Firm Made Misrepresentations to Customers and Violated Reg BI as well as FINRA’s Suitability and Supervision Rules
WASHINGTON—FINRA announced today that it has expelled broker-dealer SW Financial for multiple violations, including making misrepresentations to customers in its sales of private placement offerings of pre-initial public offering (pre-IPO) securities, churning customer accounts, and failing to supervise its representatives.
In a related settlement, FINRA suspended the firm’s co-owner and CEO, Thomas Diamante, for nine months in all capacities followed by a three-month suspension in all principal capacities, fined him $50,000, and required him to requalify by examination if he seeks to register with FINRA as a general securities principal or investment banking representative in the future.
“The serious misconduct in this case exposed customers to significant risk of harm and necessitated expulsion of SW Financial from FINRA membership,” said Christopher J. Kelly, Senior Vice President and Acting Head of FINRA’s Department of Enforcement. “Firms cannot make material misstatements or omissions when they sell securities to customers. Firms also must reasonably surveil for, and respond to, red flags of excessive trading and churning. When firms, particularly those with significant disciplinary histories, commit egregious sales practice and supervisory violations, expulsion from FINRA membership may be warranted.”
FINRA found that between January 2018 and December 2021, Diamante and SW Financial made material misrepresentations and omitted material information in connection with the sale of private placement offerings of pre-IPO securities in violation of both FINRA rules and the Disclosure Obligation of Regulation Best Interest (Reg BI). Reg BI’s Disclosure Obligation requires broker-dealers and associated persons to provide retail customers with full and fair written disclosure, prior to or at the time of a recommendation, of all material facts relating to conflicts of interest associated with the recommendation.
SW Financial informed potential investors that it would receive only a 10 percent sales commission in connection with its sale of certain pre-IPO securities when, in fact, Diamante had entered into an undisclosed agreement with the issuer under which SW Financial would receive an additional 5 percent in selling compensation and half of any carried interest (i.e., a share of profits payable to the issuer’s investment manager). In total, SW Financial sold the private offerings to 171 investors, including 163 retail customers, and the firm and its owners received approximately $2 million in undisclosed compensation —a serious potential conflict of interest that could have influenced SW Financial’s recommendations and should have been fully disclosed.
Diamante and SW Financial also failed to conduct reasonable due diligence on the private offerings and did not confirm that the issuer actually held or had access to the shares it purported to sell. As a result, SW Financial had no reasonable basis to recommend the offerings to customers, in violation of both FINRA’s suitability rule and Reg BI’s Care Obligation, which requires broker-dealers and their associated persons to exercise reasonable diligence, care, and skill to, among other things, understand the potential risks, rewards, and costs associated with a recommendation, and have a reasonable basis to believe that the recommendation could be in the best interest of at least some retail customers.
FINRA also found that between January 2016 and May 2019, SW Financial, acting through two former representatives, churned nine customer accounts, causing the customers to incur more than $350,000 in total trading costs and realized losses of more than $465,000. In one instance, a retired, 75-year-old customer whose account was excessively traded had a cost-to-equity ratio (or break-even point) of more than 103 percent, paid $101,806 in commissions, and incurred realized losses of $131,979, which comprised most of his retirement savings. SW Financial failed to reasonably follow up on red flags of the excessive trading in this customer’s – and other customers’ – accounts.
In settling these matters, SW Financial and Diamante accepted and consented to the entry of FINRA’s findings without admitting or denying them.
To help safely guide investors through the investment process, FINRA has resources available to better understand areas of risk. These include a September 2020 Investor Insights article entitled, “3 Ways to Guard Against Excessive Trading in Your Brokerage Account.” In addition, you can find more information on pre-IPO securities here, and private placement due diligence here.
FINRA is a not-for-profit organization dedicated to investor protection and market integrity. It regulates one critical part of the securities industry—brokerage firms doing business with the public in the United States. FINRA, overseen by the SEC, writes rules, examines for and enforces compliance with FINRA rules and federal securities laws, registers broker-dealer personnel and offers them education and training, and informs the investing public. In addition, FINRA provides surveillance and other regulatory services for equities and options markets, as well as trade reporting and other industry utilities. FINRA also administers a dispute resolution forum for investors and brokerage firms and their registered employees. For more information, visit www.finra.org.