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.

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.

“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.