U.S. securities regulators have sanctioned certain brokerage subsidiaries of E-Trade Financial Corp. for failing to do their part to combat microcap fraud.
The U.S. Securities and Exchange Commission (SEC) announced that it has settled with a pair of current and former brokerage subsidiaries of E-Trade after an investigation found that the firms sold billions of shares in penny stocks for customers over a four-year period, and that they ignored red flags that the offerings were being conducted without an exemption from the registration provisions of federal securities laws. When brokers facilitate an unregistered sales transaction on behalf of a customer, they must reasonably ensure that an exemption does apply, the SEC notes.
The SEC’s order finds that three customers of E-Trade routinely deposited large quantities of newly issued penny stocks they had acquired through private, unregistered transactions with little-known, non-reporting issuers into their accounts. They then sold the securities and immediately wired the proceeds out of their accounts.
“E-Trade failed to fulfill its obligation to determine whether any exemptions applied to the sale of billions of shares of securities thereby depriving investors of critical protections under the federal securities laws,” said Stephen Cohen, associate director of the SEC’s division of enforcement. “Firms must take their reasonable inquiry obligations seriously and do more than check the box, particularly when red flags are apparent.”
The firms, E-Trade Securities and G1 Execution Services (which was sold earlier this year, and was formerly known as E-Trade Capital Markets), agreed to settle the SEC’s charges by paying back more than US$1.5 million in disgorgement and prejudgment interest from commissions they earned on the improper sales. They are also paying a combined penalty of US$1 million. In addition to the monetary sanctions, without admitting or denying the SEC’s findings, the two firms also agreed to be censured, and consented to the order requiring them to cease and desist from committing any future violations of the registration provisions of the securities laws.
Along with the enforcement action, the SEC also published an alert today to remind broker-dealers of their obligations when they engage in unregistered transactions on behalf of their customers. That alert details widespread deficiencies that were discovered by the SEC’s Office of Compliance Inspections and Examinations (OCIE) during a targeted sweep of 22 broker-dealers that are frequently involved in the sale of microcap securities.
The shortcomings included insufficient policies and procedures to monitor for and identify potential red flags in customer-initiated sales; inadequate controls to evaluate how customers acquired the securities and whether they could be resold without registration; and, failure to file suspicious activity reports.
“Broker-dealers must be vigilant when facilitating sales on behalf of customers in unregistered transactions and remember that reliance on the broker’s exemption requires a reasonable inquiry of the customer and transaction,” said Stephen Luparello, director of the SEC’s division of trading and markets.
“Broker-dealers serve an important gatekeeping function that helps prevent microcap fraud by taking measures to ensure that unregistered shares don’t reach the market if the registration rules aren’t being followed,” said Andrew Ceresney, director of the SEC’s enforcement division. “Many billions of unregistered shares passed through gates that E-Trade should have closed, and we will hold firms accountable when improper trading occurs on their watch.”