Wall Street’s self-regulator blocks public scrutiny of firms with tainted brokers

This article was originally published by Reuters.com.

FINRA – the industry-financed overseer of brokerages – knows which firms tend to employ advisers with histories of misconduct sanctions, legal disputes and financial distress. But it keeps that data secret and says it can’t prevent longstanding hiring practices it acknowledges are a threat to investors.

By Benjamin Lesser and Elizabeth Dilts Filed June 12, 2017, 7 p.m. GMT

NEW YORK – In three years of managing investments for North Dakota farmer Richard Haus, Long Island stock broker Mike McMahon and his colleagues charged their client $267,567 in fees and interest – while losing him $261,441 on the trades, Haus said.

McMahon and others at National Securities Corporation, for instance, bought or sold between 200 and 900 shares of Apple stock for Haus nine times in about a year – racking up $27,000 in fees, according to a 2015 complaint Haus filed with the Financial Industry Regulatory Authority (FINRA).

Haus alerted the regulator to what he called improper “churning” of his account to harvest excessive fees. But the allegation could hardly have come as a surprise to FINRA, the industry’s self-regulating body, which is charged by Congress with protecting investors from unscrupulous brokers.

FINRA has fined National at least 25 times since 2000. As of earlier this year, 35 percent of National’s 714 brokers had a history of regulatory run-ins, legal disputes or personal financial difficulties that FINRA requires brokers to disclose to investors, according to a Reuters analysis of FINRA data.

McMahon did not respond to requests for comment. National declined to comment.

National is among 48 firms where at least 30 percent of brokers have such FINRA flags on their records, according to the Reuters analysis, which examined only the 12 most serious incidents among the 23 that FINRA requires brokers to disclose. That compares to 9 percent of brokers industry-wide who have at least one of those 12 FINRA flags on their record.

In total, the 48 firms oversee about 4,600 brokers and billions of dollars in investor funds. (See the complete list of firms with statistics for each.)

FINRA officials acknowledged in interviews with Reuters that the longstanding hiring practices at certain firms are a threat to investors. But they also argued that they can do little to stop firms from hiring high concentrations of potentially problematic brokers because doing so is not illegal.

That leaves investors like Haus vulnerable to a small group of brokerages that regularly hire advisors with blemishes on their backgrounds that would make them unemployable at most firms, former regulators and industry experts said.

The dozen FINRA flags examined by Reuters include regulatory sanctions for misconduct, employment terminations after allegations of misconduct and payments by firms to settle customer complaints. They also include brokers’ personal financial troubles, such as bankruptcies or liens for nonpayment of debts. (For a full explanation of how Reuters analyzed the data, see the accompanying article.)

Last year, a FINRA official told Reuters, the regulator identified 90 firms as posing the highest risk to investors and flagged them internally for higher scrutiny. But FINRA declined to name the firms publicly or to release statistics showing the concentration of brokers with a history of FINRA flags within each firm.

In an interview with Reuters, FINRA’s executive vice president of regulatory operations, Susan Axelrod, declined to comment on any specific firm identified by Reuters. She would not directly address why the regulator will not publicly name the firms it identified as high-risk.

“Let’s just say those are not new names to us,” she said of the firms identified by Reuters.

FINRA Chief Executive Robert Cook, however, addressed its unwillingness to name names in a speech on Monday morning in Washington at Georgetown University, according to prepared remarks released by FINRA.

“We must consider fairness and due process,” Cook said. “FINRA does not possess a crystal ball – someone who we may identify as a high-risk broker for oversight purposes is not necessarily a bad actor.”


ENFORCEMENT EFFORTS: Susan Axelrod, FINRA’s executive vice president for regulatory operations, says the industry-financed regulator has created a dedicated unit to monitor firms that may have high concentrations of unscrupulous brokers. But she declined to discuss the unit’s budget, staffing or specific duties. Financial Industry Regulatory Authority/Handout via REUTERS

The regulator has created a dedicated unit focused on those high-risk firms, Axelrod told Reuters, but she declined to discuss its budget, staffing or specific duties. Cook on Monday said the unit included an unstated number of “examiners and managers” with experience dealing with high-risk brokers.

