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A Call to Arms: CCO Appeals FINRA's Email Supervision Charges
by Howard Haykin
Thaddeus North and FINRA have been duking it out for the past 4 years - over a $5,000 fine and one "knight's" honor. Having exhausted his options in the FINRA appeal process, Thaddeus North is now taking his case to the SEC. The charges: while serving as Chief Compliance Officer of Ocean Cross Capital Markets, North:
- failed to conduct a daily review of an appropriately sized sample of electronic communications (“e-comm”), as required by his firm’s WSPs;
- failed to maintain a record of his review of e-comm, as required by the firm's WSPs;
- failed to review the e-comm generated by one person associated with the firm who transmitted some of her e-comm through a Bloomberg account.
- failed to enforce the firm's WSPs regarding the review of e-comm.
BACKGROUND. North, a resident of New Milford, CT, has 19 years’ experience with 7 firms. From August 2011 to January 2013, he was associated with start-up broker-dealer, Ocean Cross Capital Markets, where he served as CCO. During that time, the firm sponsored North's impressive array of licenses: Series 7; Series 55 (Ltd Rep – Equity Trader); Series 3 (ROP); Series 24; and, Series 9 & 10 (General Securities Sales Supervisor). He had no prior disclosures of any kind before this FINRA case, and since January 2013, he's been associated with Kuhn Brothers Securities in a non-registered capacity.
FINRA FINDINGS. In October 2013, FINRA Enforcement filed a Complaint alleging that, from September 2011 through April 2012 ("the Review Period"), North had failed to adequately review electronic communications with customers of Ocean Cross Capital Markets. FINRA asserts that North had assumed responsibility for reviewing the firm’s e-comm after he recognized “red flags” indicating that another principal was not conducting the required reviews. In an effort to comply with the WSPs, North conducted occasional, random reviews of e-comm, but not enough to comply with the requirements of the firm’s WSPs.
In his defense, North admits that he served as Ocean Cross's CCO, but denies that the firm designated him as the principal responsible for reviewing e-comm. Instead, he contends, Ocean Cross's WSPs identified firm president William Schloth as being responsible, and that Schloth had not designated another principal or individual to be responsible. Whilte North further admits that he periodically reviewed e-comm, he denies that he became the designated responsible individual. And with that, he requests that FINRA's charges and sanctions be dropped.
FACTUAL BACKGROUND (According to FINRA). Ocean Cross, a start-up broker-dealer, received FINRA approval in August 2011. Yet, the firm did not become fully functional until mid-September 2011, when it received approval to conduct business in Texas - where Ocean Cross's largest producer, Leslie King (“King”), operated. Unfortunately, Ocean Cross ceased operations approximately one year later.
Ocean Cross was based in Westport, CT, where its only 2 principals (Thaddeus North and William Schloth) worked. The firm maintained a 2nd office in Plano, TX, where King worked. Eventually, Ocean Cross expanded to around 15 registered persons who operated in offices throughout the country. FINRA approved Ocean Cross to conduct multiple types of business, but during the Review Period, the firm generated the vast majority of its revenue from King's municipal securities business.
Ocean Cross's WSPs during the Review Period required its president (Schloth) or another designated principal to review daily an appropriately-sized sample of incoming and outgoing email and instant message ("IM") correspondence, or to review any emails and IMs flagged by filtering software. The WSPs also required the reviewer to maintain all examined emails and IMs in a separate folder and initial and date an electronic correspondence review log.
Although North was not listed in the WSPs, he testified that he took it upon himself, as a practice, to review the firm's e-comm once per week during the Review Period. North testified that he “took it upon [himself] to review emails" because, although he was not the "designated principal" for email review, he knew that Schloth had not been conducting the review for which he was responsible. Yet, when North stepped in to that quasi-role, he essentailly assumed the responsibility and the role presumed title of 'designated principal'.
Ocean Cross used the Smarsh system exclusively to review its emails, King's Bloomberg chat messages, and King's Bloomberg emails - all of which Smarsh archived for Ocean Cross. And although Ocean Cross's WSPs required the person who reviewed e-comm to maintain all reviewed emails and IMs in a separate folder, and initial and date a review log, North stated that he instead relied upon Smarsh to maintain a record of his reviews – using the system’s "electronic initials.“
North further testified that his other responsibilities at Ocean Cross included drafting and reviewing the WSPs, acting as the firm's AMLCO, and handling the firm's "operational functions.” North stated that, during the first 3 months of the firm's business, he spent a large amount of time migrating hundreds of accounts to Ocean Cross - and devoting much of his time to ensuring that account forms were properly completed, executed, and processed.
FINRA examiner “JM” testified that, during FINRA's onsite visit to Ocean Cross in January 2012, both North and Schloth identified North as being the individual at the firm who was responsible for reviewing the firm's e-comm. "JM" further noted that neither Schloth nor North ever suggested that Ocean Cross stored email on any system other than Smarsh's, and neither suggested that North reviewed emails by any means other than through Smarsh. On that basis, JM requested records from Smarsh of North's email reviews. Based on Smarsh's records, FINRA observed this about North's reviews of e-comm for Ocean Cross:
- 12/14/11 was the first time that North logged onto the Smarsh system to review Ocean Cross's emails.
