Given all the fraud that has emanated from FINRA's member firm broker-dealers in recent decades, the investing public needs someone on the ramparts of Wall Street -- vigilant, on-watch, alert. Clearly FINRA has the staffing to do the job, but does FINRA get the job done? At first glance, a recent million-dollar settlement suggests that FINRA is a vigilant regulator; however, after further scrutiny, that same settlement exposes FINRA as little more than a toll-booth on Wall Street.
FINRA's September 8, 2022, Joseph Stone Capital News Release
In pertinent part, the September 8th FINRA release asserts that:
WASHINGTON-FINRA announced today that it has ordered Joseph Stone Capital LLC to pay restitution of approximately $825,000 to customers whose accounts were excessively traded by the firm's representatives. In related settlements, FINRA suspended eight current or former Joseph Stone representatives and required them to pay, collectively, an additional $211,000 in restitution to the firm's impacted customers. In addition, FINRA suspended three supervisors at the firm for failing to reasonably identify or respond to red flags of excessive trading, and barred two representatives for refusing to respond to FINRA's requests for information in connection with the investigation.
FINRA found that from January 2015 to June 2020, Joseph Stone failed to implement a supervisory system reasonably designed to comply with FINRA's rules relating to excessive trading. As a result, the firm failed to identify or address representatives' excessive and unsuitable trading in 25 customer accounts, causing the customers to incur approximately $1 million in commissions and other trading costs. The trading in these accounts generated cost-to-equity ratios-that is, the amount the accounts must increase in value just to cover commissions and other trading expenses-ranging from 21%-96%.
. . .
The excessive trading in these accounts was evident in exception reports made available to Joseph Stone by its clearing firm, including an "active account report" that flagged accounts with high-commission-to-equity ratios. However, the designated principal responsible for reviewing actively traded accounts often did not review this report. Even when a supervisor flagged an account for potential excessive trading, Joseph Stone did not respond appropriately. For example, in several instances when the firm identified red flags of excessive trading, the firm responded by prospectively restricting the commission that the representative could charge for certain trades in the account. The firm, however, did not restrict the number of trades the representative could execute in the account or the aggregate commissions that could be charged-in other words, representatives could simply place more frequent trades in the account, earning higher commissions on a larger number of trades.
In related settlements:
Three Joseph Stone principals who failed to reasonably respond to red flags of excessive trading agreed to supervisory suspensions ranging from two to five months: Adam Maggio, Joseph Scott Audia, and Anthony Joseph Graziano;
Eight Joseph Stone representatives who excessively traded customer accounts agreed to suspensions ranging from three to eight months and to pay, collectively, approximately $211,000 in restitution: Miguel Angel Murillo, Joseph A. Ambrosole, Sebastian Wyczawski, Michael James May, Douglas J. Rosenberg, Todd Franklin Kling, Martin J. Petela, and Nico Rutella. As part of the settlement, Joseph Stone also agreed to place the representatives who are still associated with the firm on heightened supervision for two years; and
Two Joseph Stone representatives agreed to bars from associating with any FINRA member for refusing to respond to FINRA's requests for information in connection with the investigation: Eugene A. McAdams and David Martin Martirosian.
In settling these matters, the respondents consented to the entry of FINRA's findings while neither admitting nor denying the charges.
By way of recap: The FINRA September 8, 2022, News Release asserts that "FINRA found that from January 2015 to June 2020, Joseph Stone failed to implement a supervisory system . . " FINRA required its member firm Joseph Stone Capital to pay $825,000 in restitution; and, also, FINRA suspended three of the firm's supervisors and eight of the firm's representatives, and required them to pay $211,000 in restitution. Notwithstanding the findings and sanctions, the News Release advises that "In settling these matters, the respondents consented to the entry of FINRA's findings while neither admitting nor denying the charges." Also see: "FINRA Sanctions Joseph Stone Capital for Failed Supervision -- Regulator Cites Suitability and Excessive Trading" (Securities Industry Commentator / September 8, 2022)https://www.rrbdlaw.com/6645/securities-industry-commentator/#jstone
What's a FINRA?
