Understanding the Proposed Financial Exploitation Prevention Act (H.R. 2478) and What It Means for Investors, Families, Financial Professionals, Broker-Dealers, RIAs, and Compliance Officers
Financial exploitation of older Americans has become one of the most serious investor-protection problems in the United States. Criminals increasingly target retirement accounts, brokerage accounts, mutual fund holdings, bank accounts, annuities, trust assets, and other accumulated savings using fraud, coercion, social engineering, impersonation, artificial intelligence, romance scams, cryptocurrency schemes, and abuse of positions of trust.
The proposed Financial Exploitation Prevention Act of 2025, H.R. 2478, is Congress’s latest effort to give financial institutions additional tools to intervene before suspicious redemptions and transfers become irreversible. As of the date of this article, H.R. 2478 remains proposed legislation. It has been introduced, reported favorably by the House Financial Services Committee, and placed on the House Union Calendar, but it has not become law. [1]
The bill would amend the Investment Company Act of 1940 to permit registered open-end investment companies and transfer agents to delay payment on certain redemptions when they reasonably believe that the redemption involves financial exploitation of a specified adult. The bill is narrower than many popular summaries suggest: it focuses on redemptions of securities issued by open-end investment companies, such as mutual funds, serviced through transfer agents, and is designed to complement, not replace, existing FINRA, state, and federal protections. [2]
For investors and families, the lesson is practical. Do not wait until money has vanished. Suspicious liquidation requests, sudden wire transfers, cryptocurrency transactions, new online relationships, caregiver pressure, changes in powers of attorney, or abrupt deviations from long-established investment patterns should be investigated immediately. For broker-dealers, RIAs, mutual fund companies, transfer agents, supervisors, and compliance personnel, H.R. 2478 is another indication that regulators and Congress expect earlier detection, better documentation, stronger escalation procedures, and effective training.
This article explains what H.R. 2478 would do, why Congress introduced it, how it fits within existing law, and what investors, families, financial professionals, and financial institutions should do now to prevent elder investment fraud and preserve legal rights when fraud is suspected.
I. America’s Growing Crisis of Elder Financial Exploitation
For millions of Americans, retirement represents the culmination of decades of work, saving, investing, and financial discipline. Those assets are supposed to provide independence, medical security, family stability, and dignity. Increasingly, however, older investors are being targeted precisely because they have accumulated assets and can authorize transactions quickly.
The FBI’s 2024 Internet Crime Report illustrates the scale of the problem. IC3 reported 859,532 complaints and $16.6 billion in losses in 2024, a 33 percent increase in reported losses from 2023. Individuals over age 60 submitted 147,127 complaints and reported $4.8 billion in losses, the highest loss total of any age group. [3]
Investment fraud was the largest reported loss category in the FBI’s 2024 data, accounting for more than $6.57 billion in reported losses. The report also identified cryptocurrency as a major descriptor, associated with more than $9.32 billion in reported losses across relevant complaint categories. [4] Cyber-enabled fraud accounted for approximately 83 percent of all reported IC3 losses in 2024. [5]
These figures almost certainly understate the actual magnitude of the problem. Many victims never report fraud because they are embarrassed, fear loss of independence, do not know where to report, or believe recovery is impossible. The CFPB has likewise reported that financial institutions filed more than 180,000 suspicious activity reports involving elder financial exploitation between 2013 and 2017, involving more than $6 billion. [6]
Congress has cited estimates that elder financial exploitation costs seniors more than $28 billion annually. [7] Whether measured by FBI complaints, CFPB suspicious activity reports, state regulatory data, or private research, the trend is unmistakable: older adults are losing life savings to increasingly sophisticated schemes.
Key Takeaway
Elder financial exploitation is not limited to isolated scams. It is a national investor-protection issue involving organized criminal networks, online fraud, cryptocurrency schemes, misuse of authority, and, in some cases, misconduct or supervisory failures within the financial services industry.
II. Why Congress Introduced H.R. 2478
H.R. 2478 did not arise in a vacuum. It is part of a broader legislative and regulatory progression that began with state elder-protection statutes, continued through FINRA’s trusted-contact and temporary-hold rules, and expanded through federal efforts to encourage reporting of suspected exploitation.
The Senior Safe Act, enacted as part of the Economic Growth, Regulatory Relief, and Consumer Protection Act, created immunity from liability for certain trained financial institution personnel who, in good faith and with reasonable care, disclose suspected exploitation of a senior citizen to a regulatory or law-enforcement agency. [8] The Senior Safe Act addressed reporting; it did not create a broad redemption-delay framework for mutual fund redemptions processed through transfer agents.
FINRA then adopted important rules applicable to broker-dealers. FINRA Rule 4512 requires member firms to make reasonable efforts to obtain the name and contact information of a trusted contact person for non-institutional accounts. [9] FINRA Rule 2165 permits member firms, in defined circumstances, to place temporary holds on disbursements or transactions involving accounts of specified adults when the firm reasonably believes financial exploitation has occurred, is occurring, has been attempted, or will be attempted. [10]
State securities regulators also acted. NASAA’s Model Act to Protect Vulnerable Adults from Financial Exploitation, adopted in 2016, encourages reporting to state securities regulators and adult protective services, authorizes limited third-party disclosures, permits delayed disbursements in appropriate circumstances, and provides immunity for good-faith compliance. [11] Many jurisdictions, including California, have enacted legislation or regulations based on or related to the NASAA model.
H.R. 2478 is the next step in that progression. The House Financial Services Committee described the bill as authorizing registered open-end investment companies and their transfer agents to delay redemptions when they reasonably believe financial exploitation is occurring or has been attempted. [12] In short, the legislation seeks to fill a practical gap in the protection of investors who hold mutual fund shares directly at the fund level or through transfer-agent relationships rather than in traditional brokerage accounts.
Legislative History
Representative Ann Wagner introduced H.R. 2478 on March 27, 2025. The bill was referred to the House Committee on Financial Services. The Committee reported the bill favorably, with an amendment, and recommended that it pass. [13] As of the date of this article, Congress.gov reflects that the bill was placed on the House Union Calendar on November 4, 2025, and has not become law. [1]
The bill has a prior legislative history. In the 118th Congress, Representative Wagner introduced H.R. 500, an earlier version of the Financial Exploitation Prevention Act. That bill passed the House under suspension of the rules by a vote of 419-0, was received in the Senate, and was referred to the Senate Committee on Banking, Housing, and Urban Affairs, but no further action occurred before the end of the 118th Congress. [14]
During the 119th Congress, the House Financial Services Committee considered H.R. 2478 in open session on September 16, 2025, adopted an amendment in the nature of a substitute by voice vote, and ordered the bill reported favorably by a recorded vote of 50-0. [15] That unanimous committee vote is significant. Protecting older investors from financial exploitation has generated bipartisan support because the problem is not ideological. It affects retirees, families, and financial institutions in every state.
III. What H.R. 2478 Would Do
H.R. 2478 is narrower, more technical, and more targeted than many readers may assume. It would amend Section 22 of the Investment Company Act of 1940 to address delayed payment or satisfaction upon redemption of certain securities in cases involving suspected exploitation of specified adults. The bill applies to registered open-end investment companies and certain transfer agents that elect to comply with the statute’s procedures. [2]
The core concept is straightforward. If an open-end investment company or transfer agent reasonably believes that a redemption involves financial exploitation of a specified adult, the company may delay redemption payment. The bill defines the protected population to include individuals age 65 or older and adults age 18 or older who are unable to protect their own interests because of a mental or physical impairment. [2]
The bill contemplates an initial delay of up to 15 days. If the company determines that exploitation has occurred, the delay may be extended for an additional 10 days. A state regulator, administrative agency, or court may extend the period further. Amounts subject to the delayed redemption must be held in a demand deposit account, and the bill establishes notification requirements
The bill also requires registered open-end investment companies and transfer agents that elect to use these procedures to notify the SEC. In addition, the SEC must report recommendations to Congress regarding regulatory or legislative changes needed to address financial exploitation of specified adults, after consulting with agencies and organizations including the CFTC, CFPB, FINRA, NASAA, the Federal Reserve, the OCC, and the FDIC. [16]
The bill does not authorize financial institutions to second-guess investment decisions simply because a customer is old, conservative, aggressive, or making an investment decision the firm considers unwise. The relevant trigger is reasonable belief of financial exploitation. That distinction is essential. Older adults do not lose autonomy because they age. Protective intervention must be based on objective evidence of fraud, coercion, deception, undue influence, or inability to protect one’s own interests.
