Pastore Representing a Large Investment Bank Wins at the Eighth Circuit

Pastore & Dailey won a complex securities and M&A appeal taken to the United States Court of Appeals for the Eighth Circuit arising from a derivative rights holder agreement and related investment banking engagement agreements. This matter was an appeal filed by Plaintiff-Appellant after Pastore & Dailey successfully defended this case in the United States District Court for the District of Nebraska.

Plaintiff-Appellants, who were shareholders to a company, brought suit against Pastore & Dailey’s client in the District Court seeking to invalidate investment banking fees owed to Pastore & Dailey’s client following a series of complex insurance corporate mergers, in which the company was acquired and merged with another company. In its appeal to the Eighth Circuit, Plaintiff-Appellants argued that the District Court erred in denying certain Post-Judgment motions made by Plaintiffs arguing their lack of standing. The Eighth Circuit affirmed the District Court ruling in Pastore & Dailey’s favor that Plaintiff-Appellants lacked standing.

Pastore & Dailey attorneys have vast experience arguing and defending matters in various federal courts across the country and are well-situated to handle similar claims involving complex contractual and investment banking issues.

Pastore & Dailey Wins Motion for Dismiss Against Texas Based Oil and Gas Company

Pastore & Dailey represented a New York plaintiff in connection with a dispute over services provided in association with the acquisition and management of various oil and gas properties in Abilene, Texas. In anticipation of this suit, Defendants wrongfully instituted an anticipatory action in the Federal District Court for the Northern District of Texas.

Pastore & Dailey submitted a Motion to Dismiss the Texas action based on the premise that the action was anticipatory of the New York Action and was an act of inequitable forum shopping. The Court found that “compelling circumstances” existed that favored the dismissal of the Texas action. Pastore & Dailey will now continue to represent the Plaintiff in his home forum of New York.

Pastore & Dailey Wins Jurisdictional Motion Involving Connecticut, Pennsylvania, and Texas

On July 23rd, 2019, Pastore and Dailey prevailed in a jurisdictional motion against a Texas defendant accused of participating in the theft of intellectual property, obtaining a ruling that denied the defendant’s motion to dismiss for want of jurisdiction. An evidentiary hearing has been scheduled to assess the jurisdictional claims of two other defendants connected to the alleged intellectual property theft, which involves the transfer of proprietary information between competing health food companies.

Pastore & Dailey Is Pleased to Welcome Allison “Alex” Frisbee and Christopher Kelly as Counsel to the Firm

Pastore & Dailey is pleased to welcome Allison “Alex” Frisbee and Christopher Kelly as Counsel to the Firm.

These additions build the Firm’s corporate investigations capabilities and further strengthened Pastore & Dailey’s  securities regulatory and corporate transactional practices.   Alex and Chris join an exceptionally talented and experienced group of attorneys in the securities and corporate practices, with experience at the SEC, NYSE, state attorney generals, AM Law 200 firms and  large wall street firms.

Alex Frisbee – At K&L Gates LLP in its Washington, DC office, Alex worked on corporate investigations, securities enforcement and white collar matters (including complex internal investigations), and represented clients before the SEC, FINRA and other regulatory bodies.  Prior to K&L Gates, Alex worked at the New York Stock Exchange in its Division of Enforcement (subsequently part of FINRA) and in the NYSE’s Office of General Counsel.  Alex has vast experience in securities regulatory matters working both as an investigator and attorney at the NYSE.   At KL Gates, she has drafted Wells Submissions, white papers, letters and other advocacy pieces to regulators on behalf of public and private companies, broker-dealers, investment companies, investment advisers, corporate officers, directors, and individuals. Alex is a graduate of Washington and Lee University School of Law and Davidson College.

