OBTAINING WHISTLEBLOWER STATUS THROUGH YOUR BROKER-DEALER’S COMPLIANCE DEPARTMENT

A financial adviser that provided a tip through his broker-dealer’s compliance department recently received a whistleblower award of $4.5 million.  In late May, the SEC accepted the Claims Review Staff’s Preliminary Determination recommending that hefty award.  

The SEC’s analysis hinged on the application of Exchange Act Rule 21F-4: whether “original information submitted by a whistleblower led to the successful enforcement of a judicial or administrative action.”  Rule 21F-4(c)(3) even allows for whistleblower status if you “reported [the] original information through [your broker-dealer’s] internal whistle blower, legal or compliance procedures for reporting allegations of possible violations of house before or at the same time of law before or at the same time to reported them to the Commission . . . You must also submit the information the Commission . . . within 120 days of providing it to the entity.  (Emphasis Added). 

This last clause is your key takeaway from this blog.  If you provide original information to your compliance department but fail to follow through with the Commission, you might lose out on millions of dollars!  It is also important to understand that 1) you are taking a risk, 2) the compliance or legal department might not investigate and report to the SEC without a push, and 3) Rule 240 is an extensive fine-print maze of definitions and procedures.  In sum, you should obtain legal counsel to help you evaluate your “original information” and guide you through a complicated process that can take years to run its course. 

There are many attorneys out there claiming on their websites that they represent whistleblowers. But if you are a financial advisor or investment adviser what you need is an attorney that has experience representing whistleblowers in the financial industry. Food for thought.

Steps To Take Upon Termination by a Broker Dealer

So the unimaginable happens. You receive a call and are told to report to HR. There you are handed a letter stating you have been terminated for cause and that the broker-dealer has terminated your registrations with the firm.

What steps should you take?

First, and before leaving HR, you should request that they not file the Form U5 until after they have been contacted by your attorney. Pursuant to FINRA rules, the broker-dealer has 30 days from the date of termination to file the Form U5 that sets forth the reasons for the termination. And, what is stated by the firm on the Form U5 will be critical in determining your ability to join another firm, have clients move with you to your new firm, and avoid a FINRA Enforcement investigation.

Experienced securities industry counsel may be successful in framing the wording on the Form U5 such that it is accurate, which would avoid the subsequent time, expense and aggravation of removing inaccurate information from your Form U5. Pursuant to the laws of some states, broker-dealers have actual immunity or qualified immunity from defamation claims for statements made on Form U5s. Therefore, it’s imperative that you have experienced securities counsel on your side to try to prevent defamatory statements from being placed on your Form U5.

Second, you need to consider the host of other legal issues that may need to be resolved. Such as whether you are going to be subject to a FINRA Enforcement investigation, what information regarding your clients you may take from the firm, or what your continuing obligations are under your broker/registered representative agreement. 

Therefore, if you are a broker agent/registered representative and you have been terminated for cause, do not delay in consulting your securities industry attorney. You should consider having counsel engage with your broker-dealer before your Form U5 is filed. If you need assistance, you may wish to consult with experienced securities industry counsel at Cosgrove Law Group.

By: Brian St. James, Cosgrove Law Group, LLC

FINRA Continues To Investigate Expense Reports

          There are numerous examples of FINRA cracking down on expense report violations.  Following are a few of the reported cases.

In September, 2017, a former Morgan Stanley corporate stock manager accepted an industry bar over allegations that “event attendees on employee’s expense report incorrectly included one person who did not attend event.”  The employee     said she “couldn’t afford to fight her dismissal or to take the time to work with the regulator.”  “The direct cause of the bar was [her] refusal to appear for the hearing into the matter.”  (https://www.investmentnews.com/article/20170926/FREE/170929952/finra-bars-former-morgan-stanley-manager-over-expense-reports)

In late 2017, “a 21-year veteran Merrill Lynch broker managing director…accepted a one-year suspension from the securities industry and a $10,000 fine for ‘violating high standards of commercial honor by improperly using Merrill funds in connection with expense reports’”  (http://www.shufirm.com/brokerage-firms-and-finra-crack-down-on-broker-expense-account-violations)

In early 2018, a former Merrill Lynch broker was fined and suspended over a “$524 claim for mileage and dinner expenses that he said represented two meetings with prospective clients.  He subsequently admitted to the firm that he fabricated the events in order to use up, and be reimbursed for, the Business Development Account money that was deducted pretax from his compensation.”  https://advisorhub.com/finra-suspends-another-broker-over-expense-issue/

FINRA gets its authority to investigate expense report and other similar documents from Rule 8210, Provision of Information and Testimony and Inspection and Copying of Books.  “A failure to comply with an 8210 Request often results in an immediate enforcement proceeding and a permanent bar from the industry.”  (https://www.seclaw.com/finra-rule-8210-request-response/) Rule 8210 Investigations often spring from violations of Rule 2010, the catch-all, which states that “[a] member, in the conduct of its business, shall observe high standards of commercial honor and just and equitable principles of trade.” 

