In the Matter
of the Association of X as a General Securities Representative
with The Sponsoring Firm Redacted Decision Notice Pursuant to
Section 19(d) Securities Exchange Act of 1934 Decision No. SD08004 |
DENIED
by National Adjudicatory Council
Hearing Held
In February 2008, the Sponsoring Firm submitted a Membership
Continuance Application (“MC-400” or “Application”) with
the Financial Industry Regulatory Authority’s (“FINRA”)
Department of Registration and Disclosure, seeking to permit X, a
person subject to a statutory disqualification, to associate with
the Sponsoring Firm as a general securities representative. In May
2008, a subcommittee (“Hearing Panel”) of FINRA’s Statutory
Disqualification Committee held
a hearing on the matter. X appeared at the hearing,
accompanied by his counsel, Attorney 1, the Proposed Supervisor,
and the Sponsoring Firm’s chief compliance officer, Employee 1.
FINRA Employee 1 and FINRA Attorney 1 appeared on behalf of FINRA’s
Department of Member Regulation (“Member Regulation”).
Pursuant to NASD Rule 9524(a)(10), the Hearing Panel submitted
its written recommendation to the Statutory Disqualification
Committee. In turn, the Statutory Disqualification Committee
considered the Hearing Panel’s recommendation and presented a
written recommendation to the National Adjudicatory Council (“NAC”),
in accordance with NASD Rule 9524(b)(1).
|
SD
Event
|
X is
statutorily disqualified because he consented to a January 2003
Letter of Acceptance, Waiver and Consent (“AWC”),
in which FINRA imposed an unqualified
bar on him.
The AWC found that from March through December 2000, X violated
NASD Rule 2110 by engaging in a practice known as “cherry
picking”—entering certain personal and customer trades into a
holding account with his then employer, Firm 1, without
designating customer account numbers, and then later, at the end
of the trading day, allocating the trades among these different
accounts. Accordingly, X had information concerning
intra-day performance of the securities underlying these trades at
the time of allocation. The AWC also
found that X violated NASD Rules 2110 and 2510(b) by exercising
discretionary authority over the accounts of six customers
by causing securities transactions to be effected in these
accounts without obtaining the customers’ prior written
authorization and Firm 1’s acceptance of the accounts as
discretionary.
|
Sentence
Expiration |
|
Prior
Industry Activity |
X first
registered in the securities industry as a general securities
representative (Series 7) in August 1994.
He requalified as a general securities representative in January
2008.
|
Background
|
X was associated with Firm
1 from July 1994 until January 2001, when Firm 1 terminated him.
The Uniform Termination Notice for Securities Industry
Registration (“Form U5”)
filed by Firm 1 in January 2001,
stated that its internal
review revealed that X “was involved in allocating trades both
to his own account and to certain client accounts some time
after those trades were executed.” Firm 1 concluded that X had:
“(1) executed trades for the benefit of certain client accounts
without proper written documentation of discretionary
trading authority; (2) executed trades without prior or
simultaneous allocations of those trades to any account, instead
allocating those trades to various accounts after market movements
had occurred; and (3) allocated
certain favorable trades to the accounts of family members or to
his own account.”
Since February 2001, X has been employed with Firm 2. X
represents that Firm 2, a former client of his when he was
employed by Firm 1, is a $400
million hedge fund that began in 1992. He states that he focuses
on investor relations and marketing at Firm 2 and has “utilized
[his] contact list of institutional and high net worth investors
to grow the size of the fund.” Currently, X is an
employee of Firm 2 and markets only Firm 2’s fund to potential
investors. X states that he has been limited in this role, and he
wants to re-enter the securities industry with the Sponsoring Firm
in order to be permitted to market the securities of numerous
hedge funds to institutional investors. X represents
that if he is permitted to re-enter the securities industry, he
will no longer be employed by Firm 2. Instead, Firm 2 will become
only one of several hedge funds that he can market to potential
institutional investors. The record shows no other disciplinary or
regulatory proceedings, complaints, or arbitrations against X.
|
ponsoring
Firm |
The Sponsoring Firm is
based in City 1, State 1, and it has been a FINRA member since May
2005. The Sponsoring Firm has
1 office of supervisory jurisdiction (“OSJ”), no branch
offices, and it employs two registered principals and 12
registered representatives. The Sponsoring Firm represents that it
is engaged
in private placements for securities and acts “as a finder for
hedge funds and other alternative investments that are formed as
investment partnerships and limited partnerships.”
