NSCPCurrents NOVEMBER 2020

Back to the Future, But SEC and FINRA Enforcement Issues from the Present (October 2020)

By Brian Rubin

About the Authors: Brian Rubin is a Partner at Eversheds Sutherland. He can be reached at [email protected].

1 NOVEMBER 2020 NSCP CURRENTS 1 NOVEMBER 2020 NSCP CURRENTS his year marks the 35th anniversary of the premier of the first Back to the Future movie, and November 5th was the 65th anniversary of Marty McFly going back in time in the TDeLorean to escape the terrorists who shot Doc Brown. Back to the Future Part II followed in November 1989, where our stars traveled from 1985 to 2015, a world of flying cars andJaws 19 (or not). And then came Back to the Future Part III in May 1990, involving a trip to the Wild West in 1885. The movies are known for many things, including the following:

• Cool things and happenings: • The hoverboard • Self-tying sneakers • The skateboard chase • Quotes: • “Why don’t you make like a tree and get outta here?” (Cf. “Why don’t you make like a tree and leave?”) (Get it?) • “Roads? Where we’re going, we don’t need roads.” • “Nobody calls me chicken.” • “Eastwood. Clint Eastwood.” (Cf. “Bond. James Bond.”) • “Who’s Vice President, Jerry Lewis?” • When Marty claimed to be from 1985, 1955, Doc asked him, “So tell me, future boy, who’s president of the United States in 1985?” Marty responded, “Ronald Reagan,” causing Doc to say, “The actor? Then who’s Vice President, Jerry Lewis? I suppose Jane Wyman is the First Lady. And Jack Benny is Secretary of the Treasury!”1 • “Great Scott!” • Songs: • Johnny B. Goode • The Power of Love

Less well known is that if you watch the movies closely enough (multiple times over many years), you’ll learn that they really deal with compliance issues, applicable to the securities industry, not unlike other popular movies and television shows.2 For example, while the movies don’t deal with insider trading (the purchase or sale of securities based on material non-public information), they do deal with something similar: betting on sporting events in the past, knowing the outcome because of an almanac from the future. For those who don’t remember, Marty got the great idea of bringing a copy of “50 Years of Sports Statistics” to the past so he could place a few bets. Doc (correctly) reprimanded him:

Doc: Marty! I didn’t invent the time machine for financial gain. The intent here is to gain a clear perception of humanity: where we’ve been, where we’re going, the pitfalls and the possibilities, the perils and the promise . . . perhaps even an answer to that universal question: Why? Marty: Oh, hey, I’m all for that, Doc, but what’s wrong with making a few bucks on the side?3

Even though Doc was not a compliance officer (as far as we know), he convinced Marty to do the right thing and throw the almanac in the trash. Later, however, Doc and Marty pieced together the following set of facts:

Doc: You see, while we were in the future, Biff got the sports book, stole the time machine, went back in time and gave the book to himself at some point in the past. Look . . . It says,

1. https://sfy.ru/transcript/back_to_the_future_ts. 2. See, e.g., Not Dead Yet: Just Flesh Wounds, Suspensions, and Fines (SEC, CFTC and FINRA Enforcement Actions in September 2020), Currents (October 2020); “The Show, er, um, Article About Nothing (other than SEC, CFTC, FINRA, and State Securities Enforcement Actions in August 2020),” Currents (September 2020); “Just When You Thought It Was Safe to Go Back in the Office (Or at Least Think About It): SEC and FINRA Examinations and Enforcement Actions in July 2020, Currents (August 2020); “Curb Your Enforcementism: SEC and FINRA Enforcement Cases in June 2020,” Currents (July 2020). 3. http://www.dailyscript.com/scripts/bttf2_3.pdf (edited).

2 NOVEMBER 2020 NSCP CURRENTS right here, that Biff made his first million betting on a horse race in 1958. He wasn’t just lucky: he knew because he had all the race results in the Almanac! That’s how he made his entire fortune! Marty: That [so and so] [or expletive deleted, if you prefer] stole my idea! Doc, he must have overheard me when I told you . . . This whole thing’s my fault. If I hadn’t bought that book, none of this would have happened. Doc: Well, that’s all in the past. Marty: You mean in the future. Doc: Whatever, it demonstrates precisely how time travel can be misused and why the time machine must be destroyed . . . after we straighten all of this out4.

So, dear readers, is Doc liable because he knew of the red flags (the almanac and the time machine), but he didn’t take sufficient steps to prevent each from being used for nefarious purposes? For example, why didn’t he burn the almanac or hide the keys to the DeLorean? And is Marty liable for aiding and abetting or causing Biff’s impermissible activity because Biff used Marty’s idea? After all, Marty did admit it was his “fault,” didn’t he? Well, luckily for us, these activities did not involve the trading of securities. (And, of course, these characters are fictitious, so who really cares?) Nonetheless, as we’ll see, other aspects of Back to the Future present lessons more applicable to the securities profession. (Warning: after reading this article, it’s possible that regulators will demand that firms build time machines so they can prevent inappropriate behavior from occurring.)

