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FINRA Fines Small Firm And its Owner For Misclassification of Expenses
October 21, 2020
The other day, our publisher Bill Singer had one of those moments when he read a recent FINRA regulatory settlement. It wasn't that Bill disagreed with FINRA's charges; frankly, he accepted the findings of misconduct. It wasn't that Bill didn't think that FINRA was justified in imposing some sanction; frankly, Bill accepted that some punishment was necessary. What got Bill agitated was that, yet again, the heavy hand of FINRA regulation seems to come down disproportionately upon one of the industry's little guys. Lacking in the settlement seemed to be balance. Lacking in the settlement seemed to be a recognition of the financial devastation of the COVID pandemic. Lacking in the settlement seemed to be some recognition of the existential threat currently posed to all of FINRA's small firms. On the other hand, when it comes to its small firms and the industry's associated persons, "lacking" tends to come up a lot in reference to FINRA.
The AWC
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, Montrose Securities International and Philip Y. Leung submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted.
In the Matter of Montrose Securities International and Philip Y. Leung, Respondents (FINRA AWC 2019061008601)
https://www.finra.org/sites/default/files/fda_documents/2019061008601
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The AWC alleges that Montrose Securities has been a member since 1994 and employs two registered representatives/general securities principals including Respondent Leung. The AWC alleges that Leung was first registered in 1983, and founded Montrose in 1993. The AWC asserts that the Respondents "do not have any relevant disciplinary history." As alleged in the "Overview" portion of the AWC:
From January 2017 through November 2018, Leung inaccurately classified certain of his personal expenses as business expenses on Montrose Securities' general ledger, in violation of FINRA Rule 2010. Leung then used the inaccurate general ledger to prepare monthly FOCUS reports, which were also inaccurate, understating the amount paid to Leung and overstating the firm's business expenses. Because Leung's conduct caused the firm's books and records to be inaccurate, Leung further violated FINRA Rules 4511 and 2010; his conduct also caused Montrose Securities to have inaccurate books and records, in violation of Section 17(a) of the Securities Exchange Act of 1934 and Rules 17a-3 and 17a-5 thereunder, and FINRA Rules 4511 and 2010.In addition, from January 2017 through November 2018, Montrose Securities and Leung failed to establish and maintain a supervisory system, including written supervisory procedures (WSPs), regarding business expense reimbursement reasonably designed to ensure compliance with FINRA Rule 4511 and Section 17(a) of the Exchange Act and Rules 17a-3 and 17a-5 thereunder. Based on the foregoing, Montrose and Leung violated FINRA Rules 3110(a) and (b), and 2010.
As to the nature of the disputed personal expense, the AWC alleges in part:
[D]uring the above period, Leung improperly characterized over $152,000 of personal expenses as business expenses, resulting in the firm paying for $152,000 of personal expenses that did not relate to the firm's business or customers such as: gas, groceries, vacation dining and hotel stays, and sporting events.
$30,000 In Fines
In accordance with the terms of the AWC, FINRA imposed upon:
- Montrose: a Censure and a $10,000 fine;
- Leung: a $10,000 fine and a one-month suspension from associating with any FINRA member in any capacities; and
- Montrose and Leung jointly and severally: a $10,000 fine.
Bill Singer's Comment
FINRA's online BrokerCheck discloses that the only "Direct Owners and Executive Officers" of the firm are Leung, who is listed as "PRESIDENT - FINOP - CHIEF COMPLIANCE OFFICER," and the owner of "75% or more" of the firm. Montrose is NOT a public company. Montrose conducts three -- and only three -- types of business: retailing corporate securities over-the-counter, selling corporate debt securities, and arranging for transactions in listed securities. Notably, Montrose does not refer or introduce customers to other brokers and dealers, and BrokerCheck further notes:
Industry ArrangementsThis firm does not have books or records maintained by a third party.This firm does not have accounts, funds, or securities maintained by a third party.This firm does not have customer accounts, funds, or securities maintained by a third party.Control Persons/FinancingThis firm does not have individuals who control its management or policies through agreement.This firm does not have individuals who wholly or partly finance the firm's business.
