NEWSFLASH: FINRA Observes Bad Actors In the Markets

February 11, 2021

Oh my! FINRA is urging its member firms to review their policies and procedures pertaining to low-priced securities. Wow, why actually get your hands dirty and regulate Wall Street when you can comfortably sit in the stands with electric hand-warmers, sippin' hot chocolate laced with bourbon, and, you know, urge the players on the field to play D-fense. On February 10, 2021, FINRA published Regulatory Notice 21-03: "Fraud Prevention / FINRA Urges Firms to Review Their Policies and Procedures Relating to Red Flags of Potential Securities Fraud Involving Low-Priced Securities" (FINRA Notice / February 10, 2021) 
To avoid accusations that I'm twisting FINRA's words, let me offer you the verbatim "Summary" portion of the FINRA Regulatory Notice 21-03:

Low-priced securities1 tend to be volatile and trade in low volumes. It may be difficult to find accurate information about them. There is a long history of bad actors exploiting these features to engage in fraudulent manipulations of low-priced securities. Frequently, these actors take advantage of trends and major events-such as the growth in cannabis-related businesses or the ongoing COVID-19 pandemic-to perpetrate the fraud.

FINRA has observed potential misrepresentations about low-priced securities issuers' involvement with COVID-19 related products or services, such as vaccines, test kits, personal protective equipment and hand sanitizers. These misrepresentations appear to have been part of potential pump-and-dump or market manipulation schemes that target unsuspecting investors.3 These COVID-19-related manipulations are the most recent manifestation of this type of fraud. 

This Notice provides information that may help FINRA member firms that engage in low-priced securities business assess and, as appropriate, strengthen their controls to identify and mitigate their risk, and the risk to their customers, including specified adults and seniors,4 of becoming involved in activities related to fraud involving low-priced securities. Firms that engage in low-priced securities business should also be aware of a recent SEC Staff Bulletin -- Risks Associated with Omnibus Accounts Transacting in Low-Priced Securities -- that highlights for broker-dealers various risks arising from illicit activities associated with transactions in low-priced securities through omnibus accounts, particularly transactions effected on behalf of omnibus accounts maintained for foreign financial institutions.5 

This Notice does not create any new requirements or expectations for member firms outside of their existing obligations pursuant to FINRA rules and applicable law, nor does implementing any of the practices cited here create a safe harbor from these obligations.

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1. For the purposes of this Regulatory Notice, the term "low-priced securities" refers to those securities that are sometimes referred to as "microcap stocks" or "penny stocks." The term "microcap stock" generally refers to securities issued by companies with a market capitalization of less than $250 to $300 million. See, e.g., U.S. Securities and Exchange Commission (SEC), Microcap Stock: A Guide for Investors (Sept. 18, 2013) and U.S. Securities and Exchange Commission, Investor Bulletin, Microcap Stock Basics (Sept. 30, 2016). The term "penny stock" generally refers to a security issued by a very small company that trades at less than $5 per share. See Fast Answers: Penny Stock Rules; Section 3(a)(51) of the Securities Exchange Act of 1934 ("Exchange Act") and Rule 3a51-1 thereunder. 

2. See also Regulatory Notice 20-13 (FINRA Reminds Firms to Beware of Fraud During the Coronavirus (COVID-19) Pandemic). 

3. As used here, "fraud involving low-priced securities" can include market manipulation and "pump and dump" schemes. 

4. "Specified adult" as defined in FINRA Rule 2165 (Financial Exploitation of Specified Adults) refers to: (A) a natural person age 65 and older; or (B) a natural person age 18 and older who a firm reasonably believes has a mental or physical impairment that renders the individual unable to protect his or her own interests. 

5. In addition to highlighting the risks described, the SEC Staff Bulletin also reminds brokers-dealers of their associated obligations under the Bank Secrecy Act (BSA), Rule 17a-8 under the Exchange Act, Section 5 of the Securities Act of 1933 ("Securities Act"), and FINRA rules. The Bulletin Endnotes states that in the view of SEC staff, sufficiently discharging existing anti-money laundering (AML) obligations under the BSA requires broker-dealers to consider, among other things, the risks associated with the multiple layers of accounts through which transactions in low-priced securities may have been routed.

How am I going to ever regain those 20 minutes of my life that I lost reading through such claptrap? Once you get past the "Summary," you are free to peruse the remaining nine pages of equally useless advice, citations, references, and 15 additional "Endnotes." 

This is not regulation. 

At best, this is the art of marketing the appearance of regulation. 

At worst, this is an outrageous bit of self promotion that doesn't even go through the motions of regulation.

Hundreds of millions of Americans are humbled in their personal and professional lives by COVID. There are those among us, however, who see all this pain and suffering as an opportunity to scam, to defraud, and to victimize.  On Wall Street, some see an opening to manipulate the markets for microcaps and pennystocks. There are those who are numbed with boredom as they social distance at home and read about the wild gyrations in stocks that are selling for pennies and, hmmm, I got nothing else to do so maybe I can play the market and, who knows, even if it's nothing more than gambling, I'm willing to take the risk. After some four decades on the Street, I'm not surprised. I've seen the floodgates open before. 

