Articles Posted in FINRA

FINRA May Put Forward Another Proposal About Possible SEC Rule Regarding Fiduciary Duty

Published on: November 28, 2011 | by Shepherd Smith Edwards & Kantas, LLP

According to FINRA CEO and Chairman Richard G. Ketchum, the SRO may put out a second concept proposal about its stance regarding disclosure obligations related to a possible Securities and Exchange Commission rulemaking about formalizing a uniform fiduciary duty standard between broker-dealers and investment advisers. Currently, the 1940 Investment Advisers Act defines the investment advisers’ fiduciary obligation to their clients, while broker-dealers are upheld to suitability rules that will be superseded next August by two FINRA rules regarding broker-dealer suitability standards.

The Dodd-Frank Wall Street Reform and Consumer Protection Act’s Section 913, however, said that it is SEC’s responsibility to determine whether these current regulatory and legal standards s are still effective and if any regulatory shortcomings that exist need to be filled. In July 2010, the SEC asked stakeholders for feedback about this mandates. After receiving over 3,000 public comments, it issued a study recommending that there be a uniform fiduciary standard for both types of representatives when giving advice to retail clients. The SEC could put out its proposed rule by the end of this year.

FINRA is working with the Commission on this and plans to stay involved in the process. It was just last year that the SRO put out a concept proposal seeking public comment about the idea that broker-dealers should have to provide retail investors with certain disclosures at the start of a business relationship. These clients would be required to give a written statement detailing the kids of services and accounts they provide, any conflicts of interests, and limits on duties that they are entitled to expect. FINRA said that regardless of what a unified fiduciary standard would look like, retail investors would benefit from getting this disclosure document at the start and that such a mandate is an “outright necessity.

Wells Investment Securities Agrees to $300,000 Fine by FINRA for Alleged Use of Misleading Marketing Materials for REIT Offerings

Published on: November 23, 2011 | by Shepherd Smith Edwards & Kantas, LLP

To settle FINRA accusations that it used misleading marketing materials when selling Wells Timberland REIT, Inc., Wells Investment Securities, Inc. has agreed to pay a $300,000 fine, as well as to an entry of the findings. However, it is not denying or admitting to the securities charges.

FINRA claims that as the wholesaler and dealer-manager of the non-traded Real Estate Investment Trust’s public offering, Wells approved, reviewed, and distributed 116 sales and marketing materials that included statements that were misleading, exaggerated, or unwarranted.The SRO contends that not only did most of the REIT’s sales literature and advertisements neglect to disclose the meaning of Wells Timberland’s non-REIT status, but also it implied that Wells Timberland qualified as an REIT during a time when it didn’t. (Although its initial offering prospectus reported that it planned to qualify as an REIT for the tax year finishing up at the end of 2006, it did not qualify until the one ending on December 31, 2009.) Also, FINRA believes that Wells Timberland’s communications about portfolio diversification, redemptions, and distributions included misleading statements and that the financial firm lacked supervisory procedures for making sure the proprietary data and sensitive customer information were properly protected with working encryption technology.

While non-traded REITs are usually illiquid for approximately 8 years or longer, certain tax ramifications can be avoided if specific IRS requirements are met. FINRA says that the Wells ads failed to ensure that investors clearly understood that an investment that is not yet an REIT couldn’t offer them those tax benefits.

Last month, FINRA put out an alert notifying investors about the risks of public non-traded REITs. Non-exchange traded real estate investment trusts are not traded on a national securities exchange. Early redemption is usually limited and fees related to their sale can be high, which can erode one’s overall return. Risks involved include:

• No guarantee on distributions, which can exceed operating cash flow.
• REIT status and distributions that come with tax consequences
• Illiquidity and valuation complexities
• Early redemption that is limited and likely costly
• Fees that can grow
• Unspecified properties
• Limited diversification
• Real Estate risk

FINRA wants investors considering non-traded REITs to:

• Watch out for sales literature or pitches giving you simple reasons for why you should invest.
• Find out how much the seller is getting in commissions and fees.
• Know how investing in this type of REIT will help you meet your goals.
• Carefully study the accompanying prospectus and its supplements.

