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The SEC Adopts Regulation Best Interestby Andrew Whiteman

The SEC Adopts Regulation Best Interest

On June 5, 2019, the United States Securities and Exchange Commission issued Release No. 34-86031, titled Regulation Best Interest: The Broker-Dealer Standard of Conduct. This much-anticipated rule takes effect on June 30, 2020.

The stated purpose of Regulation BI is to establish a standard of conduct for broker-dealers and their associated persons when they make recommendations to retail customers for any securities transaction or investment strategy involving securities. According to the SEC’s 771-page release, the Regulation BI enhances the broker-dealer standard of conduct by requiring broker-dealers “to act in the best interest of the retail customer at the time the recommendation is made,” to refrain from “placing the financial interest of the broker-dealer ahead of the interests of the retail customer,” to “address conflicts of interest by establishing, maintaining, and enforcing policies and procedures reasonably designed to identify and fully and fairly disclose material facts about conflicts of interest,” and, in certain instances, to mitigate or eliminate conflicts.

The actual regulation takes up less than six pages, while the remainder of the 771 pages consists of the SEC’s attempt to explain why this new regulation, rather than the much broader fiduciary rule that it replaces, is in the best interest of retail investors. In fact, Regulation BI is in many ways a step backward. The new was universally opposed by investor advocates, including the Public Investors Arbitration Bar Association, and falls far short of the protections investors deserve. The rule purports to require that brokers adhere to a “best interest” standard but does not actually require that they act in their customers’ best interests. The standard does not prevent brokers from placing their own interests first. It provides that brokers are not required to monitor customer accounts unless they agree “to provide the retail customer with specified account monitoring services.” Regulation BI permits broker-dealers to place their interests ahead of customers if they disclose the conflict.

The history of efforts to reform the standards applicable to broker-dealers has its origin in financial crisis that began in September 2018. In July 2010, President Obama signed the Dodd-Frank financial reform law, which gave the SEC the authority to develop a uniform fiduciary standard for retail investment advice that was no less stringent than the standard applicable to investment advisers under the Investment Advisers Act of 1940. The same year, the United States Department of Labor released a rule designed to limit conflicts of interest for financial advisers who worked with customer retirement accounts. In January 2011, the SEC staff issued a report that recommended the SEC propose a uniform fiduciary rule. On April 14, 2016, the Department of Labor issued its final version of the fiduciary rule. Full compliance with the rule was to occur by January 1, 2018. In August 2017, the Labor Department proposed that compliance with the fiduciary rule be delayed for 18 months, until July 1, 2019. By that time, President Trump had been elected. The new administration stated its opposition to imposing a fiduciary standard on broker-dealers, and Department of Labor’s rule was shelved. Regulation BI is its replacement.

The SEC commissioners adopted Regulation BI by a vote of three to one, with Commissioner Robert L. Jackson, Jr. casting the sole dissenting vote. Commissioner Jackson issued a statement in which he wrote “today’s rules retain a muddled standard that exposes millions of Americans to the costs of conflicted advice.” The Dodd-Frank law gave the SEC full authority to adopt a strong, pro-investor fiduciary standard that covered broker-dealers. Unfortunately, the SEC failed to do so.

© Andrew Whiteman 2019

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The lawyers at Whiteman Law Firm have been handling securities matters for over 30 years. Click here for more information about our securities litigation and arbitration practice. Please contact us for more information.

 

 

Andrew Whiteman Assists Securities Law Clinics with Amicus Brief Filingby Andrew Whiteman

Andrew Whiteman Assists Securities Law Clinics with Amicus Brief Filing

On April 19, 2019, Andrew Whiteman filed an amicus curiae brief in the United States Court of Appeals for the Fourth Circuit on behalf of three law school law clinics: University of Miami School of Law Investor Rights Clinic, Elizabeth Haub School of Law at Pace University Investor Rights Clinic, and St. Johns University School of Law Securities Arbitration Clinic (the “Clinics”).

