Categories
Anti-Money Laundering

Reports of Accounts with Foreign Financial Institutions (FBAR)

The FBAR or FinCEN 114

With the increase in global reach of brokerage firms today, it is more and more likely that a FINRA registered broker-dealer may open an account with a foreign financial institution. These accounts can take the form of a bank account, brokerage account, mutual fund, trust, an insurance policy with cash value or another foreign financial account. And while the requirement applies to individuals as well as businesses, the focus of this discussion will be on broker-dealers. This requirement is primarily to alert the IRS to the fact that such an account exists, and largely relates to abuses relating to hiding income or assets.

Broker-dealers operating in the United States are subject to a complex set of regulations related to the Bank Secrecy Act (“BSA”), Office of Foreign Assets Control (“OFAC”), and others that generally fall under the category of Anti-Money Laundering (“AML”) compliance programs. As such, each broker-dealer is required to designate an AML Compliance Officer and to have AML compliance procedures which are approved in writing by a senior member of management of the broker-dealer. FINRA Rule 3310 outlines the requirements related to AML compliance. It requires, among other things, that each broker-dealer conduct an independent test of its AML compliance program.

Each FINRA broker-dealer must develop procedures to ensure compliance with the BSA. It is here that we find the requirement for broker-dealers to make reports of foreign financial accounts. Specifically, 31 C. F. R Section 1010.350 requires each US person (which includes broker-dealers) having a “financial interest in, or signature or other authority over, a bank, securities, or other financial account in a foreign country” to report that fact, along with other information, to the IRS. There are special provisions for those who have an interest in 25 or more accounts but we won’t discuss that here.

Must a Broker-Dealer File?

A broker-dealer must file an FBAR if it had a financial interest in or signature authority over at least one financial account located outside the US and the aggregate value of all foreign financial accounts exceeded $10,000 at any time during the calendar year.
When is Filing Required?

When the requirements above are triggered in any calendar year, the Report of Foreign Bank and Financial Accounts (“FBAR”) must be filed no later than June 30 of the year following the calendar year being reported. For example, if an account is opened and meets the aggregate value requirements in October of 2014, the filing must be made by June 30, 2015. The actual FBAR report must now be filed through the FinCEN BSA E-Filing System. The report, which is now called FinCEN Report 114, has replaced form TD F 90-22.1.

What are the Penalties for Late or Non-Filing?

If you are required to file the FBAR and do not properly file it, or fail to file it, you may be subject to a civil penalty of up to $10,000 per instance, assuming the violations are non-willful and not due to reasonable cause. However, if the violation is found to be willful, the penalty could be the greater of $100,000 or half the balance in the account at the time of the violation – for each instance. So clearly, this requirement is one that broker-dealers should ensure that their procedures address and that they cover in their training programs.

Compliance with the BSA/AML requirements is complex and is not to be taken lightly. Mitch Atkins, FINRA’s former South Region Director, has extensive experience in AML compliance and AML independent testing. Contact FirstMark Regulatory Solutions at 561-948-6511 and speak with its principal, Mitch Atkins, for more information.

Categories
FINRA Rules

Should I Tell the Regulators?

One question that comes up in the world of broker-dealer consulting is when and what to tell a regulator. This issue can arise in the context of a regulatory examination, responding to a regulatory inquiry, determining whether to self-report, or even in a FINRA OTR.

It is important to understand the context of the request in determining how to properly respond to a FINRA inquiry. First and foremost, a broker-dealer or registered representative should understand that FINRA’s Rule 8210 requires that its members and associated persons of members provide responses that are truthful and complete. And failure to do so can result in serious sanctions, including a lifetime from the securities industry. It is also important to understand that certain items require reporting whether or not FINRA has specifically asked for the information. For example, Rule 4530 requires reporting of certain complaint information and information about internal conclusions that broker-dealers may have made.

FINRA has also said that it will provide credit to firms who self-report or otherwise demonstrate extraordinary cooperation. For more information on this, see Regulatory Notice 08-70.

There are many things that are required by FINRA Rules to be reported. There are other things that are not specifically required to be reported, but probably should be. And then there are times when a response should simply answer the direct questions being asked by a regulator. Knowing the proper approach to preparing a regulatory response is critically important on many levels. If you have received a FINRA Rule 8210 letter, a request to appear for a FINRA OTR, or if you just have an issue that may need to be reported, make sure you contact a professional with extensive experience in addressing FINRA reporting requirements.

