Brokerage Firm JSC’s Supervisory Failures – What Not to Do

Brokerage firms owe its clients the duty to supervise its employees and personnel. This is a very important duty in the financial industry, as it ensures the associated persons under the brokerage firm’s umbrella are compliant with FINRA’s rules. Firms should maintain its duty to supervise, and ensure that it has adequate procedures in place to prevent any potential misconduct that would be harmful to its clients. If your brokerage firm had inadequate supervisory procedures in place, the firm may be subject to failure to supervise claims. You need a New York Securities Industry Lawyer like the lawyers at Malecki Law.

A faulty compliance system can rise to the level of a failure to supervise. Broker-dealer Joseph Stone Capital (JSC) apparently dealt with exactly that. FINRA found that the firm’s compliance system had been insufficient in supervising its brokers, from January 2015 through June 2020. Specifically, JSC received exception reports that revealed potential excessive trading red flags. However, JSC failed to further investigate or prevent such activity.

To prevent this problem from occurring, a JSC supervisor responsible for reviewing the exception reports should have reviewed the clearing firm’s exception report daily. That supervisor would have discovered the possibility of excessive trading. If your brokerage firm failed to further investigate or prevent misconduct like JSC, it may be prone to failure to supervise claims. You need a Regulatory Defense Law Firm in New York, like Malecki Law. Additionally, after discovering these excessive trades, management should have questioned the broker about this trading activity, instead of restricting commissions. Supervisors should have reviewed every trade confirmation in the accounts in question and evaluated whether the trades were solicited (where the broker recommended the trade) or unsolicited (where the client recommended the trade). If the confirmations stated “solicited”, then management could ask for the broker’s thought process for making these trades. This would have identified the crux of the issue more efficiently and would have led to a quicker resolution. One can argue that JSC should improve its compliance software, but the software was not truly at issue during this investigation. According to all evidence, the compliance software seemed to work. The FINRA Order shows that the problem truly stemmed from JSC’s supervisors’ failure to act accordingly to stop their brokers’ activities of excessive trading. If your brokerage firm failed to act accordingly when discovering potential broker misconduct, it may be susceptible to failure to supervise claims. You need a Regulatory Defense Attorney in New York, like the lawyers at Malecki Law. It is unclear how JSC’s compliance software works, but they could also look to incorporate artificial intelligence and machine learning to generate quicker and more accurate compliance reports.

Lastly, this practice violated the broker’s fiduciary duty of loyalty. FINRA states that, “brokers have a duty to carry out the customer’s orders promptly and in a manner best suited to serve the customer’s interests”. This practice of excessive trading clearly violated the customers’ best interests. It was true that more trades led to more commission fees for the broker. There were also collateral fees that resulted from these extraneous transactions. For example, the customer is liable for higher account maintenance fees, tax implications from the higher volume of trades, and a monetary loss if any of the purchases declined in value. Excessive trading is rarely in a client’s best interest, especially if they are closer to retirement and needed more conservative, stable investments.

Unfortunately, these kinds of issues are never going to truly go away in our society. It is human nature to attempt to maximize profits using the most efficient way possible. The brokers in the JSC case study may have thought they were clever in trying to “bend the rules” to their advantages. If JSC’s supervisors exercised a little more care in overseeing the broker activities, this issue would have been caught much earlier and more monetary losses would have been prevented. If your brokerage firm failed to exercise sufficient care when overseeing brokers’ activities, the firm may be subject to failure to supervise claims. You need a New York Securities Industry Lawyer like the lawyers at Malecki Law.


Contributions by Jonathan Owens, NYLS Securities Arbitration Seminar and Field Placement Extern

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