Update on FACT Act

First, let me share my appreciation for FINRA's effort to explain the applicability of the FACT Act's Red Flag and other rules to member firms. The folks in OGC said they were working on it, and they did. Here's the link to Notice 08-69: http://www.finra.org/web/groups/industry/@ip/@reg/@notice/documents/notices/p117448.pdf

Now, let me express my dismay at the extreme lack of distinct clarity on this topic--not necessarily from FINRA, but embedded in the Act's definitions. Your firm may be subject to the regulation, or not--just read and re-read the definitions of 'financial institution,' 'transaction account, 'creditor' and 'covered account.' It's a little like solving a Rubik's cube. If all like colors end up on the same side, then yes, your firm has to implement Red Flag Rules under the Fact Act. But good luck getting there.

In reading the definitions provided in FINRA's notice, my first reaction is, "If they wanted broker-dealers to be covered, why didn't they just say so?" For instance, the term“financial institution” is specifically defined as “a State or National bank, a State or Federal savings and loan association, a mutual savings bank, a State or Federal credit union, or any other person that, directly or indirectly, holds a transaction account . . . belonging to a consumer.” And a “transaction account” is specifically defined as “a deposit or account on which the depositor or account holder is permitted to make withdrawals by negotiable or transferable instrument, payment orders of withdrawal, telephone transfers, or other similar items for the purpose of making payments or transfers to third persons or others. Such term includes demand deposits, negotiable order of withdrawal accounts, savings deposits subject to automatic transfers, and share draft accounts.” See what I mean? If they wanted B-D's to be subject to the regs, why not just include "SEC registered broker-dealers" or "brokerage accounts" or some such other simple identifiers in the definitions? That would have made it real easy... but instead, these definitions overtly exclude the whole subject of brokerage accounts and broker-dealers. And then your favorite SRO puts the onus on firms to twist and retwist the cube in order to solve the puzzle by themselves. Frankly, for most of the 5100 registered B-D's, I think this is like trying to force a square cube through a round hole: I don't think these rules should apply.

Also, while I'm ranting, this whole thing is crazy!! B-D's already have CIP rules to follow. And remember that AML rules are not just about preventing money laundering. We all know that most AML-triggered investigations end up focusing on fraud, including mail fraud and credit/debit card fraud. So firms are already obligated to attempt to identify and report fraud....why do they have to now be subject to seemingly duplicative rules? And at what cost? ...read the Notice... do you really have time to create a "Written Identity Theft Prevention Program"? One that will confuse your already confused Reps about the account opening process? This reminds me of redundant local ordinances--instead of having one rule that requires safe and responsible behavior on sidewalks, they have in place six different rules, pertaining to different possible ways to conduct unsafe and irresponsible behavior on sidewalks: skateboarding, bicycling, rollerblading, dog walking, etc.... get my point? I guess I just feel sorry for firms whose business has nothing at all to do with credit cards, withdrawals, payment transfers, etc. To think that they will have to adopt lengthy and complicated procedures on top of what they already have in place (which are already hardly deemed necessary and applicable): what a waste of resources.

But who am I ranting at, here? The Federal Trade Commission? That's a big target for a little person like me. And I don't want to trash FINRA--they did something cool by addressing the subject. I guess I would like if FINRA would go a bit farther out on the limb by actually giving its opinion on how application way firms, M&A/PP shops, and introducing firms who do not actually extend margin to clients fit into this definitional puzzle. I know they state up front that they're not the rulemakers or interpreters on this subject, but c'mon, since they go on to say that NOT complying would be a violation of just and equitable principles of trade, can't they show a little more mercy?

Another topic within this one: check out Part C of the Notice. It's about policies you have to have in place re: use of consumer reports. If your firm requests a consumer report about a new or existing customer and receives a notice of address discrepancy from a CRA, you'll have to be able to form a reasonable belief that the consumer report actually relates to the customer in question. FINRA did a nice job of laying out these responsibilities. I'm assuming the effective date of these requirements is the same delayed date as for Red Flag Rules: May 1, 2009 (although I could be wrong.)

Lastly, FINRA mentions in the Notice that FTC has indicated a willingness to work with them to "resolve on a consistent and industry-wide basis, interpretive questions that arise under these rules as applied to broker-dealers. " I love that! My advice to you and all your B-D friends: call OGC at (202)728-8071 to ask about this. Perhaps that kind of dialogue will result in 'interpretive challenges' being met head on with concrete directives from FINRA. Then you can throw that darned Rubik's cube out the window. Puzzle solved.

Networking Rocks!

Big shout out to Christine at IMS. Prompt, thorough assistance on a compliance issue. Gracias, Amiga!

r-e-s-p-e-c-t

...that's what binds both you and me.

I made that rhyme for your auditory pleasure. Say it out loud, go ahead.

I want my clients to know that, not only do I like you, I respect you--that is, I think the work you are doing is hard and you should be praised for that. Many in the media are trashing investment bankers, brokers and bankers, alike, as if they alone are to blame for the market turmoil. We know that's not true. You, my clients, are creative individuals who choose to make a living by making other people money. That ain't no crime. And the more creativity, energy and motivation you have, most likely, the more money your clients will make. (That came out a bit like Yoda-speak.)

Oh, and what I really want to say is thank-you for likewise respecting me and my work. It's an honor to help you out and I benefit everyday from your appreciation for what I do.

Oh my gosh, this touchy feely stuff is hard to take, non? Okay, back to my Rule Conversion/WSP update work...

Just a few notes on AML

Hey there, busy over here. Year-end always comes too quickly. I wish you all well in the markets and in your securities business. Hang in there.

Kinda recently, FinCEN published their newest SAR Activity review… here is the link: FinCEN Publishes SAR Activity Review- By the Numbers – Issue 11

Here is their summary analysis regarding SAR filing increases in the first 6 months of 2008:

Suspicious Activity Reports characterizing the suspicious activity type as Credit/Debit Card Fraud increased 58%, compared to the corresponding six month period in 2007.

In 2008, Suspicious Activity Reports characterizing the suspicious activity type as Mail Fraud increased 49%, compared to reports filed during the same period in 2007.

The total suspicious activity reporting volume in the first six months of 2008 increased 18%, compared to the same period in 2007.

Suspicious Activity Reports characterizing the suspicious activity type as Money Laundering/Structuring increased 15%, compared to the corresponding six month period in 2007.

And, this came out last month… as you know, investment advisers are not currently required to have AML programs in place, although most these days are adopting programs to meet the expectations of investors and broker-dealers. The announcement (see below) informs us that the proposed rule to require IA’s (SEC-registered IA’s and unregistered IA’s with $30mm under management) to have AML programs has been dropped. They say that if IA’s in the future are to be subject to FinCEN AML program requirements, a new rule will have to be proposed and adopted.

What that means for you, maybe: if you as a BD had hoped your unregistered IA friends would have their own darned AML rules to follow, so that you could rely on them to do it for you when they introduce investors to you, well, forget it. The currently-effective SEC no-action letter (effective 1-12-08) allows you to rely on federally-regulated IA's to do that--not unregulated IA's. I have that letter in my files; if you want me to email it to you, just ask.

Here is FinCEN's announcement, pulling the proposed IA rule proposal:
From: http://www.fincen.gov/news_room/nr/html/20081030.html
October 30, 2008

FinCEN Withdraws Dated AML Rule Proposals for Unregistered Investment Companies, Commodity Trading Advisors, and Investment Advisers

VIENNA, Va. – As part of its overall effort to increase its efficiency and effectiveness in administering the Bank Secrecy Act (BSA), the Financial Crimes Enforcement Network (FinCEN) has withdrawn its proposed anti-money laundering (AML) program rules for unregistered investment companies, commodity trading advisors and investment advisers. The withdrawals of the proposed program rules have been submitted for publication in the Federal Register.

