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Key Takeaways:

  • FINRA released its most recent Sanctions Guideline, effective immediately, on October 20, 2021. A link to that document can be found HERE.
  • The key change in the 2021 Sanctions Guideline is a new section which provides for sanctions attributable to omitted, late, false, inaccurate or misleading Consolidated Audit Trail System (CAT) reports. That new guideline is discussed below.
  • We also identify herein conduct that is attributable to the most onerous sanctions and compare those results to sanctions attributable to sales practice violations common to investors. The disparity in the recommended disciplines may surprise you!
  • Finally, we explore whether recently published FINRA disciplinary settlements actually fall within FINRA’s published guidelines and we offer our thoughts as to the results of that analysis.

New - Sanctions for consolidated audit trail system violations

Below is the newest sanction guideline for violations of the Consolidated Audit Trail System rules. This guidance is not found in the published guidelines from 2019, and it marks the only material difference between the former and the new version. 

Consolidated Audit Trail System (CAT) – Late Reporting; Failure to Report; False, Inaccurate or Misleading Reporting; and Clock Synchronization Failure

Principal Considerations in Determining Sanctions:

  1. Nature of FINRA CAT reporting violation.
  2. Extent to which violative conduct affected the regulatory audit trail.
  3. Whether the violation occurred over an extended period of days.
  4. Whether the violation was readily apparent from a review of reporting metric information provided to CAT reporters through the CAT Reporter Portal and feedback files.
  5. While respondents are responsible for the systems that they use and the third-party vendors that they employ, the appropriate level of sanctions will depend on whether the respondent diligently chose, installed, and tested a system that nevertheless malfunctioned; the frequency and thoroughness with which the respondent ensured that the system was operating in compliance with applicable rules; and the care that the respondent exercised in undertaking all necessary steps to correct systems-related malfunctions. The same considerations apply to a respondent that has relied on a third-party vendor’s products or services.

Monetary Sanctions:

  • First action – Fine of $5,000 - $16,000.
  • Second action – Fine of $10,000 - $77,000.
  • Subsequent actions – Fine of $10,000 - $155,000.
  • In all egregious cases, whether a first, second or subsequent action, consider a fine greater than or equal to the high end of the range for a first, second, or subsequent action.
  • Failure to Synchronize Clocks
    • First Action:  Fine of $5,000 - $16,000.
    • Subsequent Actions:  Fine of $10,000 to $77,000.

Suspension, Bar or Other Sanctions:

  • Firm:
    • Subsequent actions – Consider suspending the firm with respect to any or all activities or functions for up to 30 business days.
    • In egregious cases, consider a lengthier suspension (of up to two years) or expulsion of the firm.
  • Individual:
    • Subsequent actions – Consider suspending the responsible individual in any or all capacities for up to 30 business days.
    • In egregious cases, consider a lengthier suspension (of up to two years) or a bar.

Conduct for which FINRA recommends the largest monetary sanctions

While analyzing the newest version of the Sanctions Guidelines, we focused on what conduct garners the largest monetary sanctions. Repeat conduct in the following instances can lead to monetary sanctions up to and exceeding $310,000. Certain conduct will incur additional sanctions and penalties where egregious conduct can be shown. Examples include:

  • Best Execution – Failure to Comply with Requirements for Best Execution – Proposed monetary sanction: $5,000 - $77,000 for first action; $10,000 - $155,000 for second action; and $25,000 - $310,000 for subsequent actions.
  • Marking the Close or Open (the act of placing trades prior to the market open or close solely to influence the price of the stock) - Proposed monetary sanction - $25,000 - $310,000, with the fine exceeding $310,000 for egregious cases.
  • Excessive Markups/Markdowns and Excessive Commissions - Proposed base monetary sanction - $5,000 - $77,000 for first action; $10,000 - $155,000 for second action; and $25,000 - $310,000 for subsequent actions. Sanctions also will include in all cases, the amount of the excessive markup/markdown/commission.
  • Research Analysts and Research Reports – Failing to Comply with Rule Requirements Regarding: (1) Relationships Between Department and Investment Banking Department; (2) Compensation for Research Analysts; and (3) Relationships Between Research Analysts and Subject Companies - Proposed monetary sanction - $5,000 - $155,000 for negligent conduct; and $10,000 - $310,000 (or in excess of $310,000 for egregious cases) where intentional/reckless conduct.
  • Research Analysts and Research Reports – Failing to Comply with Rule Requirements Regarding: (1) Restrictions on Publishing Research Reports and Public Appearances of Research Analysts; (2) Restrictions on Personal Trading of Research Analysts; and (3) Disclosure Requirements for Research Reports and Public Appearances of Research Analysts - Proposed monetary sanction - $5,000 - $155,000 for negligent misconduct; and $fine of $10,000 - $310,000 (and in excess of $310,000) for cases involving intentional/reckless misconduct.
  • Supervision – Systemic Supervisory Failures - Proposed monetary sanction - $10,000 - $77,000 for responsible individuals; and $10,000 - $310,000 for the firm (with higher fines attributable with cases where aggravating factors are predominate). Restitution and disgorgement also will be considered.

