This post is designed to provide a summary of various rules and regulations requiring the establishment and enforcement of supervisory responsibilities over remote activities of a firm’s business activities. It is being presented for educational purposes only and thus, is not designed to be complete in all material respects. If you have any questions, you should contact a qualified professional.

Introduction

The Securities and Exchange Commission has provided guidance relative to “Remote Office Supervision.” Sections 15(b)(4)(E)1 and 15(b)(6)(A) 2 of the Securities Exchange Act of 1934 (Exchange Act) authorize the Commission to impose sanctions on a firm or any person that fails to reasonably supervise a person subject to their supervision that commits a violation of the federal securities laws. Section 15(b)(4)(E) also provides an affirmative defense against a charge of failure to supervise where reasonable procedures and systems for applying the procedures have been established and effectively implemented without reason to believe such procedures and systems are not being complied with. The Commission’s policy regarding failure to supervise is well established. The Commission “has long emphasized that the responsibility of broker-dealers to supervise their employees is a critical component of the federal regulatory scheme. A broker-dealer must develop a system for implementing its procedures that could reasonably be expected to prevent and detect securities law violations. In addition, a broker-dealer must have an appropriate system of follow-up and review if red flags are detected. However, establishing policies and procedures alone is not sufficient to discharge supervisory responsibility. It is also necessary to implement measures to monitor compliance with those policies and procedures.

Some broker-dealer firms have geographically dispersed offices staffed by only a few people, and many are not subject to onsite supervision. Their distance from compliance and supervisory personnel can make it easier for registered representatives (representatives) and other employees in these offices to carry out and conceal violations of the securities laws. The supervision of small, remote offices, therefore, can be especially challenging. The Commission staff has examined branch offices and the Commission has brought numerous enforcement cases involving inadequate supervision of these small, remote offices. These cases address situations in remote offices where supervisory mechanisms failed to detect and prevent misconduct.

Policies and Procedures

Clearly articulated and vigorously enforced policies and procedures, with sufficient resources to implement them, are an essential part of a supervisory system for remote offices. Comprehensive policies and procedures address all aspects of a remote office’s operations. The following policies and procedures may form part of an effective supervisory system.

Inspections. Inspections are a vital component of a supervisory system. The Commission has determined that broker-dealers that conduct business through remote offices have not adequately discharged their supervisory obligations where there are no inspections of those offices. Effective inspections can detect misconduct in its infancy, deter future wrongdoing, and prevent or mitigate investor harm. An effective supervisory system employs a combination of onsite and offsite monitoring, including the use of unannounced inspections and mechanisms for verifying that deficiencies are corrected.

Routine or “For Cause” Inspections. Onsite inspections usually take one of two forms: routine or “for cause.” Routine inspections are conducted in the ordinary course of business, while “for cause” inspections are conducted upon learning about a specific event or potential violation. It is suggested that all inspections include at least: (1) a review of a sampling of customer files, including account opening documents and trading records; (2) a review of the signature guarantee log; (3) a review of correspondence, advertisements, and sales literature made available at the remote office; (4) a review of business records, including physical and computer files; (5) in-person questioning of the representative by the supervisor about business activities, including inquiry about any unusual activity; and (6) in-person interview by the supervisor of the representative’s assistant or support staff, if any, about the remote office’s business and any unusual activity. If during the course of the examinations deficiencies are identified, examiners should consider the need to conduct a more in-depth review.

Unannounced Inspections. Routine or “for cause” inspections may be either announced or unannounced. Unannounced inspections are conducted on a random, surprise basis. Firm’s are encouraged to use unannounced, onsite inspections of remote offices to enhance supervision. They can deter and detect misconduct because they diminish the opportunity for concealment, removal, or destruction of the evidence of misconduct.

In addition, a supervisor is more likely to uncover evidence of misconduct in customer files, such as fictitious account statements, during an unannounced inspection than in an announced inspection that gives the representative an opportunity to remove such documents from customer files. An unannounced inspection might also reveal marketing materials that describe unapproved products, local billboards with unapproved advertisements, or customer account statements showing purchases of unapproved securities.

