FINRA Cracks Down on Firms Failing to Respond to Red Flags for Suspicious Activity

            The Financial Industry Regulatory Authority (FINRA) has expanded its battle against financial firms that fail to respond to red flags indicating suspicious activity in customer accounts.  The latest target is a clearing firm, COR Clearing, LLC (formerly known as Legent Clearing, LLC), which was recently hit with a $1 million fine to a clearing firm for failing to detect suspicious account activity. 

            FINRA’s action underscores the heightened responsibility that regulators impose on so-called gatekeepers in the securities markets to implement and maintain adequate supervisory controls to prevent fraud.  As a clearing firm for correspondent firms that introduce accounts, COR performs the back-office functions, such as order processing and recordkeeping tasks, that non-clearing broker-dealers cannot provide to their customers.  In that capacity, clearing firms typically do not have direct contact with the introducing broker-dealers customers other than sending out monthly account statements.  They offer no investment advisory services to the investor.

            FINRA identified numerous violations over a series of examinations of COR’s operations between 2009 and 2013 that ran afoul of the agency’s regulatory priorities of microcap fraud and anti-money laundering (AML) compliance deficiencies.  FINRA’s investigation concluded that COR’s AML program “did not reasonably address the risks” associated with the significant number of accounts introduced by its correspondent broker-dealers that were actively trading low-priced securities and engaged in significant third-party wire activity, which “present a higher risk of money laundering and other fraudulent activity.”  COR’s systems were further deficient because it was aware that many of its correspondent firms had heightened AML risks due to their histories of disciplinary actions for AML rule violations.

            COR settled the FINRA charges, without admitting or denying the allegations, and consented to the entry of the regulator’s findings.  In addition to the fine, COR is required to retain an independent consultant to conduct a comprehensive review of its policies, procedures, operations and training in order to come into full compliance with its supervisory obligations.

Massachusetts Investment Advisor Who Defrauded Dozens of Investors Ordered to Disgorge $9.8 Million

            On November 18, 2013, a U.S. District Court in Massachusetts found that Steven Palladino and his investment advisory firm, Viking Financial Group, perpetrated a fraudulent scheme that raised millions of dollars that were supposed tobe used to make short-term, high interest loans to those unable to obtain traditional financing.

            Ruling in an emergency enforcement action brought by the Securities and Exchange Commission, the court determined that Palladino and Viking lied to at least 33 customers regarding how their investment funds would be used.  Specifically, the defendants misrepresented to the investors that the loans to be made by Viking would be secured by first-position liens on real estate, and that investors would receive monthly interest payments between 7% and 15%.  Contrary to these misrepresentations, Viking made very few actual loans to borrowers.  Instead, Palladino misappropriated the money for his own use, spending the money on vacations, gambling, and luxury items.

            Ruling on the SEC’s petition, the court found that the defendants violated several provisions of the federal securities laws, and ordered them to pay nearly $10 million in disgorgement of ill-gotten gains.   Criminal charges against Palladino and Viking remain pending.

            Investors who have been defrauded by their financial advisers should consult with experienced securities attorneys to evaluate their rights and ability to seek compensation from all responsible parties

FINRA’s High-Risk Broker Initiative Is A Half-Step Measure

        In response to a Congressional inquiry, FINRA Chairman and CEO, Robert Ketchum, recently discussed a new initiative adopted by the regulator to identify and punish dishonest brokers on an expedited basis.  While FINRA should be lauded for its proactive effort to root out fraud, the regulator should use the information developed through the initiative’s data-mining metrics to promptly enjoin high-risk brokers and directly warn their customers of possible fraud until formal action is taken to permanently remove such brokers from the industry.

        On November 13, 2013, FINRA published Mr. Ketchum’s letter to U.S. Senator Edward Markey describing the regulator’s enhanced enforcement strategies that target “rogue brokers.”  The stated goal of FINRA’s recent enhancements, including improvements to its BrokerCheck database and tightening the expungement rules, is to protect investors from the increasing risks of unscrupulous brokers.

        Mr. Ketchum’s letter boasted about its oversight vigilance by noting that, between January 2011 and September 30, 2013, FINRA barred 1,342 individual brokers from the industry for a variety of violations of federal securities laws or FINRA rules.   The seriousness with which FINRA addresses the risk to investors posed by so many dishonest brokers led to its launch in early 2013 of FINRA’s High Risk Broker initiative that is intended to identify individual brokers for targeted, expedited investigation.  The initiative compiles and analyzes data including broker terminations, complaints, tips, arbitrations, and field reports from ongoing examinations to identify candidates for the high-risk designation.

