the House legislation requires the U.S. Government Accountability Office (“GAO”) to report to Congress on the costs to parties in an arbitration proceeding versus the costs to parties in litigation and the percentage of recovery in both forums. The inclusion of the GAO report is to address concerns that arbitration may not be less costly to the parties or more expedient than litigation and that arbitration may actually undermine investor interests.
The U.S. Department of Treasury in its report last June takes the most stringent approach to mandatory arbitration provisions in brokerage agreements. In its financial reform proposal, the Treasury recommends that legislation should be enacted to prohibit mandatory arbitration provisions in these contracts and that the SEC should be given “clear authority” to enforce arbitration provision violations. Like the House, the Treasury proposal also suggests that a study should be conducted to determine whether investor rights are undermined because of an inability to seek redress in court.
Historically, violations of federal securities laws were considered a non-arbitrable issue. In 1953, the U.S. Supreme Court articulated this view in Wilko v. Swan when it held that an agreement to arbitrate a claim under Section 12(a)(2) of the Securities Act of 1933 was unenforceable. 346 U.S. 427 (1953). Over 35 years later, the Supreme Court overruled its position in Wilko in Rodriguez v. Shearson/American Express, Inc. 490 U.S. 477 (1989). The Court in Rodriguez held that a predispute agreement to arbitrate claims under the Securities Act of 1933 is enforceable and resolution of the claims only in a judicial forum is not required because arbitration does not inherently undermine a person’s substantive rights under federal securities laws. Id. at 485-86. It is important to note that since the decision in Wilko, arbitration had become more common and the Federal Arbitration Act had been significantly amended strengthening judicial and legislative favor toward the use of arbitration to settle disputes, which further justified the Supreme Court’s overruling. Id. However, the Supreme Court has also held that a predispute arbitration agreement that effectively deprives a claimant of statutory remedies violates public policy and is unenforceable, thus limiting the scope of Rodriguez. Mitsubishi Motors Corp. v. Soler Chrysler Plymouth, Inc., 473 U.S. 614, 637, n. 19 (1985).
Friday, March 12, 2010
FINRA CLOSES COMMENTS ON REGULATORY NOTICE 09-70: PROPOSED CHANGES TO REGISTRATION AND QUALIFICATION REQUIREMENTS
In December 2009, the Financial Industry Regulatory Authority (“FINRA”) proposed changes to the consolidated FINRA rulebook, which incorporated the National Association of Securities Dealers (“NASD”) rules on registration and qualifications. These changes were proposed pursuant to FINRA Regulatory Notice 09-70: “FINRA Requests Comment on Proposed Consolidated Registration and Qualification Requirements” (“Proposal”).
Essentially, the purpose of the Proposal is to streamline NASD Rules 1021 and 1031. Under the NASD, these rules governed registration requirements of representatives and principals. Under current FINRA rules, investment bankers and broker-dealers of FINRA member firms must register. Additionally, FINRA member firms may register any individuals that engage in legal, compliance, internal audit, or back-office operations. The primary effect of the proposal would significantly broaden the current “permissive” registration categories to allow member firms to register certain persons employed by member firms or their financial services affiliates. Because of this expansion, FINRA also would introduce new stand-alone registration categories:
(1) active registration, for individuals engaged in investment banking or securities activities
(2) inactive registration, for individuals engaged in the “bona fide” business purpose of the member
(3) retained associate registration, for individuals functioning as financial services affiliates.
The actual text of the Proposal can be accessed here.
The comment period was slated to end February 1, 2010, but was extended to March 1, 2010. Twenty-one organizations submitted comments, voicing opinions ranging from full support to complete abandonment. The organizations included investment firms such as Edward Jones and T.Rowe Price and industry associations like the North American Securities Administrators Association, Inc. (“NASAA”) and the Securities Investment and Financial Markets Association (“SIFMA”). Most of the comments voiced general overall support, but suggested small changes to help effectuate a more efficient transition. See SIFMA Comment and Edward Jones Comment. The NASAA was one of the few who voiced complete abandonment of the acquisition of NASD rules into the consolidated FINRA rulebook. The primary objection to the Proposal is FINRA’s lack of guidance on the appropriate substance of a registered inactive person’s education and continuing education requirements. However, NASAA suggests this issue could be solved by continued use of FINRA’s current qualification examination waiver process, which would be superseded by the new rules. Further, the NASAA believes these three new registration categories constitute radical changes that are structured for the convenience of member firms not investor protection.
