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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.


Hedge Fund Firm and Senior Manager Failed to Supervise Analyst Convicted of Insider Trading


A hedge fund firm agreed to pay nearly $9 Million in disgorgement, interest and penalties and a senior research analyst was fined and barred from the industry for failing to reasonably supervise an analyst convicted of insider trading.  The SEC alleges that the firm and the supervisor ignored red flags including receiving confidential information that preceded public announcements, allowing the analyst to work out of his home, and the absence of any documentary support for recommendations.  Moreover, the supervisor violated the firm’s policies by failing to report the red flags to the firm’s Chief Compliance Officer for further investigation and testing.  The SEC asserts that the firm should have implemented heightened supervision including requiring reporting conversations with employees of public companies, requiring heightened information, and tracking recommendations.

OUR TAKE: The SEC properly placed responsibility on the firm and its line management (and not the CCO) for failing to supervise and report concerns to the CCO for further investigation.  Management should have accountability for regulatory compliance, while the compliance department owns the drafting and testing of procedures and advising management on regulatory issues.