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A recent FINRA regulatory settlement presents us with the puzzling scenario of three versions of the same event as told by the stockbroker, his employer, and the industry regulator. There seems little doubt that according to the letter of the rulebook, the stockbroker entered unauthorized trades. The more interesting question is why and whether there were circumstances that might excuse or explain the questioned use of discretion. All of which reminds me of the famed film Rashomon and its characters the bandit, the samurai, and the samurai's wife. In the end, wrong was committed but as to who did what and why -- ahhhh, that's the movie.
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, Jonathan R. Belden submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. In the Matter of Jonathan R. Belden, Respondent(AWC 2017055000501, April 12, 2018)
The AWC asserts that Belden was first registered in 2014 with FINRA member firm Merrill Lynch Pierce Fenner & Smith, Inc. The AWC states that "Belden has no disciplinary history with the Securities and Exchange Commission, FINRA,
any other self-regulatory organization or any state securities regulator."
Word of Mouth
The AWC alleges that between the relevant period of March 9, 2017 and May 22, 2017, Belden executed over 200 trades in the accounts of seven customers pursuant to their verbal
discretionary authority but he had not obtained the customers' written authorization to exercise said discretion. Further, the AWC asserts that Merrill Lynch had not authorized Belden to exercise discretion in customers'
accounts, and the accounts at issue had not been accepted by Merrill Lynch as discretionary.
Getting It In Writing
NASD Conduct Rule 2510: Discretionary Accounts imposes a relatively simple compliance regime requiring prior written authorization by the customer coupled with the firm's written acceptance. After a duly authorized and approved discretionary trade has been placed, a member firm must undertake prompt written approval of each discretionary order; and, further, must frequently undertake a suitability review of discretionary accounts. That's about as straightforward a regulatory proposition as you could imagine.
Sometimes the line between discretion and authorization gets blurred. Within the context of a telephone call or email exchange between a customer and stockbroker, things get stated that may sort of seem like the customer gave the okay to place an order. It's that "sort of" aspect that can alter what looks like a bona fide non-discretionary order into one that involves the inappropriate exercise by the stockbroker of discretion, albeit limited and perhaps disputed. When such a sort-of order is accepted, it often occurs at a time when stockbroker was speaking to the customer on the phone while filling out an order ticket while also reading an email while also waving at an assistant to tell another customer to hold on for one more second while also watching the stock-market screen on his desk. That's the swirl of confusion that exists at most branch offices throughout most business days. That's the setting in which lots of industry violations occur.
In an attempt to address circumstances when "sort of" orders often pop up, NASD Rule 2510(d)(1) carves out an exception for Time And Price ("T&P") discretion. T&P comes into play when there's a customer order for the purchase or sale of a definite amount of a specified security but it's left to the stockbroker's discretion to decide the time and price at which the order is entered. T&P is an effective order ONLY until the end of the business day on which the customer granted such discretion.
Under previous iterations of the Discretionary Rule there wasn't an intra-day limit on T&P, which explains why industry veterans often mistakenly believe that they can still use T&P the next day(s) rather than within the same trade date. Speaking of the old days, why is this still an "NASD" rule and not updated to a FINRA rule? FINRA was formed in 2007. Does it really take over a decade to transition from the old NASD rulebook to the superseding FINRA one?
NASD Conduct Rule 2510: Discretionary Accounts
(a) Excessive Transactions
No member shall effect with or for any customer's account in respect to which such member or his agent or employee is vested with any discretionary power any transactions of purchase or sale which are excessive in size or frequency in view of the financial resources and character of such account.
(b) Authorization and Acceptance of Account
No member or registered representative shall exercise any discretionary power in a customer's account unless such customer has given prior written authorization to a stated individual or individuals and the account has been accepted by the member, as evidenced in writing by the member or the partner, officer or manager, duly designated by the member, in accordance with Rule 3010.
(c) Approval and Review of Transactions
The member or the person duly designated shall approve promptly in writing each discretionary order entered and shall review all discretionary accounts at frequent intervals in order to detect and prevent transactions which are excessive in size or frequency in view of the financial resources and character of the account.
