SEC Fines Firm One Million Dollars for Compliance Violations

Jul 7th '20

Misuse of Material Nonpublic Information

The Securities and Exchange Commission (SEC) penalized a private equity firm $1 million dollars for failing to implement and enforce policies and procedures reasonably designed to prevent the misuse of material nonpublic information. According to the order, the firm invested several hundred million dollars in a public company through a loan and equity investment in 2016 that enabled it to appoint a senior employee to the company’s board. The firm’s compliance policies failed to account for the special circumstances presented: having an employee serve on the portfolio company’s board while that employee continued to participate in trading decisions regarding the portfolio company.


The firm obtained potential material nonpublic information (MNPI) about the company, including through its representative on the company’s board, relating to changes in senior management, adjustments to the company’s hedging strategy, and decisions with respect to the company’s assets, debt, and interest payments. After receiving this information, the firm purchased more than 1 million shares of the company’s common stock, which was 17% of the publicly available shares. The order finds that the firm did not require its compliance staff, prior to approving the trades, to sufficiently inquire and document whether the board representative and members of the firm’s team possessed MNPI relating to the portfolio company.


The SEC’s order finds that the firm violated the compliance policies and procedures requirements of Sections 204A and 206(4) of the Investment Advisers Act of 1940 and Rule 206(4)-7 thereunder.


Forgery of Customer Signature

FINRA fined a broker $7,500 because he forged an elderly customer’s signature on documents in connection with an exchange transaction from a variable annuity to a fixed annuity. The findings stated that the broker forged the customer’s handwritten signature in one instance and electronically forged the customer’s signature in other instances.


The broker’s forgeries are aggravated by the fact that, in order to authenticate the electronic signatures, he re-created an email address previously used by the customer and used it to verify the forged electronic signatures. Unbeknownst to the broker, the customer had passed away prior to the forgeries. Although the customer had previously signed these documents, the broker was not authorized to sign for the customer. The broker submitted the transaction-related documents to his member firm for processing as originals signed by the customer.


Incomplete Books and Records

FINRA also fined a broker $5,000 for causing her firm to maintain incomplete books and records. The broker communicated with customers regarding activity in their firm accounts by text messages sent from her personal cellular device. These communications related to the firm’s business but were not preserved by the firm as required by Section 17(a) of the Securities Exchange Act of 1934.


Non-Approved Outside Business

A broker was assessed a deferred FINRA fine of $5,000 because he did not seek his member firm’s approval or provide it with written notice before engaging in outside business activities. The findings stated that the broker engaged in a consulting business and contracted with an individual to market the mineral rights the individual owned in connection with a property. The findings also stated that the broker solicited purchase offers from energy and mineral companies through a limited liability company (LLC) that he established with two individuals who were not associated with a firm.


After the broker had been conducting business through the LLC for approximately 10 months and had been soliciting offers for the individual’s mineral rights for approximately one month, he submitted an outside business activity disclosure form to the firm. The broker stated on the form that he would buy and sell real estate, including water and mineral rights. However, the broker did not disclose the existence of the LLC or his role in it, or that he had entered into a contract with the individual through the LLC or that he had marketed the individual’s mineral rights.


Subsequently, the individual accepted one of the purchase offers the broker solicited and paid the broker $12,000 through the LLC, pursuant to the terms of the contract. Later, the firm located a copy of the LLC’s contract with the individual and marketing materials for the sale of mineral rights in the broker’s firm email account. In response to subsequent inquiries from the firm about these documents, the broker submitted a written statement to the firm inaccurately stating that the individual had not paid any fee or compensation to him for his work. The broker later acknowledged that the individual had paid a fee to him of $12,000.


Non-Compliant Promotional Email

A broker was assessed a deferred fine of $20,000 because he engaged in undisclosed outside business activities while registered through his member firm. The findings stated that the broker became a principal in an LLC in order to market and raise funds for the purchase of a property. In addition, the broker facilitated and processed payments for a nursing home that a firm customer-owned and received compensation. The broker did not provide any notice of these outside business activities to his firm, even though he received the firm’s annual certification that requested registered representatives identify all of their outside business activities.


The findings also stated that in connection with one of his outside business activities, the broker sent a promotional email to a potential investor that failed to comply with FINRA’s content standards for member communications with the public. The broker sent the email in an effort to have an investment advisor invest or raise funds to purchase the property. The email did not provide a fair and balanced discussion of potential risks arising from the potential investment and it also contained unwarranted and/or promissory claims. The investment advisor who received the broker’s email did not invest himself or obtain any other investments for the purchase of the property.


Takeaway: Communications Supervision Could Help Prevent Fraud & Violations

These recent enforcement cases are great examples of how the power of supervision and surveillance can prevent regulatory infractions. The timely review of electronic communications is a first-line defense for firms against improper conduct by employees. If the firms had not sufficiently captured and monitored electronic communications, they would have failed to identify employee’s wrongdoing.


Firms need to demonstrate to regulators that they are supervising the activities of their representatives. It is important to establish a reasonable supervisory system that flags, escalates, and enables actions to address potential fraud and violations. Firms should have a reasonable system to monitor for compliance with their electronic communication policies. There is no prescribed rule for when to review the messages, but it must be timely to find and escalate red flags.


Make sure to document your review process. Engage an archiving provider that enables compliance with the regulatory rules and has the technical ability to electronically document reviews and create an audit trail. If the message is spam, note the message as “not material,” or “junk message.” Documentation of procedures can be a powerful tool to evidence your supervision process. Also, make sure to select a vendor solution with supervision capabilities such as flagging keyword lexicons and reporting options.


The goal of reviewing electronic communications is to ensure employees and executives are not committing any wrongdoing. Examples of employee wrongdoing include unauthorized outside business activities, private security transactions, 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 regarding the reporting of internal conclusions of the violations. Minor violations can be resolved in-house while significant violations must be reported to FINRA and other authorities.


Regulatory Obligations Critical as Ever

Especially now during the pandemic, supervision is critical for retention and oversight of employee’s electronic communications. The new dynamic will not change firms’ regulatory obligations. FINRA expects member firms to establish and maintain reasonable supervisory systems designed to supervise the activities of each associated person while working from an alternative or remote location during the pandemic. Given this “new normal” and the number of employees working remotely, I expect the regulators will take a hard look at firms and individuals who ignore their recordkeeping and supervision obligations.


With increasing governance and regulatory oversight, the punitive consequences for failing to comply with retention and supervision requirements outweigh the cost of implementing technology solutions.


Source: Smarsh

Author: Marianna Shafir Esq. Corporate Counsel, 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 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.


About us

At LS Consultancy, we offer a complete solution with a range of cost effective, regulatory compliance and marketing products and solutions that are uniquely suited to supporting firms.


Explore our full range today.