Securities Law Prof Blog

FINRA Fines 3 Firms for OATS violations

FINRA fined TradeStation Securities, Inc., E*Trade Securities, LLC and CIBC World Markets Corp. a total of $1.6 million for multi-year violations relating to FINRA's Order Audit Trail System (OATS) rules and related supervisory failures.  Under the OATS rules, firms must report information related to the handling and execution of customer orders, as well as for certain proprietary orders for Nasdaq and OTC Equity securities. This information allows FINRA to recreate the life cycle of an order and is critical to effective regulation.

TradeStation Securities, Inc. was fined $750,000 for failing to report approximately 23.5 million Reportable Order Events relating to orders received. E*Trade Securities was fined $500,000 for failing to report "New Order Reports" and "Route Reports." CIBC was fined $350,000 for failing to report to OATS over 28 million orders which were generated by an affiliate.

FINRA further found that the three firms did not have adequate systems of supervision in place to monitor their OATS reporting compliance.  The fine for CIBC was reduced in recognition of the firm's actions in reporting the problem to FINRA and taking prompt remedial actions to correct the problem. In settling these matters, the firms neither admitted nor denied the charges, but consented to the entry of FINRA's findings.

SEC Approves Amendment to Narrow Definition of Public Arbitrator

In recent years FINRA has narrowed the definition of "public arbitrator" to reduce the connections of the non-industry arbitrator to the securities industry.  Effective June 9, 2008, FINRA will add an annual revenue limitation to the definition of public arbitrator, set forth in the Code of Arbitration Procedure for Customer Disputes and the Code of Arbitration Procedure for Industry Disputes. The amendment, which was approved by the Securities and Exchange Commission, seeks to ensure that individuals with ties to the securities industry may not serve as public arbitrators in FINRA arbitrations

FINRA Fines GunnAllen for Trade Allocation Scheme and Other Deficiencies

FINRA fined GunnAllen Financial, Inc., of Tampa, FL $750,000 for its role in a trade allocation scheme conducted by the firm's former head trader, as well as for various Anti-Money Laundering (AML), reporting, record-keeping and supervisory deficiencies. Kelley McMahon, the former head trader's supervisor, was suspended for six months from association with any FINRA-registered firm in any principal capacity and fined $25,000, jointly and severally with the firm.  FINRA barred Alexis J. Rivera, the former head trader, in connection with the trade allocation scheme, in December 2006. FINRA found that in 2002 and 2003, the firm, acting through Rivera, engaged in a "cherry picking" scheme in which Rivera allocated profitable stock trades to his wife's personal account instead of to the accounts of firm customers. Rivera garnered improper profits of more than $270,000 through this misconduct.

In connection with the firm's investment banking business, FINRA found that prior to March 2005, GunnAllen never put any stock of a company on a restricted or watch list even though the firm was conducting investment banking business with these companies. During the same period, GunnAllen failed to inform its own compliance department of the investment banking activities in which the firm was involved.  FINRA also sanctioned GunnAllen for failing to report to FINRA that its parent firm had entered into a consulting contract with an individual who had been previously barred by FINRA. In addition, the firm was sanctioned for failing to preserve e-mails and instant messages, for failing to implement an adequate AML compliance program and for supervisory and complaint reporting deficiencies. GunnAllen and McMahon settled these matters without admitting or denying the allegations, but consented to the entry of FINRA's findings

FINRA Issues Investor Alert on ARS

FINRA issued an Investor Alert on Auction Rate Securities: What Happens When Auctions Fail, so that, it says, investors can know about some of the options available to them in the event their ARS investment becomes illiquid and what can happen when an issuer makes a call for a partial redemption.

FINRA Issues Notice on Partial Redemptions of Auction Rate Securities

FINRA issued a Notice to Members regarding partial redemptions of auction rate securities.  In response to current market conditions, some issuers are offering partial redemptions of auction rate securities. This Notice reminds firms that when allocating partial redemptions of auction rate securities among their customers, they must adopt procedures that are reasonably designed to treat customers fairly and impartially, and must put their customers’ interests ahead of their own.

AFD $5 Million Fine for Directed Brokerage Upheld on Appeal

A $5 million fine imposed against American Fund Distributors (AFD) for directed brokerage in 2006 will stand, according to a ruling issued today by the National Adjudicatory Council (NAC), the appeals body of the Financial Industry Regulatory Authority (FINRA).  The NAC upheld a FINRA Hearing Panel decision finding that AFD violated FINRA's Anti-Reciprocal Rule when it directed more than $98 million in brokerage commissions between 2001 and 2003 to the 46 retail securities firms that were the top sellers of its mutual funds.

AFD is the principal underwriter and distributor of American Funds, a family of 29 mutual funds. In ruling on AFD's appeal of the Hearing Panel decision, the NAC concluded that AFD arranged for the direction of a specific amount or percentage of brokerage commissions to other securities firms conditioned upon those firms' sales of American Funds shares, an "outright" violation of FINRA's Anti-Reciprocal Rule.  The NAC also concluded that AFD's requests and arrangements for the direction of brokerage, conditioned upon sales, was directly at odds with the goal of the Anti-Reciprocal Rule, which is "to curb conflicts of interest that might cause retail firms to recommend investment company shares based upon the receipt of commissions from that investment company."

