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Escalating Complaints and/or Potential Red Flags

When a customer complaint is received by a broker-dealer, the appropriate personnel at the member firm must promptly be notified. This is also the case when a red flag is spotted concerning a customer account. Personnel who may require notification include the account representative, the principal over that account, the branch manager, or member of the compliance team. The process of alerting the appropriate "higher ups" is referred to as escalation. Like an escalator, this process raises something to a higher level. A complaint is a written statement by a customer-or a person acting on behalf of a customer-that alleges any grievance or dispute connected to a securities transaction or the handling of the account. Maybe a customer was recommended an investment that has suffered a large loss, an investment she now feels was unsuitable. Or, maybe the customer checks her monthly account statement and sees three purchases she doesn't recognize, with the agent claiming she told

Political Contributions

Political Contributions Municipal securities are issued by states, cities, counties, school districts, etc. Therefore, many elected officials are in a position to influence which firms get to underwrite certain offerings. They could either rig the bidding process for a competitive, sealed bid, or they could manipulate the negotiated underwritings in a way that benefits those firms willing to donate to their campaign funds. Fortunately, the securities regulators are interested in maintaining the integrity of the municipal bond underwriting process. The tax payers supporting all the school bond issues should not have to worry that some politically-connected broker-dealer is gouging them every time another bond is sold. Therefore, if any firm makes a large political contribution, they are prohibited from doing securities business with the related issuer for a period of two years. So, if your broker-dealer is a municipal bond underwriter in New Orleans, and you make a $10,000 donation to t

Gifts and Gratuities & Non-cash Compensation

FINRA does not allow member firms and their associated persons to buy influence at other firms with gifts of cash or gifts with resale value over a certain amount. Currently the amount is $100 but is expected to rise to $175 in the near future. Why would someone at your firm want to give someone at another firm a $1,000 set of titanium golf clubs? Maybe your firm would like to start getting invited to join certain municipal securities underwritings that they run as syndicate manager. Or, maybe your firm would just like the other firm to start throwing some of the smaller accounts they don't want your way? Maybe a case of expensive scotch would do the trick? While gifts and business entertainment are not completely prohibited, we are now entering a gray area that can either be considered normal business expenses or a violation of FINRA rules on influencing or rewarding the employees of other member firms. Here is how FINRA states the rule: No member or person associated with a membe

Specific Communications Rules

Investment Company Products New FINRA members must pre-file their retail communications at least 10 business days before first use with the Advertising Regulation Department of FINRA. That applies during their first year of association and applies to all retail communications other than free-writing prospectuses filed with the SEC—those can be filed with FINRA within 10 days but after-the-fact. Also, if a member firm has problems getting their advertising up to regulatory standards, FINRA can require that firm to pre-file all their retail communications or just the types that are causing the problems. After their first year of registration member firms file most of their retail communications with FINRA, but within 10 days after they have already been used. On the other hand, retail communications concerning certain investments still must be pre-filed. Not only must some of these communications be pre-filed, but also members must wait to see if any changes are demanded by FINRA and mus

Research Reports

If you're a big Wall Street broker-dealer the research reports your analysts put out encouraging customers to buy or sell a security can have an impact on the price of the stock. So, if your research department is about to issue a "strong buy" recommendation and a glowing report on Google tomorrow morning, why not buy a boatload of Google shares today, and then release the report tomorrow? Won't that be fun? Your customers will want to buy the stock tomorrow at higher and higher prices and, heck, you'll be right here to sell it to them, at higher and higher prices. FINRA defines a research report as: any written (including electronic) communication that includes an analysis of equity securities of individual companies or industries, and that provides information reasonably sufficient upon which to base an investment decision. FINRA states: Trading Ahead of Research Reports The Board of Governors, under its statutory obligation to protect investors and en

