The Financial Industry Regulatory Authority (FINRA) ended 2014 with a bang, finalizing three notable enforcement actions in December (along with several smaller cases). In the aggregate, December was FINRA's busiest enforcement month since February and resulted in the highest fines of the year.
- Ten firms were fined a total of $43.5 million in connection with the Toys "R" Us IPO for allegedly allowing equity research analysts to solicit investment banking business from Toys "R" Us and for offering favorable research coverage.
- Wells Fargo was fined $1.5 million for anti-money laundering (AML) failures.
- Monex Securities was fined $1.3 million and its chief compliance officer was suspended for 45 days for permitting numerous employees to conduct securities business without being registered with FINRA.
Of note, FINRA ended the year where it started, with all three of the enforcement actions touching issues discussed by FINRA in its 2014 enforcement priorities letter – conflicts of interest (Toys "R" Us); AML (Wells Fargo); and recidivism (Monex Securities).
Firms Must Prevent Analysts from Participating in Solicitation Efforts
On December 11, 2014, FINRA fined ten brokerage and investment banking firms a total of $43.5 million for allegedly allowing equity research analysts to participate in the solicitation of the Toys "R" Us (TRU) IPO. During the solicitation period, TRU sought presentations from research analysts to ensure that each firm, including its analyst, would stand behind the valuation provided in the solicitation. According to FINRA, the analysts' presentations factored into TRU's decision on choosing its underwriter because TRU wanted to avoid any valuation surprises down the road.
FINRA's conflict of interest rules prohibit firms from using research analysts or promising favorable research to win investment banking business. See NASD Rule 2711(c)(4) (research analyst conflict of interest rule). Any communication between an analyst and an issuer during the solicitation period presents a risk that the analyst will become part of the firm's efforts to solicit business from the issuer. An analyst may communicate with an issuer during the solicitation period as part of the analyst's due diligence efforts to gather information about the issuer, but may not communicate with the issuer as part of soliciting a role for the investment bank in the underwriting. In addition, according to FINRA, during the solicitation period a firm may not indicate to the prospective issuer client its analyst's positive views of the issuer or the issuer's prospects.
Firms Should Confirm Their Customer Identification Programs Comply with AML Laws
On December 18, 2014, FINRA fined two affiliated St. Louis-based broker-dealers, Wells Fargo Advisors and Wells Fargo Advisors Financial Network (collectively, Wells Fargo), $1.5 million for AML failures. Under the Bank Secrecy Act and accompanying regulations, every FINRA-regulated broker-dealer must establish and maintain a written Customer Identification Program (CIP) that requires the firm to obtain certain minimum identifying information from each customer prior to opening an account, maintain records of the identity verification process, and provide customers with notice that information is being collected. The CIP must also include supplemental, risk-based procedures that enable the broker-dealer to form a reasonable belief that it knows the true identity of each customer.
FINRA found that Wells Fargo failed for a period of nine years to subject approximately 220,000 new accounts to identity verification. Although Wells Fargo's policy did in fact require that new accounts be subject to identity verification in accordance with AML rules, the firm assigned some new accounts identifying numbers previously associated with former accounts. The new accounts, therefore, bypassed the CIP system and were not subjected to identity verification. Nearly 120,000 of these accounts were closed by the time the problem was discovered. After Wells Fargo discovered the flaw and applied the CIP process to the remaining accounts, the firm terminated activity in 345 accounts that could not be verified.
As explained by FINRA Executive Vice President and Chief of Enforcement Brad Bennett in FINRA’s press release:
Firms must be vigorous in the testing of their electronic systems to ensure they are operating correctly, including those designed to ensure compliance with critical aspects of the AML rules. While the firms eventually discovered the flaw in their own systems, it took far too long, resulting in hundreds of thousands of accounts to open and often close without the required identification process ever taking place.
Firms Must Ensure Employees Conducting Securities Business on Their Behalf Are Registered with FINRA
On December 30, 2014, FINRA fined Monex Securities approximately $1.3 million and suspended the firm’s chief compliance officer from acting in a principal capacity for 45 days for permitting nonregistered foreign individuals to sell securities on the firm’s behalf. The fines functioned to disgorge the collected commissions of the employees and to fine Monex Securities for failing to register and supervise these employees for a period of two and a half years. In 2014, FINRA increased its surveillance of high risk brokers, but this did not lessen its focus on protecting customers from other risks posed by unsupervised or unregistered brokers.
FINRA found that Monex Securities’ chief compliance officer had executed an agreement with Monex’s parent company in Mexico to permit employees to conduct securities business, despite those employees not being registered with FINRA. The employees collected client information to open accounts, made investment recommendations, and transmitted orders. Monex paid the employees transaction-related compensation for this work. NASD Rule 1060(b) permits nonregistered foreign individuals to be paid transaction-related compensation only if their activities are limited to making the initial customer introduction. FINRA also found that Monex failed to maintain a supervisory system or enact written procedures to ensure compliance with applicable securities laws and regulations. In 2006, Monex had terminated the registrations of all its foreign associates, but did not supervise to ensure that their job duties reflected this change.
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Please let us know if you have any questions about these developments. We will provide an update in January 2015 when FINRA releases its annual enforcement priorities letter.