An amicus curiae brief, also known as a “friend of the court brief,” is filed in an appellate court by a non-party to the dispute who has an interest in the outcome of the court’s disposition. The Clinics filed their brief in support of the appeal by the plaintiff-appellants, Rohit Saroop, Preya Saroop, and George Sofis (“Plaintiffs”). The Plaintiffs won their FINRA arbitration case. However, the arbitration decision was vacated by a judge of the United States District Court for the Eastern District of Virginia. The Plaintiffs then appealed the case to the Fourth Circuit Court of Appeals.

The case involves the following facts. In January 2017, an arbitration panel appointed by the Financial Industry Regulatory Authority (“FINRA”) rendered an arbitration award in favor of Plaintiffs against the defendant, Interactive Brokers LLC (“Interactive”). Interactive filed a motion in the District Court to vacate the arbitration award. The Plaintiffs moved to confirm it. The District Judge remanded the arbitration decision back to the panel of arbitrators for clarification of the basis for their award in favor of the Plaintiffs. After the remand, the panel issued a slightly modified version of their initial award in January 2018, again in favor of the Plaintiffs.

Upon review of the modified award, the District Court granted Interactive’s motion to vacate the award and remanded the arbitration case to a new panel of FINRA arbitrators for reconsideration of Interactive’s counterclaims against the Plaintiffs. The District Judge decided to vacate the award after finding that arbitrators based their award against Interactive solely on the ground that Interactive violated a FINRA conduct rule, Rule 4210. The Court ruled that the arbitrators’ decision constituted “manifest disregard of the law” because the law is clear that there is no private right of action to enforce FINRA conduct rules, the panel knew of and understood the law on this point, they found the law to be applicable to the case, and they ignored it.

The Clinics’ amicus brief makes several points. FINRA’s arbitration rules do not require the claimant to specify any cause of action or legal theory in a statement of claim. FINRA arbitration rules do not require the arbitrators to specify any cause of action or legal theory in an award. Under established legal precedent, the arbitrators did not manifestly disregard the law, and the District Court erred in its finding concerning the arbitrators’ rationale for the award.

This is an important case for several reasons. First and foremost, the judicial power to review of arbitration decisions is extremely limited. Judicial review of arbitration decisions has been described as “severely circumscribed” and “among the narrowest known at law.” Apex Plumbing Supply, Inc. v. U.S. Supply Co., 152 F.3d 188, 193 (4th Cir. 1998). The Fourth Circuit has stated that “a court sits to determine only whether the arbitrator did his job – not whether he did it well, correct, or reasonably, but simply whether he did it.” Wachovia Securities, LLC v. Brand, 671 F.3d 472, 478 (4th Cir. 2012). In this case, the District Court’s finding that the arbitrators’ decision was based solely on a violation of a FINRA rule is highly questionable. The Court’s analysis of the “manifest disregard” standard seems deeply flawed. It rests in part on the premise that the case law is clear that an arbitration award cannot be based on a violation of a FINRA rule. The Court cited numerous cases that have held that a FINRA Rule may constitute evidence of the broker-dealer’s duty of care to his customer, but held that those cases were inapplicable because “it was apparent on the face of the arbitrator’s decision that a violation of FINRA Rule 4210” was the sole basis for liability. Finally, the Court’s ruling that the arbitrators knew the law, understood it, knew the law was controlling, and disregarded it is based on what was in Interactive’s arbitration brief. This finding is problematical because the Plaintiffs’ submission to the panel contested Interactive’s argument and cited contrary authority.

This case provides the Fourth Circuit to provide additional guidance on the scope of judicial review of arbitration decisions.

A copy of the District Court’s opinion is here.

A copy of the Clinics’ amicus brief is here.

It is expected that the Fourth Circuit will rule on the case within six to nine months.

© Andrew Whiteman 2019

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The lawyers at Whiteman Law Firm have been handling securities matters for over 30 years. Please contact us for more information.

 

FINRA Requires Brokerage Firms to Communicate with Customers when a Broker Leaves the Firmby Andrew Whiteman

Ask questions if your broker leaves his firm.

