Failure to Supervise

LPL Financial Fined For Failure to Properly Supervise Variable Annuities Transactions

September 26, 2014 | by Staff Attorney

LPL Financial was recently fined $2 million and ordered to pay $820,000 in restitution, for violations pertaining to variable annuity exchanges. This settlement, which was reached with the Illinois Securities Department, resulted from LPL’s inadequate maintenance of books and records with regards to documenting 1035 exchanges. A 1035 Exchange is a tax-free exchange of an existing annuity contract for a new one. In order for the new contract to qualify as a Section 1035 Exchange, the policyholder must have exchanged his or her existing contract for an equivalent new contract. The annuitant or policyholder must also remain the same.

According to LPL’s BrokerCheck file, LPL “failed to enforce its supervisory system and procedures in connection with the documentation of certain salespersons’ variable annuity exchange activities.” LPL has indicated that it will seek to enhance its procedures relating to surrender charges that often result from variable annuity exchange transactions. This, LPL believes, would ensure accuracy in their books and records along with client disclosures.

The product at issue was variable annuities, which have been closely watched by regulators dues to the complexity of the product and high fee structures. Elderly investors have often been sold variable annuities, when they were entirely unsuitable, just so that brokers could earn increased commissions. Regulators have paid especially close attention to those advisors who have switched their clients from one variable annuity to another, just to enhance their commissions.

FINRA Alleges that Former Waddell & Reed Employee, Jeffrey Meyer, Engaged in 37 Private Placement Transactions without Proper Notice

September 24, 2014 | by Staff Attorney

On August 21, 2014, Richard A. March, Senior Regional Counsel of FINRA’s Department of Enforcement filed a complaint against Jeffrey Meyer, a financial advisor in Lake in the Hills Illinois who was formerly associated with Waddell & Reed, Inc. The complaint alleges that while employed at Waddell & Reed and WRP Investments, Inc. Mr. Meyer acted outside the scope of his employment with those firms by participating in 37 private securities transactions totaling more than $1.5 million, without providing prior written notice to the firms of his proposed roles in the transactions. FINRA alleges that as a result of the foregoing, Mr. Meyer violated FINRA Rule 2010. FINRA Rule 2010 states that “A member, in the conduct of its business, shall observe high standards of commercial honor and just and equitable principles of trade.”

Mr. Meyer entered the securities industry in January 2000 as an investment company products and variable contracts representative with Franklin Financial Services, Corp. In February 2001 he became a general securities representative with Focused Investments, LCC. According to FINRA, United Private Capital, Inc. was a corporate entity that was established as an investment vehicle for FOREX currency trading. Between November 2008 and September 2009, United Capital sold corporate guarantees totaling $1 million to 20 investors and Mr. Meyer participated in each of the private securities transactions. Mr. Meyer, in some instances collected checks from customers and assisted them in preparing documents to effectuate the transactions. Furthermore, on at least one occasion, Mr. Meyer presented sales material to an individual who subsequently invested at United Private Capital.

In addition, according to FINRA, Mr. Meyer participated in private securities transactions related to commercial loans through Strategic Lending Solutions, LLC as well. Those promissory notes totaled approximately $300,000 with 13 investors. Mr. Meyer received a 2% payment based on the amount of the promissory note.

NEXT Financial Group Sanctioned Over Failure to Adhere to Industry Rules

September 3, 2014 | by Staff Attorney

The Financial Industry Regulatory Authority (FINRA) sanctioned brokerage firm NEXT Financial Group, Inc. (NEXT Financial) concerning allegations that: 1) between March 17, 2009, and August 26, 2011, NEXT Financial failed to timely and accurately amend registered representatives’ Forms U4 and U5 to disclose customer complaints, judgments and liens; 2) from January 1, 2010, through August 26, 2011, NEXT Financial permitted its former general counsel to directly supervise registered persons without a principal registration; and 3) from March 17, 2009, through August 10, 2012, NEXT Financial failed to establish and maintain a supervisory system that was reasonably designed to prevent and detect unsuitable sales of structured products to retail customers.

