Broker- Dealer Law Corner

Broker- Dealer Law Corner

Dog Bites Man: FINRA’s Proposed Amendments To Code Of Arbitration Procedure Put Customers’ Interests Ahead Of Members’

Posted in Arbitration, FINRA, PIABA

In December, Ulmer & Berne is hosting four financial services webcasts, the first of which I will be presenting along with my partner, Michael Gross:  FINRA 2019: A Look Back, and Thoughts About What Lies Ahead (Wednesday, December 04, 2019, 2:00 PM EST).  The others are The Anatomy of a Whistleblower Action: Procedure, Practice Pointers, and Avoiding Pitfalls (Thursday, December 05, 2019, 2:00 PM EST); Hot Topics in SEC Regulation and Enforcement (Wednesday, December 11, 2019, 2:00 PM EST) and Data & Privacy in the Financial Services Industry: How Can You Stay Current? (Thursday, December 12, 2019, 2:00 PM EST).  They are free, and look pretty interesting.  I invite you to register to attend any or all of them by clicking this link. – Alan

As I have mentioned before, several times, PIABA is deathly concerned with the fact that sometimes customers who prevail in arbitrations are unable to collect their awards, which typically happens when the respondent firm and/or the RR leaves the industry (thus eliminating the leverage supplied by the FINRA rule that requires arbitration awards to be satisfied within 30 days or else face expulsion).  Putting aside my view that PIABA’s true interest in the subject is not that customers receive nothing but, rather, the fact that non-payment of an award means no legal fees are collected – 40% of 0 is, alas, 0 – it is pretty stunning how FINRA continues to cater to PIABA’s views, even when those views are in direct derogation of those of FINRA’s consitutent member firms.

Case in point: FINRA announced this week that it is proposing amendments to the Code of Arbitration Procedure that are directly in response to PIABA’s complaints about unsatisfied arbitration awards.  The amazing, but, I suppose, unsurprising thing is that these amendments are so one-sided in terms of who they benefit.  If you were to use your one guess to say, “the customers?” you would be correct.

Some of the proposed amendments are vanilla.  For instance, they allow a customer that has filed an arbitration against a firm or an individual who is no longer registered, or who becomes unregistered after the arbitration has been commenced, to withdraw the case and get his money back.  That’s not a bad idea, and I have no problem with the concept.

A much thornier issues arises from FINRA’s proposal to allow customers who don’t want to withdraw their arbitration instead – without seeking any leave from the hearing panel – to amend their Statement of Claim to add a new party.  Under the current rules, once the panel has been appointed, a claimant may only add a party by seeking and obtaining the panel’s consent.  The proposed amendment eliminates that requirement.

Perhaps that doesn’t sound like a big deal to you.  I would suggest that it is.  For a few reasons.

First, by allowing a claimant unilaterally to add a party to the case after the panel has been appointed, it means the new party has been effectively precluded from participating in the process of selecting the arbitration panel.  And, frankly, in many cases, that process is the single most important aspect of the defense strategy.  You can have a fantastic defense case, but if your panel is bad – and believe me, it is difficult to overstate just how bad a panel can theoretically get if the wrong people are not stricken – you will still have an uphill battle to prevail.

FINRA recognizes this problem, but blithely shrugs it off:

In this scenario, FINRA would provide the arbitrator disclosure reports of the sitting panelists to the parties and permit the parties to raise any conflicts they find with the panel.  If a party discovers a conflict, the party may file a motion to recuse the arbitrator.  The arbitrator who is the subject of the motion to recuse would consider whether to withdraw from the case and rule on the motion.  The party may also request removal of the arbitrator by the Director, under certain circumstances.

This provides absolutely no protection to the newly added party against simply bad arbitrators who are not conflicted out.  Moreover, it’s not like this is some effort by FINRA to compromise; rather, it is simply pointing out a right that any party to an arbitration has under the rules, regardless of when they become a party, and that is to exclude from the panel any arbitrator who has a conflict.  Unfortunately, it would not be a conflict meriting recusal if, say, the appointed chair of the panel was a member of PIABA with a long history of awarding money to claimants.  In that circumstance – which is not hypothetical – the newly added party would be stuck with a chair that, had he been offered a chance to participate in the ranking process, would have immediately been struck.

The other problem is that despite its protestations to the contrary, it sure seems like FINRA is actually encouraging claimants to amend their Statements of Claim to add a new respondent not because the new party has any real culpability, but simply because the new party is seen as having the fiscal means of potentially satisfying the claim.  It’s not like FINRA has done any real analysis on the subject.  Indeed, the most comfort that FINRA offers to prospective respondents is this, buried – appropriately – in a footnote: “FINRA does not believe, however, that the proposed amendments would cause member firms and associated persons to be named without having a connection to the case.”  Ha!  I have no idea on what FINRA bases its “belief,” but clearly it has not been paying attention to the real world, where people and firms are named as respondents despite having had had nothing to do with the issues underlying the complaint.

FINRA attempts to amplify this statement, but the upshot of my criticism does not change:

FINRA does not believe that the proposed amendments would encourage claimants to add members or associated persons who have no nexus to the arbitration case as some commenters fear.  While the proposed amendments to FINRA Rule 12309 would remove the requirement for arbitrator or panel approval prior to adding a claim or party, FINRA Rule 12309(d) permits any party, whether existing or newly-added, to respond to an amended pleading after it is filed by filing an answer and raising any available defenses.  Thus, if the claim or party to be added has no connection to the arbitration case, the respondents would have an opportunity to make that argument to the arbitrator or panel.  It would not be in the claimant’s interest, therefore, to add frivolous claims or unnecessary parties, as doing so would likely increase a claimant’s costs in supporting the amended pleading and would delay the outcome of the case.