            Cosgrove Law Group, LLC has represented numerous individuals in their FINRA investigations.  If you are the subject of a FINRA investigation and need counsel, Cosgrove Law Group may be able to help.

A Closer Look At Regulatory Action Disclosures On Form U4

Financial advisors who become registered with a Financial Industry Regulatory Authority (“FINRA”) member firm should be knowledgeable about Form U4, as it addresses a broad spectrum of historical events that are required to be reported to FINRA. FINRA has offered some interpretative guidance, some of which is explained below, as it relates to Form U4 actions.

Question 14 of FINRA Form U4 concerns criminal disclosures, regulatory action disclosures, civil judicial disclosures, customer complaints, arbitrations, and civil litigation. To begin with, and perhaps to no surprise, an individual who has been charged or convicted of a felony is required to disclosure that information on Question 14A. Even, an individual who has even been pardoned for a crime must report the conviction, according to FINRA’s interpretive guidance.

Financial advisors should take note that misdemeanors are also required to be reported on Form U4 in certain cases. For example, an individual who has been charged or convicted of a misdemeanor involving investments, fraudulent conduct, or wrongful taking of property would be required to disclose those incident(s).

Question 14C prompts individuals to state whether they have been found to have committed certain types of misconduct by the Commodity Futures Trading Commission (“CFTC”) and Securities and Exchange Commission (“SEC”) including: making false statements or omissions; committing a violation of investment-related statues or regulations; and causing a business to have its authorization to do business revoked or suspended.

individuals are additionally required to report on Question 14C whether they have been found by the SEC or the CFTC to have willfully violated Securities Act of 1933, Securities Exchange Act of 1934, Investment Company Act of 1940, Investment Advisers Act of 1940, Commodity Exchange Act, or Municipal Securities Rulemaking Board (MSRB) rules. Disclosure is also mandated when the individual has been found to have aided and abetted a person’s violative activities, or failed to supervise another person responsible for committing violations in the securities industry.

Similarly, Question 14(E) requires that individuals report if they have been found by a self-regulatory organization to have made false statements or omissions, violated SEC rules; or caused an investment-related business to lose authorizations to conduct securities business. Any suspensions or expulsions from those self-regulatory organizations are required to be reported. Plus, disclosure is necessitated when there have been any findings of federal securities law violations committed by the individual, or someone who the individual supervised or aided.

FINRA confirms in Question 14G that individuals are required to disclose to FINRA when they are notified that they have become subject of a regulatory complaint or proceeding brought on by the SEC, CFTC, other federal agencies, state securities commissioners and self-regulatory organizations. Investigations, according to FINRA, are signaled by the issuance of a Wells Notice to the individual or the individual being notified from FINRA staff that formal disciplinary action has been recommended by FINRA. However, not all things mean an investigation to FINRA. For example, requests for information, regulatory inquiries and subpoenas, per se, apparently do not constitute investigations.

FINRA’s guidelines further reveal that when an individual has been subject to an order from a foreign regulatory agency that is later vacated, the individual generally has to report the order because of the advisor’s obligation to report the original findings. Exceptions exist, according to FINRA’s guidelines, where the regulatory agency not only vacates the order, but confirms an intent to make that order have retroactive effect.

Individuals who are the subject of a FINRA Acceptance, Waiver and Consent are also required to disclose this information so long as the AWC concerns findings as to the individual’s misconduct identified in Question 14(E). There are some situations; however, where violations of the rules do not have to be reported, including some “minor rule violations” where the fine is no more than $2,500.00 and the individual does not contest the fine.

Financial advisors and stockbrokers often wonder how to go about making disclosures concerning negative events. If you are in a situation that mandates disclosure, such as a pending regulatory investigation, it is best to consult with an attorney. If you need assistance, you may wish to consult with the experienced counsel at Cosgrove Law Group.

