Broker-Dealer Settles Fine in Connection with Repo Transactions with an Affiliate
Commentary by Steven Lofchie
A broker-dealer settled FINRA charges for overstating its net capital, which caused several additional reporting and recordkeeping violations.
In a Letter of Acceptance, Waiver, and Consent, FINRA found that the broker-dealer misclassified the underlying securities in certain reverse repo transactions as "allowable," even though the counterparty, which was an affiliate of the broker-dealer, custodied the securities. Because the broker-dealer was not in possession or control of the underlying securities, they were "non-allowable assets" that should have been deducted from the broker-dealer's net capital and excess net capital calculations. As a result of that mischaracterization, the broker-dealer also (i) miscalculated its customer reserves, (ii) filed inaccurate FOCUS reports and (iii) maintained inaccurate books and records.
This settlement follows a 2018 censure and fine where FINRA found that the broker-dealer inaccurately calculated its Proprietary Account of Broker-Dealers reserve computations and failed to establish, maintain and enforce a supervisory system reasonably designed to ensure it properly calculated such account.
FINRA determined that the broker-dealer violated Exchange Act Section 15(c) ("Registration and regulation of brokers and dealers"), Section 17(a) ("Records and reports"), Exchange Act Rule 15c3-1 ("Net capital requirements for brokers or dealers"), Rule 15c3-3 ("Customer protection-reserves and custody of securities"), Rule 17a-3 ("Records to be made by certain exchange members, brokers and dealers") and Rule 17a-5 ("Reports to be made by certain brokers and dealers"). The broker-dealer was also found to have violated FINRA Rule 2010 ("Standards of Commercial Honor and Principles of Trade"), Rule 3110 ("Supervision") and Rule 4511 ("General Requirements").
To settle the charges, the broker-dealer agreed to (i) a censure and (ii) a civil monetary penalty of $125,000.
Commentary
One mistake that broker-dealers repeatedly make is failing to document and execute transactions with their affiliates as they would transactions with unaffiliated third parties. If anything, firms should impose a higher standard of control on affiliate transactions, not only because of the potential conflicts, but because of the tendency to be overly relaxed or trusting when transacting with affiliates.