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On April 29, 2016, the Securities and Exchange Commission (“SEC”) filed an Order Instituting Administrative and Cease-and-Desist Proceedings Pursuant to Section 4C of The Securities Exchange Act of 1934, Section 203(k) of The Investment Advisers Act of 1940, and Rule 102(e) of The Commission’s Rules of Practice, Making Findings, and Imposing Remedial Sanctions and A Cease-and-Desist Order (the “Order”) against Santos, Postal & Company, P.C. (“Santos, Postal & Co.”), an accounting firm, and Joseph A. Scolaro, CPA (“Scolaro”), a Santos, Postal & Co. partner since 2004 (collectively the “Respondents”).  The Order involves improper examinations by Santos, Postal & Co. of its clients’ funds, of which it had custody.  Further, Santos, Postal & Co. and Scolaro filed two (2) Forms ADV-E with materially false statements relating to the examinations.  Santos, Postal & Co. has been registered with the SEC’s Public Company Accounting Oversight Board since 2010, and Scolaro regularly conducted public accounting services before the SEC.

The Respondents’ improper examinations relate to the misappropriation of client funds by SFX Financial Advisory Management Enterprises, Inc.’s (“SFX”) Vice President, Brian J. Ourand (“Ourand”).  SFX first engaged Santos, Postal & Co. to perform its examinations in 2004 and continued to engage them until 2012 when SFX withdrew its registration with the SEC.

Santos, Postal & Co. is a certified public accounting and management consulting firm based in Rockville, Maryland, that provides accounting, tax, and auditing services.  Scolaro was one of five partners and owned 25% of Santos, Postal & Co.  He was the only engagement partner for services for SFX.

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On June 29, 2015, Mark F. Leone (“Leone”) submitted a Letter of Acceptance, Waiver, and Consent (“AWC”) to settle allegations made by the Financial Industry Regulatory Authority, Inc. (“FINRA”).  Currently, Leone is registered with Cambridge Investment Research, Inc.; however, FINRA alleged that while Leone was registered with Morgan Stanley, he exercised discretion in customer accounts without written authorization to do so.  To settle the FINRA allegations, Leone submitted to censure, a fine of $5,000 and suspension for fifteen (15) business days.  A copy of the FINRA AWC is available here.

Specifically, FINRA alleged that on March 10, 2014, Leone, effected five (5) discretionary transactions on customer accounts without first obtaining written authorization from the customers, or having the accounts accepted as discretionary at Morgan Stanley.  According to Leone’s BrokerCheck Report, on April 3, 2014, Morgan Stanley terminated Leone for allegations regarding discretionary trading without written authorization.  In response to those allegations, Leone stated, “five clients owned a stock and had a gain in the stock.  The market was about to close and I was going out of town.  I quickly entered sell orders to close the positions in the account. This generated a bunching report to Morgan Stanley.”

Bunching, or aggregating multiple executions into a single tape report, is prohibited under FINRA Rules Rules 6282(f), 6380A(f) and 6380B(h).  Similarly, NASD Conduct Rule 2510(b), FINRA Rule 2010, and Morgan Stanley firm policies all prohibit registered representatives from exercising discretionary control over customer accounts without written authorization from that customer and firm approval.  FINRA alleged that Leone lacked any authorization to make transactions in these customer accounts outside of one account where he was given insufficient verbal authorization.  As such, Leone violated NASD Conduct Rule 2510(b) and FINRA Rule 2010.

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On June 29, 2015, Jeffrey D. Daggett (“Daggett”) submitted a Letter of Acceptance, Waiver, and Consent (“AWC”) to settle allegations made by the Financial Industry Regulatory Authority, Inc. (“FINRA”)  The FINRA AWC alleged that Daggett, while registered with Wells Fargo Advisors, LLC made numerous unsuitable recommendations of exchange traded products to his customers in violation of FINRA rules.  To settle the FINRA allegations, Daggett submitted to censure, a fine of $20,000 and a suspension for four (4) months.  A copy of the FINRA AWC is available here.

Specifically, FINRA alleged that from March 2010 through September 2011, Daggett recommended and traded in a volatile and speculative exchange traded note (“ETN”), an inverse triple leveraged exchange traded fund (“ETF”), and a triple leveraged ETF in customer accounts that were inconsistent with the customer’s investment objectives of moderate growth and income.  The ETN was tied to long positions in futures contracts on the Chicago Board Options Exchange Volatility Index, and stated in the prospectus that it was intended for short-term trading and may not be appropriate for intermediate or long-term investment time horizons.  Similarly, the ETF prospectuses also stated that they were intended for short-term trading.  Nevertheless, the ETN and ETF positions were held in the customer account for periods ranging from one (1) month, to two (2) years.  FINRA alleged that Daggett lacked a reasonable basis for believing that the ETN and ETF purchases were suitable for his customer, and as such, violated NASD Conduct Rules 2310 and IM-2310-2, as well as FINRA Rule 2010.

