The SEC Division of Examinations recently announced its examination priorities for fiscal year 2021, discussing key risks, trends, and examination priorities in an overall effort to promote and improve compliance.
The two largest programs run by the Division, Investment Adviser/Investment Company Program and Broker-Dealer and Exchange Program, focus on the protection of retail investors and retirement savers. The Division stated in its annual report that this year’s emphasis will be on sales related to mutual funds and exchange-traded products, municipal securities, other fixed income products, and microcap securities, but the examinations will be in the context of compliance with Regulation Best Interest (“Reg BI”).
On February 1, 2021, FINRA published the 2021 Report on FINRA’s Examination and Risk Monitoring Program (“2021 Report”). Annually, FINRA publishes the Report on its Examination and Risk Monitoring Program in order to provide member firms with information they can use to assess and strengthen their compliance, supervisory, and risk management programs. The Report summarizes noteworthy findings from recent examinations, outlines effective practices that FINRA observed during its oversight, and provides additional resources that may be helpful to member firms in fulfilling their compliance obligations.
FINRA recently issued Regulatory Notice 21-03 providing information to help FINRA member firms that engage in low-priced securities business assess and, as appropriate, strengthen their controls to identify and mitigate their risk, and the risk to their customers, including specified adults and seniors, of becoming involved in activities related to fraud involving low-priced securities. FINRA issued this guidance because it has observed potential misrepresentations about low-priced securities issuers’ involvement with COVID-19 related products or services, such as vaccines, test kits, personal protective equipment, and hand sanitizers.
FINRA’s Board of
Governors met on December 2-3, 2020, to review FINRA’s 2020 financial
performance, approve the organization’s 2021 proposed budget, reaffirm FINRA’s
Financial Guiding Principles, approve rule proposals, and receive several
operational updates.
The Board approved
two rule proposals to be filed with the Securities and Exchange Commission
(SEC), directing impacting our clients. As customary, the proposed rules will
be published for public comment within the year and must be approved by the SEC
before becoming effective.
On November 2, 2020, the SEC adopted amendments to “simplify, harmonize, and improve certain aspects of the exempt offering framework” under the Securities Act of 1933. The amendments are intended to meet evolving market needs by providing, among other changes, all of the following: greater clarity around the SEC’s integration doctrine that can pose challenges for companies with ongoing or recurring financial needs to permit concurrent private and public offerings; increased efficiency of the private capital raising process by increasing the ceiling on the amount of funds that can be raised under Regulation A, Regulation Crowdfunding, and Rule 504 of Regulation D offerings; clear and consistent rules governing certain offering communications, including permitting certain “test-the-waters” and “demo day” communications; and aligned financial disclosure requirements for Rule 506(b) offerings to non-accredited investors with the requirements under Regulation A.
FINRA recently adopted Rule 3241, limiting registered representatives from being named a customer’s beneficiary or holding a position of trust for a customer. The rule limits a registered representative from being named a beneficiary, executor or trustee, or to have a power of attorney or similar position of trust for or on behalf of a client, unless specifically approved by the broker dealer prior to accepting the position of trust. The rule does not apply, however, where the customer is a member of the registered person’s immediate family.
In 2019, FINRA launched a retrospective review to assess the effectiveness and efficiency of its rules and administrative processes meant to help protect senior investors from financial exploitation. Based on feedback received during the review, FINRA is now proposing amendments to Rule 2165 regarding financial exploitation of specific adults to extend the hold period and allow temporary holds on transactions.
FINRA recently issued Regulatory Notice 20-30 “Fraudsters Using Registered Representatives Names to Establish Imposter Websites.” The Notice warns of individuals maliciously using publicly available information regarding registered representatives in order to create “imposter websites” exhibited as the registered representative’s personal website. Through these “imposter websites,” individuals are able to collect personal information from potential customers with the likely goal of committing financial fraud.
For over 40 years, the Securities and Exchange Commission (SEC) has used disgorgement as a common enforcement tool. In securities enforcement matters, disgorgement requires wrongdoers to disgorge ill-gotten profits or commissions. The Ninth Circuit has stated that “disgorgement is designed to deprive a wrongdoer of unjust enrichment, and to deter others from violating securities laws by making violations unprofitable.” See Security and Exchange Commission v. JT Wallenbrock & Associates., 440 F.3d 1109, 1113 (9th Cir. 2006).
On February 7, 2020, FINRA filed with the SEC a proposed rule change to amend FINRA’s Code of Arbitration Procedure for Customer Disputes and Code of Arbitration Procedure for Industry Disputes to apply minimum fees to requests for expungement of customer dispute information. The SEC recently approved this proposed rule change in an order dated May 26, 2020, which was published in the Federal Register on June 1, 2020.
FINRA amended its Code of Arbitration Procedure for Customer Disputes (Customer Code) to expand the options available to customer claimants dealing with “inactive members”—those firms or individuals whose FINRA registration has been terminated, suspended, canceled, or revoked, or who have been expelled or barred from FINRA. FINRA has amended the Customer Code to further the routes available to customers in situations where a firm becomes inactive during a pending arbitration or where an associated person becomes inactive either before a claim is filed or during a pending arbitration.
