FINRA Regulatory Actions July - September 2015

November 11, 2015


The Financial Industry Regulatory Authority’s (“FINRA”) enforcement division brought more disciplinary actions against registered broker-dealers in the third quarter of 2015 than the same period one year ago.1 As the tables illustrate, the total number of third-quarter fines increased, while the total dollar amount nearly doubled. Registered members have also experienced stricter penalties for violations of securities laws and regulations. The total dollar amount of fines imposed on broker-dealers through nine months of business has been on the rise since 2013.

FINRA reported nine fines of $500,000 or more during the third quarter, totaling $9 million. There were five causes of disciplinary action that alone accounted for nearly 67% of the total dollar amount for the quarter (over $10 million). The top five categories in terms of fines were Trade Reporting (32%), Financials (13%), Employee Supervision (9%), Collateralized Mortgage Obligations (6.5%), and Prospectus Delivery (6%). Similar to the third quarter of 2014, trade reporting violations occurred most frequently (44 actions). Details on the largest fines imposed for the top five categories are outlined below.

Q3 fines graph

Trade Reporting

During the quarter, a member firm was fined $1.8 million for systemic failures which affected the accuracy of its reporting to FINRA regarding billions of trades. The firm allegedly committed multiple order audit trail system (OATS) reporting violations by failing to transmit over 15 billion trades from its platform. In addition, the member transmitted over 42 billion incomplete reports to OATS over the course of eight years.

The firm did not have adequate controls in place to detect and prevent OATS reporting errors. According to FINRA, the firm failed to report the order event timestamps to OATS in milliseconds, causing the violation. FINRA Rule 7440(a)(2) states that each required record of the time of an event shall be expressed in terms of hours, minutes, seconds, and milliseconds if the member’s system captures time in milliseconds.2

Firms that are subject to OATS reporting should review their trading systems to ensure that they are not subject to FINRA Rule 7440(a)(2). More importantly, the firm should have a designated OATS principal responsible for comparing OATS reports with its trading reports to check for any issues or outliers.


There was one disciplinary action on a broker-dealer during the third quarter for deficiencies in the firm’s net capital levels and for related supervisory failures. FINRA fined the member $2 million despite the fact that the firm self-reported the event through its CRD account. On three separate occasions, the member firm allegedly did not comply with Securities and Exchange Act Rule 15c3-1(a), which requires broker-dealers to maintain minimum levels of capital at all times.3

In each instance, the firm received unusually high levels of cash from customers late in the day. The firm was unable to invest all of the funds with its approved investment counterparties. The violation occurred when the firm transferred $1 billion to its parent company in the form of an unsecured loan for the parent to invest overnight. The next morning the parent repaid the loan back to the firm, but still left the member with a net capital deficiency. The main cause for this violation was that the member’s Capital Markets Group and Treasury Group failed to consult with the firm’s Regulatory Reporting Group on the decision to create the unsecured loan. The firm’s Regulatory Reporting Group was responsible for the firm’s net capital computation.

Firms must ensure that a system is in place to determine whether intercompany transfers to the firm’s affiliates will impact the net capital requirements of the member. Only properly registered individuals at a member with bank signatory authorization should be authorized to make decisions regarding a firm’s capital withdrawals. Firms should review their written supervisory procedures to ensure that all parties involved are properly licensed and able to carry out their responsibilities. The procedures should generally also include consultation with the Financial and Operations Principal who would have ultimate responsibility of the net capital computation.

Employee Supervision

FINRA fined a member $500,000 for failure to supervise the private securities transactions of its registered representatives. The firm’s registered representatives were dually registered with a registered investment adviser (RIA). The issue was discovered during a non-office-of-supervisory-jurisdiction branch examination. A dually registered representative did not disclose his involvement in recommending managed accounts and alternative investments through an RIA. Several months later, one of the firm’s reps disclosed that he was managing an investment fund as an outside business activity. It turned out that 79 of the member’s reps were involved in advisory activities at 14 different RIAs.

The firm initially failed to investigate the disclosures of the advisory activities. More importantly, the firm did not preserve securities-related emails that the registered representatives sent and received through unmonitored email addresses. Three websites maintained by the firm’s registered representatives were discovered and had not been disclosed to the firm. The firm eventually received full disclosure from its registered representatives for their participation in these outside business activities. However, the member did not properly disclose these activities on Form U4 until four months after receiving the disclosure. FINRA Rule 3280 requires that all participation in sales of securities for compensation not conducted through the employee’s broker-dealer receive approval from a principal prior to engagement.4 This includes outside investment advisory activities. The Rule also requires members to supervise the transactions and record each transaction on its own books and records as if it were executed on the member’s behalf. The firm failed to comply with this Rule.

It is extremely important that firms inform registered representatives of their duties to disclose all outside business activities. This can be achieved several different ways depending on the size of the member firm. As a best practice, firms should require their associated persons to complete routine questionnaires to disclose updated changes including other business that the rep is engaged in or planning to engage in. Member firms are reminded to update Form U4 no later than 30 days after they are made aware that a rep is receiving compensation outside of their employment with the broker-dealer.