FINRA makes data on individual brokers’ backgrounds available through its Brokercheck website, which Axelrod said provides “unparalleled transparency” to investors. That site allows the public to search histories of complaints and sanctions against individual brokers – but only one at a time.

The regulator will not release the data in bulk form, such as a database, that would enable researchers to identify firms with high concentrations of brokers with a history of FINRA flags.

“Let’s just say those are not new names to us.” – Susan Axelrod, FINRA’s executive vice president of regulatory operations, said of the 48 brokerage firms identified by Reuters.

Reuters analyzed the FINRA data after receiving it from researchers at Columbia University Law School DataLab, who wrote computer code to extract it from the regulator’s website.

Reuters sought comment from officials at all 48 firms. Some responded that many of the FINRA-mandated disclosures do not necessarily equate to misconduct by brokers, such as when a firm pays a client to settle a complaint without admitting wrongdoing.

Cook, the FINRA chief, echoed that point in his speech Monday.

NO CRYSTAL BALL: In a speech at Georgetown University in Washington on Monday, June 12, FINRA Chief Executive Robert Cook said the agency does not release its internal risk ratings of brokerages because it does not have a “crystal ball” to see whether sanctions or allegations in the backgrounds of a firm’s brokers portend bad acts in the future. Cook is pictured here in 2012, when he served as director of the SEC’s Division of Trading and Markets. REUTERS/Gary Cameron

“A broker who has an unpaid lien because of a debt accrued due to a medical issue in her family must disclose that lien,” he said. “That event should not be treated the same as fraud or stealing money from customers.”

At least one executive from a firm identified in the Reuters analysis serves on FINRA’s 24-member Board of Governors – Brian Kovack, president of Fort Lauderdale-based Kovack Securities Inc.

Thirty-four percent of the firm’s 388 brokers have a history of FINRA flags, according to the Reuters analysis.

In a statement, Brian Kovack attributed those figures to the firm’s decision to take on a large number of new brokers from another brokerage in 2014, which prevented the firm from using its usual vetting process for new employees.

Asked why, three years later, the firm still has a high concentration of brokers with FINRA flags, Kovack said it took “considerable” time to ensure the review of new brokers’ backgrounds was “fair and transparent.” After the review, the firm asked some advisors to leave, Kovack said, without specifying how many or the reasons they were dismissed.


FINRA is not a government agency, but rather an industry-financed “self-regulatory organization” – as FINRA puts it – that is not subject to public records laws and receives no taxpayer support.

Its annual operating budget of about $1 billion – supporting about 3,500 staffers in 16 offices – comes primarily from dues paid by member firms and individual brokers. FINRA has the power to fine, suspend and ban firms and brokers, and it can refer potentially criminal cases to the Securities and Exchange Commission (SEC).

Last year, in an unlikely collaboration, Senators Elizabeth Warren, a Democrat from Massachusetts, and Tom Cotton, a Republican from Arkansas, sent FINRA a letter demanding the regulator do more to stop broker misconduct and to prevent those with troubled histories from concentrating in the same firms.

“FINRA is not doing nearly enough to fulfill its investor protection mission,” the letter read.


BIPARTISAN CRITICISM: In an unlikely alliance, U.S. senators Tom Cotton, an Arkansas Republican, and Elizabeth Warren, a Massachusetts Democrat, banded together last year to chastise FINRA for failing to prevent brokers with troubled histories from concentrating in the same firms. REUTERS/Jonathan Ernst

FINRA responded with a letter on June 15 of last year saying that it closely oversees firms “to determine whether they present a heightened risk to investors.”

From 2013 to mid-2016, the regulator told the senators, it identified 279 “high-risk” brokers. After identifying them, the regulator permanently banned 238 brokers from the industry for subsequent violations.

FINRA oversees about 3,800 brokerages and 630,000 brokers.

In interviews with Reuters, Axelrod pointed to firms that FINRA expelled. The regulator shut down about 130 firms in the six years ending in January 2017, with many cited for securities fraud, misuse of funds or falsifying records.

But the Reuters analysis of FINRA data found that the regulator did not expel the firm’s chief executive in 58 percent of those cases, leaving him or her free to join other brokerages. The brokers at those banned firms typically were also able to continue working in the industry.

