June is known for groundbreaking decisions. This year, in a thrashing of NEXT Financial's established practices with investors' personal information, an administrative law judge ruled NEXT violated privacy law and Reg S-P, described its actions in (effectively) "X-rated" terms, ordered NEXT to cease and desist these practices, and then fined the firm $125,000.
What did NEXT do? Nothing, the firm suggested, other firms didn't do. Among other things, NEXT assisted reps it was recruiting in transferring the reps' customer's personal confidential information--without obtaining prior consent of the customers.
Viewed somewhat differently, the firm confused its business recruiting slogan "the opportunity to be an owner," with its legal responsibilities to investors.
The Court found the arguments justifying these actions deficient. It rejected the argument that the "rep 'owns' the customer relationship;" that many other independent brokerage firms "do it;" that "delays" in account transfers mattered; or that the recent SEC proposal amending Reg S-P validates its actions.
Judge James Kelly described NEXT's violations in stark terms. The "proven misconduct is very serious," NEXT "acted extremely recklessly." The violations were "willful;" corrective actions were "reactive." The firm only curtailed its conduct after "the Commission's staff forced the issue."
The vast gulf between the views of NEXT and Kelly is clear and raises a basic, if impolite, question. Is the view represented in this decision the view of a single administrative law judge who misinterpreted the law and misunderstood the independent rep business model and the firm's motives? Or did NEXT stray so far out of bounds, and persist in doing so, that the tsunami of criticism heaped on by Kelly was justified? Two points stand out.
First, this decision does not alter the need to address the underlying issue: Clients must be able to choose, if they wish, to follow a departing rep from his current firm to his new firm. Reg S-P, especially when coupled with many state statutes, can make this more difficult. If customers are not assured this choice, many view Reg S-P as little more than window dressing for those abusive firm practices intended to block customers from following departing reps.
The SEC's proposal to amend Reg S-P, in part, offers relief for reps by letting them take some customer information upon departure, as long as the current firm invokes the exception.
While imperfect, this approach can lead to a more client-centric solution--one that substitutes the current firm-rep mud wrestling match for a technology-driven and client-focused best practice, that respects the legitimate business interests of B/Ds and RIAs, that discourages reps from stealing firm property, while ensuring customers are advised their rep has departed, so customers may choose to remain with the firm or depart with the rep.
Yet, this solution will not satisfy reps that still hang on to the central argument made by NEXT and championed by the Financial Services Institute (FSI). This argument maintains the SEC's interpretation of Reg S-P "came as a surprise to many independent contractor broker/dealer firms and their affiliated financial advisors who believed that the client relationship belongs to the advisor not the broker/dealer firm."
A "surprise?" Hardly. Kelly notes this argument is an outright rejection of the GLB Act and "more than twenty-five years" of regulatory opinion. If so, the real "surprise" is how those advocating for independent reps apparently overlooked established law and, curiously, the difference between a business practice and a legal responsibility.
The second point? Financial services re-regulation is in the Washington air. We can only hope NEXT is remembered for rebalancing the interests between investor privacy and investor mobility, and not the Judge's departing remark that, "NEXT does not recognize the wrongful nature of its conduct."
Knut A. Rostad
Deputy Chief Compliance and Public Affairs Officer
Rembert Pendleton Jackson
Falls Church, Virginia