Given the passage of time since these rules were first proposed in 2002 and 2003, FinCEN has determined that it will not proceed with BSA requirements for these entities without publishing new proposals and allowing for industry comments. FinCEN will continue to consider whether and to what extent it should impose requirements under the BSA on these entities.
Since the proposed rules were first published, FinCEN has concluded rulemakings for banks, broker-dealers and futures commission merchants. The financial transactions of unregistered investment companies, investment advisers, and commodity trading advisors and their clients must be conducted through, and their assets carried by, other financial institutions that are subject to BSA requirements. Thus, as FinCEN continues to consider the extent to which BSA requirements should be imposed on these entities, their activity is not entirely outside the current BSA regulatory regime.

In an effort to make its rulemaking processes more transparent, FinCEN today also established a section of its website entitled "Pending Rules" where those rules that are still awaiting comments or finalization will be made easily available.

I'm Going as a Conversion Chart for Halloween

Reason? It's the scariest thing I can think of.

Remember when NASD Reg. merged with NYSE reg.? And they said they'd be consolidating the rulebooks? Well, the first set of Rule Conversions was released by FINRA on October 16. For 34 pages of fright, see Notice 08-47 at: http://www.finra.org/web/groups/industry/@ip/@reg/@notice/documents/notices/p117255.pdf

This shows the changes that are effective in 60 days. Many changes are simply adopting current NASD Rules and incorporating old NYSE Rules into brand new FINRA Rules—with no substantive changes. But the quantity of information is scary: 564 items in the handy “Conversion Chart.”
http://www.finra.org/Industry/Regulation/FINRARules/p085560 . This chart shows the old NASD Rule number and the new, corresponding FINRA Rule number (I'm not addressing NYSE Rule changes here, since that's not my area of expertise). That’s helpful, but not as great as it could be. I mean, each of these conversion listings has links to the old and new Rules, the Federal Register with the Rule Filings and approval orders, and any amendments to Rule Filings. The chart doesn’t comment on the nature of the changes represented: minor, technical or substantive. You have to cross reference the Notice (above) for any mention of that. Or open up the Rule Filing and start reading… a lengthy process, for sure.

I've added two columns to the chart: "Summary of Changes" and "In WSP? Changes Necessary?" This way, I'll record the results of my painstaking investigation into each and every cited change. Process: open up 'filing number' link on chart; read summary; open up 'text of proposed rule change' and any amendment links, read 'til I'm cross-eyed, then summarize changes on the table. Next, go to WSP, look for old Rule citations, change them, and add any text necessary to incorporate substantive Rule changes. That's it! I only have 547 items to go. I'm on a roll.

Seriously though, many of these changes relate to things like arbitration claims procedures and other administrative Rules that are generally not included in a firm's WSP. So, maybe in the end only a handful of these announced conversions will result in real written procedural changes. (Wait, this reminds me of the difference between the 'real America' and the, well, not-so-real America and that silly Congresswoman's call for Congressional hearings to route out the fakers... oops, wrong scary blog site...) Anyway, I'm not one to make assumptions and will therefore poke through every item on this chart. I'm praying to the Great Pumpkin and Santa Claus that the next released Conversion Chart will be waaaaaay less lengthy/frightening.

I encourage you to take the time to look at the recent Notice and to open up subsequent bi-monthly Notices. Scroll down through the list of Rule changes for those that are relevant to your business. It certainly won't pay to put off attention to this. Face these demons now: 'tis the season.

Have a sweet Halloween.

FACT Act for BD's? Maybe.

A very helpful member of FINRA's Office of General Counsel looked into the whole FACT Act/ID Theft/Red Flags Rules subject. A big shout out to that person--thanks again!

I had asked him about 2 weeks ago about how these new rules might apply to registered B-D’s. He let me know that it is, specifically, FTC Rule 681, implemented under the FACT Act, that may apply. This rule goes into effect November 1. I guess FINRA is considering publishing either a reminder or guidance on the topic. Since it’s not an SEC Rule, SEC won’t be enforcing this; whether or not FINRA adds it to their examination protocols, we won’t know yet. A parallel example of FINRA enforcing an FTC rule is in the area of telemarketing restrictions. As you know, FINRA/NASD ‘adopted’ them and enforces cold calling rules.

Here is the link to the Federal Register announcing the FTC’s (and other agencies’) implementation of the FACT Act: http://frwebgate1.access.gpo.gov/cgi-bin/PDFgate.cgi?WAISdocID=080421251418+19+1+0&WAISaction=retrieve.

The operative terms within the rule are “financial institution,” “creditor” and “covered account.” I have a sense that M&A/private placement firms and straight up check & app firms (no brokerage accounts) will be able to exempt themselves; OGC seems to think introducing firms whose clients have brokerage accounts will not be exempt. But let’s wait and see…my opinion is, it’s only fair that FINRA provide some help on this complicated subject. Because let's face it: your compliance staff is working hard these days on many other issues. They're not pro-actively reading the Federal Register on weekends in an attempt to find new, unannounced rules to follow. (If they are, give them a raise or ask them to call me for a job.)

So be on the lookout for something from FINRA. In the mean time, think about clicking that link above and searching "681." You'll be way ahead of the game. (Unlike the Sox.) (Go Sox.)

Fact-ish: The FACT Act and Reg. S-P Amendments

I'm writing this to let you know I'm looking into something--that is, this is preliminary and I'll follow up later. So, put this information in the category of 'truthiness.'

I saw on FINRA's weekly e-mail the announcement of its online workshop on the subject of customer data protection issues (see: http://www.finra.org/Industry/Education/OnlineLearning/OnlineWorkshops/P117068 ). Within the workshop description the “new FACT Act” is mentioned.

This mention made me look into the FACT Act; I'd certainly seen references to new 'ID theft' compliance in other documents and online sources, but I was not familiar with the Act, nor its applicability to broker-dealers. Sometimes I'm lazy (no, not lazy: overworked!), and I rely on FINRA's Notices to announce important new requirements that will effect my clients.

Note that the FACT Act was referenced in NtM 05-49, but only in the footnotes and in reference to preventing identity theft by destruction of consumer reports.

The FACT Act is a banking regulation: the Fair and Accurate Credit Transactions Act of 2003. Financial institutions, under the Act, have a mandatory deadline of November 1, 2008, to comply with three new parts, called the Red Flag Rules (in sections 114 and 315 of the Act). New requirements include:

• Creating an identity theft prevention program
• Implementing change of address safeguards when issuing credit/debit cards
• Verifying identity upon notice of address discrepancy from a consumer reporting agency

As you can see, this stuff doesn't really seem to relate to your brokerage business. Well, my read of the FACT Act is that it doesn’t apply to broker-dealers. Here's an excerpt from the Act proposal that appears to exempt BD’s from complying with the red flag rules, including having an ID theft program:

334.90 Duties regarding the detection, prevention, and mitigation of
identity theft.
(a) Purpose and scope. This section implements section 114 of the Fair and Accurate Credit Transactions Act, 15 U.S.C. 1681m, which amends section 615 of the Fair Credit Reporting Act (FCRA). It applies to financial institutions and creditors that are insured state nonmember banks, insured state licensed branches of foreign banks, or subsidiaries of such entities (except brokers, dealers, persons providing insurance, investment companies, and investment advisers).

But, within the Act, “account” and "transaction" as defined may include certain types of brokerage accounts that allow for check writing, debit transactions,etc., that would then throw the requirements into a BD's realm. Since you, the small BD offering mutual fund investments on an application way basis, doing private placements or hedge funds offerings, or running an institutional trade desk, do not allow check writing on customer accounts, this stuff seems inapplicable and worthy of ignoring.

But.... why the mention in the online workshop announcement? The mention, itself, is a red flag for me: ooh-oh, is this something I missed? Maybe the workshop will confirm just what I surmise: the FACT Act doesn't apply to you; no worries. I would have liked it better had FINRA released guidance first, though, so that the message was way more broadly-distributed (most firms don't listen to the online workshops). I've asked FINRA if guidance is forthcoming. I'll keep you posted.

We're not done yet.

Reg. S-P is subject to pending amendments that cross reference the FACT Act. So, this may be a good thing for you or a bad thing. That is, if S-P will definitively require all BD’s to comply with the red flag rules under the Fact Act, then you'll have to waste time building procedures or justifications for not having procedures to comply. Perhaps the amendments--and FINRA's expectations of compliance—will be nuanced, such that you won't have to waste time on this. We will see.

