Author: Morrie Simkin

The Supreme Court, in Lucia v. Securities and Exchange Commission, ruled that the Administrative Law Judges (ALJs) hired by the SEC were not constitutionally appointed. The Court then said that anyone sanctioned in an SEC administrative proceeding where they objected to the ALJs powers could have the sanction overturned and have a new administrative proceeding.

Court’s Opinion

The Court ruled that Administrative Law Judges were “officers” of the United States. The constitution requires that these ALJ officers be appointed by the full Commission. That was not the SEC’s practice until late last year. Therefore, the Court said anyone objecting to the appointment of these judges was entitled to a new hearing before a new administrative law judge who had been constitutionally appointed.

Another Out

The opinion left open other grounds that could be used to challenge the constitutionality of the appointment of these ALJs. This would be another ground to strike any sanctions they issued, whether or not affirmed by the full Commission.

What next?

The SEC has stayed all pending administrative proceedings until July 21, 2018. This may be extended. The SEC has a number of choices of what to do. They could overrule all sanctions imposed in prior proceedings where the ALJ was not constitutionally appointed. But, that is not likely.

But this opens the door for parties sanctioned in a contested administrative proceeding to seek reversal of the sanctions based upon the unconstitutional status of the then presiding ALJ, either on the grounds set out in the Supreme Court opinion or other challenges.

Contact

If you have any questions, comments or would like to further discuss this, please call (212 455 0576) or email (msimkin@securitiesregslawyer.com) me.

July 2018
Morris Simkin

FINRA has solicited comments on its proposal to replace Rules 3270 (0utside Business Activities) and 3280 (Private Securities Transactions) with a new rule, Outside Business Activities (3290). The proposal reduces some of the reporting and supervisory duties imposed by Rules 3270 and 3280. Given this, it is probable that FINRA will ultimately propose this new Rule 3290. However, it leaves a number of other issues unaddressed. Attached is a New York State Bar Association comment letter on this proposal of which I was one of the draftsmen.

Current Rules—Notice and Approval
Rule 3270 prohibits any outside business activities for compensation or the reasonable expectation of compensation unless the registered person gives his firm prior written notice. Upon receipt of the notice of such outside business activity, the firm may approve, disapprove or approve it subject to limits. Rule 3280 prohibits a registered person from participating in any private securities transaction without the prior approval of his firm, if it is for compensation, and if not for compensation, then subject to such limits as the firm may set.

Proposed Rule—Notice; Limit on Required Notice; Firm Assessment
Proposed Rule 3290 requires a registered person to report to his/her firm before engaging in any outside investment related or other business activity. In the case of a proposed outside investment related activity, the firm must perform a reasonable assessment of the risks created by the activity including whether it would interfere with the registered person’s responsibilities to the firm’s customers, or if it would be viewed by customers or the public as part of the member firm’s business. The firm must also consider whether the person could engage in the activity without being a registered person of the firm. The firm must approve, disapprove or approve with limitations on the proposed activity. If limitations are imposed, the firm must supervise the person’s compliance with those limitations, but not the underlying activity. If the approved activity would require broker-dealer registration and the entity is not so registered, the member firm will be deemed to be engaged in that activity and have recordkeeping and supervisory responsibilities for it.

Proposed Rule– Exclusions
Excluded from the proposal are personal investments (but still subject to Rule 3210 to report such accounts and send trade reports to the firm) and managing immediate family money but not for a fee. If the activity is on behalf of an affiliate of the member firm it too is excluded. The proposal would eliminate the requirement that if the outside activity is acting as an investment adviser the firm must record and execute all transactions- thus subjecting such activity to the suitability, best execution, supervision and books and records rules.

Issues
Some of the issues raised by the Bar Association and others include: a) it does not permit the registered person pursuing new employment in the industry or forming a new firm without giving prior notice to the employer; b) it applies to banking, real estate and non-security insurance businesses–for example forming a partnership to buy a rental building; c) the idea that non-compensated activities are outside of the proposal’s scope is not clearly delineated, although prior FINRA notices have implied that they are subject to the prior reporting requirements; and d) the proposal that if a person is registered with two firms they can allocate supervisory responsibility appears inconsistent with the Securities Exchange Act.