Christopher Kelly – Chris has practiced corporate, securities, transactional, fund and banking law for over 30 years at the most sophisticated levels.  He has worked on a wide variety of complex transactions aggregating in value over $10 billion.  He has handled multi-billion-dollar mergers & acquisitions, asset deals, stock purchase and sale transactions, and public and private stock and debt offerings.  His securities offerings have included common stock, preferred stock, trust preferred, mortgage-backed securities, other asset-backed securities, medium-term notes and debentures.   Chris has extensive experience with fund formation (on-shore and off-shore), compliance and regulatory matters for hedge funds, private equity funds, banks, and other financial institutions, including compliance programs, compliance training, compliance testing, compliance manuals, AML/KYC, surveillance, valuations, business continuity plans, advertising and sales and trading.  He has served as general counsel and chief compliance officer of investment advisers and of a broker-dealer. Chris began his practice in New York with Skadden, Arps, Slate, Meagher & Flom.  He then served as a Partner at Silver, Freedman & Taff, a leading corporate/securities boutique representing banks and other financial institutions, before joining Proskauer Rose LLP as a Partner in its New York office.  He left Proskauer to pursue various entrepreneurial opportunities, and to now serve as Of Counsel to Pastore & Dailey LLC.  Chris is a graduate of the University of Virginia School of Law and graduated with High Honors from the University of Virginia prior to attending law school there.

SEC Proposes Regulation Best Interest for Brokers

On April 18, 2018, the SEC proposed “Regulation Best Interest,” which is the latest in a long and disputed line of proposed attempts by various governmental bodies to homogenize the duties owed by brokers and investment advisers to their respective clients. Professionals in the financial services industry and others should take note that they have until approximately July 23, 2018i to file a public comment on the proposed SEC rule, and investors should take this opportunity to educate themselves on the current differences between “brokers” and “investment advisers,” including the different standard of care that each owe their clients.


For decades, customers of the financial services industry have been confused by (if not outright unaware of) the different “standards of care” that their “brokers” and “investment advisers” have owed them.

On the one hand, “[a]n investment adviser is a fiduciary whose duty is to serve the best interests of its clients, including an obligation not to subordinate clients’ interests to its own. Included in the fiduciary standard are the duties of loyalty and care.”ii Investment advisers typically charge for their services via an annual fee assessed as a percentage of the “assets under management” (the so-called “AUM”) that the investment adviser “manages” for the client. The primary regulator of an investment adviser is either the SEC (usually for relatively larger investment advisers – i.e., those managing more than $100 million AUM) or a state securities commission (usually for relatively smaller investment advisers – i.e., those managing less than $100 million AUM).

On the other hand, brokers “generally must become members of FINRA” and are merely required to “deal fairly with their customers.”iii  FINRA Rule 2111 requires, in part, that a broker “must have a reasonable basis to believe that a recommended transaction or investment strategy involving a security or securities is suitable for the customer, based on the information obtained through the reasonable diligence of the [broker] to ascertain the customer’s investment profile” (the “suitability” standard).iv  Rather than a percentage of AUM, brokers’ compensation is typically derived from commissions they charge on each of the trades they execute for their clients. FINRA, a non-governmental organization, is the primary regulator for almost all brokers in the U.S.

At first blush, a layman retail client could easily be excused for struggling to understand the difference between the requirements of an investment adviser to “serve the best interests of its clients” and those of a broker to “deal fairly with their clients.” This confusion is exacerbated when a broker is also registered as an investment adviser, thus clouding what “hat” the advisor is wearing when dealing with a client.

Tortured Regulatory History

Regulator concern about this confusion has existed for decades.  In 2004, the SEC retained consultants to conduct focus group testing to ascertain, in part, how investors differentiate the roles, legal obligations, and  compensation between investment advisers and broker-dealers. The results were striking:

In general, [the focus] groups did not understand that the roles and legal obligations of investment advisers and broker-dealers were different. In particular, they were confused by the different titles (e.g., financial planner, financial advisor, financial consultant, broker-dealer, and investment adviser), and did not understand terms such as “fiduciary.”v

In 2006, the SEC engaged RAND to conduct a large-scale survey on household investment behavior, including whether investors understood the duties and obligations owed by investment advisers and broker-dealers to each of their clients. First, it should be noted, “RAND concluded that it was difficult for it to identify the business practices of investment advisers and broker-dealers with any certainty.”vi  Second, RAND surveyed 654 households (two-thirds of which were considered “experienced”) and conducted six focus groups, and reported that such participants –

