More On Legal & Compliancefrom The Advisor's Professional Library
- Proxy Voting RIAs are not required to vote proxies on behalf of their clients. However, when an RIA does assume responsibility for voting proxies, the firm’s policies and procedures should help to ensure that votes are cast in the best interest of clients.
- Preventing and Dealing with Client Complaints Although the SEC has not provided specific guidance on how client complaints should be handled, a firms policies and procedures should provide clear direction how to do so, as neglecting complaints can exacerbate a bad situation.
The Financial Industry Regulatory Authority (FINRA) marked on July 30 its five-year anniversary since it was created by the consolidation of the National Association of Securities Dealers (NASD) and the member regulation, enforcement and arbitration operations of the New York Stock Exchange (NYSE).
Quite a bit has happened in that five years, with, for instance, FINRA lobbying hard to become the self-regulatory organization (SRO) for advisors and legislation being introduced in the House Financial Services Committee to do just that.
Industry officials are still busy digesting another significant development—FINRA’s new suitability rule, Rule 2111, which took effect July 9. It not only puts more onerous due diligence requirements on BDs, but it also requires reps to take on what looks to be fiduciary responsibility—a development embraced by the advisory community.
A just-released midyear review by the law firm Sutherland, Asbill & Brennan finds that FINRA’s fines and disciplinary actions for 2012 are on track to “significantly outpace” those for 2011. The results of the review show that during the first half of 2012, FINRA ordered broker-dealers and associated persons to pay $39.4 million in fines.
“If fines continue to be assessed at this rate, 2012 will represent a 15% increase from the total fines reported by FINRA in 2011,” said Brian Rubin, a Sutherland partner. “Essentially, we are looking at a jump from $68 million in 2011 to projected fines of $78.4 million in 2012.”
FINRA also just launched a conflict-of-interest sweep, telling broker-dealers to compile a bunch of information and prepare for face-to-face meetings with FINRA exam personnel. While FINRA says the sweep is just a way to “better understand” BDs current practices, lawyers with BD clients suggest potential enforcement actions may be brewing.
FINRA must also consolidate the NYSE and NASD rulebooks, a project that has been ongoing for some time, but one that is nearly 90% completed, a FINRA spokesperson told AdvisorOne.
In marking its fifth birthday, FINRA highlighted seven areas of achievements, like in disciplinary actions and its focus on fraud. Here is FINRA's statement on what it claims to be its highlights over the past five years:
FINRA has acted to sanction firms and individuals who violated its rules and harmed investors. Since July 30, 2007, FINRA has brought 6,291 disciplinary actions and levied fines totaling $254.1 million. FINRA also ordered nearly $54.5 million in restitution to hurt investors. FINRA expelled 99 firms from the securities industry, barred 1,647 individuals and suspended 1,992 from association with FINRA-regulated firms. Some notable enforcement actions include the following:
- FINRA fined UBS $12 million for violations involving short sales. (October 2011)
- FINRA fined Goldman Sachs $22 million for violations related to trading huddles at the firm. (April 2012)
- FINRA fined 20 firms a total of $15.4 million involving sales of auction rate securities, and firms agreed to buy back more than $2 billion of frozen ARS from their customers.
- FINRA brought 23 actions with fines totaling $28.7 million related to the sale of subprime and mortgage-backed securities, and ordered $8.8 million in restitution.
- FINRA censured and fined Trillium Brokerage Services $1 million for using an illicit high-frequency trading strategy and related supervisory failures. (Sept 2010)
Focus on Fraud
In the aftermath of the financial crisis and significant frauds like those perpretrated by Bernie Madoff and Allen Stanford, FINRA took a look at its regulatory programs to focus on trying to make them more effective in identifying and fighting fraud. The organization made a number of critical enhancements as a result, including:
- Creating, in March 2009, the Office of the Whistleblower to expedite the review of high-risk tips by FINRA senior personnel and ensure a rapid response for tips believed to have merit.
- Establishing the Office of Fraud Detection and Market Intelligence (OFDMI), which was launched in 2009 to focus resources on the detection and investigation of suspected fraud, insider trading, microcap fraud and Ponzi schemes, and work to coordinate regulatory intelligence across the FINRA enterprise. OFDMI reviews incoming allegations of serious fraud, and serves as a centralized point of contact internally and externally on fraud issues. OFDMI has provided assistance to federal and state regulators in identifying numerous cases, many of them high-profile, involving insider trading, Ponzi schemes and microcap fraud. Since OFDMI was established, it has:
- referred more than 1,750 matters involving potential fraudulent conduct to the SEC or other federal or state law enforcement agencies; and
- made more than 775 referrals involving boiler rooms and microcap fraud, and more than 820 insider trading referrals to the SEC and other federal or state law enforcement agencies.