My guess is that Montrose is pretty much a one-man operation, and that one man is Leung. I'm betting that it's Leung who unlocks the office door each morning, turns on the lights, makes the coffee, cleans the toilet, fixes the copy machine, answers the phones, calls out and pays for lunch, replaces the roll of toilet paper, turns off the lights at night, usually remembers to lock the door behind him, and, well you get my drift here, right? Montrose is Leung and Leung is Montrose, so howsabout we cut out the crap in the Montrose/Leung AWC about how:
From January 2017 through November 2018, Montrose and Leung failed to establish and maintain a reasonable supervisory system, including WSPs, to supervise the reimbursement of firm business expenses. The firm's WSPs stated Leung was responsible for establishing and maintaining the firm's supervisory manual and for the firm's overall supervisory system. The WSPs also stated that Leung was responsible for carrying out the firm's WSPs, and for formally reviewing the firm' procedures on an annual basis.The firm's WSPs did not address what business expenses employees could be reimbursed for or require employees to submit any documentation describing the business purpose for each expense. The firm also did not conduct any reviews in order to determine whether the expenses had been improperly charged to the firm or not. Due to these supervisory deficiencies, the firm had no way to reasonably evaluate or verify whether the payments Leung recorded on the firm's general ledger as "business expenses" were accurate, as required by FINRA Rule 4511, and Exchange Act Section 17(a) and Rules 17a-3 and 17a-5 thereunder. And as a result, Leung inaccurately characterized over $152,000 of personal expenses as business expenses; he then improperly made payments for these personal expenses.
The firm did not conduct reviews?
The firm had no way to reasonably evaluate the expenses?
You mean Leung -- the owner/operator?
Yes, I freely and wholeheartedly concede that FINRA oversees its member firms and that Montrose is such a firm, and, yes, I concur that mischaracterization of expenses is a problem and may even be a legitimate example of misconduct for FINRA to sanction. As you can see, I'm not arguing the legitimacy of FINRA's regulation of mischaracterized expenses.
On the other hand, did you note that FINRA imposed a total of $30,000 in fines on Leung and his company? That doesn't strike me as fair and reasonable regulation but the charade of a regulatory speed trap for smaller firms and their mom-and-pop owners. Couldn't FINRA have just imposed a Censure on Montrose Securities and a modest suspension on Leung -- or, in the alternative, a Censure on the firm and a total of $10,000 in fines on both Leung and Montrose?
A few years ago, Merrill Lynch's former Chief Executive Officer John Thain got caught up in a mess involving expenses and whether they were bona fide or not. As reported in "Merrill Lynch CEO Thain Spent $1.22 Million On Office" (CNBC.com at https://www.cnbc.com/id/28793892 :
When John Thain became Merrill Lynch's CEO in early 2008, he hired Michael S. Smith Design to revamp his office suite, spending approximately $1.22 million according to documents.Additionally, documents showed that Thain signed off on the purchases personally, and that he used over $30,000 to pay the expenses Smith incurred in doing the work.The following is a list of the items in his suite:
- Area Rug $87,784
- Mahogany Pedestal Table $25,713
- 19th Century Credenza $68,179
- Pendant Light Furniture $19,751
- 4 Pairs of Curtains $28,091
- Pair of Guest Chairs $87,784
- George IV Chair $18,468
- 6 Wall Sconces $2,741
- Parchment Waste Can $1,405
- Roman Shade Fabric $10,967
- Roman Shades $7,315
- Coffee Table $5,852
- Commode on Legs $35,115
. . .Thain was appointed as Merrill's CEO as the firm suffered massive losses from investments tied to the depressed real estate market under his predecessor Stan O'Neal, who was ousted in late 2007.Those losses continued through 2008, forcing Thain and his management team to sell the brokerage firm to Bank of America in mid September or face near certain liquidation as investors fearing further losses began pulling lines of credit and other financing.