…could not identify correctly the legal duties owed to investors with respect to the services and functions investment advisers and brokers performed. The primary view of investors was that the financial professional – regardless of whether the person was an investment adviser or a broker-dealer – was acting in the investor’s best interest.vii

In 2010, the Dodd-Frank Act mandated the SEC to conduct a study to evaluate, among other things, “Whether there are legal or regulatory gaps, shortcomings, or overlaps in legal or regulatory standards in the protection of retail customers relating to the standards of care for providing personalized investment advice about securities to retail customers that should be addressed by rule or statute,” and to consider ”whether retail customers understand or are confused by the differences in the standards of care that apply to broker-dealers and investment advisers.”viii A conclusion of that study was as follows:

[T]he Staff recommends the consideration of rulemakings that would apply expressly and uniformly to both broker-dealers and investment advisers, when providing personalized investment advice about securities to retail customers, a fiduciary standard no less stringent than currently applied to investment advisers under Advisers Act Sections 206(1) and (2).

In 2013, the SEC issued a “request for information” on the subject of a  potential “uniform fiduciary standard,”ix but never promulgated a rule after receiving more than 250 comment letters from “industry groups, individual market participants, and other interested persons[….]”x

Finally, on April 8, 2016, the U.S. Department of Labor adopted a new, expanded definition of “fiduciary” to include those who provide investment advice or recommendations for a fee or other compensation with respect to assets of an ERISA plan or IRA (in other words, certain “brokers”) (the “DOL Fiduciary Rule”). Many brokerage firms and others (such as insurance companies) made operational and licensing adjustments to prepare for the DOL Fiduciary Rule while various lawsuits were filed in attempts to invalidate the controversial rule. Most recently, the United States Court of Appeals for the Fifth Circuit vacated the DOL Fiduciary Rule on March 15, 2018.xi

“Suitability” Standard vs. “Fiduciary” Standard

The “suitability” standard of a broker is a far cry from the “fiduciary” standard of an investment adviser.  As the SEC has stated, “Like many principal-agent relationships, the relationship between a broker-dealer and an investor has inherent conflicts of interest, which may provide an incentive to a broker-dealer to seek to maximize its compensation at the expense of the investor it is advising.”xii  Put more bluntly, “there is no specific obligation under the Exchange Act that broker-dealers make recommendations that are in their customers’ best interest.”xiii

FINRA (including under its former name, NASD) has certainly striven to close that gap via its own interpretations and disciplinary proceedings, and has succeeded to a point.  Specifically, a number of SEC administrative rulings have confirmed FINRA’s interpretation of FINRA’s suitability rule as requiring a broker-dealer to make recommendations that are “consistent with his customers’ best interests” or are not “clearly contrary to the best interest of the customer.”xiv However, the SEC has highlighted that these interpretations are “not explicit requirement[s] of FINRA’s suitability rule.”xv

This lower duty of care for brokers (as opposed to investment advisers, who have a fiduciary duty) has had and continues to have purportedly large and definitive financial consequences for retail investors:

Conflicted advice causes substantial harm to investors. Just looking at retirement savers, estimates that investors lose between $57 million and $117 million every day due to conflicted investment advice, amounting to at least $21 billion annually.xvi

A 2015 report from the White House Council of Economic Advisers (CEA) estimated that –

[…]conflicts of interests cost middle-class families who receive conflicted advice huge amounts of their hard-earned savings. It finds conflicts likely lead, on average, to:

  • 1 percentage point lower annual returns on retirement savings.
  • $17 billion of losses every year for working and middle class families.

