Securities Industry Commentator by Bill Singer Esq

SEC Files Subpoena Enforcement Action Against Terraform Labs and Its CEO (SEC Release)

Justice Department Sues Uber for Overcharging People with Disabilities (DOJ Release)

South Bay Man Sentenced to Over 8 Years in Prison for Movie Investment Scam and for Fraudulently Selling House Bought with Illicit Proceeds (DOJ Release)

Whitefish man claiming to be former a CIA agent admits scheme to defraud investor of $2.3 million to fund bogus "off the books" rescue missions (DOJ Release)

Corvallis ex-lawyer sentenced to prison for defrauding investors in real estate investment scheme, evading income taxes (DOJ Release)

Management Consulting Firm Partner Charged In Insider Trading Scheme / Defendant Was a Lead Consulting Firm Partner Advising an Investment Bank on Its Acquisition of GreenSky, Inc. (DOJ Release)

SEC Charges Partner at Global Consulting Firm With Insider Trading (SEC Release)

Queens Man Convicted of Securities and Wire Fraud Conspiracies Relating to the Foreign Exchange Market / Defendant's Scheme Targeted the Korean-American Community in Queens (DOJ Release)

SEC Brings Charges in Manipulative Free-Trading Penny Stock Scheme (SEC Release)

SEC Obtains Court Order to Enforce Investigative Subpoena for Testimony

Registration of Two Digital Tokens Halted (SEC Release)

SEC Awards Over $15 Million to Two Whistleblowers
Order Determining Whistleblower Award Claims

The Lessons of Structured Data by SEC Commissioner Caroline A. Crenshaw

A Call to Action: Recommendations for Complying with Reg BI (Remarks at the ALI CLE 2021 Conference on Life Insurance Company Products by SEC Commissioner Allison Herren Lee)

Aegis Capital Censured and Fined $1.05 Million by FINRA and Ordered to Pay $1.7 Million in Restitution and Undertake Supervisory Review

In the Matter of Aegis Capital Corp., Respondent (FINRA AWC)

Aegis Capital Branch Owner/Manager and Branch Supervisor Fined, Suspended, and Ordered to Undertake Continuing Education for Supervisory Lapses

In the Matter of Joseph Michael Giordano and Roberto Birardi, Respondents,(FINRA AWC)

FINRA Fines and Suspends Rep for Untimely Disclosure of Tax Lien

In the Matter of Jose Luis Batalla, Respondent (FINRA AWC)

FINRA Fines and Suspends Rep for Forging Customer Signature on Insurance Application

In the Matter of Andrew Timothy Durham, Respondent (FINRA AWC)

FINRA Fines and Suspends Rep for Outside Securities Account

In the Matter of Garrett Manning, Respondent (FINRA AWC)

FINRA Takes Victory Lapse in Aegis Capital Regulatory Settlement (BrokeAndBroker.com Blog)

There's Something Happening Here (at a FINRA Arbitration ) But What It Is Ain't Exactly Clear (BrokeAndBroker.com Blog)

has reason to believe that Terraform Labs and Kwon participated in the creation, promotion, and offer to sell mAssets and MIR tokens to U.S. investors. As stated in the filing, SEC staff served both Terraform Labs and Kwon with investigative subpoenas requiring the production of certain documents and compelling Kwon's testimony. According to the filing, however, despite numerous attempts to negotiate with counsel, Terraform Labs and Kwon have refused to produce any documents and Kwon has failed to comply with the testimonial obligations.

In April 2016, Uber began charging passengers wait time fees in a number of cities, eventually expanding the policy nationwide. Wait time fees start two minutes after the Uber car arrives at the pickup location and are charged until the car begins its trip.

The department's complaint alleges that Uber violates the ADA by failing to reasonably modify its wait time fee policy for passengers who, because of disability, need more than two minutes to get in an Uber car. Passengers with disabilities may need additional time to enter a car for various reasons. A passenger may, for example, use a wheelchair or walker that needs to be broken down and stored in the car. Or a passenger who is blind may need additional time to safely walk from the pickup location to the car itself. The department's lawsuit alleges that, even when Uber is aware that a passenger's need for additional time is clearly disability-based, Uber starts charging a wait time fee at the two-minute mark.   

The lawsuit seeks relief from the court, including ordering Uber to stop discriminating against individuals with disabilities. Additionally, the department asks the court to order Uber to modify its wait time fee policy to comply with the ADA; train its staff and drivers on the ADA; pay money damages to people subjected to the illegal wait time fees; and pay a civil penalty to vindicate the public's interest in eliminating disability discrimination.

SIDE BAR: If you believe you have been a victim of disability discrimination by Uber because you, or someone you were traveling with, were charged wait time fees, please contact 833-591-0425 (toll-free), 202-305-6786, or send an email to Uber.Fee@usdoj.gov.

Bill Singer's Comment: I really want to compliment DOJ for bringing this case. It involves an issue that may not be immediately apparent to the riding public, and, frankly, it may also involves aspects of a scenario that never quite "dawned' on Uber. I'm willing to give Uber some benefit of the doubt; notwithstanding, DOJ has raised valid concerns and I truly hope that Uber settles the case in a reasonable manner that best serves the disabled community.

Joiner used fake documents and forged signatures to raise millions of dollars from foreign investment firms based in South Korea and China for a movie project he said would be called "Legends" and would depict American folklore icons such as Paul Bunyan and John Henry. But Joiner's "representations proved to be as fictitious as the legendary figures his film was supposed to depict," prosecutors wrote in a sentencing memo filed with the court.

Joiner, who operated a company called Dark Planet Pictures, LLC, defrauded Korea Investment Global Contents Fund, a South Korean investment fund whose assets are managed by Korean Investment Partners Co. Ltd., which suffered $8 million in losses. Joiner also defrauded a Chinese investment firm called Star Century Pictures Co. Ltd., and its affiliate PGA Yungpark Capital Ltd., which invested $6 million into "Legends."

As part of the scheme, Joiner falsely told the investors that Netflix had agreed to distribute the picture, a claim Joiner supported with a bogus distribution agreement that contained the forged signature of a Netflix executive. Joiner subsequently told the investors that he had terminated the distribution agreement with Netflix and had secured a new agreement with Amblin Partners, all of which was false.

Approximately $5.2 million of victim investors' money was used to purchase Joiner's Manhattan Beach residence and another $4.3 million was transferred to a bank account held by Joiner that may be linked to developing an unrelated film. Prosecutors noted in their sentencing memo that, while misappropriating the victim investors' money, Joiner "continued to dissemble, concocting tales of contract negotiations with director Guillermo del Toro and a new distribution agreement with Amblin Partners in an effort to lull his victims into complacency."

After signing his plea agreement but before he entered his guilty plea in this case, Joiner in October 2019 sold his Manhattan Beach house he had purchased with the proceeds of his fraud. Before doing so, he fraudulently removed the liens his victims had placed on the house by filing documents bearing the forged signatures of attorneys who represented the victims. Caught again, Joiner entered an additional guilty plea to wire fraud in December 2019.

As part of the case, the government seized $5,572,581 from accounts belonging to Joiner, $4 million of which has already been returned to KIGCF.

[I]n the spring of 2013, Marshall began working for the victim, identified as John Doe, in Montana. Marshall convinced Doe that he was a former CIA agent and a former member of an elite Force Reconnaissance unit in the U.S. Marine Corps who had engaged in covert missions around the world. In fact, Marshall was never affiliated with the CIA in any capacity and never served in an elite Force Reconnaissance unit in the Marine Corps. Marshall received an Other Than Honorable discharge from the Marine Corps Reserve in November 1999 after accumulating 82 absences from inactive duty training. 