For those unfamiliar with Wall Street's self-regulatory-organization FINRA, the September 8, 2022, News Release offers the following under "About FINRA":
FINRA is a not-for-profit organization dedicated to investor protection and market integrity. It regulates one critical part of the securities industry-brokerage firms doing business with the public in the United States. FINRA, overseen by the SEC, writes rules, examines for and enforces compliance with FINRA rules and federal securities laws, registers broker-dealer personnel and offers them education and training, and informs the investing public. In addition, FINRA provides surveillance and other regulatory services for equities and options markets, as well as trade reporting and other industry utilities. FINRA also administers a dispute resolution forum for investors and brokerage firms and their registered employees. For more information, visit www.finra.org.
The Joseph Stone Capital FINRA AWC
In entering into its regulatory settlement with its member firm Joseph Stone Capital, FINRA set out its findings and sanctions in a settlement document known as a Letter of Acceptance, Waiver, and Consent ("AWC") https://www.finra.org/sites/default/files/fda_documents/ 2019063821607%20Joseph%20Stone%20Capital%20L.L.C.%20 CRD%20159744%20AWC%20va.pdf. Under "A. The Applicable Rules," the AWC asserts that:
FINRA Rule 3110(a) requires that member firms "establish and maintain a system to
supervise the activities of each associated person that is reasonably designed to achieve
compliance with applicable securities laws and regulations, and with applicable FINRA
rules." FINRA Rule 3110(b) requires that each FINRA member "establish, maintain, and
enforce written procedures to supervise the types of business in which it engages and the
activities of its associated persons that are reasonably designed to achieve compliance
with the applicable securities laws and regulations, and with applicable FINRA Rules."
To comply with these obligations, a firm must reasonably investigate red flags of
potential misconduct and take appropriate action when misconduct has occurred. A
violation of FINRA Rule 3110 also constitutes a violation of FINRA Rule 2010, which
requires that member firms "observe high standards of commercial honor and just and
equitable principles of trade" in the conduct of their business.
at Page 2 of the Joseph Stone Capital AWC
SIDE BAR: FINRA Rule 3110: Supervision requires in part that:
(a) Supervisory System
Each member shall establish and maintain a system to supervise the activities of each associated person that is reasonably designed to achieve compliance with applicable securities laws and regulations, and with applicable FINRA rules. Final responsibility for proper supervision shall rest with the member. A member's supervisory system shall provide, at a minimum, for the following: . . .
(b) Written Procedures (1) General Requirements Each member shall establish, maintain, and enforce written procedures to supervise the types of business in which it engages and the activities of its associated persons that are reasonably designed to achieve compliance with applicable securities laws and regulations, and with applicable FINRA rules. . . .
As enunciated in FINRA Rule 2010 and FINRA Rule 3110(a) and (b), reasonably designed supervisory systems and written supervisory procedures ("WSPs") are paramount obligations of FINRA member firms, such, that non-compliance rises to a violation of "high standards of commercial honor and just and equitable principles of trade."
2015 to 2020: Five Years of Supervisory Lapses (and Regulatory Lapses!)
The AWC alleges that FINRA member firm Joseph Stone Capital failed to supervise: "From January 2015 through June 2020, Joseph Stone's WSPs did not provide reasonable guidance about how to identify accounts that were being excessively traded" at Page 2 of the AWC.
WSPs as in "written" documents.
Written as in displaying words that are readable by a FINRA examiner.
If a WSP lacked sufficient words to "provide reasonable guidance," then that inadequacy should have been apparent to FINRA's staff as well as a regulated firm's staff.
Apparent to FINRA's examiners in 2015, 2016, 2017, 2018, 2019, and 2020 when Joseph Stone's WSPs persisted in not providing reasonable guidance.
Sadly, there are no regulators so blind as those who will not see.
3,394 FINRA Members / 3,600 Smart, Dedicated and Passionate FINRA Employees
Does FINRA have the Staff to undertake an annual review of each of its member firms?
In fact, there are more FINRA employees than the 3,394 FINRA member firms:
Visualize yourself as one of our 3,600 smart, dedicated and passionate employees - what do you see? Watch the videos below to hear employees from New York to Denver (and more) discuss what it's like to work at FINRA, and how each of them contributes to our mission of facilitating investor protection and market integrity.
