['Excessive Trading' Image by Robt Neubecker / New York Times]

by Howard Haykin

A broker, formerly with E.J. Sterling, LLC, agreed to pay a $15K fine, pay >$55K in restitution to customers, and serve a 12-month suspension to settle FINRA charges that he engaged in quantitatively unsuitable trading in the accounts of customers.

Quantitative suitability … requires a member or associated person who has actual or de facto control over a customer account to have a reasonable basis for believing that a series of recommended transactions, even if suitable when viewed in isolation, are not excessive and unsuitable for the customer when taken together in light of the customer's investment profile, as delineated in Rule 2111(a).

No single test defines excessive activity, but factors such as the turnover rate, the cost-to-equity ratio, and the use of in-and-out trading in a customer's account may provide a basis for a finding that a member or associated person has violated the quantitative suitability obligation.

FINRA FINDINGS.    Between January 2014 and February 2015 (the "Relevant Period") – essentially all of time this broker spent with E.J. Sterling – he engaged in quantitatively unsuitable trading in the accounts of 3 customers. He did so by recommending the trading in the customers' accounts – recommendations the customers followed. Accordingly, this broker had de facto control over the customers' accounts.

The trading resulted in annualized turnover rates of 45 (for customer HP), 18 (for customer KP), and 33 (for customer NK), and annualized cost-to-equity ratios of 145%, 48%, and 108%, respectively. During this period, the 3 accounts sustained collective net losses in excess of $55,000 (after accounting for certain factors, including partial restitution provided to the customers by the Firm.

FINANCIALISH TAKE AWAYS.    As we have asked so many times in the past, we now question the whereabouts of E.J. Sterling’s supervisory personnel throughout the relevant period. While FINRA does not provide an answer in the AWC Letter for the subject broker, the regulator provides an relevant information in the CRD files for the broker-dealer.

In April 2018, Allied Millennial Partners, the successor firm to E.J. Sterling, was censured by FINRA and ordered to pay partial restitution to affected customers in the total amount of $35,000, plus interest, (with no imposed fine) in response to FINRA charges that the firm failed to establish, maintain and enforce a supervisory system and WSPs reasonably designed to identity and prevent unsuitable excessive trading in customer accounts.

In its findings, FINRA stated [in relevant part] that, according to the firm’s CCO, in order to detect potentially unsuitable excessive trading, he reviewed a monthly exception report provided to the firm by its clearing firm. The CCO testified that if he noticed potential excessive trading, he would sometimes send an “activity letter” to the customer advising the customer of the level of trading in his or her account. However, the CCO could not articulate when and under what circumstances he would send an activity letter, and the firm had no procedures or other guidance addressing this issue.

FINRA further noted that the SEC specifically cited the firm in December 2013 for failing to have adequate written procedures addressing the firm’s supervision of actively traded accounts. Despite that citation, the firm did not add any such written procedures until April 2016, more than 2 years later. At least in part as a result of these supervisory failures, the firm failed to detect excessive trading in certain customer accounts.

This case was reported in FINRA Disciplinary Actions for October 2018.

For details on this case, go to ...  FINRA Disciplinary Actions Online, and refer to Case #2016050114701.