Failure to Supervise

Dawson James Securities Sanctioned Over Alleged Supervisory Failures

June 30, 2014 | by Staff Attorney

The Financial Industry Regulatory Authority (FINRA) recently sanctioned brokerage firm Dawson James Securities, Inc., (Dawson James) concerning allegations that the firm did not provide for supervision reasonably designed to comply with certain applicable securities laws and regulations.

FINRA has stated that at a minimum, written supervisory procedures should describe: (a) identification of the individual responsible for supervision; (b) supervisory steps and review procedurals to be taken by the supervisor; (c) the frequency of reviews; and (d) the documentation of reviews. FINRA found that the Dawson James’ written supervisory procedures failed to provide for one or more of the four above-cited minimum requirements for adequate written supervisory procedures for conduct concerning: (1) disclosure of potential conflicts of interests to clients; (2) trading in the opposite direction of solicited customer transactions; (3) certain broker sales practice concerns such as unauthorized trading, suitability, excessive trading, and free-riding; (4) concentration of securities in clients’ accounts; (5) the sharing of profits and losses in clients’ accounts; (6) wash transactions; (7) coordinated trading; and, (8) the review of representatives’ electronic communications, among other violations.

FINRA alleged that the firm failed to investigate numerous ”red flags” relating to the activities of one registered representative referred to by the initials “DM”, including: (1) numerous exceptions generated on the firm’ s supervisory reports which included commissions charged to DM’s clients; (2) high concentrations of one security in DM’s clients’ accounts; and, (3) numerous cancel rebill requests for DM’s clients’ accounts. FINRA also found that James Dawson failed to enforce its written supervisory procedures that required electronic correspondence be reviewed on a daily basis. FINRA also found that from January 2007 through February 2008, the firm failed to ensure that the firm’s Head Trader, referred to as the initials “AE” carried out his delegated supervisory responsibilities relating to proprietary trading; trade reporting; clock synchronization; short sale compliance; compliance with the manning rule; mark ups and mark downs; and, compliance with inventory guidelines.

Morgan Stanley Fined $5,000,000 For Failure To Supervise Sales of IPO’s

June 16, 2014 | by Staff Attorney

On May 6, 2014, the Financial Industry Regulatory Authority (FINRA) announced that it had fined Morgan Stanley Smith Barney LLC $5,000,000 for failure to properly supervise the solicitation of retail clients to invest in initial public offerings (IPOs). According to FINRA, Morgan Stanley sold shares to its retail customers in eighty-three different IPO’s between February 16, 2012 and May 1, 2013, with insufficient procedures and employee education. Some of the more commonly sold IPOs included Facebook and Yelp among other Internet favorites.

When broker dealers sell IPOs, there is a process in place for soliciting customer interest. Prior to the effective date of the registration statement, firms may only obtain an “indication of interest” from customers. An “indication of interest” is not a purchase. In order for an “indication of interest” to result in a purchase the investor must reconfirm their interest after the IPO registration statement becomes effective. Broker dealers may also solicit what is known as “conditional offers to buy.” This differs from an “indication of interest” in that the investor does not have to reconfirm. It may bind the customer after the registration statement becomes effective if the investor simply takes no action to revoke the conditional offer before the brokerage firm accepts it. According to FINRA, Morgan Stanley Smith Barney failed to institute adequate procedures and properly train its employees to ensure that its staff clearly differentiated an “indication of interest” from a “conditional offer” in their solicitation of potential investors.

Morgan Stanley Smith Barney actually adopted a policy related to the solicitation of IPO’s. In adopting this policy back on February 16, 2012, however, the firm used the terms “indication of interest” and “conditional offer” interchangeably, which implicitly disregarded the need for customer reconfirmation prior to trade execution. According to FINRA, Morgan Stanley never provided its sales teams and financial advisers any education or materials explaining the differences in terminology. As a consequence there was a strong possibility that neither the Morgan Stanley staff nor its customers properly understood the type of order that was being solicited. In addition, FINRA found that Morgan Stanley’s inadequate policies failed to comply with the federal securities laws and other FINRA rules.

FINRA Fines Investors Capital Corp. Over Failing to Supervise ETF Sales

June 12, 2014 | by Staff Attorney

The Financial Industry Regulatory Authority (FINRA) recently fined brokerage firm Investors Capital Corp. (Investors Capital) $100,000 on allegations that from at least about June 2009 through April 2011, Investors Capital failed to provide prospectuses to customers who purchased exchange traded funds (ETFs). FINRA also alleged that Investors Capital also failed to establish, maintain and enforce an adequate supervisory system concerning the sale of ETFs and the obligation to provide ETF prospectuses to customers.

