FINRA Proposes Update to Temper Expungement and Elder Abuse

FINRA’s Board of Governors recently voted to move ahead with two key initiatives for broker-dealers. One initiative would amend codes of arbitration to make it tougher for brokers to erase black marks from their public record. The proposal, which will be submitted to the SEC for approval, would incorporate existing guidance and best practices into the rules. The guidance reminds arbitrators that expungement is “an extraordinary remedy that should be recommended only under appropriate circumstances” and that “customer dispute information should be expunged only when it has no meaningful investor protection or regulatory value.” Ultimately, FINRA is trying to strike the right balance between transparency and eliminating information in a report about a broker that is either unfair or false.

The other initiative is meant to enhance protection for senior investors. The rule would require firms to obtain the name and contact information of a trusted person for the customer's account and allow firms to freeze funds in accounts of investors 65 and older when there is “reasonable belief” of financial exploitation. The proposal does not indicate precisely what constitutes a “reasonable belief” of exploitation.

Non-Traded Real Estate Investment Trusts (REITS): Danger for Retail Investors!

Are some investments so risky that they are virtually always unsuitable -- they should never be recommended -- to typical retail investors, regardless of risk tolerance?   Yes.  The purpose of this post is not to generate a list, but to focus on one particular investment that seems to fall into this category: non-traded real estate investment trusts (REITS).

According to a recent article, Fiduciary Duty and Non-Traded REITS by Craig McCann, non-traded REITS performed about as well over the past 25 years as "investing in short and intermediate term U.S. Treasury securities"  but, unlike U.S. Treasury securities non-traded REITS are illiquid and much more risky.  Not only that, non-traded REITS underperformed their traded REIT cousins.  McCann writes, "Investors in the 41 non-traded REITs that became traded REITS or were cashed out suffered $24.25 billion in underperformance."  "Non-traded REITS underperform traded REITS by approximately 6.8 percent annually."

What else is of concern about non-traded REITS? Investors pay a substantial up front fee, averaging 13.2%  This compares with mutual funds, which charge fees topping out at about 5%. 

McCann found that institutional investors tend to stay away from non-traded REITS.  He writes, "institutional investors almost never own material stakes in non-traded REITS." For retail (and institutional) investors interested in real estate there are ready alternatives, including a wide variety of mutual funds.

Non-traded REITS face the triple-whammy of being illiquid, expensive and performing poorly.  According to McCann, "Brokers and investment advisors may have a good-faith basis for recommending that a client make a focused real estate investment, but they cannot justify a recommendation to purchase a non-traded REIT."

Tips from the Guide for Legal Professionals: Elder Investment Fraud & Financial Exploitation

I offer helpful information from the "Pocket Guide for Legal Professionals, Elder Investment Fraud & Financial Exploitation" published and distributed by the Maine Office of Securities.

Asking About Financial Capacity -- Conservation Starters:

• Do you feel confident making financial decisions on your own?
• Who manages y our money day to day?  How is that going?
• Are you having any trouble paying your bills?
• Is anyone pressuring you to give them money?
• Do you receive a lot of solicitations by phone or mail?

Red Flags for Financial Exploitation:

• Senior moves away from existing relations and toward new associations with other "friends" or strangers
• Sudden appearance of previously uninvolved relatives claiming their rights to senior's affairs and possessions
• Abrupt changes to financial documents, such as POA, account beneficiaries, wills and trusts, or deeds
• Senior is accompanied by an overly protective caregiver who dominates the client
• Changes in the senior's behavior; suspicious, fearful, emotionally labile, or secretive
• Senior displays unexplained or unusual excitement over a financial windfall or prize check; may be reluctant to discuss details
• Noticeable neglect or decline in appearance or hygiene or the senior's basic needs are not being met

Vulnerability/ Risk Factors:

• Social isolation
• Bereavement
• Dependence on another to provide care
• Financial responsibility for an adult child or spouse
• Alcohol or drug abuse
• Depression or mental illness

