December 12, 2012
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, submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. (AWC 20100239765, December 10, 2012).
After entering the securities industry in 1989, Respondent was registered during the relevant time of this matter with Wells Fargo Investments, LLC from July 2002 until his August 24, 2010, termination.
Starting around January 2009, Respondent began marketing to his fee-based clients from whom he did not earn a per-trade commission, a stop-loss trading strategy that was allegedly designed to preserve capital by providing a clear exit strategy during market declines. Typically using the Power Shares QQQ Trust as the trading vehicle, Respondent's purported understanding with his clients was that if the underlying NASDAQ 100 index closed the week down more than 10% from its six-week high, he would close out the long QQQ position; thereafter, the strategy called for re-entry into the QQQ when the index moved higher from the trigger threshold of 10% below its six-week high.
By May 2010, Respondent had approximately 55 customers using his stop-loss strategy pursuant to their verbal authorizations for the stockbroker to sell the QQQs when then the trigger was reached - the AWC asserts that the clients understood that Respondent "would not be calling them prior to entering the trades."
Ah, but the devil is always in the details.
On May 7, 2010, following a drop in the QQQs and the activation of the trigger, Respondent placed market sell orders for 55 customers spread out over 79 accounts. In keeping with the stockbroker-clients' understanding, Respondent did not contact the customers to obtain their prior authorization to enter the orders.
The AWC asserts that:
Although Respondent had received prior verbal authorization to execute the QQQ trades as required by the stop-loss trading strategy, he did not have written authorization to exercise discretion in his customers' accounts. Respondent's entry of the QQQ orders therefore violated NASD Rule 2510(b) and FINRA Rule 2010.
In accordance with the terms of the AWC, FINRA imposed upon Respondent a $5,000 fine and a 10-business-day suspension from association with any FINRA member firm in any capacity.
Bill Singer's Comment
Okay, so now you know. Even if the customers say "It's okay - exercise discretion," that's not enough under the rules. You need to get it in writing from the customer (and before you enter the trade) and you need to get your firm's written approval.
Among the bedrock of Wall Street violations is unauthorized discretion. And don't think that this violation is a rare miscue. It's not. The failure to obtain properly authorized and approved account discretion plagues registered persons at indie/regional firms as well as the big boys such as Merrill, UBS, JP Morgan, Morgan Stanley, and Wells Fargo.
In this AWC, however, I find myself confronted with what I call a "Yes but" case. According to a strict interpretation of FINRA's rule, we have a stockbroker using improperly authorized and unapproved discretion. And to be fair, I'm willing to give FINRA points for making sure that registered persons understand the compelling need to only exercise discretion according to the rule. Still - we have to always be mindful that in sending such messages, there are human beings named as respondents with lives to live and businesses to run.
SIDE BAR: Online FINRA records as of December 12, 2012 disclose that Wells Fargo alleged on August 9, 2010, that it had discharged Respondent for the following reason:
CONTRARY TO COMPANY POLICIES, REPRESENTATIVE PLACED TRADES IN CLIENTS' ACCOUNTS WITHOUT RECEIVING APPROVAL PRIOR TO EACH TRANSACTION. FURTHERMORE, DURING AN INTERVIEW, THE REPRESENTATIVE ACKNOWLEDGED THAT HE "EXERCISED A BIT OF DISCRETION" FOR ONE TRANSACTION AT ISSUE.
The online FINRA document offers the following additional response dated August 9, 2010, notes that the Respondent:
[S]TRONGLY DISPUTES WELLS FARGO'S ALLEGATIONS. APPROVAL WAS RECEIVED PRIOR TO EACH TRANSACTION. EACH TRADE WAS PLACED PURSUANT TO THE CUSTOMER'S INSTRUCTIONS TO SELL SECURITIES IF THEIR VALUE FELL TO A SPECIFIC LEVEL. WELLS FARGO INTERVIEWED THE CUSTOMERS AND CONFIRMED THAT THE CUSTOMERS AUTHORIZED THE TRADES. FURTHERMORE, NO CUSTOMER DISPUTED THE TRADES AND NO CUSTOMER PAID A COMMISSION FOR THE TRADES. THIS ALLEGATION IS CURRENTLY UNDER REVIEW.
