Broker- Dealer Law Corner

Broker- Dealer Law Corner

FINRA Touts The Fact That Its Examinations Need Not Be “Fair”

Posted in Disciplinary Process, Enforcement, Examination, FINRA

While I feel I have enjoyed as much success defending respondents in FINRA Enforcement matters as anyone, I am still careful to caution clients who are unwilling to consider any settlement that going toe-to-toe with FINRA at a hearing is always a difficult proposition, even though they are presumed innocent and FINRA bears the burden of proof. No matter the facts, no matter the allegations, magically, decisions by the Hearing Officer, and by the panel itself, seem to go FINRA’s way. It is, simply, very hard to convince anyone that FINRA is even capable of being wrong. About anything.

Take this example, found in a NAC decision released last week. The case involved an alleged failure by a BD to conduct on-site branch audits. FINRA’s interest got initially piqued when it conducted a routine exam of a particular branch office that was supposed to be subject to monthly on-site visits, as a consequence of the fact that the RR in that office was subject to a Heightened Supervision Plan that included such a requirement. During the course of that exam, the RR initially told the examiner that those exams hadn’t happened, but then he changed his story and told FINRA that, in fact, they had happened.

Given that interesting development, FINRA elected to expand the exam, to see if other branch audits had taken place. I have no problem with that decision; indeed, that’s how audits are supposed to work. But, here is where it gets truly scary. Rather than test a random sample of the firm’s branch offices, FINRA deliberately restricted its review only to former RRs of the firm, i.e., guys who no longer worked there. Many of whom, admittedly, carried a grudge against the firm. From that limited, intentionally skewed sample, FINRA got a few people to claim that the annual visits hadn’t happened, and, based, on that, brought an Enforcement action.

If I stopped here, I think you would agree that this is already bad enough. Everyone understands that FINRA exams don’t look at everything a BD does; that would be impossible. Rather, the exams focus on some sample of the firm’s business, and, if that sample yields funky results, then the sample is expanded. The thing is, the initial sample is supposed to statistically significant. I am not a statistician, but I understand enough to know that if you deliberately skew the sample in one direction, the results are immediately and obviously subject to question. That is exactly what happened here, when FINRA chose only to talk to former RRs of the firm. For that reason alone, the exam results should have been deemed by Enforcement to be flawed, and the referral by Member Reg to Enforcement should have been denied. Instead, Enforcement gladly shrugged off the problem and blithely proceeded with the case.

But, it gets worse. At the hearing, perhaps in anticipation of cross-exam, the FINRA Enforcement lawyer questioned the examiner about the decision to restrict the follow-up exam only to cherry-picked former RRs. In a display of hypocrisy that rivals that of any politician, the examiner swore under oath that she consciously didn’t reach out to current RRs because she “didn’t want to disrupt [the firm’s] business.”[1] I’m sorry, but are you kidding me? This sworn testimony comes from an examiner who works for a regulator that, among other things, happily conducts surprise exams, arriving unannounced with a team of people who upon arrival don’t exactly sit quietly in a conference room, studiously careful not to disturb anyone. A regulator that routinely sends lengthy and serial 8210 requests that take hours, or even days, to respond to, time that would otherwise be spent on “business.” A regulator that is comfortable “requesting” that individuals travel at their own expense great distances to supply sworn testimony at OTRs, taking days out of their workweek. I thought it was laughable when Secretary of Commerce Wilbur Ross testified that the desire to add the citizenship question to the upcoming 2020 census was out of concern for the enforcement of the Voting Rights Act, but, compared to that, this testimony from the FINRA examiner may be the funniest thing I ever heard.

And, it gets worse.

On appeal to the NAC from the hearing panel’s decision, the respondents appropriately complained about the patent unfairness in the exam, citing Section 15A(b)(8) of the Exchange Act, which requires that FINRA provide a “fair procedure.” Well, it seems that the fairness requirement “does not extend to investigations.” According to the SEC authority cited in the NAC decision, only the adjudicatory proceeding has to be fair, apparently, but not the exam that leads to the proceeding, which commences with the filing of the complaint. So, anything that happens up to that point, since it is not part of the proceeding, need not be fair. With that in mind, the NAC just ignored the problem with the biased exam sample that FINRA selected, and, focusing exclusively on the proceeding, concluded there was no unfairness.

It is, frankly, difficult to believe that FINRA is content to operate under such a silly standard of conduct. I have repeatedly complained that FINRA rarely holds itself to the same standards as those to which its member firms are held, and that if it had to do so, it would routinely come up well short. This is just one more example of that, granted, a pretty gruesome example. So what is the solution to an exam that is being conducted in an unfair manner? Complain to the Ombudsman? Complain to Robert Cook himself? Sadly, I don’t have a good answer. But, I can tell you that you cannot count on the hearing panel to care, or the NAC, or even the SEC, since they seem only to care about fairness once you’ve been named as a respondent. Political action, as slow and uncertain as that is, may represent the only solution to this problem. Get involved, then, with FINRA, and express your views. Loudly, if necessary. Otherwise, the next time it might be you.

[1] The examiner testified that there was a second reason, as well, that she felt the firm’s owner had influenced the RR to change his story regarding whether the monthly heightened supervisory audits had taken place, and she wanted to avoid a recurrence of that. Naturally, the hearing panel bought that story, too.

Do Customers Actually Use BrokerCheck? This FINRA Complaint Suggests They Don’t

Posted in BrokerCheck, Enforcement, FINRA

I heartily endorse this post from my colleague, Chris, who’s been quiet of late.  It says a lot about FINRA, in terms of how it deigns to spend your assessment money, how fairness in the Enforcement process can be completely illusory, and how it is consistently unable to convince much of the investing public that it is serving any real function. – Alan  

FINRA’s mission is “investor protection.” In furtherance of that goal, FINRA has devoted significant resources to its BrokerCheck database, which allows investors to look up their broker, or potential broker, and check his or her background for any red flags that might give the investor reason to shy away from that broker. Basically, FINRA wants you to know which brokers might be “bad seeds” so that you, as an investor theoretically concerned with safeguarding your money, will avoid giving it to anyone with a less than perfectly clean past. And by perfectly clean, I mean perfectly – not only does FINRA want investors to know about past customer claims and regulatory actions brought against the broker, but also past terminations, tax liens, and bankruptcies. In theory, if an investor sees any of these things on his broker’s BrokerCheck report, the investor will run the opposite direction with his or her money. But does that really happen?

