Securities Law Blog

The Financial Industry Regulatory Authority (FINRA) recently released a regulatory notice to remind firms of their responsibilities when dealing with deferred variable annuities. FINRA outlines several steps that ought to be taken in order to ensure customer suitability when buying deferred variable annuities and compliance measures that can be set up by the firm.

The recommendation requirements state that:

*No recommendation of the purchase or exchange of a deferred variable annuity shall be made unless a member or person associated with a member has reasonable basis to believe that the customer has been informed of various features of deferred variable annuities, and that the customer would benefit from certain features of deferred variable annuities.

*Prior to recommending the purchase, the associated person must research the customer’s background and needs. Such fields should include but are not limited to age, income, financial situation, investment experience/objectives, assets and risk tolerance.

*After receiving necessary information, the application should be submitted to the firm’s office of supervisory jurisdiction (OSJ).

*A registered principal shall review and determine whether he/she approves the recommended purchase or exchange of the deferred variable annuities prior to submitting to the insurance company.

*Each suitability determination should be documented and signed by the person recommending, approving or rejecting the transaction.

FINRA also reminds firms that it is their responsibility to establish and maintain specific supervisory procedures reasonably designed to achieve compliance. Surveillance procedures should be implemented to prevent inappropriate exchanges and corrective measures should be in place to deal with inappropriate conduct.

Training policies or programs should be developed and documented to ensure that persons who effect and those who review transactions dealing with deferred variable annuities comply with the requirements of this Rule and understand material features of deferred variable annuities.

Since the boom of investment fraud uncovered during the financial crisis, lawmakers and state securities regulators are attempting to assume oversight of many investment advisers currently under the supervision of the Securities and Exchange Commission (SEC).

According to the testimony given by Texas Securities Commissioner and the North American Securities Administrators Association (NASAA) President Denise Voigt Crawford, “As the regulators closest to the investors, state securities regulators provide an indispensable layer of protection for Main Street investors.”

Crawford was one of many industry leaders to testify before the U.S. Financial Crisis Inquiry Commission (FCIC) during its first round of hearings in January 2010. The FCIC is a 10-member bipartisan panel established to examine the cause of the financial crisis with the intention of producing a report offering recommendations to prevent a reoccurrence.

The financial regulation proposals in Congress could bring about 4,000 advisers who manage between $25 million and $100 million in assets under the supervision of state regulators, according to NASAA. Currently the SEC says it inspects from 9% to 12% of the 11,000 advisory firms it oversees. Allowing each state to oversee anywhere up to around 600 additional advisers, as would be the case in California, would lead to more frequent examinations. State regulators are in the process of generating a mutual agreement to cooperate with one another in policing additional advisers if the proposal passes.

“Our presence did not contribute to the crisis; rather, the fact that our regulatory and enforcement roles have been eroded was a significant factor in the severity of the financial meltdown,” testified Crawford.

Since the passage of the National Securities Markets Improvement Act of 1996 (NSMIA), the responsibility of enforcement shifted from state to federal government. Now the states are fighting to get it back.

The NASAA President offered a series of recommendations to improve the ability of state regulators to pursue financial fraud. A few of these recommendations include: restoring state regulatory oversight of all Regulation D Rule 506 offerings; increasing state regulation of investment advisers; reexamining and removing the hurdles facing securities plaintiffs in private actions; and providing additional resources to uncover and prosecute securities fraud cases.

Robert Khuzami is making big moves in his first year at the helm of the Securities and Exchange Commission (SEC)’s enforcement division. The director has helped to lead the largest overhaul of the SEC in the last thirty years. Trying to move on from the SEC’s devastating missteps surrounding the Madoff scam, the changes in the enforcement division will seek to stop financial criminals in their tracks.

Khuzami’s new “whistle-blower initiative” aims to catch crooks before they have caused too much damage. The initiative is directed at individuals involved in perpetrating the scams. For those who participate in fraudulent schemes but now wish to turn in their co-conspirators, the SEC is offering escalated levels of protection. The whistle-blower’s help will be taken into consideration when taking enforcement action in what the SEC is calling “cooperation agreements.” These agreements could exempt the whistle-blower from SEC suits and provide legal help if the U.S. Department of Justice were to launch its own criminal case.

Another part of Khuzami’s revitalization efforts include pushing for legislation to add whistle-blower payments and protections to U.S. securities laws. The proposed legislation would offer big economic incentives for securities tattletales. If passed into law, an individual who provided crucial information that led to the capture of a felon could collect an award worth up to 30% of the amount regulators later recover from the scam.

According to Khuzami, having an insider will make uncovering the well-hidden tracks of white-collar criminals much easier.

“People who engage in a lot of white-collar crimes are often planning their defense at the same time as they are planning their offense,” Khuzami said.

The SEC restructuring comes after one of the worst years for securities fraud. According to “Select SEC and Market Data 2009”, the SEC:

*Obtained orders in SEC judicial and administrative proceedings requiring securities violators to disgorge illegal profits of approximately $2.09 billion and to pay penalties of approximately $345 million.

