Eccleston Law

Feb

2014

Due Diligence Risk Alert Issued to Adviser Selecting Alternative Investment

From the Desk of Jim Eccleston at Eccleston Law Offices:

The SEC is concerned with the due diligence process that investment advisors perform when they recommend or place clients’ assets in alternative investments such as hedge funds, private equity funds, or funds of private funds.

The SEC’s alter notes current industry trends and practices, and highlights certain deficiencies in several of the advisory firms examined.

According to the SEC, investment advisors tend to seek information and data directly from the managers of alternative investments, and then use third parties to supplement and validate that information. In addition, they perform additional quantitative analysis and risk assessment of alternative investments and their managers.

Notably, one deficiency is that many investment advisers failed to review their due diligence polices and procedures in their annual review.

Another deficiency is that many investment advisors do not follow their due diligence procedures described in their advisors’ Form ADV.

The attorneys of Eccleston Law Offices represent investors and advisers nationwide in securities and employment matters. Our attorneys draw on a combined experience of nearly 50 years in delivering the highest quality legal services.

Nov

2013

Jim Eccleston: Panel Orders First Command to Pay $1.1M to Former Advisors

From the Desk of Jim Eccleston at Eccleston Law Offices:

A FINRA arbitration panel has ordered First Command Financial Planning (“First Command”) to pay $1.1 million in deferred compensation to a group of eight advisors and staff who left the firm back in May 2012. According to the arbitration award, First Command “switched back to a commissions sales model, hurting their business.” In addition, the panel reprimanded First Command for filing U5 termination forms saying the reps were let go for wrongdoing, and ordered their disciplinary records to be expunged to indicate they left voluntarily. The dispute occurred in 2012, when a branch manager left First Command with his team to form an independent hybrid firm clearing through LPL Financial (“LPL”).

Oct

2013

Jim Eccleston: Non-Solicitation Agreements: What Can You Say Without Crossing the Line?

From the Desk of Jim Eccleston at Eccleston Law:

John Lindsey, a former Edward Jones broker, found himself in hot water after accusations that he violated his non-solicitation agreement. In March 2012, Mr. Lindsey left Edward Jones to go independent, taking with him about half his clients. In response, Edward Jones promptly filed a request for an injunction and temporary restraining order. Edward Jones claimed Mr. Lindsey had violated his one-year non-solicitation agreement by misappropriating client information and wrongly soliciting clients. Specifically, Edward Jones’ non-solicitation agreement prohibits an advisor from soliciting clients of the firm for one year after the advisor’s departure.

In May 2012, the Ventura County Superior Court in Ventura, California granted the injunction, upholding Edward Jones’ non-solicitation agreement. However, Judge Tari Cody’s also found that nothing in that agreement prohibited Mr. Lindsey from servicing Edward Jones clients who reached out to him directly. Subsequent to the ruling, Edward Jones asked a FINRA arbitration panel to make the injunction permanent and requested $5 million in compensatory damages. Both of those requests were denied.

The arbitrators’ decision reaffirmed previous guidance given by FINRA’s predecessor, the National Association of Securities Dealers, which had issued a notice stating “that obtaining temporary restraining orders to prevent customers from following a registered representative to a different firm may be similar to the unfair practice of delaying transfers” of clients to a new advisor.

FINRA’s position has been that firms cannot do anything to stop clients from going to a broker of their choice. The court’s ruling reflects a similar position, stating that “[n]othing herein [the non-solicitation agreement] shall prohibit [Mr. Lindsey] or anyone else from: (a) continuing to provide services to [Mr. Lindsey’s] clients who have already moved business away from Edward Jones; (b) providing services to persons who have indicated that they wish to transfer their accounts from Edward Jones to permit [Mr. Lindsey] to continue as their financial advisor.”

The attorneys of Eccleston Law represent investors and advisers nationwide in securities and employment matters. Our attorneys draw on a combined experience of nearly 50 years in delivering the highest quality legal services.

Oct

2013

Jim Eccleston: FINRA’s Proposed Procedure for Reps Not Named in Arbitration to Obtain Expungement of U-4 and U-5 Filings

From the Desk of Jim Eccleston at Eccleston Law:

FINRA has proposed new rules that would permit unnamed financial advisers who are the “subject of” allegations of sales practice violations made in investment-related customer-initiated arbitration claims, but who are not named as parties to the arbitration, to seek expungement relief by initiated In reexpungement proceedings at the conclusion of the underlying customer-initiated arbitration case. Specifically, the following are the new proposed FINRA rules: Rule 12100(z) (“Unnamed Person”); Rule 12806 (“Expungement of Customer Dispute Information by Persons Named as Parties); Rule 13100(cc) (“Unnamed Person”); Rule 13806 (“Expungement of Customer Dispute Information by Persons Named as Parties); and Rule 13807 (“Expungement of Customer Dispute Information by an Unnamed Person”).