A recent Complaint suggests the answer is “no.” FINRA’s Complaint alleges that two brokers, Kim Kopacka and Beth Debouvre, allowed Ms. Kopacka’s husband to conduct securities business and sell securities through a member firm, despite the fact that FINRA barred him from the industry in 1998. In essence, the Complaint alleges that after Mr. Kopacka was barred from the industry, his wife became registered and set up an office where Mr. Kopacka continued meeting with clients and selling them securities. Allegedly, his wife had no involvement with the clients and simply listed her name on paperwork as the registered representative of record handling those clients and those transactions. The Complaint alleges that from 2002 to 2016, Mr. Kopacka sold over $40 million in private placement securities to over 280 different customers – all while being barred from the industry.

If the conduct alleged in the Complaint is true (and that’s a big “if”), it raises several interesting questions. The first question that comes to mind is, why did it take FINRA 15 years to figure this out? The office where Mr. Kopacka was allegedly operating consisted of only himself, his wife (who was almost never present, allegedly), and a supervisor. Didn’t any FINRA audits of the office take place in 15 years? Didn’t anyone notice that a registered rep who was barred from the industry has a spouse who only took interest in becoming registered after her husband was barred, and that she suddenly started selling millions of dollars of unregistered securities, despite the fact that she had zero experience in the industry? And, how can FINRA bring a case against these reps for conduct that started (and arguably should have been detected) over 15 years ago? What about statutes of limitations? If you are interested in that issue, check out our prior blog post here.  The short answer is, traditional statutes of limitations do not apply to FINRA Enforcement actions. So, yes, you might be forced to defend something that you did in the prior millennium.

The other interesting question is, how did over 280 customers allegedly think it was a good idea to take investment recommendations from someone who was barred from the industry? There are only two answers: either they didn’t know that Mr. Kopacka was barred, or they didn’t care. Now, BrokerCheck has been available online since 1998, and it was significantly updated in 2007 to include many additional disclosures about brokers. If you search BrokerCheck for a person who has been barred, it is hard to miss the warnings that FINRA provides: on the search result page, the broker’s name will be inside a red box, and the word “BARRED” will appear in bright red directly under his or her name. If you click on the details for that person, FINRA will explicitly tell you that “FINRA has barred this individual from acting as a broker or otherwise associating with a broker-dealer firm.” It’s pretty hard to miss.

So, in Mr. Kopacka’s case (if FINRA’s allegations are true, and again, that’s a big “if”), the fact that Mr. Kopacka was barred was available to 280 customers and yet they allegedly decided to hand Mr. Kopacka over $40 million anyways. It’s probably safe to assume that 280 customers would not knowingly invest with someone who was barred from the industry, just like 280 people probably would not go to a doctor or any attorney if they knew his or her license had been taken away. So those 280 customers either didn’t know that BrokerCheck existed, or they chose not to use it. Both of those scenarios pose a problem for FINRA and its goals of protecting investors, particularly the casual investor.

FINRA often considers increasing the amount of information available on BrokerCheck. FINRA also makes it difficult for brokers to expunge information from their CRD records that appears in BrokerCheck (and FINRA is considering additional rules that will make expungement even more difficult). But, if customers are not actually using BrokerCheck to research their brokers, like the 280 investors in this case apparently didn’t do, then it doesn’t matter how many disclosures are made on the system.


FINRA Proposes To Dispense With Due Process, All Because It’s Failed To Do Its Job Of Policing The Markets

Posted in Disciplinary Process, FINRA, High-Risk firms

Reading Reg Notice 19-17 makes me think of the legal arguments that I’ve recently read regarding whether a president can be found guilty of obstructing justice if the actions in question were taken out in the open, for everyone to see. Here, FINRA’s proposed power grab is simply outrageous, but, you got to give them credit, it is certainly being done right out there for everyone to see. It doesn’t make it right, however, no more so than tweets designed to intimidate witnesses or steer DOJ investigations.

This is a long, sometimes boring Reg Notice. I wonder if, perhaps, FINRA didn’t deliberately publish a 43-page bear of a document, burdened with charts and 53 footnotes, with the specific intent of dissuading people from reading the whole thing, and figuring out what it’s all about. Lucky you, though, as I read it for you. And, frankly, if you harbor any degree of affinity for concepts like due process or presumption of innocence, you would undoubtedly be appalled by the time you finish it.

The notice addresses FINRA’s recently contrived concerns about “high-risk” firms. According to FINRA, there are certain firms that “have a history of misconduct” with “persistent compliance issues.” According to FINRA, academic studies statistically prove that these firms – which are called “Restricted Firms” here – are more likely than other firms to have disciplinary issues going forward. While FINRA claims that such firms have been “a top focus of FINRA regulatory programs,” it nevertheless complains that its “existing examination and enforcement programs” are inadequate to address the threat that these firms present. So, FINRA is offering a solution.

Before I get to that, let me first revisit what continues to remain a sore point for me. FINRA’s public stance is to express its dismay, even outrage, that these firms with relatively extensive regulatory histories still manage to exist, notwithstanding everything that FINRA has thrown at them from its already considerable arsenal of regulatory weapons. What FINRA has steadfastly refused to concede, however, is that the fact these supposedly terrible firms, firms that FINRA insists manifest a statistically proven likelihood of continuing misbehavior, have not yet been expelled from the industry is either (1) FINRA’s fault, or (2) because expulsion wasn’t necessary. How, after all, does a BD get a regulatory history? When it is named as a respondent in a disciplinary action. Who brings those actions? FINRA. Who decides what charges to file? FINRA. Who decides what sanctions to impose? FINRA. If FINRA has not been able to bring a disciplinary action against a “high-risk” firm that included charges or resulted in findings sufficient to result in the BD getting kicked out of the industry, it can only mean one of two things: either FINRA didn’t do its job, or, equally possible, the firm simply didn’t deserve to be expelled. With the current proposal, however, FINRA urges readers to conclude that these firms continue to operate, like cockroaches after the nuclear apocalypse, not because FINRA hasn’t been tough enough, and not because the evidence wasn’t there to justify an expulsion, but, rather, because FINRA’s existing regulatory tools are somehow inadequate. I just don’t buy that.

Ok, let’s get to the proposal. As I have previously complained about, the starting point for this proposal is FINRA’s need to define what a “high-risk” or “Restricted” firm is. No such definition exists, of course, so FINRA has to conjure one up. To do this, FINRA suggests a multi-step process, I suppose designed to give some impression of fairness, but which, ultimately, boils down to this: a firm is “high-risk” simply because FINRA says it is.

