B/D HOUSECLEANING 101
by Warren Forest
As our new year freshly unfolds before us, it is a perfect time to assess the past and plan for the future. By any measure, we have experienced a challenging year. The economy has taken its toll on virtually every business enterprise. Broker/Dealers and Investment Advisors certainly have seen their share of adversities.
Not only have business opportunities lessened as investors have fewer resources at their disposal, but the regulatory landscape has gotten bleaker. Both state and federal regulators are imposing more and more requirements such that the
“regulatory burden” is a very heavy load for financial service firms to carry.
One of the first things to do is decide whether to stay in the game, or not. Do we continue to suffer the slings and arrows of outrageous fortune, or take aim against the sea of troubles, and by opposing, end them?
Many times owners of financial service firms especially small companies, are surprised to learn their companies have value. All financial service firms, even dormant inactive ones have value. If you are contemplating closing your company, you may want to explore selling it first.
We have spoken to many people who were not aware that their Broker/Dealer had value, and was saleable, and filed a BDW (Broker/Dealer Withdrawal request.) And, while a BDW is a request to withdraw from FINRA membership, once it is submitted it CANNOT be withdrawn. We at Broker Dealer Place, Inc. are specialists at selling financial service companies. Before you decide to close your business, you may want to talk to us about assessing other options available to you.
If you decide to “take aim against a sea of troubles,” and persevere with your efforts, now is the best time to start the year off right with Broker/Dealer house cleaning. Annual audits for most companies will be due very soon. Make sure that you have a qualified PCAOB CPA firm preparing your audited financial statements.
One new development concerning audits is that FINRA is now requiring them to be submitted electronically. If you send a hard copy audit report to FINRA, it will not count as being submitted.
Take the time now to make sure you are set up for the electronic filing.
Review all of your documents such as Form BD, Form U-4′s, and FINRA contact information, and update your records as needed. Check your Customer New Account Forms for accuracy, and reach out to your customers. This can be a great marketing opportunity, and also ensure your customer records are all up-to-date, which is a regulatory requirement.
Your 3012 Certification, annual review of operations, branch office examinations, and AML audits should be completed, or in the process, for the prior year. Make sure you have updated all of your FINRA contact information electronically on Web CRD. If you are a small firm, you should make the “limited size and resource” notification to limit your heightened supervision obligations.
Minimum Fidelity Bond coverage increases this year. All B/D’s now must have at least a $100,000 Fidelity Bond in place. There is a hidden “kicker” as well. If you do not structure your deductable properly, you may find yourself surprised
with a charge to your net capital!
As the brokerage business becomes increasingly complex, your oversight is paramount. And, the beginning of the new year is a perfect time to start your house cleaning.
No one can be expected to do it all alone. If you have any questions, we at Broker Dealer Place, Inc. (407-774-2000), along with our sister company, Forest Brokerage Advisers, Inc. (407-696-9600) are here to help!
Posted by: editor January 15, 2012
It’s Not Too Late To Be In CE Compliance
by Warren Forest
You only have one month left! That’s right, there are just thirty days for you to complete your “Firm Element” continuing education (CE) sessions.
BD University, located at http://brokerdealerplace.com/bdp/continuing-ed, can help you accomplish this. Our CE platform has recently been upgraded to provide hundreds of relevant classes. It is affordable, user-friendly, customizable, and FINRA compliant.
Ongoing education is vital to every profession. Due to the complexities of the brokerage industry, CE is particularly involved. One of the reasons is that member firms face at least three layers of regulation, the U.S. Securities & Exchange Commission (SEC), the Financial Industry Regulatory Authority (FINRA), and the individual state securities administrators, and all of these regulators required a uniform standard that was acceptable to all parties.
A second reason is that while there exists situations common to all registered representatives and Broker/Dealers, each Broker/Dealer is unique unto its own, and has specific needs that must be satisfied. In 1995, the NASD, now known as FINRA, initiated Conduct Rule 1120, which made CE mandatory. The regulators and member firms took the cue and created a uniform standard applicable to all registered members of the profession, known as the Regulatory Element. However, they also created another CE system which required each firm to develop and design a unique specific training program, known as the Firm Element.
