May 6, 2020
The "suitability" of a recommended investment bedevils Wall Street. Not only is the industry locked in a struggle between those who support the retention of the so-called Suitability Standard and those who advocate an enhanced Fiduciary Standard, but now it's implementing something involving investors' Best Interest. In a recent FINRA regulatory settlement, we come across a member firm that can't get its supervisory act together. The firm acknowledges that it must create, implement, and maintain supervisory reviews of the suitability of the various investments recommended to its customers -- so, you know, the spirit is willing. Unfortunately, when it comes to assembling all the moving parts, keeping the machine oiled, and performing necessary maintenance, well, sadly, that's where the gears come to a grinding halt.
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, Moloney Securities, Co., Inc. submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. In the Matter of Moloney Securities, Co., Inc., Respondent (FINRA AWC 22015046315102)
The AWC alleges that Moloney Securities, Co., Inc. has been a FINRA member firm since 1995 with about 50 branches and 150 registered representatives. The AWC asserts that the firm "does not have any relevant disciplinary history with the Securities and Exchange Commission, any state securities regulators, FINRA, or any other self regulatory organization."
Seniors Concentrated in Risky ETFs
The AWC alleges in part that during the relevant period from 2013 through April 2015:
[M]oloney registered representative JM
recommended that five senior customers, with investment objectives that included
"balanced growth" and "preservation of principle/income," purchase risky oil and gas
limited partnerships and oil and gas exchange traded funds.2 As a result of JM's
recommendations, these customers became concentrated in these products. Moloney's
electronic surveillance system, however, did not flag the transactions for concentration
issues, nor was the concentration questioned or reviewed by anyone at the Firm.
Similarly, customer LM, with an investment objective of "balanced growth" and risk
tolerance of moderate, accepted JM's recommendations to purchase six different oil and
gas limited partnerships in two accounts LM held at Moloney.3 By June 30, 2015, when
LM was 78 years old, as much as approximately 64% of her net worth (excluding
residence) was invested in oil and gas limited partnerships.4 In September 2015, when
LM transferred the assets in her Moloney accounts to another FINRA member firm, she
had suffered unrealized losses of $15,574.13.5
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Footnote 2: As used herein, senior investors refers to investors aged 65 and older.
Footnote 3: Moloney defined "balanced growth" as "focus is on generating income and/or long-term capital growth."
Footnote 4: LM's account update form from the Relevant Period listed her net worth (excluding residence) as ranging from $100,000-$249,000.
Footnote 5: LM's Moloney accounts were over 90% concentrated in oil and gas limited partnerships.
FINRA deemed the above conduct to constitute violations of NASD Rule 2010 and FINRA Rules 3110 and 2010. In asserting those violations, FINRA noted that Moloney failed to establish and maintaining a supervisory system designed to comply with FINRA Rule 2111 (the "Suitability Rule"). In part the AWC noted that the then extant written supervisory procedures (the "WSPs") imposed upon each Regional Manager a daily review of all trades by assigned reps -- about 50 such individuals per manager. Further, the AWC noted that Moloney did not provide said managers with any training on conducting a Suitability review for "speculative, low priced securities" or for over-concentrated positions in high-risk securities. Finally, the AWC noted its disapproval of Moloney's practice of utilizing reviews predicated "almost exclusively through the same electronic surveillance system provided by its clearing firm," which the regulator characterized as "not equipped to reasonably surveil for concentration in high-risk products or qualitative suitability."
Moloney Terminates JM
As to the unnamed registered representative "JM," the AWC asserts that:
Moloney discharged JM on August 7, 2015.6 Additionally, during its 2015
FINRA cycle exam, Moloney retained a consultant to make recommendations regarding
the Firm's supervisory systems and written supervisory procedures. The Firm revised
and enhanced its written supervisory procedures in April 2015, including its procedures
on reviewing transactions for qualitative suitability, including concentration issues. The
Firm also started using a more robust electronic surveillance system the same year.
Finally, Moloney paid restitution totaling $195,500 to four senior customers of former
Moloney representative JM, and is paying restitution to customer LM pursuant to this
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Footnote 6: In an AWC dated April 26, 2016, JM agreed to accept a bar from associating with any FINRA member firm in any capacity for refusing to provide information and documents and for refusing to appear for on-the-record testimony, both requested pursuant to FINRA Rule 8210.
