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FINRA may add licensing exam scores to BrokerCheck and IAPD

Brokers, investment adviser representatives and other registered securities professionals may start wishing that they had studied more for their licensing exams. That’s because the SEC is suggesting that FINRA include qualification exam scores in BrokerCheck and Investment Adviser Public Disclosure (IAPD). If you’re a securities professional who passed a securities qualification exam but didn’t aim for a high score, before you blame the SEC or FINRA, understand that that the Dodd- Frank Act mandated that the SEC come up with ways to improve investor access to investment advisor and broker-dealer registration information.

In January 2011 the SEC released a study which recommended that FINRA add educational content and the ability to search by zip code to BrokerCheck and also to the IAPD registry which is owned by the SEC and operated by FINRA. The study noted that only a small minority of investors say that they use BrokerCheck or IAPD to research a broker or an adviser. The SEC also recommended that FINRA study ways to improve and expand BrokerCheck by, for example, including outside links within BrokerCheck, and by providing more information about individual brokers. The SEC study also suggested that FINRA consider permitting private firms use BrokerCheck information for commercial use. What drew the most commentary, however, was the SEC’s suggestion that FINRA include qualification exam scores in BrokerCheck and IAPD reports.

There were several supportive responses from investor advocacy groups and legal clinics, for example this one from the Pace University Investor Rights Clinic (PIRC), a pro bono law clinic for lower income investors:

“PIRC fully supports the disclosure of additional information, such as brokers’ educational backgrounds, professional designations, examination scores and comments related to a broker’s termination in the BrokerCheck reports. Additionally, granting for-profit companies access to BrokerCheck information for commercial use could be a meaningful way to increase investor exposure to such information. PIRC believes that these additional disclosures, the commercial use of BrokerCheck information, and meaningful alterations to the report design, format and content, could all enhance investor access to and understanding of the information disclosed.”

But the majority of comments on FINRA Regulatory Notice 12-10 were highly negative. The primary criticism was that exam scores do not offer any protection to an investor – that there is no correlation between securities exam scores and job performance, competence or integrity. Several comments pointed out that lawyers, physicians and other professionals are not subjected to this type of exam score disclosure.

A representative comment came from David Sobel at Abel/Noser:

“This continuous expansion of BrokerCheck is a kneejerk reaction to the 2008 financial debacle; a debacle that was not caused by the average stock broker. It was caused by the highest executives of the largest firms. And yet, those executives have received no additional scrutiny, they continue to get their multi-million dollar bonuses, they continue to skirt the regulator’s wrath, while the average street broker is being bombarded with ridiculous regulations, requirements and fees that will eventually destroy his or her business. We are already seeing this with the number of BD’s that we lose each year. From 2002 to 2010 we lost 18% of our brokerage firms (approximately 950).

Let’s start looking to where the problems lie, and not at the easy, low hanging fruit. If Dodd-Frank is meant to inform the investor, then figure out some way to inform them, to teach them about the markets, stock, debt, and derivatives. The pandering to the lowest common denominator by exposing its own members to an absurd level of exposure, scrutiny and embarrassment is the easy way out and the most public relations oriented way of making the public feel “protected.” I’ve never known another organization that is so ready to throw its own membership under the bus. We have to deal with Reg S-P and make sure that our clients’ information is sacrosanct, but our own information is fodder for the internet. We have no rights of privacy about anything.

And the outrageous over-exposure would be exacerbated even further if FINRA were to SELL our information to vendors. Are we going to get a cut of the sale price? After all it’s our information. Once that information is sold, our privacy no longer exists. All of our dirty laundry will be all over the internet forever. Additionally, it wasn’t brokers that caused the crash in 2008, it was partly caused by greedy investors who wanted mortgages with no income check; wanted CD’s producing interest that was so high it was obviously bad; or investments that paid 12% when the market was paying 2%. The average broker did nothing to make the market crash, but is now taking the brunt of over-regulation, over exposure and bad press – the sad part is that the negatives are being generated by their own organization. FINRA and the SEC should take a moment to justify these expansions with facts instead of blindly grabbing at straws.”

