First Manhattan Co.

First Manhattan Co. was fined $250,000 for failing to establish and maintain a supervisory system reasonably designed to achieve compliance with Section 5 of the Securities Act. The findings stated that the firm’s WSPs were not reasonably designed to avoid becoming a participant in the potential unregistered distribution of securities.

The firm’s WSPs did not include procedures regarding how to conduct a searching inquiry to determine whether a transaction complied with the registration requirements of Section 5. Instead, the firm’s WSPs only stated that a principal should be consulted for assistance. Moreover, even though the firm, in practice, used a pre-clearance form in connection with its Section 5 reviews, the WSPs failed to even mention the pre-clearance form.

The firm’s system for compliance with Section 5 relied entirely on the pre-clearance form that representatives were required to complete prior to the deposit or sale/transfer of microcap shares. The pre-clearance form did not provide any guidance about what documentation the representative should review prior to the deposit or sale of any microcap security to verify the information set forth on the pre-clearance form.

The firm also did not have any process for ensuring that representatives completed the pre-clearance form. As a result, the firm accepted deposits of microcap securities without first having received a completed pre-clearance form from the customer’s representative.

The findings also stated that the firm failed to establish and implement an anti-money laundering (AML) program reasonably expected to detect and cause the reporting of suspicious transactions in microcap securities. The firm’s AML procedures did not provide guidance about how to identify or address red flags of suspicious trading in microcap securities.

The firm’s procedures also failed to require that the firm monitor, for AML purposes, information collected during its pre-clearance process for microcap securities. Therefore, even when customers deposited and quickly liquidated and wired out the proceeds of microcap securities, the firm’s procedures did not require it to review those transactions for potential Bank Secrecy Act reporting.

In addition, the firm did not have a reasonable system to identify suspicious trading in microcap securities. The firm’s exclusive method for doing so was through the use of an exception report that only surveilled transactions of 50 million shares or more. As nearly all of the firm’s customers’ microcap activity involved fewer than 50 million shares per transaction, this exception report was not tailored to the firm’s business. As a result, a small number of firm customers deposited fewer than 50 million shares of microcap securities, liquidated some or all of the securities, and withdrew the funds shortly thereafter—without the firm detecting or investigating that activity.