FINRA Reprimands St. Louis Brokerage Firm for Poor Oversight

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.

District Court Retroactively Applies Dodd-Frank Ban on Pre-dispute Arbitration in SOX Whistleblower Claims

The U.S. District Court for the District of Massachusetts applied the Dodd-Frank Act (“the Act” or “Dodd-Frank”) prohibition on pre-dispute arbitration agreements under the Sarbanes-Oxley (“SOX”) whistleblower protection retroactively. In a March 1 ruling, in Pezza v. Investors Capital, et al, Judge Douglas P. Woodlock, reasoned that retroactive application was appropriate due to the lack of clear Congressional intent to restrict the temporal scope and procedural nature of Section 922.

Section 922 of the Act, among other things, confers jurisdiction on the courts, rather than to a Financial Industry Regulatory Authority (FINRA) arbitration panel, by voiding arbitration provisions in employment agreements that purport to force an employee to arbitrate, rather than litigate disputes arising under Section 806 of SOX.

The suit arose from a claim of wrongful retaliation (in violation of SOX) against the plaintiff after he raised concerns about the defendant’s misconduct in connection with securities transactions. (The plaintiff had previously filed the requisite complaints with the Department of Labor.) The defendants, Investors Capital Corp., Investors Capital Holdings, Inc., and Timothy Murphy, argued that the plaintiff was required to submit his dispute to arbitration, not the courts, pursuant to a pre-dispute arbitration provision in his employment agreement. However, while the defendant’s motion to compel arbitration was under advisement, Congress enacted Dodd-Frank, which included the prohibition on pre-dispute arbitration agreements for whistleblower claims brought under SOX.

In determining whether to apply Section 922 retroactively, the court used the framework setup by the Supreme Court in Fernandez-Vargas v. Gonzales, which essentially instructs a court to first look to whether there is any Congressional intent allowing for retroactive application. If there is no clear indication by Congress, the court then must look to whether retroactive application would result in a disfavored consequence affecting a substantive right. If the court answers in the negative, retroactive application is appropriate.

Here, Section 922 did not include any express provisions or clear statements of Congressional intent regarding retroactivity. Further, after applying the standard rules of statutory construction, the court found nothing that indicated Congress intended for the provision to apply to existing arbitration agreements. The court also found it insufficient that Congress vested the authority to limit future pre-dispute arbitration provisions with the new Bureau of Consumer Financial Protection and the CFTC. Thus the court determined that the result regarding retroactivity under Fernandez-Vargas was inconclusive.

However, under Landgraf v. USI Film Prods, the Supreme Court recognized that jurisdictional statutes may be applied retroactively absent specific legislative authorization without raising retroactivity issues. As a result, the District Court construed Section 922 to be a jurisdictional statute and relied on the holding from Landgraf instead of the retroactivity test under Fernandez-Vargas. Accordingly, the court denied the defendants’ motion to compel arbitration and concluded that Section 922 should be applied retroactively to combat bad conduct arising prior to the enactment of Dodd-Frank.

Second Circuit Reaffirms Refusal to Enforce Arbitration Clause

Arbitration provisions have been the subject of recent lawsuits, especially those found in credit card agreements. In July 2010, the Minnesota Attorney General, Lori Swanson, filed suit against the National Arbitration Forum, alleging, inter alia, that mandatory arbitration provisions in credit card agreements are unconscionable and unenforceable.

Most recently, on Monday, March 8, 2011, the Second Circuit Court of Appeals reaffirmed its earlier decision not to enforce a mandatory arbitration clause in a credit card agreement. The court’s earlier decision in In re Am. Express. Merchs. Litig. in 2009 held that the pre-dispute arbitration clause in American Express’ credit card agreements was not enforceable because it contained a provision requiring card holders to waive their rights to bring a class action suit. The Supreme Court granted certiorari in 2010 and remanded the case back to the Second Circuit.

