Federal Court Sustains FINRA / SEC Over CEO Reckless Disregard of Net Cap Rule

March 12, 2018

Keith D. Geary was the owner, Chairman, and Chief Executive Officer of FINRA member firm Capital West Securities, which became Geary Securities, Inc. During two days in May 2009 and 13 days during a three-week stretch in January and February 2010, FINRA alleged that Geary Securities operated pursuant to subparagraph (a)(2)(i) of '34 Act Rule 15c3-1, which imposes a $250,000 minimum net capital requirement based upon the firm's regular receipt of customer checks payable to the broker-dealer. FINRA alleged that the firm failed to maintain its requisite minimum Net Capital. Geary Securities filed a BDW on February 29, 2012, and purportedly ceased doing business on April 30, 2012. On September 17, 2012, FINRA's Department of Enforcement filed a Complaint against Keith D. Geary and Norman Frager, who was the firm's Financial and Operations Principal ("FINOP") and the person responsible for preparing and filing the Financial and Operational Combined Uniform Single Reports ("FOCUS Reports").

Frager FINRA Settlement

In response to the filing of a Complaint on September 17, 2012, by the Department of Enforcement of the Financial Industry Regulatory Authority ("FINRA"), Respondent Norman Frager submitted an Offer of Settlement dated October 16, 2013, which the regulator accepted.  Under the terms of the Offer of Settlement, without admitting or denying the allegations in the Complaint, Respondent Norman Frager consented to the entry of findings and violations and to the imposition of the sanctions. FINRA Department of Enforcement, Complainant, vs Norman Frager and Keith D. Geary, Respondent (Order Accepting Offer of Settlement as to Respondent Frager, FINRA Office of Hearing Officers, 2009020465801, October 23, 2013) (the "Frager FINRA Settlement Order").

As alleged in part in the Frager FINRA Settlement Order, on 15 days in 2010, Frager violated FINRA Rule 2010 by permitting Geary Securities to conduct a securities business while under the required net capital and by causing the firm to fail to give timely notice of insufficient net capital in violation of SEA Section 17(a) and SEA Rule 17a-11(b), (c) thereunder. In accordance with the terms of the Frager Settlement Order, FINRA imposed upon Frager a $10,000 fine and a 45-calendar-days suspension from association with any FINRA member firm in a FINOP capacity.


Geary contested FINRA's allegations in the Complaint that he was responsible for the net capital violations to the extent that he had violated the "high standards of commercial honor and just and equitable principles of trade" standards of FINRA Rule 2010. In Department of Enforcement, Complainant, v. Keith D. Geary, Respondent (FINRA OHO Hearing Panel Decision, No. 2009020465801, July 8, 2014)
As set forth in part in the "Introduction" to the OHO Decision:

[G]eary displayed a reckless, if not knowing, disregard for the net capital requirements. Enforcement proved, as charged, that Geary permitted the Firm to continue operating a securities business when it did not have the required minimum net capital.

In connection with the first violation, Geary caused the net capital violation. He acquired in the Firm's account almost $77 million in collateralized mortgage obligations ("CMOs") without having a buyer for the CMOs, although the Firm did not have the money to pay for the CMOs. Geary did so despite having been warned by the Firm's financial and operations principal ("FINOP") that the Firm could not do such a transaction. The Firm, which generally made $500,000 to $600,000 per year, fell into a huge net capital deficit of $11.5 million, but it continued conducting business. Although the violation was for only two days, if Geary had been permitted to implement his plan, it would have continued for weeks. Geary only remedied the deficiency at the FINOP's insistence.

In connection with the second violation, Geary knew in late January 2010 that the Firm's net capital was steadily declining and dangerously low. He was informed in early February 2010 that the Firm's net capital had fallen below the required minimum at the end of January.

