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FINRA Priorities:Quarterly Disciplinary Review, July 2017 (Part 1 of 2)
Want a sneak peek into FINRA’s disciplinary priorities - besides what you get from the Financialish.com ‘What Went Wrong’ case studies? Okay, here’s FINRA’s quarterly review, which highlights a sampling of recent disciplinary actions involving registered representatives.
The sample includes settled matters and decisions in litigated cases (National Adjudicatory Council (NAC) decisions and SEC decisions in FINRA cases), and falls under the following topics: [we present #'s 1-4 in this post, and #'s 5-9 in tomorrow’s post]
Participating in Undisclosed Private Securities Transactions and Making False Statements on Annual Compliance Questionnaires
Making Unsuitable Recommendations
Borrowing Funds From a Customer Without Notifying the Firm and Engaging in Outside Business Activities Without Prior Written Notice or Approval
Improperly Engaging in an Outside Business Activity and Creating Backdated Partnership Agreements
Providing False Information to a Member Firm Affiliate During an Internal Investigation
Structuring Cash Withdrawals to Circumvent the Federal Reporting Requirements of the Bank Secrecy Act
Impersonating Customers on Telephone Calls to an Insurance Company
Converting Member Firm Funds
Effecting Unauthorized Trades, Exercising Discretion Without Authorization, Failing to Disclose Customer Complaints, and Making Misrepresentations to the Firm
1. Participating in Undisclosed Private Securities Transactions and Making False Statements on Annual Compliance Questionnaires [Sanctions: $7.5K fine, 7-month suspension]
FINRA settled a matter involving a registered representative ("RR") who participated in undisclosed Private Securities Transactions ("PSTs") and made false statements concerning them on his firm’s Annual Compliance Questionnaires ("ACQs"). During the summer of 2012, a professional acquaintance who was performing consulting work for a privately held sports-drink company told the RR that the company was looking for a professional athlete to invest in the company and become a spokesperson for one of its products. The RR arranged and participated in an in-person meeting between one of his customers - who was a professional athlete - and the acquaintance. After the meeting, the customer expressed an interest in investing in the sports-drink company.
Between August and September 2012, the RR, the customer, and the sports drink company engaged in email communications and telephone conferences discussing the customer’s investment and the terms under which the customer would work as a company spokesman. The RR used his personal email address during this process. The customer invested $500,000 in the company and received a convertible promissory note. The customer also received a warrant entitling him to purchase equity at a reduced cost. Shortly thereafter, the customer entered into a spokesperson agreement with the company. The RR did not disclose this PST to his member firm. The RR's participation in the PST without providing prior written notice to his member firm violated NASD Rule 3040.
During that same period, the RR also completed his member firm’s ACQs on 2 occasions. In each instance, the RR answered "no" to whether he had participated in any PSTs at any point during the preceding 2 years. The RR's false responses on the ACQs were violations of FINRA Rule 2010.
2. Making Unsuitable Recommendations [Sanctions: $7.5K fine, 4-month suspension]
FINRA settled a matter involving an RR who recommended unsuitable trades in at least 3 customer accounts. The RR maintained limited trading authorization over various customer accounts maintained at his member firm, and he received compensation on the trades that he placed in such accounts.
Between January 2012 and January 2013, the RR engaged in short-term bond trading, including bond swap transactions, in 3 customers’ accounts. Although each of the customers had long-term growth investment objectives and moderate risk tolerances, more than 98% of the assets in their accounts were concentrated in bonds typically denominated in Brazilian reals. The customers also maintained significant margin balances in their accounts.
The RR did not have a reasonable basis to believe that the short-term trading in bonds, undue concentration of positions, or the use of margin was suitable for any of the 3 customers, or that such trading was consistent with their investment objectives, risk tolerances, and financial situations and needs. The RR's unsuitable recommendations violated NASD Rule 2310 and FINRA Rules 2111.
3. Borrowing Funds From a Customer Without Notifying the Firm, and Engaging in Outside Business Activities Without Prior Written Notice or Approval [Sanctions: $10K fine, 4-month suspension]
FINRA settled a matter involving an RR who improperly borrowed funds from a customer and engaged in undisclosed Outside Business Activities ("OBAs"). In October 2011, the RR borrowed $12,000 from a customer, documented by a handwritten promissory note which required the RR to repay the loan within 1 year in equal $1,000 monthly payments.
While the member firm’s WSPs prohibited its RRs from borrowing funds from customers unless previously authorized in writing by the firm, the RR did not provide the firm with notice of the loan and never sought or received the firm’s approval for the loan. In addition, the RR completed 3 ACQs for the firm between 2011 and 2013, and he indicated that he had neither solicited nor accepted a loan from a customer.
The RR made some payments on the loan, but never repaid the loan in full, leading the customer to file an arbitration claim against the RR and his member firm seeking, among other things, repayment of the loan. The firm settled the customer’s claim. The RR's improper borrowing arrangement with the customer violated FINRA Rules 3240.
From July 2011 to January 2014, the representative also participated in an OBA, a promotional item import business. In July 2011, the representative filed articles of incorporation for the business, in which he was listed as the company’s VP. In January 2014, the RR filed articles of dissolution for the business.
While the member firm’s WSPs required written disclosure of OBAs, the RR failed to provide prior written notice to or receive written acknowledgment from the firm regarding his role in the OBA, his planned participation in the activity, or his expected compensation from the activity. Moreover, the RR completed 3 ACQs for the firm between 2011 and 2013, indicating that he was not involved in any OBA. The RR's undisclosed promotional item import business violated FINRA Rules 3270.
4. Improperly Engaging in an Outside Business Activity and Creating Backdated Partnership Agreements [Sanctions: Barred from the Industry]
FINRA settled a matter involving an RR who engaged in an undisclosed OBA and created backdated partnership agreements. During the summer of 2012, the RR began working with a local tax preparer from whom he sought referral business. The RR created partnership agreements for the tax preparer’s clients and held himself out to be a partner of the tax preparer. The RR's activity was outside the scope of his business with his member firm, and he did not provide the firm with notice of this activity at any time. The RR’s undisclosed tax preparation services violated FINRA Rules 3270.
In connection with the tax preparation services, the RR created partnership agreements for the tax preparer’s customers when he had reason to believe the customers were the subject of a state tax audit. The RR understood that the audits related to tax deductions claimed by the tax preparer’s customers on partnership tax returns filed in prior years. The RR also understood that the tax preparer’s customers who were under audit did not have documented partnership agreements. The RR did not have any prior experience creating partnership agreements, nor did he have any legal or tax expertise regarding partnerships.
Notwithstanding these facts, the RR created at least 50 backdated partnership agreements for the tax preparer’s customers. The RR inserted backdated effective dates using information in the previously filed returns regarding the date the businesses were started, but the RR did not adequately investigate the purported partnerships. As a result, the RR did not know whether the agreements he drafted accurately reflected partnerships that existed as of the effective dates that he had inserted in the agreements. The RR also failed to ascertain whether the individuals who may review the newly created documents, such as state auditors, may be misled to believe that the written partnership agreements had been in existence years earlier. The RR's creation of the backdated partnership agreements violated FINRA Rule 2010.