Positioning Your Firm to Deal with Regulators in Today’s Environment

In Dep’t of Enforcement v. Fox Fin. Mgmt. Corp., Brian A. Murphy and James E. Rooney (Disciplinary Proc. No. 2012030724101), a three-person FINRA Hearing Panel found that the firm and its principal officers failed to properly supervise a representative, treating the representative’s registered investment advisory and hedge fund activities as outside business activities rather than private securities transactions. Because the firm and its principals previously had been warned about deficiencies in the firm’s supervisory systems and had taken no corrective actions, the Panel expelled the broker-dealer, barred the firm’s President and Chief Compliance Officer from principal activities, suspended the individuals from all activities, and levied fines against the Firm and principals totaling $175,000. Here are some practical tips that will help place firms in a better position than Fox when dealing with the regulators:

  • Be proactive. For outside business activities, meaningfully review all outside business activity disclosures and assess whether those activities involve private securities transactions. The same can be said for all areas of supervision and compliance.
  • Be responsive. When the regulators identify deficiencies in a firm’s supervisory system, the firm should address those deficiencies, even if it disagrees with the findings or interpretations. If the regulators determine to take action against a firm, their chances of success are high. During the past year, both the SEC and FINRA have win records of virtually 100% before their administrative law judges.
  • Be diligent. Firms should ensure compliance with their written policies and procedures, and should not rely on regulators’ silence or lack of action to justify their actions. The regulators recently have commented that firms must have a “culture of compliance,” and SEC Chair White and others have openly discussed the SEC’s current focus on the gatekeeping role occupied by compliance officers.
  • Be mindful. Disciplinary history will be considered by the regulators. FINRA’s 2015 examination priorities letter identified “recidivist brokers” as a focus area. Firms and representatives with prior disciplinary histories, even on unrelated activities, will likely receive additional scrutiny from examiners and hearing panels.

In Fox, the broker-dealer, its President (Rooney), and its Chief Compliance Officer (Murphy) determined to treat certain activities of a registered representative as outside business activities rather than private securities transactions, the latter of which would have required the firm to supervise the activities and record the transactions on its books and records. The representative’s activities included the operation of a registered investment advisor (“RIA”) and the management of three hedge funds. In his outside business activity approval form, the representative advised the firm that he was acting as an RIA, that he received “client fees and money managers’ fees” and that it was “securities related.” Respondents approved the activity as an outside business activity and neither conducted diligence on the RIA nor made any inquiry into the compensation received by the representative. Likewise, Respondents did not supervise the activities of the RIA or record its transactions on the firm’s books and records. Similar circumstances surrounded the firm’s treatment of the representative’s hedge fund activities. While Rooney testified that he and the Firm had acted on the advice of counsel, the Hearing Panel deemed that reliance unreasonable.

Several factors contributed to the severity of the penalties, among them were:

  • The Panel concluded that “Respondents Ignored Regulatory Warnings.” FINRA’s 2010 examination report concluded that Fox’s supervisory system was deficient regarding ensuring that outside business activities were not private securities transactions. The firm took no action; instead it sought to justify its approach. In 2011, the SEC notified Fox of “deficiencies and weaknesses” including failing to supervise and record private securities transactions on its books and records. The SEC directed Fox to take corrective action and inform the staff of such action. Fox made no changes; instead it disagreed with the staff’s interpretations. Finally, in 2012, FINRA sent an examination report to Fox noting its failure to comply with the rules relating to private securities transaction. Again, the firm disputed the findings and chose to take no corrective action.
  • The Panel concluded that “Respondents Failed to Take Responsibility for Their Misconduct.” The Panel took issue with the Respondents’ refusal to accept liability and their attempts to “minimize their responsibility by attempting to shift blame for their non-compliance to FINRA and the SEC.” Respondents argued that the disciplinary action was unfair because they had disputed the regulators’ interpretations, and were comforted by the regulators’ lack of follow up. The Panel rejected this, explaining “associated persons cannot rely on a regulator’s silence to justify their non-compliance,” and finding that “their attempt to shift blame demonstrates that they fail to appreciate the seriousness of their misconduct and serves to aggravate their misconduct.”
  • Finally, the Panel noted that “Rooney and Fox Have Disciplinary Histories.” Rooney admitted that his regulatory record was “disgraceful” and explained “I wouldn’t hire me.” The Panel concluded that their histories coupled with their failure to meet their obligations “demonstrate[d] their complete disregard for the regulatory process.”

While the facts and circumstances that led to the Fox decision were egregious, the decision provides insight into the current regulatory, enforcement and disciplinary environment where regulators seemingly “hold all the cards.” Indeed, during the General Session at Day 2 of SIFMA’s Compliance and Legal Society’s 2015 conference, FINRA’s Director of Enforcement touted that FINRA was virtually undefeated in matters brought before FINRA disciplinary hearing panels in 2014. In this environment, if a firm and its principals are able to demonstrate that that they have been proactive, responsive, diligent and mindful in their efforts to supervise their agents, it may place them in a more positive light during the course of regulatory examinations and if faced with a disciplinary or enforcement proceeding.