It is very telling that FINRA’s explanation is provided strictly from the claimant’s perspective, but that’s way incomplete.  The more important perspective, the one that FINRA flatly ignores, is that of the newly added party.  That person or entity, now a party in an arbitration with a panel it had zero role in selecting, has to spend the time, the money, and the effort to defend itself.  It has to hire counsel, then file an Answer, and maybe also a Motion to Dismiss.  Maybe have to appear at the hearing before it can even raise a defense on the merits?  And, yet, FINRA thinks this is a mere inconvenience, one that’s trumped by the purported need for customers to augment the likelihood of collecting if/when they prevail?

Once again, FINRA has shown how little it thinks of its own members, and how it wants to hold itself out to the world.  Once again, members’ interests are subordinate to those of the investing public.  Once again, FINRA has demonstrated its view that a procedure is fair so long as complaining customers benefit by it.  In short, there is no level playing field in FINRA arbitrations.  Time and time again, when PIABA speaks, FINRA listens, no matter what price member firms pay for that obsequiousness.

PIABA’s Anti-Expungement Tirade Is Predictably Short On Facts

Posted in Arbitration, Expungement, FINRA, PIABA, Uncategorized

Here is how PIABA’s one-track mind operates: in a Report it just issued, PIABA laments the frequency with which registered reps are able to get customer complaints expunged from their records. The sole reason for this, PIABA concludes, is that the expungement process is broken, and/or is being gamed by brokers. It does not even enter the realm of possibility for PIABA that the real reason arbitrators are receptive to requests for expungement – arbitrators who, mind you, have had it drilled into them by FINRA that expungement is an “extraordinary” remedy – is that these customer complaints are, in fact, bogus, and deserve to be expunged. That they are false, they are factually impossible, they are figments of customer’s imaginations, and, therefore, don’t belong in CRD.

That is just a possibility that doesn’t exist in PIABA world, where there is no such thing as a baseless complaint, and where every arbitration that ends in a “zero” award for the customer necessarily was a mistake and an aberration of justice, rather than the appropriate application of law to fact by the hearing panel.

Putting aside the predictable slant that always colors PIABA’s viewpoint, let’s look at the specific criticisms that PIABA lodges in its Report.

First, PIABA complains that brokers have “corrupted” the expungement process by requesting $1 in damages, a maneuver that, as dictated by FINRA’s Code of Arbitration Procedure, reduces the filing fee from $1,575 (which FINRA charges in cases where no monetary damages are sought or the damages are “unspecified”) to $50. It also reduces the number of arbitrators from three to one. I have to be honest, I don’t see how this serves to “corrupt” the system. There is simply nothing nefarious about wanting to reduce the filing fee.

And as for the number of arbitrators, PIABA couldn’t conjure up even a half-baked argument that a three-person panel is somehow more apt to deny an expungement request than a one-person panel. The reason, of course, that it cannot make that argument is because the data just don’t support it. In all the charts packed into PIABA’s Report, conspicuously absent is one comparing the results of one-person panels vs. three-person panels. All PIABA does, then, to support its thesis is include a misleading header in this section of its Report, extolling that the $1 demand somehow “Contribut[es] to The High Expungement Rates” without bothering to explain why that is supposedly the case. Ultimately, PIABA’s complaint distills down to whining about what this procedural manuever has cost FINRA in lost revenue, as if that really matters to PIABA.

Second, PIABA is unhappy that requests to expunge customer complaints are often not opposed by anyone, including the complaining customer! Even though PIABA recognizes that FINRA requires that complaining customers be apprised of the expungement request, and invited to participate in the proceeding, it begrudgingly acknowledges that the vast majority of such customers decline to do so. Somehow that is the registered rep’s problem? If these complaints have such validity that expungement amounts to a travesty of justice, I don’t think it is unfair to contemplate that the complaining customer actually show up – even if just by phone – to defend the legitimacy of his or her complaint. PIABA, of course, disagrees with me. In PIABA world, it is too much to expect a complaining customer to testify under oath about their own complaint. Indeed, among PIABA’s proposed solutions to the supposed expungement crisis it has identified is that an Advocate be created by FINRA or the SEC to play the role of complaining customer, i.e., to actually show up at the hearing and testify about the efficacy of the complaint. Seems to me it would be lot easier, and a lot more logical, for the actual customer to assume this obligation, rather than create some group that would have to investigate the complaint from scratch…which necessarily means, of course, talking to the same customer that PIABA wants to shield from any meaningful participation in the process.

PIABA also complains that not only does the complaining customer not bother to defend the expungement request, in most instances the registered rep’s broker-dealer doesn’t, either. That may be true, but it is not indicative of any unfairness in the process. BDs are not the source of the complaint in the first place; they are simply required by the rules to amend Form U-4 to disclose the complaint. It doesn’t matter how meritless a complaint may be, if it meets all the requirements for disclosure – and being meritorious is NOT one of them – then the whole world gets to see it. It makes perfect sense, therefore, that BDs are happy to see bogus complaints get expunged.

PIABA’s next complaint is also the weirdest: it doesn’t like the fact that reps seeking expungement rank highest the arbitrators most likely to grant the request. That is not gaming the system. That is not collusion. That is simply how arbitration works. Each party to the case reviews the pool of potential arbitrators and decides who among them would be the most receptive to their case, ranking those persons the highest. When I handle an expungement case, naturally, when possible, I select arbitrators with a track record of having previously granted expungement requests. That hardly guarantees I will prevail, however; it simply means that I am trying my best to identify a receptive audience. This is the very same thing that PIABA lawyers do when they rank panelists, they strike people who have a historic tendency of denying claims, and rank highest the arbitrators who tend to be claimant-friendly. To suggest that this is somehow unscrupulous is to ignore how arbitration is designed to work.

