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Month: November 2017

BDs Must Implement Beneficial Ownership Due Diligence by May

Pursuant to recent FINRA guidance, broker-dealers will have until May 11, 2018 to amend their Anti-Money Laundering programs to include risk-based procedures for conducting ongoing customer due diligence as required FinCEN’s Customer Due Diligence Rule.  Most significantly, BDs must identify the beneficial owner of each account and implement risk-based procedures for verifying customer identities.  FINRA and FinCEN will allow firms to obtain such information by using FinCEN’s standard certification form.  FINRA calls this beneficial ownership requirement the “fifth pillar” of a required AML program, which must also include reasonable policies and procedures, independent testing, a designated AML officer, and ongoing training.

OUR TAKE: Next May might seem like a long way off, but the work required to implement this fifth pillar will be significant.  We recommend following FINRA’s guidance and using the FinCEN form as a starting point.


Bank-Affiliated BD Fined $1.25 Million for Inadequate Employee Screening

FINRA fined a large bank-affiliated broker-dealer $1.25 Million for failing to conduct adequate background checks on over 8,000 associated persons over an 8-year period.  The broker-dealer relied on its bank affiliate to conduct screening of its non-registered associated persons but the bank only screened for bank disqualifying criteria, not the broader categories of disqualification pursuant to Section 3(a)(39) of the Exchange Act and FINRA rules.  Also, the firm completely failed to fingerprint over 2000 employees prior to employment.  Four employees were retained despite statutory disqualifications.  FINRA’s EVP of Enforcement warned, “Firms have a clear responsibility to appropriately screen all employees for past criminal or regulatory events that can disqualify individuals from associating with member firms, even in a non-registered capacity.”

OUR TAKE: FINRA has previously warned that it would review how firms screen for brokers with disciplinary records.  The regulator wants to put pressure on the industry to drive out the bad brokers.


Chief Accounting Officer Barred and Fined for Approving CEO Expenses

The SEC barred and fined a public company Chief Accounting Officer for approving undisclosed expense reimbursements for the company’s CEO.  The CEO ultimately repaid the $11.285 worth of perquisites incurred over a 5-year period for personal items such as private aircraft usage, cosmetic surgery, cash for tips, medical expenses, charitable donations, and personal travel expenses.  The SEC asserts that the CAO approved the expenses in violation of company policy and without appropriate backup documentation and then failed to disclose the reimbursements in the company proxy statements.  The SEC charges the CAO with causing the company to file false reports.

OUR TAKE: We wrote on Friday that the SEC is looking to hold financial executives accountable.  In this case, the SEC doesn’t even allege that the CAO derived any personal benefit by approving his boss’s expenses.  Regardless, the SEC holds him accountable for allowing wrongdoing to occur.


SEC Enforcement Division Targets Financial Executives

In its 2017 fiscal report, the SEC’s Enforcement Division cites individual accountability as one of its core enforcement principles.  The report expresses the Enforcement Division’s view that “individual accountability more effectively deters wrongdoing.”  Since Chairman Clayton took office, the SEC has charged an individual in more than 80% of standalone enforcement actions.  The report notes that it can be more expensive to pursue individuals, but “that price is worth paying.”  The report notes a modest decrease in filed enforcement actions and recoveries since 2016: 754 vs. 784 cases (excluding municipal cases) and $3.8 Billion vs. $4 Billion in total money ordered.

OUR TAKE:  “Just because you’re paranoid doesn’t mean they aren’t after you.” (Joseph Heller)  The data and the explanation imply that the SEC will prioritize prosecuting individuals, even if the money ordered is smaller than in institutional actions, because of the fear and deterrent effect.  If financial executives need another reason to engage a best-in-class compliance program, how about protecting yourselves from a career-ending enforcement action?


Consultant to PE Portfolio Company Charged with Insider Trading

A consultant to a private equity fund’s portfolio company has agreed to pay a fine and disgorgement to settle insider trading charges.  According to the SEC, the consultant obtained impending acquisition information from the acquirer’s Chief Revenue Officer and traded on the information prior to the acquisition announcement.  The SEC also alleges that she passed the information to a friend who also traded.  The SEC asserts that the consultant “violated her fiduciary duties or similar obligations arising from a relationship of trust and confidence” to the client company.

OUR TAKE: Private equity firms registered as investment advisers should ensure that portfolio company officers and consultants comply with the Code of Ethics, including reporting of securities transactions and the obligation to maintain the confidentiality of material nonpublic information.