Unannounced inspections could be employed at random, as well as when triggered by “red flags” warning of potential misconduct. When indications of impropriety reach the attention of those in authority, they must act decisively to detect and prevent violations of the federal securities laws. Red flags that could suggest the existence or occurrence of illegal activity and might prompt an unannounced inspection include: (1) customer complaints; (2) a large number of elderly customers; (3) a concentration in highly illiquid or risky investments; (4) an increase or change in the types of investments or trading concentration that a representative in a remote office is recommending or trading; (5) an unexpected improvement in a representative’s production, lifestyle, or wealth; (6) questionable or frequent transfers of cash or securities between customer accounts, or to or from the representative; (7) the disciplinary history of the representative; (8) substantial customer investments in one or a few securities or class of mutual fund shares that is inconsistent with firm policies related to such investments; (9) churning; (10) trading that is inconsistent with customer objectives; or (11) significant switching activity of mutual funds or variable products held for short time periods. It is equally important that representatives do not obtain advance notice about a particular focus of an inspection. Advance notice of the focus affords representatives an opportunity to “doctor” particular records.

Offsite Monitoring of Trading, Handling of Funds, and Use of Personal Computers. Centralized technology to monitor the trading and handling of funds in remote office accounts, as well as the use of personal computers, helps detect misappropriation of customer funds, selling away, and unauthorized trading, among other things. Thus, if firms permit communications with customers from employees’ home computers or personal computers not connected to the firm’s network, SRO rules require firms to employ systems to monitor those communications.

Designate supervisory responsibility. Explicit delineation of the supervisory hierarchy, including the designation of a direct supervisor for each representative and the assignment of specific supervisory responsibilities to the supervisor, is a necessary part of a firm’s supervisory structure. Consideration should be given to the independence of supervision when supervisory responsibility is designated. For example, one factor firms should consider is whether the supervisor stands to benefit from the representative’s sales activities. No individual can supervise themselves. As with all supervisory procedures, the Commission has stated that firms should provide a system of review and follow-up to ensure that supervision (by a branch manager or a producing manager) is diligently exercised. The Commission also encourage firms to review the number of representatives for whom a supervisor is responsible as well as the number, nature, and extent of remote offices that an office of supervisory jurisdiction oversees. The degree of supervisory effectiveness is likely to decrease if a supervisor does not have adequate resources to oversee all of the representatives for whom he or she is responsible.

Carefully review FINRA Forms U-4 and U-5 when hiring representatives. Firms should be especially cautious about employing personnel with disciplinary histories. Where a representative with a disciplinary history is employed in a remote office, the Commission has repeatedly emphasized the need for heightened supervision of the representative. Where a representative has left a firm for cause or changed firms several times, the hiring firm should try to ascertain the reason for the changes and contact prior firms as necessary.

Closely monitor outside business activities and selling away. A firm should have adequate procedures for reviewing, analyzing, or following up on the information representatives provide concerning outside activities.46 In addition, a firm should be alert to and investigate “red flags” indicating possible undisclosed outside business activities and assess all outside business activities by a representative, whether or not related to the securities business. The Commission has recognized that there is a risk that representatives will use outside business activities to carry out or conceal securities law violations. A representative appearing to live more lavishly than his business income would allow might be a “red flag” indicating pursuit of improper or outside business activities. Additionally, it is suggested that firms be wary of a representative who owns a company with a name similar to the name of the firm. A customer may make a check payable to the firm that could be altered by a representative and deposited into a bank account in the name of the company he owns.

Implement procedures to detect financial misconduct. It is suggested that firms consider implementing procedures to prevent and detect the following improper activities: (1) the receipt of checks made payable to a representative or any outside business of a representative; (2) the opening of a bank account in the firm’s name or any name similar to the firm’s name by a representative; (3) the receipt of cash and securities by a representative; (4) frequent or questionable transfers of funds or securities between customer accounts; (5) use of a post office box or an address associated with the representative for customer accounts; and (6) the transfer of customer funds or securities to employee accounts without supervisory approval. Inspections and thorough investigations of customer complaints can help detect financial misconduct.

