FINRA's recent restitution order against a Long Island brokerage once again highlights the sort of malfeasance that charging commissions for trades can all too easily create.
Fortunately, says one member of the industry, many firms have abandoned the sorts of commission-based models that have too often proved capable of tempting account representatives into excessive trading. Jon Henschen, founder of the brokerage firm Henschen & Associates, said it's a credit to FINRA and other industry regulators that most firms are instead now making their money from fees that can only be collected if investment accounts rise in value.
"There aren't too many firms charging these sorts of commissions anymore," Henschen said. "It's the exception and not the rule, easily. I think it's been really good for the industry that it's been phased out."
Of the firms still relying heavily on a commission-based model, Henschen said, many bear similarities to Joseph Stone Capital, which FINRA ordered on Sept 7 to pay more than $1 million in restitution for excessive trading in 25 customer accounts. Commission-based firms tend, for instance, to have their headquarters in one of three places: Long Island — Joseph Stone's main offices are Mineola, New York — Boca Raton, Florida; or New Jersey.
In the case of Joseph Stone, there were plenty of other warning signs besides its commission-based business model. The firm is subject to FINRA's "taping rule," meaning it had to install a system to record company officials' discussions with customers. Firm officials are then required to make reports from the recordings and send them to FINRA for review. According to FINRA, the taping rule applies to "firms with a significant number of registered persons that previously worked for firms that have been expelled from the industry or have had their registrations revoked for inappropriate sales practices."
Joseph Stone CEO Damian Maggio has worked for 14 different firms since 1997. Four of them have been barred by FINRA.
In its restitution order, FINRA found that 15 Joseph Stone representatives had recommended trades that resulted in annualized turnover rates ranging from six to 57. FINRA considers annualized turnover rates — which reflect how many trades would be made over the course of a year if the number made in a given month were repeated every month — to be suspect when they're over six.
FINRA also found Joseph Stone's trading resulted in annualized cost-to-equity ratios of 21% to 96%. FINRA starts worrying about excessive trading when cost-to-equity ratios — a measure of how great the returns an account would need to cover commissions generated by trades — rise above 20%.
Joseph Stone's excessive trading cost customers $1.037 million in commissions, fees and margin interest, FINRA said. Of that, Joseph Stone, which has 35 registered representatives and four branch offices, will pay roughly $825,000. Eight current or former representatives of the firm will be responsible for the remaining $211,000.
FINRA said the misconduct occurred in part because Joseph Stone had failed to have adequate safeguards in place between 2015 and mid-2020. Numerous red flags were raised during that period and were either ignored or not responded to appropriately by supervisors, FINRA said.
In some cases, supervisors had reduced the amount of the commission a trader could earn on transactions in an individual account. But they failed to take the additional step of restricting the number of trades that could be made, tempting firm representatives to bring in high commission amounts simply by trading more often.
FINRA's restitution order gives the example of a particular customer's account that was found to have a cost-to-equity ratio of 20% six months after being opened. Joseph Stone responded by barring representatives from collecting commissions from asset sales in the account if those sales resulted in a loss. But no such restriction was placed on sales that resulted in a gain. The customer ended up being charged more than $70,000 in commissions between January 2017 and November 2019.
Besides paying restitution, three firm representatives agreed to suspensions lasting between two and five months. And two others were banned from the industry for failing to respond to the agency's requests for information.
Attempts to reach representatives of Joseph Stone Capital were unsuccessful.
