FINRA Asks Where Was Reasonable Supervision. But Where Was FINRA?

February 2, 2017

The first line of defense on Wall Street is supposed to be the industry's compliance departments, where thousands of underpaid and overwhelmed men and women are expected to stay on top of all the rules, regulations, and policies. When those same compliance grunts actually warn their firms about the bad guys and girls who are about to bring the whole biz crashing down, some red-in-the-face, hot-head of a manager tells them that they're not being a team player. Everyone does it. I'll talk to him. Don't make a big deal out of this. We don't need those idiots from FINRA or the SEC poking around, right? You know how much he brings into the firm. If it comes down to him or you, it's him. You have to understand that there are ways things are done on the Street. Okay? We good? Glad to have had this talk. I'll let him know that it was just a misunderstanding. Make sure to erase everything from the hard drive. One other thing, do me a favor, send him an email and apologize. 

Fun and games on Wall Street! In today's Blog we consider a recent FINRA regulatory settlement involving allegations that a member firm didn't timely file reports and that it had a less than robust supervisory system. 

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, Citizens Securities, Inc. submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. In the Matter of Citizens Securities, Inc., Respondent (AWC 2016047706701, January 23, 2017).

Citizens Securities, Inc. ("CSI") is a retail brokerage FINRA member firm with about 1,250 registered persons. The AWC asserts that CSI does not have any prior relevant disciplinary history with the Securities and Exchange Commission, any self-regulatory organization or any state securities regulator. 

The Rulebook

Article V of FINRA's By-Laws: Registered Representatives and Associated Person provides [Ed: yellow highlighting provided]:

Application for Registration

Sec. 2. (a) Application by any person for registration with the Corporation, properly signed by the applicant, shall be made to the Corporation via electronic process or such other process as the Corporation may prescribe, on the form to be prescribed by the Corporation and shall contain:

(1) an agreement to comply with the federal securities laws, the rules and regulations thereunder, the rules of the Municipal Securities Rulemaking Board and the Treasury Department, the By-Laws of the Corporation, NASD Regulation, and NASD Dispute Resolution, the Rules of the Corporation, and all rulings, orders, directions, and decisions issued and sanctions imposed under the Rules of the Corporation; and

(2) such other reasonable information with respect to the applicant as the Corporation may require.

(b) The Corporation shall not approve an application for registration of any person who is not eligible to be an associated person of a member under the provisions of Article III, Section 3.

(c) Every application for registration filed with the Corporation shall be kept current at all times by supplementary amendments via electronic process or such other process as the Corporation may prescribe to the original application. Such amendment to the application shall be filed with the Corporation not later than 30 days after learning of the facts or circumstances giving rise to the amendment. If such amendment involves a statutory disqualification as defined in Section 3(a)(39) and Section 15(b)(4) of the Act, such amendment shall be filed not later than ten days after such disqualification occurs.

Notification by Member to the Corporation and Associated Person of Termination; Amendments to Notification

Sec. 3.  (a) Following the termination of the association with a member of a person who is registered with it, such member shall, not later than 30 days after such termination, give notice of the termination of such association to the Corporation via electronic process or such other process as the Corporation may prescribe on a form designated by the Corporation, and concurrently shall provide to the person whose association has been terminated a copy of said notice as filed with the Corporation. A member that does not submit such notification and provide a copy to the person whose association has been terminated, within the time period prescribed, shall be assessed a late filing fee as specified by the Corporation. Termination of registration of such person associated with a member shall not take effect so long as any complaint or action under the Rules of the Corporation is pending against a member and to which complaint or action such person associated with a member is also a respondent, or so long as any complaint or action is pending against such person individually under the Rules of the Corporation. The Corporation, however, may in its discretion declare the termination effective at any time.

(b) The member shall notify the Corporation via electronic process or such other process as the Corporation may prescribe by means of an amendment to the notice filed pursuant to subsection (a) in the event that the member learns of facts or circumstances causing any information set forth in said notice to become inaccurate or incomplete. Such amendment shall be filed with the Corporation via electronic process or such other process as the Corporation may prescribe and a copy provided to the person whose association with the member has been terminated not later than 30 days after the member learns of the facts or circumstances giving rise to the amendment.