Marshall asked Doe if he would fund "off the books" CIA-backed missions, which Marshall said would involve assault teams he would lead on rescue and other operations in foreign countries. Based on Marshall's false representations, Doe wired large sums of money, totaling about $2,355,000, to Marshall at least six times, all under the guise of funding missions for the CIA as described by Marshall. Doe first wired Marshall $400,000 in April 2013 for an "off the books" paramilitary mission to Mexico. Marshall asked Doe for money for more purported missions from October 2013 until March 2016, and Doe wired Marshall additional sums.

Marshall did not use the money from Doe for any missions, to Mexico or anywhere else. Instead, Marshall spent the money on personal expenses and loans and gifts to friends and family members. Marshall also failed to report money received from Doe in 2013 for two purported missions as income on his tax return, resulting in a tax evasion of $356,756.

[L]ords was a lawyer, who operated Eagles Landing Legal Services, PC, and a licensed realtor and general contractor, who operated Eagles Landing Construction, Inc. The construction company purported to develop real property and build homes. From 2011 to 2018, Lords defrauded 14 victims by convincing them to invest money in his construction company. Lords told the victims he would use the money to build homes, make monthly interest payments and repay the money after the homes were sold. Lords also said he would return the victims' money within 30 days of any request. Instead of using the money to fund construction projects, Lords used some of the new money to make interest payments to prior investors and lost the majority of the funds in the futures market. When some victims demanded their principal back, Lords admitted he lost more than $1 million in the futures market and did not have their money.

The government further alleged that Lords failed to declare $432,608 he received from several victims in 2015 as "other income" on his taxes, resulting in unpaid taxes of $152,734 for that year.

Between on or about November 2019 and on or about July 2020, and again between on or about April 2021 and on or about September 2021, the Investment Bank engaged the Consulting Firm to provide various consulting services related to its consideration of an acquisition of GreenSky and the post-acquisition integration of GreenSky.  DIKSHIT was one of the Consulting Firm partners leading these engagements.  In that role, he had access to material, nonpublic information, which he misappropriated and, in violation of the duties that he owed to the Investment Bank and the Consulting Firm, used to trade GreenSky call options. 

DIKSHIT engaged in this trading between on or about July 26, 2021, and on or about September 15, 2021 - at the same time he was leading the Consulting Firm team that was advising the Investment Bank about its potential acquisition of GreenSky.  At various times between on or about July 26, 2021, and on or about September 13, 2021, DIKSHIT purchased and sold relatively small numbers of GreenSky call options, which had expiration dates weeks or months from the time of purchase.  However, in the two days before the September 15, 2021, public announcement that the Investment Bank would be acquiring GreenSky, DIKSHIT sold all of these longer-dated GreenSky call options and purchased approximately 2,500 out-of-the-money GreenSky call options that were due to expire just a few days later, on September 17, 2021.  After the deal was announced, DIKSHIT sold these calls and realized profits of approximately $450,000.

[I]n the course of providing consulting services, Dikshit learned highly confidential information concerning The Goldman Sachs Group Inc.'s impending acquisition of the consumer loan fintech platform GreenSky Inc.  According to the SEC's complaint, in the days leading up to the acquisition announcement on Sept. 15, 2021, Dikshit used this information to purchase out-of-the-money GreenSky call options that were set to expire just days after the announcement.  The SEC's complaint further alleges that Dikshit violated his firm's policies by failing to pre-clear these options purchases, which he sold on the morning of the acquisition announcement for illicit profits totaling over $450,000.

[B]etween February 2012 and December 2013, Won conspired with co-defendant Tae Hung Kang and others in a scheme to defraud victims, who were largely members of New York City's Korean-American community, into investing in foreign exchange trading accounts and in their company, called ForexNPower.  The conspirators issued advertisements in Korean-language newspapers and on Korean-language radio stations claiming that ForexNPower had a secret algorithmic trading method used to trade in the foreign exchange market that guaranteed investors 10 percent monthly returns at no risk of loss.  In reality, ForexNPower had no successful trading method and all of their customer accounts suffered substantial losses.

The conspirators also induced investors to purchase stock issued by ForexNPower by falsely claiming that the invested funds would be used to expand the business to a new location in New Jersey or pooled and used to trade foreign currencies.  In truth, Won and his co-conspirators misappropriated a substantial portion of the funds, spending the remainder on, among other things, the fraudulent advertisements. 

The SEC alleges that, between 2017 and 2018, Fitchett and Robert Gandy abused the judicial system to obtain unrestricted or "free-trading" securities of two microcap issuers pursuant to Section 3(a)(10) of the Securities Act of 1933. This provision provides an exemption from registration when a company issues securities in exchange for one or more bona fide debts when the terms and conditions of the transaction are approved by a court.

The complaint alleges that the Section 3(a)(10) scheme worked as follows: first, Robert Gandy and Fitchett allegedly created fake documents to support fictitious debt CF3 purportedly purchased from creditors of two public issuers. Next, Robert Gandy and Fitchett allegedly caused CF3 to file fraudulent lawsuits against each issuer based on the false documents and fictitious debt. Then, CF3 allegedly filed with the court bogus settlement agreements and proposed judgments, which the court approved without further analysis. Robert Gandy and Fitchett then presented these judgments to the issuers' transfer agents, who issued them more than $7 million worth of unrestricted, free-trading shares.

In addition to the Section 3(a)(10) scheme, the complaint alleges that Robert Gandy and Fitchett fabricated backdated promissory notes that were convertible into unrestricted shares of the issuers' stock. According to the complaint, Chang and Givens-Gandy knowingly sold the notes to unwitting third parties, who exercised the conversion option and sold the shares into the public market. The defendants received more than $100,000 from these transactions.

[T]he SEC is investigating whether certain individuals, including Mr. Fauth and his brother-in-law, U.S. Senator Richard Burr of North Carolina, may have violated the antifraud provisions of the federal securities laws, including the STOCK Act, by engaging in unlawful insider trading. The filing states that the SEC's investigation shows that on February 13, 2020, Senator Burr sold more than $1.6 million worth of stock held in a brokerage account he owned jointly with his wife while in possession of potentially material nonpublic information concerning COVID-19 and its potential impact on the U.S. and global economies. The filing further states that, shortly after placing his trade, Senator Burr placed a call to Mr. Fauth, who one minute later placed a call to his own broker to sell certain stocks held in an account in his wife's name.

As stated in the filing, SEC staff served Fauth with an investigative subpoena in May 2020 seeking his testimony. According to the filing, however, Fauth failed to comply and provide investigative testimony, citing health concerns, while continuing to fully perform his job duties as Chair of the National Mediation Board, a federal agency.

[T]he Enforcement Division alleges that on Sept. 16, 2021, American CryptoFed filed a materially deficient and misleading registration form known as a Form 10, which purported to register two digital tokens issued by American CryptoFed - called the "Ducat" and "Locke" tokens - as equity securities.  The Enforcement Division alleges that the Form 10 failed to contain certain required information about the two tokens as well as about American CryptoFed's business, management, and financial condition, including audited financial statements.  The Enforcement Division further alleges that the Form 10 contains materially misleading statements and omissions, including inconsistent statements about whether the "Ducat" and "Locke" tokens are securities, and statements relating to American CryptoFed's purported intention to distribute (upon the effectiveness of its Form 10) its "Locke" tokens to the public using a Form S-8, which is a registration form used for securities offered to employees through employee benefit plans, without disclosing that the "Locke" tokens may not legally be distributed pursuant to a Form S-8.