SEC Issues Risk Alert Regarding Suitability of Structured Products in Retailed Sales

The SEC’s Office of Compliance Inspections and Examinations (“OCIE”) recently issued a “Risk Alert” highlighting deficiencies in broker-dealer supervision and compliance controls over retail Structured Securities Products (“SSP”) sales. SSPs are securities, often issued as corporate obligations of an affiliate of an underwriting broker-dealer. They derive their value from, and provide exposure to, a variety of underlying asset classes such as a single security, baskets of securities, indices, options, commodities, and/or foreign currencies. SSPs, which may or may not be listed on an exchange, typically have some form of embedded derivatives and may supply, among other things, principal protection, interest payments, or leveraged exposure to the referenced assets.

The Alert references deficiencies in the areas of suitability and supervision. In particular, OCIE found that all of the various examined firms failed to maintain or enforce adequate controls relating to determining the suitability of SSP recommendations and failed to conduct compliance and supervisory reviews of determinations by registered representatives of customer suitability in the SSPs, as required by internal controls.

Ultimately, the Alert offers some pointers for compliance by broker-dealers. It notes that broker-dealers should use the Alert as a chance to double-check supervisory and compliance procedures for general suitability criteria and especially for complex or structured products sold to retail customers. It also suggests that broker-dealers perform random internal audits to ensure compliance with its own rules.

FINRA Arbitration and Confidentiality: the Exception Not the Rule

Arbitration is typically "private" in the sense that there is no First Amendment right of the public to access to arbitration hearings or arbitration documents, but that doesn't mean that arbitration is strictly confidential either.  Just the opposite, confidentiality in arbitration is the exception not the rule, according to guidance available from FINRA here.

While arbitrators and FINRA staff have an obligation to "respect the privacy of the parties before whom they serve" and not to "personally disclose the details of arbitration proceedings" -- much the same obligation applicable to Judges and clerk's offices in civil litigation in court -- the parties themselves "are generally free to disclose details of their own proceeding as they see fit."  Arbitrators should rarely, if ever, grant orders requiring that everything pertaining to a dispute be kept confidential by the parties to the dispute.  So-called "blanket orders of confidentiality" may be entered only upon a showing of truly exceptional circumstances.

Although discovery in arbitration is often conducted according under agreed-to confidentiality orders, the parties may not always agree on what documents or information deserves to be treated as confidential.  When the arbitrators are called upon to decide whether particular information should be treated as confidential, they must engage in "a serious and case-by-case consideration of the issues."

Why? Unnecessary secrecy is burdensome and contrary to important public interests.  According to FINRA, "A ruling that documents are confidential may impose burdens and limitations on the receiving party, such as requiring special handling or limiting the ability of the party to discuss the documents with witnesses and others who may assist in developing the case. Likewise, such a ruling may keep regulatory officials from learning of conduct in violations of statutes and rules."

What factors should be considered?  According to FINRA, in considering questions about confidentiality, the arbitrator should consider such factors as:

1. Is the information so personal that disclosure would constitute an unwarranted invasion of personal privacy (e.g., an individual's social security number, tax return, or medical information)?
2. Is there a real threat of injury attendant to disclosure of the information?
3. Is the information proprietary containing confidential business plans and procedures or a trade secret?
4. Are there essential competing interests at stake that require confidential treatment of certain portions of the proceedings?
5. Is the information already public (e.g., has it previously been published or produced without confidentiality) or is it already in the public domain?
6. Would an excessively broad confidentiality order be against the public interest in disclosure? Keep in mind that securities arbitration is highly regulated by the Securities and Exchange Commission. The former SEC Director of Enforcement, William R. McLucas, has stated: "[P]rivate [securities] actions will continue to be essential to the maintenance of proper investor protection."
7. Are there first amendment or other issues which might be raised by excessive restrictions on the ability of parties to comment freely upon matters in which they are involved?
8. Would an unduly extensive confidentiality order impair the ability of counsel to represent other clients?

