A firm, its chief compliance officer ("CCO") and one of its supervisors (the "Supervisor") settled FINRA charges for supervisory failures relating to unsuitable recommendations made by one of the firm's representatives.
In a Letter of Acceptance, Waiver and Consent, FINRA stated that the firm and its CCO failed to create and adequately implement a supervisory system reasonably designed to ensure compliance with regulations involving the sale of collateralized mortgage obligations ("CMOs"). FINRA stated that, upon hiring the representative, the firm did not employ any principals familiar with CMOs and failed to establish related supervisory procedures for the designated supervisor despite knowing that the representative specialized primarily in inverse floaters, which are described as a particularly volatile and thinly traded type of CMO.
The Supervisor also failed to address several red flags that should have indicated that the representative's inverse floater recommendations were unsuitable or should be subject to review, including that:
- the inherently risky and illiquid nature of inverse floaters rendered them inconsistent with the conservative investment goals and risk tolerances of the representative's customers;
- the customer accounts of the representative were completely concentrated in inverse floaters;
- transactions recommended by the representative were flagged by the firm's trade review system as a result of the overconcentration of non-investment grade holdings in customer accounts;
- most of the customers were seniors who held their securities in retirement accounts;
- many of the customers had limited net worth and income; and
- regardless of age, financial circumstances, investment experience and risk tolerances, the customers purchased identical CMOs at the same time.
As a result of their supervisory failures, FINRA determined, the firm and the CCO violated FINRA Rules 2010 ("Standards of Commercial Honor and Principles of Trade") and 3110 ("Supervision"), and NASD Rules 3010 and 2510(c) ("Approval and Review of Transactions"). Additionally, FINRA determined that the Supervisor violated FINRA Rules 3110 and 2010 and NASD Rule 3010.
To settle the charges, (i) the firm agreed to a censure and partial restitution of $275,000, (ii) the CCO agreed to a $10,000 fine, 60-day suspension from association in any principal capacity with a FINRA member firm and an undertaking to complete continuing education on supervisory responsibilities, and (iii) the Supervisor agreed to a 45-day suspension from association in any principal capacity with a FINRA member firm.
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