Conduct which garners less monetary sanctions but potentially has a greater material impact on investors

In comparison, we were genuinely surprised that the Sanctions Guidelines assign a lower monetary fine on conduct that arguably has a greater direct impact on investors. Legal, Compliance and Risk teams may want to consider the potential for associated investor litigation and reputation risk in addition to the current potential fine levels when prioritizing resources and testing within compliance programs. Prime examples include:

  • Selling Away - Proposed monetary sanction - $5,000 - $77,000.
  • Sale of Unregistered Securities -Proposed monetary sanction - $2,500 - $77,000; and $5,000 - $155,000 were respondent’s conduct involved a high volume of or recurring transactions in penny stocks. Aggravating factors may call for an increased fine.
  • Improper Use of Funds or Securities - Proposed monetary sanction - $2,500 - $77,000.
  • Forgery, Unauthorized Use of Signatures or Falsification of Records -Proposed monetary sanction - For signatures or falsifications involving a transaction, if the transaction is authorized, in the absence of other violations or customer harm: fine of $5,000 to $11,000; Where a respondent affixes a signature to or falsifies a document without authorization, in the absence of other violations or customer harm: fine of $5,000 to $155,000.
  • Borrowing From or Lending to Customers - Proposed monetary sanction - $2,500 - $77,000.
  • Churning or Excessive Trading - Proposed monetary sanction - $5,000 – $116,000.
  • Use of Misleading Communications - Proposed monetary sanction - $1,000 - $31,000; and $10,000 - $155,000 for intentional or reckless conduct.
  • Day Trading Accounts – Failure to Comply with Risk Disclosure Requirements; Failure Appropriately to Approve and Account for Day Trading; Failure to Preserve Required Day-Trading Records - Proposed monetary sanction - $5,000 - $155,000; with $1,000 - $39,000 for failure to preserve required documentation.
  • Discretion – Exercise of Discretion Without Customer’s Written Authority - Proposed monetary sanction - $2,500 - $16,000
  • Guaranteeing a Customer Against Loss - Proposed monetary sanction - $2,500 - $39,000.
  • Fraud, Misrepresentation or Material Omission of Fact - Proposed monetary sanction - $2,500 - $77,000; and $10,000 - $155,000 for intentional or reckless conduct.
  • Suitability – Unsuitable Recommendations - Proposed monetary sanction - $2,500 - $116,000.
  • Unauthorized Transactions and Failures to Execute Buy or Sell Orders - Proposed monetary sanction - $5,000 - $116,000.

Discretionary and mandatory suspensions

FINRA’s guidance for suggested suspensions generally is less rigid than the guidelines regarding monetary sanctions. Indeed, FINRA gives itself wide latitude when deciding how long to seek to suspend a malfeasor. Suspensions can cover a period from 5 business days up to 2 years and well beyond. In egregious situations with no mitigating circumstances, FINRA can also consider a bar of an individual and expulsion of a firm. Under the Sanction Guidelines, there are, however, certain circumstances which warrant an automatic bar or expulsion. In these instances, FINRA has no discretion. Examples include:

  • Failure to Respond to an 8210 Request;
  • Failure to Truthfully Respond to an 8210 Request;
  • Providing a Partial but Incomplete Response to an 8210 Request, Unless the Person can Demonstrate Substantial Compliance;
  • Conversion – Regardless of the Amount Converted;
  • Forgery, Unauthorized Use of Signatures or Falsification of Records Without Authorization and in Furtherance of Another Violation;
  • Cheating, Using and Impostor, or Possessing Unauthorized Materials in Qualifications Examinations or in the Regulatory Element of Continuing Education;

FINRA enforcement settlements often include sanctions far broader than published guidelines

FINRA frequently seeks sanctions through regulatory settlements that far exceed those outlined in the Sanction Guidelines and recently published FINRA regulatory settlements illustrate that firms are accepting those settlements. The following settlements summarize instances in which the agreed upon sanctions far exceeded those recommended or recognized in FINRA’s Sanction Guidelines. 

