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Sutherland FINRA Focus #2: 2012 Due Diligence Sanctions

March 15, 2013

As reported on March 13, 2013, in Sutherland’s annual analysis of FINRA’s disciplinary actions, due diligence cases resulted in the second-highest amount of fines assessed by the regulator in 2012.1 FINRA reported $12.8 million in fines from 62 cases involving alleged due diligence violations in 2012.2 These sanctions represented a dramatic increase of 700% from the $1.6 million in fines that FINRA assessed in 2011 due diligence cases. This is the first time due diligence has appeared on Sutherland’s Top Enforcement Issues list. This Sutherland FINRA Focus delves into FINRA’s recent enforcement actions and highlights some of the key 2012 due diligence cases.

The chart below indicates the total number of due diligence enforcement actions and fines that FINRA has reported during each of the past five years.

 FINRA’s Due Diligence Sanctions Statistics, 2008-2012


Fines Reported

Percentage Change

Percentage of Total FINRA Fines

Cases Reported

Percentage Change


$ 180,000






$ 245,000






$ 481,000






$ 1.6 million






$ 12.8 million






These statistics demonstrate a substantial increase in the fines that FINRA has imposed over the past five years in cases involving due diligence allegations. The amount of fines assessed in these cases has risen each year, resulting in an incredible 7000% increase between 2008 and 2012. The number of due diligence cases filed each year has also risen dramatically. It appears this issue caught FINRA’s attention in the wake of the financial crisis, which has resulted in an explosion in the number of due diligence cases during the past two years. As FINRA continues placing a growing emphasis on complex products, it seems likely that due diligence issues will remain a key priority for the regulator.

The substantial increase in due diligence sanctions in 2012 was largely due to a series of cases involving leveraged and inverse exchange-traded funds (ETFs).3 These four cases resulted in fines of $7.35 million and restitution of $1.8 million. FINRA found that over a 17-month period these firms failed to conduct sufficient due diligence about the risks and features of these ETFs. Thus, FINRA alleged that the firms did not have a reasonable basis for recommending these securities and that the firms did not adequately supervise the sale of these ETFs. According to FINRA, leveraged and inverse ETFs are riskier than traditional ETFs because they are subject to risks associated with daily resets, leverage, and compounding. When held for longer periods, the performance of these ETFs can differ significantly from the performance of the underlying benchmark index. Brad Bennett, FINRA Executive Vice President and Chief of Enforcement, noted, "[t]he added complexity of leveraged and inverse exchange-traded products makes it essential that brokerage firms have an adequate understanding of the products and sufficiently train their sales force before the products are offered to retail customers. Firms must conduct reasonable due diligence and ensure that their representatives have an understanding of these products."4

In another case, a firm was fined $350,000 for allegedly failing to conduct adequate due diligence before offering alternative investments to customers, including hedge funds and funds of hedge funds.5 For more than a year, the firm made allegedly false statements, both publically and internally, about its due diligence efforts concerning hedge funds. FINRA found that the firm repeatedly stated it had completed qualitative and quantitative due diligence for hedge fund offerings, but it had never actually done so. These due diligence representations were contained in "pitch books" used to market alternative investments to wealthy investors. For allegedly failing to perform adequate due diligence, and for making alleged misrepresentations to potential investors about this due diligence, the firm was fined $350,000.

The message is clear: Due diligence has become an important focus for FINRA, especially when complex products are involved. The regulator will likely be carefully reviewing the thoroughness and effectiveness of due diligence materials and procedures, as well as any representations made about such procedures.

  1. Annual Sutherland Analysis of FINRA Sanctions Shows Number of Enforcement Actions Rises Slightly in 2012, Fines Jump by 15%
    During the next two days, Sutherland will release analyses on the other 2012 Top Enforcement Issues, including research report and research analyst cases and advertising cases. A Sutherland FINRA Focus for 2012’s suitability cases was released yesterday.
  2. The number of cases reported and the amount of corresponding fines come from the Disciplinary and Other FINRA Actions report that FINRA publishes each month. Many of these cases also involved other allegations, making it difficult to determine the exact amount of any particular fine attributable to an alleged due diligence violation.
  3. FINRA News Release, May 1, 2012, available at
  4. Id.
  5. FINRA Letter of Acceptance, Waiver and Consent, Nov. 7, 2011, No. 2009016627501.

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