FINRA Regulatory Actions October - December 2015

March 23, 2016


The Financial Industry Regulatory Authority’s (“FINRA”) enforcement division brought more disciplinary actions against registered broker-dealers in 2015 than either of the previous two years1. As the below tables illustrate, the total number of fines increased, while the total dollar amount decreased. Registered members have experienced greater penalties for violations of securities laws and regulations. FINRA also expelled six broker-dealers’ memberships and ordered nine members to pay restitution to customers as a result of violations involving improper sales practices. The reported restitution payments during the year ranged from $100,000 to $10 million. Disciplinary actions involving gaps in firms’ supervisory systems and processes have risen steadily since 2013.

FINRA reported 18 fines of $1 million or more in 2015, down from 23 in 2014. Five causes of disciplinary action combined to account for nearly 48% of the total dollar amount for the year (nearly $50 million). The top five primary causes in terms of fines related to supervision (24%), trade reporting (8%), sales of unregistered securities (7%), suitability (4%), and sales of options (5%).


Fourth Quarter 2015

FINRA announced 115 disciplinary actions during the final three months of 2015. The total number of fines and the total dollar amount in fines increased during the fourth quarter from the same period one year ago. FINRA levied 19 fines and disciplinary actions for trade reporting violations during the period. The largest individual dollar fines in the fourth quarter resulted from actions regarding sales of unregistered securities, suitability reviews, books and records, options trading, and supervision. Details on the largest fines for each cause of action are outlined below.

Unregistered Securities

FINRA fined a member $6 million for allegedly selling billions of shares of unregistered microcap securities. The firm allegedly did not determine if the securities being sold were registered with the Securities and Exchange Commission (“SEC”) or if they were subject to an available exemption from registration.

According to FINRA, the firm and one other broker-dealer also did not conduct reasonable due diligence on these securities before selling the shares to their customers. The shares in question are referred to as “microcap” because the companies that issue them have relatively small market capitalizations, typically between $50 million and $100 million. Microcap securities are also known for their volatile price swings, and should not be sold to customers with low or medium risk tolerances. The firm’s management did not expand its supervisory system for its unregistered securities business. Moreover, the firm delegated most of the responsibility for supervising the sales of these microcap shares to persons who were not principals. The firm also did not have adequate tools in place to detect potentially suspicious money laundering activity relating to purchases and redemptions of these securities.

FINRA expects its members to conduct due diligence on all securities that they recommend to their customers. This requirement is part of the reasonable-basis obligation component of FINRA’s suitability rule. According to FINRA Rule 2111.05, reasonable diligence will vary depending on, among other things, the complexity of risks associated with the security or investment strategy, and the member’s or associated person’s familiarity with the security or investment strategy2. A member’s or associated person’s reasonable diligence must provide the member or associated person with an understanding of the potential risks and rewards associated with the recommended security or strategy. The lack of such an understanding when recommending a security or strategy violates the suitability rule.

Firms can satisfy the reasonable-basis component of the suitability rule by conducting due diligence on the issuer, documenting their findings, and by having a principal approve the reviews that were conducted. Additionally, firms should ensure that the designated supervisors review and approve all sales of securities, either in writing or in electronic format. Firms should keep evidence of any investigations into possible red flags in each deal file. This will demonstrate to the self-regulatory organizations and federal securities regulators that the firm exercised caution before selling securities to investors.


A registered broker-dealer was ordered to pay $10 million in restitution to customers and was fined over $3 million for allegedly failing to conduct suitability reviews on sales of mutual funds. The violations resulted from a lack of supervision on mutual fund switch transactions and a failure to provide discounts to customers when they switched their investment funds.

The violations occurred because the member’s policies and procedures used an incorrect definition of a mutual fund switch, which required three separate transactions within a time frame set by the firm. The system that the firm utilized during this time generated thousands of alerts for switch transactions. However, due to the firm’s definition, a majority of these transactions got placed without oversight, and customers were not informed of the fees associated with switching their funds. FINRA also found that nearly 40% of the mutual fund transactions recommended by the firm’s personnel were improper based on the customers’ investment profiles.

