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Regulatory Sanctions

Broker-Dealer Unprepared When Its Newsletters Morph Into Research Reports

September 14, 2017

By Howard Haykin


A broker-dealer overextended its reach when it came to disseminating market research information. So where was the Chief Compliance Officer when all this took place? And isn't it the job of the CCO to protect the firm against its own transgressions? [Of course, it is - though in this case I'm not privy to all the facts.]  


Woodside Capital Securities agreed to pay a $65K fine to settle FINRA charges that it distributed newsletters that met the definition of a research report without ensuring that: (i) its personnel were properly registered as research analysts and research principals; (ii) its research-related WSPs were in place; and, (iii) required disclosures were made in the research reports.


BACKGROUND.    Woodside Capital, based in Palo Alto, CA, has been a FINRA member firm since 2010 with no prior relevant disciplinary history. The firm employs around 16 registered individuals who operate out of one branch office and. Woodside Capital had engaged in 2 lines of business - private placements and M&A advisory services. But on 8/3/12, Woodside received FINRA approval to amend its membership agreement to include distribution of “market research reports," which the firm referred to internally as *'newsletters." The newsletters would be distributed exclusively to registered investment companies (e.g., mutual funds) and hedge funds, and were not intended to constitute research reports under FINRA rules.


FINRA FINDINGS.    With FINRA’s newly granted approval, Woodside began distributing its newsletters to approximately 30 subscribers. Thereafter, Woodside began distributing free newsletters to approximately 2,000 email recipients, and then posted free newsletters on its website. Yet, somewhere along the way - specifically from September 2012 to January 2016 (the "relevant period") - Woodside's numerous communications met the definition of "Research Report" under NASD Rule 2711 and FINRA Rule 2241.


The firm, however, failed to ensure that: (i) its personnel were properly registered as research analysts and research principals as required by NASD rules; (ii) research-related written supervisory procedures (WSP’s) were in place; and, (iii) required disclosures were made in the research reports.


►   Woodside Issued Research Reports.   During the relevant period, Woodside distributed 113 newsletters that met the definition of "Research Report." The newsletters included analysis of equity securities of individual companies that provided information sufficient to make an investment decision and did not fall into any of the applicable exclusions. Because Woodside was not approved to distribute research, Woodside should have had procedures reasonably designed to ensure that the newsletters did not meet the definition of Research Report under NASD or FINRA rules. IT DID NOT.


As a result, Woodside distributed Research Reports and was required to comply with various rules applicable to Research Reports, including appropriately registering individuals involved in the preparation and supervision of the Research Reports, and making the required disclosures in the Research Reports. IT DID NOT.


►   Woodside Failed to Appropriately Register Individuals Involved with Preparation of its Research Reports.   Woodside's research personnel who prepared the 113 newsletters or “Research Reports” were overseen by 2 individuals who had not passed the required qualifying examination. The firm's failure to require these individuals to register as research principals and pass the qualifying examination or obtain a waiver VIOLATED NASD AND FINRA RULES.


Woodside also failed to properly register individuals who required registration as research analysts – i.e, those associated persons who were primarily responsible for the preparation of the substance of a research report or whose name(s) appeared on a research report. This constituted a VIOLATION OF NASD AND FINRA RULES.


►   Woodside Failed to Make Required Disclosures in its Research Reports.   The 113 newsletters or "Research Reports” failed to include one or more of the required disclosures, or they used conditional and indefinite disclosure language. With respect to 111 of these “Research Reports,” the Firm included conditional language regarding the Firm and its officers' and employees' ownership of the subject companies' securities.


  • The “Research Reports” stated “Woodside Capital Securities, its officer and employees may from time to time acquire, hold, or sell a position in the securities mentioned in this report.” Such conditional language DOES NOT COMPORT WITH NASD OR FINRA RULES.
  • In at least one instance, Woodside failed to disclose that it expected to receive compensation for investment banking services from a subject company in the next 3 months in VIOLATION OF AN NASD RULE.
  • In another instance, Woodside FAILED TO COMPLY WITH AN NASD RULE with respect to third-party research.


►   Finally, Woodside Failed to Adopt and Implement Adequate WSP’s.   


FINANCIALISH TAKE AWAYS.    I've got a couple of comments.


First, according to FINRA BrokerCheck, the firm's "Types of Business" remain unchanged from 2012 - i.e., it will "prepare market research reports for dissemination exclusively to [RIC's] and hedge funds, for a fee; ..." Presumably, they've addressed all of the deficiencies noted by FINRA in the AWC.


Second, according to FINRA BrokerCheck, the firm's Chief Compliance Officer came on board in 2012. This begets the question: Where was she when Woodside Capital was violating its Membership Agreement?  Securities rules pertaining to research reports are laid out rather clearly, and someone at the firm - namely the CCO - should have been alert to the apparent violations. That's what CCO's are paid to do, unless upper management places speedbumps or roadblocks in the way. That said, the CCO has not (yet) been charged by FINRA with failure to establish adequate policies, internal control procedures and WSPs to address the firm's business acdtivities.


While I rarely like to see CCO's sanctioned for a firm's transgressions, this is one case where such sanctions might have been warranted. Sorry!


One final comment - and that's to compliment the writer of FINRA's AWC. This AWC (case) was well-written, well-laid out, and sufficient in explaining how the facts and circumstances lead up to the sanctions. 


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

For details on this case, go to ...  FINRA Disciplinary Actions Online, and refer to Case #2015043457801.