An AML Headache: Is Your Rep Liquidating Microcap Securities?

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Olga Greenberg Gregory Amoroso

By Olga Greenberg and Gregory Amoroso

Olga Greenberg is a partner and Gregory Amoroso is a Securities Litigation Consultant at Eversheds Sutherland.

Over the past 15 months, the Financial Industry Regulatory Authority (FINRA) and the US Securities and Exchange Commission (SEC) have brought numerous cases against firms involving client deposits and liquidations of millions of shares of microcap securities. Although the primary business of many of the firms is the purchase and sale of microcap securities, not all of the cases involved microcap firms. In fact, some of the largest fines were assessed against large, well-known investment banking firms and clearing firms. All it takes is one unsavory client, using a registered representative looking to make some quick, easy money, to cause a host of issues, including possible money laundering. Therefore, firms must be diligent in identifying and assessing large deposits and sales of microcap securities.

In most of the cases, the regulators charged firms and often times the supervising principals with failing to identify “red flags” associated with these types of transactions and ultimately with failing to file Suspicious Activity Reports (SARs). In settlement documents, FINRA noted certain “red flags” that it felt firms and principals failed to identify.

Much can be learned from cases where the regulators have formally charged or settled with these broker-dealers on a neither admit nor deny basis. Below is a summary of some key allegations and findings.

Case No. 1

  •  A firm had 33 accounts that over a period of almost three years sold more than $3.7 billion shares of microcap securities for a total of more than $143 million.
  •  The regulators alleged that the firm failed to monitor for anti-money laundering (AML) red flags such as:
  • o Transactions involving penny stocks for which no registration statement was in effect;
  • o A sudden spike in investor demand, coupled with a rising price in a thinly traded security,
  • o The companies were shell companies when they issued shares;
  • o The issuer’s SEC filings were not current, were incomplete or were non-existent; and
  • o Limited public information was available about the issuer and the information that was available was from questionable sources.
  •  The firm’s supervisory controls failed to ensure compliance with Section 5 of the Securities Act resulting in the illegal distribution of more than 55 million unregistered shares of securities.
  •  The firm failed to apply risk-based procedures and controls for Foreign Financial Institutions reasonably designed to detect and report known or suspected money laundering.
  •  The firm was fined $16.5 million and agreed to provide a certification that it adopted and implemented written supervisory procedures reasonably designed to address the issues identified in the AWC. See FINRA AWC 2013038726101

Case No. 2

  •  A client deposited 13 million shares of a microcap security and promptly liquidated one million of those shares and wired out the proceeds. The firm and the principal did not identify concerns with the validity of the legal opinion accompanying the deposit despite several “red flags.”
  •  \A client attempted to deposit 10 million shares of a microcap security but neither the firm nor the principal conducted any independent due diligence on the issuer or the client that would have likely revealed Section 5 concerns. The deposit was ultimately rejected by the firm’s clearing firm.
  •  A client, who was the CEO of an issuer, purchased more than three million shares and sold more than two million shares of the issuer’s microcap securities. However, the client’s SEC filings with respect to the transactions did not match the trading conducted at the firm.
  •  The firm opened an account for a client who had recently been charged by the SEC with making material misrepresentations and omissions in a penny stock publication.
  •  The firm was fined $75,000 and the branch manager responsible for escalating suspicious activity to the AML Compliance Officer (AMLCO) was suspended for two months in all principal capacities and fined $5,000. See FINRA AWC 2014039396101

Many of the cases have resulted in regulators bringing charges not only against the firms, but also against the principals responsible for the establishment and/or implementation of the firm’s AML compliance. In the example below, a broker-dealer with AML issues filed a Form BDW to withdraw from membership. However FINRA still pursued the matter and brought an action against the firm’s AMLCO.

Case No. 3

  •  FINRA charged the AMLCO with failing to establish and implement an AML program that was reasonably designed to detect and cause the reporting of suspicious activity.
  •  The firm had one representative with eight client accounts (three that were controlled by the same individual) that deposited approximately 225 million unregistered shares of seven different microcap securities and sold approximately 173 million shares of those securities in just a matter of weeks/months. At least some portion of the proceeds of the sales of the deposited securities were typically wired to an account outside the firm.
  •  FINRA determined that the deposits and rapid sales of the unregistered securities presented “red flags” that the AMLCO should have identified.
  •  The AMLCO was fined $10,000 and suspended in all principal capacities for four months. See FINRA AWC 2012030446701

Although FINRA has brought the majority of the AML cases involving microcap securities, the SEC has brought one notable AML action. In that case, it charged a firm with systematically failing to file SARs for securities transactions that it flagged as suspicious and, when it did file, the firm frequently omitted the very information that formed the basis for filing the SARs. See SEC Complaint 2017-112

In almost every FINRA Letter of Acceptance Waiver and Consent (AWC), FINRA referred to Notice to Members 02-21 as a source of guidance regarding the obligation of a broker-dealer to monitor for and report suspicious activity. See FINRA Notice to Members 02-21 Specifically, the Notice suggests, among other things, that firms should tailor their AML programs to fit their business, monitor their business for “red flags,” and develop a process for filing SARs when they detect “red flags.” Although the Notice is obviously aged, it is apparent that FINRA still feels it is relevant. Firms would be well-advised to review the entire Notice and determine if they are following the recommendations made in the Notice.

