June 16, 2014
In recent years, the Financial Industry Regulatory Authority ("FINRA") has been on a tear about due diligence and the failure to supervise; and, frankly, you can't blame the self-regulatory organization given the recent history of disasters involving both of those issues. In today's BrokeAndBroker Blog offering, we consider the mess created by a stockbroker who was selling interests in a project to drill a well. Not only does the deal result in a fine and suspension for the selling broker but his supervisor winds up entangled in the regulatory web and also gets slapped with dollars and time off.
Case In Point
For the purpose of proposing a settlement of rule violations alleged by FINRA, without admitting or denying the findings, prior to a regulatory hearing, and without an adjudication of any issue, Harlan Kleiman submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. In the Matter of Harlan Kleiman, Respondent (AWC 2012030570702, June 9, 2014).
In 1993, Kleiman first became associated with a FINRA member firm and, thereafter, in 1995, he first became registered. In 2000, he formed Shoreline Pacific LLC, which was acquired by another FINRA member firm in 2003. The AWC asserts that Shoreline withdrew from FINRA membership in February 2013. The AWC also asserts that Kleiman had no prior disciplinary history.
Not So Amazin' Amazon
Kleiman was the Shoreline principal responsible for supervising the firm's private placement business. The AWC asserts that in August 2012, Shoreline executed an engagement agreement with Amazon Exploration (an oil and gas program sponsor) and, accordingly, Shoreline agreed to act as placement agent for up to $2,250,000 in limited and convertible general partnership interests issued by Amazon 13-30, which was formed to drill a single well in Cheyenne County, Nebraska. Purportedly three investors purchased about $77,000 in Amazon 13-30 interests through Shoreline.
Kleiman was the supervisor of the registered representative primarily responsible for placing the Amazon 13-30 securities; and for reasons known only to FINRA, the AWC refers to this registered person by the initials of "JA."
Not So Super Supervision
Given his principal/supervisor roles, the AWC asserts that Kleiman was responsible for the implementation of the firm's due diligence system and procedures; and was further obligated to reasonably supervise the Amazon 13-30 placement.
The AWC alleges that Kleiman did not adequately investigate certain "red flags," among which were the purportedly inadequate "use of proceeds" disclosures and the absence of past performance information related to the program sponsors. Further, the AWC cites Kleiman's failure to exercise reasonable diligence to understand the attributes or potential risks and rewards associated with Amazon 13-30. Finally, the AWC alleges that Kleiman did not comply with his customer specific suitability obligation by obtaining and considering required information related to the investors' investment profiles in making recommendations to purchase the security.
Deeming the above to constitute violations of NASD Conduct Rule 3010 and FINRA Rule 2010 and in accordance with the terms of the AWC, FINRA imposed upon Kleiman a $10,000 fine and a two-month suspension from association with any FINRA-member broker-dealer in a principal capacity
And just who the hell was this "JA"? Ahhhh . . . don't worry, the inveterate and indefatigable vertebrate Bill Singer got out his shovel and dug up a lot of stuff, even if he didn't hit any pockets of oil or gas.
For the purpose of proposing a settlement of rule violations alleged by the FINRA, without admitting or denying the findings, prior to a regulatory hearing, and without an adjudication of any issue, Jeffrey R. Alexander submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. In the Matter of Jeffrey R. Alexander, Respondent (AWC 2012030570701, February 24, 2014).
On The Same Shoreline
In 2007, Alexander first became associated and registered with a FINRA member firm. Following the termination of his registrations in January 2008, he purportedly left the securities industry until his June 2012 association with Shoreline Pacific LLC. and subsequent July 2012 registration. The AWC asserts that Alexander's registration was terminated in January 2013 and that the firm withdrew from membership in February 2013. The AWC asserts that Alexander had no prior disciplinary history.
Largely reciting the same litany note in the Kleiman AWC above, the Alexander AWC notes that pursuant to the agreement between Shoreline and Amazon Exploration, the FINRA member firm:
would offer and sell up to 30 partnership units in Amazon 13-30. Shoreline Pacific would receive a "success fee" of 20% of the funds it raised, as well as five Amazon 13-30 units if the firm was able raise $1 million. . .
Unreasonable Due Diligence
The Alexander AWC alleged that the registered person failed to undertake reasonable due diligence in order to determine whether Amazon 13-30 was suitable for at least some investors. Among the allegedly missed red flags were those raising purported warnings about
- the background of the principals of Amazon Exploration;
- the lack of certain disclosures in the private placement memorandum; and
- the vagueness of other disclosures.
The three investors referenced above completed subscription agreements but the Alexander AWC asserts that no other information was obtained and recorded for these individual, in apparent violation of the suitability requirements of FINRA Rule 2111. Although the Alexander AWC concedes that the subscription agreements contained some of the information necessary to perform a reasonable suitability inquiry, among the considerations that allegedly not considered were:
- the investor's age;
- other investments;
- specific information about the investor's financial circumstances;
- risk tolerance;
- liquidity needs; and
- time horizon.
The Alexander AWC
alleged that the omission of an inquiry involving the above cited factors constituted a violation of FINRA Rules 2111(a) and 2010 with respect to the three recommendations.
In accordance with the terms of the AWC, FINRA imposed upon Alexander a $5,000 fine and a 3-month suspension from association with any member of FINRA in any capacity
Bill Singer's Comment
You will permit me just a bit of head scratching here.
While FINRA is chastising the two registered Respondents for a host of failures to do this and that, the regulator sort of leaves us a bit adrift on a sea of unanswered questions:
- Did each of the three investors lose any/some/all of their investments?
- Did Amazon 13-30 go belly up or run into trouble?
- Did either Kleiman, Alexander, or Shoreline make any restitution (if any was necessary)?
How the hell do you wind up hitting the guy selling the questioned deal (Alexander) for $5,000 and a 3-month suspension but you hit the supervising principal (Kleiman) to the tune of $10,000 and a 2-month principal-only suspension? If you want to make the point that the principal/supervisor's conduct was worse and warranted a fine twice as large as the selling registered representative, that's okay -- but, hey, you sort of gotta do the leg work here and spell it out. I'm still not sure that I understand the disparity in the fines.
No . . . I am NOT suggesting that principal/supervisors are not and/or should not be sanctioned more severely than their subordinates. To the contrary, sometimes that very appropriate. What I am suggesting is that when one guy is selling and the other is supervising, you would typically think that the former is more guilty than the latter; and if that's not the case, then a regulator should at least set forth its views and rationale.
Oh, and one last parting shot.
Seriously? The Kleiman AWC couldn't disclose that "JA" is likely James Alexander? This is a great state secret? Took me about two seconds to break FINRA's joke of a code.