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FINRA’s Year in Review

Following is the text of FINRA’s year in review for 2012:

“WASHINGTON — The Financial Industry Regulatory Authority (FINRA) marked 2012 with significant accomplishments in detecting fraudulent activity, implementing cross-market surveillance, increased transparency of securities markets and fulfilling its regulatory mandate to protect investors, assessing $68 million in fines, ordering a record $34 million in restitution to harmed customers and taking measures to ensure market integrity.

Richard Ketchum, FINRA’s Chairman and CEO, said, “FINRA fulfilled its role as the first line of defense for investors through a comprehensive and aggressive enforcement program, supported by a realigned and more risk-based examination program and the provision, for the first time, of cross-market surveillance programs that more effectively detected electronic manipulative trading. Protecting investors and helping to ensure the integrity of the nation’s financial markets is at the heart of what we do every day.”

Regulatory Highlights

One of the most significant regulatory achievements this year was the range of civil and criminal actions stemming from FINRA referrals of potential fraudulent conduct. FINRA’s Office of Fraud Detection and Market Intelligence (OFDMI) conducts a robust insider trading and fraud surveillance program across nearly all U.S. equities markets. FINRA referrals and proactive sharing of regulatory intelligence have provided assistance to the Securities and Exchange Commission (SEC) and law enforcement agencies, targeting a wide variety of schemes. One example of immediate intervention as a result of an OFDMI insider trading referral was an insider trading matter involving suspicious trading by foreign accounts prior to an M&A transaction that generated more than $13 million in illicit profits in July. FINRA alerted the SEC to the suspicious trading within hours after the acquisition was announced, leading to an emergency asset freeze. In 2012, OFDMI referred 692 matters involving potential fraudulent conduct to the SEC and other federal or state law enforcement agencies, including 347 insider trading referrals and 260 fraud referrals. These referrals and cooperative regulatory efforts resulted in many SEC actions, including PIPEs transactions, microcap fraud, insider trading and market manipulation.

FINRA brought a number of highly significant disciplinary actions in 2012, including being the first regulator to address a number of ongoing frauds by taking immediate action.

WR Rice – Filed a temporary cease and desist order and complaint to halt further fraudulent sales activities by WR Rice Financial Services and its owner, as well as the conversion of investors’ funds or assets

Hudson Valley – Expelled the firm and barred the CEO for defrauding its clearing firm and customers by using their funds and securities to cover losses caused by the CEO’s manipulative day trading

TWS Financial – Filed a complaint against TWS’s president/owner, alleging a fraudulent scheme targeting the Polish community.

FINRA brought 1,541 disciplinary actions (an increase of 53 from 2011) against registered individuals and firms, levied fines totaling more than $68 million and ordered resititution of $34 million to harmed investors. In addition, FINRA expelled 30 firms from the securities industry, barred 294 individuals and suspended 549 brokers from association with FINRA-regulated firms.

Disciplinary highlights include cases involving complex products, including exchange-traded funds (ETFs), structured products and non-traded REITs, as well as research analyst conflicts, inadequate disclosure and mispricing.

FINRA finalized several high profile cases against firms in 2012.

Cases Involving Complex Products

Non-traded REITs – FINRA sanctioned David Lerner Associates, the firm’s founder, President and CEO, and the firm’s head trader in an action related to the non-publicly traded Apple REITs involving suitability and supervision violations. The settlement also consolidated numerous matters, including a municipal and CMO markup case, a pending enforcement investigation of more recent municipal and CMO markups, and 10 pending market regulation matters involving municipal markups identified through surveillance reviews.

Improper Sales of ETFs – FINRA sanctioned Citigroup Global Markets, Inc; Morgan Stanley & Co., LLC; UBS Financial Services; and Wells Fargo Advisors, LLC a total of more than $9.1 million for selling leveraged and inverse ETFs without reasonable supervision and for not having a reasonable basis for recommending the securities. The firms were fined more than $7.3 million and are required to pay a total of $1.8 million in restitution to certain customers who made unsuitable leveraged and inverse ETF purchases. In addition, FINRA also brought similar cases against Merrill Lynch and Scott & Stringfellow.

Structured Products – Merrill Lynch was fined $450,000 for supervisory failures relating to the sales of structured products to retail customers. The firm relied upon automated exception-based reporting systems to flag transactions and/or accounts that met certain pre-defined criteria, but did not specifically monitor for potentially unsuitable concentration levels.

Conflicts, Disclosure and Mispricing Cases

Research Analysts – FINRA filed an action against Goldman Sachs for failing to supervise equity research analyst communications with traders and clients, and for failing to adequately monitor trading in advance of published research changes to detect and prevent possible information breaches by its research analysts. FINRA fined Goldman Sachs $11 million. The firm also settled with the SEC for an additional $11 million fine.