According to new regulatory guidance from the Financial Industry Regulatory Authority, known as FINRA, member firms are required to do the following:

  1. In the event of a registered representative’s departure, the member firm should promptly and clearly communicate to affected customers how their accounts will continue to be serviced; and
  2. The firm should provide customers with timely and complete answers when the customer asks questions about a departing registered representative

The new requirements are spelled in Notice to Members 19-10, which was issued on April 5, 2019. The purpose of the new guidance is to ensure that customers can make a timely and informed choice about where to maintain their assets when their registered representative leaves a firm. Customers should not experience any interruption in service as a result of a representative’s departure. Member firms should have policies and procedures in place to assure that customers serviced by a departing registered representative will continue to be serviced, including how and to whom the customer may direct questions and trade instructions and the identity of the representative to whom the customer will be assigned at the member firm.

NTM 19-10 also states that the member firm should “communicate clearly, without obfuscation, when asked questions” by customers about the departing registered representative. Provided the departed representative has consented to disclosure of his or her contact information to customers, the firm must provide the departed representative’s contact information, such as phone number, e-mail address, or mailing address. All information provided by the member firm about the departing representative must be “fair, balanced and not misleading.”

Thus, under NTM 19-10, a member firm (1) must immediately notify customers that their representative has departed and assign a new representative to the customers, (2) may not attempt to hinder or delay customers’ efforts to contact their former registered representative by refusing to provide his contact information when authorized to disclose it, and (3) must provide fair, balanced, and not misleading answers to all customer questions resulting from the representative’s departure.

Senators Warner and Kennedy Introduce Bill to Expand SEC Powers to Assist Investorsby Andrew Whiteman

On March 14, 2019, Senators Mark Warner (D-Va.) and John Kennedy (R-La.), both members of the Senate Banking Committee, introduced the Securities Fraud Enforcement and Investor Compensation Act. This legislation would give the Securities and Exchange Commission power to seek restitution for retail investors harmed by securities fraud scams.

In many cases, fraudulent investment schemes are not detected for many years. For example, Bernie Madoff was able to defraud investors for decades before his investment fund was revealed to be a Ponzi scheme in 2009. A ruling by the United States Supreme Court in Kokesh v. Securities and Exchange Commission ruled that the SEC must bring disgorgement claims within five years from when the claim accrued. The SEC reported in its 2018 enforcement report that the Court’s ruling could cause the SEC to forgo up to $900 million in disgorgement claims.

The bill addresses this problem by granting the SEC the power to seek a new remedy – restitution – for a period of up to ten years.

A summary of the legislation may be found here.

© Andrew Whiteman 2019

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The lawyers at Whiteman Law Firm have been handling securities matters for over 30 years. Please contact us for more information.

 

 

 

 

SEC Announces Results of Share Class Selection Disclosure Initiativeby Andrew Whiteman

On March 11, 2019, the Securities and Exchange Commission announced that it had settled charges with 79 investment advisers who agreed to return more than $125 million to their clients, with a substantial majority of the funds going to retail investors. The SEC entered into the settlements after the  advisers self-reported violations of the Investment Advisers Act under the SEC’s Share Class Selection Disclosure Initiative (“SCSDI”).

In recent years, the SEC has increased its enforcement activities in the area of mutual fund share selection. Beginning in 2016, the SEC has brought numerous enforcement actions against advisers who received undisclosed payments of 12b-1 fees as a result of recommending the purchase of higher-cost mutual fund shares to their clients. See, e.g., In re PPS Advisors, Inc., Investment Advisers Act Rel. No. 5084 (December 20, 2018).

On February 12, 2018, the SEC announced the SCSDI, which allowed advisers who self-reported violations of federal securities laws relating to mutual fund share class selection, and who had promptly returned money to harmed clients, to avoid civil penalties. Likewise, in guidance from the Office of Compliance Inspections and Examinations (“OCIE”), the SEC stated that an adviser who advises his clients to invest in a mutual fund share class that is more expensive than other available others “when the adviser is receiving compensation that creates a potential conflict of interest and that may reduce the client’s return” may violate its fiduciary duty and the antifraud provisions of the Adviser’s Act, particularly when the adviser has not provided a full and fair disclosure of the conflict and obtained the client’s informed consent. See Proposed Commission Interpretation Regarding Standard of Conduct for Investment Advisers, Investment Advisers Act Rel. No. IA-4889 (April 18, 2018) (“Proposed Interpretation”), p. 12.

