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Whatcha See is Whatcha Get In FINRA Settlement
November 16, 2016
What you see is what you get is very true when it comes to reading regulatory settlements by Wall Street's self-regulatory organization the Financial Industry Regulatory Authority. Of course, there are skeptics of the very nature of self regulation, and I am one of the loudest, most persistent, and most persevering voices of criticism. In my role as a pesky gadfly buzzing around FINRA's head, I often roll my eyes when reading its settlements and disciplinary and arbitration decisions. Sure, whatcha see is whatcha get but what about whatcha don't see? What about all the stuff that is routinely left out of the self-regulator's published disclosures?
Under the direction of new Chief Executive Officer Robert Cook, FINRA seems to have a veteran hand on the helm and this bulky battleship of a self-regulator is slowly being turned to the right course. As such, no, I'm not going to bash Cook and, yes, I am still allowing for a honeymoon before I hold his feet to the fire. Frankly, what I'm hearing about him is encouraging and, more to the point, we're entering the holiday season. Even the prickly Bill Singer, that curmudgeonly voice of the BrokeAndBroker.com Blog has a heart, small and burnt-to-a-crisp as it may be.
So . . . I wish Mr. Cook and his minions a happy and healthy upcoming holiday season but before y'all chomp down on your festive meals, would you please read today's article and give it some thought?
For the purpose of proposing a settlement of rule violations alleged by the Financial Industry Regulatory Authority ("FINRA"), without admitting or denying the findings, prior to a regulatory hearing, and without an adjudication of any issue, John Billy Kakonikos submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. In the Matter of John Billy Kakonikos, Respondent (AWC 22015045718701, November 11, 2016).
The AWC asserts that Kakonikos was first registered in 1999 and from August 2010 through February 9, 2014, was registered with FINRA member firm Caldwell International Securities Corp. Thereafter, he was registered with another FINRA member firm until February 24, 2016. The AWC asserts that Kakonikos does not have any prior relevant disciplinary history.
117 Transactions
During the relevant period from September 1, 2012, through September 30, 2013, the AWC alleges that Kakonikos was the servicing registered representative for a customer identified only as "EP," who is further described as having:
a high-school education, annual income of approximately $25,000 per year, and no experience actively trading securities.
The AWC alleges that during the relevant period, Kakonikos recommended and executed 117 securities transactions in EP's account, of which about half were without the customer's authorization. In those instances when Kakonikos contacted EP in order to recommend a trade, the AWC asserts that the customer always authorized the recommended trade. Based upon the aforementioned circumstances, the AWC asserted that Kakonikos exercised de facto control over EP's account.
The Rulebook
In pertinent part FINRA Rule 2111: Suitability provides that:
(a) A member or an associated person must have a reasonable basis to believe that a recommended transaction or investment strategy involving a security or securities is suitable for the customer, based on the information obtained through the reasonable diligence of the member or associated person to ascertain the customer's investment profile. A customer's investment profile includes, but is not limited to, the customer's age, other investments, financial situation and needs, tax status, investment objectives, investment experience, investment time horizon, liquidity needs, risk tolerance, and any other information the customer may disclose to the member or associated person in connection with such recommendation.
Moreover, the Supplementary Material to Rule 2111 provides in pertinent part that:
.05 Components of Suitability Obligations. Rule 2111 is composed of three main obligations: reasonable-basis suitability, customer-specific suitability, and quantitative suitability.(a) The reasonable-basis obligation requires a member or associated person to have a reasonable basis to believe, based on reasonable diligence, that the recommendation is suitable for at least some investors. In general, what constitutes reasonable diligence will vary depending on, among other things, the complexity of and risks associated with the security or investment strategy and the member's or associated person's familiarity with the security or investment strategy. A member's or associated person's reasonable diligence must provide the member or associated person with an understanding of the potential risks and rewards associated with the recommended security or strategy. The lack of such an understanding when recommending a security or strategy violates the suitability rule.(b) The customer-specific obligation requires that a member or associated person have a reasonable basis to believe that the recommendation is suitable for a particular customer based on that customer's investment profile, as delineated in Rule 2111(a).(c) Quantitative suitability requires a member or associated person who has actual or de facto control over a customer account to have a reasonable basis for believing that a series of recommended transactions, even if suitable when viewed in isolation, are not excessive and unsuitable for the customer when taken together in light of the customer's investment profile, as delineated in Rule 2111(a). No single test defines excessive activity, but factors such as the turnover rate, the cost-equity ratio, and the use of in-and-out trading in a customer's account may provide a basis for a finding that a member or associated person has violated the quantitative suitability obligation.