The attorneys of Cosgrove Law Group, LLC represent investment advisors, brokers, and other associated persons nationwide in securities employment and regulatory matters, including U-5 defamation matters. Our attorneys also practice in a variety of other areas of law.  If you have a legal matter or concern, please give us a call and speak directly with one of our experienced professionals.

Get Your Own Lawyer, Darn It!

Financial advisors facing an arbitration claim or regulatory inquiry often count on their broker-dealer or registered investment advisor for legal counsel. These “employers” will frequently provide them with an ostensibly independent “conflict counsel” after they retain their own counsel. Unfortunately, however, it is arguably little more than a charade when the “independent” attorney either has, or one day hopes to represent the broker-dealer or registered investment advisor.

Consider viewing the situation in the context of an attorney's ethical duty of loyalty, her fiduciary duty to put the client's interests first, and her obligation to avoid even the appearance of failing to do so. If you (the attorney) have been hired and paid by a large client that you covet to represent an individual financial advisor that you will never see again, would you not be hesitant to suggest the financial advisor save herself – even if it injures the interests of the large corporate client? Would you really warn the advisor if you caught wind of the broker-dealer's or registered investment advisor's intention to throw him or her under the bus, or even put their interests before your client's in just a small way? And these are not mere hypotheticals. I have seen these situations, and even been caught up in them.

Loyalty and independent judgment are essential elements in the lawyer's relationship to a client. Concurrent conflicts of interest can arise from the lawyer's responsibilities to another client, a former client, or a third person or from the lawyer's own interests. For specific Rules regarding certain concurrent conflicts of interest, see Rule 4-1.8. For former client conflicts of interest, see Rule 4-1.9. For conflicts of interest involving prospective clients, see Rule 4-1.18¹.

Many years ago, I was in a fairly “steady relationship” with a large broker-dealer. But my firm was more like a second fiddle to a larger law firm they had used for years. Upon the advent of a large regulatory action, the broker-dealer hired me to represent some of their former advisors and executives. I became uncomfortable with this arrangement when it became apparent to me that many of my clients had a strong defense to the allegations, in that the broker-dealer was in large part responsible for my clients' alleged omissions. But before that day of reckoning arrived, something happened. The broker-dealer's primary attorney decided to file what appeared to me to be a frivolous motion that would not be in the best interests of my individual clients. I informed the primary attorney that my clients would not be joining the motion as he had directed. I received a major ass-chewing from him, and an order to get in line. Long story short is that I did not comply with that demand, and the broker-dealer got sanctioned for the motion. My individual clients were relieved, and ultimately dismissed from the case for zero fines or sanctions. But the broker-dealer never hired me again.

In another case, a financial advisor hired me to file a breach of fiduciary duty action against his former broker-dealer's attorney. That attorney initially represented both the broker-dealer and the advisor during a regulatory investigation. That same attorney then proceeded to play an instrumental role in throwing that financial advisor under the bus. When the dust had settled, no pun intended, the broker-dealer and attorney paid almost $4,000,000 to my client for their respective roles in the subsequent U-5 defamation and breach of fiduciary duty.

Finally, in a more recent situation, the attorneys for a broker-dealer's employee never even broached the subject of a resolution between my client and her individual client. Her firm covets their relationship with the broker-dealer far more than I had even dared to imagine. Things went south fast in our previously cordial relationship when I had the audacity to raise the “appearance” issue with her. Nothing changed in terms of proper legal representation, other than the tenor of the relationship.

The moral of these stories is this: if you are in hot water together with your employer, avoid the temptation of having your employer pay your legal bills and pick your lawyer for you. And if you are representing a broker-dealer and they ask you to serve as an unbiased loyal counsel for an employee or independent contractor, “just say no." Food for thought.

1 Comment to: RULE 4-1.7: CONFLICT OF INTEREST: CURRENT CLIENTS (https://www.courts.mo.gov/courts/ClerkHandbooksP2RulesOnly.nsf/c0c6ffa99df4993f86256ba50057dcb8/d06710dff1830d2686256ca600521205?OpenDocument)

FINRA Statutory Disqualifications and the MC-400 Process

Under the Securities Exchange Commission’s authority FINRA promulgates rules of its own as a self regulatory organization (“SRO”). Pursuant to FINRA’s By-Laws (and the By-Laws of the NASD and the NYSE before it) a person may be disqualified from membership. A person disqualified from membership would be prohibited from participation in the securities industry. In July 2007 FINRA adopted a revised version of the NASD’s definition of disqualification contained in its By-Laws such that any person subject to a statutory disqualification under the Securities Exchange Act Section 3(a)(39) also is subject to disqualification under FINRA’s By-Laws.

