A large broker-dealer agreed to pay over $28 Million in restitution, fines, interest, and disgorgement for failing to properly supervise two brokers that the SEC alleges made misrepresentations about prices and profits in connection with secondary market trading of non-agency RMBS occurring nearly 5 years ago. The SEC asserts that the two brokers misled customers about purchase/sale prices and market activity and charged excessive markups. The SEC faults the firm for failing to implement a system to monitor customer communications. This compliance breakdown constituted a failure to supervise because “the failure to have compliance procedures directed at [an underlying securities law violation] can be evidence of a failure reasonably to supervise.” Also, the SEC further faulted the firm for charging excessive markups even though such markups were within FINRA’s 5% safe harbor policy because “Regardless of the applicability of the five percent guidance, the FINRA was explicit in stating that ‘[a] broker-dealer may also be liable for excessive mark-ups under the anti-fraud provisions of the Securities Act and the [Exchange] Act.’” The two brokers were also fined and suspended.
OUR TAKE: The SEC breaks new legal ground in two ways: (1) explicitly linking underlying securities law violations by registered representatives as a predicate to a failure to supervise charge and (2) charging a firm even though it complied with a stated FINRA safe harbor. What does this mean? The SEC continues to move to a strict liability standard such that any violation by an employee constitutes a failure to supervise. Also, broker-dealers must be wary about relying on stated FINRA safe harbors.