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In Dep’t of Enforcement v. Fox Fin. Mgmt. Corp., Brian A. Murphy and James E. Rooney (Disciplinary Proc. No. 2012030724101), a three-person FINRA Hearing Panel found that the firm and its principal officers failed to properly supervise a representative, treating the representative’s registered investment advisory and hedge fund activities as outside business activities rather than private securities transactions. Because the firm and its principals previously had been warned about deficiencies in the firm’s supervisory systems and had taken no corrective actions, the Panel expelled the broker-dealer, barred the firm’s President and Chief Compliance Officer from principal activities, suspended the individuals from all activities, and levied fines against the Firm and principals totaling $175,000. Here are some practical tips that will help place firms in a better position than Fox when dealing with the regulators:

  • Be proactive. For outside business activities, meaningfully review all outside business activity disclosures and assess whether those activities involve private securities transactions. The same can be said for all areas of supervision and compliance.
  • Be responsive. When the regulators identify deficiencies in a firm’s supervisory system, the firm should address those deficiencies, even if it disagrees with the findings or interpretations. If the regulators determine to take action against a firm, their chances of success are high. During the past year, both the SEC and FINRA have win records of virtually 100% before their administrative law judges.
  • Be diligent. Firms should ensure compliance with their written policies and procedures, and should not rely on regulators’ silence or lack of action to justify their actions. The regulators recently have commented that firms must have a “culture of compliance,” and SEC Chair White and others have openly discussed the SEC’s current focus on the gatekeeping role occupied by compliance officers.
  • Be mindful. Disciplinary history will be considered by the regulators. FINRA’s 2015 examination priorities letter identified “recidivist brokers” as a focus area. Firms and representatives with prior disciplinary histories, even on unrelated activities, will likely receive additional scrutiny from examiners and hearing panels.

In Fox, the broker-dealer, its President (Rooney), and its Chief Compliance Officer (Murphy) determined to treat certain activities of a registered representative as outside business activities rather than private securities transactions, the latter of which would have required the firm to supervise the activities and record the transactions on its books and records. The representative’s activities included the operation of a registered investment advisor (“RIA”) and the management of three hedge funds. In his outside business activity approval form, the representative advised the firm that he was acting as an RIA, that he received “client fees and money managers’ fees” and that it was “securities related.” Respondents approved the activity as an outside business activity and neither conducted diligence on the RIA nor made any inquiry into the compensation received by the representative. Likewise, Respondents did not supervise the activities of the RIA or record its transactions on the firm’s books and records. Similar circumstances surrounded the firm’s treatment of the representative’s hedge fund activities. While Rooney testified that he and the Firm had acted on the advice of counsel, the Hearing Panel deemed that reliance unreasonable.

Several factors contributed to the severity of the penalties, among them were:

  • The Panel concluded that “Respondents Ignored Regulatory Warnings.” FINRA’s 2010 examination report concluded that Fox’s supervisory system was deficient regarding ensuring that outside business activities were not private securities transactions. The firm took no action; instead it sought to justify its approach. In 2011, the SEC notified Fox of “deficiencies and weaknesses” including failing to supervise and record private securities transactions on its books and records. The SEC directed Fox to take corrective action and inform the staff of such action. Fox made no changes; instead it disagreed with the staff’s interpretations. Finally, in 2012, FINRA sent an examination report to Fox noting its failure to comply with the rules relating to private securities transaction. Again, the firm disputed the findings and chose to take no corrective action.
  • The Panel concluded that “Respondents Failed to Take Responsibility for Their Misconduct.” The Panel took issue with the Respondents’ refusal to accept liability and their attempts to “minimize their responsibility by attempting to shift blame for their non-compliance to FINRA and the SEC.” Respondents argued that the disciplinary action was unfair because they had disputed the regulators’ interpretations, and were comforted by the regulators’ lack of follow up. The Panel rejected this, explaining “associated persons cannot rely on a regulator’s silence to justify their non-compliance,” and finding that “their attempt to shift blame demonstrates that they fail to appreciate the seriousness of their misconduct and serves to aggravate their misconduct.”
  • Finally, the Panel noted that “Rooney and Fox Have Disciplinary Histories.” Rooney admitted that his regulatory record was “disgraceful” and explained “I wouldn’t hire me.” The Panel concluded that their histories coupled with their failure to meet their obligations “demonstrate[d] their complete disregard for the regulatory process.”

While the facts and circumstances that led to the Fox decision were egregious, the decision provides insight into the current regulatory, enforcement and disciplinary environment where regulators seemingly “hold all the cards.” Indeed, during the General Session at Day 2 of SIFMA’s Compliance and Legal Society’s 2015 conference, FINRA’s Director of Enforcement touted that FINRA was virtually undefeated in matters brought before FINRA disciplinary hearing panels in 2014. In this environment, if a firm and its principals are able to demonstrate that that they have been proactive, responsive, diligent and mindful in their efforts to supervise their agents, it may place them in a more positive light during the course of regulatory examinations and if faced with a disciplinary or enforcement proceeding.

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