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FINRA’s 5 Key Enforcement Trends to Watch in 2012

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The significant jump in fines issued by the Financial Industry Regulatory Authority (FINRA) in 2011 provides a look into the top areas that the regulator will be focusing on in 2012, according to the law firm Sutherland Asbill & Brennan.

Sutherland’s annual FINRA Sanctions Survey ranked the Top 5 Enforcement Issues in 2011, which AdvisorOne covered Monday. The survey found that fines issued by FINRA increased significantly in 2011, jumping 51% to $68 million from fines levied by the regulator in 2010, which amounted to $48 million.

FINRA also filed 1,488 disciplinary actions in 2011, a considerable increase from the 1,310 cases it initiated in 2010. More reps were also barred by FINRA last year than in 2010: 329 last year versus 288 in 2010, an increase of more than 14%.

Read on to see why Sutherland is warning firms to be particularly cognizant of their compliance efforts in the following five areas:

1)  Advertising 

Advertising made its debut on Sutherland’s Top Enforcement Issues list in 2009, ranking fifth with $5.5 million in total fines. In 2010, advertising cases ranked first, although fines dropped to $4.75 million.  In last year’s analysis, Sutherland predicted that FINRA would continue placing greater emphasis on advertising materials.  This prediction proved to be correct in 2011, as advertising cases resulted in fines totaling $21.1 million, an increase of 344% compared with 2010.

In 2011, advertising cases involving Auction Rate Securities (ARS) played a prominent role. In fact, 45% of the 2011 advertising fines ($9.5 million) involved ARS. One of the largest sanctions imposed in an ARS advertising case was a $3 million fine against a firm for allegedly creating misleading marketing materials that were used when the securities were sold to retail customers. FINRA charged that these advertisements did not adequately disclose the liquidity risks of ARS (including the possibility of auction failure) and that they improperly described these securities as “safe and liquid investments.” 

2)  Municipal Securities

FINRA has emphasized that member firms need to understand the municipal securities they sell and corresponding regulatory requirements. FINRA’s 2011 enforcement activity reflected a growing regulatory concern for municipal securities, as the number of cases reported jumped 81% in 2011 (32 cases reported in 2010 compared to 58 in 2011). Similarly, the amount of fines reported in 2011 ($3.7 million) more than doubled the $1.5 million imposed in cases involving municipal securities in 2010.

2)  Return of “Supersized” Fines

The number of FINRA’s “supersized” fines ($1 million or more) has dwindled in recent years, from 19 reported in both 2006 and 2007, to 10 in 2009, and only six in 2010. Although the number of these large fines grew only to 10 in 2011, the total amount of these fines exploded from $14.2 million in 2010 to more than $35 million in 2011. This includes five fines of at least $3 million and a short selling case that resulted in a $12 million fine.

Sutherland’s FINRA Sanctions Survey noted that short selling cases led to the second largest amount of fines for the regulator in 2011. FINRA reported $16.8 million in fines from 38 cases involving alleged short selling violations in 2011. However, this was due largely to a single case that resulted in a $12 million fine (FINRA’s largest fine in 2011) for a firm’s alleged violations of Regulation SHO and corresponding supervisory deficiencies. Regulation SHO requires a seller to reasonably believe a security can be acquired and delivered before it may be sold short. It also requires sellers to mark the shares as either long or short. 

4)  Mutual Fund Comeback 

After yielding the most fines in both 2008 and 2009, fines stemming from disciplinary actions involving mutual funds dropped dramatically in 2010. In fact, there were only 12 mutual fund cases in 2010, totaling only $1.3 million in fines. In comparison, mutual fund cases generated more than $12 million and $10.3 million in fines in 2008 and 2009 and $104 million and $95 million in fines in 2005 and 2006.

Although the $5.1 million in 2011 fines is only a small percentage of these earlier numbers, it is a substantial increase from 2010’s figures. With the number of mutual fund cases (55) and the total amount of corresponding fines more than quadrupling during the past year compared to 2010, it seems likely that these products will once again become an area of emphasis for FINRA.

5)  Electronic Communications 

The total amount of fines stemming from alleged violations concerning electronic communications has now decreased for three consecutive years. After yielding approximately $4 million in fines in both 2009 and 2010, these cases resulted in only $3.6 million in fines in 2011. Despite this drop in fines, the number of cases actually grew from 34 reported in 2010 to 57 in 2011.

A 65% increase in the number of electronic communications cases between 2010 and 2011, along with a 10% decrease in the total amount of annual fines, may demonstrate that many firms have effectively addressed large issues such as email retention, Sutherland says. Out of the 57 electronic communications cases reported in 2011, only four resulted in sanctions of $200,000 or greater (in comparison to five out of 2010’s 34 cases). 

In 2011, there were four relatively large cases involving electronic communications.  One firm was fined more than $900,000 after it allegedly failed to retain any emails for at least three years.  Although the firms in the other three cases captured and retained emails, FINRA found that their efforts were inadequate. FINRA fined one firm $300,000 because the firm’s network allegedly retained emails for only 60 days and users could remove email records by deleting previously deleted files a second time.  Even though this firm had relied on a third-party to create its email retention system, FINRA alleged that the firm was liable for the alleged violations. 

Read FINRA’s Top 5 Enforcement Issues in 2011 at AdvisorOne.


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