Now remember, my knowledge base is minimal on this subject. No facts expressed here, only factish information. My goal is let you know that you don't have to react with alarm if you hear about firms complying with the Fact Act. Most likely it does not concern you. But stay tuned, because the Reg. S-P changes might.

If only politics were this straightforward. ... oh wait, they are.

Outside In

What does Heidi Klum say? "You are either in or you are out." It's one or the other, and the other goes home.

In years past this distinction for me has been clear: as an "outside consultant" to securities firms, I've always been treated that way by regulators--as an unwelcome outsider. I remember a few years ago, standing at a gas station in Some City, USA, on business travel. I was on my cell with a District liaison, fighting to get information from her about a rule interpretation or some such other clarification. My purpose was to assist my BD client--not to waste the liaison's time to build my personal knowledge base. I was speaking to the subject without divulging the client's name--that would have defeated my client's purpose at the time. Anyway, this experience was similar to many I've had over the past 8 years as a consultant: I act as a go-between in order to help my BD clients better meet Finra's Rules, and I'm shut down in the process by Finra staff due to a procedure they put in place that requires, without exception, the caller to identify the member firm's name when making inquiries.

I'm happy to say that my recent interaction with some Finra staff members has strayed from this model. I've been treated to assistance by folks in various offices--such as District offices and the Office of General Counsel--without the bias I was used to confronting. A great guy in Advertising has been helpful on several occasions. A kind examiner in NYC has been generous with his time. I haven't been made to feel like a spy or a cheater when engaging in intelligent dialogue. I'm hoping this trend continues. While I understand the old mantra, 'firms can call us for information without raising red flags or risking retribution...,' I also understand that many small firms simply prefer to avoid that direct contact. They'd rather have someone like me act as an information gatherer and interpreter. In my opinion, the result is the same (and mutually desirable): BD's are well-informed and better able to meet their responsibilities. The means to that end should not be restricted. It is in the investing public's best interest to let information/guidance/interpretation flow to BD's and their consultants.

I also want to thank some Finra staff members for their good-natured, prompt and extremely helpful assistance to me in months past...I won't name them, but the folks in the online learning and waiver departments are good at what they do and pleasant to work with. Thanks to all of you!

So, Heidi, am I in or am I out? I think for the time being, I'm a little of both. And on this particular reality show, that means I'm a winner.

The Law of Opposites

I haven't written for a while. Too much going on. I've been busy watching my son balance speed with caution at the age of 16, marvelling at my other son as he defies gravity on his unicycle, questioning the sanity of our polarized political system, and witnessing the end of the beginning of the end. These directional changes are making me nauseous. At least I have my work to keep me facing forward... I think.

A few thoughts for the day:

Finra has redesigned its website, just when I became adept at navigating the old site. Oh well, it's not about me. Anyway, it looks nice. www.finra.org

FinCEN's most recent report on suspicious activity reporting--SAR by the Numbers--includes totals for 2007. It's here: http://www.fincen.gov/news_room/rp/files/sar_by_numb_10_sec4.xls

From 2006 to 2007, there was a 58% increase in the number of SAR's filed by the securities and futures industry. One of the fastest areas of growth was in identity thefts. I imagine we'll see high growth again this year, since it's one of SEC's and Finra's priorities to make sure firms are filing SAR's, even in the face of 'potential' suspicious activity. (On that subject, please read Bill Singer's 'Cases of Note' comment on the James I. Black & Company and Jess Gove Tucker III case, August 2008 at: http://www.rrbdlaw.com/RegulatoryLinks/CASESOFNOTE/NASD/2008.htm .) Oh, and if you look closely at the report, you'll see only one state where, since 2003, there has never been a SAR filed. Where? The State of Alaska. Does that mean Sarah Palin supports money laundering by terrorists? Probably not, but I bet someone on cable TV would make that connection.

Back in May, Finra released a series of Notices related to the Rule Consolidation project. Notice 08-24 requested comment on revisions to supervision and supervisory controls rules. This is what we've been waiting for, right? The big Rule Consolidation Re-Write... the one that will bring us closer to an intelligent, principles-based regulatory structure that allows for flexibility depending on firm size and business niche?

Not so fast.

First, they're going to rewrite the rules so that there is less clarity, more cause for misinterpretation, broader authority leading to even more onerous procedural changes, and... oops, I didn't mean to be critical. I admit it must be a very difficult job: to take a HUGE rulebook governing many different business models, full of cross-references, overlapping definitions and nuanced contradictions, and attempt to improve it with a little tweaking. My take is, it's not gonna happen with edits--it will only happen with a complete re-write.

In the end, firms should be required to simply do the right thing and a well-managed regulatory body should be capable of discerning when those firms are not doing the right thing. The more minutia- and legalese-laden, arbitrary and seemingly non-applicable rules, the more likely firms are to treat compliance like a chess match: outwit the opponent by seizing on his lack of peripheral vision. That's not the way it should work.

Anyway, what IS interesting are the comment letters--go here, and choose some to read. http://www.finra.org/Industry/Regulation/Notices/2008/P038502 It's encouraging that firms are voicing opposition to things like: broadened supervisory requirements on outside business activities; requiring principals be assigned to supervise business areas of firms that do not require BD registration; duplicative supervisory sign-off on investment banking transactions; closer oversight of one-person OSJ's; and transaction review of reps' family member accounts, among others. I especially enjoyed reading the letter from ING Advisors Network, June 30. The author's comments are clear and rational. See: http://www.finra.org/web/groups/industry/@ip/@reg/@notice/documents/noticecomments/p038858.pdf

Now, back to the end of the beginning of the end... Did I really just say that firms should have simple, principles-based rules to follow in the way they see fit, and our regulators should be smart, motivated, united and reasonable in enforcing these new 'just do it' rules? I said that, in this market environment? What, am I nuts? Every day on the news shows all I hear is 'more regulation, more regulation, more regulation,' even from those who oppose it. I pity the team of Finra authors even more: if their mission was challenging before, it's now darned-near impossible. Whose advice do they take? Alan Greenspan said leave the short sellers alone--they're necessary and smart. Other talking heads say the short sellers are greedy and irresponsible. I hear Cox is a genius, then I hear he's an idiot. I'm not savvy enough to make up my own mind. But as a compliance consult, I do know one thing: there will be more rule changes and more rules and much, much more work to do on the part of my small BD firm clients who ALWAYS do the right thing.

In the name of opposites, I'll close quoting someone else, whose name I don't know (he was on Fresh Air): "In our country we privatize profits and socialize losses." Isn't that perfect? -er, I mean, not perfect? ....there I go again.

FinCEN's Better Website

For those of you compliance professionals who keep up with FinCEN announcements, this is not news. For you others--too busy to click every link provided in every notification--check out FinCEN's website. http://www.fincen.gov/ They redesigned it a couple of months ago and I have to say, it's a great improvement. Whereas before, a user had to have a good sense of BSA and other regulation in order to navigate the site, now users are treated more sympathetically. The site presents information grouped in several different ways, such as: industry type (like 'securities & futures' for us), statutes and regulations, forms, and most requested. It's now very easy to find the form you have to file and equally easy to quickly reference all recent published guidance. While I may find it interesting to read about regulations affecting casinos, now I don't have to wade through it on my way to information I really need. Thanks, FinCEN!

(I remember years back putting a call into FinCEN and being extrememly underwhelmed by their adminstrative infrastructure. I have to imagine they've been well funded lately to the point of stepping up their game--hiring good webmasters, for instance. I think this is good. I mean, entities like broker-dealers and the 100's of thousands of people working for them are burdened daily by AML rules: it's only fair that they should expect to rely on a functional support system to enable their efforts.)

Also check out the "international" tab on FinCEN's site. This is nice, in that it provides links to other organizatoins such as OFAC and FATF. You won't find the same ease of locating informaton on these other sites--for instance, to locate the current NCCT list on FATF's site, you have to click Key Topics>Meeting FATF Standards>NCCT Initiative in order to get to a page that has a link (on the right side) to the NCCT list. Which is empty, by the way. The list hasn't had any names since October 2006.

