FINRA fined a large broker-dealer $2.75 Million for failing to include customer complaints on Forms U4 and U5 and for neglecting to file Suspicious Activity Reports for cyber-related events. FINRA examined a small sample of customer complaints and found that the firm should have reported more than 22% of its customer complaints on Forms U4 and U5. Extrapolating the small sample that FINRA reviewed, the firm should have reported nearly 300 customer complaints over the 2013-2016 period. The firm erroneously construed the filing requirement by declining to report customer complaints unless the customer expressly requested more than $5000 in compensation. FINRA also faults the firm for providing inaccurate guidance to supervisory personnel and thereby failing to file more than 400 SARs to report cyber intrusions or attempts.
FINRA requires firms to heighten supervision over bad brokers. To ensure compliance, FINRA needs to make sure that Forms U4 and U5 include all customer complaints and other reportable activity. Compli-pros should err on the side of reporting notwithstanding the objections of producers and their supervisors.
The SEC fined and censured an investment adviser for insufficient supervision and compliance procedures, which allowed one of its investment advisers to cherry-pick trades for the benefit of favored accounts. The adviser used an omnibus brokerage account to allocate profitable trades to favored accounts to the detriment of other accounts, notwithstanding the firm’s policies and procedures and Form ADV that indicated that it would allocate trades fairly and equitably. The SEC acknowledges that the firm did conduct daily reviews of the trading but focused on suitability and concentrations, rather than trade allocation.
OUR TAKE: Failure to prevent wrongdoing creates a burden and inference that your compliance policies and procedures do not measure up. In this case, the SEC did not offer insight into how the firm should conduct allocation testing or whether such testing would have stopped the misconduct. Instead, the SEC argues that the cherry-picking itself proves that the firm failed to implement reasonable policies and procedures. This is why firms need to implement testing and monitoring and not just write a nice policy.
The SEC fined a large broker-dealer $5.75 Million for failing to allocate sufficient resources to its valuation control function, thereby allowing rogue traders to inflate securities valuations and positions. The firm eliminated 15 valuation control positions as part of a global efficiency initiative, which, according to the SEC, left the control function understaffed and under-trained to adequately implement the firm’s valuation supervision policies. One manager complained internally that four staff members were tasked with verifying prices for more than 20 trading desks that held over $200 Billion in Level 2 and 3 securities. The SEC alleges violations of the books and records and supervision rules.
OUR TAKE: Having a valuation control function is not the same as having an effective valuation control function. Global firms must consider metrics before gutting compliance and supervisory functions that could ultimately allow bad actors to put the firm at risk. Firm leaders should think of compliance and supervision as the defense to protect assets and the firm’s reputation. And, defense wins championships.
The Massachusetts Securities Division has filed a complaint against a broker and his firm for allowing the continued website publication of misleading disciplinary information. The broker’s website claimed that he “NEVER” (sic) had a complaint made against him. Although this statement may have been accurate when the website went live in 2008, several customers filed and settled complaints between 2011 and 2018. The MSD faults the firm for failing to flag the misleading website language even though it conducted 4 branch audits during the period and had actual knowledge of the complaints. The MSD criticized policies and procedures that failed to require the firm to “regularly review content after publication.”
OUR TAKE: Earlier this year, FINRA admonished member firms to heighten supervision of brokers with a disciplinary history. The states – including Massachusetts – can jump into the enforcement fray to ensure that the home office properly monitors the branch offices.
The SEC fined a broker-dealer $1.25 Million for failing to take sufficient disciplinary action against brokers that shared commissions in violation of firm policy. The SEC asserts that the one broker, who ultimately became a supervisor, assigned accounts to junior traders in exchange for off-the-book kickbacks paid by personal checks. The transactions violated the firm’s policies and procedures and books and records requirements. Upon discovering the arrangement 13 years after it began as a result of a FINRA investigation, the firm responded by issuing a memo condemning the activity and offering the participants the opportunity to resign. The SEC faults the firm for failing to discipline the wrongdoers.