The Regulatory Element is administered by FINRA, and affects only registered persons. Firms need only insure that their reps participate in computer generated Regulatory Element sessions at the required time intervals.
The Firm Element, however, is designed and administered by each FINRA Member Firm. What makes the Firm Element daunting is that FINRA does not inform its members just how they should design a Firm Element Program, nor do they let them know how frequently they must hold their sessions.
But rest assured, if the Firm Element is not done properly, or as often as the regulators deem fit, a member firm may be subject to adverse regulatory actions. This could translate into fines, sanctions, or even suspensions from the business.
A Firm Element Program must be designed to take into account the specific educational needs of each broker/dealer. In order to accomplish this management must annually complete a ‘Needs Analysis’ that serves to outline the Firm Element Program for the current year.
The Firm Element introduced a new concept called a ‘covered person’. This is any person, whether they are registered or not, that has contact with the investing public. All covered persons must attend Firm Element training sessions. Therefore, a non-registered receptionist has to participate in these sessions, while a registered trader, who has no public contact, is Firm Element CE exempt, and does not have to attend any sessions.
Registered Representatives may view the Firm and Regulatory Elements as a necessary evil, or just another compliance burden. CE is mandatory, but every registered rep should view this requirement in a positive light. After all, you would not want to entrust your physical health to a professional who had out-of-date skills. Your clients’ financial health is equally as important as their physical health. By staying informed and educated with current knowledge, as a financial professional, you will keep your clients financially healthy, which should lead to increased sales, production, and professional satisfaction for you.
If you have not done anything about your Firm Element CE, it is not too late. Simply contact Broker Dealer Place at 407-774-2000, to set up your CE program, and stay compliant. BD University offers a comprehensive product that lifts the Firm Element burden entirely. Member firms and registered reps can utilize BD University’s tools to create a ‘Needs Analysis’ and Firm Element program that will both satisfy the regulators and effectively educate covered persons.
Posted by: editor November 30, 2011
Arbitration – A Case Study
By Warren Forest
As a securities industry panelist, I recently heard an arbitration which involved two middle-aged claimants, a husband and wife, both retired. They submitted their claim against a large bank Broker/Dealer and the two registered representatives that handled their account.
The claimants, in their Statement of Claim, alleged all of the usual wrongdoings against the company and their reps. Fraud, misrepresentation, unsuitability, and negligent supervision were asserted. At first glance, this case seemed unremarkable, but it quickly became apparent that there was more to it than met the eye.
The first indication that this case differed from most was the types of investments that were involved. Many cases that I have heard involve highly speculative investments. Often, there are illiquid investments involved, and, frequently, the accounts have a very high rate of turnover.
This case exhibited none of those traits. Because the claimant lost a significant amount of money when he attempted to day trade tech stocks years earlier, he changed his investment strategy. After that humbling and costly experience, he only invested in brokered CD’s and conservative mutual fund investments.
The portfolio he brought to the bank brokerage was about as vanilla of a portfolio that one would find, and the pattern of investing that occurred continued to be extremely conservative. The broker continued to recommended CD’s and mutual funds only. At the time that the recommendations were made, the investments carried Morningstar ratings of at least four, if not five stars.
At the beginning of their testimony, the claimant made a very emotional statement that influenced the panel. They shared that they were suffering from a terminal condition, and had but a very short time to live.
The evidence seemed to indicate that the brokers and the brokerage house did everything and more, that I advise my consulting clients to do in order to prevent and successfully defend themselves against adverse arbitration actions. The rep stayed in close and frequent contact with his clients, and he kept fastidious notes about the client meetings and telephone conversations they had. The recommendations that were made based upon the evidence presented appeared to be entirely suitable given the claimants’ investment objectives, risk tolerances and time horizons.