What FINRA proposes to do is create a quantitative standard for each firm, comprised of six bad facts about the firm and the firm’s registered persons. You give the firm a point for each bad fact – “adjudicated”and “pending events” for both the firm and its reps, plus terminations and internal reviews of reps – add them up and divide by the number of reps at the firm, yielding the “average number of events per registered broker.” Then, you take the number of reps at the firm who came from a “previously expelled firm,” divide that by the total number of reps, resulting in a percentage concentration.

Armed with these data, FINRA will then numerically compare the firm to its peers, based on size. (FINRA proposes seven size categories, “to ensure that each member firm is compared only to its similarly sized peers.”) While there are some nuances to that comparison, essentially, if the firm sticks out from the pack in a bad way, based solely on this quantitative analysis, it is deemed, at least preliminarily, to fall within the new rule.

But, it wouldn’t be fair to label a firm bad based solely on numbers, right? So, the next step in the process is that FINRA then conducts an “initial internal evaluation.” The stated purpose of this evaluation is “to determine whether [FINRA] is aware of information that would show that the member – despite having met the Preliminary Criteria for Identification – does not pose a high degree of risk.” In other words…based on FINRA’s subjective consideration of the data – data that FINRA compiled pursuant to its own criteria – FINRA could step in and tell, um FINRA, that the firm ought not to have been branded as high risk. I have got to tell you, based on my historical dealings with FINRA, I am not putting a whole lot of faith in the reasonableness of any decision that FINRA might be called upon to make at this step of the process, i.e., to second-guess its own preliminary decision.

Ok, so let’s assume that FINRA doesn’t talk itself out of characterizing a firm as high-risk. The next step is that FINRA will give the firm a chance to terminate as many of its reps as necessary to reduce the bad points it accumulated in step one, the points that resulted in the firm being identified in the first place. It’s a lot like the deal already in place under the existing “Taping Rule,” when a BD hires enough reps who came from expelled firms to be forced to tape record all of its reps’ phone conversations. It’s a one-time deal, and the firm would also have to agree not to rehire any reps it fires for a year.

As gruesome as this sounds so far, the next step is even worse, and, by FINRA’s own admission, the most punitive. If a firm is still deemed high-risk at this point, FINRA will then turn its attention to calculating a number meant to represent the most money and securities that it could possibly require the firm to deposit in an account, assets which the firm cannot touch without FINRA’s approval, indeed, even if the firm goes out of business.[1] In short, FINRA proposes to make these firms deposit a whole bunch of money in an account with one essential purpose: to satisfy customer arbitrations. (Did PIABA write this rule??)

FINRA knows this will sting, and, frankly, it couldn’t care less. Indeed, it wants it to sting. FINRA admits that its “intent is that the maximum Restricted Deposit Requirement should be significant enough to change the member’s behavior but not so burdensome that it would force the member out of business solely by virtue of the imposed deposit requirement.” How nice. How magnanimous of FINRA! How industrious and clever! To be able to determine the “maximum” – its word, not mine – amount that it can require a firm to pony up as ransom, in effect, without having to declare bankruptcy. I eagerly look forward to the comments this is going to generate. And I hope that some focus on the use of the word “solely,” which leaves FINRA all kinds of running room to trample the rights of its member firms.

In its next passing effort to demonstrate a modicum of fairness, FINRA proposes to include in the process as the next step a “consultation,” that is, an opportunity for an affected firm to rebut two presumptions, that it should branded a restricted firm, and that it should be subject to the maximum deposit. Once again, the result of this lies completely within FINRA’s sole and subjective determination.

Finally, if all other steps to get FINRA to change its mind have failed, the firm may request an expedited hearing before a FINRA Hearing Officer – the same group of folks who administer Enforcement actions – to challenge FINRA’s conclusions.

I realize that this all sounds pretty crazy. But, consider this: it is actually better than an alternative that FINRA admits it’s still mulling over, and that is what it calls a “terms and conditions” approach. FINRA indicates that it could easily be convinced that this approach, which is presently employed by IIROC, the Investment Industry Regulatory Organization of Canada, and clearly something that FINRA is jealous of, would work best to address firms that “typically have substantial and unaddressed compliance failures over multiple examination cycles that put investors or market integrity at risk.” Under the “terms and conditions” regime, the regulator simply gets to decide that a firm is a problem, and unilaterally impose terms and conditions on the firm if it wants to continue to operate.[2] According to IIROC (at least as FINRA describes it), it utilizes this approach when “there are outstanding compliance issues that clearly require regulatory action, but that may be best addressed through an enforcement hearing.” On reflection, I think FINRA goes to the trouble of describing “terms and conditions” as a scare tactic, to make the ridiculous “Restricted Firm” approach sound reasonable by comparison.

In conclusion, I have read this horror show of a Notice several times, and I am still left asking, exactly what situation cannot be addressed adequately through the Enforcement program? The Enforcement scheme is hardly perfect, but at least there some deference is – by rule – paid to due process. A respondent is deemed innocent until proven guilty, and FINRA bears the burden of proof. The respondent may continue to operate despite the charges being outstanding. No deposit, of any size, has to be made as a condition of continued operations. The bottom line is that FINRA never adequately explains why its existing procedures can’t do the trick. And the reason for that is that it can’t.

FINRA’s real problem is that it simply doesn’t like having to jump through the procedural hoops that presently exist, hoops that provide safeguards to respondents. FINRA doesn’t like to have to prove its allegations. Just consider this whining, found early on in the Reg Notice: “Parties with serious compliance issues often will litigate enforcement actions brought by FINRA, which potentially involves a hearing and multiple rounds of appeals, thereby effectively forestalling the imposition of disciplinary sanctions for an extended period.” Gee, wouldn’t it be easier if we can forego the complaint, the hearing, the evidence, and jump right to sanctions? THAT, my friends, is what FINRA is proposing here.



[1] Because any cash in such an account could not be readily accessed, the proposed rule requires that such deposits be deducted when determining net capital!

[2] The terms and conditions can be appealed, but, notably, they are NOT stayed during the pendency of the appeal.

FINRA’s Proposal On High-Risk Firms Is A Must-Read, But Hardly A Must-Enjoy

Posted in FINRA, High-Risk firms

I apologize for all the posts this week, but I am traveling and am in a different time zone, so I am awake at hours when, ordinarily, I would be asleep, giving me time to muse.  Anyway, given that, I will not test your willingness to indulge my random thoughts a third time in one week.  But…you ought to be aware of what FINRA did yesterday, when it published Reg Notice 19-17.  As I have been following closely, FINRA has made it its mission in life to go after firms that it self-describes as bad — although FINRA uses the less pejorative term “restricted.”  To do this, FINRA first has to invent the standard — a quantitative standard, mind you — that it will use to identify these firms.  Then, it has to invest a mechanism for dealing with these firms.  The problems that I was able to spot in one quick read are really, troubling.