Large BD Fined $3.5 Million for Curtailing SAR Filings

The SEC fined a large bank-affiliated broker-dealer $3.5 Million for failing to file anti-money laundering Suspicious Activity Reports (SARs).  According to the SEC, the firm had an effective AML Surveillance and Investigations group, but new management attempted to reduce the number of filed SARs, investigations, and related record-keeping.  During the 15 months under the new management, the number of SARs filed per month dropped 60%, from 57 to 22.  The SEC charges that the respondent failed to file at least 50 required SARs during that period.  An employee complaint triggered an internal investigation that uncovered the failures.   Broker-dealers are required by the Bank Secrecy Act to file SARs to report transactions that the BD suspects involved funds derived from illegal transactions, had no apparent lawful business purpose, or used the BD to facilitate criminal activity.

OUR TAKE: Given the SEC’s allegations that the broker-dealer’s management intentionally tried to reduce SAR filings, the respondent and its management is fortunate that they do not face more severe civil or criminal penalties under the Bank Secrecy Act.  There is no regulatory upside for choosing not to file SARs.  When in doubt, file and avoid second-guessing by the regulators.


OCIE Reports Widespread Noncompliance by Municipal Advisers

The SEC’s Office of Compliance Inspections and Examinations (OCIE) reports widespread compliance failures among municipal advisers reviewed as part of its 2014-15 examination sweep.  OCIE staff “frequently observed” supervision failures including the failure to adopt and implement written supervisory procedures and appoint a responsible principal.  OCIE also faulted frequent failures to file and amend registration documents and to maintain required books and client and financial books and records.   By publishing the results, OCIE “hopes to encourage MAs to reflect upon their practices, policies, and procedures in these areas and to make any necessary improvements.”  Municipal advisers became subject to SEC registration and jurisdiction pursuant to the Dodd-Frank Act.

OUR TAKE: This Risk Alert is the warning shot across the bow for municipal advisers.  OCIE often publishes these types of examination findings and recommendations as a foreshadowing of impending enforcement actions.


SEC to Create Website of Bad Actors

In a recent speech, the SEC Chairman, Jay Clayton, announced that the SEC is creating a searchable website of those individuals that have been barred or suspended from the securities industry.  Mr. Clayton expressed concern that investors cannot uncover bad actors that have “shifted from the registered space…to the unregistered space.”  Mr. Clayton explained that the website “is intended to make the prior actions of repeat offenders and fraudsters more visible to investors.”

OUR TAKE: This “Scarlet Letter” approach to prevention ups the ante for those barred from the industry in civil enforcement actions.  It is unclear whether such a website will be any more or less effective than the CRD system, which reports disciplinary histories.


New FINRA Rules Facilitate Public Plan Solicitation and Distribution Activities

The SEC has approved new FINRA rules allowing Capital Acquisition Brokers to engage in distribution and solicitation activities for registered investment advisers consistent with the anti-pay-to-play rules.  Rule 206(4)-5 of the Advisers Act restricts advisers from engaging solicitors for certain government entities.  The new rules allow advisers to retain CABs consistent with previously adopted FINRA rules governing distribution and solicitation activities.  CABs are limited purpose FINRA member firms that are subject to less regulation but must limit their activities to investment banking-type activities such as advising companies on capital raising and acting as a placement agent.

OUR TAKE: These rules allow government plan solicitors to continue their activities on behalf of RIAs by submitting to the lighter CAB regulatory regime.   These rules represent a loosening of the rules that appeared very restrictive in the wake of Rule 206(4)-5’s adoption.


SEC Upholds FINRA Bar Based on Untruthful Form U4


The SEC has upheld a statutory disqualification imposed by FINRA for failing to file a truthful U4 and lying on compliance questionnaires.  FINRA barred the appellant from the securities industry because his Form U4 failed to disclose federal tax liens and a bankruptcy and because he provided false responses on his firm’s annual compliance questionnaires.  The appellant sought a stay of the disqualification on the grounds that he would get fired from his current job and suffer economic harm.  The SEC rejected his argument and denied the appeal because FINRA has an interest in protecting investors, and a stay of the statutory disqualification for material failures on Form U4 “could endanger investors.”

OUR TAKE: FINRA and the SEC take Form U4 (and annual compliance questionnaires) very seriously.  The regulators view the disclosure as a lynchpin to protecting investors.