Broker-Dealer Compliance: The Good, The Bad, The Ugly

November 2006—State securities examiners put 228 broker-dealers in 28 state jurisdictions through their paces this past spring.  The result of their compliance reviews? The identification of 654 deficiencies in five areas: books and records (49 percent of the deficiencies), supervision (22 percent,) sales practices (16 percent), registration and licensing (7 percent), and operations (6 percent).  

Now, even though one reported deficiency is one too many, there’s good news here. And that’s the fact that sales practices ranked third in the number of deficiencies identified, trailing books and records and supervision.  To the degree violations occur in securities backrooms rather than in client meeting rooms, that’s a good thing, at least in relative terms.

Also “good” is that blatantly illegal actions such as fraud and manipulation or excessive trading and churning accounted for only 6 of the 105 sales-practice deficiencies reported.  Again, even one reported instance of fraud or churning is excessive.  But we can take heart that representative sales practices by and large didn’t rise to the level of outright criminality.

So where’s the bad news? From the National Ethics Bureau’s perspective, we were disappointed that 43 of the reported 105 sales practice deficiencies related to general suitability, while another 11 deficiencies concerned variable-product suitability.  This put suitability at number two in the North American Securities Administrators Association (NASAA) Top 10 Deficiencies List.

Not only are suitability problems troubling, they’re just plain ugly.  Failing to ascertain client needs, resources, and constraints—or making product recommendations that fly in the face of what you know about a client—is not only against the law, it’s unethical. Yet even in this day and age, a significant number of securities professionals recommend products that do their clients a disservice. Isn’t it time we took suitability infractions out to the barn and put them out of their misery?

The key is to get serious about suitability.  Make it your mission in life to know what your clients need—and then deliver products and services that meet those needs.  You also won’t go wrong by implementing NASAA’s sales practice guidelines:

1. Develop effective standards and criteria for determining suitability.
2. Make sure advertisements and sales literature make full and fair disclosure and are approved prior to use.
3. Make sure seminars and handouts are approved prior to the event, including any speaker materials used.

Following these recommendations will help you avoid a showdown the next time the securities marshall rides into town. Now that’s a good thing.

What “Red Flags” are affecting your business? The National Ethics Bureau welcomes your input. Send your comments to: hlew@ethicscheck.com