But one quick read won’t do it.  I am going to have to dig in on this.  I urge you to do the same.  I will post something next week, but, in the meantime, read this Reg Notice.  See whether you think FINRA deserves the right to dispense with due process, whether it should have the right to forgo the need to bring Enforcement actions and actually prove a case against an entity presumed to be innocent, whether it can essentially impose another net capital requirement on those firms it decrees to be bad; indeed, see if you even agree that there is a problem that needs to be addressed, or, if there is a problem, whether FINRA itself has caused it through its own inability to regulate this industry.

I have read, and I certainly agree, that trust must be earned, not expected.  I, for one, am not convinced that FINRA deserves the trust it is asking for in this proposal.  But, let me read it over the weekend, and get back to you next week with the ugly details.


Voya Settlement Shows That Self-Reporting To FINRA Can Pay Off

Posted in Disciplinary Process, Enforcement, FINRA, Sanctions

I have written before about the troubling lack of clarity regarding the tangible benefit of self-reporting rule violations to FINRA. While FINRA purports to provide some potential advantage for doing so, it is so awfully loosy-goosy that it remains a relatively uncommon occurrence. That’s why when a case comes down that provides some clear indication (1) that there is, in fact, a benefit of self-reporting, and (2) what that self-reporting must look like to actually get some real credit for it, it is worth talking about.

Last week, Voya Financial Advisors entered into an AWC with FINRA to settle some supervisory charges relating to its sales of mutual funds. According to the facts outlined in the AWC, for over seven years, Voya failed to reasonably supervise the share class of mutual funds that it was selling to certain retirement plan and charitable organization customers. As a result of that failure, these customers either bought Class A shares and paid a front-end sales charge despite the fact a waiver of that charge was available, or were inappropriately sold Class B or C shares with a back-end sales charge and higher ongoing fees and expenses. Either way, it cost these customers more to buy these mutual funds than it should have, and had Voya had a better supervisory system, it wouldn’t have taken seven years for the firm to figure this out.

But, that’s not the story of this case. The story is that even though it took a long time for Voya’s lightbulb to go on, it still managed to illuminate before FINRA examiners could find the problem themselves, and the firm took significant steps right away to address the problem. Here’s how it played out.

In November 2015, the firm apparently determined it had an issue, and began an investigation of its sales of mutual funds to retirement plans and charities. About six months later, Voya formally self-reported to FINRA its problem. FINRA requested that Voya conduct a five-year look-back, to quantify the scope of the problem. For whatever reason, Voya decided that wasn’t good enough, and so volunteered to expand the look-back by an additional two years. Voya ultimately calculated that as a result of the over-charges, it owed its customers about $126,000, inclusive of interest. Of that sum, it is notable that nearly half was related to sales that had been made in the two-year time period that Voya voluntarily added to FINRA’s mandated look-back period.

In light of all the circumstances, particularly what FINRA characterized as Voya’s “extraordinary cooperation,” no fine was imposed in the AWC.

So, how do you, or your clients, achieve this same result? Simple, just follow Voya’s blueprint, as outlined in the AWC:

  1. Initiate your own internal investigation “prior to detection or intervention by a regulator”;
  2. promptly self-report to FINRA;
  3. voluntarily expand the look-back period that FINRA requests;
  4. establish a plan of remediation for customers who were impacted by your supervisory failure;
  5. promptly take action and remedial steps to correct the violative conduct; and
  6. take corrective measures, prior to detection or intervention by a regulator, to revise your procedures to avoid recurrence of the misconduct

I get that step (3) may not be applicable in all cases, and, even when it is applicable, there is no guarantee that you’ll “get lucky” like Voya and have that additional time period result in materially higher restitution to your customers, but, really, step (3) is just a bonus. It is the other five steps that will serve to augment your chances of avoiding a fine.

Bottom line, this is a good thing, and a positive development for FINRA. I mean, this makes two cases in two weeks – see my earlier blog on the Buckman settlement – in which FINRA has acted downright reasonably in terms of meting out sanctions, at least in settled cases. Let’s hope it’s just the start of a new trend.


The Folly Of ADV Disclosures: What The Robare Decision Teaches About Trying To Do It Right

Posted in Form ADV, RIA, SEC

Most of the time, the cases I write about were some other lawyer’s. In some respects, it’s easier to offer comments when it isn’t my case. I can, hopefully, be more objective, less pissed off (when the result is one I disagree with, of course), and content merely to mine the case for interesting lessons applicable to all my readers. This post, however, is entirely personal. It concerns a case that my colleague and partner, Heidi VonderHeide, and I have been working on for years for two guys – Mark Robare and Jack Jones, who own and run The Robare Group, an RIA in Texas. These are two people that anyone would be proud to represent, and who epitomize the kind of advisors that you would be comfortable recommending to your own mother to handle her nest egg. You probably think I’m biased – and perhaps I am – but even the judge who oversaw the trial stated, in his opinion, that he found Mark and Jack to be “honest and committed to meeting their disclosure requirements” and that it was “difficult to imagine them trying to defraud anyone, let alone their investment clients.”

Finally, Mark and Jack are nearing the end of what turned into a long, difficult road to clear their name. Yesterday, the D.C. Circuit Court of Appeals handed down its decision in what’s become known in legal/IA circles as the “Robare case.”

I have to concede at the outset that while the sanctions the SEC imposed against Mark and Jack were vacated, which is worth celebrating, we didn’t come away with a clean victory, as the court upheld one of the two violations that the SEC found, and remanded the case back to the SEC to determine what the appropriate sanctions – if any – ought to be now, in light of the court’s ruling.

Nevertheless, despite the finding, I can’t help but feel that Mark and Jack won. And I challenge anyone who takes the time to read the decision (and its genesis, especially the ALJ’s Initial Decision, which dismissed ALL of the SEC’s charges) to reach a contrary conclusion. The fact is, while the court partially agreed with the SEC (which had been forced to argue on appeal against the findings of its own ALJ, who had decided to dismiss all charges), the specific findings that were made by all three factfinders amply demonstrate that all my clients are “guilty” of is trying their absolute best to “meet their disclosure requirements.” The fact that THAT failure can nevertheless constitute the basis for a finding that they violated the Investment Advisors Act is, simply, silly.

And, if you work in compliance, what happened to Mark and Jack should keep you up at night.

