A U.S. insurer firm agreed to pay a $4.75 million fine to resolve allegations by Massachusetts securities regulators into the social media and trading activity of its employees, including the well-known persona “Roaring Kitty.” The state regulator said the firm failed to detect the activities of their trader, who touted GameStop stock in his spare time while he was working at the company.
At the time, the trader worked at the firm’s marketing and financial education job and was a registered financial broker in Massachusetts. State regulators found the firm failed to detect nearly 1,700 trades by the trader, who executed at least two trades in GameStop in excess of $700,000 — beyond a company limit. The regulator opened an inquiry into the matter earlier this year.
The regulator said that while the firm prohibited broker-dealer employees from discussing securities on social media, the company didn’t have “reasonable policies and procedures in place to detect and monitor” such activity. Two employees were made aware of his social media activity and the firm didn’t take any immediate action, the regulator said.
In addition, the firm inadequately supervised other agents and failed to review their social media usage or catch excessive trading in their personal accounts. The firm also agreed to overhaul its social media policies.
Failure to supervise outside business activities (OBA)
Financial Industry Regulatory Authority (FINRA) fined a firm jointly and severally with the principal supervisor. The principal was suspended from association with any FINRA member in any principal and supervisory capacity for two years and required to requalify by examination as a principal. The NAC modified the findings and sanctions imposed by the Office of Hearing Officers (OHO).
The sanctions were based on findings that the firm and the principal failed to supervise a broker’s limited partnership (LP) activities as an OBA and the principal did not conduct a reasonable investigation of the LP activities in light of red flags of which he was aware.
The findings stated that after the principal learned about the LP through a routine email review, he asked the broker to provide a written explanation of his involvement with it. The broker’s written response raised a number of red flags. When the U.S. Securities and Exchange Commission (SEC) raised concerns that the broker was engaged in OBAs in the LP, the principal did nothing to further investigate, but rather simply quoted the broker’s denials in his response to the SEC.
In addition to making material misrepresentations to customers, the broker violated FINRA rules by communicating with customers using personal email accounts. The firm and the principal were also aware that the broker and other registered representatives were using personal email to conduct securities business with customers but allowed this to continue for years. The firm’s and the principal’s failures resulted in significant losses to investors.
Findings also stated that the firm willfully violated Section 17(a) of the Securities Exchange Act of 1934 (Exchange Act) and Rule 17a-4 thereunder by failing to preserve emails. The firm and the principal failed to maintain and enforce adequate written supervisory procedures (WSPs) for the capture, review and retention of the firm’s securities-related emails. The firm, through the principal, failed to preserve emails concerning its securities business that were sent to and from the personal email accounts of the representative and other firm registered representatives.
Broker’s misleading emails cost millions
A broker was assessed a deferred fine of $25,000, suspended from FINRA for one year, ordered to pay $1,222,092.29, plus interest, in deferred restitution to customers and ordered to pay deferred disgorgement in the amount of $14,231.61, plus interest. The broker consented to the sanctions that he made unsuitable recommendations to 12 customers.
The findings also stated that the broker sent emails to certain of these and other customers about the company that contained unwarranted and exaggerated claims, opinions and forecasts, did not provide a fair and balanced treatment of the risks and benefits of the investment and contained promissory statements.
Broker sanctioned for using personal email to do business
A National Adjudicatory Counsel (NAC) decision became final in which a broker was barred from FINRA and ordered to pay $337,700 in restitution to customers. In light of the bar, the NAC did not impose fines totaling $163,000 or suspensions from association with any FINRA member in all capacities totaling four years and three months for other violations. The sanctions were based on findings that the broker made material misrepresentations of fact in widely distributed emails to current and former customers.
The findings stated that the broker sent investment summaries and emails to his customers and former customers that contained inaccurate information and failed to provide a sound basis for evaluating facts. The broker sent the emails without obtaining approval by an appropriately qualified registered principal of his member firm.
Much of the alleged misconduct involves the broker’s involvement with a private placement of preferred units in a limited partnership. The findings also stated that the broker engaged in an undisclosed, unapproved OBA with the limited partnership by being employed by it and serving as its managing member. FINRA also found that the broker used unapproved personal email accounts to conduct securities business with firm customers.
