Courts call a lifetime bar “the securities industry equivalent of capital punishment.” PAZ Sec. Inc. v. SEC, 494 F.3d 1059, 1065 (D.C. Cir. 2007). It is a draconian measure which not only permanently removes you from the securities industry but also subjects you to “statutory disqualification” under Section 3(a)(39)(A) of the Securities Exchange Act of 1934 and all the collateral consequences that come with it.

Given the seriousness of a lifetime bar, a recently released AWC presents an alarming fact pattern in which a supervisor was barred due to the transgressions of an FA he failed to properly supervise. Let’s consider the case of Michael Leahy, FINRA Case No. 2019063631802. The question is, why did FINRA go after the supervisor with guns blazing?

The Applicable Rule: FINRA Rule 3110

FINRA appropriately demands that each member establish and maintain a system to supervise the activities of each associated person. Importantly, Rule 3110 requires that the supervisory system be “reasonably designed to achieve compliance with applicable securities laws and regulations, and with applicable FINRA rules.” FINRA takes violations of Rule 3110 very seriously but rarely seeks a bar. According to FINRA’s Sanction Guidelines, violations of Rule 3110 would typically call for a monetary sanction of $5,000 to $77,000 and a suspension of up to 30 business days. Of course, in “egregious cases,” the Sanction Guidelines does call for suspensions of up to 2 years or even a bar.

Ok, so clearly FINRA thought Leahy’s conduct was “egregious.” The question is: why?

Underlying Facts

Interestingly, the underlying violations all occurred within a very short period of time: September 18, 2019 through October 9, 2019. During that period of time, according to FINRA, Leahy failed to reasonably supervisor an individual FINRA calls “PS.” According to FINRA, PS engaged in unauthorized trading, unauthorized use of margin, recommended excessive and unsuitable transactions, and charging excessive commissions.

According to FINRA, Leahy was aware of multiple “red flags” but failed to investigate those red flags or take action. The red flags highlighted by FINRA were:

• Leahy knew of PS from a prior firm and was aware of prior allegations of misconduct;
• Numerous customers complained to Leahy about PS’s supposed unauthorized trading;
• The broker-dealer’s clearing firm informed Leahy that it too received complaints of PS’s supposed unauthorized trading;
• A review of the trade blotter would have provided indicia of unauthorized trading;
• PS recommended inconsistent trading strategies. On the same day, PS would recommend that some customers buy “Security X” and other customers sell “Security X.”
• The firm’s trade blotter reflected a pattern of in-and-out trading by PS;
• PS was charging commissions that came near 5% or exceeded 5% (one time PS even charged a whopping commission of 11.8%).

Who is the Mysterious “PS”?

FINRA drops a hint by stating that the NJ Bureau of Securities issued a Summary Penalty and Revocation Order against PS. So, I did a little digging and here it is. Apparently, PS is Philip J. Sparacino, and Mr. Sparacino was apparently a very busy man at his old firm. According to the State of New Jersey, Sparacino engaged in a pattern of unauthorized and excessive trading starting in June 2019. And the numbers seem to support the Bureau’s allegation. From April 2019 through May 2019, Sparacino’s production totaled $24,258. However, once he inherited accounts in June 2019, his production skyrocketed to $1,452,514 from June 2019 through October 4, 2019. Incredibly, in the last 2 weeks of September 2019 alone, Sparacino generated production in excess of $450,000.

Not surprisingly, when FINRA reached out Sparacino he refused to respond to FINRA’s request for documents and information. As a result, Sparacino signed an AWC consenting to a bar.

Upshot

This case sends a warning to any supervisor who adopts the head-in-the-sand approach to supervisor. Clearly, FINRA will seek a bar when the facts warrant it.

