SEC Warns Never Before Examined Advisors - We're Coming! edit
Sunday, February 23, 2014 08:14

Are you ready for an SEC Exam?


If you are SEC registered and have yet to receive an exam, you better prepare.

For months the SEC has alluded to its focus on "never-before examined advisers".

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On February 20, 2014, despite tight resources at the SEC, they formally issued a letter to Firm Owners and Chief Compliance Officers.


"Our [SEC] records indicate your firm is a registered investment adviser that has never been examined by the Office of Compliance Inspections and Examinations (“OCIE”) within the United States Securities and Exchange Commission (“Commission”)." [See SEC Letter dated February 20, 2014.]


So, we have established they are coming. Now we are left with "when" and are you ready?

As a compliance consultant, I can attest that the SEC has been active. We have been neck deep in supporting advisor exams throughout the fall and coming into 2014. However, it is quite doubtful that they will get to all NBE Advisers in 2014, but your firm must prepare as if your turn is imminent.

The SEC has disclosed two approaches towards these examinations, including: a risk assessment reviews and focused reviews.

Risk-Assessment Reviews
are broader examinations that cover your entire compliance program. These reviews will focus on the effectiveness of your overall compliance program in preventing, detecting and correcting violations of the securities laws. In these examinations, the SEC will examine your overall business model and ensure you not only have the policies and procedures in place, but that your firm adheres to these policies consistently. The SEC will focus on your documentation and its consistency. [Note: If you can prove you completed a task or action, it did not happen in the eyes of the regulators. So please maintain proper documentation of business and compliance activities.]

Focused Reviews
will target specific areas of your business model, including the Compliance Program, Filings/Disclosures, Marketing, Portfolio Management, and Safety of Client Assets. While these items may sound focused, they are both broad and inherent in most aspects of your enterprise risk and compliance. If the SEC finds some areas of weakness, they are very likely to continue into a deeper examination. In addition, the SEC recently announced their 2014 Priorities, which may yield some additional insights into the topics for Focused Reviews.

So how do you prepare?

There is no single answer to this question, but certainly taking no action has a certain end result. Here are some suggestions:

  • Risk Inventory. Start with developing a risk matrix that identifies all the business and compliance processes of your firm. Rank each items for their level of risk, impact, frequency and other parameters. The outcome of this activity should be a sortable list of your risk areas that can serve as the basis to formulate priorities.
  • Review Action Plan. Develop a reasonable and continuous action plan to review the target areas on your risk assessment. [Note: you will want to cover all areas of your business over time.]
  • Document. Document. Document. It is imperative that you document the details of your reviews. If you find areas of material weakness, you may want to consult your compliance or legal partners before committing the issues to writing. However the key takeaway is that you must be able to demonstrate [through evidence] that you perform these reviews of your firm. The approach towards documentation is not defined by the regulations, but it must sufficient to demonstrate the effectiveness of the control environment.
  • Leverage your Team. Compliance has largely been left on the shoulders of the Chief Compliance Officer. An effective compliance program contemplates a "culture of compliance". Leaving the risk management to the CCO is not an effective way to manage risk and it naturally results in a low return on your investment. Integrating risk management into your organization brings accountability to all supervised persons of your firm and creates a stronger risk environment.
  • Seek External Support. If you have areas of your compliance program that require immediate attention or you are not sure how to get started, it is often best to engage external compliance resources. Mock examinations, structured compliance programs and targeted support are some of the options that are available.

Best of luck in your preparation.

For Small BDs And Clearing Firms, FINRA Legal Action Serves As a Cautionary Tale On Anti-Money-Laundering Compliance edit
Tuesday, December 17, 2013 09:36

Tags: broker-dealers | compliance

FINRA announced yesterday that it imposed a $1 million fine on a Nebraska clearing firm for repeatedly violating anti-money laundering (AML), financial reporting and supervisory requirements.  The announcement serves as a good checklist for compliance and supervisory personnel about the types of matters FINRA may investigate during firm audits.


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FINRA asserted that Omaha-based COR Clearing LLC’s AML surveillance program failed to reasonably address risks given the company's business model, because the type of accounts it deals with have a higher risk of money laundering and other fraudulent activity.


Among other findings, FINRA determined that COR’s anti-money laundering surveillance system nearly collapsed for a portion of 2012, and as a result, the firm failed to conduct any systematic reviews to identify and investigate suspicious activity.  FINRA also asserted that, in 2009, COR instituted a so-called "defensive SARS" program, under which it filed suspicious activity reports without actually completing the investigation necessary to support the reports' filings.


The regulator alleged COR committed multiple supervisory violations as well, relating to the outsourcing of back-office functions, funding and liquidity. COR also allegedly neglected to save and review emails of one of its executives and failed to ensure that its president was properly registered as a principal.  Additionally, COR was also accused of making multiple financial reporting errors, including repeatedly making erroneous customer reserve and net capital computations, and filing inaccurate financial and operational combined uniform single reports with FINRA.


The alleged violations came to light during several examinations of COR from 2009 to 2013 and included numerous repetitive violations from year to year. The sanction also resolves charges brought in an April 2012 FINRA complaint as well as additional alleged violations discovered recently.


The fine is part of a settlement resolving the allegations against COR, which neither admitted nor denied any wrongdoing.  In addition to the fine, COR was ordered to hire an independent consultant to conduct a comprehensive review of its policies, systems and training, to submit new clearing agreements for FINRA approval during the review and, for a period of one year, to have its CEO and chief financial officer certify that each executive has reviewed the firm’s customer reserve and net capital computations for accuracy prior to submission.


