FINRA/SEC ENforcement actions 2016

and the DOL's new Fiduciary rule

2015 FINRA enforcement cases

MyComplianceOffice presents our guest hosts from Sutherland Asbill and Brennan, LLC as they review the major FINRA actions of 2016 to date.


Brian Rubin

Brian is the Washington office leader of Sutherland’s Litigation group and the Administrative Partner in charge of the Securities Enforcement and Litigation Team. Brian previously served as Deputy Chief Counsel of Enforcement at NASD (FINRA) and Senior Enforcement Counsel at the SEC.


Andrew McCormick

Andrew McCormick is a Litigation Associate at Sutherland and represents financial firms in investigations, enforcement actions, and civil litigation.


 You can download a full copy of the slides from this webinar.



Full video transcript available below:

Okay, so we just covered 2015, highlights of 2015. Now we'll talk about some of the highlights more recently of 2016, looking both at the statistics and then highlighting some of the significant cases. You see in terms of the numbers, there's a small percentage decrease in terms of the number of cases that have been filed. In terms of the fines, a 10% increase, so FINRA seems to be doing really well, and those of you who study this thing a lot, you know that FINRA recently brought a $20 million case against one firm, and we'll talk about that case in a little bit, and that statistic, the $23 million, does not include the $20 million fine, so when you add that in, assuming FINRA keeps up at this rate, we're looking at a pretty big percentage increase compared to last year.

Amount of restitution, it's surprisingly small, $2.4 million. As Andrew said, there were a handful of cases and types of cases that were responsible for the restitution last year. Maybe they've run their course for those types of cases, so that could be why the restitution numbers aren't that big. That statistic, $2.4 million, does not include the $5 million restitution which was part of the $20 million case, which dealt with variable annuities. When you add that in, we're looking again at some fairly large numbers.

Let's go to the next slide please. We'll be highlighting some of the bigger cases that FINRA has brought, and I guess I'll be talking about the first one, which is the $20 million case, which I mentioned before. This was a variable annuity case primarily dealing with replacements of variable annuities. There was also a $5 million restitution component with that case. FINRA alleged that the firm made negligent misrepresentations and omissions in connection with the replacements dealing with the costs and the guarantees of the replacements.

I won't go into all of the details, but some takeaways from the case is that FINRA is looking at a number of firms dealing with replacements, checking the math, looking at the numbers. I know of a number of cases that FINRA is working on right now, so it makes sense for firms to focus on this issue to extent they haven't. It makes sense possibly to use a third-party tool to do the comparison for them. The case is interesting because it alleged negligent misrepresentations and omissions. It didn't allege fraud. It didn't allege unsuitable transactions, and it's possible that because the firm paid so much money in terms of the fine that those types of charges were not included.

Another interesting issue is that the case is based on random samples, and if you look at the data, you see there's a footnote on that. FINRA more and more is looking at a handful of data or sets of data and then using that data, FINRA is extrapolating and coming up with some of the larger numbers. FINRA also looked at New York reg 60, which is the New York provision dealing with replacements, so that's something the firms may want to focus on if they haven't focused on it already. No individuals were charged here. Again, interesting given that it's a $20 million case.

Then the other issue I want to mention in connection with variable annuities, not part of that case, but FINRA is expected to bring around 20 or so cases dealing with L-Shares variable annuities this coming year. If firms haven't focused on how they are reviewing suitability for L-Shares or how they are disclosing the comparisons between L-Shares and B-Shares, they may want to do that. Andrew and I are working on a number of enforcement exams and enforcement investigations dealing with that issue. That's something the firms will want to focus on. Andrew, do you want to talk about the next ones?

Sure thing. We'll continue to discuss some of the biggest FINRA cases that FINRA has announced so far in 2016. The second one is a $17 million fine in a recent case. In that case, there were two affiliated firms that were required to pay a combined $17 million in fines for alleged widespread AML supervisory deficiencies. In this case, FINRA alleged that the deficiencies caused the failure to prevent or detect, investigate, and report suspicious activity over a several-year period. The big takeaway of this case and one of FINRA's points they really hammered on is saying that over the 8-year period at issue, the firm grew substantially. The business was booming. It was growing a lot.

In fact, the numbers of reps and the number of branch offices both doubled, but FINRA pointed out that during that time of incredible growth that the firm's AML compliance system did not experience a similar growth as a business. I believe there was maybe either just one and then maybe ultimately 2 employees working in this area over a very large firm. FINRA really hammered the firm for not having a corresponding growth in compliance that they experienced in the business. How FINRA described the firm's AML programs is a "patchwork of written procedures and systems across different departments," and FINRA noted that there was a few silos working on different issues, but there was not a broad supervisory system or program connecting them all together so the firms could identify and investigate and monitor potential red flags. Because of that, red flags went undetected.

An interesting note in this case, there was a former compliance officer at the firm who was also swept into this issue. The officer was fined $25,000 and suspended 3 months. FINRA alleged that the individual failed to insure that these AML supervisory reviews were being actually taking place. This is a big case FINRA recently announced that I think last year. Maybe the largest fine was about $10 million, and here we already have two well above those levels, as Brian alluded to. We can at the end of the year, largely driven by these 2 cases, we can expect to see some pretty big fines for FINRA.

Some key takeaways from this case is that the compliance systems should keep up with the business. FINRA really cited that as an issue here. Maybe 2-3 years ago, there was a really big email case resulting in a substantial fine. FINRA had the same assertion in that case, the compliance and supervision has to keep up with the pace of the business.

