For ease of this article I’ll simply refer to the group as “Tokens”. The number one call that I get is from companies that want to sell their Tokens in the U.S markets. They want to buy a broker dealer along with an Alternative Trading System (ATS) and start immediately selling tens of millions of dollars of their Tokens. These Tokens, of course, are going to skyrocket in value and are the greatest things ever seen since the invention of the iPhone!!!
As much as I would like to accommodate these requests immediately, there are numerous regulatory hurdles to overcome such as receiving approval from FINRA and the SEC for a broker dealer license to sell Tokens. No, you cannot just simply buy a broker dealer or an ATS (as many have learned the hard way) and start selling Tokens to the public.
Here are some helpful tips on filing an application for Tokens with the regulatory bodies:
1. You will need a detailed business plan which describes the following:
a. What entities are the holders of the “private keys” in the DLT network that would be required to gain access to the cryptosecurities, cash-backed token holdings or digital currency? Are multiple keys needed to gain access or is a single key sufficient?
b. Who controls or has access to the DLT network where the assets are held?
c. What happens in the event of a loss or destruction of assets (either due to fraud or technological malfunction) on the network?
d. If the broker-dealer was to fail and is liquidated in a proceeding under the Securities Investor Protection Act of 1970, as amended, how would customers’ securities and funds be treated, and how would customers access their assets?
e. In instances where firms have established partnerships with other firms to serve as their back-ups and to carry out critical functions in the event of emergencies, what type of access would those back-up firms have to the private keys?
f. How will customers or the Securities Investor Protection Corporation (SIPC) trustee access the customers’ assets in the event of a defaulted broker-dealer? What parties will be involved, and what are their roles and responsibilities?
g. How does the use or application of the DLT network affect the market risk, liquidity or other characteristics of the asset?
h. How do the characteristics of a particular cryptosecurity, digital currency or other cash-backed token holdings fit within the principles of the net capital rule?
i. What information is maintained using the DLT network?
j. What will be deemed as the physical location of the firm’s records maintained on a node of a DLT network that may extend over multiple countries?
k. What parties have control or access to the firm’s records? What are their rights, obligations and responsibilities related to those records, and how are they governed?
l. What is the firm’s (and other participants’) level of access to the data, and in what format would it be able to view the data?
m. How does the DLT network interact with the firm’s own systems for recordkeeping purposes?
n. How would the records be made available to regulators?
o. How will the firm’s traditional exception reporting, used to supervise transactions, be generated from a DLT network?
p. How will the firm protect any required records from tampering, loss or damage?
q. Clearance & Settlement?
r. Anti-Money Laundering (AML) Procedures & Know Your Customer (KYC) Rules?
s. Customer Data and Privacy?
t. Trade & Order Reporting Requirements?
u. Supervision & Surveillance of Transactions?
v. Fees & Commissions?
w. Customer Confirmations & Account Statements?
x. Anticipated Customer Base?
y. Facilities?
z. Licensed & Qualified Staff
These are just some of the issues that will need to be addressed in a filing but as we have completed the alphabet, I’ll stop here.
Feel free to contact me with any questions:
Ken@Luxorbd.com
How many zeros are in a Trillion? I asked all of my smart friends (2 of them), neither knew but each ventured a guess. The first one said 9 zeros and the second said twenty. I had no idea, so I turned to the all knowing Google and found out that they were both wrong. The correct answer is 12. So one trillion dollars would look like this: $1,000,000,000,000. Currently, the United States Government owes 18 Trillion Dollars which is $18,000,000,000,000 and growing by the second.
This equates to every person in the USA owing over $41,000 and based on the way the Government keeps spending and borrowing at break neck speed it will NEVER be paid off. Just for fun, here's a great link showing what is going on: Debt Clock
For comparison let’s look at some other countries debt in U.S. dollars, rounded for easy reading:
China: $5,300,000,000,000
Russia: $246,000,000,000
France: $2,300,000,000,000
Germany: 2,200,000,000,000
Italy: $2,500,000,000,000
Greece: $424,000,000,000
So, in a nutshell, China, Russia, France, Germany,Italy and Greece COMBINED owe just about HALF of what the U.S.A. owes. Anyone see an issue here? Every time the national debt ceiling is reached, Congress plays this game of “the government is going to shut down” and then at the last minute they extend the debt ceiling and increase whatever pork they want for their districts.