In the decision released today, the NAC emphasized that AFD tracked, monitored, and facilitated the directed brokerage payments by identifying the top-selling retail firms of American Funds, providing its investment adviser with the amount of commissions to be sent, and monitoring its investment adviser's trading with, and the payment of commissions to, the selected retail firms throughout the year. The NAC also highlighted the fact that AFD directed commissions to "step-out firms" - retail firms that had no capability to execute portfolio trades for American Funds, but nevertheless obtained commissions indirectly from clearing firms that did execute the trades.  The NAC also found that AFD's conduct was intentional.  The NAC concluded that AFD's violations, while "not egregious, were quite serious" and that a "substantial" fine of $5 million was appropriate based on the facts and circumstances of the case.

FINRA Proposes Amendments to Options Communications Rule

The SEC has released for public comment FINRA's proposed amendment of NASD Rule 2220 (Options Communications with the Public), which FINRA says is being revised to better address current needs for regulating options communications practices and promote consistency across the options communications rules of other self-regulatory organizations ("SROs").  FINRA explains that it, along with other SROs, have sought to modernize their rules concerning options communications with the public. One of the goals of this rule modernization is to make the rules on options communications consistent with the general rules on communications with the public. To this end, FINRA proposes to: (1) use, to the extent appropriate, the same terminology and definitions as in its general communications rules; (2) make the requirements for principal review of correspondence concerning options the same as for correspondence generally; and (3) update the standards on the content of communications that precede the delivery of the options disclosure document ("ODD").

H&R Block Financial Advisors Exonerated in Enron Sales Proceeding

A FINRA hearing panel dismissed a November 2004 complaint against H&R Block Financial Advisors alleging sales practices and supervisory violations relating to sales of Enron Corporation bonds during the one-month period immediately preceding Enron's filing for bankruptcy protection on Dec. 2, 2001.  The panel ruled that FINRA's Department of Enforcement failed to show by a preponderance of evidence that H&R Block registered representatives misrepresented or omitted material facts in connection with sales of Enron bonds, or that the firm failed to implement adequate supervisory systems and procedures.

FINRA Issues Alert on Event-Linked Securities

FINRA issued an alert to inform investors about event-linked securities—financial instruments that allow investors to speculate on a variety of events, including catastrophes such as hurricanes, earthquakes, and pandemics ("cat bonds").

The market for event-linked securities has grown substantially since they were first developed in the mid-1990s. At present, these products are not offered directly to individual investors. But various funds, including mutual funds and closed-end funds, have purchased or are authorized to purchase them on behalf of individual investors. While not widespread, holdings of event—linked securities in these funds—especially high income funds-are also not unusual.

Event-linked securities currently offer higher interest rates than similarly rated corporate bonds. But, if a triggering catastrophic event occurs, holders can lose most or all of their principal and unpaid interest payments.

The Alert advises investors to to find out whether any funds they own invest in cat bonds or other similar event-linked instruments and to consider whether the fund manager has adequate resources and expertise to evaluate the risks of event-linked securities and whether they are a sound investment.

FINRA Proposes Rule Change Regarding Complaints of Brokers'Sales Practices

FINRA is seeking comment on proposed rule amendments that would require registered firms - for the first time - to report allegations of sales practice violations against an individual broker made in arbitration claims that do not name the broker as a respondent.  Under current practice, firms are required to report customer allegations against a broker in an arbitration claim only if the legal document specifically names the broker as a respondent. A settlement or ruling resolving the allegations also need not be reported if the broker is not named as a respondent. Increasingly in recent years, claimants and their lawyers have been naming only the firm in arbitrations; as a result, neither the allegations of sales practice violations made against the unnamed brokers nor the dispositions of those proceedings are reported to CRD.

Currently, customer complaints and settlements involving an amount of $10,000 or more are reportable to CRD, a threshold that has been in place for years without being adjusted for inflation. FINRA is proposing raising that threshold to $15,000 to more accurately reflect today's business conditions.

FINRA will be accepting public comments on the proposals for 30 days, or until May 27.

Finra Seeks Delay on Parts of Suitability Rule for Deferred Variable Annuities

Finra filed a proposed rule change with the SEC to delay the effectiveness of the principal review and supervisory/compliance procedures sections of Rule 2821 (dealing with suitability requirements for sales of deferred variable annuities).  Finra said it plans to file an unspecified substantive change to the rule in the near future.  Proposed Rule Change to Delay the Effective Date of Certain FINRA Rule Changes Approved in SR-NASD-2004-183.

NASAA Coordinates Auction Rate Securities Investigations

NASAA announced that several of its members have been conducting investigations involving auction-rate securities (ARS) and are coordinating their efforts to help investors who cannot access funds that their brokers placed in these complex investment products.  Karen Tyler, NASAA President and North Dakota Securities Commissioner, said that state securities regulators have been responding to auction-rate securities-related complaints and have had investigations underway since late February, 2008. The state investigations center on sales practices and supervisory issues related to auction-rate securities. The investigations are being conducted by individual jurisdictions through an ARS Task Force chaired by Bryan Lantagne, Director of the Massachusetts Securities Division. Task force members include state securities regulators from Florida, Georgia, Illinois, Massachusetts, Missouri, New Hampshire, New Jersey, Texas and Washington.

Auction rate securities are often promoted as being similar to cash deposits or money market accounts. However, because of tight credit markets stemming from the sub-prime mortgage crisis, many auctions where auction rate securities are traded have failed. As a result, many investors are finding that they are unable to access their money.  Complaints received by state securities regulators have the same common theme. “Investors are telling state securities regulators that they did not know that their money was being held in auction-rate securities, and were not advised about the liquidity risks,” Lantagne said.