Essentially,
the Sponsoring Firm introduces hedge funds to institutional
investors. If the investors choose to put money
into the funds, the hedge fund manager pays a fee to the
Sponsoring Firm.
Thus far, FINRA has conducted only one routine examination of
the Sponsoring Firm— the initial examination in 2005,
which resulted in a Letter of Caution (“LOC”)
for several violations, including: 1) failing to enforce written
supervisory procedures regarding the review and subsequent
approval of electronic
communications; 2) failing to notify the Securities and
Exchange Commission and FINRA that the Sponsoring Firm was
utilizing a third party
vendor to assist in retaining email communications; 3)
failing to evidence supervisory review and approval by a
registered principal of all incoming
and outgoing electronic institutional sales material; and
4) failing to implement an adequate customer
identification program.
|
Proposed
Activity |
The Sponsoring
Firm proposes
to employ X from a non-branch location in City 2. This location is
the same as the one where he is currently employed by Firm 2.
The Sponsoring Firm represents that X will work as a “registered
sales person introducing hedge funds to sophisticated investors.”
The Sponsoring Firm will compensate
X with a percentage of the total fees that it receives from the
hedge fund managers if the investors that X introduces to the
funds choose to invest in them. The Sponsoring Firm states
that a “typical fee agreement is 20% of management and
performance fees in arrears. Firm
pays 90% of the 20% to Rep.” |
Proposed
Supervisor |
The Sponsoring
Firm proposes that the Proposed Supervisor, the Sponsoring
Firm’s CEO, will be X’s primary supervisor, with assistance
from Employee 1, the Sponsoring Firm’s chief compliance officer.
The Proposed Supervisor and Employee 1 will
not be located in the same office as X. Rather,
they will be in the Sponsoring Firm’s home office in City 1,
State 1, while X
remains at Firm 2’s office in City 2, approximately one hour
away from City 1.
The Proposed Supervisor and his wife own the Sponsoring Firm.
The Proposed Supervisor first qualified as a general securities
representative in March 1989, and he requalified in that capacity
in April 2005. He qualified as a general securities principal
(Series 24) in 2004. The Proposed Supervisor currently
supervises 13 individuals at the Sponsoring Firm. The
Proposed Supervisor was previously associated with six investment
or investment-related firms from October 1988 until May 2003, when
he formed the Sponsoring Firm.
Employee 1 qualified as a general securities representative in
1982 and as a general securities principal in 1994. He joined the
Sponsoring Firm in December 2007 as the Sponsoring Firm’s chief
compliance officer and financial and operations principal (“FINOP”)
(Series 27). FINRA’s Central Registration Depository (“CRD”®)
shows that Employee
1 is also currently associated with six other firms in
capacities ranging from general securities representative to FINOP
to president.
|
Member
Regulation Recommendation |
Member
Regulation recommends that the Application be approved
because:
1) X’s disqualifying event, though serious, was his only
infraction while employed in the securities
industry;
2) X has not engaged in any
intervening misconduct since his disqualifying
event;
3) X’s proposed activities are
unrelated to his disqualifying event;
4) a sufficient period of time has
passed since X’s disqualifying event;
5) the Sponsoring Firm and the Proposed Supervisor are suitable
to supervise X; and
6) the Sponsoring Firm has submitted a solid
plan of heightened supervision.
|
Considerations |
PLAN OF HEIGHTENED SUPERVISION
The Sponsoring Firm has agreed to the following comprehensive
supervisory plan to ensure that it will be able to maintain
heightened supervision for X. The items that are denoted with an asterisk
(*) are conditions of heightened supervision for X. Other
registered representatives of the Sponsoring Firm are not subject
to these heightened supervisory conditions.
1. *The Sponsoring Firm will amend its written supervisory
procedures to state that the Proposed Supervisor is the primary
supervisor responsible for X;
2. *X will not act in a supervisory capacity;
3. *X will not be
permitted to engage in cold calling or cold contacts via email of
potential investors. Telephone reports of X’s incoming and
outgoing calls will be made available to the Proposed Supervisor.
