A review of reported disciplinary actions for January and
February 2017, finds several interesting cases worth mentioning, as well as
what might be a trend in terms of increased enforcement activity for certain
violation types in cases against registered representatives. Read on for some highlights from the monthly
notices of disciplinary actions.
Cases Against Firms
A few cases against firms are worth a brief discussion.
1. In January 2017, FINRA reported accepting an AWC from a broker-dealer firm pursuant to which the firm was censured, fined $140,000 and required to pay $78,910 in restitution to a customer. In settling the case, the firm did not admit or deny the findings, but FINRA reported that (for case number 2015047008701):
“for more than four years, [the firm] did not adequately supervise a representative who initiated hundreds of trades for two elderly customers without contacting them, and unsuitably recommended dozens of transactions to those customers. The findings stated that the firm assigned the primary responsibility for supervising the representative’s trading activity to a supervisor who was also responsible for supervising numerous other representatives and handling his own customers’ accounts. The supervisor’s supervision of the representative was not subject to adequate oversight or specific direction from the firm. Instead, the firm relied on the supervisor’s discretion and judgment, which he did not exercise appropriately.
The findings also stated that the firm did not have supervisory resources that were reasonably designed to detect the representative’s misconduct. While the supervisor received daily trade blotters and certain monthly exception reports, the firm did not provide exception reports addressing short-term trading or margin usage to the supervisor. Additionally, the firm’s exception reports addressing trading by elderly customers excluded accounts in the name of a trust, regardless of the age of the settlor or trustee, meaning that the representative’s trading activity in two of the accounts at issue did not appear on those exception reports. The findings also included that the firm failed to respond appropriately to warning signs about the representative’s business, such as a dramatic increase in his commissions without a commensurate change in the number of accounts that he handled or the type of products that he sold. The firm’s system of supervision was not reasonably designed under the circumstances to prevent violations of securities laws and rules, including rules governing trading without customers’ approval and unsuitable recommendations.”
Here, we see FINRA asserting that the firm should have noticed, and responded to, a big swing in the broker’s commissions, without a meaningful change in his book of business in addition to the firm not providing what they call “adequate oversight or specific direction” to the supervisor involved, and also implies that the supervisor may have had too many brokers to supervise, in addition to running his own book of business. This case presents a lot of issues, and it may be that the sanctions, and regulatory emphasis, were possibly heightened due to the elderly nature of the involved customers. Protecting senior investors has been a regulatory priority for years, and continues to be a priority for 2017.
2. In another case reported in January (see case number 2015046056405), FINRA accepted an AWC from a broker-dealer pursuant to which the firm was censured, fined $150,000, and ordered to disgorge commissions of $190,000, plus interest.
As with all AWCs, the firm neither admitted nor denied the findings. Here, FINRA found that the firm:
“[The firm] engaged in two separate private placements that were rife with supervisory and substantive violations, including inadequate due diligence, failure to have a reasonable basis to recommend the private placements to customers, investor offering documents that contained misleading and unwarranted statements, omissions of material information and made material misrepresentations, failure to supervise one of the offerings as a private securities transaction, failure to file offering documents for one of the offerings, and failure to supervise one offering to ensure compliance with the accredited investor requirements of Section 5 of the Securities Act of 1933 (Securities Act). The findings stated that the firm failed to follow its WSPs relating to due diligence requirements for private placements. In addition to supervisory deficiencies, the inadequate due diligence caused the firm to lack a reasonable basis to recommend one of the offerings to customers. The firm distributed offering documents to investors which negligently made untrue statements of material facts or omitted to state material facts necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, and made statements which were not fair and balanced, and were misleading, exaggerated and unwarranted. The firm acted in contravention of Section 17(a) (2) of the Securities Act. The firm failed to establish, maintain and enforce a supervisory system or written procedures to ensure compliance with the Rule 506 of Regulation D safe harbor for private offerings, and failed to enforce its related WSPs. The findings also stated that the firm, through its chief compliance officer (CCO), approved the firm president’s request to participate in an offering as an outside business activity, despite the obvious indications that his participation in the offering constituted outside securities activities for compensation subject to NASD Rule 3040. The firm failed to adhere to the requirements of its WSPs that outside business activity requests be evaluated to determine whether the activity should more properly be considered outside securities activity, and also failed to adhere to its procedures applicable to private securities transactions. In addition, these transactions were not in the firm’s books, and records and the firm did not supervise the activity. The findings also included that with respect to one of the offerings, the firm failed to submit a copy of the offering document, or notify FINRA that no offering documents were used. FINRA found that the firm conducted a securities business while failing to maintain required minimum net capital, prepared inaccurate net capital computations, and general ledgers and trial balances, and prepared and filed inaccurate FOCUS reports.” (emphasis added)
FINRA found a host of issues here, but what stands out to me is the allegation that the firm failed to conduct sufficient due diligence on this private offering before recommending it to clients. Remember that, with respect to suitability determinations, there must first be a determination that the product is suitable for some investor, and then a determination that the product is suitable for the specific investor to whom it is being recommended. It appears that FINRA makes finding in this case that the investment was not suitable for anyone, or at least that there was not sufficient due diligence done to make that decision. Private offerings can be quite risky, and inadequate due diligence can result in a host of problems, including regulatory actions like this, as well as possible civil liability as well.
