On June 12, 2017, the SRO and States Subcommittee of the ABA Securities Litigation Committee hosted three Chief Counsel from FINRA Enforcement for an engaging panel discussion on emerging regulatory issues and Enforcement priorities.
The panel featured FINRA Chief Counsel Sue Light, Gina Petrocelli and Lara Thyagarajan. Highlights are summarized below.
The panel began with an overview of FINRA Enforcement’s organizational structure. FINRA maintains two “home offices” in New York and Rockville, MD and thirteen “regional” offices across the country. There are 10 Chief Counsel, five of whom sit in the New York home office. Overall, Enforcement maintains an investigative and executive work force of approximately 200 employees.
FINRA’s Examination Department is a primary source of referrals for FINRA Enforcement. Ms. Thyagarajan explained that FINRA applies a “risk hierarchy” to open matters and designates certain exams as “high risk,” which may result in collaboration between the Examination and Enforcement teams at an earlier stage.
The 2017 FINRA Priorities Letter – the first of the Robert Cook administration – signaled to some readers that FINRA was perhaps changing its focus from the “culture of compliance” to “blocking and tackling” fundamentals, with an enhanced emphasis on brokers with a history of disciplinary activity. However, Ms. Petrocelli cautioned against reading too much into the change in tone – in her view, Mr. Cook’s letter was a “reaffirmation of FINRA’s fundamental values” of investor protection and restitution, and not a drastic change in FINRA priorities.
Ms. Petrocelli noted that FINRA would continue to pursue cases where firms and supervisors fail to detect wrongdoing committed by brokers with a history of discipline, and specifically identified senior clients as an area of enhanced concern. With respect to seniors, FINRA wants to see that brokers are considering clients’ income needs and the risk of principal loss when recommending investments, and looks for excessive or short-term trading of long-term products in senior citizen accounts. Ms. Petrocelli highlighted a recent change to FINRA’s Sanction Guidelines to include the “undue influence” consideration as a reflection of this enhanced concern, as well as the upcoming FINRA Rule 2165 (effective February 5, 2018), which will allow members to place a temporary hold on disbursement of funds or securities when there is reasonable suspicion of financial exploitation.
In the area of complex products, Ms. Petrocelli noted that FINRA is concerned with broker and supervisor training, so members should be prepared to demonstrate that their employees are familiar with the nuances of new or complex investments. When new products come to market, FINRA’s Enforcement staff undergoes significant training on the structure, fees and risks of those products. Ms. Petrocelli highlighted mutual funds share classes, variable annuities and UITs as areas of particular interest to Enforcement.
Ms. Light then led a discussion on best practices for interacting with the Enforcement team. Firms should feel encouraged to engage with their investigators and discuss issues (both substantive and technical) early on. Ms. Light noted that FINRA is generally receptive to meetings at the outset of an investigation to discuss a firm’s systems, particularly those in complex areas, and in the case of OTRs, FINRA appreciates when firms give it a heads up that an employee may not have the relevant information FINRA is looking for. A question from the audience prompted a discussion about “dormant” cases where members are reluctant to call FINRA about an investigation for fear of “reminding” Enforcement about an old, open matter. Ms. Light replied that FINRA does not “forget” about a case, and said that a phone call for a status update would not prompt Enforcement to bring an action it otherwise would have left alone.
Another inquiry from the audience addressed FINRA’s cooperation program, and a discussion ensued about the hope for greater transparency in FINRA’s calculus for determining the extent to which cooperation can reduce a potential fine. Ms. Light stated that FINRA spends a lot of time thinking about the dollar amounts associated with cooperation, but pointed out the difficulty in assigning a hard number for specific acts. Still, Ms. Light referred to the Sanctions Guidelines for guidance and specifically highlighted firms that help Enforcement reach a speedy resolution and firms that provide remediation to customers as being significant factors when assessing cooperation value. It was further noted that FINRA’s Office of Disciplinary Affairs reviews all settlements to ensure consistency in FINRA’s case valuations across the regional offices.
With respect to recent actions, Ms. Petrocelli selected four recent FINRA Enforcement matters for discussion. In Lawson Financial Corporation, Robert Warren Lawson, and Pamela Denise Lawson (January 2017), the principals of a broker-dealer misused funds from a customer’s trust account (for which the Lawsons were co-trustees) to funnel cash towards charter schools and assisted living facilities linked to revenue bonds that the firm had sold other clients. In Craig David Dima (February 2017), a broker engaged in 41 unauthorized transactions in a client’s IRA account – many of which were “round trip” purchases and sales of the same stock. When asked about the transactions, the broker told the client they were “computer glitches.” Both of these cases resulted in Offers of Settlement after FINRA filed a complaint. The panel noted that this strategy – perhaps a “wait and see if FINRA will actually pursue my case” approach – can be risky as it results in multiple public announcements (at the time of the FINRA complaint and the time of the settlement) and also inhibits the respondent’s ability to suggest changes to settlement language, as you might see with an AWC.
Ms. Petrocelli highlighted the Purshe Kaplan Sterling and Gopi Krishna Vungarala (February 2017) matter to stress the importance of supervision of outside business activities. In that case, a broker had an approved outside business activity as the investment manager for a Native American client. With that client, the broker engaged in selling away of products that were eligible for breakpoints and lower commissions, and misled the client and fund companies about the tribe’s eligibility. The broker’s actions resulted in approximately $7 million of unnecessary commissions. In Mathew C. Maczko (February 2017), an AWC barred the broker after FINRA determined that Mr. Maczko – who was accused of excessive trading in elderly client accounts – provided misleading testimony during his OTR. An audience member posed the question of whether FINRA would consider something less than a full bar when a respondent is able to provide significant or full restitution to the affected clients. Without closing the door on that possibility, Ms. Petrocelli noted that brokers who engage in egregious wrongdoing need to be barred from the industry regardless of whether a firm provides restitution.
In sum, the Chief Counsel provided a wide range of timely information and a free-flowing exchange of ideas with the defense lawyers in the audience.