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Heightened Supervision Standards Vary

Dow Jones Compliance Watch

NEW YORK (Dow Jones)–You can’t please all the people all the time, but in the

financial advisory world, not pleasing the clients a lot of the time can trigger

“heightened supervision.”

Regulators expect firms to conduct their own heightened supervision but will

sanction them if they don’t. And while these regulators leave the criteria for

such supervision up to the firms, some people think the industry, already using

broad and differing measures, isn’t efficient and consistent enough in paying

attention to problem brokers.

The National Association of Securities Dealers said about 1.2% of brokers have

three or more “disclosures” on their records – ranging from customer complaints

to pending arbitration to incidents such as DUIs.

In the past, five complaints inside a year triggered heightened supervision by

the New York Stock Exchange regulators, who monitor member firms. It has

recently stopped using this threshold alone, looking more broadly at a financial

adviser’s record. That is typically how other regulators identify which brokers

and branch offices merit extra attention.

“If firms are on top of the rep, we don’t need to duplicate what the firm is

doing,” said Grace Vogel, executive vice-president for member firm regulation at

the NYSE. “We’re looking for individuals that haven’t been identified by the

firm yet as conducting activity that’s questionable.”

In-house, firms don’t just use complaint numbers either, instead opting for a

case-by-case assessment. Often, heightened supervision is used as a probationary

period; if brokers don’t resolve problems within a set time, their firms may

terminate them.

But some question whether the extra supervision always works.

“If someone is a high producer, they might be less likely to get rid of the

person,” said Brian Rubin, a partner at law firm Sutherland Asbill & Brennan and

former enforcement attorney for the NASD and Securities and Exchange


He said heightened supervision is sometimes used as a slap on the wrist for top

brokers. But if done right, he said, it prevents recurring problems.

Poor Practice

Last month, an NASD arbitration panel ordered A.G. Edwards to pay $339,974 in

compensatory damages, punitive damages and attorneys fees when it found that a

financial adviser placed an elderly investor’s money in unsuitable variable


The FA had been fired from his previous job for refusing to participate in an

internal investigation and lost an arbitration case that alleged breach of

fiduciary duty.

A spokeswoman from A.G. Edwards said the firm disagrees with the arbitration

panel’s decision and that the FA is no longer employed by the firm. She wouldn’t

comment further.

Few firms will talk specifically about their heightened supervision practices,

but some deny production numbers play a part in their decisions. Generally, they

don’t have a clear threshold on when someone requires heightened supervision,

and when a person should be fired.

“Some situations are so egregious that one complaint alone could cause us to

terminate them,” said Bridget Gaughan, executive vice-president and general

counsel at AIG Financial Advisors, part of American International Group Inc.

(AIG). But, she said, there are times when even a high number of customer

complaints doesn’t indicate a problem.

Tell Tale Signs

Stealing or fraud are easy cases, Gaughan said, but when a financial adviser

has credit problems, for example, heightened supervision might be more


“We would put heightened supervision in place requiring them to take a credit

course, or make arrangements to pay a lien in a certain period of time,” Gaughan

said. “You just want to remove that pressure, make sure they don’t have a reason

to do things (that might be) pushing the envelope.”

Ken Madsen, chief compliance officer for H&R Block Financial Advisors, a unit

of H&R Block Inc. (HRB), said his firm uses heightened supervision for advisers

who make technical errors that don’t affect customers.

“What we’re looking at is was there an honest mistake made versus actively

harming a customer. If they’re actively harming a customer, that’s where it

needs to be stopped,” he said.

At Raymond James Financial Services Inc., a unit of Raymond James Financial

Inc. (RJF), day-to-day supervision picks up on patterns that raise red flags,

said Jim Fulp, executive vice-president of national sales. Many are benign, but

serious complaints warrant heightened supervision.

“We err on the conservative side,” Fulp said, estimating that the firm at any

given time may have a maximum of 30 or 40 financial advisers on heightened

supervision and double that on a watch list.

Supervisory Burden

Firms are supposed to craft heightened supervision plans based on the behavior

they want to watch. At Morgan Stanley (MS), senior members of its legal,

compliance and national sales teams meet regularly to determine when heightened

supervision is appropriate and what shape it should take.

In heightened supervision situations, firms often give extra scrutiny to a

FA’s daily trades, e-mails and phone conversations, and require more meetings

with supervisors to ensure compliance. That can create a burden on branch

managers, who may not always find it worth the time and effort.

“Heightened supervision is as onerous on the supervisor responsible for

conducting the supervision than it may even be for the individual subject to

heightened supervision,” said Cindy Cheney, director of private client group

compliance at RBC Dain Rauscher Inc., a unit of the Royal Bank of Canada (RY).

James Eccleston, a Chicago lawyer who represents both brokers who are the

subjects of regulatory inquiries and investors, has noticed that branch managers

have become more willing to fire FAs than they have in the past.

“What I’m starting to see is that branch management is much more eager to pull

the trigger and terminate a broker if there’s time out,” he said. “You’d think

there’d be more lenience, not less lenience.”

-By Jaime Levy Pessin, Dow Jones Newswires, 201-938-4546;