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Thou Shalt Not Exploit Thine Elders

SEC approves FINRA rule designed to protect seniors and other specified adults from financial exploitation.

The Securities and Exchange Commission (SEC) has approved a new rule proposed by the Financial Industry Regulatory Authority, Inc. (FINRA) to protect seniors and other specified adults from financial exploitation. Once it takes effect on February 5, 2018,[1]FINRA Rule 2165 and its accompanying amendments to the recordkeeping requirements in FINRA Rule 4512 will:

  • require FINRA broker-dealers to maintain a record of the name and contact information for a Trusted Contact Person who may be contacted about a customer’s Account;[2] and

  • permit FINRA broker-dealers to place a temporary hold on the disbursement of funds or securities from the Accounts of certain customers if there is a reasonable belief that the customers may be subject to financial exploitation.

BACKGROUND

According to FINRA, approximately 10,000 Americans will turn 65 every day over the next decade, with their investments accounting for more than 75 percent of all financial assets in the United States. These assets, coupled with rising life expectancies and the potential cognitive effects of the normal aging process, make seniors a prime target for financial exploitation. As the elderly population continues to grow rapidly, the financial services sector can expect a significant increase in elder financial exploitation attempts. Regulators view financial professionals as a first line of defense against threats to this vulnerable group of investors. Both FINRA and the SEC have identified senior financial exploitation as examination priorities.[3]

New FINRA Rule 2165, combined with the amendment to FINRA Rule 4512, addresses what has become a hot-button topic in recent years on both federal and state levels. FINRA’s action follows legislative actions in a number of states intended to protect senior citizens and other vulnerable adults from financial exploitation. More than 20 states currently require broker-dealers and others to file reports with a state agency or law enforcement entity if there is a reasonable belief that a senior or other at-risk adult is being or has been financially exploited. Some states’ laws provide for mandatory training or procedures with respect to filing these reports. The threshold age for defining a senior varies across states.

More recently, some states have adopted a law or rule based on the 2016 North American Securities Administrators Association (NASAA) model “Act to Protect Vulnerable Adults from Financial Exploitation” (NASAA Model Act). Some of these states permit broker-dealers to implement a temporary asset hold in the event of a report of exploitation, but not all of them permit notice to be provided to third parties (e.g., a family member) when an asset hold is put in place.

This legislative trend is not expected to slow down anytime soon. Several states’ laws became effective in 2016,[4] and one state’s new requirements went into effect last month.[5]

SUMMARY OF THE RULE CHANGES

Collection of Trusted Contact Person Information

FINRA Rule 4512, which concerns recordkeeping, was amended to require that as part of the account opening and routine and customary updating process, a broker-dealer must make a reasonable effort to collect the name of a Trusted Contact Person from an account holder. The broker-dealer must provide written disclosure that it may disclose information to the Trusted Contact Person about the customer’s account to address possible financial exploitation and confirm specifics of the customer’s current contact information, health status, or the identity of any legal guardian, executor, trustee or power of attorney. Electronic disclosure would satisfy the requirement, both for new and existing accounts. Broker-dealers are permitted, but not required, to notify the Trusted Contact Person of the designation.

FINRA does not specify the contact information to be gathered, but this would generally include a phone number, email address, and mailing address. FINRA indicated in its proposal that merely asking a customer to provide this information would satisfy the reasonable effort requirement. The inability to collect the information, if requested, would not prevent a broker-dealer from opening and maintaining an account for the customer.

Commenters requested clarification that obligation to obtain Trusted Contact Person information for existing accounts would be satisfied when the member updated the account within the 36-month period required by SEC Rule 17a-3. FINRA’s response to comments noted that the update requirement may be triggered earlier than the 36-month period if the member updates the information on the account either in the course of the member’s routine and customary business or as otherwise required by applicable law or rules.

Temporary Holds on Disbursements

New FINRA Rule 2165 provides a safe harbor for a broker-dealer and its associated persons in certain circumstances if a broker-dealer puts a temporary hold on disbursements if financial exploitation of a Specified Adult is suspected. A Specified Adult is

  • a natural person age 65 and older; or

  • a natural person age 18 and older who the broker-dealer reasonably believes has a mental or physical impairment that renders the individual unable to protect his or her own interests.