By the way, you know that your AML program requires updating for rule changes and internal, firm policy/personnel changes. The good news is, there haven't been any substantive rule/regulation changes lately. If you haven't looked at your written program recently, take a look. Be sure it includes lots of references to 'risk-based' compliance and also Section 311 of the Patriot Act (on specially-designated nationals). Also make sure you have procedures for maintaining all supporting documentation for SAR filings and for responding to law enforcement requests to keep accounts open. These subjects have shown up recently in FINRA exam results.

Now get back to your more enjoyable reading... on a chaise lounge, in the sun, with some Beth Orton or Matt Costa playing in the background... ahhh, it's August.

Another Cover-Up

Remember when John Ashcroft, serving as Attorney General under President Bush 2001-2005, required that the statues in his press room be made, well, less revealing? In an effort to protect the public, expensive fabric was draped over the age-worn marble of both Spirit of Justice and Majesty of Justice--well, at least over the more love-worn parts. The language of art was muted to satisfy our government's assumptions about our well-being. The thought art provokes, the questions it raises, and the beauty it portrays were denied an audience (what audience? ...not sure anyone was watching Ashcroft, anyway).

Mr. Ashcroft opposed nudity in art. Last week, the SEC decided it would oppose nudity in short selling. In an emergency order released July 15 (see: http://www.sec.gov/news/press/2008/2008-143.htm) SEC announced that for 19 publicly-traded financial company stocks (such as Lehman Bros., B of A, Citigroup, and of course, Freddie Mac and Fannie Mae), short sellers have to pre-borrow the subject securities, as opposed to the standard pre-locate practice. Trading firms everywhere are scurrying to devise procedures to meet this order. Some are saying 'forget it'--we just won't trade in those stocks for 8 days. And maybe that's what the SEC is hoping for: shrouding the market in a blanket heavy enough to silence the critics.

The SEC's mission was to "protect investors, maintain orderly markets, and promote capital formation." Is it possible that what the SEC is really doing is denying the rightful power of the free market to self-adjust? I mean, by shielding these firms from what the market wants to do--short the hell out of them in expectation of falling prices--isn't the federal government, with its artificial drapery, silencing the thinkers? ignoring the questions? rejecting the beauty of a sophisticated investment community? Why not let things progress as they otherwise might--let these financial houses of cards fall? Let the investors suffer for their bad choices? As they say in sports, no pain, no gain. The gain we sacrifice here is badly needed. Corporate bail-outs, no matter what form they take, don't help us progress. They just delay the pain.

On a practical note, by now you should have talked to your clearing firm about rules engines or other means of ensuring this temporary rule is enforced. And you should have informed your traders of the specific requirements. Be sure to notate your short sales as having complied with the 'pre-borrow' ethic. Keep the records; have a supervisor review the records. As for keeping your clothes on, well, that depends on how hot it gets...and your definition of 'art.' ;)

I won't call it a reversal

...but it seems like one.

Oh, I'm talking about electronic storage rules again. When I die, will someone please make sure my tombstone says something about my dedication to this cause? ...says something...not necessarily flattering.

Okay, so in the last two days I've run into situations where it appeared that 3rd party electronic storage vendors would not provide the representation letters generally expected under 17a-4(f)(2)(i)--you know the letter--the one that says the media will do the things listed under (f)(2)(ii), as follows:

(A) Preserve the records exclusively in a non-rewriteable, non-erasable format;

(B) Verify automatically the quality and accuracy of the storage media recording process;

(C) Serialize the original and, if applicable, duplicate units of storage media, and time-date for the required period of retention the information placed on such electronic storage media; and

(D) Have the capacity to readily download indexes and records preserved on the electronic storage media to any medium acceptable under this paragraph (f) as required by the Commission or the self-regulatory organizations of which the member, broker, or dealer is a member.

Since way back, when this subject was just a shadow across compliance officers' desks, the expectation--and instructions from then-NASD, I might add--was that, if the firm used a 3rd party vendor to store its electronic records, it was the 3rd party vendor who was required to make those representations in writing, on their letterhead, to the regulators. The firm would engage the vendor to store information (such as e-mails), would request the letter, would get the letter, and would mail it to Susan DeMando's office. Later, firms had to submit it to FINRA online.

Firms storing their own records electronically would make the representations themselves, in writing to FINRA.

What I just learned from a helpful and trusted FINRA staff member is this: the format representations letter does NOT have to come from the 3rd party vendor. Quoting (f)(2)(i) of the Rule: "...the member, broker, or dealer must provide its own representation or one from the storage medium vendor or other third party with appropriate expertise that the selected storage media meets the conditions set forth in this paragraph (f)(2)." The staff member said that the BD would make the representations 'unless they don't have the knowledge' to make them.

My opinion is this: most firms are hiring out because they don't have that knowledge or anything close to it. But hey, I've been wrong--or at least misled--before.

Most 3rd party vendors, in my experience, give those letters to their clients for delivery to FINRA. I would expect it if I were you. If the vendor wants to charge you for the letter, save your money and write the letter yourself.

Here's the thing , though: make sure you, the BD, get solid, written clarity from your 3rd party vendor before writing and submitting your letter to FINRA. You have to be sure the media meets the criteria. You're hiring the vendor because you can't or don't want to store the records yourself... you'll need to rest assured that the records meet the regulator's expectations, right? Otherwise, why pay their prices??

Oh, and remember: you always have to submit an 'access letter' to FINRA-complying with 17a-4(f)(3)(vii)--and that letter has to come from an independent third party (any old third party will do--as long as they know what they're talking about and they're not an affiliate or relative). Your third party storage vendor will write that letter for you--if they don't, fire them.

Thanks to Davis for his inspiration... he knows that nothing gets me going like ESM.

>

Little more input on audit function under electronic r/k rule

Quick--I promise--update on the 'audit function' under 17a-4(f)(3)(v). This week a FINRA examiner provided verbal guidance in response to a firm's written request for such. The guidance was not specific; it was based only common sense, not formal guidance from SEC or FINRA higher-ups. It consisted of recommending a periodic review of stored records to confirm that they are intact.

Okay then.

Obviously more on this subject is necessary for firms to fully understand their responsibilities.

AND...I came across another outside vendor for e-mail archiving: Global Relay Communications. I haven't gotten permission to link to them--please google them and check out their broker-dealer services. They seem quite thorough in their comprehension of FINRA members' regulatory burdens. Their materials plainly address all requirements and describe how their systems meet them... nice to see. Here's an excerpt from their presentation on the audit function (okay, I didn't get permission to copy this--but I'm hopeful the G.R. folks will appreciate the plug):

"All messages stored in the Message Archiver are forwarded directly from the Member firm’s email server, with no User intervention. During the lifecycle of a message, all actions (viewing, replying, forwarding, downloading, flagging, notation, review) by any User, Reviewer, Super Reviewer, Administrator or the system itself associated with the message are logged. The Message Archiver’s detailed logs provide a full audit trail verifying the integrity of the message. These logs automatically appended to the messages and are viewable and made available to authorized administrative Users.

As detailed directly above, Message Archiver immediately provides a full audit trail accessible to any authorized administrative User. A side benefit of the system, is that a firm also builds an audit trail for the auditors actions in the archive during an online audit.

Global Relay’s Message Archiver employs retention schedules for all audit results. Audit results are retained for the lifecycle of the message. The SEC three and six year retention requirement for records set out in paragraph (a) and (b) of this Rule 17a-4 can be applied to the audits within Message Archiver."

Happy Summer!

Bill Singer, Put Your Holster Back On

"When I decide whether to ride out of town into the sunset or slap the iron back on and walk the streets, you'll know -- I'll post that decision here."