Which brings me to the stupidest and, frankly, to me, as a lawyer who represents brokers seeking expungement, the most insulting complaint in the Report. PIABA makes this bold statement: “Expungement requests are being granted based upon one-sided and possibly false evidence presented to arbitrators.” Let me focus on the “possibly false evidence” bit, because it is flat out BS. Nowhere in its Report does PIABA actually cite any matter in which false evidence was introduced to obtain expungement, even in those cases where the request was unopposed. Rather, what PIABA does is make the fuzzy argument that “[s]ince brokerage firms do not oppose brokers’ expungement requests 98% of the time and customers oppose expungement in only 13% of cases, it logically follows that there should be procedural safeguards in place to prevent brokers from presenting one-sided, false or misleading information to arbitrators.” In other words, unless PIABA’s plan is adopted it is possible that someone may use false evidence to support an expungement request. PIABA has simply invented a non-existent problem here, merely so it can recommend a means of addressing it, i.e., the creation of the Advocate, that PIABA favors. It is beyond cavalier to suggest that lawyers who represent brokers have relied on false evidence without providing the slightest bit of proof to substantiate such an outrageous allegation. But, as we know, that’s how PIABA rolls.

Given, as I said, the fact that brokers are obliged to publicly report even blatantly false customer complaints, which can and do have a dramatic impact (and right in the pocketbook, at that) despite their falsity, expungement is a necessary and proper tool for registered reps to rid such drivel from their records. It doesn’t matter that more of these cases are being filed now than historically, or that a couple of law firms seem to specialize in bringing them, or that multiple false claims can be addressed in a single hearing. (PIABA points out that in one matter, 24 false customer complaints were expunged in a single hearing. Sorry, PIABA, but that case happened to have been handled by my partner, and I guarantee you that she didn’t rely on “false evidence.”) Unless and until the playing field is leveled, and customers have to establish that their complaints have merit before brokers are obligated to report them, expungement is absolutely needed.

FINRA’s Secret Power To Control Information

Posted in BrokerCheck, CRD, FINRA, Form U-4

In the past week, I ran across two discrete instances in which FINRA acts as a secret gatekeeper of sorts, exercising its own subjective judgment, without anyone knowing what, exactly, it is doing or why, employing unarticulated standards, and without providing any avenue for redress.  And I find that really frightening.

The first involves CRD, which, although it is nothing more than a database of information, is a weird place.  Over the years, it seems I have spent a crazy amount of time describing to people exactly what CRD is, where the information in CRD comes from, what information properly belongs in CRD, what information is in CRD but not in BrokerCheck, etc.  With that said, clearly the most common issue I encounter when it comes to people calling me about CRD is that they feel they have required disclosures – typically a bogus customer complaint – that are inaccurate and wonder what, if anything, they can do about it. Remember: RRs are required to disclose customer complaints irrespective of their lack of merit.  This situation only got worse with the advent of BrokerCheck, since the whole world can now view pretty much all of one’s negative U-4 disclosures, making inaccurate disclosures that much more impactful.

There is more than one answer to the question what to do when faced with a customer complaint that is flat out false, as it depends on whether the RR is still in the industry.  If so, it’s easy, as the RR can, at a minimum, add a comment to the DRP (i.e., the disclosure reporting page) about the disclosure simply by having their BD amend their Form U-4.  Typically, the comment goes something like, “I didn’t do what the customer claims I did and I intend to fight these scurrilous allegations vigorously.”  Most BDs are happy to add that language, for what it’s worth.  Interestingly, however, there are no rules, or even guidelines, regarding what can be included in a comment.  As far as I can tell, an RR can say whatever he or she wants, and unless the BD has some problem with the comment, it is dutifully reported in CRD, and BrokerCheck, as well.

If the rep is no longer registered, however, the procedure is different and, frankly, odd.  The RR still gets to submit a comment, but, because he is not registered, he has no ability to file, and therefore amend, a Form U-4 (because only BDs can make such filings).  As a result, the comment has to be submitted directly to FINRA, which will then make sure that it makes its way to CRD and to BrokerCheck, so the world can see that the RR denies the allegations, etc., etc.  But, that’s not the weird part.  What is weird is that FINRA will not simply say whatever the RR wants.  Rather, FINRA will review the proposed comment and decide whether or not it will be published, or perhaps just needs to be edited or redacted.

What?  FINRA will “review” the comment, and then make a subjective determination whether or not it will be shown to the public?  I am not making this up.  The following language appears on FINRA’s website on a page called “Guidelines for Broker Comments on BrokerCheck”: “FINRA will review the comment and reserves the right to reject or redact a comment that it deems to be inappropriate or does not adhere to the following criteria.”  Before I address “inappropriate,” let me talk about the “criteria.”  There are five criteria listed, and all but the last are not particularly controversial.  They require that:

  • “The individual submitting the comment is not currently registered.” That is easy enough to establish.
  • The proposed comment must “pertain to the BrokerCheck report of the individual submitting the request.” Again, easy peasy.
  • The comment must address “information disclosed through BrokerCheck.” No problem with that.
  • The comment must be “written in the first person narrative point of view to minimize any potential confusion on the part of the reader.” I like to write in the first person, so I can’t really complain about this criterion (although it is a bit amusing that FINRA cares about something like the perspective from which a comment is offer).
  • “The comment does not contain confidential or identifying information about customers or others; offensive or potentially defamatory language; or information that raises significant identity theft, personal safety or privacy concerns.” Ok, not so fast.

