Securities Industry Commentator by Bill Singer Esq.

July 31, 2018

Former Owner of Sleep Study Businesses Convicted of Fraud Conspiracy (DOJ Press Release)
Hey, how are you? This is Bill Singer, Esq the publisher of the Blog and the Securities Industry Commentator, and I am writing directly to you. Pretty clever how I snuck this seemingly official looking bit of legal commentary in here, no? Now, to be clear, I don't refer to myself as Bill Singer "Esq" but you gotta admit the title makes me come off in a more impressive manner. I mean, you know, plain-old Bill Singer isn't as impressive as Bill Singer, Esq. In any event, I don't have anything to write about the sleep study business referenced in the DOJ Press Release, but if you're like me, your curiosity is going to get the better of you and you're going to click on the link to see how a former owner of a sleep study business got convicted of federal fraud conspiracy. Like what the hell is a sleep study anyway and, assuming there is such a thing, how do you turn that not just into a single business but into multiple businesses, and, afterwards, how do you wind up in the cross-hairs of the feds when all you're doing is charging someone for listening to folks snore? If you're like me and I don't think you are because I'm told that I'm an original but, just for argument's sake, let's say that you're somewhat like me, you may be wondering how much money is in the snooze biz. I mean, after all, it can't be big bucks, right? Boy, are you in for a shock. I'm thinking I should set up an LLC and start crowdfunding. Okay, okay, you're right, I should be more respectful of your time and I'm going to change my mind and give you a titillating extract from the DOJ Press Release:

According to the evidence presented at trial, Yi used her business bank accounts to purchase personal luxury goods and real estate that she nonetheless booked as business expenses. Those falsely booked purchases included a $25,000 Rolex watch, $10,500 in mink coats, several luxury vehicles and a $1.1 million home in Sterling, Virginia.  Yi also used the proceeds of her crimes to purchase five condominiums worth more than $2.8 million in McLean, Virginia; Chicago, Illinois; and Honolulu, Hawaii.  Yi used money that she falsely booked as payments for medical supplies and health insurance reimbursements to purchase land in Great Falls, Virginia. After a February 2014 search warrant was executed at her businesses, Yi and her husband formed a purported charity, and transferred assets into that foundation to protect them from law enforcement.

FINRA Requests Comment on Financial Technology Innovation in the Broker-Dealer Industry
(FINRA Special Notice July 30, 2018 / Comment Period Expires: October 12, 2018) As set forth in the "Summary" of the Special Notice [Ed: footnotes omitted]:

New financial technology innovations, commonly known as "fintech," can offer benefits for investors and the financial services industry, but can also present investor protection concerns where the safeguards of the securities laws are not respected. FINRA's discussions with representatives of the fintech industry and our member firms through our Innovation Outreach Initiative  have enabled us to better understand market participants' interest in efforts among regulators to create an environment supportive of fintech innovations that benefit investors and the capital markets. Moreover, we have received several requests to solicit feedback from the broader public regarding how FINRA may support fintech innovation consistent with our mission of investor protection and market integrity. In response to these requests, we are seeking comments on how FINRA can support fintech development consistent with this mission. In addition, we request specific comment on certain fintech areas, including the provision of data aggregation services, supervisory processes concerning the use of artificial intelligence, and the development of a taxonomy-based machine-readable rulebook
The Financial Industry Regulatory Authority has issued yet another "Notice" -- this time not merely a regular, normal, run-of-the-mill notice but, OMG!!!, a "Special Notice." Lemme stop here so that I can catch my breath because I am breathless, breathless with anticipation, I say. Just off the press, we have: FINRA Requests Comment on Financial Technology Innovation in the Broker-Dealer Industry 
(FINRA Special Notice July 30, 2018 / Comment Period Expires: October 12, 2018).

