Tag: FINRA

FINRA and CCO Supervisory Liability

FINRA released regulatory notice 22-10 that said it generally considers the role of compliance chief an advisory position rather than a supervisory one.

Rule 3110 (Supervision) imposes specific supervisory obligations on member firms. The responsibility to meet these obligations rests with a firm’s business management, not its compliance officials. The CCO’s role, in and of itself, is advisory, not supervisory. Accordingly, FINRA will look first to a member firm’s senior business management and supervisors to determine responsibility for a failure to reasonably supervise. FINRA will not bring an action against a CCO under Rule 3110 for failure to supervise except when the firm conferred upon the CCO supervisory responsibilities and the CCO then failed to discharge those responsibilities in a reasonable manner.

This FINRA notice comes after the New York City Bar Association proposed its framework for CCO liability and the National Society of Compliance Professionals proposed its framework for CCO liability. There has been continuing concerns among compliance professionals in finance about the extent of individual liability for compliance officers.

This concern has grown as the SEC has continued to bring cases against compliance officers without using its own informally stated framework.

  1. Participating in the wrongdoing
  2. Hindering the SEC examination or investigation
  3. Wholesale failure

One and two are usually fairly obvious. Typically with one, the CCO is also wearing another hat.

It’s the wholesale failure that lacks definition and is commonly used without adding any framework to when something is a foot-fault and when it is a “wholesale failure.” Time for the SEC to take the next step and establish a formal framework for CCO liability

Sources:

FINRA Extends Parking Period from Two Years to Five Years

Registered Representatives with a broker-dealer presently have two years from their date of leaving a firm to re-register with another firm. Otherwise their qualifications, and especially their passed examinations, would lapse. Reps would sometimes try to “park” their registration at a firm to avoid having to re-take examinations. Nobody wants to re-take those exams.

FINRA just allowed for a five year gap between firms, as long as the rep takes continuing education. Effective as of March 2022, FINRA amended Rules 1210 and 1240 to create a new Maintaining Qualifications Program (MQP). That gives a rep five years to find that new firm or to explore a new opportunity before losing qualification and having to re-take exams. During those five years, the rep will have to take a new set of continuing education requirements each year during the gap between firms.

Sources:

FINRA Issues Regulatory Notice on Communications Regarding Real Estate Investments

finra

FINRA issued Regulatory Notice 13-18 on compliance with the communications with the public rule concerning communications about unlisted REITS and other real estate investments.  Among other things, FINRA is concerned about the use of pictures of real property in the marketing materials.

FINRA Rule 2210 regulates broker-dealer communications with the public. Clearly, based on the Regulatory Notice, FINRA is concerned about disclosures and marketing when it comes to private real estate. The Regulatory is focused on private REITs and direct participation plans, not private equity real estate. However, the guidance may be applicable to a placement agent involved in fundraising.

It was the limitation on pictures that caught my attention. One of the unique aspects of real estate funds is that you can show pictures of the investments. There is little guidance on how you need to treat the pictures or whether the pictures could be considered misleading. So the FINRA Regualtory Notice caught my eye.

Communications for a new program often include photographs or other images of properties owned by investments managed by the program’s sponsor that are similar to properties the program expects to purchase. In order to be clear that investors will not acquire an interest in the pictured property, prominent text must accompany each depiction explaining that the property is owned by an investment managed by the sponsor and not the program. Once the real estate program has acquired a portfolio, the communication may include depictions of properties that are limited to investments owned by the program.

That’s not much of a help. You can’t include pictures of non-fund properties unless you disclose that they are owned by a different fund.

File Your Fund’s PPM With FINRA?

finra

FINRA Rule 5123 requires each FINRA member firm that sells securities in a private placement, subject to certain exemptions, to file with FINRA a copy of any private placement memorandum, term sheet or other offering document the firm used within 15 calendar days of the date of the sale, or indicate that it did not use any such offering documents. If you are using a placement agent to help with fundraising, the placement agent will be subject to the FINRA rules. Then the fundraising is potential subject to the FINRA disclosure, unless if falls into an exemption. The exemptions for a private fund split the world into two.