  • FINRA Case #2016049087201: Where a firm was censured and fined $1,500,000 for failing to provide branch managers with reasonable training or guidance regarding how to identify prohibited transactions. The proposed monetary sanctions for systemic supervisory failure violations range from $10,000 - $310,000 for responsible firms. The settlement is almost 5 times the upper range penalty.
  • FINRA Case #2014041812501: Where a firm was censured and fined $850,000 for failing to exercise reasonable diligence to ascertain whether the venues where it routed certain equity and option customer orders provided the best market for the subject securities as compared to the execution quality that was being provided at competing markets. The proposed monetary sanctions for best execution violations range from $5,000 - $77,000 for first action and up to $310,000 for third actions and all subsequent actions. No prior actions were indicated in this instance. The settlement is more than 10 times the upper range for initial penalties.
  • FINRA Case #2019063058701: Where a firm was censured and fined $750,000 for failing to establish, maintain and enforce WSPs to address unsuitable short-term trading of mutual funds and municipal bonds in customer accounts and over-concentration of customer accounts in Puerto Rican municipal bonds. The proposed monetary sanctions for systemic supervisory failure violations range from $10,000 - $310,000 for responsible firms. The settlement is more than double the guideline upper range.
  • FINRA Case #2018057162401: Where a firm was censured and fined $30,000 for submitting inaccurate data to the Order Audit Trail System in certain ROEs consisting of combined order/execution reports with inaccurate account type codes and orders reported with inaccurate order received timestamps. Proposed monetary sanctions for inaccurate reporting within audit trail systems range from $5,000 - $16,000 for first action offenses. No prior actions were indicated in this instance. The settlement is almost double the guideline upper range.
  • FINRA Case #2018058595601: Where a firm was censured and fined $250,000 as a result of a broker-agent engaging in unsuitable and excessive equity and options trading and used margin in senior customers’ accounts. The proposed monetary sanction for unsuitability violations range from $2,500 - $116,000. The settlement is more than double the guideline upper range.
  • FINRA Case #2018059389401: Where a firm was censured and fined $1,000,000 for failing to address any of the record keeping requirements of Rule 17a-4(f) of the Exchange Act. The firm procedures failed to identify any system, location, or database where documents should be stored, describe any process for auditing the integrity of such documents, or identify the individuals responsible for achieving compliance with record retention requirements. The firm also failed to provide FINRA with requisite 90 day notice prior to storing the subject records electronically. The proposed monetary sanctions for systemic supervisory failure violations range from $10,000 - $310,000 for responsible firms. The settlement is almost is more than triple the guideline upper range.

By comparison, we found the following settlements in which the agreed upon discipline was commensurate with that recommended by the Sanctions Guidelines:

  • FINRA Case #2016048614701: Where a firm was censured and fined $250,000 for its failure to identify its alternative trading system as an SCI entity and establish Reg SCI policies and procedures for the system for two years. The proposed monetary sanctions for systemic supervisory failure violations range from $10,000 - $310,000 for responsible firms.
  • FINRA Case #2019063972801: Where a firm was censured and fined $175,000 for publishing and distributing to its institutional customers equity research reports that omitted required disclosures and/or included inaccurate disclosures relating to the firm’s involvement with and intent to seek compensation from a subject company. The proposed monetary sanctions for violations stemming from insufficient disclosures relating to research reports range from 10,000 - $310,000
  • FINRA Case #2019063187001: Where a firm was censured and fined $25,000 for selling private placement offerings claiming registration exemptions under Rule 506(b) but without having established pre-existing, substantive relationships with the offerees prior to participating in those offerings. The proposed monetary sanctions for sale of unregistered securities range from $2,500 - $77,000.
  • FINRA Case #2019060656601: Where a firm was censured and fined for $15,000 for failing to deposit investors’ funds into a bank escrow account while acting as the placement agent for a private placement, which was structured as a contingency offering of securities, on behalf of an issuer. The firm deposited investor funds into a bank account that it established and controlled, not a separate bank account as agent or trustee, rather than with a bank that had agreed in writing to hold the funds in escrow. It was also found that the firm wilfully violated the Securities Exchange Act of 1934 (Exchange Act) Rule 10b-9 by failing to promptly return funds to investors after the minimum contingency amount was reduced. The proposed monetary sanctions for improper use of client funds range from $2,500 - $77,000.

Given the disparity in results, with sanctions falling both within and significantly above the ranges contemplated by FINRA’s published Sanctions Guidelines, firms should consider whether the applicable facts and circumstances  warrant sanctions larger than what is called for in the Sanctions Guidelines and whether mitigating factors can be asserted to reduce the overall exposure. Marshalling information and presenting mitigating factors to FINRA is critical in posturing effectively during settlement negotiations. Considerations for mitigation should include:

  • No prior similar infractions;
  • Lack of customer harm;
  • Customer remediation efforts, if customer harm is present;
  • Self-reporting;
  • Significant remedial actions;
  • Elimination of the action, product or process which gives rise to the infraction;
  • Voluntary increased training.

Conclusion

In assessing and mitigating regulatory and enforcement risk, appreciation of the facts and circumstances is critical. While the industry may hope that the Sanctions Guidelines provide a degree of consistency, predictability and general fairness, practitioners should understand that results will vary significantly based on the facts of each case. FINRA member firms should seek to ensure that all possible mitigating factors are properly considered by FINRA in reaching the matter’s resolution. Savvy institutions should pay special attention to trends in FINRA enforcement actions, particularly the settlements, as the conduct that can lead to the largest fines is not always obvious, nor consistent across the industry. By staying current on enforcement trends, and seeking knowledgeable counsel to assist in the defense of regulatory enforcement matters, firms can posture themselves for more economic and efficient resolutions. If you have questions on this topic or need assistance with securities regulatory or litigation matters, please reach out to us, as we would be delighted to help with your needs.

This document provides a general summary and is for information/educational purposes only. It is not intended to be comprehensive, nor does it constitute legal advice. Specific legal advice should always be sought before taking or refraining from taking any action.