Drexel Hamilton Fined & Censured for Falsifying Retail Bond Orders

Drexel Hamilton, a well-known broker-dealer, is facing serious penalties from the Financial Industry Regulatory Authority (FINRA) after it was found to have misrepresented retail orders during new issue municipal bond offerings. The firm has been censured, fined $300,000, and ordered to return over $837,000 in profits from its improper practices, which were conducted between 2016 and 2018.

Municipal bonds, which help cities and other municipalities raise funds for public projects, are typically sold in two phases: first to retail investors and then to institutional buyers. Retail investors often get priority because municipalities prefer that bonds be bought by individuals who will hold them long-term, rather than by institutions that might quickly resell them. As a result, bond offerings have specific rules to protect retail investors, ensuring they get a fair chance to purchase these bonds before larger institutional investors step in.

But in this case, Drexel Hamilton submitted over 570 retail orders that were not truly for retail customers. Instead of working with individual investors, the firm was submitting orders on behalf of other broker-dealers, using zip codes that weren’t linked to actual retail buyers. These actions allowed Drexel Hamilton to receive bond allocations meant for real retail customers, violating MSRB Rule G-11(k), which requires orders submitted during the retail order period to be properly identified as retail and to include accurate customer information.

To make matters worse, the firm also tried to get around a $1 million cap on individual retail orders. On at least 44 occasions, Drexel Hamilton split larger orders into smaller ones, hoping to avoid detection while still securing bond allocations meant for individual investors. This practice not only violated the rules but also helped the firm earn significant commissions from sales that should have gone to legitimate retail customers.

Willful Violations & Supervisory Failures

The misconduct wasn’t limited to Drexel Hamilton as a firm—it also involved several individuals who played key roles in the violations. Michael Ivcic, a former syndicate representative at Drexel Hamilton, was responsible for submitting many of the fraudulent retail orders. He knowingly included false zip codes and split large orders into smaller ones, knowingly bypassing the rules. His actions were considered “willful” violations, meaning he knowingly broke the rules.

Other employees, including Phelan and Steigerwald, were also involved in submitting order tickets with invalid zip codes. While they weren’t the primary decision-makers, their actions contributed to the firm’s overall failure to comply with retail order period rules.

Perhaps most concerning in this case is Drexel Hamilton's lack of an adequate supervisory system. MSRB Rule G-27 requires firms to put in place proper procedures to ensure compliance with rules like G-11(k). However, during the period in question, Drexel Hamilton had no system to check that the retail orders it was submitting were for real retail customers. Supervisors failed to review the order tickets carefully to ensure they were accurate, and no one took the necessary steps to investigate when red flags arose.

Mead, a senior supervisor at the firm, was responsible for overseeing Drexel Hamilton’s municipal bond transactions, including those involving retail orders. However, despite receiving multiple warnings from municipalities and syndicate managers about potentially fraudulent orders, Mead failed to act. He did not fully investigate the issues or ensure that the firm followed the proper procedures, which further allowed the violations to continue unchecked.

As a result of these violations, FINRA has imposed several penalties on Drexel Hamilton. The firm has been censured and fined $300,000, a hefty fine that underscores the seriousness of its actions. Additionally, Drexel Hamilton must disgorge $837,353 in profits generated from these improper bond orders, essentially returning the money it made from sales that violated the rules.

Individuals at the firm, including Ivcic, Phelan, Steigerwald, and Mead, have also faced disciplinary action for their roles in the misconduct. Ivcic, for instance, was found to have knowingly and willfully violated the rules, while Mead’s failure to supervise his team properly led to significant penalties for the firm.

Failure to Implement Effective Compliance Systems

The penalties against Drexel Hamilton serve as an important reminder of the importance of fairness and transparency in the municipal bond market. Retail investors, especially those in the communities where these bonds are issued, rely on rules like the retail order period to ensure they have access to new municipal bonds before institutional buyers. By manipulating the system, Drexel Hamilton not only broke the rules but also undermined trust in the entire bond issuance process.

This case highlights the critical need for firms to have strong internal controls, particularly when it comes to supervisory oversight. FINRA’s sanctions also serve as a message to other firms: violating MSRB rules is not taken lightly, and regulatory bodies will take action to protect the integrity of the market.

Following this case, Drexel Hamilton has made improvements to its supervisory systems, putting in place better procedures to ensure compliance with retail order period rules. The firm has learned from this experience and has committed to ensuring that its practices align with regulatory standards moving forward.

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