A quote from Brad Bennett, FINRA's chief of enforcement, in the press release announcing this case is that, "Firms must allocate adequate resources to their AML compliance efforts." As I noted before, that we're seeing AML is becoming a very popular topic for FINRA, resulting in very significant fines over the past few years. Firms should consider where their programs are at and make sure that everything is working effectively as it should be.

Then finally, a key takeaway here is that when problems are discovered, you should address them and fix them, especially if you told a regulator you would previously do so. One of the firms here had a very similar enforcement action just a few years before, where they said they would update and review and improve their AML supervision and policies and procedures, and here a few years later, they had the same issues come up through enforcement again. I think that probably ultimately led to a larger fine for the firm in this case.

Andrew, a couple of additional points. One, as we're talking about the cases, if anybody wants copies of any of these cases, let us know at the end. Send us an email and we'll send you copies. The second issue with regard to this case is enforcement actions against compliance officers are alive and well, so to the extent there are any compliance folks listening out there, just be aware that despite the niceties that we've heard from both the SEC and FINRA in terms of they aren't targeting compliance officers, that's probably true, but nonetheless, there are every year, more than 20 or 30 cases against compliance officers, so be aware of that.

The last thing I want to mention, somebody did send in a question. It says, "Is one of FINRA's goals with levying big fines to make up for a lack of funding from Congress?" I don't think so. I don't think FINRA gets money from Congress, and historically, the fines have been a small percentage of FINRA's overall revenue, so I don't think that is a driver. I do think that the fines are a driver in terms of FINRA's trying to create sort of credibility. They had pushed to be the SRO for investment advisors even though they said they're no longer interested. I'm sure that's still on their mind. As we'll talk about in a minute, they are also interested in dealing with and pursuing the DOL fiduciary duty rule to the extent they can. I think they want visibility, and visibility comes from these big fines. Andrew, back to you?

All right. Thanks, Brian. The next case we'll just briefly highlight resulted in a $2.25 million fine in 2016, so quite a significant drop from the first two cases discussed but still a very large fine. In this case, FINRA alleged that the firm failed to maintain a reasonably designed supervisory system. It did not have WSPs regarding the sales of leverage, inverse, and inverse leveraged exchange-traded funds. FINRA said that this took place over a 4-year period. In this case, we're dealing with some very complex products, and essentially, FINRA found that the firm representatives who were selling these non-traditional ETFs had not performed adequate due diligence. They didn't really understand the products. They weren't trained on the products. FINRA faulted the firm for these allegations.

In light of all that, during this time period, the firm sold $1.7 billion of these products, so FINRA had the expectation that it would be robust and healthy and reasonably designed supervisory systems around that. FINRA alleged that that did not happen, that some of the WSPs were not enforced. The reps weren't trained about these issues and that the surveillance reports weren't effective and that reps could override trading restrictions, and that ultimately there were some unsuitable sales of these products, specifically citing sales to elderly investors, and that's something we've seen in cases in the past, where FINRA really focused on and even as small as a handful of elderly investors who bought really complex products that FINRA alleges that they did not understand. Because of the suitability issues here, FINRA also ordered the firms to pay just over $700,000 in restitution.

A few takeaways from this case is that reps really need to understand the products they're selling. When you're selling complex products, firms may want to consider that should require enhanced training for those representatives. If you're doing a lot of business in the area, according to this case, it was $1.7 billion, FINRA had expectations that the firms would have some very specific and healthy WSPs in place, so firms should also consider if they need specific WSPs tailored to specific products. Then, finally as I mentioned before when we were looking at the top 5 issues, suitability is always a key focus for FINRA, so it's something to look out for.

The fourth case we'll just briefly highlight resulted in a $1.4 million fine. This is a trade reporting case. As I noted just a few minutes ago, in 2014, trade reporting was a top issue for FINRA, just like it has been in the past few years, so again, we're seeing it be a key focus for FINRA. In this case, the firm allegedly failed to accurately report and adequately supervise the reporting of large option positions reports. This took place over an alleged 3-year period, and millions of reporting issues were alleged to have taken place.

An example of that was also firms were exceeding position limits of certain securities for specific customers and that the firm ultimately did not have a supervisory system in place to review the reporting of options positions. In this case, it resulted in a $1.4 million fine, and that did include some amount of cooperation credit. We're never sure how much that will ultimately save a firm in terms of actual dollars, but FINRA noted in the AWC that they provided extraordinary cooperation, that they hired an independent consultant to review the system, had implemented enhancement, if those things hadn't occurred, we can expect to have seen a larger fine overall. A takeaway here is that FINRA is taking these trade reporting issues very seriously, and they have resulted in some significant fines. Even broader, these technical issues seem to be a key focus for FINRA, and they often result in big fines, just like this case here.

Finally, the fifth largest fine for FINRA during the first half of the year of 2016 is the $1.25 million fine. This case was a unique case that I don't see too often. It's FINRA was looking at a 5-year period where the firm allegedly failed to conduct adequate background checks on about 4,500 out of its 20,000 non-registered associated persons, and so out of that bucket of 4,500 people, FINRA found that about 25% of them were allegedly never fingerprinted at all during the hiring process. A couple hundred were fingerprinted, but only after they started working. For a few thousand of them, some of them were fingerprinted, but when they did the background checks, some specific felonies and regulatory actions were not included as part of that background check and that one disqualified person associated with the firm ultimately, and the firm was unable to tell if there was 115 associated persons who were potentially disqualified, so this seems like a very non-security type issue, more of an HR, employee onboarding issue, but it took place over a lengthy period of time, and a lot of individuals were part of it. It ultimately resulted in a $1.25 million fine. A takeaway from that is that some of these issues that seem very administrative and non-security in a way can still result in significant fines for firms.


Read our blog post, "FINRA Fines 2016 - 7 Key Facts" 

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