Friday Q&A - LLCs for Independent Reps

Question: I recently went independent and intend to operate my business as an LLC. We setting up the relationship with my BD, they insist that all the paperwork will be in my name and not the LLC. Is this normal? How do I protect myself from liability?

Answer: The reason the BD insists on having the registration and agreements with you rather than your LLC is simple – securities regulations require it. Firms are not permitted to pay compensation to unregistered persons or entities. Your LLC is not registered, YOU are registered, and therefore the paperwork is with you, not the LLC.

As to liability, first, an LLC will not protect you from liability to your clients should they sue you for negligence or fraud. That is what insurance is for, and a corporate entity does not provide protection from your own wrongful conduct. You can insulate yourself from other liabilities, such as rent, premises liability, vendor suits and all non-work related hazards by using the LLC. Set up the LLC as you would for any other business, and pay the LLC a fee for rent, phones, etc. from the check that you receive from the BD.

All of the legal caveats apply, this is not legal advice. If you need assistance with this give us a call.

Friday Q&A - A Trading Account has accused me of Churning!

Question: For a number of years I had a very active client, who traded frequently, multiple times in a week. Most of the investment ideas were his, but some where mine, and we spoke constantly about the activity and the trades. I provided him with deep discounts on commissions, and followed his instructions, but now he is claiming that I churned his account! What can I do to defend myself and to prevent this from happening again.

Answer: First, and this has become a near mantra for me, you need to document your conversations, and activities in the account. While this may not help with this particular account, keeping notes about your customers will help to prevent this type of claim, and will help in the defense of the claim should it arise. The first column that I wrote for Research Magazine was on keeping records, and is a must read for every registered representative - For the Record.

My article, Churned or Traded, provides an analysis of the claim, and the defense to the claim, and I recommend a review of the article, which is posted at SECLaw.com. For the moment, the definition is important.Churning is excessive trading in a customer's account by a broker taken in the context of the customer's financial situation and investment objectives. Churning requires three elements, first, excessive trading, and second, control of the account by the Registered Representative, and three intent to defraud the customer.

The most difficult part of a churning analysis is a determination of whether the broker had control over the account, and notes and written communication between the broker (or firm) and the customer is important. The fact that the customer was picking the stocks is important, and documentation of that fact will be a great benefit in defending the claim. The customer's new account form is important, as it documents the investment objectives of the customer, as well as his investment experience and financial condition.

Although not frequently done, when an account that is going to be actively traded is opened, the customer can be asked to confirm, in writing, the trading strategy that is going to be used in the account, before the account is established. Periodic confirmations of that strategy during the life of the account can easily establish that the customer was directing the level of activity, and was therefore in control of the account.

Alternatively, many brokerage firms use activity letters in accounts with a high level of trading. Once the compliance department has identified an account as having a high level of trading, the branch manager or compliance officer will discuss the account with the registered representative, to determine the accounts goals and objectives. Assuming that the supervisor finds the level of trading to be suitable, or that the account is in the control of the customer, the firm then sends a letter to the customer, informing the customer that the trading in the account is more frequent than in a typical account, and seeking written confirmation from the customer that he is aware of the trading, and that the trading account is being handled to his satisfaction.

These letters, known as "activity letters" by some, and "suicide notes" by others, are sent to the customer and the written response is then kept in the customer's file. The activity letters are called suicide notes since the letter often becomes important evidence against the customer when he attempts to claim that his account was churned, or that he was unaware of the high level of trading in the account. A customer who has signed an activity letter has a very difficult time establishing the control aspect of a churning claim.

At the same time, if an account that has been actively trading does not return an activity letter, the customer should be contacted by the branch or compliance department, and the trading ceased, until everyone concerned is convinced that the customer is aware of, or directing, the trading.

Often broker's complain about activity letters, arguing that the letter will generate a complaint or will be sending the message to the customer that his broker is going something wrong in the account. While it is true that the wording of the letter may make a difference, the customer's refusal to sign the letter may very well identify a customer who did not truly understand the activity in the account. If that is the case, it is in everyone's interest to have the issue resolved sooner rather than later.

Friday Q&A: Should I used my firm's attorney?

Question: My firm and I have both been sued in arbitration by a customer. The firm is offering to have its attorney represent me, as well as the firm in the arbitration. Should I use the firm's attorney, or hire my own?

Answer: This is a recurring question from brokers who are named in an arbitration proceeding by a customer, and whose firm offers to provide the attorney to represent both the broker, and the firm.

Unfortunately, the answer is not simple. In the 18 or so years that I have been handling securities arbitration matters I have been on both sides of the issue – representing a broker with another attorney representing the firm, representing the firm without representing the broker. However, far more common is the situation where I represent both the broker and the firm.

Sometimes there is a conflict between the broker and the firm, and joint representation is simply not possible. However, such conflicts are rare, and in the overwhelming majority of cases, it is possible to use one attorney.

For the broker, the remaining question is whether the attorney will zealously represent the broker’s individual interest, as well as the firm’s interest. In the largest sense, the broker and the firm both have the same interest – to defend the claim. The facts and legal principles which work in the broker’s favor also work in the firm’s favor. Additionally, in the usual case, the firm is only liable if the broker is liable, as the firm itself is not accused of committing a wrong, it is the broker who is so accused. In that instance, the firm is only liable if the broker is liable, and there is truly a united interest.

