WASHINGTON — The Financial Industry Regulatory Authority (FINRA) significantly expanded and enhanced its investor protection and market regulation capabilities in 2010 in each of the areas central to its investor protection mission, including: market and firm regulation, transparency, registration and disclosure, dispute resolution and investor education. FINRA's work progressed amid continuing changes sweeping financial markets, ongoing economic challenges and the implementation of a new industry regulatory framework. Highlights of FINRA's 2010 activity include:
- Expanded its market oversight responsibilities to include 11 new markets, particularly through the NYSE EuroNext group. FINRA is now responsible for surveillance of 80 percent of the trading volume of U.S. equity markets.
- Successfully launched its Office of Fraud Detection and Market Intelligence (OFDMI), including fully staffing the Office of the Whistleblower. In 2010, OFDMI referred more than 500 matters involving potential fraudulent conduct to the SEC or other federal law enforcement agencies for further investigation. These matters involved a wide range of issues, including insider trading, microcap fraud and Ponzi schemes.
- To date, made 244 insider trading referrals to the SEC, the highest in FINRA's history. The referrals include suspicious trading ahead of material news announcements by hedge funds, institutional investors, private equity firms and retail investors. The Insider Trading Surveillance unit continues to refine its analytics to identify concealed serial insider trading rings.
- Brought 1,310 disciplinary actions and levied fines totaling $42.5 million. FINRA also ordered about $6 million in restitution to harmed investors. FINRA expelled 14 firms from the securities industry, barred 288 individuals and suspended 428 from association with FINRA-regulated firms.*(Revised, see original text below.)
- Further strengthened the executive leadership team by naming J. Bradley Bennett as the head of FINRA's Enforcement Division and Samuel H. Gaer as Chief Information Officer, and by promoting Susan Axelrod to lead the organization's Member Regulatory Sales Practice area.
- Enhanced market transparency by expanding the Trade Reporting and Compliance Engine (TRACE) to include debt issued by federal government agencies, government corporations and government-sponsored enterprises, as well as primary market transactions in eligible debt issues. This expansion represented a 50 percent increase in the number of reportable debt instruments through TRACE. FINRA is currently preparing TRACE for expansion to securitized products, which will add more than 1.2 million asset- and mortgaged-backed securities to the current 45,000 TRACE-eligible securities. The rules for reporting transaction information in securitized products become effective in May 2011.
- Completed the first major expansion of BrokerCheck since 2002. Investors now have more information, including historic complaints, on current brokers and former brokers. Records on former brokers are now available for 10 years (instead of the previous two years) after they leave the securities industry. Records of regulatory actions, criminal convictions, civil judgments and arbitration awards are permanently available. As a result, investors now have access to detailed information about nearly 1.35 million current and former securities brokers, an increase of more than 65 percent. Investors are able to use this information to research the background of former brokers who work in other sectors of the financial services industry or hold other positions of trust.
- The FINRA Investor Education Foundation released the nation's first Military Financial Capability Survey, which measures the overall financial capabilities of U.S. military personnel and their spouses. The Survey found that the military community was significantly deeper in debt than the general population. As a result of the Survey findings, the Foundation will be launching a new, specialized tool to help military service members and their families with credit management.
- The FINRA Foundation launched an interactive Web resource to display the results of America's first State-by-State Financial Capability Survey, which surveyed more than 28,000 respondents. The new website, www.usfinancialcapability.org, displays a clickable map of the United States and allows the public, policymakers and researchers to delve into and compare the financial capabilities of Americans in every state and across geographic regions.
Commenting on the year, Richard Ketchum, Chairman and CEO of FINRA, said, "While the regulatory environment continues to evolve, each of the efforts undertaken by FINRA this year contributes to our broader mission to protect investors by making sure the securities industry operates fairly and honestly, both in its dealings with individuals and through the operation of the systems and technologies that underpin today's markets."
Ketchum continued, "The organization has made real progress in enhancing our capabilities to ensure investor protection in a fast-changing marketplace." Following is a more detailed summary of FINRA's 2010 accomplishments across its key operational areas:
Market Regulation and Surveillance
In 2010, FINRA began providing regulatory services to 11 new markets. Most notably, FINRA assumed responsibility for the surveillance of NYSE EuroNext's five markets operated in the U.S. – NYSE equities, NYSE ARCA equities and options and NYSE AMEX equities and options – and extended the regulatory service agreement with NASDAQ OMX. In addition, FINRA began providing services to a second BATS equity exchange and BATS options, NASDAQ OMX PHLX's equity and options markets, and two equity exchanges operated by Direct Edge. With the addition of these markets, FINRA is now responsible for surveillance of 80 percent of the trading volume in U.S. equity markets and almost 35 percent of the volume in U.S. options markets. In total, FINRA now provides regulatory services to 17 equities and options markets operated by 11 exchanges.
