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FINRA’s Office of Hearing Officers recently rendered a decision on an issue of first impression in Dep’t of Enforcement v. NYPPEX, LLC, et al., (Disc. Proc. No. 2019064813801).  Enforcement charged FINRA member firm, NYPPEX, LLC, its former CEO, Laurence Allen, and its CCO, Michael Schunk, with numerous violations of FINRA rules. The charges stemmed from Respondents’ conduct in the wake of a temporary restraining order issued by a New York state court against Allen.  Among other things, the order, obtained at the behest of the Office of the Attorney General for the State of New York (“NYAG”), enjoined Allen from engaging in securities fraud and violating New York’s securities laws. Enforcement took the position that the TRO rendered Allen statutorily disqualified from continued association with a FINRA member firm.  Allen could have remained associated with the Firm if it applied for, and received, FINRA’s permission pursuant to FINRA Rule 9520.  Allen’s supervisor, Schunk, however, purportedly let Allen continue as an associated person at NYPPEX for over a year without seeking a waiver from FINRA.

FINRA’s disciplinary proceeding was triggered by the ex parte TRO.  After a two-year investigation, in December 2018, the NYAG commenced an action under Article 23-A of New York’s General Business Law, known as the Martin Act, against Allen and certain others.  The NYAG applied on an ex parte basis for preliminary injunctive relief against Allen, NYPPEX Holdings, and others under Section 354 of New York’s General Business Law.  The NYAG stated that a preliminary injunction was warranted because of the allegations of fraud and fraudulent practices by Allen and his refusal to produce documents or appear for testimony.  In December 2018, the Supreme Court of the State of New York granted the NYAG the relief it sought and issued the TRO without hearing from Allen or NYPPEX.  Allan was served with the Order in January 2019 and Schunk learned about it that month as well.

On December 4, 2019, the NYAG filed a complaint in the New York Supreme Court against NYPPEX, Allen and others (Index No. 452378/2019).  In February 2020, the New York Supreme Court concluded a five-day hearing and issued a preliminary injunction prohibiting Allen and NYPPEX from, among other things, violating the Martin Act and from “facilitating, allowing or participating in the purchase, sale or transfer of any limited partnership interest in [the fund].”  At this point in time, NYPPEX filed an MC-400 seeking permission for NYPPEX to remain associated with a disqualified person, Allen.  FINRA Enforcement, however, argued that Allen became statutorily disqualified when the TRO was issued in 2018, more than a year before NYPPEX filed the MC-400 Application.

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On September 19, 2022, the SEC’s Division of Examination issued a Risk Alert concerning the new investment adviser marketing rule, Advisors Act Rule 206(4)-1 (“the Marketing Rule”).   In connection with the Marketing Rule, the Commission also amended the Books and Records Rule, Advisors Act Rule 204-2 and the Form ADV.  The Marketing Rule became effective on May 4, 2021 but firms were given an 18-month transition period.  Thus, firms must be compliant with the Marketing Rule by November 4, 2022.

According to the Staff’s announcement, examinations will focus on four areas: a) Policies and Procedures, b) the Substantiation Requirement, c) Performance Advertising Requirements, and d) Books and Records

With regard to policies and procedures, the Commission’s noted that the Marketing Rule Adopting Release, stated that firms must adopt procedures that, “include objective and testable means” of preventing violations of the Marketing Rule.  Examples of such means are:

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On September 6, 2022, the SEC issued an order instituting administrative and cease-and-desist proceedings against Perceptive Advisors LLC (“Perceptive”) a New York based investment adviser.  In anticipation of the institution of the proceedings, Perceptive and the SEC entered into a Settlement.

Perceptive provides investment advisory advice to pooled investment vehicles and according to its March 31, 2022 Form ADV it had approximately $10.36 billion in assets under management.  One of Perceptive’s investment vehicles is the Perceptive Life Sciences Master Fund, Ltd. (the “PSLM Fund”).

The gravamen of the SEC’s order revolves around Perceptive’s activities concerning special purpose acquisitive companies (“SPACs”).  A SPAC is generally a publicly-traded, shell company which raises money, through an IPO, for the purpose of acquiring other, privately held companies.  SPAC’s have “sponsors” that launch the IPO and generally manage the business of the SPAC, including the process of acquiring target companies.  The sponsor is typically compensated on a percentage (often 20% to 25%) of the SPAC’s initial public offering proceeds (in the form of discounted shares and, at times, warrants).  This compensation is sometimes referred to as the sponsor’s “promote” or “founder shares,” and it is received upon completion of a SPAC’s acquisition of a target company.

