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Morgan Stanley Smith Barney Fined by FINRA for Account Holder Ponzi Scheme

Morgan Stanley Smith Barney received a censure and $200,000 fine from FINRA for inadequately supervising a client’s account that was engaged in a Ponzi scheme.

James W. Bailey Jr., who was not named in the FINRA documents, founded and operated Southern Financial Services Inc, 1031 Exchange Services LLC, and AVL Properties LLC in Asheville, North Carolina. He purportedly participated in 1031 real estate exchanges, as well as other investments. However, according to FINRA, he was actually engaged in a fraudulent Ponzi scheme that he kept afloat in part by moving money between accounts held at a Morgan Stanley Smith Barney branch office in Asheville, as well as a local HomeTrust Bank branch.

Bailey would deposit checks from his HomeTrust Bank account into the Morgan Stanley account and, almost immediately, write a check from the Morgan Stanley account back to the HomeTrust account. According to FINRA, the Morgan Stanley branch permitted Bailey to write checks against uncleared funds.

FINRA said that from 2001 to 2008, Bailey’s Morgan Stanley account had about $10.7 million in total deposits and about $10.2 million in total withdrawals. By contrast, in 2009 and 2010, the account had about $429 million in total deposits and about $424 million in total withdrawals. During this period of increased deposit and withdrawal activity, the account had almost no securities transactions, but was actually being used to kite checks.

After receiving 75 separate alerts due to the rapid movement of funds, the bank reviewed the activity and decided to no longer pay the checks on uncleared funds. Bailey’s Ponzi scheme collapsed shortly thereafter.

According to FINRA, Morgan Stanley Smith Barney failed to adequately supervise by following policies and procedures to detect and report potentially suspicious transactions.

Bailey was eventually sentenced to 32 years in a prison after pleading guilty in U.S. District Court to securities fraud, mail fraud and filing false tax returns. Prosecutors said his Ponzi scheme cheated investors out of more than $13 million.

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