FINRA Fines: Another consequence after employee misconduct in a regulated industry

October 25, 2012

Those in the corporate legal department may stay awake at night worrying about the potential that employee actions could put the business on the hook for a jury verdict or settlement. But judges and juries aren’t the only arbitrators of worker misconduct, especially for those who work in highly regulated industries.

One recent example comes from the files of the Department of Enforcement at the Financial Industry Regulatory Authority (FINRA) (hat tip: Winston & Strawn LLP). FINRA, the largest independent regulator of registered securities representatives, began investigating the activities of two traders at the CDO desk of a prominent financial services firm for discrepancies in accounts related to a failed riskless principal trade executed by one of the traders in late 2008.

According to one of the trader’s admissions to FINRA, the traders conspired to misrepresent the cost of a CLO to one of their hedge fund customers after they could not find buyers for the CLO without taking a substantial loss on it. The hedge fund questioned the deal’s value at first, but ultimately agreed to purchase the CLO along with other securities the traders offered to it. In exchange, the traders agreed to repay the hedge fund with adjustments in other sales, waiver of certain fees and a cash wire.

Customer made whole, but employer faces fines

Through the traders’ actions, the hedge fund customer was made whole. But that’s not the end of the story. FINRA cracked down on the traders for their deceptions. Earlier this year, they were both suspended and fined tens of thousands of dollars for their responsibility for the duplicitous transactions.

But their employer was fined $800,000 for its failure to supervise the two traders. According to a FINRA official, the financial services firm did not even have knowledge of the traders’ activities. But the employer was fined for its failure to detect the bogus transactions on its own books as well as for allowing its employees to defraud a customer and cook the accounts.

FINRA’s fines against the employer are just one of many cautionary tales for general counsel and others in the corporate legal department, especially when serving a business in a highly regulated sector. Risk comes from many different angles, including federal, state, and independent regulators — ensuring you have the proper policies and procedures to catch mistakes can be critical when you face a regulator’s inquiry.