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FINRA Rights REIT Wrongs With Fine and Suspension
April 18, 2022
In today's blog we are left wondering. FINRA makes an exceptionally strong regulatory case against a former Morgan Stanley registered representative, who is charged with multiple violations. All in all, it's not a pretty picture that FINRA paints. It's the strength of FINRA's case that may raise an eyebrow or two when you learn that the rep was not barred from the industry. Of course a three-month suspension isn't a light slap on the wrist. Still -- you read the allegations and see what you think.
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, Christopher J. Passero submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. The AWC asserts that Christopher J. Passero was first registered in 1994 with Money Concepts Capital Corp.
In the Matter of Christopher J. Passero, Respondent (FINRA AWC 2020066345701)
https://www.finra.org/sites/default/files/fda_documents/2020066345701
%20Christopher%20J.%20Passero%2C%20CRD%202517681%20AWC%20gg.pdf
%20Christopher%20J.%20Passero%2C%20CRD%202517681%20AWC%20gg.pdf
Share and Share Alike?
Just before the onset of the Great Recession, the AWC alleges that between 2006 and 2008, Passero had recommended investing in a
real estate investment trust (referred to in the AWC as "REIT A"). After restating its value in 2010, which precipited a share-price decline and monthly dividend reductions, REIT A gave up the ghost with a final cash distribution in August 2018. Even after making allowances for the years of distributions
and dividends, many of Passero's customers lost money on the investment. As the AWC picks up the action:
Passero began making payments to certain of his MCC customers shortly after REIT A's re-statement in value in 2010 and those payments continued through February 2020, During this period, Passero made payments to nine MCC customers to compensate them for the reduction in monthly dividends. Passero made 990 payments totaling $249,560 to the nine MCC customers, all of whom invested in REIT A. Passero made the payments on a monthly basis and in various forms, including personal checks.
How the hell does a Wall Street professional get into trouble because he compensated his clients for their losses? Good question. And, frankly, a very sensible answer -- as will be forthcoming.
SIDE BAR: Goin' to FINRA's RulebookFINRA Rule 2150: Improper Use of Customers' Securities or Funds; Prohibition Against Guarantees and Sharing in Accounts(a) Improper UseNo member or person associated with a member shall make improper use of a customer's securities or funds.(b) Prohibition Against GuaranteesNo member or person associated with a member shall guarantee a customer against loss in connection with any securities transaction or in any securities account of such customer.(c) Sharing in Accounts; Extent Permissible(1)(A) Except as provided in paragraph (c)(2), no member or person associated with a member shall share directly or indirectly in the profits or losses in any account of a customer carried by the member or any other member; provided, however, that a member or person associated with a member may share in the profits or losses in such an account if:
(i) such person associated with a member obtains prior written authorization from the member employing the associated person;(ii) such member or person associated with a member obtains prior written authorization from the customer; and(iii) such member or person associated with a member shares in the profits or losses in any account of such customer only in direct proportion to the financial contributions made to such account by either the member or person associated with a member.
(B) Exempt from the direct proportionate share limitation of paragraph (c)(1)(A)(iii) are accounts of the immediate family of such member or person associated with a member. For purposes of this Rule, the term "immediate family" shall include parents, mother-in-law or father-in-law, husband or wife, children or any relative to whose support the member or person associated with a member otherwise contributes directly or indirectly.
(2) Notwithstanding the prohibition of paragraph (c)(1), a member or person associated with a member that is acting as an investment adviser may receive compensation based on a share in profits or gains in an account if:
(A) such person associated with a member seeking such compensation obtains prior written authorization from the member employing the associated person;
(B) such member or person associated with a member seeking such compensation obtains prior written authorization from the customer; and
(C) all of the conditions in Rule 205-3 of the Investment Advisers Act (as the same may be amended from time to time) are satisfied.Supplementary Material.01 Inapplicability of Rule to Certain Guarantees. For purposes of paragraph (b) of this Rule, a "guarantee" that is extended to all holders of a particular security by an issuer as part of that security generally would not be subject to the prohibition against guarantees..02 Permissible Reimbursement by Member of Certain Losses. Nothing in this Rule shall preclude a member, but not an associated person of the member, from determining on an after-the-fact basis, to reimburse a customer for transaction losses; provided, however, that the member shall comply with all reporting requirements that may be applicable to such payment. For example, if the payment can reasonably be construed as a settlement, the member shall report the payment as a settlement under the applicable reporting requirement(s). In addition, nothing in this Rule shall preclude a member, but not an associated person of the member, from correcting a bona fide error. This Supplementary Material .02 does not apply to an associated person of a member because of the concern that any such payment may conceal individual misconduct..03 Record Retention. For purposes of paragraph (c) of this Rule, members shall preserve the required written authorization(s) for at least six years after the date the account is closed..04 Applicability of Other Rules to Sharing Arrangements. Members and associated persons should be aware that participation in a sharing arrangement permitted under paragraph (c) of this Rule does not affect the applicability of other FINRA rules, including paragraph (b) of this Rule, FINRA Rules 3210, 3270 and 3280 to such sharing arrangement.