Nevertheless, the Firm continued doing business without the required minimum net capital for 13 days, until February 26, 2010, while Geary struggled to find money to cover the shortfall. During the period of the deficit, Geary was involved in discussions with the FINOP regarding what to do. He knew that the Firm should stop doing business if it did not have the minimum net capital. In fact, the Firm's written supervisory procedures ("WSPs") expressly provided that the Firm had to stop doing business if its net capital fell below the required minimum. Geary attempted to shift blame to the Firm's FINOP for the failure to stop doing business, but the decision was, ultimately, Geary's. Geary simply ignored the requirement to stop doing business.

Pages 2 - 3 of the OHO Decision

Ignorance and Justifiable Reliance

As the OHO Panel interpreted Geary's defenses, he made two substantive arguments:

[O]ne, which is more closely tied to the May 2009 events, is that he was ignorant that the consequence of a net capital deficit was that the Firm had to cease doing business. The second, which is more closely tied to the February 2010 events, is that he relied on Frager and AR to make sure that the Firm was in compliance with the net capital rule. Geary conceded, somewhat reluctantly, that by the time of the February 2010 events, he did know that a net capital deficit could require the Firm to cease doing business.

Page 25 of the OHO Decision

In rejecting Geary's argument of his ignorance of the consequence of the cited deficit, the OHO Panel found that, even if he did not actually "know" of the potential outcome, he behaved recklessly when he had the firm take on the massive CMO positions without funding or a realistic financing plan. As to his argument of reasonable reliance, the Panel admonished that [Ed: footnotes omitted]:

[I]t is well-established that the president of a securities broker-dealer bears a heavy responsibility for his firm's compliance with all applicable rules and regulations. That includes net capital compliance. Geary was not only the president but the chairman and CEO of the Firm. He was senior management - all of senior management. It was his responsibility to stop the Firm from doing business. . .

Page 25 of the OHO Decision

Reckless Distregard (At Best)

In finding that Geary's conduct rose to an unethical dimension, the OHO Hearing Panel explained that:

Given the fundamental importance of the net capital rule to the protection of investors, as discussed above, a violation of that rule is serious. Geary's knowing, or at best reckless, disregard for the requirements of the net capital rule fell far short of the standards of the profession and placed the Firm's customers at risk. In both instances, Geary violated FINRA Rule 2010.

Page 24 of the OHO Decision

OHO Sanctions

In determining sanctions, the OHO Hearing Panel noted in part at Page 28 of the OHO Decision [Ed: footnotes omitted]:

The intentional or, at a minimum, reckless quality of Geary's misconduct persuades the Hearing Panel that stringent sanctions are warranted to protect the investing public, both to impress upon Geary himself the importance of compliance and also to deter others from engaging in similar misconduct. The net capital rule is fundamental to protecting the investing public from financial recklessness by broker-dealers who receive or hold customer funds and securities.

The Hearing Panel does not find Geary's testimony regarding his current financial difficulties mitigating. He testified that he is working, but he still owes money on the loan that he obtained to purchase the Firm. He also testified regarding his family obligations and asserted that he would not have sufficient financial resources to support his family and meet his obligations if he were suspended, and that he did not have the financial resources to pay a fine.None of this excuses his misconduct. Nor does it constitute sufficient evidence of a bona fide inability to pay. If he is financially unable to pay the monetary sanctions imposed, which are discussed below, then he can make the appropriate application for relief. To the extent that the suspensions imposed result in a financial hardship because he cannot work during that period, that is always the result of a suspension. It is not a basis for a more lenient sanction.

The OHO Hearing Panel imposed in part the following sanctions:

For permitting the Firm to conduct customer business while it had a net capital deficiency in May 2009, in violation of FINRA Rule 2010, as charged in the First Cause of Action, Respondent is fined $10,000, suspended from association with a member firm in any capacity for 30 business days, and barred from acting in a principal or supervisory capacity with any FINRA member firm. For permitting the Firm to conduct customer business while it had a net capital deficiency for 13 days during the period from January 31, 2010, until February 26, 2010, in violation of FINRA Rule 2010, as charged in the Fourth Cause of Action, Respondent is fined $20,000, suspended from association with a member firm in any capacity for 60 calendar days, and barred from acting in a principal or supervisory capacity with any FINRA member firm. The suspensions are imposed consecutively.