For funds exempt under Section 3(c)(7) of the Investment Company Act, all of the buyers will be “qualified purchasers.” Rule 5123 has an exemption for the filing requirement for offerings sold to qualified purchasers.[5123(b)(1)(B)]

For funds using the Section 3(c)(1) exemption, the analysis in not as clean. Rule 5123 has an exemption for the filing requirement for offerings sold to some types of accredited investors. [5123(b)(1)(J)] It leaves out items 6 and 7 in the definition of accredited investor.

A fundraising triggers the filing requirement if you sell to natural persons who are accredited investors, but don’t meet the standard of qualified purchaser.

In talking with a placement agent, they are including representations that the offering will be a 3(c)(7) offering so that they are protected from having to make the FINRA filing.

What Does FINRA Think About Crowdfunding?

The crowdfunding provisions in Title III of the JOBS Act provide an exemption from registration under the Securities Act of 1933 for securities offered by through crowdfunding, provided the numerous requirements are met. An intermediary that seeks to engage in crowdfunding must be registered as a broker-dealer or a funding portal. I expect many people are looking at what the regulatory requirements are going to be for this new type of entity. The JOBS Act also requires that a funding portal be a member of an applicable SRO, but limits the examination and enforcement authority of the SRO over registered funding portals to rules “written specifically for registered funding portals.”

FINRA issued Regulatory Notice 12-34 soliciting public comment on the appropriate scope of FINRA rules that should apply to member firms engaging in crowdfunding activities, either as funding portals or as brokers.

Commenters are encouraged to identify the types of requirements that should apply to registered funding portals, taking into account the relatively limited scope of activities by a registered funding portal permitted under the JOBS Act. Comments are particularly requested about possible rules concerning supervision, advertising, anti-money laundering, fraud and manipulation, and just and equitable principles of trade.

I think would-be crowdfunding portal developers are going to have a hard time dealing with the know-your-customer rules required in setting up an account.

Would established firms set up crowdfunding portals. FINRA is clearly anticipating that some of its member firms will do so. And why not? I’m sure a brokerage firm could view a crowdfunding portal as a minor league, allowing them to farm prospects for bigger alternative investments.

FINRA is already looking at potential conflicts.

FINRA also requests comment on whether engaging in crowdfunding might present special conflicts or concerns for a broker-dealer, such as might arise if a registered representative were to recommend that a customer visit the firm’s crowdfunding site.

Sources:

Pay to Play and Cash Solicitations

The Securities and Exchange Commission extended the date by which registered investment advisers must comply with the ban on third-party solicitation in Rule 206(4)-5 under the Investment Advisers Act. The SEC is extending the compliance date in order to ensure an orderly transition. Since solicitors will need to registered as an investment adviser or a broker/dealer or a municipal advisor.

Part of the rule was reliant on FINRA coming up with a rule to meet the requirements under the definition of “registered person” in 206(4)-5(f)(9)(ii)(B) for broker-dealers. FINRA has not done that yet. (Isn’t FINRA supposed to be more effective than the SEC?)

It’s not just FINRA, the the Municipal Securities Rulemaking Board has not finished its rules for municipal advisers under 206(4)-5(f)(9)(iii).

My IACCP symposium also raised the limitations in Rule 206(4)-3. That rule prohibits the use of solicitors in fundraising unless certain requirements are met. The rule specifically refers to “clients” with no further elaboration. For a private fund, that raises the distinction between the fund as a client and the fund investors as limited partners in the fund.

Fortunately, there is an interpretative letter ruling on the topic

We believe that Rule 206(4)-3 generally does not apply to a registered investment adviser’s cash payment to a person solely to compensate that person for soliciting investors or prospective investors for, or referring investors or prospective investors to, an investment pool managed by the adviser.

