FINRA Focuses Attention on BrokerCheck

Selecting a broker to invest hard-earned money can be a nerve-racking thought to many investors. With news headlines focused on the lingering results of the economic crisis and financial scandals that left many penniless, it has never been more important for investors to find a broker they can trust. Continue reading

Selecting a broker to invest hard-earned money can be a nerve-wracking process for many investors. With news headlines focused on the lingering results of the economic crisis and financial scandals that left many penniless, it has never been more important for investors to find a broker they can trust.

Luckily, there is a resource that might give them some peace of mind. In 1998, FINRA (the Financial Industry Regulatory Authority) established the website BrokerCheck as a tool for investors researching the record of a firm and its brokers. The website features professional background information on approximately 1.3 million current and former FINRA-registered brokers and 17,400 current and former FINRA-registered brokerage firms. BrokerCheck lists terminations, complaints, lawsuits and even personal bankruptcies, with the mindset that past behaviors are both telling and predictive of future behaviors.

The Dodd-Frank Act, passed in 2010 in response to the financial crisis, required regulators to make the website more user friendly and accessible. Regulators are concerned that although BrokerCheck is readily available for anyone to use, not enough people are aware of this tool. To encourage more investors to use the site, a year ago FINRA proposed a regulation that would require brokerage firms to include on their websites and social media feeds a link to FINRA’s BrokerCheck website. But many people were up in arms about this proposed rule change. After receiving dozens of comments, the filing was withdrawn in order to re-write and re-introduce it later this year with an inclusion that would require firms to describe BrokerCheck in a “prominent location”.

This renewed focus on the BrokerCheck website falls in line with FINRA’s actions to focus on prosecuting recidivist brokers, or those who have multiple complaints, disclosures and abuses on their record. A big step in curbing these behaviors that could harm the securities industry is to encourage well-informed investors.

 

Exam Alert: SEC changes broker-dealer financial responsibility rules

On October 21, 2013, the SEC will put into effect amendments to its financial responsibility rules for broker-dealers. These amendments include changes to the customer protection rule, net capital rule, books and records rules, and notification rule. Continue reading

On October 21, 2013, the SEC will put into effect amendments to its financial responsibility rules for broker-dealers. These amendments include the following changes:

Customer Protection Rule (Rule 15c-3-3)

-Carrying broker-deals that maintain customer securities and funds will be required to maintain a new segregated reserve account for broker-dealer accounts.

-The reserve requirement to protect customer cash will exclude cash deposits at affiliated banks and limit cash held at non-affiliated banks to no more than 15% of the bank’s equity capital.

-The rule will require disclosure, notice, and affirmative consent from the customer when their cash is “swept” to a money market or bank deposit product.

Net Capital Rule (Rule 15c3-1)

-The rule will require a broker-dealer to include liabilities assumed by a third party in the broker-dealer’s net worth if the third party is reliant on the broker-dealer to pay the liabilities.

-The rule will require a broker-dealer to count as a liability any contributed capital that may be withdrawn by an investor. Contributed capital that is withdrawn within a year of contribution must also be treated as a liability, unless the broker-dealer receives written permission for the withdrawal from its designated examining authority.

-Broker-dealers will be required to deduct from net capital the excess of any deductible amount over the amount permitted by SRO rules.

-Insolvent broker-dealers will be required to cease conducting a securities business.

Books and Records Rules (Rules 17a-3 and 17a-4)

-Large broker-dealers will be required to document their risk management controls.

Notification Rule (Rule 17a-11)

-The rule will establish new notification requirements for when a broker-dealer’s repurchase and securities lending activities exceed a certain threshold. Alternatively, a broker-dealer may instead report such activity monthly to its designated examining authority.

 

Source: SEC Release 2013-140: SEC Adopts Amendments to Financial Responsibility Rules for Broker-Dealers

 

This alert applies to the Series 24, Series 26, Series 7, Series 99, Series 82, Series 79, and Series 55.