FINRA Issues Guidance on Unauthorized Proprietary Trading

In the wake of several recent cases involving allegations of unauthorized or "rogue" trading resulting in substantial losses by firms both in the United States and abroad, many FINRA firms are undertaking comprehensive reviews of their internal controls and risk management systems designed to prevent such trading activity. FINRA is issuing a Notice to Members to highlight sound practices for firms to consider as they undergo that process and to remind firms that even profitable unauthorized trading can result in regulatory exposure if it involves falsification of the firm's books and records, failures in supervisory control systems, market manipulation or fraud. Therefore, internal control systems should be designed to address regulatory as well as business and reputational risk. Regulatory Notice 08-18, Sound Practices for Preventing and Detecting Unauthorized Proprietary Trading Executive Summary.

 

NASAA Submits Comment Letter On Paulson Plan

NASAA submitted today a 12-page letter commenting on Treasury Secretary Paulson's Blueprint for Financial Regulation Reform.

NASAA Announces New Model Rule on Senior Designations

NASAA announced that its membership has approved a new model rule prohibiting the misleading use of senior and retiree designations.  The model rule prohibits the misleading use of senior and retiree designations while also providing a means by which a securities administrator may recognize the use of certain designations conferred by an accredited organization.  NASAA President Tyler said NASAA’s Model Rule on the Use of Senior-Specific Certifications and Professional Designations represents the culmination of an effort NASAA and its members launched in 2003 to focus national attention on unscrupulous behavior targeting senior investors. 

The model rule addresses the growing use of financial designations or certifications that ostensibly convey expertise in advising seniors and retirees. The use of a senior designation by salespersons, whether registered or not, confers an impression that the salesperson has special qualifications or specialized education in addressing the needs of senior citizens or retirees, particular areas of finance, financial planning, estate planning, or investing.“

SROs Warn Against Intentionally Spreading False Rumors

An interesting warning from the SROs, presumably directed at abusive short-sellers:

The Financial Industry Regulatory Authority (FINRA), NYSE Regulation, Inc., and participants of the Options Regulatory Surveillance Authority (ORSA), the self-regulatory organizations primarily responsible for surveillance of trading in the U.S. securities markets, are coordinating efforts to heighten the monitoring and investigation of trading activity in issuers that may be subject to credit market-related volatility. 
Firms are reminded of the prohibitions in FINRA and NYSE Rule 435(5) and FINRA Rule 5120(e) against the circulation in any manner of sensational rumors that might reasonably be expected to affect market conditions, as well as their obligations under FINRA Rule 2110 and NYSE Rule 476 to refrain from any conduct or activity inconsistent with just and equitable principles of trade. Similarly, firms are reminded of the prohibition on trading on material, non-public information.

Market participants should be especially aware that intentionally spreading false rumors or engaging in collusive activity to impact the financial condition of an issuer will not be tolerated and will be vigorously and aggressively investigated.   This type of activity is highly detrimental both to the investing public and to companies constituting important components of the U.S.  financial system.

In addition, market participants should review their internal controls and procedures with regard to the aforementioned activity. Individuals and entities engaging in such unlawful activity may be subject to civil as well as criminal prosecution. Self-Regulators Warn Against Spreading False Rumors and Other Abusive Market Activity 

FINRA Offers Guidance on ARS

FINRA today spelled out the options available to investors holding unexpectedly illiquid auction rate securities (ARS) because of recent developments in the credit market that have resulted in many ARS auctions failures: Auction Rate Securities: What Happens When Auctions Fail.  What are the options?  They include continuing to hold the securities, selling in the secondary market, liquidating other investments, or borrowing on margin.  With respect to the latter, FINRA provides the appropriate warnings about the dangers of borrowing on margin, but this surely is a risky and dangerous option for most investors.

FINRA Disciplines CEO of Investprivate

A FINRA Hearing Panel issued a decision that imposed a 90-day suspension, a concurrent 10-day suspension, and a $12,500 fine against Scott Mathis, Chairman and CEO of New York's Investprivate, Inc. (now known as DPEC Capital, Inc.), for failing to disclose tax liens and two customer complaints on his Form U4s. Mathis and Investprivate were originally charged by FINRA with securities fraud, but those charges were later withdrawn.  The hearing panel decision addressed the last outstanding charges brought by NASD (FINRA's predecessor) in 2004 against Mathis. FINRA's Enforcement Department previously settled several other charges from that 2004 action against Investprivate; Mathis; Donald Geraghty, the firm's Director of Compliance; and Ronald Robbins, Executive Vice President of Investprivate's parent company, Diversified Biotech Holdings Corporation.

FINRA Proposes Two Changes to Arbitration Codes

The SEC published for public comment two minor revisions to the FINRA Codes of Arbitration Procedure for Customer and Industry Disputes:  to Amend the Chairperson Eligibility Requirements  and to Permit Submissions to Arbitrators After a Case Has Closed Under Limited Circumstances.

FINRA Proposes Amendment to Motion to Dismiss Procedures

FINRA Dispute Resolution is proposing to amend NASD Rules 12206 and 12504 of the Code of Arbitration Procedure for Customer Disputes (“Customer Code”) and NASD Rules 13206 and 13504 of the Code of Arbitration Procedure for Industry Disputes (“Industry Code”) by providing specific procedures that will govern motions to dismiss, and amending the provision of the eligibility rule related to dismissals. Financial Industry Regulatory Authority, Inc.; Notice of Filing of Proposed Rule Change and Amendment No. 1 Relating to Amendments to the Code of Arbitration Procedure for Customer Disputes and the Code of Arbitration Procedure for Industry Disputes to Address Motions to Dismiss and to Amend the Eligibility Rule Related to Dismissals.