Sources:

House Hearing on Investment Adviser Oversight Act

On Wednesday, the House Financial Services Committee held a hearing on the Investment Adviser Oversight Act. This bill would create a new self-regulatory organization for investment advisers.

Chairman Bachus opened up by offering to revise the list of exemptions. This worries me, since private funds are currently exempted.

My Congressman, Barney Frank, the ranking minority member of the Committee, pointed out that it is important not to leave state regulators out of the oversight mix. He pointed out that the entire budget of the SEC and CFTC  combined is less than J.P. Morgan’s derivative trading loss last month. The inadequate funding of the SEC is why the Committee is even considering a Self Regulatory Organization.

Congressman Barrett pulled out the Madoff failure as a complete indictment of the SEC. FINRA examined the broker-dealer side of Madoff several times and did a much more thorough job. (I will guess than “Madoff” will be mentioned many times today.)

Congressman Lynch raised concerns about the cost of an SRO on small advisers and the need to keep state regulators involved.

Congressman Scott thinks there is a big gap in investor protection because the SEC reviewed only 8% of the 12,000 registered advisers and compared this to FINRA’s 58% inspection rate in 2011.

Congressman McCarthy mentioned Madoff. She prefers the SEC but realizes the reality that Congress will not fully fund the SEC.

Current text of H.R. 4624, the “‘Investment Adviser Oversight Act of 2012”

WITNESS LIST

  • Mr. Dale Brown, President and Chief Executive Officer, Financial Services Institute
  • Mr. Thomas D. Currey, Past President, National Association of Insurance and Financial Advisors
  • Mr. Chet Helck, Chief Operating Officer, Raymond James Financial Inc., on behalf of the Securities Industry and Financial Markets Association
  • Mr. Richard Ketchum, Chairman and Chief Executive Officer, Financial Industry Regulatory Authority
  • Mr. John Morgan, Securities Commissioner of Texas, on behalf of the North American Securities Administrators Association
  • Mr. David Tittsworth, Executive Director and Executive Vice President, Investment Adviser Association

Mr. Brown supports the bill. “Consumers should not have to be regulatory experts to determine if they are being protected.” He cites data that 40% of investment advisers have never been examined. He endorses FINRA because they have the existing infrastructure.

Mr. Currey supports the bill and cites the same data as Mr. Brown.

Mr. Helck also supports the bill.

Mr. Ketchum supports the bill. (No surprise, since he is apparently hoping to expand the reach of FINRA.)

Mr. Morgan highlights the breadth and scope of oversight in Texas. He also pointed out the smaller income and scale of many advisers. He is concerned about the time and money a new SRO would impose on state registered advisers.

Mr. Titsworth is opposed and cites a long list of other organizations that are opposed to the SRO model and are critical of FINRA.  The cost of an SRO will greatly exceed the cost of just funding the SEC.

Chairman Bachus attacked the Boston Consulting group report on regulatory costs.

Mr. Morgan highlights some of the Constitutional concerns with requiring state regulators to report to an SRO.

The hearing turned into an attack on SROs and FINRA in particular. SROS are not required to submit to the cost-benefit analysis and FOIA requirements that an governmental regulator is subject to.

A Congressman asked why we think that creating another regulator will fix the problem. The Madoff failure was a regulator failure. (The SEC is hampered by a lack of funding.)

From the perspective of small advisers, the bill would subject state registered advisers to state regulatory oversight and SRO oversight.

Another pitch for FINRA came from the area of dual-registrants. They are already subject to FINRA on the broker-dealer side. By putting one organization in place as a regulator, you potentially fill a gap.

The panel’s score was 4 in favor, 2 against. Certainly, there is more to come.

Washington DC – Capitol Hill: United States Capitol  by Wally Gobetz
CC BY-NC-ND 2.0

Bill Backs SRO for RIAs

Financial Services Committee Chairman Spencer Bachus and Rep. Carolyn McCarthy, a member of the Committee, introduced legislation that would create a Self Regulatory Organization for retail investment advisers. The legislation would amend the Investment Advisers Act of 1940 to provide for the creation of National Investment Adviser Associations (NIAAs), registered with and overseen by the SEC. Investment advisers that conduct business with retail customers would have to become members of a registered NIAA.

