SEC Publishes for Comment FINRA Proposal to Combat Financial Exploitation of Seniors and Other Specified Adults

A proposed amendment to the Financial Industry Regulatory Authority, Inc. (FINRA) Customer Account Statement Rule (Rule 4512) and a proposed new Rule 2165 regarding Financial Exploitation of Specified Adults would: require institutions to make reasonable efforts to implement a “trusted contact” system into their customer accounts; and allow institutions to place temporary holds on accounts in order to protect seniors and other vulnerable adults.¹ 

Background 

FINRA and the financial services industry have become increasingly aware that the financial exploitation of adults over 65 is a growing issue, not only as the U.S. population ages, but also because seniors are often targeted for investment scams and other fraudulent activity.² Accordingly, in October 2015, FINRA solicited comments on a proposal to amend Rule 4512 and adopt new Rule 2165 (collectively, Proposal). After receiving 40 comment letters, FINRA filed the Proposal with the U.S. Securities and Exchange Commission (SEC) in October 2016. The SEC published the Proposal for comment on November 7, 2016. The comment period will remain open through November 28, 2016. 

Several states have already adopted laws addressing senior exploitation.³ Further, state securities regulators, through the North American Securities Administrators Association (NASAA), recently adopted a model act that has been, or is in the process of being, adopted in the same or similar form by a number of states.⁴ Some members of Congress have also addressed the issue through introduction of a bill entitled the Senior Safe Act, intended to protect financial institutions from liability if they disclose to a regulator potential instances of financial exploitation.⁵ Of course, following the election, it is not clear if the legislation will be taken up by the next Congress. FINRA’s Proposal affords member firms with resources to prevent financial exploitation of seniors in addition to state and congressional action. 

FINRA believes that its Proposal will provide member firms with a mechanism for quickly responding to situations in which such firms have a reasonable basis to believe that financial exploitation of vulnerable adults has occurred, or will be attempted. The Proposal would achieve this by explicitly permitting firms to contact non-account holders and to place temporary holds on disbursements of funds or securities. 

The Proposal includes: (1) an amendment to Rule 4512 that would require member firms to make reasonable efforts to obtain contact information of a “trusted contact person” for each “specified adult”⁶ customer; and (2) a new Rule 2165, which would grant member firms the authority to place temporary holds on disbursement of funds, or transmittal of securities, if the firm has a reasonable belief that a customer is being exploited financially. 

Trusted Contact Person Requirement 

The Rule 4512 amendment would require member firms to make reasonable efforts to obtain the “name and contact information for a trusted contact person upon the opening of a non-institutional customer’s account.” For example, if a member firm suspects that a customer is suffering from a mental disability that could make the customer vulnerable to financial exploitation, or if the firm suspects that a customer is potentially the subject of financial fraud, the firm or one of its associated persons could consult with the trusted contact to identify appropriate actions to prevent financial exploitation. Although a member firm may use its discretion in relying on the information that a trusted contact person provides, this requirement does not make a member firm responsible for determining whether a trusted contact person is mentally capable. 

Applicability to Existing Accounts 

The Rule 4512 amendment would not apply to accounts existing prior to the rule’s effective date, until such time as the member firm updates the account information, whether in the ordinary course of business or by requirement of other laws or rules. The amendment also would not prevent member firms from opening or maintaining an account without a trusted contact person, so long as the firm makes reasonable efforts to comply with this requirement. As proposed, a member firm would be viewed as making a “reasonable effort” if it asks the customer to provide the trusted contact person’s information (e.g., on the firm’s account opening form or through written communication). FINRA stated that it will provide optional template language for compliance, upon SEC approval of the rule amendment. 

Disclosure Guidelines 

As proposed, a member firm also must provide written disclosure to each customer regarding the member firm’s authority to contact, and disclose information about the customer’s account, to a trusted contact person for the purpose of preventing financial exploitation. However, a member firm would not be required to notify the named individual that he or she has been designated as a trusted contact person. 

