Recent Cases of Customer Abuse by Brokerage Firm Branch Managers Underscore Need for Effective Compliance Function

inancial advisers often are the subject of customer complaints, arbitrations and regulatory actions in connection with mishandling their customers' accounts, notwithstanding the fact that financial services firms are charged with the responsibility of establishing a supervisory and compliance system to prevent such abuse. But what happens when the most critical person "minding the store" — the branch manager — is the source of that customer abuse? Two recent actions — one regulatory, the other criminal — illustrate the problem.

In one action, a Toledo, Ohio branch manager formerly employed by Wachovia Securities, plans to plead guilty to Department of Justice charges that he stole between $17 million and $40 million from about 45 investors by using a Ponzi-type scheme. William Sirls sold non-existent "investments" in two scams. First, he promised his customers access to real estate deals known as "builder-discounted real estate." Second, he convinced customers to invest in "busted trades", which are trades that other customers purportedly had placed but not paid for, leaving the firm with such trades to sell for a profit. Sirls raised money by issuing promissory notes to investors promising short term, high rates of return when, in fact, he simply was using such funds to pay off earlier investors.

Also involved in this "selling away" fraudulent scheme was Randall Hunt, the branch manager who replaced Sirls when he left Wachovia in 2005, and who allegedly invested and made money in Sirls' Ponzi scheme. In addition to the criminal proceeding against Sirls, arbitration actions have been brought and surely more will follow against the firm, the branch managers and the financial advisers recommending such "investments." Regulatory actions will not be far behind.

In the other action, securities regulator NASD has fined Raymond James Financial Services $2.75 million for lax supervision of its more than 1,000 branch managers working in offices throughout the country. The NASD charged the firm with allowing such branch managers to supervise themselves, and faulted the firm for allowing them to recommend unsuitable mutual fund and variable annuity purchases to elderly or retirement age customers.

Specifically, NASD criticized Raymond James' supervision and compliance department for not doing their jobs, and highlighted the supervision failure in connection with one of the firm's branch managers, Donna Vogt of Wisconsin. In a press release, NASD states, "They [branch managers] approved their own transactions, opened and accepted new accounts, and reviewed their own correspondence." Although the firm relied on an electronic transaction surveillance system that the compliance department maintained, and a series of special ("exception") reports, the firm did not effectively supervise the branch managers. In particular, the NASD faulted the firm for having only three exception reports for variable annuity purchases, which three reports "did not screen variable annuity transactions for suitability based on customer net worth, annual income, investment experience or concentration of variable annuity holdings as a percentage of net worth." Additionally, the NASD criticized the firm for failing to maintain a system to review the suitability of variable annuity sub-account transactions recommended by branch managers.

These two actions (involving Wachovia Securities and Raymond James Financial Services) illustrate the need for an effective compliance function to protect customers from branch managers who seek to abuse them. For years, securities regulators have emphasized this important duty. For example, the New York Stock Exchange requires sales supervisors and compliance officials to pass qualification examinations. The "Series 14" examination for compliance officials tests the applicant's knowledge to ensure that he or she "implements and monitors the firm's procedures for opening and supervising customer and employee accounts." Moreover, the NYSE exam ensures that a compliance official "understands manual and computer systems required to capture and analyze market and trading information for surveillance purposes", "assembles internal and external data for surveillance purposes", and "reviews principal and customer daily trading activities."

Likewise, the Securities Industry Association (SIA) published a "White Paper on the Role of Compliance", which emphasizes the importance of the compliance function. The SIA states that compliance department personnel "perform a critical ongoing monitoring and surveillance function." According to the SIA, this role "often involves a detailed review of business activities, as well as surveillance of business transactions and communications, to identify potential issues relating to, among other things, the handling of customer accounts, proprietary trading, employee/employee-related trading and employee communications."

Financial services firms need to do a better job supervising and carrying out their critical compliance functions!

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James J. Eccleston is a securities attorney, representing customers as well as brokers and brokerage firms nationwide in arbitration, litigation and regulatory matters. He maintains an informative website at www.FinancialCounsel.com. He is an equity partner with Shaheen, Novoselsky, Staat, Filipowski & Eccleston, and can be reached at 312-621-4400.