You're driving on the street and come to a red light. What do you need to do to make a legal right turn? Your answer is that you need to come to a full stop at the red light, carefully check out the traffic, and slowly make the turn, right? Great answer. Except that I didn't tell you that the red light is in Manhattan in New York City. Unless there was a sign stating that you can make a right turn on the red light, it's illegal to make a right turn on red in NYC. Oddly, turning right on red is likely legal everywhere in the United States except in New York City.
What's your excuse to the cop asking to see your license? I'm from out of town, officer, and didn't know that I can't turn right at the red light. I can legally turn at a red light back home. I did come to a full stop. I did check to make sure that there was no traffic in the street into which I turned. Sorry. I won't do it again.
In contrast to your explanation, we got another driver from out of town who didn't come to a full stop, didn't look when he turned right, and wound up with a fender bender. Then we also got the driver from NYC who knew about the no-turn law but she did it anyway. Should all the above drivers have their licenses suspended and fined? Should the police exercise some discretion or does the law suffer when not applied consistently?
Wall Street is in Manhattan and you can not make a right turn there at a red light. BrokeAndBroker.com Blog publisher Bill Singer, Esq. points out, the rules of the road on the Street aren't always clear and sometimes folks think that what they're doing is legal and okay. What happens to registered reps in the biz when it turns out that they turned right at a FINRA red light? Read today's article for an interesting case.
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, Ralph Edward Martin submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. In the Matter of Ralph Edward Martin, Respondent (AWC 2014042877101, August 18. 2017).
In 1985, Martin was first registered and by 2003 he was registered with FINRA member firm Princor Financial Services Corporation, which is now Principal Securities, Inc. The AWC asserts that "Martin has no relevant disciplinary history."
Advisory Select Program
The AWC asserts that in 2008, Martin began using Princor's "Advisory Select" program of fee-based accounts in which customer funds were invested pursuant to risk models premised on asset allocations created by unaffiliated third-party advisors. When establishing Advisory Select accounts, Martin allegedly met with customers in order to select one of the available risk models. The AWC asserts that to remain within the program, "Martin was required to keep a customer's assets in balance with the selected model portfolio." By 2014, Martin purportedly had over 300 Advisory Select clients, who were largely enrolled between 2010 and 2011.
A Matter of (In)Discretion
NASD Conduct Rule 2510: Discretionary Accounts imposes a relatively simple compliance regime requiring prior written authorization by the customer coupled with the firm's written acceptance. After a duly authorized and approved discretionary trade has been placed, a member firm must undertake prompt written approval of each discretionary order; and, further, must frequently undertake a suitability review of discretionary accounts. That's about as straightforward a regulatory proposition as you could imagine.
Sometimes the line between discretion and authorization gets blurred. Within the context of a telephone call or email exchange between a customer and stockbroker, things get stated that sort of seem like the customer gave the okay to place an order. It's that "sort of" aspect that can alter what looks like a bona fide order into one that involves the inappropriate exercise by the stockbroker of discretion, albeit limited and perhaps disputed. When such a sort-of order is accepted, you may find that the stockbroker was reading an email while speaking to the customer about the trade and also waving to a sales assistant to tell another customer to hold on for one more second. That's the swirl of confusion that exists at most branch offices throughout most business days. That's the setting in which lots of industry violations occur.
In an attempt to address circumstances where "sort of" orders often pop up, NASD Rule 2510(d)(1) carves out an exception for Time And Price ("T&P") discretion. 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 it's left to the stockbroker's discretion to decide the time and price at which the order is entered. T&P is an effective order ONLY "until the end of the business day on which the customer granted such discretion . . ." Under previous iterations of the Suitability Rule there wasn't an intra-day limit on T&P which explains whyindustry veterans often mistakenly believe that they can still use T&P the next day(s) rather than within the same trade date. Speaking of the old days, why is this 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?
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 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.
The AWC asserts that, in fact, Martin spoke periodically with his Advisory Select clients regarding their accounts, and that such discussions included conversations about "what securities would have to be bought and sold to keep the account in balance with the risk model selected." In light of such communications, Martin had obtained the clients' agreement to "target prices for sales and purchases." Unfortunately, as the AWC alleges:
Martin was under the misunderstanding that he could exercise discretion in an Advisory Select account after discussing a trade with a customer and that discretion was permitted within the context of the Advisory Select accounts as to when the trade would be executed. However, the Advisory Select portfolio agreements stated that the accounts were non-discretionary, and that client consent was required for all securities transactions. Notifications sent to Martin regarding accounts that were "out of drift" with the selected risk models instructed Martin to assist clients with reallocating investments to meet the applicable risk model, and not to reallocate the investments without contacting the customers.
Notably, the AWC concedes that:
While Martin executed trades in accordance with his discussions with customers, the transactions were not always effected on the same day the discussions occurred. Martin did not have written authorization from these customers to exercise discretion in their accounts and his firm did not approve these accounts for discretionary trading.
The AWC asserts that Martin was permitted to resign from Princor effective December 31, 2014.
FINRA deemed Martin's exercise of discretion to constitute violations of NASD Rules 2510(b), 2110, and FINRA Rule 2010. In accordance with the terms of the AWC, FINRA imposed upon Martin a $10,000 fine and a one-month suspension from association with any FINRA member firm in any capacity.
