Not that two cases from two different Wall Street regulators make a trend, but we’re just about a month into 2012 and both the Financial Industry Regulatory Authority (“FINRA”) and the Securities and Exchange Commission (“SEC”) just published settlements involving the unreasonable delegation of compliance duties.  In addition to today’s column about the SEC action, read FINRA Sanctions Brokerage CEO For Delegating To Part Time Compliance Officer and FINOP (“Street Sweeper” January 30, 2012) to learn about FINRA’s similar response.

In anticipation of the institution proceedings by the Securities and Exchange Commission (“SEC”) and without admitting or denying the findings, Respondents 1st DISCOUNT BROKERAGE, INC. (“1DB”) and MICHAEL R. FISHER submitted an Offer of Settlement, which the SEC accepted. In the Matter Of 1st Discount Brokerage, Inc. and Michael R. Fisher, Respondents (Order Instituting Administrative Proceedings Pursuant To Section 15(B) Of The Securities Exchange Act Of 1934 And Sections 203(E) And 203(F) Of The Investment Advisers Act Of 1940, Making Findings, Imposing Remedial Sanctions And A Censure Order As To 1st Discount Brokerage, Inc., And Making Findings And Imposing Remedial Sanctions As To Michael R. Fisher/ Securities Exchange Act Of 1934 Release No. 66212a / Investment Advisers Act Of 1940 Release No. 3360a Administrative Proceeding File No. 3-14710/ January 23, 2012).

The Respondents

1st Discount Brokerage, Inc. is a Florida corporation based in West Palm Beach, FL. 1DB has been registered with the SEC as a broker-dealer and an investment adviser since 1995 and 2007 respectively; and  operates as an introducing broker through over 80 offices and over 200 independent financial consultants.

Michael R. Fisher, age 49, of Helen, GA, was during the relevant times, 1DB’s executive-vice. In accordance with the firm’s compliance and sales management manual, from September 2004 through May 2008, Fisher had primary responsibility to oversee 1DB’s Heightened Supervision Committee (“HSC”), which was created to reduce the firm’s exposure as a result of inappropriate registered representative conduct.

Three Strikes Plus A Lot of Foul Balls

Michael Jinyong Park was employed as a registered representative by 1DB from August 21, 2002 to June 26, 2008.

Prior to joining 1DB, Park received three customer complaints (two of which alleged excessive commissions and margin interest on unsuitable trades) pertaining to his employment at another firm from July 1995 to June 1998. This prior employer terminated Park in connection with a complaint that he had received loans from two customers without receiving the firm’s permission.

From January 1999 to February 2000, Park worked for another broker-dealer, which terminated him for forging a client’s signature on a letter of authorization instructing the firm to charge a $3,500 loss to the client.

From 2001 to 2008, Park operated a Ponzi scheme through his securities firm Park Capital Management Group, Inc. (“PCMG”) and defrauded more than 50 investors out of almost $9 million. Park fraudulently misrepresented that investors would achieve substantial returns on their PCMG accounts through investments in publicly traded securities and/or in investment pools managed by Park; unfortunately, Park misappropriated the funds to subsidize his extravagant life-style which included a $1.7 million house, expensive cars, and private school tuition for his children.

SIDE BAR: To learn more details of Park’s fraud, read the SEC’sComplaint in SEC v. Park (Middle District TN, 3:08-cv-00962, September 30, 2008)

Following the detection of Park’s fraud, the following events evolved:

• On October 29, 2008, a judgment was entered by consent in an SEC action against Park permanently enjoining him from future violations of Section 17(a) of the Securities Act and Sections 10(b) and 15(a) of the Exchange Act and Rule 10b-5 thereunder in the United States District Court for the Middle District of Tennessee.
• On December 18, 2008, the SEC barred Park from associating with any broker, dealer, or investment adviser.
• On February 27, 2009, Park pled guilty to wire and mail fraud charges brought by the United States Attorney’s Office for the Middle District of Tennessee. In his criminal plea, Park admitted to operating a fraudulent scheme from 2001 to 2008 that defrauded 28 investors in excess of $8.6 million. NOTE: The SEC civil and US Attorney criminal cases appear to allege different numbers of defrauded investors and damages, which is not uncommon and often is ascribed to the different scope of such cases or the timing of the separate investigations and dispositions.
• In September 2010, Park was sentenced to 96 months in prison. See this press release.

