An excessive trading case against two brokers at Laidlaw & Company is the latest sign that regulators are getting serious about a nearly 3-year-old rule requiring advisors to put clients' interests before their own.
The Financial Industry Regulatory Authority, the broker-dealer industry's self-regulator, reached agreements last month with
When Reg BI took effect in June 2020, it replaced an older standard that had merely called on brokers to make sure their recommendations were "suitable" for clients. The first two years of Reg BI's existence saw almost no enforcement actions as regulators gave firms time to come to terms with the new standard.
Joe Wojciechowski, an investment fraud lawyer at Chicago-based Stoltman Law, was unimpressed by FINRA's latest Reg BI case, only the second to be brought in the regulator's history. He said Cirella's and Short's excessive trading was "low-hanging fruit" that would have been illegal under the SEC's old suitability rule, as well as any number of state securities laws.
Why, Wojciechowski wondered, wasn't Laidlaw & Company also accused of violating Reg BI?
"They are taking a pelt and putting it on the wall," Wojciechowski said. "But what's not being discussed is if Laidlaw, as the broker-dealer, violated Reg BI, because they have a compliance obligation. And if you allow for this sort of trading, you are lacking the supervisory procedures and policies that are designed to achieve compliance."
A representative of Laidlaw declined to comment. A FINRA representative said the agency doesn't comment on investigations.
The Securities and Exchange Commission, Wall Street's regulator, didn't bring its first charges for violations of Reg BI until
FINRA followed shortly afterward with its own first case involving violations of Reg BI. In October, FINRA announced it agreed to settle excessive trading charges against Charles V. Malico, a broker at Network 1 Financial Securities of Huntington Station, New York, for a $5,000 fine and six-month suspension.
Since then, both regulatory groups have issued statements cautioning the industry that the enforcement of Reg BI is only going to become more common. FINRA warned in January in a
The SEC issued its own
In FINRA's second Reg BI case, the two Laidlaw & Company brokers stood accused of trading far in excess of what could reasonably be deemed beneficial to their clients. Short, for instance, recommended 204 transactions between July 2018 and December 2020 for an investor who was 77 when he opened his account. Those trades netted Short $116,589 in commissions while resulting in $185,000 in trading losses for the client. That gave the trades a cost-to-equity ratio of roughly 76%, meaning the account's value would have had to increase by that much to cover the cost of the commissions.
FINRA regulators tend to view cost-to-equity ratios of above 20% with suspicion. Likewise, brokers will raise red flags if they make trades in clients' accounts more than six times a year.
Cirella's case was similar to Short's. He was accused of recommending 46 transactions between June 2020 and January 2021 for an investor in his early 60s. Those trades cost the client $27,566 in commissions and led to about $12,000 in trading losses. In this case, the account's value would have instead needed to rise by about 37% to cover the commissions.
As a result, Short agreed to refund the $116,589 in commissions plus interest, pay a $5,000 fine and forgo all dealings with FINRA for seven months. Cirella likewise agreed to refund his commissions and interest, pay a $5,000 fine and undergo a three-month suspension.
The brokers' excessive trades were discovered through routine checks by regulators. FINRA scrutinizes the more than 3,000 brokerage firms under its jurisdiction at least once every four years. Firms that are deemed riskier are subject to more frequent examinations, sometimes annually. FINRA also conducts investigations following customer complaints or similar reports.
Sandra Dawn Grannum, a partner at Faegre Drinker Biddle & Reath, who has represented broker-dealers in banks in FINRA and SEC cases, said she has never entertained any doubts that regulators would one day step up their enforcement of Reg BI.
"It's soon going to become the norm," Grannum said. "Reg BI cases will be the new suitability cases, the new churning cases, the new taking-advantage-of-the-elderly cases. It's only news today because we haven't seen it very much."
