United States: Broker-Dealer Supervision Update

First Quarter SEC Enforcement Cases Reveal Trends, Action Items for Broker-Dealers

The U.S. Securities and Exchange Commission (SEC) had an active first calendar quarter, announcing 10 settled enforcement actions sanctioning failures to supervise.

The SEC has continued its long-standing practice of holding both firms and individual supervisors responsible for supervisory violations. For example, the SEC brought a settled action against Newbridge Securities and its head trader, Eric Vallejo, alleging their failure to detect and prevent manipulation and unregistered distribution of penny stocks by a registered representative. The violations arose within the context of a typical manipulation fact pattern. The SEC alleged that Mr. Vallejo had noticed a price increase in one of the stocks and had access to information showing that the representative had placed a large number of successively higher bids in the stocks, which was inconsistent with the representative's usual business pattern of liquidating penny stocks. Mr. Vallejo, however, failed to follow up on these red flags. The SEC also found it worthy to note in its order that Mr. Vallejo received an override on the commissions earned by the representative, implying that his objectivity might have been compromised.

Mr. Vallejo agreed to a nine-month supervisory suspension, disgorgement of the commissions he earned, and a $20,000 civil money penalty. Newbridge Securities agreed to pay disgorgement in excess of $200,000, together with an $80,000 civil money penalty. The firm also agreed to retain an independent consultant to review its supervisory procedures. (See SEC Rel. 34-59528 and 34-59529, March 6, 2009). [In a related matter, in January 2009, FINRA issued Regulatory Notice 09-05 alerting firms to the need to look for suspicious trading and, when appropriate, file suspicious activity reports.]

The other SEC settlements alleging supervisory violations against both firms and individual respondents were:

Notably, the SEC appears to be continuing its practice of not requiring independent consultants for all settlements involving findings in which supervisory practices or procedures were deficient. In Leumi Investment Services, Inc. (SEC Release 34-59437, Feb. 24, 2009) and Oppenheimer & Co., Inc., (SEC Rel. 34-59438, Feb. 24, 2009), the SEC accepted undertakings that the firms themselves would review their procedures and report their findings within 90 days, together with a written certification that the firm has "established procedures, and a system for applying such procedures, which are reasonably expected to prevent and detect, insofar as practicable, the violations described in [the SEC] Order." Given the expense and burden associated with the retention of an independent consultant, firms attempting to settle supervisory charges with the staff should consider pursuing this option. Even so, the SEC will likely continue to insist upon independent consultants in the most serious cases in order to ensure that investors are appropriately protected.

What the Regulators Are Saying

SEC Chairman Mary Schapiro's March 26, 2009 testimony before the U.S. Senate's Committee on Banking, Housing and Urban Affairs foreshadowed a number of new regulatory initiatives. The following are some quotes from her statement, and what we think they might mean on a going-forward basis.

"We are studying whether to recommend legislation to break down the statutory barriers that require a different regulatory regime for investment advisers and broker-dealers, even though the services they provide often are virtually identical from the investor's perspective." (Look for a new regulatory approach to the incidental advice that a broker has long been entitled to give in connection with the purchase or sale of a security.)

"It is time for those who buy the municipal securities that are critical to state and local funding initiatives to have access to the same quality and quantity of information as those who buy corporate securities." (Look for new initiatives to further improve transparency in the municipal securities market.)

"To ensure that all broker-dealers and investment advisers with custody of investor funds carefully review controls for the safekeeping of those assets, I expect the staff to recommend that the Commission consider requiring a senior officer from each firm to attest to the sufficiency of the controls they have in place to protect client assets." (Look for a process similar to FINRA Rule 3013, requiring FINOP certification of asset protection.)

2009 Supervision Cases: "The Tally" (Reported Through March 31, 2009)

SEC

Settled: 10
Decided: 0
SRO Appeals: 0

FINRA/NYSE

Settled: 44
Decided: 2

What's Hot for Q2?

We asked Foley Partner Richard G. Wallace, former Chief Counsel, FINRA Market Regulation, what broker-dealers can expect in the coming quarter.

"In the wake of the Madoff scandal, one of the SEC's main areas of focus is investment advisors. FINRA continues to look at mark-ups and pricing in the municipal securities markets and AML, among other topics. Needless to say, political pressure is forcing both regulators to take a close look at cases already under investigation to make sure that cases with any conceivable merit are prosecuted, and not closed."

WSP Tip

Evidence of supervisory review might be the single most important element of an effective supervisory procedure. Why? Without it, it will be difficult, if not impossible, to prove to the satisfaction of regulators that a procedure required under the firm's WSPs is, in fact, being performed by the designated supervisor. With proper documentation, the firm and the supervisor will usually get partial credit for the effort, even if the sufficiency of the procedure is subject to criticism. For more information, consult NASD Notice to Members 98-96 (Dec. 1998) and 99-45 (June 1999).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.