C.L. King & Associates, an Albany, NY-based broker-dealer, was fined $750,000 for negligently making material misrepresentations and omissions to issuers in connection with the firm’s redemptions of debt securities on behalf of a hedge fund customer.

In addition, the firm and AML Compliance Officer Gregg Miller (AMLCO) were sanctioned for having failed to adequately respond to red flags related to the liquidation of billions of shares of penny stocks indicative of potentially suspicious activity by 2 customers. Miller was fined $20K and suspended 6 months in a principal capacity. Respondents are also ordered to pay around $21K in hearing costs.

The sanctions were issued under an Extended Hearing Panel Decision. That decision becomes final after 45 days unless it is appealed to FINRA's National Adjudicatory Council (NAC) or is called for review by the NAC.

BACKGROUNDS.   

C.L. KING & ASSOCIATES.    C.L. King, a FINRA member since May 1972, is headquartered in Albany, NY, with branch offices in NYC and Boston. It provides investment research, equity and fixed income trading, corporate finance, prime brokerage, and clearing services to institutional clients and other broker-dealers. During this case, the Firm had between 70 and 105 registered persons.

In 2007, to diversify its business and bring new clients to the Firm, C.L. King formed the NYC-based Prime Services Department and it hired Jeffrey Maier as SVP to manage the new department. It was Maier’s job to bring new clients to the Firm, including institutional clients, investment firms, investment advisers, introducing broker-dealers, and hedge funds. Maier introduced about 7 new customers to C.L. King, including the 3 customers involved in this action - Lathen (and Eden Arc), PL Bank, and ABC Corp. Although Maier described his duties as a “relationship manager,” he was also the account executive on each of the new accounts he brought to the Firm, including all of the joint accounts that Lathen opened with Participants.

Once it became operational, the Prime Services Department accounted for less than 10% of the Firm’s total business. C.L. King closed the Prime Services Department in late 2013.

GREGG MILLER.    Miller first became registered with FINRA through C.L. King as a General Securities Representative in February 2001. Since joining C.L. King, Miller has been registered as a General Securities Principal, Registered Options Principal, Equity Trader Limited Representative, Municipal Securities Principal, and Research Principal. At all times relevant to this matter, he was the firm’s AMLCO and Compliance Manager. Since 2/1/15, he’s been C.L. King’s Chief Compliance Officer (CCO).

FINDINGS BY FINRA EXTENDED HEARING PANEL.    FINRA Enforcement filed a 4-cause Complaint against C.L. King and the AMLCO. The first 2 causes of action relate to the Firm’s negligent misrepresentations and omissions in connection with its debt securities business. The last 2 causes relate to the Firm’s AML obligations in connection with its penny stock business.

• Cause one charges … C.L. King with negligently making material misrepresentations and omissions to issuers of survivor bonds.
• Cause two charges … C.L. King with failing to establish and maintain a reasonable supervisory system, including written supervisory procedures, to address its handling of redemptions of the survivor bonds by Lathen and Eden Arc after the death of a Participant.

This case stems from misstatements and omissions that the Firm made to issuers of debt securities when the Firm took on the business of one of its new customers, Donald “Jay” Lathen. Lathen and his hedge fund, Eden Arc Capital Management (“Eden Arc”), pursued an investment strategy in which they recruited terminally ill persons (“Participants”) to open brokerage accounts with Lathen as joint tenants with rights of survivorship. The hedge fund paid terminally ill persons $10,000 to agree to open a joint account with the manager of the fund.

Eden Arc then used the joint accounts to purchase at a discount corporate debt securities that contained a survivor option, or death put (“survivor bonds”). The death put feature allowed Lathen, as the account’s survivor, to redeem - through C.L. King - the investments for the full principal amount before maturity upon the death of a Participant. Enforcement alleges that C.L. King had an obligation to disclose to issuers during the redemption process that terminally ill Participants were not in fact beneficial owners of the survivor bonds because Eden Arc required them to sign side agreements in which they gave up their ownership rights to the assets held in the accounts with Lathen.

• Cause three charges … C.L. King and Miller with failing to develop and implement an AML program reasonably designed to detect, investigate, and report potentially suspicious activity, as required by the Bank Secrecy Act. Specifically, the Respondents failed to: (i) tailor the Firm’s AML program to the risks presented by the penny stock liquidation business of the two customers, and; (ii) detect and investigate red flags indicative of potentially suspicious activity.
• Cause four charges … C.L. King and Miller with failing to conduct adequate due diligence and respond to red flags regarding the trading activities of PL Bank, a foreign financial institution, as required by the Bank Secrecy Act.

Here, C.L. King sold penny stocks on behalf of 2 two customers. From 2009 to 2014, the 2 customers generated proceeds of $19 million by selling billions of shares in penny stocks. A bank based in the Principality of Liechtenstein (“PL Bank”) sold 41 million shares of 40 penny stocks generating proceeds of $5 million. From 2012 to 2013, another client (“ABC Corp.”) sold more than 11 billion shares in 138 penny stocks, generating proceeds of more than $14 million. C.L. King and Miller, as its AMLCO, had a duty to ensure that its AML program addressed the risks presented by its penny stock business. Specifically, Respondents ignored red flags that included, the following:

►  the issuers whose stock the customers sold generated little or no revenue and they had little history of doing business.
►  the stocks were often the subject of promotional activity on the Internet around the time the customers sold their shares. In some cases, promoters were paid for touting the stocks. The promotional activity was a red flag suggesting the possible existence of a pump-and-dump scheme.
►  the 2 customers sometimes sold a large percentage of an issuer’s outstanding shares.

FINANCIALISH TAKE AWAYS.    Gregg Miller is, no doubt, a very capable individual- why else would C.L. King have promoted him to Chief Compliance Officer in 2015. That said, he and the firm missed some suspicious activity emanating from a relatively new, stand-alone department that was based in New York and away from the firm's Albany, NY,  headquarters.

Some reasons for "failure to supervise:"

• the remote location of a branch office;
• acquiescence by compliance personnel to pushback from a senior executive;
• reluctance on the firm's part to restrict - i.e., "clip the wings" - the activities of a (hopefully) profitable new business line; 
• complicity by firm personnel in a scheme or activity;
• inexperience on the part of compliance personnel; 
• human error or oversight.

Whatever the reason in this case, Mr. Miller failed to pick up on the AML risks associated with large penny stock transactions. Which offers the following lesson:

It's never enough to detect suspicious activities. Once detected, potential risks must be identified and investigated, and, if necessary, corrective action must be taken. And of course, the entire process should be memorialized in writing and retained in firm records.