What H.R. 2478 Is – and Is Not
H.R. 2478 is proposed federal legislation. It is not yet law.
It focuses on redemptions of certain open-end investment company securities serviced by transfer agents.
It would permit limited redemption delays when financial exploitation is reasonably suspected.
It is not a general license for financial institutions to block transactions simply because they disagree with an investor’s judgment.
IV. FINRA Rules 4512 and 2165: The Existing Framework
H.R. 2478 should be understood against the backdrop of FINRA Rules 4512 and 2165. Those rules remain central to broker-dealer elder-protection practices.
Rule 4512 requires broker-dealers to make reasonable efforts to obtain the name and contact information of a trusted contact person for a customer’s account, subject to specified limitations.[9] A trusted contact does not become a co-owner, agent, trustee, or power of attorney. The trusted contact has no authority to trade, withdraw funds, or make investment decisions. The purpose is narrower: the brokerage firm may contact that person in limited circumstances to address possible financial exploitation, confirm contact information, health status, or the identity of a legal guardian, executor, trustee, or power-of-attorney holder. [17]
Rule 2165 permits a member firm to place a temporary hold on a disbursement or transaction in an account of a specified adult if the firm reasonably believes financial exploitation has occurred, is occurring, has been attempted, or will be attempted. The rule defines a specified adult as a natural person age 65 or older, or an adult age 18 or older whom the firm reasonably believes has a mental or physical impairment rendering the person unable to protect his or her own interests. [10]
Rule 2165 also imposes procedural safeguards. The firm must provide notification, unless the person to be notified is unavailable or suspected of involvement in the exploitation; it must immediately initiate an internal review; it must limit the hold period unless extended as permitted; it must maintain written supervisory procedures; and it must keep records supporting its decision. [18]
The SEC, FINRA, and NASAA have continued to encourage trusted contacts as a practical investor-protection device. In 2025, their updated Investor Bulletin explained that a trusted contact is similar to an emergency contact and does not receive authority to make decisions or execute transactions in the investor’s account. [19]
V. How Elder Investment Fraud Occurs
The common denominator in most elder financial exploitation cases is not lack of intelligence by the victim. Victims include physicians, attorneys, accountants, professors, business owners, engineers, executives, and sophisticated investors. The common denominator is manipulation. Modern fraudsters understand psychology, technology, and timing.
Many schemes begin slowly. The victim receives a call, text, email, social-media message, or online introduction. The communication appears legitimate or emotionally compelling. The fraudster builds trust over days, weeks, or months. Eventually, the victim is encouraged to transfer money, liquidate securities, purchase cryptocurrency, change beneficiaries, grant account access, or keep the matter secret.
Artificial intelligence has increased the risk. Fraudsters can now generate polished emails, realistic voice recordings, forged documents, synthetic images, and personalized messages based on publicly available information. What once looked like obvious spam may now appear to come from a legitimate financial institution, government agency, family member, or trusted advisor.
Cryptocurrency scams are particularly dangerous because transactions can move quickly and recovery can be difficult. The FBI’s 2024 report described cryptocurrency investment fraud, often referred to as pig butchering, as a confidence-based scam in which criminals build an online relationship before introducing a fraudulent cryptocurrency investment platform. In Operation Level Up, the FBI notified 4,323 potential victims of cryptocurrency investment fraud; 76 percent were unaware they were being scammed, and estimated savings exceeded $285 million. [20]
Romance scams operate similarly. The initial request is rarely for money. The fraudster first creates emotional reliance. Eventually, an emergency, investment opportunity, travel problem, medical crisis, or business issue arises. The victim liquidates investments, withdraws retirement funds, wires money, or buys cryptocurrency because the request appears to come from someone who cares about them.
Other cases involve exploitation by family members, caregivers, trustees, or agents under powers of attorney. These cases can be harder to detect because the wrongdoer may already have access to the investor’s finances or may appear to be helping. Misuse of powers of attorney, improper beneficiary changes, self-dealing transfers, unauthorized loans, and pressure to execute estate-planning documents can all constitute financial exploitation.
Finally, some cases involve misconduct within the financial services industry itself. Unsuitable recommendations, unauthorized trading, excessive trading, selling away, misrepresentations, illiquid private placements, Ponzi schemes, and failures to supervise registered representatives may all cause recoverable losses. Not every investment loss is actionable, but losses caused by violations of legal or regulatory duties should be investigated.
Ten Warning Signs of Elder Financial Exploitation
Sudden liquidation of long-held investments.
Repeated or unusually large wire-transfer requests.
New interest in cryptocurrency without prior experience.
A new friend, romantic contact, caregiver, or relative directing financial decisions.
Requests for secrecy or instructions not to contact family members.
Unexplained beneficiary, address, or account-access changes.
Confusion about transactions supposedly authorized by the investor.
Pressure to act immediately.
Investment decisions inconsistent with decades of prior objectives.
Fear, anxiety, or reluctance when asked routine financial questions.
VI. Practical Guidance for Investors and Families
Prevention remains the best protection. Families should discuss financial safeguards before a crisis occurs. That discussion should respect independence while recognizing that fraud can affect anyone.
Investors should designate trusted contacts on brokerage accounts where available, review monthly statements promptly, verify significant transfer requests independently, use strong account-security practices, and pause before making urgent decisions. Any request to keep a transaction secret from family, counsel, accountants, or trusted advisors should be treated as a serious warning sign.
Adult children and other family members should look for changes in behavior, not merely changes in account values. Sudden secrecy, new relationships involving money, anxiety when discussing finances, unexplained withdrawals, or abrupt changes in estate planning may warrant closer review. The goal is not to take control of a parent’s finances. The goal is to ensure that decisions are being made freely, knowingly, and without coercion or deception.
When suspicious activity is detected, time matters. Contact the financial institution immediately. Ask whether transfers can be delayed, whether a fraud department can review the transaction, and whether additional account controls are available. Preserve emails, texts, voicemails, account statements, confirmations, transfer instructions, and names of everyone involved. Do not delete messages out of embarrassment.
Why Early Intervention Changes Outcomes
The practical difference between early and late intervention can be decisive. A pending wire transfer may be stopped. A recent transfer may sometimes be recalled. A suspicious redemption may be delayed if the institution has legal authority and adequate procedures. A cryptocurrency transfer, by contrast, may become effectively unrecoverable once the assets move through multiple wallets controlled by criminals.
Early intervention also preserves choices. Families may be able to involve trusted contacts before a victim becomes isolated. Counsel may be able to send preservation demands before emails, telephone recordings, account notes, CRM entries, and surveillance materials are destroyed in the ordinary course. Financial institutions may be able to conduct an internal review while employees still remember the relevant conversations. Law enforcement may be able to trace funds before they are layered through additional accounts.
Delay has the opposite effect. Victims often wait because they are embarrassed, because they trust the person asking for money, or because they hope the situation can be resolved privately. In family exploitation cases, delay may result from understandable reluctance to accuse a relative or caregiver. In romance scams, victims may continue believing the relationship is genuine even after objective evidence suggests fraud. In investment schemes, victims may be told that withdrawals are delayed only because of administrative problems or taxes.
For investors and families, the most practical rule is simple: investigate first and apologize later. Asking questions is not disrespectful. A legitimate advisor, fiduciary, family member, caregiver, or investment sponsor should be able to explain the transaction, provide documents, and allow reasonable time for review. A person who insists on secrecy, urgency, or isolation is creating a red flag that should not be ignored.
