Western International Securities, Inc. has agreed to pay a fine of $475,000 as a part of a settlement with the Financial Industry Regulatory Authority (FINRA).

From January 2016 through June 2020, Western failed to have a supervisory system that was reasonably designed to ensure compliance with applicable securities laws and regulations and with FINRA rules prohibiting excessive trading, including FINRA Rule 2111.

Under Western’s WSPs for actively traded accounts, supervisors were supposed to review daily trade blotters and monthly account statements to detect potentially excessive trading.

Western’s WSPs and trade-blotter-based surveillance were not reasonably designed to detect excessive trading. The WSPs failed to provide supervisors with guidance for evaluating cost-to-equity ratios, turnover rates, or any other useful indicators of potentially excessive trading. The trade-blotter-based surveillance did not reasonably permit supervisors to incorporate any such indicators into their review.

In addition, Western’s WSPs did not require supervisors to take reasonable steps to respond to any potentially excessive trading that they might identify. For example, the firm’s WSPs did not require supervisors to determine or document the factual justification for recommending trading in excess of specific cost-to-equity ratios or turnover rate thresholds, to contact customers by phone or in person to confirm the suitability of even the most active trading, or to impose any discipline or heightened supervision on registered representatives in response to potentially excessive trading. Instead, supervisors were only required to notify compliance staff, who were in turn supposed to send activity letters to customers.

Western compliance staff sent activity letters to customers based on notice from supervisors and also based on their own review of certain exception reports. Until early 2019, however, the exception report reviewed by compliance staff for the vast majority of the firm’s accounts did not include cost-to-equity ratios, turnover rates, or any other useful indicators of potentially excessive trading.

When the firm created a new exception report that included cost-to-equity ratios and turnover rates in early 2019, the firm did not provide it to supervisors. Instead, the firm limited the use of the new report to compliance staff, who used it primarily for the ministerial task of sending activity letters when trading exceeded certain thresholds. In addition, although the new exception report used by compliance staff presented the two indicators above on a trailing twelve-month basis, it did not track other red flag trends or patterns such as, for example, rapidly-accelerating trading.

Initially, Western used so-called “negative consent” activity letters. If customers did not respond to an activity letter about the trading in their accounts, then no additional action was taken. By 2019, Western was generally requiring that customers return a signed “trading acknowledgment” in response to an activity letter.

In certain situations—for example, if the customer affirmatively objected to the trading, claimed that it was unauthorized, or failed to return a signed trading acknowledgement, if one was requested—the firm was supposed to restrict the account. Otherwise, generally no additional actions were taken. Even if the firm identified new red flags of potentially excessive trading, it was Western’s practice not to send more than one activity letter every six months.

Western’s activity letters did not provide customers with notice explaining the firm’s concerns about the trading in their account. The letters were not part of a larger system of supervisory procedures reasonably designed to investigate red flags of potentially excessive trading, determine the relevant facts, and then take appropriate action.

Under its procedures, the firm could conclude its reviews of potentially excessive trading based on customers’ responses to these letters without taking additional steps to actually determine if the customers fully appreciated the trading activity.

As a result, the activity letter process did not provide the firm with a reasonable basis to believe that customers fully understood the risks presented by the active trading, that customers had knowingly accepted those risks, and that the trading was otherwise suitable for them, in light of their investment profile.

Western also failed to consistently enforce its activity letter procedures. If individual compliance staff failed to send activity letters, keep track of deadlines, or restrict accounts when required, there was no failsafe.

For example, a sample from the first half of 2020 showed that most compliance staff did not always record if and when an activity letter was sent and returned for a flagged account. Also, in multiple instances trading continued for a period after trading was supposed to have been restricted, in one case for more than six months.

As a result of all of the above, Western failed to reasonably review trading that appeared to be potentially excessive in approximately one hundred accounts. During the relevant period, four former Western registered representatives in particular traded excessively in certain of their customers’ accounts.

Therefore, Western violated FINRA Rules 3110 and 2010.

On top of the $475,000 fine, the firm has agreed to a censure and restitution of $1,057,632.70 plus interest.