Prior to the amendment, the NASD’s By-Laws listed some, but not all, of the grounds for statutory disqualification contained in Exchange Act Section 3(a)(39). However, after the amendment to the NASD’s then existing By-Laws, FINRA’s By-Laws provided that: “A person is subject to a ‘disqualification’ with respect to membership, or association with a member, if such person is subject to any ‘statutory disqualification’ as such term is defined in Section 3(a)(39) of the [Securities Exchange Act of 1934].”

The revised definition of disqualification incorporated three additional categories of statutory disqualification which previously did not exist. One of those additional categories of disqualification comes from the Sarbanes-Oxley Act. Section 604 of the Sarbanes-Oxley Act expanded the definition of statutory disqualification under the Securities Exchange Act of 1934 by creating Exchange Act Section 15(b)(4)(H) and then incorporating it into Exchange Act Section 3(a)(39). As a result of this change, statutory disqualification under Exchange Act Section 15(b)(4)(H) includes a person that:

is subject to any final order of a State securities commission (or any agency or officer performing like functions), State authority that supervises or examines banks, savings associations, or credit unions, State insurance commission (or any agency or office performing like functions), an appropriate Federal banking agency (as defined in section 3 of the Federal Deposit Insurance Act (12 U.S.C. 1813(q))), or the National Credit Union Administration, that --

1. bars such person from association with an entity regulated by such commission, authority, agency, or officer, or from engaging in the business of securities, insurance, banking, savings association activities, or credit union activities; or

2. constitutes a final order based on violations of any laws or regulations that prohibit fraudulent, manipulative, or deceptive conduct.

This revised definition of statutory disqualification became effective as of July 2007. The effect of the revised definition would have been the immediate disqualification of a large number of individuals subject to the new categories of disqualification. In order to remain in the securities industry, these individuals would have had to utilize the then existing NASD eligibility proceedings for persons subject to disqualification; i.e. NASD Rule 9520.

In order to avoid this result, the NASD requested that the Securities Exchange Commission Staff not recommend enforcement action to the Commission under Exchange Act Section 15A(g)(2) or Rule 19h-1(a) for those persons subject to the new definition of disqualification until the NASD could update and improve its eligibility proceedings to address the changes to the definition of statutory disqualification. As a result, the SEC, by Chief Counsel Catherine McGuire, issued a No Action Letter on July 27, 2007, informing the NASD that it would not seek enforcement against the individuals subject to the new categories of statutory disqualification if NASD did not file notice with the Commission for enforcement between the time the amended By-Laws containing the revised definition of statutory disqualification became effective and the effective date of the revised eligibility procedures. This would mean that those persons subject to the revised definition could continue membership in FINRA without going through the application process for eligibility pending the adoption of the revised eligibility procedures.

In April 2009, FINRA released Regulatory Notice 09-19 which set forth the amendments to FINRA Rule 9520 Series to become effective June 15, 2009. The revised FINRA Rule 9520 Series established procedures applicable to firms and associated persons subject to the additional statutory disqualifications as a result of the adoption of the revised definition of disqualification. Under this new construct of the Rule 9520 Series, individuals subject to one of the additional categories of disqualification would need to seek FINRA’s approval to enter or remain in the securities industry by way of an application with FINRA’s Department of Registration and Disclosure (“RAD”) only under certain circumstances. The need to file an application depends on 1) the type of disqualification; 2) the date of the disqualification; and 3) whether the firm or individual was seeking admission, readmission or continuance in the securities industry.

There are likely four different ways that a member of FINRA would know that they are required to file an application with RAD as a result of the application of revised Rule 9520 Series to an order of a state securities commission. First, Regulatory Notice 09-19 states that as of June 15, 2009, FINRA began reviewing its records to identify persons that met any of the additional conditions that would require the filing of an application under the revised Rule 9520 Series. In what manner FINRA has undertaken this review is unknown. Second, an individual could identify on their own that they are subject to an existing order which would require an application with RAD.

Third, if someone is seeking to transfer their registration to a new broker-dealer, then any existing state orders which would require an application with RAD as a result of the revised Rule 9520 Series would be disclosed by the CRD (the central licensing and registration system for the U.S. securities industry and its regulators) when it is reviewed by FINRA. Fourth, if an individual is subject to a new order of a state regulator, then an alert is sent out to all other state regulators as well as FINRA through the CRD. Whether FINRA reviews each alert it receives in order to decide to take action against an individual subject to an order of a state securities commission is unknown.