The current Code of Arbitration Procedure for Customer Disputes and the Code of Arbitration Procedure for Industry Disputes do not provide unnamed persons with express procedures to seek expungement of those types of allegations. The SEC is expected to set an approval date of early 2014.

There are several benefits for brokers. First, the new rules would allow unnamed brokers to use this explicit procedure instead of having to intervene in the arbitration filed by the investor or initiate a new arbitration case in which the broker requests expungement relief and names the investor or firm as the respondent. Another benefit is that the expungement proceedings would commence only after the underlying customer arbitration is concluded. Another benefit is the possibility that the arbitrator reviewing the In reexpungement proceedings will already be familiar with the case. Under the proposed rules, the public chairperson of the underlying arbitration would handle the In reexpungement proceedings.

While our adviser clients currently do have avenues for expungement, FINRA’s new rule proposals greatly would expedite and simplify the entire process.

Oct

2013

Jim Eccleston: Ponzi Scheme Perpetrated by Richard Schwartz Leads Indiana Officials to Freeze Assets | Investor

From the Desk of Jim Eccleston at Eccleston Law:

The State of Indiana has sought to freeze the assets of the estate of a former Kokomo investment adviser in order to provide possible, partial restitution to victims of a Ponzi Scheme. At the time, Mr. Schwartz was employed by and under the supervision of a major brokerage firm still in existence. According to Indiana Secretary of State Connie Lawson, this Ponzi scheme allegedly includes former National Football League players. Specifically, the Indiana Attorney General’s office filed the lawsuit in Howard Superior Court in Kokomo against the estate of Richard Schwartz, whom Lawson alleges deceived clients across the country out of $5 million to $10 million.

Oct

2013

Jim Eccleston: Increase in Actions Against RIAs Inevitable as Industry Shifts | Investor

From the Desk of Jim Eccleston at Eccleston Law:

State finance regulators see an uptick in actions against registered investment advisers (RIAs) since states took on the oversight of advisers with $100 million or less in assets. This increase has exposed flaws in the RIA compliance functions.

RIAs now account for 23.9% of regulatory actions by states, while broker-dealers account for 29.2%. In particular, individuals who are not licensed to sell securities account for the most actions by the states, which is 42.5%. The increase in state actions against investment advisers is also inevitable due to the fact that many broker-dealer reps have left their broker-dealer firms to open investment advisory firms.

Oct

2013

Jim Eccleston: Morgan Stanley Suffers Big Asset Loss

From the Desk of Jim Eccleston at Eccleston Law:

The nation’s largest brokerage by adviser head count, Morgan Stanley Wealth Management, lost $8.4 billion in client assets during the third quarter, as some of its major producers took their business to competing firms. In the three-month period ended September 30, 2013, the average assets under management of advisers who moved also jumped nearly 25% from the previous year, to $402.2 million. Generally speaking, adviser movement with small books of businesses is not tracked by the data, and advisers do not necessarily take all of their business to the new firm.

Four of the 10 largest departures from Morgan Stanley in the third quarter were to other wirehouses. Three teams managing $7.9 billion in assets moved to UBS Financial Services Inc., while a $1 billion team in the New York area switched to Wells Fargo Advisors LLC.Morgan Stanley did add some major advisers last quarter. However, high-profile losses appeared to offset Morgan Stanley’s recruitment successes last quarter.

Given that Morgan Stanley had 16,321 advisers and $1.8 trillion in assets at the end of the second quarter, according to the company’s regulatory filings, it still is the largest wirehouse by advisers and the second largest by assets.

The attorneys of Eccleston Law represent investors and advisers nationwide in securities and employment matters.

Oct

2013

Jim Eccleston: B-Ds Up and Running on Social Media

From the Desk of Jim Eccleston at Eccleston Law:
As technology improves and compliance fears ease, advisers at brokerage firms are joining their registered investment adviser counterparts in the social-media race. Contrary to registered investment advisers (RIAs), many broker-dealers have and continue to require preapproval of personal messages, or limit posts to canned corporate material. FINRA does not require preapproval of social-media posts, and better technology / compliance tools are easing fears.
For example, Cambridge Investment Research Inc. lets its representatives post on Twitter, LinkedIn and Facebook, subject to a post-use review. Further, Commonwealth Financial Network also allows its representatives to use LinkedIn, Twitter and Facebook. At LPL Financial, approximately 5,000 of the firm’s advisers, or about 40% of the total, are signed up to use social media. As of August 2013, that number was up almost 60%. Further, Raymond James advisers can use Facebook, Twitter and LinkedIn, but content has to be preapproved. Close to 2,000 of Raymond James’ 5,300 advisers in its independent and employee channels have connected through special software. Moreover, Bank of America Merrill Lynch allows its reps to use LinkedIn only. Lastly, Wells Fargo has had a LinkedIn pilot program in place since September 2013 in which about 50 of its advisers can post content. Meanwhile, the firm has gotten about a third of its 15,000 reps to put up a profile on LinkedIn.