Given all the fraud that has emanated from FINRA's brokerage firms in recent decades, the investing public needs someone on the ramparts of Wall Street -- vigilant, on-watch, alert. Clearly FINRA has the staffing to do the job, but does FINRA get the job done? At first glance, the Joseph Stone Capital AWC suggests that FINRA is a vigilant regulator; however, after further scrutiny, that same AWC suggests that FINRA is merely a toll-booth on Wall Street.
FINRA conducts between 1,500 and 2,000 risk-based cycle examinations each year to assess identified
risks and controls and determine whether firms are in compliance with federal securities laws, rules
and regulations. Each year, FINRA assesses your firm's business activities, the risks associated with
those activities and any factors that may influence or otherwise impact FINRA's assessment of risk to
determine whether your firm's cycle examinations will be conducted on a one, two, three or four-year
cycle. While it's possible that your firm's cycle may change from one year to the next, your firm will
receive a cycle examination at least once every four years.
at Page 1 of Preparing for a FINRA Cycle Examination
FINRA's examination cycle will likely be "at least once every four years." From an investor perspective, that's just absurd. A lot of carnage can go on in someone's retirement account over four years.
66 Months of Excessive Trading (but not excessive FINRA regulation)
The FINRA News Release states that "FINRA found that from January 2015 to June 2020, Joseph Stone failed to implement a supervisory system reasonably designed to comply with FINRA's rules relating to excessive trading." Similarly, the AWC states that "From January 2015 through June 2020, Joseph Stone's WSPs did not provide reasonable guidance about how to identify accounts that were being excessively traded."
The relevant period from January 2015 to June 2020 constitutes 66 months -- as in 18 months more than FINRA's 48-month examination cycle.
How come no FINRA examiner discovered that Joseph Stone had failed to implement a supervisory system reasonably designed to comply with FINRA's rules relating to excessive trading during the 48-months in which FINRA assures us that it will "at least" conduct a cycle exam?
Before attempting to answer that last question, consider the flagrant evidence of excessive trading set forth in detail by FINRA itself:
[J]oseph Stone's system for identifying excessively
traded accounts was not reasonably designed. During the relevant period, Joseph Stone
received exception reports through an online portal created by the firm's clearing firm,
including an "active account report" that flagged accounts with high commission-to-equity ratios. However, prior to November 2017, the firm did not require the designated
principal responsible for reviewing actively traded accounts to regularly review the active
account reports. Instead, the designated principal attempted to identify excessively traded
accounts based on his own manual calculations, which compared the commissions
charged in an account to the account's current value, rather than its average net equity,
and which often understated the cost-to-equity ratio.2
As a result of this manual review, the firm failed on numerous occasions to identify
accounts that had red flags of excessive trading, including accounts with cost-to-equity
ratios greater than 20 percent. . . .
= = = = =
Footnote 2: In a separate AWC with FINRA, the principal at the firm responsible for reviewing actively traded accounts consented to findings that he failed to reasonably supervise customer accounts for potentially excessive trading, in violation of FINRA Rules 3110 and 2010. As part of the settlement, the principal consented to sanctions including a five-month suspension in all principal capacities, a $5,000 fine, and 20 hours of continuing education.
at Page 3 of the Joseph Stone Capital AWC
66 Months of Missing Reasonable Written Guidance (and blind FINRA Staff)
If a FINRA examiner had walked into Joseph Stone Capital once every 48 months during the 66 months at issue, it should have been obvious -- as the lack of words on a WSP page -- that the firm's WSPs were not reasonable per FINRA Rule 3110. Why is there no representation in the AWC itself that FINRA had previously alerted the firm to the unreasonableness of its WSPs? If FINRA only noted the non-compliant WSPs in late 2020, then what the hell is the point of having WSPs, and what, exactly, do FINRA examiners examine during a once-every-four-year cycle examination? Consider this mind-boggling allegation in the AWC:
From January 2015 through June 2020, Joseph Stone's WSPs did not provide reasonable
guidance about how to identify accounts that were being excessively traded. . . .
at Page 2 of the Joseph Stone Capital AWC
Yet again, the calendar betrays FINRA. During some 66 months, FINRA alleges that the Joseph Stone Capital WSPs did not provide reasonable guidance about how to identify excessively traded accounts.