FINRA has not yet filed its rule proposal with the Securities and Exchange Commission, which may suggest the organization will make changes before its submission.
Friday, March 5, 2010
The Florida Office of Financial Regulation (“Office”) recently updated some of its securities rules. The Office submitted notice for several proposed rule changes that are primarily to keep its rules up-to-date with the most current federal laws and cross references. For example, references to NASD had to be switched to FINRA after the SEC approved their consolidation back in 2007. Despite these “housekeeping” changes, there are a few noteworthy proposals that are substantive in nature. The substantive proposals come pursuant to House Bill 483 that passed during the 2009 Florida legislative session. The purpose of the bill was to increase investor protection through an expansion of certain agency powers. House Bill 483 became effective July 1, 2009, but the Office of Financial Regulation is beginning to submit its proposals for the supplementary rules.
One such substantive change is Proposed Rule 69W-1000.001, which creates a set of disciplinary guidelines in accordance with House Bill 483. The rule expands the disciplinary power of the Office of Financial Regulation to impose additional sanctions against individuals and firms that are subject to regulation under the Florida Securities and Investor Protection Act (“Securities Act”). Under the new rule, the Office has the power to impose cease and desist orders in conjunction with any sanction laid out in the Securities Act and raises the levels of minimum fines. The rule also sets out an extensive and comprehensive factors list to determine the appropriate sanction.
Proposed Rule 69W-600.0011 was also added pursuant to House Bill 483. Under this proposed rule, applicants could be subject to registration disqualifying periods for dealers, issuer dealers, investment advisors, as well as “relevant persons.” “Relevant persons” for purposes of the rule include “any direct owner, principal, or indirect owner that is required to be reported on behalf of the applicant on a Form BD or a Form ADV.” A Form BD is required for the application for broker-dealer registrations, and a Form ADV is required for applications for investment advisor registration. Grounds for disqualifying periods are based upon criminal convictions, pleas of nolo contendere, and pleas of guilt, regardless of whether there was an adjudication. The disqualifying periods range from five years to fifteen years depending on whether the crime is a classified as “Class A” or “Class B.” Class A crimes are felonies involving an act of fraud, dishonesty, breach of trust, money laundering, and any other crime involving a question of “moral turpitude.” Class B crimes are misdemeanors involving “fraud, dishonest dealing or any other act of moral turpitude.” Pleas receive a disqualifying period of three years. There is also a provision allowing registrants to submit any evidence of mitigating factors that may reduce the length of disqualification.
The Office of Financial Regulation is charged with safeguarding private financial interests of the public through licensing, chartering, examining, and regulating depository and non-depository financial institutions and financial service companies in Florida. It also serves to protect consumers from financial fraud and preserve the integrity of Florida’s markets and financial service industries.
Monday, December 7, 2009
On December 3, 2009, SEC Chairman Mary Schapiro spoke at the Consumer Federation of America's 21st Annual Financial Services Conference. Ms. Schapiro noted that as a result of last year's financial turmoil the country is undergoing a "financial services revolution." While the market has improved in recent months, the SEC Chairman reminded the audience that this does not mean that the weaknesses in our financial regulatory system have been resolved. To the contrary, Ms. Schapiro urged that the country must continue efforts to reform the financial regulatory system - both at the Congressional level and at the agency level.
On the legislative front, Ms. Schapiro noted that the regulatory regime needs to focus on identifying and minimizing systematic risk. In this regard, the Chairman identified a number of areas where regulations are being reinforced or need to be reinforced by proposed legislation: 1) the creation of a regime that permits large institutions to fail without taking the system or taxpayers down with them; 2) a need to bring managers of hedge funds and other private funds under the regulatory umbrella; 3) a strong fiduciary standard for all securities professionals; and 4) greater transparency and stability to the over the counter derivatives markets - including real-time data on securities-related OTC derivatives.
Ms. Schapiro also identified that regulatory reform does not exist solely at the Congressional level. She noted that the SEC must put thought and energy into how to protect individuals who are entrusting their money to the capital markets. Ms. Schapiro discussed initiatives underway at the SEC to address issues encountered by individual investors - and she did so by discussing them from the perspective of such an investor.
First, Ms. Schapiro addressed the move to a singular standard for brokers and investment advisors. She noted that when an investor steps into the office of a local securities professional, he does not often look to see whether it says broker-dealer or investment advisor. All he wants is helpful, investor-focused advice. However, currently the duty owed to an investor is different depending on the securities professional's designation. If it is a broker-dealer, the investor is sold a product that is "suitable" for him. If it is an investment adviser, he gets treated under the higher "fiduciary duty" standard.
