Regulatory Update: Supervision Failures Continue To Bite Firms

The message is clear — ignoring red flags is a big no-no! Regulators continue to penalize firms and individuals for failing to comply with supervision obligations.

The Securities and Exchange Commission (SEC) recently fined Wedbush Securities Inc.  $250,000 and the firm has agreed to be censured to settle its failure to supervise charge in a pending administrative proceeding. According to the SEC’s March 2018 order instituting proceedings, Wedbush ignored numerous red flags indicating that one of its registered representatives was involved in a long-running pump-and-dump scheme targeting retail investors. Wedbush conducted two flawed and insufficient investigations into the registered representative’s conduct but failed to take appropriate action. The firm’s supervisors became aware of the following red flags by: (1) reviewing an email outlining her role in fraudulent transactions involving penny stocks (2) receiving copies of two FINRA arbitrations filed by her customers outlining serious allegations of her role in their investments in the same penny stock issuers; (3) learning of a FINRA inquiry into her personal trading by one of the penny stock issuers; and (4) learning of a separate FINRA inquiry into the allegations underlying the customer arbitrations. Wedbush failed to develop and implement reasonable policies, procedures and implementation systems to provide guidance to supervisors and other staff on how to reasonably follow-up on red flags of potential market manipulation by registered representatives, including the rep.

FINRA fined brokerage firm Merrill Lynch, Pierce, Fenner & Smith Inc. $300,000 for failing to reasonably supervise an associated person who, together with a third-party individual, engaged in a scheme to defraud a customer of the firm. The findings also stated that the firm failed to reasonably investigate and respond to red flags that the associated person was engaged in conduct that appeared to violate its policies and procedures. The firm failed to reasonably investigate and appropriately escalate certain email communications of the associated person, despite having been flagged and reviewed. These communications revealed her close association with the third party, that she was providing services beyond what the firm permitted, in addition to her potential involvement with private securities transactions. The firm also failed to reasonably follow up on a $1,694,233.10 default judgment entered against the associated person based on a civil complaint that alleged that she had cheated a couple who had lent money to the third party. Had the firm responded to these red flags with immediate action, it likely could have discovered the associated person’s association with the third party and gained a better position to address the risk the associated person posed to the customer and the firm. The findings also included that the firm failed to disclose certain reportable events related to the associated person to FINRA. Neither the default judgment underlying the associated person’s garnishment order nor the civil complaint that led to the default judgment were disclosed on her U4 Form. The firm also failed to disclose the felony charges against the associated person on her amended U5 Form.

Broker James Edward Armstrong Sr. was fined $5,000 and Broker James Edward Armstrong Jr. was fined $7,500. Armstrong Sr. and Armstrong Jr. consented to the sanctions and to the entry of findings that they failed to reasonably supervise a registered representative. The findings stated that the representative made unsuitable investment recommendations to elderly customers resulting in more than $200,000 in trading losses across the customers’ accounts. Armstrong Jr. failed to reasonably supervise the representative by ignoring red flags, indicating possible unsuitable trading by the representative, and failing to review his email correspondence, which would have revealed that this representative received a customer complaint, and alleviated another customer’s concerns by making misleading and promissory statements. Armstrong Sr. failed to reasonably supervise the representative by neglecting to appropriately address concerns elevated to him by Armstrong Jr. regarding the representative’s trading activity in customer accounts. Although Armstrong Sr. delegated day-to-day supervision of the representative to Armstrong Jr., Armstrong Sr. was ultimately responsible for the supervision of representatives at his branch office.

FINRA also fined broker Peter Chris Marketos $20,000 for making unsuitable recommendations to concentrate customers’ investments in speculative, high-yield bonds. The findings also stated Marketos negligently sent materially misleading emails containing factually inaccurate statements to customers regarding the risk of high yield bonds in general and the risks of certain bonds in particular. The findings also include that Marketos wrote emails to customers that contained unwarranted statements with no sound basis, did not provide fair and balanced treatment of the risks and benefits of investments, predicted future performance, and made performance guarantees.

