Morgan Stanley Smith Barney LLC a brokerage firm headquartered in New York New York has been censured and fined $10,000,000.00 by Financial Industry Regulatory Authority (FINRA) based in part upon the firm’s consent to findings that it failed to supervise its penny stock sales to ensure compliance with federal securities law. Letter of Acceptance Waiver and Consent No. 2014041196601 (Dec. 26, 2018).
According to the AWC, between January of 2011 and December of 2013, the firm neglected to create and implement a supervision system with a view towards complying with Securities Act of 1933 Section 5 – a law restricting securities from being sold without either an effective registration statement or an exemption from registration. FINRA noted that the firm’s compliance was mandated given the concerns about illicit distributions of securities.
The AWC stated that FINRA previously warned firms including Morgan Stanley about its concerns about brokerage firms’ failures to act upon red flags of possible unregistered, illicit distributions.
Evidently, the firm depended on its management of branches, compliance personnel, and another department, EFS, to assume responsibility concerning penny stock deposits and sales. The AWC stated that none of those groups adequately inquired into whether penny stocks deposited at the firm were able to be resold. Rather, the firm apparently depended on either representations made by the counsel for penny stock issuers, or certifications from customers, to assess whether the penny stocks were able to be traded. Moreover, the AWC revealed that the branch management, compliance personnel and EFS groups failed to reasonably correspond with each other even in situations when one of the branches had raised concerns about a customer possibly owning securities that were in a restricted state.
The AWC stated that in some cases, the branch management would require customers holding penny stocks to state whether there were restrictions on the stock; however, the branch management never verified that the customers’ representations were accurate. Additionally, the firm’s branch management were supposed to submit the customers’ representations to the compliance department, but management neglected its responsibility in some instances. Further, the AWC stated that the compliance department sometimes failed to confirm with the EFS group that it placed conditions on approving penny stock deposits which would have necessitated EFS’ authorization for the stocks to be resold.
Ultimately, the AWC stated that the EFS group, which was responsible for authorizing restricted and control securities before transactions were executed, had not actually reviewed or authorized transactions. The AWC revealed that it some cases, branch management were able to circumvent EFS altogether. Consequently, FINRA found that the firm’s failure to supervise securities sales was violative of FINRA Rules 2010 and NASD Rule 3010(a).