When we looked at the holding period of the account, it seemed clear as to what happened to cause the portfolio to lose value. It was not that the recommendations were flawed when they were made. It was not that the broker had a greedy objective, and wanted to maximize his commissions. Simply stated the market crashed. Only the investments that lost money were unsuitable, the other investments in the portfolio that retained or increased value were perfectly fine.
It is not a requirement that public panelists have any industry knowledge or experience. Yet, this is currently balanced out by the fact that the third panelist is an individual with in-depth industry experience. However, since FINRA recently made a rule change allowing all public panels, hearings will be decided by panels that may have absolutely no understanding of the specific investments involved in the case.
During the course of the hearing it quickly became apparent that the two public arbitrators had absolutely no knowledge or understanding of even the most basic investments, let alone the investments involved in this case. They did not know the difference between a Broker/Dealer and a Registered Investment Advisor, or a discretionary and non-discretionary account. Indeed, on their individual Arbitrator Disclosure Reports, it indicated that both public panelists have “no skill” in Security information.
Many times during the hearing we needed to break in order to discuss the nature of the recommendations, the types of investments and the role of Broker/Dealers and registered representatives versus investment advisors and their agents. Without this critical understanding the public panelists would be hard pressed to render an effective decision.
At the conclusion of the hearing, and as deliberations began, it was evident that there was dissension amongst us. The public panelists wanted to render a large award in favor of the claimants, and wanted to hold the broker fully responsible. It seemed that the full consensus needed to render a unanimous decision would be impossible to achieve.
To the credit of my public panelists, they felt as bad about this outcome as did I. We decided that more discussion would be helpful to see if we could come up with an award that all would be comfortable with. At the end of our second deliberation session we did just that. Our final decision is not one that we individually would have made, but by agreeing to disagree, we have an award that addresses the arbitrators concerns. The claimant will receive something to mitigate the loss, and the registered representative will be held faultless.
While we did not render the award I alone would have given, our joint decision restored my faith in the process. We all had the chance to fully explain our positions, and heard what we each had to say. This communication enabled us to craft a difficult award that addresses many issues to our collective satisfaction.
This case, from the very beginning, was all about communication; the communication that occurs between a registered representative and their customer, as well as with the arbitrators. As the evidence was presented, it was clear that while they talked to each other they were not really hearing. And at the deliberation table, it was clear that members of the panel heard or understood things differently.
Arbitration is a process fraught with hazard and peril. Even when one thinks their case is perfect and cannot fail, you will need to guess again, because fail it certainly can. If you can resolve your case without it going to an arbitration hearing, then make every possible effort to do so. If resolution is impossible, then do everything that you can to make sure you effectively communicate your case.
Posted by: editor June 28, 2011
Broker/Dealer Branch Offices
There Are Three Types – Can You Name All Three?
by Warren Forest
As anyone who has been in the securities business for any length of time knows, there is nothing simple about this industry. In
fact, some have gone on to say that simplicity and the brokerage business are mutually exclusive terms. One good example of this is how branch offices are defined.
Branch locations, or offices, are often essential in building a vibrant and flourishing business enterprise. McDonalds certainly could not advertise that it has sold billions and billions of hamburgers if it had to rely on just one store. In much the same way, brokerage companies often find it advantageous to have multiple locations.
Multiple offices can do many things for a company. By providing geographic dispersity they allow one to reach many more prospects. Decentralization also allows for sales persons to be physically available to clients that they service. Branding and marketing efforts are enhanced through branch operations. Regional and national presences can be made. Various business models can be employed through branch operations, such as franchising.
Now in every other type of business, a branch office is a branch office, plain and simple. Not so in the world of broker/dealers. For, in this world, there are three distinct types of branch offices. Each type has permitted activities, levels of supervision and required duties attached to it.
The first type of branch office is an Office of Supervisory Jurisdiction, or OSJ. OSJ’s are the highest level of branch office, and therefore, many high level functions are permitted to occur at an OSJ.