The pertinent facts of the case aren’t too difficult to understand. Mark and Jack create model portfolios for their advisory clients comprised of no-transaction-fee mutual funds. They pick their funds from a wide variety of fund families available to them on Fidelity’s platform, based strictly on whether the funds are good performers. At one point in time, the BD with which they were – and still are – associated informed them that Fidelity offered a program that would pay them a small fee if they happened to select “eligible,” non-Fidelity NTF funds for their customers. Considering it, their sole question for Fidelity was, if they elected to participate in the program, would they be forced to select funds they otherwise would avoid, or avoid funds they would otherwise choose. They were told, no, they could continue to choose their mutual funds based on their existing, objective criteria. If one of the funds they chose happened to be “eligible” they would receive a fraction of the fund fee paid to Fidelity.

Based on that representation, they entered into a written, tri-party agreement among themselves, Fidelity and their BD. Fidelity never told them which mutual funds were “eligible” for the fee sharing, but Mark and Jack didn’t care, since they weren’t making their investment decisions based on whether the particular mutual funds they chose for their model portfolios resulted in them getting the fee. Whatever fee payments were generated were paid quarterly by Fidelity through their BD as a commission. The BD took its normal, small percentage (in accordance with the existing commission agreement between them) and the remainder was paid to The Robare Group.

Mark and Jack may be experts at making investment decisions for their advisory clients, but they are admittedly not experts at understanding what language should be used in crafting Form ADV conflict disclosures. That is hardly a knock on Mark and Jack. As our witnesses – both fact and expert – testified at the trial, the SEC’s standard for proper disclosure of conflicts of interest was a “moving target.” The scant guidance offered by the SEC was broad and general, and not of much help. Accordingly, every single time Mark and Jack filed their Form ADV, they first obtained qualified assistance. Over the years, they engaged three different compliance consultants for help with their ADV, and they never submitted a Form ADV without the help of a consultant. In addition, they paid their BD a fee in exchange for supervisory/compliance review, including review of the Form ADV disclosures.

Having surrounded themselves with experts and advisors, they firmly believed that any conflict of interest, whether actual or potential, that was created by the deal with Fidelity was adequately disclosed to the world on their Form ADV. They testified – and it was not rebutted any witness the SEC called – that anytime anyone told them to make a change to their ADV, they said, “no problem,” and promptly made the amendment.  In fact, in the middle of the time period at issue here, The Robare Group was audited by the SEC and that audit included a review of the Form ADV. In the end, the SEC examiners expressed no problems whatsoever with the Firm’s disclosures.

Despite all that, many years later, the SEC concluded that Mark and Jack’s ADV failed to disclose the conflict the Fidelity program created. The SEC offered them the chance to settle, and even though it was a “neither admit nor deny” deal, it still included a finding that they had violated an anti-fraud provision of the Advisors Act. While that would have been the easy – and certainly cheaper – way out, Mark and Jack couldn’t do it. They did not believe they committed fraud, and would not sign a settlement agreement that made such a finding. So, off we went to trial with the SEC’s Division of Enforcement.

You have undoubtedly read all the literature out there taking issue with the SEC’s increased use of administrative proceedings in recent years, rather than litigating in court. For years, the SEC ferociously defended its right and ability to bring cases before its own ALJs. The Supreme Court, of course, recently reached the opposite conclusion, finding that the SEC’s ALJs had been unconstitutionally appointed. That aside, however, from a statistical point of view, you can’t argue with the SEC’s choice of forum: rightly or wrongly, the SEC won almost every case it filed before an ALJ.

But not this case. Mark and Jack beat the odds and won their case. ALJ Grimes, after hearing the evidence, dismissed all charges against Mark and Jack. In my favorite line from his Initial Decision, worth quoting again, he said this: “[I]n listening to Mr. Robare and Mr. Jones testify and observing their demeanor under cross-examination, it is difficult to imagine them trying to defraud anyone, let alone their investment clients.”

The Division of Enforcement appealed the dismissal to the Commission. It’s worth pausing briefly here to remember that the Commission is the very entity that authorized the filing of the case in the first place. Then, on appeal, it sits as the appellate body where, because it’s a de novo review, it is empowered to agree with, disagree with, or modify the factual or legal findings of the ALJ however it likes.

Not surprisingly, when presented with this rare instance where an ALJ bucked the statistics and dismissed the case, finding it devoid of the required evidence, the Commission reversed, although not entirely. The Commission agreed with the ALJ that there was simply no evidence of intentional conduct. It found instead that my clients acted negligently, and that they “willfully” violated Section 207 in submitting the Forms ADV. The SEC is empowered to assess first, second, or third tier monetary sanctions where someone willfully violates the Act. Here, the Commission imposed second tier sanctions (i.e., aggravated sanctions), notwithstanding the ALJ’s findings. Notably, though, the imposition of sanctions was a split decision, with one Commissioner determining no sanctions were warranted.

We then appealed to the DC Circuit, our first foray into “neutral territory.” Well, as noted above, the court didn’t entirely buy our arguments. In the most perplexing finding I can imagine, the court concluded that although Mark and Jack subjectively believed that their Form ADV was complete and accurate, based on their decision to let experts handle that difficult task, they were still “negligent.” Negligent, it seems, because even though they realized they didn’t know enough about the standards governing the disclosures in Form ADV to be able to draft them themselves, according to the court, they somehow should nevertheless have known that the disclosures drafted by their paid experts were “plainly inadequate.”

So, Mark and Jack hired experts to draft their ADV disclosures because they were NOT expert at that. Yet, they were supposed to have realized that the language their experts drafted, language that was reviewed and approved by their BD, language that was reviewed by SEC examiners, and language that the ALJ found to be just fine, wasn’t just inadequate but “plainly inadequate.” That, my friends, is a standard that exists only in the minds of jurists, but not in the real world. There is no one who could successfully thread that needle.

And that is why you can see how I am able with a very straight face to say that Mark and Jack won. Everyone agrees that they had no scienter. Heck, they didn’t even act willfully (which is why the Section 207 claim was dismissed, something for another blog post, another day). They tried their level best to meet a standard of disclosure that, apparently, even industry experts could not successfully figure out. If that makes them guilty of committing fraud, then there is a real problem with the very law they supposedly violated. That mere negligence, indeed, negligence accompanied by a good faith intent to do the right thing, can still be deemed fraudulent, is utterly nonsensical and absurd.

We are not going to ask the Supreme Court to consider this case, but I wonder…..




FINRA AWC Includes Waiver Of A Fine: Is This A Sign Of Good Things To Come?