Which means that somewhere in that 66 month continuum, FINRA should have sent examination Staff into member firm Joseph Stone pursuant to the regulator's 48-month cycle-exam stopwatch.
Assuming that FINRA is good to its word when it promises an examination cycle of no longer than every 48 months, are we to conclude that during the relevant time, no examiner noted that the firm's WSPs lacked "reasonable guidance about how to identify accounts that were being excessively traded"? And if no FINRA examiner detected the inadequacy of Joseph Stone's WSPs, then apparently no FINRA examiner brought that omission to the firm's attention during the 66 months at issue. So much for FINRA being "dedicated to investor protection and market integrity."
Active Account Report. Inactive Supervision. Inactive Compliance. Inactive Regulation
As alleged by FINRA, Joseph Stone Capital's purported supervisory/compliance lapses are serious, extensive, and of a long duration. I'm willing to accept FINRA's AWC as regulatory gospel. Having taken that vow of faith, however, I am not transformed into anything akin to a true believer in FINRA's flawed version of regulation. To better understand my reluctance, consider this allegation in the AWC:
Joseph Stone received an active account report dated April 30, 2016, that showed
Customer B had been charged more than $4,000 in commissions in the three months
since the account was opened, resulting in a cost-to-equity ratio of more than 21
percent. Joseph Stone's designated principal for reviewing actively traded accounts
did not review this report and did not review trading in Customer B's account at all
until December 2016, at which point the firm imposed a commission restriction on
the account. By that time, however, Customer B had been charged over $19,000 in
commissions in the ten months the account had been open, resulting in a cost-to-equity ratio in excess of 77 percent. Over the life of the account, the recommended
trades in Customer B's account resulted in an annualized cost-to-equity ratio of more
than 74 percent and an annualized turnover rate of more than 17.
at Page 4 of the Joseph Stone Capital AWC
By way of recap: In April 2016, Joseph Stone generated an Active Account Report showing three-months of purportedly excessive commission; however, the firm's designated Principal "did not review this report." In fact, within the first 10 months of the account's existence, the AWC admonishes that the cost-to-equity ration was over 77%.
During FINRA's 48-month examination cycle, did any FINRA examiner put eyes on the above-cited April 2016 Joseph Stone Active Account Report ?
If "Yes," why is FINRA is only first sanctioning the firm in September 2022?
If "No," then what's the purpose of having a FINRA member firm generate an Active Account Report if FINRA doesn't even review any of those reports for a 48-month period?
Re-Setting the Border Between In-House Compliance and FINRA Regulation
Compliance is what brokerage firms do in-house in terms of preventing misconduct and undertaking damage control.
Regulation is what happens when brokerage firms lose containment of misconduct. More often than not, regulators step in when compliance can't or won't to do its job.
After some four decades on Wall Street, I believe that we must re-set the boundaries between in-house compliance and outside regulation. In moving that line, we must avoid putting more -- too much -- confidential information in the hands of government regulators. As a libertarian, I am sensitive to that concern; on the other hand, we desperately need to refashion the failed state of Wall Street self-regulation.
Sadly, FINRA has not grown beyond its 1938 Maloney Act roots, and the self-regulatory-organization has become an anachronism more adept at issuing press releases than effectively regulating its broker-dealer community. FINRA appears committed to socially engineering independent/regional brokerage firms out of business -- the goal seems to be the elimination of smaller member firms in order to further consolidate the dominance of larger member firms. Making matters worse, FINRA's Board of Governors is a bloated, lackluster, gerrymandered body unwilling to pursue the necessary reforms.
FINRA should be refashioned as a Private-Sector Regulator in contradistinction to a Self-Regulatory-Organization. This reimagination of self regulation might result in a more robust form of quasi-governmental regulation -- which raises challenges in terms of Due Process and bureaucracy. If the transition is made, however, it should empower the private sector to become a partner in the regulatory process. But the "private sector" must be enlarged beyond the current myopia of only FINRA firms, and must be expanded to cover industry employees, public customers, regulators, investor advocates, public companies, etc.
