More On Legal & Compliancefrom The Advisor's Professional Library
- Where Are We Headed? The ultimate compliance goal is to help ensure that everyone associated with an advisory firm acts ethically at all times. Advisors and RIAs should do the right thing, even when regulators are not looking over their shoulders.
- RIAs and Customer Identification Just as RIAs owe a duty to diligently protect their clients privacy and guard against theft, firms also play a vital role in customer identification. Although RIAs are not subject to an anti-money laundering rule, securities regulators expect advisors to address these issues in their policies and procedures.
Among recent actions by the SEC were charges against a Miami trader for short-selling the stock of a Chinese company ahead of its offering.
FINRA took action against firms for statement and confirmation delivery and disclosure failures.
FINRA Fines UBS $575,000 for Statement Glitches
UBS Securities LLC was censured and fined $575,000 by FINRA for violations ranging from failure to deliver account statements and trade confirmations and in some cases sending those documents without required disclosures.
According to FINRA, the firm discovered during routine testing that sometimes it either failed to produce or send paper and electronic trade confirmations and account statements, or sent such confirmations and account statements without some required disclosures to certain U.S. institutional clients. Also, trade confirmations for OTC equity derivative transactions lacked certain required disclosures. In some cases, these failures went back to 2003.
Improper coding caused the system to fail to recognize that certain transactions required confirmations to be issued. Instead, the executing firm foreign affiliate produced and sent the confirmation electronically, the firm generated a confirmation without the disclosure or no confirmation was produced at all.
In addition, staff failed to enter client data that, if entered completely and accurately, would have triggered the generation of a required confirmation. Also, supervisory failures meant that the firm did not uncover the fact that institutional customers failed to receive paper or electronic confirmations, and did not uncover missing or incorrect customer addresses except primarily through returned mail.
The agency acknowledged that UBS discovered the violations itself during internal testing, and worked on correcting them before self-reporting them to FINRA, in addition to assisting FINRA during its investigation. For its part, UBS neither admitted nor denied FINRA's findings, but consented to their entry and to the sanctions.
Merrill Fined $325,000 on Omission of Disclosure Info from Reports
Merrill Lynch was censured and fined $325,000 by FINRA on findings that it failed to provide appropriate disclosure information in research reports, resulting in violations of NASD Conduct Rules 2711 and 2110, and FINRA Rule 2010.
Thanks to an acquisition, the firm’s research department was required to consider a company’s relationship with the companies that were the subject of the research report (covered companies) in determining which required disclosures to include in research reports the firm issued. But because of the acquisition's compressed timeline, the company still used separate systems from the firm after the acquisition, and research and technology teams from both entities had to aggregate information about the entities’ respective relationships with covered companies to generate complete and accurate required disclosures in research reports. The aggregation process resulted in errors that the firm did not discover for more than a year.
An upstream company file used to match companies covered by the firm’s research department with the company revenues and client relationships included inaccurate data, and the process designed to update that file failed. That meant that the company information the firm’s research data repository used to determine disclosures was stale and resulted in the omission of required disclosures in approximately 19,200 research reports.
An additional disclosure deficiency began at some point when a third-party vendor provided incomplete data to the firm relating to covered companies. As a result, research reports relating to the covered companies failed to disclose whether the firm had managed or co-managed a public offering of the covered company’s securities in the past 12 months. The missing data was discovered and corrected, but it has not been determined when the disclosure deficiency began or how many research reports were impacted by it.
Also, in September of 2008, a new third-party vendor began providing the firm with stock price information that contained incorrect data related to certain covered companies that had been impacted by a stock split. The data problem occurred in each monthly file from the vendor until March 16, 2011, and impacted nearly 14,000 fundamental equity research reports. As a result, a significant number of these reports included a price chart that retroactively adjusted the historical stock price of the covered company to reflect a subsequent stock split but did not provide the same retroactive adjustment to the historical price targets included in the chart, thus showing a distorted relationship between the historical stock price and the historical price target. These errors were also reflected on the firm’s price charts website during this period.
