The Financial Industry Regulatory Authority said Tuesday that a hearing panel censured broker-dealer C.L. King & Associates and fined the firm $750,000 for negligence in how it represented the redemption of some debt securities to a hedge fund client.
The regulator also suspended the firm’s compliance officer and fined him $20,000 for not setting up an adequate anti-money laundering (AML) program and not taking related steps tied to the liquidation of billions of shares of penny stocks, which were “red flags” of potentially suspicious activity.
According to the hearing panel, the hedge fund manager opened joint accounts at C.L. King “with terminally ill persons as joint tenants with rights of survivorship.”
The fund's strategy entailed using these accounts to buy discounted corporate bonds that had a survivor option, or "death put." The death put let the manager, as the joint account's survivor, redeem the investments from issuers for the full principal amount before maturity upon the death of a joint tenant.
Terminally ill persons were paid $10,000 to open joint accounts and were referred to the fund manager and C.L. King by a hospice in New Jersey.
The panel ruled that the broker-dealer had “an obligation to disclose to issuers during the redemption process that terminally ill joint tenants were not in fact beneficial owners of the investments, because the hedge fund required them to sign side agreements in which they agreed to give up their ownership rights to the assets in the joint accounts.”
"The FINRA matter recently decided involved a business line and relationships that [C.L. King] terminated years ago, and before FINRA brought any enforcement claims," according to attorney Christopher Robertson of Seyfarth Shaw, in a statement. "While we are disappointed that the firm was not completely exonerated, the decision recognized that the firm did have procedures in place and in no way acted deliberately or with any improper intent."
The panel denied a request for disgorgement, Robertson adds, and "assessed fines that were well below the amounts" being sought by the regulatory group.
The firm is "evaluating all of its options, including an appeal," according to its attorney.
Robertson points out that the FINRA panel's ruling in the "death puts" matter "appears to be directly at odds with the recent decision by an administrative law judge in a related SEC matter involving one of the subject clients, [which included] dismissing the SEC’s claims against that client."
Though the FINRA panel acknowledged this SEC judge's decision, it did not follow the judge's reasoning "and made legal findings, on an issue of first impression under New York law, "that contradict the SEC judge’s ruling," the Seyforth Shaw attorney explained.
C.L. King says the fines are "excessive based upon relevant precedent and other mitigating factors that were presented at the hearing but not addressed in the decision."
The firm, in business since 1972, "prides itself on its compliance with all relevant regulatory requirements, and does not believe it acted inappropriately, or that its procedures were deficient," Robertson explains. "Regardless, this is a legacy matter that has no relationship to, nor will it affect, its current business lines or operations."
Separately, the FINRA panel says, C.L. King sold billions of shares in penny stocks on behalf of two clients several years ago. One bank client in Liechtenstein, for instance, sold 41 million of shares of 40 penny stocks generating more than $4.8 million; the other customer sold more than 11 billion shares in 138 stocks for over $14 million.
FINRA’s hearing panel found that C.L. King and Miller “failed to tailor its AML program to the risks presented by its penny stock business and did not monitor the customers' trading activity for red flags indicative of potential money laundering.”
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