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.

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

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.    

Feds Take Aim at Investment Advisers

The SEC and DOJ brought a slew of cases against IAR's and RIA's in the first half of 2015. At least six cases were filed just last month alone. Here is a brief summary of a sampling of those cases.

On January 21, 2015, the SEC filed fraud charges and an asset freeze against a Fort Lauderdale, Florida-based investment advisory firm, its manager, and three related funds in a scheme that raised more than $17 million. The SEC’s complaint filed in federal court in the Southern District of Florida charged Elm Tree Investment Advisors LLC, its founder and manager, Frederic Elm, and Elm Tree Investment Fund LP, Elm Tree “e”Conomy Fund LP, and Elm Tree Motion Opportunity LP. According to the complaint, Elm, formerly known as Frederic Elmaleh, his unregistered investment advisory firm, and the three funds misled investors and used most of the money raised to make Ponzi-like payments to the investors. The complaint alleges that Elm used the funds to buy a $1.75 million home, luxury automobiles, and jewelry, and to cover daily living expenses.

On March 6, 2015, an investment adviser was hit with felony charges alleging that he defrauded clients of more than $1 million while running his own investment firm in Chicago. Philip E. Moriarty II is accused of six counts of wire fraud related to allegations that he defrauded investors of at least $1.1 million while he was the CEO of First Street Capital Partners in Chicago from 2008 to 2010. He’s accused of convincing four investors that they were investing in his businesses through the use of fraudulent documentation, and then spending the funds on personal expenses, including payments to a golf, hunting and fishing club, and $23,000 to a boarding school in New Hampshire.

Late that month, the SEC filed fraud charges against an investment adviser and her New York-based firms accusing them of hiding the poor performance of loan assets in three collateralized loan obligation (CLO) funds they managed. The SEC’s Enforcement Division alleged that Lynn Tilton and her Patriarch Partners firms breached their fiduciary duties and defrauded clients by failing to value assets using the methodology described to investors in offering documents for the CLO funds. Tilton and her firms allegedly have avoided significantly reduced management fees because the valuation methodology described in fund documents would have given investors greater fund management control and earlier principal repayments if collateral loans weren’t performing to a particular standard.

In April, 2015, a former JPMorgan Chase investment adviser was arrested on charges he stole $20 million from customers and spent the funds on unprofitable trading and other personal expenses. Michael Oppenheim allegedly took money from at least seven bank clients in a fraud scheme he operated from March 2011 to March 2015. Oppenheim worked as a JPMorgan investment adviser. He advised approximately 500 clients who collectively kept roughly $89 million in assets under his management, according to a criminal complaint filed by Manhattan federal prosecutors.

Later in April, a former Merrill Lynch and Smith Barney investment adviser already serving a federal prison term for investment fraud pleaded guilty to additional fraud charges in connection with a nearly two-decade-long scheme to defraud clients of hundreds of thousands of dollars. Jane E. O’Brien of Needham, MA, pleaded guilty to three counts of mail fraud, two counts of wire fraud, and two counts of investment adviser fraud. As alleged in the indictment, between 1995 and 2013, O’Brien defrauded several clients for whom she provided investment advisory services. As part of the scheme, O’Brien misappropriated funds entrusted to her through a variety of means, including persuading clients to withdraw money from their bank and brokerage accounts to invest. After gaining control of her clients’ money, however, O’Brien made no such investments. Instead, she used the misappropriated client funds for a variety of improper purposes, including paying personal expenses, paying purported investment returns, or repaying personal loans to other clients. Finally, in order to perpetuate her fraud and conceal it from her clients, O’Brien made false statements and misrepresentations to clients, including by making lulling payments to clients and otherwise providing them with false assurances of their financial security.

On May 15, 2015, Bryan Binkholder of St. Louis was sentenced to 108 months in prison on multiple fraud charges involving his financial planning and investment strategy businesses. In addition to the prison sentence, he was also ordered to pay $3,655,980 in restitution to the victims. According to court documents, Binkholder labeled himself “The Financial Coach” and provided investment and financial planning advice to the public through his affiliated websites and an investment related talk-radio show that aired on local radio stations. In 2008, he developed a real estate investment he termed “hard money lending.” Using his platform as an investment advisor and financial talk show host, Binkholder solicited his clients and others to invest in the hard money lending program. As part of his sales pitch he represented that he had relationships with developers who were not able to secure financing from traditional banks. As part of the hard money lending program, Binkholder told investors that they would invest money with him, and he would act as a bank and provide short term loans to these developers at a high rate of interest which would be shared with the investor. Instead of exclusively making hard money loans as promised, he took in millions of dollars of investor money, made only a small number of hard money loans and caused investors to lose more than $3,000,000.

