FINRA, the stockbrokerage industry’s regulator, often does an absolutely atrocious job of policing its members. It was not always so, but in the last few years FINRA has clearly turned a blind eye to some really outrageous conduct that is going on right under its nose.

There are two distinct types of scams that have been prevalent in the stockbrokerage industry for decades. The first involve bad investments that come down to the registered representatives from the corporate level. These scams would never be sold to investors if the firms had conducted an adequate due diligence investigation.

FINRA has a fairly high bar for its member firms when it comes to due diligence on a private placement. It tells its member firms that they may not rely blindly upon the issuer for information concerning a company, nor rely on the information provided by the issuer and its counsel in lieu of conducting its own reasonable investigation.

In the late 1980’s and early 1990’s a company called Towers Financial was selling pools of consumer debt through dozens of FINRA firms. It was ultimately revealed that the company never owned the debt and it was just a Ponzi scheme. About 200,000 investors lost close to $250 million.

The lesson of Towers Financial was that it is virtually impossible to conduct a due diligence investigation on a company claiming to hold large amounts of consumer debt without a full audit of its books.   Most companies of that size would have an audit as a matter of course. Towers was an exception. A lot of people suffered because of it. FINRA (the NASD back then) never suggested (or mandated) that its members should have been concerned about the lack of an audit. 

Fast forward to the mid-2000s. A company called Medical Capital also claimed to have pools of consumer debt which it really did not have. FINRA members helped the company raise over $1 billion from thousands of unsuspecting customers. It too was a Ponzi scheme and it too was unaudited.

FINRA did very little in the way of enforcement and again refused to simply direct its members to require an audit of any pool of consumer paper. An audit is the only way any firm can verify what the issuer is claiming.  Several of the state securities administrators raised the same questions but the brokerage industry refuses to get the point.

Last week I looked at another company for whom about 60 FINRA member firms raised a little over a $1 billion. Was it audited? No. Is it a Ponzi scheme?  No one has said so officially yet, but there are red flags everywhere. I would hope that FINRA would be all over it, but I know that they will not.  FINRA refuses to see these types of scams even when you rub their noses in them. When public customers keep losing a billion here and a billion there the regulator is clearly asleep.

Case on point.

When I was filing claims on behalf of public customers with FINRA for arbitration, it was never my practice to send a copy of the complaint to FINRA’s enforcement division.  I would only do so if I thought the offending conduct on the part of the broker or the firm was particularly obvious, onerous or both. The very last time that I sent a copy of an arbitration claim to FINRA enforcement they bobbled the ball.

The claim was on behalf of an elderly investor who had forked over about $600,000 to purchase interests in a private placement which would own an office building in the mid-West. Within a year the investors discovered that the roof leaked and that they were on the hook to replace it.  The FINRA member firms that sold the offering had not bothered to have the building inspected as part of their due diligence investigation. Most people would never buy a home without an inspection report.

The offering also described the sponsor as a “successful” developer when in fact his only prior development had ended in bankruptcy with many of the sub-contractors unpaid. The sponsor did not even hold a degree from the school listed in the private placement disclosure documents.

I documented all of this in the claim with appropriate exhibits and sent a copy to FINRA’s enforcement department.  The FINRA staffer who responded told me that the due diligence that the firm had conducted was just fine and that he felt no further action against the firm was necessary. 

I composed a response that expressed my feelings that the FINRA staffer was a ****** idiot. My partner at the time correctly decided that he would not allow me to send the letter because, in his words, you can’t fix stupid. 

Another case on point. 

A little more than a year ago I was asked to look at a series of arbitration claims that were being filed at FINRA against a small group of small brokerage firms located in the New York, Long Island and New Jersey metro area.  The attorney who sent them to me wanted my help in preparing the claims for hearing and my testimony as an expert witness (yes, I still do that) regarding the substance of the claims and the supervision of the brokers. What I discovered was conduct that was obviously intentional and truly disgusting on the part of the brokers and the firms.

There are apparently dozens of disparate customers voicing the same complaints against these firms. It was obvious that the brokers were cold-calling older businessmen and retirees in the mid-West. Quite a few listed their occupations as farmers.

The customers were complaining that the brokers had sold them on the idea that they were superior stock pickers who were and who would continue to make substantial returns for their clients.  Yes, I know that most readers of this blog would not fall for that, but apparently hundreds of public customers did.

Once the accounts were opened each customer complained that they had lost money because the brokers had churned their accounts and had made unauthorized trades. Of all of the claims that customers can make against their stockbrokers, these two in particular, excessive and unauthorized trading are the easiest allegations to prove or disprove. 

In the stockbrokerage industry a broker cannot enter a trade in a customer’s account without the customer’s prior approval. In the normal course of business a broker will get permission from the customer to buy or sell a security, hang up the phone and enter the order.  So there should always be a record of the phone call showing the time it began and the time it ended and also a time-stamped record of when the order was entered and when it was executed.

I asked the attorney if the firms had produced records of the phone calls where the brokers and customers had spoken prior to every trade. Not a one.  Obviously the firms and especially the Compliance Directors know that the trades were not authorized.

Churning or excessive trading has been a problem in the brokerage business for at least as long as my tenure in it.   If you are “investing” in a company then you are betting that the share price will move up as the company’s earnings improve. In the normal course it will take until the company’s next quarterly report before you and the market know if you were correct, often longer.

Investors will usually buy a stock and hold it for three or six months or longer. If your portfolio is worth $1 million, then you might turn over (buy and sell) its value two or three times a year. More than that is always suspect.

Traders, on the other hand, buy and sell stocks every day. That is why they gravitate to firms that charge very low commissions per trade. When you see a customer at a full commission firm turning their account over more than once every other month, they are either really foolish or the broker is crooked and taking advantage of them. In the records that I reviewed the customers were paying hundreds of dollars in commissions for each trade.

According to FINRA’s own Brokercheck™ reports there are today ten or so firms in New York, Long Island and New Jersey that have multiple brokers with multiple claims from public customers whose accounts may have been turned over more than 50 times a year, generating millions of dollars in commissions. FINRA tells customers to always look at the Brokercheck™ reports, but apparently its own staff fails to do so.

I see all these scum brokers ripping off unsuspecting customers just by reading the arbitration claims. The Compliance Directors and owners of these small firms certainly see them. The clearing firms are getting paid for every trade so they must see it too. Some of these claims are from 2015 and the brokers are still at their desks churning accounts every day.

Back in the mid-1990s the NY Attorney General published a report on small firms in NYC, Long Island and New Jersey that were churning accounts. The report suggested that several were associated with organized crime. Different firms are involved today, but the ones that allow these brokers to make unauthorized or excessive trades are still stealing money from public customers. They may or may not be “organized” but they are certainly criminals.

What will it take for FINRA to take its head out of the sand and close down these firms and bar these brokers, compliance directors and firm owners from the securities business? FINRA gives a lot of lip service to enforcement. This repugnant conduct calls for action.

(PS- If FINRA enforcement or any state securities administrator would like a list of these miscreant firms and brokers, just let me know). 

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