Can a company listed on the NYSE get away with this? Can they simply sell a never ending amount of debt and recklessly spend without failure? Of course not. So why do we do we let the government act in this way? Why is there a “debt ceiling” if every time we reach it, we simply extend it? and NO ONE is held accountable? The most astonishing part is that not only is everyone lining up to buy our debt, the government has actually issued debt at ZERO percent interest! who in their right minds would lend money at ZERO percent? Quick answer other countries where you are charged to keep a balance, so better to make ZERO then to pay for the privilege of having your money in a bank.
Does every banker in the world have their head in the sand thinking that everything is ok as long as they don’t look up? The markets have been held up through endless quantitative easing which has now become a global trend, along with access to cheap money. (Who has access to this cheap money is a story for another time). At some point the actual economy, real employment and actual productivity are going to have to come around otherwise this looks like one big Ponzi scheme to me.
A common misconception is “how is a client laundering money by risking it in the stock market” or “we got all of the paperwork so it must be good.” This attitude leads to an environment where supervisors are not even paying attention to simple patterns that would indicate a potential violation.
As always, I'm happy to provide a copy of the Written Supervisory Procedures for Red Flags. Simply send me an email: Ken@luxorbd.com and I'll send you a copy in Word Format.
Money Laundering Red Flags Include:
The client says they are acting on behalf of another person or entity and that other person or entity has privacy concerns.
The client asks a lot of questions relating to the Firm’s policies and procedures relating to money laundering.
The account has frequent activity relating to transfers in and out of the account (regardless of the dollar amount).
Any large deposit that is immediately withdrawn.
The customer’s account information shows that they earn $100,000 a year and they deposit multiple amounts in excess of their yearly earnings. (This being a statistical improbability).
Wire transfers come into or out of the client’s account from unrelated third parties (even related parties are a red flag).
The client maintains multiple accounts for no apparent purpose.
The customer is from a banned country or does business in banned countries or countries that are on government watch lists.
The client does not appear to have any legitimate source of income. (Claims he is “retired” at 40 years of age and gives vague references to his business that he sold during the tech boom).
Client shows up on a FINCEN or OFAC list.
When the client is told they are on a list they say things like “that’s my father. He is John Smith Sr. I am John Smith Jr. Happens all the time. Don’t worry about it.” (My personal favorite).
Patterns are in random order.
Pattern #1:
Customer calls the Firm (without solicitation) and says they are in possession of a “bond” that they acquired as follows a) they found it while cleaning out their parents house after they passed away b) it was issued in a foreign country c) it is some sort of bearer bond d) it is a bond issued by ________ (fill in the blank) Government through a “special” program and now it has matured.
Usually this story is followed by “the bond has a face value of a Billion Dollars” now this might sound like some sort of a prank but I can assure you that Broker Dealers get these calls on a regular basis. Now, I’m not saying that a legitimate bond doesn't exist with these characteristics, but virtually ALL of the time this will be a serious RED FLAG for which the compliance department and AML officer should contact the proper authorities.
This pattern might be from an existing “qualified” investor who has some "sophisticated" bond that he wants to deposit into his account. Even if the bond looks like it is a very standard transaction, one must be cautious as to where the client obtained the bond and where, when and to whom the proceeds go out.
Pattern #2:
A client opens an account and transfers $100,000 (The amount is not as relevant as the pattern and people may launder small amounts to avoid suspicion). They place a trade where they buy and sell a well known security then they request that the money be wired back to them.
Potential issues to watch for are as follows:
Check where the money came in from and where the wire request to send the money are from the same account as the account name is set up with.
What happens is that a client may send in the money from a business account and then wire it out to his personnel account. This could be a sign of money laundering.
Pattern #3:
Client opens an account and claims to be “heavily” involved in penny stocks and then starts sending in stock certificates from multiple companies under various corporate names that he claims he received as “payment” for services to these companies.
Potential Issues
There are several issues that arise out of this type of transaction a) trading in penny stocks is not a crime. b) Trading in several penny stocks is not a crime nor is being “heavily” involved in penny stocks illegal either. However, the compliance officer and the AML officer must carefully monitor these transactions and watch the patterns that might develop as to the volume in the stocks traded, and how quickly the client trades out of the security, where the client obtained the stock, and how, where, how often and how much of the proceeds travel out of the client’s accounts.
