FINRA Takes Action Against Network 1 for Supervisory Failures

The Financial Industry Regulatory Authority (FINRA) has initiated disciplinary action against Network 1 Financial Securities Inc. (Network 1) and one of its registered representatives, Molinaro, for their alleged failure to establish and enforce a supervisory system and written supervisory procedures (WSPs) designed to ensure compliance with the suitability requirements related to excessive trading.

The allegations stem from the period between January 2016 and March 2022, during which Network 1 purportedly neglected to establish, maintain, and enforce a supervisory system, including adequate WSPs, reasonably designed to achieve compliance with the suitability requirements specified under FINRA Rule 2111 and the Care Obligation of the Securities Exchange Act of 1934, Regulation BI. Furthermore, as of June 30, 2020, Network 1 allegedly violated Regulation BI's Compliance Obligation by failing to create, maintain, and enforce WSPs that would ensure compliance with Regulation BI.

During the period from July 2017 to March 2022, Molinaro, designated as the principal responsible for developing supervisory procedures for Network 1, is said to have violated FINRA Rules 3110 and 2010 by not establishing, maintaining, or enforcing a supervisory system, including WSPs, reasonably designed to achieve compliance with FINRA Rule 2111 and, as of June 30, 2020, Regulation BI, specifically in the context of excessive trading.

Understanding the Regulatory Framework

As of June 30, 2020, broker-dealers and their associated persons are obligated to comply with Regulation BI, which mandates that they act in the best interest of retail customers when making recommendations regarding securities transactions or investment strategies involving securities. Regulation BI's Care Obligation requires broker-dealers and their associated persons to exercise reasonable diligence, care, and skill in ensuring that a series of recommended transactions, even if suitable when viewed individually, are not excessive and are in the retail customer's best interest in light of their investment profile.

Prior to June 30, 2020, FINRA Rule 2111 necessitated that member firms and associated persons maintain a reasonable basis to believe that recommended transactions or investment strategies were suitable for customers. This rule included provisions related to excessive trading, with factors such as turnover rate and cost-to-equity ratio considered in determining whether trading activity was excessive and unsuitable.

Supervisory Failures Allegations

The allegations against Network 1 and Molinaro revolve around their purported failure to establish and enforce WSPs that would ensure compliance with FINRA Rule 2111 and Regulation BI with respect to excessive trading. During the relevant period, Network 1's WSPs did not adequately specify how supervisors should apply the relevant factors to identify potentially excessive trading in customer accounts, nor did they define the thresholds for what constituted excessive trading.

Moreover, the WSPs provided insufficient guidance on the steps supervisors should take upon identifying excessively traded accounts, including whether they should contact customers, consider restricting commissions, or take other appropriate actions.

Consequences and Sanctions

In response to these alleged supervisory failures, Network 1 and Molinaro have consented to certain sanctions imposed by FINRA:

For Network 1:

• A censure
• A fine of $200,000
• Restitution of $533,587 plus interest to eligible customers
• An undertaking to remediate the identified issues and implement a supervisory system, including WSPs, reasonably designed to achieve compliance with Regulation BI and FINRA Rules 3110 and 2010
• Submission of a certification from a senior management member within 90 days confirming remediation and implementation efforts

For Molinaro:

• A three-month suspension from association with any FINRA member in all principal capacities
• A $5,000 fine

The restitution amount, along with interest, is to be paid to eligible customers listed in Attachment A of the agreement.

These sanctions are part of FINRA's ongoing efforts to ensure that broker-dealers and their associated persons adhere to regulatory requirements, maintain appropriate supervisory systems, and act in the best interests of their clients.