Exam Alert: SEC identifies good due diligence practices for municipal securities underwriters

On March 19, 2012, the SEC staff released a risk alert that reminds firms acting as underwriters for municipal securities of their due diligence and supervisory obligations under current rules. The alert then identifies specific examples of effective due diligence practices. Continue reading

-Clear explanation of regulatory requirements and firms’ expectations: detailed written policies and procedures that make clear how to conduct due diligence and include relevant rules and guidance

-Commitment committees: firm-wide, senior level committees that provide an additional step of review for various underwritings

-Diligence checklists: checklists to record which due diligence steps have been taken

-Due diligence memoranda: memos prepared by public finance bankers that describe any due diligence concerns and provide a review of the final official statement

-Outlines for due diligence calls: outlines prepared by underwriters’ counsel or issuer’s counsel that address disclosure concerns identified during due diligence calls

-On-site examination activities: on-site examinations to check the issuer’s fiscal prospects

-Recordkeeping checklists: checklists to make sure records of due diligence activities are made and properly stored

Source: SEC Release 2012-48

This alert applies to the Series 7, Series 79, Series 24, and Series 62.

Exam Alert: MSRB requires underwriters of municipal securities to provide additional disclosure

Effective August 2, 2012, the Municipal Securities Rulemaking Board (MSRB) will require underwriters of municipal securities to provide additional disclosures to issuers (state and local governments) and abide by other requirements. The changes apply to negotiated underwritings, but not to competitive underwritings. Continue reading

-Details regarding the underwriter’s role, including that the underwriter has different financial interests than the issuer and that the underwriter does not have a fiduciary duty to the issuer

-The conditions of the underwriter’s compensation

-Any actual or potential material conflicts of interest – the interpretive notice specifically identifies the following potential conflicts of interest: third-party payments, profit-sharing with investors, and credit default swaps

-If recommending complex municipal securities transactions/products, all associated material financial risks, characteristics, incentives, and conflicts of interest

Additional requirements are as follows:

-All representations to the issuer must be accurate, truthful, and complete, with no omission or misrepresentation of material information.

-When drafting any issuer disclosure documents, the underwriter must have a reasonable basis for any representations it makes.

-The underwriter must pay a fair and reasonable price to the issuer.

-The underwriter may not recommend that the issuer not retain a municipal advisor.

This Exam Alert applies to the Series 7 Exam.

Sources:

MSRB Notice 2012-25

MSRB Establishes New Protections for State and Local Governments that Issue Bonds

Exam Alert: FINRA changes process for filing notice and information on Regulation M distributions

FINRA is implementing an electronic filing system for the submission of notice and other information required by FINRA rules for distributions subject to Regulation M. Effective June 4, 2012, firms will be required to use the new system, and the current forms for filing notice and other information on Regulation M distributions will no longer be used. Continue reading

Regulation M was put in place to prevent market manipulation by those involved in the distribution of a security. Covered, non-excepted securities are subject to a restricted period, during which time the distribution participants may not purchase the security, with certain exceptions (such as passive market making and stabilizing activities).

FINRA requires firms acting as manager in a distribution subject to Regulation M to file written notice that includes a determination as to the length/applicability of the restricted period and details on the pricing of the distribution, including the security name and symbol, the type of security, the number of shares offered, the offering price, the last sale before the distribution, the pricing basis, the SEC effective date and time, the trade date, and identification of the distribution participants and affiliated purchasers. FINRA also requires written notice of penalty bids and syndicate covering transactions in OTC equity securities.

ADF Market Makers must submit written notice of withdrawals of quotations during the restricted period. Under FINRA trade reporting rules for OTC equity transactions, firms must provide notice and information to FINRA when they use an exception to the trade reporting requirements for transactions that are part of an “unregistered secondary distribution.”

Sources:

FINRA Regulatory Notice 12-19

Regulation M Filing

FINRA Rules 5190 and 6275

This alert applies to the Series 24, Series 79, and Series 7.

Exam Alert: FINRA to implement new electronic filing system for public offerings

Firms that participate in initial public offerings must submit certain information about the offered security to FINRA, including the registration statement/offering circular and the underwriting agreement. FINRA will be shifting from the current system for filing this information to a new system in the near future:
-The last day firms may file using the old system (COBRADesk) is May 31, 2012.
-The firms may first file under the new system (Public Offering System) on June 4, 2012.
-Firms will no longer have access to the old system for data retrieval after June 20, 2012. Continue reading

FINRA will generally not be migrating data from the old system to the new one. However, FINRA will transfer over base prospectuses submitted for shelf offerings.

The new system includes new features. FINRA will be releasing further information on the new system on its website.

Emerging growth companies that choose to file their IPOs confidentially with the SEC must still file information with FINRA (all filings with FINRA under the Corporate Financing Rules are nonpublic).

Firms remain responsible for the accuracy of their filings even if the filing is made by a third party.

Source: FINRA Regulatory Notice 12-22

This exam alert applies to the Series 62, Series 79, Series 24, Series 7, and Series 82.

