Regulatory Audits & Investigations

Supreme Court Strips Securities and Exchange Commission of Its “Home-Field” Advantage

July 8, 2024 | Adam G. Schreck

In a major blow to the Securities and Exchange Commission (SEC), the Supreme Court ruled in SEC v. Jarkesy that defendants against whom the SEC seeks civil penalties for securities fraud are entitled to jury trials under the Seventh Amendment, rather than adjudication through the SEC’s “in-house” administrative law judges. While only time will tell just how impactful the Jarkesy decision will be, this ruling has the potential to dramatically reshape the SEC’s enforcement efforts as we know them today.

Following the Great Recession in 2008, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dobb-Frank), which authorized the SEC to impose civil penalties on defendants through in-house proceedings before administrative law judges or even SEC Commissioners themselves. With this built-in advantage, the SEC’s “win-rate,” as well as its ability to force defendants into unfavorable settlements, rose considerably. In essence, the SEC was authorized to serve as “judge,” “jury,” and “executioner.” If you are the target of an SEC civil action, you should consult an experienced SEC Defense Attorney, like the ones at Malecki Law.

The Jarkesy decision stripped the SEC of this “multi-role” position and relegated the SEC’s civil actions back into federal court, where the SEC was forced to fight its battles for much of its history. In or around 2010, the SEC began investigating Geroge Jarkesy, Jr. (Jarkesy) and his firm, Patriot28, LLC (Patriot28), for suspected securities fraud in connection to two investment funds that Jarkesy managed. The SEC’s enforcement action alleged that Jarkesy and Patriot28 defrauded investors through various misrepresentations and omissions. The case was initially adjudicated by an administrative law judge who submitted an initial decision in 2014. In 2020, the SEC issued its final order against Jarkesy and Patriot28, levying a $300,000 civil penalty against the defendants, disgorging profits earned by Patriot28 and barring Jarkesy from the securities industry.

Despite FINRA’s Increased Fines in 2023, the Number of FINRA’s Disciplinary Actions Continued Their Downward Trend

May 17, 2024 | Adam G. Schreck

In March 2024, Evershed Sutherland (US) LLP released its annual report (the Report) detailing disciplinary and enforcement actions initiated by the Financial Industry Regulatory Authority (“FINRA”) during the 2023 year. The Report outlines how FINRA seemingly stepped up its investigatory efforts in 2023, levying $89 million in fines against member firms and associated persons. Comparatively, FINRA reported just $54.5 million in fines during 2022, representing an increase of over 60%. Over a quarter of the fines handed out by FINRA last year can be attributed to the $24 million fine received by Bank of America Securities, Inc. for engaging in “spoofing” and related supervisory failures.

Despite FINRA’s bolstered fine revenue in 2023, FINRA ordered member firms to pay far less restitution to investors compared to past years. In 2023, FINRA ordered just $7 million in restitution compared to $21 million ordered in 2022, representing a 66% decrease. On December 6, 2023, FINRA announced sanctions against four firms, including M1 Finance LLC, Open to the Public Investing, Inc., SoFi Securities LLC, and SogoTrade, Inc., totaling over $2.6 million, which included $1 million in restitution paid to retail customers. Notably, this was the only million-dollar restitution ordered by FINRA in 2023, a stark decline from 2021 when FINRA handed out ten of such orders. If you are a financial professional who received an 8210 Request from FINRA, you should consult an experienced Securities Industry Regulatory Defense law firm, like Malecki Law in New York, to help navigate you through the process.

FINRA’s increased fine totals in 2023 were surprisingly achieved through comparatively fewer disciplinary actions. 2021 currently represents the high-water mark of FINRA disciplinary actions in recent years, totaling 569 actions. In 2023, FINRA initiated just 453 enforcement and disciplinary actions. This was the fewest number of disciplinary actions initiated by FINRA in the preceding decade and a stark contrast to FINRA’s disciplinary efforts between 2014 and 2017 when FINRA brought over one thousand disciplinary actions annually. The considerable drop-off in FINRA disciplinary actions since 2017 seems to coincide with Robert Cook taking over as FINRA’s President and Chief Executive Officer. Cook joined FINRA in August 2016 with a primary goal of taking “a fresh look at” FINRA’s enforcement program. If you are a stockbroker or financial advisor who is concerned with the language on your Form U5, you should consult a knowledgeable FINRA Expungement Attorney, like the attorneys at Malecki Law, to determine whether you can bring an action to have the concerning language removed from your Central Registration Depository (CRD).