There are numerous other Red Flags and scenarios that happen every day. It is the registered representative's and Firm’s obligation to be extra cautious in today’s environment.
Resources:
Financial Crimes Enforcement Network (FINCEN)
Securities Investor Protection Corporation (SIPC)
Financial Industry Regulatory Authority (FINRA)
Luxor Financial Group, Inc (LFG)
FINRA Rule 2111 requires that when brokers make a recommendation to a client that such recommendation is suitable. Below is a suitability checklist which encompasses the requirements of the rule.
For a copy in Word format, simply send me an email and I will send one to you. Ken@luxorbd.com
Suitability Checklist
Name of Representative: _______________________________
Name of Client: _________________________________________
Type of Account: _______________________________________
Date of Review: _________________________________________
1. Reviewed all personal information about the client including, age, occupation etc..
Yes: __ No: ___ Comments (if any) ___________________________________
2. Reviewed net income and net worth of the client and make sure there is awareness of all the client’s investments.
Yes: __ No: __ Comments (if any) ___________________________________
3. Reviewed the purpose of the account and considered whether it is long term, short term, etc.
Yes: __ No: ___ Comments (if any) ___________________________________
4. Reviewed overall investment objectives and investment time horizon of the client, ie., when the client expects to meet the financial goals set.
Yes:__ No: __ Comments (if any) ___________________________________
5. Reviewed whether investment objectives allow for speculation.
Yes: __ No: __ Comments (if any) ___________________________________
6. Reviewed Investment Risk Tolerance of the client ranging from conservative, moderate conservative, moderate, moderately aggressive and significant risk.
Yes: __ No: __ Comments (if any) ___________________________________
7. Reviewed the Financial Investment Experience of the client including experience with Mutual Funds/Exchange Traded Funds, Individual Stocks, Bonds, Options, Securities Futures, Annuities, Hedge Funds, Structured Products and Margin. Reviewed the length of time experienced in each of these products and the number of trades made per year.
Yes: __ No: __ Comments (if any) ___________________________________
8. Reviewed the Decision-Making patterns of the customer. Does the customer consult with his broker, investment advisor, CPA or other financial professional or does he or she generally make their own decisions or discuss investment decisions with family or friends.
Yes: __ No: __ Comments (if any) ___________________________________
9. Reviewed how much of the client’s portfolio will be comprised of this account.
Yes: __ No: __ Comments (if any) ___________________________________
10. Reviewed how the account will be funded: income, pension or retirement savings, funds from another account, gift, sale of business or property, insurance payout, inheritance, social security benefits, home equity line of credit/reverse mortgage or other.
Yes: __ No: __ Comments (if any) ___________________________________
11. Insured that all investments proposed were thoroughly explained and are suitable for the client in light of all the above considerations.
Yes: __ No: __ Comments (if any) ___________________________________
Customer Complaints
Customer Complaints fall into 2 categories, complaints which are reportable by the Broker Dealer to FINRA through a 4530 report and those that are reportable on a Broker’s license. The regulators have taken a broad view and essentially, if a client puts pen to paper or in most cases sends an email to the broker it is reportable under Rule 4530. Emails such as “I knew this pick was garbage”, “stock is down 2 points WTF?!” and similar emails can be interpreted as “performance complaints” and would be filed under 4530 and potentially result in the regulators requesting more information regarding these “complaints”.
If a customer alleges in an email the following two items 1) a sales practice violation IE: “I did not authorize you to buy that stock” (Unauthorized Trading), and 2) “this trade cost me $6,200” (A loss of more than $5,000), then it is a complaint which is reportable, on the Broker’s U-4 as well as by the Broker Dealer to FINRA under Rule 4530.
Getting Rid of Customer Complaints
Under the old system, complaints that were placed on a broker’s license which did not result in arbitration by the customer were eliminated from the registered representative’s license after 2 years. Under the current rule, these complaints will remain on the broker’s license FOREVER. In order to remove these complaints, a broker needs to file for a hearing to remove the complaint from their license. Such a hearing would give the client who filed the complaint an opportunity to say why the complaint should still stand absent arbitration. The process (if one represents themselves) costs approximately $1,000 along with a one day hearing in front of a FINRA panel. If the panel agrees that the complaint should be removed, the broker would then take such order to a judge for approval and then send the order to FINRA disclosure for removal from their license.