What gives FINRA the right to decide whether a comment is “offensive or potentially defamatory?”  And who, exactly, at FINRA is conducting the review and making these determinations?  And what criteria are being employed to determine whether a comment is offensive?  I am confident that there are things that would not offend me, but which other, more thin-skinned folks, would be bothered by.  Take a very specific example: would FINRA deem it to be offensive if an RR called a complaining customer a “liar” (which, frankly, many complaining customers are)?  I just can’t believe that FINRA can wield editorial power like this over an RR’s own words.

And that power only gets scarier when you consider the other standard, which is even loosier-goosier, i.e., that the comment not be “inappropriate.”  Again, exactly what does that mean?  Would a comment be inappropriate because the RR denies the complaint?  Because he points a finger at, say, his former BD?  Or at FINRA itself?  We also face the same problem regarding who at FINRA is the one deciding whether a proposed comment is appropriate or not.  Is it Robert Cook?  Seems doubtful.  Maybe it’s just some data entry clerk at CRD?  And what happens if you disagree with FINRA’s determination to “reject or redact” a comment?  There does not appear to be an appeal process.  How can that be fair?

As I stated at the outset, this is not the only hidden situation in which FINRA acts like Big Brother, deciding the merits of things behind the scenes, away from public scrutiny.  Just the other day, someone reminded me about mid-hearing disciplinary referrals made by arbitration hearing panels.  Under FINRA’s Code of Arbitration Procedure, if a hearing panel hears evidence of “any matter or conduct . . . during a hearing, which the arbitrator has reason to believe poses a serious threat, whether ongoing or imminent, that is likely to harm investors unless immediate action is taken,” it may make an immediate disciplinary referral. But, that’s not the end of the process.  Rather, FINRA Dispute Resolution first has to “evaluate” the referral before it is actually passed on to Member Reg or Enforcement.  Presumably then, even though a hearing panel has decided that something it heard it so egregious, so potentially harmful to investors that it makes an immediate disciplinary referral, FINRA can summarily – and subjectively – decide that the panel is wrong, and the referral dies there on someone’s desk, away from the light of day.

I don’t know about you, but these secret administrative processes that FINRA has created in which it wields such complete control over decision-making without also providing some window into what’s happening and who is making the decisions, not to mention some avenue of appeal, scare me.  FINRA is supposed to do the right thing, and usually does.  But not every time.  There should always be some sort of check on FINRA, to ensure that its decisions are made out in the open and subject to review by the SEC.  The two circumstances I have described here do not fit within that construct.  Who knows what else we don’t know?

FINRA’s Latest Statistical Snapshot Shows Continued Decimation Of Small BDs

Posted in FINRA

Last year, for the first time, FINRA produced a statistical report designed to provide some perspective on the firms that comprise its membership. I blogged about it, and concluded at the time that the report basically demonstrated the following:

  • FINRA is still mostly composed of small firms
  • But the number of those firms, and the influence they wield on FINRA’s direction, continues to diminish
  • If the trend continues, the landscape for broker-dealers will no longer look as it does today, as “mom-and-pop” shops will go the way of the paper tickertape and the handwritten order ticket

This week, FINRA issued its 2019 version of that Snapshot and – spoiler alert – it appears that those same alarming trends continue.

First, perhaps the least surprising data point in the entire report is that the number of FINRA member firms continues to shrink.  As of 2018, FINRA is down to 3,607 firms, representing an overall loss of 119 firms.  Since 2014 – the earliest year for which data is included in the Report – FINRA has lost over 11% of its membership.  Going back to 2003, which the earliest year for which I can find any statistics, the number of FINRA member firms has dropped by over 31%.  Consistent with this, there was also a continuation in the drop in the number of RRs, albeit a modest one.

Second, FINRA membership still consists overwhelmingly of small firms.  When you consider the three different size categories that FINRA employs – small (which FINRA defines as 1 – 150 RRs), mid-size (151 – 499 RRs) and large firms (over 500 RRs) – the data show that 3,242 of the total of 3,607 firms are small.  In other words, over 90% of FINRA member firms are small.[1]

Third, and perhaps the most alarming, it is readily evident that the reduction in the overall number of firms was driven almost entirely by the loss of small firms.  Of the 119 firms that were lost in 2018, 112 of them – over 94% – were small.  And of those 112 firms, 104 of them were BDs with 10 or fewer RRs.  You can see why the concern I voiced last year about the demise of “mom-and-pop” shops was legitimate, and why it is even more true today.  Of course, the data in the report also show why FINRA doesn’t really care about this phenomenon: of the approximately 630,000 RRs who work for FINRA member firms, only 10% work for small firms.  Yes, you read that right: while fully 90% of FINRA members are small, only 10% of all the RRs work at those firms.

Fourth, FINRA’s statistics again reveal clearly that it is hardly the regulator of choice in the securities industry.  This is evident from the data that show that while the number of BDs continues to plummet, the population of investment advisors – who are not, of course, regulated by FINRA – is going in the opposite direction.  Every year since 2009, the number of investment advisor firms NOT registered with FINRA has increased, up a total of 22.5% over that ten-year period.  By comparison, over that same time period, the number of FINRA members – whether BD-only or IA/BD dually registered – has dropped by 23.5%.  Stated another way, in 2009, there were about 20,000 more IA-only firms than BDs; ten years later, however, as people in the securities industry migrate away from the BD world to avoid having to deal with FINRA, there are now 26,639 more IA-only firms, an increase of 33%.