Despite the controversy over the DOL Fiduciary Rule and its recent, apparent defeat, the SEC has been working under the guidance of Chairman Jay Clayton since 2017 to finally rectify the confusion among investors as to the different standards of care applicable to brokers versus investment advisers.xvii

The latest development in that regard has been the proposal by the SEC of “Regulation Best Interest” (“Reg. BI”) on April 18, 2018.xviii  The proposed rule is significant in its proposed breadth. Subparagraph (a)(1) of the proposed rule would provide as follows:

A broker, dealer, or a natural person who is an associated person of a broker or dealer, when making a recommendation of any securities transaction or investment strategy involving securities to a retail customer, shall 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, or natural person who is an associated person of a broker or dealer making the recommendation ahead of the interest of the retail customer.xix

This is a sea change in the duty of care owed by brokers to their retail clients, as it would effectively enhance a broker’s duty of care to approximate that of an investment adviser’s (at least in regard to retail clients).xx

To satisfy the “best interest” obligation in subparagraph (a)(1), subparagraph (a)(2) of Reg. BI would impose four component requirements: a Disclosure Obligation, a Care Obligation, and two Conflict of Interest Obligations.xxi

For the “Disclosure Obligation,” subparagraph (a)(2)(i) of Reg. BI would require the broker to –

reasonably disclose[] to the retail customer, in writing, the material facts relating to the scope and terms of the relationship with the retail customer, including all material conflicts of interest that are associated with the recommendation.xxii

For the “Care Obligation,” subparagraph (a)(2)(ii) of Reg. BI would require the broker to “exercise[] reasonable diligence, care, skill, and prudence to” do the following:

(A) Understand the potential risks and rewards associated with the recommendation, and have a reasonable basis to believe that the recommendation could be in the best interest of at least some retail customers;

(B) 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 and rewards associated with the recommendation; and

(C) Have a reasonable basis to believe that a series of recommended transactions, even if in the retail customer’s best interest when viewed in isolation, is not excessive and is in the retail customer’s best interest when taken together in light of the retail customer’s investment profile.xxiii

Finally, for the two “Conflict of Interest Obligations,” subparagraph (a)(2)(iii) of Reg. BI would require the following:

(A) The broker or dealer establishes, maintains, and enforces written policies and procedures reasonably designed to identify and at a minimum disclose, or eliminate, all material conflicts of interest that are associated with such recommendations.

(B) The broker or dealer establishes, maintains, and enforces written policies and procedures reasonably designed to identify and disclose and mitigate, or eliminate, material conflicts of interest arising from financial incentives associated with such recommendations.xxiv

Furthermore, Reg. BI would expand the SEC’s records requirement rules (i.e., Rules 17a-3 and 17a-4) to  provide that “[f]or each retail customer to whom a recommendation of any securities transaction or investment strategy involving securities is or will be provided,” a broker obtain and maintain for six years “[a] record of all information collected from and provided to the retail customer pursuant to [Reg. BI].”xxv


The SEC’s proposed “Regulation Best Interest” is a significant proposal that could have far-reaching impact across the securities brokerage and other segments of the financial services industries. Whether this latest regulatory effort to establish a more consistent standard of care for brokers and investment advisers will succeed is unknown, but the proposed rule is certainly an aggressive step in that regard.

All those interested will have until approximately July 23, 2018 to file a public comment on the proposed rule. Meanwhile, investors should take this opportunity to educate themselves on the current differences between “brokers” and “investment advisers,” including the different standard of care that each owe their clients.


i   The specific date will be established once the proposed rule is published in the Federal Register.

ii   Staff of the U.S. Securities and Exchange Commission, Study on Investment Advisers and Broker-Dealers As Required by Section 913 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Jan. 2011) (“Study”), at iii, available at

iii  Study at iv.

iv  FINRA Rule 2111(a), available at, as of April 23, 2018.

v   Study at 96.

vi  Study at 97.

vii Study at 98.

viii Study at i.

ix  See Request for Data and Other Information: Duties of Brokers, Dealers and Investment Advisers, Exchange Act Release No. 69013 (Mar. 1, 2013), available at

x   Regulation Best Interest, Exchange Act Release No. 34-83062 (April 18, 2018) (“Reg. BI Proposal”), at 20, available at

xi  Reg. BI Proposal at 27.

xii     Reg. BI Proposal at 7.

xiii Reg. BI Proposal at 8.

xiv Reg. BI Proposal at 14, fn. 15.