Please feel free to call (212 455 0476) or email (msimkin@securitiesregslawyer.com) me with your comments or questions. The FINRA comment period has expired, but you can stills end your comments to FINRA at pubcom@finra.org and refer to RN 18-08.

Why:

FINRA has amended Rule 3310, The Anti-Money Laundering Compliance Program. It now requires brokers to include in their AML Compliance Manual the duties imposed by FinCEN’s Customer Due Diligence Rule. It also requires, as part of the annual independent party review of their AML program, testing for compliance with this additional duty.

What:

The amended rule requires that a firm’s AML Compliance Manual include conducting ongoing customer due diligence to understand the nature and purpose of the customer relationship and developing a customer risk profile. The firm is required to update the customer information. Based on this data, the firm must monitor trading in the account to identify and report suspicious transactions. This update duty is in addition to the duty to update retail customer data at least every 3 years under SEC Rule 17a-3.

Now What:

Firms will need to revise their AML Compliance Manual to reflect these new duties. They will also have to make sure that the annual review required under the rule includes a review of these new procedures.

Questions; Comments: Please feel to contact me with any questions or comments (phone 212 455 04676; e-mail: msimkin@securitiesregslawyer.com ).

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Morris Simkin
May 2018

What?

The Legal Entity Beneficial Ownership Rule adopted by Treasury Department’s Financial Crimes Enforcement Network is part of an expanded anti-money laundering program. When opening an account for a legal entity the broker must understand the nature and purpose of the customer relationship. With this understanding the broker must monitor the account for suspicious activity reporting. FINRA and the SEC are charged with enforcing this rule along with the Treasury Department.

When

The rule becomes effective May 11, 2018. It applies to broker-dealers, mutual funds, banks, and other financial institutions that open new accounts on or after May 11, 2018 for “legal entities.”

How

The rule requires obtaining specified information. This can be done by completing the Appendix to the rule (copy attached). The firm may require the individual opening the account for the legal entity to complete the Appendix or use other means to obtain the information specified in it.

Who

A “legal entity” includes most forms of business organization- corporations, partnerships, limited liability companies, and trusts. The rule excludes SEC or CFTC registered or regulated entities, publicly held reporting companies, and financial institutions. Pooled investment vehicles are not subject to the Rule’s beneficial ownership disclosure requirements, even if they are not operated by an SEC or CFTC registered entity, if the firm has the information as to the chief investment officer or similar officer.

Duty and Updating

FinCEN stated that the rule is intended to clarify the four (4) obligations of an Anti-Money Laundering Program. These are: 1. Customer identification and verification; 2. Ownership identification and verification; 3. Understanding the nature and purpose of the customer relationship; and 4. Ongoing monitoring for reporting suspicious transactions, and, on a risk basis, maintaining and updating customer information. The rule imposes no affirmative duty to monitor and update this information. That duty arises only when the firm has information brought to its attention or otherwise becomes aware of information that there is a change in the customer legal entity’s information- e.g new shareholders or chief officers.

What now?

The firm needs to understand the reason for establishing the account. Then if it becomes aware of circumstances or trades that inconsistent with the reasons for establishing the account it may be compelled to file a Suspicious Activity report. This duty can be combined with the broker’s other obligations –e.g. know your customer, suitability and related anti-fraud rules. As part of its regular program of reviewing customer trades the firm could also review the trading for its conformity to the purposes for which the customer established the account.

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Questions: Comments. If you have any questions or comments please feel free to contact me
(phone: 212 455 0476; e-mail: msimkin@securitiesregslawyer.com ).

