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Regulatory Sanctions

Failed Supervision of Outside Brokerage Accounts – FINRA Doesn't Sanction Firms

May 2, 2018

[Photo:  'Say No Evil, See No Evil, Hear No Evil', by Metal Gear /]


by Howard Haykin

Here’s a follow-up to Monday‘s Financialish story, Buying IPOs in Outside Brokerage Accounts – Two FINRA Cases, involving two brokers charged with purchasing shares in new issues through outside personal brokerage accounts.


IN CASE ONE ... a broker purchased and sold shares in 33 IPOs (over a 4-year period) in a personal brokerage account at Berthel, Fisher & Company, which was fully disclosed to his firm, Sterne Agee Financial Services.


IN CASE TWO ... a broker purchased and sold shares in 239 IPOs (over a 4.5-year period) in a personal brokerage account at Merrill Lynch, Pierce, Fenner & Smith, which was fully disclosed to only one of his two firms, Best Direct Securities or M Holdings Securities Management.


The relevant rules in these cases are rather straightforward, although employer member firms (as defined below) have some leeway (or discretion) as to how they choose (if at all) to monitor the personal trading activity of associated persons in outside brokerage accounts (i.e., held at executing member firms).


FINRA Rule 3210. Accounts at Other Broker-Dealers and Financial Institutions. 

►  No person associated with a member ("employer member") shall, without the prior written consent of the member, open or otherwise establish at a member other than the employer member ("executing member"), or at any other financial institution, any account in which securities transactions can be effected and in which the associated person has a beneficial interest.

►  Any associated person, prior to opening or otherwise establishing an account subject to this Rule, shall notify in writing the executing member, or other financial institution, of his or her association with the employer member.

►  An executing member shall, upon written request by an employer member, transmit duplicate copies of confirmations and statements, or the transactional data contained therein, with respect to an account subject to this Rule.


FINRA Rule 5130Restrictions on the Purchase and Sale of Initial Equity Public Offerings.

►  In relevant part, prohibits a person associated with a member from purchasing a new issue in any account in which such person associated with a member has a beneficial interest.


FINANCIALISH TAKE AWAYS.    We know that two brokers were sanctioned for their violative conduct, but there's no evidence that any broker-dealers - employer members or executing members - were sanctioned for their failure to prevent, detect or act upon the purchase of IPO shares by these restricted persons. [Note:  This conclusion is based on my review of each broker-dealer's CRD records - though I did not review the 534 regulatory disclosures in Merrill Lynch's CRD files].


Why did the employer members (Sterne Agee and Best Direct or M Holdings Securities) not detect the numerous purchases of IPO shares by their associated persons - presuming that they requested duplicate confirms and statements from the executing member firms? Based on my experience, any halfway attentive review of brokerage statements would disclose such purchases.


And what about the executing members (Berthel Fisher and Merrill Lynch)? Were they not aware that they held accounts belonging to employees of other broker-dealers - i.e., restricted persons? Unfortunately, FINRA offers no information to support an answer to that question.


If supervision and viable internal control procedures at broker-dealers are cited by FINRA as the industry's "first line of defense" against violative conduct - such as participation in IPOs by restricted persons - then why has FINRA seemingly taken a pass on sanctioning its member firms for their lapses or failures to supervise?


FINRA360 will succeed in addressing many of the holes in the regulators' practices and policies, but FINRA's efforts will be judged in large part by how consistent the regulator can address its efforts.