FINRA, citing Reg BI, expels New York brokerage

FINRA is invoking the nearly 3-year old Regulation Best Interest for the first time in a decision to boot a firm from the brokerage industry.

The Financial Industry Regulatory Authority, broker-dealers' self-regulator, announced Friday that it was expelling SW Financial, a Melville, New York-based firm in business since June 2007. FINRA said the decision was made in part because it had violated Regulation Best Interest with recommendations made to clients about private securities.

Regulation Best Interest, or Reg BI, took effect in June 2020 and generally calls on brokers to always look out for clients' best interests and disclose unavoidable conflicts of interest. It has been touted by its supporters as a vast improvement on the previous standard governing broker conduct, which had merely required advisors to make sure any investment they recommended was "suitable." 

But despite warnings that the hammer is about to come down, regulators have been slow to enforce the rule. So far the Securities and Exchange Commission, which oversees FINRA, has brought only one case. 

The SEC in June 2022 accused Western International Securities, a dually registered brokerage and investment advisor in Pasadena, California, and five of its brokers of not acting in its clients' best interest for recommending the purchase of unrated high-risk bonds. That case is still pending. FINRA itself has brought only a handful of cases.

In the SW Financial case, FINRA contended the broker violated Reg BI's disclosure obligation by not accurately explaining to clients how it would be compensated from its sales of private securities. The disclosure obligation calls on brokers to present "all material facts relating to conflicts of interest associated with the recommendation."

"The serious misconduct in this case exposed customers to significant risk of harm and necessitated expulsion of SW Financial from FINRA membership," Christopher Kelly, senior vice president and acting head of FINRA's department of enforcement, said in a statement. "Firms cannot make material misstatements or omissions when they sell securities to customers."

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Along with expelling SW Financial, FINRA suspended the firm's CEO and part owner, Thomas Diamante, for nine months in all capacities and additional three months in his principal capacities. The regulator also fined him $50,000. Diamante won't be allowed to return to the industry without first passing a qualification exam. 

FINRA's BrokerCheck database shows Diamante had worked for three other firms that were eventually expelled from the industry. Attempts to reach SW Financial and Diamante were unsuccessful.

Rob Herskovits, the founder of New York-based law firm Herskovits, noted that Reg BI was not the only regulation FINRA invoked in its case against SW Financial. The regulator also relied on the old suitability standard and rules governing the supervision of employees. That makes it almost impossible to know for sure, Herskovits said, how much of a role Reg BI played.

"It's hard to draw a definitive conclusion about what the appropriate sanction would have been had this been a Reg BI case alone," Herskovits said.

FINRA specifically found that SW Financial and Diamante misinformed investors from early 2018 to late 2021 that they would receive a 10% commission on sales of private securities offered ahead of a planned initial public offering. In fact, SW Financial had an undisclosed agreement giving it an additional 5% commission and a share of profits made by the securities issuer's investment manager. A FINRA spokesman declined to identify what company was issuing the shares.

FINRA found that SW Financial sold the private securities to 171 investors, 163 of whom were retail clients. The firm and its owners made roughly $2 million in undisclosed compensation. FINRA also found that SW Financial and its owners failed to live up to their obligation to make sure the issuer of the securities could actually furnish the shares they were trying to sell.

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Separately, FINRA said that SW Financial and two of its former representatives had traded excessively in nine client accounts from January 2016 to May 2019. That activity cost investors $350,000 in trading expenses and resulted in a realized loss of more than $465,000. In one case, a 75-year-old client paid $101,806 in commissions and had a realized loss of $131,979.

FINRA's BrokerCheck database shows SW Financial was licensed to do business in 52 U.S. states and territories. BrokerCheck lists five customer complaints and other disclosures against the firm. In the latest, SW Financial agreed on Feb. 27, 2018, to pay a $35,000 fine and nearly $50,000 plus interest in restitution to resolve allegations it had mishandled a client's investments in mutual funds. SW Financial's website directs clients to reach out to their former representatives or the asset custodian Axos Clearing if they have questions about their accounts.