Avoiding Supervisor Tag............3
FINRA Best Execution Rule.......6
March 12, 2012
Coming customer due diligence rule
could pose a challenge
The due diligence you would have to perform on
customers could increase dramatically under a
proposal the Treasury Department’s Financial
Crimes Enforcement Network (FinCen) is
considering.
Enforcement Alert
Firm gets dinged for failing to follow-up
on red flags in rep’s brokerage account
Don’t accept at face value a rep’s explanation for
having unusually large sums of money in his
brokerage account. Ask for some documentation that
backs up his story. The chief compliance officer of a
Tinton Falls, N.J. firm recently learned that lesson the
hard way.
A rep told Christine Cantone
Cantone, the CCO of
Cantone Research, Inc. (CRI), that the hundreds of
thousands of dollars in his account at another firm
came from his real estate dealings and his wife’s
supposed boutique business.
That seemed odd to Cantone, who also was the
rep’s supervisor, given that the rep generated under
$30,000 a year in income from his work at CRI,
according to FINRA. But Cantone didn’t follow up
on her suspicions and try to verify the rep’s story,
FINRA said.
(Red Flags, continued on page 4)
But the proposal is in the very formative stages,
and FinCEN is seeking industry input on it. The
agency wants to avoid the industry outcry it
witnessed in 2010 when it broached this idea in the
form of guidance.
One of the more controversial provisions
mentioned in a Feb. 29th Advance Notice of Proposed
Rulemaking is the idea that firms be required to
(Customer due diligence, continued on page 2)
Another arbitration panel orders
investor to pay firm’s costs
Last week, we told you about a Los Angeles
arbitration panel that ordered four, related investor
claimants who lost to pay $75,000 of the respondent
broker-dealer’s legal fees. The panel said the
investors tried to abuse FINRA
FINRA’’s arbitration system.
Now comes another arbitration award for a firm
— this one from a different L.A. panel — and
ordering the investor to pay $135,755 of the firm’s
costs.
WFP Securities Corporation, of San Diego, was
awarded the funds after the panel dismissed an
investor’s claim seeking payment for what she said
was $2.9 million in potential losses related to private
placement securities. The alleged amount included
$350,000 in lost principal spent on problematic
DBSI
DBSI, Med Cap
Cap, and Striker securities, her claim
stated.
The panel determined that the investor, Jaimie
(Arbitration, continued on page 4)
Customer due diligence (cont. from pg. 1)
identify the beneficial owner of a legal entity that is
a financial institution’s customer, and verify that the
individual is, indeed, the beneficial owner of the
entity.
Paul Tyr
yrrrell
ell, of counsel in the Boston office of
Bingham, says this could be a major challenge for
Bingham
firms unless there’s a risk-based approach governing
when such a requirement is applied.
“I think it’s really a very difficult thing to
practically apply throughout the securities industry,”
he said.
Tyrrell noted that firms can have different kinds
of accounts that are opened as all sorts of entities
that, based on where they were incorporated, may or
may not provide sufficient verification of the
beneficial owner.
The provision would expand the current
definition of beneficial owner and require the
financial institution to try to drill down and verify
the status of the named beneficial owner. Currently,
the requirement to identify the beneficial owner is
applied in limited circumstances and a beneficial
owner is described, in essence, as an individual who
has the power to control and manage the account,
either directly or indirectly.
That definition would continue to apply in those
limited circumstances when it is used now. But for
other instances, FinCEN is considering expanding
the definition and changing the requirement so that
institutions get beneficial ownership information
about all customers.
The expanded definition would apply to legal
entities that are customers. For those entities, a
beneficial owner would include:
1) Either: a) each individual who directly or
indirectly owns more than 25% of the equity
interests in the entity; or b) if no individual meets
that standard, then the individual who has at least as
great an equity interest in the entity as anybody else;
and
2) The individual with more responsibility than
anyone else for managing the affairs of the entity.
“FinCEN anticipates that such a specific and
limited definition of beneficial ownership may be
necessary to accommodate the vast array of complex
ownership structures of legal entities,” the agency
said.
Explaining the difficulty firms could face
identifying beneficial owners under that definition,
Tyrrell said, “Some states don’t require that someone
disclose the beneficial ownership of the company,
which makes it difficult to verify, if that is what the
requirement will be to do.”
The notice seeks comment on different aspects
of the proposal. Tyrrell says industry should weigh in
on the expanded beneficial ownership requirement,
from a standpoint of practicality and from a business
standpoint.
If new requirements are imposed, they should
continue to be applied through a risk-based
approach and not be applied in an across-the board
manner, Tyrrell said.