Ms. Schapiro stated that she is of the belief that all securities professionals should be subject to the same fiduciary duty, same licensing and qualification requirements, and the same oversight regime. Although this may disrupt a number of entrenched interests, Ms. Schapiro noted that the SEC is doing no service to retail investors by continuing with a different regulatory approach for professionals who perform virtually the same or similar services.
Second, Ms. Schapiro addressed the disclosures made by securities professionals with regard to compensation and conflicts. She noted that after an investor sits down with a securities professional, he is not always provided with understandable information about the products that his securities professional is trying to sell him. Ms. Schapiro stated that retail investors should be provided clear, simple, and meaningful disclosure at the time they are making an investment decision.
This should include information about the product being sold, including the compensation being received by the professional and information regarding any conflicts that may be causing the advisor or salesman to steer the investor to a certain investment. Directly related to this is the issue of 12b-1 fees which are automatically deducted from mutual funds to compensate securities professionals for sales and services provided to mutual fund investors. Ms. Schapiro stated that she believes these fees must be rethought not just with respect to their disclosure, but also with respect to whether they continue to be appropriate. This is an area Ms. Schapiro has asked the staff for a recomendation on the 12b-1 fees for SEC consideration in 2010.
Finally, Ms. Schapiro noted that while the SEC has the will to succeed, it is stretching existing resources and will not likely be able to achieve all it seeks to do without additional funding. As an example, Ms. Schapiro noted that the examination staff numbers less than 500, but is tasked with inspecting 11,000 investment advisory firms and 8,000 mutual funds. As a result, she noted that an investor has about a 10% chance of walking into an investment adviser who has been inspected by the SEC in the previous year. For this reason, Ms. Schapiro has been advocating for the SEC to be able to fund its own operations through fees it currently collects. The amount of these fees currently surpasses the amount appropriated by Congress to the SEC each fiscal year.
Ms. Schapiro wrapped up by noting that 2010 will be another year in which the SEC will pursue an ambitious reform agenda in order to restore confidence and provide the protections investors expect and deserve. We at Cosgrove Law, LLC will continue to monitor the steps taken by the SEC in carrying out this agenda. A complete copy of Ms. Schapiro's speech can be found here.
Thursday, November 5, 2009
On November 3, 2009, the Financial Planning Coalition sent a letter to members of the House Financial Services Committee expressing the Coalition's concern regarding an amendment to the Investor Protection Act of 2009 (“IPA”), which was passed by the Committee on October 25, 2009. The amendment would extend FINRA’s authority to cover investment advisors who are associated with broker-dealers already under FINRA’s authority.
The Coalition, made up of the Certified Financial Planner Board of Standards, Inc., the Financial Planning Association, and the National Association of Personal Financial Advisors, is concerned with how the amendment extends FINRA’s authority to approximately 88 percent of investment adviser representatives and implicates application of the fiduciary duty to investment advice. The members and stakeholders of the Coalition’s respective organizations believe that the issue warrants greater deliberation and through the letter are urging the committee to conduct a more thorough examination before allowing the delegation of authority from the SEC to FINRA, a self-regulatory organization ("SRO") that has no experience overseeing advisers or enforcing the provisions of the Investment Advisers Act of 1940.
The Coalition believes that the amendment would be inconsistent with the Committee’s intent with respect to the IPA because, among other things, the Committee has already approved an amendment that would change the assets under management threshold for SEC registration of advisers which would shift responsibility for the oversight of some 4,200 advisers from the SEC to the states, freeing up substantial SEC resources to enhance oversight of advisers under its jurisdiction. Moreover, the IPA allows the SEC to collect user fees from advisers to cover the costs of compliance examinations. This, along with the IPA’s authorization for a doubling of the SEC’s budget over the next five years and the shifting of the oversight burden to the states, would provide the SEC the funding necessary to oversee advisers.