Axelrod said that FINRA gives extra scrutiny to former executives of expelled firms after they show up with new jobs at other firms.


Regulators in at least one state think more can be done to crack down on brokers and brokerages with track records of violations.

Massachusetts securities regulators are considering changing their licensing practices after completing a review last year of brokerages with a high proportion of brokers with troubled histories.

“The evidence is pretty overwhelming that there is a practice here – a history here – of people moving from one firm to another and re-offending,” Massachusetts Secretary of the Commonwealth William Galvin told Reuters. “We can’t simply stand by and say, ‘The companies will do a better job.’ They won’t do a better job unless they feel some incentive.”

Some former regulators contacted by Reuters agreed with FINRA’s policy of withholding its internal risk ratings of firms from the public.

Susan Merrill – former head of enforcement at FINRA and now a partner with the law firm Sidley Austin LLP – said that releasing such ratings would be unfair to firms who have not necessarily broken laws or regulations.

“If there is a finding by the regulator,” Merrill said, “then that’s fair game.”

FINRA’s former CEO, Richard Ketchum, told Reuters last June that the regulator was considering publicly disclosing more information about firms with high concentrations of problematic brokers.

“We are looking hard at questions about how we can appropriately and fairly provide that broader disclosure … when firms have concentrations of persons that have similar problems,” Ketchum said in an interview.

Cook said Monday that FINRA was considering additional measures to rein in high-risk brokers, but he didn’t go into specifics.


SECOND THOUGHTS: Before he retired last year as FINRA’s chairman and CEO, Richard Ketchum told Reuters in an interview that the agency was considering public disclosures of more information on brokerages with high concentrations of problematic brokers. REUTERS/Brendan McDermid

We are looking hard at questions about how we can appropriately and fairly provide that broader disclosure … when firms have concentrations of persons that have similar problems.” – Richard Ketchum, FINRA’s former president


Many of the 48 firms identified by Reuters regularly cold-call customers on the phone with high-pressure sales pitches, according to regulatory complaints and sanctions against the firms and their brokers.

Long Island, New York, has historically been a haven for boiler-room brokerages, which inspired the movie, “The Wolf of Wall Street,” based on the true story of broker Jordan Belfort and his firm, Stratton Oakmont. Belfort pleaded guilty to securities fraud and money laundering in 1999.

FINRA warned in a news release last year that boiler-room tactics were on the rise, particularly those targeting the elderly and other vulnerable investors.

Brokers generally know which firms will hire them despite past sanctions, said Dean Jeske, a lawyer at Foley & Lardner and FINRA’s former deputy regional chief counsel for enforcement in the Midwest.

“When you get a mark on your (record), it’s hard to get a job at Morgan Stanley or Merrill Lynch,” Jeske said.

Mike McMahon has had little trouble landing jobs at brokerages despite a trail of allegations and settlements.

McMahon left National in 2014 and later joined a smaller firm, Long Island-based Worden Capital Management – where 43 percent of 79 brokers had a history of FINRA flags as of earlier this year.

Forty-one percent of the firm’s brokers had at some point in their careers worked at firms that were later expelled by FINRA, according to the Reuters analysis.

Jamie Worden, head of Worden Capital, said in a statement that his firm’s compliance team vets all prospective brokers and that FINRA-mandated disclosures do not necessarily indicate wrongdoing.

“The public disclosures only represent a sliver of the information surrounding any circumstance,” Worden said.

McMahon, National and another firm where he worked have agreed to pay a total of $1.35 million since 2007 to settle 10 separate client complaints involving McMahon, according to McMahon’s record on FINRA’s BrokerCheck website.

In addition, McMahon currently faces four additional complaints to FINRA – which have yet to be resolved in a settlement or arbitration ruling – from clients he advised while working with National, the regulator’s records show.

McMahon denied any wrongdoing in several of the settled complaints.

Haus – the customer who lost more than half a million dollars with McMahon and others at National – told Reuters that the ordeal made him contemplate suicide.

“I was ashamed,” said the soybean farmer and U.S. military veteran. “I didn’t want to tell anyone I’m losing my life savings.”

Haus settled his complaint against National in November for an undisclosed amount of money. The settlement required him to sign a nondisclosure agreement, and he has since not responded to Reuters’ inquiries.