SEC Publishes NYSE Proposal on Listing Standards for SPACs

The SEC published the NYSE proposal to amend the Exchange’s Listed Company Manual (the “Manual”) to adopt listing standards for special purpose companies formed for the purpose of raising capital in an initial public offering and entering into an undetermined business combination. The filing also proposes the adoption of requirements that (i) any equity security listing on the Exchange must have a closing price or, if listing in connection with an initial public offering (“IPO”), an IPO price per share of at least $4 at the time of initial listing and (ii) convertible debt issuances listed on the Exchange must have an aggregate market value or principal amount of no less than $10,000,000.  New York Stock Exchange LLC; Notice of Filing of Proposed Rule Change to Adopt New Initial and Continued Listing Standards to List Special Purpose Acquisition Companies.

FINRA Revises Portfolio Margin Risk Disclosure Statements

FINRA has revised the sample portfolio margining risk disclosure and acknowledgment statements that member firms must provide to customers who have been approved for portfolio margin. This replaces the March 2007 sample risk disclosure and acknowledgment statements.  Portfolio Margin Release.

FINRA Issues Notice on Developing New Consolidated Rulebook

Following the consolidation of NASD and NYSE Regulation into FINRA, FINRA established a process to develop a new consolidated rulebook, which is outlined in the attached Notice. The new FINRA Rules will apply to all FINRA members and will be proposed in phases to the SEC. As rules approved by the SEC become effective, they will replace the existing NASD Rules and incorporated New York Stock Exchange (NYSE) Rules.

NASAA Announces 2008 Public Policy Conference

The North American Securities Administrators Association (NASAA) today announced the line-up of speakers and panels for its 2008 Public Policy Conference, which will be held April 1 in Washington, D.C.  The conference brings together securities regulators, financial services industry representatives, policy makers, and the media, for an in-depth look at key public policy issues concerning securities regulation and investor protection.  Senator Jack Reed (D-RI), a senior member of the Senate Banking Committee and Chairman of the Subcommittee on Securities, Insurance, and Investment, will deliver the conference’s opening keynote address. SEC Chairman Christopher Cox will deliver the luncheon keynote address.

The conference also will feature two panel discussions on current policy issues facing securities regulators and Wall Street. The first panel will outline what is at stake for investors as distinctions blur between investment advisers and brokers and as the SEC continues its ongoing review of how these two financial service providers are regulated. The second panel will delve into the current debate over principles- and rules-based securities regulation, spurred by the U.S. Department of the Treasury’s Review of the Regulatory Structure Associated with Financial Institutions. Panelists will include Roel Campos, former SEC Commissioner, and Lynn E. Turner, former Chief Accountant of the SEC.,Registration information and other details are available on the NASAA website.

NY Attorney General Enters Agreements with Freddie Mac, Fannie Mae

New York Attorney General Cuomo announced agreements with Fannie Mae, Freddie Mac and OFHEO that require Fannie Mae and Freddie Mac to buy loans only from banks that meet new standards designed to ensure independent and reliable appraisals.  The agreements also create a new independent organization to implement and monitor the new appraisal standards.  The companies also agree to establish a Home Valuation Code of Conduct.  NEW YORK ATTORNEY GENERAL CUOMO ANNOUNCES AGREEMENT WITH FANNIE MAE, FREDDIE MAC, AND OFHEO.

FINRA Settles Mutual Fund Sales Violations Against Five Securities Firms

FINRA settled cases against five firms for mutual fund sales and supervisory violations - including improper sales of Class B and Class C mutual fund shares and failure to have supervisory systems designed to provide all eligible investors with the opportunity to purchase Class A mutual fund shares at net asset value (NAV) through NAV transfer programs.

For the share class sales violations, FINRA imposed an $800,000 fine against Prudential Securities and a $750,000 fine against UBS Financial Services, Inc. for improper sales of Class B and Class C mutual fund shares. A $100,000 fine was imposed against Pruco Securities for improper sales of Class B shares. In resolving the Class B and Class C share matters, these firms also agreed to remediation plans that will address over 27,000 fund transactions in the accounts of 5,300 households.

To resolve the NAV violations, Merrill Lynch, Prudential Securities, UBS and Wells Fargo agreed to remediation plans for eligible customers who qualified for, but did not receive, the benefit of NAV transfer programs. It is estimated that total remediation to customers will exceed $25 million.

In addition, FINRA fined Prudential Securities, UBS, and Merrill Lynch $250,000 each for failure to have reasonable supervisory systems and procedures to identify and provide opportunities for investors to obtain sales charge waivers through NAV transfer programs. From 2001 through 2004, many mutual fund families offered NAV transfer programs that eliminated front-end mutual fund sales charges for certain customers. Customers who redeemed fund shares for which they had paid a sales charge were permitted to use the proceeds to purchase Class A shares of a new mutual fund at NAV - that is, without paying another sales charge. FINRA found that, as a result of inadequate supervisory systems at Merrill Lynch, Wells Fargo and UBS from 2002 through 2004, and at Prudential Securities from 2002 to 2003, certain customers eligible for the NAV programs incurred front-end sales loads that they should not have paid, or purchased other share classes that unnecessarily subjected them to higher fees and the potential of contingent deferred sales charges.