The Proposed Supervisor will review and maintain copies of the
phone reports. To evidence his review, the Proposed Supervisor
will initial the reports and keep them segregated for review
during any statutory disqualification examination;
4. *X will provide the Proposed Supervisor with a list
of every proposed investor that he will contact on behalf of a
hedge fund, alternative investment vehicle or private equity deal.
This list will include basic suitability information and
contact information. He will update the list monthly with activity
information. The potential investors on the list will come from
introduction agreements with the Sponsoring Firm, X’s
relationships with high net worth individuals and institutional
investors over the past seven years, and referrals from the
Sponsoring Firm, managers/sponsors and other investors. The
Proposed Supervisor will keep the list of proposed investors
segregated for review during any statutory disqualification
examination;
5. *The Proposed Supervisor or his designee will review and pre-approve
all potential investors for introduction to a
manager/sponsor via an activity form that X will provide before an
introduction is made. If an introduced potential investor makes an
investment with a manager/sponsor before the pre-approval has been
obtained via an activity form, X will forfeit his compensation for
the introduction and an internal review will be commenced and
documented by the chief compliance officer. The outcome of that
review will be placed in the special supervision folder. One
possible outcome is termination. If X is terminated, the
Sponsoring Firm will list the cause of termination on his Form U5
as his having violated heightened supervisory procedures. The
Proposed Supervisor will copy and initial the activity form to
evidence his review and will keep it segregated for review during
any statutory disqualification examination;
6. *For the purposes of client communication, X will only be
allowed to maintain an email
account that is held at the Sponsoring Firm, with all emails being
filtered through the Sponsoring Firm’s email system. If X
receives a work-related email in his personal email account, he
will immediately forward it to Employee 1. Employee 1 or his
designee will conduct a weekly review of all email communications
that are either sent or received by the Sponsoring Firm. Employee
1 will print the documentation of this email review and maintain
it in a heightened supervision file that he will keep segregated
for review during any statutory disqualification
examination;
7. *Employee 1 will approve all of X’s outgoing
correspondence (other than email) prior to mailing, and all
incoming mail addressed to X will first be sent to the home office
of the Sponsoring Firm, to be reviewed by Employee 1, and then
forwarded to X;
8. *The Proposed
Supervisor will visit X every three weeks in X’s City 2 office
to review the activity forms and any files regarding introduced
investors. The Proposed Supervisor will document the
results of those visits and keep the documentation segregated for
review during any statutory disqualification examination;
9. *All complaints pertaining to X, whether verbal or written,
will be immediately referred to the Proposed Supervisor for review
and then to the Sponsoring Firm’s compliance department. The
Proposed Supervisor will prepare a memorandum to the file as to
the measures he took to investigate the merits of the complaint
(e.g., contact with the customer) and the resolution of the
matter. The Proposed Supervisor will keep documents pertaining to
these complaints segregated for review during any statutory
disqualification examination;
10. *If the Proposed Supervisor is to be on vacation or out of
the office, Employee 1 will act as X’s interim supervisor;
11. *The Proposed Supervisor must certify quarterly (March 31,
June 30, September 30, and December 31) to the Sponsoring Firm’s
compliance department that he and X are in compliance with all of
the above conditions of heightened supervision to be accorded X;
and
12. *For the duration of X’s statutory disqualification, the
Sponsoring Firm must obtain prior approval from Member Regulation
if it wishes to change X’s responsible supervisor from the
Proposed Supervisor to another person.
==================
- The Sponsoring Firm
Has Not Made the Strong Showing Necessary for the NAC
to Approve X’s Re-Entry into the Securities Industry Despite
FINRA’s Recent Imposition of an Unqualified Bar on X.
- X Consented to an
AWC that Imposed an Unqualified Bar on Him for Serious
Securities-Related Misconduct
- FINRA Very Recently
Imposed an Unqualified Bar on X. FINRA imposed its most
serious sanction on X in January 2003. Thus, X has served his
bar for less
than five years before the Sponsoring Firm
filed its MC-400 in this matter. NAC specifically stated that
it rejected X’s argument that more time has elapsed because
the misconduct occurred in 2000, and Firm 1 terminated him in
2001. NAC's
calculation of time begins with the statutorily disqualifying
event, which is the unqualified bar that FINRA imposed
on X in the January 2003 AWC.