xv Reg. BI Proposal at 8, fn. 6.

xvi Reg. BI Proposal at 20, fn. 28, quoting Letter from Marnie C. Lambert, President, Public Investors Arbitration Bar Association (Aug. 11, 2017) (“PIABA Letter”).

xvii    Chairman Jay Clayton, Public Comments from Retail Investors and Other Interested Parties on Standards of Conduct for Investment Advisers and Broker-Dealers, Public Statement, June 1, 2017, available at

xviii   See Reg. BI Proposal.

xix Reg. BI Proposal, at 404.

xx In a related SEC proposal regarding investment advisers that was also dated April 18, 2018, the SEC stated that “[a]n investment adviser’s fiduciary duty is similar to, but not the same as, the proposed obligations of broker-dealers under Regulation Best Interest,” and that “we are not proposing a uniform standard of conduct for broker-dealers and investment advisers in light of their different relationship types and models for providing advice[….]” See Proposed Commission Interpretation Regarding Standard of Conduct for Investment Advisers; Request for Comment on Enhancing Investment Adviser Regulation, Investment Advisers Act Release No. IA-4889 (April 18, 2018), available at

xxi Reg. BI Proposal, at 404.

xxii Reg. BI, subparagraph (B), Reg. BI Proposal, at 404.

xxiii   Reg. BI Proposal, at 404-405.

Subparagraph (b)(2) of Reg. BI would define “retail customer’s investment profile” as including, but not be limited to, “the retail customer’s age, other investments, financial situation and needs, tax status, investment objectives, investment experience, investment time horizon, liquidity needs, risk tolerance, and any other information the retail customer may disclose to the broker, dealer, or a natural person who is an associated person of a broker or dealer in connection with a recommendation.” Reg. BI Proposal, at 406.

xxiv   Reg. BI Proposal, at 405.

xxv      Reg. BI Proposal, at 406-407

Enforcement in the Second Circuit of FINRA Pre-Hearing Subpoenas and Discovery Orders

In a Financial Industry Regulatory Authority (“FINRA”) arbitration under either the Consumer or Industry Arbitration Rules, there are two mechanisms for seeking discovery.  For parties and non-parties who are not FINRA members, FINRA Rules 12512 and 13512, authorize an arbitrator to issue a subpoena for production of documents.  For parties and FINRA members, FINRA Rules 12513 and 13513, authorize an arbitrator to issue an arbitration order (not a subpoena) for the production of documents. However it is unlikely that a party seeking enforcement of either the subpoena or the order issued by a FINRA arbitration panel will find relief in the court system. But that doesn’t leave enforcement out of reach.

Parties and Non-Parties who are not FINRA members

FINRA Rules 12512 and 13512 authorize an arbitrator to issue subpoenas for the production of documents. FINRA Rules 12512(a)(1) and 13512(a)(1).  If the subpoena is not complied with, the next step for most litigators would be to move to enforce the subpoena in Federal District Court.  However such an action is unlikely to be successful.

There is split among the Circuits but the Second Circuit interprets the Federal Arbitration Act (“FAA”) Section 7 as prohibiting enforcement of subpoenas for pre-hearing discovery.  See Life Receivables Trust v. Syndicate 102 at Lloyd’s of London, 549 F.3d 210, 212 (2d Cir. 2008).  However the Second Circuit court made it clear that,

