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Regulatory Sanctions

B/D Fined for Poor Supervision Over 3rd-Party Payments, But Customers Pay the Price [Part 1 of 2]

June 27, 2017

by Howard Haykin


Financialish offers a 2-part report on FINRA sanctions against a broker-dealer that allegedly had poor supervision over 3rd-party payments. Part 1: Facts and circumstances underlying the settlement between FSC Securities and FINRA; Part 2: An illustration of the consequences to firm customers when private securities transactions are not supervised at the broker-dealer level.


SETTLEMENT.    FSC Securities Corporation agreed to pay a $200K fine to settle FINRA charges that it failed to establish, maintain, and enforce a supervisory system that was reasonably designed to review and monitor 3rd-party check requests from customer accounts.


BACKGROUND.    FSC Securities is an Atlanta, GA-based broker-dealer and a FINRA member since 1977. It conducts a general securities business employing an independent contractor model, with over 1,000 registered reps operating out of over 600 branches located nationwide.


While FSC Securities Corporation does not have a relevant disciplinary, the firm has had 50 regulatory disclosures - including 24 disciplinary actions, most of which date back prior to 2011 (that, according to BrokerCheck). However, 3 of those disciplinary actions occurred over the past year and were rather large (which might say something about the 'culture of compliance' of this firm):


  • FINRA AWC, resolved 5/3/17.  FSC agreed to pay $150K fine to settle FINRA charges that it failed to compute its net capital and excess net capital accurately.
  • FINRA AWC, resolved 4/12/17 (this case).  FSC agreed to pay $200K fine to settle FINRA charges – see detail notes in this case study.
  • SEC Cease and Desist Order, announced 3/14/16.  FSC agreed to pay $2 million in disgorgement and prejudgment interest, as well as $7.5 million in civil penalties to settle SEC charges that the firm, along with 2 affiliated advisor firms, placed certain advisory clients into mutual fund share classes with higher expense costs when lower expense cost share classes of those funds were available.


FINRA FINDINGS.    From March 2009 until April 2010, one of the firm’s registered reps sold memberships in an investment fund created by a former FSC representative. Without the firm’s knowledge or approval, the registered rep sold memberships in the fund, which was not an approved product for sale, and the firm did not supervise the representative’s sales.


While the registered rep had not disclosed the offerings to FSC Securities, the firm did have one significant opportunity to learn about or detect the transactions - i.e., in connection with those sales, the representative submitted to the firm LOA’s signed by each of the 15 firm customers authorizing 3rd-party payments in the aggregate amounting to $1.6 million. The funds were to be transferred from their firm brokerage accounts to a bank account controlled by the fund ().


As FINRA notes, the firm failed to establish and maintain written supervisory policies and procedures reasonably designed to ensure compliance with applicable securities laws and regulations. In particular, …


  • firm lacked adequate supervisory procedures that would have enabled it to identify and review for patterns involving multiple transmittals of funds from customer’s accounts to the same 3rd-party payee.


  • firm’s required annual testing of its supervisory controls and reports was not fully documented or verified, and failed to detect any issues with its review of 3rd-party check requests.


  • firm’s procedures allowed for a decentralized manual review of 3rd-party check requests.


  • firm failed to develop and utilize any exception reports to bolster its decentralized manual review of LOAs.


Consequently, the firm’s supervisory system was too limited to detect the representative’s misconduct – i.e., private securities transactions - which involved, among other things, a pattern of checks issued from customer accounts to the same 3rd-party payee. As a result, the firm failed to conduct reasonable supervision of third-party check requests coming from a single branch office, and approved the transmittal of approximately $1.6 million of customer funds to the fund.


FINANCIALISH TAKE AWAYS.    Imagine if a large number of customers doing business with a single broker all purchased shares in the same speculative company. That would be suspicious - an obvious red flag, particularly if the order tickets were marked "unsolicited." Well, the same goes for 3rd-party payments, which by their very nature bear risk. And even if a firm's "back office" staffers aren't tuned into such 'red flags', supervisory personnel should be. It's Compliance 101. And while the firm got ding'd with a $200K fine, firm customers suffered even greater losses. Unfortunately, FINRA's hands were tied, in that it had no basis for holding the firm responsible for the faulted investment recommendations.


This case was reported in FINRA Disciplinary Actions for June 2017.

For details on this case, go to ...  FINRA Disciplinary Actions Online, and refer to Case #2012034037602.