Financial Planning (June 28, 2022) - A midsize wealth manager that’s under new ownership after a compliance overhaul agreed to its second major FINRA settlement this year relating to sales of affiliated alternative products.

As part of a June 23 order, National Securities agreed to pay nearly $9 million to settle FINRA’s charges that the firm “engaged in misconduct intended to influence artificially the market for securities offered by the firm’s corporate affiliates and investment banking clients” between June 2016 and December 2018 and violated other operational and supervisory rules. Boca Raton, Florida-based National, which has 574 representatives and a parent company owned by financial services firm B. Riley Financial, settled another FINRA case in April for $663,000.

National shed hundreds of advisors in 2017 and 2018 under an overhaul aimed at culling those who had substantial numbers of disclosures on BrokerCheck. While its latest FINRA case includes allegations that it missed red flags about a rep who was falsifying clients’ suitability information, ran afoul of the rules of short-sale transactions and stock warrants, and failed to disclose information about troubled manager GPB Capital, the action primarily revolves around three initial public offerings and seven follow-on offerings. The company generated $4.77 million in net profits it must now disgorge because investigators say National induced clients to purchase shares in the prohibited “aftermarket” of the small-cap biopharma and tech IPOs.

“The firm’s conduct was aimed at artificially stimulating demand and supporting the price of the offered securities, which tended to be thinly traded, in the immediate aftermarket,” according to FINRA’s letter of acceptance, waiver and consent. “The aftermarket performance of [National’s] underwritten offerings was important to the firm’s reputation and ability to generate future investment banking revenue.”

The fact that it took four years after the alleged conduct to resolve FINRA’s case should stand out to wealth managers who are watching enforcement cases closely after the SEC filed its first enforcement action under Regulation Best Interest earlier this month, according to Michael Edmiston, an attorney with Jonathan W. Evans & Associates who is the current president of the Public Investors Advocate Bar Association.

“I could easily see the investment banking issue becoming a major focal point for the SEC's initial enforcement actions,” Edmiston said. “That's an easy prove to show it wasnt in the best interest of the customer.”

B. Riley — which purchased National’s remaining equity last year as part of the second of two transactions totaling more than $40 million — had disclosed wealth management segment losses of more than $10 million for the first quarter due to “reduced market activity combined with the impact of a settlement charge related to litigation” prior to the deal. National didn’t admit or deny FINRA’s allegations as part of the settlement. 

The firm also cooperated with FINRA’s allegation as part of taking “several measures to resolve the matters referenced as a continuation of its efforts to enhance its regulatory compliance posture,” spokeswoman Jo Anne McCusker said in an email.

National “has since exited its investment banking business and has taken active steps to de-risk the firm, including eliminating high-risk business lines and registered representatives,” she said. “In addition, [National] has systematically overhauled its compliance processes and supervisory procedures, implemented new reporting controls and electronic monitoring systems, hired new senior compliance professionals and implemented advanced training and education for advisors, brokers and supervisors.”

Besides the disgorgement of the profits from the aftermarket sales, FINRA ordered the firm to pay a fine of $3.6 million and restitution of $625,000, plus interest, to clients who purchased GPB Capital products. Another 17 clients won’t receive any restitution because they have already settled their claims against National relating to GPB’s limited partnerships. National violated Regulation M’s rules against market manipulation through the sales in the aftermarket by a security’s underwriter and by using “tie-in agreements” that linked the IPO share allocations of reps to their volume of the illegally timed transactions, according to FINRA.

“Investors are entitled to rely on a market that is free from artificial price movement created by underwriters,” FINRA Head of Enforcement Jessica Hopper said in a statement. “We will continue to vigilantly enforce rules designed to prevent underwriters from influencing the market for an offered security, including supporting the offering price by creating a perception of aftermarket demand.”