AI, Oh My – SEC Announces First Ever “AI Washing” Enforcement Actions

May 9, 2024 | Adam G. Schreck

On March 18, 2024, the Securities and Exchange Commission (the SEC) announced that it had settled charges against two registered investment advisers (RIAs) related to false and misleading representations about each RIA’s alleged use of artificial intelligence (AI) in effecting financial services, conduct which the SEC coined as “AI Washing.” In total, the SEC collected $400,000 in civil penalties from the firms, with Delphia (USA) Inc. (Delphia) agreeing to pay $225,000 and Global Predictions Inc. (Global Predictions) agreeing to pay $175,000. As AI increasingly takes over the mainstream in the coming years, investors must remain attentive to the representations RIAs and broker-dealers make about utilizing AI in the financial services they offer to public investors.

Delphia is primarily in the business of offering robo-advisory services to retail investors. “Robo-advisors” are typically algorithm driven platforms that offer investors automated investment advice based on data provided to the platform by the investor with very little, if any, human interaction. In touting its robo-advisory services to the public, Delphia represented that investor data was actively utilized to “train” and “power” its proprietary algorithms that was capable of making investment predictions up to “two years into the future.” In reality, the SEC found that Delphia never successfully implemented its investor data-driven algorithms and misrepresented its AI capabilities to the public. Notably, Delphia was also investigated by the SEC for identical conduct in 2021. If you are being investigated by the SEC, you need skilled Regulatory Lawyers in New York, like Malecki Law, to get you through the investigation.

Global Predictions offers retail investors non-discretionary investment advice, namely portfolio allocation recommendations, through its proprietary investment application PortfolioPilot and the use of proprietary algorithms. Global Predictions represented to the public that it was the “first regulated AI financial advisor” and that it actively utilized AI capabilities in the services offered to investors. After its investigation, the SEC determined that Global Predictions made false and misleading representations on its Form ADV, press releases, website, social media accounts, and paid testimonials about the company’s AI capabilities which Global Predictions was unable to substantiate. The SEC also determined that Global Predictions violated the SEC’s Amended Marketing Rule and failed to implement policies and procedures related to achieve compliance with the same. If you have made investment decisions based on AI-related misrepresentations made to you by your investment adviser or stockbroker, you should consult an experienced, AI-Securities Fraud Attorney, like the ones at New York’s Malecki Law.

Brokerage Firm JSC’s Supervisory Failures – What Not to Do

September 27, 2022 | Malecki Law Team

Brokerage firms owe its clients the duty to supervise its employees and personnel. This is a very important duty in the financial industry, as it ensures the associated persons under the brokerage firm’s umbrella are compliant with FINRA’s rules. Firms should maintain its duty to supervise, and ensure that it has adequate procedures in place to prevent any potential misconduct that would be harmful to its clients. If your brokerage firm had inadequate supervisory procedures in place, the firm may be subject to failure to supervise claims. You need a New York Securities Industry Lawyer like the lawyers at Malecki Law.

A faulty compliance system can rise to the level of a failure to supervise. Broker-dealer Joseph Stone Capital (JSC) apparently dealt with exactly that. FINRA found that the firm’s compliance system had been insufficient in supervising its brokers, from January 2015 through June 2020. Specifically, JSC received exception reports that revealed potential excessive trading red flags. However, JSC failed to further investigate or prevent such activity.

