Busted: SEC leaves FINRA with a black eye

Even before this embarrassing revelation, the US Chamber of Commerce issued a report that blasted FINRA’s lack of transparency in its governance, board composition and compensation practices, saying that its measures are ‘limited and superficial.’

In its action against the self-regulated organization, the SEC claims that paperwork provided by FINRA’s Kansas City District office to the SEC’s regional office in Chicago was doctored hours before it was handed over. The alteration of the documents, which were three records of staff meeting minutes, was found to have been the third time in eight years that FINRA or a representative from the body had committed such an unethical act.

Again, this was done three times by a regulator whose chief role is to protect investors by maintaining fairness.

‘It's impossible to know the full facts behind the settled order but, compared to the sanctions a company would face for similar conduct, even the first time, the SEC's response seemed temperate,’ says Deborah Meshulam, chair of the Securities Enforcement Practice at Washington-based DLA Piper. ‘This isn’t something I would have predicted -- a watchdog engaging in some sort of misconduct — particularly conduct involving document alterations.   You expect to see FINRA sanctioning regulated entities and associated persons for such conduct.  You don't expect FINRA officials to engage in such activities.’

This unethical move by FINRA represents a major setback for its planned expansion. In April, Richard Ketchum, FINRA’s chairman and chief executive, told DealBook about his ambitious plans to expand the influence of Wall Street’s self-regulatory agency in an effort to someday replace the SEC as the top enforcer. Currently, the regulator oversees more than 4,500 brokerage firms and already monitors more than 600,000 stockbrokers.

But manipulating documents ahead of an investigation does occur.  A solid example is Enron’s non-transparent and misleading financial statements and fiduciary rules that were altered to create the illusion of a very successful company. Unfortunately Enron’s survival strategy did not take the company very far.

Despite the Enron debacle, companies are still resorting to altering and editing documents to avoid being fined prior to an investigation.

If a company’s legal department fails to maintain documents properly, this poses a serious legal risk. Commonly forged documents can take the form of checks, money orders, deeds, financial statements, court seals, securities, bonds and currency.  

The penalties for such crimes can include serious jail time. Depending on the state, suspects can spend up to 32 years in prison or be fined anywhere between $100,000 and $750,000.

Given this, document integrity should be integrated into a company’s compliance program. Often, companies focus so much on SOX and Dodd-Frank compliance that other issues can slip through the cracks.

Meshulam (pictured right) says there isn’t a 100 percent guarantee that a firm
can prevent an employee from tampering with important documents. But there are ways to help avoid it:

(i) Tone at the top: Employees at companies whose top executives foster an ethical business culture are likely to behave ethically. More concretely, however, it is important to train employees at all levels about the importance of document integrity.  This issue was in the spotlight recently as a result of the option back dating cases.
 
(ii) Training - avoid web-based:  This can take many forms—each company should consider which modes of communication will be effective for them. Part of the training should include in-person discussions with employees so that there is a personal touch. Having face-to–face discussions are a lot more effective than requiring an employee simply to take a web-based training course.
 
(iii) Preparing documents:  In order to minimize risk in this area, a corporate secretary or compliance professional should ensure that documents such as minutes are prepared in a timely fashion. Preparing these contemporaneously will increase their accuracy.  
 
(iv) Preservation:  Finally, a company should make sure that its information is preserved with integrity. There should be a document retention system in place that preserves original documents that are important to the company's operations.

Above all, and taking FINRA as an example, be aware that unethical business practices can occur at any time. Altering business documents remains a serious crime that has sent ripples through the business environment. It is crucial to  monitor activity closely in order to detect early signs of bad business behavior before it spins out of control.