Posted in Disciplinary Process, Enforcement, FINRA, Sanctions

Way back in 2006, NASD issued Notice to Members 06-55, which tweaked the Sanction Guidelines to allow not just the size of the firm to be taken into consideration when determining the appropriate sanctions to be meted out, but, more importantly, how well, or how poorly, the firm is doing on its income statement. Specifically, the NTM resulted in a change to the Guidelines that explicitly permitted the consideration of “the amount of the firm’s revenues” and its “financial resources.” In addition, for “violations that are neither egregious nor involve fraud of the firm,” NASD gave the greenlight to adjudicators not just to “impos[e] a sanction that is proportionately scaled to the firm’s size,” but to “reduce the level of the sanction below the minimum level otherwise recommended in the Guidelines.”

That was over a decade ago. In my experience, unfortunately, it never amounted to much in real terms. FINRA Enforcement lawyers have never paid much attention to pleas for reduced fines based on a respondent firm’s financial condition. Rather, the typical response is that the sanctions sought in a given case must be viewed relative to other cases involving similar misconduct, which means that the sanctions can’t deviate much from whatever norm already exists for that misconduct as established by prior settled or litigated cases.

Well, this week, FINRA released an AWC in which it allowed the BD respondent to avoid paying any fine whatsoever, citing NTM 06-55. This was so crazy, so out of character for FINRA, that it had to take the relatively unusual step of issuing a Press Release for an otherwise unremarkable case, I guess in anticipation of all the head-scratching that the fine waiver would undoubtedly trigger.

The case itself, as I suggested, is pretty vanilla. It concerned the failure by the firm and one of its owner/principals to exercise reasonable supervision over a couple of registered reps who reported to him. The two reps both were guilty of making unsuitable recommendations, specifically, quantitatively unsuitable recommendations. (FYI, FINRA barred both of them. Shocking.) Turns out that both of the reps were trading some of their customer accounts excessively, and one of the reps also made recommendations that resulted in accounts that were over-concentrated in certain positions. The AWC includes findings that the firm’s WSPs were deficient, and also that the firm and the supervising principal failed to detect the trading issues, or, when detected, to take any appropriate responsive action.

As a sanction, the firm was required to pay restitution to the affected customers of just over $200,000, but – here’s the punchline – there was no fine. (The individual respondent was suspended as a principal for three months, fined $20,000, and required to take some continuing education.) In a footnote, the AWC recites that no fine was imposed on the firm due to its “revenues and financial resources, as well as its agreement to pay full restitution.”

Wow! As I said, it is super common to ask FINRA to consider waiving a fine, but rare that such a request gains any traction. So rare that Susan Schroeder, the head of FINRA’s Enforcement Department, felt it necessary to offer a public comment on the case. Bear in mind that FINRA doesn’t issue that many press releases in the course of a year regarding its Enforcement actions, and, when it does, it typically reserves its comments for really big cases, involving lots of firms and big dollar sanctions. This AWC is small potatoes, sanctions-wise, yet it merited a press release. That fact alone requires that we pay close attention to this case.

So, what did Susan say about the fine waiver? Here is her quote:

In this matter, FINRA has prioritized ensuring that affected customers receive full restitution, the firm fixes its supervisory flaws, and the responsible supervisor is held accountable and receives additional training. Due to the firm’s financial condition, FINRA did not impose a fine in addition to these other sanctions – the firm’s limited resources are better spent on remedial measures designed to prevent similar misconduct in the future.

This is, um, reasonable. Not sure what else to call it. FINRA holds itself out to the world as an entity interested in “investor protection,” but too often, it seems way more interested in using its member firms as punching bags. As a guy who exclusively represents respondents in FINRA Enforcement actions, it is really, really welcome news that, perhaps at last, FINRA is paying attention to its corporate mandate.

The notion that FINRA may actually take me seriously the next time I have a small BD client with limited financial resources that doesn’t deserve to be pushed to the financial brink as the result of an Enforcement action leaves me hopeful for the future. As long, that is, as FINRA is consistent with its approach, and doesn’t treat this AWC as an aberration, a one-off case that is never to be replicated. As with many things FINRA does, I suppose only time will tell if this represents a true change in its historic approach, or whether it’s more lip service.

The SEC Released A Risk Alert On Reg S-P, a/k/a How To Avoid A $1 Million Penalty

Posted in Examination, Privacy, Reg S-P, SEC

I am hardly saying that SEC Regulation S-P is the sexiest of regulations. I mean, has any customer is history actually read one of those exciting statement stuffers that discloses in some dense font a BD’s privacy policy? Likely not, but, nevertheless, it remains that in this day and age, with hacking and phishing and cybersecurity a part of the everyday vernacular, Reg S-P is something that BDs cannot afford to be even slightly unfamiliar with.

Helpfully, last week the SEC’s Office of Compliance Inspections and Examinations (“OCIE”) released a Risk Alert “providing a list of compliance issues related to Regulation S-P,” which it described as “the primary SEC rule regarding privacy notices and safeguard policies of investment advisers and broker-dealers.” It is short, a mere four pages, and it is easy to read and digest, so I heartily recommend it to everyone. But, since it is my job to make your lives easier, let me provide a thumbnail of its contents.

What OCIE did was review the results of exams that it conducted of BDs and IAs to identify the typical Reg S-P related deficiencies its staff uncovered. And before you say who cares, consider that both the SEC and FINRA have brought a bunch of Enforcement actions based on Reg S-P violations. That includes a settlement with Voya Financial Advisors in September last year that resulted in a $1 million civil penalty, and another $1 million civil penalty in a 2016 settlement with Morgan Stanley. And if that’s not scary enough, then think about the fact that the SEC has demonstrated a willingness to name individuals for Reg S-P violations when appropriate. See this and this, for example.

Anyway, the exam deficiencies fall into a couple of broad categories. The first involves the obligations to provide Privacy and Opt-Out Notices. As I assume you know, Reg S-P requires that BDs provide an “Initial Privacy Notice” at the outset of a customer relationship that describes, clearly and conspicuously, the firm’s privacy policies and practices, plus an “Annual Privacy Notice,” which repeats what was said in the Initial Notice, plus an “Opt-Out Notice,” which provides customers the right “to opt out of some disclosures of non-public personal information about the customer to nonaffiliated third parties.” According to OCIE, the problems observed include some that are really basic and obvious, including not providing the Initial Privacy Notices, Annual Privacy Notices and Opt-Out Notices to customers, or providing notices that “did not accurately reflect firms’ policies and procedures.”

The next category involves the failure to maintain appropriate or reasonable policies and procedures to ensure compliance with Reg S-P. The biggest problem that the OCIE staff observed concerned policies that were not reasonably designed to safeguard customer records and information. This is the kind of thing you read about all the time, and likely get emails from your IT Department reminding you of your obligations to keep customer information confidential.