To prevent this problem from occurring, a JSC supervisor responsible for reviewing the exception reports should have reviewed the clearing firm’s exception report daily. That supervisor would have discovered the possibility of excessive trading. If your brokerage firm failed to further investigate or prevent misconduct like JSC, it may be prone to failure to supervise claims. You need a Regulatory Defense Law Firm in New York, like Malecki Law. Additionally, after discovering these excessive trades, management should have questioned the broker about this trading activity, instead of restricting commissions. Supervisors should have reviewed every trade confirmation in the accounts in question and evaluated whether the trades were solicited (where the broker recommended the trade) or unsolicited (where the client recommended the trade). If the confirmations stated “solicited”, then management could ask for the broker’s thought process for making these trades. This would have identified the crux of the issue more efficiently and would have led to a quicker resolution. One can argue that JSC should improve its compliance software, but the software was not truly at issue during this investigation. According to all evidence, the compliance software seemed to work. The FINRA Order shows that the problem truly stemmed from JSC’s supervisors’ failure to act accordingly to stop their brokers’ activities of excessive trading. If your brokerage firm failed to act accordingly when discovering potential broker misconduct, it may be susceptible to failure to supervise claims. You need a Regulatory Defense Attorney in New York, like the lawyers at Malecki Law. It is unclear how JSC’s compliance software works, but they could also look to incorporate artificial intelligence and machine learning to generate quicker and more accurate compliance reports.

Yes, It is Possible to Negotiate a Reduced Punishment with FINRA Enforcement

September 1, 2021 | Malecki Law Team

Being a financial professional – i.e., a registered representative (RR) – regulated by the Financial Industry Regulatory Authority (FINRA) is not easy. When misconduct is alleged against the RR in a complaint to FINRA, whether brought by a customer or the employing brokerage firm, the system that is set up to resolve such allegations and disputes generally treats the RR, at least initially, as “guilty until proven innocent.” Good luck finding a “neutral” fact-finder willing to listen; instead, you will often find an ambitious FINRA staffer, looking for another notch in his or her belt to help their stats and upward mobility. If and when FINRA decides to bring charges against the RR, it helps to have an attorney who can negotiate a reduced punishment against the RR.

To protect investors and market participants, RRs must abide by the securities laws and FINRA’s rules of conduct. But even when a financial professional follows those rules, every RR knows that they remain at the mercy of both customers and their firms, who, with little effort, whether fairly or unfairly, can very easily file a public complaint to put other customers or firms on notice about the RR.

If a customer files a complaint or arbitration against the RR, the complaint is reported to and logged on the RR’s public record of disclosure within the Central Registration Depository (CRD). Any person with Internet access can then view the pending allegations against the RR by visiting BrokerCheck.FINRA.org, where those allegations can additionally surface with a Google search.

I Received A Rule 8210 Notice From FINRA, What Is Going On?

March 24, 2020 | Malecki Law Team

As we have been saying in this space for many years, getting a Rule 8210 Notice from FINRA can be a jarring event. If you have received an 8210 notice, you should take it seriously, as well as immediate steps to develop your best course of action to comply with the request. An 8210 Notice is a subpoena from FINRA that is typically sent to registered representatives in connection with an informal inquiry that does not have to be reported on your form U4. When you first receive an 8210 notice, FINRA is likely trying to determine if there have been any violations of securities and/or industry rules and/or regulations. You should notify your compliance officer, as they will likely have already received a copy from FINRA, but being transparent is important.

It is important to meet with an attorney as soon as possible to determine the best ways in which to protect your interests during the process. All involved parties will not necessarily share the same interests, i.e., your firm and/or supervisor may have their own self-preservation interests. As part of the 8210 notice, you will be required to answer a list of questions (interrogatories) and produce sometimes a wide range of documents, both business and personal. The attorneys at Malecki Law are experienced in defending FINRA registered representatives and firms in FINRA disciplinary matters and can work with you in responding to interrogatories and assist you with your document production using state of the art electronic discovery tools.

In working with your attorney to respond to interrogatories and produce documents you should also start to prepare for a potential “on the record” interview (or “OTR” for short). OTRs before FINRA involve sitting in a conference room with investigators and answering their questions under oath. You should have your attorney prepare and accompany you to an OTR. While not all cases involve an OTR, many do. Experienced counsel will know the best way to couch what happened with the right language and explanation. Furthermore, it is important to identify and explain mitigating circumstances as soon as possible before enforcement decisions are made.

