FINRA Files First Reg BI Enforcement Action

FINRA has its first Reg BI enforcement action—resulting in a six-month suspension and a $5,000 fine in a case of excessive trading.

The activity in question was a case of churning within an account that not only generated revenue for the broker (and his trading network), but cost the customer losses in addition to the cost of trading.  FINRA said its action originated from a review of a customer-initiated arbitration.  

This involved former broker[i] Charles V. Malico who, according to FINRA from July 2020 through November 2021 “…willfully violated the Best Interest Obligation under Rule 15l-1 of the Securities Exchange Act of 1934 (Regulation Best Interest or Reg BI) and violated FINRA Rule 2010 by recommending a series of transactions in the account of one retail customer that was excessive in light of the customer’s investment profile and therefore was not in that customer’s best interest.” And, arguably, that’s putting it mildly.

More specifically, Malico recommended to one of his retail customers—a 63-year-old tax preparer with an annual income of approximately $100,000 and liquid net worth of about half that. “Although Customer A’s average account balance during the relevant period was less than $30,000, Malico recommended that he make more than 350 trades in his account”—and that meant that the customer in question paid “more than $54,000 in commissions and other trading costs.”

Now if that seems like a lot—consider what kind of trades we’re talking about. The FINRA agreement notes that “Malico frequently recommended that Customer A buy and then sell a security, only to repurchase the same security weeks or even days later.” FINRA notes that on four occasions he  recommended that Customer A buy shares of a biotechnology company only to sell them on the same day or the next day. “Such in-and-out trading caused Customer A to lose more than $6,000, while generating more than $3,200 in commissions and trading costs to Malico and Network 1.” 

In fact, FINRA commented that, “collectively, the trades that Malico recommended in Customer A’s account resulted in an annualized cost-to-equity ratio exceeding 158 percent—meaning that Customer A’s account would have had to grow by more than 158 percent annually just to break even.” It continues to note that those recommendations “made it virtually impossible for Customer A to realize a profit and, in fact, Customer A lost more than $17,500 during the relevant period.”

Adopted by the SEC on June 5 2019, Reg BI establishes a “best interest” standard of conduct for broker-dealers and associated persons when making recommendations to a retail customer of any securities transaction or investment strategy involving securities. The Commission also adopted as part of that regulatory package a new rule to require broker-dealers and investment advisers to provide a brief relationship summary to retail investors, known as Form CRS. The Securities and Exchange Commission announced June 16 that it charged a registered broker-dealer and five of its representatives for failing to comply with certain obligations under the rule.