For those subject to a statutory disqualification arising from orders specified in Exchange Act Section 15(b)(4)(H)(i) and Exchange Act Section 15(b)(4)(H)(ii), find below an outline of the circumstances under which the person must file an application with RAD under FINRA’s revised Rule 9520 Series:

A. If the person is seeking admission or re-admission to the industry; and

1. the person is subject to an order under Exchange Act Section 15(b)(4)(H)(i), then the person must file an application unless the order imposing a bar on the person is time-limited and the time period is expired. However, if the bar is related to Fraudulent, Manipulative or Deceptive (“FMD”) conduct, then the person must submit an application under the circumstances described in section I.B.

2. the person is subject to an order under Exchange Act Section 15(b)(4)(H)(ii), then the person must submit an application unless:

i. the sanctions do not involve licensing or registration revocation or suspension (or analogous sanctions) and the sanctions are no longer in effect; or

ii. the sanctions do involve licensing or registration revocation or suspension (or analogous sanctions), the sanctions are no longer in effect, and the order was entered 10 or more years ago.

B. If the person was, as of March 17, 2009, a member of, or an associated person of a member of FINRA or another SRO, and was subject to a statutory disqualification as of that same date and is seeking to continue in the industry; and

1. the person is subject to an order under Exchange Act Section 15(b)(4)(H)(i); and
i. the bar is no longer in effect and is not related to FMD conduct, then no application is required.

ii. the bar is still in effect and is not related to FMD conduct then no application is required unless there is a “triggering event” - which occurs when the person subject to the statutory disqualification either changes employers or the member firm makes an application for the registration of such person as a principal pursuant to FINRA rules.

iii. the bar is still in effect and is related to FMD conduct, then an application is required.

2. the person is subject to an order under Exchange Act Section 15(b)(4)(H)(ii), then an application is required unless:

i. the sanctions do not involve licensing or registration revocation or suspension (or analogous sanctions), and the sanctions are no longer in effect; or

ii. the sanctions do not involve licensing or registration revocation or suspension (or analogous sanctions), and the sanctions are still in effect, in which event an application is required only if there is a triggering event; or

iii. the sanctions do involve licensing or registration revocation or suspension (or analogous sanctions), and the sanctions are no longer in effect, and the order was entered 10 or more years ago. However, if the order was issued less than 10 years ago, then an application is required if there is a triggering event.

C. If the person was, as of March 17, 2009, a member of, or an associated person of a member of FINRA or another SRO, and is subject to a statutory disqualification that arose after March 17, 2009, and is seeking to continue in the industry; and

1. the person is subject to an order under Exchange Act Section 15(b)(4)(H)(i), then the person must file an application unless the order imposing a bar on the person is time-limited and the time period is expired. However, if the bar is related to FMD conduct, then the person must submit an application under the circumstances described in section III.B.

2. the person is subject to an order under Exchange Act Section 15(b)(4)(H)(ii), then an application is required unless:

i. the sanctions do not involve licensing or registration revocation or suspension (or analogous sanctions) and the sanctions are no longer in effect; or

ii. the sanctions do involve licensing or registration revocation or suspension (or analogous sanctions), the sanctions are no longer in effect, and the order was entered 10 or more years ago.

Some more recent articles touching upon this process include: “Stockbroker's DUI Puts Career in the FINRA Ditch” by Bill Singer, “Bankrupt Stockbroker Winds Up Statutorily Disqualified” by Bill Singer, “U-4 Omissions and Statutory Disqualification:Much Ado About Nothing” by Alan Wolper. Do not hesitate to call us if you or your broker-dealer need assistance with a potential MC-400 application.

Broker-Dealers Using Compliance as a WMD

There seems to be a new trend in town: broker-dealers unleashing compliance or “reputation managers” upon rich-target independent branch operators.  Perhaps it isn’t really that new of a trend.  Indeed, after handling several such matters over the years, I am able to at least describe the modus operandi for these “internal raids”.

First, the broker-dealer’s “business side” identifies a branch with a substantial AUM.  As it stands, the broker-dealer is sharing in a small fraction of the revenue the branch is generating.  Coupled with an external factor, such as a desire to satiate regulators or even a mere personality conflict, executives at the highest level of the organization decide to raid the branch.  But they do it under the pretense of a newly born compliance concern, and they respond to old concerns with an utterly disproportionate sanction – termination without notice.  No Letter of Caution or fine, of course, as this would merely give the target rich financial adviser the opportunity to escape the WMD.