Marking the Close
The AWC alleges in part that during the relevant period from 2013 through April 15, 2015:
The Firm did not have a system or written procedures reasonably designed to supervise
for possible indicia of marking the close activity. The Firm also failed to reasonably
investigate two of its representatives who frequently executed purchase or sale orders of
common stock of Company X, a thinly-traded security, at or near the close of the market
FINRA deemed the above conduct to constitute violations of NASD Rule 3010 and FINRA Rules 3110 and 2010. In asserting those violations, FINRA noted that Moloney failed to establish and maintain a supervisory
system reasonably designed to prohibit Marking-at-the-Close. Pointedly, the AWC admonished in part that Moloney "did not conduct any surveillance or conduct supervisory reviews
for possible indicia of marking the close activity."
In accordance with the terms of the AWC, FINRA imposed upon Moloney a Censure, a $100,00 fine, and ordered $15,574.13 in restitution to customer "LM."
Bill Singer's Comment
The AWC makes out a very compelling case about Moloney's failure to detect the concentrated positions and the plight of elderly investors. To that extent, FINRA is on the side of angels and this settlement comes off as fair and balanced -- and hopefully, the member firm is chastened.
Corrective Action Statement
The Moloney AWC includes a provision under "III. OTHER MATTERS" that states:
D. Respondent may attach a Corrective Action Statement to this AWC that is a statement of demonstrable corrective steps taken to prevent future misconduct. Respondent understands that it may not deny the charges or make any statement that is inconsistent with the AWC in this Statement. This Statement does not constitute factual or legal findings by FINRA, nor does it reflect the views of FINRA or its staff.
As more fully explained in a 1998 NASD (FINRA's predecessor) "Regulatory Short Takes: NASD Clarifies Policy On Corrective Action And Mitigation Statements"
Respondents in a settled disciplinary action may submit a Corrective Action Statement and/or a Mitigation Statement to NASD Regulation. This article clarifies the NASD policies regarding such Statements.
A Letter of Acceptance, Waiver and Consent (AWC) permits a respondent in an NASD Regulation disciplinary action to settle the matter prior to the filing of a formal complaint. A Corrective Action Statement may be attached to the AWC, which is filed with the SEC and available to the public, provided such statement is: (1) limited to demonstrable steps taken to correct a problem associated with the disciplinary action; (2) generally no longer than 2-3 pages; and (3) contains the following legend:
This Corrective Action Statement is submitted by the Respondent. It does not constitute factual or legal findings by NASD Regulation, Inc., nor does it reflect the views of NASD Regulation, Inc., or its staff.
Separately, respondents may submit a Mitigation Statement for consideration by NASD Regulation and the National Adjudicatory Council. Generally, such Statements are used to describe mitigating circumstances surrounding the violation for the decision maker to consider in its review of the terms of a settlement. Unlike Corrective Action Statements, Mitigation Statements are not attached to the AWC or public order.
Respondents may also settle a matter after the complaint is filed by submitting an Offer of Settlement. While both Corrective Action and Mitigation Statements may be submitted to NASD Regulation in connection with Offers of Settlements, these Statements are not attached to the final Order Accepting the Offer of Settlement, which is filed with the SEC and available to the public.
NASD Regulation will not accept Corrective Action or Mitigation Statements that deny the allegations or are inconsistent with the findings in the settlement. . .
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, I don't understand why anyone would voluntarily submit a statement that typically make admissions of facts and findings; promises to correct situations that have not necessarily been acknowledged or admitted to; and, in the end, simply draws more undesired attention to the matter. If you feel compelled to attach a Corrective Action Statements, then ask yourself if you might not be better advised to argue your case before a Hearing Panel and, if necessary, on appeal. 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.
Some think that a Corrective Action Statements 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. As with any post-game analysis, it's just not going to change the score. Moreover, if during subsequent examinations, a regulator finds that you engaged in similar misconduct to that discussed in your 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.