Failure to Report

One of the rules of time travel is that you can’t alter history (as anyone who has ever engaged in time travel or watched a Back to the Future movie knows). If you do, then magical musical moments like bringing your parents together (metaphorically and otherwise) may not occur, and you may not be born. As Marty said to band leader, Marvin Berry (Chuck’s brother):

Marvin, you gotta play. See that’s where they kiss for the first time on the dance floor. And if there’s no music, they can’t dance, and if they can’t dance, they can’t kiss, and if they can’t kiss they can’t fall in love and I’m history.5

Similarly, under the securities law, you cannot go through time to alter history, and you must report certain historical events on Form U4 and U5 amendments and pursuant to Rule 4530. (Pretty good transition, huh?)

On October 27, 2020, FINRA entered into a Letter of Acceptance, Waiver and Consent (AWC) settlement with a firm, fining it $125,000 for, among other things, filing deficiencies related to Forms U4 and U5 amendments and Rule 4530(d).6 FINRA found that between May 2015 and November 2018, the firm filed four late Form U4 amendments and eight late Form U5 amendments relating to reportable customer complaints and an unsatisfied judgment. In addition, the firm failed to file five Form U4 amendments relating to reportable customer complaints. The firm also failed to report or reported late statistical and summary information for 19 written customer complaints, reported a year late a settlement of a customer’s claim for sales practice violations and submitted 34 inaccurate or incomplete filings required by FINRA Rule 4530(d). FINRA also found various violations related to the firm’s Written Supervisory Procedures (WSPs).

The firm’s failure to enforce its procedures occurred for various reasons. In some instances, firm personnel failed to identify the communication at issue as a complaint or incorrectly determined

4. http://www.dailyscript.com/scripts/bttf2_3.pdf. 5. https://sfy.ru/transcript/back_to_the_future_ts. 6. https://www.finra.org/sites/default/files/fda_documents/2017053208002%20National%20Securities%20Corporation%20CRD%207569%20AWC%20sl.pdf.

2 NOVEMBER 2020 NSCP CURRENTS 3 NOVEMBER 2020 NSCP CURRENTS that a customer complaint was not a reportable event. In other instances, firm personnel failed to timely review and process customer complaints in accordance with firm procedures. On other occasions, the firm’s registration group entered the wrong problem code or failed to identify the subject security in a FINRA Rule 4530 filing.

Takeaways:

• Regulatory filings are a FINRA priority. Such filings are one tool regulators use to perform their jobs. • Firm’s may have adequate written procedures, but if they don’t enforce them properly, firms may be sanctioned. • Although the AWC does not use the word “training,” it appears that the firm may not have adequately trained its staff on how to identify complaints and when to make regulatory filings. In addition, the firm may not have adequately supervised the employees responsible for this function.

Improper Payments of Personal Expenses

Sometimes, fees and payments are easy to understand—they are used to pay for goods or services. On the other hand, sometimes things are free. But, on the third hand (in the future, people may have three hands), sometimes things are free, but they still cost money.

Lou: Are you gonna order something, kid? Marty: Yeah, gimme a Tab. Lou: Tab? I can’t give you a tab unless you order something. Marty: Right, gimme a Pepsi Free. Lou: You wanna a Pepsi, pal, you’re gonna pay for it.7

In separate settlements, FINRA sanctioned two firms for treating personal expenses as business expenses, causing firms to maintain inaccurate books and records. In one settlement, on October 1, 2020, FINRA entered into an AWC with a firm and an individual who was its Chief Executive Officer (CEO), President, Chief Compliance Officer (CCO), Finance and Operations Principal (FINOP), and sole owner for, among other things, inaccurate classifications of certain business expenses as business expenses, causing inaccurate FOCUS reports and inaccurate books and records.8 The CEO/CCO/Etc. was suspended for one month and was fined $10,000. The firm was fined $10,000, and both the individual and the firm were fined, joint and several, another $10,000.

The CEO/CCO/Etc. paid for the firm’s expenses through the firm’s checking account or charged the firm’s business expenses to his personal credit cards, and he personally determined which charges to his personal credit cards were business expenses. He then paid for those charges using the firm’s bank account. The firm’s general ledger did not itemize the firm’s business expenses charged to his personal credit cards and recorded those payments on the firm’s general ledger as either “travel and entertainment” expenses or “office expenses.” He improperly characterized over $152,000 of personal expenses as business expenses, resulting in the firm paying for $152,000 of personal expenses that did not relate to the firm’s business or customers, such as gas, groceries, vacation dining, hotel stays, and sporting events.

