Join Oyster Consulting’s former regulators Patrick M. Dennis, Jeffrey HillerBill ReillyEvan Rosser and Ed Wegener in our new podcast mini-series, Regulators– Behind the Scenes.  In this episode, they share their experiences and perspectives as former SEC, FINRA and State regulators on Document Production and the importance of good communication with examiners. 


Transcript provided by Temi transcript services

Oyster: Welcome to the Oyster Stew podcast, where we discuss what’s happening in the industry based on what we see as we work with regulators and clients. Oyster consultants are industry practitioners; we aren’t career consultants. We’ve done your job and we know the issues you face. You can learn more about Oyster Consulting and the value we can add to your firm by going to our website, 

Patrick Dennis: Thanks for joining us for this episode of “Regulators – Behind the Scenes.” We’ve talked before this about the level of severity and how people perceive what the regulators are going to do, and I think it’d be great for us to address our thoughts and experiences on what happens with when regulators find a violation and how they deal with it. Maybe, start with Jeff. 

Jeffrey Hiller: Sure. I have been in situations when regulators have sat down and they’ve raised concerns about a particular issue. When they first raise these issues, I think it’s a good time to listen, to find out whether they have the true picture, to see what they’re trying to get at and to see whether it’s something that on the risk scale and where did you put it? So my first sort of thought would be to really listen to the issue that you’re getting to, and then seeing if there’s a good reason for saying, “Look, let’s, let’s discuss this later. Let me gather some more facts and try to put a fuller picture around it.” And at the same time, you want to escalate that in the firm to others, such as the legal department, maybe the risk department, and get more answers before you go back to talk with them. I find that candor and straightforwardness, eagerness, and zealousness to fix things and fix them quickly in a proper way are how I would address it initially. But there are cases where they’re wrong, and additional facts will help you supplement that. 

Patrick Dennis: I have had incidences where, in fact, we got a Wells notice from FINRA about something and we took a week’s worth of testimony and things on various issues. It was pretty easy to explain, saying wait a minute, you totally missed this. We talked about this during the testimony that these were just journal entries. They weren’t actually trades. They were sort of dividends that were reinvested, and things like that. So this trading activity that you’re complaining about, or you’re concerned about didn’t really occur. And there are times when there’s a misunderstanding by the regulators or by the firms as to what the issue is, and things like that. It’s always important to make sure that you understand what the concern is, and you understand how to explain it the best you can. But Ed, your thoughts on dealing with the violations? 

Ed Wegener: I think that’s spot on because I think there’s really two determinations that have to be made by the regulators, right? The first is whether there is a violation and the second is, if there is a violation, what are we going to do about it? Those are two really separate discussions. To your point, there are several points during the examination where you can provide information to help to make that determination of whether there is or isn’t a violation. And it starts to, to Jeffrey’s point, when the examiners first start talking about it.  Before there’s an exit conference, before there’s an examination report that’s issued, they’re going to let you know throughout the exam, whether there’s something that they see, and start gathering information about it. So at that point, you want to provide them as much information as you can to help show them that we don’t think that there’s a violation or again, to Jeffrey’s point, there is a violation and we’re starting to take care of it. 

Then there’s a lot of levels of review that happens. So that’s one thing – that I’m not sure people appreciate – is just the number of levels of review that go on throughout the course of the examination before there’s a final determination and examiners will turn it into their managers who review it. If it’s something where there’s a violation that looks like it might be referred to Enforcement, senior management will usually take a look at it as well. So there’s a lot of points of review, and those are also opportunities to get in front of the regulator and plead your case. But once it’s been determined that there’s a violation and that there’s evidence that supports the violation, the question becomes, “So what are you going to do about it?” And at FINRA, and this is similar, I think to what the other regulators do, we had different things that we could do, some formal actions, some informal.  So that exam could result in no action being taken. It can result in a letter of caution where we identify, these are the issues that are found, show us how you’re going to fix them. There were some cases where FINRA would hold what we called corrective action meetings.  Where it was something that was probably more egregious than a letter of caution would resolve but didn’t feel like it was something that should be referred to Enforcement. So they might call the firm in to have a discussion about it and discuss how the firm’s going to resolve the issue. If none of those things work or don’t appear to be appropriate, then the determination is made to refer it to Enforcement. 

The factors that are considered are, they’ll take a look at the violation and look to see and weigh aggravating factors and mitigating factors. Things like, was their customer harmed? Was their intent to harm the customers? Were the firm’s procedures and supervision good, or were they poor? When this was raised to the firm, what did they do about it? Did they take action? Did they dig their heels in and argue about it? All of those factors go into making the determination of whether to refer a matter to Enforcement. And there were a couple of documents from FINRA’s perspective that I would look to. One, FINRA issued an Enforcement guiding principles document, which outlined some of the factors that they look to when making those determinations.  But then also something that was recently amended, our FINRA sanction guidelines. In those sanctioned guidelines, they outline aggravating and mitigating factors based by violation. So you can see what the specific things are that regulators will look at when determining both sanctions, but also whether to make a referral to enforcement. 

