The Financial Industry Regulatory Authority’s (“FINRA”) Enforcement Division brought 108 enforcement actions and levied fines against member firms that totaled $57,981,625 in 2019. These numbers mark a significant decrease in the enforcement actions and total fines from 2018, as the tables below show.
The largest individual fines in 2019 stemmed from disciplinary actions involving alleged failures related to anti-money laundering (“AML”) practices, initial public offerings (“IPOs”), prospectus delivery procedures, Regulation SHO (“Reg SHO”), and background checks.
According to FINRA’s disciplinary announcements, 15 broker-dealers paid restitution totaling $6,583,069 for alleged violations such as excessive trading, sales charge discounts, and unfair pricing. In addition, FINRA expelled three broker-dealers for alleged violations involving unregistered securities, the statutory disqualification of associated persons, and fraud. The details regarding some of the largest fines brought against broker-dealers in 2019 appear below. A table breaking down the primary causes of FINRA’s 2019 fines and their total number and dollar amounts is provided on pages 6 and 7.
|Q1 2018||Q2 2018||Q3 2018||Q4 2018||Total 2018|
|# of Fines||86||44||40||39||209|
|Q1 2019||Q2 2019||Q3 2019||Q4 2019||Total 2019|
|# of Fines||24||24||32||28||108|
Section 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”) makes it unlawful for any person to “use or employ, in connection with the purchase or sale of any security” any “manipulative device or contrivance in contravention of such rules and regulations as the [SEC] may prescribe.”1 Furthermore, Exchange Act Rules 10b-5(a) and (c) render it unlawful for any person directly or indirectly to “employ any device, scheme, or artifice to defraud” or “to engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security”2
On May 28, 2019, FINRA’s Office of Hearing Officers (“OHO”) issued a default decision against a former member firm for allegedly violating Section 10b and Rule 10b-5 thereunder of the Exchange Act. The decision stated that the firm employed a nonregistered associated person in an operations role. That person allegedly engaged, for his own personal benefit, in a fraudulent stock allocation scheme whereby he placed undesignated trades in the firm’s average price, riskless principal, and bond inventory accounts. The employee also monitored the performance of the securities in these accounts allocating profitable trades to his account or favored employees’ accounts while leaving unprofitable trades in the original accounts or allocating them to the firm’s customers.
In addition to the above alleged violations, FINRA found that the firm failed to maintain and enforce an adequate supervisory system. The firm’s written supervisory procedures (“WSPs”) did not include how the firm would supervise trading in employee-related accounts, markup and markdown charges and disclosures, bond inventory account trading, principal and riskless principal trade pricing, proprietary trading, or the disclosure of accurate information in confirmations.
The respondent firm in this case was also held liable for the alleged actions of the nonregistered associated person. Under FINRA’s rules, a member firm may be held accountable for the misconduct of its associated persons and the final responsibility for proper supervision rests with the member.
As a result of the firm’s alleged violations, OHO expelled it from FINRA, fined it $1,000,000, and ordered it to disgorge ill-gotten gains and pay restitution. OHO also barred the nonregistered associated person from associating with any FINRA member and to disgorge ill-gotten gains.
Fingerprinting and Background Checks
Section 3(a)(39) of the Exchange Act prohibits a person from participating in or associating with a member of a self-regulatory organization if such member is deemed to be statutorily disqualified as defined in the section. Specifically, Section 3(a)(39) considers certain criminal and regulatory events to be statutorily disqualifying. In addition, Article III, Section 4 of the FINRA By-Laws notes that persons are subject to disqualification with respect to their FINRA membership or association with a FINRA member if they are subject to any “statutory disqualification” as defined in Section 3(a)(39). Therefore, member firms have a duty to determine whether an individual seeking to become associated with them falls under this definition. To do so, member firms are “responsible for obtaining a prospective employee’s fingerprints and certain required identifying information” as noted in FINRA’s Notice to Members 05-39.
On July 29, 2019, FINRA issued a Letter of Acceptance, Waiver, and Consent (“AWC”) alleged that a member firm failed to conduct timely and adequate background checks, failed to fingerprint its associated persons, and, as a result, hired at least three individuals who were subject to a statutorily disqualifying event. FINRA also alleges that these violations stemmed from the firm’s failure to maintain a reasonably designed supervisory system or procedures to identify and properly screen all individuals who became associated with it. In addition to other sanctions, FINRA censured the firm and fined it $1,250,000.