Upon termination the broker-dealer is oddly well prepared to immediately file a devastating U-5, send a highly prejudicial warning/solicitation letter to the adviser’s clients, and/or offer immediate home-office supervision or new OSJ opportunities to all of the branch’s financial advisers.  The impact upon the financial adviser is massive, as he is unable to become registered with a new broker-dealer until a naïve state regulator slowly plods through its investigation of the opportunistic and frequently defamatory U-5 disclosure.  The raiding broker-dealer will be slow but “cooperative” in responding to the regulator’s requests for documents.  In terms of private legal counsel, the financial adviser’s source of revenue will dry up at the very moment he or she needs to retain an army of lawyers.  The non-terminated financial advisers will cherry-pick their old boss’ clients.  (They will be ripe for the picking after the nasty letter they received about their now-terminated broker.)  By the time the adviser is registered with a new broker-dealer, his or her book is all but gone.

I have previously written a blog about the causes of action available to a financial adviser who has been raided in such a fashion.  But until FINRA panels start fully compensating the victims of these internal raiding schemes and awarding substantial punitive damage awards – the bombings will continue.  Moreover, state regulators need to issue provisional registration states to such financial advisors while they conduct their investigation.  Food for thought. 

See also: http://securitiesandinvestmentblog.blogspot.com/2015/12/how-to-terminate-discredit-and.html

Even General Counsels Get Defamed

What happens when the media re-states bluntly what you tried to say cleverly? A jury might find you liable for defamation, even if your statement was made in a legal document.

This observation is one of many take-aways from the litigation victory achieved by Minnesota attorney Chet Taylor. A jury awarded Chet $600,000 for a defamatory statement his former broker-dealer made in a corrective action plan attached to a FINRA consent order. The defendant added another $250,000 after the initial verdict to end the case.

Would a broker-dealer really throw former employees, including its General Counsel, under the proverbial bus? Perhaps. In this instance, broker-dealer Feltl and Company implied in the corrective action plan with FINRA that the “replacement” of certain employees, including its General Counsel, would “enhance a culture of compliance at the firm.” The Wall Street Journal subsequently published an article about Feltl utilizing a direct summary of the rather ham-handed plan: “The firm also said it replaced its general counsel...to beef up compliance.” The jury obviously did not care that Chet was not identified by name in the corrective action plan or Journal article. But they certainly cared that Chet had voluntarily departed for private practice about 2 years before the execution of the Consent Order and plan. Food for thought.

David Cosgrove has obtained monetary awards and expungements for various members of the financial industry from broker-dealers such as U.S. Bancorp Investments, Raymond James Financial Advisers, and Questar. He has also achieved negotiated confidential resolutions on behalf of other advisers and employees.

How to Terminate, Discredit, and Interfere with a Financial Adviser: the U-5

I did not design the method I am about to share with you. Nor do I condone it. But I have observed its employment repeatedly during my legal representation of financial advisers. And although some of the players on the field participate unwittingly, there is always a motivating participant. So, this is how it often works:

1. A FINRA broker-dealer needs a sacrificial lamb (or two) to satisfy a regulator, or a manager or large producer has an ax to grind, or a large producer is seeking to leave with a substantial piece of the broker-dealer's overall assets, or Compliance is too lazy to ferret out a false accusation against a financial adviser.
2. The motivating participant employs Compliance to (unwittingly?) establish an alternative pre-textual basis for termination. Sometimes it is a sales or management practice that has been accepted or overlooked for years.
3. The motivating participant and Compliance employ Legal and Registration, under cover of the attorney-client privilege, to approve and issue a sufficiently disabling Form U-5 disclosure¹. Extra damage can be done by simply checking any of the “yes” boxes under U-5 question 7. This can be too-easily justified by expanding the scope of the term “industry standards” in question 7E. 7E will trigger a public disclosure and regulatory investigation.
4. Delay #1: The broker-dealer has 30 days after the termination to file the Form U-5. It can also update it at any time should updates be necessary.
5. Delay #2: State regulators will refuse to register the financial adviser until they can investigate the basis for the U-5 disclosure. They may take weeks or months to inquire of the financial adviser and broker-dealer, giving the unmotivated broker-dealer 30-60 days to respond to their request for information. Often times this lengthy response time is used by the broker-dealer to craft a letter that is misleading and refers to the financial adviser in the worst possible light. A copy is not sent to the financial adviser.
6. Delay #3: FINRA will likely demand documents and explanations as well from all of the parties.
7. During the pendancy of #'s 3, 4, and 5, the broker-dealer may aggressively enforce non-solicitation or non-compete provisions. The successor financial adviser will call the departing financial adviser's book and, among several tactics, claim that he/she does not have contact information for the departed financial adviser. He or she may also encourage the client to view any disclosures on BrokerCheck and to stay with the current broker-dealer².
8. Finally, a promissory note balance may be used to exert extra financial pressure or silence from the financial adviser.