Bill Singer's Comment
I'm struggling with FINRA's sanctions. It seems very clear to me that we do not have a respondent who intentionally violated industry rules and regulations. Moreover, it seems clear that Martin did not engage in any fraud upon his customers or firm and did not profit to a greater degree as a result of his purported non-compliance. Pointedly, we have a registered rep who not only communicated with his customers before entering the disputed trades but even the AWC allows that he "executed trades in accordance with his discussions with customers." When all is said and done, Martin violated both FINRA's rules and his firm's policies. I'm not sugar coating that or denying the result. Just because a registered rep misunderstands a given rule or regulation does not alter the fact that a violation occurred.
Given the unique facts set forth in FINRA's settlement with Martin, the imposition of a $10,000 fine and a one-month suspension accomplishes little more than contempt for the otherwise legitimate enforcement of the Discretionary Rule. Frankly, I see no purpose in suspending Martin. Similarly, a $10,000 fine for the circumstances presented is excessive. That beings said, an AWC is a "voluntary" settlement and if Martin was satisfied with the sanctions he agreed to, then it's not my place to criticize his decision. There may be facts that were not presented in the AWC that could alter my views and they may have been left out pursuant to the give-and-take of settlement. Similarly, the AWC discloses that Martin was represented by legal counsel. Nonetheless, since others with similar fact patterns may be referred to this AWC by FINRA Staff during settlement discussions, I find it important to note my opinion and differing views.
Permitted to Resign
Online FINRA BrokerCheck records as of August 30, 2017, disclose that on December 31, 2014, Princor permitted Martin to resign based upon allegations that:
PRINCOR REQUIRES THIS [sic] ITS INVESTMENT ADVISOR REPSENTATIVES [sic] OBTAIN CLIENT APPROVAL IN ADVANCE OF EACH PURCHASE AND SALES TRANSACTIONS. PRINCOR DETERMINED THAT MR. MARTIN HAD PLACES [sic] TRADES FOR ADVISORY ACCOUNTS BASED ON INVESTMENT PARAMETERS HE HAD DISCUSSED WITH CLIENTS, BUT WITHOUT OBTAINING SPECIFIC CLIENT APPROVAL IN ADVANCE OF SPECIFIC TRANSACTIONS. MR. MARTIN'S PREFERRED BUSINESS MODEL IS BETTER SUITED TO A FIRM THAT ALLOWS DISRENTONARY [sic] TRADING.
Additionally, Princor disclosed on BrokerCheck that:
TO DATE, PRINCOR HAS RECEIVED NO CUSTOMER COMPLIANTS [sic] FROM CLIENTS OF MR. MARTIN'S RELATED TO THIS MATTER.
In response to Princor's BrokerCheck disclosures, Martin submitted this "Broker Statement":
RR BEGAN CONDUCTING BUSINESS IN THE ABOVE MANNER IN 2008. HE CONTINUED CONDUCTING BUSINESS IN THIS MANNER UNTIL JULY 2014. B/D UNDERTOOK EXAMINATIONS OF RR OFFICE AT LEAST TWICE A YEAR DURING THIS PERIOD OF TIME. B/D DID NOT INDICATE THAT RR WAS IMPROPERLY TAKING DISCRETIONARY TRADING AUTHORITY IN HIS CLIENTS' ACCOUNTS. B/D FIRST MADE THIS CLAIM IN JULY 2014, DURING A COMPLIANCE MEETING. FOR THE FIRST TIME, B/D ADVISED RR THAT HE MUST HAVE A CONVERSATION WITH CLIENTS ON THE DAY OF A TRADE DISCUSSING THE SPECIFICS. B/D FURTHER ADVISED TRADING HAD TO OCCUR WITHIN 24 HOURS OF THAT. SINCE THIS TIME RR HAS FOLLOWED THIS REQUEST. B/D AND RR MUTUALLY AGREED TO TERMINATE RELATIONSHIP
Settled Customer Disputes
Under the BrokerCheck heading of "Customer Dispute - Settled," Princor reported its receipt on:
July 17, 2008 of a customer complaint seeking $8,227.14 for "Annuity(ies) - Variable" and based upon allegations that:
CLIENT ALLEDGED [sic] I PROMISED A 5% CASH BONUS ON TOP OF RETURN IN CONTRACTS. THIS ALLEGED PROMISE WAS AT THE TIME OF THE APPLICATION.
Princor reported that it settled on August 18, 2007 for $7,081.56. In response to this posted customer complaint, Martin's "Broker Statement" asserted that:
SETTLEMENT REFERRED TO E&O CARRIER.
August 4, 2006, of a customer complaint seeking unspecified "LIFE INSURANCE" damages, which were determined to be greater than $5,000.Princor reported the complaint was based upon allegations that:
CLIENT ALLEGES THAT FUNDS WERE NOT ALLOCATED AS THEY INTENDED IN FACT WRONG BOX WAS CHECKED ON SERVICE APP, COMPLETED BY ADMINISTRATION DEPT OF EXECUTIVE BENEFIT SERVICES (EBS). AS A RESULT, THE MONEY WAS NOT DEPOSITED INTO THE ACCOUNTS CLIENT INTENDED. THEY WERE PUT INTO MONEY MARKET AND CLIENT DID NOT READ QUARTERLY STATEMENTS. THIS IS a 457 PLAN, ADMINISTERED BY EBS. DAMAGES UNSPECIFIED.
Princor reported that it settled on September 21, 2006, for $91,587.98, of which Martin did not contribute.