Do you ever get the feeling that your compliance department is the securities industry's version of the Stasi — the East German secret police who eavesdropped, opened mail and in general spied on its own citizens with ruthless efficiency? When it comes to client communications, registered reps describe a Soviet Bloc-like police state that forces them — in the interests of actually conveying real financial information and advice to their clients — to break NASD and individual firm protocol for communications.
Take “Bob,” a veteran Merrill Lynch financial advisor with more than $200 million in assets under management. To get around NASD and Merrill rules, Bob employs a little sneakiness to communicate with his clients. Like at most firms, everything Bob sends to clients — simple “thank yous,” investment ideas, market commentary — must be approved by supervisors, firm management and compliance personnel. So Bob rarely writes “letters” at all. Not official ones, anyway. Instead of having his secretary type up his words on Merrill letterhead, Bob scribbles on a notepad, sometimes writing out full investment recommendations on several pieces of notepad paper, which he then puts through branch mail without the necessary approvals. “It's absurd, I know,” he says. Similar stories can be found at every brokerage firm where advisors are struggling to run their businesses while enduring what they describe as stifling and often trivial restrictions on how they communicate with clients.
Client communication has become a game — an absurd one. One Royal Alliance-affiliated rep puts it this way: “I have the authority and the discretion to trade, to buy and sell a fund as often as I wish [on my client's behalf], but I don't have the authority to send my clients an email or letter explaining why. This frustrates me and it doesn't serve the client.” He adds, “I can see how regulators want to protect the investor, but this is ridiculous.”
The NASD rule for “communications with the public,” Rule 2210, lays out extensive conduct and content rules for firms that include some common sense direction for the brokers. For instance, the rep must give the investor a sound basis for making an investment decision; not exaggerate or make misleading claims or omit material, particularly risk disclosures. (See sidebar for more on that rule and others.) Simple really, but the simplicity is mucked up by multiple exceptions and exemptions (see sidebar). If a broker wishes to mention in writing (not even pitch, just mention) a product, say a mutual fund or an ETF, or explain a manager change to a client, other rules come into play, each requiring separate disclosures, signatures and approvals.
Fearing liability, firms often take it to another level — “compliance-plus” as one attorney calls it — with b/ds imposing their own rules and limitations that are far more strict than NASD requires. Because of the difficulty of monitoring e-communication, firms place tight restrictions on its use — most don't even allow IM — and encourage reps to use the phone or meet in person instead. One broker says email is “reserved for client conversation that is the consistency of baby food.” The irony here, of course, is that the firms are encouraging reps to use the two unmonitored channels of communications, the ones that are hardest to supervise, reps say. In the final analysis, with Sept. 11 and recent investor betrayals, like Enron and WorldCom, still fresh in people's minds, few would question the intentions of government and the resulting wariness of firms to allow their reps more freedom of communication, but some industry participants say the net, perverse effect is less communication, which is hardly in their clients' best interests.
Greg Ghodsi says his former firm's handling of his communications with clients was one reason he left to join Raymond James. Ghodsi is a veteran producer who manages a book of roughly 200 families and $250 million assets under management, much of it on a discretionary basis. He says his prior firm, a respected regional broker/dealer, so intensely and inefficiently monitored incoming and outgoing email that it disrupted his business. “I would send time-sensitive research to a client at 9 a.m. and it wouldn't arrive until late afternoon or evening,” he says. Emails sent on Fridays wouldn't arrive until Monday because no one was in the branch to approve them. All of it angered clients, especially those that preferred email for contact, making Ghodsi look unorganized and unprofessional, he says.
The “Self-Hanging” Device
Ideally, how a client communicates with his advisor should be up to the client but it turns out a lot of firms simply discourage reps from using electronic communication at all, if unofficially. “Our own CEO has called emails ‘a self-hanging device,’” says one rep, words he lives by even though the firm doesn't prohibit its use. “If a client asks, and they often do, if we can do something by email I tell them, ‘Yes, but it will be a one-way conversation, you'll email me and I'll call you with the answer.’” Likewise, if a client asks him how XYZ investment did last year, “The answer is a phone call.” He says he mentioned the name of a mutual fund once in an email to a client and forgot to include the prospectus. The manager, fearing the consequences if it came out in an NASD audit, pulled him aside and upbraided him. “Essentially, nothing goes in writing, period,” he says. “It's another fine example of the unintended consequences of the good intentions of the government.”
Bob, the notepad-using Merrill Lynch advisor, says his firm also prefers that reps use the phone or meet in person if they need to discuss anything with clients. (Merrill declined to comment when asked about its client communications policies). That doesn't keep him from conducting a lot of business through standard mail and email, but this may soon change, he says. Merrill brokers companywide received an email reminder from compliance in mid-May concerning emails sent to clients with mutual fund recommendations in them. Apparently, some reps had been sending recommendations via email to clients without following firm protocol that requires writing the word “Recommendation” in the subject line and including a lengthy explanation of share classes, the objective of the investment, strategy, risks, fees and expenses and so on.
