1 Unauthorized Trading

2 Definition  Executing a buy or sell transaction in a customer account without their knowledge and not agreed to by the customer (either expressly or implicitly).  Motive is usually to generate commissions or to conceal other activities.

3 Prohibitions against Unauthorized Transactions  FINRA Rules 2010 and 2020 and IM (a)(4)(A)(iii)  Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5

4 Time and Price Discretion  NASD Rule 2510(d) states that the written discretionary agreement requirement shall not apply to discretion as to the price at which or the time when an order given by a customer for purchase or sale of a definite amount of a specified security shall be executed.  The authority to exercise time and price discretion will be considered to be in effect until the end of the business day on which it was granted.  Any exercise of time and price discretion must be reflected on the order ticket.

5 Time and Price Discretion-cont.  An exception to having to obtain prior written authorization is time and price discretion. Time and price discretion can be defined as verbal permission as to the exact time and exact price in which a broker executes the order for the customer. (good for one day)  State rules and NASD Conduct Rule 2510 prohibits brokers from exercising discretionary authority in a customer’s account without first obtaining written discretionary authority from the customer.

6 Examination Steps to detect Unauthorized Trading  Review customer complaints Inquire as to the merits of each disputed claim of unauthorized trading Inquire as to the merits of each disputed claim of unauthorized trading Timing of complaint in relationship to the date of the disputed transaction Timing of complaint in relationship to the date of the disputed transaction  Choose a sampling of cancelled trades Include accounts alleging unauthorized trading Include accounts alleging unauthorized trading Review documentation describing reason for cancellation Review documentation describing reason for cancellation

7 Examination Steps (cont’d)  Look for patterns of frequent cancellations One particular security One particular security One salesperson One salesperson  Determine whether a significant number of accounts with a cancelled trade had no subsequent transactions

8 Examination Steps (cont’d)  Review customer accounts for suspicious trades involving the same security or salesperson Prepare chronological schedule Prepare chronological schedule  Review order tickets and confirmations  Review client file/information to determine if there is a current trading authorization which grants another individual the authority to trade in the account

9 Examination Steps (cont’d)  Review account activity to determine if there was any unsuitable trading in the account  Account activity should be reviewed to determine if the transaction(s) is/are consistent with the customer’s investment objectives and if required, a customer’s risk tolerance (i.e., Low, Medium or High)

10 Examination Steps (cont’d)  Interview salesperson(s) involved  Interview customer(s)  Interview branch manager and/or supervisor of salesperson

11 Examination Steps (cont’d)  Interview 3 rd parties (sales assistants, operations personnel, client’s spouse, etc…) who may have first hand information relating to the transaction(s)  Review Supervisory Procedures Manual of broker-dealer  Determine if and what type of exception reports are used by the broker-dealer to monitor trading activity Review firm’s exception reports for cancelled trades and excessive trading activity Review firm’s exception reports for cancelled trades and excessive trading activity

12 Proof Checklist  Element of Violation Salesperson executed the disputed trade(s) in customer account(s) Salesperson executed the disputed trade(s) in customer account(s)  Proof Order tickets Order tickets Confirmations Confirmations Account statements Account statements Salesperson’s commission records Salesperson’s commission records Admission by salesperson that trades were executed in customer’s account Admission by salesperson that trades were executed in customer’s account

13 Proof Checklist  Element of Violation Customer(s) did not authorize the transaction(s) expressly or implicitly Customer(s) did not authorize the transaction(s) expressly or implicitly  Proof Customer’s testimony Customer’s testimony Denial of expressed or implied authorizationDenial of expressed or implied authorization Realized or unrealized loss(es) were not the sole motivation for filing the complaintRealized or unrealized loss(es) were not the sole motivation for filing the complaint Documentation showing absence of customer availability (i.e., travel itinerary, medical emergencies) Documentation showing absence of customer availability (i.e., travel itinerary, medical emergencies)

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

15 Proof Checklist  Element of Violation Customer promptly complained to firm or salesperson Customer promptly complained to firm or salesperson  Proof Complaint letter to firm, state regulatory agency, FINRA, etc. Complaint letter to firm, state regulatory agency, FINRA, etc. Customer’s testimony Customer’s testimony Firm’s records regarding disposition of complaint Firm’s records regarding disposition of complaint