The Financial Industry Regulatory Authority (FINRA) ended 2014 with a bang, finalizing three notable enforcement actions in December (along with several smaller cases). In the aggregate, December was FINRA's busiest enforcement month since February and resulted in the highest fines of the year.

  • Ten firms were fined a total of $43.5 million in connection with the Toys "R" Us IPO for allegedly allowing equity research analysts to solicit investment banking business from Toys "R" Us and for offering favorable research coverage.
  • Merrill Lynch was fined $1.9 million and ordered to pay restitution of $540,000 for fair pricing and supervisory violations related to the purchase of distressed securities.
  • Wells Fargo was fined $1.5 million for anti-money laundering (AML) failures.

Of note, FINRA ended the year where it started, with all three of the enforcement actions touching issues discussed by FINRA in its 2014 enforcement priorities letter – conflicts of interest (Toys "R" Us); best execution (Merrill Lynch); and AML (Wells Fargo).

Firms Must Prevent Analysts from Participating in Solicitation Efforts

On December 11, 2014, FINRA fined ten brokerage and investment banking firms a total of $43.5 million for allegedly allowing equity research analysts to participate in the solicitation of the Toys "R" Us (TRU) IPO. During the solicitation period, TRU sought presentations from research analysts to ensure that each firm, including its analyst, would stand behind the valuation provided in the solicitation. According to FINRA, the analysts' presentations factored into TRU's decision on choosing its underwriter because TRU wanted to avoid any valuation surprises down the road.

FINRA's conflict of interest rules prohibit firms from using research analysts or promising favorable research to win investment banking business. See NASD Rule 2711(c)(4) (research analyst conflict of interest rule). Any communication between an analyst and an issuer during the solicitation period presents a risk that the analyst will become part of the firm's efforts to solicit business from the issuer. An analyst may communicate with an issuer during the solicitation period as part of the analyst's due diligence efforts to gather information about the issuer, but may not communicate with the issuer as part of soliciting a role for the investment bank in the underwriting. In addition, according to FINRA, during the solicitation period a firm may not indicate to the prospective issuer client its analyst's positive views of the issuer or the issuer's prospects.

Firms Need Systems in Place to Detect Fair Pricing in Retail Customer Transactions

On December 16, 2014, FINRA fined Merrill Lynch $1.9 million and ordered restitution of $540,000 for fair pricing and supervisory violations (best execution) related to the purchase of distressed securities. FINRA found that Merrill Lynch's Global Banking & Markets Credit Trading Desk (Credit Desk) had purchased Motors Liquidation Company Senior Notes from retail customers at prices 5.3% to 61.5% below the prevailing market price. These purchases, FINRA found, were not fair to customers. The Credit Desk then sold the notes to other broker-dealers at prevailing market prices. FINRA also found that Merrill Lynch did not have an adequate supervisory system in place to detect whether the retail customer transactions were executed at the prevailing market price. Further, FINRA found that there was no system in place to conduct post-trade best execution or fair pricing reviews of the Credit Desk.

Firms Should Confirm Their Customer Identification Programs Comply with AML Laws

On December 18, 2014, FINRA fined two affiliated St. Louis-based broker-dealers, Wells Fargo Advisors and Wells Fargo Advisors Financial Network (collectively, Wells Fargo), $1.5 million for AML failures. Under the Bank Secrecy Act and accompanying regulations, every FINRA-regulated broker-dealer must establish and maintain a written Customer Identification Program (CIP) that requires the firm to obtain certain minimum identifying information from each customer prior to opening an account, maintain records of the identity verification process, and provide customers with notice that information is being collected. The CIP must also include supplemental, risk-based procedures that enable the broker-dealer to form a reasonable belief that it knows the true identity of each customer.

FINRA found that Wells Fargo failed for a period of nine years to subject approximately 220,000 new accounts to identity verification. Although Wells Fargo's policy did in fact require that new accounts be subject to identity verification in accordance with AML rules, the firm assigned some new accounts identifying numbers previously associated with former accounts. The new accounts, therefore, bypassed the CIP system and were not subjected to identity verification. Nearly 120,000 of these accounts were closed by the time the problem was discovered. After Wells Fargo discovered the flaw and applied the CIP process to the remaining accounts, the firm terminated activity in 345 accounts that could not be verified.

As explained by FINRA Executive Vice President and Chief of Enforcement Brad Bennett in FINRA’s press release:

Firms must be vigorous in the testing of their electronic systems to ensure they are operating correctly, including those designed to ensure compliance with critical aspects of the AML rules. While the firms eventually discovered the flaw in their own systems, it took far too long, resulting in hundreds of thousands of accounts to open and often close without the required identification process ever taking place.