[i]nterpreting section 7 according to its plain meaning “does not leave arbitrators powerless” to order the production of documents. Hay Group v. E.B.S. Acquisition Corp., 360 F.3d 404, 413 (3d Cir. 2004) (Chertoff, J., concurring). On the contrary, arbitrators may, consistent with section 7, order “any person” to produce documents so long as that person is called as a witness at a hearing. 9 U.S.C. § 7. Peachtree concedes as much, admitting that “Syndicate 102 could obtain access to the requested documents by having the arbitration panel subpoena Peachtree to appear before the panel and produce the documents.” In Stolt-Nielsen, we held that arbitral section 7 authority is not limited to witnesses at merits hearings, but extends to hearings covering a variety of preliminary matters. 430 F.3d at 577-79. As then-Judge Chertoff noted in his concurring opinion in Hay Group, the inconvenience of making a personal appearance may cause the testifying witness to “deliver the documents and waive presence.” 360 F.3d at 413 (Chertoff, J., concurring). Arbitrators also “have the power to compel a third-party witness to appear with documents before a single arbitrator, who can then adjourn the proceedings.” Id. at 413. Section 7’s presence requirement, however, forces the party seeking the non-party discovery — and the arbitrators authorizing it — to consider whether production is truly necessary. See id. at 414. Separately, we note that where the non-party to the arbitration is a party to the arbitration agreement, there may be instances where formal joinder is appropriate, enabling arbitrators to exercise their contractual jurisdiction over parties before them. In sum, arbitrators possess a variety of tools to compel discovery from non-parties. However, those relying on section 7 of the FAA must do so according to its plain text, which requires that documents be produced by a testifying witness.

Life Receivables Trust v. Syndicate 102 at Lloyd’s of London, 549 F.3d 210, 218, (2d Cir. N.Y. 2008).  To obtain the aid of the Court system, the Second Circuit quoting from the Third Circuit clearly indicates that the arbitrators must order an appearance in some fashion of the object of the subpoena.  Accordingly if such an appearance is ordered, then Section 7 of the FAA is no longer a prohibition against the production of the documents even if it is a pre-hearing appearance.

Parties and FINRA Members

FINRA Rules 12513 and 13513 authorize an arbitrator to issue a discovery order for the production of documents.  If the discovery order is not complied with there is no opportunity to turn to the court system for enforcement relief because there was no actual subpoena issued.  However, turning to FINRA’s Department of Enforcement is likely to be successful.

Enforcement of a pre-hearing discovery order, issued to a non-party FINRA member under FINRA rule 13513, is largely an issue of first impression. By way of background, FINRA Rule 13513 went into effect in its current form on February 18, 2013.  Since that time there does not appear to have been any enforcement action by the FINRA Department of Enforcement for its violation.  However, there is at least one enforcement action for violation of a party’s discovery obligations in an arbitration proceeding.  See In Re Westrock Advisors.  It is a violation of FINRA Rule IM-13000 to fail to comply with any rule of the arbitration code and specifically for failure to produce a document:

It may be deemed conduct inconsistent with just and equitable principles of trade and a violation of Rule 2010 for a member or a person associated with a member to:

… (c) fail to appear or to produce any document in his possession or control as directed pursuant to provisions of the Code;…

In Westrock Advisors failure to comply with discovery orders was censured and a $50,000 fine was imposed.

Accordingly, enforcement of a subpoena or discovery order without use of the Court system is both possible and likely to be successful in obtaining documents in pre-hearing discovery from parties, non-parties, FINRA members and Non-FINRA members alike.

Pastore & Dailey Defeats AM Law 25 firm in Delaware Bankruptcy Court Concerning Investment Banking Fee

Pastore & Dailey successfully dismissed claims filed in Delaware bankruptcy court by one of the nation’s largest mineral mining companies. Pastore & Dailey represents an investment bank seeking a fee associated with $650 million in construction financing for the project. The mining company was attempting to avoid paying this fee by asserting that claims had been discharged in bankruptcy.

Commodity Futures Trading Commission Proposes New Conflict of Interest Rules

The Commodity Futures Trading Commission recently proposed new rules to implement statutory provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The proposed rules relate to the conflicts of interest provisions set forth in section 732 of the Dodd-Frank Act, which amends section 4d of the Commodities and Exchange Act, to direct futures commission merchants and introducing brokers to implemental conflict of interest systems and procedures to establish safeguards within the firm. The proposed rules seek to ensure that any person researching or analyzing the price or market for any commodity is separated by appropriate informational partitions. The proposed rules also address other issues, such as enhanced disclosure requirements.

