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There are times when the Financial Industry Regulatory Authority's regulation of its Wall Street member firms looks a lot like someone reading toe-tags in the morgue. As an exercise in explaining to us how someone died, that's fine. As an exercise in preventing their death, well, you know, it's a tad too little and too late. There are times when we need better written laws, rules, and regulations. There are times when we need more intelligent and savvy folks walkin' the beat. There are times when we need more adept prosecutors. There are times when we need more capable judges. The cohesion of the social contract depends upon the right amount of glue inserted at many points. As a recent FINRA regulatory settlement shows, there are times when self-regulation comes apart at the seams -- even if that failing takes 30 months to happen. The question is whether FINRA should be more proactive. The cynical question is whether FINRA sees its role as a hypocritical toll-taker or as an active partner in self-regulation.
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, Essex Securities, LLC submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. In the Matter of Essex Securities, LLC Respondent (AWC 2016047573901, February 13, 2018).
The AWC asserts that since 1999, Essex Securities, LLC has been a FINRA member firm conducting a general securities business from 25 branches with about 34 registered persons. In disclosing Essex'z prior relevant disciplinary history, the AWC asserts that:
In October 2014, Essex entered into an AWC in which it agreed to a censure, a fine of $20,000, restitution of $6,009.70, and an undertaking to revise the Firm's procedures and certify its compliance with applicable rules for violating NASD Rule 2310, IM-2310-2 and FINRA Rule 2010 by engaging in a pattern of unsuitable mutual fund switching in the accounts of seven customers. The Firm also violated NASD Rule 3010 and FINRA Rule 2010 by failing to establish and maintain a supervisory system, including written procedures, reasonably designed to prevent unsuitable mutual fund switching.
2 1/2 Years of Regulatory Violations
The AWC asserts that during the relevant period from at least June 30, 2014 through December 31, 2016, Essex failed to:
maintain a complete and accurate purchase and sales blotter; pointedly, the firm did not include at least 11 mutual fund transactions on its blotter, in violation of Section 17(a) of the Exchange Act, Exchange Act Rule 17a-3 and FINRA Rules 4511 and 2010;
ensure that all associated persons disclosed their outside securities accounts, or that the firm received duplicate statements for those accounts. The firm could not evidence that it had reviewed, approved or supervised associated persons' trading in such outside accounts.Accordingly, the AWC alleges that Essex failed to evaluate its registered representatives' outside securities accounts to ensure compliance with securities laws and rules, in violation of NASD Rule 3010 (for the period before December 1, 2014), FINRA Rule 3110 (for the period from December 1, 2014) and FINRA Rule 2010; and
inspect nine registered branch offices, register 16 locations, and inspect these 16 non-registered branch offices in violation of FINRA By-Laws Article IV, Section 8(a), NASD Rule 3010 (for the period before December 1, 2014), FINRA Rule 3110 (for the period from December 1, 2014) and FINRA Rule 2010.
Also, the AWC asserts that during the relevant period, Essex's written supervisory procedures failed to designate a principal to supervise registered representatives' outside business activities or specify how outside business activities were to be disclosed, reviewed and approved, as well as what related records should be maintained. Essex could not evidence review or approval of outside business activities that were disclosed in violation of NASD Rule 3010 (for the period before December 1, 2014), FINRA Rule 3110 (for the period from December 1, 2014) and FINRA Rules 3270 and 2010.),
In accordance with the terms of the AWC, FINRA imposed upon Essex a Censure; $25,00 fine (after purportedly considering the firm's revenues and financials); and an undertaking whereby:
Essex shall undertake to review its supervisory systems and written supervisory procedures relating to the violations addressed in this AWC for compliance with FINRA rules and the federal securities laws and regulations. Within 120 calendar days of the issuance of this AWC, or such additional period agreed to by a FINRA staff member in writing, an officer of Essex will certify to FINRA in writing that it has completed its review and that it has established systems and procedures reasonably designed to achieve compliance with those laws, regulations, and rules.
Bill Singer's Comment
Note that the "relevant period" comprised June 30, 2014 through December 31, 2016: some 30 months spanning three calendar years and running about 2 1/2 years.
So . . . let's step back a bit and get some perspective. For starters, I'm gonna concede that everything FINRA alleges in this AWC is correct -- and that's underscored by the signature of Essex on the settlement agreement. Frankly, there are a number of troubling violations by Respondent and the need to enhance the firm's supervisory system is clearly a priority. As such, the AWC makes a fair and strong case that this member firm engaged in the cited violations. That being said, let me set out in bullet-point fashion the gist of FINRA's case:
For over 2 1/2 years;
a FINRA member firm that was approved for membership in 1999 and operates from some 25 branch offices;
allegedly failed to
maintain a complete and accurate purchase and sales blotter;
ensure the proper disclosure and supervision of its associated persons' outside accounts;
comply with branch inspection and registration rules; and
have written supervisory procedures that designated a supervisory principal for outside business activities.
Now, let me turn the tables and ask a few pertinent questions about the state of self-regulation as practiced by FINRA:
For 30 months, no one from FINRA noticed that Essex didn't maintain a compliant Purchase and Sales Blotter?
For 30 months, no one from FINRA noticed that Essex failed to supervise the outside accounts of its associated person?
For 30 months, no one from FINRA noticed that Essex wasn't conducting the requisite branch inspections or registering locations?
For 30 months, no one from FINRA noticed that Essex lacked adequate WSPs?
I understand FINRA's decision to Censure and fine Essex and impose a comprehensive undertaking to preclude further violations. On the other hand, what steps is FINRA taking to ensure that its regulation of the industry doesn't wholly depend upon the dubious premise of self reporting? There's more than a bit of cynicism going around here when a self-regulatory-organization can't spot basic compliance and regulatory failures during 2 1/2 years. Essex is clearly in the wrong. On the other hand, FINRA doesn't come off looking all that diligent.