Supervisory Lapses Cost $350K in Fines to Morgan Stanley Owned E*Trade

JPMorgan Fine

E*Trade Securities, the self-directed platform for trading that was acquired by Morgan Stanley in October 2020, and which has 2,100 registered representatives spread across 40 branches, has been censured by Financial Industry Regulatory Authority (FINRA). The FINRA censure is for the platform’s inability to monitor trading that could be manipulative. A fine of $350K has also been levied.

‘Not reasonably designed’ was the phrase used by FINRA while making the assessment. The period during which the platform was not able to detect improper trading practices usually directed at manipulating the price of a thinly traded stock such as pre-arranged trading, wash trades, ‘marking the close’ was identified as February 2016 onwards.

The self-regulating organization (SRO) found E*Trade’s monitoring systems to be too restrictive to be able to detect such activities. They used an example of only trades over $1,000 being flagged off, without reference to the price of the underlying security, to illustrate their point.

Further, according to FINRA, their end-of-day trading reports only captured data from the final minute of trading, much too restrictive a strategy for any meaningful supervisory monitoring. Again, to illustrate, FINRA said that such a system would not detect a series of buys designed to inflate the closing price, a strategy for ‘marking the close.’

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Missing as well as any management report or method of identifying if a customer was trying to artificially inflate the price of a security through a series of buys within a short timeframe, followed by a transaction on the opposite side to reap the rewards from that inflation.

These lapses were apparently unearthed during a review conducted by the Market Regulation Department of the SRO.

Whether any specific instances of trading that could be classified as manipulative were unearthed or not, was not specified.

Other views

No comment was forthcoming from the E*Trade spokesperson. They have accepted the findings of FINRA without admittance or denial, as stated in the letter of the settlement.

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A couple of lawyers with prior experience of working with regulatory enforcement units expressed surprise at the quantum of the fine for an organization the size of E*Trade. In their experience, penny-stock manipulators usually flock to smaller brokerage firms.

Brad Bennett, formerly the chief of enforcement at FINRA, seemed to put things in perspective by saying “It’s kind of a reminder that on these platforms, you have to surveil the lower end-user to look for penny-stock manipulation.”

Former senior counsel in the Securities and Exchange Commission’s Division of Enforcement Jacob Frenkel, who was also a member and chair of Washington, D.C. law firm Dickinson Wright’s government investigations and securities enforcement unit, said “An action like this highlights the challenge of the jockeying between stock manipulators and surveillance mechanisms.”

Conclusion

Of the amount of fine that E*Trade will pay, $144,500 will go to FINRA. According to the letter of settlement, the remainder will be paid to The Nasdaq Stock Market, NYSE Arca, Investors Exchange, and Cboe EDGX Exchange for similar violations.

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