FINRA Finds That Investor Literacy is Low

The Financial Industry Regulatory Authority (FINRA) this month released the findings from its National Financial Capability Study. While, in some ways, Americans have increased their financial literacy, too many Americas are lacking in the area. The study concluded that absolute levels of financial literacy are low, and financial literacy is slightly down from 2009 levels. In 2015, only 37% of respondents to the survey answered correctly at least four of five financial literacy questions. Only 31% were offered financial education. The study also suggested that customers of today’s broker-dealers, as a whole, would score higher than the pool of individuals surveyed in connection with the study. In general, broker-dealer customers tend to have greater financial resources, and more access to investor education resources, including those provided by the broker-dealer themselves.

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Frederick Baerenz; AOG Wealth Management

A Financial Industry Regulatory Authority (FINRA) arbitration panel ordered Frederick Baerenz, president and chief executive of AOG Wealth Management, to pay $331,000 in compensatory damages after finding him liable of unsuitable trading. He allegedly misled his clients, failing to tell them about the risks of their direct private placement investments from 2006 until 2008. The couple invested $1.3 million and Baerenz put $941,000 in private placements. Before being affiliated with AOG Wealth Management, Baerenz was affiliated with Pacific West Securities, which closed in 2012.

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WFG Fined for Overcharging Clients in Alternative Investments

The Securities and Exchange Commission (SEC) recently ordered WFG Investments to pay a $100,000 fine for overcharging clients in real estate investment trusts (REIT) investments and business development companies (BDCs). The SEC alleges that these actions took place between January 2011 and August 2013 and that the firm had inadequate policies and procedures in place to prevent and detect the overcharging of its clients. The firm told its clients they would be charged commission but not advisory fees in the purchase of the REITs and BDCs, but the clients were charged for both. It alleged that the clients were overcharged $34,640 in advisory fees, and that they may not have been accurately computed or tested. The firm claimed that it “relied on random account sampling conducted manually by its staff” to monitor billing accuracy.

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FINRA Brings Enforcement Action Against Firms for Wage Garnishments and Reporting Failures

Recently, the Financial Industry Regulatory Authority (FINRA) censured and fined RBC Capital Markets on findings that it failed to amend, or to amend in a timely manner, Forms U4 for registered representatives to report unsatisfied tax liens and civil judgments. The firm allegedly received wage garnishment orders from courts and tax authorities, including the Internal Revenue Service, resulting from tax levies, civil judgments and similar actions for registered representatives. RBC failed to consistently conduct a sufficient inquiry to determine if the underlying event triggering each garnishment order involved an event that should have been reported on the affected individual’s Form U4. It also failed to ensure that it disclosed reportable unsatisfied liens and judgments of registered representatives on Forms U4, when a garnishment notice was sent to the firm, or to make sure its payroll department notified compliance or supervisory personnel to determine if the garnishment involved a reportable event, or that compliance or supervisory personnel acted appropriately to consider garnishments and disclose reportable events as necessary.

FINRA also censured and fined Florida-based Halen Capital Management $100,000 on findings that the firm distributed a private placement memorandum (PPM) for the company that did not comply with FINRA rules governing member firm communications with the public. According to the agency, the firm distributed confusing and misleading offering documents for unregistered common stock offered by a company. FINRA determined that the documents created a substantial risk that investors could be confused or misled; they were not fair and balanced and did not provide a sound basis for evaluating the facts relevant to the company’s securities being offered. Also, FINRA found that the firm participated in the sale of unregistered and nonexempt securities in violation of securities rules.

FINRA also censured and fined New York-based Jefferies LLC $235,000 after it found that, for settlement dates Jan. 15, 2010 through October 14, 2011, the firm reported 112 short interest positions in dually listed foreign securities totaling 8,944,854 shares, when it should have reported 112 short interest positions totaling 55,007,028 shares. According to FINRA, the firm failed to report to its Trade Reporting and Compliance Engine the correct identifier for S1 transactions.

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Scottsdale Capital Advisors Urging Challenge to FINRA Power

Microcap broker-dealer Scottsdale Capital Advisors Corp urged the Fourth Circuit last week to revive their challenge to the Financial Industry Regulatory Authority’s (FINRA) power. Scottsdale is accusing FINRA of taking on a “general police power” to enforce laws outside its congressional mandate. Scottsdale is facing a FINRA proceeding for allegedly selling unregistered microcap securities. This is an infraction that FINRA considers a violation of its own rules for the industry, and also a violation of the Securities Act. Scottsdale is arguing that FINRA has no power to enforce the Securities Act, and that a Maryland federal judge was wrong to say the regulator itself must hear the argument before Scottsdale can sue. FINRA claimed that Scottsdale, and its principals and former President, John Hurry, Timothy DiBlasi and Darrel Cruz liquidated 74 million shares of three penny stocks that were neither registered with the Securities and Exchange Commission (SEC) nor exempt from registration. FINRA then claimed that its brokers then sold them through a Cayman Island broker-dealer controlled by Hurry. This was also against securities rules and regulations.

