WealthManagement Magazine

No More Slap on the Wrist

In the past, almost any violation by a rep resulted in a fine. Only in the most extreme cases were severe measures, like suspension and expulsion, used. Break a rule, be found guilty, write a check without admitting or denying guilt. Not so today: You get the fine, of course, but these days you may suffer a lot more. Regulators are getting tough and creative because they suspect that fines aren't

In the past, almost any violation by a rep resulted in a fine. Only in the most extreme cases were severe measures, like suspension and expulsion, used. Break a rule, be found guilty, write a check — without admitting or denying guilt.

Not so today: You get the fine, of course, but these days you may suffer a lot more. Regulators are getting tough and creative because they suspect that fines aren't a strong enough deterrent to stop illegal behavior.

The most recent — and extreme — example comes from the SEC's landmark case against Raymond James Financial Services, a case that, pre-Spitzer, would probably have resulted in a “failure to supervise” charge and a fine against the firm, plus a suspension for the rogue broker. This time the SEC pursued Raymond James Financial Services with a civil fraud charge and is proposing to bar RJFS from hiring any registered reps or opening any new branches for six months while an independent consultant reviews its compliance procedures and implements changes. The SEC alleges that RJFS failed to supervise a rogue broker, from the firm's Cranston, R.I., branch, who stole $16.5 million from clients. (See “Raymond James Fights a Lonely Battle With the SEC” in Registered Rep.'s December 2004 issue.) RJFS declined to comment, but has denied and fought the SEC's charges.

The SEC has punished bigger firms in the past this way, but only by shutting down recruiting for days, not months. Why the harsh punishment? To kill off the perception that fines are merely a cost of doing business.

“Certainly, we've seen fine inflation,” says Timothy Burke, a securities lawyer with Boston's Bingham McCutchen, who has been following the case. “But we've also seen the regulators impose novel forms of sanctions.” It's part of a trend, he says, of regulators being creative, to put additional teeth into sanctions beyond the payment of fines.

Examples abound: Last November, the NASD fined 29 securities firms more than $9.2 million, including RJFS, for more than 8,000 late reportings of customer complaints, criminal charges and convictions and regulatory actions involving their brokers. The NASD also prohibited two firms, Merrill Lynch and Wachovia Securities, from registering new brokers for five business days. The NASD's sweep followed a July 2004 action against Morgan Stanley, when it hit the firm with a $2.2 million penalty and suspended it from registering any new brokers for a week based on 1,800 late reports of broker misconduct. The fines may seem small, but these infractions used to be considered nothing more than a failure to file paperwork. Not anymore. The failures were systematic and “deeply troubling,” NASD Vice Chairman Mary Schapiro wrote.

Such punishment is not limited to broker/dealers. Last August, for the first time, the NASD suspended National Securities Corp., a Seattle-based mutual fund, from opening new accounts for clients for 30 days as punishment for charges of market-timing and late trading.

We Mean It This Time

Don't say you weren't warned. Regulators have been promulgating this new, more aggressive stance for more than a year. “Even where there isn't a specific rule tailored to address a specific situation, a firm and its officers should be committed to do the right thing,” Schapiro told the Securities Industry Association's compliance and legal conference in Phoenix in March 2004. “It also suggests to me more creative sanctions in our enforcement cases, including taking a firm out of an entire line of business for a period of time when there have been repeated and particularly egregious violations.”

A timeout may sound extreme, but the SEC claims RJFS ignored red flags when Denis Herula, the notorious RJFS rogue broker, bilked investors by transferring money into an account controlled by his wife. Evidence at the hearing showed that the auditor who conducted the yearly review of the Cranston branch — at a time when Herula had already come close to termination for sending out unauthorized correspondence on Raymond James stationary — had no knowledge of these problems. “Simply put, RJFS' attitude toward compliance, as reflected at the hearing, is too lax and not sufficiently proactive to offer any assurances that the investing public will be protected against fraud,” the SEC argues.

In its opposing brief, RJFS asserts that “deceptive people can attempt to operate in any business model.” It further asserts that the branch manager hid Herula's malfeasance from management. It calls the SEC's proposed six-month time out on opening new branches and hiring reps “draconian, punitive and unjustified.”

Burke, for one, doesn't expect the SEC to get all that it has asked for in the Raymond James case. “They would be very hampered,” he says. But that is just the point, and securities firms should expect more sanctions like this in the future. “This is part of a new program to get remedial punishment that fits the offense,” says Lionel Pashkoff, a lawyer with the Washington, D.C., office of Proskauer Rose. “I'm not saying its right in this case.”

A ruling is expected by August. Stay tuned.

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