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Regulatory Sanctions

Unsuitable Non-Traditional ETFs – Firm Lacked Supervision

February 26, 2018

By Howard Haykin


This case prompts a follow-up discussion on the Chief Compliance Officers as 'Stakeholders'. After reading this case study below, click here:  Financialish Take Aways: Holding CCOs Responsible for Inadequate WSPs.


Capital City Securities agreed to pay a $15K fine to settle FINRA charges that it failed to adequately supervise its registered reps who, over a 3-year period, sold unsuitable Non-Traditional ETFs to firm customers. A lower fine was imposed after considering, among other things, the firm’s revenue and financial resources.


FINRA FINDINGS.    Capital City, a FINRA member since 2008 and a member of the MSRB, has 7 branch offices and about 20 registered reps. The firm had no prior disciplinary history.


From July 2011 to November 2014 (the "Relevant Period"), at least 10 of the Firm's reps sold leveraged and inverse exchange-traded funds (“Non-Traditional ETFs”) to customers, involving at least 500 transactions. Many of the firm's customers held these products for long periods of time, despite the increased risk presented when holding Non-Traditional ETFs over longer periods.


In June 2009, FINRA advised its membership in FINRA Regulatory Notice 09-31 concerning Non-Traditional ETFs that, "[d]ue to the effect of compounding, their performance over longer periods of time can differ significantly from the performance ... of their underlying index or benchmark during the same period of time." The regulatory notice further advised broker-dealers that Non-Traditional ETFs "are typically not suitable for retail investors who plan to hold them for more than one trading session, particularly in volatile markets.”


During the Relevant Period, Capital City failed to reasonably supervise these sales, specifically because:

  • Its WSPs did not address the unique features and risks associated with Non-Traditional ETFs.
  • It didn’t have exception reports or surveillance tools to monitor holding periods for Non-Traditional ETFs.


FINANCIALISH TAKE AWAYS.    Two basic take aways from this case:


  1. Firms should not registered reps to recommend or sell to customers any securities (products) that supervisory personnel do not understand.
  2. Written Supervisory Policies and Procedures ("WSPs") are living, working documents that need to be kept current, particularly for:  (i) changes in a firm’s operations; (ii) new lines and areas of business; (iii) new or amended FINRA rules and regulations; and, (iv) FINRA pronouncements regarding critical risk areas and evolving regulatory priorities.


Apparently, Capital City Securities (and its senior management failed in both respects.


This case addressed in this article was reported in FINRA Disciplinary Actions for November 2017.

For details on this case, go to ...  FINRA Disciplinary Actions Online, and refer to Case #2014039216101.