Articles Posted in FINRA

In today’s business climate we cannot seem to go a few weeks without the next big company fraud that has been foisted upon the public. The current scandal du jour is Volkswagen and tomorrow it will be who knows. At some point however, either as a result of a whistleblower or anonymous tip, a corporation will conduct an internal investigation to (1) uncover the facts surrounding the current problem and (2) advise management, including the board of directors, of the potential liability and suggest a course of action. It is a “best practice” that when conducting an internal investigation, that a company retain an outside law firm specifically for the investigation to show that the directors of the company are zealously discharging their fiduciary duties to investigate suspected wrongdoing. While these outside attorneys will undoubtedly have access to all company documents and emails, including servers, a large part of the investigation will center upon these attorneys and their interviews with company employees.

If you find yourself in the situation where you are about to be interviewed in connection with a company investigation you need to ask yourself two questions. Do I need a lawyer? Who pays? If you truly played no role in what the company is investigating you don’t need a lawyer. However, if you are a key insider who has information that will shed important details on what transpired you certainly would want to retain your own lawyer. There are many reasons why and I will address them below.

First, consider that earlier this year the Department of Justice set forth a Memorandum that identified that it would go after the individuals responsible for corporate wrongdoing and work its way inward towards the corporate hub. In addition, Justice conditioned any corporate cooperation credit that a corporation could hope to receive would be conditioned upon the disclosure of all corporate wrongdoings and all of the individuals that performed them. Think about this for a second. If the company you are working for is the subject of an investigation and wants in effect what is leniency in its “corporate sentence,” it must turn you over to Justice.

Last month, Sally Yates, Deputy Attorney General for the United States Department of Justice, set forth a six point Memorandum that identified going forward how Justice would allocate its investigation resources to more effectively go after individuals responsible for corporate wrongdoing. This new directive was the result of senior attorneys from within the Justice department meeting and discussing the best ways it could leverage its resources to identify culpable individuals at all levels of corporate management -recognizing that corporations act through individuals.  This really is not a new policy but merely the culmination or rather the continuation of the direction SEC Chair Mary Jo White has taken Justice.  For example, see my earlier post on the SEC requiring admissions of wrongdoing in order to settle “egregious cases”.   Set forth below is a summary of the Memorandum.

FIRST – To be eligible for any cooperation credit, corporations must identify all relevant facts and individuals responsible for the misconduct.

If a company wants to receive any cooperation credit, it must now disclose all relevant facts and actors. A corporation can no longer pick and choose to hide those individuals responsible based upon, position, status, or seniority. To receive cooperation credit, the company must learn all relevant information and turn this over to Justice otherwise cooperation will not be considered as a mitigating factor under USAM 9-28 et seq. Stated another way, the company must now be an active participant in its own internal investigation and must learn and discover the extent of its wrongdoings. This self-reporting is only the minimum threshold. The extent of any cooperation credit is awarded by Justice, it will still be based on the same factors that have traditionally been applied in making this determination – timeliness of cooperation, thoroughness, diligence, speed of internal investigation and whether the cooperation was proactive or not.

Well this doesn’t happen every day – or does it? The SEC finds itself being investigated for improper financial holdings. According to a November 2013 Reuters post, federal prosecutors and the office of the inspector general of the SEC contacted employees in the SEC’s New York office about trading in companies that are under SEC investigation. This is a direct violation of internal SEC rules. While the report indicates that it does not appear to be a widespread issue, it is another black eye for the SEC that is still marred by the 2009 allegations regarding insider trading by SEC employees. Stay tuned to see how this plays out.
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On July 9, 2012, the Financial Industry Regulatory Authority (FINRA) implemented a new securities rule governing the obligation of brokers to make “suitable” investment recommendations to customers. While FINRA Rule 2111 is based upon NASD Rule 2310 – the prior suitability rule – FINRA Rule 2111 expands the old rule in several significant ways.

The Suitability Obligation

Investors go to their stockbrokers not only to get advice as to which stocks are likely to offer good returns. They also are seeking input on which investments are suitable for their specific circumstance. The suitability rule is intended to provide the investor with peace of mind that his/her broker has reasonably believes the broker’s investment recommendations are appropriate at the time the investment is made. Unfortunately, we have seen far too many situations where the proposed investment makes more sense for the broker than for the investor.

Rule 2111 requires that brokers:

“have a reasonable basis to believe that a recommended transaction or investment strategy involving a security or securities is suitable for the customer, based on the information obtained through the reasonable diligence of the member or associated person to ascertain the customer’s investment profile”

FINRA Rule 2111(a) essentially takes existing case law and codifies it into three specific suitability claims. (1) reasonable-basis suitability; (2) customer-specific suitability; and (3) quantitative suitability.

1. Reasonable-Basis Suitability Reasonable-basis suitability means that a broker must perform reasonable diligence to understand the investment products and strategies that the broker recommends to her customer. The broker must also be able to demonstrate that she actually understands the product that she is recommending to her client.

2. Customer-Specific Suitability Customer-specific suitability means that a broker must have a reasonable basis to believe that her recommendations are suitable for a customer based on the customer’s “investment profile.” The broker must be able to establish that she understands who her client really is, what their needs are, and how this recommendation fits into what they are trying to accomplish.

3. Quantitative Suitability Quantitative suitability means that a broker who has control over a customer’s account must have a reasonable basis to believe that a series of recommended securities transactions is not excessive (often called a churning analysis). The broker’s must be able to establish that her overall trading record comports with the client’s goals.

New Requirements Imposed Upon Brokers

FINRA is clearly trying to send a message to brokers in this new economic climate and that message is “You will be responsible to your clients.” They are also expanding the potential definition of “clients” to include those who only had an informal relationship with the broker or prospective customers who may never have opened an account with the firm. Even recommended strategies, such a “hold” recommendation, may come under the purview of new FINAR Rule 2111. There is no requirement that the advice resulted in a commission before Rule 2111 comes into play. Simply put, brokers are now responsible for all customer recommendations.
While this is not an exhaustive discussion of the impact the new FINRA Rule will have upon brokers and their customers, it is clear FINRA is trying to chart a new course with an emphasis on protecting the individual customer from abuse. FINRA arbitration is relatively cheap and quick, especially in comparison to litigation a case in court. In fact, there is an expedited process for the elderly wherein you can file your complaint and have your case heard in less than 9 months.
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