Immediate Steps If Fraud Is Suspected
Contact the financial institution immediately and ask for the fraud or compliance department.
Request review or delay of pending transfers where legally available.
Preserve all emails, texts, voicemails, account statements, wire instructions, and screenshots.
Change passwords and enable multi-factor authentication if account access may be compromised.
Report criminal conduct to law enforcement or the FBI’s IC3 portal where appropriate.
Consult experienced securities counsel promptly before additional assets are transferred.
VII. Guidance for Broker-Dealers, RIAs, Mutual Fund Companies, Transfer Agents, and Compliance Departments
For financial institutions, H.R. 2478 should be viewed as more than proposed legislation. It reflects evolving expectations. Regulators, courts, arbitration panels, and customers increasingly expect firms to recognize patterns of exploitation, train personnel, escalate concerns, and document their decisions.
Broker-dealers should evaluate whether their Rule 4512 trusted-contact processes are effective in practice, not merely on paper. Firms should ask whether trusted contacts are obtained, updated, and used appropriately. They should also review whether Rule 2165 procedures identify who may place or extend a hold, when legal or compliance review is required, how notifications are documented, and how suspicious activity is escalated.
RIAs should consider comparable policies even where FINRA rules do not directly apply. Advisers owe fiduciary duties and often maintain long-standing relationships with clients. They may be well positioned to identify sudden changes in behavior, unusual instructions, or third-party influence. Investment adviser representatives should be trained to escalate concerns rather than informally resolving them in isolation.
Mutual fund companies and transfer agents should pay particular attention to H.R. 2478 because the bill is directed to open-end investment company redemptions and transfer-agent relationships. Firms that could elect to rely on the proposed procedures should begin considering how they would document reasonable belief, notify appropriate parties, hold redemption amounts, and coordinate with regulators if the bill is enacted.
Compliance departments should create multidisciplinary protocols involving legal, supervision, operations, fraud, technology, and client-facing personnel. A customer-service employee may see a change of address; operations may see a new ACH instruction; the advisor may see a liquidation request; compliance may see a suspicious pattern. The system must connect those observations before assets leave the institution.
Compliance Checklist for Financial Institutions
Do written supervisory procedures address elder financial exploitation directly?
Are trusted contacts obtained and updated consistently?
Are employees trained on AI scams, romance scams, crypto fraud, caregiver exploitation, and powers of attorney?
Does the firm have clear escalation procedures for suspicious disbursements and redemptions?
Are temporary holds documented with objective facts and supervisory approval?
Can the firm aggregate warnings across departments?
Are incident files sufficient for review by regulators, courts, or FINRA arbitration panels?
VIII. Legal Remedies Available Today
Investors do not need to wait for H.R. 2478 to become law before seeking legal advice. Existing remedies may be available under federal securities laws, state securities statutes, FINRA arbitration rules, fiduciary-duty principles, negligence law, contract law, elder financial abuse statutes, and common-law fraud theories.
Many disputes involving broker-dealers and registered representatives are resolved in FINRA arbitration. Potential claims include unsuitable recommendations, unauthorized trading, excessive trading, misrepresentation, omission of material facts, breach of fiduciary duty, negligence, failure to supervise, selling away, and breach of contract. FINRA arbitration is a specialized forum, and effective representation requires knowledge of securities law, industry practices, supervision, discovery, damages, and expert testimony.
California investors may also have remedies under California elder abuse law. California Welfare and Institutions Code section 15610.30 defines financial abuse of an elder or dependent adult to include taking, secreting, appropriating, obtaining, or retaining property for wrongful use or with intent to defraud, assisting such conduct, or taking property by undue influence. [21] Depending on the facts, California elder-abuse remedies may materially affect strategy and recovery.
Claims may exist not only against the immediate wrongdoer but also against broker-dealers, RIAs, supervisors, trustees, attorneys-in-fact, caregivers, family members, promoters, or financial institutions whose misconduct, negligence, breach of fiduciary duty, or failure to supervise contributed to the loss. Identifying all potentially responsible parties is often critical.
Prompt legal action matters. Electronic records can be deleted, account notes overwritten, recordings purged, witnesses lost, cryptocurrency moved through wallets, and bank wires dispersed. Preservation letters, emergency communications with financial institutions, reports to law enforcement, and early factual investigation can materially affect the ability to recover funds or prove liability.
IX. Why Experienced Securities Counsel Matters
Elder financial exploitation cases often sit at the intersection of securities law, fiduciary duty, elder abuse, banking procedures, cybersecurity, arbitration, regulatory compliance, and family dynamics. A narrow approach can miss important claims. A lawyer who sees only a family dispute may overlook broker-dealer supervision. A lawyer who sees only an investment loss may overlook undue influence. A lawyer who sees only fraud by an outsider may overlook whether a financial institution ignored red flags.
Experienced securities counsel can analyze account records, identify suspicious transactions, preserve evidence, evaluate statutes of limitation, determine whether FINRA arbitration applies, assess supervisory failures, coordinate with forensic experts where needed, and pursue recovery from responsible parties. Counsel can also advise financial professionals, broker-dealers, RIAs, and compliance personnel on policies, internal investigations, remediation, and regulatory exposure.
Shustak Reynolds & Partners represents investors, financial professionals, broker-dealers, registered investment advisers, hedge funds, and businesses in FINRA arbitrations, securities litigation, SEC and FINRA investigations, broker transition disputes, investment fraud matters, fiduciary-duty claims, and complex commercial disputes. Erwin J. Shustak, George C. Miller, and Joseph C. Mellano handle securities litigation, FINRA arbitration, broker misconduct, regulatory investigations, and financial services disputes. Robert Boeche advises broker-dealers, RIAs, private funds, and financial industry participants on regulatory, compliance, and enforcement issues.
That breadth matters. Elder investment fraud can present both investor-recovery issues and industry-compliance issues. The same fact pattern may require urgent evidence preservation, FINRA arbitration analysis, SEC or FINRA regulatory assessment, review of supervisory procedures, and practical judgment concerning family, fiduciary, and reputational considerations.
Frequently Asked Questions
No. As of the date of this article, H.R. 2478 remains proposed legislation. It has been introduced, reported favorably by the House Financial Services Committee, and placed on the House Union Calendar, but it has not become law. [1]
Does H.R. 2478 apply to every brokerage transaction?
No. The bill focuses on redemptions of certain securities issued by registered open-end investment companies and serviced by transfer agents. Existing FINRA rules and state laws may apply in different circumstances.
Does naming a trusted contact give that person control over my account?
No. A trusted contact does not receive authority to trade, withdraw money, or make decisions. The designation allows the firm to contact that person in limited circumstances, such as suspected financial exploitation or difficulty reaching the customer. [19]
Can investors recover money lost to elder financial exploitation?
Sometimes. Recovery depends on the facts, the defendants, the available evidence, applicable limitations periods, and whether a responsible party violated a legal duty. Prompt investigation materially improves the ability to evaluate recovery options.
Conclusion
H.R. 2478 reflects a broader national recognition that elder financial exploitation is a serious, growing, and increasingly sophisticated threat. Whether the bill is enacted in its present form, modified, or delayed, its policy message is clear: financial institutions must be prepared to identify suspected exploitation before retirement assets disappear, and investors and families must act quickly when warning signs appear.
Financial exploitation is no longer limited to crude scams or obvious misconduct. It now includes AI-enabled impersonation, cryptocurrency fraud, romance scams, caregiver pressure, misuse of powers of attorney, unsuitable investment recommendations, unauthorized trading, Ponzi schemes, and failures of supervision. The legal response must be equally sophisticated.
If you or a family member has sustained losses through suspected elder investment fraud, broker misconduct, unauthorized trading, unsuitable investments, financial exploitation, misuse of a power of attorney, or suspicious account activity, contact Shustak Reynolds & Partners promptly. Early legal intervention can help preserve evidence, identify responsible parties, evaluate claims, and protect remaining assets.
