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FINRA AWC Did Not Require Acceptance of Findings But Why Does Regulator Publish Denials?
August 9, 2021
A recent FINRA AWC sanctions a registered representative for engaging in a complex put strategy on behalf of two customers. FINRA is to be complimented for publishing a very credible settlement document, and industry participants and public investors would do well to read the fact pattern and learn the lessons. Once my applause has died down, however, FINRA would do well to consider some of the questions that I have raised. Notably, if the hallmark of an AWC settlement is that a respondent does not have to admit or deny the findings, how the hell does FINRA tolerate published denials on its BrokerCheck database?
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, Cesar Hurtado submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. In the Matter of Cesar Hurtado, Respondent (FINRA AWC 2020068662501)
https://www.finra.org/sites/default/files/fda_documents/2017055890901
%20Cesar%20Hurtado%20CRD%204137948%20AWC%20va.pdf
%20Cesar%20Hurtado%20CRD%204137948%20AWC%20va.pdf
The AWC asserts that Cesar Hurtado was first registered in 2000 and by January 2003, he was registered with Oppenheimer & Co., Inc.
The Put Spread Strategy
The AWC alleges that in violation of FINRA Rules 2111(a), 2360(b)18)(A), and 2010, during the relevant period between January 2013 and August 2019:
[H]urtado recommended and effected a complex put spread strategy for two customers. Both customers were inexperienced options investors with relatively conservative investment objectives. They both relied on their brokerage accounts for income. Hurtado understood that put spreads are designed as a risk-containment strategy and recommended such investments to these customers in those terms. In practice, however, with certain put spread transactions, Hurtado recommended that the customers forego this risk mitigation mechanism. Specifically, after putting on the initial put spread, Hurtado recommended that the customers take assignment of, and hold, securities whose stock prices had already declined, on occasions where he remained bullish on these securities. In many instances, after the customer held the security for a period of time, Hurtado recommended that the customer sell the security at a loss larger than the original put spread's maximum loss.For example, Hurtado recommended that one customer complete a put spread on Twitter stock. At the outset of the transaction, the customer faced a maximum loss of $92,700 on the put spread strategy. After the customer purchased the initial options contracts, the stock price of Twitter declined. Hurtado, however, did not recommend that the customer close out the positions and thus protect against further loss. Hurtado instead recommended that the customer roll the investment into long puts with lower strike prices, then eventually take assignment and hold the security. Finally, Hurtadorecommended that the customer sell the stock at a loss. The customer ultimately lost over $207,000 on the series of transactions - more than double the original maximum loss had Hurtado implemented the put spread strategy as intended.Hurtado also magnified the risk of numerous put spread transactions, and subsequentassignments, by recommending that the two customers fund assignments on margin.Executing securities transactions on margin increases risk by exposing the account tomargin calls and by requiring the customer to pay interest on the margin loan. Indeed,both accounts saw individual assignments of nearly $1 million funded on margin duringthe relevant period. Also, in 2015, Hurtado recommended that the customers overconcentrate their options investments in the energy sector, thus further increasing the risk of loss once the customers took assignment of the subject securities.
Net Losses
The AWC alleges that as a result of Hurtado's purportedly flawed strategy, two customers sustained about $1.6 million in net losses. The AWC alleges that Oppenheimer settled with the customers for $560,000 of which Hurtado contributed $280,000.
BrokerCheck Disclosures
Online FINRA BrokerCheck records as of August 9, 2021, disclose under the heading "Customer Dispute -- Settled" two FINRA Arbitration claims involving Hurtado:
1. $1.7 million in damages filed on August 13, 2019, and settled on July 16, 2020, for $275,000 ($137,500 contribution from Hurtado)
Broker Statement: I AT ALL TIMES CONDUCTED MYSELF IN AN APPROPRIATE AND PROFESSIONAL MANNER. I DENY ALL ALLEGATIONS OF WRONGDOING, AND INTEND TO VIGOROUSLY DEFEND MYSELF AGAINST THE UNWARRANTED AND UNSUPPORTABLE ALLEGATIONS
2. $1 million in damages filed on September 28, 2017, and settled on November 6, 2018, for $285,000 ($142,500 contribution from Hurtado).
