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December 7, 2018

Abuse of Authority

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Customers give registered representatives authority to act on their behalf when they provide authorization to engage in discretionary trading or permit registered representatives to act as trustees or co-trustees, hold Powers of Attorney or serve as executors or beneficiaries. FINRA reminds firms that these roles can expose investors to material risks—e.g., unsuitable or excessive trading—unless firms implement appropriate controls.

Registered representatives may engage in discretionary trading when they execute a securities transaction in a customer’s account after receiving prior written authorization from the customer. NASD Rule 2510 (Discretionary Accounts) also establishes other obligations that reduce the risks associated with discretionary trading by requiring firms to accept discretionary accounts only in writing, prohibiting firms from effecting transactions that are excessive in size or frequency relative to the financial resources and character of the account, and requiring firms to approve discretionary orders in writing and review discretionary accounts at frequent intervals.

FINRA has observed that some firms prohibit the use of all discretionary customer accounts. Firms that permit such accounts generally established and maintained robust supervisory procedures and controls, such as automated systems to detect potential excessive trading in customer accounts, inconsistencies or errors related to the completion of customer new account forms, and indications of customers granting discretionary authority to their registered representatives. Some firms also used monthly, quarterly, semi-annual, or annual attestations from registered representatives indicating whether they maintained any discretionary customer accounts or exercised discretion when servicing customer accounts. In addition, firms trained their registered representatives on the requirements of NASD Rule 2510 (Discretionary Accounts), including authorization and acceptance of discretionary accounts, review and approval of discretionary transactions, and exceptions to the rules’ requirements. Finally, firms tested their procedures and controls on discretionary accounts to verify that they reasonably ensured registered representatives’ compliance with FINRA requirements and maintained documentation to demonstrate evidence of such testing and its results.

We also observed that certain firms prohibited registered representatives from acting in some positions of trust, such as trustees or co-trustees, Powers of Attorney, executors or beneficiaries. Other firms mitigated the potential conflicts of interest involved in such roles by implementing additional supervision and review procedures. For example, certain firms asked customers to fill out questionnaires or annual attestations to confirm their intent to have representatives acting as trustees, co-trustees or in other significant roles such as Power of Attorney, executor or beneficiary.

Selected Examination Findings

FINRA has observed situations where some firms or registered representatives exposed investors to unnecessary risks and firms had not established controls—including those to comply with obligations under NASD Rule 2510 (Discretionary Accounts)—to mitigate those risks.

  • No Authorization – Some registered representatives exercised discretion in customer accounts without the customers’ prior written authorization or the firm’s approval of the discretionary account. In some instances, this occurred when a registered representative executed transactions in a single security across multiple customer accounts in a short period of time. Additionally, FINRA found that some registered representatives violated the requirements of NASD Rule 2510 (Discretionary Accounts) when they executed transactions in customer accounts as an accommodation without receiving specific customer authorization to execute that transaction.
  • Expired Authorizations – In some cases, registered representatives exercised discretion after the authority to do so had expired (e.g., pursuant to NASD Rule 2510(d)(1) (Discretionary Accounts), grants of authority to exercise time or price discretion typically terminate at the end of the business day on which they are granted).
  • Mismarking Order Tickets – Some registered representatives mismarked order tickets to obscure unauthorized discretionary trading by indicating that trades were executed in an unsolicited capacity, when, in fact, customers did not initiate the transactions and were unaware of the trading occurring in their accounts. In other instances, registered representatives mismarked order tickets and placed trades in customer accounts that did not comply with the securities’ threshold limitations or trading restrictions.
  • False Statements and Blank Forms – In some situations, registered representatives made false statements on the firm’s compliance questionnaires and attestations regarding discretionary authorization, or had customers sign blank suitability or new account forms.
  • Abuse of Trustee Status – Some registered representatives convinced senior investors to establish trusts and name the representatives as trustees or co-trustees in order to take control of the trust assets and direct funds to themselves. FINRA also remains concerned about registered representatives maintaining other significant roles in customer accounts, such as Power of Attorney, executor or beneficiary.