FINRA Issues Guidance on Heightened Supervision for Persons with a History of Past Misconduct

Monday, June 11, 2018


To reiterate the supervisory obligations of FINRA member firms regarding associated persons with a history of past misconduct that may pose a risk to investors, FINRA recently published Regulatory Notice 18-15.
FINRA Rule 3110 (Supervision) requires member firms to establish and maintain systems to supervise activities of associated persons to comply with applicable securities laws and FINRA rules. Member firms have a fundamental obligation to implement a supervisory system that is tailored to the member firm’s business and addresses the activities of all its associated persons.
Notice 18-15 highlights particular instances where heightened supervision of an associated person may be appropriate. Firms are encouraged to adopt the practices that are outlined in Notice 18-15 to strengthen their supervisory procedures. Notice 18-15 is one of several FINRA initiatives focused on associated persons with a history of past misconduct that pose a risk to investors and the firms that employ them. These initiatives are designed to strengthen oversight through guidance, rule changes, and surveillance programs.
In Notice 18-15, FINRA instructs that a firm should routinely evaluate its supervisory procedures to ensure they are appropriately tailored for each associated person and consider, among other things, the person’s activities and history of industry and regulatory-related incidents. When an associated person of the firm has a history of industry or regulatory-related incidents, the firm must determine whether its standard supervisory and educational programs are adequate to address the issues such person’s history raises or whether the firm should develop tailored heightened supervisory procedures to address such issues. The failure to assess the adequacy of its supervisory procedures in light of an associated person’s history of industry or regulatory-related incidents will be closely evaluated in determining whether the firm itself should be subject to disciplinary action for a failure to supervise should that person be the subject of a future industry or regulatory related incident.

In short, firms can’t rely on ordinary garden variety supervisory processes and procedures when a broker has a pattern of misconduct. 

Blockchain, Digital Currencies, and Securities Regulation

Thursday, May 3, 2018


As with any new investment product or asset class, cryptocurrencies and related blockchain technology have been the subject of a great deal of investor interest and regulatory activity, particularly as bad actors have exploited public interest to peddle unsuitable investments or--even worse--perpetrate frauds.

A blockchain is a public, distributed ledger that is replicated and hosted on numerous computers, creating thousands of identical digital copies that give the system credibility and oversight needed to create a secure public list of an asset.  That list can describe things such as identification, contracts, or cryptocurrencies--scarce, virtual assets represented on a blockchain.  The most well-known cryptocurrency is Bitcoin.  Other popular cryptocurrencies include Dash, Monero, Litecoin, Ethereum, and Ripple.  Blockchain technology is also sometimes referred to as distributed ledger technology (DLT) or distributed database technology. 

For regulatory purposes, federal agencies categorize cryptocurrency in different ways.  To the Internal Revenue Services it is property.  To the Commodity Futures Trading Commission it is a commodity.  The Securities and Exchange Commission says that cryptocurrency tokens can be a security. 

Many securities rules administered by the SEC and the Financial Industry Regulatory Authority (FINRA) are implicated by crytocurrency, as FINRA made clear in its report, "Distributed Ledger Technology: Implications of Blockchain for the Securities Industry" (March 2018)  For example,
  • a DLT application that seeks to alter clearing arrangements or serve as a source of recordkeeping by broker-dealers may implicate FINRA’s rules related to carrying agreements and books and records requirements;
  • DLT may have implications for trade and order reporting requirements to the extent it seeks to alter the equity or debt trading process; and
  • FINRA rules such as those related to financial condition, verification of assets, anti-money laundering, know-your-customer (suitability), supervision and surveillance, fees and commissions, payment to unregistered persons, customer confirmations, materiality impact on business operations, and business continuity plans also may to be impacted depending on the nature of the DLT application.
DLT applications are being used or tested within the equity, debt and derivative markets.

Unsurprisingly, investors have been attracted to blockchain related investments.  A new fundraising vehicle, the initial coin offering (ICO)--also called a "token generation event" or "initial token offering"--allows accredited investors (those with a net worth of more than $1 million) to bankroll the creation of a blockchain in exchange for payment cryptocurrency "coins" or tokens."  In 2017, more than 200 ICOs raised more than $4 billion.  The size and nature of ICOs vary greatly.

The SEC issued an Investor Alert: Public Companies Making ICO-Related Claims (August 2017) warning "about potential scams involving stock of companies claiming to be related to, or asserting they are engaging in [ICOs]"  According to the SEC, "Fraudsters often try to use the lure of new and emerging technologies to convince potential victims to invest their money in scams.  These frauds include 'pump-and-dump' and market manipulation schemes involving publicly traded companies that claim to provide exposure to these new technologies." 

The North American Securities Administrators Association advises investors considering putting money into an ICO to exercise "extreme caution" in its "Informed Investor Advisory: Initial Coin Offerings" (April 2018) as follows:
  • ICOs are very risky and are not suitable for many investors;
  • Use extreme caution when dealing with promoters who claim their ICO offering is exempt from securities registration yet do not ask about your income, net worth or level of investing sophistication; and
  • ask whether the “coins” or “tokens” are considered securities and whether the offering itself has been registered with appropriate securities regulators. 
State regulators, like the SEC, have engaged in active ongoing enforcement activity, including regulators in Texas, North Carolina, New Jersey, and Massachusetts.  Hey, let's be careful out there.