As Thain himself explained, in part, in his final memo to Merrill Lynch's employees on January 26, 2009: "Thain's Memo To Merrill Lynch Employees" (CNBC.com, January 26, 2009) https://www.cnbc.com/id/28854764:
It has been an honor to lead this company over the last very difficult year. The decisions that I made were always with the best interests of our shareholders and employees above all. I believe that the decision to sell to Bank of America was the right one for our company and our clients. While the execution has been difficult, I still believe in the strategic rationale of the transaction and I wish you all the best for the future of the combined companies.. . .The final topic is the expenses related to my office. The $1.2 million reported in the press was for the renovation of my office, two conference rooms and a reception area. The expenses were incurred over a year ago in a very different environment. Nonetheless, they were a mistake in the light of the world we live in today. I will therefore reimburse the company for all of the costs incurred. . . .
As to those office renovation costs that Thain incurred:
MARIA BARTIROMO: John, I want to ask you more about the environment that we're in, but I've gotta ask you first about the office. You spent more than $1 million renovating your office. Is this true?JOHN THAIN: Well, first of all, it is true. This was a year ago, actually a little bit more than a year ago, in a very different economic environment and a very different outlook for Merrill and the financial services industry. It was my office. It was two conference rooms and it was a reception area. But it is clear to me in today's world that it was a mistake. I apologize for spending that money on those things, and I will make it right. I will reimburse the company for all of those costs.BARTIROMO: Why did you need to renovate the office? What was wrong with Stan O'Neil's office?THAIN: Well, his office was very different than the general decor of Merrill's offices. It really would have been very difficult for me to use it in the form that it was in. And, you know, it needed to be renovated no matter what. It would have been better for me to simply --I should have -- simply paid for it myself at the time.
Now, I don't want to be too cynical here. After all, Thain did explain that the $1.2 million in questioned expenses wasn't just for his office but included two conference rooms and a reception area. It was an issue of "decor." Given that explanation, we really should not have been so hasty in condemning Thain's expenditures because it wasn't like the world was melting down during the onset of the Great Recession. The inappropriate use of public shareholders' money for over-priced corporate renovations should never, ever be a regulatory issue, right? You can't expect a C-Suiter to work in a tawdry C-Suite or sit in a shabby conference room or walk on the worn carpet of a reception area. A small-business owner like Montrose's Leung, however is an entirely different consideration. As FINRA's regulatory investigation and settlement suggest, Leung's misconduct was a moral outrage of exponential proportions compared to what Thain did. After all, Thain's expenses involved rugs, tables, credenza, curtains, chairs, sconces, and other furnishings; whereas Leung's expenses involved gas, groceries, vacation dining and hotel stays, and sporting events. Any idiot can see the massive difference in the nature of the expenses, right? Certainly an idiot like FINRA did.
Why am I being so sarcastic? Why I am making light of Leung's alleged misconduct?
Someone, anyone, please send me the link to the FINRA AWC involving its investigation of and sanctioning of John Thain's business expenses -- oh, and why you're at it, send me the link to the investigation and sanctioning of Merrill Lynch for the same underlying conduct. You know, like what we have set out in all its glory in the Montrose/Leung AWC.
Please, don't ask me to give Thain a regulatory pass because he ultimately repaid all or part of those lavish office expenses. If you feel that such after-the-fact contrition is enough to avoid FINRA charges and sanctions, then offer all associated persons caught cheating on their business expenses the same opportunity to write out an after-the-fact check and avoid a regulatory history. And while you're showing such mercy, keep in mind that Thain submitted his expenses to Merrill Lynch, which was a public company and whose shareholders were largely on the hook for the renovations -- in Leung's case, Monarch is essentially his alter-ego.
(BrokeAndBroker.com Blog / October 16, 2020)http://www.brokeandbroker.com/5486/finra-rule-proposal/From my perspective, FINRA is an inept and frequently ineffective regulator, which I have long characterized as the lap dog of its larger member firms. Frankly, FINRA comes off as little more than a hijacked trade-group intent on eliminating its smaller members and promoting financial superstores and regional brokerages. Harsh words? Absolutely. Off the mark and unfair? I think not.