Last year, in two high profile cases, the private regulator slapped huge fines against a small New York brokerage firm, David Lerner Associates, and an industry giant, Fidelity, stemming in part from allegations of improper marketing materials. This came after a record year for advertising-related FINRA fines in 2011 of $21.1 million, which had more than quadrupled in value from 2010, according to an annual FINRA sanctions survey published by the Atlanta law firm Sutherland Asbill & Brennan.
The rising level of fines and violations (the 45 cases in 2011 were nearly double the 24 in 2010) reflects an increasingly strident FINRA, which is eager to weed out misleading or inaccurate investor communications-particularly those that end up in front of retail clients.
In February FINRA began enforcing an elaborate set of new broker/advisor advertising guidelines that will expand the industry group's review procedures of public ad material and tack on more compliance checklists for banks, broker/dealers, insurance, mutual funds and other investment firms.
"It's a significant overhaul," says Morrison & Foerster partner Jay Baris, who chairs the law firm's investment management practice. "It's going to require firms to beef up their compliance and supervision policies, to be sure."
The changes to FINRA's advertising regulations are mainly intended to streamline existing compliance and review procedures, particularly for submitting retail-targeted materials to the trade group-formerly known as the National Association of Securities Dealers. For example, rather than requiring firms to classify the material as "advertising," "sales literature" or one of four other categories (and then determining whether the target audience would be retail or institutional), the new rules have narrowed the selection to just three groupings: retail communications, institutional communications or correspondence. Firms normally are exempt from submitting institutional investor literature for review given client industry-knowledge levels.
But the rule changes also include new guidelines governing language, disclosures and the distribution of promotional materials. For institutions, one important change may be the "reason to believe" doctrine: if a bank or other firm thinks any marketing materials intended for institutional investors or internal use could end up in a sales pitch to a retail customer, even by mistake, then it must treat the material as a retail public communication-meaning it has to be reviewed and approved by a FINRA-registered principal and reported to FINRA. In some cases, particularly for new FINRA member firms, their retail literature must be submitted to FINRA for approval at least 10 business days prior to first use.
Because of the potential for material not meant for retail users to wind up in front of mom-and-pop investors, this means firms will have to closely track the use of their materials by employees and by independent sales agents.
Brian Rubin, a partner at Sutherland, says FINRA examiners will be keen to monitor internal training programs to make sure that customer representatives are equipped to provide the true nature of the risks and rewards attached to the financial products they are selling.
Regulatory experts expect to see continued vigilance against potentially misleading wording or graphics in materials. Last year in the Lerner settlement, FINRA alleged that the firm had made false claims about the investment returns, market value and performance of real estate-investment trusts. Some of the red flags that caught the examiners' attention were the characterization of the REITS as a "fabulous cash cow" and a "goldmine" that promised investors a "windfall."
Mark Catone, senior compliance director for technology at National Regulatory Services, a compliance services vendor owned by Skokie, Ill.-based BankersAccuity, notes that FINRA ad regulations restrict firms from putting such blatant "get rich" language in promotional material. That includes pictures of treasure chests-yes, even pictures of treasure chests-that could entice investors into believing their investments will bring them a pirate's booty. "It's an exaggerated illustration to kind of make a point," Catone says. "You cannot mislead in materials."
According to Morrison & Foerster, the new rules around retail communications also put restrictions on the use of investment companies' rankings and bond-mutual fund volatility ratings.
Financial firms, of course, will need to be equipped to monitor compliance with the new rules. National Regulatory Services recently enhanced the ad and communications module on its ComplianceMax platform so that compliance officers not only can follow what materials are handed over to FINRA for review, but also track revisions before the materials are sent out to market. Firms also can keep tabs on product claims made in social media outlets by employees or by third-party sellers.