The first problem with Passero's payments is that they were made in contravention of MCC's written supervisory procedures ("WSPs"), which prohibited such customer reimbursement absent the firm's authorization; and, since Passero didn't tell the firm and never sought authorization, well, clearly he violated the house rules. Making matters worse, from 2010 to 2020, Passero alleged submitted MCC annual compliance
questionnaires in which he falsely stated that he did not share directly or indirectly in
customers' losses. And making worse matters worser (or "more worst" if you prefer) Passero violated FINRA Rule 2150(c) because the payments were made in violation of the prohibition against "sharing in losses." On top of that, a violation of FINRA Rule 2150 also constitutes a violation of FINRA Rule 2010.
Passero Lends Money to Customer
As if often the case in life and on Wall Street, any misstep often involves a cascade of unintended consequences. As set out in the Passero AWC, FINRA managed to nail the Respondent for a second, separate transgression:
In May 2015, Passero loaned $10,000 to a firm customer to assist the customer in paying a tax liability. At the time of the loan, MCC's WSPs prohibited representatives from loaning money to customers without the firm's prior authorization. Passero did not notify MCC about the loan to his customer. Additionally, in 2015, Passero completed and submitted to the firm a compliance questionnaire in which he falsely stated that he did not loan money to customers.By failing to obtain MCC's authorization to make the loan, Passero violated FINRA Rules 3240 and 2010.
Going back to FINRA's Rulebook:
SIDE BAR: Goin' to FINRA's Rulebook (A Double Dip)
FINRA Rule 3240: Borrowing From or Lending to Customers(a) Permissible Lending Arrangements; ConditionsNo person associated with a member in any registered capacity may borrow money from or lend money to any customer of such person unless:
(1) the member has written procedures allowing the borrowing and lending of money between such registered persons and customers of the member;
(2) the borrowing or lending arrangement meets one of the following conditions:
(A) the customer is a member of such person's immediate family;
(B) the customer (i) is a financial institution regularly engaged in the business of providing credit, financing, or loans, or other entity or person that regularly arranges or extends credit in the ordinary course of business and (ii) is acting in the course of such business;(C) the customer and the registered person are both registered persons of the same member;(D) the lending arrangement is based on a personal relationship with the customer, such that the loan would not have been solicited, offered, or given had the customer and the registered person not maintained a relationship outside of the broker-customer relationship; or(E) the lending arrangement is based on a business relationship outside of the broker-customer relationship; and
(3) the requirements of paragraph (b) of this Rule are satisfied.(b) Notification and Approval(1) The registered person shall notify the member of the borrowing or lending arrangements described in paragraphs (a)(2)(C), (D), and (E) above prior to entering into such arrangements and the member shall pre-approve in writing such arrangements. The registered person shall also notify the member and the member shall pre-approve in writing any modifications to such arrangements, including any extension of the duration of such arrangements.(2) With respect to the borrowing or lending arrangements described in paragraph (a)(2)(A) above, a member's written procedures may indicate that registered persons are not required to notify the member or receive member approval either prior to or subsequent to entering into such borrowing or lending arrangements.(3) With respect to the borrowing or lending arrangements described in paragraph (a)(2)(B) above, a member's written procedures may indicate that registered persons are not required to notify the member or receive member approval either prior to or subsequent to entering into such borrowing or lending arrangements, provided that, the loan has been made on commercial terms that the customer generally makes available to members of the general public similarly situated as to need, purpose and creditworthiness. For purposes of this subparagraph, the member may rely on the registered person's representation that the terms of the loan meet the above-described standards.(c) Definition of Immediate FamilyThe term "immediate family" means parents, grandparents, mother-in-law or father-in-law, husband or wife, brother or sister, brother-in-law or sister-in-law, son-in law or daughter-in-law, children, grandchildren, cousin, aunt or uncle, or niece or nephew, and any other person whom the registered person supports, directly or indirectly, to a material extent.Supplementary Material:.01 Record Retention. For purposes of paragraph (b)(1) of this Rule, members shall preserve the written pre-approval for at least three years after the date that the borrowing or lending arrangement has terminated or for at least three years after the registered person's association with the member has terminated.
Sanctions
In accordance with the terms of the AWC, FINRA imposed upon Passero a $10,000 fine and a three-month suspension from associating with any FINRA member in all capacities.