Section 732 of the Dodd-Frank Act requires that futures commissions merchants and introducing brokers “establish structural and institutional safeguards to ensure that the activities of any person within the firm relating to research or analysis of the price or market for any commodity are separated by appropriate informational partitions within the firm from the review, pressure, or oversight of persons whose involvement in trading or clearing activities might potentially bias the judgment or supervision of the persons.” While section 732 could be read to require informational partitions between persons involved in any research or analysis and persons involved in trading or clearing activities, the Commission believes that the Congressional intent underlying section 732 was primarily intended to prevent undue influence by persons involved in trading or clearing activities over the substance of research reports that may be publicly distributed.

The proposed rule establishes restrictions on the interaction between persons within a futures commission merchant or introducing broker involved in research or analysis of the price or market for any derivative and persons involved in trading or clearing activities. Further, the proposed rules also impose duties and constraints on persons involved in the research or analysis of the price or market for any derivative by, for example, requiring such persons to disclose during public appearances and in any reports any relevant personal interest relating to any derivative the person follows. The proposed rule also prevents futures commissions merchants and introducing brokers from retaliating against a person for producing a report that adversely impacts the current or prospective trading or clearing activities of the firm.

If the proposed rules are implemented, they would require that futures commission merchants and introducing brokers adopt written conflicts of interest policies and procedures, document certain communications between non-research personnel and provide other disclosures. They would also prevent non-research personnel from reviewing a research report prior to dissemination, except to verify the factual accuracy of the report and provide non-substantive edits. Non-research personnel may only communicate with research personnel through authorized legal or compliance personnel. The firm’s business trading unit may not influence the review or approval of a research personnel’s compensation and may not influence the research personnel. Futures commissions merchants and introducing brokers must keep a record of each public appearance by a research analyst. The proposed rule applies to third-party research reports as well, except where the reports are made available upon request or through a web site maintained by the futures commissions merchants or introducing brokers.

While the Commodity Futures Trading Commission is continuing to receive public comments on any aspect of the proposed rule, the Commission is particularly interested in comments about whether the rules should apply to futures commission merchants and introducing brokers of all sizes or whether the nature of the partitions should depend on the size of the firm.


Brokers and Advisors Beware

In the last two months, the SEC and FINRA have, for the first time each, taken Enforcement action — including against a broker-dealer’s chief compliance officer — in regard to the safeguarding of confidential customer information under a 10-year-old SEC rule called “Regulation S-P.”  These actions seem likely to cause a significant shift in how brokers, investment advisers and their firms handle customers’ confidential information, particularly when it comes to a broker or adviser taking his or her “book” of business to another firm.


Previously, when brokers or advisers left for new firms, they and their new firms usually only had to worry about their former firm suing them for breaches of non-compete, non-solicitation and non-disclosure clauses in their agreements, or suing the new firm for “raiding” the former firm’s agents (and, thus, their customers).

But recent SEC and FINRA actions put brokers, advisers and their firms on notice that each could suffer formal regulatory consequences (including fines and suspensions) from brokers or advisers casually — or clandestinely — taking confidential customer information to their new firms.


The SEC adopted Regulation S-P in 2001 pursuant to a mandate in the Gramm-Leach-Bliley Act of 1999, and amended it in 2005 pursuant to a mandate in the Fair and Accurate Credit Transactions Act of 2003 (the FACT Act).

Broadly speaking, Regulation S-P requires broker-dealers, investment advisers and other financial firms to protect confidential customer information from unauthorized release to unaffiliated third parties.  Included in Regulation S-P is the “Safeguard Rule” (Rule 30(a)), which requires broker-dealers to, among other things, adopt written policies and procedures reasonably designed to protect customer information against unauthorized access and use.

Of course, several headlines in recent years have focused on the reported thefts or losses of large caches of confidential customer information from banks and other businesses, so it comes as no surprise that the SEC and FINRA would seek to assert their Enforcement powers in this area.  Each of the recent SEC and FINRA Enforcement actions arose from departing registered representatives taking customer information to new employers without providing said customers with sufficient notice and opt-out procedures under €¨Regulation S-P.