The SEC for its part appears to be focused on the filing of SARs in order to ensure that questionable activity is properly investigated. In its 2016 exam priorities, the SEC specifically stated that it would “focus on firms that have not filed the number of SARs that would be consistent with their business models or have filed incomplete or late SARs.” See 2016 SEC National Exam Priorities In its 2018 exam priorities, the SEC said it would continue to assess broker-dealers’ compliance with SAR requirements and the timeliness and completeness of the SARs filed. See 2018 SEC National Exam Priorities

So what is a firm to do? Based on case law and the guidance provided by the regulators, it would appear that firms should at a minimum:

  •  Create an AML program that is tailored to the firm’s business. In multiple cases brought by the regulators they charged the firms with failing to create an AML program that was specifically tailored to their businesses. Furthermore, the SEC indicated that it would be looking for this failure in its exam priorities.
  •  Identify possible “red flags” and determine how to review them. Based on the recent cases, at a minimum firms should be looking for:
  • o The source of the securities – are they coming from persons related to the issuer, stock promoters or persons with a criminal history? Was the company a shell company when the shares were issued?
  • o The volume of sales – not only whether there are large sale transactions, but how many shares are sold in relation to the total daily volume in the security.
  • o Price movement – has the price of the securities gone up materially? If so, are there any indications that the security is part of a “pump and dump” scheme?
  • o Section 5 concerns – are the shares properly registered and/or would the sale of the securities be considered to be part of a distribution?
  • o Legal opinion – does the legal opinion accompanying the deposit of shares indicate any questions or inconsistencies?
  • o Publicly available information – are there articles/press releases or other stories from questionable sources that indicate the stock is being actively promoted? Were the issuer’s SEC filings current and complete?
  •  Deposits and liquidations of millions of shares should be an automatic review. All of the cases involved the deposit and sale of millions, and sometimes billions, of microcap shares.
  •  Stop the issue before it starts – train your registered representatives regarding risks associated with accepting large deposits of securities and then liquidating those securities.
  •  Provide sufficient resources to implement an AML program. There are at least three cases involving large firms where the regulator charged firms with failing to implement their programs adequately. Some of the deficiencies identified by the regulators in those cases include:
  • o A firm relied primarily on a manual supervisory review of securities transactions that was not sufficiently focused on AML risks and was otherwise insufficient to satisfy the firm’s AML obligations given the volume and nature of the transactions processed by the firm. See FINRA AWC 2013036434501
  • o A firm failed to conduct reviews of certain activity identified by its legacy AML system during its transition to a new AML system. See FINRA AWC 2012035224301
  • o The firm scored multiple occurrences of the same type of event once. Therefore, a single occurrence of a suspicious activity would have the exact same score as an account in which the same type of transaction occurred repeatedly.
  • o The firm failed to link accounts under the same beneficial ownership for scoring purposes.
  • o The firm failed to apply risk scores consistently, so activity by certain high-risk customers resulted in lower risk scores and such activity was not investigated.
  • o The firm failed to include certain account types in its AML monitoring system.
  • o In another matter, the regulators claimed a firm failed to ensure that the data being fed into its automated system (and that was used to calculate the values to determine whether the accounts met the thresholds for review) was adequate. See FINRA AWC 2013038726101
  • o The firm did not properly calibrate the thresholds that it used for certain scenarios to ensure that they were effective at detecting suspicious activity.
  • o The firm’s testing was insufficient to ensure that suspicious activity was not going undetected. In some instances, the firm set the thresholds too high, which artificially reduced the number of alerts.
  • o The regulators appeared to question the firm’s commitment to its AML process stating that “during the relevant period, the firm also failed to devote sufficient resources to investigating alerts generated by the automated system. The number of analysts employed by the firm at any given time (ranging from 3 to 5) did not have the ability to adequately review the tens of thousands of alerts generated in any given year.”
  • o Finally, the regulator noted that the firm hired a consulting firm to review its AML process. However, it failed to devote adequate resources and funding to resolve the issues identified by the consulting firm.


The consequences for failing to supervise this activity adequately are stiff. Not only can the monetary penalties be high, but the regulators are also increasingly targeting individuals with fines and suspensions in a principal capacity. Therefore, firms should ensure that they have adequate procedures and systems in place, that they are testing those systems, that they are adequately training their people, and that they have provided adequate resources to monitor this activity.

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