Summary of FINRA Regulatory Actions January - March 2017

June 27, 2017

Summary

In the first quarter of 2017, FINRA took approximately 100 disciplinary actions against registered broker-dealers and levied more than $24 million in fines for violations of securities laws. The total dollar amount in fines increased as the total number of fines decreased since the same period last year. FINRA expelled five members during the first quarter, which marks the highest number of expulsions in any first quarter since 2014.

Summary of FINRA fines

Violations making up the largest share of total fines involved trade reporting (22.76%), anti-money laundering (“AML”) (12.27%), margin (9.93%), consolidated reports (7.95%), and prospectus delivery (5.42%). Details on some of the largest fines in these categories in terms of dollar amount follow, and the end of this summary includes the total number and dollar amount of fines paid year to date.


Trade Reporting

FINRA fined 25 member firms for violations of FINRAs trade reporting rules during the first quarter. This amount surpassed the 18 disciplinary actions related to trade reporting violations from the same period one year ago. The average fine for trade reporting violations during the first quarter amounted to nearly $335,000.

FINRA censured one member and fined it a total of $2,450,000 for alleged failures to report over-the-counter options positions to the Large Options Positions Report (LOPR) system. During a review, the option regulation staff of FINRAs Market Regulation department (Market Regulation) determined that the member allegedly failed to report over seven million instances to the LOPR system. FINRA Rule 2360(b)(5) requires members to report each account that has established an aggregate position of 200 or more options contracts of the put class and call class on the same side of the market1. An instance for purposes of this article means a single failure to report a reportable position or an inaccurate report of a reportable position.

The firm discovered the failures mentioned above and self-reported them to FINRA as required by FINRA Rule 4530(b)2. Systems errors accounted for some of the trade reporting failures, including incorrect tax ID numbers entered on the firms accounts. The firm also allegedly used incorrect effective trade dates and used equity multipliers that were 100 times less than the accurate multiplier for calculating the number of shares per contract. According to Market Regulation, the firms written supervisory procedures did not specifically ensure the firm would conduct reviews of the accuracy of reports to the LOPR system. Member firms should consider testing their systems periodically to confirm that the information reported is accurate and complete. Firms that have a clearing broker-dealer report option positions to the LOPR system should review any options positions reports provided by the clearing firm, ensuring that the firm records all in-concert information properly and reports it to the LOPR system if required.

Anti-Money Laundering

During the first three months of 2017, four members received disciplinary actions and fines of nearly $3,400,000 from FINRA. Since 2015, FINRA has levied a total of nine fines for AML violations in the first quarter of the year. FINRA censured one member and fined it $3 million, according to the firm’s Letter of Acceptance, Waiver and Consent. The firm allegedly failed to detect and investigate red flags that indicated suspicious activity in microcap securities. The firm also allegedly failed to perform a periodic review of its foreign financial customers for which the firm executed transactions in microcap securities on a delivery versus payment basis.

The failures allegedly resulted from the firm’s flawed account opening process and inadequate ongoing monitoring process. According to FINRA staff, registered representatives assigned risk ratings to new accounts despite having inaccurate customer information. Accounts that did not match pre-defined risk parameters were automatically labeled as “low” risk and did not require review by the firm’s AML compliance officer (“AMLCO”), unlike accounts labeled “medium” or “high” risk. The AMLCO conducted 90-day lookback reviews on medium- and high-risk accounts, which generated the largest number of exception reports for the firm to review. The accounts that that traded in microcap securities and received a low-risk rating missed this additional layer of scrutiny.

The firm labeled three foreign financial institutions (“FFIs”) low-risk customers. Section 1010.610(a) of the Bank Secrecy Act requires members to establish and implement due diligence procedures to assess the AML risk posed by FFIs based upon a consideration of relevant factors enumerated in the rule3. The firm’s three FFIs did not disclose an anticipated activity involving microcap securities. However, an FFI customer liquidated over 260 million shares of microcap stocks. Due to their low-risk label, the account received no periodic review for potential suspicious activity and reporting to the Financial Crimes Enforcement Network.

Margin

FINRA censured a broker-dealer and fined it $2,750,000 for failing to comply with Securities Exchange Act of 1934 Rule 15c3-3(b)(1)4. Rule 15c3-3, commonly referred to as the “Customer Protection Rule,” requires broker-dealers to have possession and control of all fully paid and excess margin securities, and to segregate these securities in locations permitted by the rule.

The firm’s control system allegedly contained a design flaw that allowed certain securities to be released from segregation when no excess amount existed. According to FINRA staff, the firm erroneously understood that certain customer securities had been segregated when, in fact, the firm never processed the segregation. FINRA found instances of intraday deficits that ranged in value from $100,000 to roughly $1.5 million. The firm segregated customer shares at the end of the business day to correct intraday deficits in its securities counts, but the firm did not have procedures in place to investigate the cause of the deficits or to prevent the creation of intraday deficits during FINRA’s review period.

Consolidated Reports

FINRA censured and imposed a joint fine on two affiliated broker-dealers for failing to supervise the consolidated reports that its registered reps provided to customers. Consolidated reports combine a customer’s financial holdings held at the firm and away from the broker-dealer. Firms are required to review consolidated reports for fairness and accuracy, since FINRA considers the reports communications with the public subject to FINRA Rule 2210(d)(1)5.

For a period of six years, both firms allegedly reviewed only 2% of the consolidated reports generated by the firms’ registered reps. During supervisory reviews, the firms only reviewed the cover sheets, focusing on grammatical errors, customer contact information, and whether the reports contained required disclosures. In addition, after the firms generated reports, they had no ability to track which ones they sent to customers. Different business groups were unable to provide proper supervision due to the size and complexity of the firms’ consolidated reporting program.

Members should maintain policies and procedures that address the dissemination of consolidated reports of financial holdings provided to customers. The procedures should also address how the designated principal of the firm approves the use of such communications.

Other Significant Events

FINRA has continued its focus on how firms review correspondence between registered reps and customers. Three members received a total of $1,137,500 in fines during the first quarter of 2017 for violations related to email and instant messaging reviews. One firm allegedly failed to evidence its timely completion of each of its monthly reviews of email communications and Bloomberg messages in four of the firm’s six business groups. FINRA censured the firm and fined it $125,000 for violations of FINRA Rule 3110(b)(4)6.

Firms should ensure that reviews of correspondence clearly identify the reviewer, the correspondence that was reviewed, the date of review, and any actions taken by the member as a result of significant regulatory issues identified during the review. Such reviews should also be completed in a timely manner.

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

  • FINRA Rule 2360(b)(5)
  • 31 CFR Section 1010.610(a)
  • SEC Rule 15c3-3(b)(1)
  • FINRA Rule 2210(d)(1)
  • FINRA Rule 3110(b)(4)

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 provides a summary of actions taken by FINRA year-to-date.


1See FINRA Rule 2360(b)(5)
2See FINRA Rule 4530(b)
3See 31 CFR Section 1010.610 Due Diligence Programs for Correspondent Accounts for Foreign Financial Institutions
4See Rule 15c3-3(b) Customer Protection Rule
5See FINRA Rule 2210(d)
6See FINRA Rule 3110(b)(4)