In 2017, the Financial Industry Regulatory Authority (FINRA) ordered more than two times the restitution from the prior year, resulting in the fourth highest total of sanctions (fines combined with restitution and disgorgement) assessed over the past 10 years, despite a decline in the amount of fines and the number of cases. This review of FINRA’s 2017 cases analyzes the issues that resulted in the most significant fines, and identifies emerging enforcement issues and trends. Cases involving variable annuities are also separately analyzed.
Restitution, Fines, and Disciplinary Actions
In 2017, the restitution ordered by FINRA rose sharply. FINRA reported restitution of approximately $67 million in 2017, an increase of 139% from the $28 million in restitution reported in 2016,1 but still below the record of $96 million ordered in 2015.
The fines reported by FINRA in 2017 decreased significantly to $67 million from the record-setting fines of $176 million in 2016, a 62% decrease. The 2017 fines were also 29% less than the $94 million in fines reported in 2015. Despite this shortfall, fines have increased by 139% since 2008, when FINRA assessed fines of $28 million.
The number of very large or “supersized” fines of $1 million or more also declined in 2017. FINRA assessed 15 supersized fines in 2017 in contrast to 34 in 2016. Similarly, in 2017, FINRA assessed two “yuuuge” fines of $5 million or more compared to eight “yuuuge” fines in 2016.
The decrease in fines is less pronounced when FINRA’s overall monetary sanctions are analyzed. The total sanctions ordered by FINRA in 2017 (i.e., fines, restitution, and disgorgement) were $144 million. The total sanctions ordered in prior years were as follows: $207 million in 2016; $193 million in 2015; and $168 million in 2014. Although the overall sanctions in 2017 were down compared to the recent record-setting years, they were still higher than any of the previous years from 2008 through 2013.
The number of cases reported by FINRA also decreased last year. FINRA reported 1,369 disciplinary actions in 2017, a decrease of about 5% from the 1,434 cases FINRA reported in 2016. Still, the number of cases filed by FINRA has grown from 1,073 in 2008, an increase of 28%.
The number of individuals barred and firms expelled decreased slightly in 2017 compared to 2016, while the number of individuals suspended increased slightly. The number of individuals barred decreased from 517 in 2016 to 492 in 2017, a 5% decrease. The number of firms expelled by FINRA decreased from 24 in 2016 to 21 in 2017, a decrease of 13%. The number of individuals suspended, however, increased marginally from 727 in 2016 to 733 in 2017, an increase of about 1%.
The chart below displays FINRA’s fines and the number of disciplinary actions during each of the past 10 years:
Listed below are the top FINRA enforcement issues for 2017 measured by total fines assessed:4
1. Anti-money laundering (AML) cases resulted in the most FINRA fines in 2017. This is the second year in a row that AML has topped the annual list of FINRA enforcement issues compiled by Eversheds Sutherland and the fourth year in a row that AML has appeared on this list. FINRA reported 16 AML cases in 2017, which resulted in $14.6 million in fines. While the number of cases decreased by 50% from 32 in 2016, the fines reported also dropped from $45.9 million in 2016, a decrease of 68%. AML maintained the top spot due to the largest single fine in 2017 ($13 million). In that case, a firm allegedly failed to establish and implement adequate AML procedures, resulting in the failure to properly prevent, investigate, and report more than 1,000 alerts of potentially suspicious activity.5 The firm’s automated monitoring system also failed to review millions of accounts and failed to link related accounts for high-risk customers. AML’s presence at the top of this list for the second year in a row confirms that FINRA is concerned with how firms are handling their AML compliance obligations.
2. Trade reporting cases resulted in the second most FINRA fines in 2017, up from its number three spot on our list last year. This is the fifth year in a row that trade reporting has appeared on this list. In 2017, FINRA reported $14.3 million in fines in 112 trade reporting cases. Compared to 2016, fines decreased 41% from $24.4 million, and the number of cases decreased 23% from the 146 cases reported in 2016. In the largest trade reporting case, a firm was fined $3.25 million for failing to report all of its reportable conventional options positions, failing to have written supervisory procedures regarding relevant reviews, and failing to implement appropriate remediation.6
3. Electronic communications cases resulted in the third largest amount of fines assessed by FINRA, marking the first time that this issue has been on our top enforcement action list since its first-place finish in 2013. In 2017, FINRA reported $8.3 million in fines for 44 electronic communications cases. Compared to 2016, these figures represent a 39% decrease in fines from $13.6 million and a 36% decrease from the 69 cases reported in 2016. In the largest electronic communications case, a firm was fined $2 million for failing to implement a reasonable supervisory system to review emails.7The firm’s “lexicon” was not reasonably designed to detect certain potential misconduct that the firm knew or should have anticipated would recur, and the firm failed to devote adequate personnel and resources to its review team, even as the number of emails increased over time.
