Annual Sutherland Analysis of FINRA Sanctions Shows Number of Enforcement Actions Rises Slightly in 2012, Fines Jump by 15%

Deborah G. Heilizer

Washington – March 13, 2013 — Sutherland Asbill & Brennan LLP has completed its annual review of the disciplinary actions reported by the Financial Industry Regulatory Authority (FINRA) in 2012. By reviewing FINRA’s monthly disciplinary notices, Sutherland Partners Deborah Heilizer and Brian Rubin and Associate Andrew McCormick found that in 2012 FINRA brought slightly more disciplinary actions but assessed a double-digit increase in fines. This was the fourth consecutive year of increase in the number of cases filed and the second straight year of growth in the amount of fines. Sutherland also identified the top enforcement issues for FINRA in 2012, as well as emerging trends.

Brian L. Rubin

Fines and Disciplinary Actions

In its published Statistical Review, FINRA reported filing 1,541 disciplinary actions ¹ in 2012, an increase of 3.6% from the 1,488 cases the regulator initiated in 2011.² According to FINRA, 2012 was the fourth straight year of growth in the number of disciplinary actions. However, the slight rise in the number of cases filed in 2012 was considerably smaller than the 8%, 13%, and 13.6% increases in 2009, 2010, and 2011, respectively. Cumulatively, however, the number of cases initiated by FINRA has grown by 44%, from 1,073 cases in 2008 to the 1,541 actions filed last year.³ The number of firms expelled by FINRA jumped from 21 to 30 in 2012, an increase of 43%.⁴ Results involving individuals are less uniform. Although the number of individuals suspended rose from 475 to 549 in 2012, an increase of 15.6%, the number of persons barred from the industry dropped from 329 to 294, a decrease of nearly 11%.⁵

The growth in fines last year easily surpassed the small uptick in the number of actions filed, with fines jumping from $68 million in 2011 to $78.2 million in 2012, an increase of nearly 15%.⁶ (In its Mid-Year Review, published in August 2012, Sutherland had estimated that FINRA would report $78.4 million in fines in 2012.⁷) This was the second year in a row that the amount of FINRA fines has increased, and it continues a trend of increased fines since 2008. The $78 million of fines reported in 2012 marks a 179% increase from the $28 million of FINRA fines reported in 2008. While the $78 million reported in 2012 is still a far cry from the $184 million and $111 million that FINRA fined firms and representatives during the high-water mark years of 2005 and 2006, respectively, it may signal FINRA’s continued willingness to flex its enforcement muscle for the near future, particularly in areas such as restitution. In 2012, the regulator ordered firms and representatives to pay a record $34 million of restitution to investors.⁸ This represents an 80% increase from the $19 million of restitution ordered by the regulator in 2011.⁹

The chart below shows the fines and the number of disciplinary actions that FINRA has reported during each of the past eight years.

Top Enforcement Issues, Measured by Total Fines Assessed

Over each of the next four days, a Sutherland FINRA Focus will be published analyzing suitability, due diligence, research analyst and research reports, and advertising cases.¹⁰ The following are the top FINRA enforcement issues, measured by total fines assessed:

#1    Suitability cases were the top enforcement issue in 2012. FINRA assessed fines totaling $19.4 million in cases involving suitability allegations, representing a 152% increase from the $7.7 million in fines reported in 2011. In 2012, there were 117 suitability cases, a 10% increase from the 106 cases reported in 2011. The surge in suitability fines was largely driven by the $7.5 million in fines assessed in four exchange-traded fund (ETF) cases, and “supersized” fines of $1+ million in cases involving complex products such as reverse convertible notes and unit investment trusts. Suitability cases have been a mainstay on Sutherland’s Top Enforcement Issues list in recent years, placing fourth in 2010 and 2011 and second in 2008 and 2009.¹¹ The statistics show that suitability issues remain a priority for FINRA, which likely will continue in this era of increasing product complexity. While 53 suitability cases were reported in both 2008 and 2009 (when suitability was ranked second on Sutherland’s Top Enforcement Issues list), the number of cases reported in each of the past two years has doubled. In addition to fines of $19.4 million, FINRA also ordered $22.5 million of restitution in connection with the 2012 suitability cases.

#2    Due Diligence cases resulted in the second-highest amount of fines assessed by FINRA in 2012. FINRA brought 62 due diligence cases in 2012, resulting in fines of $12.8 million. These figures represent significant increases from 2011’s totals, when FINRA reported 44 cases involving due diligence allegations, which resulted in only $1.6 million in fines. The rise in the number of due diligence cases represents an increase of 41%. While that is an impressive increase, it pales in comparison to the 700% jump in the amount of sanctions imposed in due diligence cases between 2011 and 2012. This substantial increase was largely fueled by “supersized” fines of $1+ million assessed in due diligence cases involving complex products and alternative investments. In 2012, FINRA also ordered $19 million of restitution in cases involving due diligence allegations.

