The Securities Litigation Expert Blog

FINRA Issues Regulatory Notice 13-31 Suitability

Posted by Jack Duval

Oct 23, 2013 7:36:07 AM

FINRA has issued RN 13-31 to highlight effective practices for member firms when complying with Suitability Rule 2111.  (RN 13-31)

A number of highlights are worth noting, including:



  •  The manner in which the firm supervises explicit hold recommendations, including the method of documentation the firm uses when documentation occurs, as well as the information the firm considers in conducting the review...

  • Transaction red flags such as: those that appear to deviate from the firm’s internal suitability guidelines for a particular security; a long-term investment for an investor with a short-term horizon; a speculative investment or strategy held in the account of an investor with a conservative investment objective; and the same security held in the account or strategy implemented for...



The RN also emphasized compliance with the reasonable-basis component of Rule 2111:
As referenced above, reasonable-basis suitability requires a firm or associated person to perform reasonable diligence to understand the nature of a recommended security or investment strategy involving a security, as well as its potential risks and rewards, and to determine whether the recommendation is suitable for at least some investors based on that understanding. FINRA observed during examinations that many firms have in place a new product vetting process that assists them in executing reasonable diligence obligations. While many large firms have extensive frameworks for assessing products, even smaller firms established investment committees to vet complex or risky products to determine whether the product met the reasonable-basis suitability standard for retail customers, and if so, the type of customer profile for which the product would be suitable if recommended.

A firm’s vetting of new products does not, standing alone, satisfy the need for associated persons to understand the securities and investment strategies they recommend to customers.  In this regard, some firms post due diligence on products (and accompanying documents) to an internal website that associated persons can access when recommending a product. Such information includes audited financial statements, notes of interviews with key individuals of the product sponsor or issuer, and other information relevant to understanding the product and its features. Some firms use the vetting process to aid in product-focused training of their associated persons, supervisors and compliance staff.


Compliance with the reasonable-basis suitability requirement will be an important issue in the next securities litigation cycle.  Chief Compliance Officers are right to focus on this issue before the next cycle is upon them.
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Topics: reasonable basis suitability, FINRA, RN 13-31, litigation, investments, supervision, Due Diligence, SEC, Compliance, regulation.

FINRA Moves Closer to Fiduciary Standard with Conflicts Report

Posted by Jack Duval

Oct 22, 2013 10:54:25 AM

According to a release by FINRA CEO Richard G. Ketchum, the regulator is stepping up it's focus on conflicts of interest at Broker-Dealer firms.  (Release)  This increase in focus is significant because it takes a step closer to a fiduciary standard for Registered Representatives.  The full, 44 page report can be found here.

Some areas for BD focus include:



  • identifying and managing conflicts on an ongoing basis through an enterprise-level approach that is scaled to the size and complexity of a firm's business and that starts with a "tone from the top" that carries through to the organization's structures, policies, processes, training and culture;

  • establishing new product review processes that include perspectives independent from the business proposing products, that identify potential conflicts raised by new products, that restrict distribution of products that may pose conflicts that cannot be effectively mitigated and that periodically re-assesses products through post-launch reviews;

  • making independent decisions in the wealth management business about the products they offer without pressure to favor proprietary products or products for which the firm has revenue-sharing agreements;

  • minimizing conflicts in compensation structures between customer and broker or firm interests where possible and including heightened supervision when conflicts remain; for example, around thresholds in a firm's compensation structure;

  • mitigating conflicts of interest through disclosures and other information that enables customers to understand the factors that may affect a product's financial outcome—such as the use of scenarios and graphics for a particular product; and

  • including "best-interest-of-the-customer" standards in codes of conduct that apply to brokers' personalized recommendations to retail customers in order to maintain and increase investor trust.



Broker-Dealer compliance departments will need to establish a framework of policies and procedures to address actual and potential conflicts of interest.

 

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Topics: FINRA, Richard G. Ketchum, litigation, Conflicts of Interest, investments, report, SEC, Compliance, Dodd-Frank Act, regulation.

Accelerant Publishes New White Paper: "Suitability Obligations When Using Specialists"

Posted by Jack Duval

Oct 16, 2013 4:10:45 AM

The white paper can be found here.

From the introduction:

The specialist system has existed in the brokerage world since the 1980’s, however, it has not received a great deal of regulatory or expert commentary. This is remarkable since the use of specialists is common throughout the industry, particularly in the sales of complex products.

This paper explores the suitability obligations of Registered Representatives and product specialists when jointly making recommendations to clients. The origin and evolution of the specialist system is examined along with the functions typical of specialists. The industry distinction between “inside” and “outside” specialists is described, and selling agreements between Broker-Dealers (“BDs”) and outside specialists are examined as well.

Most importantly, a critical potential dilemma is explored in regards to suitability: what happens if the Registered Representative knows the client, the product specialist knows the product, but neither knows both?

