Monthly Archives: September 2014

Proposed FINRA Rule Change to Shift Professionals without Ties to Securities Industry into “Non-public” Arbitrator Pool

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By Sunny Desai

In a proposed FINRA rule change, persons who worked in the financial industry for any duration during their careers would always be classified as non-public arbitrators, as well as persons who represent investors or the financial industry as a significant part of their business. This would mean removing certain attorneys, accountants, and other professionals from the public arbitrator classification and into the non-public arbitrator classification. As such, the Public Investors Arbitration Bar Association (PIABA) is not as highly enthusiastic about the proposed rule change.

The proposed change, that would essentially shift attorneys and other professionals without ties to the securities industry into the non-public arbitrator pool, will “harm the integrity of the arbitration process” according to PIABA. PIABA takes issue with the fact that the proposed rule change would prevent attorneys and other professionals who service investors in securities disputes, from serving as public arbitrators.

Currently, a non-public arbitrator is one who is associated with the financial industry, either by being registered through a broker or dealer, spending a substantial amount of his/her career engaging in the securities industry, or working in a financial institution with securities and commodities, etc. A public arbitrator is one who is not an investment advisor and is not engaged in securities or commodities. As of now, attorneys and accountants who service investors would be classified as public arbitrators, but this proposed rule change would re-classify those individuals as non-public arbitrators.

PIABA’s letter to the Securities and Exchange Commission (SEC) asserts that the categorization of a proposed arbitrator as public and/or non-public has always focused on the nature and extent of the individual’s relationship to the financial industry. This was borne solely out of the perceived bias on the part of the industry and in the interest of protecting the investing public.

How would this proposed rule change help investors in the arbitration process? According to PIABA, it simply wouldn’t. As stated in PIABA’s letter to the SEC, “placing arbitrators with no ties to the securities industry into the non-public pool makes no logical sense and would harm the integrity of the arbitration process because parties would not have accurate disclosure information to rely on in selecting arbitration panels.” Under FINRA’s proposed rule change, arbitrators with no ties to the securities industry would be mistakenly believed to have ties to the securities industry, as they would be categorized as non-public arbitrators.

According to PIABA, this would hurt and undermine FINRA’s own stated goal of arbitrator neutrality. With investor confidence already shaken, how can investors have faith in arbitration if the parties do not have accurate disclosure information when selecting arbitration panels?

Municipal Advisors Face Increased Regulation Under Dodd-Frank

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By Nathaniel Touboul

The financial crisis of 2008 led regulators to the realization that municipalities needed a system that protects their own interests when dealing with Wall Street. To achieve this goal, the Dodd-Frank Act, among other things, created a new class of regulated persons called “Municipal Advisors” (MAs). Under new regulations, MAs may not provide advice on behalf of, or to municipal entities without first registering with the Securities and Exchange Commission (SEC). MAs will also be held to a fiduciary standard. These new regulations are aimed at issues regarding MA misconduct such as “pay to play” practices, undisclosed conflicts of interest, advice rendered without adequate qualifications and failure to place their duty of loyalty to their clients ahead of their own interests.

Ultimately, the goal is to protect the investor and the integrity of the market. The Municipal Advisor Examination Initiative (“MA Examination Initiative”) will provide the SEC with valuable information that will allow it to discover new areas of potential MA abuse. Also, the new registration process will create a direct link between MAs and the SEC, thereby facilitating oversight.

It is often the case that when an advisor orchestrates a transaction for a municipality, the advisor will provide advice and counsel to the municipality as well. The issue with this system is that not all underwriters and brokers are fair. An example of this misconduct occurred in 2008 in Jefferson County, Alabama, where a J.P Morgan Chase banker led officials into entering a complicated interest rate swap deal. Although the banker and some county officials later pleaded guilty to corruption charges related to the deal, it eventually led Jefferson County into bankruptcy in 2011.

From the investor’s perspective, scenarios such as Jefferson County’s bankruptcy show that even investments that have traditionally been viewed as “safe” such as municipal bonds are not immune from disasters. Even when making “safe” investments, it is important for investors to understand the potential risks, including the risks of a municipality defaulting on its debt obligations. These new regulations will create more oversight and facilitate compliance with new regulations designed to prevent the kind of misconduct that led to the Jefferson County bankruptcy.

To respond to situations such as the one that occurred in Jefferson County, the SEC announced that the Office of Compliance Inspections and Examinations (“OCIE”) is launching an examination initiative directed at newly regulated MAs. The OCIE examines MAs through the National Exam Program (NEP), which is comprised of staff of the SEC’s 11 regional offices and the home office in Washington, D.C. The NEP’s mission is to “protect investors and maintain market integrity through risk-focused examinations that promote compliance, prevent fraud, monitor risk and inform policy.” Through launching the MA Examination Initiative, the NEP will be able to conduct focused, risk-based examinations of MAs that are registered with the SEC, but not registered with FINRA. The MA Examination Initiative will be conducted over the next two years and will have three primary phases described as follows:

Engagement Phase:

This initial phase consists of outreach programs aimed at informing newly registered firms about their obligations under the Dodd-Frank Act and the MA Examination Initiative. This phase will also provide a forum for MA senior executives or principals to discuss issues, ask questions and communicate directly with the administrative agencies.

Examination Phase:

During this phase, the NEP staff will review the MAs selected for examination, and will determine whether they are in compliance with all applicable rules. The OCIE will focus on the following areas of identified risks:

1) Registration

2) Fiduciary Duty

3) Disclosure

4) Fair Dealing

5) Supervision

6) Books and Records

7) Training/Qualifications

Informing Policy Phase:

This final phase will consist of a final report from the NEP to the SEC containing common practices in the areas identified in the Examination phase, industry trends and other issues.

Press Releases and the Dangers of Insider Trading

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By Edel Gonzalez

Illegal insider trading has undermined the trust that investors have in the securities market for many years. It cripples public confidence in the market and hinders growth for investors and companies. In response, the Securities and Exchange Commission (SEC) has strengthened its commitment of investigating and prosecuting insider trading.

The SEC has defined illegal insider trading and what is considered permissive insider trading practices. According to the SEC, illegal insider trading is buying and/or selling a security in breach of a trust relationship and while in possession of nonpublic information, in violation of a fiduciary duty to keep such information confidential. Insider trading is permitted in certain circumstances such as when corporate insiders trade their own securities and report their transactions to the SEC.

The SEC has adopted rules to discourage and prevent such inappropriate behavior.  Rule 10b5-1 addresses the knowledge of a trader who is privy to material nonpublic information. Rule 10b5-2 states that a person receiving confidential information through non-business relationships owes a duty of confidentiality and may be found liable for violation of the duty.

The SEC has brought actions under these rules against corporate officers, government employees, friends and business associates of corporate employees, employees of law, and banking and brokerage firms with access to confidential trade information.

Just last month, the SEC charged Michael Anthony Dupre Lucarelli, a director of market intelligence at Manhattan’s Lippert/Heilshorn Investor Relations, with executing trades based on information he obtained through accessing client’s press releases from his firm’s computer network. Sanjay Wadhwa, senior director of the SEC’s New York Regional Office, commented on the investigation stating that Lucarelli knew that he was prohibited from using this information in order to gain advantage over other investors.

Lucarelli has been accused of intentionally falsifying his employment information on brokerage firms’ trading account applications in order to execute these illicit trades. The U.S. Attorney’s Office for the Southern District of New York has announced criminal charges against Lucarelli.

Cases such as Lucarelli’s pose questions as to whether these are isolated incidents in a mostly well regulated and good faith market or whether these are prevalent violations which require stronger reaction.