Securities Regulation and Litigation Lawyer & Attorney : OverRegd Blog : Lindquist & Vennum Law Firm, Minneapolis and Denver

There is a long-perceived natural tension that exists between the challenging goals of revenue production, adherence to compliance and effectively serving the customer's interests. These competing forces do not necessarily have to be in conflict. Well-run organizations and dedicated sales staffs find the correct balance, identifying proper products for the appropriate customer and generating fair returns for all of the participants to the transaction—the firm, the broker and the customer.

It is only when a party's interests are diverted from this path that problems arise. Unfortunately, there have been occasions when a broker/dealer or registered representative wandered off the path of righteousness and pursued a personal agenda to the detriment of the customer. These problems may arise as a consequence of the sales of proprietary products, such as mutual funds, annuities and private placements, or distributions in which the firm is an underwriter. Improper activities have led to regulatory sanctions against firms for tying special incentives, such as trips, cash and goods to sales of the firm's proprietary products when non proprietary products were as good, if not better and cheaper, than the product touted by the firm and the sales personnel. Sanctions have also been made against individual reps for violations of the “Know Your Customer” rule.

It will generally not suffice for  a broker  to assert that she was just following orders when she sold what is an allegedly unsuitable investment to the customer. That defense hasn't worked before NASD arbitration panels in the past, and it will probably not work in the future, either.

The customer's interests must be paramount. That much we can all agree on. Clearly, if the product were inferior, the broker would not sell it, and if she were hounded by management to sell it anyway, she  would leave the firm. But let's proceed on the assumption that the product that the firm seeks to market is not defective in some sense. Rather, let's assume for the purposes of this discussion that the firm's product provides features, rates of return and fees and costs comparable to the competition.

If the product is truly competitive as an investment, all things being equal, there may be strong reasons why a proprietary product would best serve the interests of a customer, as well as the collective interests of the firm and broker. First, if the firm is sponsoring the product, it is expected to have an in-depth familiarity with the product and a reasonable expectation regarding how it will react to various market conditions. Since the firm stands behind the product, it will be motivated to provide a ready and stable market for it and to maintain its competitive position by dint of performance and fees. Second, unless the account is “overloaded” with any one company's products—especially products that would make the account illiquid or subject to high surrender costs—or is not properly diversified by sector, then there is no reason to avoid proprietary product. A broker who is meeting his or her duty to the customer will have offered the customer various alternatives, including the proprietary product, and can justify the recommendations made. Then, it's up to the customer to decide. The firm would be on very thin ice legally if it were found to have “intimidated” its brokers into pushing its product over another that was better or, worse, retaliated against a broker for acting on her conscience.

It might be advisable for a broker to put in writing the basis for your recommendations. Contemporaneous notes may act as an insurance policy, reflecting why a particular recommendation was made at an earlier time. This document may be valuable in the event the broker gets into a scuffle with the firm regarding her “loyalty” or subsequently, with an aggrieved customer, who attacks the recommendation because he was sold a proprietary product that failed to perform to expectations.

In the end, go with your instincts. It's your license and reputation that are at stake. Once they're tarnished, they're hard to restore. If the product isn't right for the customer, don't sell it.

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One of the endless frustrations experienced in working through the Byzantine auspices of the NASD-DR is the marked reluctance of the organization to actually exercise its powers, and render a decision on procedural issues pertaining to claims in arbitration. These types of issues seem to arise with increased frequency, and may require the staff of the NASD-DR to actually enforce and uphold the Code of Arbitration Procedures. Yet, with extraordinary regularity and deftness, the staff avoid making a decision, even if the outcome would appear to be pre-ordained by the underlying rules relating to arbitration. Rather than enforce these rules, however, we hear the refrain “we will refer it to the panel for consideration,” even if to do so eviscerates the underlying motion and renders it meaningless or, worse, creates the potential for arbitrator hostility towards a party. Why is the staff so religiously reluctant to take a position? What can we do about it?

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So, how does a producer or a firm get a fair hearing when charges are brought against him/her or it by a state securities or insurance regulator? Based on the process by which state administrative actions are initiated, heard, and reviewed upon appeal, it's an uphill climb, and the incline is very steep.

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SRO Trends

The "Rogues" Report is intended to provide a roadmap for identifying "topical" or novel regulatory causes of action and the remedial measures that one may expect an SRO to impose when activity is found by the staff to be irregular or improper.

Still another emerging trend in regulatory circles for rule violations is the requirement that a firm retain an independent consultant to either create appropriate procedures or, alternatively, assess and evaluate remedial written supervisory measures adopted by the firm as a consequence of adverse regulatory findings against the firm.

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SRO Trends

Another noticeable trend in SRO administrative proceedings appears to be the size of the financial penalties imposed for technical, trade reporting violations. In the past, these fines, frequently imposed for violating OATs or TRACE reporting requirements, or late ACT transmissions, were viewed as, in essence, "parking tickets." The fines were generally in the range of $500-1,000, depending on the number of violations, and, historically, these fines were viewed by the industry as a cost of doing business. Now, the cost of business has gotten expensive, as fines seem to start at $10,000 and go up from there. And, these fines are not just being imposed against the little guys. A number of large, well-entrenched, and sophisticated firms with sophisticated trade oversight mechanisms in place to prevent, detect and avoid violations, have fallen on their swords, and resolved such SRO actions for large five figure, and in some instances, large six and seven, figure amounts. These include Allen & Co., Cantor Fitzgerald, E*Trade, Scottrade, UBS, and other industry stalwarts.

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SRO Trends

Unfortunately, one of the principal mechanisms used by the SROs to alert the industry to conduct that is or may be contrary to regulatory rule and regulation is through the initiation of administrative proceedings against a firm and/or associated persons. These proceedings frequently serve as harbingers to establish precedence with regard to the imposition of sanctions, and they become the standards against which similar conduct by others is judged and punished.

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