SEC Finds Compliance Failures at 16 Brokers Trading Microcaps, Fines E*Trade

A majority of the brokers examined by the U.S. Securities and Exchange Commission (SEC) as part of an inquiry into the sale of low-priced stocks were found to have serious compliance deficiencies, the agency said Thursday.

In an advisory, the SEC said that most of the 22 brokerages investigated in a “targeted sweep” of the microcap stock industry had inadequate compliance programs in place to trigger reviews of unregistered securities sales and file suspicious activity reports when warranted.

Separately on Thursday, the SEC announced an enforcement action against current and former subsidiaries of E*Trade Financial Corporation for improperly conducting unregistered sales of microcap stocks.

The action included a $1 million penalty and “$1.5 million in disgorgement and prejudgment interest from commissions” from the sales, according to an SEC press release.

Over a four-year period, the subsidiaries “encountered numerous red flags” linked to the stock sales but failed to conduct a “reasonable inquiry” into whether the sales should have been registered with the agency.

According to the advisory, the regulator referred 16 of the 22 firms examined to its enforcement division or to another regulatory agency to determine “whether violations of law occurred,” the advisory said.

Examiners particularly focused on instances where brokers liquidated blocks of shares for issues that may have publicly exaggerated the value of the microcap company in question to artificially inflate its share value before cashing out, the agency said.

In several instances, the brokerages failed to identify the beneficial owners behind suspicious microcap stock trades executed by offshore banks and broker-dealers through omnibus accounts, the SEC said.

Some of the accounts used to dump microcap stock had a master account, sub-account structure that also obscured the identity of the original trader, according to the advisory.

The advisory echoes the circumstances behind the Financial Regulatory Authority’s (Finra) enforcement action against Brown Brothers Harriman, said Bao Nguyen, director of risk advisory services with Kaufman Rossin in Boca Raton, FL.

In February, the private bank agreed to pay $8 million to Finra for allowing foreign banks with omnibus accounts to anonymously access the U.S. securities market as part of a pump-and-dump scheme involving the sale of 6 billion shares of microcap stocks.

Finra also took the unusual step of suspending BBH’s chief compliance officer and making him pay a $22,000 fine.

Brokers that participate or allow the liquidation of low price securities should be “very concerned” by the risk alert, said Nguyen, a former Finra examiner.