It's one thing for a brokerage firm to have a stockbroker engaging in a few trades using unauthorized discretion. In today's BrokeAndBroker.com Blog. however, we have a FINRA settlement involving seven years of improper discretion and 21 customers, a few of whom were the family members of the respondent. For some of you, today's article will be a wake-up call. You need to get discretion in writing from the customer before you start to exercise it. You need to notify your firm beforehand and make sure that you will be given permission to exercise discretion. Then there's that final issue: Don't answer "NO" on in-house compliance forms when the correct answer is "YES."
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, Sven Bernhard Karlen submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. In the Matter of Sven Bernhard Karlen, Respondent (AWC 2015044533901, November 23, 2016).
Karlen entered the securities industry in 1989 and was first registered in 1990. The AWC asserts that following the expiration of his registrations, Karlen requalified in 1999. In January 2008, Karlen was registered with FINRA member firm Wachovia Securities, LLC and remained with that firm's successor-in-interest, Wells Fargo Advisors LLC, until February 2015. The AWC asserts that Karlen had no prior disciplinary history in the securities industry.
A Matter of Discretion
The AWC asserts that:
During January 2008 through January 2015, while registered with the Firms, Respondent improperly exercised discretionary trading authority in the accounts of 21 Firm customers, some of whom were Respondent's family members. In almost all instances, Respondent did not have the customers' prior written approval to engage in such trading. Further, in no instance did Respondent obtain the discretionary trading approvals and forms required by the Firms' policies, and they did not accept the accounts as discretionary.
Let's walk a bit slowly through the above quote. What immediately strikes us is the amount of time at issue: Seven years. During that seven-year period, the AWC asserts that Karlen exercised discretion in the accounts of 21 customers but allows that "some" of those customers were family members. Maybe I'm just being picky but when we're dealing with only 21 customers, I don't think it's that difficult a task for FINRA to quantify how many family members are "some." Similarly, it appears that Karlen did not have prior written approval "in almost all instances." Again, I'm not sure why FINRA didn't either indicate something like in "all but 3 of 1,212 trades" but maybe someone at the self-regulatory organization will read this article and adjust the regulator's protocol.
The AWC asserts that during the relevant time of the cited discretionary trading by Karlens, his firms:
[G]enerally prohibited the exercise of discretion in a non-advisory customer account unless the account was maintained by the financial advisor's family member and certain conditions were satisfied, including that the family member executed a written discretionary trading agreement and certain Firm supervisors executed a discretionary trading approval form. In addition, during 2008, Wachovia's polices required that its compliance department review the customer's written discretionary trading agreement and authorize the coding of the account as discretionary before such authority could be exercised.
In submitting the cited discretionary orders, Karlen allegedly failed to comply with his firms' requirement that such tickets be marked "discretionary." As a result of said omission, Karlen rendered his firms' book and records inaccurate.
A Matter of Form(s)
In response to compliance questionnaires dated November 20, 2009, July 22, 2010, August 10, 20102, and August 2, 2013, Karlen allegedly answered "NO" about whether he had accounts in which he had exercised discretion. Similarly, the AWC asserts that Karlen provided false and misleading statements about the use of discretion on annual attestations dated April 6, 2009, May 18, 2010, September 8, 2011, August 24, 2012, November 20, 2013, and December 9, 2014.
By the Rulebook
FINRA deemed Karlen's:
In accordance with the terms of the AWC, FINRA imposed upon Karlen a $15,000 fine and a six-month suspension from association with any FINRA member in any capacity.
Bill Singer's Comment
According to online FINRA BrokerCheck records as of December 6, 2016, under the heading "Employment Separation After Allegations," on January 26, 2015, Wells Fargo Advisors, LLC. "Discharged" Karlen following allegations that:
FA VIOLATED FIRM POLICIES BY EXERCISING TIME AND PRICE DISCRETION IN NON-DISCRETIONARY ACCOUNTS, FORWARD INFORMATION ABOUT A PRIVATE INVESTMENT TO FIRM CUSTOMERS AND ADVISING FIRM CLIENTS AND OTHERS AS TO HOW TO VOTE IN A PROXY DISPUTE. TO DATE, THERE HAVE BEEN NO CLIENT OR OTHER COMPLAINTS ABOUT THESE MATTERS
NASD Conduct Rule 2510. Discretionary Accounts(a) Excessive TransactionsNo 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 AccountNo 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 TransactionsThe 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.(d) ExceptionsThis 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.