Case Study # 1: Recent SEC Disciplinary Actions

In an administrative settlement dated April 7, 2011, the SEC fined a brokerage firm’s president, national sales manager and chief compliance officer between $15,000 and $20,000 each in regard to the transfer of 16,000 customer names and addresses, account numbers and asset values to a new firm.  It did not matter that customers approved the transfer after the fact, nor did it matter that the transfer occurred because the broker-dealer was winding down its business and thus simply transferring many of its accounts to a new broker-dealer. The SEC found the firm and its senior executives liable for Regulation S-P violations and fined each of them accordingly.

Especially noteworthy is that the SEC fined the firm’s chief compliance officer for “aiding and abetting” these Regulation S-P violations by failing to improve the firm’s “inadequate” written supervisory procedures for safeguarding customer information (the “Safeguard Rule”) after “red flags” arose from prior security breaches at the firm.  (Significantly, those security breaches did not involve other instances of intentional transfer of customer data to a new firm, but rather mostly theft by outsiders of a few RRs’ laptops and the unauthorized access by a former employee of a current employee’s firm e-mail account.)

Case Study # 2: Recent FINRA Disciplinary Action

This past December, FINRA’s National Adjudicatory Council affirmed a $10,000 fine and 10-day suspension ordered by a FINRA hearing panel in a contested hearing against a broker for his downloading confidential customer information from his firm’s computer system onto a flash drive on his last day of employment and then sharing that information with a new firm.  FINRA found the broker’s actions prevented his former firm from giving its customers a reasonable opportunity to opt out of the disclosures, as required by Regulation S-P.  FINRA also found the broker’s misconduct caused his new firm to improperly receive non-public personal information about his former firm’s customers.


These Enforcement actions will change the legal and practical landscape concerning the portability of a broker’s “book” of customers.  From a contractual point of view, brokers and advisers would be well-advised to build Regulation S-P-compliant language into their agreements with their current and new firms if they anticipate ever switching firms again, as these Enforcement actions effectively sound the alarm that the SEC and FINRA will sanction a broker or adviser for furtively taking customer information to a new firm. Likewise, investment adviser and brokerage firms would be well-advised to understand the relevance of Regulation S-P when it comes to brokers or advisers moving to other firms and taking firm customer information with them.

€¨Finally, from a regulatory point of view, a broker’s or adviser’s “former” firm should implement reasonable policies and procedures to ensure compliance with Regulation S-P by all firm personnel, including brokers or advisers looking to leave the firm, and a broker’s or adviser’s “new” firm should take similar care and caution when a broker or adviser brings in confidential information regarding new customers (lest the new firm also be found liable for a Regulation S-P violation, which would have happened in the above FINRA case had the new firm done anything with the customer information it got from the subject broker).

November 2010 – SEC Adopts New Rule

On November 3, 2010, the Securities and Exchange Commission (SEC) voted unanimously to adopt a new rule requiring broker-dealers to implement risk controls before they provide customers with electronic access to the equities markets. The new rule will effectively end so-called “naked” (or “unfiltered”) access by customers to the markets, and is part of a larger effort by the SEC “to help ensure the markets are fair, transparent and efficient.”

Specifically, the rule prohibits broker-dealers from providing customers with unfiltered access to an applicable exchange or alternative trading system (ATS). It requires brokers who directly access an exchange or an alternative trading system — including those who “sponsor” customers’ access to same — to put in place financial and regulatory risk management controls and supervisory procedures that are “reasonably designed to prevent the entry of orders that exceed appropriate pre-set credit or capital thresholds, or that appear to be erroneous.” Among other things, these controls must include the programming and implementation of pre-order-entry filters by brokers in their own systems for orders directed either by them or their customers to the equities markets.

This issue of unfiltered access has been the subject of much debate, especially involving the high-frequency trading firms that use algorithms and high-speed and high-capacity computers to capture minimal and fleeting arbitrage (and other quantitative) opportunities in the markets. Some observers have estimated that such activity constitutes upwards of 70 percent of the volume traded in U.S. equity markets today.

Broker-dealers have eight months — which includes 60 days from publication of the rule in the Federal Register plus an additional six months — to comply with this new rule.