Brough, Elliott, Falabella and Sheinkop induced customers to invest in complex, illiquid and risky collateralized mortgage obligations (CMOs). Through misrepresentations and omissions, the respondents led customers to believe that through CMO investments they could safely achieve consistently high annual returns, regardless of market conditions, with the government backing the investments. The CMOs the respondents bought for customers were generally not government-guaranteed, and they were subject to price volatility, uncertain cash flows and maturities, based on changes in interest rates. The respondents failed to disclose material characteristics of, and risks associated with, different CMOs with substantially different payment structures and interest rate sensitivity, and failed to ensure that customers understood the characteristics and risks of CMOs.
The respondents failed to adequately investigate and understand the CMO products, and did not have reasonable grounds to believe that the individual CMO purchases were suitable for each customer. The risk was further magnified through the recommendations to the customers to buy CMOs on margin, and Elliott, Falabella and Sheinkop did not have reasonable grounds to believe the use of margin was suitable for customer CMO purchases based upon the customers’ disclosed investment experience, investment objectives, financial situation and needs.
In addition, Brough, Elliott, Falabella and Sheinkop exercised discretionary authority in customer accounts without obtaining the customers’ prior written authorization and their member firm’s prior acceptance of the account as discretionary. Moreover, the customers were exposed to significant risks that they did not understand, and Brough, Elliott Falabella and Sheinkop did not take the time to understand or ignored them so that some customers suffered considerable losses to their retirement savings.
Thomas Joseph Brough: No fine in light of financial status; Suspended 8 months
Eric Robinson Elliott: Fined $10,000; Ordered to pay $30,217, in restitution to customers; Suspended 6 months in all capacities;
Brian James Falabella: No fine in light of financial status; Suspended 6 months in all capacities
Jonathan Jay Sheinkop: No fine in light of financial status; Ordered to pay partial restitution in the total amount of $30,000 to customers; Suspended 12 months in all capacities.
Mello served as her member firm’s FINOP and was responsible for monitoring the firm’s financial condition to determine whether its net capital was sufficient to conduct a securities business. The firm’s registered representatives effected trades in collateralized mortgage obligations (CMOs) through the firm’s proprietary trading account. The transactions appeared to remove beneficial ownership of the CMOs from the firm, but they were sham transactions because the securities remained in the firm’s inventory.
The registered representative was able to accomplish and maintain his scheme because Mello and others at the firm reviewed his activity on a daily basis rather than in a manner that would evidence trading patterns over time and expose the firm’s losses and risk. As a result of the registered representative’s activity and the firm’s method of monitoring it, the firm conducted a securities business on multiple days while failing to maintain its required minimum net capital and, because Mello failed to discern the true effect of the registered representative’s trading on the firm’s net capital, she allowed the firm to conduct a securities business on multiple occasions while in violation of SEC Exchange Act Rule 15c3-1.
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