In an announcement dated May 1, 2018, the SEC clarified that the SCSDI does not apply to adviser share class recommendations “where one share class is higher-cost than another share class but neither share class pays a 12b-1 fee or where the adviser has no financial conflict of interest.”

While the SEC has long held the view that an adviser owes its clients a duty of “best execution,” the SEC’s earliest interpretation of that duty focused on the quantitative and qualitative factors that bear on an adviser’s selection of broker-dealers to execute securities transactions. See Interpretive Release Concerning the Scope of Section 28(e) of the Securities Exchange Act of 1934 and Related Matters, Exchange Act Rel. No. 23170 (April 28, 1986) (“1986 Interpretive Release”), at n.58. Beginning in 2016, the SEC included a best execution violation in some settled mutual fund share class selection cases, see, e.g., In Re Everhart Financial Group, Inc. Investment Advisers Act Rel. No. 4314 (January 14, 2016), ¶ 16 (citing the 1986 Interpretive Release), but has not done so in all such cases. See, e.g., In re Envoy Advisory, Inc., Investment Advisers Act Rel. No. 4764 (Sept. 8, 2017).

The SEC has not provided clear guidance as to what is meant by the duty to provide “best execution” in the mutual fund share class area. The SEC has never stated that the purchase of a higher cost class of mutual fund when a lower-cost alternative is available is always a violation of section 206(2) of the Advisers Act. Instead, the SEC’s stepped-up enforcement activity focuses primarily on advisers who failed to disclose the conflict of interest created by their receipt of 12b-1 fees. Conversely, numerous SEC publications indicate that best execution depends on the facts and circumstances. The 1986 Interpretive Release, while not specific to mutual fund share selection, states “The Commission wishes to remind money managers that the determinative factor is not the lowest possible commission cost but whether the transaction represents the best qualitative execution for the managed account.” Id., at nn.58-59. Likewise, in another OCIE publication, titled Compliance Issues Related to Best Execution by Investment Advisers (“OCIE Compliance Issues), the SEC stated that the adviser must execute transactions for clients in such a manner that the client’s total costs in each transaction are “the most favorable under the circumstances.Id., p. 1 (emhasis added). The adviser’s conduct must be analyzed, not in hindsight, but “under the particular circumstances occurring at the time of the transaction.” Proposed Interpretation, pp. 13-14.

In the area of mutual fund share class selection, the SEC stated in the Proposed Interpretation that the purchase of the least expensive investment product might not satisfy the adviser’s fiduciary duty:

Furthermore, an adviser would not satisfy its fiduciary duty to provide advice that is in the client’s best interest by simply advising its client to invest in the least expensive or least remunerative investment product or strategy without any further analysis of other factors in the context of the portfolio that the adviser manages for the client and the client’s investment profile.

Proposed Interpretation, p. 12. An adviser must have a “reasonable belief” that the investment advice is in the best interest of a client after the adviser has conducted a “reasonable investigation” into the investment. Id., at pp. 12-13. In the adviser’s analysis, the customer’s time horizon is important. For customers with short time horizons, a lower-cost fund share class “may be more costly relative to other mutual fund share classes.” See Regulation Best Interest (Proposed Rule), p. 311.

Thus, it would not be consistent with SEC guidance to require that investment advisers recommend only the lowest-cost mutual funds, without considering whether a different share class may be appropriate under the circumstances. There are valid reasons why an adviser may determine that it is reasonable for a client to invest in a higher-fee share class, even when a lower-cost fund class is available. These include, for example, the imposition of transaction fees on one class but not another, the size of the transaction, the investor’s time horizon, and operational considerations. The adviser’s conduct must be analyzed at the time of the transaction, not in hindsight.

© Andrew Whiteman 2019

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The lawyers at Whiteman Law Firm have been handling securities matters for over 30 years. Please contact us for more information.