As I said before, except for the last observation about the continuing migration away from BD world to IA world, I highly doubt that FINRA cares about the fact that its population of member firms continues to drop every year, or that small firms are quickly going the way of Blockbuster video rental stores.  I mean, who would complain about having fewer firms to worry about at the same time that your number of employees, your compensation, and the amount of money you spend continue to go up?  Less to do with more people to do it, sounds like a fantastic combination.  At some point, I suppose it is possible that FINRA will have to justify its continued existence.  Based on her history, Senator Elizabeth Warren does not appear to be a big fan.  I do not doubt that certain people in FINRA management are keeping a very close eye on who turns out to be the nominee from the Democrats.

[1] Given that the overwhelming number of FINRA members are small, isn’t it odd that according to FINRA’s By-Laws, small firms get allocated the exact same number of seats on the National Adjudicatory Council as large firms?

“The Opinions Offered Today Are Mine Alone And Do Not Represent The Commission” — A Summary Of Recent Remarks From SEC And CFTC Officials

Posted in CFTC, SEC

Selflessly, Blaine Doyle recently attended a presentation here in Chicago by the SEC and CFTC, so you didn’t have to do it yourself.  Here is his recount of the highlights. – Alan

Anyone who has sat through a talk by financial regulators is undoubtedly familiar with the refrain from the individuals that they do not speak for the Commission and that the opinions offered are their own.  Even with that disclosure (and they ALWAYS make that disclosure), regulators are still notoriously tight lipped when it comes to just about anything, but especially if it relates to Enforcement.  However, when two high ranking officials from the CFTC and SEC decided to present, as the star attractions, at the Chicago Bar Association, they had no choice but to spill the beans.  While nobody would accuse them of having given up state secrets, they did offer some insights into where their respective Commissions are and, more importantly, where they are going.  With that in mind, here is what they had to say (with special emphasis on the securities side):

While the government shutdown of early 2019 is ancient history to most of us, the speakers from both the CFTC and SEC emphasized the disruption that the break caused to their respective organizations and personnel.  Moreover, on the issue of government funding, they both noted that their organizations are understaffed from past hiring freezes and are trying to backfill positions that have been open for some time.  The speaker from the CFTC mentioned that in some respects his organization had been in “triage” mode due to personnel shortages and that he was hoping that the additional hires will help ease the work load.  So why does this matter to the reader?  If you work in the industry, it would be reasonable to expect that as both organizations hire additional staff, scrutiny on registrants and, possibly, the number of enforcement actions will increase in the coming years.

Having established that regulators will be staffing up in the near future, it might pay (or prevent you from having to pay) to understand what exactly regulators have on their “to do” lists.  Overall, and not surprisingly, both regulators repeatedly mentioned that protecting and returning money to victimized “main street” (aka retail) investors was a paramount, if not the main, concern.  Thus, on the exam side, the SEC speaker mentioned hidden fees, undisclosed conflicts of interest, firms borrowing money from customers and the protection of senior investors as points of focus.

On the enforcement side, the mission centered on how best to allocate limited resources to protect retail customers.  The speaker mentioned that they were developing data analytics as a means to identify and stop investor harm (including market manipulation) and emphasized the importance of individual accountability when issues do arise.  Owing to limited resources and the importance of registrant accountability, he highlighted the “Share Class Selection Disclosure Initiative” in which RIAs that self-reported possible securities law violations relating to the failure to disclose information concerning mutual fund share class selection received favorable settlement recommendations from Enforcement.[1]  Given that self-reporting uses less resources than when the SEC has to root out violations itself, and also compels self-imposed accountability on the part of the registrants (a big theme from the speaker), it would be reasonable to expect the roll out of similar programs for other types of violations in the near future.

There was a vibrant discussion about cryptocurrency with the SEC indicating its Crypto Unit will be looking at fraud and registration issues in ICOs (Initial Coin Offerings – the rough equivalent of an IPO) as well as whether dealings in crypto can constitute acting as an un-registered broker-dealer or even as an un-registered exchange.  Of broader interest to players in the securities industry were the comments on cyber security.  Increasingly, registrants are housing their customers’ personal information online, making it vulnerable to cyber-attack.  The SEC speaker was clear that when a registrant farms out either the storage or protection of that information to a third-party vendor, the responsibility for safeguarding the information stays with the registrant.  In other words, the excuse that “I hired XYZ Company to protect my customers’ information, so it is not my fault” will not serve as some kind of panacea in the eyes of the Commission.  Thus, it is imperative that registrants conduct due diligence reviews on third-party vendors and make appropriate disclosures to customers about their information and where it will be housed.  For larger entities, he emphasized that the Foreign Corrupt Practices Act (“FCPA”) necessitates close supervision over foreign subsidiaries by their domestic parents.  Given the current political climate in the United States, it would not be shocking if foreign subsidiaries and their business dealings come under increased scrutiny in the years to come, especially in relation to payments and favors to government officials abroad.

So that is where the Commission currently resides, but where is it headed?  The speaker reemphasized the protection of retail customers and described a concerted effort to make the enforcement process as transparent as possible.  While “transparency” might sound like a meaningless buzz word, the speaker described his concept of it being that the Commission puts out rules (no surprise there), but also tries to articulate how it views the implementation of the rules, through devices such as “No Action Letters” so that registrants can react accordingly before the Commission has to get involved.  While he did not explicitly say it, this would allow the Commission to direct its limited resources towards knowing wrongdoers instead of targeting registrants that mistakenly run afoul of its rules.  Finally, the speaker mentioned the elephant in the room, Regulation Best Interest, which goes into effect in June 2020.  Unfortunately, he did not have much to say about it except that it is already resulting in litigation relating to the scope of the rule.  Readers should be on the lookout for future releases from the Commission on the subject that will hopefully provide the promised “transparency.”  As for now, however, Regulation BI figures to be a source of consternation for registrants and their lawyers, alike.