Investors Capital is an independent broker-dealer offering brokerage services and financial planning to customers and has been a FINRA member since 1992. Investors Capital is headquartered in Lynnfield, Massachusetts, and employs approximately 539 registered persons, across 325 branch offices.

ETFs typically attempt to track an index such as a market index, a commodity, or an entire market segment. ETFs can be either attempt to track the index or apply leverage in order to amplify the returns of an underlying stock position. ETFs that employ leverage are called either non-traditional ETFs or leveraged ETFs. In an ideal world, a leveraged ETF with 300% leverage will return 3% if the underlying index returns 1%. Nontraditional ETFs can also be designed to return the inverse or the opposite of the return of the benchmark.

FINRA Fines Commonwealth Financial Network Concerning Email Supervisory Failures

June 11, 2014 | by Staff Attorney

The Financial Industry Regulatory Authority (FINRA) recently fined brokerage firm Commonwealth Financial Network (CFN) $250,000 on allegations that from December 7, 2009 to January 28, 2012, CFN’s supervisory system: (a) failed to subject about 12.6 million outgoing e-mails to daily e-mail surveillance protocol, constituting 90% of the e-mails that the firm’s registered representatives sent through doing business as (DBA) e-mail accounts; and (b) failed to survey approximately 474,380 registered representatives e-mails. FINRA also found that the firm failed to establish and maintain procedures to test its e-mail supervisory system to timely identify systemic failures.

CFN has been a member of FINRA since 1979 and the firm has approximately 4,550 associated persons operating from 1,154 branch offices. CFN’s primary office is located in Waltham, Massachusetts. CFN’s registered representatives are independent contractors and many of them operate from branch offices under one or more DBA names. Most of CFN’s brokers use non-CFN e-mail domains names.

During the period from December 2009, to January 2012, CFN used a system to archive, preserve, and supervise business related e-mails of its associated persons. FINRA found that e-mails sent through DBA email domains were automatically transmitted to CFN’s system for retention and review. CFN’s supervisory procedures required the firm’s emails to be transmitted through CFN’s server so that the firm could capture and review its brokers’ emails. CFN’s supervisory system required a daily review of its registered representatives’ e-mails including lexicon searches and a random sampling of emails.

LPL Financial Fined by FINRA for Failing to Supervise Sales of Alternative Investments

April 25, 2014 | by Staff Attorney

On March 24, 2014, LPL Financial LLC, the fourth largest broker dealer, measured by number of salespersons, was fined $950,000 by the Financial Industry Regulatory Authority (FINRA) for failing to supervise the way that its brokers marketed and sold nontraditional investments. The fine is one of many that have recently been imposed on LPL and other “independent broker-dealers,” firms that provide products, marketing, and regulatory services to independent brokers who are not their full-time employees.

LPL Financial was alleged to have deficient supervision as it related to the sales of alternative investment products, including non-traded real estate investment trusts (REITs), oil and gas partnerships, business development companies (BDC’s), hedge funds, managed futures, and other illiquid pass through investments. FINRA found that from January 1, 2008, to July 1, 2012, LPL failed to adequately supervise the sales of theses alternative investments that violated concentration limits.

Investors often rely on professional advisors like LPL Financial, which help them to diversify their portfolio while minimizing risk. LPL, like many states, has limits in place, on the portion of a client’s portfolio that can be concentrated in these riskier, alternative investments. According to FINRA, however, LPL failed to ensure adherence to these limits. FINRA explained that between 2008 and 2012, LPL utilized a manual process that relied on outdated data to conduct suitability reviews. FINRA further stated that once LPL transitioned to a new automated review system, its database was built with faulty programming.

FINRA Fines Triad Advisors and Securities America for Failure to Supervise Issuance of Consolidated Reports

April 24, 2014 | by Staff Attorney

On March 12, 2014, the Financial Industry Regulatory Authority (FINRA) announced that it sanctioned and fined Triad Advisors and Securities America, $650,000 and $625,000, respectively, for failing to supervise the use of consolidated reporting systems, after brokers from the firms inaccurately represented the value of some customer holdings, often inflating their overall worth.

Triad Advisors and Securities America, both registered broker dealers, had internal systems designed to generate consolidated reports—documents intended to combine most, if not all, of a customer’s financial holdings, regardless of where those assets or accounts are held. These reports do not replace account statements, but rather supplement the more traditional document. These two broker dealers, however, maintained consolidated report systems that allowed their respective brokers and representatives to manually create, rather than automatically generate, consolidated reports. In doing so, representatives from Triad and Securities America were able to customize the reports by manually inputting the data, entering asset values for accounts held away from the firm before providing the reports to customers.

According to FINRA, over the last few years, both firms regularly permitted their advisors to use these highly customizable reporting software systems, but in doing so, failed to maintain the proper supervisions. The lack of supervision, says FINRA, led to clients inadvertently, or in some cases intentionally, receiving inaccurate and misleading account information.