ETFs, ETNs and other exchange traded products are very popular among investment advisers who seek to expose their customers to a particular index or sector of the economy.  However, these complex products and the trading strategies utilizing them are difficult for retail investors to fully grasp, and therefore, understand the risk accompanying them.  Many investment advisers utilize intraday trading strategies regarding these products, including complex hedging strategies whereby they hedge them against futures contracts regarding the basket of underlying securities or contracts that the ETF tracks.  Additionally, many of these products have a “resetting” function that makes them unsuitable for many investors as part of a buy-and-hold strategy.  Recently, we covered the Securities and Exchange Commission’s request for public comment on ETFs and ETNs.

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On June 26, 2015, Lax & Neville LLP, a leading national securities arbitration law firm, won a FINRA arbitration award on behalf of two retail investors (the “Retail Investors”), through Ontonimo (OMO) Limited (“Ontonimo”), against BNP Paribas Securities Corp. (“BNPP”) for the sale and marketing of an unsuitable security to the Retail Investors.  A highly sophisticated and experienced three (3) person Arbitration Panel rendered the arbitration award after a ninety-five (95) day arbitration hearing (186 hearing sessions), which is the longest customer FINRA arbitration hearing in the last twenty (20) years and the second longest ever.  The Arbitration Panel awarded the Retail Investors, through Ontonimo, $16.1 million in compensatory damages, inclusive of interest.  This award of compensatory damages represents 100% of the net out-of-pocket loss plus interest and is one of the largest FINRA arbitration awards of compensatory damages in a customer dispute.  Significantly, in addition to that relief, after winning six (6) Motions For Sanctions and five (5) Motions To Compel, the Arbitration Panel awarded $500,000 in sanctions for attorneys’ fees for BNPP’s failure to comply with the Arbitration Panel’s various discovery orders.  This is the largest amount of sanctions awarded in a customer FINRA Arbitration in at least the last ten (10) years.  To view this Award, Ontonimo (OMO) Limited vs. BNP Paribas Securities Corp. – FINRA Case No. 10-04744, click here.

The single investment at issue was a Resetable Strike Equity Option Transaction, which is a highly speculative and leveraged derivative call option.  BNPP recommended that the Retail Investors invest approximately $14.3 million, which is more than 60% of their investable assets, into this one unsuitable security.  Because BNPP had a policy that prohibited the sale of this product to retail customers, BNPP required the Retail Investors to form a corporate entity, Ontonimo, through which the Retail Investors would purchase the investment in order to circumvent BNPP’s own compliance rules.  Further, BNPP required one of the Retail Investors to become a so-called “investment advisor” for Ontonimo by mandating that he execute a sham investment advisory agreement, even though he had no prior professional financial services experience and no securities licenses.  In less than one and one-half years, the Resetable Strike Equity Option Transaction became worthless and the Retail Investors lost their entire $14.3 million investment.  The Retail Investors paid BNPP in excess of $2.3 million in fees and costs for this investment.  BNPP further retained approximately $700,000 of the value of the Resetable Strike Equity Option Transaction after its expiration.

The Arbitration Panel’s message was clear:  The Retail Investors should never have been marketed and sold this unsuitable security.

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In May 29, 2015, J.P. Morgan Chase Bank, N.A. and J.P. Morgan Securities LLC (collectively “JPMorgan”) moved to renew a motion, before the United States District Court for the District of New Jersey, seeking a preliminary injunction (the “Motion”) against six (6) former registered representatives (the “Brokers”), who left JPMorgan to join Morgan Stanley.  According to court documents, the Brokers managed $2 Billion of client assets derived from four-hundred (400) families’ accounts that produce approximately $15 million in revenue per year.  The purpose of the preliminary injunction was the preserve the status quo ante by enjoining certain client solicitation activities by the Brokers, while JPMorgan and the Brokers resolved issues related to the Brokers’ transition to Morgan Stanley through arbitration.

