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Regulatory Sanctions

Microcap Stocks: Where's the Incentive to Report Suspicious Transactions?

February 20, 2018

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by Howard Haykin


Alexander Capital agreed to pay an $80K fine to settle FINRA charges that it failed to develop and implement adequate AML procedures pertaining to activities and transactions involving microcap stocks. [Yet the firm made considerably more in commissions revenues trading those stocks. More on that later.]


The settlement also calls for the firm to submit a certification that its policies, systems and procedures (written and otherwise), and training are reasonably designed with respect to the firm’s compliance with FINRA AML Rule 3310 and the requirements of the Bank Secrecy Act - including, but not limited to, those related to monitoring for and identifying, investigating, and responding to red flags of suspicious transactions involving microcap securities and the distribution of unregistered securities.


FINRA FINDINGS.    Alexander Capital (“ACLP”), a New York, NY-based FINRA member firm since 1996, currently employs some 55 registered persons in 3 branch offices. ACLP engages in a general securities business.


From February 2013 through March 2014 (the "Relevant Period), the firm monitored for potentially suspicious trading activity by conducting manual review of daily trade blotters. However, 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 particular, the Firm failed to establish and implement policies and procedures that could be reasonably expected to detect and cause the reporting of potentially suspicious activity relating to transactions involving the liquidation of hundreds of millions of shares of microcap stocks


Here are some specific activities and transactions:


Red Flags in the Accounts of Customer A.    During the Relevant Period, ACLP opened 2 DVP/RVP accounts for "Customer A," a foreign broker-dealer. Customer A told the ACLP registered rep and trader who opened the account that it traded in small capitalization stocks. And between December 2013 and March 2014, Customer A sold more than 300 million shares of more than 100 microcap securities. Those transactions generated more than $36 million in proceeds for Customer A and more than $375,000 in commissions for the Firm. 


  • Customer A sold more than 44 million shares of microcap stock A for net proceeds of >$12Mn with no corresponding buy transactions. During that same period, the stock's share price increased from a low of .10¢/share to a high of .76¢/share and Customer A's trading volume ranged from between 4% and 75% of the total market activity.


  • Customer A sold more than 5 million shares of a microcap stock B for net proceeds of >$1.8Mn. During that same period, the stock's share price quintupled to a high of $1.41/share on December 24th and was the subject of a paid promotion. At times, Customer A's trading activity accounted for more than 50% of the total market activity in microcap stock B. ln December 2013, ACLP received a regulatory inquiry concerning transactions in microcap stock B.


  • Customer A sold nearly 1 million shares of microcap stock C for net proceeds of >$2.1Mn. In late January, the ACLP registered rep who opened this account was told in an instant message exchange that the share price of microcap stock C was being manipulated. That didn't prompt an inquiry and ACLP continued to execute trades in this stock – i.e., until the SEC suspended trading in microcap stock C on February 11th.


  • In addition, Customer A refused to provide ACLP with information concerning the origin of the microcap stocks it sought to liquidate through the Firm or the identity of its customers.


Red Flags in the Account of Customer B.    During the Relevant Period, Customer B opened its account with ACLP and subsequently attempted to transfer microcap securities into its account from another broker-dealer. ACLP's clearing firm rejected 6 deposits, but accepted deposits of 4 microcap securities with a market value of approximately $1.65 million, which Customer B began liquidating.


  • Customer B liquidated more than 1 million shares of 3 microcap securities and promptly withdrew the approximately $270,000 of proceeds of those liquidations, which approximated 16% of the market value of the securities that were deposited by Customer B.


FINANCIALISH TAKE AWAYS.    At what point do responsible persons of a broker-dealer recognize as suspicious significant activities and transactions in microcap securities? At what point do those suspicions prompt investigations and the filing of SARs? The answer is ... perhaps never, so long as the cost-benefit ratio is skewed to enormous profits. Without making any judgments, Alexander Capital made around $376,000 in commissions on transactions in Customer A’s accounts, alone. Offset that against the $80,000 in FINRA fines that the firm paid. Hmmm!


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

For details on this case, go to ...  FINRA Disciplinary Actions Online, and refer to Case #2014039351101.