Although FINRA found that Wells Fargo Investments failed to have reasonable supervisory systems and procedures relating to NAV transfer programs, FINRA did not impose a fine because of the firm's proactive remedial actions taken upon its discovery of - and before FINRA's inquiry into - the violative conduct. When Wells Fargo discovered it had failed to provide certain eligible customers with NAV pricing, the firm initiated a review of its mutual fund sales and acted promptly and in good faith to repay customers and correct its system and procedures. As part of this process, Wells Fargo paid more than $612,000 in restitution to investors in Class A shares.

Each firm settled these matters without admitting or denying the allegations, but consented to the entry of FINRA's findings.

GAO Releases Report on Hedge Funds

The U.S. Government Accountability Office (GAO) released a report today on Hedge Funds (GAO-08-200).  The Report explains that after the near collapse of Long-Term Capital Management in 1998, regulators generally have increased  reviews, by means of targeted examinations, of systems and policies of their regulated entities to mitigate counterparty credit risks, including those involving hedge funds.  The Report describes those measures and explores the potential for systemic risk from hedge-fund related activities.  It notes that regulators have used risk-focused and principles-based approaches to better understand the potential for systemic risk and respond more effectively to financial shocks.  The GAO concludes that these are positive steps, but it is too soon to evaluate their effectiveness.

Oppenheimer Settles Market-Timing Charges with FINRA

FINRA announced today that Oppenheimer & Co. will pay a fine of $250,000 for supervisory and other failures in connection with improper market timing of mutual fund shares from January through September 2003. The firm will also pay $4.25 million in restitution to more than 60 mutual fund companies.

FINRA found that Oppenheimer failed to prevent a group of five traders' improper, short-term trading of mutual funds on behalf of hedge fund customers - activity that yielded about $9 million in gross revenue for the firm. Oppenheimer also failed to establish, maintain or enforce supervisory systems and written procedures to detect and prevent improper market timing activities, or to maintain required books and records of the short-term trading of mutual funds through other firms' trading platforms.  During the relevant period, the group maintained about 580 accounts for 15 hedge fund customers in an attempt to circumvent market timing trading blocks put in place by the mutual funds.

FINRA also found that the group used 51 different registered representative numbers to create the appearance that the trades were coming from registered representatives who had not previously been blocked from trading.

FINRA further found that the group sold variable annuity contracts to its hedge fund clients to allow them to use the annuity sub-accounts as yet another vehicle for market timing mutual funds. During the relevant period, the group - with the approval of at least some senior managers - purchased 159 variable annuity contracts on behalf of their hedge fund clients. Oppenheimer settled this action without admitting or denying the charges, but consented to the entry of FINRA's findings.

FINRA Charges Broker with Misappropriating Funds From Elderly Client

FINRA announced it has charged registered representative John Edward Mullins, of Margate, NJ, with misappropriating almost $400,000 from a 97-year-old nursing home resident who was a Mullins' client for more than 20 years, as well as from her charitable foundation. The customer has recently passed away. Broker Kathleen Maria Mullins, John Mullins' wife, was also charged with wrongdoing.

In its complaint, FINRA alleges that shortly after the customer's husband died in December 1999, the customer established a charitable foundation to receive and administer funds for the benefit of charities devoted to the promotion of musical arts in Philadelphia and the New Jersey Shore. From its creation, the Mullins both served as trustees and officers of the foundation. When the customer initially entered a nursing home in 2000, the Mullins were provided power of attorney over the customer's assets, including the ability to conduct banking transactions and withdraw funds.

FINRA further alleges that from about April 2006 through July 2006 - when the customer became ill and was hospitalized - Mr. Mullins misappropriated almost $400,000 from his longstanding client. With the elderly customer's health deteriorating, he took advantage of her condition by using her checking account and debit cards to pay for his and his wife's personal expenses, including paying down $375,000 in their joint mortgage credit-line account.  In addition to the customer's personal assets, the complaint charges, funds were also misappropriated from the charitable foundation account, set up by the customer at the brokerage firm that employed the Mullins'.

Under FINRA rules, a firm or individual named in a complaint can file a response and request a hearing before a FINRA disciplinary panel. Possible remedies include a fine, censure, suspension, or bar from the securities industry, disgorgement of gains associated with the violations, and payment of restitution. The issuance of a disciplinary complaint represents the initiation of a formal proceeding by FINRA in which findings as to the allegations in the complaint have not been made and does not represent a decision as to any of the allegations contained in the complaint.

NYSE Disciplines Credit Suisse Analyst for Tipping

The NYSE disclosed a disciplinary action against Adam Galeon, a research analyst with Credit Suisse, alleging that he obtained and disseminated certain information before public release. An NYSE hearing officer found that on May 24, 2005, Galeon obtained certain information from the CEO of a publicly traded company, referred to only as XYZ, relating to XYZ’s expected updated earnings guidance. That was the day before the official public release of the company’s updated earnings guidance. Galeon selectively disseminated emails to 17 Firm clients and 31 Firm sales personnel, conveying the information the CEO had disclosed to him. Subsequently, Credit Suisse and two clients of Credit Suisse who received the information in Galeon’s email traded in shares of XYZ, prior to the public release of such information. Without admitting or denying the findings, Galeon agreed to a censure, four-month bar, and a $50,000 fine.