4. Books and records cases resulted in the fourth most fines for FINRA in 2017. This is the second year in a row that this issue has appeared on our list of top enforcement issues. FINRA reported 81 books and records cases in 2017, which resulted in $6.2 million in fines. Compared to 2016, these figures represent a 72% decrease in fines from $22.5 million and an 18% decrease from the 99 cases reported in 2016. The continued presence of books and records cases on this list was driven largely by enforcement actions against three firms primarily for failing to preserve records in a “write once, read many” (WORM) format. FINRA fined these three firms a total of $1.9 million.8 In another case, a firm was fined $1.4 million for failing to maintain accurate books and records related to its accounting for extended settlement transactions.9
5. Research analyst and research report cases resulted in the fifth most fines for FINRA in 2017. This is the first time that this issue has appeared on our top enforcement issues list since its first-place finish in 2014. FINRA reported 10 research analyst and research report cases in 2017, which resulted in a total of $6 million in fines. This was a 57% decrease in fines from the $13.8 million reported in 2016 and a 23% decrease from the 13 cases reported in 2016. In the largest research analyst and research report case, a firm was fined $5.5 million for displaying inaccurate research ratings for more than one-third of its covered equity securities to its brokers, retail customers, and supervisors (e.g., rating a stock a “buy” instead of a “sell”).10 The inaccurate research ratings caused the firm’s brokers to solicit thousands of transactions that were inconsistent with the firm’s actual ratings and negligently make inaccurate statements to customers about those ratings. The firm was also ordered to pay $6 million in restitution to affected customers.
Several other enforcement trends are worth noting because these issues will likely continue to receive heightened attention from FINRA in 2018 and beyond.
• Restitution – The dramatic increase in restitution was one of the key FINRA enforcement trends in 2017. There were nine “supersized” restitution orders (of $1 million or more), of which three were “yuuuge” restitution orders of ($5 million or more). One litigated case was responsible for a large percentage of the total restitution of $67 million. A FINRA hearing panel ordered a firm to pay $24.6 million in restitution to customers for fraudulent sales in high-risk oil and gas ventures over a four-year period.11 Other significant restitution orders in 2017 involved senior/retiree investors (consistent with FINRA’s past three Priorities Letters, which indicated an increasing focus on senior investors and retirement accounts),12 and mutual funds where firms were sanctioned for selling shares with front- or back-end sales charges to certain customers who were eligible to receive sales charge waivers.13 The increase in restitution may signal that FINRA intends to order more customer remediation rather than assess fines against firms.
• Suitability – Although suitability failed to land on our top enforcement issues list in 2017, FINRA still reported 98 suitability cases, with $3.6 million in fines. The number of cases increased 13% from the 87 cases brought in 2016, although fines decreased 76% from the $15.3 million in fines reported in 2016. However, FINRA ordered $30.3 million in restitution in the 2017 suitability cases, a dramatic increase from the $5.8 million in restitution ordered in 2016. Last year, the suitability cases with the largest fines dealt with the sale of multi-share class variable annuities, including L-share contracts.14 This was the second year in a row that suitability did not crack the list of top enforcement cases after previously being a mainstay.
• Technological Issues – Another trend that emerged in 2017 related to operational breakdowns in technological systems—an area identified in FINRA’s latest Priorities Letter.15 In addition to the case discussed above involving inaccurate research ratings, one firm was fined $700,000 for failing to deliver numerous exchange-traded fund prospectuses over a six-year period in which the firm cleared more than 100 million relevant purchases because of flaws in its system, including the way in which it interfaced with a third-party vendor.16 Another firm was fined $2.8 million for systemic coding and design flaws that resulted in the failure to properly segregate customers’ securities in accordance with the Customer Protection Rule.17 Given FINRA’s continued emphasis on cybersecurity and technological compliance, firms may want to focus on how they supervise and monitor their systems and controls to prevent unintended collateral consequences that may negatively impact customers or the firm.
• Variable Annuities – While variable annuities cases failed to land on our top enforcement issues list in 2017 after its second-place finish in 2016, FINRA still reported 23 variable annuities cases with $1.9 million in fines. These figures represent a 93% decrease in fines from the $30.3 million reported in 2016 and a 23% decrease in actions from the 30 cases brought by FINRA in 2016. The largest fine in 2016 was for $20 million where a firm allegedly made negligent misrepresentations and omissions to customers about the costs and guarantees relating to replacement variable annuities.18 In contrast, the largest fine in 2017 was $750,000.19 In that case, a firm failed to supervise the sale of L-share variable annuities. Specifically, FINRA found that the firm’s written supervisory procedures failed to provide registered representatives and principals with guidance and suitability considerations for sales of different variable annuity share classes. The second largest fine in a variable annuities case in 2017 was $325,000. In that case, FINRA found that a firm failed to implement procedures and a supervisory system designed to reasonably ensure the suitability of multi-share-class variable annuity sales, including sales of L-share contracts.20 From January through April 2018, FINRA has filed two complaints related to variable annuities, and settled three actions against firms and one action against an individual.