3. One more case against a firm was worthy of mention, I think. In FINRA case number 2013035036601, FINRA accepted an AWC from a broker-dealer under which the firm “was censured, fined $650,000 and required to, within 210 days of the issuance of the AWC, certify to FINRA in writing that the firm has completed a review of its WSPs and systems concerning the reasonable safeguarding of confidential customer data and implemented necessary revisions to such procedures and systems that are reasonably designed to achieve compliance with Rule 30 of Regulation S-P of the Exchange Act.”
In this AWC, FINRA found that the firm failed to have in place a good supervisory system, including WSPs, “reasonably designed to ensure the security of confidential customer
information and records stored on electronic systems at the firm’s branch offices.” The AEC explained that “[the firm] failed to ensure that the third-party vendor the firm’s office of supervisory jurisdiction (OSJ) retained to configure the cloud server being used to store records properly installed antivirus software or data encryption for the stored documents. Subsequently, hackers with foreign Internet protocol addresses were able to access the cloud server, exposing the confidential records and information of approximately 5,400 customers. The firm reported the breach to FINRA and notified in writing the individuals who could have been affected and offered credit monitoring, without charge, for one year.” There are some other issues in this AWC, and it is a good read for firms to review, and then consider their own WSPs and supervisory systems with respect to safeguarding confidential information and the use of cloud based storage. Data protection is an area of concern, and I expect we may see additional cases like this, and also look for regulators to evaluate the manner in which firms store data and how they work to ensure its safety.
4. Finally, we see, in February 2017, three relatively large disciplinary cases against firms involving AML (anti-money laundering) violations. AML issues have been a concern of regulators for some time now, and will continue to be for the foreseeable future. Firms should ensure that they have appropriate systems and procedures in place, that they follow those, and that they follow up on red flags presented in the context of AML issues.
Cases Against Individuals
Turning now to cases against individual registered representatives, three cases stood out to me for various reasons.
1. In FINRA case #2015048357001 a broker submitted an AWC in which she was fined $7,500 and suspended in all capacities for 60 days. In this case, FINRA found that the broker, “used the text-messaging function of a non-firm- issued smartphone to exchange business related
messages with a customer. The findings stated that these messages included, among other things, recommendations of securities and discussions of the customer’s account performance at the firm. [The broker] also provided the customer with her personal email address and instructed the customer to use that email address in connection with a business-prospecting project that the customer was completing as [the broker’s] intern.” FINRA stated that the firm’s policies prohibited this type of use of personal devices and non-archived and monitored communications, and also found that some of the communications were also problematic. Using non-firm approved systems and devices to communicate about business runs afoul of most every firm’s WSPs and can lead to meaningful sanctions, as we see here.
2. In FINRA Case #2016050531801, a broker submitted an AWC to FINRA, pursuant to which the broker was barred from the industry. FINRA found that the broker, “accessed another registered representative’s credit card account and, without his authorization, converted credit card awards points earned on the registered representative’s business account for [the broker’s] own use by using those awards points to purchase goods worth $4,763 for [the broker].” Don’t do this. Plain and simple.
3. In FINRA case #2014043863301, a broker submitted an AWC in which he was barred. FINRA made findings that the broker, “converted $2,605 of his member firm’s funds by submitting false expense reports and accepting reimbursements from his firm for the ineligible expenses.” FINRA explains that the broker falsely represented that he and customers and prospects attended football games and sought reimbursement for the costs of those tickets. Problem is, it turns out, the broker did not go to the games but sold the tickets to third parties, leading FINRA to find that he submitted false expense reports, which in turn resulted in his firm maintaining books and records that were not accurate. The lesson here is to not do this stuff. Keep your expense reports on the up and up to avoid problems.
Taking a reasonably quick look at the monthly actions reported against individual representatives for January and February 2017, we see a smattering of the typical violation types, such as selling away, outside business activities, improper borrowing from/lending to customers, conversion of funds, Rule 8210 violations, and other violations.
We also see a fair number of cases involving Form U4 violations – with omissions of material information such as liens, judgments, personal bankruptcies, criminal histories, etc. My rough math shows that about 14.8% of the cases against individual reps. in January (approx. 8 out of 54 cases) involved U4 violations, as did about 9% of the cases in February (approx. 6 out of 66 cases). More important, however, is that of these combined 14 cases, 11 of them involved FINRA making findings that the omissions on the Form U4 were willful, which then resulted in the disciplined broker being subject to a statutory disqualification. (What is a statutory disqualification – learn here). I believe that most brokers do not recognize the significance of the Form U4 and do not understand that a violation with respect to it can make them ineligible to be associated with a broker-dealer. U4 violations have been a steady source of enforcement cases for FINRA, and I don’t expect to see that changing in the future. But, these numbers show that FINRA’s preference seems to be to charge and settle these cases as willful violations, resulting in very significant consequences for the broker.
In January and February, we also see a fair number of cases, perhaps unusually high, charging brokers with improper use of discretion. About 7.4% of the cases in January and 15% of the cases in February involved violations of use of discretion, typically resulting in a fine and a suspension. Improper use of discretion cases are often situations where the broker is trying to provide too much service to the client – not being able to reach the client to confirm a trade, but knowing that the client wants to do the trade, or knowing that the client does not want to be bothered with a phone call prior to each trade, etc. resulting in the broker executing the trades based upon some implied discretionary authority, but without getting the authority in writing from the customer and having the firm approve the account as discretionary. Brokers should be careful not to try to provide too much service to clients, such that it violates the rules, and hits their wallet and their CRD record with an enforcement action. We’ll watch to see if we continue to see an upswing in cases involving discretion.