Improper Reimbursement of Fees to Lobbying Group – Five firms – Citigroup, Goldman Sachs, JP Morgan, Merrill Lynch and Morgan Stanley – were sanctioned a total of more than $4.48 million for unfairly obtaining the reimbursement of fees they paid to the California Public Securities Association (Cal PSA) from the proceeds of municipal and state bond offerings. The firms violated fair dealing and supervisory rules of the Municipal Securities Rulemaking Board by obtaining reimbursement for these voluntary payments to pay the lobbying group. The firms were fined a total of more than $3.35 million and are required to pay a total of $1.13 million in restitution to certain issuers in California. This is the first case brought by regulators on the manner in which banks pay bond-lobby fees.

Mispricing of Mutual Fund Orders – FINRA ordered Pruco Securities, LLC to pay more than $10.7 million in restitution, plus interest, to customers who placed mutual fund orders with Pruco via facsimile or mail, and received an inferior price for their shares. FINRA also fined Pruco $550,000 for its pricing errors and for failing to have an adequate supervisory system and written procedures in this area.

Disciplinary Actions Ensuring Market Integrity

Direct Market Access – Master/Sub-Account – FINRA filed a number of direct market access – master/sub cases, which sanctioned firms for allowing foreign traders to conduct suspicious trading activity at the firms (Hold Brothers, Genesis, and Title Securities).

Credit Default Swap (CDS) Pricing – FINRA fined GFI Securities, Inc., and five CDS brokers/supervisors more than $2.9 million for violations related to improper communications and collusion designed to hamper customers’ efforts to obtain CDS brokerage services at rates reflecting a bona fide competitive market, and for related supervisory deficiencies. FINRA also suspended the five individuals.

Inflated Advertised Trade Volume – FINRA censured and fined Deutsche Bank Securities, Inc., $1.25 million for substantially overstating its advertised trade volume to three private service providers and for related supervisory deficiencies. FINRA also censured and fined Jeffries & Company, Inc., $550,000 for similar conduct.

Market Manipulation – FINRA expelled Biremis Corp., a brokerage that handled U.S. trading for a trading company, and barred its President and CEO for lacking procedures to prevent a trading scheme called “layering” and numerous other violations.

In 2012, FINRA initiated 1,846 routine examinations, more than 800 branch office examinations, and 5,100 cause examinations in response to events such as customer complaints, terminations for cause and regulatory tips. As part of a redesign of the platform used by examination staff to conduct exams, FINRA developed new technology to support and streamline the process with new technology, tools, data and new exam content that, along with the underlying risk hierarchy, make up the new, modernized framework for the risk-based examination process. This framework is critical to identifying and prioritizing areas of risk exposure at firms, and subsequently, helping FINRA determine the appropriate regulatory response to those risks and improve our ability to quickly make decisions regarding pursuing “red flags” and other areas of heightened focus.

In addition, FINRA devoted significant resources to monitoring the financial condition of certain firms facing franchise-threatening problems. For example, when clearing firm Penson faced bankruptcy earlier this year, FINRA’s Risk Oversight & Operational Regulation staff worked with the SEC and the firm’s management to facilitate an acquisition, saving 1.6 million customers from a SIPC liquidation. Staff also worked with Knight Capital in the wake of the technology glitch in August to facilitate the sale of its error positions and the infusion of additional capital.

Investor Protection and Transparency Initiatives

On July 9, FINRA implemented a new suitability rule requiring a broker-dealer or their associated persons to have a “reasonable basis” to believe a recommended transaction is suitable for the customer, based on information obtained through “reasonable diligence” to understand a customer’s investment profile. FINRA recently published a set of frequently asked questions on the rule.

The SEC approved a rule that requires FINRA-regulated firms that sell an issuer’s securities in a private placement to file with FINRA a copy of any private placement memorandum, term sheet or other offering document the firm used within 15 days of the date of the sale. The rule enhances FINRA’s oversight of firms’ sales activities in private placements and became effective in December 2012.

An important investor-protection initiative in 2012 was a proposal to inform customers of recruitment compensation practices when they are considering following a registered person to a new firm. The rule proposal would require the new firm to disclose the details of enhanced compensation over $50,000 paid to a registered person to any former customer of the registered person who is contacted about moving or moves his account to the new firm.