Untimely Disclosure

The AWC alleges that during the relevant time from January 2010 through June 2016, CSI failed to timely disclose 45 customer complaints and settlements on its associated persons' Uniform Applications for Securities Industry Registration or Transfer ("Form U4") and Uniform Termination Notices for Securities Industry Registration ("Form U5").

In addition, 22 associated persons allegedly reported disclosable events such as outside business activities ("OBA") or bankruptcies on their annual compliance questionnaires ("ACQs"), yet the AWC asserts that CSI did not timely amend the individuals' Forms U4.

FINRA asserts that the cited complaints, settlements, OBA, and bankruptcies should have prompted U4 or U5 amendments no later than 30 days after CSI had learned of the facts or circumstances. FINRA deemed the above disclosure events to constitute violations by CSI of Article V, Sections 2 and 3 of FINRA's By-Laws and FINRA Rule 2010.

Supervisory System

The AWC further alleges that during the relevant time, individuals at CSI who were responsible for reviewing customer complaints lacked sufficient training about the applicable deadlines and the criteria that required the firm to report customer complaints on Forms U4 and U5. Further, the AWC alleges that CSI failed to ensure that associated persons' ACQ responses were timely reviewed.

FINRA deemed CSI's training issues as a failure to establish and maintain a supervisory system reasonably designed to ensure the timely reporting of disclosable events in violation of NASD Rule 3010 and FINRA Rules 2010 and 3110.


In accordance with the terms of the AWC, FINRA inposed upon CSI a Censure and $300,000 fine.  

Bill Singer's Comment

Without question, FINRA is on the side of the regulatory and compliance angels here. What gets a bit lost in the flurry of facts about this regulatory matter is that the misconduct spanned from January 2010 through June 2016. We're not talking a few weeks or months. We're talking about ongoing violations for about 6 1/2 years. As such, the imposition of the slap-on-the-wrist "Censure" and a whopping $300,000 fine satisfies me as appropriately bespoke for this case. 

Timely disclosing customer complaints and settlements is as basic a function as one should expect from any FINRA member firm's compliance department. Not only does prompt disclosure indicate that a compliance department is on top of problems among its associated staff, but it is imperative to remember that a member firm's disclosures are frequently the only notice to FINRA and various regulators of problems that need to be investigated. Finally, once disclosure enters the regulatory pipeline, it also enters into the stream of public notice whereby matters find their way onto BrokerCheck, the Central Registration Depository, and a whole host of federal and state databases that are used for due diligence by potential customers and business associates. Again, compliments to FINRA.

Now for my dyspeptic quibble.

Remember the so-called relevant time from January 2010 through June 2016? Ummm . . . where the hell was FINRA during that same 6 1/2 years of nondisclosure? I mean, you know, after all, didn't FINRA staff likely visit member firm CSI on an annual basis for those same 6 1/2 years? How is it that Wall Street's crackerjack self-regulatory organization didn't notice that CSI's supervisory system wasn't humming along during all those years?  All of which renders this regulatory settlement more than a bit hypocritical and bordering on sanctimonious. Which is not to say that there is no merit in FINRA's case. There is and it is compelling. It is to say, however, that he who lives in a glass house shouldn't be throwing stones. 

Then there is my other bit of annoyance with this settlement. (He says as he weighs a large rock in his hand and then proceeds to toss it and catch it several times).

Was it really necessary to get that kidney punch in against CSI in terms of not only charging the member firm with failing to timely disclose but also charging it with not having a reasonable supervisory system in place? When the same set of underlying facts is at issue, why pile multiple charges on the same head of the same pin? After all, if CSI had reasonably effective compliance policies and management then, duh, the firm would have timely filed the necessary disclosures over a 6 1/2 year period. If you really want to play that game, however, then FINRA should discipline its own supervisors and examiners responsible for investigating and examining CSI during the relevant 6 1/2 years because they did not timely detect the member firm's protracted non-compliance -- and then FINRA should be sanctioned for failing to train its staff to detect those violations.