The Financial Industry Regulatory Authority reminded members and their employees through a disciplinary action that natural person registrants must advise their employers in advance of all proposed outside business activities not within the ordinary scope of their employment – including when such businesses activities may involve cryptoassets. Likewise FINRA, through another disciplinary action, reminded all financial services registrants of the importance of having up-to-date policies and procedures that reflect actual firm practices and not pie-in-the-sky aspirations or generic instructions. As a result, the following matters are covered in this week’s edition of Bridging the Week:
According to FINRA, in December 2017, Mr. Kim established a company to engage in virtual currency mining activities, engaged a third party to build and operate computer hardware and software for his company, and paid the third party for its services. Mr. Kim was subsequently terminated by Merrill Lynch in March 2018 for “fail[ing] to disclose an outside business activity.”
There was no allegation in FINRA’s Letter of Waiver, Acceptance and Consent publicizing its enforcement action against Mr. Kim that the respondent’s company actually engaged in any virtual currency mining activity.
Compliance Weeds: Under FINRA rules, no registered person may be directly or indirectly employed in any other capacity in a business activity outside the scope of his or her relationship with his or her member firm unless he or she has given prior written notice to the member. (See FINRA Rule 3270.) Additionally, a person associated with a member must provide advance written notice to his or her employer if he or she engages in a securities transaction outside the ordinary course or scope of his or her employment, including transactions involving a new offering of securities which are not registered with the Securities and Exchange Commission, subject to various exceptions and conditions. (Click here to access FINRA Rule 3280.)
In April 2018, Arthur Meunier a/k/a Arthur Breitman agreed to be suspended for two years from association with any FINRA-regulated broker-dealer to settle FINRA charges that, from February 2014 to April 2016, he participated in the development of Tezos, a blockchain technology project, without notifying the broker-dealer he was then employed by that he was engaging in such activity, as required by FINRA rules. (Click here for background in the sub-article “FINRA Fines a Tezos Co-Founder” in the April 22, 2o18 edition of Bridging the Week.)
Subsequently, in September 2018, FINRA brought a disciplinary proceeding against Timothy Ayre for soliciting investors to purchase shares in a worthless company he owned and served as president of – Rocky Mountain Ayre, Inc. (“RMTN”) – by making material misstatements in public filings, and by unlawfully offering to the public digital assets – HempCoins – that he claimed were backed by RMTN common stock. FINRA charged that the sale of HempCoins was unlawful as they were unregistered securities that were not eligible for any exemption. FINRA also claimed that Mr. Ayre engaged in private securities transactions involving RMTN while employed by a broker-dealer without disclosing such transactions to his employer, also in violation of the firm’s written supervisory procedures. (Click here for background in the article “SEC and FINRA File Three Unrelated Enforcement Actions Charging Digital Assets-Related Securities Law Violations” in the September 16, 2018 edition of Bridging the Week.) Mr. Ayre recently agreed to be barred in all capacities from the securities industry to settle all his FINRA charges. (Click here to access Mr. Ayre’s “Order Accepting Offer of Settlement.”)
This latest FINRA action against Mr. Kim, coupled with FINRA’s prior actions against Mr. Breitman and Mr. Ayre, serves as an implicit warning to FINRA-member firms that they should double-check that their written supervisory procedures track applicable FINRA rules regarding outside business activities by their registrants and private securities transactions by their APs. Moreover, registered entities should remind their employees and agents that these requirements apply to transactions involving security tokens as well as to business activities involving all digital assets, in addition to traditional securities transactions and business activities. Natural person registrants and APs of broker-dealers should also be mindful of their obligations under their employers’ applicable policies and procedures as well as under relevant FINRA rules.
During the relevant time, SEI’s AML procedures required the firm to monitor customer account activity for unusual volume, size, and pattern or type of transactions, taking into consideration risk factors and red flags particular to the firm’s business. Among the “dozens” of red flags enumerated in the firm’s procedures were several relating to the deposit of physical stock certificates involving penny stocks, including a customer engaging in a pattern of depositing stock in physical form, selling the position, and rapidly wiring out proceeds. The procedures further required SEI’s chief AML compliance officer to evaluate and investigate all suspicious activity, including activity regarding penny stock deposits.