Collateralized Mortgage Obligations

A member firm and several of its associated persons were fined by FINRA for allegedly making fraudulent sales of collateralized mortgage obligations (CMOs) to unsophisticated, elderly investors. The fines totaled over $1 million. Over the course of several years, the CEO and one of the firm’s reps intentionally misled investors regarding the risks of CMOs. The reps led its customers to believe that CMOs were government-guaranteed bonds and were suitable for investors seeking preservation of capital in their account. In reality, CMOs are not guaranteed by any government, and are considered by FINRA to be complex products involving substantial risk. Such risks include interest rate risk, as well as prepayment or extension risk.

The designated supervisor for the sale of CMOs allegedly did not review all CMO transactions during the period. The firm’s written supervisory procedures required the designated supervisor to review all new daily account forms, all incoming and outgoing correspondence, and all trades conducted the prior day with regard to their suitability for particular investors. According to FINRA, the supervisor did not review each CMO transaction for suitability purposes. Instead, the supervisor left the suitability determination up to the reps who delivered the application. The designated supervisor also failed to follow the firm’s policies and procedures when reviewing discretionary accounts, where many of the CMOs were held. The failure to perform an enhanced suitability analysis, combined with weak supervision, allowed these complex products to be sold to unsuitable investors.

FINRA Rule 3110(b)(2) requires member firms to have a designated principal review all transactions relating to their securities and investment banking business.5 Members may use a risk-based review system that allows a firm to focus on areas of the firm that pose the greatest risks of violations. Firms should ensure that sales of their securities products, especially complex products, undergo a detailed review by a principal prior to approval of the transaction. Firms that offer CMOs and other sophisticated products should ensure that all communications received by customers clearly include the name of the product (CMO), and that they make no comparison to any CDs, treasury bonds, or securities with fixed interest rates. In addition, communications should highlight the risks of CMOs. Firms also need to confirm that documentation with the disclosures noted above is completed and maintained with the firm’s books and records to the extent possible.

Delivery of Prospectuses

One member firm that provides clearing and investment services was cited for deficiencies in their prospectus delivery system and fined $450,000 for the violation. The member allegedly failed to deliver prospectuses to customers after purchases of exchange traded funds, closed-end funds, and unit investment trusts. More importantly, the firm delayed notifications of its prospectus delivery failures to the correspondent firms affected by this deficiency.

One of the main reasons for the delivery failures was that the firm’s clearing operations converted their back office system to a new electronic platform that failed to instruct its third-party vendor to deliver prospectuses. The new platform was designed to send out prospectuses at the time of purchase. However, there were issues with the coding that caused certain securities transactions not to include the delivery of a prospectus. Section 5(b)(2) of the Securities Act of 1933 states that it is unlawful to use the mail or other means of interstate commerce to sell fund shares, unless the shares are accompanied or preceded by a prospectus that is included in a registration statement which has become effective. Thus, the firm was required to deliver a final prospectus to each purchaser of shares no later than the time a confirmation of their initial purchase of shares was delivered.

Firms that do not rely on a clearing firm to deliver prospectuses must ensure that every securities transaction is accompanied by a prospectus. Since most communication today is conducted electronically, it is vital that firms test their platforms for proper delivery of account opening documents to their customers. A designated principal should ensure that the firm’s system allows for their approval of each securities transaction and that confirmation of delivery can be clearly demonstrated for each transaction with customers. Such systems also need to be periodically tested to confirm that they are still working as intended.

Securities and Exchange Commission

The Securities and Exchange Commission (SEC) levied 71 fines on broker-dealers during the first nine months of 2015, totaling roughly $116 million. The SEC reported 58 fines stemming from the Municipal Continuing Disclosure Cooperation Initiative (MCDC). The MCDC was an initiative that allowed issuers, underwriters and other obligated persons involved in the sale of municipal securities offerings to self-report possible violations of continuing disclosure requirements of SEC rules, notably Rule 15c2-12 of the Securities Exchange Act of 1934.

The firms that received disciplinary action violated Rule 15c2-12, which requires underwriters to conduct due diligence on the official statements prepared by the issuer and to undertake in writing to provide post-issuance disclosures to holders of securities of that issuer. The SEC fined the members for using municipal bond offering statements with materially false information or omissions of disclosures that the bond’s issuers should have made. The issuers allegedly failed, to submit annual financial information and certain event notices to the Electronic Municipal Market Access website (EMMA). The EMMA website serves as a public database that allows investors to check the financial health or operating condition of an issuer or the occurrence of specific events that may impact the value of the issuer’s debt. Fines ranged between $20,000 and $500,000.

ACA notes the following key securities laws and FINRA rules that were referenced in actions during the third quarter of 2015:

Firms should confirm that they have assessed their controls around their supervisory procedures to ensure that they are working as designed. Additionally, firms should ensure that they are properly approved to conduct such sales activities.

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 July 2015, August 2015, and September 2015.
2See FINRA Rule 7440.
3See Net Capital Rules For Brokers or Dealers.
4See New FINRA Rule 3280 – Private Securities Transactions.
5See FINRA Rule 3110- Supervision Rules