Public Non-Traded REITs—Perform a Careful Review Before Investing, FINRA

More Blog Posts:

Morgan Stanley Faces $1M FINRA Fine for Excessive Markups and Markdowns on Corporate and Municipal Bond Transactions, Institutional Investor Securities Blog, September 17, 2011

Citigroup Global Markets Inc. Sues Two Saudi Investors in an Attempt to Block Their FINRA Arbitration Claim Over $383M in Losses, Stockbroker Fraud, October 22, 2011

Chase Investment Services Corporation Ordered by FINRA to Pay Back $1.9M for Unsuitable Sales of Floating-Rate Loan Funds and UITs.

Published on: November 19, 2011 | by Shepherd Smith Edwards & Kantas, LLP

FINRA says that Chase Investment Services Corporation will pay back investors for losses sustained from the unsuitable recommendation made that they buy floating rate loan funds and unit investment trusts. In addition to paying back clients $1.9M, Chase must also pay a $1.7M fine.

According to FINRA, brokers with Chase recommended these financial instruments to clients even though the investments were not suitable for them—either because they had hardly any investment experience or only wanted to take conservative risks. The SRO also says that the Chase brokers had no reasonable grounds to think the financial products would be a right fit for these investors.

FINRA believes that Chase failed to properly train its brokers or give them guidance about the suitability of floating-rate loan funds and UITs, as well as the risks involved. For example, there were UITs that contained a significant portion of assets in closed-end funds with high-yield or junk bonds. Yet, despite the risks involved, brokers from Chase made about 260 recommendations that were not suitable for clients who had little (if any) investment experience or were averse to high-risk investments. These investors ended up losing about $1.4 million.

Also subject to substantial credit risk and illiquidity were the floating-rate loan funds. Despite the fact that concentrated positions in the fund were unsuitable for specific clients, FINRA says that Chase brokers still recommended these to clients who wanted low risk, very liquid investments or preferred to preserve principal. Because of these allegedly unsuitable recommendations, investors lost almost $500K.

FINRA says that WaMu, Investments Inc., also recommended that customers by floating-rate loan funds, even though these were not appropriate for the investors. The financial firm, which had merged with Chase in 2009, is also accused of not properly training or supervising its employees that sold the investments.

More About UITs
Unit investment trusts involve diversified securities baskets that may contain high-yield bonds. While junk bonds can make greater returns for investors than investment-grade bonds, they also come with a high degree of risk.

More About Floating-Rate Loan Funds
These mutual funds are invested in short-term bank loans for companies with a below investment grade crediting rating. What investors earn will fluctuate depending on what interest rates the banks happen to be charging on the loans.

In the wake of the allegations against Chase, FINRA Executive Vice President and Chief of Enforcement Brad Bennett said that it was key that financial firms provide the proper guidance and training to brokers about product sales while supervising sales practices.

JPMorgan unit fined $1.7M over investment sales, Bloomberg Business Week/AP, November 15, 2011

FINRA Orders Chase to Reimburse Customers $1.9 Million for Unsuitable Sales of UITs and Floating-Rate Loan Funds, FINRA, November 15, 2011

More Blog Posts:
Morgan Stanley Faces $1M FINRA Fine for Excessive Markups and Markdowns on Corporate and Municipal Bond Transactions, Institutional Investor Securities Blog, September 17, 2011

Wedbush Ordered By FINRA Panel To Pay $3.5M to Trader Over Withheld Compensation, Institutional Investor Securities Blog, July 16, 2011

Bank of America Merrill Lynch to Settle UIT Sales-Related FINRA Charges for $2.5 Million, Stockbroker Fraud Blog, August 22, 2010

FINRA Vows to Step Up Internal Compliance Procedures

Published on: October 30, 2011 | by Shepherd Smith Edwards & Kantas, LLP

The Securities and Exchange Commission has filed an administrative complaint against the Financial Industry Regulatory Authority accusing one of the latter’s directors of changing three sets of staff meetings minutes that SEC officials had requested. These revisions made the documents, which were delivered in August 2008, incomplete and inaccurate. This could affect FINRA’s chances of becoming the SRO for investment advisers. Currently, FINRA serves that role for just broker-dealers.