"Arbitrators should not routinely designate all discovery as confidential. Where confidentiality is appropriate, bear in mind that it should generally be accomplished in the least restrictive manner."

CFPB and SEC Jointly Issue a Consumer Advisory and Investor Bulletin on Diminished Capacity

The Consumer Financial Protection Bureau’s Office for Older Americans and the Securities and Exchange Commission’s Office of Investor Education recently issued a bulletin to help investors and consumers understand the potential impact of diminished capacity on their ability to make financial decisions and to encourage investors and consumers to plan for possible diminished financial capacity well before it happens.

The advisory bulletin makes the following recommendations to help avoid or minimize problems: (1) organize your important documents (this includes bank and brokerage statements and account information, mortgage and credit information, insurance policies, pension and other retirement benefit summaries, Social Security payment information and contact information for financial and medical professionals); (2) provide your financial professionals with trusted emergency contacts; (3) consider creating a durable financial power of attorney; (4) think about involving a trusted relative, friend, or professional; (5) keep things up to date; and (6) speak up if something goes wrong (i.e. if you ever think someone is taking advantage of you, or that you’ve been the victim of a fraud)

With regard to helping others who may have diminished capacity, the CFPB and SEC make the following recommendations: (1) have an open conversation about investments and other financial matters sooner rather than later; (2) help your relative or friend with managing finances; (3) if your family member or friend has named you to manage money or property, understand your responsibilities and how you can protect your loved one from financial exploitation. 

Finally, if you are someone who has been asked by a loved one or friend to help out with his or her finances, the CFBP and SEC notes you can do the following to help: (1) help with ongoing financial responsibilities (you may need to take on immediate tasks, such as helping to pay bills, arranging for benefit claims, preparing tax returns, or helping with investment decisions); (2) review their investment portfolio; (3) assess the riskiness of their investment portfolio; (4) contact their investment professional.

How Do I Find a Lawyer for a Securities Litigation or Arbitration?

According to the Financial Industry Regulatory Authority (FINRA), "You should consider hiring an attorney to represent you during the arbitration or mediation proceedings to provide direction and advice. Even if you do not choose to hire an attorney, brokerage firms are generally represented by an attorney. If you cannot afford an attorney, some law schools provide legal representation through securities arbitration clinics."

I agree.  At the very least "consider" hiring a lawyer if you have a securities or brokerage firm, insurance, or similar dispute!

How do you find a suitable lawyer?  For customers and brokerage firm employees, a great place to start is the Public Investors Arbitration Bar Association (PIABA).  PIABA's website includes a "FIND AN ATTORNEY" search tool that allows searches by state or zip code. 

Other options, suggested by FINRA on its website include:

• Consult with your lawyer, if you have one, about your options and whether you need a lawyer who specializes in securities arbitration or litigation.
• Call several bar associations to obtain a varied listing of lawyers in your area. Many lawyers will offer to consult with you initially for free or for a minimal fee.
• Broaden your list of potential securities lawyers by consulting directories of attorneys. The Martindale-Hubbell^® Law Directory can be found at many libraries or at at its website. It lists lawyers by state and jurisdictions. Some state and local bar associations also compile directories and may list attorneys according to specialty.

Other selective law directories include Chambers USA, Super Lawyers, Best Lawyers, and Avvo.  Attorneys are listed by location and practice area.

For customers with small claims and who are unable to afford a lawyer a number of law schools host securities law clinics.  Many of the law school clinics will only accept claims demanding less than $100,000 for claimants with a household income below $100,000, or where the customer has been unable to find counsel.  It never hurts to ask, however, since clinics offer pro bono (free) representation -- customers who may qualify and have a claim should consider representation through a clinic.  FINRA lists all the law school clinics here.