Oddly, the FINRA Regulatory Notice uses the euphemism of "low-priced securities." Sorta sounds nice when you put it that way, no? Not a "used" car but a "previously-owned" vehicle. Some microcaps will emerge from the cesspool and prove to be amazing companies -- you will wish that you had invested in them. Some pennystocks are truly under-valued or represent wonderful opportunities for growth. I'm a libertarian and a capitalist. It's your buck. You put it on black or red. It's not my place to become your daddy. I don't want the government stepping into that role. I sure as hell don't trust FINRA to be in loco parentis. What, then, do I expect from FINRA? 

I expect FINRA to do its job. 

That job is to actively regulate its member firms and their associated persons. 

Regulatory Notice 21-03 is not regulating. 

FINRA asserts in the Notice that there is a "long history of bad actors exploiting" microcaps and pennystocks. Which begs the question: What the hell are you actually doing to end that long history? Do you think that urging your member firms to review their policies and procedures is going to weed out the bad actors? Isn't that what your 3,000-plus regulatory employees are supposed to be doing each and every day? 

The "Summary" admits that bad actors "engage in fraudulent manipulations." I'm guessing most veteran industry compliance staff know that. Also, I'll bet that more than half of FINRA staff is aware of that. As such, FINRA persists in restating the obvious. Accordingly, we just don't need more notices purporting to provide "information that may help FINRA member firms that engage in low-priced securities business." Help? The report asserts that the "help" will take the form of informing those firms how to "strengthen their controls." So . . . just how the hell does pointing a disapproving regulatory finger at bad actors do anything to disengage the miscreants from fraud? It doesn't. At some point, FINRA needs to elevate its game. The regulator might want to cut back on its podcasts, videos, press releases, and notices. 

When I was a regulator in the 1980s, the examiners and investigators sure as hell seemed to be visiting brokerage firms and using their eyes and ears to ferret out fraud. That job doesn't get done via a ZOOM teleconference. That job doesn't get done via a three-day seminar with featured speakers and opportunities to network. The solutions are still old fashioned. A local cop on the beat who knows the neighborhood. That means less centralized control from Washington, D.C. and more power to the local districts, which is the model for the FBI and the US Attorneys. If FINRA's senior staff is so aware of the bad guys in our biz, then it's time to send your investigators into the offices where all the bad acts are occurring  instead of sitting in D.C. and churning out more reports and podcasts. And maybe you could reallocate more funds to the local FINRA District offices, where the best work was always done but never quite fully credited. 

While I'm on this jeremiad, how about you folks at FINRA stop with all the citations to the Securities and Exchange Commission's ("SEC's") online content. Seriously, enough already. It's absurd. Your January 2021 Regulatory Notice is urging your member firms to review their in-house policies and procedures; and then, in that same notice, you refer those firms to yet another layer of reports and notices albeit drafted and published by the SEC. You got compliance staff reading your notices, reading their in-house materias, and reading the SEC's various edicts. With that prodigious reading list, your member firms' Compliance Departments are going to have to hire a full-time employee charged with nothing else than reading the daily discharge of effluent that flows out of all of Wall Street's self-, state-, and federal-regulators.  C'mon already -- stop it!  That's not effective regulation. That's a Wall Street Book Club. It's one thing to justify the compliance costs and staffing allocations if FINRA's notices were substantive; however, it's quite another thing to justify those costs and staffing when we are confronted with this admonition at the end of the "Summary":

This Notice does not create any new requirements or expectations for member firms outside of their existing obligations pursuant to FINRA rules and applicable law, nor does implementing any of the practices cited here create a safe harbor from these obligations.

What then was the point of publishing the Regulatory Notice 21-03 if it doesn't create anything new -- it's just shootin' the breeze? FINRA, is that the best you got? 

Just by way of making a point, on February 11, 2021 the SEC posted "SEC Suspends Trading in Inactive Issuer Touted on Social Media" (SEC Release)
In the SEC Release, the federal regulator isn't urging anyone or any firm to review anything. To the contrary, the SEC announced that it had issued an Order suspending trading in SpectracScience (Symbol: "SCIE"), which, as it turned out, was an inactive company that had become the darling of social media pumping. Pointedly, the Order asserts that SpectraScience is delinquent in its reporting since 2017, and that its most recent website and phone number are non-functional. That's an example of a Wall Street regulator engaged in regulation rather than issuing mere notices.

I was once an American Stock Exchange and an NASD regulatory lawyer -- I know all too well how hard my colleagues worked, and I am all too familiar with the pernicious harm caused by corrosive industry influence/interference. Similarly, I remember all too well the enervating impact of new-hires and promotions that were not based on merit. When this pandemic is over, let's return to the old-school, boots on the ground, neighborhood policing of Wall Street. And when FINRA's staff gets the job done, let's promote those with talent, and let's give bonuses to those who did the work. On the other hand, let's stop flooding the industry with feel-good, make-work FINRA crapola. Indeed, there are significant regulatory issues attendant to the interaction of the Covid pandemic and the rise in microcap/pennystock fraud. Don't write about it. Do something! Try regulating for a change. There is a best in you. Find it. Might I refer you to Wall Street's musical regulators, the Foo Fighters, and urge you to listen to their lyrics in "Best of You," among which is this choice nugget:

You gave me something that I didn't have but had no use.