Some settling Respondents submit a Corrective Action Statement that details a proposed or in-place supervisory scheme at a current FINRA member firm -- which takes on the trappings of a proposed scheme of enhanced supervision of a statutorily disqualified individual attendant to the filing of a FINRA Membership Continuance Application (the "Form MC-400") http://brokeandbroker.com/PDF/MC400.pdf. I find that such a written proposal is an ill-advised practice because most AWC Respondents are merely suspended and fined and are not subjected to any further regulatory constraints after their time is served and the dollars paid. If FINRA wants to impose specific supervisory conditions upon a settling Respondent or require the submission of an undertaking by the registered rep or member firm, then so be it. On the other hand, why any member firm would draft an extensive list of compliance Do's and Don'ts to which a suspended rep would be subjected upon his or her return to production baffles me. Frankly, I'm old school: Don't volunteer anything and don't answer questions that weren't asked.
I appreciate that some employers/member firms think that memorializing an enhanced scheme of oversight for a settling registered person or member firm provides a hedge against future misconduct, but I don't agree with that premise. If a firm harbors such concerns about a particular associated person that the member feels compelled to memorialize in a FINRA settlement agreement an extensive, proposed supervisory protocol, then maybe that firm should terminate the individual. Similarly, if the firm intends to retain an outside, independent compliance consultant to redress in-house compliance failures, much of what needs to be reformed is likely stated at length in the AWC -- why restate the obvious or commit to steps that may prove unattainable?
And one last thing to mull over before you submit a Corrective Action Statement, just imagine what some customer's lawyer will do with that published list of proposed corrective actions if an associated person or the firm engages in future disputed conduct. A savvy Claimant's lawyer will cite the language in the AWC and will then cite your undertakings in the Corrective Action Statement. Wait and see how quickly a skilled lawyer will demonstrate that the firm promised "this" and swore it would do "that" but that was all lies -- and the brokerage firm will continue to dishonor its regulatory promises and compliance obligations unless you send it a strong message in the form of compensatory damages with the added kick of punitive damages. Yeah, I know, when I put it like that, it doesn't sound so good. Trust me, it will be put like just like that. Notwithstanding my opinions, Moloney apparently determined that it was advisable to submit a Corrective Action Statement:
STATEMENT OF CORRECTIVE ACTION SUBMITTED BY MOLONEY SECURITIES CO., INC. ("MOLONEY SECURITIES"), IN CONNECTION WITH FINRA LETTER OF ACCEPTANCE, WAIVER AND CONSENT ("AWC") NO.: 2015046315102
Moloney Securities submits this Statement of Corrective Action in connection with the foregoing AWC to demonstrate the steps it has taken to reduce the risk of recurrence of the issues addressed therein.
In the five years since the time FINRA commenced the investigation described in the AWC, Moloney Securities has engaged in significant and important to efforts to completely overhaul and enhance its compliance program and supervisory systems. The Relevant Period is defined in the AWC as January 2013 through April 2015. Following the worsening of the illness of the firm's founder and CEO and his death, the firm engaged in all of the following actions:
1. Appointed a new chief executive officer with more than thirty years' experience at the time
2. Launched a comprehensive review of the firm's compliance program, with the help of a nationally recognized broker-dealer consulting firm
3. Adopted a fully revised and entirely overhauled Written Supervisory Procedures manual that included enhanced provisions concerning suitability reviews for concentration and "mark the close" supervision
4. Replaced its chief compliance officer and later hired an additional compliance officer and additional compliance team members
5. Upgraded its trade surveillance system from the Standard version of ProtegentTM Surveillance (ProSurv), an application provided by its clearing firm, RBC Correspondent Services (RBC), and apparently used by roughly 90% of RBC's 200+ correspondent firms during the Relevant Period, to the more robust and expensive Enhanced ProtegentTM Surveillance system
6. Discharged the representative cited in the AWC for recommending over-concentrated investments
7. Terminated both representatives cited in the AWC in connection with "mark the close" issues
8. Provided restitution to several clients of the Discharged former representative
Moloney Securities' corrective actions, and the mitigating circumstances applicable to the AWC described in a statement that is not attached to the same but which has been submitted to FINRA, demonstrate the firm's long and continuing commitment to compliance and its efforts to fully address and resolve the isolated, legacy items which were the subject of the AWC. This
Corrective Action Statement is submitted by Moloney Securities Co., Inc. It does not constitute factual or legal findings by FINRA, nor does it reflect the views of FINRA, or its staff