Summary of FINRA Regulatory Actions April – June 2017

August 22, 2017

Summary

The Financial Industry Regulatory Authority’s (“FINRA”) enforcement division brought 68 disciplinary actions against broker-dealer members during the second quarter of 2017. The nearly $5 million in fines FINRA assessed during the period was a significant decrease from the second quarter of 2016, during which members paid nearly $63 million in fines with respect to 88 disciplinary actions. The total dollar amount of fines and the total number of fines has also decreased substantially since 2014. Some of the largest fines and enforcement actions during the second quarter of 2017 resulted from violations relating to trade reporting, fee waivers, markups, and third-party checks.  


Details on some of the largest fines in these categories in terms of dollar amount follow, and the end of this summary includes a breakdown of the total number and dollar amount of fines paid year to date.


Trade Reporting

FINRA fined 15 member firms for violations of FINRA’s trade reporting rules during the second quarter. The average fine for trade reporting violations during the second quarter amounted to nearly $98,000. The number of trade reporting violations year to date has far outpaced the violations from other causes for disciplinary actions. One member firm was censured and fined $675,000 for allegedly failing to report customer executions in fixed-income securities within the time limits required in FINRA Rule 67301 and MSRB Rule G-14.2
 

According to that firm’s Letter of Acceptance, Waiver, and Consent (“AWC”), the firm self-reported to FINRA that it reported late client-side executions to the Trade Reporting and Compliance Engine (“TRACE”) and the Real-Time Transactions Reporting System (“RTRS”). After receipt of the Rule 4530 filing, FINRA staff conducted a five-year-period review for compliance with trade reporting rules. During the review period, the firm was found to have failed to report over 147,000 trade executions in TRACE-eligible securities to the TRACE within 15 minutes of the time of execution. The firm also did not report the correct time of execution for the trades. In addition, the firm failed to report certain information accurately for over 132,000 trade executions to the RTRS system within 15 minutes of the time of execution.

During the review period, the firm executed riskless principal transactions where it would purchase or sell securities with the street and then would execute offsetting trades with customers. The firm allegedly filed street-side transactions to the TRACE and RTRS within the 15-minute deadline during the period.  The client-side transactions were not reported within 15 minutes of the time of execution. According to FINRA’s review, the trade-reporting failures were the result of the firm’s misunderstanding of its requirement to report customer sides of riskless principal executions to TRACE and the RTRS.

Member firms that are required to report transactions in TRACE-eligible securities can prevent noncompliance with FINRA and MSRB rules by periodically confirming that their controls are effective.  In addition, the procedures should include the steps designated principals take to review the accuracy and timeliness of trade reporting to TRACE and the RTRS. Members that have trades reported on their behalf by a clearing firm should still evidence review of TRACE reporting to verify timely and accurate corporate bond reporting to the TRACE system. TRACE daily reports should be compared to the Firm’s fixed-income transactions for that day. The designated principal must also evidence the review of the reporting on the TRACE transaction summary report in writing or electronically. 


Mutual Fund Fee Waivers

During the second quarter of 2017, FINRA censured and fined five members for supervisory failures related to monitoring mutual fund sales charge waivers. One member was censured, fined $225,000, and ordered to pay restitution to eligible customers who were overcharged for mutual fund purchases. According to the firm’s AWC, the firm allegedly violated FINRA Rule 31103 and FINRA Rule 20140 by failing to supervise the mutual fund sales to ensure that eligible customers who purchased shares received the benefit of their applicable sales charge waivers.

The violations resulted from the firm relying on its own financial advisers to determine the applicability of receiving a sales charge waiver on shares of certain mutual fund families. Compliance allegedly did not assist the advisers adequately in making the determination prior to accepting the order. FINRA found that the firm did not have procedures in place to identify sales charge waivers in fund prospectuses for eligible customers. An examination conducted by FINRA, which covered a six-year period, revealed that available sales charge waivers were not applied for 345 customers who purchased mutual fund shares.

Member firms should designate a principal to be responsible for reviewing new customer accounts for applicable sales charge waivers. Firms should not solely rely on registered reps to make this determination. To the extent the firm can, it should first confirm what the available waivers are for each of the funds that the firm offers. Eligible accounts should be flagged to verify that when mutual funds are purchased, applicable breakpoints are applied.  


Markups

FINRA censured three broker-dealers and levied just over $416,000 in fines for their allegedly charging excessive markups on municipal security sales.

One member was censured, fined $175,000, and ordered to pay nearly $63,000 in restitution to customers for alleged violations of MSRB Rules G-175and G-30.6 According to the firm’s AWC, FINRA staff identified 12 transactions in municipal securities that were sold at prices deemed to be unfair and unreasonable.