It was FINRA that reported the document problem to the Commission and then worked with the agency to resolve the matter. The SRO then appointed new leadership in the Kansas office (the director has since resigned) where the tampering took place and implemented changes that improved procedures for document handling. Modifications included more live and online ethics training, as well as greater document integrity. Other undertakings FINRA has agreed to:

• Train workers about past document integrity problems • Create a podcast on document integrity to show current and prospective employees • Talk about the importance of document integrity at yearly regulatory meetings, townhall gatherings, and at Senior Management onsite visits at district offices • Mandate that senior Office of Liaison and Counsel meet with every business that is about to undergo an on-site exam before the documents are generated for the SEC

Citigroup Global Markets Inc. Sues Two Saudi Investors in an Attempt to Block Their FINRA Arbitration Claim Over $383M in Losses

Published on: October 22, 2011 | by Shepherd Smith Edwards & Kantas, LLP

Citigroup Global Markets Inc. (C) is suing Abdullah and Ghazi Abbar. The Saudi investors have filed a FINRA arbitration claim against the Citigroup unit seeking to recover the $383 million that they say the bank lost their family’s money. The Abbars, who are father and son, are accusing Citigroup Global Markets of mismanaging their family’s savings.

Citigroup, which wants injunctive relief, says that the entities that took care of the the Abbars’ private-equity loan and leveraged option transactions are located abroad and therefore not under FINRA’s jurisdiction for arbitration. The financial firm also says that father, son, and their investment entities are not CGMI clients and their claims are not activities related it. The investment bank has noted that the Abbars chose to pursue it rather than the non-U.S. parties that they actually had agreements with that completed the transactions. The Abbars, however, say that those overseeing the Citigroup entities that took party in the daily management of their credit deal are personnel that are registered with FINRA.

Says Shepherd Smith Edwards and Kantas Founder and Stockbroker Fraud Lawyer William Shepherd, “The financial industry has created its own securities arbitration forum to resolve disputes and claims between and against its members. It is ironic when claims are filed that they often go to court to beg to get out of arbitration, their self-imposed fate. While courts in New York seem to operate to accommodate Wall Street’s wishes, the law for decades has held that decisions regarding the liability of securities firms are for the arbitrators, not the courts. If these investors have properly alleged any wrongdoing by the U.S. securities firm, the court has no business intervening. Such wrongdoing can be simply ‘control person liability,’ which is the failure to control or properly supervise the behavior or operations of a subordinate or subsidiary.”

CGMI placed $343 million of the Abbars money in hedge funds that were included in a leveraged option swap transaction. In their FINRA arbitration claim, the Abbars argue that leading CGMI officers, including ex- global wealth management chief Sallie Krawcheck and Chief Executive Officer Vikram Pandit, pursued them.

Father and son contend that because of alleged “gross misconduct” by CGMI, their wealth was lost. They say that the bank’s failure to monitor the investments properly led to their total collapse during the height of the economic collapse in 2008. The Abbars also believe that lendings related to the Citigroup investments played a role in the losses. The Abbars says that Citigroup, which then started managing the positions that remained in the portfolio while implementing a program to redeem it, will “unjustly benefit” by about $70 million from the redemption of these investments.

Citigroup Sues to Block Arbitration of Saudi Investors’ Claim, Bloomberg/Businessweek, October 6, 2011
Citigroup Aims to Stop Arbitration From Proceeding, OnWallStreet, October 7, 2011

More Blog Posts:
Citigroup Global Markets Fined $500,000 by FINRA for Inadequate Supervision of Broker Accused of Bilking Sick and Elderly Investors, Stockbroker Fraud Blog, August 16, 2011
Citigroup Ordered by FINRA to Pay $54.1M to Two Investors Over Municipal Bond Fund Losses, Stockbroker Fraud Blog, April 13, 2011
Citigroup to Pay $285M to Settle SEC Lawsuit Alleging SecuritiesFraud in $1B Derivatives Deal, Institutional Investors Securities Blog, October 20, 2011 Continue Reading ›

Merrill Lynch Faces $1M FINRA Fine Over Texas Ponzi Scam by Former Registered Representative

Published on: October 10, 2011 | by Shepherd Smith Edwards & Kantas, LLP

Two years after San Antonio broker was sentenced to prison for Texas securities fraud, FINRA has fined Merrill Lynch $1M for not properly supervising its former employer. These failures allegedly allowed Bruce Hammonds to run a Ponzi scam that defrauded investors of $1.4M.