Privacy Concerns 

In the Proposal, FINRA indicated that should a member firm need to contact the trusted contact person, such person could communicate health or potential financial exploitation concerns.⁷ Organizations such as the Florida International Bankers Association (FIBA) commented that disclosure of confidential information under the Rule 4512 amendment could potentially conflict with U.S. and foreign privacy laws.⁸ Lincoln Financial Network (Lincoln) raised the concern that disclosure of the ability to contact the trusted contact person is not sufficient under the Regulation S-P exception regarding disclosure of information to third parties.⁹ Although FINRA acknowledged this concern in its Notice of Filing, FINRA indicated that the Rule 4512 amendment is consistent with Regulation S-P.¹⁰ More generally, FINRA stated that member firms are responsible for separately considering any applicable privacy requirements in determining whether a temporary hold is necessary. 

Temporary Hold on Disbursement of Funds or Securities 

Under Rule 2165, a member firm would be permitted, but not required, to place a temporary hold on the disbursement of funds or securities from a specified adult customer’s account, if the firm reasonably believes that financial exploitation related to the subject transfer may occur. This would apply to cash disbursements, asset transfers, and customer account transfers using the Automated Customer Account Transfer Service (ACATS), but does not apply to transactions in securities. By operation of this rule, a temporary hold would expire after 15 business days. A 10-day extension is possible, however, if the required internal review supports the firm’s reasonable belief that financial exploitation is occurring. A temporary hold may be terminated before the 15-day period, by a state regulator, agency of competent jurisdiction, or court order. 

Although Rule 2165 would provide a safe harbor from other FINRA rules for member firms that place temporary holds on customer disbursements,¹¹ several commenters expressed concern about the consequences stemming from the rule’s implementation. For instance, the Financial Services Roundtable (FSR) stated that in practice the proposed safe harbor may provide only limited protection to firms, and the rule’s mere existence could subject member firms to liability if they do not withhold disbursements.¹² FINRA addressed these concerns in its Notice of Filing, indicating that Rule 2165 does not obligate members to place temporary holds, and therefore such firms would not be liable for their decision not to act. Commenters raised the issue that placing a temporary hold may cause a customer to default on legal or contractual obligations. 

Commenters further expressed concern that member firms might abuse their authority if they refused to honor disbursement of funds without actual reasonable belief. FINRA acknowledged these risks but indicated that the benefits of this ability justify the authority that FINRA would place in member firms. 

“Reasonable Belief” Standard 

Rule 2165 would permit member firms to use their judgment, after analysis of the facts and circumstances surrounding a disbursement, to determine whether a temporary hold is necessary. Red flags that FINRA identified as suggesting potential financial exploitation include: attempts to disburse money to well-known fraudulent schemes; uncharacteristic transfers of funds or securities; and a customer’s atypical degree of fear.¹³ Additional considerations identified by FINRA include a customer’s mental or physical health and his or her relationship with the recipient of a proposed transaction. 

Furthermore, member firms would not be required to report their reasonable belief of financial exploitation to relevant state authorities.¹⁴ Although this conflicts with some states that make reporting of the reasonable belief necessary, FINRA expects member firms to be responsible for determining whether they are in compliance with both state law and Rule 2165. 

Actions Required Upon Placement of Temporary Hold 

Upon placing a temporary hold, member firms would be required to immediately begin an internal review into what caused their reasonable belief that financial exploitation has occurred or will be attempted. In response to the FSR’s request for clarification on the scope of this requirement, FINRA stated that member firms have discretion in the matter because the level of review depends on the facts and circumstances of each situation. 

