On June 9, 2011, the Securities Division of the Secretary of the Commonwealth of Massachusetts (the “Securities Division”) issued a consent order (the “Order”) in settlement of an investigation of a major broker-dealer (the “Firm”). The Securities Division alleged that, in an effort to generate more revenue to pay for research activities, the Firm developed a practice in which unpublished short-term trading ideas, sometimes varying from published ratings and recommendations, were provided to favored customers following so-called “trading huddles” involving research analysts and traders, and in calls by analysts directly to a particular client’s traders. The Firm was required to pay a fine of $10 million and to undertake remedial actions specified in the Order. The Firm admitted certain factual statements but neither admitted nor denied the legal conclusions of the Securities Division.
In 2003, investigations by securities regulatory authorities raised issues concerning whether the research related activities of certain investment banks violated principles of good faith and fair dealing in various respects. Those investigations arose from claims that research analysts were influenced by the investment banking departments of their firms to produce reports favorable to investment banking clients. The regulatory authorities alleged that the firms failed to manage conflicts of interest in an adequate or appropriate manner. Those investigations led to settlements by many such firms, including the Firm. Statements of management personnel cited in the Order indicate that, following the settlement, the Firm, like other firms with research departments, sought ways to pay for the significant costs associated with producing research.
The Asymmetric Service Initiative
The Order describes an initiative begun at the Firm in 2007, called the Asymmetric Service Initiative, or “ASI”, to deliver enhanced services to certain clients with the hope of leading them to increase their business levels with the Firm. According to the Order, the Firm developed lists of clients who were prioritized to receive ASI services based on the amount of trading revenue they generated or were expected to generate. Clients who generated more revenue were moved up the list and clients who generated less revenue than expected were moved down the list. Clients at the top of the list were contacted by traders at the Firm and provided unpublished research that had been discussed at huddles between research and trading personnel at the Firm. Priority clients also sometimes received calls directly from research personnel communicating unpublished information. According to the Order, selective disclosure of unpublished research violated the Firm’s existing policies and procedures.
Findings and Undertakings
The Securities Division based its order on Section 204(a)(2)(G) of the Massachusetts Uniform Securities Act (the “Act”), M.G.L. ch. 110A, which authorizes the Secretary to impose a fine or take other appropriate action if the Secretary finds that the order is in the public interest and that the person has engaged in prohibited conduct. The Securities Division found that the Firm’s conduct had constituted each of the following: (i) it had “engaged in … unethical or dishonest conduct or practice in the securities … business;” and (ii) it had “failed reasonably to supervise agents … or other employees to assure compliance with this chapter.” Significantly, the Order states that it is not to be construed as a finding or admission of fraud under the Massachusetts Act.
In the Order, the Firm agrees to permanently discontinue both the Asymmetric Service Initiative and the trading huddles. While the Firm is permitted to provide different levels and types of research services to clients based on, among other things, the client’s preferences as to frequency and manner of receiving communications, the client’s risk profile, investment focus and perspective, and the size and scope of the overall client relationship with the Firm, the Firm must disclose information about its different levels and types of services in the Term of Use section of its internal client website.
Reports appearing in the financial press following the announcement of the Order indicate that the SEC and FINRA are also conducting investigations in this area, although neither agency will confirm or deny the existence of any investigation.