11

Unauthorized TradingUnauthorized Trading

22

DefinitionDefinition

Executing a buy or sell transaction in a Executing a buy or sell transaction in a customer account without their knowledge customer account without their knowledge and not agreed to by the customer (either and not agreed to by the customer (either expressly or implicitly).expressly or implicitly).

Motive is usually to generate commissions Motive is usually to generate commissions or to conceal other activities.or to conceal other activities.

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Prohibitions against Prohibitions against Unauthorized TransactionsUnauthorized Transactions

FINRA Rules 2010 and 2020 and IM-FINRA Rules 2010 and 2020 and IM-2310-2(a)(4)(A)(iii) 2310-2(a)(4)(A)(iii)

Section 10(b) of the Securities Exchange Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5Act of 1934 and Rule 10b-5

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Time and Price DiscretionTime and Price Discretion

NASD Rule 2510(d) states that the written discretionary NASD Rule 2510(d) states that the written discretionary agreement requirement shall not apply to discretion as to agreement requirement shall not apply to discretion as to the price at which or the time when an order given by a the price at which or the time when an order given by a customer for purchase or sale of a definite amount of a customer for purchase or sale of a definite amount of a specified security shall be executedspecified security shall be executed..

The authority to exercise time and price discretion will be The authority to exercise time and price discretion will be considered to be in effect until the end of the business considered to be in effect until the end of the business day on which it was granted.day on which it was granted.

Any exercise of time and price discretion must be Any exercise of time and price discretion must be reflected on the order ticket.reflected on the order ticket.

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Time and Price Discretion-cont.Time and Price Discretion-cont.

An exception to having to obtain prior written An exception to having to obtain prior written authorization is time and price discretion. Time and authorization is time and price discretion. Time and price discretion can be defined as verbal permission as price discretion can be defined as verbal permission as to the exact time and exact price in which a broker to the exact time and exact price in which a broker executes the order for the customer. (good for one day)executes the order for the customer. (good for one day)

State rules and NASD Conduct Rule 2510 prohibits State rules and NASD Conduct Rule 2510 prohibits brokers from exercising discretionary authority in a brokers from exercising discretionary authority in a customer’s account without first obtaining written customer’s account without first obtaining written discretionary authority from the customer.discretionary authority from the customer.

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Examination Steps to detect Examination Steps to detect Unauthorized TradingUnauthorized Trading

Review customer complaintsReview customer complaints Inquire as to the merits of each disputed claim of Inquire as to the merits of each disputed claim of

unauthorized tradingunauthorized trading Timing of complaint in relationship to the date of the Timing of complaint in relationship to the date of the

disputed transactiondisputed transaction

Choose a sampling of cancelled tradesChoose a sampling of cancelled trades Include accounts alleging unauthorized tradingInclude accounts alleging unauthorized trading Review documentation describing reason for Review documentation describing reason for

cancellationcancellation

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Examination Steps (cont’d)Examination Steps (cont’d)

Look for patterns of frequent cancellationsLook for patterns of frequent cancellations One particular securityOne particular security One salespersonOne salesperson

Determine whether a significant number of Determine whether a significant number of accounts with a cancelled trade had no accounts with a cancelled trade had no subsequent transactionssubsequent transactions

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Examination Steps (cont’d)Examination Steps (cont’d)

Review customer accounts for suspicious trades Review customer accounts for suspicious trades involving the same security or salespersoninvolving the same security or salesperson Prepare chronological schedulePrepare chronological schedule

Review order tickets and confirmationsReview order tickets and confirmations Review client file/information to determine if Review client file/information to determine if

there is a current trading authorization which there is a current trading authorization which grants another individual the authority to trade in grants another individual the authority to trade in the accountthe account

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Examination Steps (cont’d)Examination Steps (cont’d)

Review account activity to determine if there was Review account activity to determine if there was any unsuitable trading in the accountany unsuitable trading in the account

Account activity should be reviewed to Account activity should be reviewed to determine if the transaction(s) is/are consistent determine if the transaction(s) is/are consistent with the customer’s investment objectives and if with the customer’s investment objectives and if required, a customer’s risk tolerance (i.e., Low, required, a customer’s risk tolerance (i.e., Low, Medium or High)Medium or High)

1010

Examination Steps (cont’d)Examination Steps (cont’d)

Interview salesperson(s) involvedInterview salesperson(s) involved Interview customer(s)Interview customer(s) Interview branch manager and/or Interview branch manager and/or

supervisor of salespersonsupervisor of salesperson

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Examination Steps (cont’d)Examination Steps (cont’d) Interview 3Interview 3rdrd parties (sales assistants, operations parties (sales assistants, operations

personnel, client’s spouse, etc…) who may have personnel, client’s spouse, etc…) who may have first hand information relating to the first hand information relating to the transaction(s)transaction(s)

Review Supervisory Procedures Manual of Review Supervisory Procedures Manual of broker-dealerbroker-dealer

Determine if and what type of exception reports Determine if and what type of exception reports are used by the broker-dealer to monitor trading are used by the broker-dealer to monitor trading activityactivity Review firm’s exception reports for cancelled trades Review firm’s exception reports for cancelled trades

and excessive trading activityand excessive trading activity

1212

Proof ChecklistProof Checklist

Element of ViolationElement of Violation Salesperson executed the disputed trade(s) in Salesperson executed the disputed trade(s) in

customer account(s)customer account(s) ProofProof

Order ticketsOrder tickets ConfirmationsConfirmations Account statementsAccount statements Salesperson’s commission recordsSalesperson’s commission records Admission by salesperson that trades were executed Admission by salesperson that trades were executed

in customer’s accountin customer’s account

1313

Proof ChecklistProof Checklist

Element of ViolationElement of Violation Customer(s) did not authorize the transaction(s) Customer(s) did not authorize the transaction(s)

expressly or implicitlyexpressly or implicitly ProofProof

Customer’s testimonyCustomer’s testimony• Denial of expressed or implied authorizationDenial of expressed or implied authorization• Realized or unrealized loss(es) were not the sole motivation Realized or unrealized loss(es) were not the sole motivation

for filing the complaintfor filing the complaint Documentation showing absence of customer Documentation showing absence of customer

availability (i.e., travel itinerary, medical emergencies)availability (i.e., travel itinerary, medical emergencies)

1414

Proof ChecklistProof Checklist

Proof – (cont’d)Proof – (cont’d) Absence of oral discretion including time and price Absence of oral discretion including time and price Trade(s) inconsistent with investment historyTrade(s) inconsistent with investment history Account StatementsAccount Statements Firm’s records regarding disposition of complaintFirm’s records regarding disposition of complaint Similar complaints from other customers of Similar complaints from other customers of

salespersonsalesperson

1515

Proof ChecklistProof Checklist

Element of ViolationElement of Violation Customer Customer promptlypromptly complained to firm or complained to firm or

salespersonsalesperson ProofProof

Complaint letter to firm, state regulatory Complaint letter to firm, state regulatory agency , FINRA, etc.agency , FINRA, etc.

Customer’s testimonyCustomer’s testimony Firm’s records regarding disposition of Firm’s records regarding disposition of

complaintcomplaint