This Rule shall not apply to:
(1) discretion as to the price at which or the time when an order given by a customer for the purchase or sale of a definite amount of a specified security shall be executed, except that the authority to exercise time and price discretion will be considered to be in effect only until the end of the business day on which the customer granted such discretion, absent a specific, written contrary indication signed and dated by the customer. This limitation shall not apply to time and price discretion exercised in an institutional account, as defined in Rule 3110(c)(4), pursuant to valid Good-Till-Cancelled instructions issued on a "not-held" basis. Any exercise of time and price discretion must be reflected on the order ticket;
(2) bulk exchanges at net asset value of money market mutual funds ("funds") utilizing negative response letters provided:
(A) The bulk exchange is limited to situations involving mergers and acquisitions of funds, changes of clearing members and exchanges of funds used in sweep accounts;
(B) The negative response letter contains a tabular comparison of the nature and amount of the fees charged by each fund;
(C) The negative response letter contains a comparative description of the investment objectives of each fund and a prospectus of the fund to be purchased; and
(D) The negative response feature will not be activated until at least 30 days after the date on which the letter was mailed.
Also, the AWC alleges that:
On four occasions between April 21 and 26, 2017, Belden mismarked order tickets for trades as
unsolicited when, in fact, he solicited the trades, in violation of FINRA Rules 4511 and 2010.
Belden engaged in this conduct to facilitate transactions in a security on the Firm's restricted list.
Because the Firm's electronic order system did not allow solicited orders in securities on the
restricted list to be processed absent further Firm review, Belden mismarked the orders as
Side Bar: FINRA Rule 4511: General Requirements
(a) Members shall make and preserve books and records as required under the FINRA rules, the Exchange Act and the applicable Exchange Act rules.
(b) Members shall preserve for a period of at least six years those FINRA books and records for which there is no specified period under the FINRA rules or applicable Exchange Act rules.
(c) All books and records required to be made pursuant to the FINRA rules shall be preserved in a format and media that complies with SEA Rule 17a-4.
The AWC asserts that on July 20, 2017, Merrill Lynch filed a Uniform Termination Notice for Securities Industry Registration ("Form U5") disclosing that on July 6, 2017, Belden had been discharged for "conduct involving unauthorized trading in client accounts."
FINRA deemed Belden's cited misconduct as
effecting some 200 securities transactions in seven customers' accounts without written discretionary authority from the customers and without acceptance of the accounts as discretionary by Merrill Lynch as consituting violations of NASD Rule 2510(b) and FINRA Rule 2010; and
mismarkiong order tickets for trades as unsolicited when, in fact, he solicited the trades, in violation of F1NRA Rules 4511 and 2010.
In accordance with the terms of the AWC, FINRA imposed upon Belden a $10,000 fine and a 60-calendar-days suspension from associating with any FINRA member in any capacity.
Bill Singer's Comment
As set forth in FINRA's online BrokerCheck as of April 16, 2018, under the heading "Employment Separation After Allegations," Merrill Lynch disclosed that it had "discharged" Belden on July 6, 2018, based upon allegations that:
Conduct involving unauthorized trading in client accounts.
In response to his firm's disclosure, Belden provided a "Broker Statement" that appears as follows on BrokerCheck:
Employment terminated due to discretionary trading in clients investment advisory accounts (not brokerage accounts). Respondent had prior verbal authorization from said clients to engage in discretionary trading but had no formal paperwork on fie (since they were "orphaned" accounts) which resulted in termination. With regards to these discretionary trades: (1) all clients were on a fee-based platform thus there was no financial incentive trade accounts and trades were made with regard to fiduciary responsibility and what twas thought best for clients. (2) there were no client complaints from said trades. (3) respondent was a member of a team that operated under discretion and was in good standing with the team. Said clients had online access to their accounts and could account status at moment's notice. All trades had post client confirmation via trade confirmations and review.
I'm not sure which version of events to believe: Merrill Lynch's, Belden's, or FINRA's? Starting with the earliest point in time, Belden's employer said that it had fired him because of conduct "involving unauthorized trading in client accounts." Okay, that's fine but for the fact that even FINRA concedes that the clients at issue gave Belden verbal discretion -- so it's not like the trades were wholly unauthorized as we would use that word in common discourse. Then we come across Belden's expansive BrokerCheck statement, which sort of surprised me with its detail and counterfactual. I don't know why some of the mitigation he presented wasn't reflected in Merrill Lynch's disclosure. but to Belden's credit, he memorialized his position. Then we have the FINRA's presentation of facts in the AWC, which makes no reference to any of the mitigation stated by Belden in terms of the accounts being orphaned and fee-based; and there is no discussion of the absence of customer complaints or the purported discretionary nature of Belden's team.
No . . . I am NOT arguing that mitigation is the same as exculpation. Yes . . . FINRA and Merrill presented a strong case for the lack of the necessary written discretionary authorizations. I am merely noting that the AWC should be meticulous in presenting the fact pattern at issue so that we may better understand the appropriateness of sanctions. Either FINRA discredited Belden's version of events or it didn't. If his version was wholly or substantially correct, it should have been better reflected in the AWC.