“Essentially, the email was telling us to not only include a prospectus but to write it out too,” he says. For now he thinks the firm is just “covering itself” in terms of liability, but he's gotten pushback on other issues, too. For instance, the seminars that he's run three times a year for the past 10 years took several weeks to approve this year, far longer than in the past. “Compliance just made me take the menu off my seminar invitation,” he says. Yes, “menu” as in the food to be served. “They didn't give me a reason for that one.” Additionally, the firm pressed him to send the invitations as letters, but compliance relented and let him use email when he complained. “Clearly the message from above is to use the phone or meet in person,” he says, because those are the two forms of communication not monitored, whereas emails and letters live for at least three years, the required amount of time a firm must store all communications, per NASD Rule 3110. “But in the interests of time, ours and our clients, the phone or a meeting are not always the best option,” says the Merrill broker.
Life for registered investment advisors (RIAs) and their investment advisor reps (IARs) is far less complicated. The NASD, which regulates b/ds and their reps, did not return calls for comment on this issue but the SEC made light of the contrast between the two regulatory regimes by sharing the way it regulates communication for RIAs and their investment advisors. According to Gene Gohlke, associate director in the SEC's Office of Compliance and Inspection, the SEC has followed a path of “principles-based guidance in regard to client communication,” preferring to provide fewer specifics and allow firms to figure out implementation. For instance, there's no SEC requirement for getting prior approval of communication between advisor and client, and the regulator doesn't tell advisors what can or can't be said to clients, only requiring that it be “truthful and consistent with a fiduciary relationship,” says Gohlke. The two relevant rules are SEC Rule 204-2 (record keeping) and SEC Rule 206 (the anti-fraud rule). In short, it's a lot easier being an investment advisor than a rep when it comes to client communications.
But while the NASD and its member firms impose “tougher,” more-detailed rules, it's not without reason. “It all comes down to supervision and liability,” says Thomas Giachetti, an attorney with Stark & Stark in Princeton, NJ., who says managing hundreds or thousands of reps selling products from multiple locations stands in high contrast to fiduciaries advising clients from one or two locations. To further understand the industry's fear of email in particular, one needs to look no further than Citigroup's Jack Grubman, Merrill's Henry Blodgett and the other equity analysts who were skewered with the aid of incriminating emails, which cost them and their firms millions. (Ten firms paid a total of $1.4 billion to settle the research/investment banking scandal with Attorney General Spitzer; Citigroup paid $400 million, Merrill paid $100 million in fines; Grubman and Blodgett, who lost their jobs, together paid nearly $20 million in fines and were permanently banished from the securities industry.)
Reps who do use email or instant messaging, either with or without their firms' approval, should exercise some common sense, say attorneys. Any inappropriate or unprofessional email can be used against you, even if it isn't technically “illegal.” Case in point: Craig Stein, an attorney with Stein Rosenberg & Stein in Boca Raton, Fla., says he recently won a judgment against a female broker who had sued his client for an off-color remark his client allegedly made to her in passing. “We subpoenaed her email and found that of the 3,400 emails in her inbox, hundreds of them were dirty jokes and stories that she had sent out,” he says. From the perspective of firms, erring on the side of compliance overkill starts to appear wise. “Sure, many reps are sophisticated professionals, but as soon as the firm makes one exception they have to make 100 of them,” says Giachetti. “I don't see the b/ds changing, so if a broker has a serious concern about that he should think about going to an RIA.”
So to have an honest, open and substantive dialogue with a client, do you actually have to pick up the phone or haul the client into your office? That better not be the case. To be seen as a professional in this business, you need to put things in writing no matter what your b/d or the NASD requires of you, says Nancy Lininger, founder of The Consortium, a compliance consulting firm in Camarillo, Calif. “Reps that say they don't send anything in writing, that everything is verbal to their clients — to put it plainly, I wouldn't use that financial advisor.”
To Know ‘Em Is To Break ‘Em?
Registered reps should re-acquaint themselves with the rules that govern proper rep-client communications. Here's a brief outline of some of the key rules; for a complete list, please go to the NASD website.
NASD Rule 2210 says “communications with the public” must:
- Be based on principles of fair dealing and not omit material information, particularly not disclosure;
- Not make exaggerated, unwarranted or misleading claims;
- Give the investor a sound basis for making an investment decision;
- Not contain predictions or projections of investment results.
NASD Rule 3010 says firms must establish, maintain and enforce written procedures for communications and ensure compliance with all laws and rules.
NASD Rule 3110 says reps must save 36 months worth of advertisements, sales literature and business related electronic communication.
SEC Rule 482 contains specific standards for any discussion of or performance of a specific mutual fund or variable annuity and also requires any such information be accompanied by a prospectus.
How the NASD defines different kinds of communication. For complete definitions, refer to Rule 2210 on the NASD Web site.
With the exception of options communications, advertisement refers to a communication made available to the public through media such as radio, television, newspapers, magazines, billboards, telephone directory listings (beyond routine line listings), computer bulletin boards, blogs and publicly available Web sites.
Refers to communications made available to the public, which do not meet the definition of advertising. Sales literature includes circulars, market letters, research reports, form letters, seminar texts, and telemarketing scripts. An email or instant message sent to 25 or more prospective retail customers is considered sales literature and requires prior written approval.
Any written letter or electronic communication prepared for delivery to one or more current retail customers and less than 25 prospective retail customers within a 30-day period. Correspondence is not a required filing. However, correspondence is subject to the content standards of Rule 2210(d)(1) and the applicable Interpretive Materials under Rule 2210. An email or instant message is considered correspondence if it is sent to a) a single customer (prospective or existing) or b) to an unlimited number of existing retail customers and/or less than 25 prospective retail customers (firm-wide) within a thirty day period.