(Customer due diligence, continued on page 3)
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March 12, 2012
Customer due diligence (cont. from pg. 2)
Jeff Ziesman
Ziesman, counsel in the Kansas City office of
Br
yan Ca
ve , sees the beneficial ownership provision
Bry
Cav
as inherently risk-based the way it is now. But he
expressed concern about another provision: one that
calls for ongoing customer due diligence.
“It’s not just customer due diligence at the outset.
It’s some type of ongoing monitoring,” he said.
The notice says financial institutions should
update their customer due diligence information as
needed based on the overall risk of the customer.
Changes might be needed to the information
collected to deal with changes in a customer’s risk
profile such as more red flags in the account, or
changes in the account’s purpose, for instance,
FinCEN says.
As for the proposed beneficial owner changes,
Ziesman said, “I think that there’s a rule of reason in
these rules as there are in most broker-dealer
obligations, and I think that what the regulators,
including FINRA and FinCEN, are going to be
looking for, are reasonable steps that broker-dealers
take to verify beneficial ownership, consistent with
what’s set forth in this notice, if it becomes the law.
So, you have to take reasonable steps, make a
reasonable inquiry and then document what you find
from that reasonable inquiry.”
Other major provisions call for continuing to
follow the current requirements of:
✔ verifying the identity of each customer to the
extent reasonable; and
✔ understanding the purpose and nature of each
account.
Both Ziesman and Tyrrell said they expect the
proposal to advance in some form. Both said the
beneficial ownership provision is among the sections
more likely to see some change. And Ziesman said
the continuing customer due diligence provision is
another one that many in the industry might want
changed.
FinCEN wants an explicit customer due diligence
requirement across financial institutions because of
the inconsistency it sees across such institutions now.
In addition, a broadly applied rule could make
examinations easier, and help fight transnational,
illicit finance, it said.„
Actions to consider to avoid the tag of
‘supervisor’ and a failure charge
Whether it’s a myth or not that compliance
officers are at greater risk of facing a failure-tosupervise charge, there are steps you can take to
lessen the chance you may be labeled as a supervisor
in the first place.
For example, in your policies, name the person
within the business unit who must sign off on the
policy and would be expected to react to violations
“so it’s clear from the outset that the compliance
officer” isn’t the supervisor, recommended James
Ander
son
Anderson
son, a partner with WilmerHale in
Washington. He spoke March 8 at an industry
conference in Washington.
“It is a myth” that a CCO acting in her capacity
istine
would trigger the title of supervisor, said Chr
Christine
Car
sman
Carsman
sman, senior VP/deputy GC with Af
Afffiliated
Mana
ger
oup in Boston. The myth has only
Manag
erss Gr
Group
grown in the aftermath of the SEC’s dismissal of the
Ted Urban case. Still, she added, “we can’t do that
job everyday if we’re worried ... about our liability.”
The Urban dismissal exorcises the ALJ decision
that termed him a supervisor, meaning the case is
nothing more than “fodder for conferences like this
one,” said Rober
Robertt Plaze
Plaze, deputy director of the SEC’
SEC’ss
Division of Investment Management. But he
acknowledged the industry would benefit if it were
more clear as to when a compliance officer becomes
a supervisor.
Commissioner Daniel Gallagher addressed the
topic again for the second time in two weeks (BD
Week, March 5, 2012), stating “I hope we can find a
way to provide more clarity on this issue soon.”
No bright line in current standard
The existing standard could lead to a failure-tosupervise charge against a compliance officer who
demonstrates the ability to influence the behavior of
another staffer or who takes part in management’s
solution to a certain issue, said Anderson. “The ability
to influence conduct is not a very bright line,” he
added.
If you participate with management toward a
solution of an issue, make it clear to senior leaders
that they must state what is expected of you “so you
(Supervisor Tag, continued on page 4)
March 12, 2012
3
Supervisor tag (cont. from pg. 3)
know what it is that you have to do” and then
complete the task, advised Anderson.
If you sit on committees, confine your role to
keeping minutes and providing compliance advice
but don’t vote, he continued. Urban had voted on a
committee that oversaw a troubled rep and the ALJ
cited this as support for the label of supervisor.
Mar
y K
eef
e , managing director/director of
Mary
Keef
eefe
een Asset Mana
gement ($100B in
compliance, Nuv
Nuveen
Manag
AUM) in Chicago, recommended compliance officers
reduce their risks by following up on red flags,
getting business to monitor staff with compliance
playing the role of overseeing business’s efforts and
integrating business into your reviews of compliance
policies and procedures.
In past cases where CCOs were caught up in
enforcement actions they usually involved
compliance personnel who simply didn’t do their job
or actually covered up or concealed fraud, e.g., by
withholding documents in an SEC exam, said Plaze.
Commission and exemptive authority
Gallagher’s address also included his view that
the Commission should use its exemptive authority to
“temper the effect” of Dodd-Frank and suggested it
could be used to offer regulatory relief to newly
registering private funds.
