The day after Christmas, FINRA issued a press release announcing that five big firms – Citigroup, J.P. Morgan Chase, LPL, Morgan Stanley and Merrill Lynch – had each entered into a settlement, collectively agreeing to pay a $1.4 million fine. Their offense? They each violated FINRA’s supervisory rules because for a number of years, dating all the way back to 2014, none of them had adequate written supervisory procedures regarding UTMA and UGMA accounts. Specifically, the firms failed to have procedures in place that would ensure that the appointed custodians of such accounts – which, of course, exist for the benefit of minor children – lost their ability to continue directing trading in these accounts once the beneficiaries reached the age of majority.
My issue here is a very narrow one. I don’t care so much about the actual rule violation; indeed, the fact pattern seems pretty cut-and-dried, and apart from the fact that FINRA is going after misconduct that is six years old – which makes it unfair to any respondent who might be inclined actually to fight the charges, rather than settle – the cases make sense. I also am not particularly unhappy about the size of the fine, as these firms can certainly afford it.
No, my concern, or perhaps better phrased, my question, stems from what appears to be a very benign section of the five AWCs that these firms each submitted, the section called “Relevant Disciplinary History.” The reason that section is included in every AWC – indeed, in every FINRA settlement and every adjudicated decision that FINRA reaches – lies within the FINRA Sanction Guidelines, which recite that because “[d]isciplinary sanctions should be more severe for recidivists, . . . [a]djudicators should always consider a respondent’s relevant disciplinary history in determining sanctions and should ordinarily impose progressively escalating sanctions on recidivists.”
So, what, exactly, does “relevant disciplinary history” mean? The phrase is not defined in the Sanction Guidelines. But, I can tell you that in each of the five AWCs that is the subject of the press release, the “Relevant Disciplinary History” section states that the respondent firm “does not have any relevant disciplinary history with the Securities and Exchange Commission, any state securities regulators, FINRA, or any other self-regulatory organization.” I found that statement rather surprising; given how long these firms have been around and the sheer number of prior disciplinary cases that have been brought against them, it struck me as odd that none had ever been written up before for a supervisory violation. Turns out I was right.
According to BrokerCheck, Citigroup has 1,180 total disclosures, 537 of which are characterized as “regulatory events.” BrokerCheck defines a “regulatory event” to be “a final, formal proceeding initiated by a regulatory authority (e.g., a state securities agency, self-regulatory organization, federal regulator such as the U.S. Securities and Exchange Commission, foreign financial regulatory body) for a violation of investment-related rules or regulations.” Of those 537 regulatory events, easily over a 100 appear to have involved a violation of a supervisory rule.
J.P. Morgan has 478 total disclosures, of which 334 are regulatory events. Of those 334 regulatory events, maybe close to 100 involved a supervisory violation.
LPL has 253 total disclosures, of which 175 are regulatory events, perhaps 20 or more of which involved a supervisory violation.
Morgan Stanley – at least in its current incarnation – has 140 total disclosures, of which 50 are regulatory events, and about 20% of those included the violation of a supervisory rule.
Finally, Merrill Lynch has 1,442 total disclosures, of which 565 are regulatory events. Of those, it seems that over 100 involved a supervisory violation.
Clearly – and here, finally, is the point of this post – inasmuch as none of the AWCs which these five firms agreed to submit includes a recitation of any “relevant disciplinary history,” despite the statistics I have just cited, FINRA somehow does not deem them to be recidivists when it comes to supervisory violations.
Let me be clear: I am not saying that this is right or wrong. This is FINRA’s game and its members have to play by FINRA’s rules. So, if FINRA does not deem any of these BDs to have any relevant disciplinary history, I suppose that’s ok with me. I’m not sure the investing public would be as understanding if this was explained to them, but, as I have made clear over the years, my clients are BDs, not investors.
But…with that said, I do insist on fair treatment of all respondents. While I cannot cite you any statistics, I can tell you anecdotally, coming from someone who’s negotiated dozens of settlements with FINRA, that its Enforcement attorneys do not take the same approach with small firms, at least not the small firms I have represented. When it comes to small firms, it seems that FINRA will deem any prior supervisory violation, no matter how factually disparate, to be relevant disciplinary history for the purposes of determining the sanctions. Did the prior case include a violation of Rule 3010 (or 3110)? If the answer is yes, regardless of the specific facts of the case, then FINRA ratchets up the fine.
And I expressly invite any other practitioners who may read this to weigh in, to tell me whether their experience has been the same as mine. I will dutifully report what I learn.
 Given the sheer number of reported regulatory events for these firms – which comprise hundreds of pages – I did not go through the BrokerCheck reports page by page; rather, I did a search for “3010” and “3110,” i.e., the numbers of the supervisory rules.