- The Sponsoring Firm’s Proposed Supervisory
Structure for X Is Inadequate.
NAC focused on the fact that the Sponsoring Firm proposes
that the Proposed Supervisor and the back-up supervisor,
Employee 1, will be located in the Sponsoring Firm’s home
office in City 1, State 1, while X works from a non-branch
location in City 2. The two offices are separated by a distance
of 35 miles.
The Sponsoring Firm proposal that the Proposed Supervisor
will visit X in City 2 “every three
weeks . . . to review the activity forms and any files
regarding introduced investors.” did not meet the “stringent
oversight” standard required for supervision of a
statutorily disqualified individual. Even given the Sponsoring
Firm’s limited business model and low volume business, the
NAC found it unacceptable
for a person who has been unqualifiedly barred by FINRA for a
securities-related violation to reenter the securities
business with such minimal face-to-face supervision.
The Sponsoring Firm proposed that Employee 1 will conduct
only a “weekly
review of all of X’s email communications” while
providing immediate review of other incoming and outgoing
correspondence. On its face, this proposal is inadequate, and
it becomes even more so because X
testified at the hearing that virtually all of his client
communications are via email. Thus, the
Sponsoring Firm is actually proposing only a weekly review of
all of X’s written communications with his clients in
addition to the absence of a daily on-site supervisor. Since
X testified that he writes only 10-15 emails per day, NAC find
it surprising that the Sponsoring Firm apparently considered
it too burdensome to conduct a daily review of his emails.
The NAC noted that the Sponsoring Firm’s 2005
LOC found deficiencies in the Sponsoring Firm’s review and
approval of electronic communications.
|
Citations |
“[b]ars
are intended to prohibit completely a person’s ability to engage
in any future securities business with any member firm,
thus precluding re-entry into the securities industry absent
extremely unusual circumstances.” See, The Ass’n of
X as a Gen. Secs. Representative, Redacted Decision No. SD01016,
at 4 (2001), http://www.finra.org/web/groups/enforcement/documents/nac_stat_dq_decisions/p011593.pdf;
The Ass’n of X as an Inv. Co. & Variable Contracts
Products Representative, Redacted Decision No. SD99023, at 3
(1999), http://www.finra.org/web/groups/enforcement/documents/nac_stat_dq_decisions/p012616.pdf.
A FINRA-barred
applicant is required to make an extremely strong showing
for us to find that approval of an application for re-entry would
serve the public interest. The Ass’n of X as an Inv. Co.
&.Variable Contracts Products Representative, Redacted
Decision No. SD99023 at 3.
“[A]ny member wishing to employ such a [statutorily
disqualified] person . . . must ‘demonstrate why the application
should be granted.’”). M.J. Coen, 47 S.E.C. 558, 561 (1981)
See. Gerson Asset Mgmt., Inc., et al., Exchange Act Rel.
No. 52880, 2005 SEC LEXIS 3120, at *2-3 & 11 (Dec. 2, 2005)
(imposing bar on registered
representative who purchased securities in an omnibus account and
unfairly allocated the trades to his own and customer
accounts later in the trading day); cf. Paul Joseph Sheehan, Inv.
Advisors Act Rel. No. 2211, 2004 SEC LEXIS 214, at *1 (Feb. 3,
2004) (imposing bar on investment advisor for engaging in “a
fraudulent, cherry-picking
scheme whereby he improperly allocated profitable
securities trades to his personal accounts at the expense of his
clients’ accounts”); see also Andrew J. Hardin, 2007 NASD
Discip. LEXIS 24, at *1 (NASD NAC July 27, 2007) (imposing
sanctions on representative for exercising discretionary
authority in a customer’s account without prior written
authorization from the customer and written approval from the
firm).
Citadel Sec. Corp., Exchange Act Rel. No. 49666, 2004 SEC LEXIS
949, at *13 (May 7, 2004) (“[I]n determining whether to permit
the employment of a statutorily disqualified person, the quality
of the supervision to be accorded that person is of utmost
importance. We have made it clear that such persons must be
subject to stringent oversight by supervisors who are fully
qualified to implement the necessary controls.”)
|
|