Q: An advisor I supervise was recently involved in a disciplinary action for improper mutual fund switching. I’ve now been brought up on a failure to supervise claim. I’m not sure what I could have done differently, but maybe you can give me some guidance? -J. N., Florida
A: FINRA Rule 3110(a) requires each member to "establish and maintain a system to supervise the activities of each associated person that is reasonably designed to achieve compliance with applicable securities laws and regulations, and with applicable FINRA rules."
An individual supervisor may be held liable under Rule 3110(a) when he or she fails to provide reasonable supervision. But simply having those procedures in place is not enough. Generally speaking, when a supervisor is charged with a failure to supervise, it’s because he or she has failed to act on the so-called red flags the examiners felt were evidence of wrongdoing.
In your specific situation, for example, some red flags that could have alerted you to the problem include the number reports or alerts the switches might have generated; how many clients the advisor was putting into shares with up-front sales loads; the amount of commissions the advisor was generating; the nature and type of clients he or she had (i.e., elderly); and whether you saw any signed switch letters from clients.
Failure to take reasonable steps to follow up on these red flags will often result in FINRA finding you failed to reasonably supervise.
Q: I know an investment advisor who has a FINRA CRD number and is registered with the SEC. When an advisor is registered with both the SEC and FINRA, do both regulators conduct anti-money laundering exams on the advisor? Or does FINRA defer to The SEC? T. P., Arizona
A: FINRA would not conduct an AML exam of an RIA. FINRA is a self-regulatory organization that only examines member firms (aka Broker-Dealers). The CRD/IARD system is, in essence, one computerized database. So regardless of whether a firm is a B-D or an RIA, their assigned number will show up on both the Investment Adviser Registration Depository database and the Central Registration Depository database.
Although the phrase CRD number is meant to refer to B-Ds, and an IARD number is meant to refer to RIAs, the terms are often used interchangeably. When you look up an entity on either of those sites, they will generally show up in both places, so you have to look carefully to see if they are registered as a B-D or an RIA.
Unless the entity is dually registered as both an RIA and B-D, the websites will redirect you to either the IARD or CRD site, as appropriate, when you request a report of the firm. The reports those two sites generate are similar, but there are slight differences. So, for dually registered entities, you should pull both reports to make sure you have all the relevant information.
With that understanding, the CRD number an RIA may have does not necessarily mean it is subject to FINRA regulation, as it could actually be an IARD number and is just showing up on the FINRA BrokerCheck site because the site is pulling information from the same database.
Note that, while there are no AML rules yet for SEC-registered investment advisors, as a best practice, RIAs should have some sort of AML policy and procedure, even if it’s just to note that it relies on the B-D to perform a background check.
Alan J. Foxman is a contributing writer for On Wall Street, a partner in the law firm of Dew Foxman & Haugh and a senior consultant with National Compliance Services in Delray Beach, Fla.
- FINRA Sanctions 3 Brokers in Market Manipulation Case
- As Obama Winds Down, SEC Aims High
- LPL Must Pay Broker $630K After ‘Defamatory’ Letter Campaign