FINRA Charges Firm and CEO for Facilitating Excessive Trading
Commentary by Steven Lofchie
FINRA charged a firm and its former CEO with failing to detect and prevent excessive trading in an elderly customer's accounts.
According to a Complaint before FINRA's Office of Hearing Officers, the firm and its CEO failed to supervise a representative who "recommended and effected 2,217 trades in two accounts" of an 89-year-old retired customer over a 17-month period. FINRA alleged that this activity resulted in "staggering and ruinous" trading costs exceeding $2.9 million—an amount representing nearly 35 percent of the firm’s total commission revenue during that time. FINRA claimed that the trading resulted in realized losses of $1.2 million and annualized cost-to-equity ratios as high as 46 percent, meaning the accounts needed to appreciate by that amount just to break even.
FINRA alleged that the CEO, who directly supervised the representative, ignored multiple "red flags," including extraordinary trading volumes, high turnover rates, and persistent use of margin. The CEO allegedly accepted the representative's claim that he was executing a "replication strategy" mirroring a third-party asset manager, despite evidence that the representative's trading frequency was exponentially higher than the strategy he claimed to follow.
In addition, FINRA claimed that the firm failed to establish reasonable written supervisory procedures ("WSPs") to comply with Regulation Best Interest. FINRA alleged that the firm’s WSPs lacked specific metrics or quantitative tools to detect excessive trading and provided no guidance to principals on how to review for such misconduct. FINRA also alleged that the firm failed to reasonably supervise electronic communications, relying on a fragmented and undocumented email review process.
FINRA charged the Respondents with violating Exchange Act Rule 15l-1 ("Regulation Best Interest"), as well as FINRA Rules 3110 ("Supervision") and 2010 ("Standards of Commercial Honor and Principles of Trade").
FINRA is seeking (i) findings that the Respondents committed the violations alleged, (ii) sanctions including full disgorgement of ill-gotten gains and restitution, and (iii) an Order requiring the Respondents to bear the costs of the proceeding pursuant to FINRA Rule 8330 ("Costs of Proceedings").
Commentary
At some point, what might in small dollars look like a plain vanilla suitability violation begins to look a lot more like felony theft worthy of jail time.