That is a quote from Bill Singer's blog entry of May 16. The good news is, he wrote a subsequent entry--"The Dead-Animal Man"--yesterday, on May 21. The bad news is, he didn't reveal his decision. I'm reluctant to assume he's back in the saddle again, since this latest, delightfully-dreary, entry did not address our favorite subject (the one that so wears on Mr. Singer that he is forced to consider retiring to the comforting chaos of his Pandora's box): securities regulation and its many splendid forms. Is Bill back? Or still in the barn? I, for one, am waiting with great hope that he'll darken FINRA's doorway again soon.

Bill's blog: http://www.rrbdlaw.com/brokeandbroker/index.php

Exam Priorities

FINRA just put out its annual notice on exam priorities. Below I've listed the areas they prioritize (many), along with summaries and few comments. Far below, I note some recent findings I've seen on exams. This isn't overly original or interesting, but I thought I'd throw it in my blog, since I've been way too busy lately to write anything else... :)

Senior Investors – hot topics include misleading advertising, shameless, fear-inducing sales pitches and of course, suitability. Advice: don’t let your reps claim to be qualified
‘senior investing’ specialists and make sure each transaction is well documented to establish suitability.
Deferred Variable Annuities – new Rule 2821 went into effect, sort of, on May 5. Reps have to document their reasonable basis for recommending a Def. V/A purchase or switch; principals in the future will also be required to ensure reasonableness. Training is in Def. V/A rules and products is required. Here is the link to the April Phone-In Workshop on the subject - phone-in workshop; also reference my notes on this in an earlier blog entry.
Anti-Money Laundering (AML) – final rule 312 of Patriot Act went into effect in Feb; most small firms are not effected since they don’t have foreign banking relationships. Examiners are looking for suspicious activity monitoring and SAR filings; also making sure firms are having independent testing as required. Remember, follow-up on testing recommendations and keep records of your follow-up action taken.
Protection of Customer Information – issues include online account hacking (not relevant for most small firms) and protecting information stored electronically (on hard drives, portable drives, laptops and PDA’s). Exam deficiencies include failure to provide privacy notices (and keep records of providing them), failure to have procedures addressing disposal of consumer report information, failure to obtain required confidentiality agreements from third parties; failure to insure that outsourcing entities maintained the confidentiality of customer information; and failure to include a required “opt out” clause in their privacy policies. While firm procedures may address safeguarding their information, it’s a good idea to have a separate “IT” type document detailing the administrative, technical and physical safeguards used to secure data.
Supervision and Supervisory Controls – I guess a lot of firms are still struggling with the difference between supervisory procedures under 3010 and control procedures under 3012/3013. Exams focus on separate control procedures, review of producing manager, heightened supervision of high-risk brokers, annual testing and verification and CEO certifications.
Sales of New or Non-Conventional Products – firms have to have procedures for approving of new products; examiners are also focusing on recommendations in new and non-conventional products, such as hedge funds, CMOs/CDOs, REITS, auction rate securities and other structured products. Guidance references MSRB notices for firms doing muni business.
Transaction Reporting – accuracy of reported transaction information is the firm’s responsibility, no matter how it’s reported. Trade Reporting Facility participants must transmit certain information regarding last sale reports of transactions in designated securities. Examiners are also finding firms to have incorrectly reported riskless principal transactions, incorrectly reported transactions with the long/short-sale indicator and not properly submitted OATS data with accurate order information, terms and conditions, and/or special handling codes.
Business Continuity Planning (BCP) – the exam priorities publication states that firms should periodically test their plan to ensure all of its components work as envisioned…but this is not required by the Rule itself or in FINRA’s 2006 NTM 06-74 on the subject. Firms should decide if periodic testing is necessary, given their size and customer services.
Data Integrity – exams will look at CRD filings, complaint reporting and clearing firm reporting to ensure accuracy and timeliness. Firms face steep fines for late filings.
Bank Sweep Programs – for broker-dealers sweeping customer credit balances into deposits at banks. All sorts of issues, here, including: protection of funds, net capital requirements, written agreements, reconciliations, books and records, SIPC/FDIC coverage, and account statements. Call district contact to discuss before setting up such a program.
Agency Lending Disclosure – for firms that operate an agency securities lending business. Exam findings show firms not performing principal counterparty credit risk monitoring or reconciliations and not resolving contract differences nor computing securities borrow deficit capital charges at the principal counterparty level. Ref: 05-45.
Inventory Valuations – firms should have controls to independently validate the pricing of inventory positions.
Outsourcing – outsourcing is not a substitute for internal controls and compliance monitoring; outsourcing should be monitored and overseen. Outsourcing to foreign entities may result in risks and should be closely monitored.
Order Audit Trail System (OATS) – as of February 4, 2008, OATS reporting requirements include OTC equity securities such as orders for OTC equity securities traded on the OTCBB, Pink Sheets or otherwise, as well as orders for certain foreign equity securities and other securities meeting the definition of OTC equity security in NASD Rule 6951. Best to visit the OATS web site (OATS) and FAQs to understand the complexities of OATS reporting.
Regulation NMS -- SEC Rules 610 (the Access Rule) and 611 (the Order Protection Rule) were fully implemented for all NMS stocks as of October 8, 2007. Initial FINRA exams show that some firms mistakenly may believe that Reg NMS does not apply to them, either because they make markets in a limited number of NMS stocks or because they infrequently execute orders internally. Note that Reg NMS does not include any exception to the definition of “trading center” based on de minimis activity. Firms are reminded that the requirements for ISOs apply to “any broker or dealer” that uses ISOs, and are not limited solely to broker-dealers that operate as trading centers. Refer to online resources for clarity on this: Spotlight On Regulation and Frequently Asked Questions on Rules 610 and 611.

Additional areas of exam findings:

Changes in Account Name or Designation – changes in account name or designation, including error accounts, must be approved by a designated principal and there must be records to show that s/he was personally made aware of the essential facts concerning the change. Approval must be noted on the order or another record.
Time and Price Discretion – when relying on a verbal, one-day time and price discretion exception to Rule 2510 (discretionary accounts), firms must note the reliance on tickets and must not extend the discretion beyond the close of business that day. (Doesn’t apply to institutional accounts in ‘good-til-cancelled’ transactions on a ‘not held’ basis.)
Net Capital – violations include inaccurate inventory valuations of prop. positions and mark-to-markets performed by traders; and improper treatment of ‘cash-like’ investments offered by banks (non-allowable).
Customer Protection – 15c3-3 violations include: inaccurate treatment of stock record allocation positions; non-bona fide reserve bank deposits; and creation of segregation deficits by deliveries, securities loaned and securities borrowed returns.
Back-Office Transaction Processing – inaccurate trade processing and reconciling. Conversions of processing systems often leads to a lot of trade breaks and unreconciled items, creating inaccuracies in books and records, charges against net capital and increased customer reserve requirements.

What I have seen lately in exam results:

Audit of Electronic Storage Input -- failure to have procedures for/comply with the ‘audit’ function under the SEC electronic books and records rule (17a-4(f)(3)(v). I have requested guidance from four FINRA staff members; three clients have directly requested guidance, verbally and/or in writing, from their examiners and/or liaisons, but NONE has been provided. At very least, perhaps firms should ‘check to see that the records are there’—paraphrased advice from one FINRA staff member.
Notify Outside Brokerage Firms of Employee Accounts – Rule 3050. If reps opened accounts prior to being associated persons of the firm, they will not have informed the outside brokerage firm of their status as RR. Firm should send letter to outside brokerage firm with request to provide duplicate statements/confirms.
Provide Copy of U5 to Term’d Rep – copies of U5’s must be provided to terminated reps within 30 days of termination; keep a record to show that the U5 was indeed provided.
Maintain Updated Contacts on FCS – be sure when updating contact information that you hit “save” or the changes will be lost. Changes of most CRD information should be made within 30 days of the change or of knowing of the change.
Provide BCP Disclosure Summary – required for all firms, including those with institutional customers. Provide at account opening and when the information changes (not an annual disclosure requirements, but a good idea to include in annual disclosures).
Register Personnel with Access to B/R – back office or administrative staff who have access to customer records or the firm’s financial b/r should be registered on CRD as “NRF” employees. Fingerprint cards and certain personal data are filed.
Obtain AML Information (CIP) -- new account forms or other such forms should include all required CIP information—name, physical address, TIN and DOB if individual. Verification must be in evidence and customers must be informed of firm’s CIP verification efforts—keep records of all compliance with this rule.