On May 21, 2015, The Securities and Exchange Commission filed fraud charges against an Atlanta-based investment advisory firm and two executives accused of selling unsuitable investments to pension funds for the city’s police and firefighters and other employees. The SEC’s Enforcement Division alleged that Gray Financial Group, its founder and president Laurence O. Gray, and its co-CEO Robert C. Hubbard IV breached their fiduciary duty by steering these public pension fund clients to invest in an alternative investment fund offered by the firm despite knowing the investments did not comply with state law. Georgia law allows most public pension funds in the state to purchase alternative investment funds, but the investments are subject to certain restrictions that Gray Financial Group’s fund allegedly failed to meet. The SEC alleged that Gray Financial Group collected more than $1.7 million in fees from the pension fund clients as a result of the improper investments.

On June 3, 2015, the SEC filed two cases against purported investment advisers who falsified their credentials. In one case, the SEC charged that Todd M. Schoenberger of Delaware solicited at least a dozen people to invest in promissory notes issued by LandColt Capital, an unregistered advisory firm. According to the SEC, he said the notes would be repaid from management fees. Just a few days later, a Chicago investment adviser was arrested on federal charges that he defrauded his clients of at least $1 million, some of which he allegedly gambled away at local casinos. Alan Gold was charged in a criminal complaint that was unsealed following his arrest.

On June 11, 2015, the United States Attorney for the Western District of Wisconsin announced the unsealing of a 21-count indictment charging Pamela Hass with wire fraud and money laundering. The indictment also contains a forfeiture allegation seeking $460,831.27 in criminal proceeds. The indictment alleges that Hass engaged in a wire fraud scheme to defraud investors by promising returns from an investment in internet pop-up ads. According to the indictment, Hass falsely told investors they would obtain a return of anywhere from five to 20 times their original investment, and that if the investment failed, she would personally guarantee the return of the original investment plus 7 percent interest.

Also last month, The Securities and Exchange Commission announced fraud charges against a Washington D.C.-based investment advisory firm’s former president accused of stealing client funds. The firm and its chief compliance officer separately agreed to settle charges that they were responsible for compliance failures and other violations. SFX Financial Advisory Management Enterprises is wholly-owned by Live Nation Entertainment and specializes in providing advisory and financial management services to current and former professional athletes. The SEC alleged that SFX’s former president Brian J. Ourand misused his discretionary authority and control over the accounts of several clients to steal approximately $670,000 over a five-year period by writing checks to himself and initiating wires from client accounts for his own benefit.

Just a day later, Kenneth Graves, a former investment adviser representative in Corpus Christi whose license to sell securities was revoked last year by the Texas Securities Commissioner, was indicted on fraud charges related to the sale of investment contracts and excessive fees for his firm’s services. The indictment alleges that Graves defrauded six clients of his firm, Warren Financial Services LLC, through the sale of $420,720 in investment contracts. The indictment alleges that in a separate fraud in 2013 and 2014, Graves misapplied $128,918 in fees he had collected from clients of Warren Financial.

Finally, on June 17, 2015, the SEC announced fraud charges against a Massachusetts-based investment advisory firm and its owner for funneling more than $17 million in client assets into four financially troubled Canadian penny stock companies in which the owner had an undisclosed financial interest. The SEC alleged that clients at Interinvest Corporation may have lost as much as $12 million of their $17 million investment based on the recent trading history of shares in the penny stock companies, some of which were purportedly in the business of exploring for gold or other minerals. Interinvest’s owner and president Hans Black served on the board of directors of these companies, which have collectively paid an entity he controls approximately $1.7 million. Black’s involvement with these companies and his receipt of payments from them created a conflict of interest that he and Interinvest failed to disclose to their advisory clients.

On a final note--Investors and accountants should take the time to read Brian Carroll's article regarding investment advisory fraud in the Journal of Accounting.