The Coalition also states that the SEC is more appropriate as a primary regulator for advisers for several reasons. First, the SEC has been overseeing advisers for seven decades under a principles-based approach designed to regulate those providing advice, while FINRA has no experience in regulating investment advice. FINRA’s rules-based regulatory approach and focus, while fine for the brokerage community, is not readily adaptable to advisers. Moreover, FINRA oversight of advisers who are associated with broker-dealers would create a new, parallel system of regulation for advisers. The Coalition argues that this could create a new opportunity for regulatory arbitrage, with advisers and brokers making decisions on their business models based on a preferred regulatory model. Finally, FINRA is an SRO comprised of broker-dealers and would be inclined to bring a broker’s perspective to adviser regulation. The Coalition believes that this conscious or subconscious conflict of interest could result in a broker bias in FINRA oversight of advisers, and otherwise increase the differences in how broker-associated advisers are regulated versus independent advisers.
A copy of the Coalition's letter to the House Financial Services Committee can be found here.
Saturday, October 31, 2009
During the financial industry meltdown over the last two years, countless individuals have witnessed their life savings and retirement funds dwindle. At the SIFMA annual meeting on October 27, 2009, FINRA Chairman Rick Ketchum addressed these concerns and discussed some of the new patterns emerging within the financial industry, including proposed regulations and emerging business practices. The highlights of Chairman Ketchum’s address are set forth below:
One of the main points of emphasis with regard to regulatory reform over the past few months has been the harmonization of the standard of care for broker-dealers and investment advisers. As Chairman Ketchum noted, most investors cannot distinguish between the two, in part because their services have begun to overlap each other in many respects. Accordingly, FINRA “whole-heartedly embraces” the Obama administrations goal of harmonizing the fiduciary standard for broker-dealers and investment advisers.
In addition to reforming the standard of care, the financial industry must find a way to harmonize the oversight and enforcement of that standard to ensure compliance by industry professionals. As Chairman Ketchum emphasized, for such a reformation to be effective, compliance “must be regularly and vigorously examined and enforced to ensure the protection of investors.”
Chairman Ketchum also discussed FINRA’s renewed focus on detecting and combating fraud. Namely, FINRA has enhanced its examination programs, procedures and training to help deter fraudulent conduct. In addition, FINRA recently established an Office of the Whistleblower—which handles high-risk tips—and announced the creation of an Office of Fraud Detection and Market Intelligence—which will in essence provide FINRA with a centralized anti-fraud division.
With the emergence of social networking as a means to keep in contact with friends and interact with potential customers, FINRA is facing new regulatory challenges. As Chairman Ketchum noted, many younger registered representatives use sites such as Facebook, LinkedIn and Twitter as part of their everyday lives, and financial institutions cannot easily supervise their employees’ communications on these sites. As such, most firms have established rules prohibiting their employees from using these sites for business purposes. In reality, however, there is no cost-effective way to enforce these rules.
Accordingly, FINRA recently formed a Social Networking Task Force to “explore how regulation can embrace technological advancements in ways that improve the flow of information between firms and their customers.”
As is evident, the financial industry is currently facing an emergence of new patterns and challenges, both in regulation and in business practices. FINRA, as a self regulatory organization, is charged with embracing these paradigms and enacting regulations to ensure that investors stay protected. Click here for a complete copy of Chairman Ketchum’s address at the SIFMA annual meeting.
Thursday, October 1, 2009
THE SEC AND CFTC TO ISSUE A JOINT REPORT ADDRESSING HARMONIZATION OF FUTURES AND SECURITIES REGULATION
On September 2-3, 2009, pursuant to the recommendation of the Obama administration, the SEC and CFTC held joint meetings to discuss assessments of the current regulatory schemes for futures and securities, a first for the two agencies. Within the next two weeks, the chairmen of the SEC and CFTC plan to issue a joint report to Congress addressing the differences between the regulatory schemes for futures and securities and recommending legislative and regulatory actions to close the regulatory gaps and address the inconsistencies.
A release by the SEC indicated that the report will likely discuss the following issues:
• Product listing and approval
• Exchange/clearinghouse rule approval under rules—versus principal-based approaches
• Risk-based portfolio margining and bankruptcy/insolvency regimes
• Linked national market and common clearing versus separate markets and exchange-directed clearing
• Market manipulation and insider trading rules
• Customer protection standards applicable to broker-dealers, investment advisors and commodity trading advisors
• Cross-border regulatory matters
The upcoming report will surely verify the SEC and CFTC’s efforts during recent months to harmonize the two agencies and “reduce regulatory arbitrage, avoid unnecessary duplication and close regulatory gaps.” We will provide a further update once the report is issued.
For a complete reading of the SEC’s press release, click here.
