Results tagged “Herskovits” from Securities Industry Lawyer Blog

January 15, 2013

FINRA Is Looking for Additional Disclosure on Up Front Loans to Reps

Depositphotos_2505951_xs.jpgIt is commonplace in the securities industry for reps to transition from one broker-dealer to another. If the rep is a big producer, it is typical for the hiring firm to offer the rep a "forgivable loan" as an inducement to join. Depending upon the size of the producer's book, the forgivable loan can equal 100% to 200% of the producer's trailing 12 month's of production, and is typically forgiven in equal increments annually over a 7 to 9 year period.

FINRA just published Regulatory Notice 13-02, seeking comments on a proposed rule to
require disclosure of "conflicts of interest" relating to recruitment compensation practices. The proposed rule, called "Enhanced Compensation", has the following components:

  • For one year following the rep's start date, the "recruiting" broker-dealer must disclose the "details" of the enhanced compensation "at the time of first individualized contact by the recruiting member or registered person with the former customer after the registered person has terminated his or her association with the previous firm." That should make for an interesting first conversation with the customer.
  • If the disclosure is made orally, "the recruiting member also must provide the disclosure in writing to the former customer with the account transfer approval documentation."
  • If the customer seeks to transfer absent contact by the new firm, disclosure must still be made in writing with the ACAT paperwork.
  • The written disclosure must be "clear and prominent." According to Regulatory Notice 13-02, disclosure "must include information with respect to the timing, amount and nature of the enhanced compensation arrangement."
  • The proposed rule requires no disclosure to institutional accounts that meet the definition of FINRA Rule 4512(c) (unless the rep is a registered investment adviser) or for enhanced compensation less than $50,000.

The premise of the proposed rule is that a "conflict of interest" exists when a broker receives a
recruitment package from a new employer. I, for one, reject that premise and FINRA should
publish its studies - if such studies even exist - which support its premise. Why should a broker
be required to disclose his or her total compensation to a customer? Brokers are not held to a
fiduciary standard, and have no obligation under the law to disclose their compensation beyond
the fees charged to any given customer.

The proposed rule is a follow-on to former SEC Chairman Mary Schapiro's "open letter" to
broker-dealers dated August 31, 2009 (
letter.pdf). In the letter, Schapiro warned broker-dealers not to incentivize churning by giving
an incoming rep increased compensation for hitting a commission target.

However, what if a broker's book is entirely fee-based, surely that would eliminate the
Commission's concern about "churning?" Nevertheless, FINRA's proposed rule gives no carve-
out for fee-based brokers. And what if the hiring broker-dealer offers no increased commission
targets in its compensation package? Nevertheless, FINRA offers no carve-out for that either.

The bottom line is that FINRA's rule is ill-conceived and unsupported. FINRA should articulate
these "conflicts" and then give carve-outs for all "conflict free" compensation packages.

October 23, 2012

FINRA Provides Guidance for Supervisory Review of Email

FINRA recently released an Acceptance, Waiver and Consent signed by Deutsche Bank Securities, Inc. (FINRA Matter No. 2010023096302). The AWC is instructive because it speaks to supervisory review of electronic correspondence and should be considered by broker-dealers when crafting a lexicon-based search system for electronic correspondence.

Background Facts

Depositphotos_11071264_M.jpgDeutsche Bank's Private Client Services division has 16 offices with approximately 240 registered representatives. Deutsche Bank's Boston office employed a registered representative who engaged in questionable conduct, including: borrowing $220,000 from a customer, issuing personal checks totaling $860,000 which were returned for insufficient funds, failing to repay the customer loan in full, failing to obtain Firm approval to borrow from a customer, and charging personal expenses to a corporate credit card.

Clearly, Deutsche Bank had a problem broker on its hands and FINRA asserted that Deutsche Bank was on notice of the employee's financial troubles though various "red flags", including: charging personal expenses to a corporate credit card, bouncing 2 checks to a credit card company, and bouncing a personal check to a co-worker.


FINRA treated Deutsche Bank with a heavy hand by issuing a censure, assessing a fine in the amount of $100,000, and forcing undertakings which include a revision to Deutsche Bank's system of supervision as it relates to supervisory review of electronic correspondence.

Takeaway Lesson

As is commonplace in the securities industry, Deutsche Bank employed a lexicon-based search system to flag electronic correspondence for supervisory review. The supervisory system was required to comport with NASD Rule 3010(d), which requires that: "Each member shall develop written procedures that are appropriate to its business, size, structure, and customers for the review of incoming and outgoing written (i.e., non-electronic) and electronic correspondence with the public relating to its investment banking or securities business, including procedures to review incoming, written correspondence directed to registered representatives and related to the member's investment banking or securities business to properly identify and handle customer complaints and to ensure that customer funds and securities are handled in accordance with firm procedures."

The AWC chastised Deutsche Bank's system of supervision by stating that:

"The lexicon, however, failed to include any search terms to detect communications concerning loans, liens, personal bankruptcies, delinquent payments, bounced checks or other indications that a registered representative might be experiencing financial difficulties and/or violating certain applicable laws, regulations and rules. As a result of DBSPs failure to include such search terms in the lexicon, the Firm did not review numerous MJ e-mails that contained evidence of red flags regarding his misconduct."

Had Deutsche Bank's lexicon-based system included the search terms noted by FINRA, it is claimed that Deutsche Bank would have become aware of various emails which underscored the registered representative's financial pressures.

The upshot of this AWC is clear: If you employ a registered representative under financial duress, your supervisory system for communications must be tailored to ensure supervisory review of potentially problematic emails. Given the inherent costs associated with additional layers of supervisory review, it begs the question of whether the cost is justified by the producer's revenue. Odds are it isn't because financial pressures often flow from a lack of production. As FINRA noted in the AWC, the broker "was generating little revenue of the Firm."

The AWC also suggests that FINRA will take issue with any lexicon-based system which does not adequately root out emails concerning matters which may lead to a disclosure item on a Form U4.