In a recent settlement with FINRA, a major broker-dealer agreed to pay over $3 million in monetary sanctions due to supervisory failures related to short-term trading recommendations. These trading activities, which spanned a two-year period from January 2017 to December 2018, resulted in client losses while generating significant profits for the firm.

Background:

FINRA’s investigation revealed that the firm failed to adequately supervise its registered representatives, particularly regarding unsuitable short-term trading of syndicate preferred stocks, closed-end funds (CEFs), and medium-term notes (MTNs). One representative alone was responsible for over 100 short-term trades, many of which led to client losses when positions were sold within 180 days of purchase. Despite internal red flags and warnings, the firm did not take timely or sufficient action to restrict the representative's activities, allowing these practices to continue for months.

Key Findings:

• Unsuitable Trades: One representative recommended short-term trades that led to significant client losses but resulted in $578,023 in selling concessions and $282,564 in sales commissions for the firm.

• Firm-Wide Issue: FINRA uncovered that at least 40 other representatives engaged in similar practices, leading to over $1.45 million in selling concessions and $316,000 in sales commissions.

• Supervisory Lapses: A critical issue cited in the case was the firm’s automated alert system, which only flagged short-term trades occurring within 90 days. This left a gap in the oversight of over 1,200 transactions where securities were held between 91 and 180 days.

FINRA’s Response:

FINRA concluded that the firm’s supervision of its representatives was insufficient to prevent unsuitable trading practices. As part of the settlement, the firm has agreed to pay $599,025 in restitution to affected customers and a $400,000 fine. Additionally, the firm has been ordered to disgorge over $2 million in profits earned from these transactions.

The firm has since taken steps to rectify these issues, including implementing an enhanced trade review system and revising its supervisory procedures to better identify and monitor unsuitable short-term trading.

Insights:

This case highlights the importance of robust supervisory controls in the broker-dealer space, particularly regarding short-term trading recommendations. Inadequate oversight can result in not only significant financial penalties but also reputational damage. Firms must ensure their surveillance systems are comprehensive, capable of detecting improper trading activity across various timeframes, and that swift corrective action is taken when issues arise.

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