In addition to founding the Investment Adviser Rep Syndicate, David Cosgrove, a former regulator and prosecutor, is the founding Member and Manager of Cosgrove Law Group, LLC. The law firm represents both investors and investment advisers across the nation. In doing so, the firm's members have a unique strategic advantage and insight when it comes to litigation or conflict resolution in the financial services and investment arena. 

The SEC’s Compliance Outreach Program for Investment Companies and Investment Advisers

The SEC recently announced that it will be hosting a national compliance outreach seminar for investment companies and investment advisers.  The seminar will be held on January 30, 2014 at SEC headquarters in Washington D.C.  The SEC’s Office of Compliance Inspections and Examinations (OCIE), Division of Investment Management, and the Asset Management Unit of the Division of Enforcement will co-sponsor the event.

The following topics will be covered in the seminar:

-          Program Priorities in 2014 with presentations from OCIE, Division of Investment Management, Division of Enforcement (Asset Management Unit), Joint or Coordinated Initiatives and Large Firm Engagements;
-          Private Fund Advisers with an emphasis on presence exam observations, JOBS Act, private fund initiatives/guidance, and private equity issues; 
-          Registered Investment Companies with an emphasis on 15c process/observations, alternative mutual funds, exchange traded products, and distribution in guise;
-          Valuation Issues specifically focusing on basic legal framework, valuation techniques and practices, difficult-to-value investments, and the role of persons other than the investment adviser (e.g., Board, Pricing Services); and
-          The Role of the CCO including presentations on SEC staff observations, CCO presence, access, and empowerment, and recent enforcement actions.  

“The compliance outreach program is an important part of the Commission’s initiative to share information about observed risks to assist firms in assessing and enhancing their compliance and control programs,” said OCIE Director Andrew Bowden.  “Past compliance outreach program events have been well attended and well received, and we look forward to a candid exchange of ideas with participants at our upcoming event.”

Click here for more information about registration.     

This announcement came just a few days before the SEC issued enforcement results for its fiscal year 2013, which ended in September.  The agency’s 686 enforcement actions in fiscal year 2013 resulted in a record $3.4 billion in monetary sanctions ordered against wrongdoers. Disgorgement and penalties resulting from those actions are 10 percent higher than fiscal year 2012 and 22 percent higher than fiscal year 2011, when the SEC filed the most actions in agency history.

If you need representation in an enforcement proceeding or need compliance consulting, contact the attorneys at Cosgrove Law Group, LLC.  

Furthermore, David Cosgrove, the managing-member of Cosgrove Law Group, LLC and former securities industry regulator, has recently established the Investment Adviser Rep. Syndicate.  This is a group dedicated to the interests of investment adviser representatives through the provision of educational and training opportunities.  In addition to these opportunities, the Syndicate, in general, is intended to address the specific interests and concerns of the representatives, rather than the representatives’ RIA or broker-dealer.

The Syndicate currently intends to hold its first annual conference in Saint Louis in the summer of 2014.  Stay tuned for the launching of the website that will include information on how to become a member, for additional announcements, and blog entries.  We are eager to be a part of the first national organization dedicated solely to the professional interests of investment adviser representatives.   

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.   

Finra Sends Out a Busy Signal to Telemarketing

The Financial Industry Regulatory Authority (“Finra”) recently  announced the approval of new Finra Rule 3230 by the U.S. Securitiesand Exchange Commission (“SEC”), thereby replacing NASD Rule 2212. Finra Rule 3230 speaks directly to the telemarketing activities of Finra member firms and their associated persons and has an effective date of June 29, 2012.

Finra Rule 3230

NASD Rule 2212, NYSE Rule 440A and NYSE Rule Interpretation 440A/01 were all invalidated by the SEC’s approval of Rule 3230. That said, however, the new rule does adopt certain provisions of NYSE Rule 440A and its Interpretation and is substantively similar in context to FTC rules and regulations dealing with telemarketing activities and other such deceptive and abusive practices.

FinraRule 3230 contains several components, each of which is highlighted below.

1. General Telemarketing Requirements

Rule 3230 states that no Finra member firm or associated person of a member firm may initiate an outbound telephone call to any personal residence prior to 8:00am or after 9:00pm local time at the location of the called individual. However, such a call is permissible if the member firm meets one of the following exceptions:

• The member has an established business relationship with the person being called;
• The member has received the person’s prior permission or invitation; or,
• The person phoned is a broker or dealer.

If one of the defined exceptions is not met, such a call would be deemed a rule violation.

