This case is similar to an action against another bank-affiliated broker-dealer back in 2017. Large firms with multiple regulated affiliates must ensure compliance with each regulatory regime. Compliance with one financial services statute does not necessarily mean compliance with another. Firms should hire compliance specialists with substantive backgrounds in the applicable laws and regulations.
The staff of the SEC’s Office of Compliance Inspections and Examinations (OCIE) has issued a Risk Alert reporting significant compliance and supervision deficiencies. Based on data collected from a 2017 sweep of over 50 advisers, OCIE found significant weaknesses in how firms hired, supervised, and disclosed information about employees with disciplinary histories. The OCIE staff also cited frequent compliance deficiencies including failures to supervise how fees are charged, what marketing materials are distributed, and whether remote workers complied with firm policies. OCIE also discovered that many advisers allocated compliance responsibilities but failed to assign those responsibilities or neglected to require documentation. The OCIE staff recommends that advisers “reflect on their practices” and implement such best practices as enhanced hiring due diligence, background checks, heightened supervision, and remote-office monitoring.
How many times must OCIE warn the industry about compliance, and how many enforcement actions will it take, before firms implement a legitimate compliance program? An investment adviser should spend at least 5% of revenue on compliance, hire a dedicated Chief Compliance Officer, adopt tailored policies and procedures, test the program every year, and prepare a written compliance report of deficiencies and remediation.
On the positive side, requiring what amounts to a net capital penalty should get the attention of senior leaders at these problem firms. On the other hand, FINRA needs to be careful that such a firm doesn’t make a cold calculation to hire a bad broker if the broker’s production offsets the additional financial obligation.
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.
OUR TAKE: A motivated miscreant will find the weaknesses in your compliance and supervisory system. To avoid this type of theft, a firm should prohibit any third party money movement without the review of a supervisor or compli-pro.
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.
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.”
FINRA fined a large bank-affiliated broker-dealer $1.25 Million for failing to conduct adequate background checks on over 8,000 associated persons over an 8-year period. The broker-dealer relied on its bank affiliate to conduct screening of its non-registered associated persons but the bank only screened for bank disqualifying criteria, not the broader categories of disqualification pursuant to Section 3(a)(39) of the Exchange Act and FINRA rules. Also, the firm completely failed to fingerprint over 2000 employees prior to employment. Four employees were retained despite statutory disqualifications. FINRA’s EVP of Enforcement warned, “Firms have a clear responsibility to appropriately screen all employees for past criminal or regulatory events that can disqualify individuals from associating with member firms, even in a non-registered capacity.”