In June 2019, the SEC adopted Regulation Best Interest. The Regulation requires broker-dealers (and natural persons associated with broker-dealers) to act in the best interest of their retail customers in making a recommendation of any securities transaction or investment strategy involving securities. Since the rule’s promulgation, there have been several questions relating to compliance with Regulation Best Interest. Accordingly, within the past few months, and as recent as February 2020, the U.S. Securities and Exchange Commission (SEC) Division of Trading and Markets released answers to Frequently Asked Questions (FAQs) relating to compliance with Regulation Best Interest.
FINRA released its 2020 Risk Monitoring and Examination
Priorities Letter. The Letter addresses
emerging priorities for FINRA’s risk monitoring, surveillance, and examination
programs in the coming year.
The FINRA Board of Governors met on December 4-5, 2019 to
discuss the organization’s 2020 proposed budget, reaffirm its Financial Guiding
Principles, discuss several operational updates, and approve two rule
proposals.
Of noted importance to our clients, the Board approved two rule proposals to be filed with the Securities and Exchange Commission (SEC). Both proposed rules will be published for public comment within the year and must be approved by the SEC before becoming effective.
FINRA is seeking comments on a new rule proposal that would limit any registered person of a broker-dealer from being named a beneficiary, executor or trustee, or to have a power of attorney or similar position of trust, for or on behalf of a customer. FINRA believes being a customer’s beneficiary or holding a position of trust may present significant conflicts of interest and hopes the proposed rule would help further address misconduct in this area.
On October 16, 2019, FINRA published its 2019 Report on Examination Findings and Observations (“The Report”). The Report essentially details observations from recent examinations of broker-dealer firms. In the past, broker-dealer firms have used these reports to anticipate potential areas of concern and improve their procedures and controls accordingly.
In recently published Regulatory Notice 19-31, FINRA responded to questions regarding how members can comply with FINRA’s communications rules, Rules 2210 through 2220, when using electronic media. FINRA issued this guidance to facilitate simplified and more effective disclosure in communications with the public, particularly in the context of members’ marketing and advertising of their products and services using websites, email, social media, search advertisements, mobile applications, and other electronic media.
FINRA recently issued Regulatory Notice 19-28 addressing member firms’ supervisory responsibilities as it pertains to customer accounts owned by municipal entities. The guidance was issued to clarify misconceptions surrounding the definition of the term “municipal advisors” and to ensure compliance with relevant FINRA and SEC regulations.
FINRA commenced a retrospective review of its rules and administrative processes meant to help protect senior investors from financial exploitation and is now requesting comment on suggested changes to and creation of rules and administrative processes addressing the issue.
FINRA recently issued Regulatory Notice 19-23 addressing “extraordinary cooperation” by broker dealers and broker dealer firms. The Notice highlights FINRA’s hopes to incentivize broker dealers and broker dealer firms to take “proactive and voluntary steps beyond those required under FINRA rules” by crediting such cooperation in FINRA’s regulatory enforcement decisions. The Notice also clarifies the difference between “required cooperation” and “extraordinary cooperation” by broker dealer and broker dealer firms, in light of FINRA rules and policies that already require cooperation in regulatory investigations.
FINRA released its 2019 Risk Monitoring and Examination Priorities Letter. Compared to previous years, this Letter takes a novel approach by highlighting those topics that will be materially new areas of focus for FINRA’s risk monitoring and examination programs this year. The Letter also identifies areas of ongoing concern that FINRA will continue to review.
FINRA launched a retrospective review of its outside business activities and private securities transactions rules in May of 2017 to assess their effectiveness and efficiency. This request for comment stems from that review of FINRA Rule 3270 (Outside Business Activities of Registered Persons) and FINRA Rule 3280 (Private Securities Transactions of an Associated Person). The proposed rule would replace FINRA Rules 3270 and 3280 and is intended to reduce unnecessary burdens, while strengthening investor protections relating to outside activities.
Arbitration case filings through December 2017 reflected a 6 percent decrease compared to cases filed in 2016 during the same time frame. More specifically, 3,681 cases were filed in 2016, but 3,456 cases were filed in 2017. Of the 3,456 cases filed, 65 percent or 2,260 were customer disputes and 35 percent or 1,196 were intra-industry disputes.
FINRA released its annual list of Regulatory and Examination
Priorities for 2018. FINRA will continue
its focus on high-risk and recidivist brokers in terms of rulemaking initiatives
and examinations. This year’s priority includes strengthening the current
operation, while becoming more efficient.
Our firm recently obtained an award from a FINRA panel granting a Motion for Expungement. The claim (Arbitration number 16-01770) was filed in June, 2016 and alleged negligence, breach of fiduciary duty, negligent supervision, and breach of contract. The claims were related to charges Claimant suffered when he surrendered a fixed annuity and losses he incurred in various types of moderately aggressive investments.