In addition, no member firm or associated person may make an outbound telephone call to a person whom has previously requested to not be contacted by the member firm or who has registered his/her telephone number with the FTC national Do-Not-Call Registry.

2. Do-Not-Call Registry

The rule states that a member firm telemarketing calls will not be held to have committed a violation of 3230(a)(3) by phoning a person on a phone number registered with the national Do-Not-Call Registry if:

• The member has an established business relationship with the recipient of such a call (It should be noted, a request to be placed on the firm’s Do-Not-Call list ceases the business relationship, even if the person continues to conduct business with the firm.);
• The member has obtained the prior express written consent of the recipient to receive such a call; or,
• The associated person placing the call has a personal relationship with the recipient of the call.

3. Safe Harbor Provision

A member firm or associated person of a member will be deemed to not be liable of violating 3230(a)(3) if the member can demonstrate that such violation is the result of an error and that the member meets the following benchmarks:

• The member has established and implemented written procedures to comply will the rules and requirements of the national Do-Not-Call registry;
• The member has trained its personnel and any 3^rd parties assisting with the member’s compliance on the member’s procedures established pursuant to the national Do-Not-Call registry;
• The member has maintained and recorded a listing of all telephone numbers which it may not contact; and,
• The member utilizes a process or procedure whereby it seeks to prevent any outbound telephone call to any telephone number on any Do-Not-Call registry, using a version of the national Do-Not-Call registry obtained from the administrator of the registry not more than 31 days prior to the date any such call is made, and the member maintains records documenting such a process.

4. Procedures

Prior to employing telemarketing activities, a member firm must first develop and establish procedures to comply with Rule 3230. Such procedures must, at a minimum, satisfy the following:

• Members must have a written policy for the maintenance of a Do-Not-Call registry.
• Personnel of a member that engage in telemarketing activities must be informed of and trained on the use of such a Do-Not-Call registry.
• A member who receives a request from a person not to receive calls from that member must record the request and place the person's name, if provided, and telephone number on the firm's Do-Not-Call registry at the time the request received. Members must honor such a request within a reasonable time, not to exceed 30-days from the date the request is made. A member will be held liable for the failure to honor such a request, even if such requests are recorded or maintained by a 3^rd party placing calls on behalf of a member.
• A member or associated person of a member making an outbound telephone call must provide the call recipient with the name of the individual caller, the name of the member, an address or telephone number at which the member may be contacted, and inform the recipient that the purpose of the call is to solicit the purchase of securities or related services. In addition, the telephone number provided may not be a 900 number or any other number for which charges exceed local or long distance transmission charges.
• Unless specifically requested to the contrary, a person's do-not-call request shall apply to the member making the call and will not apply to any affiliated entities unless the consumer reasonably would expect such affiliated entities to be included given the identification of the caller and the product being advertised.

5. Wireless Communications

All provisions of the rule shall also apply to calls made by the member and its associated persons to wireless telephone numbers.

6. Outsourcing Telemarketing

A member shall still remain accountable for certifying compliance with the provisions of the rule, even if it should outsource some or all of its telemarketing services to an outside party.

7. Called ID Information

Any member that engages in telemarketing activities must ensure that the telephone numbers used and, where available, the name of the member is appropriately displayed on any caller ID devices utilized by the recipient of an outbound call. Such a telephone number provided must be available during normal business hours for a recipient of such a call to make a Do-Not-Call request.

8. Unencrypted Consumer Account Numbers

No member or associated person shall disclose or receive, for consideration, unencrypted consumer account numbers for use in the member’s telemarketing activities. The term “unencrypted” shall mean not only complete, visible account numbers, but also encrypted information with a key to its decryption.

9. Submission of Billing Information

For any telemarketing transaction, a member or its associated person must obtain the express consent of the person to be charged.

In any telemarketing transaction involving preacquired account information and a free-to-pay conversion feature, the member must:

• Obtain from the customer, at a minimum, the last four digits of the account number to be charged;
• Obtain from the customer an express agreement to be charged; and,
• Make and maintain an audio recording of the entire telemarketing transaction.

In any other telemarketing transaction involving preacquired account information not described above, the member must:

• Identify the account to be charged with sufficient specificity for the customer to understand what account will be charged; and,
• Obtain from the customer an express agreement to be charged and to be charged using the account number identified.