For broker-dealers, RIAs, mutual fund companies, transfer agents, supervisors, and compliance officers, H.R. 2478 is an opportunity to review policies before the next crisis. Effective procedures, training, documentation, and escalation are not merely regulatory obligations; they are essential tools for protecting clients and reducing legal and reputational risk.
This article is for informational purposes only and does not constitute legal advice. Every matter depends on its own facts, and readers should consult qualified counsel regarding their specific circumstances.
Shustak Reynolds & Partners, P.C. focuses its practice on securities and financial services law and complex business disputes. We represent many investment advisors, financial professionals, broker-dealers, registered representatives, investors and businesses. Attorney Erwin J. Shustak can be reached in the firm’s San Diego office at (619) 696-9500.
2. Congress.gov, H.R. 2478 summary, describing the bill as establishing procedures for delaying redemption of certain securities when an investment company or agent believes an older individual or impaired adult has been financially exploited, https://www.congress.gov/bill/119th-congress/house-bill/2478.
3. Federal Bureau of Investigation, Internet Crime Complaint Center, 2024 IC3 Annual Report, pp. 3, 7-8, reporting 859,532 complaints, $16.6 billion in losses, and $4.8 billion in losses reported by individuals age 60 and older, [PDF DOWNLOAD] https://www.ic3.gov/AnnualReport/Reports/2024_IC3Report.pdf.
4. FBI IC3, 2024 Annual Report, pp. 9-10, reporting investment-fraud losses of $6,570,639,864 and cryptocurrency-nexus losses of $9,322,335,911.
5. FBI IC3, 2024 Annual Report, p. 11, reporting that cyber-enabled fraud accounted for almost 83 percent of IC3-reported losses in 2024.
7. H. Rept. 119-361, Financial Exploitation Prevention Act of 2025, Background and Need for Legislation, citing AARP Public Policy Institute estimates that financial exploitation costs seniors more than $28 billion annually, https://www.congress.gov/committee-report/119th-congress/house-report/361/1.
8. Congress.gov, H.R. 3758 – Senior Safe Act of 2017, summary describing immunity for trained financial institution personnel who disclose suspected senior exploitation in good faith and with reasonable care, https://www.congress.gov/bill/115th-congress/house-bill/3758.
12. H. Rept. 119-361, Purpose and Summary, describing H.R. 2478 as allowing registered open-end investment companies and transfer agents to implement safeguards delaying redemptions where financial exploitation is reasonably suspected.
13. H. Rept. 119-361, Committee report language noting introduction of H.R. 2478 by Representative Ann Wagner on March 27, 2025, referral to House Financial Services, and favorable report with amendment.
14. H. Rept. 119-361, Committee Consideration, 118th Congress history of H.R. 500 and House passage by vote of 419 yeas and 0 nays.
15. H. Rept. 119-361, Committee Votes, noting that on September 16, 2025, the Committee ordered H.R. 2478, as amended, to be reported favorably by recorded vote of 50 yeas and 0 nays.
16. H.R. 2478, as reported, Section 2(b), requiring the SEC to report recommendations to Congress after consulting with the CFTC, CFPB, FINRA, NASAA, Federal Reserve, OCC, and FDIC.
18. FINRA Regulatory Notice 17-11, SEC Approves Rules Relating to Financial Exploitation of Seniors (Mar. 30, 2017), discussing Rules 2165 and 4512, temporary holds, trusted contacts, notification, recordkeeping, supervision, and training, https://www.finra.org/rules-guidance/notices/17-11.
19. SEC/FINRA/NASAA Investor Bulletin on Trusted Contacts, explaining that naming a trusted contact does not give the person authority to execute trades, make decisions, or act as power of attorney.
20. FBI IC3, 2024 Annual Report, Operation Level Up discussion, reporting notifications to 4,323 cryptocurrency investment-fraud victims, 76 percent of whom were unaware they were being scammed, and estimated savings exceeding $285 million.
The International Chamber of Commerce (ICC) remains the world’s leading institution for the administration of international commercial arbitrations. On June 1, 2026, the ICC’s revised Arbitration Rules took effect. While many of the revisions codify practices that had already developed in ICC proceedings, several changes are significant and will affect the strategy, cost, and efficiency of future arbitrations.
For businesses engaged in international commerce, and for lawyers who draft arbitration clauses or litigate cross-border disputes, understanding these changes is essential. The revisions are designed to improve efficiency, enhance transparency, and increase confidence in the arbitral process while maintaining the flexibility that has long distinguished ICC arbitration from traditional court litigation.
Why the 2026 Revisions Matter
The ICC’s revisions reflect broader trends affecting international dispute resolution. Corporate clients increasingly demand faster resolutions, lower costs, greater transparency, and more active case management. International arbitration institutions worldwide have responded by introducing expedited procedures, technology-driven case administration, and stronger disclosure requirements.
The ICC’s new rules seek to balance efficiency with procedural fairness. The revisions are particularly important because they will likely influence practice not only before the ICC but also before other leading institutions, including AAA-ICDR, JAMS, FINRA, SIAC, LCIA, HKIAC, and similar forums.
Elimination of Mandatory Terms of Reference
For decades, the Terms of Reference represented a unique feature of ICC arbitration. The process required parties and tribunals to prepare a document defining the claims, defenses, issues, and procedural framework of the dispute.
Although the Terms of Reference often served a useful purpose, many practitioners viewed the process as expensive and time-consuming. Under the 2026 Rules, the mandatory requirement has been eliminated. Tribunals instead conduct an early Case Management Conference.
The practical impact is likely to be substantial. Cases should move more quickly from initiation to substantive proceedings. Businesses can expect lower front-end costs and fewer procedural delays. Counsel, however, must ensure that pleadings are drafted carefully because the initial submissions will now play an even more important role in defining the scope of the arbitration.
Early Determination Procedure
One of the most important innovations is the formal adoption of an early determination procedure. Tribunals now possess explicit authority to dispose of claims or defenses that are manifestly without merit or outside the tribunal’s jurisdiction.
This development addresses a common criticism of arbitration—that weak claims sometimes survive longer than they would in court litigation. The new procedure gives parties a mechanism to eliminate legally deficient claims before substantial resources are expended on document production, expert testimony, and evidentiary hearings.
Businesses should view this change favorably. Early determination can significantly reduce costs and shorten the life cycle of a dispute.
Expanded Expedited Arbitration
The ICC has expanded the availability of expedited arbitration procedures by increasing the monetary threshold applicable to those procedures.
Expedited arbitration typically involves a sole arbitrator, streamlined submissions, fewer procedural steps, and accelerated timelines. For disputes of moderate value, these procedures may provide a highly cost-effective alternative to traditional arbitration.
Companies negotiating international contracts should evaluate whether expedited procedures align with their business objectives and risk tolerance.
Highly Expedited Arbitration
Perhaps the most innovative feature of the 2026 Rules is the introduction of a highly expedited arbitration process. The objective is simple: provide a binding and enforceable award within an extremely compressed timeframe.
For disputes involving supply chain disruptions, licensing agreements, technology contracts, and ongoing business relationships, speed may be nearly as important as the outcome itself. A procedure capable of delivering a final decision within months rather than years may create substantial commercial value.
Emergency Arbitrator Enhancements
The revised Rules strengthen emergency arbitrator procedures and expand available interim remedies. Businesses frequently face situations requiring immediate relief, including preservation of evidence, protection of trade secrets, prevention of asset transfers, or maintenance of the status quo.
The enhanced emergency arbitrator provisions provide additional flexibility and strengthen the effectiveness of interim relief mechanisms available under ICC arbitration.
Arbitrator Independence and Disclosure
Confidence in the neutrality of arbitrators remains central to the legitimacy of international arbitration. The revised Rules impose enhanced disclosure obligations and encourage arbitrators to disclose potential conflicts whenever doubt exists.
This approach promotes transparency and reduces the risk of later challenges to arbitrator appointments. It is particularly important in modern commerce, where complex corporate structures often create relationships that may not be immediately apparent.