Education for representatives. It is incumbent on firms to provide representatives with training so that the representatives understand the responsibilities under the firm’s procedures, as well as under the securities laws and rules applicable to their business. As with all compliance and sales practice matters, firms are more likely to prevent misconduct if they provide training for representatives and periodically reinforce that training.

Monitor and verify customer address changes. SEC rules require firms to send notification of a change of address to a customer’s old address for each account with a natural person as a customer or owner. This verification enhances customer protection, and we encourage firms to send such verifications for all customer address changes. Moreover, a customer address change to a post office box or an address affiliated with a representative warrants additional steps to verify that the change is genuine.

Record use of the signature guarantee stamp. A firm should have procedures to deter misuse of the signature guarantee stamp to prevent forgeries. These procedures might include maintaining a log of all uses of the stamp and using a stamp with a counter that records each use of the stamp.

Maintain copies of and review incoming and outgoing correspondence. The Exchange Act and rules thereunder require firms to maintain copies of incoming and outgoing correspondence, while SRO rules require firms to review and retain such correspondence, including all documents, reports, profit and loss statements, e-mails, or other materials sent to customers by a representative or received from customers. Firms can enhance the effectiveness of their inspections by reviewing e-mails between representatives. One method of monitoring use of facsimile machines in remote offices is to program these machines to automatically send duplicate incoming and outgoing facsimiles to an office of supervisory jurisdiction.

Contact Us:

With extensive courtroom, arbitration and mediation experience and an in-depth understanding of securities law, our firm provides all of our clients with the personal service they deserve. Handling cases worth $25,000 or more, we represent clients throughout Florida and across the United States, as well as for foreign individuals that invested in U.S. banks or brokerage firms. Contact us to arrange your free initial consultation.

At the Fort Lauderdale Law Office of Russell L. Forkey, we represent clients throughout South and Central Florida, including Fort Lauderdale, West Palm Beach, Boca Raton, Sunrise, Plantation, Coral Springs, Deerfield Beach, Pompano Beach, Delray, Boynton Beach, Hollywood, Lake Worth, Royal Palm Beach, Manalapan, Jupiter, Gulf Stream, Wellington, Fort Pierce, Stuart, Palm City, Jupiter, Miami, Orlando, Maitland, Winter Park, Altamonte Springs, Lake Mary, Heathrow, Melbourne, Palm Bay, Cocoa Beach, Vero Beach, Daytona Beach, Deland, New Smyrna Beach, Ormand Beach, Broward County, Palm Beach County, Dade County, Orange County, Seminole County, Martin County, Brevard County, Indian River County, Volusia County and Monroe County, Florida. The law office of Russell L. Forkey also represents South American, Canadian and other foreign residents that do business with U.S. financial institutions, investment advisors, brokerage and precious metal firms.

Securities and Exchange Act Rules 10-b9 and 15c2-4 contain requirements that must be satisfied in “Contingency” or “Best Efforts” offerings. FINRA (the Financial Industry Regulatory Authority) has provided guidance to broker/dealers regarding the requirements of these rules and to remind broker-dealers of their responsibility to have procedures reasonably designed to achieve compliance with these rules.

Broker-dealers that participate in best efforts public and private securities offerings that have a contingency (i.e., an underlying condition or qualification that must take place by a specified date prior to the issuer taking possession of the offering proceeds) must safeguard investors’ funds they receive until the contingency is satisfied. If the contingency is not met, broker-dealers must ensure that investors’ funds are promptly refunded. There are various contingencies that might need to be satisfied in addition to meeting a subscription amount.