Exam Alert: SEC adopts definitions for security-based swap rules

Under the Dodd-Frank Act, the SEC and CFTC (Commodity Futures Trading Commission) regulate the OTC swaps market. On April 18, 2012, the SEC adopted rules that provide definitions for terms used in the law, specifying who will be subject to regulation. Continue reading

The rules provide two categories of persons subject to SEC registration: “security-based swap dealers” and “major security-based swap participants.” In essence, a security-based dealer is a person that regularly trades security-based swaps for their own account. A de minimis exemption exists for dealers who traded up to $3 billion worth of credit default swaps over the past year and up to $150 million worth of other security-based swaps. Note that there is a different de minimis threshold of $25 million for security-based swaps involving “special entities,” including certain government agencies.

A major security-based swap participant is a person who maintains a “substantial position” in any of the major security-based swap categories, or whose outstanding security-based swaps create “substantial counterparty exposure.” Note that hedging positions are not counted towards the “substantial position” threshold if the person is not a “highly leveraged financial entity,” meaning a financial entity with a ratio of liabilities to equity in excess of 12-to-1. Two tests are provided for determining “substantial position,” and two thresholds are provided for “substantial counterparty exposure.” The specifics of these tests and thresholds may be found in the SEC release, along with background information, a plan to phase-in the de minimis rule, a safe harbor to avoid being considered a major participant, and other details.

The rule will become effective 60 days after publication in the Federal Register, though the deadline for registration will be given in SEC’s final rules for registration of dealers and major participants.

Source: SEC Release 2012-67

This exam alert applies to the Series 62, Series 79, Series 99, Series 65, and Series 66.

Exam Alert: FINRA rules to change to reflect Dodd-Frank changes to whistleblower laws

Dodd-Frank changes to federal law have prohibited predispute arbitration agreements from applying to whistleblower claims made under the Sarbanes-Oxley Act. Effective May 21, 2012, FINRA’s rules on predispute arbitration agreements will be revised to reflect this change. Continue reading

FINRA’s amended rules will state that disputes that arise under whistleblower statutes that prohibit predispute arbitration agreements are not required to be arbitrated. These disputes may only be arbitrated if both parties agree to do so after the dispute arises.

Source: FINRA Regulatory Notice 12-21

This exam alert applies to the Series 62, Series 79, Series 24, Series 7, and Series 82.

Exam Alert: JOBS Act will change standards for IPOs, securities registration

The Jumpstart Our Business Startups Act (JOBS Act) was signed into law on April 5, 2012. The act lessens regulations for the initial public offerings of certain companies and alters other federal rules. FINRA is expected to change some of its rules to reflect the new standards. Continue reading

Here is a breakdown of the changes:

-IPOs for “emerging growth companies” are subject to fewer restrictions limiting communication between research analysts and investment bankers (Chinese Walls). An emerging growth company is defined as a company with less than $1 billion in annual revenue that had its first IPO no more than five years ago. This has been estimated to cover as much as 90% of companies looking to go public (Source: Reuters).

-Banks are allowed to publish research reports on emerging growth companies immediately after they take them public. The old rule required a 40 calendar day quiet period for IPOs.

-There are fewer restrictions on advertising emerging growth companies to accredited investors.

-Emerging growth companies are exempt from certain disclosure requirements.

-Startup companies can sell small amounts of shares to several investors to raise up to $1 million without being required to register the security (crowdfunding). An investor can contribute up to at most $10,000, though the individual maximum may be lower based on the investor’s annual income or net worth.

-The Act increases the number of shareholders a non-bank company may have before it is required to go public, from 500 persons to 2000 persons or 500 non-accredited investors.

-The Act increases the amount of funds that can be raised before a company is forced to register with the SEC, from $5 million (under Regulation A) to $50 million.

-Up to 2,000 shareholders may invest in a bank holding company before registration is required (up from 500).

-Various other issuer registration requirements have been modified (see the SEC’s JOBS Act FAQ).

The Act itself may be found here.

Sources, further reading:

http://dealbook.nytimes.com/2012/04/04/wall-st-examines-fine-print-in-a-new-jobs-bill/

http://dealbook.nytimes.com/2012/04/11/regulator-seeks-feedback-on-jobs-act/

http://www.sec.gov/divisions/corpfin/cfjobsact.shtml

http://www.gpo.gov/fdsys/pkg/BILLS-112hr3606enr/pdf/BILLS-112hr3606enr.pdf

http://www.reuters.com/article/2012/04/11/us-jobsact-ipos-idUSBRE83A0Z820120411

http://www.reversemergerblog.com/2012/03/17/summary-of-jobs-bill-and-update/

http://www.csmonitor.com/USA/Politics/2012/0308/What-does-the-JOBS-Act-actually-do-Six-questions-answered/What-s-in-the-JOBS-Act

http://www.pcmag.com/article2/0,2817,2402657,00.asp

http://www.forbes.com/sites/jjcolao/2012/03/21/jobs-act/

This alert applies to the Series 79, Series 62, Series 24, Series 7, and Series 82.

