According to FINRA, Network 1 Financial Securities Inc. was censured, fined $200,000, and ordered to pay $533,587 plus interest in restitution to customers on August 31, 2023. Michael Robert Molinaro was fined $5,000 and suspended from association with any FINRA member in any principal capacity for three months.
FINRA found that the firm and Molinaro failed to establish, maintain, and enforce written supervisory procedures reasonably designed to achieve compliance with FINRA Rule 2111 and the Care Obligation of Regulation Best Interest as they pertain to excessive trading. The firm's procedures did not set forth how supervisors should apply certain factors to identify potentially excessively traded accounts, did not identify what cost-to-equity ratio or turnover rate was suggestive of excessive trading, and did not provide supervisors with reasonable guidance about what steps to take after identifying an excessively traded account.
Furthermore, the firm and Molinaro did not revise the firm's procedures to reference Regulation Best Interest until eight months after the rule became effective. Even after revision, the procedures provided no guidance about what steps the firm's principals or representatives should take to prevent, detect, or promptly correct violations of Reg BI.
The firm and Molinaro also failed to establish and maintain a reasonably designed supervisory system to identify and respond to red flags of excessive trading. The firm received exception reports from its clearing firm that were relevant to identifying excessive trading, including monthly reports flagging accounts with high cost-to-equity ratios. Instead of reviewing those reports, the firm limited its reviews to an internal report identifying the 100 accounts with the largest year-to-date aggregate commissions, which excluded smaller accounts with high commission amounts relative to their equity value.
Even when the firm identified excessively traded accounts, it did not take steps to investigate and act upon the results. Molinaro, as the designated principal responsible for determining actions upon identifying red flags, did not require the firm to take any steps until nearly two years after taking over this responsibility. As a result, representatives continued charging high commissions even after the firm had notice of excessive trading. The firm's representatives recommended that customers place frequent trades, and the customers routinely relied on those recommendations, causing these customers to pay more than $533,500 in commissions and trading costs.
Investors should be aware that excessive trading, also known as churning, occurs when a broker places trades to generate commissions rather than to benefit the customer's investment objectives. Firms must have robust supervisory systems to detect and prevent such harmful practices.
