SEC Continues Focus on Retail Customers

The Commission’s enforcement program continued its focus on retail customer protections this week. The agency filed settled administrative proceedings against a broker dealer – investment adviser based on a coding error which left the firm in violation of the customer protection rule. In the Matter of Wedbush Securities, Inc., Adm. Proc. File No. 3-18357 (Feb. 5, 2018).

Wedbush is a dual registered broker dealer and investment adviser based in Los Angeles. The firm has 99 offices and over 70 correspondent offices. It also has an extensive regulatory history.

The proceedings centered on Exchange Act Rule 15c-3, the customer protection rule. That rule requires broker dealers that maintain custody of customer securities and cash to safeguard those assets by segregating them from the broker dealer’s proprietary business activity. Then in the event the firm fails, the segregated securities and cash will be available to cover those of the customers. The amount of the reserve is calculated using a formula appended to the rule. Essentially that formula requires the broker dealer to net its obligations to the customers against those of the customer to the firm. Typically, broker dealers calculate the amount of the reserve weekly.

Wedbush made the customer reserve calculation on a weekly basis. In funding its reserve the firm typically maintained a cushion over and above the required amount as a hedge against calculation and other errors, thereby ensuring compliance.

In 2014 and 2015 however, the firm had a coding error in the programing used to make the calculation which left Wedbush under funded. The coding error was tied to certain repurchase agreement the broker dealer engaged in which its parent company to reduce certain administrative costs. Specifically, in July and August 2014 the firm began doing certain repos with its parent regarding Ginnie Mae bonds. The coding error resulted in the calculation for the customer reserve incorrectly accounting for these repo transactions. While the cushion maintained by the firm covered the errors at first, since they occurred on a weekly basis eventually the firm underfunded its customer protection account by amounts which exceeded the cushion. Thus from September 2014 through January 2015 the reserve was under funded by amounts that ranged from $10 million to $193 million on a weekly basis. This resulted in the firm not being in compliance with the rule and filing incorrect FOCUS reports which contained the numbers related to the reserve.

In late January 2015 a FINRA examination raised questions relating to the manner in which the repo transactions were handled in the calculation of the customer reserve. Wedbush then uncovered the coding error and the incorrect calculations. To correct the deficiency the firm was required to deposit $133 million in easily accessible funds. Wedbush could not immediately fund the obligation. To the contrary it took the firm several weeks to fund it.

This is not the first regulatory violation by Wedbush. Previously the firm has been sanctioned for violations by the Commission, FINRA and Nasdaq five time. It also settled charges with FINRA concurrent with the filing of these proceedings. The Order alleges violations of Exchange Act sections 15(c)(3) and 17(a)(1). In resolving the proceedings the firm agreed to retain an independent consultant to review its procedures and make appropriate recommendations. In addition, Wedbush consented to the entry of a cease and desist order based on the sections cited in the order and agreed to pay disgorgement in the amount of $275,851 along with prejudgment interest of $28,346 and a penalty of $1 million.

Tagged with: ,