The Insider Trading Surveillance unit of the OFDMI has referred 244 matters to the SEC so far in 2010. The referrals include suspicious trading ahead of material news announcements by hedge funds, institutional investors, private equity firms and retail investors. As a result of the combination of NYSE's and FINRA's insider trading programs in 2010, FINRA is now responsible for insider trading surveillance for all exchange-listed and OTC equity securities across the U.S., regardless of the platform on which a trade is executed. The combination of NYSE Regulation's and FINRA's aggregated trade history and case repositories has created a centralized library of regulatory data that serves as an invaluable investigative tool in uncovering serial insider trading rings.
The Fraud Surveillance unit of the OFDMI has also referred 255 matters to the SEC so far in 2010. The referrals include matters involving issuer fraud, pump-and-dump schemes, market manipulation and account intrusions. The consolidation of the NYSE's and FINRA's Fraud Surveillance units has also resulted in enhanced surveillance for potential manipulation and issuer fraud occurring across markets.
FINRA also brought several significant cases involving trading violations, including:
- The first high-frequency trading case in the U.S. against Trillium Brokerage Services, LLC, fining the firm $2.3 million for repeatedly entering improper "layered," non-bona fide, market moving orders to create a false appearance of buy- or sell-side pressure.
- Fining Phoenix Derivatives Group, three of its principals and three brokers at other firms $3.6 million for improper communications about customers' proposed brokerage rate reductions in the wholesale credit default swap (CDS) market; filing a complaint against GFI Securities LLC, four of its former CDS brokers, and a competing CDS broker at another firm for colluding to resist mutual clients' proposals to lower brokerage rates for CDS trades in 2005 and 2006.
- Bringing 20 cases against firms for improper order entry procedures, including improperly exercising an option after the exercise cut-off time, and finalizing 10 stipulations on behalf of NYSE markets for a range of matters, including failure to supervise and operating an unregistered broker-dealer.
- Expelling a firm, APS Financial, and barring its president for excessive markups and supervisory failures in connection with transactions in high-yield bonds and collateralized mortgage and debt obligations.
Enforcement
Through November 30, FINRA brought 1,173 disciplinary actions, levied fines totaling $41.1 million and ordered the payment of almost $8 million in restitution to harmed investors. FINRA expelled 14 firms from the securities industry, barred 270 individuals and suspended 407 from association with FINRA-regulated firms.
The sweeps and targeted exams FINRA conducted in 2010 included: Regulation D offerings, placement agents, trading activity fees, direct market access and junk bonds.
In the sweep of retail sales of private placement interests, as well as broker-dealers affiliated with private placement issuers, FINRA focused on firms' compliance with suitability, supervision and advertising rules, as well as potential instances of fraud and unregistered sales of securities. A number of these investigations led to the filing of private placement/Reg. D actions, including one against Provident Asset Management that resulted in an expulsion of the firm for marketing fraudulent private placements offered by its affiliate, Provident Royalties, that was engaged in a massive Ponzi scheme.
Most recently, Enforcement filed a complaint and a request for a temporary cease-and-desist order against Pinnacle Partners and its president, Brian K. Alfaro, to halt an alleged ongoing fraud involving eight private placement offerings in oil and gas joint ventures. Through a "boiler room" from which brokers placed thousands of cold calls, Alfaro and Pinnacle have raised more than $10 million from over 100 investors for offerings that are alleged to materially misrepresent or omit material facts. Additional cases are expected to be filed in the coming year.
In its continuing effort to prevent misconduct in the sale of private placements, FINRA will file amendments to expand FINRA's rule that governs private placements. The proposal seeks to expand disclosure, filing requirements and limitations on the use of offering proceeds to a wider range of private placement offerings.
FINRA also focused this year on improprieties in the sale of structured products, as evidenced by two cases arising from the sale of reverse convertible notes. Enforcement brought a case against Ferris, Baker Watts LLC, now part of RBC Wealth Management, fining the firm $500,000 and ordering $190,000 restitution for inadequate supervision of sales of reverse convertible notes to retail customers as well as unsuitable sales of reverse convertibles to 57 accounts held by elderly customers who were at least 85 years old or customers with a modest net worth.
The collapse of the mortgage-backed securities market gave rise to a number of investigations into the manner in which these securities had been underwritten and sold to investors. Earlier this year, FINRA settled an action against Deutsche Bank Securities in which the firm was found to have negligently misrepresented and underreported the percentages of mortgages that were delinquent in the prospectus supplements of six subprime residential mortgage-backed securities (RMBS) issued in 2006. Deutsche Bank was fined $7.5 million.
FINRA also settled a case involving floating rate Collateralized Mortgage Obligations (CMOs) against HSBC Securities (USA) Inc. The firm was fined $375,000 for recommending unsuitable sales of inverse floating rate CMOs to retail customers and for failing to adequately supervise the suitability of the CMO sales and fully explain the risks of an inverse floating rate or other risky CMO investment to its customers.
