Enforcement Actions
Financial Industry Regulatory Authority (FINRA)
CASES OF NOTE
2010
NOTE: Stipulations of Fact and Consent to Penalty (SFC); Offers of Settlement (OS); and Letters of Acceptance Waiver, and Consent (AWC) are entered into by Respondents without admitting or denying the allegations, but consent is given to the described sanctions & to the entry of findings. Additionally, for AWCs, if FINRA has reason to believe a violation has occurred and the member or associated person does not dispute the violation, FINRA may prepare and request that the member or associated person execute a letter accepting a finding of violation, consenting to the imposition of sanctions, and agreeing to waive such member's or associated person's right to a hearing before a hearing panel, and any right of appeal to the National Adjudicatory Council, the SEC, and the courts, or to otherwise challenge the validity of the letter, if the letter is accepted. The letter shall describe the act or practice engaged in or omitted, the rule, regulation, or statutory provision violated, and the sanction or sanctions to be imposed.
November 2010
Thomas Joseph Brough (Principal), Eric Robinson Elliott (Principal), Brian James Falabella, and Jonathan Jay Sheinkop
OS/2007011348301/November 2010

Brough, Elliott, Falabella and Sheinkop induced customers to invest in complex, illiquid and risky collateralized mortgage obligations (CMOs). Through misrepresentations and omissions, the respondents led customers to believe that through CMO investments they could safely achieve consistently high annual returns, regardless of market conditions, with the government backing the investments. The CMOs the respondents bought for customers were generally not government-guaranteed, and they were subject to price volatility, uncertain cash flows and maturities, based on changes in interest rates. The respondents failed to disclose material characteristics of, and risks associated with, different CMOs with substantially different payment structures and interest rate sensitivity, and failed to ensure that customers understood the characteristics and risks of CMOs.

The respondents failed to adequately investigate and understand the CMO products, and did not have reasonable grounds to believe that the individual CMO purchases were suitable for each customer. The risk was further magnified through the recommendations to the customers to buy CMOs on margin, and Elliott, Falabella and Sheinkop did not have reasonable grounds to believe the use of margin was suitable for customer CMO purchases based upon the customersí disclosed investment experience, investment objectives, financial situation and needs.

In addition, Brough, Elliott, Falabella and Sheinkop exercised discretionary authority in customer accounts without obtaining the customersí prior written authorization and their member firmís prior acceptance of the account as discretionary. Moreover, the customers were exposed to significant risks that they did not understand, and Brough, Elliott Falabella and Sheinkop did not take the time to understand or ignored them so that some customers suffered considerable losses to their retirement savings.

Thomas Joseph Brough: No fine in light of financial status; Suspended 8 months

Eric Robinson Elliott: Fined $10,000; Ordered to pay $30,217, in restitution to customers; Suspended 6 months in all capacities;

Brian James Falabella: No fine in light of financial status; Suspended 6 months in all capacities

Jonathan Jay Sheinkop: No fine in light of financial status; Ordered to pay partial restitution in the total amount of $30,000 to customers; Suspended 12 months in all capacities.

Tags:  CMO    Margin     |    In: Cases of Note : FINRA
Bill Singer's Comment
I must be getting soft in my old age but this is a well-explained case.
October 2010
Lisa Renee Mello (Principal)
AWC/2008012444202/October 2010

Mello served as her member firmís FINOP and was responsible for monitoring the firmís financial condition to determine whether its net capital was sufficient to conduct a securities business. The firmís registered representatives effected trades in collateralized mortgage obligations (CMOs) through the firmís proprietary trading account. The transactions appeared to remove beneficial ownership of the CMOs from the firm, but they were sham transactions because the securities remained in the firmís inventory.

The registered representative was able to accomplish and maintain his scheme because Mello and others at the firm reviewed his activity on a daily basis rather than in a manner that would evidence trading patterns over time and expose the firmís losses and risk. As a result of the registered representativeís activity and the firmís method of monitoring it, the firm conducted a securities business on multiple days while failing to maintain its required minimum net capital and, because Mello failed to discern the true effect of the registered representativeís trading on the firmís net capital, she allowed the firm to conduct a securities business on multiple occasions while in violation of SEC Exchange Act Rule 15c3-1.

Lisa Renee Mello (Principal): Fined $8,000; Suspended as FINOP for 6 months
Tags:  CMO    Proprietary Traders    Net Capital    FINOP     |    In: Cases of Note : FINRA
Bill Singer's Comment

As I noted in the apparent companion case of Kevin Bradley Martin:

According to FINRA, Martin erred because:

The registered representative was able to accomplish and maintain his scheme because Martin reviewed his activity on a daily basis rather than in a manner that would evidence trading patterns over time and expose the firmís losses and risk.

I suspect that FINRA wanted to say -- meant to say -- something a bit different than how this came out.  If you take the statement as written, the Supervisor is being chastized for doing a daily review of his subordinate's trading.  And that's wrong, why?  If FINRA suggests that the daily review was improper, then the regulator owes its members a far more cogent explanation (if not warning), than to merely note that the the review should have been undertaken "in a manner that would evidence trading patterns over time and expose the firm's losses and risk."  Just exactly what is the regulator suggesting would have been preferable -- and not just for the sake of debate but for the pointed reason of eliminating Martin's liability for failing to review prop trading activity over a given period of time. Moreover, assuming that Martin was victimized by the fraud of the subject trader (which FINRA oddly doesn't note pro or con), is there any proof that a different frame of review would have elicited the patterns that, in hindsight, FINRA now concludes are so apparent?

August 2010
George Ernest Reilly (Principal)
2007007329501/August 2010
Reilly failed to establish and maintain a supervisory system with written supervisory procedures reasonably designed to prevent excessive markups in CMO bond transactions, and failed to exercise his supervisory responsibilities to ensure that the firmís CMO trader and other firm representatives complied with NASD Rules 2110 and 2440. Reilly made notations of his reviews of CMO trades for markups on a daily trade blotter but did not conduct reviews to ensure that the markups were fair, reasonable and consistent with market prices. Reilly had the authority to reverse or cancel CMO trades for unreasonable or excessive markups but did not do so, despite the fact that under his supervision, markups for CMO transactions were excessive.
George Ernest Reilly (Principal): Barred
Tags:  Supervision    CMO    Mark-Up Mark-Down     |    In: Cases of Note : FINRA
Robert Norman Gest Jr. (Supervisor)
OS/2007011348301/August 2010

Gest

  • recommended risky and illiquid CMO positions to his customers, and intentionally and/or recklessly made misrepresentations of material facts and omitted to disclose material facts to customers in connection with their CMO investments;
  • failed to provide his customers with material information concerning the bonds as contained in prospectuses, prospectus supplements or any offering circulars relating to the particular CMO tranches purchased that document various applicable risk factors that an investor should consider before investing;
  • recommended CMO positions to customers without investigating and understanding the products and without reasonable grounds to believe that CMO investments were suitable, as he lacked an understanding of the material characteristics of, and risks associated with, the CMOs offered;
  • lacked reasonable grounds to believe the CMO program and CMO investments were suitable for his customers based upon their disclosed investment experience, investment objectives, financial situation and needs, and he did not have reasonable grounds to believe that the use of margin was suitable for customer CMO purchases;
  • exercised discretionary authority in customer accounts without his customersí prior written authorization and his member firmís prior written acceptance of the accounts as discretionary; and
  • willfully failed to timely update his Form U4 with material facts.
Robert Norman Gest Jr. (Supervisor): No Fine in light of financial status; Suspended 18 months
Tags:  CMO        Discretion     |    In: Cases of Note : FINRA
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