D Best-winning lawyer Rogge Dunn breaks down FINRA’s newest proposed regulations.
FINRA has proposed a new rule designed to protect investors by imposing various obligations, including financial requirements, on member firms. These additional obligations would be triggered if a Firm exceeds certain thresholds involving disclosure events, regulatory issues, and compliance failures.
FINRA has created the thresholds based on its analysis of the number of compliance disclosures involving a particular firm compared to the average compliance disclosures at similarly situated financial institutions. If a firm exceeds the threshold, FINRA would designate them as a “Restricted Firm.”
Financial Advisors should be cautious about working for financial institutions against whom FINRA imposes these obligations. Restricted Firms will be under heightened scrutiny by FINRA. Financial Advisors who work for Restricted Firms will likely face increased scrutiny from FINRA and perhaps other regulators.
The proposed new regulations appear in Rule 4111 (“Restricted Firm Obligations”). Under the proposed rule, FINRA can require Restricted Firms to make cash/qualified securities deposits that cannot be withdrawn unless FINRA approves the withdrawal. FINRA can impose other conditions on Restricted Firms.
In recent years one area FINRA has focused on is recidivist offenders. As part of this focus, FINRA identifies financial advisors who have U-4s and U-5s replete with customer complaints and/or rule violations. FINRA has also identified financial advisors who “job hop” as another primary regulatory concern.
FINRA monitors firms that employ a significant percentage of financial advisors who have a history of misconduct. Firms that consistently hire such individuals and fail to reasonably supervise their activities are high on FINRA’s radar.
FINRA also targets firms that operate a retail business with vulnerable clients/potential clients, and cold call investors with investment recommendations. Firms that lack quality supervision, have a lackadaisical compliance culture, hire financial advisors with poor compliance records or firms that engage aggressive sales practices with retail customers are targets. FINRA is more likely to investigate firms or financial advisors when sales practices involve risky investments like unregistered penny stocks, non-marketable securities or private placements.
FINRA has identified firms that have excessive compliance disclosures. At the end of 2018, 20 small firms (firms with less than 150 Registered Representatives) had 30+ compliance disclosures in the previous five years.
Financial Advisors and firms with a checkered past pose a challenge for FINRA under existing enforcement procedures. While FINRA’s investigators can currently identify compliance failures or concerns under the existing rules, FINRA’s investigators do not have authority to require a firm to change its operations. The current enforcement process is slow, subject to delays and multiple appeals. Accordingly, it takes a long time before FINRA can impose sanctions that can stop fraudulent practices.
Under the new rule FINRA will be able to impose sanctions quickly. This change would be significant and allow FINRA to act quickly against unscrupulous financial advisors and firms. Some firms have complained that the new rule would allow a rush to judgement and implementation of restrictions before a firms has been found to be at fault—thus denying a firm due process.