Honor System Fails In FINRA Email Settlement

June 25, 2015

If there is a hallmark of the Financial Industry Regulatory Authority's ("FINRA's") approach to Wall Street regulation, it is likely found in the self-regulatory organization's FINRA Rule 2010: Standards of Commercial Honor and Principles of Trade:

A member, in the conduct of its business, shall observe high standards of commercial honor and just and equitable principles of trade.

It's a lovely sentiment, no?  Wall Street's industry cop requires its members to observe high standards of commercial honor. Of course, in recent years -- okay, in recent decades -- that concept of "commercial honor" seems a somewhat elusive one for many of FINRA's largest member firms. I mean, you know, it's sort of been in the news. Maybe you saw some of the cases involving municipal bonds, mortgages, high frequency trading, LIBOR, Madoff, Stanford, Ponzi schemes, elder fraud, price fixing, bid rigging, and, well, go look it up. As such, I read with great interest a recent FINRA regulatory settlement in which the self regulator apparently demands that its member observe high standards of commercial honor but it doesn't much care for the implementation of the "honor system" when it comes to compliance and supervision.

Case In Point

For the purpose of proposing a settlement of rule violations alleged by FINRA, without admitting or denying the findings, prior to a regulatory hearing, and without an adjudication of any issue, PFA Security Asset Management, Inc.  submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. In the Matter of PFA Security Asset Management, Inc., Respondent (AWC  # 2014038912201, June 22, 2015).

Since 2000, PFA has been a FINRA member firm retailing mutual funds and variable annuities through six registered representatives. The AWC asserts that the firm had no prior disciplinary history with the Securities and Exchange Commission, any state securities regulator, or any self-regulatory organization.

Honor System

The AWC alleges that from January 27, 2010, through June 25, 2014, PFA's written supervisory procedures did not specify how electronic communications should be retained. According to FINRA's allegations, PFA relied upon an "honor system" pursuant to which registered representatives were to print business-related emails sent from and sent to clients. The printed emails were reviewed at PFA's Operations Committee meetings, and then scanned and electronically saved as PDF files.

According to the AWC, there were three main areas of shortcomings in PFA's email oversight:

  1. Although some business-related emails referenced attachments, not all attachments were retained.
  2. Although some emails referenced earlier emails, those prior communications were not always retained.
  3. Two registered representatives appeared to have used personal email accounts to communicate with customers, but not all of those emails were retained by PFA. FINRA deemed PFA's conduct to constitute violations of NASD Conduct Rule 3110(a) (for the conduct on or before December 4, 2011), FINRA Rule 4511 (for the conduct on or after December 5,2011), Rule 17a-4 of the Securities Exchange Act of 1934, NASD Conduct Rules 3010 (a) & (b), and FINRA Rule 2010,

Alas, other than advising its representatives of their responsibilities to print business-related emails and attachments, PFA apparently did nothing further to ensure that its honor system was being honored and that it was working successfully. The AWC alleges that PFA had no means to test or ensure that its representatives were, in fact, printing their emails and attachments. And even more damning, the AWC asserts that the firm did not review any registered representatives' firm-provided or personal email accounts to ensure compliance.


PFA apparently submitted a Corrective Action Statement via letter dated June 10, 2015, in which the firm stated:

In response to the violations regarding e-mail retention and review, PFA Security Asset Management, Inc. (PFA) has engaged Global Relay to provide e-mail archiving services for the firm. Accordingly keywords have been established to flag e-mails for review. A random sampling of e-mails not containing keywords also will be flagged and reviewed. Reviews will be performed approximately monthly by our Chief Compliance Officer and results documented and memorialized at PFA's Operations Committee Meetings. Emails requiring further review with a representative will also be documented.

This Corrective Action is submitted by the Respondent. It does not constitute factual or legal findings by FINRA, nor does it reflect the views of FINRA, or its staff. .

In accordance with the terms of the AWC, FINRA imposed upon PFA a Censure and a $20,000 fine.

Bill Singer's Comment

FINRA AWCs permit the attachment of a Corrective Action Statement to demonstrate the steps taken by a respondent to prevent future misconduct subject to the understanding that such an attachment may not deny the charges or make any statement that is inconsistent with the AWC. Further the Corrective Action Statement does not constitute factual or legal findings by FINRA, nor does it reflect the views of FINRA or its staff.

What are we to make of PFA's Corrective Action Statement? For starters, the member firm has engaged a third-party service provider for email archiving and the firm intends to use keywords and random sampling to flag and review emails. And the reason that such a statement was necessary was what?  Why was it not simply enough -- simply good enough, at that -- to just sign off on the AWC and not offer further comment?  

What happens if things don't pan out with Global Relay? Will FINRA cite to the Statement of Corrective Action in support of a harsher, subsequent regulatory response?

What exactly is meant by the CCO's "approximately" monthly review? Is that more frequently than every calendar month . . . or is that less frequently? Again, how will FINRA respond if the review occurs every fifth or sixth week?

I am no fan of Corrective Action Statements and rarely, if ever, advocate their use.  Given that the premise of an AWC is a settlement made without admitting or denying the findings, barring extreme circumstances, I don't understand why anyone would prepare a statement that tends to typically make admissions, promises to correct situations that have not necessarily been acknowledged, and, in the end, simply draws more undesired attention to the matter. If you feel compelled to attach a Corrective Action Statement, then you may want to pause before signing the AWC and ask yourself if you might not be better advised to argue your case before a Hearing Panel and, if necessary, on appeal afterwards.  

If you conclude that the costs and/or risks of contesting the charges aren't worth it, then just sign the damn AWC and get over it. There's no need whatsoever to engage in a post-game, public analysis. Some think that this after-the-fact statement gives you a parting shot at unfair regulation or an opportunity to put your own spin on the matter. I would suggest that you simply avoid the temptation. Keep in mind that a Corrective Action Statement may actually set you and your firm up for heavier sanctions down the road if you acknowledge wrongdoing and propose a set of remedial actions.  If during subsequent examinations, a regulator finds that you engaged in similar misconduct to that discussed in the statement, or, it is alleged that you failed to  implement the promised revised policies and procedures, your own words may prove blunt instruments used to beat you into submission. Notwithstanding my opinion, PFA apparently determined that it was advisable to submit a Corrective Action Statement.

All of which leads us to today's musical interlude. A no-brainer. Dipping back to 2000, we have the punk rock band Honor System and their ever-so appropriate song "The Blaming Game."