All of which brings me to the yeah but portion of this commentary.
Yeah, Respondent may well have failed to get prior written authorization from his clients BUT did his misconduct truly require the imposition of $5,000 fined and a 10-business-day suspension? Given the facts in this case, I think the sanctions were heavy handed.
For starters, the clients were all fee-based, so there wasn't any substantial financial motivation to engaging in the unauthorized trades because Respondent realized no commissions. Moreover, it appears that the stockbroker had meticulously presented his trading strategy and had extracted the prior oral consent of his clients for the anticipated entry of buy and sell orders pursuant to the trigger. Flawed and improper as such prior oral consent may have been, at least it demonstrates some good faith effort to comply with the concept of getting prior authorization to enter orders.
In a recent "BrokeAndBroker" column, I reported about a FINRA case in which a stockbroker's Bar by the Office of Hearing Officers was reduced on appeal by FINRA's National Adjudicatory Council ("NAC") to a $5,000 fine and six-month suspension. See, "Hartford Life Wholesaler Fabricated Embassy Suite Bill For School Donation" (December 11, 2012). In justifying its reduction of sanctions, the NAC noted in its Decision:
FINRA sanctions may be remedial, but must not be punitive. McCarthy v. SEC, 406 F.3d 179,188-89 (2d Cir. 2005); Guidelines, at 2. A remedial sanction is designed to correct the harm done by respondent's wrongdoing and to protect the trading public from any future wrongdoing the respondent is likely to commit. McCarthy, 406 F.3d at 188. In addition to remediation, deterrence may also be relied upon as an additional rationale for the imposition of sanctions. Id
FINRA's sanction in the QQQ matter that is the topic of today's column is not remedial in nature but, in fact, borders on being punitive given the totality of the circumstances. In light of:
I don't think this registered person posed any particular threat to the trading public and see no justified remediation or deterrence in the imposition of a five-figure fine and a 10-business-day suspension. A $5,000 fine strikes me as sufficient. On the other hand, this was not a contested case but an AWC in which Respondent submitted an offer of settlement. Consequently, if he is satisfied with the nature of the sanction, so be it.
Also see these Rule 2510 columns:
Below is the full-text version of FINRA's Discretion Rule. Read it!
NASD Business Conduct Rule 2510: Discretionary Accounts
(a) Excessive Transactions
No member shall effect with or for any customer's account in respect to which such member or his agent or employee is vested with any discretionary power any transactions of purchase or sale which are excessive in size or frequency in view of the financial resources and character of such account.
(b) Authorization and Acceptance of Account
No member or registered representative shall exercise any discretionary power in a customer's account unless such customer has given prior written authorization to a stated individual or individuals and the account has been accepted by the member, as evidenced in writing by the member or the partner, officer or manager, duly designated by the member, in accordance with Rule 3010.
(c) Approval and Review of Transactions
The member or the person duly designated shall approve promptly in writing each discretionary order entered and shall review all discretionary accounts at frequent intervals in order to detect and prevent transactions which are excessive in size or frequency in view of the financial resources and character of the account.
This Rule shall not apply to:
(1) discretion as to the price at which or the time when an order given by a customer for the purchase or sale of a definite amount of a specified security shall be executed, except that the authority to exercise time and price discretion will be considered to be in effect only until the end of the business day on which the customer granted such discretion, absent a specific, written contrary indication signed and dated by the customer. This limitation shall not apply to time and price discretion exercised in an institutional account, as defined in Rule 3110(c)(4), pursuant to valid Good-Till-Cancelled instructions issued on a "not-held" basis. Any exercise of time and price discretion must be reflected on the order ticket;
(2) bulk exchanges at net asset value of money market mutual funds ("funds") utilizing negative response letters provided:
(A) The bulk exchange is limited to situations involving mergers and acquisitions of funds, changes of clearing members and exchanges of funds used in sweep accounts;
(B) The negative response letter contains a tabular comparison of the nature and amount of the fees charged by each fund;
(C) The negative response letter contains a comparative description of the investment objectives of each fund and a prospectus of the fund to be purchased; and
(D) The negative response feature will not be activated until at least 30 days after the date on which the letter was mailed.