“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.