So there you have it.  While the regulators did not say anything earth shattering, they did provide limited insight into how they view matters so that you, as registrants, can stay off their radar.  Once on their radar, however, the Commissions’ position conveniently seems to be that quick confession will lead to lesser penalties.  That is, of course, a fine notion, unless the allegations against the registrant happen to be meritless, in which case the registrants will find themselves in the unenviable and pricey position of hiring lawyers and taking on the Commission.


[1] See

TD Ameritrade Latest Victim Of Head-Scratching Arbitration Award

Posted in Arbitration

I was catching up on my reading and came across a column in Investment News by Mark Schoeff  that described the results of a recent FINRA arbitration, results which I found a bit alarming.  I caution you: reading too much into any arbitration award can be dangerous and/or foolhardy since they don’t always follow – or, occasionally, even slightly resemble – the rule of law.  Indeed, screwy arbitration awards abound, and sometimes all you can say is dang, glad it wasn’t me.  That’s why, in the eyes of the law, anyway, arbitration awards, even those that are well reasoned and sensible, do not constitute binding legal precedent.

Nevertheless, this award serves as a nice cautionary tale for firms that are willing to open accounts for advisory customers but not serve as the actual advisor, which is an altogether common practice in the securities industry.  Remember: investment advisors can recommend securities transactions, but they cannot actually effect any trades.  To make a securities trade that was recommended by an IA, the customer must have a securities account at some broker-dealer.  Some advisors are dually registered, and work for a BD, and that’s where the account is generally opened.  Many other advisors, however, are not associated with a BD, so their advisory clients need a brokerage account somewhere.  Often, that somewhere is a discount BD that charges low commissions, like TD Ameritrade, the respondent in this particular arbitration.

Here is all I know about the case, which I gleaned from the award itself and the article – the author of which, Mr. Schoeff, an excellent reporter on securities matters, included several quotes from the claimant’s attorney – as well as other public sources that I have cited/linked to:

  • Michael D. Bayliss used to be a registered rep, but, according to BrokerCheck, hasn’t been associated with a BD since 2004.
  • According to IARD, however, he was registered as an investment advisor with his own firm through August 2016, when his registration was revoked by the State of Nevada. (In 2018, the State of Nevada also filed criminal charges against Mr. Bayliss, accusing him of having committed securities fraud.)
  • Apparently, Mr. Bayliss had his advisory clients open securities accounts at TD Ameritrade.
  • While I don’t know everything that Mr. Bayliss may have advised his clients to purchase, according to a Form D that he filed with the SEC, he did manage to convince 16 people to invest a total of almost $2.3 million in Wealth Strategies Opportunity Fund, a private placement he created. It is noteworthy that the arbitration award recites that the case related to the claimant’s investment in “Wealth Strategies Funds,” which I am going to presume is the same entity as that identified in the Form D.
  • According to the article, the claimant, a Nevada doctor, “invested with Mr. Bayliss because of his association with TD Ameritrade.” Claimant’s attorney is quoted as saying, “In [claimant’s] mind, the fact that the accounts were at TD Ameritrade gave her confidence in the investments.”  That dovetails with another statement in the article that “[t]he arbitration case didn’t revolve around the investments in Mr. Bayliss’ fund so much as the imprimatur TD Ameritrade gave Mr. Bayliss by allowing him to operate on its platform.”
  • Claimant sought $407,050 in compensatory damages and other costs; the hearing panel apparently didn’t think that was enough, and awarded her $728,816 in compensatory damages.

Let’s just take a second to review that, in case I went too fast: this is money that was awarded against TD Ameritrade, not Mr. Bayliss, and that was even though it was undisputed that (1) Mr. Bayliss, not TD Ameritrade, recommended the investment, and (2) Mr. Bayliss was never registered with TD Ameritrade in any capacity.

I have to tell you, THIS is why respondents often choose to settle arbitrations rather than take them to hearing.  Even when the facts and the law are on your side, you just never know what a hearing panel may do.  For me, I have a hard time looking at this case and figuring out exactly what TD Ameritrade supposedly did wrong.  Claimant’s attorney supposedly asserted that the firm “didn’t properly vet Mr. Bayliss or his investment fund.”  But, what was TD Ameritrade supposed to have vetted?  Let’s start with the fund.

TD Ameritrade didn’t recommend the investment.  That means under FINRA rules it had no suitability obligation, either customer specific or reasonable basis.  In other words, TD Ameritrade did not have to perform due diligence on the fund to ensure it was suitable for any human being – reasonable basis suitability – or take care that the fund was specifically suitable for the claimant – customer specific suitability.  All TD Ameritrade had to do was to maintain custody of the investment for the claimant, and it certainly seems that the firm fulfilled that duty.

What about vetting Mr. Bayliss?  Again, Mr. Bayliss did not work for TD Ameritrade, either as a registered representative or as an investment advisor; he simply had his advisory clients open accounts there so they could buy and sell the securities he was recommending and for their assets to be custodied.  In light of that, what obligation did TD Ameritrade have to do any due diligence on Mr. Bayliss?  Admittedly, there are a ton of things that TD Ameritrade would have had to do if it was looking actually to hire Mr. Bayliss in terms of reviewing his background, talking to prior employers, maybe running a credit check, etc.  But under the circumstances of this case, those obligations were not triggered.