Exam Alert: SEC releases risk alert on unauthorized trading

On February 27, 2012, the SEC released a risk alert providing suggestions for techniques and controls a firm may use to help avoid conducting unauthorized trades. The alert has a large focus on supervisory procedures, but also addresses other ways in which firms can make it harder for employees to engage in unauthorized trading. The alert identifies alternative methods to more readily detect unusual trading activity and stresses the importance of a culture of openness and compliance. Continue reading

Suggestions for supervisory procedures include:

-Have more than one chain of control be responsible for monitoring the integrity of the business, i.e. don’t have all your compliance personnel report to the same person.

-Managers and supervisors should understand any complex products and strategies being employed by traders.

-Supervisors should engage in discussions with traders and portfolio managers and address positions that are unusual (given the strategies and/or client objectives involved).

-Make sure the payment structure for traders and supervisors encourages responsible risk-taking.

-Try to avoid having one person or desk fulfill multiple roles.

-Have an “open-door” policy that encourages traders to report unexpected losses promptly.

-Limit trader access to their appropriate portfolios – don’t let them keep access to ones that they are no longer authorized to trade in.

-Consider additional controls (several are listed in the alert).

Other suggestions include:

-When an employee transfers into the trading department, remove any prior system access he or she had.

-Have controls in place to confirm extended settlement trades and rollovers.

-Review delays and discrepancies in the customer trade confirmation process to check for unauthorized trading.

-Require mandatory vacations for traders with no remote access to accounts, then assign their portfolio(s) to a supervisor or experienced trader for the duration. Use this time to check for unusual activity.

-Have the audit and compliance departments review trading strategies, business performance, and risk profile.

-If the firm has multiple recordkeeping systems, try to integrate them.

-Test the controls put in place to discourage unauthorized trading.

-Maintain a corporate culture of honesty, integrity, accountability, and responsible risk-taking.

Source: SEC Release 2012-33

This exam alert applies to the Series 24, Series 26, Series 6, Series 7, Series 62, Series 79, Series 82, and Series 99.

Exam Alert: SEC approves revised FINRA telemarketing rule

The SEC has approved a new consolidated FINRA telemarketing rule. The rule will become effective July 29, 2012. The new rule contains provisions that are similar to FTC standards. Continue reading

The SEC has approved a new consolidated FINRA telemarketing rule. The rule will become effective July 29, 2012. The new rule contains provisions that are similar to FTC standards. Changes to the prior rule include:

-Do-not-call lists: Under the old rule, do-not-call requests were required to be honored for five years. Under the new rule, do-not-call requests must be honored indefinitely.

-Unencrypted consumer account numbers: Firms may not buy or sell unencrypted consumer account numbers for telemarketing purposes.

-Submission of billing information: Firms must obtain the informed consent of a customer in order to charge them for a telemarketing transaction. The firm must also identify the account to be charged. If the transaction involves “pre-acquired account information and a free-to-pay conversion feature,” then the firm must make an audio recording of the telemarketing transaction.

-Abandoned calls: Firms may not abandon outbound calls, unless they meet the following safe harbor provisions:

1. The firm employs technology that drops no more than 3% of answered calls over a 30-day period (or the duration of a single calling campaign that lasts less than 30 days).

2. The firm lets the phone ring for 15 seconds or 4 rings before disconnecting the unanswered call.

3. If there is no associated person available to speak with the person answering the call within 2 seconds of the person’s completed greeting, the firm plays a recording giving the name and number of the firm.

4. The firm retains records of compliance with the safe harbor.

-Prerecorded messages: Except as noted above (under “abandoned calls”), firms may not make outbound calls that deliver prerecorded messages unless they have the written consent of the person receiving the call. The call must include an opt-out mechanism, as well.

-Credit card laundering: Credit card laundering is prohibited. Credit card laundering is “the practice of depositing into the credit card system a sales draft that is not the result of a credit card transaction between the cardholder and the firm.” Soliciting someone else to engage in credit card laundering is prohibited as well. Obtaining unauthorized access to the credit card system is also prohibited

These rules also apply to associated persons of a firm.

Source: FINRA Regulatory Notice 12-17

This exam alert applies to the Series 62, Series 6, Series 26, Series 24, Series 7, and Series 82.