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Failure to Supervise

FINRA is the Financial Industry Regulatory Authority and is the regulatory body that oversees all brokerage firms. A cornerstone of FINRA regulation is the mandate that firms must develop supervisory procedures to ensure consumer protection. Branch managers and compliance personnel are required to review a multitude of reports, usually computer generated, to determine and pinpoint any irregularities in their offices. This process is in place to protect the clients from their own financial advisors. One standard check and balance is the exception report which is supposed to “red flag” any troubling occurrences. Though these reports exist, they are routinely ignored by management. In a particular situation, a client’s account was being churned by the broker. Churning means that the broker was making recommendations to continuously buy and sell securities which is rarely, if ever, in the best interest of the client. The computerized supervisory system concluded that the account had a very high turnover rate, which is a technical term indicating the account was being churned. Though compliance had the red flag alerts, they did nothing to supervise the broker. Besides suing the firm for churning and unsuitability, the client also had a case for failure to supervise.

In another matter, the broker was recommending the same product for almost all his clients. Compliance personnel can run reports assessing the type of products/securities a financial advisor was recommending for all his clients. Generally, an advisor will have different clients with different needs and risk tolerances. As such, the advisor’s “book of business” would naturally be varied, with different portfolios for different client who naturally fall into diverse categories. In this instance, the advisor had almost all his clients in the exact same product, regardless of age, objective and risk tolerance. That pattern should have been a red flag for the compliance department. However, it was neglected and they did nothing about it. The product in question resembled that of a Ponzi Scheme and all the clients ended up with considerable losses.

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