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FINRA wants a member firm to enforce its written supervisory procedures. And FINRA wants a member firm to recommend securities that fit within the customer’s investment objectives. And certainly FINRA wants a member firm to avoid falsification of business records. So what happens when a member firm doesn’t quite live up to FINRA’s expectations? Let’s play the over / under game and try to guess the size of the FINRA sanction when a member engages in the following misconduct:

• Failure to enforce WSPs governing the sale of high-risk mutual funds subject to significant volatility
• Failure to reallocate portfolios to reduce risk or otherwise update investment objectives to correspond with the assumption of additional risk
• Failure to properly investigate exception report alerts
• And here’s the real ugly one: “adjustment” of customers’ risk tolerances and investment objectives without first seeking the customers’ input. Rest assured, it was clever lawyering that got FINRA to delete the word “falsification” and instead use the word “adjustment.”

Well, if the respondent were an individual, as opposed to NY Life, and the broker sold unsuitable securities, disregarded firm policy, and falsified new account forms, what would FINRA do? According to FINRA’s Sanction Guidelines: (a) “recordkeeping violations” can lead to a bar if aggravating factors predominate; and (b) unsuitable recommendations will likely lead to a bar if aggravating factors predominate.

Given that FINRA would wallop an individual, surely they’ll do the same with an institution that can readily pay a sizable fine….right?? Given FINRA’s allegations, we must be talking about a significant seven-figure fine, right?

Well….read on.

Case In Point

In the Matter of NYLIFE Securities LLC, FINRA Matter No. 2016050685102 (click here to read the AWC) Sanctions

• A fine of $250,000
• Restitution and rescission to 28 customers. The restitution amount equals $76,643. The rescission offer pertains to customers with unrealized losses totaling approximately $250,000.
• Censure

Hmmm….it looks to me like NYLIFE cut a sweetheart deal with FINRA.

Underlying Facts

From September 2014 to December 2016, NYLIFE had procedures for supervising the sale of higher-risk mutual funds as measured by volatility. The procedures, as one would expect, required such sales to align with the customers’ risk tolerances and investment objectives. During this time period, NYLIFE’s automated surveillance system flagged potentially unsuitable trades. For example, an alert was generated if a customer with an investment objective of “income with moderate growth” and a risk tolerance of “moderately conservative” sought to purchase a higher-risk mutual fund in an amount that exceeded 30% of the customer’s overall portfolio.

The alerts were reviewed by a group of “reviewers” who, in conjunction with registered persons, offered customers a choice: reallocate the portfolio to reduce risk, or change your investment profile to reflect a higher risk tolerance and more aggressive investment objective.

All of that was well enough; however, NYLIFE apparently didn’t allocate sufficient resources to the “reviewer” department and un-reviewed alerts began to pile up. To rectify this:

“Respondent’s reviewers adjusted customers’ investment profiles to accommodate a sale of higher-risk mutual funds without determining whether a representative had discussed the option of reallocation with the customer and typically without first contacting the customer. In fact, some customers’ investment profiles were changed before Respondent obtained information about the customers’ true risk tolerance and investment objective.”

The upshot of this was that the portfolio for a number of customers (approximately “four dozen” according to FINRA) with relatively conservative investment objectives was excessively weighted with high-risk mutual funds.

Analysis

I get that a $250,000 is not chump change. And I also recognize that the BD has to offer restitution and restitution, and apparently settled other customer complaints prior to FINRA’s intervention. Nonetheless, the allegations present a fairly damning fact pattern. FINRA alleges a complete breakdown of the system of supervision. And brazenly mismarking a customer’s investment objectives is conduct one expects from a bucket shop, not from a highly regarded financial institution.

Based on the facts alleged, along with the guidance in FINRAs Sanction Guidelines, it really seems like NYLIFE got off easily. According to the Sanction Guidelines:

Failure to Supervise – for systemic supervisory failures, the adjudicator should consider imposing an undertaking, such as engaging an independent consultant to revamp the supervisory systems. Where aggravating factors predominate, the adjudicator should consider suspending or even barring the firm. Additionally, the adjudicator should consider a fine of up to $310,000, or higher if aggravating factors predominate.

Suitability – the adjudicator should consider a monetary sanction of up $116,000 and consider suspecting a firm with respect to a set of activities for up to 90 days.

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