Regulators Looking for Firms' "Best Practices" in Dealing with Senior Investors

In a joint press release, the SEC, NASAA and FINRA announced a new initiative on behalf of senior investors. The goal of the initiative is to identify effective practices used by financial services firms in dealing with senior investors, and to provide information about these practices publicly.  According to the press release:

As regulators have increasingly focused on protecting older investors, many investment advisers and broker-dealer firms are evaluating their current practices in serving seniors.   SEC staff, NASAA, and FINRA will solicit input from all interested parties in order to identify strong supervisory, compliance and other practices used by financial services firms serving seniors in the following areas: marketing and advertising to seniors; account opening; product and account review; ongoing review of the relationship and appropriateness of products; discerning and meeting the changing needs of customers as they age; surveillance and compliance reviews; and training for firm employees. The findings will be published so all firms can improve their service to older investors.

It is not expected that there will be a “one-size-fits all” approach to effective practices in these areas, and there may be many different practices that are effective.  The goal of the initiative is not to impose new regulatory requirements, but to help firms better meet their current obligations to, as well as more generally to serve, their senior customers.

Massachusetts Sues Merrill Lynch over CDOs Sold to City

The Massachusetts Secretary of State is suing Merrill Lynch in connection with the firm's sale of CDOs to the city of Springfield, charging that it was an unsuitable investment.  Yesterday the firm bought back, at the original sale price of $13.9 million, the CDOs that it sold to Springfield last spring.

BOSC Settles Unsuitable DVA Sales Charges

FINRA continues to crack down on sales of deferred variable annuities to senior citizens.  It fined Banc One Securities Corporation (BOSC) of Chicago $225,000 for making unsuitable sales of deferred variable annuities to 23 customers and for having inadequate systems and procedures governing annuity exchanges. Twenty-one of the 23 customers were over 70 years old.  FINRA is also requiring the firm to allow each of the 23 customers to sell their variable annuities without penalty. Ordinarily, these variable annuities would have been subject to a six-year "surrender period" during which time the customers would have been required to pay surrender charges as high as 7 percent of the amount invested if they were sold in the first two years. The firm will also pay restitution of about $6,500 to two customers who incurred surrender charges when exchanging annuities.

In 2006, BOSC merged with J.P. Morgan Securities, Inc.

FINRA found that in each of the 23 transactions between January 1, 2004, and June 30, 2005, BOSC representatives recommended that the customers exchange their fixed annuities then paying a minimum of 3 percent, for variable annuities. Following the exchange, the customers placed 100 percent of their assets into the fixed rate feature of the variable annuity, which paid a maximum of 3 percent - as recommended by BOSC representatives. All but one of the fixed annuities were beyond the surrender period - that is, the customers were not subject to any financial penalties if they withdrew any of their funds from the fixed annuity. Each of the newly purchased variable annuities was subject to a six-year surrender period requiring the customers to pay a penalty if they withdrew more than the sum of their earnings and 10 percent of their principal. FINRA found that each of these 23 recommendations was unsuitable, given the customer's age, investment objective, financial situation and income needs.

The settlement cites one example of an 80-year old customer who exchanged a fixed annuity earning 3 percent for a variable annuity, in which he invested the entire $80,000 balance in the fixed income feature, which also paid 3 percent interest. This new variable annuity was subject to a six-year surrender period. Within the first year of owning the variable annuity, the customer withdrew $9,000. Sixteen months after buying the variable annuity, the customer liquidated it and incurred a $4,628 surrender fee.

In concluding this settlement, BOSC neither admitted nor denied the charges, but consented to the entry of FINRA's findings.

Securities Arbitration Case Filings Down for 2007

FINRA has updated arbitration and mediation statistics on its website.  Arbitration case filings for 2007 were down 30% from 2006; the total (3238) was the lowest since at least 1992 (as far back as the website shows).  The number of cases closed in 2007 was also down 26% from 2006.  The overall turnaround time was up slightly (13.9 months in 2007, compared with 13.8 months in 2006), but the turnaround time in hearing decisions was down (16.0 in 2007, compared with 16.6 in 2006). 

FINRA Fines Brokerage Firm for Improper Soft Dollar Payments

FINRA has fined SMH Capital Inc. (f/k/a Sanders Morris Harris, Inc.) of Houston, TX, $450,000 for failing to adopt adequate supervisory procedures and systems designed to address its prime brokerage and soft dollar services to hedge funds. As a result, SMH made improper payments of $325,000 in soft dollars to a hedge fund manager.  The firm's failures also included drafting and distributing hedge fund sales materials that did not adequately disclose material investment risks to potential hedge fund investors. In addition, SMH entered into an improper compensation arrangement with two SMH brokers who also managed hedge funds, allowing them to share in commissions earned from fund trading contrary to representations made in the offering documents and a separate agreement.  In addition to the fine, SMH was ordered to retain an Independent Consultant to conduct a comprehensive review of the adequacy of the firm's policies, systems, procedures and training with regard to its hedge fund operation.

FINRA found that SMH commenced its hedge fund services business in July 2000 and eventually established relationships with more than 15 different hedge funds, making the hedge fund business an important part of the firm's overall operations. SMH provided a platform of services to hedge fund managers including office space (complete with desks, computers, telephones and internet access), marketing assistance and capital introduction, with the fund managers paying for such services through commissions earned on trades directed to SMH.

The firm also operated soft dollar accounts for hedge funds that opted not to join SMH's prime brokerage services platform. These accounts collected a portion of the commissions earned when SMH executed trades for each fund. Fund managers could then submit, or cause to be submitted from third party service providers, invoices for products and services. SMH then paid the providers from the balances accumulated in the soft dollar accounts.