Monday, September 28, 2009
Broker-Dealers, have you ever thought about what a state regulator considers when initiating an enforcement action?
There are a number of considerations that a state regulator takes into account in a regulatory action. Below are a few of them taken from the NASAA Broker-Dealer Section Report on Principal Considerations for Regulatory Actions. We urge you to contact us if you have been contacted by a regulator. Hiring counsel experienced in these matters and doing so promptly can greatly help you going through an investigation and/or an enforcement action.
• Did the firm have adequate written supervisory policies and procedures in place to identify and prevent the alleged misconduct? The regulator will consider whether the firm’s internal compliance procedures were sufficient to detect the misconduct by reviewing the firm’s WSPs. If the firm’s procedures were inadequate, has the firm adopted new and more effective internal controls and procedures designed to prevent the misconduct?
• Did the firm conduct a thorough review of the misconduct? A regulator will consider what steps the firm took to reasonably identify the extent of the misconduct and identify all the parties involved. Did the firm spend the time and resources required to find the problem and address it?
• Were there “red flags” present that the firm missed? Are the firms WSPs adequate in regards to “red flags”? Remember, adequate WSPs are supposed to prevent and detect misconduct and identifying red flags and having procedures in place to address them is a good tool in your prevention and detection efforts.
• How did the firm respond to the State’s requests in the investigation and did they cooperate? This doesn’t mean you have to jeopardize any defense. But having good counsel to help you respond to a regulator’s inquiry and advocate on your behalf is an important component when on the receiving end of an enforcement action.
These are just a few of the considerations. You can see how important it is to have knowledgeable counsel to help you respond to an audit or enforcement inquiry. If you find yourself contacted by a regulator we urge you to contact us to ensure you have experienced counsel assisting you.
Monday, September 21, 2009
Cosgrove Law members attended the North American Securities Administrators (NASAA) annual conference last week. The conference provided us with great opportunities to interact with state regulators from around the country and directly hear from these regulators about their issues. They focused on a wide variety of topics involving broker-dealers and investment advisers because the regulatory changes being discussed at the federal level was on everyone’s mind. Where these discussions will lead and what effect any regulatory changes might have on everyone is not known at this time. What we did take away is that all of us need to be aware of the changes being proposed e.g. the Consumer Financial Protection Agency, understand the implications to our businesses, and be ready to implement best practices to ensure compliance.
Blue Sky Compliance for Investment Advisers-NASAA’s findings from Audit Sweep
Tuesday, September 1, 2009
SEC Chairman Mary Schapiro issued an order yesterday to broker-dealer firms addressing concerns regarding the recruiting methods for broker-dealer registered representatives. Ms. Schapiro noted that some types of recruiting methods, such as enhanced compensation practices wherein firms provide large up-front bonuses and enhanced commissions for sales of investment products, may in turn lead to greater risks for investors. In particular, recruiting methods based on these types of financial rewards create the risk that broker-dealer registered representatives will act in their own interest when selecting investment products for their customers, thereby violating their obligations to investors.
As such, Ms. Chapiro issued the order to remind broker-dealer firms, and in particular their CEOs, of the “significant supervisory responsibilities [they] have under the federal securities laws to oversee broker-dealer activities, particularly with respect to sales practices.”
A copy of the order can be found here.
Thursday, July 9, 2009
Through routine compliance examinations, the SEC keeps a close eye on SEC-registered investment advisors, investment companies, broker-dealers, and other types of registered firms to ensure that these firms are maintaining compliance with federal securities laws, and also to identify any potential weaknesses in the SEC’s compliance and supervisory controls.
In June 2007, the SEC for the first time issued its "ComplianceAlert," which provides financial firms with a periodical summary of select compliance areas the SEC examiners are concerned with, thereby providing firms with a forewarning of these problem areas so that they can review and modify their practices where necessary. In its most recent ComplianceAlert, dated July 2008, the SEC noted concern over the following selected practices by SEC-registered firms:
(a) Investment Advisors/Mutual Funds
a. Personal Trading by Advisory Staff—SEC compliance examiners reviewed advisors’ international compliance controls surrounding their employees’ trading and trading by the firms for their own proprietary accounts.
b. Proxy Voting and Funds’ Use of Proxy Voting Services—SEC compliance examiners reviewed practices with respect to the use of third-party proxy voting services, including oversight and operational aspects of mutual funds’ proxy voting, and how advisors managed conflicts of interest in proxy voting.