Patrick Dennis: One of the things that we’ve all talked about in preparing for this, is some number of firms that think everything, every violation is going to turn into Enforcement referral and frankly, we know that’s not the case. The number of exams that turn into Enforcement or Enforcement referrals or Enforcement actions is really pretty small, at least from my experience, and I think everybody else agrees. The other challenge is that there are a lot of steps before we get to Enforcement referral. You guys correct me if I’m wrong, but there are deficiency letters that require corrective action or a corrective action statement that’s required. I don’t know if they’re still doing compliance conferences, but they used to you in and have a conference with you, discuss the issues and concerns, and that those are much more prevalent. An Enforcement referral is sort of the almost final step in the process, if they have some very serious violations and deficiencies. Jeff, did you have something to add? 

Jeffrey Hiller: I would agree that there are many, many steps before you would ever get to an Enforcement action. If it arises from the course of an examination and they have an issue that they’ve decided, or told you, they’re going to refer to Enforcement, I think that before that time, you would have had a lot of opportunities to probably steer it in a different direction or at least to make sure that they have all the information they need. 

Bill Reilly: Patrick, if I can add a couple of things, maybe from a state perspective? One of the things, and I’m not sure a lot of people in the industry are aware of this, is that unlike the SEC is able to enforce of course, SEC and FINRA rules, and FINRA has certain regulations, but one of the things that a lot of States do is adopt FINRA, SEC, MSRB and NAASA model rules and guidelines, as well as state statutory references for each individual state. So one of the things that needs to be clear is that a state can bring an action based upon a state law, a FINRA rule or regulation, SEC regulation, MSRB regulation. So that’s something, to make sure you understand the jurisdiction of the regulator that you’re dealing with. 

And think one of the other things that’s really important – understand, meet those regulators, because there were many people in the industry that knew me, and they would feel very comfortable calling me. Ed, you kind of mentioned the situation of people reaching out there from the regulatory side or from the industry side to the regulator. And I can tell you many times when examiners were conducting exams or investigations, they would bring attorneys in. They would bring consultants in, very much like us here on the panel today, and the one thing that people would say before you get to that point of resolving that case, we want to have the opportunity to come in and talk to you. We want to meet with you. We want to make sure that we’re all at the same understanding, want to make sure that if someone did not provide a record to you and we can correct that, we want to do that. So I think it’s imperative to know the rules or regulations, but it’s also important, if you can, to know who the players are because, as Ed said, many times most cases will end up in a cautionary or deficiency letter.  A large percentage of cases will end up in a formal, but a negotiated settlement. And very few cases actually go to administrative proceeding. That’s just the way the process works. So understand rules, regulations, processes, players, and people. That’s my recommendation. 

Ed Wegener: And Phil, just to your point, and I want to emphasize this, is there have been a number of times that I’ve been involved with where something looked like it was going to be a violation and maybe an enforcement referral, and even late in the game information or evidence is provided that says, “Hey, either this isn’t a violation or it might be a violation, but has significant mitigation that we’ve changed our minds.” So I would never foreclose on reaching out to the regulators, providing whatever information that you think would be helpful, because they don’t want to be at a hearing and have that information come at that point. 

Patrick Dennis: I would agree. And I think we all have discussed to some degree that the fact that the examiners and the people that you deal with in the field don’t necessarily have the final say on what’s going to happen or what the outcome’s going to be. But you occasionally will get some pretty zealous examiners that think everything is a major issue and a major problem, but gets back to the more seasoned, experienced folks at the office. A lot of those things get toned down, or I think reduced in the severity and the consequences, and all of that. There is some logic and some appreciation for talking to supervisors, asking to talk to an examiner supervisor, asking to take things up the chain. If you really have an issue you feel strongly about, or you think you’re being mistreated, it’s not the right word, but if you think you’re being misunderstood or you think that there is a serious difference in what you think the rule requires and what the examiner does, it’s sometimes is worth going to a supervisor, asking to talk to a supervisor and dinging up the chain before it gets too far along. And that’s an issue that I think we’ve all dealt with. Evan, your thoughts on that? 

Evan Rosser: Examiners in the field conducting the examination are rarely going to give you any certainty as to any findings at that stage. As everyone here has pointed out it, even an exam deficiency goes through a process by which it’s reviewed. Nevertheless, that examiner in the field is the person giving the information to the people up the line. When you get an indication that that examiner might have found a problem, and you can tell by the questions, by the documents, by the follow-up, whether that might be the case, I think it’s then you need to say, “Look, maybe there’s something else here I can explain to you,” because maybe your best defense, your best explanation, is not in those written documents that they’ve you’ve produced, and they’ve requested. Now, it’d be great if it is, that’s the goal, but sometimes your best explanation is outside those documents and you need to make the examiner aware of it. 