Also READ:
50% Return Needed to Break Even
As to the nature of the trading in EP's account during the relevant period, the AWC offers this analysis:
[T]he trading conducted by Kakonikos in EP's account during the Relevant Period generated an annualized turnover rate of 13.68 and an annualized cost-to-equity ratio of 49.79%. Considering EP's financial situation, lack of investment experience and needs, requiring a minimum return of nearly 50% just to break even, Kakonikos' trading in EP's account was excessive and quantitatively unsuitable for EP. The excessive unsuitable trading in EP's account resulted in realized trading losses of $72,524.53, while generating $41,617.56 in fees and commissions on those realized trades. Overall, during the Relevant Period, the account generated $53,168,22 in cumulative costs, including margin interest, resulting in a cost-to-equity ratio of 62.23%.
As a result of the aforementioned conduct, the AWC asserted that Kakonikos violated FINRA Rules 2111 and 2010.
Unauthorized Trading
During the relevant period, the AWC asserts that Kakonikos effected 55 purchase and sale securities transactions in EP's account without EP's authorization, knowledge or consent, in violation of FINRA Rule 2010.
FINRA Sanctions
In accordance with the terms of the AWC, FINRA imposed upon Kakonikos a $10,000 fine; $72,524.53 plus interest restitution to EP; and a suspension for 18 months from associating with any FINRA member firm in any capacity.
Will EP ever see a penny of restitution? Hard to say but the AWC does at least provide for this mechanism:
Restitution amounts ordered, pursuant to this disciplinary action, are due and payable immediately upon reassociation with a member firm, or prior to any application or request for relief from any statutory disqualification resulting from this or any other event or proceeding, whichever is earlier. The imposition of a restitution order or any other monetary sanction herein, and the timing of such ordered payments, does not preclude customers from pursuing their own actions to obtain restitution or other remedies. If for any reason Respondent cannot locate customer EP after reasonable and documented efforts within such period, or such additional period agreed to by the staff, Respondent shall forward any undistributed restitution and interest to the appropriate escheat, unclaimed property, or abandoned property fund for the state in which the customer is last known to have resided.
Bill Singer's Comment
Let me start off by complimenting FINRA for drafting an excellent AWC, which comprehensively explains the trading at issue and bolsters its allegation in a commendable manner. To the extent that whatcha see is whatcha get, I applaud the optics.
What is missing from the Kakonikos AWC and is missing from many (if not most) FINRA AWC's is what I have called sufficient "content and context." Reduced to its basics, the Kakonikos AWC presents us with a FINRA regulatory settlement that is about allegedly unsuitable and unauthorized trading in one customer's account. From the allegations and assertions in the AWC, we are left to draw our own inferences as to the character of Kakonikos and the nature of his brokerage firm's supervision. Frankly, as with many so-called "isolated incident" cases, there could be (and often are) extenuating circumstances and explanations that place the issues in a benign light. If such mitigation is warranted, I take no issue.
On the other hand, if there are issues in a given registered representative's background and the disclosure of those concerns add content and context such that we are prompted to make reasonable inferences about an individual's character and the zeal with which an employing firm discharged its obligation to supervise, then any regulator should present that fuller picture so as to make its settlement more coherent.