 

FINRA Extends Deadline for Firms to Self-Report Violations under its 529 Share Class Initiativeby Andrew Whiteman

FINRA has extended the deadline for firms to self-report violations under its 529 Plan Share Class Initiative.

The Financial Industry Regulatory Authority (“FINRA”) announced on March 6, 2019, that it is extending the deadline for firms to self-report violations under FINRA’s 529 Plan Share Class Initiative to April 30, 2019. Participating firms must confirm their eligibility by submitting the additional evidence specified in Regulatory Notice 19-04 by May 31, 2019. In addition, FINRA has published a set of frequently asked questions about its 529 Plan Share Class Initiative in response to inquiries it has received from firms and trade associations.

On January 28, 2019, FINRA issued Regulatory Notice 19-04 and announced its “529 Plan Share Class Initiative.” According to the Notice, the purpose of the 529 Plan Share Class Initiative is to allow firms the opportunity to self-report violations related to recommendations that customers of 529 plans purchase shares in classes that carry expenses that are higher than the expenses charged by otherwise identical funds offered by the same issuer.

A 529 plan is a popular investment vehicle that allows individuals to invest money for the educational expenses of a designated beneficiary. According to FINRA’s Regulatory Notice, Class A shares typically impose a front-end sales charge, but lower annual fees compared to other classes. Class C shares typically impose no front-end sales charge but carry higher annual fees than Class A shares. These classes may have a different cost impact on the customer depending on the length of time the customer holds the securities. For most long-term investors, the fees charged by Class C share funds over the life of the investment will be greater than if the customer had purchased Class A shares. FINRA’s Notice suggests that the break-even point may be six or seven years, meaning that when assets are expected to be invested for more than six to seven years (for example, in a 529 plan purchased for the future college expenses of a beneficiary who is 12) an A share fund might be the more cost-effective choice.

FINRA’s Department of Enforcement will recommend that FINRA accept favorable settlement terms for firms that self-report violations and provide FINRA with a detailed remediation plan. FINRA anticipates that the settlement of a self-reported violation will include restitution to customers for the financial impact of the higher-cost share class and a censure, but no fine. Recommended settlements will also include either an acknowledgment that the firm has or will voluntarily undertake corrective actions.

© Andrew Whiteman 2019

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The lawyers at Whiteman Law Firm have been handling securities matters for over 30 years. Please contact us for more information.

 

 

Securities arbitration – Should you hire an attorney?by Andrew Whiteman

Here is a well-written article, co-authored by FINRA and PIABA, about why investors who are considering securities arbitration should hire an attorney.

Securities Arbitration – Should You Hire an Attorney?

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The lawyers at Whiteman Law Firm have been representing investors in securities claims for over 30 years. We represent individuals and businesses who have suffered financial losses due to fraudulent investment schemes sold by unscrupulous or inept investment promoters, stockbrokers, investment advisors or insurance salesmen. If you have suffered losses due to the misconduct of an investment professional, you need competent attorney representation to help you recover your losses. Whiteman Law Firm assists investors to recover losses through litigation and arbitration. Our attorneys represent investors in all types of securities disputes. We handle everything from complex federal and state court litigation to individual customer arbitrations. We can review the facts of your case on a confidential, no-cost basis, and advise you on your options for recovering your investment losses.

Please contact us for more information.

 

FINRA will Seek to Ban Compensated Non-Attorney Representatives from Arbitrationsby Andrew Whiteman

Whiteman Law Firm supports action by FINRA to ban compensated non-attorney representatives (“NARs”) from representing parties in securities arbitrations.

FINRA’s Board of Governors met on December 12 and 13 for its fourth quarter meeting. The Board approved filing with the SEC proposed amendments to the codes of arbitration and mediation procedure to prohibit compensated NARs from practicing in the FINRA arbitration and mediation forums. See FINRA’s press release dated December 21, 2018, for a full report.

This change was supported by the Public Investors Arbitration Bar Association (“PIABA”), a membership organization of attorneys who represent investors in securities arbitrations. See PIABA’s statement in support of the proposed rule change to ban compensated NARs.

