In the second quarter of 2015, the Financial Industry Regulatory Authority (“FINRA”) took 91 disciplinary actions1 against registered broker-dealers and levied more than $20 million in fines for violations of securities laws. As the table illustrates, the total number of second-quarter fines increased, but the total amount in dollars decreased slightly from the same period a year ago.
The violations accounting for the largest shares of total fines related to Supervision (49%), Short-Interest Reporting (10.7%), Suitability (5%), Anti-Money Laundering (“AML”) (4.3%), and Options Trading (4.1%). Details on the largest fines imposed for the top five categories are outlined below.
FINRA took disciplinary action against a member firm for failure to supervise that resulted in a fine of $10 million. The firm allegedly failed to supervise sales of various complex products to its retail customers during a period covering multiple years. Regulatory Notice 12-03 states that any product with multiple features that affect its investment returns differently under various scenarios is considered to be potentially complex.2 Firms that offer complex products to customers are required to maintain heightened supervisory procedures over such products. In this case, the products that were involved included: exchange-traded funds (“ETFs”), variable annuities, and non-traded ETFs that were allegedly sold to the firm’s customers without adequate supervision of either the sales or the account activity. Additionally, the firm allegedly failed to have a system in place to monitor the length of time customers held ETFs in their accounts, and the firm also did not enforce the limits on the concentration of these securities in the customers’ portfolios. Furthermore, the firm allegedly appeared to not have provided its representatives with adequate training on the complex products that it offered. The firm was also alleged to have been using an automated system that excluded mutual fund “switch” transactions in its variable annuities accounts, thus allowing potentially unsuitable recommendations to be made without supervisory approval. The supervision of the sales of complex products is a top priority of FINRA in 2015 and each of the three products mentioned in this section were included on FINRA’s exam priorities list.3 Firms should confirm that they train their registered representatives on complex products. They also must ensure that their representatives obtain the customer’s financial profile to make a determination if a different product may be a better fit. Finally, firms should conduct periodic reviews to ensure that the accounts invested in complex products are efficiently monitored for the customer’s stated risk tolerance.
A member firm was fined $2 million during the second quarter of 2015 for alleged short-interest reporting violations. FINRA Rule 4560 requires all member firms to maintain a record of total “short” positions in all customer and proprietary firm accounts in all equity securities. These positions must be included in a report that and must be submitted electronically to FINRA on a bi-weekly basis. The firm allegedly failed, over several years, to effectively and accurately report its short positions to FINRA. Firms can prevent the occurrence of violations in short-interest reporting by having an efficient system in place that calculates the total amount of reportable short positions held at the firm. Firms should also conduct periodic reviews of their systems to ensure that all gross positions for existing customers are included in the calculation. The person responsible for filing reports with FINRA should also maintain evidence that a final review was conducted prior to FINRA submission.
FINRA fined a broker-dealer $1 million for its alleged involvement in improper sales of structured investment products to its customers. These structured products, or notes, featured a high-yielding interest rate that was tied to the performance of another asset class, such as stocks. The investment products were deemed by FINRA to be complex products and were only suitable for investors with a higher tolerance for investment risk. For several years, the firm allegedly failed to detect that 99 of its registered representatives sold over 300 structured products to over 200 customers. These customers maintained conservative investment objectives. Additionally, these customers lost over $1.1 million from investment in the structured products. Furthermore, the firm was also cited for allegedly failing to follow its own suitability guidelines during the time that these transactions took place. Firms should ensure that all investments that are recommended by registered persons are subject to a principal suitability review. Firms should also confirm that its associated persons receive written acknowledgement that the customer understands the terms of the complex products and that the investment matches the customer’s risk profile. Finally, firms should maintain records of their suitability reviews for all investments sold by the broker-dealer.
