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Protecting Senior Investors - FINRA FAQs

Posted by Jack Duval

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Jan 17, 2018 7:48:00 AM

 

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This blog post continues a series that I began in 2012 highlighting regulatory efforts to protect senior investors.  (My previous blog posts on protecting senior investors can be found here.)

On January 3, 2018, FINRA posted guidance in the form of Frequently Asked Questions (“FAQs”) relating to protecting senior investors.

They did this in advance of FINRA Rule 2165 – Financial Exploitation of Specified Adults and Rule 4512 – Customer Account Information becoming (respectively) effective and amended on February 5, 2018.  Both rules were approved by the SEC in March 2017 and discussed in FINRA RM 17- 11.

I summarize and discuss a few of the more important points made in the FAQs and how they relate to account supervision.

Rule 2165 – Financial Exploitation of Specified Adults[1]

Q.1.1. May a member place a temporary hold on a securities transaction pursuant to Rule 2165?

A. Rule 2165 provides a safe harbor for a member to place a temporary hold on a disbursement of funds or securities from the account of a specified adult if the member reasonably believes that financial exploitation of the specified adult has occurred, is occurring, has been attempted or will be attempted. (Emphasis added)

This FAQ illustrates one of the key deficiencies with Rule 2165, that trading may continue in accounts where financial exploitation is occurring.  This is especially relevant to instances where the perpetrator of the exploitation is the Registered Representative.  In these instances, the Registered Representative could generate excessive compensation for herself without triggering a red flag under Rule 2165.  Indeed, it is conceivable that abusive trading could occur even if the account was under a temporary hold.

In these instances, the Registered Representative would be making withdrawals from the account through the broker-dealers own compensation mechanism.

An example of this could be the selling of a long-held low cost basis stock and using the proceeds to buy a high commission products.  The Registered Representative would get paid twice, once on the stock sale and once on the product purchases.  The payment of the commissions would not be reflected as a “disbursement of funds” and thus not flagged by a compliance system.

This scenario is not far-fetched.  I have seen cases where Registered Representatives have churned accounts after the client has died.

Supervisors must know the clients and their accounts well enough to detect abuse by Registered Representatives.

Q.1.2 Under Rule 2165, may a member that has a reasonable belief of financial exploitation of a Specified Adult regarding a disbursement or disbursements place a temporary hold or restrictions on an entire account if the member permits legitimate disbursements from the account?

A. FINRA has stated that, where a questionable disbursement involves less than all assets in an account, a member should not place a blanket hold on the entire account. Each disbursement should be analyzed separately.  (Emphasis added)

Here FINRA wants to avoid the failure of paying of legitimate bills and other disbursements even if a temporary hold has been placed on the account.  This would require significant diligence from the supervisor and Registered Representative to insure the disbursements were legitimate.

Rule 4512 – Customer Account Information[2]

Q.3.2. does the requirement in Rule 4512(a)(1)(F) to make reasonable efforts to obtain the name and contact information for a trusted contact upon the opening of a non-institutional customer’s account or when updating account information for an existing non-institutional account apply to all non-institutional accounts?

A. Rule 4512(a)(1)(F) provides that the trusted-contact provision “shall not apply to an institutional account”.  Accordingly, the trusted-contact provision applies to any account that does not meet the definition of an “institutional account” in Rule 4512(c), including accounts of non-natural persons that do not meet the definition.

FINRA defines an “institutional account” as:[3]

(1)  A bank, savings and loan association, insurance company or registered investment company;

(2) An investment adviser registered either with the SEC under Section 203 of the Investment Advisers Act or with a state securities commission (or any agency or office performing like functions); or

(3) Any other person (whether a natural person, corporation, partnership, trust or otherwise) with total assets of at least $50 million.

The key provision of this guidance is that member firms should try to obtain trusted contact information for all accounts, including entities such as trusts, corporations, and partnerships.

Also, in my experience, even if a client meets the “institutional” account criteria by having assets of $50 million or greater, they are just as subject to potential abuse as anyone else.  Furthermore, having more assets does not imply greater sophistication or protection from bad actors.

Supervisors should monitor these accounts with the same diligence as they do other accounts.

Q.3.4. When is a member required to seek to obtain the trusted-contact information for accounts in existence prior to the effective date of the amendments to Rule 4512 (“existing accounts”)?  When is a member required to update the trusted-contact information?

A. Consistent with the current requirements of Rule 4512(b), a member would not need to seek to obtain the trusted-contact information for existing accounts until such a time as the member updates the information for the account either in the course of the member’s routine and customary business or as otherwise required by applicable laws or rules.

Since knowing the client is an ongoing duty[4], asking clients for trusted contact information should be done at least as soon as the next contact with the client.  Client contact could be when making a trade recommendation, when presenting an account review, or for other reasons.

Q.4.1.  What is a member allowed to disclose to the trusted contact about a customer’s account?

A. Supplementary Material .06(a) to Rule 4512 requires that, at the time of account opening, a member disclose in writing (which may be electronic) to the customer that the member or an associated person is authorized to contact the trusted contact and disclose information about the customer’s account to address possible financial exploitation, to confirm the specifics of the customer’s current contact information, health status, or the identity of any legal guardian, executor, trustee or holder of a power of attorney, or as otherwise permitted by Rule 2165.[5]

… A member also could reach out to a trusted contact if it suspects that the customer may be suffering from Alzheimer’s disease, dementia or other forms of diminished capacity.

The disclosures should be limited to what the trusted contact would need to know to help make a determination as to any suspected exploitation or diminished capacity.  In most instances, it would not be necessary to disclose the total account value and details about a client’s investments with the trusted contact.

In the case of suspected possible financial exploitation, the focus would likely be on distribution requests.  If diminished capacity is suspected, no financial information would need to be disclosed, unless it was part of the indicia of the diminished capacity.

_________________

Notes:

[1]       Frequently Asked Questions Regarding FINRA Rules Relating to Financial Exploitation of Seniors;  January 3, 2018; Available at: http://www.finra.org/industry/frequently-asked-questions-regarding-finra-rules-relating-financial-exploitation-seniors; Accessed January 15, 2018.

[2]       Id.

[3]       FINRA Rule 4512 – Customer Account Information; Available at: http://finra.complinet.com/en/display/display.html?rbid=2403&element_id=9958; Accessed January 16, 2018.

[4]       See FINRA Rule 2111 – Suitability, regarding client profiling, and FINRA Rule 2090 – Know Your Client regarding diligence in the maintenance of client accounts.

[5]       FINRA also confirms that disclosures of financial information to a trusted contact would not be in violation of Regulation S-P (the SEC’s Privacy of Consumer Financial Information rule), since any disclosures would have been made with the customer’s consent.  See Regulation S-P Final Rule, available at: https://www.sec.gov/rules/final/34-42974.htm.  Accessed January 17, 2018.

For information about securities expert Jack Duval, click here.

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Topics: Protecting Senior Investors, Senior Investors, fraud, Elder Abuse, dementia, Alzheimer's, supervision, financial exploitation

    

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