FINRA COMPLAINT DISMISSED BECAUSE ENFORCEMENT FAILED TO SHOW FRAUD OR INADEQUATE SUPERVISION
A FINRA Hearing Panel dismissed a complaint brought by FINRA’s Department of Enforcement against a broker-dealer that recommended Enron bonds. The Hearing Panel concluded that Enforcement failed to prove that the Respondent omitted material facts or that its supervisory system was inadequate. The Hearing Panel found that the firm disclosed all relevant facts to its customers about the Enron bonds including that the bonds carried a higher yield because of Enron’s financial problems. The Hearing Panel noted that the Respondent made widespread news reports about Enron available to the customers. The Panel also concluded that the Respondent was entitled to rely on the investment grade ratings of the bonds. The Hearing Panel noted that Enforcement acknowledged that the recommendations were suitable. The Hearing Panel rejected Enforcement’s argument that the supervisory structure, which was otherwise adequate, required a heightened level of supervision. Commenting on Enforcement’s reliance on customer statements, the Hearing Panel stated that “It is evident that many of the words in the declarations were chosen by Enforcement, not the customers.”
Our take: The Hearing Panel’s decision provides a roadmap to designing and implementing a compliance and supervisory structure that can protect a firm against a regulatory action (and possibly litigation) in the event a recommended security does not perform as expected. Key elements include full (over) disclosure, suitability, and multiple layers of supervision. The case also shows that firms can successfully challenge FINRA’s Department of Enforcement.