May 31, 2018
BrokeAndBroker.com Blog readers know that our publisher Bill Singer Esq. is no fan of self-regulation or of Wall Street's leading self-regulatory-organization, the Financial Industry Regulatory Authority. Bill's critiques, criticisms, concerns, and reservations aside, today is a rare day for the pages of the BrokeAndBroker.com Blog because Bill does not come to bury FINRA but to praise it! A recent FINRA AWC regulatory settlement shows how self-regulation should work and also shows how FINRA is capable of rising to the occasion. At issue in the settlement is a member firm's handling of sales of unit investment trusts and an electronic messaging system. Not the most exciting of regulatory and compliance issues but certainly the day-to-day stuff of Wall Street regulation and compliance. FINRA published a settlement document that uses plain English to explain the background and underlying events. Thereafter, FINRA builds a compelling case and justifies its sanctions, which are measured and appropriate. Maybe FINRA CEO Robert Cook is slowly turning the battleship of self-regulation? Alas . . . only time will tell. Be that as it may, Bill urges all serious investors and industry professionals to read today's analysis of FINRA's settlement.
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, Capitol Securities Management, Inc., submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. In the Matter of Capitol Securities Management, Inc., Respondent (AWC 2017052215401, May 25, 2018).
The AWC asserts that Capitol has been a FINRA member firm since 1985 and has about 54 branch offices and 188 registered personnel.Under the heading "Relevant Disciplinary History" the AWC states that:
See Capitol Securities Management, Inc., No. 2011025548801 (AWC Oct. 2015)
In 2015, the Firm entered into an AWC where it consented to the entry of findings that it failed to supervise the sale of reverse convertible notes.
In introducing the underlying fact pattern, the AWC first presents an excellent profile of the products and general compliance policies at issue:
A UIT is a SEC-registered investment company that offers shares or "units" in a portfolio of securities in a public offering. Generally, a UIT's portfolio is not actively traded and follows a "buy-and-hold" strategy. UITs terminate on a specified maturity date, often after 15 or 24 months, at which point the underlying securities are sold and the proceeds are paid to investors.
UITs impose a variety of sales charges. For example, during the Relevant Period, a typical 24-month UIT imposed: (1) an initial sales charge, which was 1% of the purchase price; and (2) a deferred sales charge, which was up to 2.5% of the offering price. Also, most UIT sponsors charged a creation and development fee ("C&D fee"), which was generally 0.5% of the offering price.2 The initial sales charge generally was charged at the time of purchase; the deferred sales charge and C&D fee typically were charged during months three through six of the UIT's duration.
Because of the long-term nature of UITs, their structure, and upfront costs, short-term trading of UITs may be improper and raises suitability concerns . . .
Footnote 2: In addition to these charges, most UITs charge annual operating expenses that are paid to the sponsor out of the assets of the UIT.
The AWC alleges that during the relevant period from March 15, 2011 to March 15, 2017, Capitol had no procedures to specifically address the suitability of short-term trading in UITs. Although FINRA conceded that in April 2013, Capitol had instituted a policy requiring the submission of a UIT switch form to detect the premature sales of UITs, the self-regulator found that the policy was not enforced. Moreover, FINRA found that Capitol did not generate during the relevant period any surveillance or exception reports designed to detect unsuitable UIT short-term trading
Also, the AWC alleges that during the relevant period:
at least three Capital [sic] representatives recommended and effected short-term trades of UITs in their customers' accounts. The majority of the UITs recommended by these representatives had two-year maturity dates and carried sales charges ranging from 1.95% to 3.95%. Nevertheless, these representatives repeatedly recommended that their customers sell their UIT positions approximately one year after purchase. Indeed, the average holding period for the UITs acquired in these customer accounts was less than 325 days. In addition, on several occasions, these representatives recommended that their customers use the proceeds from the short-term sale of a UIT to purchase another UIT with identical investment objectives. As a result of this trading, customers paid excess sales charges in the amount of approximately $44,740.33.
The AWC alleges that during the relevant period, Capitol utilized at its headquarters the "Message Pal" instant messaging system for internal communications. Some 40 associated persons used the Message Pal system for business-related communications with co-workers, among which were the Chief Compliance Officer, four registered principals, and other senior executives. The AWC alleges that during the relevant periood, Capitol failed to retain any Message Pal messages.
FINRA deemed that Capitol failed to
- establish, maintain and enforce a supervisory system and written supervisory procedures reasonably designed to detect and prevent unsuitable short-term trading in Unit Investment Trusts ("UITs") in violation of NASD Rule 3010 and FINRA Rules 3110 and 2010; and
- retain instant messages from 41 employees, including the Firm's senior management and compliance staff in violation of 17 of the Securities and Exchange Act of 1934 and Rule 17a-4 thereunder, NASD Rule 3110 and FINRA Rules 4511 and 2010.
In accordance with the terms of the AWC, FINRA imposed upon Capitol a Censure, $100,000 fine, and $44,740.33 in restitution to be paid to customers.
Bill Singer's Comment
I got no complaints about nuthin'. Overall an excellent effort. Keep up the good work.