FINRA Lawyer Blog

SEC BRINGS FIRST CHARGES FOR VIOLATION OF REGULATION BEST INTEREST

June 23, 2022 | Herskovits, PLLC

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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:

ELON MUSK AND MARK CUBAN FILE AMICUS BRIEF URGING SUPREME COURT TO TAKE UP THE SEC GAG RULE

June 3, 2022 | Herskovits, PLLC

Since 1972 the Securities & Exchange Commission (the “SEC”) has maintained a rule that imposes a gag order on settling defendants in civil enforcement actions. In 2003, Barry D. Romeril, CFO for Xerox, entered into a consent agreement with the SEC that included the following language:

“Defendant understands and agrees to comply with the [SEC]’s policy ‘not to permit a defendant . . . to consent to a judgment or order that imposes a sanction while denying the allegation in the complaint . . . .’ 17 C.F.R. § 202.5. In compliance with this policy, Defendant agrees not to take any action or to make or permit to be made any public statement denying, directly or indirectly, any allegation in the complaint or creating the impression that the complaint is without factual basis. If Defendant breaches this agreement, the [SEC] may petition the Court to vacate the Final Judgment and restore this action to its active docket. Nothing in this paragraph affects Defendant’s: (i) testimonial obligations; or (ii) right to take legal or factual positions in litigation in which the [SEC] is not a party.”

Language to this effect is in every consent agreement with the SEC. The CFTC and FINRA also place substantively identical injunctions regarding what defendants can say about their cases once they settle.

FINRA HITS AN FA FOR RUNNING A SUBSCRIPTION-BASED INVESTOR WEBSITE

May 20, 2022 | Herskovits, PLLC

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On May 16, 2022, FINRA published an Acceptance, Waiver and Consent (“AWC”) in which FA, Robert Bennett Zamani, accepted a 14-month suspension and a $27,500 fine for violations of FINRA Rule 3270 (Outside Business Activities), Rule 2210 (Communications with the Public), Rule 4511 (Books and Records) and, as always, Rule 2010 (Standards of Commercial Honor). The investigation of Zamani was triggered by a Form U5 filed by his former firm, Morgan Stanley.

The Rule 4511 violation was based on Zamani’s alleged use of business-related text messages that were not retained by Morgan Stanley, effectively causing Morgan Stanley to violate its obligation to maintain such communications under Rule 4511. This is an easily avoidable rule violation that many FAs fall prey to.

More interesting, however, are Zamani’s alleged violations of 3270 and 2210. Zamani formed a company in 2015 before becoming associated with Morgan Stanley. Without ever disclosing the company to Morgan Stanley, between January 2017 and April 2020, Zamani, through this company, offered subscription-based investment content. On its website, which was established and operated by Zamani, the company touted itself as a subscription-based platform providing investment content for aspiring day traders to “learn from professionally licensed stock traders the skills needed to become a profitable trader.” The company maintained a blog on its website, containing investment-related content, and maintained a publicly-available YouTube channel, with investment-related videos and distributed periodic newsletters to subscribers. Remarkably, during that 3-year stretch, Zamani earned $360,000 from his subscriber-based investment advice company.

FINRA RELEASES PAPER REGARDING EXPUNGEMENT OF CUSTOMER COMPLAINTS

May 11, 2022 | Herskovits, PLLC

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On May 6, 2022, FINRA released a “Discussion Paper – Expungement of Customer Dispute Information” (the “Discussion Paper”) to address what FINRA clearly sees as problems with the current system for expunging customer complains. Let’s be clear from the outset, FINRA is openly hostile to the expungement of customer complaint information. FINRA is particularly hostile to what they describe as “straight-in” expungement arbitrations where the financial advisor seeks expungement by naming their firm as the respondent (typically after a customer arbitration has settled).

As many practitioners know, FINRA passed an amendment, effective September 14, 2020, establishing a minimum filing fee for expungement arbitrations. The Discussion Paper touts the success of this amendment in reducing the number of straight-in expungement actions by 37% between 2019 and 2020. Thus, FINRA makes it clear that its goal is reduction of expungement claims rather than making sure the claims have merit.