10. Abandoned Calls

No member shall “abandon” any outbound telemarketing call. An outbound call is considered to be “abandoned” if a person answers it and the call is not connected to a person associated with a member within two seconds of the person's completed greeting.

A member shall not be liable for violating this provision of the rule if:

• The member employs technology that ensures abandonment of no more than three percent of all telemarketing calls answered by a person, measured over the duration of a single calling campaign, if less than 30 days, or separately over each successive 30-day period or portion thereof that the campaign continues;
• The member allows the telephone to ring for at least 15 seconds or four rings before disconnecting an unanswered call;
• Whenever a person associated with a member is not available to speak with the person answering the telemarketing call within two seconds after the person's completed greeting, the member plays a recorded message that states the name and telephone number of the member or person associated with the member on whose behalf the call was placed; and,
• The member retains records establishing compliance with this provision of the rule.

11. Pre-recorded Messages

No member shall initiate an outbound telemarketing call that delivers a prerecorded message other than a prerecorded message permitted for compliance with the call abandonment safe harbor unless:

• The member has obtained from the recipient of the call an express written agreement that:
  • The member obtained only after a clear and conspicuous disclosure that the purpose of the agreement is to authorize the member to place prerecorded calls to such person;
  • The member obtained without requiring, directly or indirectly, that the agreement be executed as a condition of opening an account or purchasing any good or service;
  • Evidences the willingness of the recipient of the call to receive calls that deliver prerecorded messages by or on behalf of the member or its associated persons; and,
  • Includes such person's telephone number and signature (which may be obtained electronically under the E-Sign Act);

• The member allows the telephone to ring for at least 15 seconds or four rings before disconnecting an unanswered call; and within two seconds after the completed greeting of the person called, plays a prerecorded message that promptly provides the disclosures above, followed immediately by a disclosure of one or both of the following:

• For a call that could be answered by a person, that the person called can use an automated interactive voice and/or keypress-activated opt-out mechanism to assert a do-not-call request at any time during the message. Such a mechanism must:

• automatically add the number called to the member's Do-Not-Call registry;
• Once invoked, immediately disconnect the call; and,
• Be available for use at any time during the message.

• For a call that could be answered by an answering machine or voicemail service, that the person called can use a toll-free telephone number to assert a do-not-call request. The number provided must connect directly to an automated interactive voice or keypress-activated opt-out mechanism that:

• Automatically adds the number called to the member's Do-Not-Call registry;
• Immediately thereafter disconnects the call; and,
• Is accessible at any time throughout the duration of the telemarketing campaign; and,

• The member complies with all other requirements of Rule 3230 and other applicable federal and state laws.

12. Credit Card Laundering

Except as expressly permitted by the applicable credit card system, no member or person associated with a member shall:

• Present for payment, a credit card sales draft generated by a telemarketing transaction that is not the result of a telemarketing credit card transaction between the cardholder and the member;
• Employ, solicit, or otherwise cause a merchant, or an employee, representative or agent of the merchant, to present for payment, a credit card sales draft generated by a telemarketing transaction that is not the result of a telemarketing credit card transaction between the cardholder and the merchant; or,
• Obtain access to the credit card system through the use of a business relationship or an affiliation with a merchant, when such access is not authorized by the merchant agreement or the applicable credit card system.

13. Definitions

Finra Rule 3230 adopts definitions that are substantially similar to the FTC’s

definitions.

Supplementary Material

Rule 3230 also includes as Supplementary Material a provision that is similar to NYSE Rule Interpretation 440A/01 and which reminds members that the rule does not affect the obligation of any member or its associated person that engages in telemarketing to comply with relevant state and federal laws and rules.
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Cosgrove Law, LLC welcomes guest blogger Jeffery Barton.  Mr. Barton is able to offer a variety of compliance consulting services which can be used as an extension of the compliance services offered by Cosgrove Law, LLC. 

TWEETING, POSTING, and FRIENDING: Social media’s two-edged sword for Investment Advisers

Regulators and compliance departments alike have been shaking their heads at the potential pitfalls of social media. How to support and allow Investment Adviser’s to use social media tools and still protect the investor from bad actors and misinterpreted posts or tweets is no easy task. The rapid fire tweets and the “share everything” mentality become permanent, potentially discoverable, records. But Investment Advisers are finding that social media provides valuable avenues never before available to share and gain information, to find new clients, and to better understand existing clientele.