1. Best Efforts Contingency Offerings

In a best efforts offering, a broker-dealer does not commit to purchase any securities from the issuer or guarantee that the issuer will receive any amount of money from the offering (This is in contrast to a firm commitment). Furthermore, a best efforts offering subject to satisfaction of an underlying condition is deemed to be a “contingency offering.” The most common contingency offerings reviewed by FINRA are either “all-or-none” or “part-or-none” offerings that require all or a certain amount of the securities to be sold for the offering to close. Under Securities Exchange Act Rule 10b-9, a best efforts offering subject to either an “all-or-none” or “part-or-none” contingency must provide for the prompt return of investor funds in the event the requisite contingency fails to be met by a specific date.

1. Broker-Dealer Responsibilities in a Best Efforts Contingency Offering.

As discussed in Regulatory Notice 10-22, a broker-dealer that participates in an offering and recommends a security must, among other requirements, conduct a reasonable investigation of the security and the issuer’s representations about it. If the security is offered as part of a contingency offering, the broker-dealer’s reasonable investigation must include a review of the terms of the contingency, including any agreement and disclosure by the issuer regarding the contingency.

III. Requirements Concerning Manner of Handling Investor Funds

Securities Exchange Act Rule 15c2-4 requires that upon receiving money or other consideration from an investor in a contingency offering, a broker-dealer must promptly:

• deposit those funds into “a separate bank account” for which the broker-dealer is the account holder and is designated as agent or trustee “for the persons who have the beneficial interests therein”; or
• transmit those funds to a bank that has agreed in writing to act as the escrow agent for the offering.

The manner in which a broker-dealer must handle investor funds generally will be determined by two factors. First, pursuant to SEA Rule 15c3-1, only a broker-dealer that maintains at least $250,000 in net capital is allowed to carry customer accounts and receive or hold funds or securities for those persons. Therefore, while not a requirement of SEA Rule 15c2-4, a broker-dealer that maintains less than 250,000 in net capital and deposits investors’ funds into a separate bank account rather than transmitting those funds to an independent bank escrow agent would violate SEA Rule 15c3-1. Second, when a participating broker-dealer is an affiliate of the issuer, investors’ funds must be transmitted to an independent bank escrow agent.

1. Escrow Agreements

In contingent offerings that require an escrow agent, the escrow agreement must be executed with a bank that is unaffiliated with the broker-dealer and the issuer. The escrow account should be established before the broker-dealer receives any investor funds. The escrow account may not be controlled by the issuer, the broker-dealer or an attorney. As a general matter, the escrow agent must be a financial institution that meets the definition of a “bank” under SEA Section 3(a)(6), although the SEC staff has provided no-action relief to permit certain other entities to act as escrow agents.

1. Prompt Transmittal of Funds

SEA Rule 15c2-4(b) requires that a broker-dealer promptly transmit funds to either an escrow agent or a separate bank account. SEC staff has interpreted “promptly” to mean by noon of the next business day. Failure to promptly transmit funds to either the escrow agent or a separate bank account has resulted in sanctions. However, in certain offerings, such as direct participation programs that require suitability determinations by the issuer, the SEC staff has provided procedural guidance under which a broker-dealer can still comply with the “promptly” component of SEA Rule 15c2-4 even if the funds are not transmitted by noon the next business day after they are received.

A broker-dealer’s responsibility does not end when it promptly transmits investor funds to an escrow agent or separate bank account. A broker-dealer must also promptly refund investors’ funds if the contingency is not met.

1. Disbursal to the Issuer

Broker-dealers must segregate investor funds they receive at least until the contingency is met.

It is important to keep in mind that the private security offerings that are not offered through a broker/dealer are subject to many of the core requirements discussed in this post.

Please keep in mind that the above summary is being provided for educational purposes only. It is not designed to be complete in all material respects. If you have any question relative to the contents of this post, you should contact a qualified professional.