In addition, Respondent is ordered to pay the costs of the hearing in the amount of $5,056.70, which includes a $750 administrative fee and the cost of the transcript. The cost shall be payable on a date set by FINRA, but not less than 30 days after this decision becomes FINRA's final disciplinary action in this matter.

Page 30 of the OHO Decision

NAC Decision

Geary appealed the OHO Decision to FINRA's National Adjudicatory Council ("NAC"). In Department of Enforcement, Complainant, v. Keith D. Geary, Respondent (FINRA NAC Decision, No. 2009020465801, July 20, 2016)
The NAC affirmed the OHO Decision on liability but modified the sanctions to transform the sanctions parsed among the First Cause of Action ($10,000 fine; 30-business-days suspension in any capacity; and principal/supervisory Bar) and Fourth Cause of Action ($20,000 fine; 60-calendar-days suspension in any capacity; and principal/supervisory Bar ) into a unitary $20,000 fine. 30-business-days suspension in all capacities, principal/supervisory Bar, and payment of $5,056.70 in costs.
In considering the appeal and the imposition of sanctions, the NAC noted in part that [Ed: Footnotes omitted]:

We agree with Geary that his acts were not motivated by fraud. We find, however, that Geary's reckless disregard of the consequences of his proprietary trading in May 2009 and his intentional disregard in February 2010 of the net capital rules and his own Firm's written supervisory procedures, obligating the Firm to cease operations while net capital deficient, warrant significant sanctions. See William K. Cantrell, 52 S.E.C. 1322, 1327 (1997) (finding sanctions neither excessive nor oppressive when respondent permitted the firm to operate with substantial net capital deficiencies thereby depriving its customers protections afforded to them by the net capital requirements and exposing them to undue risk).

Page 18 of the NAC Decision

It appears that the NAC did wrestle with the nuance between a reprimand versus a condemnation when assessing Geary's conduct. Pointedly, the NAC noted that [Ed: Footnotes omitted]:

In regard to the second principal consideration for determining sanctions for net capital violations, we find there is no evidence in the record that Geary tried to conceal GSI's net capital deficiencies. When FINRA inquired at an on-the-record interview about the violation in May 2009, Geary was forthcoming and testified that Frager backdated the trade date "to make the capital violation go away." With respect to the February 2010 net capital violation, Geary argues that he "acknowledged the alleged misconduct to FINRA." Whereas GSI was obligated under Exchange Act Rule 17a-11(b) to file the deficiency notices, we note other instances in which GSI alerted FINRA to the net capital issues at the Firm. For instance, prior to the February 2010 net capital violation, Frager emailed GSI's FINRA regulatory coordinator for GSI on January 22, 2010, informing FINRA that GSI planned to close a CEMP transaction "which in and of itself will restore significant capital to the broker-dealer entity," and, if for some reason the closing is delayed, that GSI's parent company "will arrange to infuse additional capital into the [Firm] next week." And on February 10, 2010, in addition to Frager filing the first net capital deficiency notice on behalf of the Firm, AR left a message for FINRA staff regarding net capital issues at the Firm. Although the Firm did not file its first net capital deficiency notice until February 10- six days after Geary learned about the net capital deficiency-we attribute this delay to sloppiness as opposed to an effort to conceal.