Exam Alert: FINRA provides reporting exceptions to avoid duplicative filings, permits online filing

FINRA will let members:
-avoid needing to independently report information that is already contained on Form U4
-avoid needing to independently report actions that FINRA takes against firms and agents
-file required copies of criminal complaints, civil complaints, and arbitration claims online Continue reading

Effective March 4, 2013, FINRA will let members avoid needing to independently report information that is already contained on Form U4. FINRA will also implement an exception for reporting regulatory actions that FINRA takes against firms and associated persons (since FINRA will already have the details of the action on file).

Effective July 1, 2013, FINRA will let firms file required copies of criminal complaints, civil complaints, and arbitration claims online.

Source: FINRA Regulatory Notice 13-08: FINRA Amends Rule 4530 to Eliminate Duplicative Reporting and Provide the Option to File Required Documents Online Using a New Form

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

Exam Alert: FINRA provides guidance on new communication rules

FINRA has provided guidance on its new communication rules. The guidance addresses various questions and details about the new rules. The rules take effect February 4, 2013. Continue reading

On February 4, 2013, the new communication rules described in this alert will take effect. FINRA has provided guidance on the new rules. This guidance provides that:

-educational material provided to other broker-dealers is considered “institutional communication,” not “internal communication”

-a firm’s one-year period of needing to file all public retail communication in 10 business days in advance now begins when the firm’s FINRA membership becomes active; free writing prospectuses may instead be filed within 10 business days of first use

-retail communications regarding “registered structured products” must be filed within 10 days of first use; examples of “registered structured products” include “exchange-traded notes that are not registered under the Investment Company Act but are registered under the Securities Act, registered reverse convertibles, registered structured notes, registered principal protection notes, and any other registered security that includes embedded derivative-like features”

-disclosure requirements for recommendations do not apply when discussing the past performance of a mutual fund

-a sales script used in a seminar is considered retail communication if the script is used with more than 25 retail investors in a 30-day period – this means that the firm must approve the script before use

-a firm’s name must be disclosed in scripted public appearances (both in the script and on any slide presentations or brochures used)

The guidance also addresses transitional issues for implementing the new rules.

Source: Regulatory Notice 13-03: FINRA Provides Guidance on New Rules Governing Communications With the Public

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

Exam Alert: FINRA requires orders with alternative triggers to be clearly distinguished from stop orders

Effective January 21, 2013, FINRA will revise its rules relating to stop orders in equity securities. The new rule provides that any market or limit order that triggers off of an alternative condition (any condition other than a transaction occurring at a specified price) must be clearly distinguished from a “stop order” or “stop limit order.” Continue reading

Effective January 21, 2013, FINRA will revise its rules relating to stop orders in equity securities. The new rule provides that any market or limit order that triggers off of an alternative condition (i.e., any condition other than a transaction occurring at a specified price) must be clearly distinguished from a “stop order” or “stop limit order.” For example, an order that triggers when a quote occurs at the stop price may be referred to as a “stop quotation order” or “stop quote order.”

If a firm provides orders that trigger off of alternatives conditions, the firm must disclose the nature of these orders in paper or electronic format to its customers prior to the customer placing such an order. For example, this disclosure could occur when a customer first opens an account with the firm. A firm that routes an order triggered by alternative conditions to another broker-dealer or to an exchange must take “reasonable steps” to ensure that the order is handled or executed in the correct manner.

Source: FINRA Regulatory Notice 12-50: SEC Approves Amendments Relating to Stop Orders

This alert applies to the Series 7, Series 65, Series 66, and Series 24.

Exam Alert: SEC requires resource extraction issuers to disclose payments to governments

The SEC will require “resource extraction issuers” to disclose certain payments made to the U.S. government and to foreign governments. Resource extraction issuers are companies that engage in the development of oil, natural gas, or minerals. Continue reading

The SEC will require “resource extraction issuers” to disclose certain payments made to the U.S. government and to foreign governments.  Resource extraction issuers are companies that engage in the development of oil, natural gas, or minerals.

