Broker-Dealer Fined for Margin Violations in Affiliate Transactions

A broker-dealer settled FINRA charges for failing to collect required initial and maintenance margin on certain over-the-counter ("OTC") equity option contracts.

According to the Order, the firm entered into customized OTC equity option contracts with affiliated entities which were used to hedge credit risk. FINRA found that the firm improperly held the OTC contracts in cash accounts, rather than margin accounts and that the firm did not collect the required initial and maintenance margin. (FINRA noted that the failure was due to a discontinued manual reporting process for calculating margin requirements, which occurred following a management change, and which left the firm without a process for margin collection during the relevant period.)

FINRA said the firm's failure to collect margin resulted in (i) significant margin deficiencies, with amounts ranging from approximately $16 million to $2.2 billion for one affiliated entity and from $1 million to $81.1 million for another at various times during a sample period; (ii) the firm improperly extending credit to the affiliated entities associated with the options trading; and (iii) the firm miscalculating the required margin leading to and overstatement on its net capital in FOCUS reports. 

FINRA determined that the firm violated FINRA Rules 4210 ("Margin Requirements") and 2010 ("Standards of Commercial Honor and Principles of Trade"); Exchange Act Sections 7(c) ("Margin requirements"), 15(c)(3) ("Registration and regulation of brokers and dealers") and 17(a)(1) ("Records and Reports"); Exchange Act Rules 15c3-1 ("Net capital requirements for brokers or dealers"), 17a-3 ("Records to be made by certain exchange members, brokers and dealers") and 17a-5 ("Reports to be made by certain brokers and dealers"); and Section 220.8 ("Regulation T").

To settle the charges, the firm agreed to (i) a censure, (ii) pay a fine of $1,400,000 and (iii) implement corrective measures to prevent future misconduct.