Hammonds persuaded 11 people to invest in the Texas Ponzi scam, which he operated under the name B&J Partnership. It was supervisors at Merrill Lynch that gave the green light for him to open an account for B & J. The supervisors also are accused of not monitoring the funds that moved between customers and Hammonds.

Rather than putting investors’ money in a Merrill Lynch fund, he put $1.4 million of their funds in his working capital account. He even gave clients charts showing how the B & J fund was performing even though the fund wasn’t real. Hammonds used the money to pay for his personal spending, including a supposed house-flipping business.

He later pleaded guilty to federal securities charges. In addition to five years behind bars and three year supervised release. Hammond has been barred from the securities industry. All investors have been paid back in full for their losses.

In deciding to fine Merrill Lynch, FINRA found that the financial firm did not have a supervisory system that did a satisfactory enough job of monitoring accounts of employees for signs of possible misconduct. The system was only able to immediately capture accounts opened by an employee if he/she used his/her social security number as the main tax identification number. The SRO also said that between 1/06 and 6/10 Merrill Lynch did not monitor another 40,000 employee/employee-interested accounts.

By agreeing to settle, Merrill is not denying or admitting to the charges.

Failure to Supervise
It is a brokerage firm’s responsibility to establish written procedures for how to properly supervise its employees’ activities. These procedures must then be implemented to prevent broker fraud. When misconduct does arise and failure to supervise played a role in allowing the incident to happen, the financial firm can be held liable for securities fraud.

Brokerage companies have to supervise every broker that they license to work for them. Even if an accused broker is later found not liable, there is still a possibility that the brokerage firm or supervisor can be held liable for failure to supervise and be ordered to pay damages. For example, a broker may not have received the proper training or was given the wrong information by the financial firm, and this resulted in Texas securities fraud that caused an investor to suffer losses.

FINRA Fines Merrill Lynch $1 Million for Supervisory Failures That Allowed a Registered Representative to Operate a Ponzi Scheme, FINRA, October 4, 2011
Shepherd Smith Edwards & Kantas LTD LLP is Investigating Merrill Lynch in Light of Recent FINRA Fines Against the Firm for Failure to Supervise, MarketWatch, October 5, 2011
More Blog Posts:
Former Merrill Lynch Employee, Guilty of $1.4 Million Texas Securities Fraud Scheme, Receives Prison Term, Stock Broker Fraud Blog, October 5, 2009
Wedbush Securities Ordered by FINRA to Pay $2.8M in Senior Financial Fraud Case Over Variable Annuities, Stock Broker Fraud Blog, August 31, 2011
Actions of Former Ferris, Baker Watts, Inc. General Counsel Accused of Supervising Rogue Broker to be Reviewed by SEC, Institutional Investors Securities Blog, December 9, 2010 Continue Reading ›

FINRA Cannot Enforce Disciplinary Actions Through the Courts, Says Federal Appeals Court

Published on: October 6, 2011 | by Shepherd Smith Edwards & Kantas, LLP

The United States Court of Appeals for the Second Circuit says that the Financial Industry Regulatory Authority does not have the authority to take its members to court in order to enforce disciplinary actions. The ruling comes after a years-long legal battle involving penny stock brokerage firm Fiero Brothers and owner John J. Fiero.

Fiero and his financial firm were expelled from FINRA and ordered to pay a $1 million fine for naked short selling and other violations of federal fraud statutes. It was in 1998 that NASD Regulation Inc. filed a complaint accusing Fiero and co-conspirators of engaging in the illegal short-selling of securities to purposely push down the price 10 NASDAQ securities. The financial scam eventually led to the collapse of both Hanover Sterling, which served as the securities’ underwriter and Adler, Coleman Clearing Corp. A NASD hearing panel found that Fiero committed extortion and violated short selling rules. The $1 million fine and expulsion were imposed in 2001.