That story goes along up the line. And ideally, maybe that possible deficiency doesn’t go up the line. If you can shut it down during the exam process, the one question or the one issue that I’ve heard for years from firms about examinations, is they say the examiner doesn’t understand my business. I have to take my time to explain my business to the examiner. Well, that’s not such a bad idea to explain your business to the examiner. In fact, it’s a pretty good idea. And sometimes the examiner will ask questions just to hear you explain it. It’s not that they may not know it or understand it, but they want you to explain it to them. So, if they want you to explain your business, I would, rather than heave a deep sigh and roll your eyes, take the opportunity to explain it and to provide the explanation that puts your business and your program in the best light. 

Jeffrey Hiller: I think it’s a good point. I would say some of the initial meetings I’ve attended with the regulators, I generally had my CEO of whatever asset management company I was working for come into the initial meeting to say, we want to cooperate to set the tone. I have also seen circumstances or been involved in a circumstance where the legal department decided to fight something with the document production and made it worse. What didn’t necessarily have to, end up in an Enforcement action, they took months and months and months because they said they were reviewing emails, and then when the examiners got the emails, it was readily apparent by what was in the emails, with pornography, advertisements and everything, that they knew that the firm wasn’t being straight. And so it’s a delicate balance as to what you have to do and the way you do it. 

Ed Wegener: You know, I’ve seen firms that have done this really well, where the examiners would come in on the first day and they would sit down with them with a PowerPoint presentation and explain the firm, the activities they were involved in, the products they sell, how the firm was organized, who did what. It took a little time. But to the earlier point, you want the examiners to understand your business, because if they have violations, you want them to be able to put that in the context of what you do. The other thing too, is it starts the examination off on a positive now that you’re there and you’re going to help them. You also then really own the message because you’re explaining to them what the firm does, as opposed to them trying to figure it out on their own. So to the extent that you can do that and educate the examiners at the beginning of the exam, I think it definitely a benefit and I think will really go a long way. 

Patrick Dennis: One of the things that, when you were talking about explaining your firm or explaining what you do and things, I was the CCO for a firm that was wholesaling structured products and structured notes.  Right from the get go, we got an exam six months after the firm got registered. I spent a while explaining to the examiner how we actually operated what we did, how the firm did it, all of those sorts of things. So if your business lines are a little unusual or a little different, or relatively new or something, that’s not day-to-day sort of operations, you may want to be prepared to explain to the examiner what your business is, what your business model is, why it works, why you’re exempt from submitting stuff for advertising, because it’s all for internal use only, those kinds of things. I went through a lot of those issues. They had that and had we not gone about it with the idea that we were going to explain it and cooperate and everything else, that exam could have gone very differently. It turned out to be very successful, very few minor issues, but a lot of it was knowing upfront that we were going to have to do a lot of explaining, to make sure that they understood because it was a relatively new business model at the time that we did it. 

Jeffrey Hiller: I’ve heard a lot of people say that they have to educate the SEC or FINRA, or whoever comes in, and I will say that many of the firms that I went to or worked with, it could take me a year to understand their business because it was so complex. They might’ve had sub-advisors and little boutiques. So I would approach explaining the business to the examiners as an opportunity to steer them to what the culture is and what the business really does. It’s not that simple from the outside, looking in. 

Patrick Dennis: Thanks for listening and join us again on our next episode, where we discuss cooperation with the regulators and the importance of culture. 

Oyster: Thanks for listening, and if you like what you heard, make sure to follow the Oyster Stew podcast on whatever platform you listen to. If you’d like to learn how we can help firms start, run, protect, and grow their business, visit our website 

About The Podcast Speakers
Photo of Bill Reilly

Bill Reilly

Bill Reilly is a respected financial services professional with over 35 years of consulting and regulatory experience. Bill leverages his industry expertise and relationships with state and federal regulators and self-regulatory organizations to guide broker-dealers, investment advisers and law firms providing legal representation through both proactive and reactive regulatory processes and compliance issues.

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Ed Wegener

Ed Wegener is an innovative compliance, risk management and supervisory controls expert with deep understanding of Federal Securities Laws and the rules of self-regulatory organizations, as well as technology optimization and risk mitigation. Prior to joining Oyster, Ed held several posts in FINRA, most recently as  Senior VP and Midwest Regional Director.

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Evan Rosser

Evan Rosser is an experienced and respected securities industry professional with over 25 years of experience managing complex securities investigations for NASD/FINRA and providing compliance expertise to both broker-dealers and investment advisors.  Evan has served as CCO for both investment advisors and broker-dealers, as well as providing compliance support to numerous broker-dealers and registered investment advisors.

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Jeffrey Hiller

Jeffrey Hiller is an industry professional with over 25 years of experience, specializing in Investment Advisor services.  Prior to joining Oyster, Jeffrey was Chief Compliance Officer and Managing Director of Principal Global Investors where he created and managed the firm’s global compliance program. Jeffrey began his compliance career as Senior Counsel in the Securities and Exchange Commission’s Division of Enforcement in Washington, D.C.

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Patrick M. Dennis, Esq.

Patrick M. Dennis has been involved in the securities industry for over 30 years, most recently as one of the Founding Principals of Oyster Consulting, LLC, a compliance, regulatory, operations, clearing advisory, software and technology consulting firm for broker-dealers, investment advisers, mutual funds and hedge funds.

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