December 19, 2017
The laws of physics don't always apply to the regulation of Wall Street. Sometimes, things appear out of thin air and exist but then suddenly don't but then, just as mystifying, return to our realm of existence . . . or do they? The one constant throughout this metaphysical setting is that the Financial Industry Regulatory Authority stands ready to impose fines. In a recent regulatory settlement, FINRA seems to suggest that one of its small member firms had written supervisory procedures but, then again, didn't, or, perhaps put another way, maybe those procedures existed but were never fully compliant, but, on the other hand, those procedures were compliant when first approved but lapsed into non-compliance, but, oddly, it's not clear as to when things went from compliant to non-compliant but, hey, a $20,000 fine should stop you from asking more questions. Welcome to the world of hypocrisy.
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, RNR Securities, L.L.C. submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. In the Matter of RNR Securities, L.L.C., Respondent (AWC 2016047644601, December 15, 2017).
The AWC asserts that RNR has been a FINRA member firm since 1997, and is presently servicing retail customer through 32 registered representatives at seven branch offices. The AWC asserts that "RNR does not have any disciplinary history with the Securities and Exchange Commission., FINRA, or any other self-regulatory organization or state securities regulator."
The AWC asserts that between the relevant period of May 2015 and May 2016, RNR's written supervisory procedures ("WSP"):
[D]id not specify how RNR would conduct reviews of its securities related emails. RNR's written procedures stated. only that all emails received and sent by RNR would be reviewed by a compliance principal and that reviews would occur no less than annually. RNR's procedures failed to set forth a methodology to review emails, establish a percentage of emails to be reviewed, or set forth an escalation process for problematic emails.
Also during the Relevant Period, RNR failed to conduct any supervisory email reviews for eight of its registered representatives. And, for the email reviews that RNR did conduct during the Relevant Period, RNR failed to document those reviews.
SIDE BAR: FINRA Rule 3110: Supervision
(a) Supervisory System
Each member shall establish and maintain a system to supervise the activities of each associated person that is reasonably designed to achieve compliance with applicable securities laws and regulations, and with applicable FINRA rules. Final responsibility for proper supervision shall rest with the member. A member's supervisory system shall provide, at a minimum, for the following:
(1) The establishment and maintenance of written procedures as required by this Rule.
(2) The designation, where applicable, of an appropriately registered principal(s) with authority to carry out the supervisory responsibilities of the member for each type of business in which it engages for which registration as a broker-dealer is required.
(3) The registration and designation as a branch office or an office of supervisory jurisdiction (OSJ) of each location, including the main office, that meets the definitions contained in paragraph (f) of this Rule.
(4) The designation of one or more appropriately registered principals in each OSJ and one or more appropriately registered representatives or principals in each non-OSJ branch office with authority to carry out the supervisory responsibilities assigned to that office by the member.
(5) The assignment of each registered person to an appropriately registered representative(s) or principal(s) who shall be responsible for supervising that person's activities.
(6) The use of reasonable efforts to determine that all supervisory personnel are qualified, either by virtue of experience or training, to carry out their assigned responsibilities.
(7) The participation of each registered representative and registered principal, either individually or collectively, no less than annually, in an interview or meeting conducted by persons designated by the member at which compliance matters relevant to the activities of the representative(s) and principal(s) are discussed. Such interview or meeting may occur in conjunction with the discussion of other matters and may be conducted at a central or regional location or at the representative's(') or principal's(') place of business.
(b) Written Procedures
. . .
(4) Review of Correspondence and Internal Communications
The supervisory procedures required by this paragraph (b) shall include procedures for the review of incoming and outgoing written (including electronic) correspondence and internal communications relating to the member's investment banking or securities business. The supervisory procedures must be appropriate for the member's business, size, structure, and customers. The supervisory procedures must require the member's review of:
(A) incoming and outgoing written (including electronic) correspondence to properly identify and handle in accordance with firm procedures, customer complaints, instructions, funds and securities, and communications that are of a subject matter that require review under FINRA rules and federal securities laws.
(B) internal communications to properly identify those communications that are of a subject matter that require review under FINRA rules and federal securities laws.
Reviews of correspondence and internal communications must be conducted by a registered principal and must be evidenced in writing, either electronically or on paper.
FINRA deemed RNR's cited supervisory issues to constitute violation of FINRA Rules 3110 (a), (b)(4) and 2010. In accordance with the terms of the AWC, FINRA imposed upon RNR a Censure and $20,000 fine.
Bill Singer's Comment
Small FINRA Member Firm
Let's keep in perspective that RNR employs all of 32 reps at 7 branches, which works out to four or five folks per branch (unless you want to pretend that you can employ 4.57 human beings -- what the hell would you pay to .57ths of an employee?) As such, RNR is not a FINRA member firm employing thousands of folks in hundreds of branches. Does a FINRA member firm's small size give it license to violate the industry's rules and regulations? Of course not. I merely offer the firm's size for context.
The first issue that jumps out at me concerning the RNR AWC is that the alleged misconduct took place during one year between May 2015 through May 2016. As such, did FINRA conduct an annual review of this member in 2015 and 2016? If "yes," did FINRA bring the 2015 email procedures deficiencies to RNR's attention in 2016?
Take a look at FINRA's online "Statistics" page https://www.finra.org/newsroom/statistics, on which the self-regulatory-organization states:
FINRA is responsible for regulating every broker and brokerage firm doing business with the U.S. public. The selected statistics below will be updated on a regular basis.
Among the data displayed as of December 19, 2017, on FINRA's "Statistics" page is the following:
3,836 FINRA member firms at the end of 2016
"Conducted more than 4,100 exams in 2016"
"3,500+ employees dedicated to market integrity and investor protection"
Just doing the rough math, with less than 3,900 member firms and FINRA claiming to have done over 4,100 exams in 2016, that sort of sounds like FINRA examined each member firm during that year. Moreover, the self-regulatory-organization boasts about one regulatory employee for each member firm, and let's keep in mind that each and everyone of those employees is "dedicated to market integrity and investor protection." As such, I'm expecting that FINRA examines each member firm each year.
WSP Out of Thin Air?
What gets lost in these Rule 3110 cases is that WSPs are required to be in place before FINRA approves a firm for membership. Since 1997, little old FINRA member firm RNR had a set of WSP; and during each and every examination over the ensuing 20 years, FINRA's dedicated employees should have asked the firm to produce its WSP and those dedicated regulators should have carefully read through the firm's WSP to ensure that the market retains its integrity and investors are protected.
All of which raises an interesting question: At what point in time did RNR's WSP become non-compliant with FINRA Rule 3110? We know that the firm's WSP was purportedly non-compliant as to email as early as May 2015 but assuming that the firm didn't rewrite its procedures each year, exactly when did the email provisions become inadequate? Did FINRA's dedicated employees give RNR a head's up when its WSP first became deficient concerning emails?
Some tough questions
The RNR AWC asserts that as early as May 2015, RNR's WSPs did not specify how RNR would conduct reviews of its securities related emails -- had the firm's WSP properly specified the cited email reviews before? You know, "before" as in from 1997 to 2015? Wasn't the adequacy of RNR's WSP on the exam checklist that FINRA's dedicated examiners used when they visited the member firm during those prior years?
Since the AWC alleges that "RNR's procedures failed to set forth a methodology to review emails, establish a percentage of emails to be reviewed, or set forth an escalation process for problematic emails," for how many years prior to 2015 were these omissions extant but never detected by FINRA exam staff?
Is FINRA asking us to believe that RNR's WSP was compliant from 1997 through 2015 and that during that last year, the firm totally revised its WSP and, voila, the email provision was inadequate?