 

A payment or series of related payments must be disclosed if:

-the payment(s) are made to further the commercial development of oil, natural gas, or minerals;

-the payment(s) total $100,000 or more to a government within one fiscal year; and

-the payment(s) fit into certain categories, including:

–Taxes

–Royalties

–Fees (including license fees)

–Production Entitlements

–Bonuses

–Dividends

–Infrastructure Improvements.

 

Various details about the payments must be disclosed, including:

-the types of payments,

-the amount paid,

-the currency used,

-the financial period in which the payments were made,

-the business segment of the issuer that made the payments,

-the government that received the payments, and

-the project the payments relate to.

 

These disclosure are made on a new form, Form SD, which is filed annually.  The form must be filed within 150 days of the end of the company’s fiscal year.  The rule applies to fiscal years ending after September 30, 2013.

 

Source: SEC Adopts Rules Requiring Payment Disclosures by Resource Extraction Issuers (SEC Release 2012-164)

 

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

Exam Alert: SEC requires issuer disclosure regarding source of certain minerals

The SEC will require issuers that use “conflict minerals” in their manufacturing to disclose details about their origin. Continue reading

The SEC will require issuers that use “conflict minerals” in their manufacturing to disclose details about their origin.  The “conflict minerals” the new rule will apply to are gold, tantalum, tin, and tungsten.  Issuers must disclose whether the materials are from the Democratic Republic of Congo or an adjoining country.  If the materials are from one of those countries, the issuer must attempt to determine whether the purchase of the minerals benefits armed groups and disclose its findings.

The disclosure must be made both with the SEC, through Form SD, and publicly, via a website.  The first disclosure must be made on May 31, 2014 (for the 2013 calendar year) and then annually on May 31 in subsequent years.

Source: SEC Adopts Rule for Disclosing Use of Conflict Minerals (SEC Release 2012-163)

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

Exam Alert: Department of Labor requires additional disclosure to 401(k)-type plan participants

The U.S. Labor Department has released a final rule that will require the administrators of 401(k)-type retirement plans to provide additional information to plan participants. The rule states that investment of plan assets is a fiduciary act governed by fiduciary standards. The rule requires that if a plan gives investment responsibilities to its participants, that the plan administrator must regularly inform them of those responsibilities. The plan administrator must also provide specified plan-related information and investment-related information, as detailed below. Continue reading

The U.S. Labor Department has released a final rule that will require the administrators of 401(k)-type retirement plans to provide additional information to plan participants.  The rule states that investment of plan assets is a fiduciary act governed by fiduciary standards.  The rule requires that if a plan gives investment responsibilities to its participants, that the plan administrator must regularly inform them of those responsibilities.  The plan administrator must also provide specified plan-related information and investment-related information, as detailed below.

 

Plan-related information consists of three categories:

-general plan information (structure and mechanics of the plan),

-administrative expense information (fees deducted from all accounts), and

-individual expense information (fees charged for individual actions).

This information must be given to participants on or before the date they can first direct their investments, and annually thereafter.  Participants must also receive quarterly statements showing the actual charges for plan-related fees and expenses and a description of services provided.

 

Investment-related information includes –

For investments with a fixed rate of return:

-the annual rate of return

-the term of the investment

For investments that do not have a fixed rate of return:

-1-, 5-, and 10-year returns

-name and returns of an appropriate broad-based securities market index over the same 1-, 5-, and 10-year periods

-total annual operating expenses as a percentage of assets and as a dollar amount per $1000 invested

For all investments:

-any shareholder-type fees or restrictions on the participant’s ability to purchase or withdraw from the investment

-an address for a website that provides current, specific, additional information

-a general glossary of terms

Investment-related information must be given to participants on or before the date they can first direct their investments, and annually thereafter.  It must be provided in a comparative format, such as a chart.

 

Additional stipulations:

-The rule protects the plan administrator from liability for the completeness and accuracy of information given to participants if the administrator reasonably and in good faith relied on information given by a service provider.

-A participant must be given any materials the plan receives for that participant’s investments regarding voting, tender, or similar rights.