CFTC issued an Order filing and simultaneously settling charges against Futures Commission Merchant R.J. O'Brien & Associates LLC (RJO).  The Order asserts that between at least January 2013 and January 2014, RJO failed to diligently supervise its employees to ensure that they properly processed bunched orders allocated post-execution, and that they appropriately monitored post-execution trade allocations for unusual activity -- which delayed the detection of a post-execution trade allocation scheme carried out by an RJO client (Client). Further, the Order asserts that cited supervisory failures by RJO violated a 2013 Commission Order, in which the firm was charged with failure to supervise its employees in their processing of certain bunched orders, including the failure to employ adequate procedures to monitor, detect, and deter unusual activity concerning trades allocated post-execution.The CFTC Order requires RJO to pay a $600,000 civil monetary penalty and to cease and desist from further violations of the Commodity Exchange Act, as charged.READ the FULL TEXT CFTC Order

What's in a Name? Regulation Best Interest v. Fiduciary (Speech by SEC Commissioner Hester M. Peirce) A thoughtful and provocative bit of commentary and observation by SEC Commissioner Peirce. As always, whether Blog agrees or disagrees with a given perspective, we welcome those who prompt constructive dialog and those who further discourse in a credible fashion. We commend Commissioner Peirce's full speech to our readers and offer this extract as indicative of her concerns:

Never mind that it took many pages of regulation and lots of interpretation to explain what "fiduciary" meant in the new DOL iteration.  Never mind that even lawyers and financial professionals do not have a universal understanding of what the term means.  Never mind that the Commission felt it necessary, at the same time it proposed Regulation Best Interest, to propose an interpretive release "to address in one release and reaffirm - and in some cases clarify - certain aspects of the fiduciary duty that an investment adviser owes to its clients under section 206 of the Advisers Act."[14]  We may not have even gotten the interpretation right yet.  In fact, I take issue with one important aspect of the proposed interpretation of an adviser's fiduciary duty.  The Commission states that the duty of loyalty component of an adviser's fiduciary duty requires the adviser to acquire "informed consent" from its clients to any material conflict of interest that could affect the advisory relationship.[15]  However, as authority for this position the Commission cites, not a court decision or other weighty legal precedent, but an Instruction to Form ADV.[16]  An early commenter raised other issues with the proposed interpretation.[17]  In short, the term fiduciary duty is not easy to define even within the advisory context. 

The term "fiduciary" has become such an oft-repeated mantra that I worry it will have the perverse effect of harming investors.  Investors are told repeatedly that all they need to ask is one simple question about their financial professional: Are you a fiduciary?  Suggesting that a single word assures you that the person with whom you are dealing will serve you well dissuades investors from asking the questions they should ask before choosing a financial professional.  It provides a false sense of reassurance to retail investors.

The word "fiduciary" is so powerful that some people seem to be assessing our proposed Regulation Best Interest solely based on the absence of the word in the new standard.  If we are not calling the standard fiduciary, it must not be good, in the minds of some.  Instead, we used another term, but one that also gives me pause-"best interest." 

The term "best interest" may not be as old as "fiduciary," but it is not new either.  It has been bandied about Washington over the last decade as if it were an incantation that could cure all that is wrong in the retail investor space.[18]  Just as the word "fiduciary" seems to carry with it mystical medicinal powers, so too-in some quarters-the term "best interest" is apparently imbued with special healing abilities.

As with the fiduciary standard, however, one has to ask: regardless of how nice it sounds, what does "best interest" actually mean?  The Commission spent hundreds of pages describing the new "best interest" standard, but it is not clear that people understand it.  We have yet to receive many letters in our comment file, but some of the most vocal critics are the same people who said that the current "suitability" standard is insufficient because it allows broker‑dealers to place their own financial interests ahead of those of their customers.[19]  The Commission now has proposed to require that a broker-dealer when making a recommendation of any securities transaction or investment strategy involving securities to a retail customer act in the best interest of the retail customer at the time the recommendation is made, without placing the financial or other interest of the broker, dealer . . . ahead of the interest of the retail customer.[20] 

The critics remain unsatisfied, but the basis for their dissatisfaction seems to be that we have not used the favored "fiduciary" terminology. 

A bigger concern for me is that the best interest standard suffers from the same problem the fiduciary standard does-a term that is wonderful for marketing purposes, but potentially misleading for investors.  Just as "fiduciary" has been used to lull investors into not asking questions about their financial professional, so "best interest" runs the risk of becoming a term that encourages investors simply to rely on the fact that their best interest is being taken care of.  If we retain the term, we-as regulators-and you-as advisers and brokers-ought to make an effort to encourage investors to look beyond nice terms to the substance of what their financial professional is doing-or not doing-for them and how much she is charging.