Street Legal: Roads Not Taken

Street Legal: Roads Not Taken

There is a troubling lack of uniformity among regulators.

Are regulators applying consistent standards when meting out justice over problems with software errors? Consider the following.

PlanMember Securities Corporation, an NASD/FINRA broker-dealer since 1983, employs about 460 registered representatives at 308 branch offices. PlanMember's core business is retirement planning through the sale of its mutual fund products to participants in 403(b) plans (a tax-advantaged retirement savings plans available for public education organizations, qualified non-profits employees, and self-employed ministers).

Third-Party Vendor's Software Bug

In July 2001, PlanMember outsourced its breakpoint determinations to a third-party vendor. Around 2007, the vendor experienced a software programming error that failed to take certain B shares into consideration and, as a result, 30 PlanMember customers were overcharged about $4,000 for their mutual fund purchases. Subsequently, all of the overcharged customers were fully reimbursed.

If you ask me, no big deal. Based upon the limited number of customers and dollars at issue, I don't get the sense that PlanMember was negligent or reckless. As many of us in the business know, sometimes a third-party vendor encounters a glitch. There's nothing the client can really do when these remote errors happen aside from damage control — and, of course, yelling at the vendor. These snafus should not become regulatory cases. But the Financial Industry Regulatory Authority has a totally different view.

Censure and $20,000 Fine

FINRA concluded that PlanMember did not have any system or procedures for supervising the vendor's breakpoint determinations. Pursuant to a settlement in April in which PlanMember did not admit or deny FINRA's findings but was censured and fined $20,000, FINRA found that

“PlanMember's decision to outsource certain of its breakpoint determinations to a third party did not relieve the Firm of its ultimate responsibility for the outsourced activity. During the relevant period, PlanMember failed to have in place adequate policies and procedures to monitor the outside vendor's compliance with the terms of its agreement with the Firm, and to assess the outside vendor's continued fitness and ability to perform the outsourced activities…”

The SEC's China Syndrome

Contrast FINRA's PlanMember settlement with the recent settlement between the Securities and Exchange Commission and China Yuchai International Limited (“CYI”). Between 1998 and 2004, a subsidiary of CYI (NYSE ticker “CYD”) had been consistently profitable; however, in the second half of 2005, the subsidiary's financial statements began to reflect worsening monthly losses. The subsidiary's management and finance department?believed that?technical problems with new accounting software installed earlier that year resulted in a discrepancy of about $21 million.

On Jan. 20, 2006, the subsidiary's finance department input an adjusting entry of $21 million for the period ending Dec. 31, 2005. Unfortunately, no one at the subsidiary informed CYI of the adjustment, which caused CYI's 2005 annual report to incorrectly report $8.5 million in net income. On May 30, 2008, CYI filed an amended report, which reversed the adjusting entry and reported a $4 million net annual loss (a reversal of about $12.5 million).

The SEC alleged that CYI had committed violations of the reporting, books and records and internal controls provisions of the securities laws. In settling its case against CYI, which neither admitted nor denied the findings, the SEC entered a Cease and Desist Order against CYI — no censure, no fine, no nothing else. That's it: Go and sin no more.

To my eye, one trained through nearly three decades on Wall Street, I fail to appreciate any significant difference between PlanMember and China Yuchai — if anything, China Yuchai seems more directly involved in the software error that resulted in a $12.5 million reported error. As to PlanMember's liability, it seems largely predicated on its third-party vendor's miscue. While I understand that FINRA member firms must exercise reasonable oversight of outsider service providers, FINRA has not convinced me that this member firm's conduct warranted a censure and a $20,000 fine — particularly since a NYSE-listed company seems to have engaged in far worse supervision and merely agreed to a Cease and Desist order.

Writer's BIO:

Bill Singer
is the publisher of and

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