June 7, 2017
A recent FINRA regulatory settlement presents us with the case of a registered representative who entered allegedly false information into his firm's customer database and also engaged in improper Time and Price discretion for one account. Industry participants will learn some valuable lessons from this settlement and should take note of the issues raised. Unfortunately, BrokeAndBroker.com Blog publisher Bill Singer, Esq. takes issue with what's not set forth in the published settlement. Hopefully the good folks at FINRA will consider Bill's critique and respond to it in a constructive fashion.
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, Laurence M. Rothstein submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. In the Matter of Laurence M. Rothstein, Respondent (AWC 2016051183801, May 31, 2017).
The AWC alleges that Rothstein was first registered in 2002 with FINRA member firm Edward Jones. The AWC asserts that he had no prior relevant disciplinary history in the securities industry.
The AWC asserts that from September 22, 2015, through September 30, 2015, Rothstein entered into an Edward Jones database $10,000 "savings goals" for 75 of his customers. The database was used to track customer contacts and information. The AWC alleges that Rothstein had made the entries without previously speaking to each customer about the goal or the purpose for the savings. Further, the AWC asserts that because Rothstein had not previously communicated with the customers about their savings goals, he "knew that this information was false."
FINRA deemed that Rothstein conduct in entering false savings goals caused Edward Jones's books and records to be inaccurate in violation of Section 17(a) of the Securities Exchange Act and Rule 17a-3 thereunder; and, accordingly, Rothstein violated FINRA Rules 4511 and 2010.
Also, the AWC alleges that on November 27, 2015, January 19, 2016, and March 8, 2016, Rothstein entered 16 orders to sell securities from customer DK's account without speaking to or obtaining specific authorization from DK as to the securities, the price, the amount or the timing of each order. The AWC asserts that during the relevant times, Edward Jones did not allow its registered representatives to exercise discretion in customer accounts and required registered representatives to obtain specific authorization from the customer as to the security, the price, the amount, and the timing of each order.
FINRA deemed Rothstein's conduct to have involved the exercise of unauthorized discretion in violation of NASD Rule 2510(b) and FINRA Rule 2010.
According to online FINRA BrokerCheck records as of June 7, 2017, Edward Jones "Discharged" Rothstein on August 2, 2016, based upon allegation that he had "Violated terms of an email restriction."
In accordance with the terms of the AWC, FINRA imposed upon Rothstein a $10,000 fine and a two-month suspension from association with any FINRA regulated broker-dealer in any capacity
Bill Singer's Comment
According to FINRA's online BrokerCheck database as of June 7, 2017, under the heading of "Customer Dispute -- Closed-No Action/Withdrawn/Dismissed/Denied," on September 28, 2014, Edward Jones received a customer complaint against Rothstein alleging:
THE CLIENT ALLEGES SHE WAS NOT ALLOWED TO REVIEW THE MUTUAL FUND SELECTIONS PRIOR TO PURCHASE AND THE FINANCIAL ADVISOR DID NOT DISCLOSE THE COMMISSION ON THE PURCHASE.
On October 31, 2014, Edward Jones denied the customer's complaint and request for $12,000 in damages. This disclosure reflects an event that took place about one-year before the earliest misconduct cited in the AWC.
There is not a single word of explanation in the AWC as to how FINRA discovered that Rothstein had entered the allegedly false savings goals for 75 customers and the 16 unauthorized trades for DK. Further, other than the 2014 customer complaint noted above, Edward Jones did not file a BrokerCheck disclosure about any other customer complaints. How then did FINRA learn of the underlying issues that prompted its investigation and subsequent settlement?
Many industry participants and even FINRA itself may think it unnecessary or irrelevant to offer an explanation as to how a member firm or the self-regulator was alerted to misconduct. Frankly, I find that a myopic view of compliance and regulation. Member firm supervisors are educated by an exposition of the forensics involved in uncovering industry misconduct. More cynically, associated persons musing about taking "short-cuts" may be deterred upon learning that the very misconduct they contemplate was easily uncovered and resulted in fines and suspensions.
A Matter of Time
While we're critiquing this AWC, let's put some dates into perspective:
- The earliest misconduct cited in the AWC took place in November 2015;
- the last cited act of misconduct took place on March 8, 2016 (an allegedly unauthorized trade);
- Rothstein was terminated by Edward Jones in August 2016; and
- on May 31, 2017, FINRA entered into the AWC with Rothstein.
In fairness to FINRA, let's say that the regulator only became aware of Rothstein's termination in September 2016. In an abundance of fairness, let's assume that FINRA's investigation of Rothstein did not even start until October 2016.
Why did it take FINRA about 7 months (from October 2016 until May 2017) to develop and settle its case against Rothstein?
All 75 of the savings goals data entries took place within about one week in September 2015. That suggests that once FINRA uncovered the first few dubious entries, the rest fell in a cascade. Similarly, the 16 discretionary trades all took place in only one customer's account.
Of course it takes time for a regulator or broker-dealer to uncover false data entries in 75 accounts. The 16 trades in DK's account spanned four months and may have involved a protracted investigation. I'll give you all of that. I am NOT asserting that FINRA took too long or was too aggressive. I am, however, asserting that an AWC should present the underlying facts of a case with sufficient content and context so that we have some sense of what prompted a regulatory investigation.
NASD Rule 2510
NASD Conduct Rule 2510: Discretionary Accounts imposes a simple compliance regime of prior written authorization by the customer coupled with the firm's written acceptance. Upon placing a duly authorized and approved discretionary trade, a member firm must undertake prompt written approval of each discretionary order; and, further, must frequently review all discretionary accounts to ensure that the transactions are suitable.
SIDE BAR: NASD Conduct Rule 2510 is about as straightforward a regulatory proposition as you could imagine. One thing though: Why is this rule still an "NASD" rule and not updated to a FINRA rule? FINRA was formed in 2007. Does it really take over a decade to transition from the old NASD rulebook to the superseding FINRA one?
Rule 2510(d)(1) carves out an exception for Time And Price discretion - known in the biz as "T&P." T&P comes into play when there's a customer order "for the purchase or sale of a definite amount of a specified security" but the actual entry of the order is exercised at a time and price determined by the stockbroker. T&P is an effective order ONLY "until the end of the business day on which the customer granted such discretion . . ." In the old days, there wasn't such an intra-day limit on T&P, which is why the one-business-day limit trips up some industry veterans. Familiarize yourself with the full-text of the rule:
NASD Conduct Rule 2510. Discretionary Accounts
(a) Excessive Transactions
No 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 Account
No 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 Transactions
The 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.
This 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 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.