Page 14 of the NAC Decision

Ultimate Responsibility

As to Geary's efforts to shift enough blame and justifiable reliance on others who were delegated various aspects of ensuring that the firm remained Net Capital compliant and maintained adequate books and records, the NAC admonished that [Ed: Footnotes omitted]:

As president and CEO of GSI, Geary ultimately was responsible for ensuring that the Firm complied with all regulatory requirements. He also controlled those responsible for the Firm's financial recordkeeping and net capital reporting. Geary not only caused the May 2009 net capital violation through his proprietary trading, but he had actual knowledge of the Firm's net capital insufficiency as of February 4, 2010, but nonetheless permitted the Firm to effect securities transactions. Thus, any claimed lack of awareness or involvement with respect to requirements surrounding GSI's financial reporting does not negate Geary's responsibilities as president of the Firm. Cf. Block, 2001 NASD Discip. LEXIS 35, at *16 ("[E]ven if there has been an effective delegation of financial compliance responsibilities, a controlling executive who is directly involved in accounting and net capital violations incurs responsibility for those violations.").

Page 11 of the NAC Decision

Financial Harship

As to Geary's appellate argument that he lacks the ability to pay the fine, the NAC found that [Ed: Footnotes omitted]:

[G]eary testified that he currently does not have financial resources to satisfy his unpaid financial obligations or meet all his obligations if he is suspended, but he submitted no additional evidence or any documentation showing financial hardship. This evidence is insufficient under our jurisprudence. See Dep't of Enforcement v. Levitov, Complaint No. CAF970011, 2000 NASD Discip. LEXIS 12, at *33-34 (NASD NAC June 28, 2000) ("We require all respondents who wish to make a claim of inability to pay to verify the accuracy of their financial condition through the submission of signed and notarized documents evidencing financial hardship."). Geary also did not demonstrate that he was unable to borrow or otherwise raise additional funds. Cf. Dep't of Enforcement v. Tomlinson, Complaint No. 2009017527501, 2014 FINRA Discip. LEXIS 4, at *30-31 (FINRA NAC March 5, 2014) (declining to impose a fine and costs where respondent demonstrated insolvency). Based on the record, we conclude that Geary has not demonstrated an inability to pay.

Page 19 of the NAC Decision

SEC Appeal

On appeal to the Securities and Exchange Commission ("SEC"), the federal regulator sustained FINRA's findings and sanctions. In the Matter of the Application of Keith D. Geary For Review of Disciplinary Action Taken by FINRA (Opinion, '34 Release No. 80322; Admin. Proc. File No. 3-17406  / March 28, 2017)

The SEC quickly shreds Geary's core defenses by noting that [Ed: Footnotes omitted]:

[W]ith respect to both the May 2009 and February 2010 violations, Geary failed to ensure that the firm was operating with sufficient net capital despite being aware of the conditions that led to the violations.

Geary attempts to distance himself from the firm's net capital violations by arguing that he delegated and relied on qualified industry professionals who he claims were ultimately responsible for the violations. According to Geary, he did not have any "personal involvement" with GSI's violations and "Frager -- without consulting Geary -- made all of the decisions that are the bases for the violations." But it is undisputed that Geary, not Frager, ordered the CMO purchase that caused the May 2009 deficiencies and that he did so despite Frager's warnings. Moreover, it was his, not Frager's, decision to continue the firm's violative operations notwithstanding his awareness of deficiencies that were continuing in February 2010. He again disregarded reminders of his obligation to suspend operations in making that decision.

Geary also contends that he "lacked any knowledge, awareness or suspicion" of the May 2009 net capital violations and did not intend to violate the rule. As an initial matter, intent is not necessary to establish a responsible person's liability for a net capital violation. 

Page 9 of the SEC Opinion

In reviewing Geary's objections to FINRA's sanctions, the SEC noted in part [Ed: Footnotes omitted]:

Under Exchange Act Section 19(e)(2), we will sustain a FINRA sanction unless we find that it is "excessive or oppressive" or imposes an unnecessary or inappropriate burden on competition. As part of this review, we consider any aggravating or mitigating factors; we also consider whether the sanctions are remedial in nature and not punitive. Although the Commission is not bound by the Sanction Guidelines, we use them as a benchmark for our review. Geary argues that the sanctions FINRA imposed were inconsistent with FINRA's Sanction Guidelines and failed to appropriately consider mitigating factors. We disagree and find the sanctions satisfy the statutory requirements.