DBA Blinders

In the SEC’s view, the independent contractor broker model utilized by 1DB requires greater supervision than that of a traditional wire house brokerage firm. During Park’s tenure at 1DB, he and other independent contractors typically operated their securities business through a “doing business as” (“DBA”) name and paid expenses for the business by using a DBA Account.

Park used PCMG (his DBA) to accept investments from victimized investors and to make payouts. For example, in May 2007, PCMG recorded an investor’s $40,000 deposit as an “Initial Stock purchase;” and a September 2005 check written by Park to an investors was characterized as a “Liquidation of Account.” The SEC asserts that in reviewing PCMG’s activities, 1DB’s review was limited to investigating whether 1DB was a party to any leases or contracts entered into by the registered representative.  The SEC asserted that this review was inadequate and more reasonable policies and procedures could have discovered the Ponzi scheme.

Writing On the Wall

In 2004, a 1DB compliance auditor noted that Park’s signage at the front of his office door inappropriately failed to state that Park sold securities through 1DB. In 2005, a different auditor noted Park’s inappropriate use of a temporary sign. In 2006, a third auditor noted that Park’s sign did not display 1DB’s name.  The SEC found it troubling that the signage noncompliance persisted over three years and three different auditors.

Not So Surprising

1DB compliance auditors annually conducted announced audits of its registered representatives’ operations – for example, Park received a “reminder” a month in advance of an annual audit that effectively gave him the opportunity to conceal his fraudulent activity. Armed with such a head’s up, Park put up temporary signage for announced compliance audits and then removed them after the audits were completed.  Such prior notice by 1DB was contrary to its compliance and sales management manual, which  stated that the firm would conduct “[u]nannounced inspections and audits, including reviewing customer accounts and other records, [and] sales methods.”

Pointless Exercise

Compounding the advanced warning of the annual audits was the fact that , 1DB did not provide subsequent auditors with the previous audits.  Bizarrely, each annual audit was duly documented by completing an audit report with information about the operations, appearance, and possible deficiencies in the registered representative’s business.  Although such prior years’ reports would likely have been helpful to identify potential red flags, the current year’s auditors went in blind.  Without a prior audit report, the auditor’s had no benchmark to compare current and past compliance conduct. Further, any memorialized prior concerns were largely rendered meaningless by not being provided to the current auditors, who, as a result, lost the ability to consider prior red flags of warning – the noncompliant signage being one such example.  To an experienced compliance auditor, the persistence of inadequate signage may well have constituted a red flag suggesting that Park was trying to conceal his 1BD affiliation in order to avoid providing a potential complaining customer with the name of a third party to which complaints could be directed.

Lowered Supervision

Finally, the SEC tackled 1DB’s HSC. From 2004 to 2008, Respondent Fisher was delegated the responsibility to oversee 1DB’s Heightened Supervision Committee (“HSC”), which required him to have a system to implement the firm’s policies and procedures regarding the periodic review of all activities of 1DB’s registered representatives.  The SEC alleged that a reasonable review of Park’s activities by the HSC likely would have included an inquiry into Park’s declining commissions, which fell from a high in 2003 of $72,000 to an annualized low in 2008 of $9,500.  Following up on this point, the SEC asserts that

An inquiry into this dramatic decline would have included examining Park’s remaining customer accounts and contacting customers who were closing or liquidating their accounts. Contacting these customers would have revealed that many of them were closing and/or liquidating their accounts in order to invest with Park’s other business, a Ponzi scheme.

Similarly, the SEC notes that in  March 2007 a 1DB customer filed a complaint alleging that Park engaged in unauthorized trading in the customer’s account, but that complaint was never investigated by the HSC — which likely would have led to the detection of Park’s Ponzi scheme through inquiries of other Park clients.

