by Howard Haykin

Capitol Securities Management, a Glen Allen, VA-based broker-dealer, agreed to pay $145K in fines and restitution to settle FINRA charges that it failed to prevent or detect and address unsuitable short-term trading in unit investment trusts (“UITs”). The firm also failed to retain instant messages (“IMs”) from employees, including its senior management and compliance staff.

SHORT-TERM SALES AND SWITCHING OF UITS.    From March 2011 to March 2017 (the "Relevant Period"), at least 3 Capitol registered reps (“RRs”) recommended and effected short-term trades of UITs in their customers' accounts. Even though most of the recommended UITs had 2-year maturity dates and carried sales charges ranging from 1.95% to 3.95%, these RRs repeatedly had customers sell their UIT positions within one year of purchase. In some instances, proceeds from these UIT sales were used to purchase other UITs with identical investment objectives. As a result of the short-term trading and switching of UITs, customers paid excess sales charges totaling $44,740.33.

A UIT is a SEC-registered investment company … that offers shares or "units" in a portfolio of securities in a public offering. Generally, a UIT's portfolio is not actively traded and follows a "buy-and-hold" strategy. UITs terminate on a specified maturity date, often after 15 or 24 months, at which point the underlying securities are sold and the proceeds are paid to investors.

FINRA Rule 3110 and its predecessor, NASD Rule 3010, … require that each member establish and maintain a system, and establish, maintain and enforce WSPs, to supervise the activities of each RR, registered principal, and other associated person that is reasonably designed to achieve compliance with applicable securities laws and regulations, and with applicable NASD and FINRA Rules.

FAILURE TO RETAIN INSTANT MESSAGES.    During the Relevant Period, Capitol utilized an instant messaging system called "Message Pal" for internal communications at its Glen Allen headquarters. Some 41 associated persons used Message Pal for business-related communications with co-workers, including the Firm's CCO, 4 other registered principals, and other senior executives. These IMs were not retained – in violation of FINRA Rule 4511 (Books and Records).

FINANCIALISH TAKE AWAYS.    In the AWC Letter, FINRA prominently noted that Capital Securities Management had recently paid $700,000 in fines and disgorgement/restitutions to settle FINRA charges that it had failed to supervise the sale of reverse convertible notes – a Relevant Disciplinary History. This commentary prompts me to ask the following questions:

• Why did the firm – and, in particular its CCO - not address similar and subsequent abusive sales practices (i.e., UIT short-term trading) until 2017, when FINRA presumably discovered it?
• Why did the CCO and other supervisory personnel not elevate the firm’s supervisory policies and procedures once a problem had been flagged by FINRA ?
• And, if we were to accept these statements or questions as fact, why for example has Capitol’s CCO - who's served in that position since 2012 - not been cited for his or her role in these violations?

►   Nor was the CCO cited for the firm’s failure to retain ‘Message Pal’ IMs (frankly, a basic Books and Records Rule violation).

Perhaps FINRA is currently negotiating a settlement with the CCO and others – but you’d never know by reading the Capitol Securities Management AWC Letter.  

YET, BY FAILING TO DISCLOSE OR TAKE ACTION AGAINST RESPONSIBLE INDIVIDUALS, FINRA IS SENDING OUT THE WRONG MESSAGE AND IS CONTINUING TO COMMIT A DISSERVICE TO ITS MEMBERS. 

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

For further details, go to ...  FINRA Disciplinary Actions Online, and refer to Case #2017052215401.