In another AWC, FINRA staff identified alleged excessive markups on 55 corporate bond transactions during a pricing sweep conducted by the SRO’s Market Regulation Fixed Income Investigations Group. The excessive markups were charged by one of the firm’s representatives. The representative would place an order with a trader, and the trader would report the execution back to the representative and make a journal entry to move the bonds to the representative’s account at a markup for the trader. The representative would then sell the bonds back to a customer at another markup in violation of FINRA Rule 2010. The CEO of the firm was responsible for reviewing the firm’s trade blotter and for supervising markups. According to FINRA, the trade blotters did not identify the total markup charged by the firm. Instead, one blotter showed purchases and sales for the trader’s account and another showed purchases and sales for the representative’s account. The CEO allegedly did not calculate both markups despite knowing of the practice of marking up a security twice.

As a best practice, firms should ensure that a designated principal reviews daily trade pricing information (e.g., trade blotters) to confirm that markups are not excessive.   Any markup reviewed by the principal that exceeds 3% should be documented with a written explanation of the order’s reasonableness in anticipation of scrutiny from a regulator such as FINRA or the SEC.


Third-Party Checks

FINRA censured and fined a member $200,000 for allegedly failing to review and monitor third-party check requests from customer accounts, resulting in violations of FINRA Rules 3110 and 3120.7 The firm allegedly failed to monitor a registered representative who sold interests in an investment fund owned and controlled by the rep that ultimately ended up collapsing due to poor performance. The sales of interests in the fund were not an approved activity in the firm’s membership agreement. According to the AWC, there was no indication of whether FINRA viewed the rep’s sales of interests as private securities transactions.8


The registered representative submitted 23 letters of authorization (“LOAs”) to the firm, each signed by a firm customer and authorizing checks payable to the bank account of the fund controlled by the representative. The checks were being drawn on brokerage accounts held by the firm. The third-party check requests and LOAs were never flagged by the compliance function due to the firm’s decentralized manual review of third-party check requests. The firm did not use exception reports to support the manual review process. In addition, FINRA noted that the firm’s annual supervisory controls testing for the period did not detect any issues with third-party check requests and that its review of this activity was not fully documented or verified. As a result of these deficiencies, the firm allowed over $1.6 million of customer funds into the investment fund.

To avoid such occurrences, firms should ensure that all outgoing transmittals to third parties from customer accounts are reviewed by a designated principal. The review should generally include three steps. First, firms should receive a copy of the LOA or letter of instruction from the customer and approve the transmittal in writing or electronically. Second, firms should run a check on the third party through OFAC and/or a reliable vendor to identify potential issues or negative news about the third party. Third, firms should monitor reports from their clearing firm that isolate occurrences of a large number of transmittals to the same third party and/or from one branch office. The principal should review such reports and evidence the date of the review in writing. 


Other Significant Events

FINRA levied fines on three members during the second quarter for their failure to retain electronic messages. These firms allegedly violated FINRA Rule 45119 and Rule 17a-410 under the Securities Exchange Act of 1934 (“Exchange Act”). These three amounts were comparable to the amounts levied in the previous quarter of this year. Two affiliated broker-dealers that shared the same servers, retention systems, and email-monitoring system each received a $65,000 fine for the violations. As part of a routine update and test, two of their servers were not reloaded with the email retention-and-monitoring system. One firm spotted this error during a compliance review nearly nine months after the test and self-reported the incident to FINRA. According to FINRA, the mishap occurred due to human error and resulted in that firm losing approximately 547,000 emails during the nine-month period.

Firms should periodically test their archiving and retention systems to ensure that messages are being captured and retained for the period required by Exchange Act Rule 17a-4. ACA has identified instances in some of our reviews in which certain individuals’ messages have not been captured by a firm’s archiving systems. As a best practice, compliance departments should have all registered representatives send an email and then immediately check to see if anyone’s email is missing from the archiving systems’ daily results. Any issues discovered should be escalated to the firm’s information technology group to be resolved immediately.

During the second quarter, two members paid fines to FINRA for their failure to supervise the private securities transactions of their associated persons. One member was expelled by FINRA and ordered to pay a $100,000 fine for failing to supervise the private securities transactions of one of its registered representatives. The firm’s CCO and president also was suspended from membership and ordered to pay a fine.