FINRA is focusing on social media
Regulators are probing how brokerages use social media such as TikTok, Twitter, Instagram, Facebook and other social media platforms to land new customers.
In an examination sweep launched this month, FINRA will assess how firms utilize online “influencers” to promote themselves and how they protect customer data culled from social media activities. “FINRA is conducting a review of firm practices related to the acquisition of customers through social media channels and how firms manage their obligations related to information collected from those customers and other individuals that may provide data to firms,” states an example examination letter posted on the FINRA website.
FINRA launched the exam sweep shortly after the SEC released a request for comment about the “digital engagement practices” used by investment advisers and broker-dealers. The SEC said it is looking into ways that advisers use tools that appeal to investors’ behavioral tendencies (such as game-like features known as gamification) to shape their activities on websites, portals and mobile apps.
The FINRA examination covers social media communications from Jan. 1, 2020, through a date this year that varies for each firm involved in the sweep. A sweep typically is limited to “a small number of firms,” FINRA says on its website. It declined to say how many are targeted for the social media exam.
How to prepare your firm for FINRA examinations
Firms are obligated to retain records of electronic communications that relate to their “business as such” as required by Rule 17a-4(b). Firms need to be aware of the electronic communications environment and ensure they archive all business communications sent to, and received by, their brokers, whether those brokers communicate via email, social media, text messaging, instant messages, or other forms of electronic communication.
Even if firms choose to adopt a policy of prohibition, firms need policies and procedures in place to detect and monitor it, and to prove that that policy is actually working.
Firms should review the adequacy of their electronic communications recordkeeping and supervisory policies. At a minimum, your policies should identify the reviewers, describe the process the reviewers will follow to conduct each review, the timing and frequency of the review, and how the reviewers will evidence that the required supervisory steps were taken. This would include provision for escalation of regulatory issues to the designated supervisor or other appropriate department.
Reviewers may not conduct supervisory reviews of his or her own electronic communications. WSPs should not be updated only to reflect changes to regulations, but also when changes are made to the supervisory process. Ensure the policies are properly enforced and followed by the designated reviewers. Make sure all employees are trained and well-aware of all policy guidelines, including social media policies. Most importantly, enforce the policies for the review of electronic communication.
A helpful strategy to monitor employees is to create keywords and key phrases to flag the risk of brokers using prohibited channels. Red flag examples include: “Facebook chat,” “DM me,” “my TikTok video,” and “let’s take this offline.” Use examples from enforcement cases to create lexicons to target your search and enhance your supervision process. It’s not enough just to have the policies. Firms’ lexicon policies need to be reasonably designed in light of the compliance risks of the firm. It’s important to make sure that lexicons are flagging high-risk communications.
Protect your organization
All these steps will advance your compliance program, supervisory systems, and protect your business. They will also ensure that compliance rules are followed to protect against accidental violations. New advancements in archiving technology and solutions make this easy and possible, so brokers can more easily communicate with customers while remaining in compliance.
As the technology landscape expands, so does the scope of potential regulatory violations. The above enforcement actions confirm and substantiate that prohibition policies are not an effective or viable policy when it comes to electronic communications in regulated firms. Moreover, if your firm knows or should know that your brokers are communicating over prohibited channels, your firm is at risk for fines and reputational damage.
Author: Marianna Shafir Esq. Regulatory Advisor at Smarsh
Marianna Shafir, Regulatory Advisor at Smarsh, is responsible for regulatory affairs worldwide. With her expertise in financial services industry, compliance and e-discovery, Marianna counsels Smarsh clients on meeting regulatory obligations, leveraging technology and guidance on best practices related to electronic communications supervision. Prior to joining Smarsh, Marianna worked for BNY Mellon and Invesco where she was an instrumental member on compliance teams.Marianna has also served as an adjunct professor at New York Career Institute where she taught Law Office Management and Real Estate Law. She earned her Juris Doctorate from Nova Southeastern University. She is a frequent speaker at industry conferences and a contributor to various online publications.
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