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Morris Simkin
April 2018

The SEC and FINRA recently sanctioned a firm and its principals including its anti-money laundering compliance officer for failure to file Suspicious Activity Reports (SARs). The firm was fined $750,000 by the SEC and $550,000 by FINRA. Yet, if properly used filing SARs can be a shield for brokerage firms.
Financial Crimes Enforcement Network requires broker-dealers to file an SAR if conduct through that broker-dealer involves $5,000 or more and the broker knows or suspects that the transaction itself or is part of a pattern of transactions that involves either:

1. Funds derived from illegal activity or is to disguise or hide funds derived from an illegal activity;
2. Is designed to evade the Bank Secrecy Act;
3. Has no business or apparent lawful purpose or is not the sort that customer would normally be expected to engage in and the broker has no reasonable explanation for it after examining the the available facts; or
4. Involves using the broker-dealer to facilitate a crime.

How does this help the broker? All SARs that are filed are secret. The filing broker has no right to disclose to anyone other than law enforcement, the SEC and FINRA that an SAR has been filed or its contents. Further, the broker voluntarily filing an SAR is protected from liability to any person because it filed such SAR.

Often a broker is investigated by the SEC or FINRA on the grounds that it aided and abetted a violation by one of its employees or by a customer. Aiding and abetting requires knowledge and some degree of participation in the violative conduct. Filing an SAR regarding that conduct should serve as a shield to such a charge. Not only did the firm see it, but it called the conduct to the government’s or FINRA’s attention.

FINRA Rule 4530 requires member firms to notify FINRA within 30 days if the firm concludes or reasonably should have concluded that an associated person or the firm has violated any applicable law, rules or regulations or FINRA rules. FINRA enforcement’s practice is to open an investigation based upon such a filing. Filing an SAR before the 30 day period within which such a report is required should serve as a shield in the case of a FINRA investigation of a failure to file such a report.

Bottom Line. If you’re a brokerage firm and you see something that doesn’t pass the “smell” test, you could save yourself some trouble by filing an SAR reporting this activity, rather than run the risk of an SEC or FINRA exam turning it up and all that that entails.

Morris Simkin
April 2018

Morrie Simkin December 2017
FINRA has adopted Rule 2165 that is intended to protect individuals from financial exploitation; however, brokers need to be aware that following the rule may invite a law suit. Fortunately, there are some ways that brokers can protect themselves.
FINRA Rule 2165, together with amendments to Rule 4152, effective February 5, 2018, allow a broker to withhold the proceeds of sales of securities and delivery out of the contents of an account of a “specified person” for 15 business days, expandable to 25, if the broker reasonably believes there has been or will be a financial exploitation. But the rule and amendments do not protect the broker from suits by the customer or the third parties who would have received the funds or account’s securities. Let me explain how this works, and how a broker can protect a customer whom he believes is the subject of financial exploitation.
A specified person, the object of these rules, is either a person 65 or older or a person over 18 who the broker reasonably believes has a mental or physical impairment. When such a person opens an account the broker is to ask for a “Trusted Personal Contact” whom the broker can contact if the broker suspects financial exploitation. “Financial Exploitation” is the wrongful taking or use of a specified person’s funds or any act or omission to obtain control over a specified person’s money, assets or property or to obtain control over them. If the broker reasonably believes there has been or will be a financial exploitation s/he may contact the Trusted Contact Person and may freeze the account for up to 15 business days, expandable to 25 business days if supported by the facts and circumstances.
While these rules permit this, they only apply to FINRA member firms and their registered personnel. They do not apply to the customer, the Trusted Contact Person or anyone who would have received the funds or assets in the account. Further, these rules could lead to a violation of the privacy rules (SEC Regulation S-P). The SEC has stated that it is permissible under Regulation S-P to report elder abuse to appropriate state authorities. But nothing was said about freezing the account or disclosing the freeze to the Trusted Contact Person, and possibly others.
So what is a broker to do if he or she suspects that a client may be subjected to financial exploitation under the rule? We recommend that the broker not freeze the account or disclose the situation to a third party. Rather, file a Form SAR-SF with FinCEN, under the Bank Secrecy Act Rules. This filing allows the confidential disclosure to FinCEN of possible violations of law. A broker filing a Form SAR is prohibited from disclosing that it has filed one, and the contents of what it has filed. This way the broker can notify the government, protect its client and not expose itself to litigation. If you have any questions about the interpretation of the rule or how you might want to change your own practices, please contact our office.