Culture of Compliance: Do You Put Your Money Where Your Mouth Is?

You will often hear regulators and compliance professionals speak about the need for investment advisers and broker dealers to establish a culture of compliance within their firms. Instituting this type of atmosphere requires more than simply creating a compliance manual and code of ethics. Establishing a culture of compliance also means dedicating knowledgeable staff and sufficient resources to insure that your firm properly implements your compliance program. Last August, we sited a survey by Cipperman Compliance Services which indicated that the compliance function in the surveyed firms was underfunded and understaffed.

The survey’s finding came to fruition for one firm on June 23, 2015, when the Securities and Exchange Commission (SEC) settled an administrative proceeding against an investment adviser for, among other things, failure to complete their annual compliance review and failure to implement and enforce provisions of its policies and procedures and code of ethics. The SEC indicated that these failures were caused substantially because the adviser’s President “dedicated insufficient resources to compliance, which contributed substantially” to the failures of their compliance program. Not only did senior management of the adviser hire a Chief Compliance Officer with limited experience, they failed to provide the CCO with adequate guidance regarding his duties and required him to have various additional job functions ranging from research analyst to CFO. The CCO realized that he needed help to fulfill his compliance responsibilities and made multiple requests for help to senior management. In response, they expressed that their primary concern was serving their clients and did not provide the CCO with any additional resources. Ultimately, an SEC exam found that the advisory firm failed to complete its annual compliance review for two consecutive years and had multiple code of ethics violations related to its trading program. The SEC’s sanctions included monetary fines totaling $285,000 and the suspension of its President from acting in a supervisory role for a twelve month period.

While serving your clients may be your primary concern, serving a suspension because you failed to provide resources to your compliance program could hinder your ability to do so. It is also completely unnecessary. As noted by the SEC, one of the remedial acts undertaken by the adviser was eventually retaining a compliance consultant to help monitor their compliance program reviews and act as a compliance resource to the firm’s employees. Should you find that your CCO is stretched thin or fear that your compliance program is threatening to jeopardize your business, Red Oak is here to help you enhance your program and aid in its implementation.

Please click here to read the full SEC order.

Title IV of the JOBS Act of 2012

As of June 19, 2015 it will become much easier for small business startups to raise capital, as Title IV of the Jumpstart Our Business Startups Act of 2012 (“Act”) goes into effect. The new Act revises some of the regulation that, combined with limitations on availability to capital, has made it difficult, costly and time consuming for startups to get off the ground. The Act accomplishes this with the removal of the accredited investor requirement, an individual with a net worth of $1M or more or $200,000 in annual income, for small startups wishing to raise large sums of money, as well as eliminates the wait to be approved by state regulatory bodies and the requirement to issue quarterly reports and list their shares on an exchange. Additionally there is a “test the water” provision which allows startups to run their ideas by the media and investors before they are required to spend the money on a formal proposal to be reviewed by the Securities and Exchange Commission.

On June 19 small startups will be able to raise money, values of $20M to $50M, through crowdfunding programs. This means that any individual of adult age residing in the United States will be able to take part in small offerings.

FINRA Kicks off Proposed BrokerCheck Rule revisions with National Ad Campaign

On May 27, FINRA filed a rule change with the SEC proposing an amendment to rule 2210 to require each FINRA member’s website to include a “readily apparent reference” and hyperlink to BrokerCheck.

The reference and hyperlink would only need to be included on the firm’s initial webpage and any other webpage that includes a professional profile of one or more registered persons who conduct business with retail investors. This requirement will not apply to directory pages limited to registered persons’ names and contact information.

This rule’s requirements will only apply to broker-dealers that provide products or services to retail investors. FINRA believes this requirement aligns with its goal of increasing retail investor awareness and usage of BrokerCheck.

On June 1, FINRA also launched a national ad campaign promoting BrokerCheck. The ads caution investors to check the backgrounds of individuals they are thinking of engaging before they make their final decision. FINRA showcases the need for checking BrokerCheck in 15-second cable television spots containing humorous examples of people taking action without conducting any background research. A print ad also ran in the Wall Street Journal on June 2.

“People immediately go online to check out a new restaurant where they might spend $25 for a meal, but don’t think to use BrokerCheck when they’re handing over $2,500—or $25,000 of their life’s savings or even more—to an investment professional to invest,” said FINRA chairman/CEO Richard Ketchum. To help investors make informed choices about brokers and firms “that has to change, and we hope this campaign will help,” he added.

We think the next step may be a “Yelp” for financial professionals. Can’t help but wonder how to monitor such sites for potential customer complaints. It will be interesting to watch as it evolves.

Compliance Officer Receives Whistleblower Award in excess of $1 Million

The Securities and Exchange Commission announced an award of more than a million dollars to a compliance professional who provided information that assisted the SEC in an enforcement action against the whistleblower’s company. By law, the SEC cannot disclose information that might directly or indirectly reveal the identities of whistleblowers so the complete information regarding this action is not available.

Andrew Ceresney, the Director of the SEC’s Division of Enforcement stated “This compliance officer reported misconduct after responsible management at the entity became aware of potentially impending harm to investors and failed to take steps to prevent it.”

According to the SEC, this is the second award to an internal audit or compliance professional. These verdicts may change how upper management views compliance officers, more as adversaries rather than risk management partners. Compliance officers should consider having an outside and independent firm audit the firm's regulatory compliance to help alleviate this situation.

Please click here to read the release.

Inadequate Written Supervisory Procedures Results in SEC Settlement

On March 4, 2015 the Securities and Exchange Commission (SEC) brought charges to Irving, Texas based Broker Dealer, H.D. Vest Investment Securities (the Firm). The SEC alleged that the Firm failed to supervise two registered representatives, who misappropriated customer funds.

The theft occurred because the Firm lacked sufficient written supervisory procedures regarding registered representatives’ outside business activities. Because of these lack of controls, the two representatives were able to defraud these customer, in one case, by transferring or depositing customer brokerage funds into their outside business accounts.

The Firm, without admitting or denying wrongdoing settled with the SEC. They settled the charges with the SEC by paying a $225,000 fine and engaging the services of an outside compliance consultant. Click here to read the full SEC release.

FINRA Issues Exam Priorities Letter

FINRA has released its 10th Annual Regulatory and Examinations Priorities Letter, highlighting its 2015 regulatory focus. FINRA announced they will highly scrutinize certain product offerings including interest rate sensitive fixed income securities (long duration bonds, MBS, interest-only bond funds), variable annuities, liquid alts, and non-traded REITS. The FINRA examiners will focus on the implementation of the revised supervision rules including reviews of branch offices and OSJs and compliance testing. FINRA will analyze IRA rollovers, sales of private placements suitability, failure to offer required fund breakpoint discounts, and anti-money laundering procedures. Firms should also review their valuation procedures to ensure adequate net capital, their cybersecurity programs, and their order routing and best execution practices. Please click here to read the full release.

FINRA Amends and SEC adopts FINRA Rule 3110(e) Requiring Background Checks Starting in July

FINRA's rule requiring member firms to conduct a public records search to verify the accuracy and completeness of information on a Rep's Form U4 has been approved and goes into effect in July. The amended rule requires a public records search to be completed no later than 30 calendar days after the U4 is filed." The public records search must verify the name and address; search criminal, bankruptcy, and litigation records; investigate liens; and review business records. The rule only requires "a national search of reasonably available records." In addition, the rule requires a review of the individual’s U-5 if they have been registered previously. Please click here to read the full SEC release.