Financial exploitation means

  • the wrongful or unauthorized taking, withholding, appropriation, or use of a Specified Adult’s funds or securities; or

  • any act or omission by a person, including through the use of a power of attorney, guardianship, or any other authority regarding a Specified Adult, to:

(i)

obtain control, through deception, intimidation or undue influence, over the Specified Adult’s money, assets or property; or

(ii)

convert the Specified Adult’s money, assets or property

Broker-dealers are permitted, but not required, to place a temporary hold on a disbursement of funds or securities from the Account of a Specified Adult under the following circumstances:

  • if the broker-dealer reasonably believes that financial exploitation of the Specified Adult has occurred, is occurring, has been attempted, or will be attempted;

  • the broker-dealer, not later than two business days after the date that it first placed the temporary hold on the disbursement of funds or securities, provides notification orally or in writing, which may be electronic, of the temporary hold and the reason for the temporary hold to:

  • all parties authorized to transact business on the Account, unless a party is unavailable or the broker-dealer reasonably believes that the party has engaged, is engaged, or will engage in the financial exploitation of the Specified Adult; and

  • the Trusted Contact Person, unless he or she is unavailable or the broker-dealer reasonably believes that the Trusted Contact Person has engaged, is engaged, or will engage in the financial exploitation of the Specified Adult; and

  • the broker-dealer immediately initiates an internal review of the facts and circumstances that caused the broker-dealer to reasonably believe that the financial exploitation of the Specified Adult has occurred, is occurring, has been attempted, or will be attempted.

The broker-dealer may place a temporary hold on a disbursement of funds or securities for up to 25 business days when the requirements of the rule listed above are met, unless the hold is otherwise terminated or extended by the appropriate state regulator or agency (e.g., a state securities regulator or state adult protective services agency), or by a court of competent jurisdiction. Of course, FINRA encourages its members to attempt to resolve the issue without a hold, unless the member reasonably believes that doing so would cause further harm to the Specified Adult.

FINRA notes that a broker-dealer’s reasonable belief that financial exploitation of a Specified Adult is or may be occurring may be based on the facts and circumstances observed in the broker-dealer’s business relationship with the Specified Adult.

Holds on Transactions Not Permitted

The permitted temporary hold does not apply to transactions in securities. Accordingly, the rule does not provide a basis to refuse to follow a customer instruction to liquidate a position, but it does authorize a broker-dealer to refuse to follow a subsequent instruction to disburse the proceeds from the account in accordance with the provision described above.

Holds on ACATS Permitted

FINRA noted that for purposes of Rule 2165, it would consider disbursements to include automated customer account transfers via ACATS, noting that as with any other temporary hold, the member must have a reasonable belief of financial exploitation in order to hold the processing.

Written Supervisory Procedures

FINRA Rule 2165 requires broker-dealers that wish to avail themselves of the safe harbor to establish and maintain related written supervisory procedures (WSPs). The required WSPs must include procedures to identify, escalate and report matters relating to financial exploitation of Specified Adults.

The WSPs must also identify the title of each associated person of the broker-dealer who is authorized to place, terminate or extend a temporary hold on behalf of the broker-dealer. Associated persons with this authority must serve in a supervisory, compliance or legal capacity for the broker-dealer.

Broker-dealers should also monitor for requests by customers to make changes to their designated Trusted Contact Persons, which may itself be a sign of potential financial exploitation – for example, a Specified Adult seeking to change the Trusted Contact Person from an immediate family member to a third party that is not known to the broker-dealer.

Training

Broker-dealers would be required to develop and document training policies or programs reasonably designed to achieve compliance with the requirements of new FINRA Rule 2165. FINRA noted that members have discretion in determining how best to structure training. FINRA and several states have published related training materials.

Recordkeeping

Broker-dealers would be required to retain records relating to their obligations and actions under the rule, including

  • requests for disbursement that may constitute financial exploitation of a Specified Adult and the resulting temporary hold placed by the broker-dealer;

  • the finding of a reasonable belief that financial exploitation has occurred, is occurring, has been attempted, or will be attempted underlying the decision to place a temporary hold on a disbursement;

  • the name and title of the associated person that authorized the temporary hold on a disbursement;

  • notifications to the relevant parties pursuant to new Rule 2165; and

  • the internal review of the facts and circumstances pursuant to new Rule 2165.

OTHER CONSIDERATIONS

Privacy Concerns

FINRA noted that a broker-dealer’s disclosure of information to a Trusted Contact Person pursuant to Rule 2165 would be consistent with the Regulation S-P exception for disclosures to comply with federal, state, or local laws, rules and other applicable legal requirements. As support, FINRA cites to prior Interagency Guidance issued by the SEC and other federal financial regulators in 2013 that “clarifies that reporting suspected financial abuse of older adults to appropriate local, state, or federal agencies does not, in general, violate the privacy provisions of the [Gramm-Leach-Bliley Act] or its implementing regulations,” which include Regulation S-P. That guidance further notes another exemption that may be available to a financial institution to disclose nonpublic personal information to protect against or prevent actual or potential fraud, unauthorized transactions, claims, or other liability.