FINRA found that, by failing to have policies and procedures to police its soft dollar payments, SMH sent two improper soft dollar payments totaling $325,000 to a hedge fund manager, despite red flags that the payments were improper. In settling this matter, SMH neither admitted nor denied the charges, but consented to the entry of FINRA's findings.

FINRA Fines 19 Broker-Dealers for Overstating Advertised Trade Volume

FINRA fined 19 broker-dealers a total of $2.8 million for substantially overstating their advertised trade volume to three private service providers.  FINRA compared the firms' advertised trade volume in selected securities with the firms' executed trade volume for the same securities in August 2006 and found substantial overstatements for each firm in one or more of the securities reviewed. FINRA also found that, prior to September 2006, all of the firms lacked an adequate supervisory system and procedures for communicating trade volume to such services.  The firms' overstated trade volumes were made available to market participants by the service providers. The service providers also used the firms' inaccurate advertised trade volumes to compile rankings and reports, including reports that rank the most active broker-dealers by security.

In the actions announced today, eight firms were fined $200,000 each (Broadpoint Capital, Inc., CIBC World Markets Corp., Lehman Brothers, Inc., Merrill Lynch, Pierce, Fenner & Smith, Inc., Needham & Company, LLC, Robert W. Baird & Co., Inc., Thomas Weisel Partners, LLC and UBS Securities, LLC). Six firms were fined $150,000 each (Bear, Stearns & Co., Inc., BMO Capital Markets Corp., Cowen and Company, LLC, Deutsche Bank Securities, Inc., Leerink Swann & Company, Inc. and RBC Capital Markets Corp.). Four firms were fined $50,000 each (Friedman, Billings, Ramsey & Co., Inc., Jefferies & Company, Inc., JMP Securities, LLC and Pacific Crest Securities, Inc.).

The fine for one firm, Piper Jaffray & Co., was reduced to $100,000 because the firm conducted its own extensive internal investigation and then voluntarily provided the results to FINRA.

In concluding these settlements, the 19 firms neither admitted nor denied the charges, but consented to the entry of FINRA's findings.

FINRA Eliminates Requirement that Confirmation Include Securities Market on which Transaction was Effected

FINRA Amends NYSE Rule 409(f) (Statements of Accounts to Customers) to Eliminate the Requirement to Include the Name of the Securities Market on which a Transaction is Effected; Effective Date: January 1, 2008.  Dual Member firms will not be required to disclose the name of the securities market on which the transaction was effected on confirmations or reports as required under NYSE Rule 409(f). This change makes permanent the temporary relief that was granted in March 2007 and extended until January 1, 2008.  FINRA concluded that because of member firms' best execution and disclosure requirements, the usefulness of including on a confirmation the securities market on which a transaction was effected does not outweigh the operational difficulties of capturing the information after adoption of Regulation NMS.  FINRA Regulatory Notice 07-65.

FINRA Proposes New Rule on Expungement Procedures

FINRA announced today that its Board of Governors approved a rule proposal that would impose expungement procedures requiring arbitrators to take specific steps, including issuing a written explanation, before recommending expungement of information related to arbitration cases from a registered person's Central Registration Depository (CRD) record. This proposal is designed to assure that expungement occurs only when one of the narrow grounds specified in the FINRA rules—factual impossibility, no involvement by the registered person or falsity—is determined and documented by the arbitrators.

The proposed rule would require arbitrators considering an expungement request to hold a recorded hearing session by telephone or in person and provide a brief written explanation of the reasons for ordering expungement. In cases involving a settlement, arbitrators would be required to review the settlement documents to evaluate culpability by examining the amounts paid to any party and any other terms and conditions of the settlement before awarding expungement.

Expungement has been an ongoing controversy.  Investors' advocates say it rewrites history and that customers are entitled to know if their brokers have been in disputes with their customers, while industry representatives say that brokers need protection against frivolous complaints or simple misunderstandings.  The Nw York Times had an article today, reviewing the respective positions.  NYTimes, Site That Tracks Brokers Questioned on Erased Cases.

FINRA Fines J.P. Morgan For Failures to Disclose to MSRB

FINRA today announced that it fined J.P. Morgan Securities, Inc. $500,000 for failing to disclose to the Municipal Securities Rulemaking Board (MSRB) that it had used consultants to obtain numerous municipal securities offerings and had made payments to consultants connected to particular offerings. FINRA is responsible for enforcing MSRB rules.  J.P. Morgan inaccurately stated in its filings with the MSRB that no municipal securities business had been obtained by its consultants and that it had made no payments to consultants connected with particular transactions. In fact, FINRA found, during the period from January 2002 through June 2004, J.P. Morgan used 16 different consultants to obtain at least 70 separate underwritings and paid at least $750,000 to six consultants connected to particular transactions.

During the time period at issue in this case, MSRB Rule G-38 required firms to disclose in quarterly filings with the MSRB any municipal securities business obtained or retained by a consultant. The rule also required firms to disclose payments made to consultants connected to particular municipal securities offerings. The rule is intended to address potential abuses in connection with the awarding of municipal securities business. It was revised in August 2005 to prohibit payments to any person not affiliated with a firm to solicit municipal securities business on behalf of the firm.

In settling this matter, J.P. Morgan neither admitted nor denied the charges, but consented to the entry of FINRA's findings.