Mitch Atkins, FINRA’s former SVP and Regional Director is experienced in assessing FINRA regulatory inquiries and “FINRA Rule 8210 letters.” For help with your regulatory responses or a regulatory investigation, contact Mr. Atkins who is now Principal at FirstMark Regulatory Solutions in Boca Raton, Florida at 561-948-6511. Mr. Atkins is not an attorney and FirstMark Regulatory Solutions is not a law firm. Neither Mr. Atkins nor FirstMark Regulatory Solutions provide legal services.

Categories
Broker-Dealer Information

Regulation S-P and the Closure of a Broker-Dealer

One of the many challenges involved in closing down a broker-dealer is ensuring the security and privacy of customer data. There have been some very public instances in which broker-dealers have done this incorrectly and as a result, regulatory sanctions were imposed, in some cases against individuals. And regulatory bodies have shown that they are willing to take these cases, even if most of these cases are relatively small in the scope of all that they handle. This is because regulators take customer privacy very seriously, and they consider breaches, however small, to be serious.

The requirements related to this area are spelled out in Regulation S-P. And Rule 30 of that regulation includes requirements related to safeguarding and disposal of customer records. Regulation SP requires that broker-dealers deliver a notice of its privacy policy upon the opening of an account, and annually thereafter. These notices should contain a policy statement regarding what data the firm collections, how it uses that data and how it protect the data. If broker-dealers share information with certain third parties they must include an appropriate notice in the document along with an opt-out provision in the event that customers desire to opt-out of the broker-dealer sharing of their information. This opt-out provision is particularly important for firms that operate in the independent channel, as they typically allow departing representatives to take customer data with them upon departure. When a broker-dealer closes, the provision of customer information to third parties must be compliant with these provisions of Regulation SP. Also, the form of the opt-out notice is specified in the rule. For example, simply including an address to which the customer should write is not acceptable.

Finally, when a broker-dealer closes, there will invariably be customer data (electronically stored and in paper format) which will at some point require either transfer, storage and/or disposal. Any records that contain customer information (account numbers, account holdings, dates of birth, etc.) must be disposed of properly. And broker-dealers cannot transfer this information to other firms without first having provided the requisite privacy notice with the opt-out provision (and giving clients 30 days to opt-out before the transfer). Disposal of records should be by secure means and should not violate records retention rules spelled out in SEA Rule 17a-4. Also, there are many places one might not expect to find customer information, such as the hard drives now included with most copy machines. Finally, there are requirements related to storage of records and the appointment of a custodian of records when a broker-dealer closes. The custodian must be registered with the firm at the time of the filing of Form BDW.

Mitch Atkins, FINRA’s former SVP and Regional Director has extensive experience in Regulation S-P compliance and customer information protection.

For help with your data protection and Regulation SP compliance, contact Mr. Atkins at FirstMark Regulatory Solutions in Boca Raton, Florida at 561-948-6511.

Categories
Broker-Dealer Information

FINRA Broker-Dealer Cyber Security Matters

FINRA broker-dealers operate in one of the industries most frequently targeted by cyber criminals. In 2014 alone, there were numerous instances of highly-publicized cyber security and data breaches. And being a victim of these types of breaches comes with the added embarrassment of the negative press that invariably follows.SEC Chair Mary Jo White in a speech earlier this year said about Cyber threats,

“This is a global threat.  Cyber threats are of extraordinary and long-term seriousness.  They are first on the Division of Intelligence’s list of global threats, even surpassing terrorism. And [the] director of the FBI, has testified that resources devoted to cyber-based threats are expected “to eclipse” resources devoted to terrorism.”

Fortunately, there is a significant amount of information available to broker-dealers that can help to ensure they are reasonably compliant with industry standards. FirstMark Regulatory Solutions conducts risk assessments in the area of cyber security and provides recommendations to broker-dealers that help to ensure compliance with industry requirements. Every broker-dealer has an obligation to protect customer information which is spelled out in the safeguarding standards of Regulation SP.

