- LPL Financial: Off with their heads!
- May 27, 2013
- Law Firm: The Law Offices of Roger D. Wiegley - New York Office
LPL Financial: Off with their heads!
To quote in part from the FINRA press release of May 21, 2013, “[FINRA] announced today that it fined LPL Financial LLC (LPL) $7.5 million for 35 separate, significant email system failures, which prevented LPL from accessing hundreds of millions of emails and reviewing tens of millions of other emails. Additionally, LPL made material misstatements to FINRA during its investigation of the firm's email failures. LPL was also ordered to establish a $1.5 million fund to compensate brokerage customer claimants potentially affected by its failure to produce email. . . . In addition, LPL likely failed to provide emails to certain arbitration claimants and private litigants. LPL will notify eligible claimants by letter within 60 days from the date of the settlement and the firm will deposit $1.5 million into a fund to pay customer claimants for its potential discovery failures.”
It is hard to say which is more surprising: the size of the FINRA settlement demand or LPL’s acceptance of it.
More from the press release:
“. . . . FINRA found that from 2007 to 2013, LPL's email review and retention systems failed at least 35 times, leaving the firm unable to meet its obligations to capture email, supervise its representatives and respond to regulatory requests.
“Some examples of LPL's 35 email failures include the following.
• Over a four-year period, LPL failed to supervise 28 million "doing business as" (DBA) emails sent and received by thousands of representatives who were operating as independent contractors.
• LPL failed to maintain access to hundreds of millions of emails during a transition to a less expensive email archive, and 80 million of those emails became corrupted.
• For seven years, LPL failed to keep and review 3.5 million Bloomberg messages.
• LPL failed to archive emails sent to customers through third-party email-based advertising platforms.”
A fine of $7.5 million? A fund for “discovery sanctions” of $1.5 million? These amounts are astonishing, particularly when one reads the facts set out in the Letter of Acceptance, Waiver and Consent (AWC) signed by FINRA and LPL (FINRA Case No. 2012032218001). Specifically, there was (i) no finding that customer accounts had been adversely affected or put at risk, (ii) no finding that emails has been permanently lost during the required three-year retention period, only that they were inaccessible or corrupted for certain periods and later recovered (in the millions, to be sure, but they were always recoverable), (iii) no finding that the failure to produce all emails requested by state and federal regulators prevented them from taking action that they otherwise would have taken, (iv) no finding that had the DBA, Bloomberg and other messages been reviewed, violations of FINRA or SEC rules would have been discovered, (v) no finding that the misstatements to FINRA were made with the intent to deceive, and (vi) no finding of fraud, willful misconduct or concealment of other violations.
According to the AWC, in September 2011, LPL reported the DBA email issue to FINRA. Oddly, FPL’s self-reporting in not acknowledged in the AWC as a mitigating factor, as is usually the case in FINRA settlements. Another mitigating factor, discernable from the facts but not specifically mentioned, is that prior to LPL’s report of the problem, all the emails that were inaccessible or corrupted had been restored and review procedures for messages not previously reviewed had been initiated.
This settlement is really quite remarkable. Over the past 24 months, there have been more than 700 FINRA settlements. Most of the fines agreed to in those settlements were in a range from $10,000 to $100,000. Approximately ten percent were over $100,000, with all but a few of those under $500,000. Only one fine exceeded $1,000,000: GFI Securities LLC agreed to a fine of $2,100,000 for collusion and anti-competitive behavior in a scheme to frustrate customers’ efforts to get brokerage services on certain transactions at competitive commission rates (FINRA Case #2006005158309, December 2012).
More striking, perhaps, is the fact that in the same two-year period there were over 25 settlements involving failure to retain and/or review emails, in some cases this violation being one among other, unrelated, violations. Many of these settlements involved the use of personal email address by registered representatives or the failure of branch office or home office employees to forward emails to a central location. In all but four of these settlements the fine was $100,000 or less. Two of the fines were $200,000, another was $250,000 and the largest was $750,000. In the latter case, involving Citigroup Capital Markets Inc., the AWC states that a “review of information the firm provided reflecting email usage rates of the affected associated persons for a three-month sample period indicated that the firm failed to retain millions of emails”. [Emphasis added] Note that the Citigroup matter involved a failure to retain emails, not just a failure to review emails, yet the fine was only one-tenth the size of the LPL fine.
Unquestionably, there was a failure to supervise at LPL over a long period of time. And, as the AWC makes clear, there were employees who were aware of the lack of proper email supervision and who recommended remedial action. Why such remedial action was not taken sooner is hard to explain, but it appears, albeit on sketchy facts, to be more a case of poor internal coordination—or perhaps a misalignment of responsibility and authority—and not a case of intentionally ignoring a problem.