Page 11 of the SEC Opinion

In pressing his appeal, Geary argued in part that FINRA had not fairly imposed the sanctions against him. Among his contentions on this point was that FINRA did not reasonably consider his alleged financial inability pay and, as such, the sanctions were rendered improperly "punitive' in nature. As analyzed by the SEC [Ed: Footnotes omitted]:

Geary argues the $20,000 fine is punitive in light of his other financial obligations. But while a bona fide inability to pay is a proper consideration, "[i]t is well settled that a respondent bears the burden of demonstrating an inability to pay, and that [FINRA] is entitled to make a searching inquiry into any such claim," including by requiring appropriate documentation. We agree with FINRA that Geary did not establish his inability to pay a $20,000 fine, particularly when he failed to document his income, assets or expenses. Geary's additional claim that the suspension will hamper his ability to pay the fine is unavailing. Such a collateral effect of his misconduct does not justify any reduction of the fine.

Page 17 of the SEC Opinion

10 Circuit Appeal

On appeal to the United States Court of Appeals for the Tenth Circuit ("10Cir"), Geary petitioned for the Court's review of the SEC's ruling affirming FINRA's disciplinary action. 10Cir denied the petition solely on the briefs without oral argument as requested by both parties. Keith D. Geary, Petitioner, v. Securities and Exchange Commission, Respondent (Order and Judgment, 10Cir, 17-9522 / March 9, 2018) http://brokeandbroker.com/PDF/Geary10Cir.pdf

Although Geary argued that resort to the backdating of trading records can be used as a technique to remediate a Net Capital deficiency, 10Cir noted that unlike the SEC's position to the contrary, he could not cite any precedent for his contentions. 10Cir found that the backdated trades did not reflect the reality of the transactions because the firm clearly held the CMOs on both May 28 and May 29th.  Accordingly, 10Cir found that the CMOs were in the firm's inventory and had placed the firm under Net Capital and FINRA and the SEC's findings on that issue were correct.

As to Geary's contentions that the SEC improperly disregarded applicable mitigating factors and failed to identiry a "remedial" versus "punitive" purpose for FINRA's sanctions, the Court declined to simply substitute its views on that issue for those of the SEC, for which it believed substantial judicial deference was appropriate.

As to Geary's contention that the SEC had failed to consider evidence of his inability to pay FINRA's fine, 10Cir observes that:

[H]e points to his own testimony about his family's financial circumstances. But the SEC held that FINRA is entitled to require documentation of a bona fide inability to pay, and Mr. Geary failed to document his income, assets, or expenses. The SEC's conclusion is consistent with the Sanctions Guidelines. See Add. at 21 ("The burden is on the respondent to raise the issue of inability to pay and to provide evidence thereof. . . . Adjudicators should require respondents who raise the issue . . . to document their financial status through 16 the use of standard documents that FINRA staff can provide[]."); see also ACAP Fin., 783 F.3d at 768 (noting the SEC's rejection of a claim of inability to pay due to a lack of information about financial circumstances).

Pages 15 - 16 of the SEC Opinion

Finally, 10Cir addressed Geary's assertion that FINRA's sanction were so harsh and inappropriate as to have become transformed into impermissible penalties [Ed: Footnotes omitted]:

Mr. Geary contends that the SEC failed to articulate a remedial purpose for the sanctions imposed, which he claims are impermissibly punitive. But the SEC explained that the sanctions were necessary to protect investors. In holding that significant sanctions were warranted, the SEC noted Mr. Geary's "troubling attitude" regarding regulatory compliance, his display of "a disturbing lack of understanding and ignorance of FINRA rules," his repeated failure to heed warnings regarding protecting GSI's capital, and "concerns about his ability to comply with regulatory requirements generally." Admin. R., Vol. 1 at 29, 32, 33 (internal quotation marks omitted). Because Mr. Geary continues to work in the securities industry, the SEC decided that an all-capacities suspension was appropriate to impress on him the need to comply with regulatory requirements, rather than addressing violations after they occur. He has not demonstrated that the sanctions imposed lack a remedial purpose.