-Upon request, the plan administrator must give disclosure documents associated with an investment (prospectuses, financial reports, statements of valuation and of assets held).

 

The initial annual disclosure required under the rule must happen by August 30, 2012.  The initial quarterly disclosure required under the rule must happen by November 14, 2012.

 

Source: Final Rule to Improve Transparency of Fees and Expenses to Workers in 401(k)-Type Retirement Plans (DOL Fact Sheet)

 

This alert applies to the Series 62, Series 6, Series 26, Series 24, Series 7, Series 65, Series 66, and Series 82 – these exams address ERISA considerations.

Exam Alert: SEC requires new exchange listing standards and proxy disclosures

Effective July 27, 2012, the SEC has adopted a new rule that requires national securities exchanges to modify their listing standards. The rule provides new standards for compensation committees and compensation advisers. The SEC also requires companies to disclosure of conflicts of interest for their compensation consultants. Continue reading

Effective July 27, 2012, the SEC has adopted a new rule that requires national securities exchanges to modify their listing standards.  The rule provides new standards for compensation committees and compensation advisers.  The SEC also requires companies to disclosure of conflicts of interest for their compensation consultants.

 

The new listing standards must include provisions that require each member of a company’s compensation committee to be a member of the board of directors and to be independent.  Independence will be gauged based on the source of the person’s compensation and whether the person is affiliated with the company, among other factors.

 

The standards must provide that the compensation committee:

-may retain a compensation adviser,

-be responsible for the selection, payment, and supervision of the compensation adviser, and

-is properly funded.

 

The standards must only allow a compensation committee to select a compensation adviser after considering:

-other services provided by the adviser to the company

-amount the adviser has earned from the company

-policies to prevent conflicts of interest

-relationships between the adviser and members of the compensation committee

-whether the adviser owns company stock

-relationships between the adviser and company executives

 

The following companies will be exempt from the compensation committee independence requirements:

-limited partnerships

-companies in bankruptcy proceedings

-registered open-end management investment companies

-foreign private issuers, though they must explain why they don’t have an independent compensation committee in their annual reports

The exchanges can establish additional exemptions.

 

The following companies are exempt from the compensation committee listing standards altogether:

-controlled companies

-smaller reporting companies

 

Under new proxy disclosure rules, companies must disclose whenever the work of a compensation consultant raises a conflict of interest, if that consultant has a role in setting the level of executive and director compensation.

 

Source: SEC Release 2012-115

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

Exam Alert: MSRB provides guidance on required disclosures and fair practices for municipal underwriters

The MSRB on July 18, 2012, released guidance regarding an interpretive notice on the application of Rule G-17. The interpretive notice takes effect on August 2, 2012. The guidance comes in the form of “practical considerations” provided by the MSRB to help explain and clarify certain provisions of the notice. Continue reading

The MSRB on July 18, 2012, released guidance regarding an interpretive notice on the application of Rule G-17.  The interpretive notice takes effect on August 2, 2012.  The guidance comes in the form of “practical considerations” provided by the MSRB to help explain and clarify certain provisions of the notice.

 

The MSRB guidance organizes the guidance into categories, and within each of these categories gives a number of “statements of principle” that reflect key policies from Rule G-17.  Then for each of these statements, the MSRB provides applicable information from the interpretive notice (if any), along with the “practical considerations.”  Since the “practical considerations” are new, but also require context, this alert will focus on them, organized by associated “statement of principle.”  For insight into changes caused by the interpretive notice, see this prior exam alert or the MSRB guidance.  Categories are italicized below, summarized statements of principle are underlined.

 

Statements and Representations

An underwriter must not misrepresent material information.

-Underwriters must have a reasonable basis for any assumptions underlying provided information.

-The less certain an underwriter is of its underlying assumptions, the more important it is to disclose its uncertainty.

-A request for proposal is subject to the rule, and “should not be treated as merely a sales pitch.”