Passero's Corrective Action Statement
FINRA AWCs permit the attachment of a Corrective Action Statement to demonstrate the steps taken by a respondent to prevent future misconduct subject to the understanding that such an attachment may not deny the charges or make any statement that is inconsistent with the AWC. Further the Corrective Action Statement does not constitute factual or legal findings by FINRA, nor does it reflect the views of FINRA or its staff.
I am no fan of Corrective Action Statements and rarely, if ever, advocate their use. Given that the premise of an AWC is a settlement made without admitting or denying the findings, I don't understand why anyone would prepare a statement that tends to typically make admissions, promises to correct situations that have not necessarily been acknowledged, and, in the end, simply draws more undesired attention to the matter. If you feel compelled to attach a Corrective Action Statement, then you may want to pause before signing the AWC and ask yourself if you might not be better advised to argue your case before a Hearing Panel and, if necessary, on appeal afterwards.
If you conclude that the costs and/or risks of contesting the charges aren't worth it, then just sign the damn AWC and get over it. There's no need whatsoever to engage in a post-game, public analysis. Some think that this after-the-fact statement gives you a parting shot at unfair regulation or an opportunity to put your own spin on the matter. I would suggest that you simply avoid the temptation. Keep in mind that a Corrective Action Statement may actually set you and your firm up for heavier sanctions down the road if you acknowledge wrongdoing and propose a set of remedial actions. If during subsequent examinations, a regulator finds that you engaged in similar misconduct to that discussed in the statement, or, it is alleged that you failed to implement the promised revised policies and procedures, your own words may prove blunt instruments used to beat you into submission.
Notwithstanding my opinion, Passero apparently determined that it was advisable to submit a Corrective Action Statement and hopefully that step will prove favorable to the firm:
CORRECTIVE ACTION STATEMENT
ON BEHALF OF CHRISTOPHER J. PASSERO (CRD NO. 2517681)FINRA MATTER NO. 2020066345701This Corrective Action Statement is submitted by the Respondent, Christopher J. Passero (CRD No. 2517681). It does not constitute factual or legal findings by FINRA, nor does it reflect the view of FINRA, or its staff.Since disclosing to Money Concepts Capital Corp. (MCC) (CRD No. 12963) the payments he made to nine (9) customers, Christopher J. Passero has taken the following continuing education courses (assigned by MCC's Compliance Department). Certificates for each completed course are attached:In addition to the formal coursework, MCC's Chief Compliance Officer met with Mr. Passero in May 2020 for a one-on-one compliance training to review MCC's policies and procedures. Among the issues discussed were the applicable rules, exemptions, and reporting requirements when giving a gift to a client; managing conflicts of interest; ensuring all customer transactions are authorized, suitable, and properly documented (including client signatures); and, ethical handling of customer accounts. Mr. Passero also was placed on heightened supervision.
- Gifts and Entertainment (Course No. 237627) (completed 5/23/2020)
- REITs: Risks, Benefits, Distribution and Suitability (Course No. 377) (completed 2/14/2022)
- Whether REITs are Right or Wrong (Course No. 836) (completed 2/14/2022)
- Annuity Suitability and Disclosure (Course No. 390-MN) (completed 3/21/2022)
- Suitability of Annuity Transactions Under Best-Interest Standard, 2nd Ed. (Course No. 176- 2) (completed 3/21/2022)
- Sales Practices for Senior Clients (Course No. 963) (completed 3/23/2022)
- Anti-Money Laundering- General (Course No. 3514) (completed 3/23/2022)
- Cybersecurity- Threats & Trends (Course No. 933) (completed 3/23/2022)
Mr. Passero experienced serious health issues in 2020 and 2021. These issues prevented him from attending additional courses and substantially limited his ability to work.Mr. Passero met again with MCC's Chief Compliance Officer and other MCC principals in January 2022. His heightened supervision was extended through at least May 31, 2022.The heightened supervision includes an in-person audit by MCC's Compliance principal within the first two quarters of 2022, during which Mr. Passero must be present. Additionally, prior to making a recommendation in any alternative investments, Mr. Passero must contact MCC's principal to discuss Mr. Passero's reasoning behind the proposed recommendation. Mr. Passero understands that MCC, at the principal's discretion, may require a written statement signed by the client, outlining the client's understanding of the lack of liquidity with the investment; the risks involved; the client's time horizon; their investment objective; and, the reasons they want to continue with the transaction. Such written statement from the client would be in addition to the signed Disclosure Statement. Further, Mr. Passero understands that MCC may call the client to verify the details provided on the New Account Form, evaluate the client's understanding of the offering's features (e.g. holding period, liquidity events, etc.), and ask the client to verbally confirm they want to continue to invest in the offering.