American Portfolios Financial Services, Inc. has agreed to pay a fine of $225,000 as a part of a settlement with the Financial Industry Regulatory Authority (FINRA).
Between January 2019 and August 2022, American Portfolios opened new accounts for multiple customers that transacted in low-priced securities. Ten customer accounts deposited over 48 million shares of low-priced securities, liquidated over 42 million shares, and generated nearly $17 million in proceeds during this period. Notwithstanding the heightened level of risk presented by this activity, the firm failed to establish and implement policies and procedures that could be reasonably expected to detect and cause the reporting of suspicious transactions involving low-priced securities.
The firm’s AML procedures were not reasonably designed to detect and respond to red flags concerning low-priced securities. Although the procedures identified red flags of suspicious activity in low-priced securities, such as issuer promotional activity, atypical trading patterns including price and volume spikes, coordinated trading among accounts, and suspiciously timed deposits, liquidation, and wires, they failed to provide guidance regarding how to detect suspicious activity and how to monitor for those red flags.
The procedures also failed to provide guidance on how to conduct or document a review of an identified red flag, including whether additional investigation, customer due diligence measures, or a SAR filing might be warranted. Additionally, the firm’s AML compliance program failed to include appropriate risk-based procedures for conducting ongoing customer due diligence, including how and when to identify and report suspicious transactions in low-priced securities.
In practice, to detect potentially suspicious activity concerning low-priced securities, the firm relied exclusively on an exception report prepared by its clearing firm that showed basic information concerning deposits of low-priced securities, such as the account, security, date of deposit, number of shares, price, and total dollar amount.
The report did not show historical or aggregated information and, therefore, was not a reasonable tool to identify patterns of suspicious activity in low-priced securities. Nor did the firm conduct ongoing due diligence of customers transacting in low-priced securities.
The firm also failed to take reasonable steps to monitor and investigate hundreds of transactions in low-priced securities that raised red flags in at least ten accounts held by four customers. Each of these customers engaged in a suspicious pattern of depositing shares of low-priced securities, liquidating some or all of those shares, and withdrawing the funds shortly thereafter.
Many of the liquidations occurred during spikes in share price and volume or during promotional campaigns. In addition, American Portfolios failed to reasonably investigate at least one of these customers who had disciplinary history presenting increased risk and was engaged in marketing work for issuers of low- priced securities.
For example, one of the firm’s customers deposited 330,000 shares of a low-priced security in January 2021, liquidated the entire position the same day, and wired out the proceeds five days later. The deposit and liquidation occurred in the midst of a promotional campaign for the security, which resulted in price spikes and surging volume. Although these facts implicated multiple red flags set forth in the firm’s AML compliance program, the firm failed to detect and investigate this activity.
Because the firm’s AML program was not reasonably designed to detect and report suspicious activity involving low-priced securities, American Portfolios violated FINRA Rules 3310(a), 3310(f), and 2010.
Between January 2019 and August 2022, the firm’s supervisory system, including written procedures, titled “Unregistered Resales of Restricted Securities,” was not reasonably designed to achieve compliance with Section 5. The firm’s written procedures did not provide reasonable guidance as to how to determine whether a transaction complied with the registration requirements of Section 5.
In practice, American Portfolios relied primarily on a low-priced security questionnaire completed by the registered representative on the account to determine if low-priced securities deposited at the firm were freely tradeable. The questionnaire directed representatives to attach documents and information evidencing the transaction through which the customer acquired the shares.
The questionnaire, however, did not specify what documentation should be collected and reviewed prior to the deposit or sale of low- priced securities or explain how to verify information provided by customers.
American Portfolios did not have a reasonable process for documenting its review of the questionnaire or ensuring that registered representatives completed the required questionnaire. As a result, the firm failed to consistently collect and maintain all the necessary documentation to determine whether deposited securities were freely tradeable.
In addition, on multiple occasions, the firm failed to conduct independent due diligence before allowing customers to deposit and liquidate potentially restricted securities.
For example, when the firm was advised that a transfer agent had removed the restricted legend from a low-priced security, it did not take any further steps to obtain a questionnaire, documents, or information to conduct an independent analysis regarding resale eligibility.
By failing to establish, maintain, and enforce a supervisory system reasonably designed to achieve compliance with Section 5, American Portfolios violated FINRA Rules 3110 and 2010.
In addition to the $225,000 fine, the respondent has agreed to a censure.