Confidentiality and Technology
The 2026 Rules continue the trend toward digital proceedings. Electronic filings, virtual hearings, and hybrid proceedings are now fully integrated into modern arbitration practice.
The revisions also strengthen confidentiality obligations applicable to arbitrators. While parties remain free to share information when necessary for business, regulatory, or legal purposes, tribunals retain broad authority to issue confidentiality protections tailored to specific disputes.
Lessons for Businesses and Contract Drafters
The new Rules present an opportunity for companies to review existing arbitration clauses. Issues deserving attention include the choice of arbitral institution, seat of arbitration, governing law, number of arbitrators, language provisions, confidentiality requirements, and emergency relief mechanisms.
Sophisticated arbitration clauses frequently determine the efficiency and cost of future dispute resolution long before any dispute arises.
How the ICC Changes Compare to Other Arbitration Forums
Many of the ICC’s revisions mirror developments that have occurred elsewhere. AAA-ICDR has emphasized case management and expedited procedures. JAMS continues to market efficiency and flexibility. FINRA arbitration has adopted procedural mechanisms designed to streamline securities disputes.
The ICC’s revisions demonstrate a global trend toward efficiency while preserving procedural fairness. Businesses should view the changes as part of a broader evolution in international dispute resolution rather than an isolated institutional development.
Our Firm’s Arbitration Practice
Our firm represents businesses, executives, investors, professionals, and institutions in complex domestic and international arbitrations. We regularly advise clients concerning arbitration agreements, dispute avoidance strategies, and proceedings before the ICC, AAA, ICDR, JAMS, FINRA, and other leading arbitral institutions.
Our experience spans commercial disputes, partnership and shareholder conflicts, securities matters, international business transactions, professional services disputes, and cross-border enforcement proceedings. We assist clients from contract drafting through final award enforcement, providing strategic and practical advice designed to achieve business objectives while controlling cost and risk.
As arbitration continues to evolve, sophisticated counsel can make a substantial difference in both outcome and efficiency. Understanding the implications of the 2026 ICC Rules is an important step for any company engaged in international commerce.
Conclusion
The 2026 ICC Arbitration Rules represent a meaningful modernization of international arbitration practice. By eliminating mandatory Terms of Reference, introducing formal early determination procedures, expanding expedited arbitration options, strengthening disclosure requirements, and enhancing emergency relief mechanisms, the ICC has responded to the needs of modern businesses and dispute resolution professionals.
Companies involved in international commerce should review their existing arbitration provisions and evaluate how the new Rules may affect future disputes. Attorneys advising those companies must understand not only the text of the revisions but also the strategic implications they create. The firms and practitioners who master these changes will be best positioned to help clients navigate the increasingly complex world of international arbitration.
Shustak Reynolds & Partners, P.C. focuses its practice on securities and financial services law and complex business disputes. We represent many investment advisors, financial professionals, broker-dealers, registered representatives, investors and businesses. Attorney Erwin J. Shustak can be reached in the firm’s San Diego office at (619) 696-9500.
Artificial intelligence (“AI”) has rapidly become part of everyday life. Millions of people now use AI systems such as ChatGPT, Gemini, Claude, and similar programs to draft emails, summarize documents, answer questions, conduct research, and create written content. Businesses are using AI to improve efficiency, reduce costs, and automate tasks that previously required significant human involvement.
AI is now being used in the legal profession to assist with legal research, document review, contract drafting, discovery, case summaries, deposition preparation, marketing materials, and even the preparation of court filings. Used properly, AI can save substantial time and reduce costs for clients. Used improperly, however, it can create serious risks.
Those risks have become increasingly apparent over the past two years. Courts across the country have sanctioned attorneys who filed legal briefs containing fictitious court cases generated by AI systems. Lawyers have also faced criticism for inputting confidential client information into public AI platforms without understanding how that information might be stored or used. In addition, concerns have emerged about bias, discrimination, and inaccurate information generated by AI tools.
California lawmakers concluded that existing ethical rules governing attorneys needed to be clarified and strengthened to address these new technologies. In response, the California Legislature introduced Senate Bill 574 (“SB 574”), which specifically regulates the use of generative AI by attorneys and arbitrators.
The principal reason for the legislation is simple: AI systems can make serious mistakes.
Unlike traditional legal research databases, generative AI systems do not actually “understand” the law. Instead, they predict and generate language based upon patterns in the data on which they were trained. As a result, AI systems can sometimes produce completely fabricated information while presenting it in a highly convincing manner. This phenomenon is commonly referred to as an AI “hallucination.”
Several widely publicized cases have involved attorneys submitting court filings containing nonexistent court decisions and fake legal citations created by AI programs. In some instances, judges imposed monetary sanctions on the attorneys involved and questioned their professional competence. Legislators and bar regulators became increasingly concerned that lawyers might rely too heavily on AI-generated material without independently verifying its accuracy.
Another Major Concern Involves Confidentiality
Many publicly available AI systems collect and retain information entered by users. Some systems may use that information to further train their models. If an attorney inputs confidential client information into a public AI platform, privileged or sensitive information could potentially be exposed or misused.
The legal profession imposes strict duties of confidentiality upon attorneys. California law already requires lawyers to preserve client confidences “at every peril.” SB 574 was designed to make clear that these duties continue to apply when lawyers use AI technologies.
Lawmakers were also concerned about the possibility that AI systems could generate biased or discriminatory content. AI models are trained using massive amounts of data gathered from the internet and other sources. Because those data sources may contain historical biases or inaccurate assumptions, AI systems can sometimes produce outputs that unfairly disadvantage certain groups or individuals.
In short, California concluded that while AI can be a valuable tool, lawyers must remain fully responsible for the accuracy, fairness, and confidentiality of the work they produce.
SB 574 does not prohibit lawyers from using AI. Instead, the bill establishes rules and safeguards governing how attorneys may use generative AI in the practice of law. The legislation essentially codifies ethical obligations that already exist and applies them specifically to AI-related conduct.
Among its most important provisions are the following:
1. Protection of Confidential Information
The bill would prohibit attorneys from entering confidential, personally identifying, or other nonpublic information into public generative AI systems.
This provision directly addresses concerns about lawyers uploading client documents, medical records, financial information, discovery materials, or litigation strategies into publicly accessible AI platforms. The law recognizes that clients are entitled to expect that their confidential information will remain protected, regardless of whether lawyers use advanced technology tools in their practice.
SB 574 requires attorneys to take reasonable steps to verify the accuracy of AI-generated material and to correct any erroneous or hallucinated content. This means lawyers cannot simply rely on AI-generated research, summaries, or citations without independently checking them.
3. Prevention of Bias and Discrimination
The bill also requires attorneys to ensure that their use of AI does not unlawfully discriminate against protected individuals or groups. This provision reflects broader concerns regarding algorithmic bias and fairness in AI systems. Lawyers cannot use AI tools in ways that produce discriminatory outcomes or perpetuate unlawful bias.
SB 574 further requires attorneys to consider whether disclosure is appropriate when AI is used to create content intended for the public. Although disclosure is not mandated in every circumstance, the bill signals growing concern regarding transparency when AI-generated content is used in professional settings.
One lesser-known aspect of SB 574 is that it also regulates arbitrators.
The bill would prohibit arbitrators from delegating any part of their decision-making responsibilities to generative AI systems. Arbitrators also would be prohibited from relying upon AI-generated information outside the evidentiary record without appropriate disclosure to the parties. This reflects concern that AI should not replace human judgment in dispute resolution proceedings.
The bill primarily affects attorneys practicing in California, law firms, in-house legal departments, arbitrators conducting California proceedings, and clients whose lawyers use AI technologies.
Although SB 574 is a California law, its impact will likely extend far beyond California. Many law firms operate nationally, and legal ethics rules in one large state often influence developments elsewhere.
For clients, SB 574 provides several important protections.
