July 8, 2020
A recent FINRA regulatory settlement shines a harsh light on problems involving the delicate interplay between investment banking and research. As most Wall Street professionals know, there's supposed to be a wall of sorts separating those two functions. It's not a real wall like President Trump is trying to build. It's more of a theoretical wall. The thing is, theoretical walls aren't always that good at dividing things because, well, hey, you can literally walk through a theoretical wall and like who's gonna know, right?
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, Chardan Capital Markets, LLC submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. In the Matter of Chardan Capital Markets, LLC, Respondent (FINRA AWC 2017054925801)
The AWC asserts that Chardan Capital Markets, LLC has been a FINRA member firm since 2002 with about 43 registered representatives. As set forth in part in the AWC, Chardan's:
investment banking group underwrites public offerings as well as private
investments in public entities ("PIPEs") for small to mid-cap issuers, mostly in the
healthcare and technology sectors. The research group produces and publishes research
reports on similar companies, some of which had a direct investment banking relationship
with the Firm. . . .
The AWC asserts that Chardan "does not have any relevant disciplinary history with the Securities and Exchange Commission, any state securities regulators, FINRA, or any other self-regulatory organization."
123 Disclosure Deficiencies
The AWC alleges that during the review period from March 5, 2013 through August 31, 2016, Chardan published at least 103 research reports covering 15 subject companies; however, the firm omitted or erroneously included 123 disclosure deficiencies. As set forth in the AWC:
- FINRA Rule 2241(c)(4)(C)(i) and NASD Rule 2711(h)(2)(A)(ii)(a) require
members to disclose in research reports if they "managed or co-managed a
public offering of securities for the subject company in the past 12 months[.]"
During the Review Period, Chardan failed to disclose that it was the co-manager of a securities offering in 16 reports to which this disclosure applied.
- FINRA Rule 2241(c)(4)(C)(ii) and NASD Rule 2711(h)(2)(A)(ii)(b) require
that members disclose in research reports if they "received compensation for
investment banking services from the subject company in the past 12
months[.]" During the Review Period, Chardan failed to disclose that it
received compensation for investment banking services in 10 reports to which
this disclosure applied. Further, Chardan inaccurately disclosed in 35 research
reports that it received compensation for investment banking services from the
subject company when this disclosure did not apply.
- FINRA Rule 2241(c)(4)(G) and NASD Rule 2711(h)(8) require that a
member "disclose in research reports if it was making a market in the subject
company's securities at the time that the research report was published."
During the Review Period, Chardan failed to disclose in 62 reports that it was
a market maker in securities issued by the subject company at the time of
The AWC alleges in part that
[C]hardan's supervisory systems and written procedures were not reasonably designed to achieve compliance with these disclosure requirements because the Firm failed to reasonably track and communicate the information necessary to make required disclosures to the research supervisors who were responsible for reviewing and approving each research report before publication. Further, this resulted in the disclosure deficiencies set forth in the section above.
FINRA deemed the above supervisory lapses to constitute violations of FINRA Rules 3110(a) and (b)(1) (for
conduct on and after December 1, 2014), NASD Rules 3010(a) and (b)(1) (for conduct
before December 1, 2014) and 2711(i) (for conduct on and before September 24, 2015),
and FINRA Rule 2010.
During the 2013 through 2016 review period, the AWC alleged that Chardan's investment banking department consisted of 16
employees, seven of whom were members of the Special Equities Group ("SEG") until SEG's personnel left the firm around May 2019). As alleged in part in the AWC, Chardan:
failed to enforce
its policies and procedures to block direct email communications between the SEG
investment banking personnel and research personnel or ensure that compliance acted as
an intermediary for communications between the SEG investment banking personnel and
During the Review Period there were a number of direct email communications between
SEG personnel and research personnel without compliance as an intermediary or any
other institutional safeguards or supervisory review. Further, some direct email
communications between SEG personnel and research personnel included improper
suggestions by SEG investment bankers that research personnel should help solicit
investment banking clients.7 For example:
- In an email dated February 24, 2015, sent by a SEG employee to other
SEG employees and two research analysts, the SEG employee proposed
establishing weekly meetings between research and investment banking,
and stated that the investment banking department would use research
staff "as the first introduction to new companies to bait them in" and get
investment banking's "foot in the door[.]"
- An email dated November 19, 2015, sent by the head of SEG to a research
analyst, asked whether the head of SEG should have the head of research
"show some love" to a prospective investment banking customer.
= = = = =
Footnote 7: The review of this matter found no evidence that the activities suggested ultimately occurred.
The AWC deemed the above conduct to constitute violations of FINRA Rule 3110(b)(1) (for conduct on and after December 1, 2014), Rules 2241(b)(1), 2241(b)(2)(G) and 2241(b)(2)(M)(i) (for conduct on and after December 24, 2015) and 2010, and NASD Rules 3010(b)(1) (for conduct before December 1, 2014) and 2711(i) (for conduct on and before September 24, 2015).
In accordance with the terms of the AWC, FINRA imposed upon Chardan a Censure and $100,000 fine. Additionally, Chardan agreed to undertake a review of its supervisory system and procedures concerning research reports and the supervision of research analysts for compliance with FINRA rules and the federal securities laws and regulations.
Bill Singer's Comment
Compliments to FINRA for an unusually well-crafted AWC replete with content and context. I would love to get in a couple of well-deserved shots about the alleged violations, but, gee, FINRA has done such a wonderful job in the AWC that I will keep my mouth shut. Hint to FINRA; If you want to keep me quiet, keep doing a wonderful job.