The firm neither admitted nor denied the findings, but consented to their entry and to the fine.
J.P. Turner Order to Pay $700,000 for Unsuitable ETF Sales
FINRA has ordered Atlanta-based broker-dealer J.P. Turner & Co. LLC to pay $707,559 in restitution to 84 customers for sales of unsuitable leveraged and inverse exchange-traded funds (ETFs) and for excessive mutual fund switches.
As FINRA explains, leveraged and inverse ETFs "reset" daily, meaning that they are designed to achieve their stated objectives on a daily basis so their performance can quickly diverge from the performance of the underlying index or benchmark. It is possible that investors could suffer significant losses even if the long-term performance of the index showed a gain. This effect can be magnified in volatile markets.
FINRA found that J.P. Turner failed to establish and maintain a reasonable supervisory system and instead, supervised leveraged and inverse ETFs in the same manner that it supervised traditional ETFs. The firm also failed to provide adequate training regarding these ETFs. In addition, J.P. Turner allowed its registered representatives to recommend these complex ETFs without performing reasonable diligence to understand the risks and features associated with the products.
As a result, many J.P. Turner customers held leveraged and inverse ETFs for several months. J.P. Turner also failed to determine whether the ETFs were suitable for at least 27 customers, including retirees and conservative customers, who sustained collective net losses of more than $200,000.
In addition, J.P. Turner engaged in a pattern of unsuitable mutual fund switching. Mutual fund shares are typically suitable as long-term investments and are not proper vehicles for short-term trading because of the transaction fees and commissions incurred from repeated buying and selling of mutual fund shares. J.P. Turner failed to establish and maintain a reasonable supervisory system designed to prevent unsuitable mutual fund switching and lacked sufficient procedures to adequately monitor for trends or patterns involving mutual fund switches.
In settling the matter, J.P. Turner neither admitted nor denied the charges, but consented to the entry of FINRA's findings.
SEC Charges Miami Trader with Insider Trading, Short-Selling Violations
Charles Raymond Langston III, a Miami-based trader, was charged by the SEC with insider trading in the stock of a Chinese company and conducting illegal short sales in the securities of three other companies.
Langston came across confidential information in the course of being solicited by placement agents to invest in a secondary offering of AutoChina International's stock.
The opportunity was apparently too tempting. Despite the fact that Langston promised to keep the information to himself and not trade on it, he promptly sold short 29,000 shares of AutoChina stock in advance of the company’s public announcement that it had completed the secondary offering, and racked up $193,108 in illegal profits thanks to the inside information. The value of the stock was significantly reduced in the course of the actions.
To hide what he did, Langston made the trades through an entity he owned using a different broker and different account than he used to purchase shares in the company’s initial offering.
But that wasn't all. Langston and two of his companies, Guarantee Reinsurance and CRL Management, violated Rule 105 of Regulation M, which prohibits the short sale of an equity security during a restricted period — usually five business days before a public offering — and the purchase of that same security through the offering. The rule addresses illegal short selling that can reduce offering proceeds received by companies by artificially depressing the market price shortly before the company prices its public offering.
Through Guarantee Reinsurance and CRL Management, Langston made short sales in advance of separate secondary offerings by Wells Fargo, Mitsubishi UFJ Financial Group and Alcoa, then bought shares in the same offerings. That netted him illegal gains of more than $1.3 million, the SEC says.
While he neither admits nor denies the charges, Langston has agreed to settle the insider trading charges by paying disgorgement of $193,108, prejudgment interest of $22,204 and a penalty of $193,108. In addition, Langston and the two companies also agreed to be fined for the short-selling violations an amount to be determined later by the court.
Check out SEC Enforcement: ‘Trader’ Bilks Elderly Investors to Pay Mortgage on ThinkAdvisor.