OUR TAKE: Having policies and procedures, but taking no significant action against those who violate them, eviscerates their purpose. This compliance voodoo – the mere appearance of a compliance program – will draw the ire of the regulators.
A portfolio manager of an activist investment firm failed to disclose a $3 Million personal loan to the CEO of a company in which he invested. The portfolio manager made the loan, according to the SEC, to secure the CEO’s support for his election to the Board as part of a broader initiative to exert control over the company. The SEC asserts that the portfolio manager violated his fiduciary duty to his clients by concealing his personal interest and that the investment manager failed to file a Schedule 13D (indicating more than passive investment). Also, the SEC faults the adviser for failing to implement a reasonable compliance program because the policies and procedures “did not discuss conflicts of interest more broadly in sufficient depth so as to capture and train employees to recognize other violative conduct not specifically identified.”
OUR TAKE: Because portfolio managers are often treated like the rock stars of investment management, compli-pros must implement heightened supervision to protect against reckless actions that will ultimately hurt the firm. Procedures should include reviews of investment decisions, due diligence about personal dealings, reviews of transactions outside the ordinary course, and training all employees how to identify unlawful activity.
FINRA has outlined recommended heightened supervisory procedures for brokers with a history of past misconduct. FINRA suggests that firms should (i) designate a principal with supervision responsibility; (ii) provide specific training to the bad broker; (iii) require written acknowledgements; and (iv) conduct periodic reviews of the plan’s effectiveness. FINRA also describes certain characteristics of an effective heightened supervisory plan: physical proximity of the supervisor to the broker, ongoing contacts and reviews, frequent monitoring, and expediting customer complaints. FINRA has also proposed rules that would subject member firms that hire bad brokers to additional FINRA monitoring and reporting.
OUR TAKE: FINRA wants to make it difficult on firms that hire brokers with a disciplinary record by imposing additional regulatory, monitoring and reporting requirements.
A hedge fund firm agreed to pay over $10 Million in fines, disgorgement and interest for failing to stop two portfolio managers from using sham broker quotes in a scheme to inflate fund NAVs. The SEC faults the firm for failing to observe its own valuation procedures by allowing the PMs significant influence to override pricing services, failing to conduct adequate due diligence of the brokers, and neglecting to obtain at least 3 broker quotes for a price override. The SEC also fined and barred the firm’s CFO for failure to supervise by ignoring red flags such as the frequency that the PMs overrode prices and that overrides almost always resulted in higher valuations. The SEC previously charged the portfolio managers.
OUR TAKE: Investment firms and supervisors cannot turn a blind eye to questionable valuations and performance. According to the SEC, the respondent collected over $3 Million in unearned performance and management fees, making the firm ultimately responsible for its employees’ wrongdoing.
FINRA fined a broker-dealer $550,000 for failing to properly monitor and detect red flags related to small cap securities traded via delivery versus payment accounts. According to FINRA, the respondent did not implement the same level of due diligence as it utilized with accounts held at the broker-dealer. FINRA also alleges that the firm failed to enhance its compliance procedures even after warnings from the SEC and its clearing firm. FINRA faults the firm for over-relying on branch managers to conduct surveillance and report red flags.
OUR TAKE: It’s never a good idea to rely on producers or their supervisors to monitor activities. They are not regulatory professionals, and they often have a significant conflict of interest with respect to activities that affect their compensation.
FINRA has proposed a new outside business activities supervision rule that would exclude independent investment advisers. Under the proposal, third party investment advisers would need to receive informed consent for their activities, but the BD would not have supervisory obligations. The BD could impose certain requirements based on a required risk assessment of conflicts of interest and customer confusion. The proposal also limits BD obligations to supervise non-investment related activities.
OUR TAKE: That sound you heard yesterday was the Greek chorus of cheers from investment advisers who have had to pay their broker-dealers a percentage of their advisory fees for required supervision. We expect the larger independent broker-dealers will lobby heavily against this proposal as it cuts off a lucrative revenue source. The proposal would help smaller regional firms that want to recruit reps but don’t have the currently-required supervisory resources. We expect much debate.