In the Seinfeld sitcom which has been in syndication for years, Jerry’s friend, George Costanza, found himself in trouble at work for obviously inappropriate conduct. George’s response was: “Was that wrong? Should I have not done that? I tell you, I gotta plead ignorance on this thing because if anyone had said anything to me at all when I first started here that that sort of thing was frowned upon, you know, ‘cause I’ve worked in a lot of offices and I tell you people do that all the time.” Just as George’s excuse was ineffective, registered representatives and broker-dealers commit obvious transgressions where there is little to be said in their defense.
From time to time, we will look at recent FINRA disciplinary actions and SEC enforcement actions against registered reps and broker-dealers. In many instances, it should have been readily apparent to the persons involved that regulators would sanction them if they were caught. We hope that a short discussion of these disciplinary and enforcement actions will serve as a reminder to broker-dealers and registered reps that no matter what regulatory changes occur in Washington, FINRA and the SEC will still be identifying and sanctioning misconduct.
FINRA publishes a quarterly review which is designed to provide firms with a sampling of recent disciplinary actions involving misconduct by registered reps. The range of misconduct goes from the obvious to the not-so obvious. The SEC also takes action when it believes that registered reps and broker-dealers have crossed the line, obvious or otherwise.
On January 9, 2017, the SEC charged two New York-based brokers with fraudulently using an in-and-out trading strategy to enrich themselves. The SEC alleged that the strategy was unsuitable for customers in order to generate hefty commissions for themselves. The brokers sold securities within a week or two of purchasing them. They made commissions on each of those transactions. The case was another example of the SEC’s pursuit of brokers who trade excessively, which is good for the broker and not for the customer.
The SEC warned investors about excessive trading and churning in an Investor Alert published on the same day. The publication referenced this action against the two brokers who were charged with fraud for churning three customers’ brokerage accounts and for recommending an investment strategy to 27 customers without having a reasonable basis to believe that the strategy was suitable for any of them. The SEC alleged that the brokers’ frequent trading, combined with the high cost-per-trade, all but guaranteed losses for the customers. The SEC complaint, as well as the Investor Alert, can be found at: https://www.sec.gov/news/pressrelease/2017-2.html.
You can bet that when the SEC publishes an Investor Alert, the Commission and FINRA will be on the lookout for this type of misconduct during examinations. In its 2017 Regulatory and Examination Priorities letter, FINRA urged firms “to evaluate whether their supervisory systems can detect activity intended to evade automated surveillance for excessive switching activity. For example, we have observed situations where registered representatives switch customers across products to evade surveillance that focuses on switching within the same product class. Similarly, FINRA has observed situations where registered representatives switch customers through several investments to conceal the source of funds from switching surveillance tools.”
Regulators possess sophisticated data analytical tools that can be used to identify excessive trading. Once they’re caught, George’s “Was that wrong?” defense is unlikely to hold up, especially if it looks like registered reps are trying to cover their tracks.
Les Abromovitz can be reached at NCS Regulatory Compliance by calling 561-570-1813 or by e-mailing him at firstname.lastname@example.org. Les is the author of THE INVESTMENT ADVISOR’S COMPLIANCE GUIDE, which was published by the National Underwriter Company, a division of ALM. The second edition will be published in March, 2017.