On October 12, 2011, FINRA hosted a webinar titled “Enforcement Case Trends.” The following are highlights from the program, in which FINRA staff, in-house counsel and outside counsel discussed issues of concern for FINRA, recent cases from which members could draw lessons, and issues relating to investigations, settlement, and litigation.  

Trends and Developments

Thus far in 2011, the number of Letters of Acceptance, Waiver and Consent (AWCs), complaints, and overall actions has been notably larger than during the same period in 2010. Similarly, the amount of fines to date was $43 million, compared with $34 million during the same period last year. FINRA staff also emphasized the number of penalties greater than $1 million. The increase in the number of actions is likely due to Enforcement finalizing cases relating to the 2008 market crash and a greater number of investigations.  

The panel discussed a case that held FINRA did not have the authority to file a civil action to collect its fines.1 That case will likely have little impact on Enforcement’s efforts because only five such cases have been filed. In addition, the payment of the fine is generally a condition to continued FINRA membership or to reinstatement.  

According to the FINRA staff, the following are recent trends and developments in how Enforcement investigates and brings actions:  

  • First, the Case Development Team (CDT) has new leadership as well as new personnel. The CDT handles sweeps, and seeks to anticipate enforcement issues.
  • Second, Enforcement has been conducting more onsite examinations (10 unannounced onsites this year). Enforcement decides whether to conduct an unannounced examination by considering various factors such as whether Enforcement believes ongoing harm can be prevented. Such exams are sometimes important because during the exam, the staff can conduct forensic data capture. While member firms do have the ability to preliminarily review documents for privilege, FINRA staff stated that it is a firm’s duty to cooperate with FINRA and provide access to materials.
  • Enforcement uses expedited proceedings, most frequently where an individual does not cooperate with Enforcement. Enforcement may impose a temporary cease-and-desist order against a member firm, as it did in a recent action.2
  • Finally, there are steps in place to expand the chronological coverage of the materials available through FINRA’s Disciplinary Action System.

Recent Cases and Lessons Learned

“Postage and Handling”

Enforcement recently brought five actions in which firms mischaracterized commissions on trades as “postage and handling.”3 These “postage and handling” cases underscore the importance of clearly communicating to clients the services performed by the firm and the fees paid in return. According to FINRA staff, where a fee is transaction-based, the firm should identify the fee as a commission or mark-up. The firm should also ensure that the fees are reasonable in relation to the service performed; a $100 fee for postage and handling is not reasonable according to FINRA staff.

Penny Stocks

There has been an increasing number of cases involving penny stocks. These cases are troubling to Enforcement because penny stocks are often sold in connection with distributions of unregistered securities or as part of a larger manipulation or fraud, characteristics of which FINRA is aware and actively investigates. In addition, firms sometimes have failed to understand the risks of penny stocks and even ignore red flags because such sales can be lucrative. FINRA staff believes that firms therefore must ensure that the field is educated regarding these products and that their supervisory systems (such as anti-money laundering and suspicious activity report policies and procedures) are adequate. Although these cases often involve smaller firms, Enforcement currently is investigating a number of larger firms as well.

Yield-Chasing Products/Structured Products

As investors seek higher-yielding investments in the current economy, they and member firms are increasingly turning to new products. According to FINRA staff, before selling these products, firms must understand the associated risks. The risks of products can also change with the market, as was the case with auction rate securities. Accordingly, FINRA staff stated that the new product approval process should not be a one-time occurrence. Training the field is important because such products may not be suitable for all customers and because customers to whom the products are sold must receive fair and balanced representations and appropriate risk disclosures.

Areas of Concern


On October 4, 2011, FINRA issued an investor alert regarding non-traded REITs.4 The alert noted that non-traded REITs tended to be illiquid, that pricing and valuation can be difficult, and that the redemption process may be hard to understand and expensive. FINRA staff also referenced the REIT case against David Lerner & Associates.5

Enforcement is also scrutinizing sales of reverse convertibles, which are another type of yield-chasing product that is unsuitable for certain investors. FINRA staff cited the case against Ferris, Baker Watts,6 stating that another case would soon be announced.

Rogue Traders

The disclosure of the rogue trader at UBS7 was the latest of periodic massive losses caused by rogue traders. The in-house counsel emphasized that proper supervision is the key to preventing such losses. To that end, firms should closely monitor trading activity, scrutinize sudden profits, be cautious when back office personnel move to the front office (and make certain that computer access and passwords are disabled), strictly enforce behavioral controls, and review access reports.

The panel then discussed other issues regarding supervision. As firms attempt to cut costs, they should be mindful of whether conflating the responsibilities of two individuals is a good idea or whether it is better to keep certain functions separate. Because Enforcement will look up the line to see who has been involved, a chief compliance officer should check her firm’s organizational charts and policies and procedures to determine whether she might be considered a direct or line supervisor. The panel agreed that firms should still look to the SEC’s Gutfreund8 case as guidance regarding whether a CCO is an indirect supervisor, and should follow the SEC’s action against Theodore Urban as it works its way through the appeals process.9

Self-Reporting and Cooperation

The panel discussed how member firms should respond to new FINRA Rule 4530. Rule 4530 contemplates firms having a formal process in place for investigating potential misconduct and reporting it to FINRA. Member Regulation might review firms’ procedures on this issue. When a firm learns of potential violations, the firm must evaluate the nature of the conduct, how it will address the conduct, potential remedial steps, and to which regulator the firm should report. Even if the firm reports to the SEC, it may also have to report to FINRA. Given Dodd-Frank’s expansion of whistleblower recoveries, a firm should consider starting a dialogue with FINRA early on so that the whistleblower is not the first person from whom the regulators hear one version of the facts.

With respect to enforcement actions under Rule 4530, Enforcement will bring actions only in egregious cases, and may choose not to bring an action for failure to report if the firm can demonstrate that it undertook a good-faith effort in determining whether to report.

With respect to cooperation, FINRA staff stated that prior guidance issued by FINRA remains relevant. Credit can take a number of forms, such as a reduction in the nature of charges brought or in the sanctions. However, according to FINRA staff, it is unrealistic to believe that Enforcement will forego an enforcement action altogether.

Wells Notices

If a firm demonstrates a willingness to settle and the firm and Enforcement appear in agreement on the charges and sanctions, there have been instances where Enforcement has not issued a Wells Notice. However, Enforcement typically will issue a Wells Notice where individuals are involved.

Litigation or Settlement

During a discussion about the merits of litigation versus settling, the in-house counsel noted that respondents have had some success in reducing the penalties when appealing to the NAC.10