For the first time, FINRA invoked the nearly three-year-old best interest regulation when deciding to remove a firm from the brokerage industry.
Broker-dealers’ self-regulator, the Financial Industry Regulatory Authority, announced Friday that it is firing Melville, New York-based SW Financial since June 2007. FINRA said it made the decision in part because it violated regulatory requirements by recommending clients’ best interests about private securities.
Best Interest Regulation (Reg BI), which came into effect in June 2020, generally requires brokers to always look out for the best interests of their clients and to disclose unavoidable conflicts of interest. It is touted by its proponents as a vast improvement over previous standards of broker conduct, which only required advisers to ensure that any investments they recommended were “suitable.”
But despite the warning the hammer is coming down, regulators have been slow to enforce the rule. So far, only one lawsuit has been filed by the Securities and Exchange Commission, which oversees FINRA.
SEC June 2022 Sued Western International Securities, A dual-registered brokerage and investment advisor in Pasadena, California, and five of its brokers recommended buying unrated, high-risk bonds that were not in the best interests of their clients. The case is still pending. FINRA itself has Only a handful of cases have been brought up.
In SW Financial, FINRA held that brokers violated their Reg BI disclosure obligations by failing to explain to clients precisely how they would be compensated for the sale of private securities. The disclosure obligation requires brokers to provide “all material facts pertaining to conflicts of interest relevant to a referral.”
“The serious misconduct in this case exposed clients to significant risk of harm and necessitated the removal of SW Financial from FINRA membership,” Christopher Kelly, senior vice president and acting head of FINRA’s Enforcement Division, said in a statement. No material misstatement or omission may be made in selling securities to clients.”
Along with the firing of SW Financial, FINRA also suspended the company’s CEO and shareholder Thomas Diamante for nine months from all duties and three months from principal duties. Regulators also fined him $50,000. Diamante is not allowed to return to the profession without a qualifying examination.
FINRA’s BrokerCheck Database It was revealed that Diamante worked for three other companies that were eventually fired from the industry. Attempts to contact SW Financial and Diamante have been unsuccessful.
Rob Herskovits, New York-based founder Herskovitz LLP, noting that Reg BI is not the only statute FINRA has invoked in its case against SW Financial. Regulators also rely on old suitability standards and rules governing employee oversight. It’s nearly impossible to determine how much Reg BI has helped, Herskovits said.
“If this is just a Reg BI case, it’s hard to draw a firm conclusion on the appropriate sanction,” Herskovits said.
In particular, FINRA found that from early 2018 to late 2021, SW Financial and Diamante misled investors that they would receive a 10% commission on sales of private securities ahead of a planned IPO. In fact, SW Financial has an undisclosed agreement that gives it an additional 5% commission and a share of the profits of the security issuer’s investment manager. A FINRA spokesman declined to say which firm issued the shares.
FINRA found that SW Financial sold private securities to 171 investors, 163 of whom were retail clients. The company and its owners received an undisclosed sum of approximately $2 million. FINRA also found that SW Financial and its owners failed to meet their obligations to ensure that issuers of securities were able to actually offer the shares they were trying to sell.
Separately, FINRA said that from January 2016 to May 2019, SW Financial and two of its former representatives engaged in excessive trading in nine customer accounts. The campaign cost investors $350,000 in transaction fees and resulted in realized losses of more than $465,000. In one case, a 75-year-old client paid $101,806 in commissions and lost $131,979.
FINRA’s BrokerCheck database shows SW Financial is licensed to do business in 52 US states and territories. BrokerCheck lists five customer complaints and other disclosures against the firm. Most recently, SW Financial agreed on February 27, 2018 to pay a $35,000 penalty and nearly $50,000 in restitutional interest to resolve allegations that it mishandled client mutual fund investments. Shenwan Financial Website Clients are directed to contact their former representative or asset custodian Axos Clearing if they have questions about their account.