FINRA Lawyer Blog

GAG ORDERS USED BY FINRA UNDER REVIEW BY SCOTUS

April 19, 2022 | Herskovits, PLLC

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When settling a FINRA investigation, the Staff drafts a letter of Acceptance, Waiver and Consent (AWC) setting forth the terms of the settlement. In the AWC, FINRA routinely demands the settling party consent to the following restraint on speech:

“Respondent may not take any action or permit to be made any public statement, including in regulatory filings or otherwise, denying directly or indirectly, any finding in this AWC or create the impression that the AWC is without factual basis.”

A matter before the U.S. Supreme Court may upend FINRA’s use of a gag order.

HERSKOVITS PLLC INVESTIGATES DEFERRED COMP CLAIMS FOR FORMER MORGAN STANLEY ADVISORS

April 3, 2022 | Herskovits, PLLC

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Herskovits PLLC is investigating whether Morgan Stanley unlawfully “forfeited” deferred compensation otherwise due and payable to financial advisers formerly employed by the firm. A class action lawsuit involving similar claims has begun in the U.S. District Court for the Southern District of New York. That litigation is in its early stages and may carry on for years before a resolution is reached.

Morgan Stanley’s Deferred Compensation Plan

Morgan Stanley compensates FAs based on revenues generated from the FA’s customers’ accounts. Morgan Stanley typically defers a portion of the fees generated as “deferred compensation” and allocates a substantial percentage of the FA’s deferred compensation to the Morgan Stanley Compensation Incentive Program. 75% of the deferred compensation vests over a six-year period and 25% vests over a four-year period. However, Morgan Stanley “cancels” the deferred compensation if the FA leaves Morgan Stanley prior to the vesting dates.

FINRA Enforcement Puts Chief Compliance Officers on Notice

March 22, 2022 | Herskovits, PLLC

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On March 17, 2022, FINRA released Regulatory Notice 22-10.

The regulatory guidance discusses the application of FINRA Rule 3110 – Supervision — as it relates to Chief Compliance Officers (“CCOs”). The notice begins by making it clear that, as a general matter, supervision is the responsibility of the senior business management and compliance personnel serve in an advisory role rather than supervisory. FINRA notes however, that it will bring enforcement actions against CCOs in circumstances when a firm has expressly or impliedly designated its CCO as having supervisory responsibility.

FINRA explains that a CCO may have supervisory responsibility in a number of ways. For example, the CCO may have dual roles as both CCO and business management. The CCO as management would have a responsibility to supervise or delegate such supervision under Rule 3110. A firm may also designate its CCO as a supervisor as part of its written supervisory procedures. A firm’s president or CEO could also “expressly or impliedly” designate the CCO as a supervisor over a particular issue on an ad hoc basis or for exigent circumstances.

Will We See a Spike in Margin Liquidations Due to SEC Guidance?

March 15, 2022 | Herskovits, PLLC

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We are all painfully aware of the recent volatility in the markets, which has not gone unnoticed by the SEC. On March 14, 2022, the Staff of the Division of Trading and Markets stated that “broker-dealers should collect margin from counterparties to the fullest extent possible in accordance with any applicable regulatory and contractual requirements.” We shall see whether Wall Street acts upon the SEC’s guidance, and whether investors are caught flat-footed by stepped-up maintenance margin requirements.

Regulatory and Contractual Requirements

The regulatory requirements for margin are set forth in FINRA Rule 4210. Although the rule is lengthy, and incorporates other rules including Federal Reserve Board Regulation T, the essence of the rule allows a broker-dealer to lend a customer up to 50% of the total purchase price of an eligible stock. A margin call may be issued if the margin account falls beneath the maintenance margin requirements (generally 25% of the current market value of the securities in the account) or if the margin account falls below the firm’s “house” maintenance margin requirements (which can be substantially higher than 25%). Brokerage firms can, and often do, upwardly adjust “house” maintenance margin requirements if the firm has risk concerns relating to outstanding margin loans. Most margin account agreements specifically permit broker-dealers to increase maintenance margin requirements at the sole discretion of the firm. In light of the SEC’s recent guidance, it seems likely that broker-dealers will act upon its contractual rights and demand enlarged collateral from customers to protect its margin loans.

Summary of FINRAs Examination and Risk Monitoring Program Findings for 2022

March 7, 2022 | Herskovits, PLLC

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FINRA recently published its 2022 Report on FINRA’s Examination and Risk Monitoring Program to provide member firms with guidance and insights gathered by FINRA’s Examinations and Risk Monitoring programs over the course of the year. The report also serves to inform firms what FINRA sees as “emerging” compliance risks that FINRA’s Examinations and Risk Monitoring programs intend to focus on for 2022.

Among the various areas covered by the report is a section addressing outside business activities (“OBAs”) (FINRA Rule 3270) and private securities transactions (“PSTs”) (FINRA Rule 3280). FINRA noted in its “Exam Findings” section a number of common mistakes being made by firms.

FINRA Rule 3270 requires registered representatives to notify their firms in writing of any proposed outside business activity. Member firms are then required to “evaluate the advisability of imposing specific conditions or limitations on a registered person’s outside business activity, including where circumstances warrant, prohibiting the activity.”

Hacking the Unhackable and Tracing the Untraceable

February 16, 2022 | Herskovits, PLLC

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A New York couple, Ilya Lichtenstein, 34, and his wife, Heather Morgan, 31, were recently arrested in connection with the theft of approximately 120,000 Bitcoin from the Bitfinex exchange in 2016. The couple was charged however, not with computer hacking and theft but of violating 18 U.S.C. § 1956(h) (Money Laundering Conspiracy) and 18 U.S.C. § 371 (Conspiracy to Defraud the United States).

