An irreverent Wall Street Blog
The FINRA Thrum Of Stamping Settlements
April 6, 2017
Wall Street regulation often takes on the imagery of a Kafka story. Lots of bureaucrats. Inexplicable laws. Unfathomable rulings and interpretations. Waiting for nothing. No lessons. Nothing to be learned.
In a recent Financial Industry Regulatory Authority settlement, some of the charges appear valid. On the other hand, much of what's presented to us comes off as the byproduct of going through the motions of a pre-fabricated settlement and moving on to the next case. We come away with more questions than answers. In the background, we can barely make out the noise. Sort of sounds like rubber stamps being pounded down and down and down. It is the thrum of regulation on Wall Street.
Case In Point
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 Blakezuniga submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. In the Matter of John Blakezuniga, Respondent (AWC #2016048453601, April 3, 2017).
The AWC asserts that Blakezuniga was first registered in 1981 and by 1999 he was associated with FINRA member firm Vanguard Capital. The AWC asserts that Blakezuniga had the following prior "Relevant Disciplinary History:"
In August 2011, Blakezuniga entered into an AWC (No. 2010024761201) in which he agreed to a 30-business day suspension and a $5,000 fine for failing to disclose an outside business activity.In March 2011, Blakezuniga was the subject of a consent order (S-11-0228- 110Rl) by the Arkansas Securities Commissioner in which he was fined $3,500 for failing to update his outside business activity notification form to disclose his position as Chief Executive Officer of a company.
Borrowing
The AWC alleges that:
Vanguard Capital's procedures prohibited Blakezuniga from borrowing money from any customer. In violation of the firm's procedures, Blakezuniga borrowed (i) $300,000 in February 2007 from a trust established by a firm customer and (ii) $475,000 in June 2013 from a separate trust established by another firm customer. Blakezuniga has not repaid the full principal amount owed for either of these loans.
FINRA deemed Blakezuniga's conduct to constitute violations of NASD Rules 2370 and 2110 for the 2007 loan, and FINRA Rules 3240 and 2010 for the 2013 loan.
ACQ
In addition to having violated FINRA's Borrowing Rules and Vanguard's internal policies, Blakezuniga also allegedly completed his firm's 2013 annual compliance questionnaire ("ACQ") and wrongly answered "NO" to a question about whether he had "ever" borrowed money from a customer. FINRA deemed Blakezuniga's ACQ response to constitute a violation of FINRA Rule 2010.
ETF
The AWC asserts that from 2010 through 2014, Blakezuniga recommended to 85 customer accounts about 1,280 non-traditional ETF transactions. In recommending these positions, FINRA deemed that Blakezuniga did not have reasonable grounds for believing that the investments were suitable. That regulatory conclusion appears to have been based upon Blakezuniga's alleged recommendation to the 85 accounts that they hold the ETFs from about 30 days to several years despite FINRA's position that said ETFs were short-term trading vehicles designed for single-day investment.
FINRA deemed Blakezuniga's ETF recommendations to constitute violations of NASD Rule 2310 (prior to July 9, 2012) and FINRA Rules 2111 and 2010 (after July 9, 2012).SIDE BAR: As set forth in the 'Executive Summary" of FINRA Regulatory Notice 09-31 (June 2009): Non-Traditional ETFs: FINRA Reminds Firms of Sales Practice Obligations Relating to Leveraged and Inverse Exchange-Traded Funds:Exchange-traded funds (ETFs) that offer leverage or that are designed to perform inversely to the index or benchmark they track-or both-are growing in number and popularity. While such products may be useful in some sophisticated trading strategies, they are highly complex financial instruments that are typically designed to achieve their stated objectives on a daily basis. Due to the effects of compounding, their performance over longer periods of time can differ significantly from their stated daily objective. Therefore, inverse and leveraged ETFs that are reset daily typically are unsuitable for retail investors who plan to hold them for longer than one trading session, particularly in volatile markets.This Notice reminds firms of their sales practice obligations in connection with leveraged and inverse ETFs. In particular, recommendations to customers must be suitable and based on a full understanding of the terms and features of the product recommended; sales materials related to leveraged and inverse ETFs must be fair and accurate; and firms must have adequate supervisory procedures in place to ensure that these obligations are met. . .
Sanctions
In accordance with the terms of the AWC, FINRA imposed upon Blakezuniga a $25,000 fine and a 22-month suspension from associating with any FINRA member in any capacity.