Deferred Variable Annuities--The New Rule

Hi. And Happy Earth Day. While you're in your backyard digging holes and planting things, perhaps include this information (-'er, I don't mean bury it--I mean, plant it in your mind so that it may bloom and grow).


Rule 2821 is effective May 5. But not the whole thing: paragraphs (c) and (d) have been put on hold indefinitely, pending SEC's response to FINRA's forthcoming amendments (that's some kinda vague, isn't it?). What this means is: your Reps have to perform and document a suitability analysis for def. v/a purchases and exchanges, but you as Principal don't have to follow the new approval rules--you don't have to make a suitability determination, too. At least not yet. You still have to approve the business like you've always done. The other part of the Rule that will be effective May 5 is the training part: you have to train your reps on the new Rule and on def. variable annuities in general, along with the specific products they offer. I have a feeling you're doing this already for C/E purposes. But be sure to train, by May 5, the reps on the specifics of their new obligations under the Rule; also train them on any new forms you've devised to help them document their suitability analysis. Lastly, interestingly, your firm has to comply with these effective parts of the Rule, but you don't have to have written procedures in place describing the compliance elements you're adopting. That paragraph (d) has been delayed. If you're in the process of updating your WSP manual, or will be soon, it wouldn't hurt to go ahead and include new procedures: you can revise them later, if necessary.


I listened in on the Def. V/A Phone-In Workshop last Friday. Here are the notes I typed up. My apologies for the tone of brevity. FYI: I didn't learn a lot on this phone call and found that the "cya" and "not our job" messages were loud and clear, as usual.


Notes on Rule 2821: Deferred Variable Annuities Phone-In Workshop
April 18, 2008

Presenters: Larry Kosciulek and Andy Favret

1400 participants signed up for call
Questions submitted in advance; no live questions from listeners
(cya introduction: FINRA doesn’t endorse any compliance practice)

Link to materials: http://www.finra.org/EducationPrograms/Materials/p038332

1. UPDATE:
Paragraphs (c) and (d) –effectiveness delayed indefinitely. See rule filing notice sent April 17 by Finra: http://www.finra.org/RulesRegulation/RuleFilings/2008RuleFilings/P038354

2. APPLICABLE TO:
Rule applies to stand-alone purchase of def. v/a and exchange of one for another. Includes purchases in IRA accounts, not transaction in employer-sponsored plans. Does not apply to re-allocation in sub-accounts or to subsequent investments in sub-accounts. Does not apply to recommendations to SELL v/a’s (but other, general rules such as Communications with the Public--Rule 2210--apply to these transactions). Rule would apply to specific recommendations made to individual plan members of an employer-sponsored plan.

Rule applies to recommended transactions (not all communications constitute recommendations)—but the text of Paragraph (c) (that may be amended and is not now effective) states that a principal must treat “all transactions as if they have
been recommended for purposes of this principal review” and must make a suitability determination… FINRA is considered truly making the Rule apply ONLY to recommendations.

3. SCOPE:
Rule pertains to:
Reps who recommend these transactions
Principal who approve them
WSP’s
Training

4. REPS:
When recommending purchase or exchange, must get info and review existing assets. Effective date: May 5

Q: What does “liquidity needs” mean? What info is required?
A: See 2821(b)(2). Liquidity needs is not defined, but age, income, net worth, dependents, short term cash needs for homes, education, etc. are factors to consider.
IRA funds are not liquid assets—because they require a penalty/fee to tap.

Information must be captured so it can be reviewed: no special form is required under the Rule.

Q: Document and sign determinations: what form to use? Is the intent: to provide rationale for transaction or to give disclosure to client?
A: Form should be firm’s choice as appropriate. This is not about disclosure to customer; it’s about suitability.

Remember, investment time horizon—these securities are long term investments. Access to funds before end of surrender or waiting period is costly.

Rep must determine suitability based on factors listed in rule. Must document and sign some record to show this.

Exchanges: primary purpose cannot be RR’s profit. Consider:
Triggers surrender charge?
Lose benefits, increase in fees/charges?
Compare fees/etc. of both
Does customer benefit?Has customer done exchange w/in last 36 months?

Q: The 36-month exchange reference—does it refer to the particular customer’s account?
A: No, in any account w/in 36 months.

Q: Does customer have to sign acknowledgement of disclosures?
A: No but firm may decide to require this.

Remember: ‘Intended use’—important to suitability consideration. Need for cash---not a good reason to buy v/a.

Q: Is an exchange within 36 mos. a call to action?
A: No, an exchange with a customer having done an exchange w/in the last 36 months may not necessarily be prohibited. This information is just part of the necessary background information used to make suitability determination. A yes answer may end up triggering more supervision or a closer look at the proposed transaction.

5. PRINCIPAL:

Paragraph (c) of Rule—Principal must review before sending to insurance co/vendor for processing. This paragraph is not in effect; delayed effective date.

Discussing it anyway….

Q: If customer sends $ directly to vendor how can Principal review transaction before sending for processing?
A: Doesn’t apply to non-recommended transactions or to reinvestments.

Rule is in state of flux for now. Par. (c) will be amended and FINRA will provide guidance.

A: What about in the interim? Bet. May 5 and ultimate effective date of (c) and (d)?

No interim requirement. Keep doing what you’re doing re: Principal review… firms can adopt new procedures now if they want.

Principal doesn’t need insurance license to approve this business. 26, 24 or 9-10 license is okay.

Rule now states that Principal must approve within 7 business days of the customer signing the application. The workshop presenters said it was 7 days from the date the OSJ received the completed application. Assumption: clarification is forthcoming with Rule change.

Application must be sent by next business day after Principal approval (noon on Day 8 at latest)

Firms can hold customer checks pending Principal review—relief from net capital reserve and n/c rules. “Promptly transmit” is waived if 2821 is met.:
Copy check, record date rec’d and date transmitted to vendor or returned to customer. (i.e., on checks rec’d forwarded blotter)
$ must be sent by noon next day after approval.

Possible Rule change about use of suspension a/c’s at ins. companies. This would allow funds to be send pending Principal approval.

6. WSP:

Although this part of the Rule has been delayed, it (paragraph (d)) will not change. Firm will be required to have written procedures.

Automated systems to review/approve v/a business is NOT permitted.

7. TRAINING:

Training program must be in effect by May 5.

Training required on more than just general characteristics--on specific products offered by firm.


Rely on 3rd parties, such as wholesalers, ins. co’s? Okay, but firm ultimately responsible.
Train all reps on 2821 by May 5.
Can put in c/e firm element, but some training should be provided by May 5.

Use webcasts and e-learning to provide training.

For wholesalers who promote v/a products to firms—training req. does not apply (no recs to customers)

8. MISC:

Q: Offshore V/A’s—included?
A: Rule focuses on whether it’s a registered product, not if it’s offshore (no explicit answer to question)

FINRA “Relies on firms to set their own parameters for suitability”—FINRA doesn’t set.

Q: What is reasonable for procedures/disclosures?
A: Firm decides. For instance, could require customer sign-off on purchase/exchange.

Q: Does FINRA have any plans for an online tool like the Mutual Fund expense analyzer to use with V/A analysis?
A: They are exploring this.

Q: Will FINRA be providing other tools, like disclosure forms? Replacement forms?
A: No, they’re not working on this.


Workshop time estimated: 75 minutes; actual time: 50 minutes.

If I Were a Golfer I'd Follow This Guy's Advice

Personally, I hate golf. But my relatives are pretty darned good at it--including a 2nd(?) cousin on my father's side named Tommy Weiskopf. Now that I've established credibility, read on...

For you compliance professionals who like the game of golf but hate the way it makes you want to throw your clubs in the nearest water hazard, I recommend this book: Peace and Par, Enjoying Golf in the Now. My most enlightened friend, Mike Shingleton, wrote it and he did the golfing world a favor by introducing ancient breathing techniques to this too-often stress-inducing game. Read this book, practice the technique, and you'll be: a) happier and b) a better golfer. Oh, and you'll laugh along the way: Mike is a very funny guy.