“…the policy of the Congress that each financial institution has an affirmative and continuing obligation to respect the privacy of its customers and to protect the security and confidentiality of those customers’ nonpublic personal information.” – Gramm-Leach Bliley Act

Also, broker-dealers are required under FINRA’s supervision rule to have procedures that are reasonably designed to achieve compliance with rules applicable to each area of the firm’s business. Customer information protection is one of those areas.  

FirstMark advises clients on cyber security and customer data breach issues. With the former, security enhancements can include simple items such as restricting access to certain devices and technologies which can facilitate rapid transfer of large amounts of data (e.g. high speed data ports, copiers connected to the internet, portable media devices, etc.) to sophisticated penetration testing on a broker-dealer’s network. With the latter (data breaches), it is important to remember that many states have very significant penalties for failure to notify clients that their data has been compromised. For example, Florida implemented one of the toughest laws in the nation on July 1, 2014. An unreported breach could yield up to a $500,000 fine.

It is critical that broker-dealers are aware of these requirements and have procedures in place that are sufficient to address the risks inherent it their businesses. FINRA and the SEC have been conducting cyber-security sweep exams in 2014, and have indicated they will continue to do so going forward. For small firms, FINRA has created an excellent resource on cyber security that can be found here.

Mitch Atkins, FINRA’s former SVP and Regional Director has extensive experience in cyber security compliance and customer information protection. For help with your cyber security compliance, contact Mr. Atkins at FirstMark Regulatory Solutions in Boca Raton, Florida at 561-948-6511.

Categories
FINRA Rules

A New Approach to Branch Office Inspections

There has been quite a bit of recent news about FINRA’s revisions to its Supervision Rule. The details are spelled out in FINRA Regulatory Notice 14-10. Updates to the rule became effective on December 1, 2014. Since there are numerous articles already written on the FINRA Notice, the key focus of this discussion is the requirement to inspect branch offices. This requirement remains largely unchanged, other than the elimination of the producing branch manager requirements (replaced with identifying and managing conflicts). Taking a look back over the last several years, it is clear that the direction FINRA is moving on its expectations of its members’ branch inspection programs is similar to what it is doing with its own examination program – going risk-based.

If your firm is still conducting branch office examinations based simply on the time since the last review and whether or not the location is an OSJ, it may be time to revisit the design of the program. Simply put, a risk-based program employs the use of data to essentially risk-rank the branch offices (and representatives working in them). This may involve assigning a risk score to the representative and/or the branch office. To develop this risk score, firms consider all available data on the branch and its representatives including: complaints, disclosures, regulatory inquiries, production, outside business, and product mix to name just a few. Once a firm has identified its risk factors and compiled risk scores for each office/representative it may then tailor its branch program to those risks.

An effective risk-based branch inspection program will use the risk scores to drive both the frequency and intensity of the inspection. For example, a higher risk score may result in a more frequent (or even unannounced) visit to the branch. A risk score heavily weighted by outside business activities may drive in-depth reviews from the home office or by outside due diligence providers. And clearly, there are some risks that do not lend themselves to scoring – many have seen events that the information the firm maintains did not predict. For those, an element of randomness in the reviews is warranted as well.

A risk-based approach can yield benefits in terms of maximizing the yield of the branch inspection program. Broker-dealers will want to direct their limited resources to the places where they are most needed. Effective use of data can accomplish this. And both FINRA and the SEC have stated that they expect firms to conduct risk assessments to drive the frequency, intensity and focus of branch examinations. For more information on their views, see Joint SEC/FINRA National Examination Risk Alert – November 30, 2011 and FINRA Regulatory Notice 11-54

If you have questions about developing a risk-based branch inspection program, Mitch Atkins, FINRA’s former South Region Director has extensive experience in this area. Mitch Atkins, Principal at FirstMark Regulatory Solutions, can be reached by calling 561-948-6511.

Categories
FINRA Rules

On-the-Record Testimony

FINRA’s Rule 8210 is one of its most powerful investigative tools. It permits FINRA, in connection with an examination or investigation, to request documents and information. Sometimes, instead of a letter requesting information, FINRA asks for an appearance before a court reporter. If you have received a notice from FINRA requesting that you appear for on-the-record testimony (or an “OTR”), this is one letter you must take seriously. FINRA uses the OTR to conduct investigative testimony. Rule 8210 gives FINRA the authority to compel persons subject to its jurisdiction (generally persons associated with a FINRA registered broker-dealer) to appear before a court reporter and provide sworn testimony.

