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BD and Principal Punished for Failing to Observe Information Barriers (Again)

A broker-dealer and its principal were censured and fined for failing to observe information barriers intended to safeguard material nonpublic information contained in research reports.  According to the SEC, notwithstanding the BD’s written supervisory procedures, (i) the principal and other employees engaged in active personal trading without pre-approval, (ii) the firm failed to observe information barriers between research and sales, (iii) employees disseminated material information such as price targets to existing and prospective customers, and (iv) the firm failed to prevent trading ahead of research reports or decisions to commence coverage.  FINRA had previously cited the firm about similar issues.  The SEC alleges violations of Section 15(g) of the Exchange Act, which requires broker-dealers to establish and enforce policies and procedures to prevent the misuse of material nonpublic information.

OUR TAKE: The SEC will bring an enforcement action based on issues raised by other regulators (e.g. FINRA) but not adequately remediated.  The regulators will throw the book at recidivists.  (see e.g. In re Morgan Stanley).


BD to Pay $28 Million Despite FINRA Safe Harbor

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.


Broker-Dealer Responsible for Trading Desk’s Unlawful Trading Practices

An interdealer broker agreed to pay $2.5 Million in disgorgement for failing to disclose markups and markdowns on securities traded for clients.  According to the SEC, the broker-dealer’s Cash Equity Desk marketed its services as agency only, charging commissions between 1 and 3 cents per share.  However, the SEC alleges that during periods of market volatility, the Cash Equity Desk charged additional markups and markdowns on trades without telling clients and then misleading them about actual purchase/sale prices.  The conduct also violated its compliance policies.  The SEC faults the entire firm for the unlawful misconduct because the employees were “acting within the scope of their authority.”

OUR TAKE: Firms encountering bad conduct by a small number of employees will have a hard time making the “rogue employee” defense.  The SEC has increasingly taken a more strict liability approach whereby the firm is liable for all actions of all employees.


Massachusetts Fines Large BD $1 Million for Sales Contest


The Massachusetts Securities Division fined a large broker-dealer $1 Million for compensating financial advisers to encourage clients to open securities-based lending accounts at an affiliated private bank.  The MSD asserts that the firm violated its own policies against sales contests and failed to quickly stop the program after Compliance raised objections.  The MSD cites statistics showing significant growth in securities-based lending associated with the program.  The MSD charges supervisory violations and failure to ensure “commercial honor and just and equitable principles of trade.”

OUR TAKE: The MSD could not assert a suitability violation because the securities-based lending accounts are not securities.  Instead, the regulator employed the “equitable principles” catch-all doctrine, which looks very much like a fiduciary standard.  Even if the DoL rule dies and the SEC refuses to move on a fiduciary standard, watch out for the state regulators.


Proprietary Trading Firm Failed to Register as Broker-Dealer

The SEC censured and fined a proprietary trading firm for failing to register as a broker-dealer.  The firm offered $5000 memberships to individual traders who could use a limited amount of firm capital and also had access to firm research, training, software, and execution services.  The SEC maintains that the firm’s principals benefitted through access to better execution resulting from higher trading volumes.  The SEC charges violations of Section 15(a) of the Exchange Act for effecting transactions in securities without registering as a broker-dealer.

OUR TAKE: It is unclear why the firm could not rely on Rule 15b9-1, the exemption generally utilized by proprietary trading firms.  In fact, two years ago, the SEC proposed to close the exemption but never followed through with a final rule.  Maybe, the SEC intends to take a narrow reading of the rule in enforcement cases rather than change the rule.