The answer, in short, is that the Registered Representative has ultimate responsibility for the suitability of all recommendations to the client. However, if the Registered Representative involves a specialist in the recommendation at any time, then both must know the client and the investment well enough to make a suitability determination. If either fails in this regard, then the recommendation cannot be said to be suitable.


The paper is co-authored by John Duval, Sr. and Jack Duval.

 

 

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Topics: FINRA, registered representative, broker dealer, litigation, white paper, suitability, supervision, Accelerant, SEC, specialists, Jack Duval, John Duval Sr., Compliance, regulation.

Leveraged and Inverse ETFs: Trojan Horses for Long-Term Investors

Posted by Jack Duval

Aug 28, 2013 2:34:25 AM

Accelerant has a new white paper about leveraged and inverse Exchange Traded Funds ("ETFs"), here.  The paper includes the following:


  • Historical background on ETFs;

  • The introduction of leveraged and inverse ETFs;

  • How leveraged and inverse ETFs have been misused;

  • An explanation of the internal rebalancing mechanism of leveraged and inverse ETFs;

  • A review of prospectus language;

  • A literature review, including popular and financial press, academic, and industry sources;

  • FINRA Suitability Rules;

  • RIA Suitability Regulations, including the fiduciary duty;

  • Supervision and compliance implications for both Broker-Dealers and RIA firms.


 

 

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Topics: FINRA, RIA, Leveraged and Inverse, Investment Advisors, litigation, Senior Investors, investments, rebalancing; investments; FINRA, '40 Act; Suitability; Supervision; Compliance, SEC, ETF, Compliance, regulation.

3 Dangerous Trends for Senior Investors

Posted by Jack Duval

Jun 6, 2013 2:39:24 AM

After 13 years of volatile markets that have left many retirees with their assets depleted, some of them are taking desperate measures to make ends meet.  Recent articles have highlighted three of these methods:


  • Reverse Mortgages.  Allow a homeowner to monetize their home while living in it. (CNBC)

  • Early IRA Withdrawals.  Allow an IRA holder to make withdrawals before age 59 1/2 or before Required Minimum Distributions start. (Forbes)

  • Pension Loans.  Allow a pensioner to monetize their income stream. (NYT)


None of these are sustainable and they all put the retirees at risk of running out of money.  If utilized, they should be used to fund living expenses and not investments.

Under the FINRA Suitability Rules (2111), "investment strategies" are covered, so a recommendation by a Registered Representative for a client to use one of these strategies would come under the rule.  This is similar to the "Liquified Home Equity" strategy that became common during the housing bubble.  (NTM 04-89)

Compliance and supervisory personnel should monitor accounts for deposits from these strategies and insure that they are not going into securities - a sequence that would almost certainly involve fees and/or penalties from the liquidity source and fees from the subsequent reinvestment.

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Topics: Rule 2111, FINRA, Pension Loans, Investment Advisors, early IRA withdrawals, reverse mortgages, Senior Investors, investments, SEC, Compliance, NTM 04-89, regulation.

FINRA CEO Ketchum Calls for a Uniform Fiduciary Standard for Broker Dealers

Posted by Jack Duval

May 23, 2013 2:48:35 AM

Speaking at the FINRA Annual Conference in Washington, FINRA CEO Richard Ketchum called the SEC out on implementing the uniform fiduciary standard contemplated under Section 913 of the Dodd-Frank Act.  (A1)  Furthermore, if the SEC doesn't act, Ketchum said that FINRA would

"look hard (at issuing) an additional disclosure rule with respect to broker-dealer firms."

Section 913 of the Dodd-Frank Act can be found here.
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Topics: FINRA, Investment Advisors, litigation, SEC, Dodd-Frank Act, fiduciary standard, regulation.

Florida State Court Rules State Statues of Limitation Apply to FINRA Arbitrations

Posted by Jack Duval

May 17, 2013 6:02:36 AM

A Florida State Supreme Court recently ruled that the State's statutes of limitations can apply to FINRA arbitration claims.  (TR)  This is significant because FINRA allows a six year window to bring a claim, whereas the Florida laws may limit the window to four or two years.

 Florida's statute of limitations can apply not only to court proceedings, but to securities arbitration cases between investors and their brokers, the Florida Supreme Court ruled Thursday.

The ruling, in favor of Raymond James Financial Services Inc , could, at least in Florida, empower securities arbitrators to cut the time investors have to file a complaint with Financial Industry Regulatory Authority from six years to four years or even two years. And other states could follow.

The decision clarifies a longstanding question about whether FINRA arbitrators can apply a Florida law to determine whether a case is filed in a timely manner. Many securities arbitrations are filed in Florida due to the state's large number of retirees.

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Topics: FINRA, Florida, litigation, arbitration, regulation.