In many cases, the firms identified by Reuters continue to operate after years of repeated run-ins with FINRA and other regulators.

Take Los Angeles-based WestPark Capital Inc, where about half of the firm’s 95 brokers have FINRA flags on their records. More than 47 percent of WestPark brokers once worked at firms that were later expelled by FINRA.

Regulators including FINRA and the New Jersey Bureau of Securities have sanctioned WestPark six times in the past 11 years for a variety of alleged violations.

In 2004, FINRA suspended WestPark’s chief executive, Richard Rappaport, for 30 days from his management role and fined him and the firm $50,000 in response to allegations that WestPark omitted critical information from investment research reports and lacked supervisory controls.

Without admitting wrongdoing, Rappaport agreed to the punishment in a settlement with FINRA. But he then ignored the suspension and continued to actively manage WestPark, according to FINRA disciplinary records reviewed by Reuters.

His punishment for ignoring the 30-day suspension? Another 30-day suspension from FINRA and a $10,000 fine.

In 2016, West Park saw a hiring opportunity. The firm started taking on dozens of brokers from Newport Coast Securities – a firm that FINRA banned from the industry that year for excessive trading in client accounts to rack up fees and for recommending unsuitable investments. Newport appealed the expulsion.

By early 2017, WestPark had hired about 40 brokers from Newport Coast – including its former CEO, Richard Onesto.

WestPark and Rappaport declined to comment. Onesto did not respond to requests for comment.


Another firm Reuters identified in its analysis – Windsor Street Capital – has been fined 12 times by FINRA since 2000 but may now face much stiffer penalties from the SEC.

Fifty-eight percent of the firm’s 48 brokers had FINRA flags on their records, according to the Reuters analysis. Over the years, FINRA fines have cost the firm about $300,000, and Windsor has appealed two other fines totaling more than $1 million.

In January, the SEC brought administrative actions against Windsor Street Capital and its former anti-money laundering officer, John Telfer, for allegedly facilitating a $25 million pump-and-dump scheme – in which investors promote or “pump” the value of a dubious stock they own just before selling, or “dumping” it.

Windsor declined to comment to Reuters but denied any misconduct in an SEC filing.

The SEC alleges that Windsor allowed clients to sell hundreds of millions of unregistered penny stocks through Windsor brokerage accounts and did not report the suspicious transactions to the U.S. Treasury Department.

The Windsor clients bought stock in dormant shell companies, spread false information to promote the companies’ products and then dumped the shares as other investors bought in at inflated prices, the SEC alleges in a case that is still pending.

Windsor made about $500,000 in commissions and fees from transactions related to the scheme, according to the SEC.

When asked if FINRA investigators contributed to the SEC’s investigation, an SEC official declined to comment and pointed to the agency’s press release, which only credits SEC investigators.

FINRA did not respond to requests for comment on whether it had a role in the Windsor investigation.


At Long Island-based Joseph Stone Capital, 71 percent of the firms’ 59 brokers had FINRA flags on their records, according to the Reuters analysis.

Joseph Stone was investigated by the state of Montana after one of its sales representatives, Lawrence Sullivan, cold-called the office of Montana’s Commissioner of Securities and Insurance to pitch an investment on January 15, 2016, according to a report on the incident by the regulator.

The securities commission launched an investigation into the firm after the call, during which Sullivan quickly backtracked and denied he was pitching securities, according to the report.

Reuters could not reach Sullivan for comment. The staffer he called – Patrick Navarro, an assistant analyst at the state regulator – did not respond to requests for comment.

Investigators ultimately unearthed “fraudulent and unethical” practices, including excessive trading in client accounts – resulting in commissions totaling 28 percent of the $877,493 invested by clients in Montana, according to the regulator’s report.

The firm settled with the state on April 18, agreeing to pay $30,000 in restitution to clients without admitting wrongdoing.

During the call that got the firm into trouble, Sullivan pitched Navarro on an investment in Paypal stock, the report said. After Navarro informed Sullivan that he worked for the state’s securities regulator, Sullivan blurted out “Happy New Year!” and hung up.