The Second Circuit’s 2009 decision applied the Supreme Court’s analysis laid out in dicta in Green Tree Financial Corp.-Alabama v. Randolph. In Greentree, the Supreme Court ruled that a mandatory arbitration clause was unenforceable against a party who proves that the costs of arbitration of a federal statutory claim are so high, such that the arbitration costs effectively prohibit that party from vindicating statutory rights. Accordingly, the Second Circuit concluded that individual arbitrations would be cost-prohibitive and preclude cardholders from asserting their statutory rights under federal antitrust laws. Thus, the arbitration clause was unenforceable.

Subsequent to the Second Circuit’s decision, the Supreme Court ruled in Stolt-Nielsen S.A. v. AnimalFeeds Int’l Corp. that arbitration clauses, which are silent on the issue of class arbitrations, could not be read by arbitrators as reflecting the parties’ agreement on the issue of class arbitration. Pursuant to this decision, American Express petitioned for certiorari, which was granted.

Upon remand, the Second Circuit again concluded that the pre-dispute arbitration clause was unenforceable, determining that the Stolt-Nielsen decision did not alter its previous analysis because Stolt-Nielsen focused on the ability of arbitrators, not courts, to interpret clauses in mandatory arbitration provisions.

This spring, the Supreme Court is set to make another decision regarding class arbitrations in AT&T v. Concepcion. The issue in AT&T is whether the Federal Arbitration Act preempts states from mandating that class arbitration be available as part of an arbitration agreement.

New Form ADV Part 2 “Plain English Rule” Deadlines Fast Approaching

In July 2010, the Securities and Exchange Commission (“SEC”) adopted changes to Form ADV, Part 2, which became effective October 12, 2010. This section is commonly referred to as the “brochure” and explains an investment adviser’s qualifications, investment strategies, and business practices to investors. Essentially, the amendment requires registered investment advisors to now make disclosures in plain English, as opposed to a fill-in-the blank and check box form. To learn more about the substantive changes of the amendment, please visit our previous securities and investment blog regarding these changes.

The Old Deadlines

When the amendments were adopted, the SEC established two separate deadlines for delivering brochure supplements for existing investment adviser registrants (“Existing Registrants”). Originally, Existing Registrants were required to provide brochure supplements to new and prospective clients upon filing their annual updating amendment to Form ADV for the fiscal year end 2010, and to existing clients within 60 days of filing the annual updating amendment. Noting that most Existing Registrants have a fiscal year end on December 31, existing registrants would be required to deliver their first brochure supplements no later than March 31 and to deliver to existing clients no later than May 31.

New investment adviser registrants (“New Registrants”) applying for registration on or after January 1, 2011 would be required to provide brochure supplements to clients upon registration.

The New Deadlines

However, based on concerns expressed about the deadlines, on December 28, 2010, the SEC extended compliance dates for portions of Form ADV, Part 2. Specifically, the compliance date for Form ADV, Part 2B and the provisions of Rule 204-3 concerning the delivery of brochure supplements is extended approximately four months. Note the extension does not apply to the annual updating amendment deadline.

For Existing Registrants with a fiscal year ending on December 31, 2010 through April 30, 2011, delivery of the brochure supplements to new and prospective clients must occur by July 31, 2011. Delivery to existing clients has been extended to September 30, 2011.

For New Registrants filing applications between January 1, 2011 and April 30, 2011, delivery to new and prospective clients must occur by May 1, 2011. New Registrants have until July 1, 2011 to deliver brochure supplements to existing clients.

Important Dates
March 31, 2011	Filing deadline for all applicants for Form ADV annual updating amendment, including the new Part 2A brochure
May 1, 2011	Delivery deadline for new registrants to deliver brochure supplements [Form ADV, Part 2B] to new and prospective clients
July 1, 2011	Delivery deadline for new registrants to deliver brochure supplements to existing clients
July 31, 2011	Delivery deadline for existing registrants to deliver brochure supplements [Form ADV, Part 2B] to new and prospective clients
Sept. 30, 2011	Delivery deadline for existing registrants to deliver brochure supplements to existing clients

The North American Securities Administrators Association has recommended that state securities authorities provide the same extension for state-registered investment advisors. However, state-registered advisers should contact the states where they are registered to confirm compliance dates. The attorneys at Cosgrove Law, LLC have experience with investment adviser registration matters, including annual and as-needed Form ADV updates and reviews. If you or your company has concerns regarding these amendments to ADV Part 2, please do not hesitate to contact us.