There were four violations identified by FINRA in the AWC. The first violation was failure to supervise because the firm did not review emails. (NASD Rules 3010(a) and (d)(2)). The second violation was a violation of SEC record-keeping rules, which require broker-dealers to keep all correspondence for a period of three years, the first two years in an easily accessible place (SEC Rule 17a-4; FINRA Rule 3110). FINRA found that FPL Financial did not have millions of emails in a “readily accessible” place. Third, there was a failure to supervise because the firm did not have systems and procedures in place to ensure that its internal audit department properly conduct an audit of compliance with FINRA and SEC rules; specifically, the firm did not have procedures for stopping an audit in progress (NASD Rule 3010(a) and FINRA Rule 2010). Instead, one person stopped an audit without giving any reason (or at least none is given in the AWC). The fourth violation is questionable: making inaccurate statements to FINRA was a violation in that the firm’s conduct did not meet FINRA’s “high standards of commercial honor and just and equitable principles of trade” (FINRA Rule 2010). This is a serious finding because it reflects on the integrity of the firm and the individuals involved. There are no facts recited in the AWC to support the inference that the misstatements were intentional or not made in good faith. Arguably, it should not have been included by FINRA as a violation. (To say that the firm agreed to it means very little, as anyone who has negotiated a FINRA settlement will attest.)
Finally, the $1.5 million fund that LPL must establish raises a number of issues. FINRA states in its press release and the AWC that it is likely brokerage customer claimants who brought arbitration or litigation against LPL between Jan. 1, 2007, and which were closed by Dec. 17, 2012, did not receive all emails requested by them. Under the AWC, those customers will receive, upon request, emails that the firm failed to provide them. Claimants will also have a choice of whether to accept a standard payment of $3,000 from LPL or have a fund administrator determine the amount, if any, that the claimant should receive depending on the particular facts and circumstances of their individual case. Maximum payment in cases decided by the fund administrator cannot exceed $20,000. If the total payments to claimants exceed $1.5 million, LPL must pay the additional amount.
The AWC describes these payments as “discovery sanctions”. However, it is not at all clear that the FINRA Department of Enforcement has the authority to impose discovery sanction in the context of third-party arbitration or litigation. True, LPL agreed to the terms of the AWC. Nonetheless, FINRA should not be asking for remedies that are not within its disciplinary rules. Moreover, some claimants may have been prejudiced by the failure of FPL to produce emails, but others undoubtedly were not prejudiced, particularly those who won their cases against LPL. And according to facts set forth in the AWC, the periods during which most of the inaccessible emails were actually inaccessible were relatively short, not the six years covered by the $1.5 million fund. Thus, many claimants would have received all the emails they requested. Yet FINRA has simply decided it is likely that all claimants did not receive all the emails requested. And finally, rules of discovery relating to electronic documents, as applied by courts, only require that a party produce documents in its custody or control. The question of what a party could have produced and when is one for a court. It is not an issue to be deducted in a general way on the basis of speculation, without case-specific facts, over a wide range of cases.
To Settle or Not to Settle: that is the question.
It would be unfair to second-guess LPL’s decision to settle. The decision to enter into an AWC with FINRA is one that each firm must make based on the facts known to the firm and its assessment of the risks and costs of a formal disciplinary hearing. Moreover, fighting FINRA charges, including appeals, can take years. Many firms simply want to get the matter resolved quickly,
Without questioning LPL’s decision, it is useful to consider FINRA settlements generally. One reason often given for settling is the so-called “settlement discount”, a phrase used by the staff of FINRA’s Department of Enforcement to convince a broker-dealer or an individual to settle rather than allowing FINRA to bring charges and initiate a formal disciplinary hearing. According to conventional wisdom, the sanctions proposed as part of a settlement are less severe than the sanctions that would be sought by the Department of Enforcement at the hearing. In theory, this provides an incentive to settle rather than litigate. However, it is not always the case that the Department of Enforcement seeks more severe penalties at a disciplinary hearing than that offered in pre-hearing settlement negotiations. Moreover, the sanctions sought by the Department of Enforcement at a hearing are not necessarily what a panel is willing to impose. Some sanctions recommended by the Department of Enforcement are simply too severe. A fine of $7.5 million and a $1.5 million “discovery sanctions” fund might well fall into that category. It is hard to image a panel awarding more than the amount of the LPL settlement on the same facts. In fact, the most likely outcome would probably be something much lower, if not from the panel then on appeal.
The reason most cases settle is not the “settlement discount”. It is simply the amount involved. If the fine is less than $100,000—and most are—it is simply not cost-effective to go to a hearing because of the legal fees involved. On the other hand, if the LPL settlement motivates FINRA’s Department of Enforcement to propose large fines in future cases, there will undoubtedly be more disciplinary hearings.