The FINRA Codes of Arbitration and Mediation Procedure currently allow compensated non-attorney representatives (“NAR”) to represent clients in securities arbitration and mediation subject to some exceptions. Some parties are represented by relatives or friends who assist with case preparation or presentation. NAR firms typically provide public investors an alternative to representation by attorneys in disputes between investors and broker dealers. FINRA is conducting a review of the efficacy of continuing to allow such representation and is accepting comments from member firms and other interested parties.
In Ex parte Locklear Chrysler Jeep Dodge, LLC and Locklear Automotive Group, Inc., the Alabama Supreme Court granted a Petition for Writ of Mandamus (“Petition”), finding that the trial court exceeded its discretion when it granted a Motion to Compel discovery on issues unrelated to arbitration while a Motion to Compel arbitration was presently pending.
Every October, FINRA’s Office of Dispute Resolution significantly reduces mediation prices in order to encourage mediation and settlement of customer and industry disputes. The goal of Settlement Month is to encourage parties to experience the benefits of mediation for the first time and to reinforce its value and effectiveness for those who have been through the mediation process already.
The
Department of Labor (“DOL”) recently submitted a proposal to delay
implementation of the remaining parts of its fiduciary rule from January 1,
2018 until July 1, 2019. Two provisions
of the rule, which greatly expands the definition of who counts as a fiduciary
under the Employee Retirement Income Security Act and the Internal Revenue
Code, took effect on June 9, 2017. One
remaining provision includes the best interest contract exemption, which allows
brokers to charge variable compensation for products as long as they sign a legally
binding agreement to put their clients’ interests ahead of their own. The other exemptions include those for
principal transactions and for insurance agents and brokers.
The
SEC approved a proposed rule change to amend FINRA Rules 12402 and 12403 of the
Customer Code and Rule 13403 of the Industry Code to allow the Director of
FINRA’s Office of Dispute Resolution (“Director”) to send the list generated by
the Neutral List Selection System to all parties at the same time, within 30
days after the last answer is due. The
list will now be sent within this time, regardless of whether the parties agree
to extend any answer due date.
Our
firm recently obtained an award from a FINRA panel denying all of Claimant’s
claims and finding for Respondents. The
panel also granted our Motion for Expungement.
The claim (Arbitration number 16-03568) was filed in December,
2016. Claimant alleged claims of breach
of fiduciary duty, breach of contract, failure to supervise, violation of the
Alabama Securities Act, violation of securities regulatory rules, ongoing
fraud, and common law claims of misrepresentation, unjust enrichment and
negligence. The claims were related to
Claimant’s purchase of preference plus variable annuities in 2005 and 2007.
In Regulatory Notice 17-20, FINRA announced it is requesting comments on Rules 3270 and 3280 governing outside business activities and private securities transactions. The request for comments comes as a result of FINRA’s new retrospective rule review. The review concentrates on rules governing broker dealer employees’ business and securities activities carried out away from their firm—activities that are outside the regular course of scope of their employment with the firm.
Arbitration case filings for year-end 2016 reflected a 7 percent increase compared to cases filed in 2015 during the same time frame. More specifically, 3,435 cases were filed in 2015, but 3,681 cases were filed in 2016. Of the 3,681 cases filed, 68 percent or 2,519 were customer disputes and 32 percent or 1,162 were intra-industry disputes.
In SEC v. Levin, the United States Court of Appeals for the Eleventh Circuit (“Eleventh Circuit”) held that the safe harbor provision of Regulation D’s Rule 508(a) is available to a defendant in a Securities and Exchange Commission (“SEC”) enforcement action based on a failure to register securities under Section 5 of the Securities Act.
FINRA allows for expedited arbitration proceedings in cases involving senior and seriously ill parties. While there is no specific rule within the Code of Arbitration Procedure, once FINRA determines that a matter involves an elderly or ill party, the case is flagged as an expedited case. FINRA then endeavors to complete the arbitration process as quickly as possible. FINRA recently formed a committee to determine how to process expedited cases more efficiently.
FINRA released Regulatory Notice 16-25 reminding broker dealers that claimants have a right to request arbitration through FINRA at any time and do not forfeit that right by signing any agreement with a forum selection provision specifying another dispute resolution process or an arbitration venue other than the FINRA arbitration forum.
FINRA recently authorized filing with the SEC two proposed amendments to rules from the Code of Arbitration Procedure for Customer Disputes and Industry Disputes. The rules affect chairperson eligibility in arbitration and the arbitrator panel selection process.
FINRA issued Regulatory Notice 16-19 in an effort to encourage firms to review their practices regarding stop orders. Registered representatives often recommend stop orders as a tool for managing market risk. Investors use stop sell orders to protect profit position in the event a stock’s price declines and stop buy orders if they have a short position to limit losses in the event a stock’s price increases. Once stop orders are triggered, they become market orders, which are inherently risky, especially in volatile market conditions.
The SEC recently approved the adoption of FINRA Rule 2273 which creates an obligation to deliver educational communication in connection with firm recruitment practices and account transfers. The new rule affects financial firms that want to recruit the former clients of newly hired representatives.