Scottsdale then sued in Maryland federal court in March, seeking to stop the proceeding by FINRA. The brokerage firm’s argument was that the regulator does not have the authority to enforce the Securities Act law. The firm argued that FINRA can only bring actions under the Exchange Act, while Securities Act claims are under the SEC’s control. U.S. District Judge Deborah K. Chasanow dismissed the suit in April, saying the Exchange Act gives the brokerage ample opportunity to defend itself against the allegations, first with FINRA, then the SEC, then in federal court. Scottsdale then argued that it was their right to have federal court step in, because FINRA had clearly overstepped the bounds of its authority.

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Morgan Stanley Fined $1 Million by SEC for Cybersecurity Enforcement

The Securities and Exchange Commission (SEC) recently forced Morgan Stanley Smith Barney to pay $1 million in a settlement that marked a turning point in the agency’s focus on cybersecurity issues, an area that the agency has proclaimed a top enforcement priority in recent years. The settlement addressed various cybersecurity deficiencies that led to the misappropriation of sensitive data for approximately 730,000 customer accounts. Morgan Stanley violated the “Safeguards Rule.” Adopted in June 2000, the rule requires registered broker-dealers, investment companies and investment advisers to (1) adopt written policies and procedures that address administrative, technical and physical safeguards reasonably designed to insure the security and confidentiality of customer records and information, (2) protect against anticipated threats or hazards to the security or integrity of customer records and information and (3) protect against unauthorized access to or use of customer records or information that could result in substantial harm or inconvenience to any customer.

The SEC found that MSSB failed to implement sufficient safeguards to protect customer information. MSSB lacked reasonably designed and operating authorization modules restricting employee access to only customer data for which the employee had a legitimate business need, failed sufficiently to audit and/or test module effectiveness and did not adequately monitor and analyze employee access to, and use of, information portals. Because of this, a financial advisor, Galen Marsh, was able to access sensitive personally identifiable information relating to the customers of other financial advisors, including their account balances, securities holdings and other personal information. The information he obtained was then offered for sale on at least three sites. This settlement is the first significant enforcement action undertaken by the SEC since it began prodding financial firms to shore up their cybersecurity defenses five years ago.

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FINRA Losses Amount to Minimal Pay Raises for Executives

The Financial Industry Regulatory Authority (FINRA) lost $39.5 million in 2015, down from $129 million in 2014. This resulted in minimal pay increases for the executives at the firm, under one percent, according to its annual report, released Thursday. Chief executive Richard Ketchum made $2.91 million in salary, incentive pay and deferred compensation last year, up 0.7 percent from 2014. Eight FINRA executives pulled in one million or more in total pay last year. Overall, FINRA’s revenues were $992.5 million, down 0.4 percent from 2014. Expenses increased 7.6 percent to $1.04 billion. Total fines decreased year over year to $93.8 million, from $132.6 million.

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Arbitration Filings Up 20% This Year

The market continues to be volatile, but customer and intra-industry complaints filed with the Financial Industry Regulatory Authority (FINRA) through the end of May were up 20% from the 2015 period. 1,050 customer complaints were filed, while 436 were filed between securities firms and employees. The fastest-growing issues cited by customers were fraud, misrepresentation, breach of fiduciary duty, negligence, failure to supervise and omission of fact. Many of these stemmed from the extreme energy and stock market volatility that occurred in the first months of 2016. In the first six weeks of the year, the Dow Jones Industrial Average closed up or down by more than 100 points on all but six days. In the first five months, 269 common stock cases were filed with FINRA arbitrators by customers, up 33%.

Municipal bond, muni bond fund, limited partnerships and Puerto Rico bond fund cases also contributed to the rise in claims in the early part of the year. Puerto Rico has been another big contributor to the claims in the past couple of years. UBS disclosed in quarterly findings that it faces over $1 billion in arbitration claims involving municipal bonds from Puerto Rico. Bank of America Merrill Lynch, Banco Popular and Santander Securities are also battling those customer claims tied to the Puerto Rican bonds. There were 217 municipal bond fund cases filed with FINRA in the first five months, up from 72% from the comparable 2015 period, while cases citing individual municipal bonds were up 41% to 182. Customer claims citing limited partnerships grew 58% this year through June 1st, to 57. Many of these cases can involve more than one issue.

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States Attempt To Shut Down Reg A+: Industry Responds

Earlier this week, the United States Court of Appeals, DC Circuit, denied a case challenging the Securities and Exchange Commission and their rules under Title IV of the JOBS Act, otherwise known as Reg A+. The case was brought by the states of Montana and Massachusetts and rejected Reg A+, which incorrectly removed the state’s ability to require additional disclosure under the exemption. Before, any company utilizing the exemption was required to receive approval from each state where they wanted to open the offer. This was a costly and time-consuming process that forced issuers to use other methods of raising capital, such as Reg D. Under the JOBS Act, Congress mandated the SEC to update and fix the rules. This was part of a larger initiative by the North American Securities Administrators Association (NASAA). Since Reg A+ went into effect, there has been a new interest and activity from smaller companies that view the securities exemption as a viable option to raise capital.

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The Financial Industry Regulatory Authority (FINRA) named Robert W. Cook as its new president and CEO. This will take effect sometime in the second half of this year. Cook with succeed Richard G. Ketchum as CEO. Cook is a partner at the law firm of Cleary Gottlieb Steen & Hamilton. Before joining that firm in 2013, he was director of the division of trading and markets at the Securities and Exchange Commission (SEC). Mr. Ketchum also is chairman of FINRA, and the agency will name a new chairman in the coming months.

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