The firm’s WSPs stated the CEO was responsible for the firm’s supervisory manual and for the firm’s overall supervisory system. The firm’s WSPs did not address what business expenses employees could be reimbursed for or require employees to submit any documentation

7. https://sfy.ru/transcript/back_to_the_future_ts. 8. https://www.finra.org/sites/default/files/fda_documents/2019061008601%20Montrose%20Securities%20International%20CRD%2035603%20Philip%20Y.%20Leung%20CRD%20 1121435%20AWC%20%20va.pdf.

4 NOVEMBER 2020 NSCP CURRENTS describing the business purpose for each expense. The firm also did not determine whether expenses had been improperly charged to the firm. Due to these supervisory deficiencies, the firm could not reasonably determine whether the payments the CEO recorded as “business expenses” were accurate. In the second settlement, on October 8, 2020, FINRA entered into an AWC with a firm where “MK” (that’s what the AWC called him), the firm’s owner, CEO, and CCO, used the firm’s credit card and bank account to pay for approximately $265,000 of his personal expenses.9 The firm then misclassified his personal expenses as business expenses of the firm, causing the firm’s books and records to be inaccurate. In fact, the personal expenses included plane tickets and lodging for family members, as well as purchases for personal goods or services. The firm was fined $15,000.

Takeaways:

• Firms can be sanctioned if they misclassify expenses. While these two cases may appear to be extreme, firms can be sanctioned for less egregious offenses. Information on how and why firms pay for expenses can be critical when regulators assess the financial condition of firms. • Both of these cases dealt with a firm where the owner played multiple roles, including acting as CEO, president, and CCO. When one person wears multiple hats, an argument can sometimes be made that the fox is guarding the henhouse. In such cases, firms may want to institute additional checks and balances. • In one case, the CEO was charged. It is not clear why the CEO was not charged in the other case. Policy Issues on Sanctions and Charges Back in the day (in the past, or in the future, or in the past pretending it was the future— depending on your point of view), charges and sanctions were as easy as threatening to vaporize or melt someone’s brain to get the job done. In this scene, Marty threatened to discipline his father, George, as he convinces his father to go to the school dance with Marty’s future mother, Lorraine, so they can fall in love, etc. (Don’t ask what “etc.” stands for.)

Marty: Silence, Earthling! [after several more beeps] George: Who — who are you? Marty: You, George McFly, have created a rift Marty: [imitating Darth Vader] My name is Darth in the space-time continuum. The Supreme Vader. I am an extra-terrestrial from the planet Klingon hereby commands you to take the Vulcan. female earth-person called “Baines Lorraine” George: I must be dreaming... to the location known to you as Hill Valley Marty: This is no dream! You are having a Close High School exactly 4 earth cycles from now — Encounter of the Third Kind! You have reached Saturday night in your language. the Outer Limits of the Twilight Zone! George: You mean, take Lorraine to the dance? George: Mom! Dad! Marty: Affirmative. Marty: Silence! My heat ray [really, a portable George: But I don’t know if I’ll be able— hair dryer] will vaporize you if you do not obey [Marty turns on the Walkman again, playing Van me! Halen. George SCREAMS!] George: All right! I surrender! Turn it off! George: Turn it off! Please, turn it off! [Marty lowers it. Now his digital watch alarm [Marty turns it off.] begins BEEPING. Marty raises his wrist as if it Marty: Insolent Earthling! Do you wish me to were a radio.] melt your brain? Marty: Silence! I am receiving a transmission George: No! Please! I’m sorry, I’ll do it! I’ll take from the Battlestar Galactica! her to the dance — but please don’t turn that noise on again.10

9. https://www.finra.org/sites/default/files/fda_documents/2018056386401%20CapFi%20Financial%20Partners%20LLC%20CRD%20113795%20AWC%20va.pdf. 10. http://www.dailyscript.com/scripts/bttf4th.pdf.

4 NOVEMBER 2020 NSCP CURRENTS 5 NOVEMBER 2020 NSCP CURRENTS Back in the real world (not MTV’s “The Real World”), the SEC and FINRA can’t go around threatening earthlings and registered representatives with vaporizing them (although it would be interesting if Enforcement staff dressed up as storm troopers on Zoom calls every once in a while). Therefore, both regulators often analyze sanctions and liability and modify them as appropriate.

• Sanctions: FINRA revised its Sanction Guidelines to take into account customer’s age or physical or mental impairment.10

On October 20, 2020, FINRA revised the “Principal Considerations” in its Sanction Guidelines to expressly consider whether a customer’s age or physical or mental impairment could render the individual unable to protect his or her own interests.11 FINRA’s Sanction Guidelines are used by FINRA, in both settlements and litigation, to assist in determining appropriate sanctions.