FINRA increased investors’ ability to obtain information on financial professionals through BrokerCheck by including a zip code search and a combined search function that provides easy access to information on investment advisers from the SEC’s Investment Adviser Public Disclosure (IAPD) database. FINRA also obtained Board approval in September 2012 to file proposed rule changes to require firms to include a reference and a link to BrokerCheck on their websites, to provide for disclosure of additional information through BrokerCheck, and to establish the legal and technical framework for the provision of BrokerCheck data; and implemented changes in October 2012 to effect the display of links to BrokerCheck in response to Internet search engine queries on the names of broker-dealers and associated persons.

In November, FINRA Dispute Resolution released data reflecting the outcomes of cases heard under its all-public panel program, a program implemented in February 2011 allowing investors the option of a panel comprised of all public arbitrators versus a panel made up of one arbitrator with securities industry experience (nonpublic arbitrator) and two public arbitrators. The all-public panel option represents an investor-friendly change to the program, designed to ensure a fair playing field for all parties. To date, the data indicate that in cases decided by three public arbitrators, customers were awarded damages 51 percent of the time, whereas in cases decided by a panel including one nonpublic arbitrator and two public arbitrators, investors were awarded damages 32 percent of the time.

FINRA and the FINRA Investor Education Foundation engaged in a comprehensive outreach strategy to investors that included distributing more than 630,000 educational brochures and other resources to investors. The FINRA Foundation delivered its Outsmarting Investment Fraud curriculum to more than 9,000 investors at more than 170 live events nationwide. Over one million copies of FINRA’s Job Dislocation: Making Smart Financial Choices after a Job Loss have been distributed since the end of 2008.

The Foundation also delivered tools and resources to thousands of military families through the Foundation’s military financial readiness project, including distribution of free FICO® Scores to more than 46,000 service members and spouses, and reached more than 3,700 service members at 33 educational forums across the globe.

During 2012, the FINRA Foundation approved 25 new grants totaling $2.68 million and managed 111 existing grant-funded projects to research, improve, expand, innovate, sustain, and evaluate financial and investor education and protection services across the United States. Many of these projects comprised two grassroots initiatives administered in partnership with the American Library Association and United Way Worldwide to bring reliable, unbiased financial education to underserved communities.

Market-Integrity Initiatives

In 2012, FINRA implemented comprehensive cross-market surveillance patterns for the markets it regulates (the NYSE and NASDAQ families of markets and the OTC market for listed equities). These patterns address more than 50 threat scenarios and canvas approximatly 80 percent of the listed equities market. FINRA will continue to pursue potential cross-market abuses and refine its surveillance patterns based on new threat scenarios and regulatory intelligence. FINRA also introduced a suite of surveillance patterns to further enhance oversight of trading in non-exchange-listed OTC equities, which will allow FINRA to better review for potential manipulative trading activity, such as frontrunning and marking the close. In addition, as TRACE has provided increased transparency to the debt markets, FINRA has enhanced its ability to review for potential abuses common in transparent markets, such as wash sales, marking the close and trading ahead. In 2012, FINRA Market Regulation’s Trading and Market Making Examination (TMMS) program continued to implement a more risk-based approach to planning and conducting examinations. Thematic and cause examinations focused on trading issues associated with alternative trading systems, information barriers, the SEC’s market access rule and amendments to FINRA’s order protection rule.

FINRA is working with the national exchanges to develop a National Market System (NMS) plan to implement a consolidated audit trail (CAT). CAT will give regulators a database of customer-level trading details, which will significantly increase regulators’ ability to conduct surveillance across multiple markets and identify problematic trading activity. The development of CAT will also improve regulators’ ability to perform market reconstruction and analysis.

FINRA continued to bring transparency to the fixed income markets. On Nov. 12, 2012, FINRA began disemminating price and other transaction-level information on Agency Pass-Through Mortgage-Backed Securities traded to be announced (TBA transactions), which represent more than 80 percent of asset-backed security (ABS) transaction volume.

FINRA also filed a rule proposal to further expand price transparency in the ABS market by requiring the dissemination of mortgage-backed securities (MBS) traded in Specified Pool Transactions and Small Business Administration (SBA)-backed ABS. The proposal has been approved by the SEC, and dissemination will begin on July 22, 2013.


FINRA is committed to ensuring that the capital-raising objectives of the JOBS Act are advanced in a manner consistent with investor protection. To that end, FINRA has solicited comments on the specific rules that it should adopt for registered funding portals that become FINRA members. FINRA has also asked for comment on the application of existing rules to broker-dealers engaging in crowdfunding activities. In the near future, FINRA will issue an Interim Form for Funding Portals. This voluntary form seeks essential information from prospective funding portals intending to apply for membership with FINRA. Prospective funding portals would file the interim form with FINRA voluntarily until final SEC and FINRA rules governing funding portals are in place.”


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