How Might a Brokerage Firm Fail to Supervise Its Brokers’ Misconduct?

Securities Industry Background

The securities industry is one of the most regulated industries in the United States. Statutes, common law, and federal regulations all govern the conduct of securities firms and their representatives. Securities firms must register with the Financial Industry Regulatory Authority (FINRA). FINRA is a self-regulated organization (SRO) that protects investors by ensuring that the securities industry operates honestly and fairly. An SRO is an organization that has power to create and enforce industry regulations on its own. This means that FINRA has the authority to create and enforce its rules on securities firms that register with FINRA. A broker-dealer is a securities firm that must register with FINRA. Broker-dealers engage in the business of buying and selling securities. Broker-dealers also offer services such as trade execution, selling securities out of inventory, and lending. Since all broker-dealers and its registered representatives (its individual brokers) must register with FINRA, FINRA’s rules and regulations apply to broker-dealers. If you notice all your investments declined at the same time, it may be a clue that your broker engaged in misconduct. Your brokerage firm has a duty to supervise its brokers to detect and prevent misconduct. You may have a failure to supervise claim. You need a New York Failure to Supervise Lawyer like the lawyers at Malecki Law to review your portfolio, at no cost.

Failure to Supervise Broker Misconduct

Recently, FINRA investigated broker-dealer, Joseph Stone Capital (JSC). FINRA discovered that some brokers of JSC engaged in excessive trading in its customers’ accounts. Excessive trading means that the broker(s) placed more trades in the customer’s account than necessary. These excessive amounts of trades usually go against the client’s objectives.

The reason that brokers execute these trades is so that they can generate more commission fees. A commission fee is a fee that goes to the individual broker when he/she places a trade on behalf of the client. Commission fees are usually a percentage of the value of an individual trade. For example, if a trade is valued at $100 and the commission fee is 0.25% of the value of the trade, the broker would earn $0.25 in commission on this individual $100 trade. That was just an abstract example. Trades are usually worth a lot more and are often, more complex than this example. As one can predict, if a broker places excessive amounts of trades in a client’s account, these commission fees will add up in the aggregate, and thus, benefit the broker. Apparently, JSC’s practice of excessively trading in client accounts violated numerous FINRA rules pertaining to a firm’s fiduciary duty to supervise its employees and a broker’s fiduciary duty of loyalty to his/her client(s). If your broker excessively traded in your account(s), you may have a failure to supervise claim against your brokerage firm. You need a Failure to Supervise Law Firm in New York like Malecki Law to explain your rights and remedies.

Firms owe their clients a duty to supervise their employees and to ensure that their employees are following FINRA’s rules. FINRA conduct rule 3010 states that “each member shall establish and maintain a system to supervise the activities of each registered representative that is reasonably designed to achieve compliance with the applicable securities laws”. This rule says that every firm should have a compliance system in place that allows management to catch questionable broker activity. FINRA found that from January 2015 to June 2020, JSC did not have a sufficient compliance system in place to properly supervise its employees. JSC, apparently, received exception reports from its clearing firm that reflected this high trading activity; however, according to FINRA the supervisors of JSC did not review this report often. Even when a supervisor did review the report, according to FINRA, JSC did not follow their internal procedures properly. FINRA found that JSC would only restrict the commissions earned from certain trades, but they would not restrict the number of trades that a broker could place in an account. For example, if a broker made $1,000 commission off a trade, FINRA found that JSC would step in and say that the broker can only make $200 in commissions on that type of trade moving forward. Such a policy did not address the issue but encouraged the brokers to make more trades. To get around this new restriction, a broker would just need to make five of these types of trades to make his/her $1000 commission. Essentially, the broker-dealer only addressed “the tip of the iceberg” when it came to this issue of excessive trading. Your brokerage firm has a duty to supervise its brokers. You may need a Failure to Supervise Attorney in New York like the attorneys at Malecki Law to do an analysis and assess whether your brokerage firm failed to supervise your broker.

Your brokerage firm has a duty to supervise its registered persons, such as your broker. Part of this duty is to properly monitor your broker’s work. There may be instances where your brokerage firm was aware of your broker’s misconduct because red flags of the misconduct were present. In other instances, your brokerage firm would have been aware of the misconduct, had there been adequate supervision in place. The brokerage firm’s failure to detect and prevent your broker’s misconduct can rise to the level of a failure to supervise. If your brokerage firm failed to supervise your broker, you may have a viable claim. You need a New York Failure to Supervise Lawyer like the lawyers at Malecki Law to analyze and determine whether your brokerage firm failed to supervise your broker.


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


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