#3    Research Report and Research Analyst cases resulted in $12.4 million of FINRA fines in 2012. Although the number of “research” cases dropped from 15 cases in 2011 to 13 in 2012, the total fines from these cases jumped from $1.5 million to $12.4 million. This exponential increase is due to a single case that resulted in an $11 million fine to FINRA (and an $11 million penalty to the Securities and Exchange Commission). This case involved allegedly improper communications about research analyst ratings and resulted in the largest fine assessed by FINRA in 2012.

#4    Advertising was the fourth-biggest fine generator in 2012. This is the first time advertising has not been ranked first in Sutherland’s Top Enforcement Issues list since 2009. FINRA reported 50 cases involving alleged advertising violations in 2012, which resulted in fines of $10.4 million. Although the number of advertising cases increased from the 45 reported in 2011 (an increase of 11%), the amount of fines decreased dramatically from 2011’s $21.1 million. This 51% decrease largely stems from the steep decline in the number of auction rate securities (ARS) cases filed by FINRA. While FINRA assessed fines of $9.5 million in 2011 in ARS cases involving advertising allegations, there were no such cases reported in 2012.

#5    Exchange-Traded Fund (ETF) cases were an important area of focus for FINRA in 2012. While FINRA reported only four cases involving ETFs in 2011, this number jumped to nine in 2012, an increase of 125%. The four 2011 ETF cases resulted in only $123,000 in fines, but FINRA imposed $7.6 million in fines in 2012 ETF cases, an increase of more than 6000%. This explosion in fines was the result of four cases that each resulted in a fine of at least $1.5 million. Those cases concerned leveraged and inverse ETFs that FINRA alleged were unsuitable for conservative investors and were sold without sufficient due diligence review.

Trends

“Supersized” Fines. The return of “supersized” fines of $1+ million was an important enforcement trend in 2011 and the increased use of these mammoth fines in 2012 signals that they may be here to stay. While only six “supersized” fines were reported in 2010 ($14.2 million of total fines), this number grew to 10 in 2011 ($35 million of total fines). In 2012, both of these numbers continued to increase. FINRA imposed 16 “supersized” fines in 2012 for a total of $43 million. These totals include seven fines of at least $2.5 million.

Complex Products. This area was an important focus for FINRA in 2012. Although what constitutes a complex product is subjective, some of the following products might be considered to be complex for certain investors: collateralized mortgage obligations ($6.8 million in fines), unit investment trusts ($4.3 million), real estate investment trusts (REITs) ($3.1 million), private placements ($1.7 million), and leveraged and inverse ETFs ($7.35 million).

Electronic Communications. After years of declining enforcement activity relating to electronic communications, there was an uptick in activity in this area in 2012. FINRA imposed only $4 million in fines in electronic communication cases in both 2009 and 2010, and only $3.6 million in 2011. This amount shot up to $6.5 million in 2012, an increase of 81%. This increase was partially driven by a case where a firm allegedly failed to retain millions of emails, resulting in a $750,000 fine. The number of cases concerning electronic communications also rose from 57 in 2011 to 63 in 2012, an increase of 11%.

Auction Rate Securities (ARS). Cases involving ARS have generated substantial fines for FINRA during the past three years, including $3.5 million in 2009, $1.8 million in 2010, and $9.9 million in 2011. However, FINRA reported only one ARS case in 2012, which resulted in a $200,000 fine. This suggests that the wave of ARS cases that resulted from collapse of ARS auctions during the financial crisis could be over.

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Footnotes

¹ FINRA defines disciplinary actions as Letters of Acceptance, Waivers and Consents; Complaints; Rule 9522 suspensions; and Minor Rule Violations.
² FINRA Statistics, available at http://www.finra.org/Newsroom/Statistics/index.htm.
³ Id.
⁴ Id.
⁵ Id.
⁶ The fine amounts reported come from the Disciplinary and Other FINRA Actions reports that FINRA published each month in 2012. For an analysis of 2011 data, see Deborah G. Heilizer, Brian L. Rubin, and Andrew M. McCormick, Annual Sutherland FINRA Sanctions Survey Shows a 51% Jump in Fines in 2011, March 12, 2012.
⁷ Deborah G. Heilizer and Brian L. Rubin, Mid-Year Review: FINRA’s Sanctions in 2012 On Pace To Far Surpass 2011’s Totals, August 9, 2012.
⁸ FINRA News Release, 2012: FINRA Year in Review, January 8, 2013, available at http://www.finra.org/Newsroom/NewsReleases/2013/P197624. (FINRA’s news release also references the amount of fines assessed in 2012. The total fines reported in FINRA’s news release differ from the total fines reported in the monthly Disciplinary and Other FINRA Actions publications published in 2012; the latter data is used in Sutherland’s analysis.)
⁹ FINRA 2011 Year in Review and Annual Financial Report, p. 2, available at https://www.finra.org/web/groups/corporate/@corp/@about/@ar/documents/corporate/p127312.pdf.
¹⁰ Because cases may involve more than one alleged violation (e.g., suitability and due diligence), a case may be included in more than one category in this analysis.
¹¹ Heilizer, Rubin, and McCormick, supra note 6.

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