Firms can avoid mutual fund switching violations by establishing and following policies and procedures that ensure every switch transaction is reviewed and approved by a registered principal. Firms that are approved to sell mutual funds to retail customers should review their policies and procedures to identify the requirements governing mutual fund switch transactions. The procedures should include a requirement for the registered person to obtain an explanation for why the customer wishes to switch an investment. Most importantly, the switch letter should state why and how the customer would benefit from such a transaction.

Firms should also conduct routine spot-check reviews of customers’ accounts. The aggregated amount invested in each mutual fund transaction for the customer should be a major focal point of each review. As a best practice, firms should document why certain recommendations for transactions just below the breakpoint threshold were accepted through the broker-dealer. A registered representative with a history of sales recommendations just below the breakpoint threshold could be an indication of potential sales practice abuses.

Books and Records

A member was fined $2.6 million for failing to retain securities-related books and records in a required electronic format, and for failing to retain certain electronic correspondence of the firm’s associated persons. For nearly three years, the firm allegedly failed to capture over 168 million outgoing emails to the firm’s write-once, read-many (“WORM”) storage system.

The firm did not have one centralized document-retention process for all of its departments to follow. FINRA found that the firm did not designate anyone with final responsibility for retaining broker-dealer books and records, and for ensuring the capture of electronic copies. Employees of the firm were saving books and records of the broker-dealer onto a restricted share drive that was not WORM-compliant.

Firms can take several measures to prevent non-compliance with electronic recordkeeping requirements. Firms must conduct testing of their email archiving systems to ensure that they capture all associated persons’ emails. As a best practice, firms can require their employees to send emails to one inbox, and then perform a spot check for each individual’s message. If emails from certain domains do not appear in that day’s search results, Compliance must immediately address the issue. The firm’s Information Technology Department may need to get involved depending on the size and scope of the firm and the activities it conducts. More importantly, firms must ensure that they save books and records in a non-rewriteable and non-erasable format if they do not maintain hard copies of them.

Broker-dealers should also contact vendors who maintain books and records in an electronic format to confirm that the storage medium they use complies with SEC rules. Vendors should be able to provide the firm with a letter certifying their compliance with federal securities rules, also referred to as a “Third Party Undertaking Letter.” The letter will certify that the electronic storage medium is WORM-compliant, and that the vendor will agree to supply certain information to the SEC, self-regulatory organizations, or state securities commissioners in response to any reasonable request3.


FINRA fined a member $2.4 million for violations dating from January 2010 involving FINRA’s options reporting rules. The firm allegedly failed to report millions of instances of options trades that should have been reported to FINRA’s large options positions reporting (“LOPR”) system. FINRA Rule 2360(b)(5) states that firms are required to report options positions when accounts held by customers, partners and employees of the firm, non-member brokers and dealers, and the firm itself hold more than 200 positions on the same side of the market4. To calculate a long position, firms must aggregate all calls purchased and puts written on the same underlying security. To calculate a short position, firms need to aggregate calls written and puts purchased on the same underlying security.

The firm allegedly failed to have an adequate supervisory system in place to ensure that trades were being monitored against the position reporting limit. More importantly, the firm did not designate anyone to conduct daily reviews of its options positions. The firm self-reported the deficiency after realizing it was in violation of securities laws.

As a best practice, all firms that conduct an options business with the public in both standardized and conventional options should verify that an options principal reviews for position limit reporting on a daily basis. Principals of firms with high trading volume must confirm that their electronic systems track the reporting thresholds for each security in each account that is covered by FINRA Rule 2360(b)(5). Firms that generate exception reports for options trading should document that the large option position reports are reviewed daily. The reviewer should be licensed as a registered options principal and hold the Series 4 exam. Any positions that meet the reporting requirement in FINRA Rule 2360(b)(5) should be reported in the LOPR system no later than by close of business on the next day following the day on which the transaction or transactions requiring the filing occurred.