Later, Plaze responded that it’s not likely
Commission staff would offer “broad exemptive relief
at this time,” attempting to quash any hopes that
private equity or hedge fund advisers might be able
to avoid registration by seeking an exemption.„
Arbitration (cont. from pg. 1)
Davis
Davis, failed to prove by a preponderance of the
evidence any of her allegations against the firm, the
tis Sathr
e, III or registered rep
firm’s president, Cur
Curtis
Sathre,
John Ev
an Sc
hooler
Evan
Schooler
hooler. The allegations included
unsuitable recommendations, breach of fiduciary
duty, breach of contract, failure to supervise, and
violation of the California Corporations Code.
The firm withdrew from FINRA registration last
May.
The panel determined that, under California law,
the statute of limitations for the alleged violations ran
out in April 2009, but Davis filed her claim in
February 2010. The panel also found that it is “highly
likely” that Davis sought double recovery because
she filed claims in additional forums in violation of
FINRA Rule 12209. These forums consisted of the
Amer
ican Arbitr
ation Association and JAMS
American
Arbitration
Arbitr
ation, Mediation and ADR Ser
vices
Arbitration,
Services
vices, and filing
a court case against sponsors of several of her
investments, according to the March 1 award issued
by FINRA Dispute Resolution. Some of the claims
have settled and others are pending, the panel said.
Davis also alleged that Schooler told her orally
that her investment in a security called Castle Pines
was a safe one, even though the panel said she
offered no proof to back that up. But she also
testified that she read the private placement memo
for that security, which the memo described as
highly risky, according to the panel.
The panel said that even if Schooler told Davis
that investment was safe, that wouldn’t be enough to
bring a claim against him, given that she read a clear
warning in the PPM.
Br
andon Reif
Brandon
Reif, the attorney for the firm, said, “It
is highly unusual for a FINRA panel to shift the costs
of the case to the claimant. There is often a
compelling reason for it. In this case, the Panel
recognized that the claimant attempted to seek
double recovery at great expense to the respondents
by pursuing recourse outside of the FINRA forum
and not giving credit for these recoveries.”„
Red Flags (cont. from pg. 1)
As it turns out, that rep, Maxwell Baldwin Smith
Smith,
had been selling fake investments to some of his
brokerage clients and placing the money in his
personal brokerage account, FINRA said in a Feb. 22
settlement with Cantone and CRI.
For failing to act on red flags that might have
detected Smith’s wrongdoing, FINRA jointly fined
Cantone and CRI $10,000 and suspended Cantone
from serving in a supervisory capacity for three
months. The regulator also fined CRI $15,000 for
failing to maintain adequate written supervisory
procedures for monitoring reps’ outside brokerage
accounts. In addition, Cantone and CRI must jointly
pay partial restitution of $200,000 to customers
who were harmed, FINRA said.
Cantone is the wife of the firm’s president,
Anthon
y Cantone
Anthony
Cantone. She’s also the firm’s vice
(Red Flags, continued on page 5)
4
March 12, 2012
Red Flags (cont. from pg. 4)
president and FINOP.
As a result of the shortcomings, Smith was able
to misappropriate more than $1.6 million of CRI
customers’ funds, FINRA said.
“Throughout the time period of Smith’s
association with CRI, Cantone was aware of certain
‘red flags’ that should have alerted her to his
misconduct,” FINRA said. “For example, she simply
accepted Smith’s unverified representations about
the large dollar deposits and withdrawals in one of
his accounts at another member firm.”
Under the scheme, Smith had customers
withdraw money from their brokerage accounts and
write personal checks for him to deposit in a Merrill
Lynch account that they thought would be used for
the investment.
Among FINRA’S findings at CRI:
✔ The firm had general procedures requiring the
disclosure of outside brokerage accounts, a
requirement that it get duplicate statements for
those accounts, and procedures requiring that reps
be questioned about suspect transactions in those
accounts. But the WSPs lacked specific requirements
regarding reasonable follow-up or review of suspect
transactions — such as requesting documentation on
questionable transactions, comparing deposit activity
in outside accounts to withdrawal activity in
customer accounts, or speaking with customers.
✔ When Smith joined CRI, Cantone asked him to
transfer his account to CRI but Smith objected, citing
several reasons including that he needed to pay
certain bills from that account. Cantone allowed him
to keep that outside account. But Cantone reviewed
the statements from that account, and noticed that
most of the withdrawals were checks written to
Smith, or to cash, as opposed to going to pay bills.
✔ Cantone told Smith she was concerned about
the aggregate amount of funds going into Smith’s
account. Example: In November 2005, Cantone
noticed that the account received $925,000 over the
course of the year, and asked Smith about it. But she
accepted Smith’s explanation about the money
coming from his real estate business and his wife’s
boutique business.