With regard to this last point, OCIE provided some specific and helpful observations about common deficiencies in policies and procedures regarding the confidentiality of customer personally identifiable information (“PII”):

  • failure to safeguard customer information on personal devices, such as where employees regularly stored and maintained PII on their personal laptops;
  • failure to address the inclusion of customer PII in electronic communications, such as employees who send unencrypted emails to customers containing PII;
  • Policies and procedures that appropriately required customer information to be encrypted, password-protected, and transmitted using only registrant-approved methods, but which, in practice, were ineffective because employees were not provided adequate training;
  • Failure to prohibit employees from sending customer PII to unsecure locations outside of the firm’s networks;
  • Failure to require outside vendors to contractually agree to keep customers’ PII confidential, even though such agreements were mandated by policies and procedures;
  • Failure to identify all systems on which customer PII was maintained (which can cause a firm to be unaware of the categories of customer PII being maintained);
  • Inadequate written incident response plans that did not address who was responsible for implementing the plan, the actions required to address a cybersecurity incident, and assessments of system vulnerabilities;
  • Unsecure physical locations for the storage of customer PII, such as unlocked file cabinets in open offices;
  • The dissemination of customer login credentials to more employees than permitted under firms’ policies and procedures; and
  • Allowing former employees to retain access rights after their departure, thereby potentially providing continuing access to restricted customer information.

According to the SEC, the “key takeaway” from the Risk Alert is this: “Through sharing some of the Regulation S-P compliance issues it observed, OCIE encourages registrants to review their written policies and procedures, including implementation of those policies and procedures, to ensure compliance with the relevant regulatory requirements.” I couldn’t have said it better. This is a wake-up call. Hit snooze at your own peril.

Is FINRA’s New Regulatory Notice On Departing Reps A Unicorn?

Posted in Disclosure, FINRA, Registered Representative

FINRA came out with a slightly weird Regulatory Notice last week. In a succinct document, barely over two pages, FINRA addressed something that may, or may not, actually be of concern to anyone. In short, Regulatory Notice 19-10 states FINRA’s position on what a broker-dealer is supposed to tell the customers of a registered representative who “departs” the firm…at least those customers who bother to ask. According to FINRA, the reason it has chosen to supply this guidance is “to ensure that customers can make a timely and informed choice about where to maintain their assets when their registered representative” leaves (for whatever reason). But, as I suggested at the outset, I am not entirely certain what prompted the Notice. Is it that BDs aren’t telling customers that their assigned rep have left (so they can try to keep the customer)? That they aren’t telling the truth about why they left (to avoid a possible defamation suit)? That they are taking steps to prevent customers from communicating with their “departed” former reps (again, for competitive reasons, presumably)?

Regardless, it is now clear what is supposed to happen when a rep leaves. And it boils down to just a few things.

First, firms need to have “policies and procedures reasonably designed to assure that the customers serviced by that registered representative are aware of how the customers’ account will be serviced at the member firm.” That means that when a rep leaves, the firm “should promptly and clearly communicate to affected customers how their accounts will continue to be serviced.” According to FINRA, this means explaining to customers “how and to whom” they “may direct questions and trade instructions following the representative’s departure.” It also means informing customers to whom their accounts are being assigned. That seems pretty self-evident, but, apparently, this has been an issue for some customers.

Second, and perhaps more significant, firms “should communicate clearly, and without obfuscation, when asked questions by customers about the departing registered representative.” Let’s unpack this.

My initial thought is, how interesting that, based on how this was phrased, FINRA only requires this sort of candid conversation in response to questions posed by customers. In other words, it appears that firms need not volunteer the reasons why a rep has left; but, if a customer is curious enough to ask, the firm then has to provide the sordid details, “[c]onsistent with privacy and other legal requirements,” of course. Like when selling a house. The seller doesn’t have to volunteer most hidden defects, but, if the prospective buyer asks, then the seller has the legal obligation to provide an honest and complete answer. I suppose this means that in cases of terminations for cause, mere disclosure on Form U-5 won’t suffice. I cannot imagine that firms are thrilled at the prospect of having conversations like this, given the willingness of many terminated reps to raise the prospect of an arbitration seeking damages for defamation. While truth is most assuredly a defense, we all know that in the funky world of arbitration, legally recognized defenses are often disregarded.

The next requirement outlined in this Notice is “clarifying that the customer has the choice to retain his or her assets at the current firm and be serviced by the newly assigned registered representative or a different registered representative or transfer the assets to another firm.” I can’t argue with this. Too many times, a rep’s departure is immediately followed by a fight over the customers left behind, who are subject to pressured calls from the jilted BD, encouraging them to stay or, worse, not even suggesting that the customers have the right to move, too. Better to make it clear that the BD advise the customer of his or her options.

FINRA gets this. And we know it does by virtue of the final admonition in the Notice, which is that – again, when asked by a customer – BDs must provide the customers the departed RR’s “reasonable contact information,” such as the phone number, email address or mailing address, so the customers may then contact the RR, and decide whether they want to move their accounts or stay with the old BD (albeit with a new RR). So, no more stonewalling by the BD by claiming ignorance of the RR’s new whereabouts in order to buy time to continue to pound on the customer to try to keep the account where it is.

On balance, I like the tenor of this Notice. It seems to be fair to the BD, to the departed RR, and, most importantly, to the customers impacted by the departure. As I said, I am just unsure what prompted it. Is it an effort to protect the RRs who leave, and encounter trouble from their former BDs when trying to get their customers to follow them? Is it, instead, designed to help the BDs, which may now provide all the nasty details surrounding an RR’s termination knowing that they can defend themselves by arguing that “FINRA made me do it?” Is it intended to help the poor, forgotten customers? Or is it a true unicorn, the rarest of beasts, an initiative that works in everyone’s best interest? I don’t suppose I can answer that last one, since, really, I can’t recall if I’ve ever spotted one of those!

Wedbush Learns That It’s Not Enough Just To Spot Red Flags

Posted in SEC, Supervision

I have been busy the last month getting ready for a big arbitration, and attending the first week of what looks like is going to be a four- or five-week slog when all is said and done. So, I am just catching up on some recent developments, and mulling over what might be of interest to readers of this blog. I debated discussing the arbitration itself, and some of its more surreal moments, but I will wait for it to conclude before doing that. Ultimately, I came across an SEC settlement that was the subject of a nice article by an old friend, Jeff Ziesman, another former FINRA Enforcement lawyer who’s also on the defense side of the table, and shared his view that the case contains some really helpful guidance on what it actually means to respond to “red flags.”

