Independent Broker Dealer Consortium

Key Issues Discussed at SIFMA’s C&L Society Regional Seminar in Boston

SIFMA’s Compliance & Legal Society held a regional seminar in Boston on May 21, 2019. The conference hosted four panels comprised of regulators and various attorneys in the securities industry, as well as a “Fireside Conversation” with the SEC Deputy Director of the Division of Investment Management, Paul G. Cellupica. The panels covered a wide range of subjects, including SEC and FINRA enforcement priorities, upcoming rule-making initiatives and hot topics in the securities industry, such as self-reporting and cooperation credit, complex products, protection of senior investors, non-disclosure of confidential customer data, and digital assets. This article provides an overview of some of the key topics discussed and important takeaways for consideration. 

Self-Reporting and Cooperation Credit: 

FINRA and SEC representatives on two panels discussed self-reporting initiatives and cooperation credit. Robert Baker, Assistant Regional Director, SEC Asset Management Unit, and Kevin Kelcourse, Associate Regional Director, SEC Compliance Inspection and Examination, stated that the SEC has brought actions against 79 firms that self-reported under the Share Class Selection Disclosure Initiative, an effort to identify and promptly correct ongoing harm in the sale of mutual fund shares by investment advisers. The SEC will begin examining firms that should have self-reported under the Initiative but did not. In addition, FINRA Senior Vice President and Deputy Head of Enforcement, Jessica Hopper, stated that FINRA was pleased with the number of firms that self-reported under the 529 Plan Share Class Disclosure Initiative that wrapped up earlier this year. This discussion sparked a lively debate as to whether, from the perspective of securities firms, regulators provide enough cooperation credit for self-reporting. 

The regulators agreed that cooperation credit is an imperfect science. “Extraordinary cooperation” – when a firm self-reports and takes significant steps to correct the issue and remediate injured customers – could lead to an SEC Order or FINRA Letter of Acceptance, Waiver and Consent (AWC) without additional fines or penalties. However, more often than not, cooperation typically leads to a reduced penalty. Ms. Hopper recognized the frustration that some in the industry feel with cooperation credit, and stated that FINRA anticipates updating its guidance on this issue. The panel also discussed concerns that enforcement actions often lead to the filing of costly civil actions and arbitrations by investors, even if the enforcement actions resulted from self-reporting and extraordinary cooperation. The regulators were cognizant that the potential for costly litigation could affect cooperation and self-reporting. 

Complex Products: 

As one of the perennial subjects of examination and scrutiny, the regulators also discussed complex products. They explained that despite the high volume of disciplinary actions that the SEC and FINRA file every year involving complex products, many brokers continue selling them without fully understanding their features and costs. Too often, brokers are incentivized by the high commissions these kinds of products offer on the front end. Before approving a complex product, firms should thoroughly vet the product, train sales representatives on the risks, characteristics and costs of the product, and establish supervisory procedures/controls for monitoring risks. A point of emphasis was training the sales force so they understand the products and are able to clearly explain them to clients. 

Disclosure of Revenue Sharing Provisions: 

A common thread among the panelists was the SEC’s laser focus on full and accurate disclosure of revenue sharing programs and potential conflicts of interest these programs may create. Regulators discussed the importance of examining how brokers and firms make money and ensuring that those fees are fully and accurately disclosed to customers. They have focused on firms with multiple branches or acquisitions of smaller firms that may not have fully integrated supervisory systems or disclosures. Regulators also discussed the D.C. Circuit Court of Appeal’s recent decision in Robare Group, LTD. v. SEC, which found that the Robare Group was negligent in its disclosures regarding a fee it received for the sale of mutual funds. Regulators advised that enforcement of inadequate Form ADV disclosures will continue. 

Recidivist Firms and Financial Advisors: 

Ms. Hopper of FINRA discussed proposed Rule 4111, which would impose certain restrictions on the hiring of brokers with prior disciplinary history. The proposed Rule should motivate firms to seriously consider the risks of hiring financial advisors with a checkered disciplinary history and strengthen their hiring procedures and background checks. The comment period on the proposed Rule ends on July 1, 2019. 

Protection of Senior Investors: 

Another SEC priority this year is to protect senior investors who may be more vulnerable to fraud and abuse. The SEC has found that less than half of all brokerage firms have policies and procedures in place for senior investors or no procedures in place at all for flagging elderly customers who may be victims of fraud. The SEC Office of Compliance Inspections and Examinations has scrutinized firms’ practices to determine whether they have written policies in place that provide specific guidelines on the protection of senior investors, clear procedures for escalating potential fraud, internal training of all brokers and staff on these procedures and appropriate internal enforcement. 

Protecting Customer Data From Disclosure: 

The SEC remains concerned with the inadvertent disclosure of customer information. Regulators advised that third-party vendors that store confidential customer data on behalf of firms are especially vulnerable to inadvertent disclosure, and warned that firms should thoroughly vet vendors and require them to have strong safeguards in place for protecting customer information. A point of emphasis was ongoing correspondence with vendors to vet and monitor their processes for safeguarding confidential customer data. The SEC has also focused on inadvertent disclosure through online hacking and encouraged firms to find and patch any “bugs” in their system. 

Digital Assets: 

The SEC continues to view most digital coins and other cryptocurrency (referred to as “digital assets”) as falling within the definition of a “security,” and subjects firms to applicable federal securities laws and regulations. If a firm approves the sale of digital assets to customers, there must be full and accurate disclosure of the peculiar risks involved in this type of investment that are inexistent for other types of securities. For example, digital assets are subject to certain operational risks because of the way the assets are held. Cryptocurrency exchanges have gotten hacked and coins stolen, causing millions of dollars in losses.

In sum, the panelists provided valuable information on a wide variety of topics, particularly with regards to regulatory compliance and enforcement. The next SIFMA C&L Society Regional Seminar will take place on June 18, 2019 in St. Louis.

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