The bill exempt private fund managers from having to belong to a NIAA. It looks like it uses the current definition of “private fund” as a company exempt under Section 3(c)(1) or 3(c)(7) of the Investment Company Act. For real estate fund managers still wondering if the SEC cares about you, the bill also include those funds relying on the exemption under Section 3(c)(5)(C) of the Investment Company Act for real estate funds to be exempt from the NIAA requirement.

For investment advisers that have a combination of retail and fund management, the bill sets the the threshold at 90% fund management for the exemption.

The question for investment advisers is what organization will try to be a (the?) NIAA. FINRA is an obvious candidate and one that will upset many.

As for fund managers, presumably they would remain subject to SEC oversight and examination instead of NIAA oversight.

Sources:

More from FINRA on Social Media and Mobile Devices

In January 2010, FINRA issued Regulatory Notice 10-06 in an attempt to provide guidance on the application of FINRA rules governing communications with the public to social media sites. The guidance did not provide much that was new. Largely, FINRA pointed out that the existing communication and record-keeping rules applied. Too bad that the site did not allow you to take the steps needed to comply with the existing rules.

Apparently, the guidance raised enough questions that FINRA decided to provide some additional guidance. It is not intended to alter the principles or the guidance provided in Regulatory Notice 10-06. Anyone expecting something new or innovative will be disappointed.

Q1: Does determining whether a communication is subject to the recordkeeping requirements of SEA Rule 17a-4(b)(4) depend on whether an associated person uses a personal device or technology to make the communication?

A1: SEA Rule 17a-4(b)(4) requires a firm to retain records of communications that relate to its “business as such.” Whether a particular communication is related to the business of the firm depends upon the facts and circumstances. This analysis does not depend upon the type of device or technology used to transmit the communication, nor does it depend upon whether it is a firm-issued or personal device of the individual; rather, the content of the communication is determinative. For instance, the requirement would apply if the electronic communication was received or sent by an associated person through a third-party’s platform or system. A firm’s policies and procedures must include training and education of its associated persons regarding the differences between business and nonbusiness communications and the measures required to ensure that any business communication made by associated persons is retained, retrievable and supervised.

The FINRA rules came first and they are in place for a good reason. It’s up to the firm to find a may to meet the compliance standards if they want to use third-party websites to publish information, communicate with the public, or communicate with clients.  If cloud providers want to take over company-hosted communications they need to but more effort into the record-keeping and compliance requirements of the business world.

Sources:

Twitter Fail and Compliance


FINRA has long regulated and limited the ability of broker/dealers to communicate with the public. One of their missions is to protect the investing public from unscrupulous securities brokers. Twitter is a communications tools and any messages posted to Twitter will need to be in compliance.

It was inevitable that we would see a FINRA regulated party make a mistake using Twitter. The time has come.

FINRA also found that during eight months in 2009, the registered representative maintained a Twitter account and had more than 1,400 followers. Without notifying a principal of her employer firm, the registered representative posted 32 “tweets” related to a particular security. The tweets were unbalanced, overly positive and often predicted an imminent price increase. In the tweets, the representative failed to disclose that she and her family held a significant number of shares of the security. FINRA concluded that this conduct violated NASD Rules 2210 (communications with the public) and IM-2210-1 (guidelines to ensure that communications with the public are not misleading), and FINRA Rule 2010 (ethical standards).

To me, this sounds exactly like the behavior FINRA is trying to prevent by imposing Rule 2210 on financial representatives.

I don’t want to overstate the effect of this Twitter failure on the discipline. The registered representative was doing some other things in violation of the rules. I would guess that once a registered representative is under investigation FINRA takes a look at that person’s social networking activity to see if they have been doing other bad things.

Sources:

Image is 2008wmonroe by Liza P
CC BY-NC-ND 2.0