Bill Singer's Comment
When commenting about AWCs, I concede that if the settlement terms were acceptable to the Respondent, it's not my place to criticize or second-guess. That being said, I'm not quite sure how FINRA came up with that quirky 22-month suspension but it is what it is.
Any Complaints or Lawsuits by the Trusts?
As a former industry regulator, I know that it is difficult (if not impossible) to uncover the existence of an undisclosed loan between a registered rep and his or her customer unless the customer has complained to the firm or a regulator. As such, the AWC is woefully remiss in not stating whether the lending trusts complained to Vanguard or FINRA about the loans at issue. Similarly, the AWC should disclose whether the trusts filed a lawsuit against Blakezuniga.
A Matter of Trust
FINRA Rule 3240: Borrowing From or Lending to Customers specifically warns that:
(a) Permissible Lending Arrangements; Conditions No person associated with a member in any registered capacity may borrow money from or lend money to any customer of such person unless:
The Borrowing Rule does not prohibit borrowing from "any customer" but restricts such activity to "any customer of such person." Consequently, an associated person could conceivably borrow or lend to a customer of the employing firm provided that said customer was not serviced by the associated person. More than mere semantics, this distinction is a critical element in determining whether or not certain conduct rose to the level of a violation of a FINRA rule.
As a matter of law, a trust is not necessarily the same legal "individual" as the individual who creates it. Given that legal issue, the AWC should have specified whether FINRA had deemed the two trusts to have been customers of Blakezuniga. If, in fact, FINRA deemed the two trusts to be customers of Blakezuniga's, then the AWC should have explained whether the customer status of the trust was predicated upon either:
- Blakezuniga's being the servicing registered representative to the trusts (which would clearly make them his customers); or,
- FINRA had interpreted various facts and circumstances as creating a customer relationship between the trusts and Blakezuniga notwithstanding that another registered representative may have serviced the trust accounts or that the trusts may never have had accounts at Vanguard.
Violation of In-house Procedures
If we re-read the AWC's allegations pertaining to Blakezuniga's borrowing from the two trusts, we find this:
Vanguard Capital's procedures prohibited Blakezuniga from borrowing money from any customer. In violation of the firm's procedures . . .
The above-cited language establishes two critical points. One, that Blakezuniga violated Vanguard's procedures (and not necessarily Rule 3240); and, two, that the in-house procedures prohibited borrowing from any firm customer (which would include any customer of a an associated person).
As FINRA often admonishes, a violation of a member's procedures may rise to a violation of:
FINRA Rule 2010: Standards of Commercial Honor and Principles of TradeA member, in the conduct of its business, shall observe high standards of commercial honor and just and equitable principles of trade.
Blakezuniga may have borrowed money from two firm customers in violation of Vanguard's procedures and, accordingly, in violation of Rule 2010. Beyond that, the AWC has not presented a sufficient basis upon which to also charge a violation of its Rule 3240. Supportive facts may exist but they have not be presented in sufficient detail in the AWC.
A Matter of Principal
FINRA made a point of disclosing that the full principal of the 2007 and the 2011 loans was not repaid. What the regulator failed to disclose, however, was whether any of the original principal had been repaid. Further, the AWC failed to disclose whether either lending trust had complained about late- or non-payment.
The existence of complaints from the trusts would not eliminate a violation of FINRA's Borrowing Rule. If the regulator is going to gratuitously disclose the existence of an unpaid principal balance, however, then FINRA should at least disclose whether the lenders had complained about belated or non-payments. Similarly, the AWC should have disclosed whether the trusts had granted extensions for payment to Blakezuniga. Among the more bizarre omissions from the AWC's fact pattern are such basic terms as whether there was a written loan agreement, a schedule for repayment, or an amount of interest to be paid.
More Than One Missed Opportunity
Assuming that the ETFs were unsuitable to be held in a customer account after the expiration of one day (as stated in the FINRA's NTM 09-31), didn't that threshold get crossed in 2010 when the first of the 1,280 cited investments was made? How the hell do more than 1,000 exotic ETF positions get carried for periods of months and years in some 85 customer accounts and no in-house exception report is triggered? And while we're asking that question, let's also ask how FINRA examination staff missed this multi-year, ongoing violation during on-site visits in 2010, 2011, 2012, 2013, 2014, 2015, and 2016. How did FINRA miss 1,280 unsuitable exotic ETF trades over such an extended period of time?