NEXT Financial is a general securities broker-dealer located in Houston, Texas and a member of FINRA since 1999. The firm currently has approximately 900 registered persons and 590 registered branch locations.

FINRA Rules require that every application for registration (Form U4) filed with FINRA shall be kept current at all times by supplementary amendments. Supplementary amendments must be filed within 30 days after learning of facts or circumstances that would require an amendment. FINRA also requires that a notice of termination (Form U5) be filed with FINRA within 30 days after an individual’s association with a member firm is terminated and the form must be kept current at all times by supplementary amendments.

Brokerage Firm Safeguard Securities and Peter Mooney Sanctioned Over Numerous Supervisory Failures

August 22, 2014 | by Staff Attorney

The Financial Industry Regulatory Authority (FINRA) sanctioned brokerage firm Safeguard Securities, Inc. (Safeguard Securities) and broker Peter Mooney (Mooney) concerning allegations that during a FINRA examination of the firm Safeguard Securities provided certain outside business activity (OBA) forms to FINRA that had been backdated. FINRA found that Mooney, who signed the backdated forms, knew or should have known that the forms had been backdated. In addition, FINRA identified many supervisory and recordkeeping failures relating to: the review and retention of electronic communications; outside business activities; private securities transactions; the supervision of producing managers; and branch registration and fingerprinting of personnel.

FINRA found that Mooney was the firm’s principal and supervisor responsible for establishing and implementing supervisory procedures. FINRA alleged that Safeguard Securities, through Mooney, failed to establish and/or implement adequate supervisory procedures in numerous respects. First, it was alleged that the firm failed to establish and implement an adequate supervisory system for the review and retention of electronic communications relating to the business of the firm. For example, between July 14, 2008, and November 4, 2012, it was alleged that Safeguard Securities failed to maintain any record to evidence its review of electronic communications. Further, FINRA alleged that the firm failed to take any steps to monitor registered representatives who used e-mail addresses at domains other than the firm’s e-mail system.

In another instance of supervisory failure, FINRA alleged that during 2012, Mooney knew that a broker by the initials “WM” was engaging in private securities transactions for compensation. Notwithstanding the fact that the firm prohibited such activity, FINRA found that Mooney failed to take any steps to stop the broker’s participation in those transactions. Under NASD Rule 3040, a duty is imposed on member firms to supervise the transaction as if the transaction were executed on behalf of the member.

FINRA Fines Merrill Lynch For Overcharging Mutual Fund Customers

July 17, 2014 | by Staff Attorney

On June 16, 2014, the Financial Industry Regulatory Authority (FINRA) announced that it fined Merrill Lynch, Pierce, Fenner & Smith, Inc. $8 million for charging excessive fees relating to the sales of mutual funds in retirement accounts. FINRA also ordered Merrill Lynch to pay $24.4 million in restitution to those customers who had been wrongfully overcharged. The mandated restitution was in addition to the $64 million Merrill Lynch has already paid to compensate disadvantaged investors.

Mutual funds offer several different classes of shares. Each class has separate and distinct sales charges and fees. Generally, Class A shares have the lowest fees as compared to Class B and Class C. Class A shares, however, charge customers an upfront sales charge. This initial sales charge, however, is usually waived for retirement accounts, with some funds also waiving these fees for charities.

Merrill Lynch’s retail platform offers a variety of different mutual funds. Most of those funds explicitly offered to waive the upfront sales charges and disclosed those waivers in their respective prospectuses. According to FINRA, despite these disclosures, Merrill Lynch did not actually waive the sales charges many times since at least January 2006. On various occasions, Merrill Lynch charged the full sales charges to certain customers who qualified for the waiver. In doing so, Merrill Lynch allegedly caused nearly 41,000 small business retirement plan accounts and 6,800 charities and 403(b) retirement accounts for ministers and public school employees to pay sales charges when purchasing Class A shares. Those that did not want to pay the fee for the Class A shares were forced to purchase other share classes that needlessly exposed them to greater ongoing costs and fees. According to FINRA, Merrill Lynch became aware of the fact that its small business retirement plan customers were being overcharged, but yet they continued to sell the costly mutual fund shares and never reported the issue to FINRA for over five years.