There are seven distinct functions that must happen at an OSJ branch: 1) Order Execution and Market Making; 2) Structuring
of Public Offerings or Private Placements; 3) Maintaining Custody of Customer Funds and/or Securities; 4) Final Acceptance/Approval of New Accounts on Behalf of the Member; 5) Review and Endorsement of Customer Orders; 6) Final Approval of Advertising or Sales Literature; and, 7) Responsibility for Supervising the Activities of Persons Associated with the Member. Not every member firm will conduct business in each of these functions, but if you are doing any of them, the location
better be registered as an OSJ.
The second type of office location is simply known as a Branch Office, or non-OSJ. A non-OSJ branch office is defined as any
location where one or more associated persons of a member regularly conducts the business of effecting any transactions in, or inducing, or attempting, to induce the purchase or sale of any security, or is held out as such, and does not conduct any of the seven activities permitted to happen at an OSJ.
If you are selling securities, or are trying to do so, and you are not doing any of the functions that are permitted to occur at an OSJ, then your location is simply a branch office. A little different from the norm, it is a location where sales functions are allowed, and a location where certain activities can never happen.
Now here is where things start to get a little more complicated. The third type of branch location is known as the “Non Branch” location, or NBL.
There are seven exclusions that define an NBL: 1) Any location established solely for customer service and/or back office
functions; 2) Any location that is the associated person’s primary residence; 3) Any location that is used for securities business less than 30 business days per calendar year; 4) Any office of convenience where associated persons occasionally, and exclusively, meet with customers by appointment; 5) Any location from which an associated person effects no more than 25 securities transactions in one calendar year; 6) The Floor of a registered national securities exchange; and, 7) A temporary location established in response to the implementation of a business continuity plan. * Business days are considered to be working at the NBL for four hours or more.
Any office that supervises the activities of associated persons conducting business as an NBL is considered to be a branch office. And each and every branch location must undergo a self inspection by the Member Firm. Exactly how often does the internal inspection have to occur? Well, that depends on how the office location is defined.
OSJ branches and non-OSJ offices that supervise one or more NBL’s must undergo an internal inspection at least once a year. Non-OSJ offices that are not responsible for supervising associated persons must be physically inspected at least every three years. And, NBL’s need to be inspected on a regular periodic schedule with no particular time-frame required.
Opening a branch office is not an automatic event, as firms that desire to have multiple locations must be approved by FINRA to do so. While the rules allow very limited flexibility in this area, typically increasing branch locations, as well as, the number of permitted personnel to staff the locations, is handled pursuant to a Continuing Member Application.
A formal request must be made, and the firm must evidence its ability to implement the changes. This is done by demonstrating
the supervisory system that will be in place, furnishing the procedural changes that will be made and designating specific individuals that can show experience in managing branch office locations.
FINRA also likes to see a minimum level of supervision in place. That minimum level is one designated principal, usually a Series 24 General Securities Principal, for every ten registered representatives that require supervision. Sometimes firms may need a higher level of supervision, such as, one designated principal supervising less than ten individuals.
As the complexities of branch office rules, requirements and regulations indicate, FINRA does not take these activities lightly. Many firms have made the mistake in the past to grow rapidly through geographic dispersion, and neglect to oversee the actions that occur at remote locations.
Firms that make sure that they have qualified experienced branch managers in place, and clearly establish the lines of responsibility, will do much to deflect the adverse actions that could otherwise occur. Coupling the people with quality procedures can do much to ensure that branch office operations will be a successful part of a firm’s business model.
*Please note that these exclusions are highlighted from the FINRA Rule 3010. To ensure that your location meets one of the
standards of an NBL, please seek professional advice.
Posted by: editor May 19, 2011
All-Public Arbitration Panels
Is There Fairness Without Representation
by Warren A. Forest
Virtually all security industry disputes are decided through an arbitration process rather than through litigation. Instead of having a judge hear a grievance and render a decision, customers and firms elect to have arbitrators listen to their dispute and grant an award to one party or the other.
Historically, most arbitration panels are composed of three members. Two of the panelists are “public” arbitrators meaning that they derive no income from, and have no direct ties to the security industry.