1DB Steps Up

In March 2009, 1DB entered into a voluntary settlement agreement with all of Park’s victims, the majority of whom were not customers or clients of 1DB and had no contractual or other legal connection with 1DB. Pursuant to the voluntary settlement, 1DB contributed $2 million to be distributed among Park’s victims.

SEC Imposes Sanctions

As a result of the conduct described above, Respondents failed reasonably to supervise Park, when they each failed to supervise Park with a view to preventing and detecting his violations of the federal securities laws.  In determining to accept the Offers, the SEC considered remedial acts promptly undertaken by the Respondents and cooperation afforded its staff.  Accordingly, the SEC ordered

• Respondent 1DB is censured and ordered to pay civil penalties of $40,000 to the SEC per four installments within 360 days; and
• Respondent Fisher is suspended from association in a supervisory capacity with any broker, dealer, or investment adviser with the right to reapply for association in a supervisory capacity after nine (9) months; and ordered to pay civil penalties of $10,000.

Bill Singer’s Comment

This is the second day in a row that I’ve commented on a regulatory case in which the delegation of compliance tasks came under scrutiny — yesterday by FINRA and today by the SEC.  In comparing the two settlement decisions side by side, the SEC’s is more compelling and presents a more meaningful recitation of the underlying facts and the rationale for sanctions.

An unfortunate byproduct of what I view as the overly accommodating nature of Wall Street’s present day regulatory scheme is that the cost of maintaining adequate compliance is more easily carried by large firms such as Merrill Lynch, JP Morgan, Morgan Stanley Smith Barney — and by larger organizations such as LPL or TD Ameritrade.  Why is this?  In my opinion, it’s because recent regulations have taken on an absurd one-size-fits-all character that imposes reporting obligations upon smaller firms that often amounts to little more than endlessly ticking off “not applicable” or “does not apply.”

Notwithstanding, please do not misconstrue my criticism.  Without question, it is incumbent upon Wall Street to implement and maintain a comprehensive and effective system of compliance and regulation.  There is no qualification of my position.  I am a long-time advocate of regulatory reform — not regulatory elimination.  Endless regulations drafted by folks with little understanding of the industry that they regulate offers only the thinnest patina of regulation — a surface that easily buckles and cracks under the slightest pressure.  Effective regulation is bespoke in nature and intelligently crafted for a diverse industry in order to ensure reasonable accommodation for the variations and nuances within a given sector. Wall Street’s failed regulatory scheme is the result of political corruption, unbridled influence by powerful self-interests, and an overly burdensome crush of rules, regulations, and laws.

In the SEC’s 1DB case we see many troubling issues.  First and foremost is the fact that 1DB was willing to register Park in light of his firings by two prior brokerage firms for misconduct.  Second, having brought a Bad Boy into its midst, 1DB’s compliance oversight was certainly less than intensive, as the SEC correctly notes.

Of course, one should also be troubled by the apparent absence of any oversight by the industry’s regulators.  Given Park’s troubling history and his loose affiliation as an indie contractor at 1DB, isn’t it also fair to ask where the SEC, FINRA, and other regulators were during the several years that this guy apparently ran amok?

Ultimately, 1DB is frightening because it demonstrates how meaningless and ineffective much of Wall Street’s regulation is.  As I often complain, reading toe tags at the morgue may tell you who died and of what but it sure as hell doesn’t prevent any crimes.  We need to move the art and science of Wall Street compliance and regulation off the cold slabs at the coroner’s office and into a far more pre-emptive undertaking that catches fraud earlier.

For the purpose of proposing a settlement of rule violations alleged by the Financial Industry Regulatory Authority (“FINRA”) and without admitting or denying the findings, prior to a regulatory hearing and without an adjudication of any issue, John Derek Lane submitted a Letter of Acceptance, Waiver and Consent (“AWC”), which FINRA accepted. In the Matter of John Derek Lane, Respondent (AWC 2010020872301, January 27, 2012).

Respondent Lane was first registered in 1969, and during the relevant time of February 26, 2002 to December 9, 2011, he was a registered representative and principal through Lane Capital Markets, LLC, (the “Firm”) where he served as the firm’s President and Chief Executive Officer.

Questionable Delegation