Gilford Securities Fined by FINRA Over Deficient Supervisory Procedures

July 1, 2014 | by Staff Attorney

The Financial Industry Regulatory Authority (FINRA) recently sanctioned brokerage firm Gilford Securities, Inc. (Gilford Securities) concerning allegations that from April 2010 through March 2012, Gilford Securities failed to: (i) make certain disclosures in research reports; (ii) have approval of certain research reports; (iii) implement written supervision policies reasonably designed to comply with NASD Rule 2711; (iv) establish and enforce written supervisory control policies concerning the supervision of producing managers; and (v) implement a reasonably designed Anti-Money Laundering Compliance Program (AMLCP).

Gilford Securities has been a FINRA member since January 1980, has eight branch offices, and 78 registered representatives. Gilford Securities’ principal place of business is New York, New York.

FINRA rules require disclosure of any material conflict of interests of the research analyst of which the research analyst knows or has a reason to know in the publication of the research report. FINRA found that from April 2010, through March 2012, Gilford Securities published 503 research reports. FINRA found that each of those reports failed to disclose that the research analyst received compensation of commissions on transactions the analyst’s customers made in the securities covered in violation of the FINRA Rules.

Dawson James Securities Sanctioned Over Alleged Supervisory Failures

June 30, 2014 | by Staff Attorney

The Financial Industry Regulatory Authority (FINRA) recently sanctioned brokerage firm Dawson James Securities, Inc., (Dawson James) concerning allegations that the firm did not provide for supervision reasonably designed to comply with certain applicable securities laws and regulations.

FINRA has stated that at a minimum, written supervisory procedures should describe: (a) identification of the individual responsible for supervision; (b) supervisory steps and review procedurals to be taken by the supervisor; (c) the frequency of reviews; and (d) the documentation of reviews. FINRA found that the Dawson James’ written supervisory procedures failed to provide for one or more of the four above-cited minimum requirements for adequate written supervisory procedures for conduct concerning: (1) disclosure of potential conflicts of interests to clients; (2) trading in the opposite direction of solicited customer transactions; (3) certain broker sales practice concerns such as unauthorized trading, suitability, excessive trading, and free-riding; (4) concentration of securities in clients’ accounts; (5) the sharing of profits and losses in clients’ accounts; (6) wash transactions; (7) coordinated trading; and, (8) the review of representatives’ electronic communications, among other violations.

FINRA alleged that the firm failed to investigate numerous ”red flags” relating to the activities of one registered representative referred to by the initials “DM”, including: (1) numerous exceptions generated on the firm’ s supervisory reports which included commissions charged to DM’s clients; (2) high concentrations of one security in DM’s clients’ accounts; and, (3) numerous cancel rebill requests for DM’s clients’ accounts. FINRA also found that James Dawson failed to enforce its written supervisory procedures that required electronic correspondence be reviewed on a daily basis. FINRA also found that from January 2007 through February 2008, the firm failed to ensure that the firm’s Head Trader, referred to as the initials “AE” carried out his delegated supervisory responsibilities relating to proprietary trading; trade reporting; clock synchronization; short sale compliance; compliance with the manning rule; mark ups and mark downs; and, compliance with inventory guidelines.

Morgan Stanley Fined $5,000,000 For Failure To Supervise Sales of IPO’s

June 16, 2014 | by Staff Attorney

On May 6, 2014, the Financial Industry Regulatory Authority (FINRA) announced that it had fined Morgan Stanley Smith Barney LLC $5,000,000 for failure to properly supervise the solicitation of retail clients to invest in initial public offerings (IPOs). According to FINRA, Morgan Stanley sold shares to its retail customers in eighty-three different IPO’s between February 16, 2012 and May 1, 2013, with insufficient procedures and employee education. Some of the more commonly sold IPOs included Facebook and Yelp among other Internet favorites.