While both whistleblowers provided substantial assistance to the staff in the Division of

Enforcement, Claimant 1's information was more significant, as it alerted Commission staff to the fraudulent scheme, prompting the opening of the investigation. Claimant 1's information also was more comprehensive, relating to the overall scheme, whereas Claimant 2's information was more limited in nature and had less of an impact on the success of the enforcement action. As a result, a Redacted percent ( ***%) award to Claimant 1, and a  ***percent  ( ***%) award to Claimant 2 appropriately reflects their respective levels of contribution to the Covered Action. 

Introduction

Thank you Mike [Schlanger] for that introduction, and thank you for inviting me to speak at this year's conference. I want to note at the outset that I appreciate all the work this organization does to support structured data, including enhancing the usefulness of the data in SEC filings. The work you do benefits the users of that data, including investors, academics, and of course, the SEC staff and other regulators. You have been vocal and energetic advocates for XBRL, and I appreciate that. So thank you.

And before I begin my remarks, I need to mention that the views I express today are my own and do not necessarily reflect the views of the Commission or its staff.

In putting together my remarks for today, I reflected on the history of XBRL and the SEC, including the series of decisions that the SEC made to require the use of structured data formats, and XBRL in particular, in data filed with us.

Our history with XBRL began when the Commission established a voluntary XBRL filing program for corporate financial statements in 2005. Then, in 2007, the voluntary program was expanded to permit mutual funds to submit their risk/return summary information as XBRL exhibits. These voluntary programs for operating companies and mutual funds were made mandatory in 2009.

The SEC followed with rules in 2009 requiring rating agencies to provide certain credit rating histories in XBRL on their websites. In 2018, the Commission adopted rules requiring operating company financial information and mutual fund risk/return summary information to be submitted in Inline XBRL, a specification of XBRL that is both human-readable and machine-readable. And in 2020, the Commission adopted rules that added Inline XBRL requirements for certain disclosures submitted by registered variable annuity and life insurance separate accounts, registered closed-end funds, and business development companies.[1]

Requiring entities to change their filing and disclosure practices is not costless, and at every point, we carefully considered the costs and benefits of imposing these requirements. Today, looking back at this history, I believe it is clear that implementing structured data requirements has been a success. While there are certainly areas where data quality could be improved, XBRL has made it easier and less costly to extract, filter, compare, and analyze the information in SEC filings. XBRL facilitates the comparison of a company's information across time periods, against other companies, and between data in SEC filings and other agency filings. It allows for faster and more sophisticated analysis by regulators, investors, and academics. This increased usability has benefits for investors of all types.

I gave a speech earlier this year pointing out some areas in which I believe there are gaps in the information available to the SEC and investors.[2] I believe one of the lessons of XBRL is that the Commission should not hesitate to take action to fill those gaps, in order to get data we need to fulfill our mission of protecting investors, maintaining fair, orderly, and efficient markets, and facilitating capital formation.

Now, turning to the theme of today's event, I want to talk a bit about what XBRL delivers for the SEC and investors, how we can all work together to ensure shared access to higher quality data, and what XBRL might be able to deliver in the future.

What Does XBRL Data Deliver?

The Commission's implementation of XBRL requirements has allowed EDGAR to provide machine-readable data that have improved transparency in a number of ways. For example, XBRL has enabled automatic processing and analysis by software tools, which lowers costs and offers more timely insights. Users can access better and more granular information about these data, like the accounting codifications and guidance associated with it. Machine-readable languages like XBRL and iXBRL allow machine learning and artificial intelligence programs to leverage both numeric and narrative disclosures.[3] It allows the automation of all manner of disclosure analysis - identifying what is and is not reported, identifying data quality errors, comparing results across data sets, performing other analytics, generating time series charting and benchmarking, and much more.

While this is all fairly technical, for me anyway, the bottom line is that it makes these data more useful. And we know that XBRL data are used by investors - institutional investors of course, but also retail investors, who rely on tools and analyses that are facilitated by structured data.[4] The SEC is, of course, a user of the data, and I know that later today you will hear more about some or our recent use cases. But we also know that XBRL data are used by other regulatory agencies, including the IRS, Treasury, and the Census Bureau, to name a few.[5] XBRL data are used in academic research,[6] and are also used by financial analysts,[7] news media,[8] data aggregators,[9] operating companies,[10] and a host of others.

All of this user activity adds up to more market transparency and more efficient markets. For example, since the implementation of the XBRL mandate, we have seen stock prices become more reflective of firm-specific disclosures;[11] we've seen increased quantitative disclosure from firms;[12] and we've seen decreased earnings smoothing.[13] It also adds up to fairer, more competitive markets. Research indicates that XBRL disclosures reduce the advantages enjoyed by insiders, relative to non-insiders,[14] as well as the advantages of locals relative to non-locals.[15]

Some research has indicated that the use of XBRL leads to more equal outcomes between large investors and analysts and small ones,[16] and reduces the advantages enjoyed by institutional investors as compared to individuals.[17] Research has also suggested that XBRL leads to a better-informed investing public, as a result of improved financial analysis.[18] We know that this is especially relevant to retail investors, who often rely on analysts and media to inform them about the markets.[19]

XBRL disclosures may also facilitate capital formation, as some academics have found that companies that use it enjoy a lower cost of capital.[20] This is particularly true for smaller companies, which tend to receive more analyst attention following XBRL adoption.[21] It also results in higher investment efficiency for companies,[22] and enables improved performance benchmarking and acquisition analysis.[23]

Finally, the SEC's use of the data facilitates better investor protection; our staff leverages structured data tools in enforcement, examinations, and policymaking.[24] And I believe you will be hearing more about that later today.

I know that was a bit of a laundry list, and thank you for bearing with me. Ultimately, the point I want to make is that, while there are costs associated with complying with the XBRL mandate, the benefits are well-documented and extensive. And that is why I feel very comfortable saying that the story of the XBRL mandate is a successful one.

How Can We Deliver Better Data?

However, while I believe XBRL data are delivering myriad benefits, there is room for improvement in terms of the quality and accuracy of the data. Some users have found material error rates in data tagged in our filings, including errors in tags that are likely to be crucially important to investors like Revenues, Net Income, and Assets, and scaling errors that can be impactful.[25]

Both filers and the SEC have roles to play in mitigating these errors. The primary responsibility lies with filers, of course, and there are many tools available to aid with the submission of high-quality, accurate data. For example, EDGAR provides validation warnings which flag data quality issues, such as the use of outdated tags.[26] When submitting filings to the Commission, filers should ensure that they address those warnings.

In addition, the organization hosting us today, XBRL US, provides data quality validation rules registrants can use before submitting filings.[27] Use of these is not required but can assist in identifying errors, and I would encourage filers to take advantage of this free resource. XBRL US also publishes information about which filings have data quality errors, as measured against their validation rules - that information is available to the public, and I would encourage filers to take a look.[28]

XBRL allows for the use of individualized, custom tags. Custom tags have informational value, when used appropriately, and can increase investor understanding. However, some filers may overuse these tags. Filers should make an effort to use standard tags, and only use custom tags when appropriate - that is, when no standard tag is applicable.[29]

The SEC's Office of Structured Disclosure publishes staff guidance and regular data quality reminders, that I encourage filers to review.[30] Recent alerts have flagged issues like scaling errors on public float data and incorrect period end dates. And of course, if filers or others have technical questions on structured data and data quality, they can always reach out to the Office of Structured Disclosure by email.[31]

As I noted earlier, data quality is primarily the responsibility of filers. However, there are things that the SEC can do to help, as well. In addition to the resources offered by the Office of Structured Disclosure that I just mentioned, the SEC staff has released public comment letters regarding deficiencies in XBRL filings. The SEC staff should utilize this tool as much as possible, to help highlight and address common errors. The SEC could also consider expanding the requirements for auditor assurance, to provide for more third-party verification and validation of tags.

