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The Financial Industry Regulatory Authority (“FINRA”) recently expelled broker-dealer SW Financial and suspended the firm’s CEO. The Letter of Acceptance, Waiver, and Consent (“AWC”) related to the misconduct alleges that SW Financial exposed customers to significant risk of harm. The AWC provides insight into how FINRA will continue to enforce and apply Securities Exchange Act Rule 15l-1(a) (“Reg BI”), which became effective in June 2020.
Reg BI requires broker-dealers and their associated persons to act in the best interest of retail customers when making investment recommendations. The Disclosure Obligation within Reg BI requires broker-dealers and associated persons to provide retail customers full disclosures of all material facts relating to conflicts of interest prior to making investment recommendations.
The AWC claims that SW Financial falsely informed investors and FINRA that it would receive only a ten percent sales commission. FINRA argued that SW Financial failed to disclose it would receive an additional five percent in selling compensation and half of any carried interest. In total, the compensation arrangement SW Financial allegedly failed to disclose resulted in approximately $2 million in undisclosed compensation.
Reg BI also requires those engaged in selling a private placement to conduct reasonable due diligence prior to offering the investment to customers. The AWC asserts that SW Financial violated this rule by failing to take reasonable steps to verify that the Issuer had access to the pre-IPO shares that were the subject of the Offerings. These shares were the Offerings’ only purported assets. Furthermore, SW Financial allegedly did not determine the amount of the markups by the Issuer or disclose this information to customers.
The AWC also claims SW Financial engaged in churning of numerous customer accounts. Churning is excessive trading with an intent to defraud or with a reckless disregard of the customer’s interests. In churning customer accounts, SW Financial violated Section 10(b) of the Exchange Act, Exchange Act Rule 10b-5 and FINRA Rules 2111, 2020, and 2010.
Lastly, the AWC added that by allowing these violations to occur, SW Financial failed to establish and enforce a supervisory system reasonably designed to achieve compliance with the Securities Exchange Act and FINRA Rules relating to private placements and churning. The AWC specifically explained that while SW Financial had reasonable written supervisory procedures (“WSP”), they failed to follow the required procedures. For example, under the WSP, a designated supervisor was responsible for ensuring that the firm performed reasonable due diligence for each private offering and was required to complete a due diligence checklist. Yet, this was not performed for 21 specific Offerings.
“When firms, particularly those with significant disciplinary histories, commit egregious sales practice and supervisory violations, expulsion from FINRA membership may be warranted” said Christopher J. Kelly, Senior Vice President and Acting Head of FINRA’s Department of Enforcement.
SW Financial has not accepted any of the above facts as true but agreed to sign the AWC in order to resolve the alleged violations of FINRA’s Rules.