First, it reinforces that lawyers remain fully accountable for the quality and accuracy of their work. Clients should not bear the consequences of an attorney blindly relying on flawed AI-generated information.
Second, the bill strengthens protections for confidential client information. In an era when data privacy concerns continue to grow, this is a significant issue for businesses and individuals alike.
Third, the legislation recognizes that AI can create risks of bias, misinformation, and unfair treatment. By imposing duties upon attorneys to monitor and verify AI-generated material, the bill seeks to reduce those risks.
Finally, the law sends a broader message that AI is a tool and not a substitute for professional judgment.
AI technology will continue evolving rapidly. Its use within the legal profession is almost certain to expand.
Properly used, AI can improve efficiency, reduce costs, speed document review, and assist lawyers in managing increasingly complex information. Many attorneys already use AI tools responsibly and effectively. At the same time, the risks associated with AI are real. Courts, regulators, and legislators are making clear that attorneys cannot avoid responsibility by blaming technology for errors or misconduct.
SB 574 reflects an effort to strike a balance. The legislation does not reject AI or attempt to stop technological innovation. Instead, it establishes guardrails intended to ensure that lawyers continue meeting their professional obligations while using these powerful new tools.
AI may change how legal work is performed, but it does not eliminate the attorney’s duty to protect confidential information, verify accuracy, avoid bias, and exercise independent professional judgment. California’s proposed legislation is designed to ensure that those responsibilities remain firmly in place as AI becomes more integrated into the practice of law.
Shustak Reynolds & Partners, P.C. focuses its practice on securities and financial services law and complex business disputes. We represent many investment advisors, financial professionals, broker-dealers, registered representatives, investors and businesses. Attorney Erwin J. Shustak can be reached in the firm’s San Diego office at (619) 696-9500.
Artificial intelligence is no longer a back-office tool in financial services. It is now embedded directly in how retail investors—particularly self-directed clients—research, evaluate, and execute investment decisions. For broker-dealers, registered investment advisors, and registered representatives, this shift is not merely technological. It is creating a new and evolving layer of regulatory exposure, litigation risk, and supervisory complexity.
Recent industry developments confirm a clear trend: AI tools are moving from passive assistance to autonomous action. What began as tools for summarizing research or generating reports now includes systems capable of interpreting investor instructions, shaping strategies, and in some cases, executing transactions with limited real-time human oversight.
For firms and professionals operating in the financial services space, this evolution raises a fundamental question: when AI materially influences an investment decision, where does responsibility begin—and where does it end? The answer is not settled. But regulators and arbitrators are unlikely to accept the position that responsibility lies solely with the client.
Self-directed investors now have unprecedented access to tools that allow them to act independently. They can construct portfolios, respond to market volatility, and execute complex trades without ever consulting a broker or advisor. While this autonomy reduces friction and cost, it also increases risk, particularly when decisions are influenced by opaque or misunderstood AI outputs.
At the same time, broker-dealers and RIAs remain subject to core regulatory obligations, including know-your-customer requirements, suitability standards, and supervisory duties. These obligations do not disappear simply because an account is self-directed or because technology is involved. If anything, they become more difficult to satisfy.
For registered representatives, the issue is equally acute. Even in a limited role, questions may arise as to whether warning signs were missed, whether client communications were sufficient, or whether activity in an account should have triggered heightened scrutiny. The presence of AI does not reduce these expectations; it complicates them.
One of the most immediate areas of exposure is AI-assisted fraud. Bad actors are increasingly using AI to impersonate voices, generate convincing emails, and manipulate investors into authorizing transactions. These schemes are particularly effective against self-directed investors, who often lack a human intermediary capable of identifying red flags. When losses occur, the dispute inevitably shifts to the firm. Clients may argue that suspicious activity should have been detected; that controls were inadequate; or that the firm failed to protect them. These claims can be difficult to defend, even where the firm had no direct involvement in the fraudulent conduct.
The litigation and arbitration environment further complicates matters. There is limited historical precedent addressing disputes driven by AI-influenced decisions. As a result, outcomes are less predictable, and traditional risk assessments are less reliable. At the same time, claimants tend to be viewed sympathetically, increasing the risk of adverse awards. These dynamics make early dispute resolution a critical consideration. Firms that move quickly to investigate the facts, understand how the transaction occurred, and evaluate potential exposure are better positioned to manage both legal and reputational risk. Early resolution can also provide valuable insight into emerging fraud patterns and operational vulnerabilities.
That said, reactive strategies are not enough. Firms should be reassessing their supervisory frameworks in light of AI-driven activity. This includes evaluating whether (1) existing surveillance systems can detect AI-influenced anomalies, (2) documentation practices adequately capture decision-making processes, and (3) internal policies address the use of AI by both clients and employees.
There is also a growing need for client education. Investors often overestimate the reliability of AI tools and underestimate the risks. Clear communication regarding the limitations of these tools, and the potential for manipulation, can help mitigate exposure.
Importantly, AI should not be viewed solely as a source of risk. It can also be deployed defensively. Firms are increasingly leveraging AI to monitor transactions, identify unusual patterns, and flag potential fraud before it occurs. The firms that succeed will be those that integrate these capabilities into a broader compliance and risk management strategy. Looking ahead, the trajectory is clear. AI will continue to play a larger role in investment decision-making, and self-directed investing will continue to expand. The legal and regulatory framework, however, will evolve more slowly. In the interim, firms and professionals must operate in an environment defined by uncertainty, heightened scrutiny, and increasing dispute risk.
For broker-dealers, RIAs, and registered representatives, this is not a theoretical issue. It is a developing risk that requires immediate attention. Firms that proactively adapt their compliance, supervisory, and dispute resolution strategies will be better positioned to navigate what comes next.
What should Investment Advisors and their Firms do?
If your firm is evaluating how AI-driven investing may impact your regulatory obligations, supervisory practices, or litigation exposure, experienced counsel can make a meaningful difference. Our firm represents broker-dealers, investment advisors, and financial professionals in regulatory matters, arbitrations, and complex disputes. We work closely with clients to assess risk, respond to claims, and implement practical strategies designed to protect both the business and its reputation.
We invite you to contact us to discuss how these developments may affect your organization and how we can assist in addressing the challenges ahead.
Shustak Reynolds & Partners, P.C. focuses its practice on securities and financial services law and complex business disputes. We represent many investment advisors, financial professionals, broker-dealers, registered representatives, investors and businesses. Attorney Erwin J. Shustak can be reached in the firm’s San Diego office at (619) 696-9500.
California is close to putting generative AI obligations for lawyers into a statute. Senate Bill 574 (SB 574), authored by Senator Thomas Umberg, would add explicit duties for attorneys who use generative AI in the practice of law and would restrict certain uses of AI by arbitrators.[1]
SB 574 has already passed the California Senate unanimously (39–0) and is now in the Assembly, where it has been read for the first time and is currently held at desk.
The bill does not try to stop lawyers from using AI. Instead, it makes the lawyer (and, in arbitration, the arbitrator) legally responsible for managing predictable risks such as confidentiality leakage, fabricated citations, and biased or discriminatory outputs.
Why the Legislature Thinks This Is Necessary
Generative AI is already being used for legal research, drafting, summarizing records, and client communications. The efficiency gains are real, but so are the risks. AI can produce confident but false answers, invent citations, and recycle or expose sensitive information depending on how it is used.
California courts have already dealt with AI-driven filing errors. In a published decision, Noland v. Land of the Free, L.P., the Court of Appeal sanctioned counsel after a brief included fabricated quotations and other AI-generated errors, emphasizing that lawyers must personally read and verify what they cite. [2]
Until now, the core guardrails have come from professional responsibility principles and State Bar guidance.[3] SB 574 would move key expectations from “best practice” into “black letter” law.