FINRA ISSUES PROPOSAL EXPANDING POOL OF ARBITRATORS QUALIFIED TO HEAR INDUSTRY PROMISSORY NOTE DISPUTES

An exciting blog this will not be. But alas, some of the most routine rule changes carry the potential of consequences worthy of consideration. Most of you readers know that broker-dealers frequently loan funds to their agents in exchange for a promissory note. These loans and notes are frequently exchanged as part of a broker-dealer's retention incentive program. You may also know that many are the times that the incentives prove insufficient and the broker-dealer ends up suing its former agent for repayment. Indeed, at least one major broker-dealer in St. Louis has an entire division of its legal department dedicated to litigating such matters.

SR-FINRA-2011-05, if approved after public comment, will expand the roster of FINRA arbitrators eligible to hear such matters by removing the current statutory discrimination claim qualification requirement. By doing so, it is likely that a more diverse field of arbitrators will begin hearing these cases. Whether that is a positive development for agents or broker-dealers is yet to be seen. Promissory note cases can be particularly difficult to defend, particularly if they are below the threshold for the expedited FINRA procedures. Valid and meritorious affirmative defenses, particularly those based in equity, are already difficult to develop and present with the restricted discovery available in FINRA arbitrations. Defending the case without any discovery or even a hearing is an even greater challenge. But while SR-FINRA-2011-005 will not remove this current barrier to the full development of equitable affirmative defenses, it may bring a fresh set of eyes to the legal debate surrounding the enforceability of promissory notes. That prospect alone is worthy of the entire industry's support of the proposed amendment to Rule 13806.

Click here if you would like to review the entire rule proposal, including FINRA's “Statement of Purpose” for the proposed rule change. Click here for the SEC's subsequent proposal in the Federal Register.

CFTC Tries On New Dodd-Frank Authority for Size

The Commodity Futures Trading Commission has recently filed over a dozen enforcement actions against entities allegedly involved in illegally soliciting foreign currency (forex) transactions or engaging in unregistered forex transactions. Thirteen of these actions were filed simultaneously across the country in what the CFTC has dubbed a nationwide sweep. The most recent action was filed on February 18, 2011 against a St. Peters, Missouri resident and three of his Missouri-based business entities for $2.8 Million.

These actions represent the CFTC’s first use of its new authority pursuant to Section 742 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Under this Section, entities that participate in the forex market must register with the CFTC and abide by new investor protection rules, such as maintaining certain capital requirements. These additional requirements are purportedly to increase transparency and reduce risk.

As previously forecasted on the Cosgrove Law, LLC blog, Section 742 could potentially expand the “Zelener fix” in the 2008 Farm Bill. The “Zelener Fix” authorizes the CFTC to pursue anti-fraud enforcement actions for transactions conducted on a margin or leveraged basis, especially in the retail forex market. Indeed the CFTC interprets the language in Section 742 as expanding on its enforcement authority, citing that it is taking this opportunity to aggressively pursue enforcement in this sector after the Zelener decision effectively quashed the agency’s efforts in 2004 and the 2008 Farm Bill did little to bolster its enforcement position. The CFTC hopes that this sweep will warn unregistered or noncompliant firms to “shape up or be sued.”

In addition to regulating forex transactions, Section 742 also specifically addresses margined or leveraged retail commodity transactions. However, this Section contains an exception for contracts of sale that either “result in actual delivery within 28 days...” or “create an enforceable obligation to deliver between a seller and a buyer that have the ability to deliver and accept delivery, respectively, in connection with the line of business of the seller and the buyer.” This language loosely tracks state commodity regulation language which exempts certain precious metals contracts, but there are some key differences in term usage. The CFTC has yet to define the distinct terms within this Section. However, none of the actions filed so far pursuant to Section 742 have involved retail commodities dealers, but rather have focused on firms engaging in forex transactions. This is consistent with the Legislature’s primary concern in enacting this portion of Dodd-Frank—to deal with unregulated swaps and foreign currency transactions. Regardless, precious metals firms operating in this area should tread carefully until the CFTC fully defines the scope of this exception.