For quite sometime, we have attempted to bring to the attention of the investing public, especially seniors, the pitfalls that an investor is exposed to when investing in precious metals of all kinds. The primary area of abuse that retail investors is exposed relates to the sale and purchase of gold and silver bullion and coins. This post relates to a case involving bullion. On September 25, 2020, the Commodity Futures Trading Commission (CFTC) and 30 state regulators that are members of the North American Securities Administrators Association filed a joint civil enforcement action against two precious metals dealers and their companies for perpetrating an alleged $185 million fraudulent scheme.

The complaint charges TMTE, Inc., d/b/a Metals.com, Chase Metals, LLC., Chase Metals, Inc. (collectively Metals.com) Barrick Capital, Inc. and its principals, Lucas Asher a/k/a Lucas Thomas Erb a/k/a Luke Asher and Simon Batashvilli with an ongoing nationwide fraud. According to the complaint, from at least September 1, 2017 to the date of the filing of the action, the defendants fraudulently solicited and received over $185 million in customer funds, including more than $140 million in retirement savings, from at least 1,600 persons throughout the United States for the purpose of purchasing precious metals bullion.

One of the largest areas of abuses in retail precious metals transactions relate to the markup on purchases and the markdown on sales (the commission) of bullion and coins. In the Metals.com case, it is alleged that the prices charged customers had no bearing on the true value of the purchases. It is alleged by the government that the markup charged to the investor bore no relationship to the then prevailing market price. Metals.com charged markups of anywhere between 100 percent to more than 300 percent. Just to put this into perspective, this means that in order for the investor to approach breakeven an investor would have to make back the full amount of the markup and enough to pay the markdown on the sale. It is no wonder that nearly every customer lost the vast majority of their funds with the defendants.

According to the complaint, what makes this situation even more egregious is that to perpetuate their fraud, when questioned by a customer about the value of the precious metals they purchased, the defendants falsely claimed that the precious metals bullion was rare and carried a premium far above the base melt value of the metal, which was not true.

What is the melt value of metal? It really does not have anything to do with the value of quality bullion. It has a lot to do with the value of coins, which is another bad story. The melt value of bullion or coins is basically what the metal of the bullion or coin is worth if you were to melt the bullion or coin down. Even if you have a totally ruined coin, it’s metal content is still worth something, especially if it is made out of precious rare metals like gold, silver and platinum.

If you are contemplating investing in bullion, you can due some level of due diligence yourself. By going to Kitco.com you can research the spot value of the metal you are looking to purchase or sell. The difference between the spot price and what you are quoted by the broker would be the markup. The spot price is of gold or silver is the current price in the precious metals marketplace at which a raw ounce of gold or silver can be bought or sold for immediate delivery. The spot price fluctuates constantly.

Contact Us:

With extensive courtroom, arbitration and mediation experience and an in-depth understanding of elder abuse, exploitation and securities law, our firm provides all of our clients with the personal service they deserve. Handling cases worth $25,000 or more, we represent clients throughout Florida and across the United States, as well as for foreign individuals that invested in U.S. banks or brokerage firms. Contact us to arrange your free initial consultation.

At the Boca Raton Law Office of Russell L. Forkey, we represent clients throughout South and Central Florida, including Fort Lauderdale, West Palm Beach, Boca Raton, Sunrise, Plantation, Coral Springs, Deerfield Beach, Pompano Beach, Delray, Boynton Beach, Hollywood, Lake Worth, Royal Palm Beach, Manalapan, Jupiter, Gulf Stream, Wellington, Fort Pierce, Stuart, Palm City, Jupiter, Miami, Orlando, Maitland, Winter Park, Altamonte Springs, Lake Mary, Heathrow, Melbourne, Palm Bay, Cocoa Beach, Vero Beach, Daytona Beach, Deland, New Smyrna Beach, Ormand Beach, Broward County, Palm Beach County, Dade County, Orange County, Seminole County, Martin County, Brevard County, Indian River County, Volusia County and Monroe County, Florida. The law office of Russell L. Forkey also represents South American, Canadian and other foreign residents that do business with U.S. financial institutions, investment advisors, brokerage and precious metal firms.