Maybe his next work will help compliance folks breath easier during routine exams. I'll keep you posted. (But seriously, Mike Shingleton, a former institutional bond broker, leads in-office stress management sessions that are remarkably effective in reducing workplace anxiety. Even if you don't golf, Mr. Shingleton may be able to help you and your company.)

Here is the link to Mike's website: http://www.thenowsound.net/
And here is how you buy his book: http://www.amazon.com/Peace-Par-Enjoying-Golf-Now/dp/1419681419/ref=sr_1_1?ie=UTF8&s=books&qid=1207058765&sr=8-1

“In like a lion…”: no kidding! I can’t wait for the lamb.

Plenty of action going on at FINRA these days. I count 24 announcements made in the first 20 business days of March. That’s 1.2 announcements per day! I’ve pulled out a few items to share, in case you haven’t been reading.

In FINRA’s March 24 exam priorities letter we heard about…
1. a change in examination protocol. Firms will no longer reply to their exit conference memo…from now on, they’ll wait to receive an “Examination Report” and they’ll have 30 days to respond. The final document from FINRA after an exam will now be called the “Examination Disposition Letter,” which will enumerate exceptions/deficiencies classified as: No Further Action, Cautionary Action, Compliance Conference, or Referral to Enforcement for Review and Final Disposition. Obviously, we’ll need new acronyms… goodbye, LOC.

2. a new name for your helpful FINRA contact person: “Coordinator.” They say that for most of you, the Coordinator is the same person you used to call “Liaison.” Of course this person could be different from your Core Examiner and Finance Coordinator. In any case, perhaps this new title will last longer than the last one did.

3. advance notice of examinations. The new timeframe is “up to 30 days”…but not necessarily 30 days… that will depend on the risk perceived. In some cases, firms will get up to 60 days, for instance those firms with lots of retail branches where beaucoup information requests will have to be met. Side note: for those of you who have not gotten Web IR entitlements, I suggest you do that now. That way, when you get your exam notice, you’ll be able to login to the Web Information Request site and get started—you’ll have more time to prepare for the exam, this way.

4. paying careful attention to senior customers. If only FINRA had beaten the sub-prime horse to death, as it does with this issue…maybe my portfolio would be in better shape (etc., etc., etc….it’s not all about me, I know that). Not that this issue isn’t important, but, well, if this is the first you’re hearing about your obligations to ensure suitability when dealing with senior citizens, I bet you’re dizzy right now from your recent space travel.

5. the new deferred variable annuities rule—2821. Partly effective May 5, 2008, so look it up. You may find that your firm is already complying because you generally adhere to a best practices ethic. A few parts of the rule that concern supervisory approval have been delayed until August at the earliest. Check out NtM 07-53 to know what’s in store for you—or listen to the phone-in workshop on April 18.

6. data protection and how important it is to have your IT staff/vendor set you up right. Protect customer records! OK, easier said than done. I mean really, hackers are better than most IT staff and vendors. But that’s no excuse to do nothing. CD’s, thumb drives, laptops, i-pods all have to be protected somehow.

7. new MSRB rules that parallel FINRA’s supervisory rules… if this applies to you, see MSRB Notices 2008-06, 2007-32 and 2007-16.

8. other things like new product sales, fee-based accounts, transaction reporting, information barriers, inventory valuations, and the ever-present OATS, among others. Please see the link below for FINRA’s emphasis on these topics.

I won’t copy all of FINRA’s links to references for these items; rather, here is the link to their exam priorities letter, which contains many helpful links. http://www.finra.org/web/groups/corp_comm/documents/home_page/p038169.pdf

Also in March:

In Notice 08-12 we learned about an exception to the principal approval requirements for certain filed sales material—in Rule 2210. This is good for you firms out there that use mutual fund or variable annuity sales literature produced by the sponsor…now your designated principal doesn’t have to re-approve this material if it has already been submitted to and granted approval by FINRA. As they say really, really fast on the radio, “Certain conditions apply.” So read the Notice before giving up your advertising review processes.

In a podcast released Mach 25 that followed an information notice published March 12, we were informed that the big rulebook consolidation process is in the works. Meaning, NASD Rules and NYSE Rules will be harmonized into one new “Consolidated” rulebook. Key points made:
·Eliminating duplicative NASD/NYSE rules;
·Looking at both sets of rules to determine if one set can ‘inform’ the
other—meaning, turn two bad rules into one good rule;
·Considering different approaches to the application of rules, such as a
principles-based or tiered approach according to firm size, business model and customer type (retail or institutional). (Did I just write this or am I dreaming? Let’s all keep our fingers crossed on this one!)
·The process will be lengthy (my word, not theirs): the SEC will have to approve all rule changes. Some changes will be put out for comment first (don’t be shy);others will go directly to the SEC. Importantly for small firms, the newly-elected Small Firms Advisory Board will have a say in the changes.

In a March 6 news release we heard about some State Farm RR’s being busted for not taking their firm element online training; rather, they had someone else do it for them. Read my entry below about the $5,000/hour C/E course for a Word to the Wise.

A March 10 podcast reminds us of an earlier announcement about not having to keep copies—paper or electronic—of certain CRD filings. Yahoo! Filings that don’t require a Rep’s signature will now be officially maintained on your behalf by CRD. This applies to U4 and U5 amendments (but not DRP’s or any such filing that requires the rep to sign it) and BR filings. See the information notice from February 21 to read all about it.

We learned on March 17 that certain webcasts had been converted to a new format: the “video tutorial.” The VT is more like an E-Learning Course; it has a mastery test so you can use it as a C/E firm element training tool that will test your reps’ comprehension. The bad news it, now these lessons cost money, whereas before they were free. There are still many free webcasts online, but I’m wondering if eventually they’ll all go the way of VT? I don’t have the scoop on this. (Anyway, at the bargain annual subscription rate of $45 for unlimited E-Learning and VT courses, who’s complaining?)

On March 24, FINRA put out a Q&A on electronic filing requirements under Rule 3170. I can’t say I learned anything, but maybe if you’ve never dealt with the system this info piece will be useful. I was hoping for a bright, shining light on ESM rules (see my numerous, proof-I’m-obsessed-with-this-issue entries, below)…for instance what does ‘audit system’ mean, anyway?...but no such luck.

Lastly, on March 28 FINRA announced changes to the New Membership Application process...again. Form NMA has been restructured to be more logical and to prompt more detailed input; fewer items are sent hardcopy; funding of the application fees is done right up front; and applications are no longer filed with the district office--now they go to FINRA's HQ ("the Department"). These changes are effective June 26, 2008. Before then, follow the old process. These changes seem good to me; see Notice 08-14 for the details.

I did not comment on all recent announcements; if you want to see the full list go to http://www.finra.org/Resources/RecentAnnouncements/index.htm .

One last thing, not from FINRA: Investment News wrote on March 24 about the SEC’s expected proposal (by summer) that would cap 12(b)-1 fees charged to investors in Class C mutual fund shares. Here is the link to their article: http://www.investmentnews.com/apps/pbcs.dll/article?AID=2008468162776.

Thanks for reading. Now let’s hope that lamb shows up.

Optional Comments on Your DRP: some are not an option

In Bill Singer's recent blog entry ("Regulatory Double Standard: Dissing your Settlement," 24 Mar 2008), he exposes FINRA's double standard in its enforcement practices. Mr. Singer tells the story of an industry heavyweight not being sanctioned or otherwise formally punished for remarks it made that violated the terms of its settlement agreement (it had agreed to not deny FINRA's allegations but then appeared to do just that). The story continues to show the flip side of enforcement...a registered rep was fined and suspended for doing the same thing, but in a different manner. On his U4, he denied the allegations named in his AWC (Acceptance, Waiver and Consent agreement). He did this in the "Comment (Optional)" question on the DRP. You should click this link and read Bill Singer's entry: it is interesting and provides a cautionary tale. http://www.rrbdlaw.com/brokeandbroker/index.php?a=blog&id=38

I'd just like to reiterate the lesson to be learned here.

