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Regulatory Sanctions

Overreliance on Automated Compliance Systems – A Broker-Dealer Pays the Price

September 20, 2017

by Howard Haykin


This case illustrates an excellent warning to firms and supervisory principals who place inappropriate reliance on automated compliance systems. They can be wonderful tools, but in they’re not intended to serve as an “end-all-be-all.” And, readers may appreciate the cautionary message in this case – it’s significantly greater than the small number of exceptions noted by FINRA or the small size of its sanctions.


Hilltop Securities Independent Network (fka SWS Financial Services) and Douglas Hodges have agreed to settle FINRA charges that the firm, while acting through regional OSJ manager Hodges, failed to reasonably supervise a registered rep’s unsuitable investment recommendations to customers. The settlement calls for:

  • Hilltop to pay over $45K in fines and restitution;
  • Hodges to pay a $5K fine and serve a 15-day principal capacity suspension.


BACKGROUND.    Hilltop, based in Dallas, TX, has been a FINRA member since 1986. It is a full service broker-dealer and an MSRB member, with 136 registered personnel. The firm operates out of offices of supervisory jurisdiction (“OSJ”) and single-person, non-OSJ offices throughout the country. The firm currently operates 161 branch offices.


Douglas Hodges, a resident of Celina, TX, has 17 years’ experience with 3 firms. He’s been continuously associated with Hilltop since August 2000, and currently holds the Series 7, Series 24 and Series 66 securities licenses. During his tenure with Hilltop, Hodges was also concurrently associated with 2 other FINRA member firms - including Hilltop's affiliated broker-dealer, Hilltop Securities, Inc. (from November 2014 to present). During the relevant time period, Hodges served as a Regional OSJ Manager who was responsible for supervising some 70 registered reps.


FINRA FINDINGS.    From May 2012 through March 2014, a Hilltop registered rep (“RR”) engaged in unsuitable short-term trading and switching in open-end mutual funds (“OMFs”) and unit investment trusts ("UITs"), and engaged in unsuitable trading in closed end funds ("CEFs"). The violative trading took place in 4 different customer accounts, with 3 of them incurring a total of $5,300 in losses.


The firm employed a compliance software system to provide red flag alerts and supervisory reminders. However, for various reasons, Hilltop, acting through Hodges, failed to address several compliance issues that FINRA picked up on. Among FINRA’s findings:


►    Hilltop's WSP’s required the completion of a switch letter ... anytime a customer switched from a variable product, OMF or UIT to another similar security. Hodges was alerted to missing switch letters via an alert from the compliance software system utilized by Hilltop.


  • In 7 instances, the firm, acting through Hodges, failed to obtain required switch letters from the RR for certain OMF and/or UIT transactions that the RR had executed in customer accounts.
  • In 6 instances, Hodges noted that he had emailed the RR and requested the missing switch letter. However, prior to receiving a response back from the representative, Hodges marked each alert as "resolved" and the alert was closed without the required switch letter being received.
  • Even when required switch letters were submitted by the RR, Hilltop and Hodges failed to follow-up on red flags in the submitted letters. For example, …

♦   failed to investigate a missing date for the original securities purchase on a switch letter;
♦   failed to investigate vague rationales for the switch transactions that were contained on certain switch letters;
♦   failed to investigate similar rationales on switch letters for several unrelated customers.


►    As part of Hilltop's supervisory system, ... the firm's supervisors received alerts for actively traded accounts. Hilltop's WSP’s required supervisors to conduct active account reviews through the use of the firm's blotters and/or its compliance software system. The WSP's also required that the reviews be documented by completing an Active Account Review form or documenting the review in the compliance software system.


  • From July 2012 to January 2014, 12 active account alerts were triggered for trading activity in the RR’s customer accounts, including 8 for the accounts of the 4 customers at issue.
  • Each alert was "closed by the system," and there was no documented evidence that any action had been taken in response to the alert.
  • Hodges did not document his reviews by completing an Active Account Review form or making notations in the compliance software system as required by Hilltop's WSPs.


►    Hilltop failed to have a reasonable supervisory system to ... detect patterns of unsuitable short-term trading and/or switching of OMFs and UITs, or unsuitable trading of CEFs.


  • The parameters of the firm's automated compliance software system were too limited to detect unsuitable trading;
  • The volume of transactions being manually reviewed by individual supervisors was too high for the supervisor to be able to reasonably detect patterns and trends of possible unsuitable trading activity.


FINANCIALISH TAKE AWAYS.    Hold on, there. You say that, over a 2-year period and thousands of transactions, a Hilltop principal missed a handful of errant trades by a registered rep that led to just $5,000 in customer losses? Isolated incidents. Forget about it. No big deal.


Yes, even I felt somewhat sheepish about posting this case. Until I recognized the big angle to this ‘little’ story.


In this age of technology, we’re often tempted to take our eye “off the ball,” and maybe nod off for a moment. We do it all the time when watching sporting events - because we can simply catch the replay of, say, Aaron Judge hitting that game-winning home run.


But here, in financial services, when dealing with customers’ money, we’re called on to dot all the “i’s” and cross all the “t’s.” Which means that ...

We should strive for perfection - 0% error rates.

We should seek to improve what we do and how we do it, when we fall short of that goal.

We should appreciate the tools that technology offers, but not fall into the trap of over-relying on them. 


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 #2013034954002.