Firm Settles FINRA Charges for Supervisory Deficiencies in Syndicate Preferred Stock Trading
Commentary by Jeff Ziesman
A firm settled FINRA charges for (i) failing to supervise unsuitable short-term trading of syndicate preferred stocks and (ii) allowing representatives to profit from repeated short-term trades that led to customer losses.
According to the AWC, during a two-year period, firm representatives recommended 1,986 purchases of syndicate preferred stocks to retail customers, only to recommend selling these securities within 180 days, often at a loss. FINRA found that "[m]ultiple ... representatives engaged in repeated short-term buying and selling of syndicate preferred stock," and, in many instances, customers were encouraged to purchase additional syndicate preferred stocks, generating further commissions for the representatives. FINRA found that the firm earned $2,645,537 in sales concessions from issuers and $343,914 in sales commissions from these transactions.
FINRA determined that the firm's supervisory system was insufficient to detect and address these activities. FINRA said that the firm's surveillance system screened for preferred stock trades held for less than 90 days and focused only on representatives with the highest volume of such trades, leaving a significant portion of short-term trading activity unsupervised. FINRA added that even when trades were flagged, the firm often failed to follow up or investigate adequately.
FINRA concluded 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 $500,000 fine, (iii) pay $343,914 in restitution to affected customers and (iv) disgorge $2,645,537 in ill-gotten gains, with interest.
Commentary
FINRA continues to bring cases in the preferred stock space. What is lamentable about this matter is the age of the alleged misconduct. The relevant period is from January 2017 to December 2018—in other words, the end of the relevant period was nearly six years ago. In 2000, the SEC held, in the Hayden case (an appeal from a New York Stock Exchange disciplinary decision), that fundamental fairness dictated that the matter be dismissed due to the NYSE's delay in bringing the case. In particular, the SEC held that "the delay in the underlying proceedings was inherently unfair," although it did not specify a precise time frame in which matters must be brought after regulatory detection. The untimely nature of the instant preferred stock matter, and other recent proceedings, leads one to believe that another Hayden challenge may be coming.
The thrust of these preferred stock cases is that these securities are purchased for income—as FINRA notes, they typically offer more consistent income payments than common stock and higher payments than many bonds. The securities are typically intended to be, and are, held long term.
In this matter, FINRA found instances in which representatives recommended and traded preferred stock, received the sales concession, and then sold the preferred stock. In particularly problematic instances, other types of preferred stocks were then purchased. FINRA found that the firm did not provide adequate guidance to the field sales force regarding appropriate holding periods for preferred stock. FINRA also found that the firm had inadequate surveillance tools to ascertain instances of potential abuse for the premature sales of preferred stock. In the end, the firm paid a hefty fine of $500,000, disgorgement (which equaled the amount of commissions) of over $2.6 million, and restitution of nearly $344,000.