Last month, FINRA fined a clearing firm $5.3 million for anti-money laundering (AML) failures as well as recordkeeping, financial, and operation violations involving penny stock shares. Despite clearing and settling billions of penny stock shares dating back to 2012, FINRA discovered that the clearing firm failed to institute an AML program to detect and report potentially suspicious transactions. Not only did the firm not have surveillance reports to monitor potentially suspicious penny stock liquidations in place until June 2014, it also did not require its employees to document their reviews of the surveillance reports that did exist.

Further, the SEC penalized the same firm an additional $860,000 for AML violations, including failure to file suspicious activity reports (SARs). Aside from its failure to file SARs, the firm was also found to have failed to promptly produce requested documents to the SEC during the course of its investigation, and to have lost approximately 40,000 emails over a four-month period in violation of SEC Rule 17a-4.

In related actions, the clearing firms’ introducing broker and its CCO/AML Officer agreed to settle similar charges with the SEC. According to the SEC, from October 2013 to June 2014, the introducing broker liquidated more than 12.5 billion penny stock shares for seven of its customers and the clearing firm settled the transactions. Though these transactions raised red flags, the firm failed to file any SARs. Meanwhile, the CCO/AML Officer, who was responsible for filing those SARs, was found to have willfully aided and abetted, causing the firm’s violation of Exchange Act Section 17(a) and Rule 17a-8. The firm agreed to pay a $1 million penalty, and the CCO/AML Officer was fined $15,000. Moreover, the CCO/AML Officer has been barred from the industry for at least 3 years.

Another brokerage firm was fined a total of $1,470,000 and ordered to pay $51,624, while its CCO was fined $140,000 and suspended for one year. These sanctions were based on findings that the firm willfully violated Rule 203 (b)(1) of Regulation SHO and failed to reasonably supervise instant message communications. The firm and its CCO improperly delegated the review of instant messages by its representatives to an unregistered person at the firm. The findings also indicate that the firm failed to establish and implement reasonable AML policies and procedures to detect, investigate and report suspicious trading activity where appropriate.

Takeaway:

These actions by FINRA and the SEC are the latest in a series of regulatory fines by U.S. and European regulators over AML and recordkeeping controls. Firms need to capture, archive, and supervise all written business communications. This includes retention of electronic communications such as email, text messages, instant messages, social media and more. That makes this a good time to review your Written Supervisory Procedures (WSP’s) to ensure the policies properly address your firm’s business activities and comply with the provisions of recordkeeping rules. Periodically test your electronic archive systems to ensure all communications are being captured and messages are being archived for the defined period of time. The alternative — discovering that there are technical issues during a regulatory enforcement action — is less than ideal.

Firms should be sure to comply with their own AML policies that require monitoring and supervision of trading activity, investigation of red flags, and reporting of suspicious trading activity through SARs. When a firm fails to take reasonable steps to supervise, that’s when a violation occurs.

A particularly noteworthy lesson from the aforementioned SEC action was the regulator’s decision to hold an individual CCO accountable for failing to file SARs. Recently, regulators have demonstrated greater willingness to bring charges against CCOs in enforcement actions. At this year’s FINRA conference, the topic was discussed at the “Enforcement Initiatives, Developments and Priorities” session. The FINRA enforcement panel moderated by Susan Schroeder, FINRA Executive Vice President, Department of Enforcement, said that most of the cases involve CCOs who wear “multiple hats” or, in other words, serve in several capacities, such as a CCO who is also the CEO or CFO of the firm. Misconduct in such other roles has led to FINRA and SEC enforcement actions. Regulators will bring action against CCOs where they engage in misconduct and/or fail to carry out their responsibilities as CCOs. As in the above example, the CCO was also the AML Officer and failed to perform the compliance tasks that he was responsible for under the firm policies.

The key takeaway here is that supervision doesn’t have to be perfect, but it has to be reasonable. Firms are obligated to implement a reasonable supervisory system to detect and report financial misconduct. As these fines demonstrate, the cost of noncompliance is significantly greater than compliance.