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Finra’s Disciplinary Focus is Shifting, Lawyers Warn

By Rita Raagas De Ramos September 26, 2017

Finra seems to be shifting the attention of its disciplinary actions toward the “nuts and bolts” areas of financial advice compliance, new analysis seems to suggest.

But the regulator insists its top enforcement priorities haven’t changed. They remain investor protection and market integrity, according to spokeswoman Michelle Ong, who stresses Finra’s focus is cases where investors are most at risk – such as theft, fraud and excessive trading.

Brian Rubin, a partner at law firm Eversheds Sutherland, says Finra had fewer disciplinary actions and imposed lesser fines in the first six months of 2017 compared with the same period last year. But the emphasis of these actions was on core regulatory issues such as suitability, books and records, trade reporting, and supervisory policies and procedures, according to the law firm’s analysis.

Yet Ong points to Finra’s 2017 Regulatory and Examination Priorities Letter as a better indication of Finra’s enforcement focus.

“A common thread running through this year’s annual regulatory priorities letter is a focus on core issues of compliance, supervision and risk management,” she says. “Firms should pay attention to these core regulatory requirements and ensure they are allocating adequate resources to their compliance efforts.”

Finra imposed $23.5 million in total fines in the first half of this year, 70% lower than the $79.4 million in the first half of 2016, the law firm’s analysis shows. If Finra continues to assess fines in 2017 at the current rate, Eversheds Sutherland estimates total fines for 2017 would total $47 million – some 73% lower than the $176 million in 2016. The law firm says the record low full-year total for Finra fines was $42 million in 2010.

Ong says disciplinary action statistics should be taken in the proper context. “The quantity of fines alone is not an effective measurement of Finra’s enforcement program,” she says.

She cites two example cases with “significant outcomes” that did not involve fines. Both disciplinary actions took place in August, however, which isn’t covered in the period analyzed by Eversheds Sutherland.

Finra expelled New York-based Hallmark Investments and barred its CEO Steven Dash over a scheme to sell shares of stock to customers at fraudulently inflated prices. Finra also suspended Hallmark representative Stephen Zipkin for two years and required him to pay more than $18,000 in restitution to affected customers. Finra found that Hallmark, Dash and Zipkin used an outside brokerage firm, manipulative trading, and misleading trade confirmations to sell nearly 40,000 shares of stock the firm owned to 14 customers at fraudulently inflated prices.

In the second case Ong cites, Finra barred Craig Scott Capital principals Craig Scott Taddonio and Brent Morgan Porges, as well as broker Edward Beyn for churning client accounts and the principals’ failure to supervise broker Beyn’s churning. Finra didn’t impose any monetary sanctions in the case since two of the three parties involved had filed for bankruptcies.

To illustrate Finra’s efforts at fighting for the benefit of investors, Ong says the Craig Scott Capital case “required four lawyers to present evidence from 15 different witnesses over the course of a three-week hearing.”

Meanwhile, Finra had 459 disciplinary actions during the first half of this year – some 16% fewer than the 547 disciplinary actions it had in the first half of 2016, the Eversheds Sutherland analysis shows.

Eversheds Sutherland says Finra’s disciplinary actions in the first six months of 2017 focused on cases involving trade reporting, books and records, mutual funds, senior retirees, and form U4/U5/3070.

Trade reporting cases resulted in the most Finra fines in the first six months of 2017, up from its number three spot in the full year of 2016 on Eversheds Sutherland’s top enforcement issues list. Finra reported 59 trade reporting cases that resulted in $8 million in fines in the first half of this year.

Eversheds Sutherland cites a significant trade reporting case that resulted in a $3.25 million fine, which was “the largest fine against a firm” in the first half of this year. The fine was for failing to report all the firm’s reportable conventional options positions, failing to have written supervisory procedures regarding relevant reviews, and failing to implement appropriate remediation.

Finra reported 38 books and records cases that resulted in $2.2 million in fines in the first half of this year. One books and records case in the first half resulted in $550,000 in total fines imposed on multiple affiliated firms for applying inaccurate accounting and net capital treatments of investment advisory fees and failing to prepare and maintain accurate financial records, including general ledgers, balance sheets, trial balances and net capital computations.

In July, which is after Eversheds Sutherland’s review period, Finra fined a firm $1.5 million for, among other things, failing to preserve records in “write once, read many” (WORM) format. This case was similar to WORM cases last year, when Finra fined 12 brokers $14.4 million – including Wells Fargo Advisors and LPL Financial – for failing to update their records correctly in the WORM format. Finra says the failure left customer and broker-dealer data open to increasingly aggressive hackers.

Finra reported 25 mutual fund cases that resulted in $754,000 in fines in the first half of this year. That’s lower than 20 cases in the same period last year but the fines were more than the previous $215,000.

Eversheds Sutherland says Finra has been focused on the same types of mutual fund cases that it brought last year, which involve sanctioning firms for selling mutual fund shares with front- or back-end sales charges, to certain customers who were eligible to receive sales charge waivers.

One explanation for “fairly low” total fines relative to the number of mutual fund cases is the self-reporting of issues to Finra. Such self-reporting led to firms paying $7.7 million in restitution in the first half of this year instead of being fined.

Finra reported 37 senior/retiree cases that resulted in $558,000 in fines in the first half of this year. That’s far higher than the 11 cases and $37,500 in fines in the same period last year. Eversheds Sutherland believes the increase is consistent with the regulator’s stated goal of increasing its focus on senior investors and retirement accounts.

Finra reported 57 form U4/U5/3070 cases that resulted in $1.2 million in fines in the first half of this year. That’s lower than the 55 cases and $720,000 in fines in the same period last year. Form U4 is used for the application for securities industry registration or transfer. Form U5 is used for the securities industry termination notice. Form 3070 is no longer applicable because it has been replaced by Finra Rule 4530, which identifies various reporting requirements.


Eversheds Sutherland says these cases, mainly against individual representatives, were partly due to Finra’s greater emphasis on registered representative disclosures, typically focusing on failures to disclose tax liens, bankruptcies, criminal histories and other events on Forms U4.

Finra ordered $38.1 million in restitution during in the first half of this year, the analysis shows. If Finra continues to order restitution at a similar pace, Eversheds Sutherland estimates the restitution amount for 2017 would total $76 million. That would be 171% more than the $28 million in total restitution in 2015 but 21% lower than the record-setting $96 million in 2015, the law firm says.

“Such a dramatic increase for the year seems unlikely,” however, because this year’s first half figure includes a case where a Finra hearing panel ordered a firm to pay $24.6 million in restitution to customers for fraudulent sales in high-risk oil and gas ventures over a four-year period, the analysis shows.

Finra is currently undergoing a comprehensive self-evaluation and organizational review, which it refers to as Finra 360. The review includes rules and rule implementation. Broker-dealer firms are calling for an end to regulation by enforcement, which they say should be replaced by succinct, clear, tell-it-as-it-is guidelines.