NASD Charges Member For Pursuing Research Biz. Or Was That FINRA?

February 9, 2017

Today's BrokeAndBroker.com Blog covers a fairly mundane bit of self regulatory esoterica in the form of a FINRA member firm's failure to update its Membership Agreement. As esoteric as the issue is, however, there are aspects of the regulatory settlement that raise questions: What is meant by "relevant" and who gets to make that determination? Then there's that bit of hypocrisy on the part of FINRA that renders the settlement as more than a bit . . . hmmm . . . what's the word that I'm looking for . . . oh, yeah . . . hypocritical.

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, CV Brokerage, Inc. submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. In the Matter of CV Brokerage, Inc., Respondent (AWC 2015043384601, January 18, 2017).CV Brokerage has 55 registered representatives spread among two registered branch offices and multiple non-branch locations. The AWC presents this about the firm:

RELEVANT DISCIPLINARY HISTORY

In October 2014, pursuant to a Letter of Acceptance, Waiver and Consent in Matter No. 2013035122101, CV Brokerage was censured and fined $5,000 for, in addition to another rule violation, conducting a research business without first filing a continuing membership application to engage in a research business.

Research Reports

The AWC asserts that during the relevant time between December 2013 and January 2015, three CV Brokerage registered representatives distributed research reports to institutional customers. At the time these research reports were distributed, CV Brokerage's FINRA Membership Agreement allegedly did not permit the firm to engage in a research business. Moreover, the AWC asserts that CV Brokerage failed to file a Continuing Membership Application for authorization to engage in a research business.

The Rulebook

A FINRA member firm's Membership Agreement requires amendment when the following events occur, as set forth in pertinent part in:

NASD Membership and Registration Rule 1017: Application for Approval of Change in Ownership, Control, or Business Operations
(a) Events Requiring Application
A member shall file an application for approval of any of the following changes to its ownership, control, or business operations:
(1) a merger of the member with another member, unless both are members of the New York Stock Exchange, Inc. or the surviving entity will continue to be a member of the New York Stock Exchange, Inc.;
(2) a direct or indirect acquisition by the member of another member, unless the acquiring member is a member of the New York Stock Exchange, Inc.;
(3) direct or indirect acquisitions or transfers of 25% or more in the aggregate of the member's assets or any asset, business or line of operation that generates revenues comprising 25% or more in the aggregate of the member's earnings measured on a rolling 36-month basis, unless both the seller and acquirer are members of the New York Stock Exchange, Inc.;
(4) a change in the equity ownership or partnership capital of the member that results in one person or entity directly or indirectly owning or controlling 25 percent or more of the equity or partnership capital; or
(5) a material change in business operations as defined in Rule 1011(k) . . .

Sanctions

In referencing NASD Rule 1017(a)(5) above, the AWC asserts that:

The addition of a research business constitutes such a "material change in business operations."

FINRA deemed CV Brokerage's conduct to constitute a violation of NASD Rule 1017 and FINRA Rule 2010. In accordance with the terms of the AWC, FINRA imposed upon CV Brokerage a Censure and $25,000 fine.

Bill Singer's Comment

Relevant Prior History

In researching CV Brokerage's FINRA disciplinary history, I came across four documents, which disclosed the following AWC history (quotes are taken directly from the respective AWC):

1. In the Matter of CV Brokerage, Inc., Respondent (AWC 2012035026501,August 30, 2016):

In Matter No. 20120350265, the Department of Market Regulation reviewed the firm's compliance with Rule 203(b)(1) of Regulation SHO during the period of January 1, 2011 through March 31,2013 (the "Review Period"). The review resulted in certain findings of violations of Rule 203(b)(1) of Regulation SHO, NASD Rule 3010, and FINRA Rule 2010, as described below.

2. In the Matter of CV Brokerage, Inc., Respondent (AWC 2013035122101,October 27, 2016):

From June 2013 to August 2013, CV failed 10 file an application with FINRA for approval of a material change of its business operations involving conducting a research business. Based on the foregoing, CV violated NASD Membership and Registration Rule 1017 and FINRA Rule 2010.

From May 2013 to August 2013, CV failed to report 33 customer-side transactions to the Real-time Transaction Reporting System in the manner prescribed by Municipal Securities Rulemaking Board ("MSRB") Rule G-14. Based on the foregoing, CV violated MSRB Rule G-14.

3, In the Matter of CV Brokerage, Inc., Respondent (AWC 2013037285201, March 18, 2017)

During the review period, the firm failed to transmit 874 Reportable Order Events ("ROEs") to OATS on 114 business days. The 874 ROEs represented 15.3 percent of all ROEs (5,711) that the firm was required to transmit to OATS during the review period, The conduct described in this paragraph constituted separate and distinct violations of FINRA Rule 7450(a).

4. In the Matter of CV Brokerage, Inc., Respondent (AWC 2015043384601, January 18, 2017)[Discloses #2 above]:

RELEVANT DISCIPLINARY HISTORY/ In October 2014, pursuant to a Letter of Acceptance, Waiver and Consent in Matter No. 2013035122101, CV Brokerage was censured and fined $5,000 for, in addition to another rule violation, conducting a research business without first filing a continuing membership application to engage in a research business.

I am a bit puzzled as to the AWC's representation of CV Brokerage's prior disciplinary history as limited to the prior October 2014. I take due note that the 2017 AWC has qualified CV Brokerage's prior history as being limited to only that which is "RELEVANT," but I would like to know who at FINRA makes such a determination and what is considered relevant when it comes to undertaking such a regulatory triage. In many AWCs the only reference is to the absence of "any disciplinary history" although many AWCs also use the phrase "has no relevant disciplinary history." Is this a uniform policy or ad hoc? Please note that I am not criticizing any FINRA protocol that would fairly restrict disclosure of any prior regulatory events to those that are "relevant" to any current matter. What I am questioning is whether this policy is even-handedly applied to all respondents who opt to settle a regulatory case. Not saying it isn't. Not saying it is. Just raising a Practice Pointer for respondents and their lawyers when it comes to negotiating the terms of an AWC.

Talking About History

What was charged in this AWC was a violation of NASD Membership and Registration Rule 1017. which sets forth when and how a FINRA member firm submits a request to change its ownership, contol or business operations. That critical aspect of FINRA membership is still dictated by an NASD Rule? How absurd that in 2017, FINRA could cite one of its member firms for failing to timely submit proper notice of the alteration of its business mix but the self-regulatory organization, founded over a decade ago in 2007, can't even update its membership rules from those of NASD to FINRA.

To make matters worse -- and even more absurd -- in CV Broker's AWC, the violation charged pertains to the definition of a "material change in business operations, " which is still listed under NASD Membership and Registration Rules 1011(k):

(k) "material change in business operations"

The term "material change in business operations" includes, but is not limited to:(1) removing or modifying a membership agreement restriction;(2) market making, underwriting, or acting as a dealer for the first time; and(3) adding business activities that require a higher minimum net capital under SEC Rule 15c3-1;

Not that I would ever think of calling FINRA a hypocritical self-regulatory organization (I mean, you know, "hypocritical self-regulatory organization" lacks a certain flow, a certain poetic color, if you will) but FINRA is a hypocritical self-regulatory organization (oops, so much for flow and poetry) when it charges CV Brokerage for failing to update its Membership Agreement to reflect a material change in the firm's business operations but FINRA has failed for 10 years to update its rules to reflect the material change of its name!

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NASD Charges Member For Pursuing Research Biz. Or Was That FINRA?

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