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The lawyers at Whiteman Law Firm have been representing investors in securities claims for over 30 years. We represent individuals and businesses who have suffered financial losses due to fraudulent investment schemes sold by unscrupulous or inept investment promoters, stockbrokers, investment advisors or insurance salesmen. If you have suffered losses due to the misconduct of an investment professional, you need competent attorney representation to help you recover your losses. Whiteman Law Firm assists investors to recover losses through litigation and arbitration. Our attorneys represent investors in all types of securities disputes. We handle everything from complex federal and state court litigation to individual customer arbitrations. We can review the facts of your case on a confidential, no-cost basis, and advise you on your options for recovering your investment losses.

Please contact us for more information.

 

 

 

A Third of FINRA Arbitration Awards Go Unpaidby Andrew Whiteman

A third of FINRA arbitration awards are unpaid.

Richard W. Berry, FINRA Executive Vice President of Dispute Resolution, recently provided a statement to the SEC Investment Advisory Committee on customer recovery in FINRA arbitration cases. According to Mr. Berry, “about a third” of cases in which FINRA arbitrators award damages to customers result in unpaid awards. Unpaid awards represent only about 2% of the 13,000 customer arbitrations closed between 2012 and 2016. The vast majority of cases are closed by settlement, not by a decision by the arbitrators. However, the fact that a third of arbitration awards go unpaid is significant and disturbing.

Investors should be aware that most broker-dealers do not carry insurance for the types of claims typically brought in FINRA arbitration cases. To make matters worse, the regulatory capital required to conduct business as a FINRA broker-dealer is surprisingly low. The continued existence of a thinly-capitalized firm may be jeopardized if the firm experiences a number of customer claims within a short period of time.

Mr. Berry’s statement indicates that FINRA will consider advocating for rulemaking by the SEC to maintain additional capital.

Until that happens, investors are encouraged to investigate the financial position of a broker-dealer before doing business with that firm. A broker-dealer’s annual financial statements are required to be submitted to the SEC on Form X-17A-5 and are available to the public through the SEC’s Edgar Company Filings database.

Mr. Berry’s entire statement may be accessed here.

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The lawyers at Whiteman Law Firm have been representing investors in securities claims for over 30 years. We represent individuals and businesses who have suffered financial losses due to fraudulent investment schemes sold by unscrupulous or inept investment promoters, stockbrokers, investment advisors or insurance salesmen. If you have suffered losses due to the misconduct of an investment professional, you need competent attorney representation to help you recover your losses. Whiteman Law Firm assists investors to recover losses through litigation and arbitration. Our attorneys represent investors in all types of securities disputes. We handle everything from complex federal and state court litigation to individual customer arbitrations. We can review the facts of your case on a confidential, no-cost basis, and advise you on your options for recovering your investment losses.

Please contact us for more information.

 

 

 

 

It’s time to have a serious conversation with your financial advisor.by Andrew Whiteman

The bull market that began in mid-2009 may be over. According to a Bloomberg article posted earlier today, the stock markets closed at a 14-month low as a result of continued uncertainty over economic conditions, possible interest rate increases, and international trade policy. The S&P 500 is down nearly 5% this year. The current market volatility is usually indicative of an impending decline. Investors should check their holdings and talk to their financial advisors about whether changes in their portfolios are warranted.  According to Alan Greenspan, former Federal Reserve Chairman, investors should prepare for the worst.

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The lawyers at Whiteman Law Firm have been representing investors in securities claims for over 30 years. We represent individuals and businesses who have suffered financial losses due to fraudulent investment schemes sold by unscrupulous or inept investment promoters, stockbrokers, investment advisors or insurance salesmen. If you have suffered losses due to the misconduct of an investment professional, you need competent attorney representation to help you recover your losses. Whiteman Law Firm assists investors to recover losses through litigation and arbitration. Our attorneys represent investors in all types of securities disputes. We handle everything from complex federal and state court litigation to individual customer arbitrations. We can review the facts of your case on a confidential, no-cost basis, and advise you on your options for recovering your investment losses.

Please contact us for more information.

 

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