The Ramifications That Can Result From an Enforcement Action

Last month, The New York Times reported the ongoing issues faced by LPL Financial with respect to customer complaint arbitrations and regulatory enforcement actions.  According to the report, recent customer complaints and other matters have caused LPL to be on the radar screen of state and federal regulators “more than any other firm.”  In the past 18 months, state regulators in Illinois, Massachusetts, Montana, Oregon and Pennsylvania have sanctioned LPL for allegations of failure to supervise its brokers in an appropriate manner.  As a result, LPL reports that it increased its risk and compliance budgets by 5 and 11 percent, respectively, in 2013.  Although such efforts may assist in preventing regulatory and legal battles in the future, such an adjustment will likely have no impact on LPL’s ongoing attempt to resolve actions based upon prior actions.

When state and federal (namely FINRA and the SEC) regulators investigate and sanction broker / dealers and their registered representatives, the regulatory enforcement actions are usually only a portion of the headaches the broker / dealers will experience.  Although the regulatory enforcement action process can be frustrating and painful, especially the branch inspections, on-the-record interviews (“OTRs”) and ultimate findings, the effect of those actions can be even more painful and frustrating.  For example, if a state regulator commences an enforcement action, said action should only apply to the broker / dealer’s activities within that state.  Depending on the state’s findings, the federal regulators (i.e., FINRA and the SEC) may commence similar enforcement actions involving the broker / dealer’s activities in other states.  Furthermore, depending on the severity and nature of the allegations, the enforcement actions could result in criminal proceedings or result in similar actions by the IRS.  Finally, after any of the regulators (state or federal) make a finding of wrongdoing by the regulators, the vultures will begin to circle to pick at the remnants of the broker / dealer’s carcass, namely the claimants and their counsel hoping to take advantage of the regulators’ various findings by obtaining arbitration awards against broker / dealers and recovering said awards from the firms’ insurance policies.  In any customer-based arbitration, exhibit A will always be the findings of any state or federal regulators in the event the enforcement action is even remotely related to the basis of the customers’ complaints.

Given all the ramifications that can result from an enforcement action, regardless of the size or enforcing body, it is important that the subject firm be prepared for all possible outcomes.  The best way to be prepared is through the retention of counsel who is not only well-versed in the enforcement action process, but likewise is prepared represent the firm in customer-complaint arbitrations.  For example, some counsel will respond to a document request in an enforcement action without giving consideration to potential arbitration or litigation defenses.  Furthermore, counsel may produce communications with an attorney in response to an enforcement action request without considering whether a waiver of the attorney-client privilege is appropriate in order to preserve a reliance on counsel defense.  Finally, counsel may not consider the bigger picture from the enforcement action – namely the inevitable customer-complaint arbitrations – and as such may not preserve sufficient insurance policy funds for the purpose of defending the arbitrations rather than spending all available funds on the enforcement action.  Fortunately for firms, there are counsel who can handle all of these matters and concerns, but without them, the unfortunate fate of the firm is inevitable.

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