The attorneys of Eccleston Law represent investors and advisers nationwide in securities and employment matters. Our attorneys draw on a combined experience of nearly 50 years in delivering the highest quality legal services.

Oct

2013

Jim Eccleston: FINRA Provides Additional Guidance for Financial Services Firms to Comply with New Suitability Rule | Advisor

From the Desk of Jim Eccleston at Eccleston Law:
FINRA (the Financial Industry Regulatory Authority) has had an opportunity to examine how financial services firms are complying with FINRA Rule 2111, effective July, 2012. The new rule made several important changes, especially related to recommendations of investment strategies and recommendations to hold securities positions. Based upon examinations of firms conducted during the last year, FINRA has issued Regulatory Notice 13-31. Let’s highlight the key provisions.

As background, Rule 2111 relates to recommendations made by a financial adviser and his or her firm. Historically, the application of the rule was limited to recommendations to buy or sell securities. In the new rule, FINRA added recommended investment strategies involving a security or securities, including the explicit recommendation to “hold” a security or securities.

Also, in making a recommendation, Rule 2111 continues with the requirement that the financial adviser and his or her firm have a “reasonable basis” to believe that the recommendation is “suitable.” However, the new rule added several requirements. First, FINRA expanded the list of information required to ascertain the customer’s suitability profile. The list includes the customer’s age, investment experience, time horizon, liquidity needs and risk tolerance as information items that advisers and their firms must attempt to obtain and analyze.

Second, the new rule recited the “three main suitability obligations” according to Regulatory Notice 13-31. They are “reasonable-basis”, “customer-specific” and “quantitative” suitability obligations. In short, reasonable basis means that a recommended security or investment recommendation is suitable for at least some investors; customer-specific means that the recommendation is suitable for a particular customer; and quantitative means that “a series of recommended transactions, even if suitable when viewed in isolation, are not excessive.”

In light of the new requirements of the suitability rule, FINRA examiners have analyzed the firms’ “controls”, including testing the firms’ supervisory and compliance systems. FINRA examiners also have reviewed for “Red Flags” of possible deficiencies. Those Red Flags include: a long term investment for an investor with a short term time horizon; or a speculative investment or strategy held in the account of a conservative investor. FINRA concludes in its regulatory notice that the most common deficiency among firms was having inadequate procedures for “hold” recommendations.

Based upon those examinations, Regulatory Notice 13-31 discusses numerous “observations of effective practices” to provide guidance to firms and their advisers. For example, in the guidance regarding reasonable-basis suitability, FINRA commented on an effective way some firms use to ensure that their financial advisers understand the (sometimes complex) products that they are recommending. Those firms “post due diligence on products (and accompanying documents) to an internal website that [advisers] can access when recommending a product.” The information “includes audited financial statements, notes of interviews with key individuals of the product sponsor or issuer, and other information relevant to understanding the product and its features.”

Likewise, in the guidance related to customer-specific suitability, FINRA comments that some firms bolstered compliance by requiring specific customer suitability information such as high risk tolerance, low liquidity needs, substantial investment experience, and an indication that the recommended transaction represents a small percentage of a balanced portfolio.

Finally, the guidance regarding investment strategies and hold recommendations is notable. FINRA notes that effective compliance and supervisory systems included the following:

• A “hold ticket” or “hold blotter” that captures hold and, in certain instances, other types of strategy recommendations;
• Notes of discussions with clients regarding explicit hold or other strategy recommendations by associated persons maintained in customer files;
• Firm branch office inspections focused on the documentation of hold and other strategy conversations with clients;
• Modified new account forms to include specific investment strategies (determined by the firm) which could be identified if an adviser recommends them at the time of the account opening;
• New or amended account opening forms that must be signed by the customer when advisers recommend changes to a previously recommended account investment strategy; and
• A prohibition on advisers’ engaging firm clients in any business activity that an adviser conducts outside of his or her firm.

Although FINRA states that Rule 2111 generally does not impose explicit documentation requirements, some documentation likely is necessary for adequate supervision. The regulatory notice states, “The type or form of documentation that may be needed is dependent on the facts and circumstances of the investment strategy or hold recommendation, including the complexity and risks associated with the security or investment strategy at the time of the recommendation.” Firms must find a way “to capture hold and other strategy recommendations.”
As one can see, Regulatory Notice 13-31 contains a great deal of helpful guidance for firms to implement to ensure that recommendations are suitable.

The attorneys of Eccleston Law represent investors and advisers nationwide in securities and employment matters. Our attorneys draw on a combined experience of nearly 50 years in delivering the highest quality legal services.