Broker Statement: MR. HURTADO AT ALL TIMES CONDUCTED HIMSELF IN AN APPROPRIATE AND PROFESSIONAL MANNER. HE DENIES ALL ALLEGATIONS OF WRONGDOING AND INTENDS TO VIGOROUSLY DEFEND HIMSELF AGAINST UNWARRANTED AND UNFOUNDED ALLEGATIONS. FURTHERMORE, THE ACCOUNTS EXPERIENCED SIGNIFICANT GAINS WHILE SERVICED BY MR. HURTADO
FINRA Sanctions
In accordance with the terms of the AWC, FINRA imposed upon Hurtado a $5,000 fine, a 45-day suspension from associating with any FINRA member in all capacities, and an undertaking to attend and complete at least 10 hours of continuing education concerning options trading and suitability.
Bill Singer's Comment
First and foremost, compliments to the FINRA Staff responsible for this AWC -- a very well-written settlement document that methodically explains the underlying options strategy, and, as a result, provides helpful guidance to industry participants and the investment public.
Alas . . . we now come to the infamous "on the other hand."
Where Was Oppenheimer's Compliance Department?
Given that Hurtado had recommended his options strategy between January 2013 and August 2019, where the hell Oppenheimer & Co., Inc.'s Compliance Department was for over six and half years? After all, the AWC alleges that [Ed: highlighting added]:
During the relevant period, Hurtado recommended and effected a complex put spread strategy for two customers. Both customers were inexperienced options investors with relatively conservative investment objectives. They both relied on their brokerage accounts for income. . . .
I mean, c'mon, how the hell did Oppenheimer's Compliance Department fail to flag the two accounts on a timely basis? And that question raises a further question: Why is there not a single reference in the AWC to Oppenheimer's supervision and/or the firm's compliance role?
2019 FINRA Oppenheimer AWC
In 2019 FINRA issued "FINRA Orders Oppenheimer & Co. Inc. to Pay $3.8 Million in Restitution to Customers for Supervisory Failures Involving Unit Investment Trusts" (FINRA News Release / December 30, 2019) https://www.finra.org/media-center/newsreleases/2019/finra-orders-oppenheimer-co-inc-pay-38-million-restitution-customers Frankly, the FINRA Press Release's headline pretty much tells the whole story. In the aforementioned 2019 Oppenheimer AWC, the cited relevant period ran from January 2011 through December 2015 -- which began about two years before the Hurtado options strategy was deployed but covered the entire 2013, 2014, and 2015 years during which the Hurtado strategy was in play. How did FINRA sign off on a multi-million supervisory-failure case at Oppenheimer in 2019 without having apparently made timely inquiry as to other ongoing supervisory failures such as Hurtado? Keep in mind that FINRA's BrokerCheck discloses that the two "Settled" arbitrations against Oppenheimer/Hurtado were filed in September 2017 (the $1 million in claimed damages) and in August 2019 (the $1.7 million in claims damages), and, as such, both of those pending claims were a matter of record for over two years and for four months, respectively, when FINRA entered into its December 30, 2019 UIT AWC with Oppenheimer.
FINRA's Suspect Math
The AWC alleges Hurtado's two customers sustained about $1.6 million in net losses; and that Oppenheimer settled with the customers for $560,000 of which Hurtado contributed $280,000.
In contrast, the BrokerCheck disclosures assert "alleged damages" of $1,700,000.00 and $1,000,000.00 -- which adds up to $2.7 million, which is $1.1 million larger than the AWC's reported losses.
I fully understand that FINRA's calculation of "losses" may differ from that of "damages;" however, the AWC should have disclosed the different dollar valuations and offered a brief explanation.
Unsettling Settlement
The AWC asserts that the two customers received $560,000 in settlement payments but there is no explanation as to why FINRA did not order disgorgement or restitution for the "shortfall" between the $1.6 million in losses that the AWC asserts and the $560,000 that was paid via settlement. Yes -- I fully understand that the two customers entered into a settlement with Oppenheimer, and if that's FINRA's basis for not ordering further payments by Oppenheimer/Hurtado to the customers, then the AWC should have so stated. Hopefully, FINRA inquired of the two customers as to why they accepted half of their alleged losses, but the AWC should have disclosed such an inquiry and explained how it factored into the regulator's imposition of sanctions.
Without Denying?
As is set forth in the boilerplate for all AWCs:
Respondent hereby accepts and consents, without admitting or denying the findings . . .
Hurtado's two "Broker Statements" as extant on BrokerCheck deny wrongdoing in response to two customer complaints, which are the only customer complaint disclosures on his BrokerCheck record, and, by deduction, they must be the same customer complaints referenced in the AWC. If an AWC is entered into with the acknowledgment that a respondent does not deny the findings, how does FINRA reconcile that requirement with the express, published language on BrokerCheck in which Hurtado clearly denies the allegations?