As the curtain fell on 2015, FINRA issued four Letters of Acceptance, Waiver and Consent (AWCs) providing guidance – and in many cases, pointed internal supervisory control reminders – in a broad range of broker-dealer activities: theft from senior citizen customers (Senior Citizen Matter); selling billions of unregistered microcap shares (Microcap Securities Matter); filing inaccurate blue sheets with the SEC and FINRA (Blue Sheet Matter); and unsuitable mutual fund transactions (Mutual Fund Suitability Matter).  

Not only do these AWCs provide a litany of proper internal controls, but, in the Microcap Securities Matter, they emphasize that personal accountability is important to FINRA, and, in the Mutual Fund Suitability Matter, that self-disclosure may result in a lower fine. How much? FINRA doesn't say, but the regulator clearly recognized the firm's cooperation in specific areas, starting with an internal investigation prior to regulator detection or intervention.  

Senior Citizen Matter  

One entity was fined $500,000 and ordered to pay $530,000 in restitution for its violation of NASD Rule 3010 resulting from its failure to detect and prevent the theft of more than $1 million from nine customers, eight of whom were senior citizens. Over a period of many years, an individual targeted former customers from another brokerage firm from which she had been fired. Posing as a broker from her former firm, the broker convinced these individuals to open over 50 individual and joint (with her) accounts, converting over $1 million to her benefit. The broker pleaded guilty to wire fraud, was sentenced to 15 years in prison, and was ordered to pay $2 million in restitution.  

The firm was censured and fined for multiple failures of internal, anti-money laundering-type, controls, resulting in its failing to detect or act upon the fact that:

  1. All of the 50 accounts shared one or more elements of common customer information;
  2. There was a consistent pattern of transfers from customers' accounts, to joint accounts, to either the broker's individual accounts or to her third-party account; and
  3. The firm failed to question or terminate calls or transactions when the broker, impersonating a customer, could not answer account verification questions or otherwise failed to provide a reasonable explanation for a transaction. AWC No. 2014041374401 (Dec. 18, 2015).

Microcap Securities Matter  

Another entity was fined $6 million and order to pay to FINRA the commissions it earned (plus interest) on the sale of more than 73.6 billion shares of microcap securities without conducting adequate due diligence. In addition, the firm's Executive Director of Equity Capital Markets was suspended "in all principal capacities" for a period of three months and fined $35,000, while another representative was suspended in all capacities for two months and fined $25,000.  

The fine against the firm was based on several factors, each instructive:

  1. The firm's internal control system "was not reasonably designed to achieve compliance" with Section 5 of the Securities Act, in particular, it did not establish, maintain, or enforce:
    1. Procedures to determine if the shares sold were restricted or control securities;
    2. Guidance on determining if sales of restricted or control securities were exempt from registration requirements; or
    3. Processes for supervisors to identify red flags indicating unlawful distribution of unregistered securities (inadequate exception reports). Section 5, Securities Act, NASD Rule 3010, FINRA Rule 2010.
  2. The firm failed to (a) establish or (b) implement an anti-money laundering program reasonably designed to (i) detect and (ii) cause the reporting of, potentially suspicious microcap business activity. Neither the company's program nor its training was tailored to identify the risks of microcap securities. FINRA Rule 3310(a), 31 CFR 1023.320.
  3. The firm expanded its microcap business into new lines without taking necessary steps to ensure that its supervisory structure "was reasonably designed" to ensure that the new line of business complied with the securities laws. FINRA Reg. Notice 09-05.
  4. The individuals were penalized for:
    1. Knowing or having reason to know that the shares sold were not acquired in a public sale, yet made "inadequate efforts to determine the registration status of the shares sold or whether the transactions were exempt from registration."
    2. Failing to respond to red flags indicating that the firm's supervisory system was inadequate and delegating, but not managing, supervisory responsibility in a number of major, systemic, ways. NASD Rule 3010 and FINRA Rule 2010. AWC No. 20120349643 (Dec. 21, 2015).

Blue Sheet Matter  

In another situation, FINRA fined the company $2.95 million for failing to provide accurate blue sheets upon request over a period of approximately three years. The rough totals provided in the AWC state that the firm filed "at least" 1,143 inaccurate blue sheets to the SEC (misreporting "at least" 178,318 transactions) and "at least" 600 inaccurate submissions to FINRA that misreported at least 160,971 transactions.  

The cause of the inaccurate reporting was, apparently, the failure of two automated systems, installed by the firm in 2012, to function properly in multiple ways. The result was that the company routinely submitted inaccurate reports in violation of SEC Rules 17a-4(j) and 17a-25, requiring broker-dealers to submit "legible, true, complete, and current" data to the SEC and FINRA Rules 8211 and 8213, requiring similar reporting.  

As is frequently the case, the broker-dealer was penalized not just for its failure to comply with SEC and FINRA rules, but also for its failure to maintain an adequate audit system under SEC Rule 17a-4(f)(3)(v) and the more general FINRA Rule 2010. Even with the fact that the firm detected and self-reported the violations, initiated internal reviews upon its discovery of the violations, identified the cause of the violations, and engaged in remediation, it was censured, fined $2.95 million, and given 90 days to certify to FINRA that it has reviewed its systems and put in place policies, systems and procedures to ensure compliance. AWC No. 2014041862801 (Dec. 23, 2015).  

Mutual Fund Suitability Matter  

In this AWC, the firm was ordered to pay more than $10 million in restitution to affected customers for (a) mutual fund-related suitability violations, and (b) failing to provide applicable breakpoint discounts, censured, and fined $3.75 million. As is FINRA's practice, the penalty is not just for violating NASD rules, but also for failing to have in place adequate "supervisory systems and written supervisory procedures for supervising the sale of mutual fund to retail customers." NASD Rules 2310(a), 3010(a) & (b); FINRA Rules 2010, 2111(a), 3110(a) & (b).  

In particular, for a period of five years, the AWC states that the firm failed to have a supervisory system "reasonably designed" to:

  1. Ensure that mutual fund transactions for its retail brokerage customers were suitable based upon customer investment objectives, risk tolerance and account holdings.
  2. Prevent unsuitable mutual fund switches (and incorrectly defined mutual funds switches), switches where the transaction fees undermined any financial gain or investment objective.
  3. Ensure that customers received breakpoint discounts by failing to have a system in place to aggregate appropriate mutual fund purchases.

The $3.75 million fine recognized the firm's cooperation in (a) initiating its own investigation, prior to any detection by a regulator; (b) retaining an outside consultant to conduct mutual fund reviews that will result in significant remediation to customers; (c) promptly communicating with customers; and (d) assisting FINRA in its investigation.