This is the basic anatomy of a tortious scheme to interfere with a financial adviser's business relationships. If you are currently or about to be a part of this game, either as a victim or hesitant participant, I urge you to contact me³ immediately.

1Most U-5 disclosures, however, are free of defamatory content or tortious intent. In other words, most broker-dealers satisfy their obligation to ensure a full, fair, and accurate reporting.

2This is a critical footnote. One or more of the players may simply be mean-spirited or incompetent. While this person may be the motivating player, he or she is usually manipulated and used by the motivator. The ultimate financial adviser victim—typically our client—frequently has a character defect (like all of us) that is exaggerated and exploited.

3David Cosgrove has handled U-5 matters involving MetLife Securities, US Bancorp Investments, Questar, US Allianz, Edward Jones, Raymond James, Morgan Stanley, ING Financial partners, and others.    

A Wrinkle in the Arbitration of Broker Promissory Notes

Little did Laura Facsina know that when she joined Morgan Stanley (MS) in 2009 as a financial adviser (FA) she would battle, not only the wirehouse for gender discrimination, but MS’s right to arbitrate the matter.

After bringing suit in court against MS, Ms. Facsina received a forgivable loan settlement of $280,000. But, a FINRA panel subsequently ordered that she repay a $419,000 promissory note, which was upheld in district court. The panel’s ruling is now before the 6^th Circuit U.S. Court of Appeals, where Facsina is claiming there is a crucial jurisdictional issue negating FINRA’s determination.

According to the suit, it was not Morgan Stanley Smith Barney (MSSB) that owned the note, but rather its non-FINRA member subsidiary Morgan Stanley Smith Barney FA Notes Holdings. As such, Facsina argues, FINRA had no standing to entertain the arbitration, as only members may compel use of the forum by associated persons and clients.

“Moreover, Facsina’s settlement states that unless approved by all parties, no portion of the agreement – including the promissory note – is assignable. Facsina never gave consent for the note to be assigned to MSSB FA Notes Holding.”[i] This, she claims, is just one example of an on-going deceptive practice in which the true holders of promissory notes have been hidden, with significant consequences for hundreds of brokers.

Citing the research of a former MS employee turned whistleblower, website Think Advisor in its article “Ex-Morgan Advisor, in Unusual Move, Takes FINRA Arb Case to Federal Court,” found that between June 2009 and August 2015, of the 382 cases against advisors, only 12 were won by (ex-)employees and 330 by the company. Of those, MSSB FA Notes Holdings were believed to hold 160 of the notes.

These promissory notes are the overwhelming majority issue heard by FINRA’s arbitration panels. Notably, the panels also serve as the basis counterclaims in defamation and tortious interference claims brought by FAs. Food for thought…

---

[i] Ex-Morgan Advisor, in Unusual Move, Takes FINRA Arb Case to Federal Court (2015 November 24). Retrieved from http://www.thinkadvisor.com/2015/11/24/ex-morgan-advisor-in-unusual-move-takes-finra-arb?page_all=1

SEC’s Investor Advisory Committee Recommends Extending Fiduciary Duty to Broker-Dealers

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."

FINRA Releases Comprehensive Report on Conflicts of Interest

Last month FINRA issued a 44-page report on conflicts of interest within the financial services industry. The report focuses specifically on the conflict management practices of broker-dealer firms. During my experience representing both investors and FINRA members, or while serving as an expert witness, I have frequently identified a conflict of interest to as genesis of the legal claim. FINRA's report is an outstanding review of both the source of troublesome conflicts and current best practices within the industry.

