A FINRA member firm came up with an interesting idea: The firm's customers could engage in so-called copycat, mirrored, or follow-on trades by targeting traders or trading services. It's an intriguing idea. You like the approach of a particular trader? Great -- instruct your broker-dealer to enter into your account whatever that professional is doing. You follow a trading service and want to do as they say? Okay -- tell your broker-dealer to buy and sell in lock-step. In theory, a provocative idea. In practice, well, FINRA wasn't all that happy. See what went down.
Case In Point
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, Ditto Trade, Inc. submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. In the Matter of Ditto Trade, Inc., Respondent (AWC 2014039218101, July 29, 2015).
Since July 2010, Ditto Trade has been a FINRA member firm with five registered representatives operating through only one branch office. The AWC asserts that Ditto did not have any prior disciplinary history.
Self-Directed Trading Accounts
According to the AWC, Ditto's business is as follows:
The Firm primarily offers self-directed trading accounts, and within those accounts, offers its customers the ability to copy the trading activity of other market participants with the consent of such participant.
As more fully set forth on Ditto's website :
How it works
. . .
When someone you're attached to, like a Lead Trader, initiates a trade, Ditto's technology instantly checks for Followers that are on Ditto All. It then calculates the number of shares for each Follower.
As of August 19, 2015, at the bottom of the Ditto's webpages are a number of legal disclaimers, of which this pertinent one appears:
Ditto Trade DOES NOT perform background checks or attempt to validate any Lead Trader or Service. Ditto Trade does not recommend or endorse Lead Traders or Services, their trading strategies or investments decisions. All trading signals and recommendations are generated or made solely by the designated Lead Trader or Service and not by Ditto Trade. Ditto Trade does not make any inquiry as the suitability of any particular Lead Trader or Service for any customer. Customers should investigate and research carefully any Lead Trader or Service prior to registering for the alerts of, or attaching to, a Lead Trader or Service. Ditto Trade does not imply or guarantee that any customer will make a profit or achieve favorable results from using any Lead Trader or Service. No Lead Trader or Service is affiliated with Ditto, and Ditto does not verify or vouch for the credentials, claims or representations of any Lead Trader, Service or strategy.
A Matter of Due Diligence
During the relevant period between January 2011 and February 2013, Ditto offered its customers the copy-cat or follow-on abilities noted above.
According to the AWC, at the time, Lead Traders were required to establish accounts at Ditto and had agreed to allow other Ditto customers to automatically mirror their trading activity.
Signal Services were not required to establish accounts at Ditto, and their trades could not be automatically followed by a Ditto Trade customer. Customers wishing to copy Signal Services received a trade alert and had to decide on a trade by-trade basis whether to copy a given trade.
The AWC asserts that Ditto customers who engaged in copying activity entered into agreements with Lead Traders or Signal Services (Ditto was not involved in these negotiations) to automatically follow or to receive trading alerts to permit the customer to follow the Lead Trader's or Signal Service's trades in the customer's own Ditto Trade account.
The payments from the customers to the Lead Traders/Signal Services were facilitated by Ditto pursuant to the negotiated terms and the brokerage firm would debit customer accounts and credit the Lead Traders/Signal Services accounts. An affiliate of Ditto maintained a website that both identified Lead Traders/Signal Services available to be followed on the Firm's trading platform and provided a link to the websites of those Lead Traders/Signal Services.
The AWC alleges that during the relevant period, Ditto failed to conduct adequate due diligence relating to the registration requirements for the hosted Lead Traders and Signal Services in order to ensure that they were registered or exempt from the registration requirements of the Investment Advisers Act of 1940.. The AWC asserts that:
In light of both the nature of the activity engaged in by Lead Traders and Signal Services and the Firm' s role in facilitating payments to Lead Traders and Signal Services, the Firm should have conducted robust due diligence on Lead Traders and Signal Services to ensure that they were properly registered as investment advisers or were exempt from registration. FINRA deemed that lack of due diligence to constitute a violation of NASD Rule 3010(a) and FINRA Rule 2010.
Additionally, the AWC alleges that Ditto also violated SEC Rule 17a-5, FINRA Rules 4524 and 2010 when between March 2013 and June 2014, Ditto failed to timely file (between 1 and 25 business days late):
In accordance with the terms of the AWC, FINRA imposed upon Ditto a Censure and $30,000 fine.
Bill Singer's Comment
Frankly, this AWC could have been better written to address what I consider an important issue:
Was the current Legal Disclaimer, which clearly admonishes that Ditto does not undertake what amounts to due diligence (robust or otherwise), in effect during the relevant period from 2011 to February 2013?
I am not necessarily supporting or criticizing FINRA's regulatory policy here; however, I am clearly trying to figure out just what the hell it is. Is this a policy of disclaim or perform "robust" due diligence -- and, while I'm at it, what's the difference between "robust" and plain-vanilla due diligence? I have no idea whether FINRA is asserting that firms such as Ditto: