It would have been an easy bit of adjudication by a FINRA arbitrator to find that a now-barred rep was the bad guy, that he victimized his clients and his employer, and, in the end, hell no, it's just not fair for his employer brokerage firm to be burdened with having to foot the bill for a fine caused by the former rep's misconduct. The arbitrator did not opt for that easy decision; and, as a result, the industry is on notice that there are consequences to a failure to supervise -- as in it could jeopardize indemnification claims.
In a FINRA Arbitration Statement of Claim filed in September 2022, FINRA member firm Claimant McNally Financial Services Corporation asserted churning and breach of contract. Claimant sought $50,000 in compensatory damages. Associated person Respondent Goldstein generally denied the allegations and asserted affirmative defenses.
In the Matter of the Arbitration Between McNally Financial Services Corporation, Claimant, v. Lawrence Burton Goldstein, Respondent (FINRA Arbitration Award 22-02143 / February 2, 2023)
Apparently, Claimant McNally Financial is a FINRA brokerage firm and had filed the arbitration claim against the firm's former registered representative/independent contractor Respondent Goldstein. At issue is whether Respondent will be on the hook by way of indemnification for repayment of a $50,000 fine imposed upon the firm by the Nevada Secretary of State. The FINRA Arbitration Award asserts in part that:
Claimant seeks indemnification from Respondent for $50,000.00, the amount of the civil penalty imposed on Claimant as a result of a series of regulatory investigations regarding Respondent’s trading activities and Claimant’s duty of supervision undertaken by the SEC in 2017-18, FINRA in 2019-20, and Securities Division of the Nevada Secretary of State Office (“NSD”) in 2020-21. The $50,000.00 civil penalty imposed by NSD December 27, 2021, was expressly consented to and paid by Claimant.
Claimant seeks indemnity from Respondent specifically under Section II Administration, Subsection (C) (5) of the parties’ Independent Contractor Agreement (“ICA”) dated April 15, 2010. Without more, Claimant’s Statement of Claim simply asserts “C.(5) clearly states that he is liable for this fine, and he has refused to reimburse [Claimant]”. In response, Respondent denies any contractual obligation to reimburse or indemnify Claimant for the civil penalty imposed on Claimant for its failure to supervise, but if such were found, any award must be proportionate to commissions earned.
ICA Section II, Subsection C.(5) provides:
“In the event that through willfulness, negligence or carelessness, RR fails to comply with the provisions of applicable federal or state laws, or the procedures of the Company, FINRA, SEC or state securities commission or other like governmental or a self-regulatory body of the Company, the RR agrees that Company may assess against RR such expenses as the Company incurs in the resolution of any action, including without limitations attorney's fees and expenses[.]”
November 2020: Goldstein FINRA 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, Lawrence Goldstein submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted.
In the Matter of Lawrence Goldstein, Respondent (FINRA AWC 2018058820102 / November 10, 2020)
The Goldstein AWC asserts that Lawrence Goldstein entered the industry in 1992; and by 2010, he was registered with McNally Financial Services Corporation. In accordance with the terms of the AWC, FINRA imposed upon Goldstein a Bar from association with any FINRA member in any capacity. The Goldstein AWC asserts in part that [Ed: footnote omitted]:
On October 30, 2020, in connection with an investigation into whether Goldstein engaged in unsuitable excessive trading in a customer's account, FINRA staff sent Goldstein a written request for on-the-record testimony, pursuant to FINRA Rule 8210. As stated during a phone call with FINRA staff on November 2, 2020, and in an email to FINRA staff on November 2, 2020, and by this agreement, Respondent acknowledges that he received FINRA's request and will not appear for on-the-record testimony at any time. By refusing to appear for on-the-record testimony as requested pursuant to FINRA Rule 8210, Respondent violated FINRA Rules 8210 and 2010.
November 2021: McNally Financial Services FINRA 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, McNally Financial Services Corporation submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted.
In the Matter of McNally Financial Services Corporation, Respondent (FINRA AWC 2018058820103 / November 23, 2021)
The AWC asserts that McNally Financial Services Corporation has been a FINRA member firm since 2002 with about 27 registered representatives at 10 branches. In accordance with the terms of the AWC, FINRA imposed upon McNally Financial Services a Censure, $35,000 fine, and an undertaking to revise its policies and procedures attendant to the cited violations. The AWC asserts under "Overview" that [Ed: footnote omitted]:
From March 2014 through March 2019, MFS failed to establish and maintain a supervisory system and enforce written supervisory procedures (WSPs) reasonably designed to achieve compliance with FINRA Rule 2111 in relation to the sale of nontraditional exchange traded products (NT-ETPs).
MFS also failed to reasonably supervise a registered representative who recommended complex options trading strategies to customers. MFS was aware of red flags in the options trading that indicated the trading and strategy may be inconsistent with the customers' investment profiles but failed to take reasonable action to investigate these red flags.
As a result, MFS violated FINRA Rules 3110, 2360(b)(20)(C), and 2010, and NASD Rule 3010.
December 2021: State of Nevada Administrative Consent Order
As disclosed on FINRA's online BrokerCheck as of February 6, 2023, the State of Nevada, Office of the Secretary of State, Securities Division:
[A]LLEGED RESPONDENT FAILED TO COMPLY WITH REQUIREMENTS OF NEVADA'S UNIFORM SECURITIES ACT AND BE IN VIOLATION OF NRS 90.420(1)(I) BY FAILING TO ESTABLISH AND MAINTAIN A REASONABLE SYSTEM TO SUPERVISE A FORMER SALES REPRESENTATIVE
In the Matter of McNally Financial Services Corporation and Lawrence Burton Goldstein, Respondents (Administrative Consent Order, State of Nevada, Office of the Secretary of State, Securities Division / File No., INV21-090 / December 30, 2021)
https://www.nvsos.gov/sos/home/showpublisheddocument/10270/637828450238000000, the Nevada Administrative Consent Order ("ACO") imposed the following sanctions:
In pertinent part, the ACO alleges that:
WHEREAS, the U.S. Securities and Exchange Commission (SEC) began a routine examination of Respondent MFSC in late 2017, and in June of 2018, the SEC informed Respondent MFSC that it appeared that excessive trading had occurred in two of its customers' accounts. The SEC referred the matter to FINRA, which then opened an investigation;
WHEREAS, in the two accounts beginning in May 2017, Looper Turnover Rates exceeded 5.0 and did not align with trading strategies. Both accounts were managed by Respondent Goldstein. These trades produced gross commissions of $85,936 in commissions the clients netted losses of over $50,000. It was not uncommon for Respondent Goldstein to make as many as 14-15 trades in some 3 months, holding the trades for a very short period;
WHEREAS, Respondent Goldstein had limited discretionary authority in one of the accounts and in the other account, at times, he had no conversations regarding his trading strategy. On more than one occasion, Respondent MFSC suggested that Respondent Goldstein consider changing his approach to the way he made trades. Respondent Goldstein claimed to lower the size of his trades; however, the account statements reflected no such changes;
WHEREAS, FINRA did an on-the-record interview with Respondent MFSC in May 2019. During said interview, Respondent MFSC's witness testified that it supervised trading activity electronically. and that if any concerns arose during branch inspections, such were discussed directly with Respondent Goldstein;
WHEREAS, two branch audits of one of MFSC's representatives occurred in May 2014 and March 2017. In both audits, "no issues [were] identified" however there are no analysis or information in the firm's records that supported the conclusion that no issues were identified such as looking at cost to equity ratios or Looper turnover rates;
WHEREAS, Respondent MFSC informed FINRA that when a representative of MFSC was asked about certain accounts, a reasonable explanation for the activity was given, and therefore, nothing else needed to be done;
WHEREAS, in response to FINRA's concern that certain accounts were "re-papered", Respondent MFSC stated: "We want to make sure the investment objective is in line with the trading activity that's going on."
WHEREAS, regarding one account in particular Respondent MFSC noted that the active trading was being done to recoup losses. Respondent MFSC did not follow up with Respondent Goldstein in the subsequent 1.5 years to determine if the trading strategy had been halted. WHEREAS, it is a violation of NRS 90.420(1)(I) to fail to establish and maintain a reasonable system to supervise a sales representative, employee, or representative of an investment adviser;
WHEREAS, it is a violation of FINRA Rule 3110 to fail to establish and maintain a system to supervise the activities of its associated persons that is reasonably designed to achieve compliance with the applicable securities laws and regulations and FINRA rules; . . .
By way of recap:
Turning back to the 2023 FINRA Arbitration, we find Claimant McNally Financial suing Respondent Goldstein for indemnification of the $50,000 fine imposed by Nevada (note that no claim was made per the $35,000 FINRA fine). Sole FINRA Public Arbitrator Paul H. Lamboley notes in part that:
The developed factual record demonstrates the investigations undertaken by SEC, FINRA and NSD were focused on Respondent’s excessive trading activity as well as Claimant’s duty of supervision, and culminated in written Administrative Consent Order (ACO) in NSD File No. INV21-090, order at issue here.
at Page 3 of the FINRA Arbitration Award
Clearly, FINRA Arbitrator Lamboley has taken careful note of the nature of the various regulatory investigations and resolutions; namely, that it took two to tango in this waltz or non-compliance:
It is evident from the factual record developed here that the regulatory investigations and resultant ACO focused on the conduct of both parties, and imposed separate penalties based on the violative conduct and fault of each party. Thus in short, Claimant’s indemnification claim poses the question whether under ICA Section II Subsection C.(5) Respondent agreed and is obligated to pay the $50,000.00 civil penalty imposed on Claimant for Claimant’s failure to supervise Respondent. The answer is no.
at Page 3 of the FINRA Arbitration Award
Ultimately, the Arbitrator denied Claimant's claims for indemnification of its $50,000 Nevada fine, and, in part, the Arbitrator offers this rationale:
Despite the contractual recognition of responsibility for supervision, the record clearly demonstrates that Claimant failed to utilize trading analytics, or review Respondent’s account records, or take steps to immediately terminate Respondent’s trading activity when concern noticed. It is evident these failures were one focus of the regulatory investigations and formed the basis for the resulting civil penalty imposed on Claimant.
Lastly, it may even be contrary to or violate public policy in the securities industry for Claimant to attempt to avoid or transfer by indemnity the liability for its own wrongdoing in failing to
supervise which is duty-specific to Claimant. While Respondent’s excessive trading was violative conduct related to supervision, the duty of supervision itself is an important customer protective and preventative ingredient, and functions as a separate, fundamental obligation of Claimant for the required oversight of Respondent’s conduct. Respondent’s excessive trading conduct resulted in specific commission recessions and permanent disbarment from securities business in Nevada. Claimant’s failure to supervise conduct resulted in the stated civil penalty. Each party received separately stated sanction or penalty for their conduct.
at Page 4 of the FINRA Arbitration Award
Bill Singer's Comment
My profound compliments to Sole FINRA Public Arbitrator Paul H. Lamboley, who not only penned a patient and compelling Award, but, in my opinion, got it right. The denial of indemnification on the facts at hand was the proper resolution when we consider NOT just what may have been fair for Claimant McNally Financial but when we also consider the larger (and more important) context of what's best in terms of public policy.
An easy resolution here for Arbitrator Lamboley would have been to say, in effect, screw it, and slam Goldstein with the full cost of indemnification. Goldstein is not a sympathetic figure; and his cited misconduct seems to have amounted to unsuitable and excessive trading -- moreover, by refusing to cooperate in FINRA's investigation, Goldstein has somewhat forfeited the opportunity to offer his version of events. Consequently, the Bars imposed on Goldstein by the Arizona and FINRA seem wholly justified.
Arbitrator Lamboley gets many things right via his refusal to shift regulatory burdens from the member firm to its former associated person. Regardless of Goldstein's non-compliant conduct, the whole purpose of a robust in-house compliance regime is to detect abuses and promptly interdict them. In many cases of a renegade rep, the fraud used to engage in cited trading may include well-designed efforts to inhibit the best efforts by a compliance department to detect misconduct. In such cases, customers and the member firm are often victims. On the other hand, for a FINRA member firm to successfully plead that it was a victim, it would need to demonstrate that reasonable compliance policies and procedures were in place and that they were implemented in an appropriate manner.
As Arbitrator Lamboley concluded, however, McNally Financial "failed to utilize trading analytics, or review Respondent's account records, or take steps to immediately terminate Respondent's trading activity . . ." Moreover, Arbitrator Lamboley's conclusion is consistent with that of the State of Nevada, which also alleged that McNally Financial had failed to "establish and maintain a reasonable system to supervise " Goldstein.
Without question, Arbitrator Lamboley is spot-on in his enunciation of an important public policy consideration against indemnification; namely, that it may be contrary to "public policy in the securities industry for Claimant to attempt to avoid or transfer by indemnity the liability for its own wrongdoing in failing to supervise which is duty-specific to Claimant. . ."
In the end, you and I are likely left with a bitter taste in our mouths. To some extent, McNally is another victim of Goldstein's alleged misconduct, much like the customers cited by FINRA and Nevada. As even Nevada conceded: "on more than one occasion, Respondent MFSC suggested that Respondent Goldstein consider changing his approach . . ." Unfortunately, despite Goldstein's claim to reduce the size of this trading at issue, he did not -- and that lack of follow-through was available for all to see on account statements. Did McNally see the troubling pattern of trading? Did the firm raise concerns? Apparently "yes," but as to the intensity of such oversight, the Nevada ACO damningly asserts that the firm "did not follow up with Respondent Goldstein in the subsequent 1.5 years to determine if the trading strategy had been halted."
It would have been an easy bit of adjudication by Arbitrator Lamboley to find that Goldstein was the bad guy here, that he victimized his clients and his employer, and, in the end, hell no, it's just not fair for McNally Financial to be burdened with having to foot the bill for the Nevada fine when it was all caused by Goldstein. Sure -- Lamboley could have taken that facile route. He didn't. And as a result, the industry is on notice that there are consequences to a failure to supervise -- as in it could jeopardize indemnification claims. Further, the investing public is comforted by the fact that FINRA firms will have to pay the fare for not staying on top of errant stockbrokers.
Securities Industry Commentator: A legal, regulatory, and compliance feed curated by veteran Wall Street lawyer Bill Singer https://www.rrbdlaw.com/6873/securities-industry-commentator/
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