Why should I give the SEC everything they have requested?

February 10, 2020 | Malecki Law Team

Receiving a subpoena from the Securities and Exchange Commission (SEC) is a serious matter as is the associated document production most SEC subpoenas call for. Not only do most all SEC subpoenas require the production of vast amounts of documents, electronic files and data, the manner in which the SEC strictly requires production (see here for SEC data delivery standards) can be confusing for most, especially those not familiar with electronic discovery. Our securities regulatory attorneys frequently assist clients with examining, gathering and producing responsive documents and data for production in a format accepted by the SEC. Our securities regulatory attorneys utilize state of the art electronic discovery software and tools that reduce both the amount of time required of you and the billable hour.

All the documents and electronic data called for by the subpoena may seem overwhelming, however, ensuring that your production is both completely responsive and delivered in compliance with the SEC data delivery standards is one of the only ways in which you will be able to help the investigation proceed quicker to a final resolution. Often an issue for clients is the seemingly broad wording of SEC subpoenas, our securities regulatory attorneys are practiced in helping clients better understand what items are being sought by the SEC. Thus, allowing you to limit your time spent searching for documents and data. A responsive and compliant production also limits the amount times that you and/or your attorney will need to spend in working with the SEC. It is important to turn off any auto-delete functions that you may have in place to preserve your data and documents and DO NOT destroy anything. Not only will the destruction of any documents complicate your matter you may also face an obstruction charge.

It is imperative that you carefully comply in a timely manner with an SEC subpoena. The SEC can enforce a subpoena if you fail to comply with what the subpoena calls for and a failure to comply with court orders could result in contempt charges. Our securities regulatory attorneys are often able to negotiate the scope and timing of productions, including an extension of time for clients document production and testimony (if called for).It is also important that your response to the subpoena includes any legal objections that you may be entitled to. Remember, your response does not end the process. The SEC may consider your Subpoena response for weeks or months before they decide whether further investigation is necessary.

FINRA’s 2019 Risk Monitoring and Examination Priorities Letter

January 31, 2019 | Malecki Law Team

Financial professionals handling compliance keep abreast with changes in the regulatory landscape to effectively allocate resources. At the start of each year, regulatory agencies Financial Industry Regulatory Authority and the Securities and Exchange Commission publish their priorities. FINRA’s recently released Risk Monitoring and Examination Priorities Letter states emerging issues as well as ongoing concerns for the upcoming year. In an introductory note, Robert Cook explains that this year’s letter more broadly relays FINRA’s priorities for risk monitoring with a more pronounced focus on new issues. Firms can use the information contained within this letter to ensure that their compliance, supervisory and risk management programs reach FINRA’s standards. Distinct from earlier times, the FINRA letter focuses on explaining new issues and risk analysis.

The main new issues on the regulatory agency’s radar are the firm’s involvement with online distribution platforms, fixed income mark-up disclosure, and regulatory technology. Specifically, FINRA is concerned with how firms meet AML requirements, supervise communications with the public and conduct suitability analysis when involved with the distribution of securities on online distribution platforms. FINRA plans to evaluate the risks of excessive or undisclosed compensation arrangements between firms and issuers for offerings exempt from registration under Regulation A. Furthermore, FINRA intends to assess how firms handle risks with sales of offerings under Regulation D to non-accredited investors. FINRA expects firms to follow FINRA rule 2232 and MSRB Rule G-15 to comply with mark-up or mark-down disclosure obligations on fixed income transactions. As more firms use regulatory technology for compliance, FINRA plans to examine the efficiency and risks involved.