The case is FINRA Department of Enforcement v. Legent Clearing LLC, case number 2009016234701, in the FINRA Office of Hearing Officers. For BDs and clearing firms, FINRA's findings and actions serve as a cautionary tale.

SEC Bars Four CPAs For Audit Failure; Rare Prosecution Of CPA Auditors For Failing To Fulfill Their Professional Obligations Raises A Question For Financial Advice Professionals edit
Thursday, November 07, 2013 17:28

Three New York CPAs today were prohibited from practicing before the Securities and Exchange Commission for at least five years, and another was barred for at least three years. Should it have been a lifetime bar?


It's rare that the SEC bars a CPA from a small audit firm because it is usually too difficult to establish that the accountant should have known a fraud was amiss. If someone is intent on fraud, it can be hard to detect. However, in this case the most basic financial facts about the company appear not to have been verified by the auditors.

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The SEC says the CPAs, from Sherb & Co. LLP, engaged in improper professional conduct in auditing two China-based companies, China Sky One Medical (and another called--you can't make this stuff up--Wowjoint). On September 4, the SEC charged China Sky and and its chief executive with fraud for recording fake sales of a weight loss product to inflate revenues in the company’s financial statements to the tune of $1 million a month.


If, like me, you are fascinated by fraud stories, check out this one. China Sky traded as high as $23 a share in January 2010. It now trades for 12 cents.


"China Sky One Medical Inc. (CSKI) falsely stated in 2007 annual and quarterly reports that it had entered into a strategic distribution agreement with a Malaysian company that would become the 'exclusive' distributor of CSKI’s 'slim patch' in Malaysia and generate $1 million per month in sales," according to the SEC's September release in the China Sky case. "However, the company never actually entered into any such agreement.  CSKI instead created approximately $19.8 million in phony export sales to Malaysia that were recorded as revenue in its financial results for 2007 and 2008."



Point is, if revenue can be fabricated so easily and the existence and fulfillment of major contracts by pubicly-held companies are not verified by the auditor, that's a major  failure by the professionals involved and getting barred three or five years just isn't enough.


Let these guys keep their professional designations, so they can earn a living preparing taxes for the rest of their lives. That's a fate worse than jail.


But if a CPA is guilty of failing to fulfill his or her professional obligations as an auditor, as the SEC charged, the SEC should not let them ever practice again as an auditor of publicly held companies.  


Nowe here's an exercise for those of you who want the delivery of financial planners and investment advisors to be a profession. If a financial advisor is guilty of gross incompetence, would he or she get the same treatment as the CPAs--accepted professionals.  The answer: No.


The SEC does not prosecute IA reps for failing to fulfill their professional obligations. If you want to have a profession, shouldn't the SEC be able to do that? 


SEC Rewards Whistleblower With $150,000 Payout; This Is One Part Of Dodd Frank That Is Working edit
Monday, November 04, 2013 10:50

Tags: compliance | fraud | sec

The Securities and Exchange Commission today announced an award of more than $150,000 to a whistleblower whose tips helped the agency stop a scheme that was defrauding investors. 

While the July 2010 enactment of Dodd-Frank legislation has been a slow and messy process, this was the sixth whistleblower to be awarded through the SEC’s whistleblower program since it began two years ago. This will help increase trust in the U.S. investment system.

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Summarizing The Current Position Of Stakeholders In Decision On Naming FINRA To Oversee RIAs edit
Sunday, June 23, 2013 15:16

Tags: Dodd-Frank | fiduciaries | FINRA

As Congress and the SEC near a time for reckoning on implementing Dodd-Frank reforms in the regulation of investment advisers, Wall Street, RIAs, FINRA, and other stakeholders are digging in their heels and readying for a Washington, D.C. showdown. 


With that dramatic backdrop, Mark Schoeff wrote a solid piece of reporting in today’s Investment News profiling FINRA. Schoeff provides a balanced appraisal of the self-regulatory-organization (SRO) landscape in the financial services industry.


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Schoeff quotes Tamar Frankel, an esteemed securities law professor at Boston University School of Law, attacking FINRA’s credibility as a regulator. “It (FINRA) is built on its membership,” Frankel is quoted as saying. “Whenever brokers really care [about an issue], and FINRA goes against them, they will trump FINRA.”
FINRA's executive vice president of regulatory operations,, Susan Axelrod, responds to Frankel’s highly disparaging remarks saying, “We can be informed by the industry, but in no way are we instructed by them.”
That's great reporting and it really lays out the different players and their positions succinctly.
Schoeff shows how the 2007 merger of FINRA with the New York Stock Exchange was the beginning of a push to create an SRO that would oversee all financial advisors. Then, David Tittsworth of the Investment Advisers Association is quoted saying the merger “has created a large organization that is intent on growing further and extending its jurisdiction to investment advisers.”
This is a great piece of reporting that summarizes the current position of FINRA on overseeing investment advisers.
When you read a story like this, it makes you understand why FINRA remains likely to ultimately be named as the SRO overseeing RIAs.
I’m not saying FINRA should get the responsibility for regulating RIAs, but it is a convenient solution and it does have the bureaucratic heft to do it. Also, I’m so jaded, I believe Congress gets bought and won’t ever shut down Wall Street’s sales machine—even in the unlikely event a Congressman actually understands the issues well enough to know why it would be bad for consumers and retirees for FINRA to be chosen as  the SRO of RIAs.
Wall Street remains incredibly powerful despite its prominent role in causing the financial crisis, and nothing much has been done to reform the investment advice business since the financial crisis.
That part was not in Schoeff’s story. He’s doing straight reporting. But I’d love to hear what he thinks.

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