Let's see what, if any, additional content and context could have been added into the Kakonikos AWC, and see if the inclusion of such information prompts you to make reasonable inferences that did not occur from the AWC itself:
Customer Dispute - Settled
According to online FINRA BrokerCheck records as of November 16, 2016, under the heading of "Customer Dispute - Settled," we find two disclosures:
I. On September 14, 2008, FINRA member firm J.P. Turner & Company, LLC reported settling a 2008 customer complaint that had become a FINRA Arbitration. The initial damages sought were $345,582. As noted in BrokerCheck, the "Allegations" were that:
CHURNING, EXCESSIVE TRADING, NEGLIGENCE, BREACH OF CONTRACT AND BREACH OF FIDUCIARY DUTY
In J.P. Turner & Company, LLC's reported portion of this matter, it is asserted that the case settled for $100,000 and that Kakonikos did not contribute. In Kakonikos's reported portion of this matter, it is asserted that the case settled for $100,000 but that he contributed $9,500. I'm wondering if anyone at FINRA noticed this discrepancy in the contributed amounts.II. On November 20, 2008, FINRA member firm J.P. Turner & Company, LLC reported settling a 2006 customer complaint that had become an NASD Arbitration. The initial damages sought were $23,256 and the settlement was for $2,000, of which Kakonikos purported paid the whole amount. As noted in BrokerCheck, the "Allegations" were that:
CUSTOMER ALLEGES "BREACH OF CONTRACT," "BREACH OF FIDUCIARY DUTIES," AND "MISREPRESENTATION/NON-DISCLOSURE."
The "Firm Statement" attached to this disclosure offers this somewhat odd comment:
DUE TO ADMINISTRATIVE OVERSIGHT FIRM DID NOT AMEND LICENSE IN TIMELY MANNERI'm wondering if anyone at FINRA noticed this seemingly non-responsive firm statement.
Customer Dispute - Closed - No Action/Withdrawn/Dismissed/Denied
According to online FINRA BrokerCheck records as of November 16, 2016, under the heading of "Customer Dispute - Closed - No Action/Withdrawn/Dismissed/Denied," we find three disclosures:
I. On September 21, 2004, FINRA member firm JP Turner And Company reported receiving a customer complaint on August 10, 2004, seeking $109,536 in damages based upon allegations:CUSTOMER ALLEGES UNAUTHORIZED TRADING AND CHURNING OF HIS ACCOUNT.According to Kakonikos's statement:IN A LETTER DATED 9/21/2004 [CUSTOMER] WITHDREW HIS ALLIGATIONS [sic].
II. On January 21, 2009, FINRA member firm JP Turner And Company reported receiving a customer complaint on November 10, 2008, seeking $17,442 in damages based upon allegations:
CUSTOMER ALLEGES "BREACH OF CONTRACT," "BREACH OF FIDUCIARY DUTIES," AND "MISREPRESENTATION/NON-DISCLOSURE."
III. On March 12, 2011, FINRA member firm Hunter Scott Financial reported receiving a customer complaint on September 22, 2008, seeking $130,000 in damages based upon allegations:
CUSTOMER ALLEGED EXCESSIVE TRADING IN THEIR ACCOUNT.
According to Kakonikos's statement:
IN FINRA LETTER DATED 9/22/2008 FROM ASSOCIATE DIRECTOR [FINRA OFFICIAL] IT WAS DETERMINED, "OUR INVESTIGATION INCLUDED ANALYSIS OF THE INFORMATION YOU PROVIDED AND ADDITIONAL DETAILS WE COLLECTED DURING THE EXAMINATION PROCESS. BASED ON OUR ASSESSMENT OF THE INFORMATION, FINRA HAS CLOSED ITS INVESTIGATION OF THIS MATTER. IF NEW INFORMATION DEVELOPS, FINRA MAY RE-OPEN ITS INVESTIGATION."
Judgment/Lien
According to online FINRA BrokerCheck records as of November 16, 2016, under the heading of "Judgment/Lien" we find 12 disclosures comprising filing dates from 2005 to 2013, and reflecting IRS, New York State, and New York City tax liens and two civil judgments from other creditors.