FINRA to Investors: Beware of "Regulator" Impostor Scams

Tuesday, February 27, 2018

The Financial Industry Regulatory Authority (FINRA) recently issued an Investor Alert, warning investors to beware of financial scammers posing as regulators.

Gerri Walsh, FINRA’s Senior Vice President for Investor Education warns, “Financial fraudsters go to great lengths to appear legitimate, making it difficult for investors to recognize their ruses.” “That’s why we are telling investors flat out that FINRA does not guarantee investments, and our officers play no role in facilitating investment opportunities. We want people to know that and to understand how they can verify who the real FINRA is.” 

Financial fraudsters have gone so far in recent times as to use FINRA’s name and logo in correspondence—and a fake signature from FINRA President and Chief Executive Officer Robert W. Cook—to create the impression that FINRA provided guarantees related to an investment opportunity that was, in fact, an advance-fee scam. 

One common fraudulent scheme involves luring investors into sending money to cover administrative or regulatory charges associated with a buyback of shares of stock that are generally worthless or underperforming. Once investors send the money, they never see it—or any money promised from the stock buyback—again. Sometimes, the con artists will ask for additional money or simply disappear. 

On other occasions, fraudsters send e-mails to unsuspecting individuals, purporting to originate from FINRA’s CEO, notifying potential victims that “approval has been granted for the release and payment of your outstanding inheritance fund.” The victim would be asked to fly to another country—outside of the jurisdiction of any U.S. regulator or law enforcement officer—to claim the “inheritance.” The victim is asked to provide personal information, including a copy of their passport—a common tactic used in phishing scams. 

To avoid losing money in these types of scams, FINRA advises investors to hang up on suspected fraudulent callers and delete e-mails from these individuals. Walsh adds, “If you’re unsure whether an investment solicitation is legitimate, do your own independent search for the official number for the government agency, office, or employee, and call to confirm its authenticity.” 

If an investor is suspicious about an offer or thinks the claims might be exaggerated or misleading, FINRA offers a Scam Meter tool to help investors assess whether an opportunity is too good to be true. FINRA also developed a Risk Meter, which determines if an investor shares characteristics and behavior traits that have been shown to make some individuals particularly vulnerable to investment fraud.

FINRA Proposes Special Procedure for Simplified Cases

Wednesday, February 21, 2018

The Financial Industry Regulatory Authority (FINRA) proposes to amend the Code of Arbitration Procedure for Customer Disputes and the Code of Arbitration Procedure for Industry Disputes to include a Special Proceeding for Simplified Arbitration. FINRA claims involving $50,000 or less would benefit by having an additional, intermediate form of adjudication that would provide the chance to argue cases before an arbitrator in a shorter, limited telephone hearing format. The Special Proceeding would be limited to two hearing sessions. 

The highlights: 

  • A Special Proceeding would be held by telephone unless the parties agree to another method of appearance 
  • The claimants, collectively, would be limited to two hours to present their case and 1⁄2 hour for any rebuttal and closing statement, exclusive of questions from the arbitrator and responses to such questions 
  • The respondents, collectively, would be limited to two hours to present their case and 1⁄2 hour for any rebuttal and closing statement, exclusive of questions from the arbitrator and responses to such questions 
  • Notwithstanding the above-mentioned conditions, the arbitrator would have the discretion to cede his or her allotted time to the parties; in no event could a Special Proceeding exceed two hearing sessions, exclusive of prehearing conferences 
  • The parties would not be permitted to question the opposing parties’witnesses 
  • A customer could not call an opposing party, a current or former associated person of a member party, or a current or former employee of a member party as a witness, and members and associated persons could not call a customer of a member party as a witness 

FINRA believes the proposed rule change would provide parties with claims of $50,000 or less with an additional, cost-effective hearing option for resolving disputes and limit the potential costs of a hearing and provide parties with the opportunity to present their case without cross-examination from their opponents.

The ability to present their case without cross-examination may benefit those who would otherwise be intimidated by a direct confrontation. FINRA believes that the broader role of arbitrators for a Special Proceeding in asking questions of the parties would serve a similar function to cross-examination, effectively charging the arbitrator with clarifying issues, and asking questions necessary to assess witness credibility.

FINRA 2018 Regulatory and Exam Priorities Released

Thursday, February 1, 2018

The Financial Industry Regulatory Authority (FINRA) recently released its 2018 Regulatory and Examination Priorities Letter (the “Priorities Letter”), highlighting topics FINRA will focus on in 2018.

FINRA regulates brokerage firms doing business with the public in the United States. FINRA writes rules; examines for and enforces compliance with FINRA rules and federal securities laws; registers broker-dealer personnel and offers them education and training; and informs the investing public. FINRA provides surveillance and other regulatory services for equities and options markets, as well as trade reporting and other industry utilities. FINRA also administers a dispute resolution forum for investors and brokerage firms and their registered employees. 

