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fact-check
The North American Securities Administrators Association (NASAA) recently released its Enforcement Report for 2012. A copy can be found here.

NASAA is an association primarily comprised of state securities regulators. Through the association, its members engage in multi-state enforcement actions and other collaborative activities. NASAA’s Enforcement Section tracks trends in securities fraud and oversees the activities of various Project Groups, including: Internet fraud investigations, oil/gas ventures, Reg D investigations, securities investigation database and enforcement zones.

The Enforcement Report contains a multitude of interesting statistics. According to NASAA:

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On October 24, 2012, Susan Axelrod (FINRA’s executive vice president, member regulation sales practice) spoke at PLI’s seminar for broker-dealer regulation and enforcement. Broker-dealers and registered representatives should take note because FINRA’s enforcement agenda was made clear. Issues of concern for FINRA include:

Cyber Security

FINRA has seen an uptick in instances where a customer’s email account has been hacked and the perpetrator sends a phony email to a brokerage firm requesting an outbound wire transfer. Given that NASD Rule 3012 requires diligent supervision concerning the outbound transmittal of funds, FINRA requested that “broker-dealers reassess their policies and procedures for accepting instructions to withdraw or transfer funds via electronic means to ensure that they are adequately designed to protect customer accounts from the risk that customers’ email accounts may be compromised and used to send fraudulent transmittal or withdrawal instructions.” (FINRA Regulatory Notice 12-05). In that Notice, FINRA recommended that firms verify that the email was sent by the customer and adopt policies to identify “red flags” such as transfer requests that are out of the ordinary or to an unfamiliar third-party account.

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FINRA recently released an Acceptance, Waiver and Consent signed by Deutsche Bank Securities, Inc. (FINRA Matter No. 2010023096302). The AWC is instructive because it speaks to supervisory review of electronic correspondence and should be considered by broker-dealers when crafting a lexicon-based search system for electronic correspondence.

Background Facts

Deutsche Bank’s Private Client Services division has 16 offices with approximately 240 registered representatives. Deutsche Bank’s Boston office employed a registered representative who engaged in questionable conduct, including: borrowing $220,000 from a customer, issuing personal checks totaling $860,000 which were returned for insufficient funds, failing to repay the customer loan in full, failing to obtain Firm approval to borrow from a customer, and charging personal expenses to a corporate credit card.

In Fidelity Brokerage Services LLC v. Morgan Stanley Smith Barney LLC and Brian Wilder(FINRA Arbitration No. 11-03937), a FINRA arbitration panel found against respondents and annexed a 25 page Arbitrators’ Report to the Award which excoriated respondents for misappropriation of trade secrets (Fidelity’s customer list) among other violations. The Award stands out for various reasons, including the punitive damages awarded against Morgan Stanley and the sizable attorneys’ fees awarded to Fidelity. Most interesting, however, is the Arbitrators’ Report itself, which carefully applied the facts to the law and is a must-read for any broker who may be considering jumping ship from a firm which is not a signatory to the Protocol for Broker Recruiting.

Facts of the Case

The underlying facts are straightforward. The rep had an employment agreement with Fidelity which contained non-solicitation and confidentiality clauses. The confidentiality clause stated that customer lists and contact information were deemed to be trade secrets by Fidelity. Prior to leaving Fidelity, the rep met with counsel and created a list of customer contact information purportedly in conformity with the Protocol for Broker Recruiting even though Fidelity is not a signatory to the Protocol. Upon leaving Fidelity, the rep began calling his former customers to inform them of his new employment and sent ACAT forms to a sub-set of his former customers.

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Two recent FINRA arbitration awards highlight increased focus by FINRA arbitrators concerning discovery abuses by litigants. FINRA’s rules require cooperation of the parties in discovery (Rule 12505) and specifically empower the arbitrators to issue sanctions for lack of cooperation, failing to comply with the discovery rules, or frivolously objecting to the production of documents or information (Rule 12511). Rule 12511 also permits the panel to dismiss a claim, defense or proceeding if prior warnings or sanctions have proven ineffectual.

Miriam Dean v. Wells Fargo Advisors, LLC (FINRA Arbitration No. 11-03911)

Although the power to dismiss a claim is in the rule book, until recently, you would be hard pressed to find an award which exercised that power. That changed with Miriam Dean v. Wells Fargo Advisors, LLC (FINRA Arbitration No. 11-03911), wherein the customer asserted claims in connection with an investment in a reverse convertible note. Apparently, the customer ignored the first discovery order. Somewhat miffed by the customer’s non-compliance, the arbitrator issued a second order giving the claimant the following 3 options:

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FINRA issued its summary of disciplinary actions reported for June 2012. Certain actions are noteworthy and are indicative of regulatory trends effecting broker-dealers and registered representatives.

Herskovits PLLC comments on the following regulatory actions:

Net Cap Violations

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The Financial Industry Regulatory Authority (FINRA) views its mandate as investor protection and as such, they have given notice that a new suitability rule, Rule 2111, will go into effect on July 9, 2012.

As long as there have been investors and brokers, there have been people who take advantage and people who are taken advantage of. This rule codifies a standard that FINRA thinks is best for the investing public by imposing more stringent regulations on securities that a broker recommends to buy/sell, including those within a client’s existing portfolio. Rule 2111 has significant implications for broker-dealers who maintain retail brokerage accounts. The rule by its own terms, carves out institutional accounts: So if you are a broker-dealer that sells to hedge funds, this is not a game changer. But if you are selling to Main Street as opposed to Wall Street, then this is a very significant rule.

The new rule contains three guiding principles. Each recommendation must have:

Regulators are examining whether Morgan Stanley, the investment bank that shepherded Facebook through its highly publicized stock offering last week, selectively informed clients of an analyst’s negative report about the company before the stock started trading.

Rick Ketchum, the head of the Financial Industry Regulatory Authority, the self-policing body for the securities industry, said Tuesday that the question is “a matter of regulatory concern” for his organization and the Securities and Exchange Commission.

The top securities regulator for Massachusetts, William Galvin, said he had subpoenaed Morgan Stanley. Galvin said his office is investigating whether Morgan Stanley divulged to only some clients that one of its analysts had cut his revenue estimates for Facebook before the stock hit the market on Friday.

French investors urged New York’s top court on Wednesday to reinstate their lawsuit over losing $43 million out of $50 million they put into two structured investment vehicles.

The investors claim Barclays Bank, Standard & Poor’s and two management companies were complicit in leaving investors with plummeting securities shortly before the Wall Street collapse. Oddo Asset Management claimed collateral managers Avendis Financial Services Ltd. and Solent Capital Ltd. conspired with Barclays in early 2007 to transfer subprime mortgage-backed securities from Barclays to the two vehicles.

The investors also claimed S&P was complicit by confirming inflated note ratings for Golden Key Ltd. and Mainsail II Ltd.

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