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FINRA Turns 300 Orally Authorized Trades Into 300 Trades Of Unauthorized Discretion
October 30, 2020
In the hurry-up world of Wall Street, profits are often measured in seconds. Timing is everything. Get in early. Get out before it's too late. But in an industry so dependent upon timing, the rules about when and how an order is taken and when it is executed are not clear. While a stockbroker or a trader frets about when is the right time to buy or sell, profits may be squandered and losses accumulate. In a recent FINRA regulatory settlement, time ran out for one industry respondent.
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, Samuel K. Van Allen, submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. In the Matter of Douglas William Stopkey Respondent (FINRA AWC 2018059872901 / October 26, 2020)
https://www.finra.org/sites/default/files/fda_documents/2018059872901
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The AWC alleges that Stopkey was first registered in 1992 with FINRA member firm Merrill Lynch, Pierce, Fenner & Smith, where he remained until September 2018. The AWC discloses under the heading "Relevant Disciplinary History":
In January 2020, Respondent entered a Settlement Order with the Commonwealth of Virginia's State Corporation Commission, Division of Securities and Retail Franchising relating to the misconduct described below. In that Order, Respondent settled allegations of, among things, exercising discretion without prior written authority and agreed to pay a fine of $10,000 and costs of $5,000.
A Matter of (In)Discretion
The line between discretion and authorization is not always a bright one, and sometimes the distinction between the two gets blurred. Within the context of a telephone call or email exchange between a customer and stockbroker, things get stated that may sort of seem like the customer gave the okay to place an order. It's that "sort of" aspect that can alter what looks like a bona fide non-discretionary order into one that involves the inappropriate exercise by the stockbroker of discretion, albeit limited and perhaps disputed. When such a sort-of order is accepted, it often occurs at a time when a stockbroker was speaking to the customer on the phone, while filling out an order ticket, while also reading an email, while also waving at an assistant to tell another customer to hold on for one more second, while also watching the stock-market screen on his desk. That's the swirl of confusion that exists at most branch offices throughout most business days. That's the setting in which lots of industry violations occur. Not intentional. Inadvertent. A misunderstanding. A misinterpretation. Good luck arguing nuance to FINRA.
NASD Conduct Rule 2510: Discretionary Accounts (replaced effective May 8, 2019, by FINRA Rule 3260: Discretionary Accounts) imposed a relatively simple compliance regime requiring prior written authorization by the customer coupled with the firm's written acceptance. After a duly authorized and approved discretionary trade has been placed, a member firm must undertake prompt written approval of each discretionary order; and, further, must frequently undertake a suitability review of discretionary accounts. That's about as straightforward a regulatory proposition as you could imagine.
NASD Rule 2510(d)(1) carved out an exception for Time And Price ("T&P") discretion. T&P comes into play when there's a customer order for the purchase or sale of a definite amount of a specified security but it's left to the stockbroker's discretion to decide the time and price at which the order is entered. T&P is an effective order ONLY until the end of the business day on which the customer granted such discretion. Under previous iterations of the Discretionary Rule, there wasn't an intra-day limit on T&P, which explains why industry veterans often mistakenly believe that they can still use T&P the next day(s) rather than within the same trade date.
Between January 7, 2016 and June 20, 2018, Stopkey effected approximately 300 trades in seven accounts owned by four senior customers without first speaking with the customers on the days he effected the trade orders. Although the customers orally authorized Respondent to exercise discretion in their accounts, they had not given written authorization for the accounts to be discretionary. Nor did the firm approve the customer accounts as discretionary.On three firm compliance questionnaires dated March 14, 2016, March 13, 2017, and March 14, 2018, Stopkey inaccurately stated that he had not utilized time or price discretion, or entered trade orders prior to speaking with a client, in a client account. Further, in response to compliance staffs inquiry into one of the subject trades, Stopkey inaccurately suggested that the trade was the customer's idea.
Notwithstanding that none of Stopkey's four senior customers complained about the 300 trades and notwithstanding that Stopkey admitted the misconduct at issue, the AWC found that Stopkey's above-cited conduct constituted violations of NASD Rule 2510(b) and FINRA Rule 2010.
[UN]Solicited
The AWC further alleges that in violation of FINRA Rules 4511 and 2010:
Between January 7, 2016 and June 20, 2018, Respondent marked order tickets for approximately 65 trades in the seven customer accounts referenced above as "unsolicited" although he did not discuss the trades with the customers.
In accordance with the terms of the AWC, FINRA imposed upon Stopkey a 30-calendar-day suspensions with any FINRA member in any capacity. In declining to impose a fine, the AWC notes that:
In determining the appropriate sanctions in this matter, FINRA considered, among other factors, that Respondent previously paid a fine of $10,000 and costs of $5,000 to the Commonwealth of Virginia as referenced above.