Some of the key topics identified in the Priorities Letter as areas of focus in 2018 are fraud, high-risk firms and brokers, operational and financial risks—including technology governance and cybersecurity—and market regulation. Other areas of priority in 2018 include: 
 
  • Sales practice risks, including recommendations of complex products to unsophisticated, vulnerable investors 
  • Protection of customer assets and the accuracy of firms’ financial data 
  • Market integrity, including best execution, manipulation across markets and products, and fixed income data integrity 

In the Priorities Letter, FINRA CEO Robert Cook wrote, “The coming year will bring both continuity and change in FINRA’s programs. . . . The continuity comes, first and foremost, in our unwavering commitment to our mission: protecting investors and promoting market integrity in a manner that facilitates vibrant capital markets. Change will come in how we accomplish that mission.” 

FINRA flags the following significant new rules that are currently scheduled to become applicable in 2018. 

  • Financial Exploitation of Specified Adults – FINRA Rule 2165 will become effective February 5, 2018. The rule permits members to place temporary holds on disbursements of funds or securities from the accounts of specified customers where there is a reasonable belief of financial exploitation of these customers. 
  • Amendments to FINRA Rule 4512 (Customer Account Information) – An amendment to FINRA Rule 4512 requires members to make reasonable efforts to obtain the name of and contact information for a trusted contact person for a non-institutional customer’s account. The amendment will become effective February 5, 2018. 
  • Amendments to FINRA Rule 2232 (Customer Confirmations) – The amended FINRA Rule 2232 requires a member to disclose the amount of mark-up or mark-down it applies to trades with retail customers in corporate or agency debt securities if the member also executes offsetting principal trades in the same security on the same trading day. The amended rule also requires members to disclose two additional items on all retail customer confirmations for corporate and agency debt security trades: (1) a reference, and a hyperlink if the confirmation is electronic, to a web page hosted by FINRA that contains publicly available trading data for the specific security that was traded, and (2) the execution time of the transaction, expressed to the second. These amendments are scheduled to become effective on May 14, 2018. 
  • Margin Requirements for Covered Agency Transactions (Amendments to FINRA Rule 4210) – FINRA’s new margin requirements for Covered Agency Transactions are slated to become effective June 25, 2018. Covered Agency Transactions include (1) To Be Announced (TBA) transactions, inclusive of adjustable rate mortgage (ARM) transactions; (2) Specified Pool Transactions; and (3) transactions in Collateralized Mortgage Obligations (CMOs), issued in conformity with a program of an agency or Government-Sponsored Enterprise (GSE), with forward settlement dates. Members are reminded that the risk limit determination requirements under the amendments to Rule 4210 became effective on December 15, 2016.

FINRA Proposes Amendments to the Codes of Arbitration Procedure Regarding Requests to Expunge Customer Dispute Information

Wednesday, December 27, 2017

Through Financial Industry Regulatory Authority (FINRA) Regulatory Notice 17-42, FINRA proposes establishing a roster of arbitrators with certain training, backgrounds, or experience to handle requests to expunge customer dispute information. These arbitrators would decide expungement requests where the underlying customer-initiated arbitration is not resolved on the merits (e.g., settled) or the associated person files a separate claim requesting expungement of customer dispute information.

FINRA also proposes additional changes to the expungement process, such as changes to the timeframe in which an associated person can seek expungement of the customer dispute information, as well as unanimous consent of a three-person panel of arbitrators to grant expungement.

This is one piece of a larger series of initiatives FINRA is considering related to the expungement process. Comments are requested. The comment period expires February 5, 2018.

FINRA Board Accused of Conflicts of Interest

Tuesday, December 5, 2017

As reported in InvestmentNews, the Public Investors Arbitration Bar Association (PIABA) issued a report asserting that certain “public governors” on the Financial Industry Regulatory Authority’s (FINRA) 24-person board serve on too many corporate boards and/or have connections to Wall Street such that they cannot represent the publicly effectively and face conflicts of interest.

FINRA is a self-regulatory organization which oversees thousands of broker-dealers on behalf of the Securities and Exchange Commission (SEC). It has 13 public governors, 10 industry governors and one seat for its CEO. The PIABA report notes that, under FINRA’s by-laws, its public governors shall not have any material business relationship with a broker or dealer or other self-regulatory organization.

PIABA states that, instead of bringing a customer-oriented view to the table, FINRA’s public governors “often provide additional representation for security industry constituencies.” PIABA also critiques the selection of public governors with ties to the security industry. It states, “In many instances FINRA’s public governors join the board after long careers in the securities industry. . . . Although some academics and former regulators do serve on FINRA’s board as public governors, the board only infrequently includes persons primarily identified as investor protection advocates. This absence is troubling for an organization that publicly characterizes itself as dedicated to investor protection.”

InvestmentNews also reports that a FINRA spokesperson defended the FINRA board and its public governors, noting that “Each governor, regardless of his or her affiliation or classification, is responsible for serving in an unbiased and objective manner, and voting on matters for the good of the investors, industry and marketplace.”