Joseph Stone Capital's Active Account Report failed to prompt an effective in-house compliance response; but that same report also failed to prompt an effective FINRA regulatory response. Joseph Stone's compliance staff either didn't know how to use the Active Account Report; or, another possible explanation, is that the firm's management interfered in the proper response to the alerts. What happens when a Compliance Department has the knowledge of misconduct and the tools to fix it, but, for whatever reason, nothing is done to remediate the problem? Supposedly, when a brokerage firm loses containment of its in-house compliance docket, the regulators step in. But FINRA didn't run in or waltz in or even quick-step its way into the excessive trading problem at Joseph Stone Capital. FINRA seems to have stewed this particular mess for at least 66 months, and then, even after FINRA knew or should have known of Joseph Stone's compliance problems, it took about two more years to finalize the AWC.
I'm sorry but that's just not good enough.
It's not investor protection.
It's not in the best interest of FINRA member firms.
An Exception Report embodies a "What-If-Then" approach. When the protocol for setting the parameters of what is culled into an Exception Report is properly established, the harvested data should be limited. As such, these reports should be focused in scope to avoid excessive amounts of findings and overwhelming compliance staffs with overly broad data.
FINRA should promulgate by Rule a list of required Exception Reports (among which an Account Activity Report would be one such iteration) that should be generated by each member firm on a daily/weekly/monthly basis (as appropriate). When those Exception Reports are generated, I would require that copies be contemporaneously sent to the FINRA examiner assigned to a given member firm -- and the FINRA examiner should contact the firm's Compliance Director and require a written incident report; and, if appropriate, the examiner should confidentially contact the customer and confirm the customer's awareness of the excepted activity.
FINRA's role in monitoring its member firms' Exception Reports should not immediately trigger any regulatory sanctions or reportable event. In this instance, FINRA must embrace a role as a partner in the private sector regulation of Wall Street and work with the member firm in addressing the reasons that a given customer account has triggered a report.
Pursuant to the identification of OTC exercise limits, FINRA's Trading and Financial Compliance Examination Group originated a matter that was resolved by FINRA imposing upon member firm BofA Securities Inc. a $5 million fine. BofAS consented to the entry of FINRA's findings, without admitting or denying the charges; and the firm agreed to a penalty of a Censure and a certification that BofAS has established, maintains and enforces supervisory procedures reasonably designed to achieve compliance with FINRA Rule 2360.
Read the full Acceptance, Waiver & Consent settlement ("AWC") at https://www.finra.org/sites/default/files/2022-09/BofAS-AWC-091222.pdf
As alleged in part in the FINRA News Release:
FINRA Rule 2360 requires member firms to report large options positions to the LOPR, which FINRA uses to surveil for potentially manipulative behavior, including attempts to corner the market in the underlying equity, leverage an option position to affect the price, or move the underlying equity to change the value of a large option position. The accuracy of LOPR reporting is essential to FINRA's surveillance, and is particularly important with respect to the OTC options market because there is no independent source of data for regulators to review OTC options activity.
Between January 2009 and October 2020, BofAS failed to report OTC options positions to the LOPR in more than 7.4 million instances, in violation of Rule 2360 as well as Rule 2010 (Standards of Commercial Honor and Principles of Trade). Twenty-six of the unreported positions were also over the applicable OTC position limit of either 25,000 or 50,000 contracts. In addition, FINRA found that from January 2014 through October 2020, the firm's supervisory system was not reasonably designed to comply with its LOPR reporting obligations, a violation of FINRA Rules 3110 (Supervision) and 2010. Among other things, the firm did not have an effective system to detect whether there were positions that should have been reported to the LOPR but were not.
Bill Singer's Comment
I mean, seriously, FINRA thinks that it should take a victory lap when it's citing -- in 2022 -- misconduct that transpired from January 2009 through October 2020? Not only didn't FINRA catch the earliest non-reporting going back just shy of 13 years, but, somehow, the self-regulatory-organization missed 7.4 million instances of failed reporting. Frankly, this AWC offers little more than a pathetic display of lame-ass self-regulation. Can't wait to see what FINRA publishes by way of press release tomorrow!