FINRA urges broker-dealers to use discretion in disclosing information to the Trusted Contact Person, including

  • With respect to the customer’s health status, FINRA believes it would be reasonable for a broker-dealer to communicate with the Trusted Contact Person regarding any concerns the broker-dealer may have about a customer’s health.

  • FINRA believes that a broker-dealer should be allowed to communicate with the Trusted Contact Person to address possible financial exploitation of the customer, even if the broker-dealer has not decided to place a temporary hold on a disbursement.

FINRA also cautions broker-dealers to consider potential applicable non-US privacy requirements when determining whether to place a temporary hold on a customer’s Account.

Identifying an Appropriate State Agency for Reporting

Although some commenters argued that FINRA should mandate reporting of senior exploitation, FINRA declined to do so. Nonetheless, some state laws already mandate reporting of senior exploitation, and almost all others expressly permit it. FINRA noted that it would expect members to comply with all state reporting and other requirements and may request related records during the examination process.

One practical question that may arise is how broker-dealers identify the appropriate state agency to which they can report potential financial exploitation. State procedures vary widely. In many states, reports are submitted to the Adult Protective Services agency. In others, reports are either permitted or required to be made to other agencies, such as local law enforcement, or more recently (in keeping with the NASAA Model Act) to the state securities regulator.

Requirements for Self-Directed and Electronic Accounts

FINRA notes in the proposal that a broker-dealer’s reasonable belief that financial exploitation of a Specified Adult is or may be occurring may be based on the facts and circumstances observed in the broker-dealer’s business relationship with the Specified Adult. The opportunity for such observations is clear in a traditional brokerage relationship that involves in-person and telephone interaction with the client. Less clear is how such facts and circumstances may be observed when the business relationship involves self-directed and electronic accounts.


[1] Based on comments received in response to the proposal, FINRA extended the implementation deadline to 12 months after SEC approval instead of the original 6-month period that was proposed.

[2] The term “Account” would mean any account of a broker-dealer for which a “Specified Adult” has the authority to transact business. Institutional accounts are excluded.

[3] The SEC Office of Compliance Inspections and Examinations recently published its Examination Priorities for 2017. FINRA also recently published its 2017 Annual Regulatory and Examination Priorities Letter.

[4] See, e.g., Ala. Code §§ 8-6 et seq. (2016).

[5] La. R.S. § 51:725 et seq.  (2016).

Copyright © 2017 by Morgan, Lewis & Bockius LLP. All Rights Reserved.

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About this Author

Amy Natterson Kroll, Morgan Lewis Law Firm, Financial Services Attorney
Partner

 

Amy Natterson Kroll counsels US and non-US financial institutions on US regulatory requirements and best practices related to broker and dealer activities. Clients seek Amy’s advice on, among other things, issues related to implementation of new regulations, such as the Volcker Rule and Municipal Advisor regulation; the acquisition and sale of broker-dealers; expansion of business and related regulatory requirements for financial institutions; and regulations related to the capital markets, such as research activities and research analysts, supervisory controls...

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Mary Dunbar, Broker-dealer and securities market regulation attorney, Morgan Lewis Law Firm
Of Counsel

Mary M. Dunbar counsels clients on broker-dealer and securities market regulation, including compliance, supervision, and reporting issues. She represents clients in SEC and FINRA investigations and disciplinary proceedings, and conducts internal investigations.  Mary also advises clients on broker-dealer formation, mergers and acquisitions, and FINRA and exchange membership issues. Mary brings to Morgan Lewis experience as a vice president and deputy general counsel with The Nasdaq Stock Market, Inc., as well as other FINRA and governmental experience. Mary is admitted to practice in the District of Columbia and New York only.

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Nicholas J. Losurdo, MorganLewis, SEC, finance, lawyer
Associate

Nick Losurdo advises broker-dealers, equity and option exchanges, investment advisers and ATSs on various regulatory, compliance, transactional and enforcement matters. He also utilizes his diverse capital markets and financial services experience to guide private equity funds through strategic and financial acquisitions, dispositions and restructurings involving these financial institutions. Clients look to Nick for insight on SEC rules and regulations, FINRA’s rules and membership, and the membership and compliance requirements of state regulators, equity and option...

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Kathleen H. Shannon, Morgan Lewis, Government Investigations Lawyer, Trading Disclosures Attorney
Associate

Kathleen H. Shannon represents clients in litigation, regulation, and enforcement matters. Kathleen has experience in government investigations and examinations, as well as internal investigations and corporate compliance and due diligence reviews. She also counsels various financial institutions on investment management issues, including trading, disclosure, and other regulatory matters. Kathleen is admitted in New York only, and her practice is supervised by DC bar members.

202-373-6526