Reasons why the process is tedious
The state Regulators, (State Regulators) need to retain their rights to regulate individuals who wish to conduct licensed activities in their state. As such, they don’t want brokers to simply have the ability to remove potentially damaging information from their records that the public may use in evaluating that broker’s services. Therefore, if a broker goes to a hearing and gets a judge to sign off on the removal of such information, the states have effectively policed the broker and helped to ensure the safety of the investing public from predatory brokers.
For more information or if you have any questions related to your specific situation please go to:
Luxor Financial Group
Buying an existing Broker Dealer:
Buying an existing Broker Dealer or filing a New Member Application is a question that I get asked on a regular basis and depends on many factors as follows:
The lines of business that the existing Broker Dealer is approved for (This is very important as buyers think that they can simply put a new business line such as Digital Platforms or other specialty lines of business into the broker dealer and start operating. The business lines must match exactly what you wish to do otherwise you should start a new application).
The current clearing agent
The background of the Firm
The seller’s willingness to work with the purchaser
The purchaser’s expectations
The purchaser’s qualifications and resources
No restrictions from FINRA
The Process:
1. Find a Broker Dealer for sale. The Broker Dealer should have the lines of business that you use most. (You can add additional lines of business during the process).
2. Conduct due diligence. At a minimum, collect the following:
Current membership agreement
Corporate documents including formation and operating agreements
Any loans/Liens of credit or other debt obligations
Clearing agreement (if any)
Copy of form BD
Last 4 Focus reports
Current Annual Financial Audit
Copies of the last FINRA and any other regulatory body review and the Firm’s response
Copies of the Firm’s fidelity bond
Copies of the Firm’s SIPC registration
Corporate Formation Documents & Operating Agreement if applicable
Vendor Agreements (Including Leases, email archive & personnel/consulting Agreements)
3. Enter into a purchase agreement
Be sure that the purchase agreement lists all the items that you expect as a purchaser and conforms to FINRA’s rules and regulations.
4. File the Continuing Membership Application (the 1017 application) with the applicable district. (This is a detailed application which has too many nuances to go into detail here).
5. Wait for a response from the district. (This response will have numerous questions regarding the structure, financing and supervision etc, of the proposed ownership).
6. Respond to the district. (Answer all of the districts questions with as much detail as possible).
7. Wait for next response then repeat 5, 6 and 7 until approved or denied.
You will typically need the following:
1. General Securities Principal: Licensed Series 24, with at least one year of direct supervisory experience, (or 2 years indirect) relating to all the lines of business that the Firm will engage in.
2. Financial Operations Principal: Licensed Series 27 this is the person that will file the Firms FOCUS reports either quarterly or monthly depending on the Firms net capital requirement.
3. Adequate resources in the bank (usually 12 months worth of expenses.)
4. Business Plan
5. Continuing Education Plan
6. Email compliance program
7. Anti Money Laundering Procedures
8. Written Supervisory Procedures
9. Business Continuity Plan
10. Pro-Forma Financials
11. LOTS of PATIENCE!
The above is designed to give a general overview of the process. Feel free to contact me to discuss your specific situation. Also, be aware that under FINRA Rule, while a Firm may effect the change before the final, written decision is issued, FINRA may place an interim restriction prohibiting the proposed purchaser from conducting any business which may remain in effect until the application is approved or denied.
Filing an application for a new Broker Dealer:
Filing for a new Broker Dealer is essentially the same process except for a) you will have to wait to get approval before conducting any transactions (4-6 months) b) All of the items have to be done from scratch (Fidelity bond, SIPC etc).
Buying an existing Broker Dealer:
Pros: Operating and transferring of ownership within 45 days
Cons: Cost around $65,000 (for a non producing shell with limited business lines) and requires a due diligence process.
Filing a new application:
Pros: Save $65,000 no due diligence, fresh Firm with no potential issues and custom tailored to your business.
Cons: Takes 4-6 months for approval
Resources:
Financial Regulatory Authority (FINRA)
Luxor Financial Group, Inc (LFG)
