In today’s industry, we can never stress the importance of well-drafted Written Supervisory Procedures (“WSPs”) to our clients enough. This month’s Risk Management Tip will discuss a December 2018 case further exemplifying the importance of such matters. As further described below, the firm in question ultimately lost its FINRA hearing, resulting in censures and a fine of $500,000. But fine aside, the peripheral costs of this case – such as time, reputation and legal fees, further expound the damages experienced by the firm. Windsor Street Capital, LP fka Meyers Associates, L.P.
In the case Windsor Street Capital, LP fka Meyers Associates, L.P. (CRD #34171, New York, New York) (FINRA Case #2015046971701) sanctions were based on findings that Windsor Street Capital failed to construct sufficient WSPs or establish and maintain a reasonable supervisory system. The firm also failed to reasonably supervise two registered representatives who were unsuitably trading in an account owned, through a trust, by an elderly couple.
In this case, FINRA argued the firm’s WSPs were woefully inadequate. Many Broker-Dealers believe that when WSPs are very general, not specific, and doesn’t name specific supervisors, then the enforcement is lax, and they have more freedom and liberty to operate under their own terms. However, that is the specific reason for this firm’s failures. Not only were the procedures within the WSPs not reasonably designed to achieve compliance, but they were vague, unspecific, and required no accountability for to anyone at the firm.
Below are a few considerations as highlighted by FINRA that were not in the WSPs and not implemented or completed by the firm. Specifically, Windsor Street Capital:
- Lacked a systematic process for monitoring, detecting, investigating, or addressing improper sales practices and unsuitable trading.
- Failed to require documentation or record of transactions.
- Claimed that their WSPs included a specific section detailing procedures for addressing actively traded accounts, like the trust account in question. But upon further inspection of the WSPs, FINRA found that the section and the procedures did not exist.
- Relied heavily on supervisors to review the daily blotters for improper trading practices. But upon review, the blotters were inadequate and lacked the necessary historical information needed to see patterns of trading, commissions and accumulated loss.
- Failed to adequately train supervisors on what constitutes unsuitable trading or how to identify it.
- Failed to implement remedial measures or sanctions upon the finding of unsuitable trading (in the WSPs, had a problem or potential problem been discovered; it was up to the supervisor’s discretion how to address the problem, and suggested actions would only involve internal discussions).
- Failed to provide specificity in its WSPs that supervisors independently verify information, such as by contacting the customer.
These issues, among others, led to their failure to reasonably supervise the unsuitable trading behaviors of two representatives in a trust account. The firm continuously neglected the many red flags that should have otherwise been identified, and failed to act, investigate, remediate, and/or prevent similar future misconduct.
Although there were deficiencies in the trade blotters, the observed behaviors of the firm should have raised two red flags:
- The unusually large size of the trades; and
- The repetition and frequency of the unusually large trades each month.
It should be noted that more red flags should have been raised/identified when monthly exception reports from the BD’s clearing firms were reviewed (if they were reviewed). As these reports contain historical information and revealed patterns of accumulating losses, high commissions and high turnover.
Despite all the warnings and apparent red flags, the firm never identified the trading behaviors as potentially problematic. According to FINRA’s observations, the lack of internal discussions regarding concerns about the trading behaviors – either with the representatives or with the customers, were also highly concerning and seen as neglect. Seemingly oblivious toward adequate procedures within their WSPs, their failure to also inquire whether the elderly client authorized and understood the trading in their account showed immense lapse in judgement and neglect to client protection.
Further, when the aforementioned customers became aware of the unusual trading and contacted the firm to cease such trades, the firm was unresponsive and failed to take any action to remedy the issue It wasn’t until approximately four months after the customers issued their first complaint that the firm finally closed the account; but not before charging a substantial commission on the last transaction, only to return the customers’ remaining, greatly reduced, principal. Thus, not only did the firm fail to identify, monitor and/or discuss apparent red flag issues, but it neglected to timely respond to the clients’ complaints or take any remedial actions.
Lessons Learned – The Value of WSPs
Firms should regularly review and evaluate the efficacy of their own WSPs. If your WSPs cannot or do not specifically outline what should be done, by who, how and when then that is your assignment post haste.
But having adequate WSPs is not enough, either. At JLG, we encourage regular reviews/testing of WSPs. There should also be procedures created that specify the nature and documentation of such reviews.
What we can learn from this case is that there are many ways that FINRA can get you, from Order Audit Trail System (OATS) and Trade Reporting And Compliance Engine (TRACE) to trading practices. Generally, WSPs are established to develop systems and processes for a firm’s unique business model and culture. They set a tone, expectation and protection for the organization and their clients. A frequent mistake seen in the industry is implementing “generic” or “template” WSPs that fail to be customized to a firm’s business operations. This often leads to WSP failures. We encourage firms to continually review WSPs to ensure they are and remain applicable the firm’s business practices
For assistance in developing, reviewing and/or testing your WSPs, or for information on other regulatory considerations, please contact us at email@example.com, or (619) 298-2880. Also, please visit our website at www.jackolg.com for additional Legal Risk Management Tips.
Author: David M. Sobel., FINRA Specialist; Editor: Robert R. Boeche II, Esq., Senior Associate, Jacko Law Group, PC (“JLG”). JLG works extensively with investment advisers, broker-dealers, investment companies, private equity and hedge funds, banks and corporate clients on securities and corporate counsel matters. For more information, please visit https://www.jackolg.com/.
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