Question 13 on the Regulatory Action DRP states, "Comment (Optional). You may use this field to provide a brief summary of the circumstances leading to the action as well as the current status or disposition and/or finding(s). Your information must fit within the space provided." After going through the lengthy and emotionally draining settlement process, some of you who stalwartly maintain your innocence may be tempted to include an optional comment such as, "I deny the allegations" or some similar, perhaps more veiled denial. Based on the disciplinary action described in Bill Singer's blog entry and his follow-up explanation of the implicit bargain struck in every AWC, this type of optional comment is NOT AN OPTION. (btw: Mr. Singer provided that explanation in response to my rant about reps having a right to free speech--I'm not an attorney and can sometimes get lost standing on a soap box).

So, following a final settlement with FINRA, make sure you live by the terms of that settlement, including not going around denying the allegations--especially on your U4. As Mr. Singer so eloquently put it, "It's a minor thing to ask someone to just keep their mouth shut and get on with their life."

Many thanks to Bill Singer for this lesson.

Understanding Eliot: Thank Goodness for Rule 3011!

...otherwise, you may not have understood how Eliot Spitzer got caught.

Hmmm, what am I talking about? I'll explain. FINRA (NASD) Rule 3011 is the rule that broker-dealers follow when ensuring anti-money laundering compliance. You BD's set up written programs, supervisory structures, recordkeeping procedures, risk assessment strategies, reporting requirements and red flag escalation practices so that you meet Rule 3011 and the various requirements under even more various rules, regulations, acts and official guidance (such as the Bank Secrecy Act, the Money Laundering Control Act, The Travel Rule and of course, the USA Patriot Act, to name a few). By virtue of this compliance, you're familiar with terms like 'structuring,' 'politically-exposed persons,' and ' suspicious activity reports.' These terms have now migrated all the way from the Federal Register to NY tabloid publications--who'd a thought? But only readers like you, who have been subjected to the recent, rather annoyingly, non-stop attention to the AML subject, can really visualize how Eliot's bust materialized. The going story: he structured payments by wiring funds under the $10,000 reporting threshold; the bank didn't have complete information on the recipient of the third party wires; and Eliot was subjected to heightened scrutiny as a politically-exposed person. Voila. Sounds familiar and justified, non? Not in my understanding...

First of all, structuring to avoid reporting: the BSA's requirement to file reports on transactions exceeding $10,000 refers to currency, not wire transfers. A Currency Transaction Report would not be required for wires over $10,000. It's the Travel Rule that dictates records requirements for wires over $3,000...which brings me to the second point: the bank investigating the recipient of his wire transfers. The Travel Rule requires only that the initiating institution identify the recipient of the wire if it's a third party wire (not going to the sender's other account): the rule doesn't require due diligence on the recipient. If, instead, the institution were receiving a wire for a non-customer (for whom the institution had never done its CIP work), then yes, the institution would have to perform CIP on the recipient to verify his/its identity. This wasn't the case. So Eliot's bank (from what I've read) looked deeper into the receiving party which is what led, ultimately, to the suspicion. Lastly, Eliot's bank applied a higher level of scrutiny than normal, due to his status as a politically-exposed person. The problem here: Section 312 of the Patriot Act requires enhanced scrutiny of senior foreign political figures. The rule says nothing about US political figures. Eliot's bank obviously had its own heightened scrutiny procedures, and they're allowed to do so--all financial institutions may adopt and implement custom, risk-based AML procedures.

So, the escalation of poor Eliot's financial transactions to the level of suspicious activity reporting was based--in part, and according only to my reading of media reports--on bank employees' mistaken or overzealous compliance with AML rules. He didn't avoid CTA reporting under BSA rules; his wire recipients did not require CIP due diligence under the Travel Rule or Section 326 of the Patriot Act; and he as Governor did not require heightened scrutiny under Section 312 of the Patriot Act. And he still got busted.

The questions this fly-smashed-in-the-typewriter trail of events raises are these: Is Spitzer's case indicative of the purpose of federal AML rules and regulations? Does the public think it is acceptable to rely on these anti-fraud/theft/money laundering mechanisms to interfere with someone's private (if pathetic) life? Should banks and broker-dealers really take to heart the current "we're all in law enforcement now" ethic? Is it too much to ask of you, the broker-dealer, to devote time and resources to this type of non-financial crime investigation? Lastly, and importantly for your AML staff: do you understand your true obligations under Rule 3011, the BSA, the Patriot Act and other guiding FinCEN/OFAC rules? If not, my advice is to brush up.

Now if only the federal government had enacted a one-word violation called "hypocrisy." Eliot is clearly guilty of that.

Recommended reading on new hire precaution

Thanks to a new industry resource, theSIPA.com, I was treated to a well-written and intriguing essay on FINRA's new definition of 'statutory disqualification.' This revised, broader definition carries with it unforeseen pitfalls for firms like yours when hiring new reps. If you hire someone who has signed a consent agreement with a State regulatory body that includes reference to certain violations, there's a chance that person is now technically 'statutorily disqualified' and ineligible for FINRA membership...and you wouldn't even know it! And guess what? You'd be breaking Conduct Rule 3010(e) by not doing your homework if you hire him or her, completely unaware of this definitional change.

I'm not doing justice to this topic: I suggest you read Alan Wolper's essay on theSIPA.com in order to understand what I'm babbling about... it is worth your time. Go to: http://thesipa.com/asktheregulator.html

No CIP for clearing firms...but not vice versa

I remember the moment in Miss Anita's 5th grade class when she taught us the definition of vice versa...she used the example, "Jimmy has a crush on Sharon and vice versa." The color I turned!...a lovely shade of bright red. Well here's an announcement that will tickle clearing firms pink.

Fresh off the press: FinCEN has released a no-action position relating to CIP requirements of clearing firms. In summary, if the clearing firm has a written agreement with its introducing firm, and that agreement exclusively allocates to the introducing firm the functions of opening and approving customer accounts and directly receiving and accepting orders from introduced customers, then ONLY the introducing firm must comply with the CIP requirements for BD's. FinCEN has stated in this release that it will not take action against clearing firms in this situation. Of course, the written agreement must be clear in its allocation of duties.

Small introducing firms oftentimes express frustration with CIP rules and state their belief that, since the clearing firm has to ultimately accept the account and since it is the clearing firm that maintains the customer's securities accounts, why does it have to meet CIP rules--why not the clearing firm instead? I think it's interesting that this FinCEN release does not include a vice versa clause...that is, it doesn't offer no-action to introducing firms if the clearing agreement allocates exclusive final account approval to the clearing firm, instead. This clearly codifies the practical understanding of CIP rules: it's the front line that matters. The process of opening accounts and taking orders for transactions is an important first step to AML awareness and compliance. While the clearing firm has credit risk and handles the funds, it's the Rep-Customer relationship that counts when detecting and deterring illegal activities. I'm not saying clearing firms don't have AML obligations in this instance--they do, any many of them, as reiterated in FinCEN's release--but CIP, the cornerstone of a broker-dealer's AML compliance practices, is squarely in the hands of the introducing firms.

I have to be thorough by noting one point: an introducing firm may, indeed, be relieved of some or all of its CIP duties, but only if this arrangement is reasonable, in writing and renewed annually, and the CIP duties are performed by a federally-regulated entity subject to AML regulations. So the clearing firm can, in the end, perform CIP for its introducing firms, but that arrangement must be subject to an iron-clad agreement and is not something that can be inferred based on loose allocation language in a clearing agreement. Most clearing firms do not include CIP agreements in their clearing agreements. Other note: if your firm wants to rely on an SEC-registered IA firm to do CIP for you, it can under a 2004 SEC no-action letter that has been extended to be effective through January 12, 2010. But again, reliance is subject to strict conditions. See: SEC's no-action relief January 2008 .

Here's the link to FinCEN's no-action release: FinCEN's CIP no-action position .

And for the record, Miss Anita was right.