Revamped Exam Program
FINRA revamped its examination program to hopefully better detect potential fraud and focus on areas of greatest risk. In addition to examining each firm on site, it has continued to build out a surveillance program that monitors firms off site on a continuous basis, and has reshaped its ability to capture and leverage more granular operational and risk data to help better understand each firm's business model and the embedded risk of that model.
Furthermore, FINRA examiners place greater focus at the point of sale, increasing the number of branch exams and spending more time on site at the branch offices. FINRA also has increased the number of staff in district offices who are tasked with having an in-depth and ongoing understanding of specific firms, including increased real-time monitoring of business and financial changes.
In June 2010, FINRA completed the second stage of regulatory consolidation with the New York Stock Exchange by reaching an agreement with NYSE Euronext to assume responsibility for performing the market surveillance and enforcement for NYSE Euronext's U.S. equities and options markets—the New York Stock Exchange, NYSE Arca and NYSE Amex. FINRA already provided regulatory services to the NASDAQ Stock Market, NASDAQ Options Market, NASDAQ OMX Philadelphia, NASDAQ OMX Boston, The BATS Exchange and The International Securities Exchange.
As a result, FINRA is able to view aggregated trade data across 80% of the U.S. securities markets. FINRA also expanded the Order Audit Trail System (OATS) to include all National Market System (NMS) securities to create a uniform order audit trail to serve as a foundation for the cross-market surveillance program. FINRA is now performing cross-market surveillances, and this will allow FINRA to play an important role following the SEC's recent vote to adopt a consolidated audit trail through the development of an NMS plan.
In the wake of the 2010 Flash Crash, FINRA worked with the SEC and exchanges to develop and implement measures designed to address extraordinary market volatility issues. This collaboration resulted in the implementation of single-stock circuit breakers.
FINRA and the exchanges also proposed new standards for marketwide circuit breakers and a new limit up-limit down framework to replace the existing single-stock circuit breakers. In May of this year, the SEC approved these two proposals on a one-year pilot basis, which will be implemented next February. During the one-year pilot period, FINRA, the exchanges and the SEC will assess their operation and consider whether any modifications are appropriate.
FINRA has made several improvements in recent years to its free online tool to help investors research the professional backgrounds of brokers. In 2009, BrokerCheck was expanded to make records of all final regulatory actions against brokers permanently available to the public, regardless of whether brokers continue to be employed in the securities industry. A ZIP code search and centralized access to information about securities and investment advisory firms and their registered employees were also recently added to make BrokerCheck easier to use.
FINRA enhanced market transparency by expanding the Trade Reporting and Compliance Engine (TRACE) in March 2010 to include agency debentures and new issue transactions. In May 2011, TRACE was further expanded to include reporting of transactions in asset- and mortgage-backed securities for regulatory purposes.
In July 2012, the SEC approved a FINRA proposal to publicly disseminate so-called TBA transactions, and FINRA continues to evaluate additional dissemination as appropriate. Through the expansion of TRACE, the number of eligible securities has increased from 37,000 in 2007 to 1.4 million in 2012. Studies show transaction costs have been reduced, saving investors an estimated $1 billion per year, and mark-to-market valuation has improved.
In 2011, FINRA implemented a rule allowing investors to choose all-public panels in all customer cases with three arbitrators. Providing this option was an important step to enhance confidence in FINRA's arbitration process and gives investors an additional choice in selecting their arbitrators when they file claims.
In addition, in 2009, FINRA introduced a rule limiting motions to dismiss in arbitration, thus ensuring that claimants have a full opportunity to argue their case. Under the new rule, a motion to dismiss before a claimant's case is presented can only be granted on three specific grounds, and there are stringent new sanctions against parties for engaging in abusive case-dismissal practices.
During the last five years, FINRA Investor Education issued investor alerts warning investors about an array of complex investment products, troubling trends and outright scams. Topics covered range from understanding exchange-traded notes to avoiding gold scams—and from how to weather tough financial times to investing in the stock of bankrupt companies.
The FINRA Foundation launched a research-based campaign to help investors spot and avoid investment fraud. Tricks of the Trade: Outsmarting Investment Fraud, a documentary that is a centerpiece of this campaign, has aired more than 750 times on 170 public television stations across 30 states.
In 2009, in consultation with the U.S. Department of the Treasury and the President's Advisory Council on Financial Literacy, the FINRA Foundation fielded America's first National Financial Capability Study comprising three linked surveys. The largest of these, the State-by-State Financial Capability Survey, allows the public, policymakers and researchers to delve into and compare the financial capabilities of Americans in every state and across geographic regions. In the coming months, the FINRA Foundation, in consultation with the U.S. Department of the Treasury and with the support of the President's Advisory Council on Financial Capability, will field a second wave of the military and state-by-state components of the National Financial Capability Study.