Communications with the Public

Communications with the Public Before we distinguish the types of communications, let's understand the main points:  A principal (compliance officer) must approve the firm's communications and file them.  The communications cannot be misleading in any way. (1) Standards Applicable to All Communications with the Public  (A) All member communications with the public shall be based on principles of fair dealing and good faith, must be fair and balanced, and must provide a sound basis for evaluating the facts in regard to any security or type of security, industry, or service. No member may omit any material fact or qualification if the omission, in the light of the context of the M4-terial presented, would cause the communications to be misleading.  (B) No member may make any false, exaggerated, unwarranted or misleading statement or claim in any communication with the public. No member may publish, circulate or distribute any public communication that the member knows or has reas

Code of Arbitration

Code of Arbitration When broker-dealers are arguing over money, they must take it to arbitration. Under the Code of Arbitration members of FINRA must resolve disputes with an arbi¬trator or arbitration panel, which cuts to the chase and makes their decision quickly. There are no appeals to arbitration. If they say your firm owes the other side one mil¬lion dollars, your firm must cut a check for one million dollars. End of story. A customer is free to sue a firm or registered rep in civil court unless the customer signs the arbitration agreement. Once that's signed, the customer is also bound by the Code of Arbitration, which means they can't sue their agent of broker-dealer in civil court. Which is why most firms get their customers to sign arbitration agreements when the new account is opened. Civil court is too costly and time-consuming. Arbi¬tration can be very painful, but at least it's quick. If the arbitration claim is for a small amount of money, Simplified Industry

Code of Procedure (COP)

Code of Procedure (COP) FINRA investigates violations of the conduct rules through Code of Procedure. When we mentioned words such as "suspend, expel, bar, and censure," those are all part of the Code of Procedure. Maybe a staff member of FINRA found out some disturbing information during a recent routine examination of a firm, or maybe a customer is upset about losing 90% this year and then found out her agent was break¬ing rules along the way. Either way, the respondent is notified and asked to respond to the charges in writing. All requests for information must be met within 25 days. All registered persons must cooperate with the investigation, producing documents or testimony as required. And if it's decided that the respondent broke a rule, he could be censured, fined, sus¬pended, expelled, or barred. Respondents receive an offer from FINRA to use what they call "summary complaint procedure," and if they want to avoid a hearing, they must accept it within 1

Gifts and Gratuities

Gifts and Gratuities FINRA does not allow member firms and their associated persons to buy influence at other firms with gifts of cash or gifts with resale value over a certain amount. Currently the amount is $100 but is expected to rise to $175 in the near future. Why would someone at your firm want to give someone at another firm a $1,000 set of titanium golf clubs? Maybe your firm would like to start getting invited to join certain municipal securities underwritings that they run as syndicate manager. Or, maybe your firm would just like the other firm to start throwing some of the smaller accounts they don't want your way? Maybe a case of expensive scotch would do the trick? While gifts and business entertainment are not completely prohibited, we are now entering a gray area that can either be considered normal business expenses or a violation of FINRA rules on influencing or rewarding the employees of other mem¬ber firms. Here is how FINRA states the rule: •    • • • • • • • •

Supervision

FINRA requires principals to supervise registered representatives. The member firm must establish and maintain written procedures to supervise the types of business it's engaged in and must supervise the activities of registered representatives. They must also designate a principal responsible for supervising each type of business in which the firm engages, and they must designate an "OSJ" (Office of Supervisory Jurisdiction). The firm must perform internal inspections: •    • • • • • • • • • • • • • •    Each member shall conduct a review at least annually, of the    • •    businesses in which it engage; which review shall be reasonably • •    designed to assist in detecting and preventing violations of and    • achieving compliance with applicable securities laws and regula- •    don; and with the Rules of this Association. Each member shall • •    review the activities of each office, which shall include the periodic • •    examination of customer accounts to detect an