Most of the time, these OTRs are conducted at a FINRA district office. However, FINRA sometimes makes exceptions, depending on the circumstances of the proposed witness. One of the common exceptions occurs when a witness who is not near a FINRA district office requests that FINRA travel to his or her location due to a medical or financial hardship. FINRA does not always grant these requests, but if this is your situation, it is worth a try. Remember, FINRA may request evidence of your hardship. FINRA may also be flexible about the specific date of the OTR, depending on the urgency of the investigation. Either way, make sure you act promptly upon receiving a notice. Failure to appear for an OTR, absent exceptional circumstances, will likely result in a bar from the industry.

FINRA usually has several participants in an OTR. Generally, a FINRA attorney is present along with one or more staff members. As a witness you are permitted to bring an attorney as well. However, FINRA does not permit the participation of others (such as a compliance officer, a friend or a coworker). FINRA requires that anyone participating in an OTR with a witness be an attorney representing that witness.

Generally, an OTR lasts one or two days, depending on the complexity and volume of issues being discussed. FINRA may or may not give a witness much detail about what will be discussed, but they will usually give a very general outline.

An OTR starts with a court reporter swearing in the witness. Then FINRA reads a statement of instructions and begins asking a series of questions about whatever issue they are investigating. FINRA’s authority under Rule 8210 grants them the ability to specify the conditions under which the OTR will be taken, and that includes the prohibition of the use of recording devices by the witness. FINRA will generally make the transcript of the OTR available to the witness, either for review at the FINRA district office, or for purchase directly from the court reporting service.

FINRA’s OTRs are often utilized when the nature of the inquiry does not lend itself to a standard inquiry letter. For example, during an OTR, FINRA may present an exhibit to the witness and ask the witness questions about the exhibit. Document intensive questioning generally is not well suited to letter writing.

If you have been notified by FINRA that you are being requested to appear for an OTR, it is important that you take the request seriously and that you act immediately. Your first step should be to consider hiring an attorney who is experienced in representing clients in FINRA OTRs. Further, depending on the issues at hand, you may want to hire an experienced consultant to assist with the issues surrounding the investigation.

Mitch Atkins, FINRA’s former SVP and Regional Director has extensive experience as a consultant working with complex FINRA investigations. Contact him at FirstMark Regulatory Solutions in Boca Raton, Florida at 561-948-6511.

Mr. Atkins is not an attorney and does not provide legal services.

Categories
Variable Annuities

A New Twist on Variable Product Suitability

Mitch Atkins, FINRA’s former South Region Director who is now Principal of FirstMark Regulatory Solutions, recently had the opportunity to participate on a panel at FINRA’s South Region Compliance Seminar. The panel, which also included a member-firm representative and two FINRA representatives covered the topic of suitability, and focused in particular on two products, non-traded REITs and L-Share Variable Annuities.

The FINRA panelists expressed concern regarding what they are seeing as improper or unsuitable sales of L-Share classes of variable annuities. Several issues of note mentioned by the FINRA panelists included the time horizon of the customer and the fee structure of the product. Before we get into that here, a primer on L-Shares may be worthwhile.

L-Shares, like any other share class, are designed with a specific purpose in mind. First, an L-Share typically has a surrender period of 3 to 5 years, compared to a typical B-Share variable annuity which has a surrender period of 7 years. Typically, deferred sales charge variable annuities have a declining surrender charge. In the instance of a B-Share, this surrender fee schedule might be: 7%, 7%, 6%, 5%, 4%, 3%, 2%, 0%. Meaning if the product is surrendered in year one, the fee is 7%, year two, the fee is 7%, year three, the fee is 6% and so on. But in an L-Share situation, the surrender fee schedule looks more like this: 8%, 7%, 6%, 5%, 0%. So clearly the L-Share recoups a higher percentage if surrendered earlier. In exchange for this early termination of the surrender period, the products have higher M&E fees (Mortality and Expense). For example, a typical B-Share may have an ongoing M&E expense of 1.25% which is charged to the contract holder each year. However in a typical L-Share product, this ongoing fee is 1.65%. As a result, the higher ongoing fees over time can be substantial.