Delivering More

Looking ahead, I want to briefly mention a few areas where I think XBRL can play a role in delivering even greater benefits to investors and the market.

In her remarks at this conference last year, my fellow Commissioner Allison Herren Lee noted that structured data could play a role in making disclosures of climate change and other ESG risks and impacts usable and comparable.[32]

Since then, we have requested comment on climate change disclosures in particular, and have heard from a number of commenters who support structuring that data.[33] I look forward to working with the staff in carefully considering those comments and the potential benefits.

Similarly, Commissioner Lee mentioned the potential benefits of using structured data in Form N-PX, which provides information about proxy voting by investment funds. Since then, we have re-proposed amendments to that form, including a requirement to report information in a structured data language.[34] Again, commenters have supported that potential requirement, and I look forward to working with the staff to consider potential approaches.[35]

Now, as I've discussed at length today, the potential benefits of tagging data are extensive. So we at the SEC should continue to investigate where else data structuring can improve our disclosure ecosystem. The tagging of narrative disclosures, even just block tagging,[36] could enable data users to more easily extract and compare non-structured disclosures, like management discussion and analysis, earnings reports, and executive compensation. This could be relevant in the context of ESG disclosures, SPAC disclosures, and elsewhere.

Finally, I would be remiss not to mention the potential benefits of incorporating the Legal Entity Identifier (LEI) into more of our forms and filings. As most of you undoubtedly know, the LEI is a code that provides a single, unique, international identifier for legal entities.[37] As such, it facilitates the reliable, consistent identification of entities within and across data sets.

Last year, the LEI in XBRL Working Group published an LEI XBRL taxonomy enabling its use in XBRL applications to unambiguously identify companies.[38] The inclusion of LEIs in XBRL data has the potential to increase the usefulness of these data in SEC filings in a number of ways - for example, consistently identifying relevant entities in supply chains, or linking information on an entity across multiple regulatory data sets.

While the SEC has taken steps to incorporate LEIs into our filings,[39] I believe we should continue to leverage their benefits by incorporating them into our forms and filings wherever it makes sense to do so. The ability to use LEIs in XBRL data only increases their potential utility for users of our data.

Conclusion

Before I conclude my remarks, I want to return to what I said earlier about reflecting on the lessons of XBRL, after nearly 15 years. As I've outlined today, I believe that, while there is always room for improvements, the story of XBRL and the SEC is a successful one. The Commission's decision to require the use of structured data in our filings has had a host of benefits for investors and the markets.

In the speech I gave earlier this year, I pointed out some areas in which I believe there are gaps in the information available to the SEC and investors.[40] And, I believe that a key lesson of the SEC's history with XBRL is that the Commission should not hesitate to act to ensure that we have the information we need to fulfill our mission.

The areas I identified for attention included private markets, trade and order data - specifically, the urgency of completing the Consolidated Audit Trail, or CAT - and investor testing of certain disclosures. In each of those areas, I think our experience with XBRL offers valuable lessons.

For example, with respect to private markets, I believe it should be a priority to act to finalize the changes the SEC proposed in 2013 to strengthen filing and disclosure requirements. This would provide some needed visibility into private issuers and offerings.

We should also take action to get the information we need about the effectiveness of Form CRS and the disclosures required under Regulation Best Interest, by engaging in investor testing of the actual forms and disclosures that investors receive in order to determine whether or not they are effective.

Finally, with respect to the CAT, I think it is vital to ensure that it reaches its full potential as a tool for understanding and analyzing the markets we regulate. The CAT operates pursuant to a National Market System plan, under which the national securities exchanges and FINRA share responsibility for its operation and administration. If that approach is not working, we should not hesitate to take whatever action may be necessary to accomplish the objective of a complete, accurate, and accessible source of market data, including further rulemaking, if needed.

With XBRL, and with all reporting and disclosure requirements, we need to be cognizant of the impact on market participants. However, as I've noted in the past, the lack of useful data has a cost as well.[41] In the case of XBRL and structured data formats more generally, the Commission has taken a number of actions over the years to ensure that investors, academics, the SEC staff and other regulators, and the public more generally can all benefit from the data filed with us.

While there is more work to be done, I believe our efforts to incorporate structured data formats and open-source identifiers into the data filed with us have been a success. I appreciate all the work of this organization in helping us get to where we are, and I look forward to working with you as we continue to use these technologies to improve transparency for investors and others.

Thank you so much, and I look forward to your questions.

= = = = =

[1] See Securities and Exchange Commission, Structured Disclosure at the SEC: History and Rulemaking (May 21, 2020).

[2] Caroline Crenshaw, Mind the (Data) Gaps (May 14, 2021).

[3] See, e.g., Baranes et al., Earning Movement Prediction Using Machine Learning-support Vector Machines (SVM) (2019), Journal of Management Information and Decision Sciences; Singh, Blockchain and XBRL: The Myth, CFA Institute (2020).

[4] See, e.g., Goldman Sachs Asset Management, First Take: From Flat to Down, ‘19 Pension Review (2020); Cong et al., Are XBRL Files Being Accessed? Evidence from the SEC EDGAR Log File Dataset, Journal of Information Systems (2018); Blankespoor, Elizabeth and deHaan, Ed and Marinovic, Ivan, Disclosure Processing Costs, Investors' Information Choice, and Equity Market Outcomes: A Review, Journal of Accounting & Economics (JAE), Forthcoming (January 2020).

[5] See, e.g., Toppan Merrill, 100% XBRL Coverage Has Transformed SEC Review and Enforcement (November 19, 2019); XBRL US, FDIC Reporting.

[6] See, e.g., Hoitash et al., Do Sell-Side Analysts' Qualifications Mitigate the Adverse Effects of Accounting Reporting Complexity?, SSRN (2019); Hoitash et al., An Input-Based Measure of Financial Statement Comparability, SSRN (2018); Henselmann et al. Content analysis of XBRL filings as an efficient supplement of bankruptcy prediction? Empirical evidence based on US GAAP annual reports, Working Papers in Accounting Valuation Auditing (2012).

[7] See, e.g., Morgan Stanley Research, Who's Using XBRL Data and Why: Case Studies (2017).

[8] See, e.g., Trentmann, Companies Adjust Earnings for Covid-19 Costs, but Are They Still a One-Time Expense? The Wall Street Journal (2020).

[9] See, e.g., XBRL US, How Third Party Data Providers Use Structured Data and Why; XBRL US, Financial Fundamentals Analysis - What Analysts Can Do with Structured Data (March 2016).

[10] See, e.g., Berkman, XBRL: What are the Benefits?, Financial Executives International (2019); Rao et al., Using XBRL and big data to improve decision-making, Financial Management (2020).

[11] See, e.g., Huang et al., Information Processing Costs and Stock Price Informativeness: Evidence from the XBRL Mandate, Australian Journal of Management (2020); Kim et al., Information‐Processing Costs and Breadth of Ownership, Contemp Account Res. (2019); Efendi et al., Do XBRL filings enhance informational efficiency? Early evidence from post-earnings announcement drift, Journal of Business Research (2014). 

[12] See Blankespoor, The Impact of Information Processing Costs on Firm Disclosure Choice: Evidence from the XBRL Mandate. Journal of Accounting Research (2019).

[13] See, e.g., Kim et al., Does XBRL Adoption Constrain Earnings Management? Early Evidence from Mandated U.S. Filers, Contemporary Accounting Research/Accepted Articles (2019).