NASAA President Testifies on Holiday Scams

In testimony before the U.S. Senate Committee on Banking, Housing, and Urban Affairs, NASAA President Karen Tyler said investment fraud, a year-round problem, hits home during the holidays when consumers may face a financial crunch with increased expenses from holiday gifts and travel, or may be considering end-of-year investment or tax-savings opportunities.  State securities regulators are concerned that this predatory conduct, combined with a convergence of financial challenges - higher gasoline prices, a volatile stock market, lower housing values, and general economic unrest - may lead individuals to make hasty, ill-informed decisions in the pursuit of higher returns on their investments.  NASAA urges investors to be especially vigilant in protecting their assets from Internet, telephone and in-person promotions for alternative investment opportunities.

NASAA Testifies in Support of Arbitration Fairness Act

Tanya Solov, Director of the Illinois Securities Department, testified on behalf of NASAA in support of the Arbitration Fairness Act of 2007 introduced by Sen. Russ Feingold, saying that it is “a positive step in the right direction” toward improving the fairness of the system of securities arbitration.

“NASAA believes that securities arbitration system should be truly voluntary, that more meaningful and accurate statistics concerning arbitration outcomes should be compiled and disseminated, and the balance in the composition of arbitration panels should be restored,” Solov testified.

Solov said FINRA should require its member firms to offer their customers a meaningful choice between binding arbitration and civil litigation. “If arbitration really is fair, inexpensive, and quick, as its adherents claim, then these benefits will prompt investors to choose arbitration,” Solov testified. “If, on the other hand, arbitration does not offer these advantages, then this mode of dispute resolution should not be forced upon the investing public.”

NASAA also suggested changes to the current securities arbitration system: 

Removing mandatory industry arbitrators from the arbitration process, and for public arbitrators to have no ties to the industry.

Improving the statistics that FINRA collects and disseminates on arbitration, particularly with respect to outcomes. Currently, FINRA statistics treat any award of damages to a customer as a "win," even if the amount is a small percentage of what was asked for.

FINRA Issues Guidance on Supervision of Electronic Communications

FINRA issued Regulatory Notice 07-59, Supervision of Electronic Communications, containing guidance setting forth principles for firms to consider when developing supervisory systems and procedures for electronic communications that are reasonably designed to achieve compliance with applicable federal securities laws and SRO rules.  The guidance was issued in final form after FINRA released it earlier this year for comment.  In the guidance FINRA makes clear that it expects a firm to have supervisory policies and procedures to monitor all electronic communications technology used by the firm and its associated persons to conduct its business.

Do the U.S. Markets Need an Overhaul? Point and Counter-Point

In response to Treasury Secretary Paulson's requests for comments on overhauling the U.S. capital markets:

NASAA responds: “Our existing regulatory structure, particularly as it pertains to the securities markets, needs no fundamental restructuring.”  It cautioned against a significant overhaul in an effort to enhance the competitiveness of U.S. capital markets.

“The millions of investors in this country – for the most part hardworking, middle class citizens, not Wall Street CEO’s – deserve a much better justification for a regulatory overhaul if their financial futures are to be placed at risk,” NASAA President and North Dakota Securities Commissioner Karen Tyler wrote in a comment letter to the U.S. Department of the Treasury regarding its Review of the Regulatory Structure Associated with Financial Institutions.

NASAA noted that recent calls for regulatory reform share a universal set of “improvements” designed to ease perceived industry burdens.  “Each reform package offers industry less bureaucracy, fewer constraints, and wide latitude in matters of conduct,” Tyler wrote. “We are troubled, however, by the lack of discussion about the effects of these reforms on the retail investor. We observe a lack of principle within “principled regulation” models that have nothing to say about investor protection.”

SIFMA, in turn, responds that the U.S. Regulatory Structure Needs Reform. “One of the great challenges facing the financial services industry is the need for regulatory reform in the U.S.,” said Marc Lackritz, SIFMA president and CEO.  “This process, initiated by Secretary Paulson, provides an excellent opportunity to reform an antiquated system and simultaneously move financial services regulation in the U.S. into the 21st century.  With a regulatory landscape plagued by duplication and conflicting standards, the need to improve regulation couldn’t be greater.  Doing nothing is not an option.”

“Our businesses and our markets are increasingly converging and driven by technology.  It’s time for regulation to catch up,” Lackritz added.  “The U.S. regulatory regime is in need of both substantive and structural reform.  We need reform to move to principles-based regulation, coupled with prudential supervision and liability reform, to ensure that regulation becomes flexible, encourages innovation and competition, protects against systemic risk, and protects investors.”

Whom do you think Treasury Secretary Paulson will pay more attention to?

FINRA Sanctions Brokerage Firm for Facilitating Late Trading by Hedge Funds

FINRA announced today that it has sanctioned Rafferty Capital Markets, LLC, for facilitating improper market timing practices and for failing to have an adequate supervisory system to prevent deceptive market timing and late trading, among other violations.  FINRA ordered Rafferty Capital to refrain for 90 days from opening new mutual fund brokerage accounts for any new or existing customers. The firm was also fined $350,000 and ordered to pay $59,605 in restitution to two mutual fund families in connection with customer profits derived from improper market timing. In addition, Rafferty Capital was ordered to review its procedures and certify that it has established systems and procedures to prevent late trading and deceptive market timing, to retain electronic communications, and to record the times of receipt and entry of mutual fund orders.

FINRA found that from about January 2001 through August 2003, the firm assisted six hedge fund customers in circumventing market timing restrictions and escaping detection by opening and using multiple related customer accounts, as well as by using different broker branch codes for market timing, among other methods.  In concluding this settlement, Rafferty Capital neither admitted nor denied the charges, but consented to the entry of FINRA's findings.