March 20, 2019
As this historic bull market rumbles on, many investors have dabbled with a number of so-called non-traditional exchange traded products. Sometimes the investment yields a profit; other times, not so much. Wall Street isn't an insurance policy, however, it's more like a casino: Place your bets. Hands off the table. Dice comin' out!! In a recent FINRA regulatory settlement, we come across one stockbroker who solicited about 1,910 purchases and 1,663 sales of so-called non-traditional exchange traded products from only seven customers, resulting in $279 million in purchases and $275 million in sales, and generating about $890,000 in commissions. In the end, the brokerage firm, its Chief Compliance Officer, and its Chief Executive Officer wind up settling various FINRA regulatory charges.
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, Corinthian Partners, LLC, Richard Calabrese, and Mitchell Manoff submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. In the Matter of Corinthian Partners, LLC, Richard Calabrese, and Mitchell Manoff, Respondents (FINRA AWC 2016047621801, March 18, 2019)
The AWC asserts that Corinthian, which employs about 27 registered representatives, has been a FINRA member firm since 1996, when it was founded by Respondents Calabrese and Manoff, who are its majority owners. Calabrese was first registered in 1986, has been Corinthian's Chief Compliance Officer since 2004, and the firm's Chairman and President since its founding. Manoff was first registered in 1975, has been Corinthian's Chief Executive Officer since its founding.
FINRA's 2009 ETF Reminder
The AWC asserts that during the relevant period of January 2013 to May 2016, only one Corinthian registered representative (referred to in the AWC as "VV") solicited customer purchases and sales of so-called Non-Traditional Exchange Traded Products ("NT-ETPs"). In recent years, Wall Street's regulators have admonished the industry to be more attentive to sales practices attendant to such NT-ETPs as leveraged and inverse Exchange Traded Funds ("ETFs").
In the Executive Summary of the FINRA NTM 09-31:
Exchange-traded funds (ETFs) that offer leverage or that are designed to perform inversely to the index or benchmark they track -- or both -- are growing in number and popularity. While such products may be useful in some sophisticated trading strategies, they are highly complex financial instruments that are typically designed to achieve their stated objectives on a daily basis. Due to the effects of compounding, their performance over longer periods of time can differ significantly from their stated daily objective. Therefore, inverse and leveraged ETFs that are reset daily typically are unsuitable for retail investors who plan to hold them for longer than one trading session, particularly in volatile markets.
This Notice reminds firms of their sales practice obligations in connection with leveraged and inverse ETFs. In particular, recommendations to customers must be suitable and based on a full understanding of the terms and features of the product recommended; sales materials related to leveraged and inverse ETFs must be fair and accurate; and firms must have adequate supervisory procedures in place to ensure that these obligations are met. . .
VV's 7 Customers' 1,910 Purchases and 1,663 Sales
The AWC alleges that starting in January 2013, some three and a half years after the publication of FINRA NTM 09-31, VV allegedly started soliciting the purchase and sales of NT-ETPs. As asserted in part in the AWC:
[T]he solicited transactions
included approximately 1,910 purchases and 1,663 sales of NT-ETPs. VV
typically purchased and sold the same NT-ETPs for seven customers at or around
the same time. The trading involved 60 different leveraged or inverse NT-ETPs,
with approximately $279 million in purchases and $275 million in sales, and
generated approximately $890,000 in commissions, which represented a
significant portion of the Firm's revenue.
Not-So Reasonable WSP
Given FINRA's 2009 NTM warning about its member firm's "sales practice obligations in connection with leveraged and inverse ETFs," Corinthian was clearly on notice that its Written Supervisory Procedures ("WSP") should have laid out with some particularity, the firm's supervisory approach over NT-ETP transactions. FINRA found that Corinthian, Calaberese, and Manoff had violated NASD Rule 3010, and FINRA Rule 3110 and 2010 by failing to establish, maintain, and enforce a reasonably designed supervisory system and WSP regarding the NT-ETPs:
[C]orinthian failed to have reasonable policies and procedures that provided
meaningful customer eligibility standards for NT-ETP recommendations. The
WSPs merely stated that recommendations be made only to customers "whose
new account documentation will support" a determination that they are suitable to
trade NT-ETPs. Moreover, the Firm failed to ensure that new account
documentation was complete and accurate. Consequently, certain customer new
account forms failed to provide risk tolerance information for suitability
determinations. For example, an account for a theological seminary had a new
account form that listed its investment objectives as "capital preservation growth
and income" with no information about risk tolerance. VV nevertheless
recommended that the seminary's account purchase millions of dollars of
Corinthian also lacked a reasonably designed supervisory system and written
policies and procedures to ensure that trading in NT-ETPs was suitable for its
retail customers, including monitoring the risks particular to NT-ETPs, such as
the risk posed by long-term holding of a product that resets daily. For example, the Firm did not have any exception reports regarding NT-ETPs, such as reports
monitoring for potentially unsuitable holding periods.
