Finra is playing hardball with a broker-dealer that recently lost a securities arbitration, according to the chief executive of the small broker-dealer that's battling with the regulator.
According to John Hsu, CEO of Pyramid Financial Corp. of Cupertino, Calif., the
Financial Industry Regulatory Authority Inc. informed him Aug. 24 that, as a result of the arbitration loss, Pyramid was in violation of net-capital requirements and was required cease operations.
Two days later, Mr. Hsu responded by suing Finra, disputing Finra's declaration that Pyramid did not meet net-capital rules and seeking a temporary restraining order to allow it to stay in business.
But on Friday, a federal judge in U.S. District Court for the Northern District of California in San Jose dismissed the petition for a TRO. Pyramid and Mr. Hsu “must exhaust their claims before Finra and the SEC before seeking review in the federal courts,” wrote Judge Lucy H. Koh.
A slew of small and independent broker-dealers have ceased operations this year because they ran afoul of Finra's net-capital requirements. That list includes a few fairly well-known firms, including GunnAllen Financial Inc. and Jesup & Lamont Securities Corp.
It appears that dozens of other broker-dealers are facing millions of dollars in potential legal claims stemming from investments that crashed during the
recession. Some brokerage executives and securities lawyers have become openly fearful that Finra will use the net capital rule — and how B-Ds book losses from arbitration claims — to shutter firms. (To read more about this,
click here).
“I feel like my personal rights and business rights are not being protected,” said Mr. Hsu, who is also Pyramid Financial's principal owner. Last week, “Finra just walked in and demanded we close our offices.”
The firm's profile on Finra's BrokerCheck shows that on Aug. 16, Pyramid Financial lost a $339,000 arbitration award involving common stock and options.
According to Ms. Koh's decision, the arbitration award left Pyramid left with insufficient reserves to meet it net-capital requirements. That provision — a Securities and Exchange Commission regulation — requires broker-dealers to maintain a certain amount of net capital at all times.
The levels, however, vary widely from firm to firm. And according to a court document, management at Pyramid Financial believed it had a 30-day grace period to raise the money to pay the arbitration award — and therefore believed the firm did not face an immediate shutdown.
Mr. Hsu claimed Finra has a negative attitude toward small firms because of a perception that those firms are more likely to have problems with compliance. He added that Pyramid had foreign accounts. Finra, he says, believes that small firms with offshore clients present a higher business risk.
Finra has taken other actions against Pyramid, according to BrokerCheck. Last month, Finra rebuked the firm after it found that Pyramid's chief compliance officer had used personal e-mail to conduct firm business. The regulator also cited the firm for failing to conduct identity checks on clients and failing to implement adequate money-laundering policies
Mr. Hsu said his lawyer had returned to court today in an effort to get the restraining order.
Nancy Condon, a spokeswoman for Finra, declined to comment.
