[ by Howard Haykin ]

FINRA disciplined Houston-based Sanders Morris Harris Inc. - fka SMH Capital, Inc. - and 2 of its Registered Principals - each worked in Ohio branches -  pertaining to deficient pols and procedures or committed rule violations involving heightened supervision of registered persons, to supervision of options trading by branch RRs, to actions taken or not taken by the firm's designated AMLCO, and to failures to maintain minimum net  capital, among other things. 

Profiles of Respondents. SMH became a member of FINRA and registered with the SEC in 1987.  The firm, a full service brokerage, also is a registered broker-dealer with MSRB.    Paul Charles Blackman, a Registered Principal, entered the securities industry in October 1968 as a General Securities Rep with a FINRA firm.  He became associated with SMH in 2005, where he maintains his Series 7 and 24 licences.  Blackman remained with the firm until February 2009, and currently is not registered with another FINRA firm.  Pak Cheung Fung, a Registered Principal, entered the securities industry in 1994 as a General Securities Rep at a FINRA firm.  He since has been serially associated with 7 member firms, including SMH from 2002 through January 2009 where he served as the firm Anti-Money Laundering Compliance Officer.  Fung maintained his Series 7 (obtained 2005) and Series 24 (obtain 2007) licenses with SMH until his departure from the firm in March 2009.  Fund currently is registered with another FINRA firm.

FINRA Findings and Allegations.   

(1) Regarding the Heightened Supervisory Plan for one Registered Rep ("RR").  Sanders Morris Harris, acting through Blackman and another principal, apparently failed to reasonably supervise an RR who was subject to a heightened supervision plan, in the following ways:

• they failed to preapprove low-priced equity transactions the RR executed.
• they failed to evidence that they carried out the supervisory step of contacting the RR's customers each and every quarter.

(2)  Pertaining to Options Trading by RRs. 

• firm failed to establish and maintain a reasonable supervisory system to supervise the options trading effected by its RRs at a branch office.
• firm allowed options trading at a branch office which had more than 3 RRs and where the principal supervisor was not qualified as either a registered options principal or a limited principal-general securities sales supervisor.

(3)  AMLCO Reviews in Search of Suspicious Activity.  The firm, acting through Fung, its AMLCO, was responsible for detecting and identifying potential suspicious activity taking place in all 4 clearing platforms that the firm used to process its universe of transactions.  Yet, the firm repeatedly failed to accomplish this compliance obligation, because of deficiencies "up and down the line."  FINRA alleges that the firm, acting through Fung: 

• failed to establish and maintain an adequate AML compliance program ("AMLCP") for detecting and identifying potential “red flags” for suspicious activity.

• failed to document any reviews for exception reports related to transactions taking place on 3 of the 4 clearing platforms - the reports supposedly were programmed to identify potential suspicious activity on each clearing platforms.

• were using a firm AML-CP  (Compliance Procedures) manual that was incomplete because it only called upon supervisors to review activity conducted through only 1 of the 4 clearing platforms; 

• never scrutinized the trading activity or exception reports for 3 of the 4 trading platforms and thus never identified any transactions as being suspicious in nature. 

• never conducted manual reviews of activity for those 3 platforms whose exception reports either were never provided or provided but never reviewed. 

• All told transactions on these 3 clearing platforms accounts for about 40% of firm-wide transactions. 

• As a result, firm never had in place pols and procedures that could adequately and effectively review for suspicious activity.

(3A) AMLCO Due Diligence Reviews of Correspondent Accounts for Foreign Financial Institutions. Sandesr Morris, acting through Fung, also was responsible for conducting due diligence reviews of correspondent accounts for foreign financial institutions.  However, numerous deficiencies apparently rendered these controls ineffective;  they allegedly:   

• failed to implement adequate or effective pols and procedures for conducting due diligence reviews of correspondent accounts for foreign financial institutions. 

• firm procedures called upon personnel to forward correspondent accounts of foreign financial institutions to the AMLCO for his review upon opening of the account.

• firm WSPs made the AMLCO responsible for identifying correspondent accounts for foreign financial institutions and conducting the required due diligence.

• never maintained adequate documentation for evidencing that such procedures were carried out for its 5 correspondent accounts for foreign financial institutions.

• never conducted an adequate testing of its AMLCP:

   

  • testing never included reviews for CIP compliance
  • testing never reviewed the adequacy of suspicious activity monitoring
  • testing never picked up or reported on the fact that the firm continuously never monitored for suspicious activity or potential red flags of customer accounts held at 3 of its 4 clearing platforms

(3B) Annual Report of Foreign Bank and Financial Accounts.  Firm failed to file a report of foreign bank and financial accounts for a calendar year, and filed its report for the following year after the deadline for its one foreign bank account.

(3C)  Erroneous Accounting for Proposed Credit Agreement Between a Bank and Firm's Parent Company. The firm learned from FINRA that it had been incorrectly accounting for a proposed credit agreement for more than 18 months. 

As part of the agreement, the firm's parent pledged the assets of its subsidiaries, which caused a net capital charge to the firm;  and the firm should have noted the entire amount borrowed as a liability for calculating its net capital requirement. 

This revelation from FINRA, in turn, meant that the firm had been inaccurately calculating and reporting its net capital requirement for more than 18 months.  Specifically, the firm's net capital was calculated to be deficient by more than $6.1 million.   The parent company alleviated the firm of the financial obligations and increased its net capital position to bring it out of net capital deficiency and bring it into compliance.

FINRA Sanctions. To settle the numerous violations charged by FINRA , Sanders Morris Harris Inc agreed to a $150K fine - $50K of which pertains to the MSRB rule violation, $10K of which is joint and several with Blackman;  $10K is joint and several with Fung; $5K of which is joiny and several with an undisclosed principal.

Paul Charles Blackman accepted a 30-day suspension in a principal capacity, in addition to the $10K fine cited immediately above.

Pak Cheung Fung accepted the $10K fine cited above.

For further details on this case or others, go to:   [FINRA Disciplinary Actions for October] and [FINRA AWC #2008015360002].