Meyers Associates: Black Marks and Red Flags

April 15, 2014 | by Staff Attorney

The Financial Industry Regulatory Authority (FINRA) maintains a public database, called BrokerCheck, which acts as a free tool for investors looking to research the backgrounds of FINRA registered personnel. BrokerCheck covers brokerage firms, brokers, investment adviser firms and representatives. Searches allow investors to draw upon filings by firms, regulators, and other investment professionals, to reveal licensing status and history, employment history, and any reported regulatory infraction, customer dispute, criminal actions, financial issues, and other related matters.

These black mark events, revealed by BrokerCheck, are known as “disclosure events” and are often viewed as red flags by investors and the industry. Advisers and brokers who have marred records with multiple events carry inherent regulatory risk. As a consequence, most of the elite broker dealers and advisory firms will shy away from hiring representatives with such backgrounds.

Enter Meyers Associates, L.P.

Centaurus Financial Sanctioned Over Allegations of Supervisory Failures

April 10, 2014 | by Staff Attorney

The Financial Industry Regulatory Authority (FINRA) sanctioned Centaurus Financial, Inc., (Centaurus) concerning allegations that Centaurus failed to supervise the business activities of five representative in the dissemination of communications concerning the risks of certain private placements. FINRA fined the firm $25,000

Centaurus became a FINRA member firm in 1993 and is headquartered in Anaheim California. The firm has 367 branch offices and approximately 585 registered individuals. The firm operates as a privately held independent broker-dealer and engages in various securities businesses including corporate and municipal debt, mutual funds, direct investments, and private placements.

FINRA alleged that at various times during from February 2009, through January 2010, five Centaurus registered representatives functioned as wholesalers for an unaffiliated investment management firm. FINRA alleged that Centaurus written supervisory procedures did not address the supervision of wholesaling activities and Centaurus did not supervise the wholesaling activities of the five representatives in violation of NASD Rule 3010. FINRA found that the five representatives did not use their Centaurus e-mails for wholesaling activities and instead used the investment management firm’s email address to send communications.

Barclays Capital Fined $3.75 Million Regarding Record Retention Failures

April 8, 2014 | by Staff Attorney

The Financial Industry Regulatory Authority (FINRA) fined Barclays Capital Inc. (Barclays) $3.75 million for systemic failures relating to the failure to preserve electronic records, emails, and instant messages in the manner required for a period of at least 10 years. The retention of electronic correspondence and records is critical for the proper supervision of brokerage activities. Without a proper record retention system, brokerage firms are essentially blind to certain types of securities misconduct.

Federal securities laws and FINRA rules require that business electronic records must be kept in non-rewritable, non-erasable format — also referred to as “Write-Once, Read-Many” or “WORM” format — to prevent alteration. The Securities and Exchange Commission (SEC) has stated that a firm’s books and records are the primary means of monitoring compliance with the securities laws.

FINRA found that from at least 2002 to 2012, Barclays failed to preserve many of its required electronic books and records—including order and trade ticket data, trade confirmations, blotters, and account records in WORM format. FINRA found that Barclays retention failures were widespread and included all of the firm’s business areas. Thus, FINRA alleged that Barclays was unable to determine whether all of its electronic books and records were maintained in an unaltered condition.

Former Newport Securities and Securities America Broker fined by FINRA for Selling Away

April 2, 2014 | by Staff Attorney

On December 11, 2013, the Financial Industry Regulatory Authority (FINRA) sanctioned broker Michael T. Ryan. Mr. Ryan was registered with FINRA brokerage firms from 1992 until November 1, 2013, including an eight-year stint with Securities America, Inc. (Securities America) and two years with Newport Coast Securities.

The basis for the underlying action brought against Mr. Ryan by FINRA, involved Ryan’s failure to accurately notify Securities America of his outside business activities. FINRA alleged that during a period spanning early 2009 through mid 2011, Ryan began working with an individual known as ZE, while Ryan was registered with Securities America. FINRA has alleged that Ryan began receiving compensation from and was an officer and board member of entities controlled by ZE, namely Kensington Leasing, Ltd, (Kensington) and a private entity known as WM were in direct violation of NASD Rule 3030 and FINRA Rule 3270. Throughout this time, FINRA alleged that Ryan did not submit proper notifications nor did he update the requisite information, in violation of NASD Rule 3030 and FINRA Rules 3270 and 2010.

Ryan also allegedly recommended that Securities America customers purchase restricted stock of two companies, Lenco Mobile, Inc. and Casablanca Mining Ltd. from ZE controlled entities. Ryan never notified Securities America of these private transactions in violation of NASD Rule 3040, which prohibits registered representatives from participating “in any manner in a private securities transaction,” unless the registered representative first notifies his or her member firm in writing.