As noted previously in this blog, the SEC and other regulatory agencies continue to display an increased interest in the issue of internal and supervisory controls. The Financial Industry Regulatory Authority (“FINRA”) has continued this trend, recently bringing charges against a number of member firms related to allegedly inadequate supervisory controls.
For example, on May 6, 2015, FINRA announced that it had entered into an agreement with the brokerage firm LPL Financial (“LPL”) in which LPL agreed to pay $11.7 million to settle charges that they had failed to maintain sufficient supervisory controls. LPL neither admitted nor denied the charges, but allegedly “failed to have adequate systems and procedures in place to supervise certain aspects of its business,” and consequently, “[m]ultiple deficiencies affected LPL’s systems.” Among other things, LPL allegedly “failed to reasonably supervise” the sale of exchange traded funds, including not monitoring the length of time that its customers held these securities, despite the well-known risks of intermediate and long-term holding. Additionally, LPL failed to implement adequate systems to monitor “suspicious activity” in connection with their anti-money laundering (“AML”) compliance program. While LPL ostensibly had a surveillance program to detect transactional anomalies and generate AML alerts for further investigation, FINRA found that coding errors in the program prevented LPL from receiving all AML alerts for approximately six weeks. LPL also failed to identify and review trades that potentially violated their policies and procedures, including low priced equity transactions, concentrated positions and employee front-running trades. Once again, FINRA alleged that LPL’s surveillance software “was beset by multiple deficiencies” that prevented their supervisors from reviewing potentially problematic trades in customer accounts.
These violations were not LPL’s first. Between 2007 and 2013, LPL was found to be in violation of numerous FINRA Rules related to supervision, and FINRA levied multiple fines that added up to more than $11 million. This time around, LPL’s conduct was alleged to have violated FINRA Rule 3110 in that it failed to “maintain a system to supervise the activities of each associated person that is reasonably designed to achieve compliance with applicable securities laws and regulations, and with applicable FINRA rules.” As a result of LPL’s failures, they agreed to pay a $10 million fine and nearly $1.7 million in restitution to its customers, and agreed to submit a written plan to FINRA to review and improve its supervision practices.
The LPL settlement highlights several important takeaways. First, firms that have a record of skirting supervisory rules may endure enhanced FINRA scrutiny. As noted above, LPL had been implicated in more than ten different FINRA investigations related to supervisory controls between 2007 and 2013. The Settlement Agreement notes each occurrence in detail, which suggests that LPL’s long history with supervisory failures played a part in FINRA’s decision to impose a relatively severe penalty this time. Second, FINRA does not appear to have been swayed by potentially mitigating factors that may have affected LPL’s failures. For example, the Settlement Agreement notes that LPL has significantly expanded in recent years; since 2007, LPL has more than doubled its number of registered representatives. While this expansion could explain some of LPL’s breakdowns in supervisory controls, FINRA demonstrated no lenience, noting that LPL “did not accompany [its] rapid growth with a concomitant dedication of sufficient resources to . . . meet its supervisory obligations.” Likewise, although several of LPL’s failures concerned surveillance system software malfunctions or bugs, FINRA did not view this as a mitigating factor. Consequently, firms should be vigilant in ensuring that all electronic monitoring systems are working properly. Third, in determining the appropriate sanction, FINRA did note that LPL had “hir[ed] . . . additional legal and compliance personnel.” Accordingly, where supervisory controls are found to be lacking, firms should quickly retain the legal and compliance employees to remedy the problems.
Given the increased regulatory focus in this area, FINRA member firms are advised to take an inventory of the securities laws, regulations and FINRA Rules that are relevant to its business and perform a top-to-bottom assessment of its current system of supervision to ensure that its systems, policies and procedures are in compliance with those laws and rules.