In more complicated cases, the interest of the firm and the broker may be different. For example, in a case where there are the usual sales practice allegations mixed with a market manipulation case, the broker may feel that the case will focus on the market manipulation theories, for which he has no responsibility, and impact his defense of the sales practice case. Separate representation may be desirable in that instance.

In other situations, such as where the broker has left the firm, even if a dispute does not exist, joint representation may be precluded by a simple lack of trust between the firm and the broker. Another cause for concern is where the broker, by his contract with the firm, is responsible for the loss, and, regardless of the outcome of the arbitration proceeding, he will be forced to pay the award, as well as the attorneys’ fees.

In this instance, the broker is sometimes concerned that the firm will force him to settle the matter when he wants to defend himself, and that the attorney, selected by the firm, will take the firm’s “side” in a settlement dispute. Other times, the broker simply feels that having an attorney who was responsible for his aspect of the case would give him better legal advice.

There are compelling reasons not to use separate attorneys. In cases where the broker is still employed by the firm, the usual practice is for both to use the same attorney. Deviating from this norm may send the wrong signals to the customer and his attorney, inadvertently telling them that there is a dispute between the respondents. If the customer believes that such a dispute exists, he may press his claim with more zeal, he may not be willing to discuss settlement, or he may simply make unreasonable settlement demands because he thinks he has discovered a weakness in the defense.

Cost is also a factor. While using two attorneys does not necessarily mean that the costs are doubled, there is an obvious increase in the defense legal bill, and in the costs. While defense counsel will decide which attorney is going to take the lead, and will divide the work, there is an obvious overlap in effort.

The reality is that in most cases, one attorney can, and does, represent the firm and the broker, and usually the other respondents in the arbitration who are employed by the same firm, and there is no reason to do otherwise.

The most important factor in making the decision is to be represented by an attorney who you trust and who you have confidence in. You also need an attorney who knows the securities laws, who understands the regulations and practices at issue, and who understands the arbitration process. Typically, that will be the firm’s attorney, whether he is in-house, or outside counsel. However, if the firm’s attorney does not meet this description, I suggest a frank and honest conversation with the attorney, to iron out any issues or concerns. If that does not work, brokers should not hesitate to retain their own attorney, and deal with the costs and appearance issues later.

After all, the money spent on a second attorney pales in comparison to the money that can be lost in an arbitration.

The full article on this topic is available at SECLaw.com - The Firm's Lawyer or Your Own.

Friday Q&A: Can I sell stocks in a foreign country?

Friday Q&A - I am licensed in the US with all of the applicable securities licenses. I would like to being servicing customers in England, France and Spain. Do I need any additional licenses?

Having a license to provide investment advice in the United States does not mean that you can automatically charge for that advice everywhere else. Most countries (though not all) have their own securities laws and rules which govern the activities of persons offering or selling securities in their country. Many countries have adopted regulations similar to those in the United States, some have very different regulations, and others have very few.

Despite the fact that you do not reside in the foreign country, you need to comply with their regulations regarding the offer and sale of securities. It might be tempting to believe that a US broker-dealer is beyond the reach of a foreign securities regulators, but that is simply not the case, as doing business in a foreign country subjects you to the jurisdiction of that country. This issue is really just theoretical, since FINRA and the SEC may consider violation of another country's securities laws a violation of US securities laws.

FINRA has previously released two Notices to Members regarding these issues. The first, NASD Notice to Members 98-91, was titled "NASD Alerts Members To Their Obligations Concerning Cold Calling And Advertising To Persons In The United Kingdom" and was apparently released by the NASD at the request of the securities regulators in the United Kingdom. Two years later a second Notice to Members was released, again reminding members of their obligations in foreign countries. NASD Notice to Members 00-02 - NASD Alerts Members To Their Obligations Concerning Soliciting Business In Foreign Jurisdictions.

On December 10, 2001, the NASD released NASD Notice to Members 01-81 titled "NASD Provides Interpretive Guidance On The Conduct Of Business Abroad." The release is an attempt to provide an overview and interpretation of the NASD's rules regarding overseas operations, and is in a question and answer format, dealing with some of the more common issues in foreign business operations.

Current NASD rules on the topic include:

* The NASD permits firms to register certain persons working in foreign offices as Foreign Associates without requiring qualification examinations (NASD Rule 1100).

* The NASD authorizes member firms to maintain registrations for persons who are engaged in the investment banking or securities business of a foreign securities affiliate or subsidiary (NASD Rules 1021(a) and 1031(a)).

* The NASD allows, in limited circumstances, member firms and persons associated with a member to pay transaction-related compensation to non- registered foreign persons, or foreign finders (NASD Rule 1060(b)).

* The NASD permits persons registered in certain foreign countries to work in the U.S. as general securities representatives after taking an abbreviated examination (NASD Rule 1032).

A careful reading of the Notice, and other comments from the NASD reflect a growing concern with operations in foreign countries. Readers are advised to move carefully into these markets, as violation of the applicable regulations can subject one to civil and criminal prosecution in the foreign country, as well as disciplinary action in the United States.