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On August 23, 2022, FINRA published an AWC reflecting a settlement with ViewTrade Securities, Inc.  The AWC alleges that ViewTrade failed to establish and implement written AML policies and procedures that could reasonably detect and cause the reporting of suspicious transactions in violation of FINRA Rule 3310.  FINRA Rule 3310 requires that each member firm develop and implement a written AML program reasonably designed to achieve and monitor the member’s compliance with the requirements of the Bank Secrecy Act (31 U.S.C. 5311, et seq.) (BSA).  Rule 3310(a) further requires firms to, “[e]stablish and implement policies and procedures that can be reasonably expected to detect and cause the reporting of transactions required under [the BSA]  . . . . ”  The regulations implementing the BSA, in turn, require every broker-dealer to file a Suspicious Activity Report (“SAR”) with the Financial Crimes Enforcement Network any time they detect, “any suspicious transactions relevant to a possible violation of law or regulation.”

FINRA’s past guidance on this issue (NTM 02-21 and Regulatory Notice 19-18) advised firms to look for red flags and provided several examples:

  • Customers’ mailing address is associated with multiple other accounts or business that do not appear related,

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FINRA recently released Regulatory Notice 22-18, reminding firms about their obligation to supervise registered representatives to prevent falsification of digital signatures.  FINRA’s guidance comes on the heels of multiple investigations concerning instances when registered representatives forged or falsified client signatures on account transfer documentation or on disclosure forms, “acknowledging a products alignment with the customer’s investment objective and risk tolerance . . . .”

FINRA’s notice explains the varied methods used to forge or falsify electronic signatures and how firms can thwart such forgeries or detect them after the fact.  Generally, electronic signatures have an audit trail with identifying information such as the recipient’s IP address and e-mail address.  Financial advisors have been admonished for sending documents to their personal e-mail addresses or to an assistant to sign the documents themselves.  Firms also found instances where documents were sent to an IP address that was the same as the registered representative or that was inconsistent with the customer address on file.  Sometimes representatives sent e-mails to the e-mail address associated with an outside business activity.  FINRA’s guidance recommends that firms review correspondence to look for these red flags.

FINRA reports that, in some cases, administrative staff raised issues to management about pressure by representatives to manipulate the digital signature process.  FINRA encourages training for such staff to encourage them to resists such pressure.

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What is a securities dealer?  The answer is more complicated than people might think.  On August 2, 2022, the SEC announced that it had reached a settlement with a Long Island firm, Crown Bridge Partners, LLC (“Crown Bridge”) and the two brothers who owned the firm Soheil and Sepas Ahdoot, for failing to register as a dealer.  As part of the settlement, the Defendants agree to pay disgorgement and prejudgment interest of $8,390,601.27 and a civil penalty of $810,307, and to a five-year penny stock bar.

According to the SEC’s complaint, Crown Bridge purchased approximately 250 convertible notes from approximately 150 penny stock issuers.  In all, during the Relevant Period, Crown Bridge sold into the public markets approximately 35 billion shares of unrestricted, post-conversion shares of penny stock issuers, for millions of dollars in profits.  Soheil and Sepas initially found companies interested in issuing convertible notes by reviewing OTCMarkets.com, a website that includes a news feed of SEC filings and press releases from penny stock issuers.  They used the website to identify issuers that appeared to need or had expressed a need for financing. They then cold called the issuers directly.  Over time, as Crown Bridge grew its business and became known in the industry, issuers, brokers, and finders reached out directly to Soheil and Sepas to seek funding.

Absent their apparent failure to register Crown Bridge as a Dealer under Exchange Act Section 15(a) [15 U.S.C.§ 78o(a)], Soheil and Sepas executed what appears to have been a very shrewd and successful business plan.  Crown Bridge purchased convertible notes directly from penny stock issuers.  They negotiated the terms of the notes that led to millions of dollars in profits when the notes were converted into shares of stock.  The notes typically contained terms that were highly favorable to Crown Bridge and reduced Crown Bridge’s exposure to market risk such as a conversion discount ranging from 25% to 50% to the prevailing “market price,” a term the notes typically defined as the lowest trading price, or lowest closing bid price, of the issuer’s common stock during the 10 to 25 days on or before the date of the conversion notice.  Also critical was Crown Bridge’s right to convert the notes in increments, enabling Crown Bridge to convert what it could sell immediately, while shielding the remaining balance from exposure to market price movements.