The tone of the Discussion Paper starts off somewhat defensive as FINRA makes sure to let the public know how few expungements are actually awarded every year. Between January 2016 and December 2021, approximately 8 percent of financial advisors registered with FINRA had a customer dispute disclosure on their record and only 1 in 10 had customer dispute information expunged during that time period. If expungement of customer dispute information is so rare, it is hard to understand why FINRA has as they put it, “engaged in longstanding efforts with NASAA and state securities regulators to explore a redesign of the current expungement process.” I recently blogged about the Alabama Securities Commission’s (“ASC”) intervention into an expungement award confirmation proceeding and the ASC’s very dim view of the “straight-in” expungement process. In light of the intervention and then the subsequent release of this Discussion Paper, it seems likely that more state regulators than just Alabama are unhappy with the current expungement system.

STATE SECURITIES REGULATOR MOVES TO VACATE A FINRA ARBITRATION EXPUNGMENT AWARD

May 5, 2022 | Herskovits, PLLC

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At a FINRA arbitration in September 2021, Mr. Kent Kirby, a financial advisor at UBS Financial Services, Inc., sought the expungement from CRD of five customer complaints spanning a time frame from 2002 through 2011. Mr. Kirby was successful in obtaining an award expunging all five occurrences despite the fact that one customer opposed the expungement in a pre-hearing brief and at the hearing. In a detailed award, the arbitrator found that each of the claims against Mr. Kirby were “factually impossible or erroneous” as required by FINRA Rule 2080(b)(1)(A) and “false” as required by FINRA Rule 2080(b)(1)(c). Mr. Kirby then filed an action in the Circuit Court of Palm Beach County, Florida to confirm the award. Kent Kirby v. FINRA, Case No. 50-2021-CA-013816 (15^th Judicial Cir., Palm Beach County, FL).

Many are familiar with FINRA Rule 2080, which involves the expungement of customer complaint information from a registered representative’s Form U4 and from the Central Registration Depository (“CRD”). Rule 2080 requires any arbitration award granting expungement of customer complaint information to be confirmed by a court order. In addition, the rep must name FINRA as a part to the court proceeding or request FINRA to waive that requirement.

What many practitioners may not know is that when FINRA receives a request for a waiver, it takes that request, along with accompanying documents, and sends it to all of the state regulators in each state where the individual is registered. See https://www.finra.org/registration-exams-ce/classic-crd/faq/finra-rule-2080-frequently-asked-questions

FINRA RULE 3280: WHAT DOES IT MEAN TO “PARTICIPATE” IN A PRIVATE SECURITIES TRANSACTION?

April 25, 2022 | Herskovits, PLLC

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Most financial industry professionals are familiar with the prohibition on “selling away,” the somewhat ambiguous term contemplated by FINRA Rule 3280. FINRA Rule 3280 states that, “[n]o person associated with a member shall participate in any manner in a private securities transaction except in accordance with the requirements of this Rule.” Among other things, the Rule requires a financial advisor to provide written notice prior to participating in a private securities transaction even when the financial adviser receives no compensation.

While it is generally understood that FAs cannot sell securities to customers that are not offered by their broker-dealer without first receiving permission from the broker-dealer, much of the guidance around this rule focuses on what qualifies as a private securities transaction (a term that is arguably poorly defined in the Rule). Many financial advisers, however, are unaware of how broadly FINRA interprets what it means to “participate” in a private securities transaction.

FINRA recently made a determination (not yet publicly released) that a registered representative “participated” in a private securities transaction because he; a) set up a zoom conference call between the outside fund manager and the investor, b) forwarded the original offering materials to the investor, and c) forwarded amended offering materials approximately a year after the original investment.