FINRA also proposes to require that member firms notify all parties authorized to transact business with respect to the account, including the trusted contact person (if available), within two days after the inception of the temporary hold. Some commenters expressed concern that the requirement to notify all parties, rather than any party authorized to transact business on the account, is overly burdensome considering the time sensitive nature of such situations.¹⁵ However, FINRA believes that the requirement to notify all persons is important because: (1) it increases the likelihood of preventing financial exploitation; and (2) authorized persons on an account have a reasonable expectation of being contacted when a temporary hold occurs.¹⁶ 

Compliance Requirements 

Rule 2165 would require member firms to develop training policies to ensure compliance by registered and associated persons. Member firms would also have to keep records related to compliance with the rule, including: the original request for disbursement leading to the temporary hold; the reasoning behind a member firm’s belief that financial exploitation exists; and the name of the associated person who authorized the temporary hold. 

In addition to maintenance of records, member firms would be required to implement written procedures reasonably designed for compliance with Rule 2165. These procedures, at a minimum, must identify the title of any person authorized by a member firm to exercise discretion over a temporary hold, and provide for escalation measures meant to prevent financial exploitation. 

Conclusion 

If the SEC approves the proposed changes, the time and money needed for member firms to make the necessary changes will be a factor in determining the Proposal’s implementation date. A primary concern is that firms may be charged with unlawful interference for acting upon their reasonable belief that financial exploitation will occur. Although FINRA has acknowledged these concerns by saying there is no obligation to act, members would benefit from additional insight into what protections they have if they do act on their suspicions. 

Footnotes 

_{1) See Notice of Filing of a Proposed Rule Change to Adopt FINRA Rule 2165 (Oct. 19, 2016), 81 FR 78238 (Nov. 7, 2016) (Notice of Filing) and FINRA Regulatory Notice 15-37 (Oct. 2015).
2) In support of its rule proposal, FINRA relied on various recent studies finding that financial exploitation of seniors is a serious problem. See The Met Life Study of Elder Financial Abuse: Crimes of Occasion, Desperation, and Predation Against America’s Elders (June 2011) (discussing the increasing prevalence of elder financial abuse). See also FINRA Investor Education Foundation, Financial Fraud and Fraud Susceptibility in the United States: Research Report from a 2012 National Survey (2013) (indicating that U.S. adults age 65 and older are more likely to be targeted for financial fraud, including investment schemes, and are more likely to lose money once targeted).
3) See, e.g. DEL. CODE ANN., tit. 31 § 3910 (2015); MO. REV. STAT. §§ 409.600-.630 (2015); WASH. REV. CODE §§ 74.34.215, 220 (2015); and IND. CODE ANN. § 23-19-4.1 (2016).
4) See NASAA Legislative Text and Updated Commentary for 2017 Legislative Session regarding Model Legislation or Regulation to Protect Vulnerable Adults from Financial Exploitation, at 3 (stating that Alabama, Indiana, Vermont and Louisiana have adopted similar provisions to the Model Act).
5) The Senior Safe Act was introduced in the Senate by Senators Susan Collins and Clair McCaskill, and in the House by Representative Krysten Sinema. See S. 2216, 114th Cong. (2015); see also H.R. 4538, 114th Cong. (2016).
6) A “specified adult” under Rule 2165(a) is: (1) a natural person at least 65 years of age; or (2) a natural person at least 18 years of age who the member reasonably believes cannot protect his or her own interests due to a physical or mental impairment. “Financial exploitation” is either the wrongful taking of a specified adult’s funds or securities, or any act or failure to act by a person to obtain control of a specified adult’s assets by way of undue influence.
7) See Notice of Filing, at 9, 61.
8) FIBA Comment Letter (Nov. 30, 2015).
9) Lincoln Comment Letter (Nov. 30, 2015).
10) See Notice of Filing, at 59.
11) The rule provides a safe harbor from FINRA Rules 2010, 2150 and 11870, which require that member firms conduct business in a just and equitable way and conduct transfers of assets in an expeditious manner.
12) FSR Comment Letter (Nov. 30, 2015).
13) See Notice of Filing, at 107-108.
14) See Notice of Filing, at 72.
15) Insured Retirement Institute Comment Letter, (Nov. 30, 2015); Securities Industry and Financial Markets Association Comment letter (Nov. 30, 2015).
16) See Notice of Filing, at 50-51.}