Thaddeus James North was fined $40,000 and suspended from association with any FINRA member in any principal and supervisory capacity for 30 business days. This will be followed by a two-month suspension from association with any FINRA member in any principal and supervisory capacity. These sanctions were based on findings that North willfully violated Municipal Securities Rulemaking Board (MSRB) Rule G-27(a), (b), (c) and (e) by failing to establish a reasonable supervisory system for the review of electronic correspondence and to reasonably review that correspondence. The findings stated that during his tenure as chief compliance officer (CCO) at his member firm, North failed to establish reasonable procedures and amend the firm’s Written Supervisory Procedures (WSPs) to specify basic parameters for reviewing electronic communications. While the firm’s WSPs identified a system to be used in reviewing electronic communications, no guidance was provided as to how the system should be used to conduct those reviews, and consequently, North never used the system to review the firm’s Bloomberg messages or chats. The findings also stated that North failed to report to FINRA that a registered representative at his firm entered into an outside business relationship with a statutorily disqualified individual and failed to conduct an independent examination of the relationship despite knowing that the individual was subject to a disqualification.


It is critical to supervise your employees and respond to red flags! As you can see in the above enforcement cases, having a set of Written Supervisory Policies is not enough. It’s important to establish a reasonable supervisory system that flags, escalates and enables actions to address potential fraud and violations. Not following your firm’s policies and procedures is just as bad as not having any in first place. One of the most frequently cited violations is failure to follow Written Supervisory Procedures. 

Firms must establish a supervisory system for the review of all electronic correspondence with procedures for reasonable review. WSPs must be tailored to the specific risks of the firm and address all activity in which your firm engages. At a minimum, WSPs must identify the designated supervisor, outline the process to follow to conduct each review, when (i.e., how frequently) actions will be taken, and how to document that required supervisory steps were taken. WSPs should be updated to reflect regulatory changes, as well as changes made to the supervisory process. It’s important to ensure policies are properly enforced and followed by the designated reviewers. Supervision is critical for retention and oversight of electronic communications. Firms need to demonstrate to regulators that they are supervising the activities of their associated persons. Monitoring electronic communications can be incredibly effective to find potential violations of fraud, criminal behavior, undisclosed reportable events – as well as client complaints.

All WSPs must specify basic parameters for reviewing electronic communications. There is no prescribed formula for determining how many emails to review, but enough should be reviewed for an advisor to be able to defend it as reasonable. FINRA recommends that firms adopt a combination of lexicon and random review of electronic correspondence. Policies and procedures are not required to specify exact percentages or quantities to review. The most important takeaway here is to review as many messages as are specified by the firm’s WSPs. If the policies call for a review of four percent of all emails each month, reviewing only two percent in a quarter is missing the mark.

The takeaway is that firms must develop and maintain policies and procedures reasonably designed to prevent and detect securities law violations by associated persons working for them. Firms must also have systems to implement their supervisory procedures that would reasonably be expected to prevent and detect violations by persons subject to their supervision.

Failure to meet FINRA and SEC retention and supervision requirements results in serious consequences for firms and their associated persons, including fines and other disciplinary actions.

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Marianna Shafir Esq.

Marianna Shafir Esq.

Corporate Counsel, Regulatory Advisor at Smarsh
Marianna Shafir is Corporate Counsel and Regulatory Advisor at Smarsh, where she’s responsible for legal and regulatory affairs worldwide. With her expertise in financial services industry, compliance and eDiscovery, Marianna counsels Smarsh clients on meeting regulatory obligations, leveraging technology and guidance on best practices related to electronic communications supervision. Prior to joining Smarsh, Marianna worked for BNY Mellon and Invesco where she was an instrumental member on compliance teams.Marianna has also served as an adjunct professor at New York Career Institute where she taught Law Office Management and Real Estate Law. She earned her Juris Doctorate from Nova Southeastern University. She is a frequent speaker at industry conferences and a contributor to various online publications.
Marianna Shafir Esq.

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