FINRA Fines Firm $10M on Gift Spending

We have a great case study this week for compliance and internal control folks worried about lavish spending on gifts and entertainment: FINRA just fined a financial services firm $10 million for providing clients luxury meals and event tickets in exchange for business deals, and for a weak recordkeeping system that allowed employees to cover it all up.

FINRA, the regulator for broker-dealer firms, imposed the enforcement action on Monday against First Trust Portfolios, a privately held firm in Illinois with $250 billion in assets, roughly $1 billion in annual revenue, and a reputation for aggressive sales tactics. In addition to the $10 million fine, First Trust’s senior management must also submit annual compliance certifications to FINRA for the next three years. 

So what happened here? As described in the FINRA settlement order (allegations that First Trust neither admits nor denies, naturally), First Trust employees showered clients with luxury meals, Broadway theater tickets, courtside seats at NBA games, golf outings, and the like; all in exchange for those clients purchasing more products and services from First Trust. 

The misconduct ran from 2018 into 2024. While we don’t know how much improper spending First Trust allowed in total, the numbers for individual incidents were eye-popping: $1,800 for Broadway tickets here, $400 for a high-end bottle of booze there, $3,200 for courtside NBA seats on another occasion. All of that violated FINRA Rule 2341, which caps gifts and entertainment spending at $100 per person per year. 

Worse, First Trust also had a loosey-goosey recordkeeping system, which employees exploited to cover up the improper spending. For example, some sales reps submitted expense reports that listed client attendees who had died or were out of the securities business. The recordkeeping system also allowed employees to modify expense reports after those reports were submitted and approved, without controls in place to assure that those changes were warranted.

Where the Failures Were

First we have to consider the culture of compliance at First Trust, or the lack thereof. This is misconduct that went on for years. On multiple occasions, First Trust employees coordinated with each other about falsifying their expense reports — which means they were colluding with each other, a huge red flag for a poor corporate culture. 

Consider this, too: these were First Trust employees giving lots of goodies to their sales prospects at retail broker-dealer firms. Those broker-dealers had their own policies limiting the value of gifts and entertainment that their employees could accept. Well, First Trust employees even helped those sales prospects circumvent their own policies on spending, and supervisors at First Trust were involved in the deception schemes. From the FINRA order: “[A]t least two supervisors suggested to wholesalers ways to submit expense reports so that the expenses merely appeared (but were not in fact) compliant with client firms’ internal limits on non-cash compensation.”

Long-running periods of misconduct; multiple employees colluding together; management employees involved in deception schemes — those are all symptoms of a culture failure. No wonder FINRA fined First Trust $10 million, which is quite high by FINRA standards.

All that said, I was more interested in the poorly designed recordkeeping system that allowed this misconduct to happen. Broker-dealers are required to make and preserve books and records under FINRA Rule 4511, but lots of other industries have similar concerns — say, pharmaceutical firms that must track spending on physicians, to comply with the Anti-Kickback Statute. So what lessons can we all learn here? 

For starters, it seems that while First Trust did have policies and procedures in place that addressed gifts and entertainment spending, those policies and procedures had no real teeth. They existed on paper, and First Trust employees did supply information about how much money they spent, but according to FINRA … 

[T]hose policies and procedures did not provide guidance regarding how to evaluate whether non-cash compensation was too frequent or excessive. In addition, although First Trust required employees to submit expense reports for review and approval, the firm lacked a reasonable system for supervising the accuracy of such reports. 

That part about lacking a reasonable system for supervising the accuracy of the reports is especially troubling. First Trust relied almost exclusively on individual wholesalers to accurately report non-cash compensation expenses, and the Firm did not take reasonable steps to verify the accuracy of those expense records,” FINRA said — all trust, no verify. 

That’s no way to bring necessary skepticism to compliance oversight. It opened the door to misconduct such as First Trust employees listing client attendees who were actually deceased, or who had left the securities profession years ago. Either nobody at First Trust bothered to check the accuracy of those expense reports (a culture problem) or nobody had the means to check the accuracy (a system design flaw).

Moreover, the system also allowed employees to go into the files and alter expense reports after the reports were submitted and approved, a weakness that should send internal control and SOX compliance teams into a stroke.

We could say both of these errors feed on each other: the poor culture of compliance led to weak policies and procedures for recordkeeping; the weak recordkeeping allowed misconduct that fed a poor culture of compliance. One reinforced the other. 

The solution, of course, is a commitment from senior management to a strong culture of compliance; which in turn would lead compliance teams to build, and employees to follow, strong policies and procedures for regulatory compliance. 

It’s a tale as old as time. 

The Remediation Measures

The good news is that First Trust did implement numerous reforms starting in 2024. Among them:

• Committing to create a new compliance and audit function that reports to executive management (although “committing to create” is doing a lot of work in that sentence, and one wonders to whom the compliance function previously reported).  
• Dedicating the compliance team to testing and monitoring compliance with FINRA’s rules for providing gifts and entertainment to clients.
• Overhauling the firm’s systems and procedures for gifts and entertainment, including a new system to track event tickets so the firm can keep a better eye on who is doling out which goodies to whom. 
• Taking disciplinary action against dozens of employees, including suspending some without pay and imposing fines or extra supervision on others. (Not clear whether anyone got fired.)

That’s enough for today. For anyone who has to worry about gifts and entertainment expenses, however, and the proper tracking of them — lots to learn from this case.