Securities Regulation Daily Wrap Up, TOP STORY—FINRA fines JPMorgan $2.8M for Customer Protection Rule violations, (Dec 27, 2017)

By Anne Sherry, J.D.

J.P. Morgan Securities, LLC, settled FINRA charges of violating the SEC’s Customer Protection Rule and related supervisory failures. According to FINRA, until June 2016, the firm’s successor did not have reasonable processes in place to ensure that its possession or control systems were operating properly. Shares that should have been segregated were available for the firm’s use, and the firm created deficits in foreign and domestic securities valued at hundreds of millions of dollars. The firm agreed to be censured and pay a $2.8 million fine.

Customer Protection Rule. Exchange Act Rule 15c3-3 requires broker-dealers to protect securities left in their custody. Broker-dealers must promptly obtain, and thereafter maintain, physical possession or control of all customers’ fully paid and excess margin securities by segregating these securities in a "good control location" separate from the broker-dealer’s own assets.

System failures. The alleged violations were on the part of J.P. Morgan Clearing Corp. (JPMCC), which merged with J.P. Morgan Securities (JPMS) in October 2016. Throughout the eight-year period ending in mid-2016, JPMCC did have possession or control systems, but they did not work as anticipated. Errors relating to coding or bank account instructions meant that instructions for securities to be moved to good control locations were not executed. On one sample day, the firm created a deficit in 81 Italian securities worth about $146 million.

Also, due to design flaws, JPMCC’s optimization engine treated securities recalled from a depository bank loan as available to meet segregation requirements. This resulted in intraday deficits that were not captured in JPMCC’s deficit reports, meaning this ongoing issue went undetected. In a three-day sample period in April 2015, JPMCC created seven intraday deficits totaling $12.7 million.

Failure to supervise. JPMCC also violated NASD and FINRA rules pertaining to supervision. The firm’s possession or control function was carried out by disparate individuals in different groups who did not effectively communicate with each other about the company’s overall compliance. The tools created to identify compliance were not reasonably designed to identify trends or ongoing issues, and there were no reasonable procedures in place to test the firm’s segregation processes, which had been in place since 2008.

Cooperation credit. The order notes that JPMCC, itself the successor to Bear Stearns Securities Corporation, has no relevant disciplinary history with the SEC or any state securities agency, nor with FINRA or any other self-regulatory organization. FINRA also credited the firm’s "extraordinary cooperation" by unilaterally engaging an independent consultant, undertaking a comprehensive review and reporting findings to FINRA, creating a new team responsible for the possession or control process, and designing and implementing new monitoring tools and systems. JPMS consented to the entry of FINRA’s findings without admitting or denying the charges.

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