- North next logged onto the system on 1/31/12.
- Thereafter, North reviewed Ocean Cross's emails sporadically throughout February, about once or twice per week in March, and twice in all of April 2012.
- In order to review King's Bloomberg email, North would have had to conduct searches that were separate and independent from his searches of Ocean Cross's emails.
- King’s Bloomberg messages were available for review every day beginning 10/21/11.
- Yet, North did not log onto the Smarsh system to review King’s Bloomberg messages until 2/2/12.
- Thereafter, North accessed the Smarsh system to review King's Bloomberg messages only 6 more times through 4/30/12.
NAC AFFIRMS OHO'S DECISION. FINRA's NAC concurred with the findings and previous decisions of FINRA's Office of Hearing Offices (OHO), and affirmed the charges that Thaddeus North failed to enforce his member firm's WSPs regarding the review of e-comm.
FINANCIALISH TAKE AWAYS. Based on the facts and circumstances presented by FINRA, one might be swayed to support FINRA's postion. However, Thaddeus North's cannot be summarily discarded - in fact, based on facts and circumstances that I uncovered, I'd say Mr. North may have a pretty solid argument in his appeal to the SEC. Let's have a quick look at the opposing arguments.
SUPPORT FOR FINRA’S POSITION. Here are some of strong points in support of FINRA's sanctions against North:
- Ocean Cross had only 2 registered principals – North and Schloth – which meant that the firm had no choice but to delegate all its supervisory procedures between these two individuals. [a difficult, if not improbable, situation]
- Each principal had the option of delegating certain of his supervisory tasks to another individaul; that said, delegation of such duties would in no way diminish the principal's ultimate supervisory obligations – i.e., he would still have to ensure that the delegatee carried out all required tasks in accordance with the firm's WSPs.
- When it became apparent that Schloth was unwilling or unable to supervise the firm's electronic communications, and he had made no attempt to delegate those obligations, North took it upon himself to conduct some level of e-comm reviews.
- In doing so, North assumed de facto responsibility for supervising the firm's e-comm.
- And, while FINRA may have viewed North's efforts as valient, the regulator nonetheless deemed North's partial and infrequent reviews to be grossly inadequate and incomplete.
- Given his role as CCO (and one of only 2 firm principals), North was charged with significant tasks: (i) to implement and maintain adequate internal controls and supervisory procedures that he memorialized in the firm's WSPs; (ii) to ensure that all firm business activities are supervised in accordance with the firm’s WSPs; and, (iii) to take charge to there's an apparent disconnect between the procedures mandated by the firm's WSPs and the supervisory reviews that firm principals are actually conducting.
- Based on the foregoing, North had responsibility for the failed supervision of firm electronic communications.
SUPPORT FOR NORTH’S POSITION. Beyond the snippets of North's testimony that FINRA provides in its case write-ups, here are some strong points in support of North’s contention that FINRA charges and sanctions should be dismissed:
The following details were extracted from FINRA Disciplinary Actions for November 2013:
- In September 2013, William Schloth entered into 2 settlements with FINRA – one of which addresses some of the same supervisory issues that FINRA is now trying to pin on Thaddeus North.
- In FINRA AWC #2012030527501 (September 2013), Schloth agreed to FINRA's conditions that he pay a $20K fine and not serve in a principal capacity for 6 months to settle various FINRA charges.
- “Without admitting or denying the findings, Schloth consented to the described sanctions and to the entry of findings that:
► As CEO, CFO and FinOp of the firm, Schloth handled all investment banking responsibilities at the firm, including interactions with current and potential banking clients, conducting due diligence on possible investment banking deals to be sold by the firm and supervising any private placement transactions.
► The findings stated that Schloth was responsible for the firm’s WSPs; however, he was not the firm’s CCO or municipal securities principal.
► Schloth failed to conduct adequate due diligence on a firm private placement offering and failed to ensure that the firm established, maintained and enforced an adequate supervisory system, including WSPs, addressing due diligence of private placements.
► The findings also stated that Schloth was the registered principal responsible for the supervision of all firm registered representatives when a registered representative sent an email regarding a private placement offering to current and prospective investors.
► The email, which Schloth reviewed and approved, constituted a communication with the public and contained various false and misleading statements.
► The findings also included that Schloth failed to ensure that the firm established, maintained and enforced an adequate supervisory system, including WSPs, addressing, inter alia, municipal securities, safeguarding customer information and the retention of business-related communications.
► The WSPs were not tailored to address the needs of the firm’s business and they provided little useful guidance as to what reviews and other supervisory steps were required by firm personnel.
► Schloth also failed to enforce certain firm procedures, including those requiring the firm to contract with its clearing firm to provide material disclosures to customers prior to purchasing a municipal security, relating to the inspection of the firm’s branch offices and regarding the use of personal email addresses for sending business related emails
As such, a strong argument can be made that FINRA is attempting to “DOUBLE DIP,” by charging both William Schloth and Thaddeus North for the same charges pertaining to supervision of email.
FINRA, YOU CAN'T HAVE IT BOTH WAYS!
This case was reported in FINRA Disciplinary Actions for October 2017.
For details on this case, go to ... FINRA Disciplinary Actions Online, and refer to Case #2012030527503.