IRVINE, Calif. — The Securities and Exchange Commission is getting close to bringing a first-of-its-kind privacy case against a broker-dealer for using client data in the account transfer process, and industry attorneys said that the SEC is investigating similar cases against as many as a dozen other firms.
The SEC last month told NEXT Financial Group Inc. of Houston that it intends to file charges related to the firm’s practice of instructing broker recruits to provide customer information to the firm in anticipation of a move.
Although NEXT’s attorneys met with senior SEC enforcement staff and regulatory officials in Washington in January in an attempt to head off the charges, enforcers claim that the firm violated SEC Regulation S-P on consumer privacy, and aided and abetted violations by the brokers it recruited.
NEXT provided a response to the agency this month in which it disputed the SEC’s legal interpretations. The firm laid out what its lawyers said will be a spirited defense should the SEC pursue the charges.
The case has been in the works for more than a year and is causing consternation among the broker-dealer community (InvestmentNews, Nov. 27).
“We’re now waiting to hear” what the SEC will do, said Peter Anderson, partner at Sutherland Asbill & Brennan LLP of Washington, one of NEXT’s attorneys.
Kenneth D. Israel Jr., district administrator in the SEC’s Salt Lake City office, which is pursuing the case, declined to comment.
Mr. Anderson said SEC staff understand that there are public-policy issues involved with any action that could negatively affect account transfers — a perennial source of investor complaints.
“We’re hopeful we might persuade the SEC to engage in rule making or ... get input from industry and consumer groups,” said Shane Hansen, a partner at Warner Norcross & Judd LLP of Grand Rapids, Mich., which is also defending NEXT.
The Financial Services Institute Inc. in Atlanta, which represents independent firms, also plans to discuss with SEC officials issues raised by the case , said Dale Brown, the FSI’s executive director.
“It’s an important priority issue,” he said.
Mr. Anderson is playing up the possible impact to small investors, who he says would be abandoned if brokers could not easily transfer large books.
He has raised the small-investor issue with state regulators.
Joseph Borg, president of the North American Securities Administrators Association in Washington and director of the Alabama Securities Commission in Montgomery, said he is aware of the case and will be learning more about it.
The SEC is not targeting individual reps, only firms that may have violated privacy laws. So far, it has made inquiries only of independent-contractor firms, lawyers said.
Helping reps take client data is a common practice among the independent firms.
Beginning about a decade ago, independents began aggressively competing for recruits by offering to automate much of the account transfer process using data provided by the new hire, said Kevin Carreno, an attorney and owner of Experts Counsel Inc., a Tampa, Fla., regulatory consulting firm.
He was formerly chief compliance officer of Robert Thomas Securities Inc., which now operates as part of
Raymond James Financial Services Inc. of St. Petersburg, Fla.
As a result, the SEC may find a treasure trove of privacy violations among the independents, observers said. SEC investigators found other broker-dealer targets by searching the Internet for firms offering broker transition services, Mr. Anderson said.
“There are probably at least 50 to 100 firms doing the same thing” that NEXT was, he said.
NEXT’S lawyers said that SEC staff holds the view that before brokers leave a firm, they should ask clients for consent to use any information. But that would be difficult for brokers to do at many firms, Mr. Hansen said.
Even if information sharing is included in a firm’s privacy statement, which is a form of consent, “you still can’t turn over certain [sensitive] information,” such as account numbers and
Social Security numbers, said Steven Insel, an attorney and partner at Jeffer Mangels Butler & Marmaro LLP in Los Angeles, who is not involved with the case.
Mr. Anderson said that NEXT Financial recruits would “sometimes” take
Social Security numbers and other account information.
But he argued that through the use of exemptions, the SEC can interpret Reg S-P to allow brokers and firms to use client information for purposes of transferring and servicing accounts.
Mr. Insel disagrees, saying that only broker-dealers are covered under privacy rules exemptions — not associated persons.
Under Reg S-P, even such basic client information as an address or phone number — unless it is clearly public information — cannot be shared with outside entities without consent or notice. As a result, NEXT has changed its privacy policy statements to say that brokers leaving the firm may take some information.
Merrill Lynch & Co Inc. of New York and
Raymond James allow a departing broker to take customer information.
Merrill Lynch lets departing reps take some information under terms of a recruitment protocol it has signed with several competitors.
But other firms have yet to include in their privacy statements to clients that firms may share client information when brokers leave.