[14] See Huang et al., Insider Profitability and Public Information: Evidence From the XBRL Mandate, SSRN (2019). Available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3455105 ; Zhu, The Effect of XBRL on Insider Trading Profitability, Erasmus Univeriteit Rotterdam (2018).

[15] See Li et al. (2020), The Impact of XBRL Adoption on Local Bias: Evidence from Mandated U.S. Filers, Journal of Accounting and Public Policy (2020).

[16] See, e.g., Bhattacharya et al., Leveling the Playing Field between Large and Small Institutions: Evidence from the SEC's XBRL Mandate, The Accounting Review (2018).

[17] See Zhu, The Effect of XBRL on Insider Trading Profitability, Erasmus Univeriteit Rotterdam (2018).

[18] See, e.g., Liu et al., XBRL's Impact on Analyst Forecast Behavior: An Empirical Study, Journal of Accounting and Public Policy (2014); Felo et al., Can XBRL detailed tagging of footnotes improve financial analysts' information environment?, International Journal of Accounting Information Systems (2018).

[19] See, e.g., Kim et al., Investor Sentiment, Stock Returns, and Analyst Recommendation Changes, SSRN (2019); Lawrence et al., Investor Demand for Sell-Side Research, The Accounting Review (2016); Kothari et al., The Effect of Disclosures by Management, Analysts, and Business Press on Cost of Capital, Return Volatility, and Analyst Forecasts: A Study Using Content Analysis, The Accounting Review (2009).

[20] See, e.g., Lai et al., XBRL adoption and cost of debt, International Journal of Accounting & Information Management (2015); Ra et al., XBRL Adoption, Information Asymmetry, Cost of Capital, and Reporting Lags, iBusiness (2018).

[21] See, e.g., Li et al., Does XBRL Adoption Reduce the Cost of Equity Capital?, SSRN (2012).

[22] See, e.g., Feng et al. Information processing costs and firms' investment efficiency: evidence from the SEC's XBRL mandate, SSRN (2020).

[23] See, e.g., Berkman, XBRL: What are the Benefits?, Financial Executives International (2019); Rao et al., Using XBRL and big data to improve decision-making, Financial Management (2020).

[24] See, e.g., Toppan Merrill, 100% XBRL Coverage Has Transformed SEC Review and Enforcement (November 19, 2019).

[25] See Calcbench, The Quality of XBRL Filings (2014) ("[T]here are a non-trivial number of errors in tags which are likely to be heavily used by analysts and investors (e.g., Revenues, Net Income, Assets, etc.)"); see also XBRL US, Aggregated Real-time Filing Errors.

[26] Securities and Exchange Commission, EDGAR XBRL Validation Warnings (June 2021).

[27] XBRL US, Approved Validation Rules (October 2021).

[28] XBRL US, Filing Results and Quality Checks.

[29] See17 CFR 232.405(c)(1)(iii)(B) ("An electronic filer must create and use a new special element if and only if an appropriate tag does not exist in the standard list of tags for reasons other than or in addition to an inappropriate standard label.") (emphasis added).

[30] Securities Exchange Commission, Staff Observations, Guidance, and Trends (October 2021).

[31] For technical questions on structured data and data quality, contact the Office of Structured Disclosure at Structureddata@sec.gov.

[32] Allison Herren Lee, The Promise of Structured Data: True Modernization of Disclosure Effectiveness (November 17, 2020).

[33] SEC.gov | Comments on Climate Change Disclosures

[34] See Enhanced Reporting of Proxy Votes by Registered Management Investment Companies; Reporting of Executive Compensation Votes by Institutional Investment Managers, Release Nos. 34-93169; IC-34389 (December 14, 2021).

[35] See https://www.sec.gov/comments/s7-11-21/s71121.htm

[36] See XBRL US, Comment letter re: Management's Discussion and Analysis, Selected Financial Data, and Supplementary Financial Information, File Number S7-01-20 (April 28, 2020).

[37] See Global Legal Entity Identifier Foundation (GLEIF), Introducing the Legal Entity Identifier.

[38] SeeXBRL,LEI Taxonomy finalized(July 3, 2020).

[39] See, e.g., Regulation SBSR - Reporting and Dissemination of Security-Based Swap Information, Release No. 34-74244 (Feb. 11, 2015), 80 FR 14439 (Mar. 19, 2015); Investment Company Reporting Modernization, Release No. 33-10231 (Oct. 13, 2016) 81 FR 81870 (Nov. 18, 2016).

[40] See Caroline Crenshaw, Mind the (Data) Gaps (May 14, 2021).

[41] Id.

Thank you, Steve [Stephen Roth] for that kind introduction. Before I begin, a reminder: the views I express today are my own and do not necessarily represent the views of my fellow Commissioners or the staff.

It's a pleasure to join you today to help kick off your 2021 Conference on Life Insurance Company Products. Your agenda over the next two days is comprehensive and touches on many of the important issues that matter to those who invest in these products. It's great to see so many individuals from the Commission's Divisions of Investment Management, Examinations, and Enforcement on the agenda. The variable insurance products offered and sold by those of you in this room are an important component in the retirement savings of many Americans. On-going dialogue between the Commission and the industry, particularly on issues such as disclosure, conflicts, and sales practices, helps us both to better serve investors.

In that spirit, I want to focus my remarks today on Regulation Best Interest.[1] As Chair Gensler has stated-and as I have expressed before-the Commission intends to work, both directly and together with FINRA and others, to ensure that Reg BI lives up to its name; that is, to ensure that investors receive not merely suitable recommendations, but recommendations that are truly in their best interest.[2] As you all know, the rule is largely principles-based, and its application should and will be flexible to account for evolution in the market and the needs of investors.[3] Why does this matter? Because, in addition to the many millions of Americans who have long invested their savings through retail brokerages, we are currently witnessing a substantial influx of new, less experienced investors relying on an increasingly high tech brokerage community to navigate the investment process.[4] A number of the largest brokerages are reporting substantial growth in account openings during 2020-by some measures exceeding 10 million new accounts in 2020 alone-and a decrease in the average customer age and account size.[5] Our focus on the needs of retail investors has never been more important.

As the Commission and its staff embark on a new fiscal year and examination cycle, I want to discuss two critical aspects of Reg BI that are relevant to today's audience. First is the scope of what constitutes a "recommendation" and the approach that the Commission should take in interpreting that term under Reg BI. And second is the way in which both the Commission and firms should approach conflicts of interest.

Recommendation: An Evergreen Term for the Evolving Broker-Dealer Landscape

In adopting Reg BI, the Commission sought to ensure that financial intermediaries act in the best interest of retail investors regardless of whether they engage a broker-dealer or an investment adviser. While an adviser's fiduciary obligation applies to the entirety of the advisory relationship, a broker-dealer's obligation under Reg BI applies only at the time that the broker-dealer or its associated person makes a recommendation to a retail customer.

Thus, firms should bring enhanced focus to whether a recommendation has occurred because that is what triggers the enhanced standard of care under Reg BI-and, once triggered, firms must comply with each of the specific component obligations: disclosure, care, conflict of interest, and compliance.[6] The Commission declined to adopt a bright line rule in Reg BI for what constitutes a recommendation, explaining that doing so "could result in a definition that is over inclusive, under inclusive, or both."[7] Instead, the Commission reiterated its belief that a principles-based approach, explicated by existing precedent and guidance, would provide the necessary clarity for determining whether a broker-dealer has made a recommendation.[8]

The Commission's reliance on existing precedent, however, does not mean that the concept of a recommendation is static or that it applies exclusively to facts and circumstances described in past pronouncements. To the contrary, the use of a principles-based framework for determining whether a recommendation has occurred ensures that the application of Reg BI can and will evolve with the broker-dealer community. As the landscape shifts, the Commission can continue to interpret and apply Reg BI in a manner that is both consistent with precedent and designed to protect investors in increasingly modernized markets.