The AWC also alleged that the Respondents all failed to reasonably supervise VV's NT-ETP recommendations in violation of NASD Rule 3010, and FINRA Rule 3110 and 2010. Focusing on the conduct of Calabrese and Manoff, who FINRA asserts had jointly supervised VV, the AWC alleged that the Chief Compliance Officer and the CEO, respectively, had failed to:
Beyond merely questioning whether CCO/Chair/President Calabrese and CEO Manoff sought to ensure that VV had followed the appropriate pre-investment protocol, the AWC also questioned whether Calabrese and Manoff themselves had the capacity to understand the nature of the NT-ETPs at issue -- which goes to the very heart and soul of being able to supervise such transactions. Pointedly, the AWC alleged that Calabrese and Manoff had failed to:
- ensure that
customer files contained letters or emails memorializing that VV had, in fact, discussed the
risks and volatility of NT-ETPs with the customers before they invested;and
- take steps to determine whether
VV ever had such pre-investment discussions with customers.
- take reasonable steps to ensure that they
adequately understood the unique features and risks associated with NT-ETPs that
VV recommended, such as the volatility risks associated with underlying
derivative investments and compounding risks due to the daily reset feature; and
- take reasonable steps to adequately understand
the basis for VV's NT-ETP recommendations, and they lacked reasonable
grounds to believe VV's recommendations were suitable for the customers.
FINRA appears to have concluded that Manoff's and Calabrese's approach to supervision over the firm's NT-ETP transactions largely consisted of delegating such duties, by default, to VV when it came to his clients' activities:
Additionally, neither Manoff nor Calabrese implemented a process for reviewing
NT-ETP transactions that reasonably addressed the unique risks of NT-ETPs,
including risks associated with leverage, daily rebalancing of the product's
components, and compounding of each day's return over time. Instead, they
relied on VV's judgment and failed to reasonably monitor holding periods or
question VV's recommendations despite red flags that warranted follow-up.
Red Flags Flappin'
Finally, in an attempt to tie up the various supervisory short-comings of the Respondents, the AWC alleges that Calabrese and Manoff had failed to identify and reasonably respond to the following
- NT-ETPs Held for Extended Periods. Notwithstanding disclosures in
prospectuses and related SEC filings, and FINRA's regulatory notice, about
the risks of holding NT-ETPs for longer than one trading session, all NT-ETP
positions were held multiple days. The average holding period for the
NT-ETPs was 24 days, with the longest holding period 211 days.
- Unusually Large Orders for Shares of Particular NT-ETPs. Between February
2014 and January 2016, the theological seminary's account, on 28 occasions,
purchased NT-ETPs with principal va lues over $1 million (including one over
$2 million). Additionally, between January and April 2014, a joint account of
two individuals, on four occasions purchased NT-ETPs with principal
amounts over $300,000. According to Corinthian's WSPs, the sizes of these
transactions were red flags of "unusually large orders" that required supervisory follow-up, including review for "heavy concentration" and
personal contact with the customers to verify that the transactions were
appropriate. However, Calabrese and Manoff failed to take these supervisory
In accordance with the terms of the AWC, FINRA imposed the following santions:
Corinthian: Censure, $30,000 fine, and an undertaking to certify within 90 days the compliant nature of the firm's NT-ETP policies, systems, and procedures.
Calabrese: $10,000 fine and 30-business-days Principal suspension
Manoff: $10,000 fine and 30-business-days Principal suspension
The AWC discloses that in calculating Corinthian's fine that FINRA opted to impose a "lower fine in this case against Corinthian after it considered, among other things, the Firm's
revenues and financial resources." Further, the AWC discloses that Calabrese's and Manoff's Principal suspensions will run consecutively, with Calabrese's commencing first and Manoff's suspension to begin two business days following the conclusion of Calabrese's.
Bill Singer's Comment
Corinthian seems to have a crappy WSP and the firm's supervision of VV's NT-ETP biz comes off as lackluster, at best, and conflicted, at worst. As the AWC asserts, VV's NT-ETP transactions:
generated approximately $890,000 in commissions, which represented a significant portion of the Firm's revenue.
The AWC makes a number of fair and important points about not delegating critical aspects of supervision and compliance to a registered rep responsible for generating significant portions of a member firm's revenue. FINRA makes a strong case that Corinthian's oversight of VV's NT-ETP business was inadequate.
Having given FINRA it's due, now let me take FINRA to task.
When they drafted the modern-day rules for baseball, they decided that if a batter hits the ball out of the ballpark in fair territory that such a hit would be called a home-run. In making that rule, the drafters could have gone a number of ways. They could have said that the home-run consisted of a single, double, triple, and four-bag hit. They could have required the batter to run to first, then back to home, then to second, then back to home, then to third, then back to home, and finally, provide for a run around all three bases with a finish at home plate. In coming up with the rules for a home-run, I like the current iteration of the rule. It's clean. It's simple.
Unlike baseballs' home-run rule, a FINRA AWC often treats a regulatory home-run as a combination of a single, double, triple, and the final step on home plate. In the Corinthina/Calabrese/Manoff AWC, the essence of the charges is that a single registered rep was allowed to engage in a prodigious amount of NT-ETP transactions without adequate supervision. I don't argue that. In fact, sure, the WSP was likely deficient. And yeah, okay, there wasn't an adequate supervisory plan. Oh, okay, there should have been more paperwork memorializing oversight. On top of that, you're right, exception reports should have been generated and followed-up on. Like I said, FINRA makes a strong case and I'm not questioning the regulator's findings or its settlement. On the other hand, geez, couldn't FINRA have just trotted once around the bases and be done with it?
