The SEC recently released a settlement with COR Clearing LLC stemming from charges related to systemic failures to detect and report suspicious activity in the sale of penny stocks during the period of January 2015 to June 2016. In addition to a monetary penalty of $800,000, COR agreed to significantly limit the sales of penny stocks deposited at the firm, essentially exiting the firm from the penny stock clearing business. During the relevant period, COR was the second ranked broker-dealer in total dollar value cleared for sub-one dollar stocks.
Under the Bank Secrecy Act, broker-dealers are required to have policies and procedures in place reasonably designed to detect, prevent and report suspicious activity. The SEC found that during the relevant time period 193 of COR’s customer accounts were engaged in depositing large blocks of penny stocks. The blocks were then rapidly sold to the market and the proceeds withdrawn shortly thereafter. Many of the accounts were engaging in this suspicious pattern of activity across multiple securities.
Although COR had an automated system to surveil penny stock activity, the surveillance was deficient because it was designed to generate alerts for sales of low-priced securities below $1. Securities regulators have publicly stated that penny stocks are stocks that do not trade on a public exchange and which are priced under $5 per share. The automated surveillance system also did not monitor penny stock trades by customers across multiple securities or within certain data ranges. In some instances, alerts were not generated by the automated surveillance system although the activity fell within the monitoring parameters. The monitoring deficiencies resulted in COR failing to detect potentially suspicious penny stock activity in the 193 customer accounts that engaged in such activity and report it as required.
Firms engaged in the clearing business, especially clearing functions involving low-priced and penny stocks, need to ensure that there are appropriate controls in place to detect and report suspicious activity. Broker-dealers should periodically review and test their automated surveillance systems to ensure that they comply with regulatory requirements and expectations and are operating as intended. In doing so, firms can avoid costly fines and the loss of business from SEC enforcement actions.