SEC Fines Broker for Inconsistent Application of SAR Rule

The filing of SARs – suspicious activity reports – appears to be an increasing area of interest for the Commission. Typically the cases brought have focused on aggravated fact patterns such as the transfer in of millions of penny stock shares followed by the sale of those shares with the funds wired out almost immediately. Now, however, the agency appears to be focusing on a different view. Its most recent case is keyed not to penny stocks or millions of dollars of cash flowing through a broker but inconsistent standards being applied under which some conduct which merited the termination of a client relation resulted in the filing of a SAR while in others instances it did not. The precise meaning of this approach is, at best, unclear. What is apparent, however, is the fact that a $2.8 million penalty was imposed. SEC v. Charles Schwab & Co., Civil Action No. 18-cv-3942.

Schwab, a broker-dealer and investment adviser, offers a broad range of services to Investment Advisers and their clients. Those advisers are independent third-parties who contract with Schwab for custodial and execution services. In 2012 and 2013 Schwab terminated its relationship with 83 Advisers. The terminations were based on Schwab’s conclusion that the advisers had violated internal firm policies, presenting a risk to the broker-dealer or its customers. Of the 83 terminated advisers, 47 engaged in transactions that met the dollar limit for filing a SAR. Schwab chose to file SARs regarding only 10 of the 47, three of which were filed after the Commission filed an enforcement action against the terminated adviser.

Under the Bank Secrecy Act and the related rule, brokers are required to file SARs with the Financial Crimes Enforcement Network or FinCEN in certain circumstances. Specifically, brokers are required to report a transaction that involved at least $5,000 when the firm knew, suspected, or had reason to suspect that it involved funds from illegal activity, was designed to evade the requirements of the Bank Secrecy Act, had no business or apparent lawful purpose or involved the use of the broker to facilitate criminal activity. Section 17(a) of the Exchange At and the related rules effectively implement these requirements.

Here 47 of the terminated advisers engaged in transactions over the $5,000 limit but only 10 SARs were filed. The firm’s “failure to file the SARs at issue resulted from its inconsistent implementation of policies and procedures for identifying and reporting transactions under the SAR Rule. Schwab had a SAR policy that stated it should file a SAR on any transaction of $5,000 or more that ‘involves potential fraud.’” The policy also includes a broad definition of Securities Fraud. Nevertheless, the broker-adviser failed to make filings regarding transactions that involved: 1) possible self-dealing or conflict of interest; 2) the use of Schwab’s management fee system to charge client accounts excessive advisory fees; 3) patterns of potentially fraudulent transactions such as “cherry picking;” 4) advisers who used the client login information to effect or confirm a transaction; and 5) advisers who allowed their registration to lapse but continued to execute client trades and collect advisory fees. Schwab also used an “unreasonably high” standard to determine if a SAR should be filed regarding transactions it suspected involved possible misappropriation or other misuse of client funds, according to the complaint.

Examples of Schwab’s failings include: 1) The broker suspected that $295,000 in wire transfers were suspicious and that it was possible the adviser used client funds “for the purchase of his property but this can not be confirmed.” In researching the transaction the firm determined that the clients authorized the transfers on recorded lines. Neither client complained. The matter was closed. The client relation was terminated. The “standards requiring a SAR filing were met . . .” the complaint states. 2) Another adviser with $50 million in AUM and 476 subaccounts was terminated after Schwab found that over a two year period the client had allocated 17 profitable day trades to itself that had profits of $75,000. The adviser had been counseled twice regarding suspicious trading. 3) The registration for some advisory firms lapsed but they continued to advise clients and charge fees. This conduct is alleged to have violated Exchange Act section 17(a) and rule 17a-8 thereunder. To resolve the action Schwab consented to the entry of a permanent injunction based on the section and rule cited in the complaint. The firm also agreed to pay a penalty of $2.8 million.