David C. Cannata of Uniondale, New York, a stockbroker with Craig Scott Capital, LLC, was charged by the Financial Industry Regulatory Authority (FINRA) Department of Enforcement in a Complaint alleging that Cannata excessively traded and churned customer accounts; and also failed to comply with a FINRA investigation into his alleged misconduct. Department of Enforcement v. Cannata, No. 20130378570-01 (Dec. 22, 2015).
According to the Complaint, from March 2012 – April 2014, while Cannata was associated with Crag Scott Capital, LLC, he excessively traded and churned three customers’ accounts. The Complaint indicated that as a means to turn over the accounts quickly and generate outsize commissions for himself and his Firm, Cannata had used an aggressive short-term trading strategy in his customers’ accounts that had relied heavily on buying and selling equities of companies releasing their earnings report.
Cannata reportedly often solicited, or entered on his own, buy transactions just prior to the earnings’ announcements and then sold the positions shortly after the earnings reports were released to the public in order to lock in profit or avoid loss. Cannata, according to the Complaint, used this approach with hundreds of trades for his customers in their accounts. FINRA has alleged that based on the level of trading and commissions charged, there was little to no possibility that customers would profit from his trading strategy, and further found that the level of trading was quantitatively unsuitable for some of Cannata’s customers.
The Complaint further indicated that Cannata’s affected customers had high annualized turnover rates during the relevant time periods that ranged from 172 – 262, while their cost/equity ratios were 169% – 618% during the relevant periods. Cannata reportedly used a combination of agency trading and riskless principal transactions which caused the true cost of active trading to be concealed from the customers. Cannata apparently failed to explain to customers what riskless principal trading entailed, and the customers had never heard of such riskless trading, nor any markups or markdowns. FINRA found that by this information not being communicated to the customers via confirmations, the customers did not know how to determine what commission were actually being paid on the riskless principal trading.
The Complaint additionally stated that Cannata exercised control of customers’ account without seeking their authorization to do so. Cannata allegedly failed to discuss with customers the specific trades that Cannata intended on executing, had controlled the timing of trades and solely determined the amount and number of shares to be purchased/sold in their accounts.
FINRA alleged that Cannata had abused customers’ trusts by excessively and fraudulently trading in the customers accounts – and as a result of the high volume of trading and exorbitant commissions and fees it generated, the customers’ accounts suffered significant losses during the relevant time periods, which ranged from $114,171 – $1,263,527.
In the case of eighty-nine year old investor JB, the Complaint stated that from March 2012 – July 2012, Cannata generated approximately $91,680 in commissions for himself and the firm and approximately another $3,300 in margin interest and other fees on average monthly account equity of approximately $69,649. The Complaint further stated that Cannata’s excessive trading and churning in the account resulted in annualized cost/equity ratios of approximately 327% and an annualized turnover rate of approximately 262%. Cannata reportedly used margin in the account in order to perpetuate active trading, and had masked the true costs of the trading by executing large numbers of riskless principal trades. Cannata, according to the Complaint, marked 95% of trades as solicited. JB’s account sustained an approximate $188,598 loss during the relevant period.
In the case of customer DB, Cannata’s trading during July 2013 and April 2014 generated him $629,478 in commissions for himself and the firm and another $61,325 in margin interest and other fees on average monthly account equity of approximately $487,775. Cannata’s excessive trading reportedly resulted in an annualized cost/equity ratio of 169% and an annualized turnover rate of 201. The Complaint further indicated that with customer TD, Cannata generated $127,688 in commission for himself and roughly $3,621 in margin and other fees on average monthly account equity of roughly $84,927. Cannata’s excessive trading and churning of the account, according to FINRA, resulted in an annualized cost/equity of approximately 618% and the annualized rate of approximately 172.
The Complaint additionally indicated that FINRA staff sent Cannata seven letters requesting that Cannata appear for an on-the-record testimony at FINRA’s offices. Cannata allegedly failed to appear for his testimony, for the seventh time. FINRA is alleging in their Complaint that Cannata violated NASD Conduct Rule 2310, FINRA Rules 2111 and 2010 as a result of excessive trading; Cannata violated Section 10(b) of the Securities and Exchange Act of 1934, Exchange Act Rule 10b-5, and FINRA Rules 2020 and 2010 as a result of churning; failure to Cooperate with a FINRA Investigation in violation of FINRA Rules 8210 and 2010, and the willful failure to timely disclose two tax liens in violation of Article V, Section 2(c) of the FINRA By-laws, FINRA Rules 1122 and 2010.
Churning is a type of fraudulent conduct in a broker-customer relationship where the broker over-trades a customer’s account to generate inflated sales commissions. According to FINRA Conduct Rule IM-2310-2, churning occurs when, to generate excessive commissions, a broker causes securities in a customer’s account to be bought and sold with a frequency too great in light of the customer’s financial needs, resources, and investment objectives.
Churning or excessive activity is examined in light of the customer’s investment objective and the type of securities being traded. For example, it may be inappropriate to pay a sales charge by buying and selling a mutual fund in a period of a year. The short term trading of fixed income securities over a period of year may also be inappropriate. However, during this same period, it may not be inappropriate for a person seeking to trade options turn over their account twenty times.
Section 10(b) of the Exchange Act makes it unlawful “to use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.”
Four elements are necessary to show in finding a violation of Section 10(b) of the Exchange Act, Rule 10b-5: 1) misrepresentations and/or omissions were made; 2) misrepresentations and/or omissions were material; 3) representations and/or omissions were made with requisite intent (e.g. scienter), and 4) misrepresentations and/or omissions were made in connection with the purchase or sale of securities.
Public disclosure records via FINRA’s BrokerCheck indicate that Cannata has been subject to eleven disclosure incidents. On December 1, 1997, Cannata settled a customer dispute for $100,000.00 after a customer alleged excessive activity. On August 31, 2013, Cannata settled a customer dispute for $13,000.00 after the customer alleged frequent trading. Cannata then dealt with two tax judgments/liens in 2013. On October 27, 2014, Cannata became subject to a pending customer dispute where the customer is requesting $130,000 in damages associated with allegations of churning, unsuitability, breach of fiduciary duty, common law fraud, breach of contract and negligent supervision. On January 20, 2014, Cannata became subject to a customer dispute where a client is requesting $25,000 after alleging fabrications of investment details.
On April 10, 2015, Cannata became subject to a pending customer dispute where a claimant is requesting $900,000 associated with allegations of breach of contract, breach of duty of good faith and fair dealing, intentional torts and negligence. On May 1, 2015, Cannata settled a customer dispute for $338,454.00 after a client alleged negligence, breach of fiduciary duty, churning, unsuitability and unauthorized trades.
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