More on Registration & Exemptions

More on Registration Requirements Many people in the industry ask, "If I stop selling for a while, can I just park my license at the firm until I'm ready to use it again?" Here is how FINRA answers that: •    • • • • • • • • • • • • • •    A member shall not maintain a representative registration with    • •    FINRA for any person (1) who is no longer active in the member's • investment banking or securities business, (2) who is no longer •  functioning as a representative, or (3) where the sole purpose is to • •    avoid the examination requirement prescribed in paragraph (c).    • •    • • • • • • • • • • • • • So, if the registered representative is out for two years or more, he must take his Series 6 or Series 7 exam again. Item (3) is saying that a member firm had better not pretend the agent is associated just so he can skip the requirement to requalify by exam. A broker-dealer also could not sponsor someone for the Series 7 exam just so the person could

Principals

Principals Member firms need principals who review correspondence, approve every account, initial order tickets, handle written customer complaints, and make sure there's a procedural manual for the office to use. In other words, somebody at the firm is ulti¬mately responsible for the business of the firm—that person is the principal. FINRA says: •    • • • • • • • • • • • • • •    All Principals Must Be Registered    • •    All persons engaged or to be engaged in the investment banking or • •    securities business of a member who are to function as principals • shall be registered as such with F1NRA in the category of regis- •    •tration appropriate to the function to be performed as specified in • •    Rule 1022. Before their registration can become of ffective, they    • •    shall pass a Qualification Examination for Principals appiv-  • priate to the category of registration as specified by the Board of •    Governors.    • •    • • • • • • • • • • • • • Here is how FINRA de

FINRA Membership

FINRA Membership If your firm wants to join FINRA, it must: •    meet net capital requirements •    have at least two principals to supervise the firm •    have an acceptable business plan detailing its proposed activities •    attend a pre-membership interview If your firm becomes a member of FINRA, they must agree to: •    abide by the rules of the "Association" •    abide by all federal and state laws •    pay dues, fees, and membership assessments What are these fees the firm must pay? •    Basic membership fee •    Fee for each rep and principal •    Fee based on gross income of the firm •    Fee for all branch offices Membership, Registration and Qualification Requirements FINRiVs Central Registration Depository (CRD) is the electronic registration system for member firms, principals, and registered representatives. FINRA reminds their member firms not to file misleading information. As the FINRA Manual says: •    • • • • • • • • • • • • • •    Filing of Misleading Info

FINRA

FINRA The Securities and Exchange Commission has authority over broad aspects of the securities industry. They are granted this authority under the Securities Exchange Act of 1934. Under this landmark securities legislation the SEC requires securities exchanges such as NYSE and CBOE to register. These self-regulatory organizations in turn register and regulate their own member firms and the associated persons of those firms. Securities have long traded both on the New York Stock Exchange and the Over¬The-Counter (OTC) market. In 1938 Congress passed the Maloney Act, a law providing for the regulation of the OTC securities markets through national associations registered with the SEC. The National Association of Securities Dealers (NASD) then registered under the act. In 2007 the NASD and the regulatory arm of the NYSE formed FINRA, which stands for the Financial Industry Regulatory Authority. FINRA, along with NYSE and CBOE, is a self-regulatory organization (SRO) registered with the S

Investment Advisers Act of 1940

Investment Advisers Act of 1940 If you want to give people your expert securities advice based on their specific investment situation and receive compensation for doing so, you must register under the Investment Advisers Act of 1940 or under your state securities law. Portfolio managers, financial planners, pension fund consultants, and even many sports and entertainment agents end up having to register to give investment advice to their customers. All open- and closed-end funds are managed by registered investment ad¬visers, and pension funds typically farm out their assets to many different investment advisory firms. Because the role they play is so important and so potentially danger¬ous, all investment advisers must be registered unless they qualify for some type of exemption. Federal covered advisers are subject to the provisions of the Investment Advisers Act of 1940. A federal covered investment adviser with offices in various states only complies with the recordkeeping requirem

