NASD REGULATION, INC.

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NASD Conduct Rule 2110

Section 7(f) of the Securities Exchange Act of 1934 ("Exchange Act"), 15 U.S.C. § 78(g), 15 U.S.C.§ 78(f).
     Regulation X (12 C.F.R. § 224 et seq)
     Regulation T (12 C.F.R. § 220 et seq)

RR personal trading losses and Reg.T/X violations. 3 month suspension all capacities, 2 years as principal, FINOP/GSP requalification, personal trading restrictions, and $30,000 fine.

Given the difficult economic times, it should come as no surprise that many registered representatives are finding it hard to make ends meet. We recently discussed the case of a financially strapped registered representative who got into trouble when he borrowed money from his clients (See, NASDR, DEPARTMENT OF ENFORCEMENT v. JAMES S. DAVENPORT). Now, lets consider the case of another RR who tried to trade his way out of his money woes --- only to wind up in worse shape.  

In 1988, Patrick H. Smith joined Jackson & Smith (J&S), an NASD broker-dealer started in 1931 by his grandfather.  Smith functioned as a General Securities Representative, a General Securities Principal, an Equity Trader, and a Financial and Operations Principal (FINOP). In 1998 his wife, who was expecting their second child, quit work and the loss of her income created a financial burden. Unfortunately, Smith thought that he could make up some of the short fall through day trading. 

Between January 7, 1999, and November 15, 2000, Smith effected 242 purchases --- totaling more than $11 million ---in his personal securities account at J&S.  Apparently, the overwhelming majority of these trades were day-trades.  Unfortunately,Smith did not have sufficient personal funds to pay for these day-trades, but he apparently thought that he had found away around that problem.  Somehow he believed that he could net-out his short-term positions against other trades in his account; thus, avoiding the need to make payment.  Regardless of his good-faith misunderstanding, you can't utilize such netting to avoid your obligation to pay for day trades upon settlement.  

Bad enough that he wasn't paying for the day trades, Smith's investment strategy seems to have been flawed. Compounding his misunderstanding of his payment obligations, he accumulated about $500,000 in losses.  Ultimately, Smith’s father contributed approximately $350,000 from his own savings toward his son's debt.  Smith came up with the balance by selling other securities he owned. 

In time, the NASD Regulation (NASDR) found out about Smith’s conduct and filed a complaint.  An NASDR Hearing Panel found that Smith violated NASD Conduct Rule 2110 and Regulations X and T by not paying on settlement date for the securities he purchased.  Further, he was found to have violated Regulation X by arranging for the extensions of credit (as J&S’ FINOP) in violation of Regulation T. 

NASDR urged the Hearing Panel to impose severe sanctions given the number of violative trades and the extended period of misconduct. Smith countered that he had implemented corrective measures before the NASD intervened and cooperated with the ensuing investigation.  He also expressed deep remorse for his mistakes, but noted that no customers were harmed or involved. 

The Hearing Panel would have none of it.  They seemed quite put-off by Smith's “casual characterization that he simply was caught up in the frenzy of day trading, causing him to lose sight of his obligations.”  True, the market had tanked and Smith, along with millions of others, lost significant sums of money.  But it wasn't the "frenzy" of day trading, nor the dramatic sell-off in stocks that was the issue before the Panel.  The focus was Smith's conduct that exposed his BD to financial risk and to regulatory scrutiny.  It's one thing to lose a lot of your own money.  However, it's another thing when you're the firm's GSP, Equity Trader, and FINOP and you're not timely paying for millions of dollars of trades.  

Pointedly, the Panel underscored that as J&S’ FINOP, Smith was responsible for the firm's compliance with Regulation T.  The Panel was not interested in his explanations that market volatility was a culprit and that he never intended to harm others.  The potential for harm, if not disaster, was their concern. Essentially, the Panel focused on Smith’s risky trading (which put J&S at risk) and the fact that he ignored his responsibilities as a registered principal while engaging in a “sustained pattern of misconduct.”  In plain terms, the Panel felt that he should have known better and acted more responsibly. 

Consequently, the Panel imposed the following sanctions: 

(1)   A three-month suspension in all capacities;

(2)   A 2-year suspension as a GSP and FINOP;

(3)   Requalification as a GSP and FINOP prior to resuming such roles;

(4)   For one year following his association with a member firm, his firm shall review and pre-approve all transactions for his personal accounts (including all accounts in which he has a beneficial interest) and require that he have sufficient funds in his accounts to settle all transactions before they are executed;

(5)   $30,000 fine plus specified fees and costs of the proceeding. 

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