The third panel member is an “industry” arbitrator, and this person is tied to, and derives a significant portion of their income from the securities industry. More importantly, the industry arbitrator is familiar with industry rules, laws and regulation, and can lend considerable insight into often complicated issues that arise during the course of an arbitration hearing.
Unanimous decisions are strongly encouraged in arbitration proceedings. However, a majority decision will prevail, and is enough to render an arbitration award.
On February 1, 2011, FINRA announced that the SEC approved its proposed rule change to allow customers in all FINRA arbitrations the option to have an all-public arbitration panel. The amended rule will apply to all customer cases in which a list of potential arbitrators has not yet been sent to the parties.
According to Mr. Frank Ketchum, FINRA Chairman and Chief Executive Officer, “this change will give investors an additional choice in selecting their arbitrators when they file claims. We believe that giving investors the ability to have an all-public panel will increase public confidence in the fairness of our dispute resolution process.”
FINRA sought the rule change shortly after the arbitration results were tabulated for 2007, which was the worst year for investors that had their disputes decided by arbitration over the last six years. Securities firms prevailed in their cases nearly 60% of the time in 2007. Coincidentally, during the pilot program that soon ensued, customers chose all public panels nearly 60% of the time.
There are over five thousand arbitration cases filed every year. Yet, the pilot program to effect this rule change included the participation of only fourteen member firms, which is less than half-a-percent of the firms involved in an arbitration in any given year.
In the subsequent years, investors increasingly prevailed. In 2009, customers won almost 45% of their cases, and in 2010 the odds of a customer winning an arbitration case was just shy of 50%. FINRA was still concerned about perceptions, and claimed that “investors regularly accepted a non-public (industry) arbitrator, but the ability to have an all-public panel will increase public
confidence in the fairness of our dispute resolution process.”
Securities arbitration has a long history in the United States. Disputes between member firms, and between member firms and registered persons, must be decided through arbitration.
Grievances between member firms and customers can be resolved through arbitration as long as both parties use a pre-dispute
arbitration agreement where both sides voluntarily agree to arbitrate any dispute before any dispute actually arises. The use and validity of Pre-dispute Arbitration Agreements was upheld by the United States Supreme Court in Shearson v. MacMahon, 482 U.S. 220 (1987).
Arbitration is a preferred method for dispute resolution because it is typically faster, simpler and less expensive than litigation, most certainly for the claimants. Since almost all customer cases are handled on a contingency basis, the customer usually pays nothing until their case is decided.
The downside to arbitration is that you only get one shot at having your case heard. Since arbitration is binding, the grounds for
vacating an award are extremely few, therefore, virtually all awards rendered are final, and cannot be appealed.
The vast majority of customer initiated disputes against member firms involve only a few allegations. These allegations are suitability, excessive transactions, excessive commissions, negligence, and failures to supervise.
While the allegations are the same, customers historically make these allegations only when there is a monetary loss. In falling markets, arbitration cases soar, in rising markets they diminish. It becomes even more important during times of increasing arbitration cases that panels be as knowledgeable and informed as possible.
Arbitration is a forum of equity not a court of law. In recognition of this, the perception of equity is equally important as is the actuality of equity. That is why there have historically been two public arbitrators instead of two industry arbitrators on three member arbitration panels.
Security arbitrations often involve complex issues that an industry panelist can shed light on and explain to the public members of the panel. Without this important input, the process, let alone the perception of the process can be critically flawed.
While it is still extremely early to determine the outcome of this amendment on all of the parties involved, member firms, and customers alike, should be extremely wary of the change. Arbitration cases that are not adequately heard and understood by panels will have an adverse effect on all participants involved.
Member firms have never had equal representation on arbitration panels. To deny them of any representation at all has at least the perception of defeating any chance of equity for them. Since arbitration is a voluntary process, firms may want to consider litigation in lieu of arbitration until the perception of equity is restored for them.
Posted by: editor March 22, 2011
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