Investment Company Act of 1940

Investment Company Act of 1940 The SEC summarizes this federal securities law like so: This Act regulates the organization of companies, including mutual funds, that engage primarily in invest¬ing, reinvesting, and trading in securities, and whose own securities are offered to the investing public. The regulation is designed to minimize conflicts of interest that arise in these complex operations. The Act requires these companies to disclose their financial condition and investment policies to investors when stock is initially sold and, subsequently, on a regular basis. The focus of this Act is on disclosure to the investing public of information about the fund and its investment objectives, as well as on investment company structure and operations. It is important to remember that the Act does not permit the SEC to directly supervise the investment decisions or activities of these companies or judge the merits of their investments. So, mutual funds must register their securities and p

Trust Indenture Act of 1939

Trust Indenture Act of 1939 The SEC describes the Trust Indenture Act of 1939 like so: This Act applies to debt securities such as bonds, debentures, and notes that are offered for public sale. Even though such securities may be registered under the Securities Act, they may not be offered for sale to the public unless a formal agreement between the issuer of bonds and the bondholder, known as the trust indenture, conforms to the standards of this Act. As we see above, the Trust Indenture Act of 1939 is all about protecting bondholders. If a corporation wants to sell $5,000,000 or more worth of bonds that mature outside of one year, they must do it under a contract or indenture with a trustee, who will enforce the terms of the indenture to the benefit of the bondholders. In other words, if the issuer stiffs the bondholders, the trustee can get a bankruptcy court to sell off the assets of the company so that bondholders can recover some of their hard-earned money. Sometimes corporations

Securities Exchange Act of 1934

Securities Exchange Act of 1934 As mentioned, the Securities Exchange Act of 1934 is broader in scope than the Securities Act of 1933. As the SEC explains on the same page of their website: With this Act, Congress created the Securities and Exchange Commission. The Act empowers the SEC with broad authority over all aspects of the securities in¬dustry. This includes the power to register, regulate, and oversee brokerage firms, transfer agents, and clearing agencies as well as the nation's securities self-regulatory organizations (SROs). The various securities exchanges, such as the New York Stock Exchange, the NASDAQ Stock Market, and the Chicago Board of Options are SROs. The Financial Industry Regulatory Authority (FINRA) is also an SRO. The Act also identifies and prohibits certain types of conduct in the markets and provides the Commission with disciplinary powers over regulated entities and per¬sons associated with them. The Act also empowers the SEC to require periodic reporti

Securities Act of 1933

Securities Act of 1933 The Securities Act of 1933 aims to ensure that investors have all the material infor¬mation they need before buying stocks and bonds issued on the primary market and that this information is accurate and not misleading. As the SEC explains on their website: Often referred to as the "truth in securities" law, the Securities Act of 1933 has two basic objectives: •    require that investors receive financial and other significant information concerning securities being offered for public sale; and •    prohibit deceit, misrepresentations, and other fraud in the sale of securities. The scope of this securities law is narrower than the far-reaching Securities Exchange Act of 1934. The Securities Act of 1933 focuses solely on the offering of securities to public investors for the first time. The Act requires issuers to register an offering of securities with the SEC before the issuer can offer or sell their securities to the public. Because of this securities

Prohibited Activities Related to Trading

Broker-dealers and their agents are not allowed to take advantage of customers through churning, excessive mark-ups, breakpoint sales, front-running, market ma­nipulation, and the improper sharing in profits and losses with customers. Churning Agents and their broker-dealers are paid to execute trades. Therefore, the more trad­ing a customer does, the better for the agent and the firm he represents. However, frequent trading has not shown to benefit retail investors. As Professor Brad Barber and Terrence Odean found by studying the habits of U.S. retail investors, investors who were in the bottom 20% for trading activity had an average annual portfolio return of 18.5%, while those in the top 20°/o had an average annual return of just 11.4 %. (Source: Brad Barber and Terrence Odean (1999) 'The courage of misguided convictions' Financial Analysts Journal, November/December, p. 50.). Recommending the customer engage in excessive trading is a violation known as churning. Based on t