Firm Settles Charges for Supervisory and Transaction Reporting Failures
Commentary by Glen Barrentine
A firm settled FINRA charges for supervisory failures over transaction reporting and the collection of customers’ investment profile information relevant for making suitability determinations.
According to the AWC, the firm supervises mutual fund transactions, in part, by reviewing exception reports relevant to identifying potential sales practice violations, including potentially unsuitable transactions. FINRA stated that the firm used its daily trade blotter to generate such exception reports; however, the firm did not have a reasonable system to ensure that direct business transactions, that is, transactions placed directly with product sponsors on behalf of firm customers, appeared on the firm’s daily trade blotter. FINRA said that the firm was on notice that certain of its representatives were engaging in direct business transactions when it received commission records from product sponsors. FINRA found that the firm did not have any system or procedures in place to require registered representatives to report those transactions to the firm. As a result, over a five-year period approximately 490,000 direct business transactions involving over 14,000 customers were not reported on its daily trade blotter, which caused the firm to fail to reasonably supervise the suitability of such transactions.
FINRA found that the firm also failed to have a supervisory system to ensure that it collected and maintained information about its direct business customers’ investment profiles—such as the customers’ ages, investment time horizons and liquidity needs—that was relevant for making suitability determinations. FINRA said that the firm relied on its representatives to collect such information by completing new account forms; however, the firm did not take steps to ensure that representatives completed new account forms for new customers placing direct business transactions.
FINRA noted that the firm undertook a retrospective review of its direct business transactions and attempted to collect missing information about customers’ investment profiles. The suitability of certain of the transactions could not be determined because the firm was unable to, at the time of the retrospective review, collect complete information about customers’ investment profiles, including their investment time horizons or liquidity needs that would have been relevant at the time of the purchase.
FINRA found that the firm violated Exchange Act Section 17(a) and Rule 17a-3 ("Records and reports"), FINRA Rules 4511 ("General requirements"), 3110 ("Supervision") and 2010 ("Standards of Commercial Honor and Principles of Trade") and NASD Rule 3010.
To settle the charges, the firm agreed to (i) a censure and (ii) pay a $500,000 fine.
Commentary
Procedures, no matter how good they may be, only work to the extent the underlying inputs are complete. Here, the firm was on notice that one relevant input, daily trade blotter information, was incomplete; the firm's system did not capture direct business transactions. As a result, the firm was unable to review such transactions for suitability and other potential sales practice violations. Similarly, the firm’s investment profile information, which was used by the firm to review suitability determinations, did not extend to its direct business customers. While it can be hard to see what is not there, here the firm was on notice that the direct business transactions were not populating its daily trade blotter. Further, the firm failed to consider what impact that would have on its sales practice reviews.