WASHINGTON — The Financial Industry Regulatory Authority ordered San Juan-based Santander Securities on Tuesday to pay more than $6.4 million for supervisory failures related to Puerto Rican municipal bonds.
The $6.4 million includes $4.3 million in restitution to certain customers who were solicited to purchase Puerto Rico bonds, $2 million for supervisory failures related to sales of the bonds and Puerto Rican closed-end funds, as well as $121,000 in restitution and offers to buy back securities sold to customers who were affected by Santander’s failure to supervise employee trading.
The order follows a Sept. 29 combined Securities and Exchange Commission and FINRA settlement with UBS Puerto Rico where UBS paid $34 million because it failed to supervise the suitability of transactions in Puerto Rican closed-end fund shares, as well as a broker who urged customers to invest in the CEFs using money borrowed from an affiliated bank.
In this case, FINRA found that between December 2012 and October 2013, Santander did not ensure its proprietary product-classification tool properly reflected market risks with the bonds and did not adequately supervise its customers’ use of margin and concentrated positions in their accounts. Santander did not require a review of the tool and specifically did not review the tool’s Puerto Rico bond risk classifications after Moody’s downgraded certain of the island’s bonds on Dec. 13, 2012, FINRA said.
The self-regulator also found that between October 2010 and April 2014 Santander failed to monitor possible conflicts of interest when brokers filled customer orders through positions held in the broker’s own personal brokerage account.
"This is a strong reminder to firms that they must focus on customers' exposure to market risks and suitability, particularly in those markets like Puerto Rico that present unique risks and challenges," said Brad Bennett, FINRA's executive vice president and chief of enforcement.
Santander neither admitted nor denied the charges, but consented to the entry of FINRA’s findings. A spokesperson said the firm “is pleased to resolve this matter and will comply with the terms of the FINRA letter” including taking steps to “enhance its controls in connection with the activities described.”
The order is somewhat similar to one Santander entered into in April 2011, where FINRA imposed a $2 million fine for deficiencies it found in the firm’s structured products business between September 2007 and September 2008. In addition, Santander was directed to reimburse customers by than $7 million for losses associated with the deficiencies after April 2011.
Prior to the period examined in the current order, Puerto Rico bonds had been attractive to investors on the island because they offered special tax exemptions and generated steady income frequently at higher yields than equivalent non-Puerto Rico investments. Under these conditions, FINRA found Santander solicited its Puerto Rico customers to purchase about $180 million in the commonwealth’s bonds and more than $101 million in Puerto Rico closed-end funds.
During that period, the firm relied on a proprietary system it called Securities Master that placed securities into one of three risk categories: lower, moderate, or high.
Santander started reducing its Puerto Rico bond inventory on Nov. 29, 2012 after the value of Puerto Rico bonds began deteriorating and then stopped purchasing Puerto Rico bonds its customers wanted to sell the day after the Moody’s downgrade. It eventually started buying them on a short-term basis on Jan. 31, 2013, but had entirely eliminated its inventory of the territory’s bonds by October 2013.
FINRA found that Santander violated Municipal Securities Rulemaking Board Rule G-27 on supervision when it failed to review its Securities Master in the wake of the downgrade to “ensure that the guidance it provided accurately reflected the market risks of investing” in the bonds under the circumstances.
Santander also violated Rule G-27, NASD Conduct Rules 3010(a) and (b) on supervision, and FINRA Rule 2010 on standards in trading because it did not have procedures for accounts with high concentrations in Puerto Rico investments to assess whether new purchases were suitable in light of existing positions. NASD was FINRA’s predecessor.
The firm violated those same rules when it failed to supervise its employees’ trading for possible conflicts of interest. It required pre-approval for all employee account transactions, but did not have a way to identify the transactions or make sure they had pre-approval before execution.
The lapse allowed for about 1,449 of the 3,515, or 41% employee and employee-related transactions, to be effected without approval during the identified trading period of October 2010 to April 2014.
During that period, there were about 400 unmonitored transactions where employees sold directly from their accounts to customer accounts or bought directly from their customers. The transactions involved more than 40 employee and employee-related accounts and 260 customers and accounted for more than $50 million in principal amount without Santander being able to identify or mitigate potential conflicts of interest inherent in the trades, FINRA said.
In addition to its fines, Santander agreed to review all its written policies and procedures to ensure they are consistent in terms of concentration levels in customer accounts, the use of margin, the supervision of customer transactions, and reports and tools available to registered representatives.
