[ by Howard Haykin ]

A Chicago-based broker-dealer agreed to settle FINRA charges that it facilitated a customer's resale of unregistered and restricted shares of low priced stock issued by at least 3 companies in contravention of Section 5 of the Securities Act of 1933, and other violations. 

Profile of Respondent Firm.   Chicago, IL-based Gar Wood Securities, LLC, a FINRA member since February 2006, is also a member of the NFA (National Futures Association) and ARCA.  The firm primarily conducts an equities and options business with institutional clients, although it does maintain a small number of retail accounts. The firm further acts as 3rd-party marketer of outside hedge funds.  As of 2011, the firm had 32 registered reps, 4 OSJ offices, 3 non-OSJ registered branches, and 1 non-registered branch. 

FINRA Findings and Allegations.   At various times between February 2008 and January 2010 ("the relevant period"), Gar Wood allegedly sold on behalf of a customer account unregistered and restricted shares of low priced stock issued by at least three companies.  Additionally, between February 2008 and January 2010, Gar Wood failed to identify suspicious "red flag" activity in the ICG account, and failed to properly investigate any "red flags" and file a Form SAR-SF on such activity, as appropriate. 

Section 5 of the Securities Act prohibits any person, directly or indirectly, from selling a security in interstate commerce unless a registration statement is in effect as to the offer and sale of that security or there is an applicable exemption from the registration requirements.

Between approximately August 2008 and October 2010, a certain entity, ICG, maintained an account at Gar Wood.

• ICG made loans to other entities or individuals who held low priced stock in exchange for a pledge of that low-priced stock.
• ICG then sold the pledged stock, and ICG retained any profit upon the sale of the stock. 
• ICG deposited the pledged stock in its Gar Wood account.
• Consistent with its business model, ICG regularly deposited mostly penny stocks into the account, followed almost immediately by the sale of the penny stocks and subsequent wiring out of the proceeds.
• During the relevant period, penny stocks from approximately 24 different issuers were transferred into the ICG account and liquidated in large volumes, in many instances involving millions of shares, with the proceeds being wired out soon after.
• The penny stock shares-were all used as collateral by individuals making non-recourse loans to ICG.
• On at least 3 instances, physical shares bearing no restricted legend that were received into the ICG account and subsequently sold were in fact restricted from resale

Supervision.     NASD Rule 3010(a) requires that firms "establish and maintain a system to supervise activities of each RR, Reg'd Principal, and other associated person that is reasonably designed to achieve compliance with applicable securities laws and regulations, and with applicable NASD Rules." All such systems must be documented in the firm's WSPs, and must set out mechanisms for ensuring compliance and for detecting violations, and not merely set out what conduct is prohibited.  Gar Wood's written supervisory procedures included descriptions of possible "red flags" and required registered personnel to provide additional documentation for certain "red flag" penny stock transactions.

However, in at least the 3 instances discussed above, Gar Wood allegedly failed to enforce its supervisory procedures or systems when it failed to conduct an inquiry about whether deposited shares were registered or exempt from registration. Instead, Gar Wood relied on its transfer agent and clearing firm, which required that customers self-report through the submission of a Deposit Securities Request Questionnaire (DSRQ) related to each transaction. 

The DSRQ form sought information related to the reason for the deposit of physical certificates, the date the security was acquired, the manner of payment, whether shares were received as compensation, how many shares of the issuer are owned or controlled by the security owner, and whether the security is restricted and why, among others.  Gar Wood could not evidence that the DSRQ was reviewed as required.

In addition to its failure to review the DSRQ form, Gar Wood also allegedly failed to conduct an independent assessment of the information representing the transaction on each DSRQ form.  Gar Wood failed to confirm or investigate the customers and issuers' backgrounds, confirm the sellers' affiliation status and conditions under which the shares could be resold, verify that the issuer was current in its filings with the SEC and the issuers' information was publicly available, review thoroughly and critically any opinion of counsel, restricted stock legend, offering materials or prospectus and other relevant documents for reasonableness. Gar Wood failed to confirm how long the customer held the securities, how the customer acquired the securities, whether the customer intended to sell additional shares of the same class of securities through other means, whether the customer solicited or made any arrangement for the solicitation of buy orders in connection with the proposed resale of unregistered securities, whether the customer made any payment to any person in connection with the proposed resale of securities, the number of shares or other units of the class outstanding, and the relevant trading volume. Gar Wood also failed to collect order records/transaction reports, new account records, records of certificates received, and designated supervisor's record of action taken, as required by its WSPs.

Alleged Violations and Agreed Upon Sanctions.      Failure to implement an effective supervisory system or enforce its WSP, as described above, would be in violation of NASD Conduct Rules 3010 and 2110 and FINRA Rule 2010.  Facilitating the sale of such restricted securities for a customer would constitute a contravention of Section 5 of the Securities Act of 1933 ("Securities Act") and violate NASD Rule 2110 and FINRA Rule 2010.   Such alleged actions also would violate NASD Conduct Rules 3010 and 2110 and FINRA Rules 3310 and 2010.

Gar Wood agreed to pay a $75K fine to settle the charges.

For further details, go to:   [ FINRA Disciplinary Actions for April 2013 ]        [ FINRA AWC #2010021003301 ].