As stated in the Adopting Release for Reg BI, "[f]actors considered in determining whether a recommendation has taken place include whether the communication 'reasonably could be viewed as a call to action' and 'reasonably would influence an investor to trade a particular security or group of securities.'"[9] Moreover, past Commission and FINRA guidance is clear that recommendations to engage in, for example, day trading would constitute a recommendation even if the communication did not mention particular securities.[10] And, as always, the Commission will evaluate the relevant facts and circumstances and the context in which a communication is made in determining whether a recommendation has occurred.[11] Consistent with the Commission's and FINRA's historical approach, those facts and circumstances may include the nature of the broker-dealer's customer base and whether-by reason of age, inexperience, lack of sophistication, or other factors-it may be more likely for the firm's communications to reasonably influence its customers' trading decisions.[12]

Broker-dealers should be thinking critically and carefully about the extent to which nascent practices in the industry may in fact, constitute recommendations. Emerging uses of technology present a clear example of an area that warrants close scrutiny, especially when such technologies are used to engage and communicate with retail customers in a way that is reasonably likely or designed to influence investment or trading behavior, even if such influence is subtle. It is also evident that, in an increasingly commission-free trading environment where broker-dealers generate substantial revenue from payment for order flow, incentives are shifting more and more from recommending particular securities to recommending day trading more broadly, irrespective of the securities traded.

As the Commission stated in adopting Reg BI, the broad scope of what constitutes a recommendation "appropriately recognizes that customers may rely on firms' and associated persons' investment expertise and knowledge, and therefore the broker-dealer should be responsible for [] recommendations, regardless of whether [they] result in transactions or generate transaction-based compensation."[13] And customers may especially rely on their broker's knowledge or expertise when the broker is employing technology to streamline their investing experience. The use of algorithms, prompts, machine-learning, or other forms of technology to generate these communications does not relieve a broker-dealer of its responsibilities under Reg BI. The question is whether these practices may reasonably be viewed as a "call to action" or whether they "reasonably would influence an investor to trade."[14]

Likewise, in light of the regulatory import of making a recommendation, broker-dealers should also reevaluate longstanding practices, such as those related to account opening, to determine whether Reg BI may apply. The Commission's recent experience with the Share Class Selection Disclosure Initiative and other similar cases may be instructive in this respect.[15] In those cases, investment advisers were causing clients to purchase and/or hold mutual fund share classes that were more expensive (but usually more lucrative for the adviser or its affiliates) than otherwise available share classes, including in the context of money market funds used as cash sweep vehicles.[16]

What lessons might be learned from this in the broker-dealer context? Compliance personnel should closely evaluate account opening procedures, to consider whether practices for selecting default account options or presenting or otherwise highlighting a subset of investment options might implicate Reg BI. Depending on the facts and circumstances, the use of a default investment or the presentation of a small subset of investment options on an account opening form may well constitute a recommendation under existing interpretations of that term.

So, let me conclude this section of my remarks with a recommendation of my own: when evaluating the ways in which Reg BI applies to your business, think broadly about your communications with customers-no matter the form-to evaluate whether they might be recommendations.

Conflicts of Interest and Mitigation: An Ounce of Prevention

In addition to the Commission's focus on broker-dealer communications and recommendations, we should continue to emphasize the importance of effective mitigation to address conflicts of interest under Reg BI, both at the firm level and for its associated persons.

By its terms, Reg BI does not expressly require the mitigation of all conflicts of interest. Instead, Reg BI's conflict of interest obligation requires that a broker-dealer "identify and at a minimum disclose" all conflicts of interest associated with recommendations.[17] In addition to prohibiting certain sales practices, the rule broadly requires mitigation in two circumstances: (1) when a conflict might cause an associated person to place their own interest ahead of the customer's; or (2) when limitations on the fund's product menu might cause the broker-dealer or its associated persons to place their own interest ahead of the customer's.[18]

Notwithstanding the focus on disclosure for conflicts of interest at the firm level, it is important to reiterate that Reg BI's overarching best interest obligation is not satisfied through disclosure alone.[19] That is, a broker-dealer that is subject to Reg BI has an affirmative obligation to make recommendations in its customers' best interest and cannot simply rely on disclosure to discharge that requirement.[20] Thus, in circumstances where mitigation may not be strictly required by the rule text, the absence of mitigation may well heighten the risk of a tainted recommendation that will violate Reg BI's care obligation.[21] This is especially true when, in light of the communication and other technologies discussed above, it is increasingly common for recommendations to come from the firm itself rather than, or in addition to, its associated persons. Firms should expect close scrutiny of recommendations made in the face of an unmitigated conflict.

Where mitigation is specifically called for by the rule text, the requirement necessarily demands steps beyond mere disclosure. The Commission was clear that disclosure alone will not sufficiently reduce the potential effect that certain conflicts may have on recommendations.[22] Broker-dealers must take steps to affirmatively reduce the potential effect of conflicts so they do not taint recommendations.[23] This means our Division of Examinations should focus on firms' efforts at mitigation to ensure that measures are reasonably designed and effective in protecting retail customers. This is also an area where it would be helpful for Exam staff to publish its findings about those practices that are-and are not-effective at achieving this outcome.

In thinking about mitigation, it may be helpful to consider the various contexts in which conflicts arise for a firm's representatives. Some are not affirmatively created by the firm, but rather are built into the products that a firm permits its representatives to recommend (e.g. some products pay higher commissions than others, or make revenue sharing payments when others do not). Some conflicts originate with the firms themselves (e.g. setting quotas, offering bonuses or other rewards, certain hiring incentives, payout grids, etc.). Firms must mitigate all of these conflicts, and have various options for doing so. However, a threshold question to ask about an incentive is whether it should be created or permitted at all. Sometimes the best mitigation is simply to avoid from the outset an inducement that might cause representatives to put their own interests ahead of their customers.

One final note worth mentioning here is something about which I know you are all well aware. The mitigation requirement in Reg BI represents a distinction from NAIC's model regulation for annuity sales.[24] That model, which was designed exclusively for the sale of insurance products, requires only disclosure of the producer's compensation, and explicitly excludes that compensation from the conflicts of interest that require mitigation.[25] Under Reg BI, which applies to the entire range of securities and includes variable insurance products, the Commission came to a different conclusion about the need for and benefits of mitigation. As states continue to adopt and implement the NAIC model, I encourage those of you in the securities and insurance industries to evaluate your policies and procedures to ensure they are consistent with both standards.

*          *          *

In sum, the Commission remains committed to ensuring that Reg BI elevates the standard of care beyond suitability and that investors receive recommendations that are in their best interest. As the industry continues to change, and as technology increasingly plays a vital role in communicating with and servicing clients, I encourage you to think broadly about when the rule is triggered and how best to deal with all manner of conflicts that arise when Reg BI applies. In that regard, I will leave you with a favorite quote from novelist and social reformer Upton Sinclair: "It is difficult to get a man to understand something when his salary depends on his not understanding."[26] The updated version of that quote, of course, would not be limited to just men. Nevertheless, its wisdom endures and bespeaks prudence and care in addressing conflicts of interest and ensuring that Reg BI lives up to its promise for America's retail investors. Thank you for having me today.

= = = = =

 

[1] See 17 CFR 240.15l-1 ("Reg BI").