In its Motion, JPMorgan alleged, inter alia, that since transitioning from JPMorgan to Morgan Stanley, the Brokers illegally solicited JPMorgan clients and converted JPMorgan’s confidential and proprietary client information.  JPMorgan’s Motion argued that a preliminary injunction preventing the Brokers from continuing to solicit JPMorgan clients is necessary because the resulting financial harm and loss of customers’ confidence is unascertainable and as such, no other adequate remedy at law exists.

On June 8, 2015, the Brokers filed a forty-page Memorandum of Law in Opposition to Motion for Injunctive Relief (“Opposition”).  Generally, the Brokers’ Opposition argued that the District Court should deny JPMorgan’s Motion because JPMorgan is a signatory to the Protocol for Broker Recruiting (the “Protocol”) and all of the Brokers’ activities were permitted under the Protocol.  Briefly, the Protocol is an agreement between many of the major securities firms that is designed to give clients the opportunity to choose their financial advisory on the merits of their relationships, rather than though the court system.  Under the Protocol, a registered representative who transitions from one Protocol signatory firm to another is permitted to solicit his or her clients once they join the new firm and is permitted to retain certain limited client information.

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On June 5, 2015, E1 Asset Management, Inc. (“E1 Asset Management”), Ron Y. itin (“Itin”), and Ahsan R. Shaikh (“Shaikh”) submitted a Letter of Acceptance Waiver and Consent (“AWC”) to settle allegations by the Financial Industry Regulatory Authority (“FINRA”) that they collectively failed to maintain a reasonable supervisory system at E1 Asset Management.  Both Itin and Shakih are employed by E1 Asset Management in supervisory capacities.  A copy of the FINRA AWC may be found here.

FINRA alleged that E1 Asset Management, Itin, and Shaikah violated NASD Rules 3010, 2110 and FINRA Rule 2010 by failing to establish and maintain E1 Asset Management’s supervisory systems.  According to the AWC, from July 2008 to April 2012, Itin and Shaikh failed to establish a supervisory system reasonably designed to: 1) review registered representatives’ communications with the public; 2) review trading to detect and monitor potential churning activity; 3) review the new account opening process to ensure customer suitability profiles were properly established; 4) perform adequate suitability review for leveraged exchange traded funds (“ETFs”) in customer accounts; and 5) supervise the activities of registered representatives subject to E1 Asset Management’s heightened supervision program.

The FINRA allegations of supervisory failures came after numerous customers commenced FINRA arbitrations alleging sales practice abuses by E1 Asset Management registered representatives.  According to FINRA, many of these arbitrations concluded in settlements.  However, the form release agreements that E1 Asset Management utilized during this time contained ambiguous language that could have been interpreted by the customers as prohibiting them from cooperating with regulatory investigations.  Specifically, those agreements stated that customers must not “[c]ommence or prosecute, or assist in the filing, commencement or prosecution in any government agency, arbitral tribunal, self-regulatory body or court in any claim or charge against E1 Asset Management.”  FINRA alleged that E1 Asset Management, Itin, and Shaikah violated NASD Rule 2111 and FINRA Rule 2010 for including impermissible confidentiality provisions in its form settlement and release agreements.

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On June 12, 2015, the Securities and Exchange Commission (“SEC”) solicited public comment on its approval and regulation of exchange traded products (“ETPs”).  ETPs are similar to open-ended mutual funds, but can be bought and sold throughout the day at market prices, rather than net-asset value.  ETPs include, but are not limited to, exchange-traded funds, pooled investments, and exchange-traded notes.  The SEC’s request for comment asked fifty-three (53) sets of questions touching on subjects such as arbitrage mechanisms, pricing, listing standards, legal exemptions, suitability requirements, and broker-dealer marketing and sales practices with respect to ETPs among other subjects.

According to the SEC, the number of ETPs available to retail customers rose dramatically from 2006-2013.  As of 2014, the SEC estimates there are approximately 1,664 ETPs listed on U.S. exchanges, with a market value surpassing $2 trillion.  Some financial firms design complex ETPs and market them to retail clients in an effort to outperform the market.  In a press release accompanying the SEC’s request for industry comment, SEC Chairwoman Mary Jo White stated,  “[a]s new products are developed and their complexity grows, it is critical that we have broad public input to inform our evaluation of how they should be listed, traded and marketed to investors, especially retail investors.”

In line with the SEC’s concern for retail investors, the SEC solicited industry comment regarding broker-dealer sales practices and investors’ understanding and use of ETPs that generally focused on:

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On Monday, June 22, 2015, the Securities Exchange Commission (“SEC”) Office of Compliance Inspections and Examinations (“OCIE”) announced that it was launching a multi-year Retirement-Targeted Industry Reviews and Examinations (“ReTIRE”) Initiative.  The new ReTIRE Initiative follows OCIE’s 2015 Examination Priorities, which focuses on “examining matters of importance to retail investors and investors saving for retirement.”