This week, the Wall Street Journal had an article on this very subject. While little official guidance has been provided to Registered Investment Adviser firms on proper social media policies, reviewing the current guidelines for client communication can offer guidance to compliance and legal departments when they are requested to develop a road map for their firm and its social media policies. The potential pitfall in having a detailed policy is that once it is in black and white, it must be followed, and either an individual or a department must be charged with ensuring this—quite a task for a such a vast medium. However, given the free-range but permanent aspects of social media, RIA’s of all sizes should begin discussing and seeking legal counsel on how they will address this matter given the current regulations in place that govern client and potential client communications. The alternative--waiting for a post or a tweet to cause a problem--can be a dangerous course to take.

Additionally, many employees may appreciate the guidance and opportunity to hear and be heard on this matter as they try to use social media to the best use without exposing their record or license to unnecessary risk. Part of being in a highly regulated industry is staying ahead of the curve so that potential problems don’t become actual ones.

FINRA has provided Broker Dealers with specific guidelines regarding social media. Using these rules as a framework for RIA’s social media policies may be another helpful tool when the RIA firm is looking for a place to start the discussion on this topic.

Cosgrove Law, LLC offers consulting to RIA firms on a wide range of compliance matters.

Client’s Ponzi Scheme Gets Law Firm and Attorney Sued

A bankruptcy trustee filed suit April 28th against Estate Financial Inc.’s (EFI) former attorney and her employing firm, Bryan Cave LLP, alleging that their legal advice led to more than $100 million in losses from over 1,500 investors.

The complaint claims that Bryan Cave LLP, an international law firm with lawyers in St. Louis, and one of its attorneys from its Los Angeles office, Katherine Windler, failed to advise EFI to conform to various California and federal laws.

The suit, filed in the central district of California, alleges that Windler and Bryan Cave were retained to conduct a compliance review and audit of EFI’s business practices. The compliance review revealed that EFI was in violation of “countless real estate, securities and corporate laws, rules and regulations.” According to the complaint, regardless of this knowledge, Windler “counseled EFI to continue its current business activities,” which allegedly allowed EFI principals Karen Guth and Josh Yaguda to steal over $100 million from investors through a ponzi scheme. The scheme involved selling membership interests in a fund held by EFI, the Estate Financial Mortgage Fund, LLC, under restricted or expired permits. The complaint cites to various documents and email communications between Windler and EFI’s principals evidencing her purported knowledge of the fraud.

In 2009, Guth and Yaguda pleaded guilty to 26 felony counts of fraud. Guth is serving 12 years in prison and Yaguda 8 years.

This lawsuit serves as a tragic reminder to attorneys that performing in accordance with the rules of professional responsibility should always be at the forefront of any client matter. It also provides a chilling warning to corporations about the need for reputable and honest compliance counseling.

SEC Whistleblower Program: Compliance Nightmare or Missed Opportunity?

As part of Dodd-Frank Wall Street Reform and Consumer Protection Act passed last summer, the Securities and Exchange Commission was given the authority to establish a whistleblower program with monetary incentives as a way to entice individuals to come forward about corporate financial wrongdoings. Section 21F provides that whistleblowers who provide new information to the SEC about financial misconduct are able to collect monetary awards totaling between ten and thirty percent of the sanctions recovered through civil or criminal proceedings that total more than $1 million. The SEC characterizes “new information” as information that is original and “based on independent knowledge not already known to the Commission nor taken exclusively from public sources.”

According to the SEC, the new whistleblower authority will help the agency maximize its resources and effectiveness by increasing the number of high-quality tips that it might not otherwise receive without the incentives in place. SEC spokesman, John Nester, has already reported that that SEC has seen a “significant increase in high-quality tips.”

However, the whistleblower program is highly controversial. Many argue that such an incentive program pits employees against employers and creates a disincentive for employees to utilize internal compliance structures mandated by the 2002 Sarbanes-Oxley Act. According to Susan Hackett, senior vice president and general counsel for the Association of Corporate Counsel, the new program encourages “a lot of people who are being opportunistic or who are looking to actually help create problems they can then profit from.” She argues that compliance culture morphs from a “let’s fix it” attitude into a self-enterprising one, which creates clear compliance challenges. Tom Quaadman, vice president of the Capital Markets Competitiveness at the U.S. Chamber of Commerce takes a similar stance. Both advocate that whistleblowers should first be required to make use of internal reporting and investigative systems before submitting their complaints to the SEC. Further, these organizations call for a ban on monetary recovery for individuals who were engaged in the underlying misconduct before reporting. Quaadman asserts that whatever rules are finally implemented need to operate in such a way so as to promote good corporate behavior, not employee contrivance.