FINRA's report does not pull any punches. It comes out of the gate with the following observation: “Conflicts of interest can arise in any relationship where a duty of care or trust exists between two or more parties, and as a result, are widespread across the financial service industry...[M]any broker-dealer firms have made progress in improving their conflicts management practices, but...firms should do more to manage and mitigate conflicts of interest in their businesses.” (report link)

The report is broken out in to a review of “three critical areas.” FINRA evaluates and discusses: 1) firm-level frameworks, 2) new financial products, and 3) registered rep. compensation. FINRA defines firm-level frameworks as “the combination of underlying ethics culture, organizational structures, policies, processes, and incentive structures.” I found the report's second section regarding the introduction and promotion of new financial products to be worthy of a “must read” classification for both the compliance and the executive sales side of any firm. The final section of the report lays out what FINRA believes to be six “effective practices” for mitigating conflicts of interest generated by rep. compensation arrangements.

Now that FINRA has spoken in great detail on the matter, firms should be very hesitant about going forward without implementing the practices suggested in the report. While FINRA specifically disavows the report as rule-making, firms will be caught flat-footed if they face an investor claim or regulatory action rooted in the absence of the suggested best practices.   

SEC Charges Brokerage Executives With Violations of Regulation S-P

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.

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.

New Year, New Fiduciary Standard?

It has been about six months since the passing of the Dodd-Frank financial reform law—and that means the results from the many studies commissioned by the Act will begin to be released. Dodd-Frank specifically required the Securities and Exchange Commission to look into regulatory standards and oversight gaps between investment advisors and brokers. Last week, the SEC released the results of its study on Section 913 and 914 dealing with the fiduciary duty issue and stricter investment-adviser examinations, respectively.

The issue of whether to impose a uniform fiduciary standard has been met with both fierce support and opposition. Currently, advisers are held to a fiduciary standard that requires them to act in the best interest of their clients, while brokers are only required to offer suitable products to retail customers. The problem with the dual standard arises where brokers offer advice and sell investment products—blurring the lines for retail investors and making it hard to tell when they are receiving sound investment advice or just a sales pitch.

However, last Friday, the SEC handed over its staff study to Congress recommending a uniform fiduciary standard. The study, if implemented as is, would hold brokers to the same fiduciary level as investment advisers under the Advisers Act when brokers are providing personalized investment advice about securities to retail investors. Therefore, under this study, brokers would only be held to a higher fiduciary duty when acting like an investment advisor.

Justification for a uniform standard stems from the issue of retail investors being unable to distinguish between a broker and an investment advisor. According to the SEC, if consumers are receiving investment advice, regardless of the source—broker or advisor—retail consumers should be protected uniformly. Accordingly, such a standard would achieve that goal. The SEC study also states that it attempted to balance retail investors’ need for protection with their ability to have access to various investment products. Because the standard only applied to brokers when giving investment advice, the SEC takes the position that a wide array of products will continue to still be available.

Further, in an attempt to close oversight gaps and keep implementation costs “to a minimum,” the SEC study also “recommends that when broker-dealers and investment advisers are performing the same or substantially similar functions” the regulatory protections should be “harmonized”, but the study lacks specific details on how to achieve this “harmonization.”

Ultimately, however, the staff study suggests additional research and analysis into this area before any implementation. Additionally, there is no statutory deadline for any follow-up rulemaking pursuant to this study, so it seems unlikely that much will be done without further research and analysis. SEC Commissioners Kathleen Casey and Troy Paredes share this view in their Statement Regarding Study on Investment Advisers and Broker-Dealers and emphasized the need for further research before any uniform fiduciary standard rulemaking begins.

FINRA Issues Regulatory Notice on Sales Practices for Commodity Futures-Linked Securities

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.)

In sum, due to the volatility of commodities prices and, correspondingly, the performance of commodity futures-linked securities, and due to the prospect that commodity futures-linked securities may produce unexpected results for investors who are not familiar with futures markets, firms should take the necessary precautions to ensure that the sales of commodity futures-linked securities comply with federal securities laws and FINRA rules. A complete copy of Regulatory Notice 10-51 can be found here.

NASAA Identifies Top Broker-Dealer Compliance Issues

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:

1. Develop effective standards and criteria for determining suitability.
2. 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.
3. 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.
4. 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.
5. 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.
6. 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.
7. Advertisements and sales literature must be balanced, make full and fair disclosure, and be approved, as necessary, prior to use.
8. 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.
9. 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.
10. 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.
    

The NASAA press release announcing the 2010 Broker-Dealer Coordinated Examination Report can be found here.

Senate and House Strike Deal on Fiduciary Duty Issue

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.

The Uncertain Future of Mandatory Arbitration Provisions

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).

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.