The ReTIRE Initiative addresses high-risk areas of broker-dealers’ or investment advisers’ sales, investment and oversight procedures, with emphasis on select areas where retail investors saving for retirement may be harmed.  Specifically, the ReTIRE Initiative will focus on the following areas:

  • Reasonable Basis for Investment Recommendations: Broker-dealers and investment advisers must have a reasonable basis when making recommendations or providing investment advice.  OCIE staff will assess how registered representatives and investment adviser’s: 1) select account types; 2) perform due diligence on investment options; 3) make initial investment recommendations; and 4) provide on-going account management.
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On June 22, 2015, the Financial Industry Regulatory Authority, Inc. (“FINRA”) announced that it had reached a near $1 million settlement with Morgan Stanley Wealth Management (“Morgan Stanley”) and Scottrade Inc. (“Scottrade”) for failing to supervise wire transfers.  Brad Bennett, Executive Vice President and Chief of Enforcement at FINRA, commented on the settlements and stated, “Firms must have robust supervisory systems to monitor and protect the movement of customer funds. Morgan Stanley and Scottrade had been alerted to significant gaps in their systems by FINRA staff, yet years went by before either firm implemented sufficient corrective measures.”  A complete copy of the FINRA press release is available here.

Through a Letter of Acceptance Waiver and Consent (“AWC”), Morgan Stanley submitted to censure and agreed to pay a $650,000 to settle charges that from at least June 2009 through November 2014, Morgan Stanley failed to establish, maintain and enforce reasonable supervisory systems and written procedures regarding outgoing wire transfers and branch check disbursements from customer accounts.  Additionally, from approximately June 2009 through September 2011, Morgan Stanley failed to establish and maintain reasonable supervisory systems regarding its third-party service provider’s coding and acceptance of money orders, which were deposited into customer accounts.  The Morgan Stanley AWC may be found here.

Specifically, FINRA alleged that between October 2008 and June 2013, three (3) Morgan Stanley registered representatives, in two (2) branch office locations, collectively converted approximately $494,400 from thirteen (13) Morgan Stanley customer accounts by causing fraudulent wire transfers and branch checks to be sent to third-party accounts.  During this time, Morgan Stanley had no supervisory procedures in place to detect and monitor disbursements from separate accounts to the same third-party account.  Additionally, Morgan Stanley’s system did not address comparing customers’ signatures on outgoing wire transfer request forms with those on file.  Furthermore, Morgan Stanley’s third-party service provider miscoded certain types of customer deposits that would have raised red flags earlier.  Together, FINRA alleged that Morgan Stanley’s supervisory failures constituted violations of NASD Rule 3012, NASD Rule 3010, and FINRA Rule 2010.

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On May 28, 2015, the Financial Industry Regulatory Authority (“FINRA”) released its second proposed rule designed to help investors understand what financial incentives their broker may have to transition between member firms and how those transitions could affect the customer’s investments.  The complete FINRA release regarding the new rule may be found here.  FINRA encouraged all interested parties to comment on the proposal no later than July 13, 2015.

Rule 2272 — “Educational Communication Related to Recruitment Practices and Account Transfers” (the “Proposed New Rule”) would require delivery of a FINRA created educational communication focusing on key considerations for customers contemplating transferring their assets, with their broker, to the recruiting firm.  According to FINRA, a recruiting firm is any member firm that hires or associates with a registered representative who was previously associated with another member firm.  FINRA created the Proposed New Rule because it was concerned that retail customers were not aware of important factors they should consider when making the decision to transfer assets to the transitioning registered representative’s new firm.

FINRA’s educational communication is intended to motivate customers towards making inquiries of the transitioning registered representative and the customer’s current firm, to the extent that the customer considers the content of the educational communication important to his or her decision.  Specifically, FINRA’s educational communication highlights the potential implications of transferring assets to the recruiting firm and suggests questions the customer should ask questions regarding: 1) whether financial incentives received by the representative may create a conflict of interest; 2) assets that may not be directly transferrable to the recruiting firm, and, as a result, the customer may incur costs to liquidate and move those assets or incur inactivity fees by leaving them with the current firm; 3) the potential costs related to transferring assets to the recruiting firm, including the difference in the pricing structure and fees imposed between the customer’s current firm and the recruiting firm; and 4) the differences in products and services between the customer’s current firm and the recruiting firm.

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