[2] We must work to ensure that Reg BI lives up to its name, but we should also be prepared to consider changes to the standard if our experience through examinations and enforcement suggests that changes are warranted. Indeed, as the Commission stated at the time of Reg BI's adoption, "we will continue to monitor the effectiveness of Regulation Best Interest in achieving the Commissions goals." See Regulation Best Interest: The Broker-Dealer Standard of Conduct, Exchange Act Rel. No. 34-86031, 84 FR 33318 (July 12, 2019) ("Reg BI Adopting Release").

[3] See, e.g., id. at 33334 ("[C]ompliance with each of the specific component obligations of Regulation Best Interest, including the 'best interest' requirement in the Care Obligation, will be applied in a principles-based manner. This principles-based approach to determining what is in the 'best interest' is similar to an investment adviser's fiduciary duty, which has worked well for advisers' retail clients and our markets. As proposed, whether a broker-dealer has acted in the retail customer's best interest will turn on an objective assessment of the facts and circumstances of how the specific components of Regulation Best Interest are satisfied at the time that the recommendation is made . . . We understand that markets evolve and we encourage broker-dealers to have an open dialogue with the Commission and the Commission's staff as questions arise.").

[4] See Staff Report on Equity and Options Market Conditions in Early 2021 (Oct. 14, 2021) at 9-10.

[5] See id. at 9-10. See also New Army of Individual Investors Flexes Its Muscle, Wall St. J. (Dec. 30, 2020), https://www.wsj.com/articles/new-army-of-individual-investors-flexes-its-muscle-11609329600 (citing estimates that individual investors opened more than 10 million new brokerage accounts in 2020). 

[6] Reg BI Adopting Release, supra note 2, at 33333 ("The specific component obligations of Regulation Best Interest are mandatory, and failure to comply with any of the components would violate the General Obligation.").

[7] Id. at 33335.

[8] Id. at 33330.

[9] Id. at 33335 (internal quotations omitted).

[10] Id. at 33339. See also FINRA Regulatory Notice 12-55, Guidance on FINRA's Suitability Rule, at Q7 (Dec. 2012), https://www.finra.org/rules-guidance/notices/12-55 ("Rule 2111 states that the term "investment strategy" is to be interpreted 'broadly' . . . The 'investment strategy' language would apply to recommendations to customers to invest in more specific types of securities, such as high dividend companies or the 'Dogs of the Dow,' or in a market sector, regardless of whether the recommendations identify particular securities. It also would apply to recommendations to customers generally to use a bond ladder, day trading, 'liquefied home equity,' or margin strategy involving securities, irrespective of whether the recommendations mention particular securities.") (internal citations omitted).

[11] See Reg BI Adopting Release, supra note 2, at 3335 ("[I]n our view, the determination of whether a broker-dealer has made a recommendation that triggers application of Regulation Best Interest should turn on the facts and circumstances of the particular situation and therefore, whether a recommendation has taken place is not susceptible to a bright line definition."). See also FINRA Regulatory Notice 11-02 (Jan. 2011), https://www.finra.org/rules-guidance/notices/11-02 ("The determination of the existence of a recommendation has always been based on the facts and circumstances of the particular case . . . For instance, a communication's content, context and presentation are important aspects of the inquiry. The determination of whether a 'recommendation' has been made, moreover, is an objective rather than subjective inquiry. An important factor in this regard is whether-given its content, context and manner of presentation-a particular communication from a firm or associated person to a customer reasonably would be viewed as a suggestion that the customer take action or refrain from taking action regarding a security or investment strategy."); NASD, Notice to Members 01-23, Suitability Rule and Online Communications (Apr. 2021), https://www.finra.org/sites/default/files/NoticeDocument/p003887.pdf ("[T]he 'facts and circumstances' determination of whether a communication is a ‘recommendation' requires an analysis of the content, context, and presentation of the particular communication or set of communications. The determination of whether a 'recommendation' has been made, moreover, is an objective rather than a subjective inquiry. An important factor in this regard is whether-given its content, context, and manner of presentation-a particular communication from a broker/dealer to a customer reasonably would be viewed as a 'call to action,' or suggestion that the customer engage in a securities transaction. Members should bear in mind that an analysis of the content, context, and manner of presentation of a communication requires examination of the underlying substantive information transmitted to the customer and consideration of any other facts and circumstances...").

[12] See, e.g. Gordon Scott Venters, 51 S.E.C. 292 (Feb. 8, 1993) (observing, in finding (1) that an associated person made a recommendation; and (2) that the recommendation was unsuitable, that the associated person "aggressively promoted [a company's stock] to his unsophisticated customer and stating that "[a]t the very least, when [the associated person] learned about his customer's age and situation, he had a duty to abandon the promotion in which he was engaged") (emphasis added); F.J. Kaufman and Co. of Va., 50 S.E.C. 164 (Dec. 13, 1989) (rejecting associated person's claim not to have made a recommendation by pointing to, among other things, the fact that one of the relevant customers "had no options trading experience before she opened her first account" and that other customers had no "prior understanding of the margined buy-write strategy", and would not have engaged in the strategy absent the associated person's involvement"). See also Michael F. Siegel, Exchange Act Rel. No. 58737 (Oct. 6, 2008) (stating that, in evaluating whether a recommendation has occurred, "sophistication of the investor may be relevant, [but] sophistication alone does not mean that a communication is not a recommendation"); Michael F. Siegel, NASD, National Adjudicatory Counsel (May 11, 2007) (acknowledging that "customers' sophistication may sometimes affect the recommendation issue" and stating that "the discussion ... concerning the customers' sophistication and wealth pertains only to whether a recommendation was made"). Such an approach is also consistent with the Commission's focus on similar factors when evaluating the reasonableness of a broker-dealer's mitigation measures. See Reg BI Adopting Release, supra note 2, at 33391 ("Reasonably designed policies and procedures should include mitigation measures that depend on the nature and significance of the incentives provided to the associated person and a variety of factors related to a broker-dealer's business model (such as the size of the broker-dealer, retail customer base (e.g., diversity of investment experience and financial needs), and the complexity of the security or investment strategy involving securities that is being recommended), some of which may be weighed more heavily than others. For example, more stringent mitigation measures may be appropriate in situations where the characteristics of the retail customer base in general displays less understanding of the incentives associated with particular securities or investment strategies[.]")

[13] Reg BI Adopting Release, supra note 2, at 33339.

[14] Id. at 33335.

[15] See Securities and Exchange Commission, Division of Enforcement, Announcement: Share Class Selection Disclosure Initiative (Feb. 12, 2018), https://www.sec.gov/enforce/announcement/scsd-initiative ("SCSDI"). The SCSDI was a self-reporting initiative in which the Division of Enforcement agreed to recommend more favorable settlement conditions to investment advisers that self-reported (than those that did not) violations of the Advisers Act relating to practices involving mutual fund share class selection and related disclosures. As part of the initiative, the Division agreed to limit the charges to violations of Advisers Act Sections 206(2) and 207 for failure to disclose certain conflicts of interest; it also agreed not to recommend civil penalties. Self-reporting advisers generally settled to charges that they violated their duty of loyalty by failing to disclose the conflict of interest associated with recommending mutual fund share classes charging 12b-1 fees. Such fees, which investors are charged directly by the relevant mutual fund, are often paid to the adviser, its IARs, or an affiliated broker-dealer, thus creating an incentive for an adviser or broker-dealer to recommend those share classes. In many instances, advisers recommended the more expensive share class even when a less expensive share class of the same fund was available and presented a more favorable value to the client under the circumstances. For those advisers that did not self-report as part of the SCSDI, the Commission also brought a number of settled and litigated enforcement cases against advisers alleging, in addition to the charges included as part of the SCSDI, that advisers violated Section 206(2) by failing to seek best execution.

