On September 30, 2021, the US Securities and Exchange Commission instituted an administrative Cease and Desist order in the matter of LPL Financial LLC, a broker-dealer headquartered in South Carolina, resolving an investigation into LPL’s failure to comply with anti-money laundering regulations.
The investigation arose from the use of an LPL brokerage account by Eugenio Garcia Jimenez, Jr., beginning in April 2016, to transfer funds from an account owned by Mayaguez Economic Development, Inc. (MEDI) but controlled by Garcia. According to the SEC order and the fraud complaint filed against him, Garcia acted as an investment advisor to a city in western Puerto Rico, and in doing so misappropriated approximately $7.1 million. To execute his scheme, Garcia purchased $9 million in US Treasury notes, used the notes as collateral for margin loans, and executed wire transfers to place $4.1 million of the city’s funds into his own possession. Following these wire transfers, the brokerage firm handling the account challenged Garcia’s investment strategy, eventually insisting that Garcia liquidate the account or transfer its assets elsewhere.
Hence, in April 2016, Garcia applied to an LPL representative in California to transfer the MEDI account to LPL. During the transfer process, LPL did not verify the personal identification document provided by Garcia, did not verify the address provided by Garcia for MEDI (the account holder) despite the inconsistency being flagged by LPL’s customer identification program, and despite LPL policies that required verification of both. Moreover, LPL’s Financial Intelligence Unit twice recommended that the MEDI account transfer be rejected due to elevated risks -- the first time prior to obtaining additional clarifications from Garcia, and the second time after Garcia listed himself as the beneficial owner of MEDI and supplied LPL with a bogus shareholder ledger showing 100% ownership by Garcia, in direct contradiction to MEDI’s articles of incorporation.
Although the contradictory information raised questions within various LPL departments, the information was not coordinated within a central reporting function that might have prevented Garcia’s plan to go forward, and LPL allowed him to open the requested investment account, transfer the $4.1 million margin liability to the account, and re-leverage the assets. Soon after opening the account, Garcia began ordering wire transfers out of the account, and although some were rejected and others flagged for review, several were approved. Only in July 2016 did LPL freeze activity on the account and resolve to terminate the relationship with the account holder, designated by Garcia as Mayaguez Economic Development Financial Strategies, Inc. (MEDI FS), an entity controlled by Garcia.
As alleged by the SEC, LPL’s failure to identify, halt and report Garcia’s fraudulent activity violated:
- the Customer Identification Program Rule, 31 CFR § 1023.220(a), which requires broker-dealers to collect basic information about its customers, follow risk-based procedures to verify their customers’ identities, and establish procedures for maintaining records of customer identification information;
- Section 17(a) of the Securities Exchange Act of 1934 and Rule 17a-8 thereunder which require broker-dealers to comply with the recordkeeping, retention and reporting requirements of the Bank Secrecy Act, and;
- Section 206(2) of the Advisers Act of 1940, which prohibits any transaction that operates as a fraud or deceit upon a client or prospective client.
In assessing the terms of the settlement, the SEC took into consideration LPL’s cooperation with the investigation, and the remedial measures taken by LPL since 2016. These measures include the establishment and implementation of enhanced policies and procedures such as added staff, centralized surveillance and investigation functions, improvements in quality control testing, customer due diligence, transaction monitoring, and standardized procedures for escalation and reporting. In light of these and other factors, the SEC censured LPL, ordered the company to cease and desist from further violations, to pay a civil money penalty of $750,000, and to return $141,202 in disgorgement and prejudgment interest. The disgorgement and prejudgment interest requirement, however, was deemed to have been satisfied by LPL’s payment of $3,269,975, plus interest of $848,901, to MEDI to compensate for the loss suffered by MEDI and the client city as a result of the violations caused by LPL’s failures.