Page 16 of the 10Cir Opinion

Bill Singer's Comment

Compliments to FINRA on issuing superb presentations of content, context, and rationale in both the OHO and NAC Decisions. Regardless of whether you agree with the allegations, the findings, or the sanctions, the self-regulatory-organization produced two excellent explanations of what their panels found had happened and why the imposed sanctions were deemed appropriate. Similarly, the SEC and 10Cir did equally fine jobs tackling the expansive fact pattern and providing compelling justification for their affirmations.

An interesting aspect of Geary is that it presents a scenario in which we are asked to consider the separate spheres of influence of a broker-dealer's CEO and FINOP -- and in other cases, we are often confronted with the delineation of roles of a firm's CEO and Chief Compliance Officer. There are times when an industry regulator acknowledges that a firm's CEO has the right to reasonably delegate certain actions and conduct to others. Pointedly, Wall Street's regulatory scheme anticipates that a CEO will delegate financial, operational, and compliance roles to designated principals. Inherent in such delegation, however, is an expectation that the CEO will reasonably supervise those discharging such delegated responsibilities.

We are reminded of the seminal SEC case on the issue of ultimate supervisory responsibility in "SEC News Digest" (Issue 86-121 / June 24, 1986) 


The Commission has reduced sanctions imposed by the NASD on Juan Carlos Schidlowski of Sedalia, Colorado, former president of OTC Net, Inc., a Denver securities firm. The sanctions imposed on Schidlowski were reduced to a censure and a ten-day suspension as principal.

The Commission found, as had the NASD, that, from November 1 to December 15, 1980, Schidlowski was responsible for deficient supervision in connection with his firm's failure to register its compliance officer with the NASD as a principal. However, the Commission set aside the NASD's findings that Schidlowski was also responsible for deficient supervision in connection with certain unlawful sales of unregistered securities and related recordkeeping violations. In setting aside those findings, the Commission stated: "There is no evidence here of any dereliction of duty or knowledge of the violations at issue. A firm's president is not automatically at fault when other individuals in the firm engage in misconduct of which he has no reason to be aware." In reducing the sanctions imposed by the NASD, the Commission noted that it had set aside the major portion of the NASD's findings of violation, including the most serious misconduct. (ReI. 34-23347 - June 19)

Notwithstanding the Schidlowski carve-out, Wall Street's regulators often admonish that in order for a CEO to utilize the safe harbor, he or she must demonstrate that the delegation at issue was reasonable, that the individual to whom duties were delegated was capable of discharging those duties, that the CEO was not aware of any irregularities in the handling of any delegated roles. In cases rejecting the Schidlowski defense, we often see a CEO who has disregarded warning signs that all is not well. Further, we often see a CEO who, when he or she finally recognizes an issue, either takes no action or takes ineffective action.

In Geary, FINRA, the SEC, and 10Cir concluded tha regardless of FINOP Frager's failures, Geary was on notice of the Net Capital deficiency and it was his job as CEO to shut down the firm until such time as it was back in financial compliance. The misconduct at issue was not merely Geary's failure to supervise his FINOP but, at its heart, Geary's failure to discharge his CEO's role when on notice of likely industry violations. 

The CEO is not viewed merely as a spectator but as a firm's ultimate firewall. There may be smoke alarms. There may be fire extinguishers. There may be sprinklers. But, if all those should fail, the firewall is supposed to stand up against the flames. That may be a quaint, somewhat anachronistic view of modern corporate life on Wall Street; however, I offer this summation merely to explain the current state of interpretation. It is what it is.