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The Failure of Wall Street Compliance and Regulation: A Case In Point
December 12, 2018
They will try to convince you that Wall Street has an effective two-tier system to protect investors. First, there's the in-house Compliance Staff. Second, there's the federal, state, and self regulators. If the first line of compliance defense fails, you have the Imperial Guard regulators held in reserve. It all sounds good. The problem is that it's all nonsense. It's not so much that the system doesn't work, as much as it is that the system is not designed to work but only to give so much of an appearance as necessary. Wall Street's brokerage firms underpay, understaff, and undercut their compliance departments. As far as compliance goes, it's pretty much viewed as window dressing. When it comes to Wall Street's regulators, well, recent history pretty much speaks volumes on that subject. All in all, Wall Street's approach and dedication to effective investor protection amounts to little more than reading toe tags at the morgue. More after-the-fact than preventative medicine. In a recent FINRA regulatory settlement, we see the futility of compliance and regulation at its worst. Where were Wall Street's cops during the years when this one investor was victimized? All the warning signs were there and mounting -- year after year, lost dollar after lost dollar. Did no one notice? Or did no one care?
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, Sean J. Waters submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. In the Matter of Sean J. Waters, Respondent (AWC 2017054755203,, November 28, 2018).
The AWC asserts that Waters entered the industry in 2001 and by December 2010, he was registered with FINRA member firm Financial West Group. until April 2017. The AWC asserts that "Waters has no relevant disciplinary history."
2010 AO Opens Individual Account
The AWC asserts that in December 2010, a 67-year-old customer identified only as "AO" transferred her individual retail brokerage account to Financial West and Waters served as her registered representative. At that time, AO was married, working as an administrative assistant for a construction company, and had limited investment experience.
2012: Widow AO Retires
In 2011, AO's husband died; and at the end of 2012, she retired. At the time of her retirement, the AWC asserts that:
her sole source of income became her monthly Social Security benefits and her savings, and her net worth was approximately $275,000. In the beginning of 2013, AO's individual account at Financial West contained cash and securities worth approximately $62,000, and included a recent deposit of $30,000 from the sale of her condominium. In October 2013, AO initiated an IRA rollover to open a separate account at Financial West with cash and securities totaling approximately $88,000. AO's investment objectives for both her individual account and IRA were capital appreciation and income, with a moderate risk tolerance.
2013: $275,000 Net Worth
[F]rom January 2013 through March 2016, Waters executed a total of 523 trades in AO's individual account. And from October 2013 through March 2016, Waters executed a total of 527 trades in AO's IRA account. In total across both accounts, Waters executed 540 purchase transactions (with a total principal value of approximately $1.986 million), executed 510 sale transactions (with a total principal value of approximately $1.972 million), and charged AO commissions, markups/markdowns and fees totaling approximately $115,000.
. . .From January 2013 through December 2016, the annualized turnover rate in AO's individual account (which is the number of times per year the securities in the account were replaced by new securities) was 7.20. The annualized cost-to-equity ratio (which is the percentage the account had to appreciate to break even) was 41.11 percent. The annualized turnover rate and cost-to-equity ratio in AO's IRA account from October 2013 through March 2016 were similar: 7.23 and 39.85 percent. A turnover rate of six or a cost-to-equity ratio in excess of 20 percent generally indicates that excessive trading has occurred.Waters's trading resulted in more than $88,000 in cumulative losses to AO out of the $150,000 she initially transferred to Financial West, while Waters generated commissions, markups/markdowns and fees totaling approximately of $115,000. In fact, during the four-year period of 2013 through 2016, Waters earned 40 percent of his total commissions solely from the trading he did in AO's two accounts. . .
FINRA Sanction
Bill Singer's Comment
We got AO the widow.
We have her dependent upon her social security and savings.
During the time that AO was 70 to 73 years old, Waters executed 523 trades in her individual account and 527 trades in her IRA.
The AWC calculates that during the relevant period, Waters purchased just under $2 million in stocks and sold about the same -- resulting in commission/fees charged to AO of about $115,000.
All told, FINRA figured that Waters's trading caused over $88,000 in cumulative losses to the customer while generating over $115,000 in commissions/fees for Waters.
Then there's this very telling finding in the AWC:
[D]uring the four-year period of 2013 through 2016, Waters earned 40 percent of his total commissions solely from the trading he did in AO's two accounts. . .
Where was Financial West's Compliance Department?
Where was FINRA?
Ultimately, this regulatory settlement is a scathing indictment of the failures of Wall Street's in-house compliance policies and regulatory oversight. I mean, c'mon, if we can't protect an elderly widow from the trading deprivations of one stockbroker when the warning signs are glaring and the alarms are sounding at full volume, then what good is the double-layer system of in-house compliance as a first line of defense backed up by federal, state, and self regulators? And don't gloss over the significance of this disclosure in the AWC:
Waters was registered with Financial West until April 2017. From April 2017 until February 2018, Waters was registered with another member firm.
Notwithstanding the carnage that went on from 2013 through 2016 in AO's accounts, Waters managed to remain with Financial West until early 2017, and then moved on to another FINRA member firm, where he remained until early this year. I mean, seriously?
For a four year period, we have one -- count 'em: ONE -- stockbroker who is earning 40% of his commissions from trading in two accounts belonging to an elderly widow. If such a horrific pattern goes undetected for those same years by a broker-dealer's in-house compliance staff, then what the hell is even the point of permitting Wall Street to hire its own employees to purportedly ensure that stockbrokers are handling their customers' accounts in a compliant manner? Taking things a step farther, what the hell is Wall Street's three layers of regulators doing if no one detected the rapacious trading in a vulnerable widow's account?
Online FINRA BrokerCheck records as of December 12, 2018, disclose that FINRA member firm Financial West Group has 22 final regulator events and 7 arbitrations. Most notably, on August 17, 2018, pursuant to FINRA Rule 9553, FINRA suspended Financial West Group's membership for failing to pay $73,109.16 in fees due to FINRA. For four years, no one at FINRA apparently noticed Waters' shenanigans when they devastated a widow's savings -- I'd love to know exactly how long it took FINRA to notice that Financial West Group was in arrears on $73,109.16, an amount less than the losses sustained by AO and less than the commissions/fees earned on the customer's account by Waters.
Gotta give FINRA credit. Despite being late to the party, the self-regulatory-organization sure as hell knows how to pile on. Churning. Excessive trading. Unsuitable trading. Willful violation. Section 10(b). Rule 10b-5. Rule 2020. Rule 2111. Rule 2010. A Bar. Amazing how the weight of regulation comes down after the carnage is done. When all is said and done, merely barring Waters isn't a victory for FINRA but more of a demonstration of the impotence of modern-day Wall Street regulation. It amounts to nothing more than reading toe-tags in the morgue -- it's all too late to do any good.