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Category: Written Supervisory Procedures

Firm’s Weekly Email Reviews Were Not Adequate According to FINRA

FINRA censured and fined a broker-dealer for inadequate email reviews.  Although the firm, through its President/CCO, conducted weekly reviews, FINRA charges that the firm’s random sampling and lexicon-based reviews were not sufficient given the firm’s size and risk areas.  The firm used 24 search terms provided by its email provider, but FINRA asserts that the search terms did not reflect a meaningful assessment of risk areas and resulted in a large number of false positives.  FINRA faults the firm for failing to change the email reviews “[d]espite the obvious indications that the firm’s lexicon system was not reasonably designed.”  FINRA also criticizes the firm’s Written Supervisory Procedures for omitting specific email review procedures. 

Just doing email reviews isn’t enough.  A firm must conduct effective email reviews that can statistically assess whether supervised persons are complying with the securities laws.  We call this “compliance alchemy” i.e. the appearance of compliance without the implementation of adequate procedures and testing.

Firm’s Procedures Did Not Guide Management on How to Respond to Red Flags

A large broker-dealer was fined and censured for failing to act against a longtime broker charged with participating in pump-and-dump transactions.  The SEC faults the firm for ignoring red flags including emails outlining the illegal activity, FINRA arbitrations, and customer complaints.  One supervisor explained that he did not act more aggressively because the broker worked at the firm for 30 years and her business partner was a partial owner of the firm. The SEC asserts that the firm’s supervisory system “lacked any reasonable coherent structure to provide guidance to supervisors and other staff for investigating possible facilitation of market manipulation.”  The SEC also maintains that the firm “lacked reasonable procedures regarding the investigation and handling of red flags.”

Reasonable policies and procedures must do more than simply restate the law and the firm’s commitment to comply with the law.  The compliance manual or WSPs must specifically describe HOW a firm will prevent and address regulatory misconduct. 

Weak WSPs Result in Failure to Supervise Charges

The SEC charged a broker-dealer with failing to supervise because its Written Supervisory Procedures failed to adequately detail how firm employees should respond to regulatory red flags.  The SEC asserts that the firm failed to supervise a broker that charged with participating in a penny stock pump-and-dump scheme.  The SEC maintains that the firm uncovered multiple red flags including a supervisor’s report, customer emails, arbitrations, and FINRA examinations.  However, the SEC alleges, the firm’s WSP’s did not specify who should investigate or how such investigations should proceed.  The firm did conduct two “flawed investigations” that failed to document its findings or detail a remedy.  The Director of the SEC’s New York Regional Office advised broker-dealers that this case “sends a clear message that we will not tolerate broker-dealers that fail to exercise appropriate supervision over employees.”

OUR TAKE: We predicted that the regulators would hold brokers accountable for the bad actions of their registered reps.  WSPs should follow the 5 Ws Rule: Who is responsible?  What is to be done?  Why are you doing it?  When is it due?  Where should it be presented?

http://www.sec.gov/litigation/admin/2018/34-82954.pdf

BD Fined $6.25 Million for Allowing Illegal Margin Lending

three 3D men as symbol of say, see or hear nothing

FINRA fined a large broker-dealer $6.25 Million for failing to prevent customers from using lines of credit to purchase securities, thereby violating the margin rules.  The BD offered a program whereby customers could borrow against their brokerage accounts and use the proceeds for purposes other than buying securities.  However, FINRA alleges that the firm failed to implement adequate supervisory procedures to educate and train employees and customers and prevent the misuse of the lending proceeds.  FINRA maintains that customers often borrowed and invested in securities within 14 days.

OUR TAKE: This case shows the difference between policies and procedures.  A policy states a firm’s position on a course of conduct or practice.  Procedures are then required to implement that policy and ensure compliance.   Firms that stop at broad policy statements have not implemented an adequate compliance program.