Bill Singer's Comment
Upfront, let me be clear -- this is a well written AWC replete with sufficient content and context so as to render it intelligible. Moreover, the sanctions imposed (and not imposed) reflect a fair and balanced regulatory approach by FINRA. All in all, a fine settlement.
Now, do me a favor. Read and then re-read FINRA Rule 3260(d)(1):
SIDE BAR: FINRA Rule 3260: Discretionary Accounts (Effective May 8, 2019 replaced NASD Rule 2510)(a) Excessive TransactionsNo member shall effect with or for any customer's account in respect to which such member or his agent or employee is vested with any discretionary power any transactions of purchase or sale which are excessive in size or frequency in view of the financial resources and character of such account.(b) Authorization and Acceptance of AccountNo member or registered representative shall exercise any discretionary power in a customer's account unless such customer has given prior written authorization to a stated individual or individuals and the account has been accepted by the member, as evidenced in writing by the member or the partner, officer or manager, duly designated by the member, in accordance with Rule 3110.(c) Approval and Review of TransactionsThe member or the person duly designated shall approve promptly in writing each discretionary order entered and shall review all discretionary accounts at frequent intervals in order to detect and prevent transactions which are excessive in size or frequency in view of the financial resources and character of the account.(d) ExceptionsThis Rule shall not apply to:(1) discretion as to the price at which or the time when an order given by a customer for the purchase or sale of a definite amount of a specified security shall be executed, except that the authority to exercise time and price discretion will be considered to be in effect only until the end of the business day on which the customer granted such discretion, absent a specific, written contrary indication signed and dated by the customer. This limitation shall not apply to time and price discretion exercised in an institutional account, as defined in Rule 4512(c), pursuant to valid Good-Till-Cancelled instructions issued on a "not-held" basis. Any exercise of time and price discretion must be reflected on the order ticket;(2) bulk exchanges at net asset value of money market mutual funds ("funds") utilizing negative response letters provided:
(A) The bulk exchange is limited to situations involving mergers and acquisitions of funds, changes of clearing members and exchanges of funds used in sweep accounts;(B) The negative response letter contains a tabular comparison of the nature and amount of the fees charged by each fund;(C) The negative response letter contains a comparative description of the investment objectives of each fund and a prospectus of the fund to be purchased; and(D) The negative response feature will not be activated until at least 30 days after the date on which the letter was mailed.
Now that you've read the Rule 3260, let's consider the highlighted portion below:
Okay, so, let's try these two hypotheticals and see how FINRA Rule 3260(d)(1) provides guidance:(d) ExceptionsThis Rule shall not apply to:(1) discretion as to the price at which or the time when an order given by a customer for the purchase or sale of a definite amount of a specified security shall be executed, except that the authority to exercise time and price discretion will be considered to be in effect only until the end of the business day on which the customer granted such discretion, absent a specific, written contrary indication signed and dated by the customer. . . .
1. Customer Smith calls Registered Representative Repp at 5 p.m. Eastern Time on a Tuesday. The markets are closed. Customer Smith tells Repp to "sell my 200 shares of XYZ stock tomorrow at a time and price you think is best."2. Customer Smith calls Registered Representative Repp at 5 p.m Eastern Time on a Friday. The markets are closed. Customer Smith tells Repp to "sell my 200 shares of XYZ stock on Monday at a time and price you think is best."
Is the "business day" set out in the Rule the same as a "trading day?" Does the "business day" set out in the Rule end at 4 p.m. Eastern Time when the markets purportedly close -- or does that day expand to when the branch office closes? Since Order #1 was submitted after a trading day ended, may Repp exercise T&P discretion during the next trading day on Wednesday?
Solely referencing the yellow highlighted portion of FINRA Rule 3260(d)(1), would Repp be able to exercise T&P for Order #2?
Is the "business day" set out in the Rule the same as a "trading day?" Does the "business day" set out in the Rule end at 4 p.m. Eastern Time on a Friday, when the markets purportedly close for the weekend -- and if a Friday order placed after the "close" is deemed to have been submitted after the end of a "trading day," can T&P be exercised "until the end of the business day" on Monday?
The purpose of this exercise in attempting to decipher FINRA's rulebook is designed to present you with an example of the poorly drafted nature of many of the industry's many laws, rules, and regulations. Using whatever online search tool you prefer, see if you can find a working FINRA definition of "business day" for purposes of deciphering FINRA Rule 3260(d)(1). See if you can find a formal FINRA Interpretation about the specific issues raised in Orders #1 and #2. Oh . . . by the way . . . the stockbroker Repp doesn't have hours or days to investigate. He has a customer's order. There are consequences to not entering the order for execution. There are consequences for entering the order if it involves unauthorized discretion. You'd like to think that an industry professional could just read FINRA Rule 3260(d)(1) and get the answers to the two simple questions that I posed. Think again.