FINRA Issues NTM Regarding Unlisted REITs

Posted by Jack Duval

May 7, 2013 4:58:50 AM

FINRA has issued NTM 13-18 Communications with the Public, providing guidance on communications with the public concerning unlisted REITs and DPPs.  (NTM 13-18)  Several things are of note:

1. As always, providing a prospectus does not satisfy the required disclosures in written and oral communication.

 Providing risk disclosure in a separate document, such as the prospectus, does not substitute for the required disclosure, even if a communication is accompanied or preceded by a prospectus.

2. Firms may not state the distribution rate is a "yield" or "current yield".  This is because distributions have historically included a return of principal.

3.  Firms may not imply that the values of the fund are stable just because they are offered at the initial offering price.

 The fact that a program offers its securities at par value, or at another relatively stable price, does not evidence stability in the value of the underlying assets.  A communication also may not state that the price at which the program is offered is stable or that its volatility is limited without disclosing that price stability does not indicate stability in the value of the underlying assets, which will fluctuate and may be worth less than the real estate program initially paid, and that the investor may not be able to sell the investment.

4. Firms may not compare the performance of an unlisted REIT to a listed REIT.

Compliance and supervisory personel would be wise to implement this guidance when conducting their reasonable basis suitability determinations, review of advertising, Registered Representative communications, and customer specific suitability.  Especially in light of investor's yield chasing.

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Topics: FINRA, Apple REIT 10, suitability, investments, supervision, REIT, DPP, SEC, fixed income, Compliance, regulation.

New York City Bar Securities Arbitration and Mediation CLE Program

Posted by Jack Duval

May 6, 2013 2:44:41 AM

The New York City Bar Association is sponsoring a half-day program on Securities Arbitration and Mediation on June 4, 2013 from 9am to 1:15pm.  (NYCB)  Here's the schedule:

9:00 - 9:05 a.m. Introduction 

9:05 - 9:25 a.m. FINRA: Breaking News… New Rules, Proposed Rules, Large Case Pilot Project, Pre-Dispute Arbitration Agreements and the Class Action Waiver Linda D. Fienberg 

9:25 – 9:45 a.m. All Public Arbitrator Panels: Special Advocacy Tips, The Importance of Experts, & Expanded Discovery Rules Scott C. Ilgenfritz & Theodore Krebsbach 

9:45 – 10:00 a.m. Who is a Customer? Sandra D. Grannum & Joseph Peiffer 

10:00 - 10:20 a.m. Expungement, In Rem Proceedings & Joint Representation Issues Sandra D. Grannum & Joseph Peiffer 

10:20 - 10:30 a.m. Break 

10:30 - 11:00 a.m. Supervision of “Complex” Products, Non-traded REIT’s, & Leveraged/Inverse ETF’s Darya Geetter & Joseph Peiffer 

11:00 - 11:30 a.m. New Suitability Rule Scott C. Ilgenfritz, Michael Schwartzberg & James Wrona 

11:30 – 11:45 a.m. Claims by and Related to Seniors Theodore Krebsbach & Joseph Peiffer 

11:45 - 12:00 p.m. Interplay Between Arbitration Proceedings and Regulatory Proceedings Sandra D. Grannum, Joseph Peiffer & Michael Schwartzberg 

12:00 – 12:15 p.m. Conversation Between the Audience and the Panel: What do arbitrators want from advocates; The increasing complexity of arbitration

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Topics: FINRA, litigation, supervision, SEC, NYC Bar, Compliance, regulation., education

Finra Appoints First Chief Economist

Posted by Jack Duval

May 1, 2013 4:10:23 AM

Finra has hired Jonathan S. Sokobin to be the SROs Chief Economist.  (TR)  Sokobin was trained at the University of Chicago and holds a Ph.D. in Finance.  His primary task will be to prepare cost-benefit analyses of proposed regulations.  From the Thomson Reuters article:

The move is part of a broader effort at FINRA to more deeply scrutinize the potential costs and benefits of securities industry rules it wants to propose.

The U.S. Securities and Exchange Commission, which must approve changes to FINRA's rules, wants FINRA to better support the economic aspects of proposals it submits to the SEC for review, Robert Colby, FINRA's chief legal officer, said last year.

The SEC became more concerned about costs and benefits of industry rules when a federal court, in 2011, threw out an important part of the Dodd-Frank financial oversight law involving shareholders' ability to nominate corporate directors, saying the agency's economic analysis was flawed.

Wall Street's top lobbying group, the Securities Industry and Financial Markets Association, has also been pushing for more detailed analyses of the costs of certain rules to the industry.

Sokobin, who received an MBA and PhD in finance from the University of Chicago, joined the Treasury Department in 2011 as chief of analytical strategy in the office of financial research. Earlier, he was acting director of the SEC's division of risk, strategy and financial innovation. He joined the SEC in 2000 and was named deputy chief economist in 2004.

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Topics: FINRA, SIFMA, chief economist, SEC, cost-benefit analysis, Dodd-Frank Act, Jonathan S. Sokobin, regulation.

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