For the purpose of proposing a settlement of rule violations alleged by the Financial Industry Regulatory Authority ("FINRA"), without admitting or denying the findings, prior to a regulatory hearing, and without an adjudication of any issue, KeyBanc Capital Markets, Inc. submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. In the Matter of KeyBanc Capital Markets, Inc., Respondent (AWC 20090185906, May 16, 2012).
KeyBanc Capital Markets, Inc, headquartered in Cleveland, OH, has been a registered FINRA broker-dealer since 1998, when its parent company KeyCorp bought McDonald & Company Investment. Inc. Around February 2007, KeyBanc (known, at the time, as McDonald Investments Inc.) sold its retail brokerage business resulting in KeyBanc's business becoming exclusively institutional - all retail accounts formerly held at McDonald, including employees' accounts, were transferred to a non-affiliated retail broker-dealer. At present, KeyBanc provides investment banking, equity and debt underwriting services to large corporations and middle-market companies, as well as fixed income and equity trading capabilities to institutional investor customers.
Following the 2007 sale of McDonald's retail brokerage business, KeyBanc revised its various policies and procedures, but it was not until January 1, 2009, that the firm introduced revisions relating to its employees' personal investments ("PIP").
During 2007 through 2008, the PIP provided that only under "extremely limited circumstances," could an employee receive approval to have an outside personal account; and all employee transactions had to be reviewed by a branch supervisor, with particular supervisory attention to "frequent or aggressive trading." Moreover, an employee outside account required branch supervisors to review trade confirmations and account statements for unusual activity, including, among other things, employee trades that were executed at a price better than the price at which a customer of the firm bought or sold the same security during the same period of time.
SIDE BAR: Until the January 2009 Revised PIP, all employee accounts were required to be held internally at the firm; however, since all retail accounts, including employee accounts, had been transferred in 2007 to a non-affiliated broker-dealer, the AWC alleged that the policies and procedures in effect were not appropriately tailored to the firm's changed structure.
- NASD Conduct Rule 3010(a) requires firms to "establish and maintain a system to supervise activities of each registered representative, registered principal, and other associated person that is reasonably designed to achieve compliance with applicable securities laws and regulations, and with applicable NASD rules."
- NASD Conduct Rule 3010(b) requires that supervisory systems be documented in the firm's written supervisory procedures and enforced. The procedures must be tailored to the specific nature of the business engaged in by the firm, and must put in place procedures for ensuring compliance and for detecting violations, and not merely set out what conduct is prohibited.
After the 2007 transfer of the employee accounts to another broker-dealer, KeyBanc continued to review employee trading through its Control Room Group, which monitored employee trading to prevent employees from buying or selling securities on the Restricted or Watch Lists. FINRA detected an anomaly in KeyBanc's supervision because the PIP in existence at the time contemplated supervisory reviews of employee trades by branch office supervisors, who no longer existed following the retail business divestiture.
Got You Covered
On January 1, 2009, KeyBanc's Revised PIP required that employees identified as Covered Persons maintain their personal brokerage accounts at one of three approved broker-dealers and to have all personal transactions pre-cleared by the Control Room Group, to which requests for personal trades were submitted by email.
You're Too Sensitive
Also, the Revised PIP required that Information Sensitive Employees ("ISEs") who routinely work in business units that generate or have access to material, non-public information, obtain prior approval from the Control Room Group and a Supervisory Principal before undertaking any personal transactions. As of March 2, 2009, ISEs expanded to include, among other groups, the fixed income sales and trading group. Under the policy applicable to ISEs, once the Control Group cleared a transaction, a Supervisory Principal was required to approve or deny the requested transaction via email.
What's The Issue?
As part of the approval process for trade requests by ISEs, Supervisory Principals were supposed to identify the issuers in order to determine any potential conflict of interest. During the period from March 2, 2009 until around October 2009, when filling out requests for desired personal transactions, employees were only required to identify the quantity, price and CUSIP number involved in the transaction - Supervisory Principals were not required to identify the issuer prior to approving an employee's request. FINRA alleged that the Supervisory Principals were not provided with specific guidance on what steps they should take prior to approving an employee's personal transaction request.
During the relevant period, the PIP did not prohibit employee trades involving securities maintained in inventory. At least twenty-seven transactions on behalf of five ISEs in the fixed income sales and trading group were approved by a Supervisory Principal without examining the requested trades to determine if there was a potential conflict of interest, despite the fact that the transactions involved CUSIP numbers of securities maintained in the Firm's inventory and traded by those employees.
In accordance with the conduct cited above, the AWC imposed upon KeyBanc sanctions of an $85,000 fine and a Censure.
Bill Singer's Comment
Trading Away from one's employer brokerage firm is not an uncommon occurrence but it is a situation that raises many compliance concerns - and for good reasons, many of which were noted in this case. See these "Street Sweeper" columns for a more in-depth discussion:
Among the most basic motivations for employees having brokerage accounts at other firms is that the other firms may offer discounted executions. Another issue is that away accounts may be joint accounts with spouses, family members, or acquaintances, and those other parties prefer that the assets be held someplace other than the subject registered person's employer.
Given the recent prosecutions for insider trading, there is much legitimacy in limiting, if not prohibiting, these away accounts. One can only imagine the complexities faced by compliance staff at such humongous organizations as Bank of America, Wells Fargo, Citigroup, and JP Morgan when it comes to implementing and maintaining similar policies - all the more exacerbated by the inclusion of retail businesses. Which may well explain the reluctance of many financial institutions to permit away accounts, and, accordingly, may also explain the focus of FINRA and other regulators on such policies and procedures. Sometimes it truly is simpler to just say "No."
One quibble that I have with FINRA is the smugness with which it files many of these written supervisory procedures ("WSP") cases. After all, if KeyBanc's WSPs were deficient in 2007, 2008, and 2009, how come no regulator caught those specific shortcomings during those years? Why did it take until 2012 for FINRA to impose sanctions?
While much of regulation is understandabley an exercise in "gotcha," it still bothers me that a regulator with a mandate to conduct annual inspections of its members, apparently fails to contemporaneously notice deficiencies in a member's WSPs over a span of a few years, and then slaps that firm with a five- or six-figure fine. In KeyBanc's case, assuming that its WSPs were not relevant for three years because they reflected "retail" policies and procedures (and I concur that such is not acceptable), how come no state, federal, or self-regulator timely caught those deficiencies?
Hey,regulator, heal thyself first.