How we analyzed the data FINRA doesn’t want you to see

By Benjamin Lesser and Elizabeth Dilts

FINRA requires brokers to disclose 23 types of incidents that might give investors concern, such as regulatory sanctions, lawsuit judgments and bankruptcies. The regulator then publishes those disclosures on its Brokercheck website, allowing investors to search the backgrounds of individual investment advisors.

But FINRA refuses to release that data in bulk form, which would allow for database analysis to find patterns at brokerages that might also trouble investors – such as a firm’s propensity to hire brokers with a history of client complaints or regulatory run-ins.

Reuters obtained that bulk FINRA data from researchers at Columbia University Law School Datalab, who wrote code to extract it from FINRA’s Brokercheck website.

To analyze it, reporters Benjamin Lesser and Elizabeth Dilts chose to analyze only 12 of the 23 required FINRA, isolating only those incidents that might cause investors the most concern.

The reporters examined firms with at least 20 brokers, and FINRA-mandated disclosures between the years 2000 and 2015.

The FINRA flags included regulatory sanctions, customer complaints that resulted in a payment, criminal cases that resulted in a plea agreement or conviction, and bankruptcies. For a full list, with definitions, click here.

The incidents analyzed by Reuters varied in severity. Some involve final legal determinations of misconduct, such as criminal convictions, civil judgments or regulatory fines. A very small percentage of those cases remained under appeal by the broker or firm involved, according to the FINRA data.

The analysis also included incidents with no finding of misconduct, but that did come at a cost to the firm or employee involved – such as broker terminations after allegations of misconduct, or settlements in which firms paid restitution to customers but admitted no wrongdoing.

Reuters applied the same metrics to every firm overseen by FINRA and identified those where at least 30 percent of brokers had one or more of the 12 flags.

Reuters used the data provided by Columbia Law School researchers to identify firms meeting the above criteria. Reporters then manually updated the data, using the Brokercheck site, to include FINRA-mandated disclosures by brokers at those firms through the beginning of 2017.

FINRA flags explained

The Financial Industry Regulatory Authority, or FINRA, requires brokers to publicly disclose 23 different incidents that the regulator believes could cause investors concern. Reuters identified 48 financial firms where at least 30 percent of brokers had disclosed one of the 12 most serious incidents among those 23. Here are the definitions – written by FINRA – of the 12 incidents used in the Reuters analysis.

    Customer dispute – settled: A consumer-initiated, investment-related complaint, arbitration proceeding or civil suit containing allegations of sale practice violations against the broker that resulted in a monetary settlement to the customer.

    Customer dispute – award/judgment: A consumer-initiated, investment-related arbitration or civil suit containing allegations of sales practice violations against the broker that resulted in an arbitration award or civil judgment for the consumer.

    Regulatory – final: A final, formal proceeding initiated by a regulatory authority for a violation of investment-related rules or regulations.

    Judgment/lien: An unsatisfied and outstanding judgment or lien against the broker

    Employee separation after allegations: The broker voluntarily resigned, was discharged, or was permitted to resign after being accused of (1) violating investment-related statutes, rules, regulations or industry standards of conduct; (2) fraud or the wrongful taking of property; or (3) failure to supervise in connection with investment-related statutes, regulations, rules, or industry standards of conduct.

    Financial – final: Involves a bankruptcy, compromises with one or more creditors, or Securities Investor Protection Corporation liquidation involving the broker or an organization the broker controlled that occurred within the last 10 years.

    Criminal – final disposition: Involves a criminal charge against the broker that has resulted in a conviction or plea arrangement.

    Civil – final: Involves (1) an injunction issued by a court in connection with investment-related activity. (2) a finding by a court of a violation of any investment-related statute or regulation or (3) an action brought by a state or foreign financial regulatory authority that is dismissed by a court pursuant to a settlement agreement

    Civil bond: Involves a civil bond for the broker that has been denied, paid or revoked by a bonding company.


Concentrated risk

FINRA, the primary regulator of U.S. brokerages, requires brokers to disclose incidents in their past that might give investors concern. Reuters analyzed the most serious of those incidents to identify firms with high concentrations of brokers with such FINRA flags, which include regulatory sanctions, civil judgments, personal bankruptcies and broker terminations after allegations of misconduct.

At least 30 percent of brokers at the 48 firms listed below have a history of such FINRA-mandated disclosures. See full methodology here.

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