While the COVID-19 pandemic has required both SEC and FINRA staff to make adjustments in the way they conduct examinations and investigations of municipal advisory firms, both agencies continue their activities with a special focus on fiduciary duties.
Panelists at a compliance outreach program for municipal advisors hosted by the SEC discussed the Commission’s and FINRA’s processes for examinations and enforcement of their rules for municipal advisors and municipal securities broker-dealers, including how the agencies select firms for examinations, when violations can raise to the level of an enforcement action, and how the respective agencies are dealing with challenges relating to remote communication during the coronavirus pandemic.
Examinations. Aaron Pabst, a senior staff accountant in the SEC’s Fort Worth Regional Office, discussed how examinations staff conduct examinations of municipal advisors. He said that rather than having a set routine or schedule, the SEC uses a risk-based approach. Risk priorities may be associated with a particular SEC initiative, new rules, or something else the SEC has determined to be a priority. The SEC will also consider known factors about a particular firm or a business model, as well as the amount of time that has passed since the firm was last examined or if the firm has never been examined at all.
Pabst said typically he will contact a firm to introduce himself and let the firm know his office is opening an exam. He will present the firm with a document request list to which the firm should respond within two weeks, preferably on a rolling basis so the staff can start its review right away. Due to the COVID-19 pandemic, staff is not conducting on-site examinations but the staff and firms have adjusted to conducting interviews via teleconference. While there are advantages to on-site examinations—indeed, Pabst said that many registrants prefer to meet the staff in person—between the use of videoconferences and emails, the staff is able to obtain the documents needed to conduct an examination. In the beginning of the pandemic shutdown, examination timeframes were initially stretched out but since then the process has normalized, according to Pabst.
Gene Davis, director of Member Supervision Specialist Programs at FINRA, said that like the SEC, his office also uses a risk-based approach to examinations for the roughly 120 broker-dealer/municipal advisors it oversees. The staff pulls in data such as customer complaints and Forms MA and assigns firms a quantitative rating, roughly 1-120. However, Davis advised that FINRA does not just use what this model "spits out"; the staff will also apply a qualitative approach to assign a risk rating, he explained.
According to Davis, some firms in the municipal advisory business are looked at every year or every other year by FINRA, meaning that just because a firm was examined the previous year doesn’t mean it will not face an exam in the following year. He added that FINRA will look at a firm’s "footprint" in the municipal advisor space when determining which firms to examine. This means, for example, that while a firm may not think of themselves as being a large firm, FINRA will look at the sectors in which the firm participates and may choose to examine a firm that substantially advises in a particular sector or industry. He noted that FINRA wants to be smart about choosing what firms to examine and will consider whether it is really a good use of FINRA’s resources to have back-to-back examinations of a particular firm.
Davis also discussed how FINRA is conducting examinations in the COVID era. After it announces its intent to conduct an exam of a firm, there is usually a 60- to 90-day lead time, which may be extended now that examinations are conducted virtually. Given the adjustments necessary during the pandemic, Davis stressed that firms should communicate with FINRA staff on deadlines and due dates. He noted that due to so many employees working remotely, firms may face difficulties complying with a request for a document that may only exist in hard copy at a particular branch location or office. "If you need more time, give us a call," he encouraged. Davis added that the number of exams FINRA is conducting has not decreased—it is just doing them a little bit differently.
Pabst said that the most common deficiencies found by SEC examination staff of municipal advisors relate to the Rule G-44 requirement to establish and maintain written compliance policies and written supervisory procedures (WSPs). The staff will review what the firm said it would do and compare it to what it actually has done, he said. Around 60 percent or more of examinations have findings relating WSP, he added. Conflicts of interest findings are also common according to Pabst.
Davis said that conflicts of interest findings are also common in FINRA’s examinations. In particular, FINRA staff frequently finds that while a firm may have disclosed a conflict of interest, it was not done in a timely manner as required by Rule G-42. Sometimes firms will attempt to comply through the use of a form letter "just to get it out" so they can start providing advice, he said. Responding to a question about advertising-related violations, Davis said that he rarely sees "nefarious" advertising but, instead, will come across claims on firm websites that are unable to be substantiated, such as "we’re the best municipal advisor in the country."
Enforcement. Gina Petrocelli, FINRA’s chief counsel of enforcement, said that in enforcement matters FINRA maintains a close dialogue with both the SEC and the MSRB. In addition, FINRA’s Department of Enforcement works closely with FINRA’s examinations staff for potential referrals of cases for enforcement actions. She noted that most of FINRA’s enforcement actions end in a settlement, which can include monetary sanctions or the requirement that a firm retain an independent consultant or commit to undertakings to prevent future violations.
Panel moderator Bri Joiner of the MSRB asked Heidi Mitza of the SEC’s Public Finance Abuse Unit about how examination findings make their way to the Division of Enforcement. According to Mitza, if the examination team makes a referral, the matter goes through a review process to determine if an enforcement action is needed. This can depend on how serious the matter is, she said, adding that breaches of fiduciary duty are taken seriously. Enforcement may seek a formal order of investigation, which allows the staff to seek subpoenas for documents and testimony. She recommended that firms cooperate with examination staff to resolve problems before they make it to enforcement, but even taking remedial measures does not preclude an enforcement action. In addition, enforcement staff may refer other matters discovered during its investigation to the examination staff, she said.
As an example of the SEC’s enforcement efforts against municipal advisors, Mitza discussed an SEC enforcement action currently being litigated in the Northern District of Illinois. The SEC brought charges against Comer Capital Group for breaching its fiduciary duty. The Harvey Public Library District, a small, unsophisticated issuer that had never issued bonds before, hired Comer to serve as its municipal advisor for a contemplated bond offering which was intended to finance the expansion and renovation of the District’s library building. According to the SEC, Comer breached its fiduciary duty to the District because it deferred entirely to the underwriter of the bonds, which lacked experience leading an underwriting for these types of bonds, and it ultimately sold them at a price that was not fair and reasonable to the District.
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