Another concern about the proposed Whistleblower Program is that there will be an increase in the number of frivolous allegations. This concern arises from acknowledgement that whistleblower complaints can act as a double-edged sword: they can be instrumental in identifying and correcting corporate misconduct but often, such complaints are made by underperforming employees in an attempt to advance personal grievances against their employer.

To counter these arguments, proponents of the whistleblower program cite to other successful programs with robust monetary rewards like that under the False Claims Act, which helped facilitate large settlements with pharmaceutical giants Pfizer and Eli Lilly for corporate misconduct. They take the stance that individuals who become aware of misdeeds are not eager to blow the whistle, but merely do so to keep their jobs or do what is right. Even among supporters, there is dissonance regarding the scope of the SEC’s proposed program. Some advocate for a broader definition of “whistleblower” and others are skeptical about the program’s potential for success because of limited resources and the program’s failure to address coordination of investigations between overlapping federal agencies.

In November 2010, the SEC released its proposed set of rules that will be used to implement the whistleblower program. The comment period for these rules expired on December 17, 2010, but the SEC has not issued final rules yet. Under the deadline set by Dodd-Frank, the SEC was supposed to have its final rules for the Whistleblower Incentives and Protection Program in place by April 21, 2011. In an April 26 interview, Mary Shapiro, chairman of the SEC, disclosed that the SEC is “now finalizing its whistleblower rules.” However, according to the SEC’s implementation calendar, the planned finalization of the rules is slated to be released between now and July. So far, the only completed installation of the program is the establishment of the new Whistleblower Office and appointment of Sean McKessy as the new director of that office.

Despite the delay in final rules and implementation, whistleblowers are currently protected from retaliation and entitled to applicable monetary rewards because Dodd-Frank provided temporary rules applicable for anyone who came forward after July 22, 2010. These temporary rules remain in effect until the SEC passes its final rules.

FINRA SHIFTS FROM NOTICES TO ENFORCEMENT WHEN IT COMES TO PRIVATE PLACEMENT DUE DILLIGENCE

NASD Rule 3040 regarding Private Securities Transactions of Associated Persons has been around since 1985. NASD issued Notices to Members on the subject in 1985, 1991, 1994, 1996, 2001 and 2003. The title to the 2001 Notice was: “NASD Reminds Members of their Responsibilities Regarding Private Securities Transactions Involving Notes and Other Securities and Outside Business Activities.” In 2002, a law firm issued a “Client Memorandum” entitled “Be Alert: Regulators are Keeping a Watchful Eye on Outside Business Activities.” Notably, the memorandum began by stating: “Selling away and outside business activities have become hot topics for regulators. The NASD, in particular, has brought numerous formal disciplinary actions...”

Perhaps things really do stay the same the more they change. Earlier this month FINRA issued a news release about sanctions it levied against two firms and several registered representatives that failed to satisfy the mandates of Rule 3040.

On its face, Rule 3040 doesn't appear to be particularly complicated. But its compliance has been eluding industry members for over two decades now.

Rule 3040 requires an associated person to provide written notice to its FINRA member “describing in detail the proposed transaction and the person’s proposed role therein” when the person will be receiving “any compensation paid directly or indirectly from whatever source in connection with or as a result of the purchase or sale of a security.” The rule defines a “private security transaction.” Once the member receives the written notice, it can either deny approval of the associated person's proposed participation, or, if it approves: “[record] the transaction...on the books and records of the member and...supervise the person's participation in the transaction as if the transaction were executed on behalf of the member.”

Despite the rule's clear mandate, FINRA's recent enforcement actions demonstrate that associated persons continue to forge ahead on private placements without getting permission from their member firm, and members continue to punt on their due diligence obligations before they give approval in response to a request. That due diligence obligation requires the broker-dealer to perform both a client-specific and reasonable-basis suitability analysis. The latter requires a reasonable investigation of the sale of the private transaction or placement. And simply relying upon information provided by the issuer of the security does not pass the muster as a “reasonable investigation.”