However, according to FINRA, during the relevant time, no person at SEI followed these procedures to assess potentially suspicious activity. The task was formally delegated to the firm’s outside counsel whom no one at SEI supervised. Moreover, when the counsel occasionally reported a suspicious activity to management, no one at the firm followed up or considered when a suspicious activity report might have to be filed with the Financial Crimes Enforcement Network of the US Department of Treasury. As a result, charged FINRA, SEI violated its rule requiring members to put in place and maintain a written AML program reasonably designed to comply with applicable law. (Click here to access FINRA Rule 3310.)
This failure led to the firm not identifying or investigating the deposit by SEI’s customers of “billions” of shares of companies with little or no business that were “routinely” liquidated within days of deposit followed by the customers’ rapid withdrawal of proceeds.
FINRA also charged SEI with charging customers excessive commissions in violation of another of its rules (click here to access FINRA Rule 2121), as well as falsifying certain documents provided to its clearing firm.
Compliance Weeds: Policies and procedures of financial service company registrants should serve two essential functions: (1) communicate the firm’s processes to comply with applicable law and (2) lay out a road map of operations, risk management and compliance that help a company perform its daily tasks and to provide the bedrock of a strong compliance culture. Written supervisory procedures should supplement ordinary policies and procedures by setting forth how the company takes reasonable measures to help ensure that its policies and procedures, as well as applicable law, are ordinarily followed.
All policies and procedures, including WSPs, must be tailored to the specific business of a company and should be regularly reviewed and amended to reflect new or changed businesses, new or changed laws and actual practices. Generic or outdated policies and procedures and policies can be less than helpful on a day-to-day basis, and downright problematic when a regulator compares them to actual conduct when something goes wrong.
Separately, Markus Groebner, a nonmember, was assessed a fine of US $50,000 and suspended from becoming a member or accessing any CME Group exchange for trading for three years for entering orders on multiple occasions during pre-open trading periods that were not entered to achieve bona fide transactions.
For further information:
Broker-Dealer AML Manual Promised a Lot, Actual Practices Delivered Too Little Says FINRA in Enforcement Settlement:
CME Member Sanctioned for Orchestrating Wash Trades and Misallocating Trades to Avoid Margin Requirements:
Ex-FINRA Member Employee Sanctioned for Not Disclosing Personal Cryptocurrency Business Activities to Employer:
Happiness for All Not Likely From CFTC Revised Position Limits Proposal Warns Commissioner Stump:
NFA Announces September 30 Effective Date for New Supervisory Requirements for Members’ Swap Activities:
Thunder and Lightning at the CFTC – Commissioner Behnam Leads Discussion of Climate Related Financial Market Risk:
The information in this article is for informational purposes only and is derived from sources believed to be reliable as of June 15, 2019. No representation or warranty is made regarding the accuracy of any statement or information in this article. Also, the information in this article is not intended as a substitute for legal counsel, and is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. The impact of the law for any particular situation depends on a variety of factors; therefore, readers of this article should not act upon any information in the article without seeking professional legal counsel. Katten Muchin Rosenman LLP may represent one or more entities mentioned in this article. Quotations attributable to speeches are from published remarks and may not reflect statements actually made. Views of the author may not necessarily reflect views of Katten Muchin or any of its partners or employees.
Gary DeWaal is currently Special Counsel with Katten Muchin Rosenman LLP in its New York office focusing on financial services regulatory matters. He provides advisory services and assists with investigations and litigation.
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Bridging the Week by Gary DeWaal: June 10 – 14, and June 17, 2019 (Outside Business Activities; Policies and Procedures)Jump to: AML and Bribery Bitcoin Ecosystem Bridging the Week Cleared Swaps Compliance Weeds Policy and Politics Position Limits Supervision Trade Practices (including Disruptive Trading) Uncleared Swaps