GAG ORDERS USED BY FINRA UNDER REVIEW BY SCOTUS

April 19, 2022 | Herskovits, PLLC

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When settling a FINRA investigation, the Staff drafts a letter of Acceptance, Waiver and Consent (AWC) setting forth the terms of the settlement. In the AWC, FINRA routinely demands the settling party consent to the following restraint on speech:

“Respondent may not take any action or permit to be made any public statement, including in regulatory filings or otherwise, denying directly or indirectly, any finding in this AWC or create the impression that the AWC is without factual basis.”

A matter before the U.S. Supreme Court may upend FINRA’s use of a gag order.

HERSKOVITS PLLC INVESTIGATES DEFERRED COMP CLAIMS FOR FORMER MORGAN STANLEY ADVISORS

April 3, 2022 | Herskovits, PLLC

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Herskovits PLLC is investigating whether Morgan Stanley unlawfully “forfeited” deferred compensation otherwise due and payable to financial advisers formerly employed by the firm. A class action lawsuit involving similar claims has begun in the U.S. District Court for the Southern District of New York. That litigation is in its early stages and may carry on for years before a resolution is reached.

Morgan Stanley’s Deferred Compensation Plan

Morgan Stanley compensates FAs based on revenues generated from the FA’s customers’ accounts. Morgan Stanley typically defers a portion of the fees generated as “deferred compensation” and allocates a substantial percentage of the FA’s deferred compensation to the Morgan Stanley Compensation Incentive Program. 75% of the deferred compensation vests over a six-year period and 25% vests over a four-year period. However, Morgan Stanley “cancels” the deferred compensation if the FA leaves Morgan Stanley prior to the vesting dates.

FINRA Enforcement Puts Chief Compliance Officers on Notice

March 22, 2022 | Herskovits, PLLC

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On March 17, 2022, FINRA released Regulatory Notice 22-10.

The regulatory guidance discusses the application of FINRA Rule 3110 – Supervision — as it relates to Chief Compliance Officers (“CCOs”). The notice begins by making it clear that, as a general matter, supervision is the responsibility of the senior business management and compliance personnel serve in an advisory role rather than supervisory. FINRA notes however, that it will bring enforcement actions against CCOs in circumstances when a firm has expressly or impliedly designated its CCO as having supervisory responsibility.

FINRA explains that a CCO may have supervisory responsibility in a number of ways. For example, the CCO may have dual roles as both CCO and business management. The CCO as management would have a responsibility to supervise or delegate such supervision under Rule 3110. A firm may also designate its CCO as a supervisor as part of its written supervisory procedures. A firm’s president or CEO could also “expressly or impliedly” designate the CCO as a supervisor over a particular issue on an ad hoc basis or for exigent circumstances.

Will We See a Spike in Margin Liquidations Due to SEC Guidance?

March 15, 2022 | Herskovits, PLLC

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We are all painfully aware of the recent volatility in the markets, which has not gone unnoticed by the SEC. On March 14, 2022, the Staff of the Division of Trading and Markets stated that “broker-dealers should collect margin from counterparties to the fullest extent possible in accordance with any applicable regulatory and contractual requirements.” We shall see whether Wall Street acts upon the SEC’s guidance, and whether investors are caught flat-footed by stepped-up maintenance margin requirements.

Regulatory and Contractual Requirements

The regulatory requirements for margin are set forth in FINRA Rule 4210. Although the rule is lengthy, and incorporates other rules including Federal Reserve Board Regulation T, the essence of the rule allows a broker-dealer to lend a customer up to 50% of the total purchase price of an eligible stock. A margin call may be issued if the margin account falls beneath the maintenance margin requirements (generally 25% of the current market value of the securities in the account) or if the margin account falls below the firm’s “house” maintenance margin requirements (which can be substantially higher than 25%). Brokerage firms can, and often do, upwardly adjust “house” maintenance margin requirements if the firm has risk concerns relating to outstanding margin loans. Most margin account agreements specifically permit broker-dealers to increase maintenance margin requirements at the sole discretion of the firm. In light of the SEC’s recent guidance, it seems likely that broker-dealers will act upon its contractual rights and demand enlarged collateral from customers to protect its margin loans.

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