Let’s take a step back from Covid-19 news, for a moment, which, rightfully, has dominated the news and everyone’s collective conscience, and focus on something that has been pervasive in the broker-dealer world for much, much longer than this virus, and which has taken its own toll on the industry in terms of dollars – in both fines imposed by regulators and awards handed down by arbitration panels – and suspensions and bars: unsuitable recommendations.
Last week, FINRA announced that it had accepted a Letter of Acceptance, Waiver and Consent – an AWC – from Moloney Securities. It was not accompanied by any fanfare. I don’t recall reading any articles about it in any of the industry magazines. But, it merits some attention here for the various lessons it imparts about how easy it is to find oneself the focus of regulatory scrutiny in a suitability case.
First, an observation: none of this should be news to anyone even half awake. Seemingly every stinkin’ year – including this year – FINRA includes “suitability” in its annual list of “hot topics” as something on which it will be focusing its exams. Month after month, when FINRA publishes the disciplinary actions it took over the preceding 30 days, there are tons of suitability cases included in the mix. Yet, violations continue to occur, at an alarming rate. No flattening of the curve here.
Ok, what happened with Moloney? According to the AWC – which, as I am sure you know, includes findings that Moloney neither admits nor denies, but which it “accepts” – during the pertinent time period – January 2013 through April 2015 – the firm committed two supervisory violations: it failed
to establish and maintain a supervisory system reasonably designed to: (1) achieve compliance with FINRA’s suitability rule with respect to qualitative suitability and concentration in high-risk products; and (2) achieve compliance with applicable NASD and FINRA Rules pertaining to the detection and prevention of a form of manipulative trading known as marking-the-close.
I am going to focus on the first of these two violations. But, before I do, take a second to appreciate just how OLD this misconduct is! The pertinent time period started over seven years ago, and had ended over five years ago! The books and records at issue were already long past the required retention period! You think the wheels of justice grind juuuuuust a bit slowly at FINRA? You think that maybe FINRA won’t sniff out something just because it happened during President Obama’s second inauguration? Think again.
But I digress. Moloney’s problems related principally to two things: qualitative suitability and concentration in high-risk products. Per the firm’s written procedures, its Regional Managers were “responsible for conducting a daily review of all trades executed by the registered representatives assigned to them (approximately 50 registered representatives per Regional Manager during the Relevant Period).” FINRA had no issue with that. But, it is one thing to delegate supervisory responsibility to others. If you are going to do that, you actually have to ensure that the individuals to whom the responsibility has been delegated know what they are doing, and have the proper tools at hand to do their jobs. Neither of those things happened here.
The AWC recites that Moloney’s written supervisory procedures “contained a cursory discussion of monitoring for qualitative suitability, including procedures related to speculative, low priced securities, and no discussion of concentration in high-risk products.” Given this, you can see why it ultimately became a firm problem, not a problem for the Regional Managers. They were obliged to do what the firm’s WSPs dictated; but if the WSPs were deficient, their efforts to supervise would undoubtedly have left considerable room for problems to occur.
So, takeaway no. 1: review your WSPs for suitability and make sure that they do more than simply repeat verbatim the language from Rule 2111. Make sure they outline exactly how/when a supervisor is to review a particular trade for suitability. And, just as important, make sure they also outline how a supervisor should also review any particular trade in the context of previous trades, to look for patterns (which could, potentially, result in over-concentration in a certain security or class of securities).
The AWC then provides that “the Firm did not provide any training to its Regional Managers on reviewing the suitability of recommendations in such products, nor did the firm issue any instructional materials or alerts, such as compliance bulletins, addressing these issues.”
Takeaway no. 2: it is not enough even to have robust WSPs. Your policies must be augmented by periodic training sessions, and supplemented by alerts and compliance bulletins as subsequent developments – like the publication of a relevant Enforcement action, like this one, for instance, or a Regulatory Notice – dictate. Proper supervision is a marriage of written rules and policies – WSPs, compliance manuals – and execution of those rules and policies by appropriately qualified and trained people. A failure of either component is sure to attract FINRA’s attention.
Next, the AWC states that
Moloney Regional Managers responsible for daily reviews of all trades executed by registered representatives reviewed equity transactions almost exclusively through the same electronic surveillance system provided by its clearing firm. The electronic surveillance system provided to and utilized by Moloney during the Relevant Period, however, was not equipped to reasonably surveil for concentration in high-risk products or qualitative suitability. While Moloney generally instructed Regional Managers to review transactions for potential suitability concerns, the Firm did not provide reasonable guidance, written procedures or training programs to address how to conduct those reviews.
This was clearly a bitter pill for Moloney to swallow, to have to accept a finding that even though it paid for and utilized its clearing firm’s electronic surveillance system, that was still deemed to be unreasonable by FINRA. How do I know Moloney was bitter? Well, the firm elected to append to the AWC a Statement of Corrective Action. Every individual and BD that submits an AWC is offered the right to submit such a Statement. Most don’t, likely for a couple of reasons. But Moloney did here, and in that Statement, it wrote that it had “[u]pgraded its trade surveillance system from the Standard version of ProtegentTM Surveillance (ProSurv), an application provided by its clearing firm, RBC Correspondent Services (RBC), and apparently used by roughly 90% of RBC’s 200+ correspondent firms during the Relevant Period, to the more robust and expensive Enhanced ProtegentTM Surveillance system.” You can see what Moloney is saying here: c’mon, FINRA, 90% of RBC’s introducing firms used the same system we did, yet you are coming after us? And, you are making us – not the other 90% — shell out more money for the “more robust” system? What is fair about that?
Takeaway no. 3: there is no safe harbor simply because you use what your clearing firm offers. You must independently review whatever electronic surveillance system is available to you to determine whether it actually does a reasonable job. Here, despite the fact the Regional Managers used RBC’s system, it apparently did not pick up concentration problems. Specifically, the AWC includes a finding that “Moloney registered representative JM recommended that five senior customers, with investment objectives that included ‘balanced growth’ and ‘preservation of principle [sic] /income,’ purchase risky oil and gas limited partnerships and oil and gas exchange traded funds,” causing these customers to become concentrated in these products. But, “Moloney’s electronic surveillance system . . . did not flag the transactions for concentration issues, nor was the concentration questioned or reviewed by anyone at the Firm.”
The last takeaway is to take serious note of the fact that the specific customers who FINRA singled out in the AWC as examples of people who suffered as a result of Moloney’s supervisory failure are all seniors. Rightly or wrongly, FINRA places special emphasis on senior investors, and is constantly touting what a wonderful job it does of protecting them. If you have any senior investors, and heaven forbid they engage in an investment strategy other than buying and holding blue chip stocks (or, even better, buying CDs), you had better be prepared to answer questions about how you allowed that to happen.
As I said at the outset, this is a routine, vanilla AWC, one that you could easily miss even if you make it a practice of reviewing FINRA enforcement actions for the lessons they teach. But, as you can see, it is actually chockful of practical knowledge that likely has relevance to your own business. So, maybe there is one more takeaway: spend a few minutes every week, and read – carefully – what FINRA does to other firms and RRs. Those decisions and settlements paint a very vivid picture of what FINRA is focusing on.
 First, what’s the point? From my experience, seems unlikely that the Statement has much, if any, impact on whether the AWC will be accepted. Given that, why spend the time, money and energy to prepare it? Second, why provide a potential roadmap to attorneys for your customers who may want to file arbitrations that allege supervisory failures? While the Statement may not be deemed to be admissible (because it reflects subsequent remedial measures), you just never know how an arbitration panel will rule.