✔ Many of the amounts deposited in Smith’s
account corresponded to withdrawal amounts from
his customers’ accounts at CRI made shortly before
the deposits. But Cantone didn’t make the
connection.
Walter Baumgar
dner
Baumgardner
dner, the lawyer for Cantone
and CRI, said, “I think they were just victims of
circumstances in this case. There certainly wasn’t any
intent to violate any rules. If this guy hadn’t been
such a great con man, he probably would have been
caught a long time ago.”
The problem was detected when a CRI
customer’s attorney who was doing estate planning
asked firm management about an investment Smith
had sold the customer, and the Cantones told him
they didn’t know what he was talking about,
Baumgardner said. Smith was in the hospital at the
time, and when he got out he admitted that it was a
scam, Baumgardner added.
He noted that Smith carried out his fraud even
when working at previous firms, but CRI was Smith’s
place of employment when his wrongdoing came to
light. Smith worked at CRI from Jan. 7, 2005 to April
3, 2009. But he started victimizing investors as early
as 1992, even though most of the seven victims were
customers of Smith at CMI, the settlement says.
In November 2009, Smith pleaded guilty to
criminal charges, including first-degree money
laundering and mail fraud, arising from the scheme.
He is awaiting sentencing. FINRA barred Smith in
February 2010 under a settlement in which he
neither admitted nor denied the scheme.
Under the scheme, Smith convinced individuals to
invest in a product he called “Health Care Financial
Partnership Direct Loans” (HCF) that really didn’t
exist, FINRA said. He convinced customers to
withdraw money from their brokerage accounts and
use personal checks to buy HCF. stock. Smith
instructed them to make the checks payable to
Merrill Lynch, and to put a certain account number
on the check. The customers didn’t know that the
number was for Smith’s account, FINRA said.
After the money went into Smith’s brokerage
account, which he shared with his wife, he would
then transfer the funds to a personal bank account
by writing large checks payable to himself or cash.
Merrill Lynch cited for letting Smith abuse account
In a related matter, FINRA fined Merrill Lynch
(Red Flags, continued on page 6)
March 12, 2012
5
Red Flags (cont. from pg. 5)
$400,000 last year because it failed to enforce its
anti-money laundering procedures in connection
with Smith’s activities, thereby allowing him to use
his account in this way, according to a June 8, 2011
settlement with FINRA.
The settlement says that from 1992 to at least
March 2009, Smith moved more than $9 million of
misappropriated funds through his Merrill Lynch
cash management brokerage account. One of the
customers, a man over 90 years old, accounted for at
least $8.6 million of those funds.
Merrill Lynch failed to follow its procedures to
require third-party checks submitted for deposit to
explicitly state who owned the account, FINRA said.
unsolicited basis, instructed the firm to route its
order to a particular market, says Amy Lynch,
president of FrontLine Compliance LLC
LLC, a
regulatory compliance consulting firm based in
Leesburg, Va. and New York. Supplementary Material
.08 says that in those instances, you’re not required
to make a best execution determination beyond the
customer instruction.
Among some of other the areas addressed, make
sure you have WSPs for:
✔ Instances when there’s limited quotation or
pricing information, and
✔ How you will achieve the most favorable
terms available for your client when dealing with
markets in foreign jurisdictions. „
The firmed lacked internal controls to ensure
compliance with its deposit acceptance procedures
for third-party checks.
In addition, the firm disregarded certain
indications of Smith’s misconduct, such as him
depositing large amounts of money into, and moving
large amounts out of, an account that had no market
investment activity, and doing so through large
checks written to cash or to himself, FINRA said.
Group Publisher
Hugh Kennedy
Ex
ecutiv
e Editor Vincent Taylor
Executiv
ecutive
Contr
ibuting Editor
Contributing
Carl Ayers
The only respondent in that settlement is the
firm.
BD Week strives to provide you with accurate, fair and balanced
information. If for any reason you believe we are not meeting
enned
y at 301this standard, please let us know. Contact Hugh K
Kenned
ennedy
287-2213 or [email protected]
“Nobody in their compliance department was
sanctioned for failure to obey the money laundering
act requirements,” Baumgardner said.„
Our Addr
ess:
Address:
Enhanced guidance for best execution
rule can be used to beef up your WSPs
With some tweaks to FINRA
FINRA’’s best execution
rule taking effect May 31, you might want to review
your written policies and procedures in this area to
make sure your bases are covered (Regulatory
Notice 12-13 .)
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Some of the Supplementary Material to Rule
5310 has been altered, placing an emphasis on
written supervisory procedures in this space.
One of the bright lights is more clarity that
addresses situations where the customer has, on an
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March 12, 2012