There were six regulatory actions imposed on member firms during the second quarter of 2015 for AML violations. These disciplinary actions resulted in fines totaling $900,000. One member was fined $225,000 for allegedly failing to implement a reasonably designed AML program to detect, investigate, and report suspicious activities. FINRA’s findings state that the firm’s written supervisory procedures provided specific examples of suspicious activity to which the firm was exposed. However, the firm allegedly could not provide evidence of how it monitored various trades involving low-priced securities. Additionally, the firm allegedly did not have a surveillance system in place and instead relied on its clearing firm to inform the firm of any red flags. Furthermore, it was brought to FINRA’s attention that the firm’s 2011 independent audit of the AML program was allegedly deficient. The individuals conducting the audit did not take steps to review for deficiencies in the firm’s process for suspicious activity monitoring. Firms’ anti-money laundering compliance officers and senior management should ensure that all transactions that take place at the firm are monitored. Firms that rely on another institution for certain AML tasks should have a written agreement in place outlining each institution’s responsibilities. The agreement should be signed and reviewed annually by senior management. Senior management should ensure that the audit of the firm’s AML program includes a review of transactions for each of the firm’s business lines. The firm conducting the audit should identify the transactions that were tested and reviewed. The broker-dealer should ensure that the auditor’s findings are addressed at a meeting with members of senior management subsequent to the AML review.
A member firm was issued a disciplinary action for alleged violations relating to its options trading business, and was fined $650,000 by FINRA. The firm allegedly failed to timely and accurately report positions to the Securities Industry Automation Corporation (SIAC), a market data information distributor and communication network of the exchanges. FINRA Rule 2360(b)(5) requires members that conduct trading in options to report to FINRA accounts with aggregate positions of 200 or more option contracts on the same side of the market covering the same underlying security. The firm allegedly failed to properly identify and aggregate the positions of all of its options accounts. Also, the firm’s written supervisory procedures allegedly did not contain policies for reviewing submissions or ensuring that reportable positions were actually reported to the SIAC by the firm. Firms should designate an appropriately registered person to be responsible for reviewing the positions of the options accounts held at the firm. The review should indicate whether or not the aggregate limit was reached and should be documented and kept as part of the firm’s books and records. Furthermore, firms should designate individuals that will be responsible for filing reports on behalf of the firm.
Other Significant Trends
During the second quarter of 2015, several member firms were fined for alleged violations involving the sale of private placements. One member was fined $15,000 by FINRA for such violations. The firm allegedly failed to properly deposit investor funds into an escrow account while acting as a placement agent on a contingent private offering of securities. According to FINRA, the offering memorandum stated that all investor funds would be placed in an escrow account until the minimum offering amount was reached. Instead, the firm placed the funds into the company’s bank account and then allegedly transferred the funds to a separate account that was neither under the firm’s control, nor used exclusively for holding investor funds. Additionally, the offering allegedly did not raise enough funds to meet the minimum contingency offering requirement. The issuer decided to lower the minimum contingency offering amount. However, the firm allegedly failed to return the investor funds as required by Section 10(b) of the Securities Act of 1933.
FINRA also fined a member for allegedly effecting a material change in its business operation without undergoing a Continuing Membership Agreement (“CMA”) with FINRA, as required by NASD Rule 1017. There are a number of changes that may require a firm to file a CMA, including: making substantive changes to the firm’s business operations; making asset transfers; and changing control or ownership, including mergers or acquisitions involving the firm. FINRA requires all firms looking to expand the scope and size of their businesses to seek a materiality consultation if they are unsure if the resulting change qualifies as material in nature. The member firm was fined $10,000 for allegedly acting on a principal basis for trades with its customers. The firm’s membership agreement allegedly did not allow the member to act in a principal capacity, and the firm allegedly did not disclose its correct capacity on the customer trade confirmations.
ACA notes the following key securities laws and FINRA rules that were referenced in actions during the second quarter of 2015:
- FINRA Rule 3120 (Supervisory Controls System)
- FINRA Rule 4560 (Short-Interest Reporting)
- FINRA Rule 2111 (Suitability)
- FINRA Rule 3310 (Anti-Money Laundering)
- FINRA Rule 2360 (Options)
- NASD Rule 1017 (CMA)
- Section 10(b) of the Securities Act of 1933
Please contact Dee Stafford at (310) 322-8840 for information on how ACA provides initial and ongoing assistance to help firms consistently meet these and other compliance requirements
1See “Disciplinary and Other FINRA Actions” for April 2015, May 2015, and June 2015
2 See Regulatory Notice 12-03
3 See “2015 FINRA Regulatory and Examination Priorities Letter”