FINRA's news release provides additional details regarding the individual’s sanctioned for their participation in the sale of placements offered by Medical Capital Holdings and Provident Royalties, LLC and the firms for their lack of due diligence on these two placements, as well as those issued by DBSI, Inc. According to FINRA: “without performing proper due diligence, the firms could not identify and understand the inherent risks of these offerings.” Considering the multitude of firms that peddled DBSI notes and TICs in apparent oblivion of Rule 3040, one can surely anticipate future enforcement actions in this area.

IS FINRA RULE 3040 REALLY THAT DIFFICULT TO FOLLOW?

A recent enforcement action and consent order highlights the broker-dealer community's ongoing struggle with FINRA Rule 3040. Huntleigh Securities Corp. was fined $300,000 by the Missouri Securities Division for failing to supervise a broker that engaged in over $4 million of private securities transactions. In most instances, the broker simply fails or ignores the need to obtain his or her broker-dealer's approval for the transactions. In the Huntleigh matter, as was the case with certain broker-dealers approving the sale of non-registered but securitized 1031 exchanges, the broker-dealer approved the transactions but failed to supervise them. They also failed to even recognize that the broker was selling unregistered securities.

To simplify a very simple rule, Rule 3040 requires a broker to submit a detailed written request to engage in the sale of a product that is outside the scope of his or her broker-dealer's normal course of business. If the broker is receiving any kind of compensation for the transaction – even a finder's fee – the broker-dealer is required to supervise the transactions and carry it on it's book and records as if it were a non-private securities transaction. That means, among other things, that the broker-dealer is required to engage in a reasonable-basis product suitability analysis and provide the broker the training necessary to conduct a thorough customer-specific suitability analysis. And as part of the reasonable-basis analysis, the broker-dealer must conduct a due diligence analysis which goes beyond a mere spoon-feeding by the third-party product sponsor.

As part of the consent order with the Securities Division, Huntleigh “agreed” to – among other onerous measures – retain at its expense an outside consultant to review and report back on its compliance and supervisory policies and procedures relating to the outside business activities of its agents.

Cosgrove Law, LLC provides consulting and auditing services and works in tandem with other industry experts to assist securities and commodities broker-dealers in achieving compliance with rules such as FINRA 3040. We also represent investors that suffer severe consequences when they are persuaded to participate in unsuitable private securities transactions. But, when it's all said and done, it doesn't matter who you hire for assistance if you remain ignorant of Rule 3040 and its mandates.

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.

Is Broker/Trader liable for what Broker-Dealer approves?

There is an interesting albeit short article in this month's edition of Corporate Counsel regarding Goldman Sachs and its very own "Fabulous Fab". As you may recall, Goldman settled with the SEC recently for $550 million (without admitting wrongdoing) for its role in allegedly selling a mortgage backed securities vehicle to its customers that Goldman allowed a hedge fund to both assemble and bet against. Goldman's trader Fabrice Tourre became infamous for not only reducing to writing his callous appreciation for the irony of Goldman's position, but also for dubbing himself "Fabulous Fab." Now wonder pride is one of the 7 deadly sins. But I digress. General Counsel notes that one of the defenses Fabulous is asserting in response to the SEC's claims against him is that the product and procedures at issue had been vetted and approved by Goldman's compliance and legal departments. General Counsel oddly characterizes this as a "novel defense." I'm not sure it is novel or without merit. Indeed, it reminds me of a case I worked on where I represented the former brokers of a large regional broker dealer that was sued by a state regulator for its role in the traditional sale, but unexpected liquidity demise, of Auction Rate Securities. The regulator sued the broker-dealer and its trading desk employees for failing to train and disseminating inaccurate information regarding the risks and characteristics to its sales force/registered representatives. But it also simultaneously sued the allegedly untrained and inadequately informed representatives that sold the product to investors (why chose a coherent theory of liability unless you have to?). Of course, as predicted, the regulator dismissed the suit against the individual brokers--one months away from dieing from cancer--once the broker-dealer coughed up millions of dollars. So while Fab's arrogance may provide some insight in to a culture on Wall Street that needs to evolve for the better, his affirmative defenses aren't so novel, and may just have some merit. It is one thing when a broker disregards compliance and legal and engages in negligent or self-serving conduct, but it seems to be an entirely different story when he or she is merely selling a product that has structural deficits literally designed by his employer and principle, including legal and compliance experts. Stay tuned.