[16] See id. See also Jonathan Roberts Advisory Group, Inc., Advisers Act Rel. No. 5832 (Aug. 25, 2021) (finding that the adviser violated its duty to seek best execution related to cash sweep accounts by, among other things, causing its clients to purchase and/or hold share classes of money market funds that charged higher fees and paid revenue sharing to an unaffiliated broker-dealer even though other share classes of the same money market funds, which charged lower fees and did not pay revenue sharing, were available).

[17] 15 CFR 240.15l-1(a)(2)(iii)(A).

[18] See 15 CFR 15l-1(a)(2)(iii)(B) and (C). See also Reg BI Adopting Release, supra note 2, at 33326-27.

[19] Reg BI Adopting Release, supra note 2, at 33319 ("Regulation Best Interest establishes a standard of conduct under the Exchange Act that cannot be satisfied through disclosure alone").

[20] 15 CFR 240 15l-1(a)(2)(ii) (setting out Reg BI's so-called care obligation, which requires, among other things, that a broker-dealer or associated person exercise reasonable diligence, care, and skill to "have a reasonable basis to believe that the recommendation is in the best interest of a particular retail customer based on that retail customer's investment profile and the potential risks, rewards, and costs associated with the recommendation and does not place the financial or other interest of the broker, dealer, or such natural person ahead of the interest of the retail customer."). See also Reg BI Adopting Release, supra note 2, at 33441 ("Regulation Best Interest is not limited to disclosure; rather, the Disclosure Obligation is just one component of Regulation Best Interest that as a whole will enhance the efficiency of recommendations that broker-dealers provide to retail customers, help retail customers evaluate the recommendations received, and improve retail customer protection when receiving recommendations from broker-dealers. In particular, in addition to the Disclosure Obligation, both the Care Obligation and the Conflict of Interest Obligation, discussed below, are designed to promote more efficient investment decisions by imposing affirmative obligations on the broker-dealer that cannot be fulfilled through disclosure alone, regardless of whether the retail customer fully incorporates disclosed information into its investment decisions.").

[21] See Reg BI Adopting Release, supra note 2, at 33389 ("[W]e emphasize that pursuant to the overarching obligation, elimination of conflicts of interest is one method of addressing the conflict, in lieu of disclosure, which broker-dealers may find appropriate in certain circumstances even when not required by Regulation Best Interest.").

[22] Id. at 33390 (discussing firm-level conflicts in the context of the Conflict of Interest Obligation).

[23] Id. at 33390. See also id at 33391 ("By requiring that a broker-dealer establish policies and procedures reasonably designed to 'mitigate' these conflicts of interest, we mean the policies and procedures must be reasonably designed to reduce the potential effect such conflicts may have on a recommendation given to a retail customer.").

[24] See National Association of Insurance Commissioner (NAIC), Suitability in Annuity Transactions Model Regulation (#275) (Feb. 13, 2020).

[25] See id.

[26] Upton Sinclair, I, Candidate for Governor: And How I Got Licked (1935).

From July 2014 through December 2018, Aegis failed to establish, maintain, and enforce a supervisory system, including written supervisory procedures (WSPs), reasonably designed to achieve compliance with the suitability requirements of FINRA Rule 2111 as it pertains to excessive trading. As a result, Aegis failed to identify trading in hundreds of customer accounts that was potentially excessive and unsuitable, including trading conducted by eight Aegis registered representatives in the firm's Melville and Wall Street branches whose trading in the accounts of 31 firm customers resulted in an average annualized cost-to-equity ratio (or break-even point) of 71.6%, an average annualized turnover rate of 34.9, combined customer costs (including commissions, markups or markdowns, margin interest and fees) of more than $2.9 million, and cumulative losses of $4.6 million. 

Additionally, from July 2014 to June 2019, Aegis failed to establish, maintain, and enforce a supervisory system, including WSPs, reasonably designed to achieve compliance with the suitability requirements of FINRA Rule 2111 when selling leveraged, inverse, and inverse-leveraged Exchange-Traded Funds (Non-Traditional ETFs) to retail customers. As a result, Aegis failed to identify customers who purchased and held Non-Traditional ETFs for extended periods of time, or whose purchase was inconsistent with their recorded investment objective, risk tolerance or finances. 

By virtue of the foregoing, Aegis violated NASD Rule 3010 and FINRA Rules 3110 and 2010.

From July 2014 through December 2018, Giordano and Birardi failed to reasonably supervise six Aegis registered representatives who worked in the firm's Melville branch (the Aegis Representatives). As the designated supervisory principals, Giordano and Birardi were presented with but did not respond to multiple red flags identifying potentially excessive and unsuitable trading in customer accounts managed by the Aegis Representatives, including, among others, more than 700 exception reports generated by Aegis's clearing firm. 

As a result, the Aegis Representatives engaged in excessive and. unsuitable trading in at least 23 customer accounts, generating annualized turnover rates ranging from 4.2 to 96.3, annualized cost-to-equity ratios ranging from 21.3% to 164.6%, combined customer costs (including commissions, markups or markdowns, margin interest and fees) of more than $2.6 million, and cumulative losses of $4 million. 

By virtue of the foregoing, Giordano and Birardi violated NASD Rule 3010 and FINRA Rules 3110 and 2010.

In August 2017, Batalla received notice that the IRS had filed a tax lien against him in the amount of $188,016.01 on August 15, 2017. Although Batalla was required to disclose the tax lien via the filing of an amended Form U4 within thirty days of receiving notice of its existence, Batalla did not amend his Form U4 to disclose the lien until January 28, 2019. Batalla entered into a payment plan with the IRS, but to date, he has not satisfied the tax lien. 

Therefore, Batalla violated Article V, Section 2(c) of FINRA's By-Laws and FINRA Rules 1122 and 2010.

In February 2019, Durham completed and submitted an application for a life insurance policy issued by Allstate Financial's insurance affiliate, with a face value of $50,000, for a customer. For premium payments, Durham input his personal bank account information but falsely indicated the bank account belonged to the customer. Durham created a fake email address for the customer and forged the customer's electronic signature on the policy application. After Durham electronically submitted the application, Allstate Financial's insurance affiliate approved the customer's policy in February 2019. Durham never possessed the customer's permission or authority to sign the policy application on the customer's behalf. 

Durham started paying the monthly premiums on the customer's policy in February 2019 but stopped paying the monthly premiums in April 2020, at which point the policy lapsed. 

In approximately January 2017, prior to becoming registered with FINRA, Manning opened a securities account in his own name at a FINRA member firm. Manning did not seek written consent from FBL to maintain the outside securities account in March 2018, or at any other time. Manning also failed to notify the member firm where he held the outside securities account that he was associated with FBL. 

In July 2019, when Manning became associated with MML, he informed MML that he maintained an outside securities account at another member firm. Shortly thereafter, MML directed Manning to close the account. Despite the direction, Manning maintained the outside securities account until April 2021, when MML asked for confirmation that the account had been closed. Manning failed to notify the other member firm where he held the account that he was associated with MML. In addition, in June 2020, while registered through MML, Manning opened a second outside securities account at another member firm without obtaining MML's prior written consent. Manning, however, disclosed his association with MML to the firm where he held the second outside securities account. Manning did not disclose the second outside account to MML until February 2021, after FINRA inquired about his outside securities accounts. 

In 2018, while associated with FBL, and in 2019 and 2020, while associated with MML, Manning falsely attested on the firms' annual compliance questionnaires that he maintained no outside securities accounts. 

• Securities Industry Commentator
• Bill Singer