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Rules & Regulations
Can a Broker Recommend a Penny Stock to Customers While He's Selling It?
In FINRA Disciplinary Actions for April 2017, Feltl & Company agreed to a $150K fine to settle FINRA charges that it had failed to establish, maintain and enforce internal controls and supervisory procedures (“WSPs”) that were reasonably designed to supervise the personal trading activity of persons associated with the firm for conflicts of interest.
BACKGROUND. Feltl, a FINRA member since 1975, is headquartered is in Minneapolis, MM. The firm has 8 branch offices and approximately 98 registered individuals. Its revenue is derived from securities commissions, as well as underwriting and investment company activity.
FINRA FINDINGS IN THE CASE. Over a 2-year period, from October 2008 through October 2010, a registered rep (“RR”) sold more than 900,000 shares in a penny stock that he personally owned, at or around the same time he was recommending to his firm customers that they purchase shares in the same stock. During that time, 59 of the RR’s customers purchased 1.27 million shares of the stock. All transactions were effected in Feltl brokerage accounts.
FINRA noted that Feltl generated exception reports that identified trades involving securities held by its employees and customers that occurred on the same date. However, these reports were primarily used to identify instances of “front-running.”
- i.e., the reports were not designed to detect or monitor for conflicts of interest where a firm employee was selling a stock he was recommending his customers purchase.
- the firm had no other procedures for monitoring for such conflicts of interest, or for ensuring that proper disclosures were made to customers.
- as a result, the trades went through and nothing further was done – that is, until FINRA identified the transactions – presumably during an on-site visit.
- p.s. Feltl terminated the RR in October 2010, about the time that the firm updated its WSPs.
FINANCIALISH TAKE AWAYS. Years ago, when this writer was a compliance consultant, we ran across a similar scenario at a BD-RIA. When we asked the adviser how he could justify selling the same security that he was buying for his clients, he explained that he traded his own risk-oriented account, whereas he invested for his conservative clients.
While that same logic might have been in play in this case, we would fault the RR for apparently not disclosing to his customers that he was a seller while his customers were buyers of a particular penny stock.
However, given the fact that Feltl ultimately terminated the RR, we'd say that there was the RR more than likely relied on customer purchases to maintain the share price as he sold off his position. We just don't have the information to know for sure.