A recent FINRA regulatory settlement seems to have gotten it right. A member firm had the capacity to review correspondence but came up short. In the end, the self-regulatory organization imposed a fair sanction. What veteran lawyer Bill Singer sees in this case, however, is an important opportunity to highlight the hidden costs of compliance.
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, Eight Pines Securities LLC submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. In the Matter of Eight Pines Securities LLC, Respondent (AWC #2014039129001, May 29, 2015).
FINRA member firm Eight Pines Securities LLC has been registered since May 2012 and is a limited-purpose broker-dealer approved only for the private placement of securities. The firm employs only nine registered individuals in four states. The AWC asserts that the firm has no prior formal disciplinary history.
Review of Incoming / Outgoing Correspondence
During the times relevant for this AWC, NASD Conduct Rule 3010: Supervision was in effect, and, in pertinent part, this section:
(d) Review of Transactions and Correspondence
. . .
(2) Review of Correspondence
Each member shall develop written procedures that are appropriate to its business, size, structure, and customers for the review of incoming and outgoing written (i.e., non-electronic) and electronic correspondence with the public relating to its investment banking or securities business, including procedures to review incoming, written correspondence directed to registered representatives and related to the member's investment banking or securities business to properly identify and handle customer complaints and to ensure that customer funds and securities are handled in accordance with firm procedures. Where such procedures for the review of correspondence do not require review of all correspondence prior to use or distribution, they must include provision for the education and training of associated persons as to the firm's procedures governing correspondence; documentation of such education and training; and surveillance and follow-up to ensure that such procedures are implemented and adhered to.
СМЕРШ???? No, SMARSH
Eight Pines used Smarsh, which describes itself on its website as:
With over 200,000 customers, Smarsh is the leading provider of archiving & compliance solution for companies in regulated and litigious industries . . .
During November 2012 through November 2013, Eight Pines' written procedures mandated a review of:
СМЕРШ: "Death to Spies" versus Smarsh "We Archive Everything"
The AWC asserts that Eight Pines' Smarsh system retained all of the firm's incoming and outgoing emails (during the relevant time this amounted to about 157,000 emails) and provided an interface for review of the archived content. The AWC alleges that notwithstanding the capability to review retained emails, Eight Pines did not and, accordingly, the firm failed to enforce its written supervisory procedure for the review of electronic correspondence with the public relating to its securities business in violation of NASD Conduct Rule 3010(d)(2).
From FINRA With Love
In accordance with the terms of the AWC, FINRA imposed upon Eight Pines a Censure and $7,500 fine.
Bill Singer's Comment
An interesting aspect of this settlement is the disclosure that a small FINRA member firm (nine registered reps) still accumulated about 157, 000 emails during a one-year span -- that's over 13,000 emails a month or about 430 per day for a 365-day year or 628 per day if you figure a 250-business-day year. Assuming it took one person about 30 seconds to review each email, that would require 30 seconds X 628 or 314 minutes per day -- that's about 5 1/4 hours a day for one person to do nothing but review a given day's incoming and outgoing correspondence.
Don't read into the above paragraph and come away with the belief that I am against regulation or compliance, or that I am criticizing any aspect of this AWC. You would be wrong, very wrong, on all counts!
I am pointedly NOT trying to make a point against the need for a daily review of correspondence. What I am trying to note, however, is that for a small firm with only nine registered reps, you would likely need to hire someone to do nothing but a review of incoming/outgoing correspondence for nearly an entire day (if you factor in a one-hour meal break). Note that the ONLY thing this employee would be doing is reading incoming and outgoing correspondence.
Let me reiterate for those of you who too often read with blinders on: I am NOT arguing against the critical need to maintain an effective in-house compliance effort. Moreover, I am not even criticizing the need for the daily correspondence reviews noted in this FINRA AWC. Frankly, FINRA seems to have gotten it right here and the firm was deficient. To FINRA's credit, the self-regulatory organization appears to have taken the facts and circumstances into consideration and imposed a fairly modest sanction.
Whenever you impose a compliance or supervisory obligation on a firm, it comes with a cost. As those day-to-day costs mount, you are also increasing the barrier to entry into an industry and making it more difficult for smaller businesses to start-up, survive, and flourish. I have often lamented that much of regulation seems a clumsy attempt to socially engineer small member firms out of business and to transform FINRA into a trade group for firms employing hundreds and thousands of registered reps. That is why regulation must be fair and effective -- and that is why criticism of overly expansive regulation is necessary. As to where effective regulation ends and overly-expansive regulation begins is an age-old battle with ever-shifting trench-lines.