Despite the challenges posed by the global coronavirus pandemic, Financial Industry Regulatory Authority (FINRA) remained at full speed penalizing individuals for noncompliance with recordkeeping and supervision obligations.
Conversion (FINRA Rule 2010)
A broker was barred from association with any FINRA member in all capacities for an unapproved conversion of $275,000 given to him by a relative. The findings stated that the broker obtained the funds by falsely representing that the funds would be invested in private placements through an employee investment program offered by his then member-firm employer. However, the firm program the broker described did not exist. Instead, the broker used the relative’s funds, without the relative’s knowledge or consent, to pay for his own personal expenses and to satisfy pre-existing debts he owed to other individuals.
The broker concealed his conversion by lying to his relative about the status of his investment, his expected returns, and his repayment date. The findings also stated that the broker provided false written statements and on-the-record testimony to FINRA in connection with its investigation that led to a previous AWC. In his written statement to FINRA and during his testimony, the broker stated that he edited an internal firm email and sent it to his personal email address to document an investment idea he was working on at the time.
The broker also stated that he did not forward or send the email to anyone. In fact, the broker sent the email to his relative to obtain additional funds for his personal use. In another written statement to FINRA, the broker falsely stated that he borrowed $275,000 from his relative for living expenses. However, the broker knew that the relative tendered the funds for investment in the firm employee program the broker had described and not for his personal use.
Outside business activities (FINRA Rules 3270 and 2010)
FINRA fined a broker $5,000 because she exceeded the scope of her approved outside investment advisory business by charging asset-management fees. The findings stated that the broker created her own registered investment advisor, of which she was the sole owner and employee. In seeking approval for this outside business, the broker told her member firm in an email and in a disclosure questionnaire that her advisory business would only charge hourly fees and fixed, one-time financial planning fees. The firm approved her outside business based on these representations.
Subsequently, the broker began offering a new service to her advisory clients where she would charge an annual 1.5% asset-management fee for managing variable annuity subaccounts. The broker did not disclose this new service or the associated fees to the firm. The findings also stated that the broker made inaccurate statements in her annual compliance questionnaires to the firm. In response to questions asking whether her advisory business had assets under management and if she was compensated through a percentage of the assets under management, the broker incorrectly stated that she did not manage assets and only charged hourly fees.
Outside business activities (FINRA Rules 3270 and 2010)
A broker was assessed a deferred fine of $12,500, suspended from association with any FINRA member in all capacities for 14 months and ordered to pay deferred disgorgement of commissions received in the amount of $1,600, plus interest. The findings stated he engaged in an outside business activity without providing prior written notice to his member firm.
The broker was employed as an assistant to the founder and chairman of a company. The broker’s company-related activities included coordinating the founder’s meetings and appointments, reviewing correspondence, making banking deposits, attending and participating in trade shows, and testing the functionality of the company’s website. The broker had a company-issued email address and received approximately $5,000 as compensation from the founder for his services.
The findings also stated that the broker personally invested in the company and participated in private securities transactions for which he received selling compensation, without providing prior written notice to or receiving written approval from his firm. The broker solicited and referred individuals, including firm customers, to invest in shares of the company. The broker recommended that his firm customers and the other individuals invest in the company — endorsing the company and its management — and referred them to the company to complete their investment. The broker also collected the investors’ checks and delivered them to, or deposited them on behalf of, the company.
The individuals ultimately invested a total of $99,900 in the company, for which the broker received approximately $1,600 in commissions. The broker also personally invested $4,300 in the company. The findings also included that the broker made false statements to the firm during its internal investigation regarding the compensation he received and the number of individuals he solicited.
Capturing and archiving electronic communications can be useful for both defensive purposes and to detect problems before they turn into big problems. Those records can be used as a proactive tool to understand and gather insight into the firm’s operations. As the above enforcement cases show, the emails were a first-line defense for the firms and proof of the employees’ wrongdoing. The firms were not penalized by the regulators for the employees’ wrongdoing because they proactively and sufficiently captured and monitored the emails, complying with regulatory obligations.
The goal of reviewing electronic communications is to ensure employees and executives are not committing wrongdoing. Examples of employee wrongdoing include unauthorized outside business activities, fraud, promising investment returns and sharing non-public information. What happens if you find a potential regulatory violation? At a minimum, firms’ procedures should clearly identify the person(s) responsible for determining whether a violation has occurred and whether it is of a nature that requires reporting under regulatory rules.
Procedures should also document the level of seniority of the person(s) (e.g., General Counsel, Chief Compliance Officer or a senior staff committee) responsible for determining if violations occurred. Also, provide a protocol for escalating violations, and potential violations, to such person(s), and provide a protocol for reporting internal conclusions of the violations. Minor violations can be resolved in-house while significant violations must be reported to FINRA and other authorities.
With more employees working remotely, this is a good time to review your firm’s retention policies. Retention of broker-dealer books and records is governed by Exchange Act Section 17(a)(1), Securities and Exchange Commission (SEC) Rules 17a-3 and 17a-4, and FINRA Rule 4511; for investment advisors, Rule 204-2 of the Investment Company Act of 1940. A review of regulatory obligations and industry best practices to ensure compliance with current data retention policies is recommended.
This has never been more critical than it is today, as the pandemic has accelerated the digital experience and the volume of digital bartprint. Firms must rethink how employees can best communicate and collaborate while staying compliant.
Featured Guide – Electronic Communications Compliance Checklist for Broker-Dealers
Author: Marianna Shafir Esq. Corporate Counsel, Regulatory Advisor at Smarsh
About Marianna Shafir
Marianna Shafir, Regulatory Advisor at Smarsh, is responsible for regulatory affairs worldwide. With her expertise in financial services industry, compliance and eDiscovery, 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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