Fiero Brothers and its owner refused to pay. FINRA took them to court to obtain payment. The SRO first brought its case to New York state court, where the state’s highest court eventually threw out a ruling in FINRA’s favor. Fiero then brought the case to federal court. There, he sought a declaratory judgment that FINRA did not have the power to pursue the fine in court. FINRA then counter-sued.

Now, however, the three-judge panel is saying that FINRA’s housekeeping rule from 1990, which gave it the right to go to court to go after monetary sanctions and the country’s foundational securities laws, does not give the SRO the right to collect disciplinary fines through the court system. The federal appeals court’s ruling overturns a lower court’s decision.

Some are saying that the court’s ruling reduces FINRA’s power and vindicates complaints that have been made accusing the SRO of going beyond its statutory power and abusing the process of rule making. Even ex-FINRA enforcement head Susan Merrill believes that the ruling casts a shadow on FINRA’s housekeeping rules. The court said the 1990 rule needs to be more formally examined because rather than just being a matter of housekeeping, it impacts the rights of members that have been suspended or barred.

Banned brokers are not allowed to reenter the industry unless the pay all fines. As a result, obtaining fines is not usually a problem for FINRA. Now, however, seeing as FINRA doesn’t have the right to enforce payment in court, an action that it has taken over the last two decades, it will be interesting to see how other barred brokers may choose to respond to fine demands.

Meantime, FINRA has said that this latest ruing will not limit its ability to enforce securities laws and FINRA rules, protect investors, or discipline financial firms.

Court: FINRA cannot use lawsuits to collect fines, Reuters, October 5, 2011
Court Says Regulator Exceeded Its Power, New York Times, October 6, 2011
NASD Regulation Bars John Fiero, Expels Fiero Brothers, Inc., and Imposes $1 Million Fine For Illegal Short Sales, Market Manipulation and Extortion, NASD/FINRA, January 8, 2011

More Blog Posts:
Five Broker-Dealers Fined by FINRA Over Allegedly Misrepresenting Commissions as Fees to Clients, Stockbroker Fraud Blog, September 16, 2011
Texas Securities Fraud: FINRA Fines Bluechip Securities for Ex-Employee’s Alleged Churning of Public Customer Accounts, Stockbroker Fraud Blog, August 28, 2011
Wedbush Ordered By FINRA Panel To Pay $3.5M to Trader Over Withheld Compensation, Institutional Investor Securities Blog, July 16, 2011 Continue Reading ›

Morgan Stanley Smith Barney Employee Fined and Suspended by FINRA Over Unauthorized Signatures

Published on: September 19, 2011 | by Shepherd Smith Edwards & Kantas, LLP

The Financial Industry Regulatory Authority has imposed a 60-day suspension on Carmela L. Knieriem, a former Morgan Stanley Smith Barney female employee over allegations that while employed by the financial firm, she signed other employees’ signatures without obtaining the required approvals and authorizations. FINRA is also fining Knierem $5,000. While she has submitted a Letter of Acceptance, Waiver and Consent to settle the charges, Knierem is not denying or admitting to the findings.

According to Forbes.com, Between November 2009 and October 14, 2010, Knieriem was associated with the financial firm’s Rancho Bernardo Branch, where she was tasked with providing branch managers, financial advisers, and other employees with administrative support. Part of her job was to prepare specific internal administrative forms related to the processing and documenting of verbal requests, known as “Verbal Forms,” that were made by customers.

FINRA says that when Knieriem made the unauthorized signatures when preparing these Verbal Forms she violated FINRA Rule 2010 10 times. The SRO contends that in six instances, at the request of the financial advisor EP, she prepared an instruction form documenting a client’s verbal request for journal funds between the client’s accounts, the transfer of money from a client’s account, the release of account statements to a third party, and the issuance of a $75,397.22 check from the customer’s account. Knieriem also is said to have followed a financial advisor GT’s request to prepare an instruction form for a client’s verbal request that a stop payment be placed on one of his checks. She also followed the request of a financial adviser CL, who asked her to prepare an instruction form to issue a $95.62 for a client. Also, FINRA says that branch manager RL asked her to prepare an instruction form to journal funds between accounts.

