Top Broker Dealer Compliance Issues Disclosed By State Securities Regulators

September 10, 2012

Red flags

A NASAA report points out lots of red flags -- but what to do about them isn't exactly spelled out

On September 9, 2012, the the North American Securities Administrators Association ("NASAA") identified the top Broker-Dealer  ("BD") compliance violations as a result of analysis of a nationwide series of examinations conducted by state securities examiners as part of the Broker-Dealer Operations Project Group.  Once more, once again, a regulator points at the flapping red flags.  Yeah, we know - we've seen those pretty banners snapping in the wind for years.

SIDE BAR:  Here's a breakdown of the nature and size of branch offices examined:

  • One-person branch offices: 44%;
  • home offices: 23%;
  • branch offices with 2-5 agents: 20%;
  • branch offices 6 or more agents: 11%; and
  • non-branch offices: 2%.

Five Areas

As a result of some 236 examinations/audits/investigations conducted between January 1 and June 30, 2012, 453 types of violations were found in five compliance areas:

  1. books and records (29%):;
  2. supervision (27%);
  3. sales practices (24%);
  4. registration and licensing (14%); and
  5. operations (6 percent).

In the Books And Records basket, NASAA noted the following hierarchy of problems running from the most common to the lesser:

  1. Maintenance of Customer New Account Info
  2. Advertising / Sales Literature
  3. Outgoing / Incoming Correspondence
  4. E‐mail Correspondence
  5. Complaints / Arbitrations / Litigation
  6. Blotters / Exception Reports
  7. Supervisory approval of Customer Acct Info
  8. Customer Statements / Confirmations
  9. Order Tickets
  10. Providing customers a copy of agreements
  11. Provide customer a copy of New Acct Info

In the Sales Practice basket, over 75% of the cited violations fell within the categories of Suitability, Outside Business Activities, and Selling Away.

Top Five Violations

Embedded within NASAA's published findings, the top five types of violations as:

  1. failure to follow written supervisory policies and procedures,
  2. suitability,
  3. correspondence/e-mail,
  4. maintenance of customer account information, and
  5. internal audits.

Bill Singers Comment

In concluding its report, NASAA recommended ten purported best compliance practices to address various concerns. Frankly, the bulk of these supposed best practices border on the inane - they merely regurgitate tired and worn suggestions of the ilk of do more or do better. While the report presents interesting statistical factors and underscores the need for BDs to stay on top of compliance, beyond the nature of exhortation there is little of value in the suggested ways to improve compliance.

BDs struggle daily with the obligations of a compliance regime.  And struggle they should because they're in the customer service business notwithstanding a fairly tawdry record in that regard.  Further, internal conflicts create an incessant tension between implementing sound compliance practices and the desire to preserve and increase revenues. It is a tension that will always be with Wall Street, no matter that the firm be an indie/regional or a financial superstore, no matter that the branch be a mom-and-pop or staffed with a hundred stockbrokers.  Merrill LynchWells Fargo, JP Morgan, Morgan Stanley Smith Barney, struggle with this dynamic just as Charles Schwab, LPL, as does the small storefront at the nearby strip mall.

Accordingly, I wish that when regulators publish these annual reports or disseminate their surveys, that beyond the mere collection of data would be far more in the way of meaty, meaningful, helpful suggestions about what to do and how to do it.  By way of example, consider this simplistic and circular bit of "best practices" in the NASAA report:

Suitability. Broker-Dealers must develop effective standards and criteria for determining suitability. State regulations and FINRA Rules 2090 and 2111 require registered persons to "know your customer" and receive training sufficient to demonstrate knowledge of products pre-sale.

Develop, Update, and Enforce Written Supervisory Procedures. BDs also should ensure that staffing and expertise are commensurate with the size of the BD, type(s) of business engaged in by the firm, and the individual responsible for specific procedures.

NASAA's self-styled best practices recommendations are, in truth, more along the lines of warnings - which are fine and serve a purpose but are not detailed suggestions of how to avoid problems or respond to indications of trouble. Additionally, we've sort of heard these warnings before, many times.

Among the less eye-rolling tidbits in the report, one finds the warning that when reviewing exception reports, "BDs that rely solely upon conversations with salespersons to address exception reports without contacting investors may subject themselves and supervisory staff to regulatory and/or legal action." As often reported in "Street Sweeper," too many supervisors and managers are responding to red flag items on compliance exception reports by simply asking for an explanation from the subject registered person - and some of the explanations provided clearly demand follow-up, which is frequently not forthcoming.

In terms of a likely checklist that securities examiners will be using, NASAA urges the industry to include within any internal branch audit program:

  • meaningful audit document/plan,
  • unannounced visits,
  • a means to convey audit results, and
  • a follow-up plan requiring that the branch take corrective action.

In recent months, "Street Sweeper" has reported on regulatory cases involving BD whose concept of a "surprise" audit included a head's-up to the branch.  Similarly, we have discussed a number of settled cases in which supervisors/managers were aware of compliance deficiencies disclosed during a routine audit but, inexplicably (or perhaps not), chose to disregard the issues or failed to memorialize any follow-up.

As to the old standard of dealing with customer complaints, NASAA reminds the industry that "Timely reporting and remediating customer harm are some of the factors under NASAA guidelines to determine if the firm is entitled to credit for cooperation."  There are still some brownie points available for showing good faith.

READ these recent "Street Sweeper" columns:

Pre-Announced Compliance Audits Criticized In SEC Ponzi Settlement

FINRA Sanctions Brokerage CEO For Delegating To Part Time Compliance Officer and FINOP

Wall Street Compliance Practices Come Under Scrutiny by FINRA and the SEC