Northern Trust Securities, a wing of Northern Trust Corp. (NTRS), has been fined $600,000 by the Financial Industry Regulatory Authority (FINRA) for inadequately overseeing collateralized mortgage obligations’ (CMOs) sales and lacking proper systems to supervise certain high-volume securities trades.
FINRA has found that between October 2006 and October 2009, the Northern Trust unit could not capture or analyze a major chunk of the company’s business that included all CMO transactions and certain trades of 10,000 equity shares or more, along with trades of 250 or more of fixed-income bonds. As a result, 43.5% of the firm’s business from January 2007 to June 2008 was not reviewed at all.
With a flawed system at work, Northern Trust could not properly monitor the customer accounts against possibly unsuitable CMO concentration levels. Moreover, due to the lack of proper system to oversee the large block equity and fixed income trades, the company failed to analyze these trades for suitability, concentration, excessive trading, excessive mark-ups or commissions, or for trading in restricted stocks. This, in turn, exposed the investors to the risk of losing billions.
CMOs, a type of mortgage-backed security, are bonds that represent claims to specific cash flows from large pools of home mortgages. The streams of principal and interest payments on the mortgages are distributed to the different classes of CMO interests, known as tranches, according to a complicated deal structure. CMOs are often highly sensitive to interest-rate fluctuations and get affected by any resulting change in the rate at which homeowners sell their properties, refinance, or otherwise pre-pay their loans.
Following the financial crisis, the government is rigidly scrutinizing the role of the Wall Street banks that had sold such instruments during the housing boom. With the housing market slump and homeowners’ defaults, investors have lost billions in such securities.
Northern Trust neither admitted nor denied the charges, but consented to the entry of FINRA’s discovery.
Our Take
Any penalty on Northern Trust’s practices does create a dent on its reputation and financials to some extent. However, we believe that Northern Trust’s recent acquisition of Bank of Ireland Securities Services (BoISS) from Bank of Ireland Group (IRE) will enhance its asset administration services in Ireland, making it more competitive in the market. It is also poised to benefit from its growing client network. But, we expect the low interest rate environment to continue restraining earnings, thereby impacting net interest income and securities lending fees at Northern Trust.
We expect increased asset management and servicing fees based on equity market improvements and higher volumes to benefit Northern Trust. However, the Dodd-Frank Act will ring in numerous regulatory changes over the next several years, which might act as a deterrent to the company’s fundamentals.
Northern Trust currently retains its Zacks #4 Rank, which translates into a short-term Sell rating.
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