I hope that you agree that, as I said at the outset, this award is alarming.  The hearing panel’s willingness to impose liability on a firm whose obligations to the claimant were largely, if not entirely, ministerial in nature is downright scary.  It reminds me a lot of those handful of cases in which a clearing firm has been liable for something that went wrong at the introducing firm.[1]

Those cases are few and far between, given that every clearing agreement I have ever read explicitly puts the responsibility for suitability determinations exclusively in the hands of the introducing firm.  But, there are a couple, and they stand as stark warnings – as this case does – that when it comes to arbitrations, anything can, and does, happen.


[1]It should be noted that TD Ameritrade Clearing was also named as a respondent, and the award was against both respondents jointly and severally.  So, I suppose here is one more oddball case in which a clearing firm has been made to bear the brunt of an unhappy arbitration panel for supposedly not doing something that it had no obligation to do in the first place.

It Is Not Possible To Predict When FINRA Will Charge Something As Willful. Or Is It?

Posted in Disciplinary Process, Enforcement, FINRA, Willfullness

I have written a few times about FINRA’s ceaseless interest in bringing cases against registered reps who fail to update their Form U-4 in a timely manner to disclose the fact that a tax lien has been filed against them.  Or several tax liens.  The problem with these cases is not so much the sanctions that FINRA imposes, as they tend to be fairly modest, e.g., a fine of $5,000 or less plus a suspension, maybe of 30 or 60 days in length.  No, the problem is that FINRA often likes to characterize these failures as “willful,” which results in the registered rep being statutorily disqualified from continuing to work in the securities industry, necessitating the filing of a MC-400 application to seek FINRA’s approval to remain a registered rep notwithstanding the modest nature of the rule violation.

Well, this week, FINRA accepted a very interesting AWC from J.P. Morgan Chase, which included a $1.1 million fine, as a result of the fact that JPMC failed to update the Forms U-5 of 89 former registered representatives, over a six-year period, to disclose the fact that these RRs were the subject of an internal review concerning allegations that they had misappropriated or transmitted “proprietary Firm information,” took customer information in connection with the transfer to another broker-dealer, or violated some “investment-related banking industry standard of conduct.”[1]  A repeat violation for the firm, too.

Eighty-nine failures to update Form U-5 in a timely manner, over six years.  But, guess what?  FINRA did not consider this to have been willful!  Thus, unlike all those poor RRs who failed maybe ONCE to update their U-4 to disclose a tax lien who FINRA insisted did act willfully, and were, thus, statutorily disqualified, that was not the case of the firm here.

And, look, this was hardly a ticky-tack AWC.  JPMC paid $1.1 million, and for good reason, it seems.  The misconduct that JPMC failed to disclose was serious.  Thirteen of the RRs had “misappropriated funds from banking customers.”  Another five misappropriated funds from JPMC.  Other RRs were alleged to have “engaged in structuring or other suspicious activity, falsified, forged or altered bank-related documents, engaged in unauthorized trading, made unsuitable recommendations, engaged in selling away or undisclosed outside business activities, and borrowed from customers.”  A vertiable murder’s row of sales practice violations.

On top of that, because the firm failed to make these disclosures, by the time FINRA found out about the alleged misconduct, it had lost jurisdiction over more than 30 of the RRs (because more than two years had elapsed), thus precluding it from taking any disciplinary action against them.  Another 36 RRs who are still in the securities industry had already changed broker-dealers, preventing both FINRA and the new employers from adequately reviewing their applications for registration.

I cannot even begin to tell you the number of times I have argued with some FINRA Enforcement lawyer, or a hearing panel, about the issue of willfulness.  It is, sadly, abundantly clear that there is zero consistency from case-to-case, from lawyer-to-lawyer.  It always comes down to “prosecutorial discretion,” which is vast and nearly unassailable.  What does that mean in real life?  It means it is impossible to predict with any real sense of accuracy how a case is going to be charged, and the inability to make that determination spells trouble for respondents, who remain at FINRA’s mercy.

I don’t want to over-generalize anything from one AWC, but let’s just say that there are those among us who are of the view that at least one thing IS predictable, and that is disparate treatment by FINRA between big BDs and small BDs, or, similarly, between big BDs and individuals who work for small BDs.  I didn’t handle this case for JPMC, so I don’t know what transpired during the negotiations that led to the AWC.  Which means I don’t know if FINRA initially wanted to charge the extended failure here to update the RRs’ Forms U-5 as willful and was later convinced to change its mind, or if, for some reason, FINRA never characterized the failure as willful.  Regardless, it is fascinating to speculate what FINRA would have done if this was a small firm and not JPMC.





[1] According to the AWC, while all the RRs were registered with JPMC, most were associated with the firm’s bank affiliate.

Two (More) Scary Tales Of FINRA’s Abuse Of Rule 8210

Posted in Examination, FINRA, Rule 8210

Once again – twice again, actually – FINRA has used Rule 8210 as a cudgel, beating the poor unfortunate recipients of the “request” for documents and information into submission, or worse.  This has got to stop.

The first case is a repeat of one I blogged about earlier this year, and it involves the use of 8210 to demand that a computer be produced to FINRA so it can make a complete copy of the hard-drive.  Here’s what happened.  At 8:45 am on Wednesday, I received by email an 8210 letter, telling me that my client had to provide “immediate access to FINRA staff to inspect and copy” “[h]ard drive(s), Google drive(s), and USB thumb drive(s).”  The letter also included this threat/promise; note that the use of bold and underlining appears in the original, just to ensure these words are not skipped:

If your client fails to provide immediate access to FINRA staff of the requested information, they may be subject to the institution of an expedited or formal disciplinary proceeding leading to sanctions, including a bar from the securities industry.