Famously, in 2016 someone hacked into the Bitfinex platform and engaged in roughly 2000 unauthorized transactions by which they transferred the Bitcoin out of Bitfinex to a digital wallet. Maybe it was Lichenstien and Morgan maybe not. This is another example that shows that, despite the secure nature of the blockchain to prevent fraud and theft, any exchange where you can trade Bitcoin can be a weak link. The 2016 heist was the largest but there have been a string of Cryptocurrency thefts from trading platforms that are just increasing in number each year.

See https://techcrunch.com/2021/06/02/what-10m-in-daily-thefts-tells-us-about-crypto-security/

FORM U4 CRIMINAL HISTORY DISCLOSURES

January 21, 2022 | Herskovits, PLLC

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Maybe you were caught using a fake ID when you were in college or maybe you got into a heated exchange after a fender bender. Each of these could lead to a variety of criminal charges that vary by state and by prosecutorial discretion. Criminal charges have obvious negative consequences. Many people however – even criminal defense attorneys – ignore the more subtle issue of whether or not a registered representative will have to disclose these indiscretions on FINRA’s Form U4 and publicly display them on BrokerCheck.

What Needs to be Disclosed on Form U4?

The Form U4 requires registered representatives to disclose if they have ever been “convicted of or pled guilty or nolo contendere (“no contest”) in a domestic, foreign, or military court to any felony” or if they have been “charged with any felony.” The Form U4 also requires the disclosure of any conviction, guilty plea or nolo contendere plea for any “misdemeanor involving: investments or an investment-related business or any fraud, false statements or omissions, wrongful taking of property, bribery, perjury, forgery, counterfeiting, extortion, or a conspiracy to commit any of these offenses” or if the registered representative has ever been charged with such a misdemeanor.

FINRA HITS AN FA FOR REASONABLE-BASIS SUITABILITY VIOLATION WITH NON-TRADITIONAL ETFs

July 7, 2021 | Herskovits, PLLC

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An AWC issued on July 1, 2021, reflects that FINRA suspended an FA formerly registered with David A. Noyes & Company (now known as Sanctuary Securities) for three-months and imposed a deferred fine of $5,000. This AWC demonstrates FINRAs ongoing concerns around the sale of leveraged and inverse exchange traded funds to retail customers. This week’s AWC is the book-end to an AWC issued in May 2021 against Sanctuary for a variety of violations, including the failure to establish, maintain and enforce a supervisory system designed to meet FINRAs suitability standards for non-traditional ETFs. Sanctuary was fined $160,000 and ordered to pay customer restitution of $370,161.

By way of background, the broker-dealer permitted FA Stuart Pearl to resign in March 2019. According to statements on BrokerCheck, Mr. Pearl resigned while on heightened supervision and the firm alleged that Mr. Pearl had not followed the heightened supervision plan.

Product at Issue: Non-Traditional ETFs

FINRA ARBITRATION AWARD DESCRIBES MERRILL LYNCH’S “RECKLESS DISREGARD FOR THE TRUTH” IN A FORM U5 FILING

May 6, 2021 | Herskovits, PLLC

In September of 2018, Merrill Lynch terminated the Claimant in this arbitration for allegedly opening up a Bank of America bank account for a customer without authorization. In 2020, the Claimant brought an arbitration against Merrill Lynch seeking expungement of the alleged defamatory reason for termination and also sought $50,000 in compensatory damages. The FINRA arbitration award is viewable here.

The arbitration was conducted under FINRA’s simplified rules before a single public arbitrator and the Claimant represented herself without an attorney. Merrill Lynch was represented by the law firm Seyfarth Shaw LLP.

In her findings, the single arbitrator seemed particularly concerned that Merrill Lynch failed to even speak with the customer about the allegations in dispute. Merrill Lynch also failed to have the customer sign an affidavit supporting the allegations. The client in question was known to be suffering from memory problems so significant that Merrill Lynch terminated her as a brokerage client despite an account balance in excess of $500,000. The client had previously complained about unauthorized trading in her account by her primary advisor.

SEC DENIES ODD-BALL WHISTLEBLOWER CLAIM

January 27, 2021 | Herskovits, PLLC

On January 14, 2021, the SEC issued an Order Determining Whistleblower Award Claims (the “Order”). The Order grants “Claimant 1” a $600,000 award while completely denying any award to “Claimant 2.” The heavily-redacted Order makes it impossible to determine what Covered Action and monetary sanction triggered the claims for a Whistleblower Award. You can quickly tell when reading the Order, however, that things are not going to go well for Claimant 2 when the commission notes early on in the Order that:

“Enforcement staff responsible for the Covered Action confirmed that they did not receive any information from Claimant 2, nor did they have any communications with Claimant 2, before or during the investigation.”

Claimant 2’s theory, we learn, is that his tip did not have to be communicated directly to the Enforcement Staff responsible for the Covered Action. It turns out that Claimant 2 provided information about a company to Enforcement Staff in an entirely different regional office. An investigation was commenced and Enforcement Staff was unable to substantiate Claimant 2’s claims. The investigation was closed without commencement of an enforcement action. The Commission pointedly defines the redacted company as the (“Unrelated Company”) and the investigation as the (“Unrelated Investigation”).

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