-If an underwriter would be uncomfortable with an issuer relying on provided information, the underwriter should either refrain from providing the information or provide additional disclosures as to the reliability of the information.

-Underwriters must clearly distinguish opinion from fact.

An underwriter in a negotiated underwriting must not recommend against using a municipal adviser.

-An underwriter may not imply that the underwriter can provide that same services as a municipal adviser.

 

Fairness of Financial Aspects of an Underwriting

The underwriter’s compensation must be reasonable.

The price the underwriter pays to the issuer must be fair.

Profit-sharing arrangements with investors that purchase IPO shares may not be allowed, particularly if the investor resells the shares shortly after they purchase them.

-An arrangement can be inferred to exist based on a pattern of transactions, even without a written agreement.

-An underwriter should consider whether any such arrangement would result in an unfair price for the issuer.

An underwriter should not seek to be reimbursed for lavish expenditures made for the personal benefit of issuer personnel.

 

Required Disclosures to Issuers

An underwriter in a negotiated underwriting must disclose information about its role to the issuer.

-If the underwriter is operating in agency capacity (by working as a placement agent) rather than principal capacity, the underwriter does not need to state that the underwriter’s financial interests are independent of the issuer’s.

-If the underwriter is operating in agency capacity rather than principal capacity, the underwriter does not need to state that the underwriter lacks a fiduciary duty to the issuer.

-In offerings with no official statements, the underwriter does not need to disclose a duty to review the official statement.

An underwriter in a negotiated underwriting must disclose its actual and potential material conflicts of interest.

-An underwriter in a negotiated underwriting must disclose payments, values, credits, and other material conflicts of interest regardless of the complexity of the issue.

-Payments to third parties only need to be disclosed when they would cause a conflict of interest; routine business payments would not generally trigger the requirement.

-An underwriter should focus on giving a complete picture of conflicts of interest, rather than trying to organize their disclosure based on the categories provided by the notice.

If an underwriter in a negotiated underwriting recommends a complex form of financing to the issuer, the underwriter must disclose the material characteristics and risks of the financing.

-Not all negotiated underwritings involve a recommendation by the underwriter (i.e. when the issuer or a financial advisor has already decided on the form of financing and the underwriter merely executes the transaction).

-An underwriter must make the judgment of whether a form of financing is complex.  A relatively common financing structure or product may still be complex.

-As an issuer becomes more experienced with a complex financing structure or product, less disclosure may be necessary.  If an experienced employee of the issuer (in a relevant position) is replaced with a relatively inexperienced one, more disclosure may be necessary.

-The underwriter must tailor its disclosures to the specific issuer and the specific complex financing structure/product, rather than handing out a general form with various types of complex financing structures/products described.

-The underwriter may have a set of standardized descriptions of complex structures/products that it selects from and modifies as necessary to form the disclosure document provided to the issuer.

If an underwriter reasonably believes that an employee of the issuer is unfamiliar with a financing structure that it recommends, the underwriter must provide material information on that structure (regardless of whether a typical municipal securities professional would be familiar with the structure).

 

Manner and Timing of Providing Disclosures to Issuers

-Disclosures for a complex financing must not consist of “page after page of complex legal jargon in small print.”

-For complex financing involving a swap, the swap dealer must have reasonable basis to believe that a municipal client has an independent representative that can evaluate the transaction (including its risks, pricing, and appropriateness).

-The agreement among underwriters should designate a syndicate manager to give disclosures to the issuer (besides firm-specific conflict of interest disclosures).

-It may not always be feasible to strictly adhere to the timelines provided for disclosure.  The important thing is that the issuer is kept informed throughout the process.  The notice is not intended to cause technical violations as long as the underwriters act “in substantial compliance” with the timeframes and meet the “key objectives” for providing the disclosure.

 

Sources:

MSRB Provides Guidance to Underwriters on Implementation of New Obligations to State and Local Governments

Guidance on Implementation of Interpretive Notice Concerning the Application of MSRB Rule G-17 to Underwriters of Municipal Securities

 

This alert applies to the Series 7.