The FINRA staff’s point in this scenario is that broker-dealers and their associated persons must have a reasonable basis to believe that a recommended transaction in a variable annuity is suitable for a customer based on the information obtained from that customer about their investment profile. If a customer has a long term time horizon, an L-Share may not be the most appropriate share class to recommend.

Here are several key points were made during the presentation about monitoring transactions in L-Share variable annuities. First, broker-dealers must conduct an effective due diligence process such that they understand the products being sold, as well as the features of those products and for which of their clients that product may be appropriate. Second, broker-dealers must have written procedures that are designed to address the specific features of the products they sell, including in this instance, L-Shares. Some broker-dealers do not have specific procedures addressing these products. Third, firm training programs must address the unique features of these products, and that also means training the principals reviewing the transactions, not just the representatives selling them. Fourth, firms are required to monitor the sales of the product and the riders selected. In some instances, long-term riders are inappropriately being recommended with the shorter-term L-Share. Finally, questions regarding the suitability of the product should be confirmed directly with the customer when appropriate.

Broker-dealers should ensure that their supervisory systems are adequate to match customer time horizons with recommendations in L-Shares. These share class issues are not new. However, just like the days of the A vs. B share mutual fund, FINRA is now seeing issues with variable annuity share classes. As with any other recommendation, documenting the rationale for the recommendation is a critical aspect of a good recordkeeping system.

If you have questions regarding this aspect of suitability or any other issue, contact Mitch Atkins, Principal of FirstMark Regulatory Solutions at 561-948-6511.

Categories
FINRA Product Focus

FINRA Product Focus

Non-Traded REITS

Non-Traded REITS have been the subject of quite a bit of controversy over the past few years, not the least of which has been the recent announcement by one large organization about accounting concerns. In recent years, FINRA has focused both its examination and rule making resources on the sellers of these products. Earlier this year, FINRA announced significant enforcement actions against two large sellers of non-traded REIT products. Additionally, FINRA has proposed changes to the requirements affecting how positions in non-traded REITS are valued on customer statements. Mitch Atkins, FINRA’s former South Region Director, has extensive experience with the compliance issues that are unique to these products. Here, he discusses some of the key issues he has observed both as a regulator and a consultant to broker-dealers.
Non-Traded REITS are not inherently bad products. Unfortunately, there are some sellers of the products that have recommended the products to clients who, under FINRA rules, were unsuitable purchasers. Further, there have been instances in which sellers have misrepresented the products in their advertising and sales literature, or in direct communications with clients. This may have prompted FINRA to conduct its spot-check of non-traded REIT advertising and to issue a Regulatory Notice addressing the issue of REIT advertising.
Whatever the issue, it seems that sales of these products is continuing to grow, with many broker-dealers seeing significant increases in revenues over the last few years. This has a lot to do with the current market environment, interest rates and customer desire for higher returns.
There are several practices which seem to make a difference in the success or failure of a non-traded REIT compliance program. The first is an effective due diligence approach. Prior to permitting the sale of a non-traded REIT product, broker-dealers should conduct thorough due diligence. And following approval, ongoing due diligence is a must. Material events that could change the initial due diligence decision should be addressed by the broker-dealer and appropriate actions taken. The second key to an effective non-traded REIT compliance program is a supervisory system covering the suitability of sales of the product to customers. Most firms (and states for that matter) limit the amount of a client’s liquid net worth that may be invested in non-traded REITs. This threshold varies, as does the suitability standard imposed by each state on a particular product. But generally, firms and states limit the percentage of a client’s liquid net worth that may be invested in a single non-traded REIT to 10 percent.

An effective suitability review process is critical to preventing inappropriate sales to clients. The third key to compliance when selling these products is a thorough and effective advertising and sales literature review process. A simple review of the recent FINRA disciplinary actions yields plenty of information on what not to do in this space. The most important of which seems to be adequacy of disclosure and taking care not to misrepresent the illiquidity of the product. Finally, an effective training program for these products is a must. Many broker-dealers require their salespersons to complete an online training module for each product sold as well as general modules about the features of non-traded REITs. These online modules are easy to administer and cost-effective. It is important to note that broker-dealers must also train the principals who are responsible for supervising the sales staff in the features of the products it sells.

Mitch Atkins, FINRA’s former Senior Vice President and Regional Director, has extensive experience in non-traded REIT compliance. To speak with Mitch Atkins, call FirstMark Regulatory Solutions at 561-948-6511.