BrokeAndBroker.com Blog publisher Bill Singer, Esq. is a stickler for detail when it comes to disclosures by Wall Street's regulators. Bill is angered when he sees the heavy-hand of a regulator who is dealing with a respondent not represented by a lawyer. It's not that those charged are innocent -- often they are guilty of a violation. Guilt aside, two issues arise when matters are settled by pro se respondents: 1) the sanctions imposed are not always consistent with those imposed against similarly situated respondents represented by lawyers; and 2) the respondent's permanent record does not always contain accurate and fair allegations pertaining to the cited misconduct. A recent FINRA regulatory settlement highlights Bill's concerns.
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, David K. Stone submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. In the Matter of David K. Stone, Respondent (AWC 2016049134901. April 13, 2017).
The AWC asserts that in 1996, Stone first became registered and by August 2007, he was registered with FINRA member firm Liberty Tree Advisors, LLC. The AWC asserts that Stone had no prior formal disciplinary history with the Securities and Exchange Commission, any self-regulatory organization or any state securities regulator.
A Man of Many Hats
During the relevant period of May 2015 to January 2016, the AWC asserts that Stone was registered with Liberty Tree Advisors as a General Securities Representative, General Securities Principal, Introducing Broker-Dealer Financial and Operations Principal, Investment Banking Limited Representative and Operations Professional.
Cannabis Industry Fund
The AWC alleges that:
In approximately May 2015, Firm registered representative KG and two partners
created a fund to raise capital for investment in commercial and industrial real estate associated with the legal cannabis industry in Colorado (the "Fund"). Stone discussed the Fund with KG and was aware that KG was seeking to raise capital through the sale of limited partnership interests in the Fund. Despite this awareness, Stone mistakenly determined that KG's sale of interests in the Fund did not involve private securities transactions that required his supervision.
During the Relevant Period, KG raised approximately $1.4 million in investments in the Fund from approximately seven investors. Because Stone considered the Fund an "outside business activity" and not "private securities transactions," Stone did not supervise KG's sale of interests in the Fund and the Fund's transactions were not recorded on the Firm's books and records.
FINRA deemed Stone's conduct to constitute violations of NASD Rule 3040 (prior to September 21, 2015) and FINRA Rule 3280 (on or after September 21, 2015), and FINRA Rules 3110 and 2010.
In accordance with the terms of the AWC, FINRA imposed upon Stone a $5,000 fine and a two-month suspension from associating with any FINRA member firm in a principal capacity.
Bill Singer's Comment
There are numerous aspects of this AWC that I don't like; as such, let's just get to it.
The AWC presents Stone as if he were merely hired by Liberty Tree Advisors in 2007 and served in a multi-registered capacity with his primary role as supervising the firm's salesforce. In fact, online FINRA BrokerCheck records as of April 20, 2017, disclose that Liberty Tree Advisors, LLC was formed in 2006 and ceased being registered with FINRA on November 8, 2016. Under the heading "Direct Owners and Executive Officers," David Kimball Stone is listed as a "75% or more" owner who directs the management or policies of the firm. Stone's position is listed as "MANAGING DIRECTOR, CFO, CCO, FINOP, EXEC. REP."
After reading the firm's BrokerCheck report, I infer that Liberty Tree Advisors was a small, a very, very small, FINRA member firm, and that Stone was likely the guy who turned on and off the lights, unlocked and locked the doors, refilled the water cooler, jiggled the stuck copier, rebooted the frozen computer, paid the bills, and stared at nights at his ceiling wondering if he was going to cover the month's nut. That's a far different picture than some purportedly lax supervisor. Being busy and being multi-registered does not excuse failure to supervise. On the other hand, there is no need to present Stone in anything less than a fair light.
PST: The First Step
Next, let's consider the language from:
FINRA Rule 3280: Private Securities Transactions of an Associated Person
No person associated with a member shall participate in any manner in a private securities transaction except in accordance with the requirements of this Rule.
(b) Written Notice
Prior to participating in any private securities transaction, an associated person shall provide written notice to the member with which he is associated describing in detail the proposed transaction and the person's proposed role . . .
Clearly, Rule 3280 requires that it is incumbent upon the associated person to provide prior written notice to the member describing in detail the proposed private securities transaction ("PST"). There is absolutely no assertion in the AWC that KG took that first step and provided the required written notice to Liberty Tree Advisors. What is asserted in the AWC is that;
Stone discussed the Fund with KG and was aware that KG was seeking to raise capital through the sale of limited partnership interests in the Fund.
Discussing the Fund with KG may have raised Stone's awareness about the rep's intention to raise capital but that does not obviate the need for KG to have first provided prior written notice to Liberty Tree Advisors. The AWC should have unequivocally disclosed whether KG submitted the required PST notice.
FINRA seems to have built its case against Stone based on the fact that he "discussed" the fund with KG and had an awareness of what the rep was doing. FINRA then attempts to nail Stone as a result of his discussion with KG because the AWC states that:
Despite this awareness, Stone mistakenly determined that KG's sale of interests in the Fund did not involve private securities transactions that required his supervision.
At the bottom of the AWC appears only Stone's signature and not that of any lawyer, which strongly suggests that he was not represented during the AWC negotiations and possibly during the investigation. I wish FINRA had clarified the legal representation issue because I think it matters more in this type of case than most.
FINRA Rule 3280 implemented a PST regulatory regime that is clearly predicated upon the obligation of the associated person to disclose in writing the parameters of the transaction. In the absence of any assertion in the AWC to the contrary, I assume that KG failed to submit the requisite prior notice.
FINRA finds Stone liable for a failure to supervise, which is apparently based upon this non-lawyer's purported awareness of a proposed transaction, which FINRA characterizes through the comfort of hindsight as a PST but, at the time, in the trenches, Stone characterized as an outside business activity ("OBA"). To his credit, Stone at least recognized that there was something about KG's proposed activity that required some regulatory/compliance consideration. Unfortunately, Stone seems to have guessed wrong about what the actual regulatory/compliance issue was. He thought it was OBA. FINRA says it was PST.
Making a wrong guess in good faith does not strike me as a failure to reasonably supervise. It strikes me as what the AWC said it was: a mistake. Perhaps Stone would have benefited from a bit of aggressive lawyering?
The Numbers Game
Moving along, we address the fact that KG raised about "$1.4 million in investments
in the Fund from approximately seven investors." Nice for FINRA to have put those numbers in Stone's AWC. Odd what the regulator failed to flesh out about those numbers. Doesn't seem that the "seven investors" were also customers of Liberty Street Advisors; if they were, you'd sort of think that FINRA would have wanted to spell that out. I mean, you know, FINRA must have been "aware" as to whether the investors were also customers of Stone's firm. Then there is the odd lack of disclosure about whether any of the investors lost money. Then there is the further odd lack of disclosure about whether any of the investors filed a complaint or sued.
If My Aunt Were A Man, She'd Be My Uncle
Stone did not supervise KG's PST because Stone apparently thought the transaction was an OBA. The PST wasn't recorded on Liberty Tree Advisors' books and records because Stone didn't think it was a PST requiring such recording. If Stone hadn't made a mistake, then he would not have made one. Duh.
The AWC never asserts that Stone "should have" determined that the activity was a PST. Go read the AWC and you will see no such claim. I'm not arguing that Stone didn't screw up. I'm just not sure that what he did or didn't do necessarily rose to the level of something other than a good-faith error in judgment for which the imposition of a $5,000 fine and Principal suspension seem silly and of no value to anyone.