Firm Fined for Unsuitable Recommendations and Supervisory Failures
Commentary by Glen Barrentine
A firm settled FINRA charges for (i) failing to supervise unsuitable short-term trading of preferred stocks, closed-end funds and medium-term notes that were sold by a syndicate of which the firm was a member and (ii) allowing representatives to profit from repeated short-term trades that led to customer losses.
FINRA found that a representative at the firm recommended 118 purchases of preferred stocks and closed-end funds to retail customers, only to recommend selling them within 180 days, often at a loss. FINRA said that in several cases, the representative encouraged customers to buy another distributed product soon after the sale, generating additional sales concessions and commissions. FINRA said the firm detected some of these trades through its automated alert system but failed to adequately follow up on the red flags.
FINRA also found that at least 40 other representatives at the firm recommended 1,504 similar short-term trades of such products to retail customers, resulting in losses, while the firm collected over $2 million in concessions and commissions.
FINRA determined that the firm violated FINRA Rule 3110(a) and (b) ("Supervision") and Rule 2010 (Standards of Commercial Honor).
To settle the charges, the firm agreed to (i) a censure, (ii) pay a $400,000 fine, (iii) pay $599,025.29 in restitution to affected customers and (iv) disgorge $2,031,972.10 in ill-gotten gains.
Commentary
As stated in the AWC, the investment products at issue, (i.e., syndicate preferred stocks, closed-end funds ("CEFs") and medium-term notes ("MTNs")), are generally purchased for their income features and held long-term.
In this case, FINRA found that the firm was a member of the selling syndicate for each of these products and typically received a selling concession from the issuer of 2 percent for preferred stock, and between 1 percent and 2 percent for CEFs and MTNs. FINRA also stated that it was typical for the firm to charge customers sales commissions on these products and to share a portion of the selling concession and the sales commission with the representatives.
According to the AWC, the firm's written procedures stated that syndicate products were generally supposed to be held long-term. Specifically, the firm's Syndicate Policy stated that "[s]ecurities purchased through a syndicate offering are generally intended to be long-term holdings and are not intended for short-term trading," and that "Registered Associates must not: Encourage or solicit short-term trading of new issues." While the firm did have an electronic system to identify short-term trading in syndicate preferred stock, CEFs, and MTNs, FINRA said that the system only generated alerts when there was a liquidation within 90 days of purchase of these types of securities and did not generate alerts for securities sold thereafter. When the firm did flag short-term trades of these syndicate products through electronic and manual reviews, FINRA found the firm sometimes failed to take effective and prompt action to ensure that short-term trading in these products did not continue.
The bottom line here is that firms need to have appropriate surveillance procedures and reviews that cover an appropriate holding period. Here, taking into account the front-end sales concessions and the back-end sales commissions, a 90-day holding period was generally too short a time period to allow these securities to generate a positive return. For this reason, the firm should have used a longer surveillance period. Moreover, once improper sales practices are discovered, the firm must take prompt steps to ensure that the problematic activity is terminated, which the firm failed to do here.