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On July 15, 2022, FINRA filed Regulatory Notice 22-15 and announced the amendment of its Code of Arbitration for Industry Disputes to conform to the Ending Forced Arbitration of Sexual Assault and Sexual Harassment Act of 2021, Pub. L. No. 117-90, 136 Stat. 26 (2022).  The amendments permit person with claims of sexual assault or sexual harassment to pursue those claims in court irrespective of any agreements otherwise mandating arbitration.

Background

FINRA members historically forced employees to arbitrate claims of sexual harassment or assault by use of agreements containing pre-dispute arbitration clauses.  The pre-dispute arbitration clauses were typically contained within a Form U4, employment agreements or provisions within an employee manual that the employee was bound by.

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Practitioners are familiar with the fact that a failure to respond to a FINRA Rule 8210 request almost automatically results in an industry bar.  Except when it doesn’t.  The Office of Hearing Officers (the “OHO”) recently published a decision in which it discussed what the Hearing Officer referred to as a “partial but incomplete response” to FINRA’s requests for testimony.

In March, the OHO rendered a decision against Jason DiPaola who was accused by FINRA Enforcement of taking discretion in his mother’s E-trade account without written instructions and without disclosing the account to his employer Chardan Capital Markets, LLC (“Chardan”) in violation of NASD Rule 3050.   Dep’t of Enforcement v. DiPaola, Discip. Proc. No. 2018057274302 (OHO Mar. 25, 2022).  The OHO, however, claimed that the “most serious allegation” was DiPaola’s failure to appear and provide on-the-record (“OTR”) testimony.

DiPaola was not a trader at Chardan and had no retail customers.  DiPaola worked in the firm’s equity capital markets group.  DiPaola was first interviewed by FINRA Staff in January of 2018.  The Staff obtained account statements for DiPaola’s E-trade accounts and his mother’s E-trade account.  FINRA also obtained over a million e-mails from Chardan.

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On July 7, 2022, FINRA’s Office of Hearing Officers issued its decision in Dep’t of Enforcement v. Burford, Discip. Proc. No. 2019064656601 (OHO July 7, 2022).   Here, the Hearing Panel found that Burford caused no customer harm.  There was no evidence that Burford gained monetarily from his actions.  Burford was “polite, respectful, and cooperative” throughout the investigation and disciplinarily proceeding.  Nonetheless, the Hearing Panel refused to deem these factors “mitigating” and whacked Burford with a 6-month suspension – double the suspension sought by Enforcement – and $10,000 fine.  At its core, this is a case of registered representative alleged to have improperly taken instructions from a deceased customer’s widow.  This case highlights the perils of efforts by a financial adviser to assist an individual when those efforts skirt the policies of a broker-dealer.

Background Facts

Burford was registered with Hilltop Securities Independent Network, Inc.  In November 2019, Hilltop discharged Burford and filed a Form U5 alleging a “failure to follow firm policy regarding the death of a client.”

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In April 2018, the SEC proposed a new regulation that would govern the standard of conduct that applies when broker-dealers make recommendations to retail customers.  Specifically, the proposal sought to established an express best interest obligation that would require all broker-dealers and associated persons to act in the best interests of their retail customers at the time a recommendation is made without placing the financial or other interests of the broker-dealer or associated person ahead of the interests of the retail customer.

At the time, the Commission received over 6,000 comments on the proposed rule.  Ultimately, in July 2019, the SEC adopted Rule 15l-1(a) of the Securities Exchange Act of 1934 (“Reg BI”).  On June 15, 2022, the SEC filed the first complaint for a violation of Reg BI since it was enacted.  The SEC filed a complaint against Western International Securities, Inc. (“Western”) and five of its registered representatives for violating Reg BI in connection with the sale of high risk, illiquid and unrated debt securities known as L Bonds issued by GWG Holdings, Inc. (“GWG”).

Compliance with Reg BI consists of four components: the Disclosure Obligation, the Care Obligation, Conflict of Interest Obligation, and the Compliance Obligation.  Registered representatives must comply with the Disclosure Obligation and the Care Obligation, which include:

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