As noted, firms must establish procedures to determine whether a prospective associated person is “statutorily disqualified” as defined in Exchange Act Sections 3(a)(39) and 19(b)(4). Such procedures may include, but are not to be limited to, obtaining fingerprints from prospective employees and conducting timely, comprehensive background investigations as required by FINRA rules and regulations.
FINRA Rule 3310 requires firms to develop and maintain a written anti-money laundering ("AML") compliance program that includes adopting policies, procedures, and internal controls reasonably designed to achieve compliance with the Bank Secrecy Act (“BSA”) and its implementing regulations.
Under Rule 3310(a), a firm’s AML program must, at a minimum, establish and implement policies and procedures that can be reasonably expected to detect and cause the reporting of the suspicious transactions required under 31 U.S.C. § 5318(g). If a broker-dealer detects red flags, it should perform additional due diligence before proceeding with the underlying transaction.
On June 11, 2019, FINRA issued an AWC in which it alleges that the subject firm failed to implement a reasonable AML program. The firm’s written AML procedures required it to monitor account activity for unusual size, volume, and patterns or types of transactions. The procedures listed dozens of red flags and risk factors to be considered. In addition, the firm’s written AML procedures required it to determine whether and how to investigate and otherwise follow up on potentially suspicious activity. Such follow-up could include gathering additional information, freezing an account, or filing a suspicious activity report with the Financial Crimes Enforcement Network.
In its AWC, FINRA alleges that the firm did not implement those measures. Further, the firm had delegated its monitoring of suspicious activities to an unregistered person: its outside counsel. In addition, even when the Firm’s outside counsel identified numerous signs of potential suspicious activity, the firm did not conduct follow-up investigations.
Given these circumstances, FINRA fined the firm $250,000 and ordered restitution and a suspension of certain activities until the firm satisfies two conditions. First, it must implement measures to remedy the alleged AML violations noted in the AWC. Second, the firm’s chief compliance officer must certify in writing to FINRA that the firm has implemented an AML compliance program reasonably designed to detect and cause the reporting of suspicious activity.
Under the Exchange Act, Reg SHO regulates short sales. Rule 200(a) of the regulation defines a short sale as any sale of a security that the seller does not own that is completed by the delivery of the security borrowed by or for the account of the seller. This regulation imposes the requirement that broker-dealers locate a source of borrowable shares before selling short. In addition, Firms that clear and settle trades must purchase shares to close out these “fails-to-deliver” within 13 days. Furthermore, Rules 204(a) and Rule 204(b) of Reg SHO restrict short selling in securities when the close-out requirement is not satisfied unless the broker-dealer borrows or arranges to borrow the security.
On March 5, 2019, FINRA issued an AWC in which it alleged that a firm failed to establish, maintain, and enforce a supervisory system, including WSPs, that was reasonable designed to achieve compliance with Reg SHO’s Rule 204 requirements. The firm was allegedly using a manual system to identify its obligations under Rule 204(a). Over a period of four years, the firm had increased its trading activity to 79 billion shares. FINRA determined that, considering such activity, the firm’s supervisory system “was not acceptable.” Furthermore, FINRA noted that, even when the firm’s compliance personnel identified and reported red flags, the firm did not change its supervisory system to reflect its trading activity.
In addition, the firm’s WSPs allegedly failed to address the provisions of Rule 204(b) related to a penalty box and providing notice under the Rule 204(c) requirement.
In FINRA’s judgment, the firm allegedly violated Reg SHO Rules 204(a), (b), and (c), NASD Rules 3010(a) and (b), and FINRA Rules 3110(a) and (b). The sanctions it laid out in its AWC included a $2 million fine, censure, and the imposition of other requirements related to the firm’s policies, systems, and procedures.
How ACA Can Help
ACA’s Broker-Dealer Services Division helps firms comply with regulatory requirements. Our services include compliance program development, trading reviews, conflict management analyses, corrective action assessments, supervisory control and AML testing, WSPs assistance, initial and ongoing membership application help, and customized regulatory and compliance consulting.
Please contact Dee Stafford at firstname.lastname@example.org for more information about ACA's services for broker-dealers.