When broker dealers sell IPOs, there is a process in place for soliciting customer interest. Prior to the effective date of the registration statement, firms may only obtain an “indication of interest” from customers. An “indication of interest” is not a purchase. In order for an “indication of interest” to result in a purchase the investor must reconfirm their interest after the IPO registration statement becomes effective. Broker dealers may also solicit what is known as “conditional offers to buy.” This differs from an “indication of interest” in that the investor does not have to reconfirm. It may bind the customer after the registration statement becomes effective if the investor simply takes no action to revoke the conditional offer before the brokerage firm accepts it. According to FINRA, Morgan Stanley Smith Barney failed to institute adequate procedures and properly train its employees to ensure that its staff clearly differentiated an “indication of interest” from a “conditional offer” in their solicitation of potential investors.

Morgan Stanley Smith Barney actually adopted a policy related to the solicitation of IPO’s. In adopting this policy back on February 16, 2012, however, the firm used the terms “indication of interest” and “conditional offer” interchangeably, which implicitly disregarded the need for customer reconfirmation prior to trade execution. According to FINRA, Morgan Stanley never provided its sales teams and financial advisers any education or materials explaining the differences in terminology. As a consequence there was a strong possibility that neither the Morgan Stanley staff nor its customers properly understood the type of order that was being solicited. In addition, FINRA found that Morgan Stanley’s inadequate policies failed to comply with the federal securities laws and other FINRA rules.

FINRA Fines Investors Capital Corp. Over Failing to Supervise ETF Sales

June 12, 2014 | by Staff Attorney

The Financial Industry Regulatory Authority (FINRA) recently fined brokerage firm Investors Capital Corp. (Investors Capital) $100,000 on allegations that from at least about June 2009 through April 2011, Investors Capital failed to provide prospectuses to customers who purchased exchange traded funds (ETFs). FINRA also alleged that Investors Capital also failed to establish, maintain and enforce an adequate supervisory system concerning the sale of ETFs and the obligation to provide ETF prospectuses to customers.

Investors Capital is an independent broker-dealer offering brokerage services and financial planning to customers and has been a FINRA member since 1992. Investors Capital is headquartered in Lynnfield, Massachusetts, and employs approximately 539 registered persons, across 325 branch offices.

ETFs typically attempt to track an index such as a market index, a commodity, or an entire market segment. ETFs can be either attempt to track the index or apply leverage in order to amplify the returns of an underlying stock position. ETFs that employ leverage are called either non-traditional ETFs or leveraged ETFs. In an ideal world, a leveraged ETF with 300% leverage will return 3% if the underlying index returns 1%. Nontraditional ETFs can also be designed to return the inverse or the opposite of the return of the benchmark.

FINRA Fines Commonwealth Financial Network Concerning Email Supervisory Failures

June 11, 2014 | by Staff Attorney

The Financial Industry Regulatory Authority (FINRA) recently fined brokerage firm Commonwealth Financial Network (CFN) $250,000 on allegations that from December 7, 2009 to January 28, 2012, CFN’s supervisory system: (a) failed to subject about 12.6 million outgoing e-mails to daily e-mail surveillance protocol, constituting 90% of the e-mails that the firm’s registered representatives sent through doing business as (DBA) e-mail accounts; and (b) failed to survey approximately 474,380 registered representatives e-mails. FINRA also found that the firm failed to establish and maintain procedures to test its e-mail supervisory system to timely identify systemic failures.

CFN has been a member of FINRA since 1979 and the firm has approximately 4,550 associated persons operating from 1,154 branch offices. CFN’s primary office is located in Waltham, Massachusetts. CFN’s registered representatives are independent contractors and many of them operate from branch offices under one or more DBA names. Most of CFN’s brokers use non-CFN e-mail domains names.

During the period from December 2009, to January 2012, CFN used a system to archive, preserve, and supervise business related e-mails of its associated persons. FINRA found that e-mails sent through DBA email domains were automatically transmitted to CFN’s system for retention and review. CFN’s supervisory procedures required the firm’s emails to be transmitted through CFN’s server so that the firm could capture and review its brokers’ emails. CFN’s supervisory system required a daily review of its registered representatives’ e-mails including lexicon searches and a random sampling of emails.