While this year’s letter pays more mind to new issues, FINRA briefly restates ongoing problems that have already been named as top priorities. Notably, FINRA mentions suitability determinations, outside businesses activities, and private securities transactions; private placements; data quality and governance; communications with the public; trade and order reporting; anti-money laundering (AML); net capital and consumer protection; best execution; fraud; insider trading and market manipulation; record keeping, risk management and supervision related to these and other areas. As per usual, FINRA will be mindful of how firms supervise and respond to associated persons with flawed disciplinary records. In the rest of the letter, FINRA categorizes the other concerns into sales practice risks, operational risks, market risks, and financial risks.

What is the Difference Between a SEC Subpoena and a FINRA 8210 Request?

December 12, 2018 | Malecki Law Team

At some point in their careers, many financial professionals will find themselves on the receiving end of a subpoena from Securities and Exchange Commission (“SEC”) or a Financial Industry National Regulatory Authority (“FINRA”) 8210 Request. The receipt of such documents signifies the regulatory or self-regulatory agencies’ request for information and/or documents in relation to an investigation of a potential securities laws violation. While the Securities and Exchange Commission will formally issue a subpoena, FINRA sends parties the equivalent inquiry letter, often referred to as an “8210 Request.” Both entities can request the receipt of a wide range of information and a high number of documents within a short amount of time. Furthermore, recipients who do choose not to respond to these critical requests honestly could ruin their careers and lives. While the SEC subpoena and FINRA 8210 request may share some similarities, and as we have explained in this space before, there are many differences based on the powers allotted to the respective regulatory agencies.

The Securities and Exchange Commission is a federal government regulatory agency entrusted to develop national regulations and enforce federal laws. Upon reasonable suspicion of securities laws violations, the SEC can issue a subpoena to anyone. Meanwhile, FINRA is not an official government entity, but rather the security industry’s self-regulated membership organization. FINRA has the authority to request documents, information, and testimony from those under its’ jurisdiction in a FINRA 8210 letter. Both the SEC and FINRA run a similar on-the-record “OTR” interview, with the option of an attorney present in the event of a testimony request. However, the SEC offers more response flexibility, protections under the Fifth Amendment and investigation information access in comparison with FINRA.

In the face of a potential securities law violation, the SEC will often send subpoenas to the targets as well as any potential witnesses with information. A SEC subpoena can demand documents (duces tecum) or oral testimony (ad testifcandum) without including context. The SEC can start an investigation by presenting their suspicions in a formal order of investigation. Chiefly, a former SEC Enforcement attorney, John Reed Stalk alleges that there is a “low standard” of cause needed for approved subpoena issuance. The formal order of investigation mainly contains information regarding the scope and possible subjects of the investigation. Subpoenaed parties and their attorneys can request the order.

Brokerages Are Making Brokers More Powerful: How Will That Effect The Securities Industry?

April 4, 2017 | Malecki Law Team

As reported in the Wall Street Journal, there has been a recent trend at big brokerages of shifting the power from the headquarters to brokers and branch managers. Apparently big brokerages like Bank Of America, UBS Group, and Merrill Lynch are “unleashing” their brokers and moving power closer to the brokers and their managers, both to keep brokers from leaving their firms and to increase revenues.

These modifications come in the wake of declining revenues and broker exoduses several big brokerages have experienced after the financial crisis. They have also witnessed that brokers who dislike or disagree with their managers and find them unhelpful tend to leave the brokerages more easily. The big brokerages have had to deal with rising regulatory costs and competing with an increasing number of independent advisers. According to research conducted by consulting groups, the registered investment adviser model is more successful as it is a smaller and more tightly integrated groups. Taking a cue from that, the zillion dollar brokerages are making changes aimed at empowering, training and giving their brokers more control over day to day decisions over clients, growth, and resource allocation. Merrill Lynch has plans to restructure the brokerage leadership, emphasize more on productivity and training, and reduce the number of divisions. UBS also made similar changes last year.

There are plans underway to also automate investment advisory and make use of robos to cater to a younger clientele so that the brokers can be freed up to deal with high net worth clients. All in all, this gradual shift is geared towards taking things back to how they were before the financial crisis hit, when the field agents and managers had more autonomy to structure their branches, price and sell services, be less accountable to corporate headquarters, hold more power and sway.