FINRA Fines Leonard & Co. for Sale of Unregistered Securities, Bars Broker for Unregistered Penny Stock Sales, Other Violations
FINRA Issues Regulatory Notice Regarding Sales of Unregistered Securities
Washington, D.C. — The Financial Industry Regulatory Authority (FINRA) announced today that it has fined Leonard & Co. of Troy, MI, $225,000 for numerous violations, including the illegal sale of more than two million shares of penny stock on behalf of customers. FINRA also required the firm to retain an independent consultant to review its supervisory systems and procedures.
In addition, FINRA has barred Robert J. Cole, formerly a registered representative with Leonard & Co., for his role in the illegal sales.
In a related action, FINRA today issued Regulatory Notice 09-05, Unregistered Resales of Restricted Securities, to remind firms and brokers of their obligations to determine whether securities are eligible for public sale before participating in what may be illegal distributions. It also discusses the importance of recognizing "red flags" of possible illegal, unregistered distributions and reiterates firms' obligations to conduct searching inquiries in certain circumstances to avoid participating in illegal distributions.
"This action, and the accompanying Regulatory Notice, demonstrate FINRA's continuing commitment to ensuring that brokerage firms live up to their responsibilities as gatekeepers to the securities markets," said Susan L. Merrill, Executive Vice President and Chief of Enforcement. "FINRA will aggressively pursue firms and individuals who ignore those responsibilities and participate in illegal sales of unregistered securities."
FINRA found that Leonard & Co. and Cole participated in an illegal distribution of a penny stock, Shallbetter Industries, by selling over 2.2 million unregistered shares of the stock into the public markets from three related customer accounts. Cole, who handled the accounts, was aware that trading in the accounts was directed by a "control person" of Shallbetter. A control person is generally an individual who owns 10 percent or more of the stock of a company and can influence its policies and decision-making.
Most of the shares were deposited into the accounts in certificate form with restrictive legends attached to the certificates. Although the sales were made on behalf of a control person of Shallbetter, Cole arranged to have the restrictive legends removed from the stock certificates so the unregistered shares could be sold into the public markets.
Shallbetter is a thinly-traded penny stock. During the time of the sales activity, the company claimed in public filings with the Securities and Exchange Commission (SEC) that it owned mineral exploration licenses and interests in Outer Mongolia. The sales from the Leonard & Co. accounts occurred between August and November 2006 and generated over $3.1 million in proceeds for the accounts.
FINRA found that the sales coincided with a campaign by third parties to promote Shallbetter through widespread spam e-mail and the issuance of numerous press releases. The campaign resulted in significant increases in the price and trading volume of Shallbetter stock. During five days of the period, sales of Shallbetter from the accounts at Leonard & Co. accounted for more than 20 percent of the stock's total trading volume.
FINRA found that Cole had been told about the promotional campaign in advance by Shallbetter insiders. While in possession of this information, Cole purchased 15,000 Shallbetter shares for his own account and solicited purchases of 10,000 Shallbetter shares for two customers. He also acted to support the price of Shallbetter stock in advance of the promotional campaign by placing trades and by soliciting purchases of Shallbetter stock.
FINRA found that by selling more than two million shares of unregistered Shallbetter stock into the public markets for control persons of Shallbetter, Cole and Leonard & Co. violated the registration provisions of federal securities laws. FINRA also found that Cole and Leonard & Co. failed to conduct an adequate review of Shallbetter before recommending its purchase to customers of the firm. FINRA further found that Cole participated in a scheme to manipulate the price of Shallbetter stock, purchased and recommended purchases of Shallbetter stock while in possession of material nonpublic information and sent numerous emails to customers that inappropriately touted various stocks, including Shallbetter.
In addition, FINRA found that Leonard & Co. was aware of numerous red flags indicating that an illegal distribution might be underway, but failed to conduct a reasonable inquiry into them. In fact, the firm failed to conduct an adequate inquiry even after FINRA's Market Regulation Department inquired about the unusually high volume of trading in Shallbetter stock. FINRA found that the facts available to Leonard & Co had it conducted a reasonable inquiry included:
- That the accountholder/control person who had deposited over two million Shallbetter shares into accounts at Leonard & Co. had the same address as Shallbetter, was closely associated with Shallbetter's management and controlled over 10% of Shallbetter's outstanding stock.
- That the accountholder/control person used shares in the account, or proceeds from shares in the account, to pay legal and auditing expenses for Shallbetter.
- That a former president and director of Shallbetter - who at the time was living with the accountholder/control person - directed the trading and transfers in the account.
FINRA found that Leonard & Co. failed to maintain a supervisory system reasonably designed to comply with the registration requirements, but instead relied on its clearing firm to provide such a review. FINRA, the SEC and the courts have repeatedly held that firms cannot rely on outside counsel, clearing firms, transfer agents, issuers, or issuer's counsel to discharge their obligations to undertake an inquiry into circumstances such as those present in this case. FINRA also found that Leonard & Co. failed to reasonably supervise Cole and ignored numerous red flags that he was engaging in activity that violated securities laws and regulations.
Other violations found by FINRA include the firm's failure to implement an adequate anti-money laundering (AML) program and failure to timely file suspicious activity reports in connection with certain activities, including liquidation of a large position of a thinly-traded unregistered penny stock at the direction of a corporate insider; the wiring of proceeds to third parties, some of whom were overseas; and, the accountholder's refusal to provide requested information about an entity to which he proposed to transfer funds.
Leonard & Co. also failed to retain email for 23 accounts, including the firm's executive management, registered operations staff and non-registered administrative staff, and allowed its Chief Operating Officer to act as a principal before he had requalified to act in that capacity as required by a prior settlement with FINRA.
In settling these matters, neither Leonard & Co. nor Cole admitted or denied the charges, but consented to the entry of FINRA's findings.
Investors can obtain more information about, and the disciplinary record of, any FINRA-registered broker or brokerage firm by using FINRA's BrokerCheck. FINRA makes BrokerCheck available at no charge. In 2007, members of the public used this service to conduct 6.7 million reviews of broker or firm records. Investors can access BrokerCheck at www.finra.org/brokercheck or by calling (800) 289-9999.
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