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Regulatory Sanctions

An AML Folly with Penny Stock Transactions

October 19, 2018

by Howard Haykin


A firm sees what it wants to see and disregards the rest. [in large part, attributed to Paul Simon]


A New York City-based broker-dealer agreed to pay a $40K fine to settle FINRA charges that it violated FINRA Rule 3310(a), Anti-Money Laundering Compliance Program, by failing to have in place adequate AML policies and procedures to monitor suspicious transactions pertaining to low-priced securities.


The Firm, a FINRA member since 2007, currently employs 37 registered individuals and has 3 branch offices. The Firm's principal business is proprietary trading and, until 2016, had engaged in a retail securities business.  [Financialish Note: An interesting business description, given the fact that the cited violations involved institutional (DVP) securities customers.]


FINRA FINDINGS.    Between January 2013 and June 2015 (the "Relevant Period"), the Firm’s AML procedures stated that it would monitor customers' account activity for unusual size, volume, pattern or type of transactions. The Firm's AML procedures classified as "high risk" those accounts that "regularly receive large shares of low priced securities," including accounts with a pattern of receiving stock in physical form or the incoming transfer of shares, selling the position and wiring out proceeds.


And to put an exclamation point on suspicious activities, the AML procedures also listed the following "red flags" related to the issuers of low-priced securities:

  • Company has experienced frequent or continuous changes in its business structure;
  • Company undergoes frequent material changes in business strategy or its line of business; and
  • Company has no business, no revenues and no product.


CUSTOMERS A, B, C, D.    Notwithstanding the 'declarative nature of the Firm's AML Procedures, four institutional customers each triggered one or all of the above-described red flags in their ‘delivery versus payment’ ("DVP") accounts at the broker-dealer. Collectively, these customers liquidated 5.2 billion shares of low-priced securities, which generated over $24 million in proceeds.


Customer A, a foreign financial institution, engaged in a pattern of liquidating low-priced securities, selling some 29 million shares for total proceeds of over $13 million. Many of these securities were the subject of contemporaneous online stock promotion campaigns. Also, during this period, the firm received multiple regulatory inquiries concerning Customer A's trading activities.


Customers B, C, and D each provided financing to small companies, and, in exchange, received stock or debt instruments that could be converted to stock. During the Relevant Period, they collectively sold over 5 billion shares of low-priced securities, generating proceeds of >$11 million, which they then wired out shortly after the sales. On multiple occasions, Customers B, C, and D deposited and liquidated shares of the same low-priced securities during the same time period. Often, these liquidations occurred at the same time as an online stock promotion campaign for these securities during which the stock price and trading volume experienced dramatic spikes.


WHAT WENT WRONG.    While the AML procedures stated that the Firm would monitor for suspicious activity through the receipt and review of exception reports provided by its clearing firm, the firm had no exception reports that tracked the deposit and liquidation of low-priced securities. Instead, in practice, the firm's system for reviewing this trading activity was to conduct a manual review of daily trade blotters. Given the high volume of the low-priced securities transactions being conducted by the Customers A, B, C, and D, this manual review was not reasonably designed to detect patterns of potentially suspicious activity that might occur over the course of days, weeks or months.


In addition, the Firm failed to detect any of Customer A, B, C and D's activities as potentially suspicious despite numerous red flags, such as the deposit and liquidation of billions of shares of low-priced securities, regulatory inquiries concerning the trading in certain low-priced stocks, and stocks being traded contemporaneous with online stock promotion campaigns.


This case was reported in FINRA Disciplinary Actions for October 2018.

For details on this case, go to ...  FINRA Disciplinary Actions Online, and refer to Case #2014039400901.