*Sought emergency relief from federal courts in the form of temporary restraining orders to halt ongoing fraudulent conduct in 71 actions, and sought asset freezes in 82 actions.

*In SEC-related criminal cases, prosecutors filed indictments, informations, or contempts in the 2009 fiscal year in 154 cases.

The regulatory agency has never before caught as many crooks or ordered as much money returned to investors. The numbers also reflect that millions of investors lost billions of dollars before the crooks were caught, and will be lucky to recover what little they can.

What could derail the SEC and Khuzami’s entire initiative? The current federal prison sentence being served by former international banker, Bradley Birkenfeld. Birkenfeld turned in his bosses at Swiss banking agent UBS, leading to one of the largest IRS settlements in history. Supporters of Birkenfeld are seeking a pardon for him as a reward for his cooperation with the government. Despite his cooperation, the Justice Department sought prison time for Birkenfeld, saying he turned in his superiors but did not disclose his own role in helping one of his clients.

Although Khuzami had no role in the Birkenfeld case, the SEC could face problems in launching a successful whistle-blower program while one whistle-blower is sitting in federal prison.

In an effort to create more clarity for financial services firms surrounding the use of social media networks, the Financial Industry Regulatory Authority (FINRA) released a Regulatory Notice on January 25, 2010 entitled “Guidance on Blogs and Social Networking Web Sites”.

While the industry regulator does not codify any direct actions that need to be taken by financial firms, they do make several suggestions that could protect a firm’s liability when communicating over the internet. Organized in a Question and Answer format, FINRA sheds light on potential compliance issues and offers possible policies and procedures that firms could adapt in order to deal with supervisory and recordkeeping responsibilities.

The main message for firms throughout the Notice seems to be, if you plan on using it, you better be able to supervise it, we don’t care how or what you use to do it but it better be done and it better be done right.

Some key points in the Notice:

*If a firm communicates or allows its employees to communicate through social media sites, it is the firm’s responsibility to keep records of communications that relate to “business as such”. Firms need to ensure that associated personnel using social media sites for business purposes are adequately supervised, have necessary training in such activities, and do not present undue risk to investors.

*Requirements set forth by Federal securities laws and FINRA rules may be triggered when registered representative’s communications include recommending specific investment products. Additional disclosures should be made available to the customer to prevent any skepticism that a firm’s associate was misleading in anyway. FINRA suggests that firms should prohibit all interactive electronic communications that recommend a specific product unless a registered principal has previously approved the content.

*For static information, which could include profile, background or wall information, on social networking sites that are established by the firm or a registered representative, a registered principal of the firm must approve all information before it is posted. It is advised that these approvals also be documented.

*For interactive electronic communication, it is not required to have a registered principal’s approval, but it still must be supervised by the firm. FINRA suggests that firms adopt supervisory procedures similar to those used for electronic correspondence. It is up to the firm to develop policies that address communication liability and ensure that they are “reasonably designed to ensure that interactive electronic communications do not violate FINRA or SEC rules”.

*It is also the firm’s responsibility to prohibit personnel from engaging in business communication on social media sites that are not subject to firm’s supervision, and to take disciplinary action if firm policies are violated.

The overall goal of the Notice is to protect investors from misleading representations and allow firms to take part in the benefits of social media while effectively and appropriately supervising their associated persons’ involvement with these sites.

The collapse of Bernard Madoff’s estimated $65 billion dollar Ponzi scheme in 2008, was the precursor to the “Year of the Ponzi” in 2009. Defrauded investors saw an estimated $16.5 billion dollars disappear as more than 150 pyramid schemes unraveled, according to the Associated Press analysis of scams in all fifty states. Madoff’s very public decline brought a heightened public awareness and increased scrutiny to Ponzi schemes. But he wasn’t the only securities fraudster who made headlines.

Following the breakdown of Ponzi schemes nationwide, there was a drastic increase in federal securities fraud investigations opened in 2009. The FBI alone increased its securities fraud investigations by 1,750 from 2008. The Securities and Exchange Commission (SEC)’s Ponzi scheme investigations now make up 21 percent of the SEC’s enforcement workload. The Commodity Futures Trading Commission more than doubled its amount of civil actions in Ponzi cases this past year.

In its continuing effort to avoid being burned by another major Ponzi scheme, the SEC is developing new investigative units to improve its enforcement. A major focus will be to encourage companies and individuals to cooperate more closely in providing information, and to better analyze tips and complaints the SEC receives. The cooperation efforts will include similar incentives that have been used by the Justice Department in its criminal investigations. Included in these incentives will be written cooperation agreements under which SEC attorneys recommend leniency for parties providing information in their proposals to the SEC commissioners.

With the surge of federal fraud investigations in 2009 and those that date back to the credit crisis in 2007, an increase in federal prosecutions of financial crimes is expected to follow in 2010.