A firm's surveillance system automatically flags an unusual trading pattern that resembles a prohibited practice, without any employee having reported anything. A principal is asked whether the firm's obligation to investigate is different than it would be if a colleague had escalated the same pattern through a report. What should she conclude?
- A.The obligation is lower for a surveillance-generated flag, since no individual has made a specific, credible allegation.Wrong. A credible automated flag carries the same investigation obligation as a human report.
- B.The obligation is higher for a surveillance-generated flag, since automated systems are presumed more reliable than human reports.Wrong. The obligation doesn't scale based on an assumed reliability difference between the two sources.
- C.The obligation applies only once a surveillance flag has recurred on multiple separate days.Wrong. A single credible flag is sufficient to trigger the investigation obligation, not only a recurring pattern.
- D.The obligation to investigate is the same regardless of whether the pattern was surfaced by an employee report or by automated surveillance.Correct. The investigation obligation does not depend on how the red flag was discovered.
Why: The obligation to investigate a credible indication of prohibited trading activity applies the same way regardless of whether it was surfaced through an employee's escalated report or through the firm's own automated surveillance; the source of the discovery does not change the duty to look into it.
A principal's automated surveillance system flags several accounts for potential unauthorized trading -- trades that appear on statements the customers later say they did not request. The principal closes each alert after speaking briefly with the representative involved, who denies any wrongdoing each time. Is this an adequate response?
- A.Yes, as long as the representative has no prior disciplinary historyWrong. A clean disciplinary history does not substitute for independently investigating the specific alerts raised.
- B.No, but only because the surveillance system itself should be replaced with a different vendorWrong. The issue is the inadequacy of the investigation process, not a flaw in the surveillance system's alerting itself.
- C.Yes, since the representative directly denied any wrongdoing each timeWrong. This is the exact trap the question describes; relying solely on the accused representative's denial is not an adequate independent investigation.
- D.No, the principal must independently review order tickets, communications, and contact the customers directlyCorrect. A meaningful investigation of potential unauthorized trading requires independent verification, not reliance on the representative's own denial.
Why: Not necessarily. Relying solely on the representative's own denial, without independently reviewing order tickets, communications, or contacting the customers directly, does not constitute a meaningful investigation of a serious red flag like potential unauthorized trading. The principal must conduct an independent review, not treat the accused representative's explanation as dispositive.