I read a fascinating piece the other day in BankInvestmentConsultant about FINRA’s Enforcement program, specifically about the notion of broker-dealers self-reporting problems, and whether that was a smart thing to do. Some of the quotes attributed to FINRA senior Enforcement management are really interesting, so I wanted to share them with you in the event you missed this article.
In January 2010, the SEC launched a formal program that outlined specific benefits available to individuals and firms who self-report, and self-remedy, problems. Done correctly, such cooperation can result in fewer charges and lesser sanctions, sometimes dramatically less. There are plenty of examples of cases where the respondent’s cooperation was explicitly cited – favorably cited – as the reason that sanctions were mitigated.
By comparison, FINRA has no such formal program. Instead, it issued fairly vague guidance, back in Regulatory Notice 08-70, that suggested “extraordinary cooperation,” examples of which were provided, could possibly influence “the sanctions [FINRA] will seek in the context of settlement discussions that precede the filing of a formal disciplinary action.” Perhaps the vagueness is a function of the fact that FINRA Rule 4530 requires that firms promptly report when they have a problem, at least serious problems.[1] Thus, there really is no question whether or not a firm should self-report, because there is no option not to do so.
But, clearly, there is a difference between, on the one hand, simply making a 4530 report and, on the other hand, going beyond that and doing the sorts of things that would get you cooperation credit from the SEC, or which FINRA has identified as being “extraordinary.” So, the real question is, is it in a firm’s best interest to exceed the simple 4530 requirements in an attempt to get some credit from FINRA?
According to the article in question, the answer is yes. The reporter there wrote, “FINRA’s enforcement officials are willing to cut a break for firms that demonstrate ‘extraordinary cooperation,’” citing comments from Jessica Hopper, a senior vice president with FINRA Enforcement. The reporter continued, saying FINRA “is urging firms to take the difficult but important step of informing the regulator when they detect serious compliance failures.” Here is where it gets good. “Doing so, [Ms. Hopper] said, not only fulfills a firm’s regulatory responsibilities, but it can also mean the difference between a slap on the wrist and a steep fine, should the infraction elevate to an enforcement case.”
This sounds amazing, admittedly. I just wish it was true. But, the notion that FINRA would choose to slap a firm on the wrist rather than crush a firm with sanctions simply because the firm self-reports a “serious compliance failure” is incredible, i.e., not credible. Granted, there have been a number of cases since 08-70 in which FINRA acknowledged that the respondent demonstrated “extraordinary cooperation,” resulting in some diminution of the sanction. Indeed, in July and October 2015, FINRA historically imposed no fines on several firms in two very large group settlements involving mutual fund overcharges because the firms “were proactive in identifying and remediating instances where their customers did not receive applicable discounts.” But, in those cases, the firms voluntarily paid their customers almost $50 million in restitution. How many broker-dealers have the ability to do that, if that’s what’s considered “extraordinary cooperation?” And, if that’s what it takes to get some serious cooperation credit, maybe it would be better simply to get fined.
Back to reality. My clients report to me an extreme reluctance to volunteer to FINRA any discovery of a problem, for fear that FINRA will reward them not with a slap on the wrist but, rather, a full-blown investigation, complete with serial 8210 letters and OTRs, culminating in an Enforcement action and big fines. To the extent FINRA does give cooperation credit, no one actually expects to get it. If FINRA truly wants its members to provide extraordinary cooperation, then it needs to do more than talk the talk; it has to do a much better job of making clear that cooperation will materially reduce the scope of an exam, and thus the time and expense of dealing with the exam; increase the likelihood that the exam will not get referred to Enforcement; and significantly reduce any sanctions that may be meted out should the exam go to Enforcement. If FINRA cannot or will not do that, then it should not be surprised how few firms actually attempt to take advantage of cooperation credit.
The good news, perhaps, is that FINRA appears to have recognized this. The article again quotes Ms. Hopper: “”We’re taking a fresh look at credit for cooperation and how we are going to be handling it. I don’t think there’s as much clarity as people would like on the credit for cooperation.” No kidding.
[1] Subsection (b) of the Rule provides that “Each member shall promptly report to FINRA, but in any event not later than 30 calendar days, after the member has concluded or reasonably should have concluded that an associated person of the member or the member itself has violated any securities-, insurance-, commodities-, financial- or investment-related laws, rules, regulations or standards of conduct of any domestic or foreign regulatory body or self-regulatory organization.” In the Supplementary Material, FINRA explains that it “expects a member to report only conduct that has widespread or potential widespread impact to the member, its customers or the markets, or conduct that arises from a material failure of the member’s systems, policies or practices involving numerous customers, multiple errors or significant dollar amounts. With respect to violative conduct by an associated person, FINRA expects a member to report only conduct that has widespread or potential widespread impact to the member, its customers or the markets, conduct that has a significant monetary result with respect to a member(s), customer(s) or market(s), or multiple instances of any violative conduct.”