SB 574 would add Business & Professions Code section 6068.1 and impose four practical obligations on any attorney using generative AI in the practice of law:
1. Keep Confidential and Nonpublic Data Out of Public AI Systems
An attorney would have to ensure that confidential, personally identifying, or other nonpublic information is not entered into a public generative AI system. In plain English: do not paste client facts, documents, or identifiers into consumer tools unless you have clear protections on retention, training, access controls, and confidentiality. Most of the paid subscriptions to ChatGPT, for example, provide a “private” space and promises the input, and output, will not be used outside of that closed environment or to train its AI models. The free versions of ChatGPT, however, do not offer this kind of privacy and client protection environment. With AI, you get what you pay for.
2. Avoid Unlawful Discrimination and Disparate Impact
An attorney would have to ensure the use of AI does not unlawfully discriminate or disparately impact individuals or communities based on protected characteristics. If AI is used to sort, screen, prioritize, or recommend actions, bias risk becomes an express compliance issue.
3. Take Reasonable Steps to Verify Accuracy and Remove Harmful Content
An attorney would have to take reasonable steps to verify accuracy, correct hallucinated or erroneous output, and remove biased, offensive, or harmful content in AI material used. The output is not the end of the job; it is the start of the review.
4.Consider Disclosure When AI-Generated Content Is Provided to the Public
The bill would not mandate disclosure across the board, but it would require lawyers to consider whether disclosure is appropriate when AI is used to create content provided to the public (for example, marketing, public-facing advisories, or other broad communications). Our firm, as an example, updated our standard client retention agreements to specify how and when we use AI and we assure our clients it not only makes our attorneys and staff more productive, but we do not charge for the actual use of AI. We also clearly disclose our AI policy on our website.
The Sharpest Edge: Filings and Citations
SB 574 would also amend Code of Civil Procedure section 128.7 (California’s sanctions statute for improper filings). It would add an explicit requirement: no brief, pleading, motion, or other paper filed in court may contain citations the attorney has not personally read and verified, including citations generated by AI.
This is the provision that will change behavior fastest. It turns what many judges already expect into a statutory bright line: if it is cited to the court, the lawyer is on the hook for it.
AI and Arbitration: No Outsourcing the Decision
SB 574 would add Code of Civil Procedure section 1282.1, regulating arbitrators’ use of generative AI. The theme is straightforward: AI may not become a silent decision-maker.
An arbitrator could not delegate any part of the decision-making process to generative AI, and AI could not replace the arbitrator’s independent analysis of facts, law, and evidence.
If an arbitrator intends to use AI-generated information outside the record, the arbitrator would have to disclose it in advance and, as far as practical, give the parties an opportunity to comment.
If an AI tool cannot cite independently verifiable sources, the arbitrator may not assume those sources exist or that the AI’s characterization is accurate; the arbitrator remains responsible for the award.
If enacted, SB 574 will push firms toward clearer policies and better documentation of AI workflows. Three near-term implications are worth highlighting:
1. Tool Selection Becomes a Professional Responsibility Issue
Lawyers will need to distinguish between public consumer tools and systems with enterprise-grade confidentiality and retention controls. “We didn’t know how the tool handled data” will not be a good answer. Attorneys must know and must ensure client data is not disseminated outside of a secure work area.
2. Verification Becomes a Defined Step in the Work Product Pipeline
Firms should expect to implement checklists and supervision rules, citation pulls, record checks, and required human review before anything goes to a client or court.
3. Litigation Risk Increases When AI Is Used Casually
A single hallucinated authority can now lead more directly to sanctions exposure, reputational damage, and malpractice claims. AI can speed up drafting, but it can also accelerate mistakes.
What Clients Should Ask and Why It Matters
Clients should not need to fear AI, but they should care how it is used. A few direct questions can prevent misunderstandings and reduce risk:
Are you using generative AI on my matter, and if so, for what tasks?
What protections prevent my confidential information from being entered into a public AI system?
What is the human review process before AI-assisted work product is delivered or filed?
How do you handle billing when AI increases speed, especially in hourly matters?
For some matters, clients may also want to address AI use explicitly in engagement letters or outside counsel guidelines, especially around confidentiality, acceptable tools, and retention of matter data.
As of March 24, 2026, SB 574 has cleared the Senate unanimously and has moved to the Assembly. It has been read for the first time in the Assembly and is currently held at desk. Next steps are committee referrals and hearings, followed by an Assembly floor vote. If amended, the bill would typically return to the Senate for concurrence before going to the Governor.
SB 574 would make one point unavoidable: lawyers can use AI, but they cannot outsource judgment. If it passes, California will have a clear statutory framework that forces responsible AI use in the practice of law and gives courts and clients a cleaner yardstick to measure it.
Shustak Reynolds & Partners, P.C. focuses its practice on securities and financial services law and complex business disputes. We represent many investment advisors, financial professionals, broker-dealers, registered representatives, investors and businesses. Attorney Erwin J. Shustak can be reached in the firm’s San Diego office at (619) 696-9500.
On November 17, 2025, the staff of the Securities and Exchange Commission (“SEC”) issued a no-action letter to the Financial Services Institute that meaningfully alters the regulatory landscape governing how registered representatives may receive transaction-based compensation. Previously, there was an absolute ban on broker-dealers paying transaction-based compensation to anyone other than the registered person generating the commissions. For the first time, however, the SEC staff stated it would not recommend enforcement action when a broker-dealer pays transaction-based compensation to an unregistered, pass-through, personal services entity wholly owned by one or more registered representatives, provided a detailed set of conditions is satisfied.
Although the relief is narrow, it addresses a long-standing structural problem for independent registered representatives who wish to operate through an entity (LLC, SubS corporation, partnership, etc.) for tax, administrative, estate-planning, or liability reasons. At the same time, the letter underscores the SEC’s continued insistence on strict supervision, control, and separation between registered and unregistered activities.
Regulatory Background
For decades, SEC staff has viewed the receipt of transaction-based compensation as a hallmark of broker activity. Even if an individual was properly registered and supervised, payment of commissions to an entity—rather than directly to the registered individual—often was treated as evidence the entity itself was acting as a broker. As a result, personal services, pass-through entities owned by registered representatives, were effectively barred from receiving commissions unless they registered as broker-dealers. Many of our registered clients operate with pass-through entities and receive commissions from their broker-dealers personally and deposit those funds into their wholly owned entities. In several instances, however, the IRS has recast those payment transfers with substantial, negative repercussions to the individual registered person.
FINRA Rule 2040 reinforced this position by prohibiting members and associated persons from sharing transaction-based compensation with unregistered persons or entities, including wholly owned entities. Although the rule was intended to prevent payment for unregistered brokerage activity, its practical effect was to prohibit entity-based compensation structures and the favorable tax consequences of having the entity pay various expenses related to the practice, even where no unregistered activity occurred.
The cumulative result was regulatory rigidity, particularly from the SEC and IRS, that ignored the economic reality that the registered representative, rather than the entity, performed the brokerage services, and that the entity was a way to operate the day to day business in an entity format.
Scope of the No-Action Relief
The SEC staff’s letter represents a limited but important shift. The relief permits a broker-dealer to pay transaction-based compensation to a personal services entity without requiring the entity to register as a broker-dealer, provided that several core principles are observed.
1. Ownership and affiliation must be tightly controlled. The personal services entity must be wholly owned by one or more registered representatives, all of whom must be registered with the same broker-dealer making the payments. No outside owners are permitted.
2. Only registered persons may perform brokerage services. Neither the entity itself nor any unregistered employee or contractor of the entity may engage in activities requiring broker registration. Unregistered personnel may perform only ministerial, clerical, or administrative functions.
3. Supervision must remain with the broker-dealer. The broker retains responsibility for supervising the registered representatives and the compensation process. The broker, not the entity, determines the amount and timing of transaction-based compensation.
4. The entity may not hold itself out as a broker. Any public-facing materials must distinguish between the broker-dealer’s regulated activities and any other business conducted by the entity.
Contractual and Operational Requirements
The no-action relief is conditioned on the existence of a detailed written independent contractor servicing agreement. The agreement must reflect numerous obligations, responsibilities, and limitations designed to preserve regulatory oversight.
