A firm settled FINRA charges for failing to calculate customer reserves accurately.

In a Letter of Acceptance, Waiver, and Consent, FINRA found that the firm failed to make sufficient deposits into its reserve account, resulting in nine deficiencies in violation of SEA Rule 15c3-3 ("Customer protection-reserves and custody of securities"). The hindsight deficiencies resulted from:

  • inaccurate pricing of Treasury Inflation-Protected Securities ("TIPS"), which were pledged by a customer as collateral in the customer's margin account;
  • an overdraft in a foreign bank account that the firm erroneously excluded from its reserve formula computation; and
  • an inadvertent deposit of ineligible securities into its reserve account.

By failing to properly calculate its customer reserve requirement, the firm created and failed to maintain accurate books and records, and filed inaccurate Financial and Operational Combined Uniform Single (FOCUS) reports, in violation of SEA  Section 17(a), SEA Rules  17a-3 ("Records to be made by certain exchange members, brokers and dealers") and  17a-5(a)(2) and FINRA Rule 4511 ("General Requirements").

Further, FINRA found that the firm had no supervisory system or written supervisory procedures designed to ensure (i) that TIPS pricing was accurate or that errors in TIPS pricing would be escalated for investigation, (ii) that overdrawn bank balances were identified for the customer reserve calculation, or (iii) that only eligible securities were used as collateral, in violation of FINRA Rule 3110 ("Supervision").

As a result, the firm also violated FINRA Rule 2010 ("Standards of Commercial Honor and Principles of Trade").

To settle the charges, the firm agreed to (i) a censure and (ii) a $125,000 fine.

Commentary Steven Lofchie

One unusual aspect of this enforcement action was that it was largely precipitated by the firm's misevaluation (likely unintentional) of the securities pledged by the customer as collateral for a margin loan. It serves as a caution that firms must have good procedures for valuing securities that they do not trade as principal.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.