FINRA has been conducting a retrospective review to assess how it helps protect senior investors from financial exploitation. In connection with that review, FINRA amended the Sanction Guidelines to expressly consider the customer’s age or physical or mental impairment. The amendments reflect FINRA’s “concerns regarding protecting customers and the . . . explicit consideration of elder abuse as well as its general experience with imposing more stringent sanctions in cases involving senior investors or mentally impaired customers.”

FINRA amended Principal Consideration No. 19 to explicitly include “whether the customer had a mental or physical impairment that rendered him unable to protect his or her own interests.” In addition, new Principal Consideration No. 20 considers whether the customer is age 65 and older.

Takeaways

• These changes are not surprising. FINRA, as well as other regulators, have previously considered various attributes and characteristics of customers. • Given that FINRA has placed certain customers in a “heightened” class, some firms may institute additional controls or processes to apply to those customers.

• Charges: SEC Commissioner expressed concerns about enforcement actions against compliance officers.

Two years ago, SEC Commissioner Hester Peirce spoke at NSCP’s national conference about the important function compliance personnel, including CCOs, serve in facilitating the work of the Commission.12 On October 29, 2020, at this year’s national conference, she noted that she “shared the concerns expressed in some quarters that the increasing specter of personal liability could cause talented individuals to forgo a career in compliance, among other negative effects.”13 Commissioner Peirce also analyzed the three categories of cases where the SEC has charged compliance officers: (1) cases where compliance officers participated in the underlying misconduct unrelated to their compliance duties; (2) cases where compliance officers obstructed or misled Commission staff; and (3) cases where “the CCO has exhibited a wholesale failure to carry out his or her responsibility.”

Of note, Commissioner Peirce stated that the Commission could provide guidance about when it will and will not bring enforcement actions against compliance officers. Such a framework “would help the compliance community by eliminating uncertainty and inspiring good practices: and be

10. https://www.ada.gov/ada_title_I.htm 11. https://www.finra.org/rules-guidance/notices/20-37. 12. https://www.sec.gov/news/speech/speech-peirce-103018. 13. https://www.sec.gov/news/speech/peirce-nscp-2020-10-19.

6 NOVEMBER 2020 NSCP CURRENTS useful for me and my colleagues at the SEC to use in deciding whether to charge CCOs.” She then stated that she is considering “developing a draft framework to share with my colleagues. I welcome your input on what factors you believe are relevant to the decision about whether to charge compliance personnel.” She also discussed creating a “public-private advisory group” and “conducting periodic public roundtables with compliance officers.”

Takeaways

• Enforcement actions against compliance officers are alive and well, although not very common. • Watch this space for future developments. Lessons

The Back to the Future movies have important lessons, not just related to securities compliance. They also have important life lessons that apply to us today. (Perhaps because Marty and Doc traveled to the future to read this article?) (Or not.) For example:

• Sometimes, our cool expressions aren’t as neat as we think they are.

Marty: This is heavy. [repeated on multiple occasions] Doc: There’s that word again, heavy. Why are things so heavy in the future? Is there a problem with the Earth’s gravitational pull?14

• Sometimes, predictions are just plain wrong.

Doc: I’m sure that in 1985, plutonium is available at every corner drugstore, but in 1955 it’s a little hard to come by.15

• Styles change:

•Today’s Tesla may be yesterday’s DeLorean

Marty: Are you trying to tell me you built a time machine out of a DeLorean? Doc: The way I figured it, if you’re going to build a time machine into a car, why not do it with some style?16

•Today’s Tommy Johns may be yesterday’s Calvin Kleins

Marty: Calvin? Why are you calling me Calvin? Lorraine: Well, isn’t that your name—Calvin Klein? It’s written in your underwear.17

• You control your future (and possibly your past, if you have a DeLorean and plutonium).

• Jennifer:18 Dr. Brown, I brought this note back from the future and - now it’s erased. • Doc: Of course it’s erased! • Jennifer: But what does that mean? • Doc: It means your future hasn’t been written yet. No one’s has. Your future is whatever you make it. So make it a good one, both of you. • Marty: [Marty wraps his arm around Jennifer] We will, Doc.19

14. https://sfy.ru/transcript/back_to_the_future_ts. 15. Id. 16. http://www.dailyscript.com/scripts/bttf4th.pdf. 17. Id. 18. Because attorneys are so important to our society (and to some of our households), we would be remiss if we didn’t highlight this attorney trivia. Marty’s girlfriend/wife was originally named “Suzy.” However, director Robert Zemeckis renamed her “Jennifer” in honor of his attorney’s daughter. https://www.imdb.com/title/tt0099088/characters/ nm0000502. 19. https://www.imdb.com/title/tt0099088/characters/nm0000502.

6 NOVEMBER 2020 NSCP CURRENTS 7 NOVEMBER 2020 NSCP CURRENTS