Finra announced today that it has expelled Melville, N.Y.-based broker-dealer SW Financial for multiple Reg BI and suitability violations, including making misrepresentations to customers in its sales of private placement offerings of pre-IPO securities, churning customer accounts and failing to disclose commissions.
It is the first such expulsion that involves violations of Reg BI rules, a Finra spokesperson confirmed.
"The [acceptance waiver and consent] for SW Financial is the first settlement document of its kind with the sanction of expulsion stemming in part from Reg BI violations," the spokeperson explained.
Both SW Financial and its CEO and co-owner, Thomas Diamante, who founded the firm in 2007, settled Finra’s charges without admitting or denying the findings, according to Finra.
Under the settlement, Finra suspended Diamente for nine months in all capacities, followed by a three-month suspension in all principal capacities. Diamente also agreed to pay a $50,000 fine and to requalify by examination if he seeks to register with Finra as a general securities principal or investment banking representative in the future.
“The serious misconduct in this case exposed customers to significant risk of harm and necessitated expulsion of SW Financial from FINRA membership,” Christopher J. Kelly, senior vice president and acting head of Finra's Department of Enforcement, said in a prepared statement.
“Firms cannot make material misstatements or omissions when they sell securities to customers. Firms also must reasonably surveil for, and respond to, red flags of excessive trading and churning. When firms, particularly those with significant disciplinary histories, commit egregious sales practice and supervisory violations, expulsion from FINRA membership may be warranted,” Kelly added.
Finra examiners said they discovered that between January 2018 and December 2021, Diamante and SW Financial made material misrepresentations and omitted material information in connection with the sale of private placement offerings of risky pre-IPO securities, which violated both the disclosure obligation of Regulation Best Interest’s (Reg BI) and Finra rules.
Reg BI’s disclosure obligation requires broker-dealers and associated persons to provide retail customers with full and fair written disclosure, prior to or at the time of a recommendation, of all material facts relating to conflicts of interest associated with the recommendation, Finra said in a statement.
Customers of the broker-dealer also received inaccurate information regarding the commissions SW Financial earned on the sales, Finra said.
“SW Financial informed potential investors that it would receive only a 10% sales commission in connection with its sale of certain pre-IPO securities when, in fact, Diamante had entered into an undisclosed agreement with the issuer under which SW Financial would receive an additional 5% in selling compensation and half of any carried interest (a share of profits payable to the issuer’s investment manager),” Finra said.
SW Financial then turned around and sold the private offerings to 171 investors, including 163 retail customers, “and the firm and its owners received approximately $2 million in undisclosed compensation—a serious potential conflict of interest that could have influenced SW Financial’s recommendations and should have been fully disclosed,” according to the self-regulatory organization.
Diamante and SW Financial “also failed to conduct reasonable due diligence on the private offerings and did not confirm that the issuer actually held or had access to the shares it purported to sell,” Finra said.
As a result, SW Financial “had no reasonable basis to recommend the offerings to customers, in violation of both Finra's suitability rule and Reg BI’s Care Obligation, which requires broker-dealers and their associated persons to exercise reasonable diligence, care, and skill to, among other things, understand the potential risks, rewards, and costs associated with a recommendation, and have a reasonable basis to believe that the recommendation could be in the best interest of at least some retail customers,” Finra said.
Between January 2016 and May 2019 Finra also found that SW Financial, acting through two former representatives, churned nine customer accounts causing the customers to incur more than $350,000 in total trading costs and realized losses of more than $465,000.
“In one instance, a retired, 75-year-old customer whose account was excessively traded had a cost-to-equity ratio (or break-even point) of more than 103%, paid $101,806 in commissions, and incurred realized losses of $131,979, which comprised most of his retirement savings. SW Financial failed to reasonably follow up on red flags of the excessive trading in this customer’s – and other customers’ – accounts,” Finra said.
An attorney said the case brings clarity to how Finra's rules apply to private placements.
“The one thing that catches my eye is how specific this enforcement is to private placements. I like that Finra is connecting the prior standards for private placements and their suitability rules. It should be common sense that the same standards exist in Reg BI, but nice to see that Finra is making it crystal clear,” said Joe Wojciechowski, a partner at Stoltmann Law Offices in Chicago.
That clarity is also important because “the House Financial Services Committee is on a mission to change the definition of accredited investor and expand access to private markets for all investors. It is critical going forward to the extent that a broker-dealer is involved that the rules are clear because private market issuances have lapped public market issuances,” Wojciechowski added.