FINRA fined a member $2 million for supervisory failures related to sales of closed-end funds, and for failing to supervise the employee trading activity in one of its branch offices. The firm was also ordered to pay restitution of $121,000 to certain customers impacted by the violations. For nearly one year, the firm allegedly failed to monitor the sales of bonds issued in jurisdictions deemed to be high risk. One rating agency downgraded the credit rating of the bonds to one level above junk during the period.

FINRA noted that the firm’s proprietary product risk-classification tool was not working properly. Registered sales persons used the tool’s risk rating before recommending the above-mentioned bonds to customers. During inspection, FINRA found that the tool did not factor in the risk of investing in the bonds that were sold by the firm. FINRA also found that the firm did not have any system in place to track the concentration risk of each account that purchased the bonds. Due to this deficiency, the broker-dealer’s customers were unaware of the amount of risk they assumed by investing in these bonds.

Firm employees also sold securities from their own personal brokerage accounts to customers. The firm did require pre-approval before employees could place trades, but there was no mechanism in place to ensure employees obtained that pre-approval before executing the trades. Because of this gap, nearly 41% of employee-related trades were effected without the firm’s approval.

FINRA Rule 3110(b)(2) requires member firms to have a designated principal review all transactions relating to their securities and investment banking business5. Firms should make certain 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 sales of high-risk bonds should ensure that their policies and procedures clearly describe how the trading is supervised and how the risk of these bonds is monitored. Due to the amount of risk such transactions pose to the firm, specific exception reports should be reviewed by the designated principals and Compliance to identify the concentration of high risk bonds in customers’ accounts.

Firms also must ensure that their mechanism for reviewing employee trading activity is able to track potential violations of securities rules. Under National Association of Securities Dealers (“NASD”) Rule 3050, employees of a broker-dealer are responsible for disclosing to their employer all personal securities accounts for which they have a beneficial interest prior to executing a trade. The broker-dealer must approve each account and request that the executing member transmit to the firm duplicate copies of statements or other information with respect to the account. As a best practice, firms should utilize trading review systems that notify supervisors of employees’ trades. This will confirm that the firm is aware of the trading activity that takes place. The practices of firms should be confirmed to verify that reviews of personal trading activity should include a requirement for each associated person of the broker-dealer to obtain pre-approval from Compliance before entering trades with their brokerage firm.

Other Significant Events

There were seven instances involving electronic communication review violations during the fourth quarter of 2015. One firm was fined $200,000 for failing to properly retain and review attachments of certain electronic communications that were sent to and received by firm employees. The firm used both emails and instant messaging to communicate internally and externally, therefore the firm was required to review both types of communications. During the review period, Bloomberg changed the way it posted files of its messages to the firm’s file transfer protocol site. Because of the change, the firm failed to review over 8 million message attachments. The firm discovered the problem and self-reported the issue to FINRA.

Members are responsible for making sure that a principal or delegate of the firm reviews all written and electronic communications. It is important for firms to review the address book or contact list in their retention systems to ensure all associated persons are included. More importantly, firms should test their email systems to confirm that they are capturing all messages and that they perform the reviews called for by their procedures.

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

  • FINRA Rule 2111
  • Rule 17a(4)(f) of the Securities Exchange Act of 1934
  • FINRA Rule 3110
  • FINRA Rule 2360
  • NASD Rule 3050

ACA Compliance Group’s Broker-Dealer Services Division helps firms ensure their compliance with regulatory requirements. Our services include compliance program development, trading reviews, conflicts management analysis, corrective action assessments, supervisory control and AML testing, written supervisory procedure assistance, initial and ongoing membership application help, and customized regulatory and compliance consulting.

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 2015 Monthly and Quarterly Disciplinary Actions.
2See FINRA Rule 2111.
3See SEC Interpretation: Electronic Storage of Books and Records.
4See FINRA Rule 2360(b)(5).
5See FINRA Rule 3110- Supervision Rules