The representative in question submitted an outside business activity request form to the firm, which the CCO approved and signed off on in writing. According to the AWC, however, the firm did not conduct an inquiry into what activity the representative would be engaging in or the compensation he would receive from his activities. The outside business in this case involved being a registered employee at a registered investment adviser and a general partner of several unregistered investment funds. The representative had disclosed the receipt of “money manager fees” and client fees” and described the securities-related activity on his annual compliance questionnaires. Under FINRA rules, the firm should have treated the securities transactions taking place away from it as private securities transactions for compensation. The firm did not record any transactions on its own blotter nor did it approve the series of transactions prior to execution.

Firms can prevent noncompliance with FINRA Rule 3280 by identifying whether an employee’s outside business activities involve securities transactions.  Such transactions include trade orders sent to other broker-dealers in an investment adviser capacity. Should a firm identify and verify such activity, they should advise the representative in question to disclose each transaction prior to a sale or order being closed or executed. Firms should then notify the representative requesting the transaction in writing (or electronically) of their approval or disapproval of his or her role in the activity. A copy of the decision for their books and records should also be maintained.

ACA notes the following key securities laws and FINRA and MSRB rules that were referenced in actions during the second quarter of 2017:

  • FINRA Rule 6730
  • MSRB Rule G-14
  • FINRA Rule 3110
  • FINRA Rule 2010
  • MSRB Rule G-17
  • MSRB G-30
  • FINRA Rule 3120
  • FINRA Rule 3280
  • FINRA Rule 4511
  • SEC Rule 17a-4

For More Information

ACA Compliance Group’s Broker-Dealer Services Division helps firms ensure their compliance with regulatory requirements. Our services include compliance program development, trading reviews, conflicts management analysis, corrective action assessments, supervisory control and AML testing, written supervisory procedure assistance, initial and ongoing membership application help, and customized regulatory and compliance consulting.

Please contact Dee Stafford at dstafford@acacompliancegroup.com for more information. 


Fines Year To Date

 

The table below summarizes most of the actions taken by FINRA year-to-date.
 

Primary Cause

# of Fines

Total $ Amount

Advertising

2

$170,000

AML

6

$3,513,750

Average Price

1

$30,000

Blue Sheets

1

$50,000

Bond Swaps

1

$140,000

Confirmations

1

$275,000

Conflicts of Interest

1

$150,000

Consolidated Reports

4

$2,200,000

Corporate Bonds

1

$210,000

Customer Notifications

2

$1,000,000

Customer Orders

1

$15,000

Customer Statements

1

$100,000

Disclosures

1

Expelled

Duplicative Orders

1

$50,000

Emails

6

$1,300,000

ETFs

2

$75,000

Excessive Fees

1

$750,000 fine/ $3.4 million restitution

Failure to Deliver

2

$135,000

Failure to Follow Customer Instructions

1

$25,000

Fee-Based Accounts

1

$230,000

Fee Waiver

5

$470,000

Financial

1

$28,500

Fraud

2

Expelled

IRA

1

$750,000

Limit Order

4

$120,000

Margin

1

$2,750,000

Margin Loans

1

$125,000

Market Access

1

$6,500

Market Making

1

$35,000

Market Orders

2

$32,500

Markups

3

$416,673

Misused Customer Funds

1

Expelled

Mortgage-Backed Securities

1

$500,000

Municipals

9

$770,000

Mutual Fund

3

$3,161,072 Restitution

Net Capital

2

$20,000

OBAs

3

$182,500

Options

1

$30,000

Order Management System

1

$65,000

Order Tickets

1

$52,000

Payment for Order Flow

1

$10,000

Principals

1

$2,500

Private Placements

3

$188,000

Private Securities Transaction

3

$110,000

Prospectus Delivery

2

$1,550,000

Reg NMS

4

$77,500

Registration

6

$558,000

REIT

1

$30,000

REITS

1

$30,000

Research

1

$75,000

Restriction Period

1

$27,500

Security of Customer Info

1

$650,000

Short Interest

2

$210,000

Short Positions

1

$27,500

Short Sales

2

$65,000

Statements

1

$50,000

Suitability

3

$635,000

Supervision

5

$1,062,045

Surveillance

1

$20,000

Third-Party Checks

1

$200,000

Ticket Charges

1

$45,000

Trade Allocations

1

$10,000

Trade Blotters

1

$180,000

Trade Reporting

40

$7,020,000

Trade Volume

1

$975,000

Trade-Throughs

1

$17,500

Unregistered Securities

1

Expelled

Grand Total

168

$29,847,968

 


[1] FINRA Rule 6730
[2] MSRB Rule G-14
[3] FINRA Rule 3110
[4] FINRA Rule 2010
[5] MSRB Rule G-17
[6] MSRB Rule G-30
[7] FINRA Rule 3120
[8] FINRA Rule 3280
[9] FINRA Rule 4511
[10] SEC Rule 17a-4