c. Valuation and Liquidity Issues in High Yield Municipal Bond Funds—SEC compliance examiners reviewed the portfolio composition, valuation and transaction activity of high yield municipal bond funds.
d. Soft Dollar Practices of Investment Advisors—SEC compliance examiners reviewed the soft dollar arrangements maintained by registered investment advisors, including the arrangements these advisors may have with both third-party and proprietary providers.
a. Examinations of Securities Firms Providing “Free Lunch” Sales Seminars—SEC, compliance examiners, in coordination with FINRA and NASAA, performed over 100 examinations of broker-dealers, investment advisors and other financial services firms that offer “free lunch” sales seminars targeting seniors in particular.
b. Valuation and Collateral Management Processes—SEC compliance examiners, in coordination with FINRA, reviewed large broker-dealer firms to assess their valuation and collateral management practices as they related to subprime mortgage-related products, including the firms’ controls around the valuation process.
c. Broker-Dealers Affiliated with Insurance Companies—SEC compliance examiners conducted targeted reviews of a number of broker-dealer subsidiaries of insurance companies.
d. Supervision of Solicitations of Advisory Services—SEC compliance examiners reviewed broker-dealer firms that had designated their registered representatives as “solicitors” for an investment advisor, including how supervision was implemented for these registered representatives’ activities as solicitors.
e. Mortgage financing as Credit for the Purchase of Securities—SEC compliance examiners conducted risk-targeted examinations of broker-dealer firms to evaluate their practice of recommending that their customers finance the purchase of their securities by obtaining a second or reverse mortgage on their home through a bank affiliated with the broker-dealer.
f. Office of Supervisory Jurisdiction Supervisory Structure—SEC compliance examiners reviewed broker-dealer firms’ supervisory and compliance controls under an Office of Supervisory Jurisdiction (OSJ) structure, including each firm’s supervisory structure and practices, and its supervision of its branch offices.
(c) Transfer Agents
a. Practices with Respect to “Lost SecurityHolders”—SEC compliance examiners reviewed transfer agents in order to understand current practices with respect to the search process performed for “lost” securityholders and the use of third-party “search firms” that search for lost securityholders.
Notably, not all of the above-referenced practices are legal requirements, but instead some are merely suggestions by the SEC compliance examiners. Based upon the SEC’s June 2007 and July 2008 release dates for its prior ComplianceAlert letters, it is likely that the 2009 alert will be released shortly. We will provide you with a summary of the SEC’s most recent compliance concerns at that time.
Monday, June 22, 2009
On June 18, 2009, just one day after President Obama unveiled his white paper, SEC Chairman Mary L. Schapiro gave an address at the New York Financial Writers' Association Annual Awards Dinner in which she acknowledged that Obama's regulatory reform plan makes real progress in strengthening the SEC and ultimately improving investor protection.
In her address, Ms. Schapiro emphasized that under Obama's new plan the SEC still has an underlying duty to protect individual investors, and opined that one way to protect investors is to resolve the inherent problems associated with the regulatory regimes governing financial service providers. Accordingly, the SEC is re-assessing the standards of conduct applicable to all financial service providers in an effort to help investors more fully understand what is required of their financial professionals. “Investors are not well-served by a confusing array of varying disclosure, liability, recordkeeping and conflict management requirements,” Ms. Schapiro said.
Ms. Schapiro noted that although there are a multitude of choices for investors to consider when seeking financial advice or assistance, financial service providers often perform similar and overlapping functions. However, despite this commonality of services, financial professionals such as broker-dealers and investment advisors are subject to varying and inconsistent legal standards. Such a regulator structure, Ms. Schapiro stated, is faulty in that “when investors receive similar services from similar financial service providers, they should be subject to the same standard of conduct.” As such, the SEC is now focused on instituting consistent fiduciary standards of conduct applicable to all financial service providers that provide personalized investment advise about securities, regardless of their labels, which will help ensure that these professionals act at all times in the interests of the individual investors.
Harmonizing the regulatory regimes for financial service providers will no doubt minimize the confusion investors must face under the current regimes. However, in her address, Ms. Schapiro correctly acknowledged that the implementation of consistent fiduciary standards of conduct will do nothing to ensure that financial professionals adhere to the requisite standards. Instead, such a change is merely a first step aimed at protecting individual investors.
Our firm provides effective legal advice and representation for individuals who have been subject to investment fraud, negligent misrepresentation or breach of fiduciary duty by their financial advisers. For more information, please visit our website here.