The case was against Wedbush Securities, and resulted in a $250,000 civil penalty against the firm. According to the SEC, while Wedbush “was aware of certain aspects of” the suspicious activities of one its RRs as far back as 2012 and 2013 – in other words, although Wedbush managed to spot the red flags – “its supervisory policies and implementation systems failed reasonably to guide staff on how to investigate” them. And here is where the case provides its utility in describing what NOT to do when confronted with red flags.

But, first, let’s talk about the RR. Not a good employee. For six years, from in or around 2008 to 2014, the RR “was involved in a manipulative trading scheme” along with someone not associated with Wedbush. (That guy, you will be pleased to learn, is currently serving a 151-month sentence after pleading guilty to securities fraud, among other things). The scheme involved penny stocks controlled by the guy now in prison. The RR would buy those “stocks in her customers’ accounts, or encouraged her customers to buy the stocks, in exchange for undisclosed compensation in the form of shares and cash.” In addition, she “engaged in manipulative trading designed to create a false appearance of volume and increase or stabilize the price of securities.”

Ok, so what did Wedbush know, and when? A lot, it seems, and pretty early on, too. The first red flag was an email that revealed the RR’s role in the scheme. It was discovered by the RR’s supervisor, who actually seems pretty on-the-ball. Consider that the SEC found that when he became the RR’s supervisor in April 2009, he “conducted a review of the trading and customer portfolios of each representative he supervised,” including the “bad” RR. “Based on his experience in the industry, he had general concerns about the quantity of penny stocks in [the RR’s] customers’ accounts.” So far, so good, right? He even “took measures to restrict [the RR’s] trading activity by limiting her trading in the last hour of the day and restricting all customer trading in certain penny stock securities.” More good stuff. But, because the RR “had been at the firm for 30 years and her business partner was a partial owner of the firm,” the supervisor “felt he had to ‘be gentle’ in terms of restricting [the RR’s] activities and could not take more ‘draconian action’” (even though, personally, he called the email “the smoking gun . . . whatever suspicions or worries I had, this confirmed a lot of the worst of them.”).

Well, it seems he (or Wedbush, more accurately) was too gentle. In late 2012, the supervisor reviewed the email in question, which was from the RR to one of her customers “who was substantively involved” in the penny stock scheme. It outlined the customer’s “efforts to assist in inflating the price of penny stocks, many of which were held in Wedbush accounts by [the RR] and her customers.” Moreover, the email “noted that one of the deals had to be handled through a different broker-dealer because [the RR] was restricted from any purchases through Wedbush during the last hour of trading,” i.e., the very restrictions the supervisor had placed on the RR.

Faced with this pretty glaring evidence, the supervisor “escalated” the matter up to Wedbush’s president, who “reviewed and initialed the email,” but that’s about it. In addition, the SEC determined that “[l]egal and compliance personnel also were aware of the email,” but did nothing.

Next red flag – or flags – were two FINRA arbitrations against Wedbush filed by customers of the RR around the same time as the customer email. As with the email, the president, legal and compliance were all aware of these filings. The customers in the first case alleged that the RR (1) solicited their investments in certain penny stock issuers, (2) guaranteed no losses, and (3) was involved in manipulating the securities in their accounts in order to guarantee them profits. The second arbitration contained allegations describing “similar transactions involving [the RR] in similar securities.” Both cases settled, and because Wedbush determined that the RR was “culpable,” she paid half.

Finally, besides the email and the two arbitrations, Wedbush also learned of two FINRA inquiries regarding the RR, one into her personal trading in one of the penny stock issuers, and the other into the allegations underlying the customer arbitrations. The SEC was troubled by the fact that Wedbush let the RR draft her own responses to FINRA’s requests for information, and even though she sent them to compliance for review, compliance “did not take any steps to investigate or confirm the veracity of [her] responses,” or follow-up at all when certain responses the RR gave to FINRA at an interview “were inconsistent and contradicted what the firm had already learned from” the customer email and the two arbitrations.

It’s not like Wedbush did nothing. Both legal and compliance conducted investigations into the RR, but, as the SEC put it mildly, both were “flawed,” for a variety of reasons:

  • Wedbush did not document or otherwise clarify the scope of each investigation;
  • There was no process as to how the results of the investigations were to be documented or reported;
  • The lack of documentation or other reporting mechanism resulted in no coherent response to the red flags. Indeed, it was “unclear what, if anything, was reported from legal or compliance to Wedbush’s management”;
  • Although Wedbush placed the RR on heightened supervision for a year, this was done “to resolve the ongoing FINRA matter, rather than in response to any misconduct by [the RR] related to the red flags”;
  • Despite the fact the FBI interviewed the RR about her role in the penny stock scheme, and she reported this promptly to her supervisor, who, in turn, brought it to the attention of legal and compliance, no one in compliance interviewed the RR about the FBI interview, no internal investigation was done in response to the FBI’s interview or the topics that RR discussed, and no old investigations were reopened or revisited.

Given all this, it is easy to see why the SEC concluded that

Wedbush’s policies and supervisory systems lacked any reasonable coherent structure to provide guidance to supervisors and other staff for investigating possible facilitation of market manipulation by registered representatives. . . . There was substantial confusion as to whose responsibility it is to conduct investigations related to red flags of potential market manipulation by [the RR].

In short, “Wedbush had no clear process for how to handle red flags of potential market manipulation.” The real lesson of the case can be found in the sanctions that the SEC meted out. In addition to the hefty civil penalty I mentioned earlier, Wedbush had to update “its policies and procedures relating to internal investigations to address the allegations in the Division’s OIP,” adding the following specific provisions in order to document:

  • when internal investigations will occur,
  • who shall conduct the investigations,
  • how the results should be escalated, and
  • how the investigation should be documented and, as appropriate, reported to regulatory or other authorities.

It really comes down to this: it is clearly not enough simply to spot red flags; when spotted, they must be investigated in a clear, logical manner, with the results shared among appropriate decision-makers, and, of course, well documented. There is no such thing as getting partial credit; I mean, sure Wedbush found that customer email, which must mean its email surveillance system worked. But, armed with that knowledge, it then proceeded to whiff when given the chance to do something about it before customers were harmed. The only happy story here belongs to the RR’s supervisor, who appears to have done as much has he could reasonably be expected under the circumstances. He saw the red flags. He reported them promptly. He took action by restricting the RR. Do what he did, and you’ll be sitting pretty even when the SEC goes after your firm, and its legal and compliance personnel.