by Howard Haykin

WHAT WENT WRONG, LEADING TO 'WILLFUL' VIOLATIONS.    The individual in this case served as Chief Compliance Officer (“CCO”) for Southridge Investment Group during the Relevant Period of this case, from July 2009 to August 2011. Southridge had approximately 50 registered reps during the Relevant Period in at least 3 branch offices; the firm’s home office was in Ridgefield, CT. 

According to a 2013 complaint filed by FINRA Enforcement, a routine examination of Southridge disclosed that, among other things, the CCO had:

• failed to establish and maintain a reasonable supervisory system for the review of electronic correspondence, in violation of NASD Rule 3010(a) and (d) and FINRA Rule 2010, and in willful violation of MSRB Rules G-27(b) and (e) and G-17; and,
• failed to adequately review electronic correspondence, in violation of NASD Rule 3010(b) and FINRA Rule 2010, and in willful violation of MSRB Rules G-27(a) and (c) and G-17.

NOTE:  MSRB rules are applicable because this case involves municipal securities subject to MSRB regulation. FINRA's By-Laws provide that member firms and their associated persons agree to comply with MSRB Rules, and that FINRA is authorized to impose sanctions for violations of MSRB Rules.

Southridge used a vendor, Smarsh, Inc., to archive its electronic communications (“E-Comm”) and provide a platform for reviewing them. The firm’s E-Comm consisted of: (i) firm emails; (ii) Bloomberg messages; and, (iii) Bloomberg chats. Bloomberg communications accounted for 85% or more of all of the email that the CCO was obligated to review.

The review procedures were governed by the firm’s written supervisory procedures (“WSPs”) – prepared in 2008 (before the CCO arrived at Southridge) and revised in 2010. Both WSPs were considered deficient because they each failed to specify a method or frequency of review, the size of the review sample, or how the CCO should document his reviews.

• Responsibility for the Supervisory System.    The CCO was responsible for … maintaining Southridge’s supervisory systems, including its WSPs. And because he was aware of the deficiencies, yet knowingly took no action to correct or address those deficiencies, the CCO was charged with violating NASD and FINRA rules, and with willfully violating MSRB rules. [A violation is deemed willful if “the person charged with the duty knows what he is doing" – i.e., “voluntarily committed the acts that constituted the violation.”]

• Responsibility for Reviewing E-Comm.    The CCO was also responsible for … reviewing Southridge’s E-Comm, which he failed to adequately perform. He admitted that he never reviewed any Bloomberg communications during the relevant period (again, that accounted for at least 85% of firm’s E-Comm), and his reviews of the remaining 15% of Southridge’s E-Comm were done sporadically. From July 2009 through September 2011, the CCO conducted just 36 email reviews – as documented in Smarsh Reports This conduct violated FINRA Rule 2010 and, because his actions were voluntary, his violation of MSRB Rule G-27 was willful.

DISQUALIFYING EVENTS.    Under Section 3(a)(39) of the Exchange Act, a person who willfully violates MSRB rules is subject to a statutory disqualification from the securities industry. A willful violation of the securities laws means ‘“that the person charged with the duty knows what he is doing.’” Such a finding does not require that the respondent “also be aware that he is violating one of the Rules or Acts”; it simply requires the voluntary commission of the acts themselves. Here, [the individual] acted voluntarily in failing to establish reasonable written supervisory procedures and in failing to reasonably review electronic correspondence. The SEC found, and [the individual] did not contest on appeal, that his violation of MSRB Rule G-27 was willful and subjects him to statutory disqualification. [Willful violation of MSRB rules results in statutory disqualification.]

FINANCIALISH TAKE AWAYS.    Statutory disqualification is an unimaginable fate for any dedicated Chief Compliance Officer, yet it's a real possibility, as we've evidenced here. Additionally, there's tremendous risks of significant fines and legal expenses (attorneys fees and costs of hearings). The CCO in this case incurred $40,000 in fines and thousands in legal expenses. The penalties are scary enough for every compliance officer to question whether he or she might be committing some fundamental mistake(s) that could lead to the same fate as the CCO in this case.

[For further information on Statutory Disqualifications, click on General Information on FINRA’s Eligibility Requirements and see the “Disqualification Defined” section.]

This case was reported in FINRA Disciplinary Actions for February 2019.

For further details, go to ...  FINRA Disciplinary Actions Online, and refer to Case #2010025087302.