Among other requirements, the broker must maintain a dedicated bank account for transaction-based compensation paid to registered representatives through personal services entities. This structure facilitates regulatory examinations and reinforces the broker’s control over compensation flows.
The broker must instruct the entity regarding compensation payments, and the entity is expected to distribute compensation promptly in accordance with those instructions. While the entity may retain a portion of the funds to cover overhead and administrative expenses, it may not use transaction-based compensation to reward unregistered personnel or pay bonuses tied to brokerage revenue.
The agreement must also address recordkeeping, audit access, compliance cooperation, and termination rights, ensuring that the broker can enforce compliance with the SEC’s conditions.
Interaction with FINRA Rule 2040
FINRA Rule 2040 remains in effect, but the no-action letter provides a framework under which compliance with the rule is possible. FINRA’s supplementary material expressly allows members to rely on SEC no-action letters when determining whether a payment requires broker registration.
Accordingly, where the conditions of the no-action letter are met, a broker-dealer should be able to conclude that payments to a qualifying personal services entity do not violate Rule 2040. Brokers relying on the relief should still adopt written policies and procedures specifically addressing these arrangements.
What the Letter Does Not Permit
The SEC staff was clear about the limits of the relief. The no-action letter does not permit transaction-based compensation to be paid to unregistered finders, marketers, or consultants who introduce investors or solicit brokerage business. Nor does it permit entities to disguise brokerage activity under alternative labels.
Similarly, the relief does not eliminate the need for careful analysis of hybrid structures in which an entity provides both regulated and unregulated services. In those cases, firms must ensure that compensation is properly allocated and that the entity does not hold itself out as engaging in brokerage activity.
Practical Considerations
For registered representatives, the no-action letter opens the door to entity-based compensation planning that was previously unavailable. At the same time, the operational and compliance burden is significant, and not all firms will be willing to support these arrangements.
For broker-dealers, the relief presents both opportunity and risk. While it may enhance recruiting and retention, it also requires robust supervision, detailed agreements, and ongoing monitoring. Firms should expect regulators to scrutinize these structures closely.
Conclusion
The SEC staff’s no-action letter provides long-awaited but tightly circumscribed relief for paying transaction-based compensation through personal services entities owned by registered representatives. It reflects a pragmatic recognition of modern business realities while reaffirming the central role of broker-dealer supervision and investor protection.
Firms considering reliance on the letter should proceed deliberately, with careful attention to documentation, supervision, and compliance. The relief is useful, but only for those prepared to follow its conditions precisely.
If you are considering recasting future commission payments from individual, registered representatives to their wholly owned, personal services entities, contact us to discuss.
Shustak Reynolds & Partners, P.C. focuses its practice on securities and financial services law and complex business disputes. We represent many investment advisors, financial professionals, broker-dealers, registered representatives, investors and businesses. Attorney Erwin J. Shustak can be reached in the firm’s San Diego office at (619) 696-9500.
Managing Partner, Erwin J. Shustak, recently sat down with Chad Franzen of the Rise25.com Podcast to discuss how Erwin decided, at a young age, he wanted to be a lawyer and the path that brought him to his legal career that has spanned four decades.
Watch the podcast by clicking on the logo image below.
Shustak Reynolds & Partners, P.C. focuses its practice on securities and financial services law and complex business disputes. We represent many investment advisors, financial professionals, broker-dealers, registered representatives, investors and businesses. Attorney Erwin J. Shustak can be reached in the firm’s San Diego office at (619) 696-9500.
Our firm was one of the principal sponsors of IR Global’s 2022 Annual Conference held in the exciting city of Barcelona last month. Partners Erwin Shustak and Paul Reynolds attended the conference, along with 350 other IR Global members from around the world. The theme of this year’s conference was “Shaping the Future” and speakers and discussion focused on how the pandemic has changed work habits, offices, global business, and impacted other aspects of our professional and business lives.
Erwin and Paul joined the Disputes Committee on a tour of the Barcelona Bar Association Library and building which dates to 1830, as well as the Barcelona Arbitration Center. Spain is just entering the age of mediation and arbitration and its nascent arbitration/mediation programs are necessary to avoid the more than seven years it takes for a normal, civil case to wind its way through the Spanish legal system.
IR Global is a multi-disciplinary professional services network that provides legal, accountancy, and financial advice to companies and individuals around the world. Through our long-standing ties with IR Global, we are able to offer our clients access to top quality legal and other professional advice in over 155 jurisdictions around the world in more than 60 practice categories. Our firm was one of the first U.S. members of the organization and is the exclusive IR Global member in California for Commercial Litigation and Arbitration. Partner Erwin Shustak has been an active member of the Disputes Committee for over 10 years. For more information, visit IRGlobal.com.
On Wednesday July 7th, the White House announced President Biden intends to issue a Presidential Executive Order limiting the use of non-compete agreements in employment situations. While this anticipated Order will impact a broad swath of industries, it may have potentially have significant consequences for the financial services/brokerage industry.
As of now, the exact wording and scope of the Order is unknown, and it is unclear if the Order also will limit or eliminate non-solicitation clauses. Elimination of both, or either, may change the landscape of broker transitions in the same way the Broker Protocol reshaped the transition landscape when first adopted over 15 years ago.
President Biden’s Executive Order would direct the Federal Trade Commission to create and promulgate rules intended to “help to curtail” non-compete agreements, according to White House Press Secretary Jan Psaki. Psaki said, “Roughly half of private sector businesses require at least some employees to enter non-compete agreements, affecting over 30 million people. This affects construction workers, hotel workers, many blue-collar jobs, not just high-level executives.” Psaki said President Biden “believes that if someone offers you a better job you should be able to take it.”
Brokerage and financial services firms relied more heavily on non-compete clauses before the 2004 Protocol for Broker Recruiting, first signed by only a handful of the largest brokerage firms, to which now more than 1,500 firms of all sizes and types are signatories. The Protocol was a real game-changer, allowing brokers to leave one firm and join another taking their clients and certain client information to the new firm without fear of the usual aggressive litigation and threat of a dreaded Temporary Restraining Order by the firm they were departing.
Since the Protocol was adopted, many brokerage firms have withdrawn from it, including several of the early signers, who have created alternative protections intended to discourage defectors from taking clients, client information and soliciting those clients to change firms. For example, Morgan Stanley withdrew in 2017 and, the day it withdrew, insisted its brokers sign new, non-solicitation agreements. Both UBS and Citigroup withdrew in 2018. As alternatives to the Protocol, non-Protocol firms have instituted various devices to keep their brokers and client information hostage, including deferred compensation packages which brokers forfeit if they leave their firm, and non-solicitation clauses justified by firms as intended to protect clients’ privacy.
Several states have adopted their own restrictions on non-compete and non-solicitation agreements. For example, in May, the Illinois Senate and House of Representatives passed an amendment that changed the standards required to enter into and enforce employee non-compete agreements by imposing an annualized earnings requirement and by outlining restrictions and requirements that apply to non-solicit agreements.
We will continue updating once the formal announcement is made and the FTC promulgates its actual rules and applicability. As they say, the “devil is in the details.”
Shustak Reynolds & Partners, P.C. focuses its practice on securities and financial services law and complex business disputes. We represent many broker-dealers, registered representatives, investment advisors, investors and businesses. Attorney Erwin J. Shustak can be reached in the firm’s San Diego office at (619) 696-9500.
Our partner, Erwin Shustak, was one of three panelists on a national webinar presented by Stafford Publications on the topic of Non-Retained Experts: Leveraging the Opinions of Specialized Eye-Witnesses and Participants. Erwin focused on privilege issues regarding non-retained witnesses in state and federal courts and the “Sword and Shield” doctrine as it applies to testimony by otherwise privileged communications and documents.
Shustak Reynolds & Partners, P.C. focuses its practice on securities and financial services law and complex business disputes. We represent many broker-dealers, registered representatives, investment advisors, investors and businesses. Attorney Erwin J. Shustak can be reached in the firm’s San Diego office at (619) 696-9500.
