Articles

Client Alert: The Compliance Problem Inside a Fraction of a Share

Edward Jones settled FINRA charges over fractional-share trades it did not report. The case is less a story about one firm than a map of where a new retail product can outrun the systems built to supervise it.

Edward D. Jones & Co. agreed to a $125,000 fine and a censure to settle FINRA charges that it had failed to report approximately 2.7 million fractional-share liquidations to a FINRA trade reporting facility. The matter resolved through a Letter of Acceptance, Waiver, and Consent, the negotiated procedure by which a firm consents to FINRA’s findings to resolve a disciplinary action without litigating it. The firm also paid the regulatory transaction fees owed on the unreported trades.

The number looks alarming. The underlying conduct is more instructive than alarming. Edward Jones did not conceal trades or game the tape. It reported the whole-share side of customer orders and did not report the fractional side, in transactions worth pennies, generated by the same retail programs the industry has spent a decade making more accessible. The reporting requirements were written for whole shares. Fractional shares became a mass-market product later, and the firm’s reporting systems took time to account for them. That lag, not any want of good faith, explains the case.
 

The reporting rules apply to every principal trade, including the smallest.

FINRA Rules 6380A and 6622 require a member to report its principal-capacity trades. Rule 6380A governs trades in NMS stocks reported to the FINRA/Nasdaq Trade Reporting Facility. Rule 6622 governs trades in over-the-counter equity securities reported to the OTC Reporting Facility. The rules draw no exception for fractional shares, and they should not be expected to. A clear and uniform reporting obligation is what makes the consolidated tape reliable, and the value of that reliability is the reason the obligation reaches the small trade as firmly as the large one. A failure to report also implicates FINRA Rule 2010 and its requirement that a member observe high standards of commercial honor.

The obligation tracks how a firm fills the order. When a customer sells a position that includes a fractional share, Edward Jones routes the whole-share portion to the market as agent and fills the fractional portion from its own account, as principal. The principal leg is the reportable leg. Most of the unreported trades came from customers liquidating fractions accumulated through the firm’s dividend-reinvestment and dollar-cost-averaging programs, two features designed to help ordinary investors build positions over time. The compliance question arrived as a byproduct of a customer benefit.
 

Fractional trading created a reporting obligation the existing systems did not anticipate.

Fractional-share investing has reshaped retail brokerage. It lets a customer own a portion of a high-priced stock, reinvest a small dividend or invest a fixed dollar amount on a schedule. The mechanics that make it possible, including the firm’s purchase of the residual fraction as principal, generate reportable trades that a reporting system built for round lots will not necessarily capture. Edward Jones is not the only firm to have confronted that gap between a new product and an older reporting process. The settlement reads as a case study in a problem much of the industry has had to solve.

The firm’s response shows how exacting the work is. Edward Jones began reporting fractional-share transactions in November 2019. That captured the principal trades from its reinvestment and averaging programs, the largest source of the omission. One category remained. The firm continued to omit fractional trades generated when it liquidated fractional positions during customer account transfers through the Automated Customer Account Transfer Service. ACATS does not transfer fractional shares between firms, so a fraction must be sold before the account can move, and that sale is a principal trade. Reporting resumed for the program liquidations and continued to lag for the transfer liquidations through April 2021. The remaining omission was narrow and specific, the kind a reasonable process can miss precisely because it is narrow and specific.
 

The supervisory timeline is the part worth studying.

FINRA found that Edward Jones did not have a written supervisory procedure addressing complete and accurate reporting of fractional-share transactions until September 2020. When the firm did install supervisory reviews that month, those reviews did not yet reach the fractional trades arising from ACATS transfers, the same category the reporting correction had not yet captured.

That sequence is the lesson, and it is a sympathetic one. A useful new product reached customers. The reporting process adapted to it in stages. The written supervision adapted on its own track. For a period, the product was active, the reporting was partial, and the procedures were still being written. None of that reflects indifference. It reflects the ordinary difficulty of fitting a fast-moving retail innovation into a supervisory framework that, by design, changes deliberately.
 

Implications for broker-dealers.

The practical takeaways are concrete and forward-looking.

1. Inventory the reportable legs of any new retail product before launch. Fractional shares, riskless-principal fills and account-transfer liquidations each generate principal trades that a reporting system built for whole shares can overlook. A product map that identifies every principal leg costs less than a look-back.
2. Treat written supervisory procedures as part of the product launch, not a later refinement. A reporting obligation with no corresponding written procedure is a supervisory gap regardless of how diligently the trades are otherwise handled, and the procedure is most useful when it exists before the first trade rather than after the first inquiry.
3. When remediating, test the correction against every category that produces the trade. Edward Jones addressed the largest category first and reached the ACATS category later. The interval between the two is where the residual exposure accrued. A remediation that asks what else generates this same trade tends to close the second omission at the same time as the first.

Two numbers describe this case. The first is 2.7 million trades, the size of the omission. The second is the interval between the product going live and the supervision reaching it, and that number carries the lesson. Read alone, 2.7 million looks like a control breakdown. Read against the timeline, it is what a diligent firm produces when a useful new product moves faster than the procedures written to supervise it. The remedy is neither complicated nor expensive. Measure that interval for every new product, and close it before the trades begin rather than after the examiner asks. A firm that does will not appear in the next settlement of this kind.

Dale G. Mullen, JD, MBA, is a Partner and Co-Chair of the Corporate and Securities Law Section at Whiteford Law, where he advises clients on regulatory compliance and government enforcement.
 
Andrew L. Bolton is Counsel at Whiteford Law and a former state prosecutor who represents clients in government investigations and enforcement matters and advises on the federal legislative and regulatory developments that shape them.

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