Take the whole WSP thing. It's stated, and stated again, and re-stated, and over-stated. The AWC makes a big deal about how:
[C]orinthian lacked a reasonably-designed supervisory system and WSPs to ensure the suitability of NT-ETP recommendations to its customers. Corinthian failed to have reasonable policies and procedures that provided meaningful customer eligibility standards for NT-ETP recommendations. . .
So, lemme see here, FINRA issued NTM 09-31 in 2009.
The AWC pegs the relevant period of VV's cited NT-ETP transactions as starting in January 2013 and running to May 2016.
The AWC was issued in March 2019.
Now that we have our timeline in place, let me ask a very simple question: When did FINRA staff discover that member firm Corinthian's WSP inadequately addressed NT-ETP?
The AWC states that Corinthian has been a FINRA member firm since 1996. Per NTM 09-31, we know that the self-regulatory organization was troubled by inverse and leveraged ETFs as early as 2009. Since Corinthian's WSP was deemed non-compliant with FINRA's rule pursuant to the 2019 AWC, I'm inferring from the AWC that Corinthian's WSP was NT-ETP non-compliant in 2009, 2010, 2011, 2012, 2013, 2014, 2015, 2016, 2017, and 2018. You notice how I cleverly tried to impress upon FINRA the annoying nature of over-charging by listing each and every year rather than simply saying from 2009 to 2018? No wonder I earn the big bucks. If Corinthian's WSP was deficient during FINRA staff examinations of the member firm in 2009 to 2018, why didn't FINRA staff bring such deficiencies to Corinthian's attention during each and every one of those years? After all, if FINRA examination staff missed the supervisory short-comings, why is it okay to sanction the member firm and the two executives for also missing the inadequate procedures? I don't like gotcha regulation.
Then there's the issue as to why both Corinthian's CCO Calabrese and its CEO Manoff got slapped with suspensions. If you want to sanction the firm for lousy WSP, have at it. If you want to sanction the firm's CCO for a lousy WSP and non-compliant supervision, have at it. When you're not only taking a whack at the firm and the CCO but also sending the CEO to the penalty box, well then you have to make out a much, much stronger case than is presented in this AWC. For one thing, FINRA has to explain its hypocrisy in suspending both Calabrese and Manoff for what appears to be the same core issue of VV's NT-ETP misconduct but FINRA never quite seems to find its way to suspending the CCO and CEO of any of its Large Member firms. You know, those large firms with the banks and broker-dealers and the bogus account openings and the retaliatory terminations and the discriminatory workplace practices and the anti-veteran foreclosures, and, well, read a headline once in a while, okay?
I'm not going to criticize Calabrese and Manoff for agreeing to a double-suspension because I don't know what I don't know and there may have been far more to FINRA's case than made it into the AWC. As I often say about AWCs, it's not my place to second-guess any respondent because I have no idea about whatever got left out of the settlement's fact pattern or the degree of complicity that may not have been trumpeted by FINRA. Moreover, an AWC is a settlement, and if the respondents opted to sign off on the deal with FINRA, that's good enough for me. That being said, I sure as hell would have put up one helluva fight before agreeing to that double suspension. For all I know, the Respondents did.
By the way, I found this on FINRA's online Arbitration database:
In the Matter of the Arbitration Between New Brunswick Theological Seminary, Claimant, v. Pamela Calabrese
Corinthian Capital Corporation
Corinthian Holdings, L.L.C.
Corinthian Partners Asset Management L.L.C.
Corinthian Partners, L.L.C.
Victoria Anne Vandyke, Respondents, (FINRA Arbitration Decision 17-01878 / January 12, 2018)
In a FINRA Arbitration Statement of Claim filed in June 2017, public customer Claimant New Brunswick Theological Seminary asserted suitability; breach of
fiduciary duty; negligent supervision; violation of FINRA Rules 2090 and 2111; and
control person liability. in relation to "various securities including ETFs" Claimant sought $3,229,097 in compensatory damages, restitution, fees, and costs. Claimant dismissed Respondents
P. Calabrese, R. Calabrese, Corinthian Capital, Corinthian Holdings, Corinthian
Partners Asset Management, Corinthian Partners, and Manoff without prejudice. The sole FINRA Arbitrator found Respondent Vandyke liable and ordered her to pay to Claimant $3,229,097 in compensatory damages plus interest. It may well be that "Victoria Anne Vandyke" is the "VV" cited in FINRA AWC. Also READ: In the Matter of the Arbitration Between the New Brunswick Theological Seminary, Petitioner, v. Victoria Anne Van Dyke, Respondent (Order to Confirm Arbitration Award, New York State Supreme Court, August 13, 2018)
Online FINRA BrokerCheck records disclose that on August 18, 2017, Vandyke was barred by FINRA for failure to repond to FINRA request for information.