Regulation of Firms
FINRA has successfully strengthened and increased the scope of its regulation of securities firms, changing the way it deploys resources to monitor and examine firms. It also made progress in transforming its sales practice examination program to be more risk-based. Exams are more targeted to focus on the business lines engaged in by the firms that pose the highest risk to investors. FINRA also added a leverage measure to its alert-monitoring criteria so that it could better understand the risk of firms that are highly levered. Additionally, FINRA continues to monitor material business changes to ensure that firms undergoing significant systems conversions or change of control remain financially strong.
Through November 30, FINRA had conducted approximately 2,600 cycle examinations and 6,600 cause examinations.
FINRA has also continued to increase its collaboration with international regulators to support and improve its oversight of firms with multinational operations, including signing a memorandum of understanding (MoU) with the Australian Securities and Investments Commission (ASIC) in June 2010 and with the United Kingdom's Financial Services Authority (FSA) in September 2010. Both agreements complement the already existing MoUs FINRA has signed with France's Autorité des Marches Financiers (AMF) and the Investment Industry Regulatory Organization of Canada (IIROC), and will facilitate the exchange of information on firms and individuals under common supervision, investigate possible cross-border market abuse, collaborate on enforcement matters, and allow further sharing of regulatory techniques, including approaches to risk-based supervision of firms.
Transparency
FINRA expanded its Trade Reporting and Compliance Engine (TRACE) program to include debt issued by federal government agencies, government corporations and government-sponsored enterprises, as well as primary market transactions in eligible debt issues. This development represents a 50 percent increase in the number of reportable debt instruments through TRACE. FINRA also gained approval from the SEC to collect transactions in securitized products (asset-backed securities, including mortgage-backed securities). Reporting on these products will begin in May 2011.
Registration and Disclosure
In November 2010, FINRA expanded BrokerCheck to increase the available records on securities brokers by more than 65 percent. Detailed records, including all historic complaints, are now available on 1.35 million brokers – including nearly 640,000 current and more than 700,000 former brokers. This expansion provides additional information about current brokers and increases the information available to investors on former brokers who may now work in other sectors of the financial services industry or hold other positions of trust. FINRA now discloses criminal proceedings, civil injunctions, customer complaints and records on former brokers whose registrations have terminated within the last 10 years. Final regulatory actions, criminal convictions, civil judgments and arbitration awards are available through BrokerCheck on all current and former brokers, regardless of the date their registration terminated. Investors and others will view over 18 million BrokerCheck records in 2010.
Dispute Resolution
In order to increase investor choice, this year FINRA filed a rule proposal with the SEC that would expand the Public Arbitrator Pilot Program to all investor disputes against any firm and any individual broker. If the rule is approved, no investor would have an industry arbitrator on their case unless they chose one.
In 2010, the three most common issues in cases filed in FINRA's arbitration forum were breach of fiduciary duty, negligence and misrepresentation. Thus far this year, approximately 5,242 cases were filed in arbitration, a decrease of 21 percent over 2009. To date, 788 cases commenced in mediation, an increase of 51 percent over 2009.
Investor and Financial Education
FINRA continued to focus on expanding its financial education efforts and those of the FINRA Investor Education Foundation in order to provide underserved Americans with the tools and resources to manage their money with greater confidence. During the year:
- The FINRA Foundation expanded the senior investor protection program to eight states – Alabama, Colorado, Florida, Maine, North Carolina, Vermont, Washington and West Virginia – and expanded access to high-quality, freely available financial education resources through public libraries in 32 states that serve a combined population of nearly 25 million.
- The FINRA Foundation's award-winning documentary, Trick$ of the Trade: Outsmarting Investment Fraud, has aired on more than 95 public television stations in 24 states to date.
The State-by-State Financial Capability Survey echoed several of the findings of the smaller-scale national and military surveys released earlier, finding that:
- More than half of all Americans are living paycheck-to-paycheck. Fifty-five percent of Americans report spending more than or about equal to their household income.
- A significant majority of Americans (60 percent) do not have a "rainy day" fund to cover three months of unanticipated financial emergencies.
- More than one in five Americans (24 percent) have engaged in some form of higher cost non-bank borrowing during the last five years, including taking out a payday loan or getting an advance on a tax refund.
- Americans, on average, were able to correctly answer just three of five questions about fundamental financial concepts.
About FINRA
FINRA is the largest independent regulator for all securities firms doing business in the United States. FINRA is dedicated to investor protection and market integrity through effective and efficient regulation and complementary compliance and technology-based services. FINRA touches virtually every aspect of the securities business – from registering and educating all industry participants to examining securities firms, writing and enforcing rules and the federal securities laws, informing and educating the investing public, providing trade reporting and other industry utilities, and administering the largest dispute resolution forum for investors and registered firms. For more information, please visit www.finra.org.
- * This bullet was revised with final year-end statistics. It previously read:
- Brought 1,173 disciplinary actions and levied fines totaling $41.1 million. FINRA also ordered almost $8 million in restitution to harmed investors. FINRA expelled 14 firms from the securities industry, barred 270 individuals and suspended 407 from association with FINRA-regulated firms.