        According to Mr. Ketchum’s letter, since February 2013, FINRA has designated 42 brokers as High Risk Brokers.  As of November 13^th, 16 enforcement actions have been brought, all of which resulted in bars from the industry.  Such preemptive efforts to address broker fraud are commendable, but stop short of fully protecting victimized investors who remain unsuspecting customers of identified rogue brokers.  By not immediately enjoining the activities of brokers identified as High Risk, and not warning the customers of such brokers of its designation, FINRA is foregoing a meaningful opportunity to prevent further investor losses.

        FINRA plans to expand the High Risk Broker initiative in 2014, and to create a dedicated Enforcement team to prosecute such cases.  That means FINRA will have greater knowledge of a significant number of brokers it believes should be out of the industry but nonetheless are allowed to continue their potentially fraudulent activities until formal action is taken.  FINRA should more aggressively use the information developed through its initiative to stop rogue brokers as soon as they are identified.

SEC Continues to Roll Out New Enforcement Strategies

             Over the past several months, the SEC has embarked on innovative and aggressive strategies to protect investors by stopping schemes to defraud early in their development.   The latest example of the SEC’s new approach emerged earlier this month when it announced the first deferred prosecution agreement with a former hedge fund administrator who assisted the agency in taking actions against a hedge fund manager who was stealing investor funds.  Never before had the SEC entered into a deferred prosecution agreement with an individual.

            According to the agreement, Scott Herckis was the administrator of a Connecticut-based hedge fund known as Heppelwhite Fund, LP, which was managed by its founder, Berton M. Hochfield.  Mr. Herckis provided significant assistance to the agency by contacting authorities about Mr. Hochfield’s conduct and producing records establishing the nature and extent of Mr. Hochfield’s fraud.  With the information provided by the administrator, the SEC was able to quickly file an emergency enforcement action to stop Mr. Hochfield’s misappropriation, which by that time had resulted in $1.5 million in investor losses.  The SEC not only stopped Mr. Hochfield’s fraud in its tracks, the early action allowed the agency to be able to distribute $6 million to the fund’s investors who were harmed by the misappropriations.

            Although the SEC determined that Mr. Herckis aided and abetted the manager’s securities law violations prior to blowing the whistle, the agency opted to enter into a deferred prosecution with him rather than seek criminal liability.  Under the agreement, Mr. Herckis is prohibited from acting as a fund administrator for five years, cannot associated with an investment advisor or registered investment company, and had to disgorge $50,000 in fees earned as the fund administrator. 

In a news release announcing the agreement, an associate director in the SEC’s Division of Enforcement, Scott W. Friestad, expressed the SEC’s commitment “to rewarding proactive cooperation that helps us protect investors.”  Recognizing that “most useful cooperators often aren’t innocent bystanders,” Mr. Friestad described the agreement as a way “to balance these competing considerations” by holding Mr. Herckis “accountable for his misconduct but [it] gives him significant credit for reporting the fraud and providing full cooperation without any assurances of leniency.” 

16 NFL Players Sue BB&T for $53 Million Misappropriated by their Financial Advisor

        Earlier this month 16 current and former National Football League players filed suit against Branch Banking and Trust Co. in the U.S. District Court in Miami for $53 million in losses caused by the bank allowing a financial advisory firm to loot the players accounts.

        The players, who include Ray Lewis, Jevon Kearse, Santonio Holmes, Clinton Portis, Brandon Meriweather, and others, allege that BB&T is the successor-in-interest to BankAtlantic, which opened several checking accounts based on forged signatures and allowed the players’ financial advisor, Jeff Rubin, to withdraw tens of millions of dollars without their knowledge or consent.  Last year Rubin was stripped of his securities license by the Financial Industry Regulatory Authority, in part because of conduct that at issue in the recently filed lawsuit.

         The players allege that Rubin made unauthorized transactions including loans and other transfers to a failed casino project in Alabama known as Country Crossing.  The casino was shut down soon after it opened because the state governments deemed it to be illegal gambling under Alabama law.

         Block & Landsman is part of the group of attorneys representing the players in their lawsuit against BB&T.