Morgan Stanley Faces $1M FINRA Fine for Excessive Markups and Markdowns on Corporate and Municipal Bond Transactions

Published on: September 17, 2011 | by Shepherd Smith Edwards & Kantas, LLP

The Financial Industry Regulatory Authority has fined Morgan Stanley Smith Barney LLC and Morgan Stanley & Co. Inc. $1 million for charging excessive markdowns and markups to corporate and municipal bond transactions clients. The SRO has also ordered that the financial firm pay $371,000 plus interest in restitution to these investors. By agreeing to settle, Morgan Stanley has not denied or admitted to the securities charges.

According to FINRA, the markdowns and markups that Morgan Stanley charged ranged from under 5% to 13.8%. Considering how much it costs to execute transactions, market conditions, and the services valued, these charge were too much.

The SRO also determined that the financial firm had an inadequate supervisory system for overseeing markups and markdowns of corporate and municipal bonds. Morgan Stanley must now modify its written supervisory procedures dealing with markups and markdowns involving fixed income transactions.

FINRA Market Regulation Executive Vice President Thomas Gira has said that Morgan Stanley violated fair pricing standards. He noted is important for financial firms that sell and purchase securities to make sure that clients are given reasonable and fair prices whether/not a markdown or markup exceeds or is lower than 5%.

A Markup is what is charged above market value. It is usually charged on principal transactions involving NASDAQ and other OTC equity securities. Markups on principal transactions usually factor in the type of security, its availability, price, order size, disclosure before the transaction is effected, the type of business involved, and the general markups pattern at a firm.

A markup on an equities security that is over 5% is seldom considered reasonable or fair. Regulators have rules in place for how much registered representatives can charge customers for services rendered. Not only do the charges have to be reasonable, but also they must be fair and not show particular preferences to any clients.

The 5% policy also applies to agency transactions. Commissions for such transactions also must be “fair and reasonable.” Commissions that go above that must be justified and are often closely examined by regulators.
While most securities professionals are committed to doing their jobs fairly and ethically, there are those determined to take advantage of the system to defraud investors. There are also honest mistakes that can occur that also can result in investor losses.

Financial firms and their representatives are responsible for protecting investors and their money from unnecessary losses resulting from securities fraud or other negligence.

Morgan Stanley Fined $1M Over Muni-Bond Markups, Bloomberg, November 10, 2011

More Blog Posts:
Whistleblower Claims SEC is Illegally Destroying Records of Closed Enforcement Cases, Institutional Investor Securities Blog, August 31, 2011

Ex-Bank of America Employee Pleads Guilty to Mortgage Fraud Scam Using Stolen Identities to Buy Homes Not For Sale, Institutional Investor Securities Blog, August 30, 2011

Securities Lawsuits Expected to Reach Record High in ’11, Says Advisen Ltd. Report, Institutional Investor Securities Blog, April 23, 2011

**This blog has been backdated.

FINRA Tells Congress It Is Ready to Act as SRO for Investment Advisors

Published on: September 13, 2011 | by Shepherd Smith Edwards & Kantas, LLP

Speaking before a House Financial Services Committee, Financial Industry Regulatory Authority Chief Executive Richard Ketchup said that the self-regulatory organization is ready to set up a new entity to oversee investment advisers and make sure they are in compliance with federal securities laws. Ketchum also said the SRO would hire experienced staff to do the job and that regulatory oversight to tailored to investment advisers would be put into place.

Currently, the Securities and Exchange Commission is the watchdog for investment advisers. Staffing issues, however, prevent the commission from doing a thorough and frequent job-checks are about once every 11 years. Last year, the SEC was only able to examine 9% of all registered investment advisers.

Yet there are many in the financial industry that have expressed a preference for this status quo, or, if change has to happen, they would like state regulators to do the job. Some have expressed worry that FINRA would uphold investment advisers to rules more that applicable to broke-dealers. Others are not sure that the SRO is up to the task. Many are still not happy with FINRA’s performance as a financial industry watchdog prior to financial crisis. (It is important to note that FINRA has taken some responsibility for not discovering the Bernard Madoff Ponzi scam earlier.)