At 9:00 – 15 minutes later – the examiners showed up at my client’s office and demanded that they be provided the computers so the hard drives could be copied, in their entirety.  Now remember from my previous blog post that I have been down this very road before with FINRA.  The last time this happened, in the face of essentially the same 8210 letter, my other client elected to produce the computer rather than face an Enforcement action.  Despite that, sadly, the matter still eventually ended up as an Enforcement case.  At the hearing in that case, I objected to the 8210 request as being unlawful, as it exceeded the scope of the rule (which does not permit computers to be seized and imaged).  The Hearing Officer asked me if an objection had been lodged at the time the initial 8210 request was served, and I had to say no.  Well, then, ruled the Hearing Officer, you waived your right to object here by not objecting sooner.

Armed with this background, when faced with Wednesday’s 8210 request, I told the examiners, who were poised to start the forensic imaging of the computers, that I objected to the request.  They told me that my objection was “noted,” whatever that means, and asked if they could start.  So much for the lesson I thought I had learned from the Hearing Officer.

The fact is, there is no way to object to an 8210 request, no matter what a Hearing Officer may think.  You either produce what’s requested or you don’t, and if you don’t, you will become a respondent in an 8210 case with FINRA seeking to bar you.  As I have said many times before, the 8210 process needs to be fixed, specifically to allow for objections of the sort that the Hearing Officer suggested.  I don’t know what will be the outcome of this exam, and I sure hope that my client doesn’t find itself in an Enforcement setting, but, to be honest, part of me would relish the opportunity to get back in front of the same Hearing Officer and see how he rules this time on the propriety of the 8210 request, given the fact that I objected loudly and immediately.  I don’t harbor much hope that anyone connected with FINRA will ever concede that Rule 8210 has limits, but, someday I am going to find a client with the gumption and the money to press that issue up the chain to make it to a federal judge, who will actually understand and acknowledge that 8210 has been abused.[1]

As bad as this scenario sounds, however, the other 8210 situation is even worse, an even more egregious demonstration of FINRA’s willingness to use 8210 to achieve unfair ends.

My client has been registered with BDs on and off (but mostly on) for over 20 years, but it’s never been his sole job.  He has also served as a consultant to the industry at times and, more importantly, to companies and other entities outside the securities industry as a result of his overall financial and consulting experience, and, in particular, his expertise in investment banking, capital markets, underwriting, risk management, compliance and controls.  In that unregistered role, my client was engaged quite a while ago to provide some assistance to a small group of affiliated companies, some public, some private, which were looking for strategic advice and seeking to raise capital.  None was in the securities business.  He drafted some documents, offered feedback on others, provided strategic advice in certain areas, but he had no decision-making authority (regardless of the fact that he bore a “C” level title at a couple of the entities); he simply did what he was asked to do on an issue-by-issue basis.

Unfortunately for him, these companies later attracted FINRA’s interest (because some sales of securities in these companies were made by a couple of individuals who happened to be registered with a BD at the time, and FINRA was interested in whether the transactions were handled properly by the BD as a private securities transaction or outside business activity).  So, because my client was associated (but registered) with a member firm, FINRA sent him an 8210 request asking for copies of documents he might still have in his possession as a result of the work he’d been asked to do for these companies.

If the story ended there, it would be routine, i.e., he’d produce the documents and get on with life, especially since FINRA had no real interest in him, but, rather, only in his documents.  But, the story doesn’t end there.  Turns out that a long time ago, in a move that preceded the FINRA exam by years and which had absolutely zero to do with FINRA, the companies whose documents FINRA wanted to see had each passed a corporate resolution that precluded anyone from producing company documents to anyone other than the courts, the government or in response to a subpoena.  FINRA, of course, is not the government and has no subpoena power.  Accordingly, the companies informed my client that in light of the longstanding resolutions, if he produced to FINRA the corporate documents that had been requested, they would likely sue him, as the corporate resolutions prescribed, as well as pursue other damaging actions.

Are you getting the picture now?  My client was as between a rock and a hard place as anyone ever: on the one hand, he could produce the documents in his possession to FINRA and thus avoid be barred, but to do so meant he would likely get sued by the companies whose documents he produced; on the other hand, he could choose not to produce those documents, thus avoiding the likelihood of civil suit and other potentially damaging actions, but inviting the FINRA bar.

We brought this situation to FINRA’s attention.  We said it was completely unfair to put my client in such an untenable situation, where no matter what he did, no matter which decision he made regarding the documents, he would lose.  FINRA just shrugged.  We pointed out that the corporate resolutions were not passed in response to the FINRA exam or to the 8210 letters, and therefore should govern.  FINRA disagreed and said that was his problem, that when he elected to become a registered person, thereby subjecting himself to Rule 8210, he ought to have known that someday FINRA could compel him to produce documents that he happened to possess from third parties that had absolutely nothing whatsoever to do with his role as a registered representative. In other words, FINRA said if the corporate resolutions were a problem, he ought never to have associated with a BD.

Faced with the choice between a bar from FINRA and a civil suit from the companies, my client took the bar.  And FINRA had no problem with that.

The Supplementary Material to Rule 8210 provides that the scope of documents which FINRA is entitled to inspect “does not ordinarily include books and records that are in the possession, custody or control of a member or associated person, but whose bona fide ownership is held by an independent third party and the records are unrelated to the business of the member.”  Clearly, this language is meaningless, as FINRA routinely ignores it, as it did here.  The documents that got my client barred weren’t his; they were corporate documents from his corporate clients, copies and drafts of which he happened to possess.  They were utterly unrelated to whatever securities activities he performed as a registered or associated person (none of which, by the way, ever involved sales).  And yet FINRA vowed to, and did, pursue him.

FINRA knows how powerful, how coercive Rule 8210 is, and it doesn’t hesitate to remind people.  Just look at the bold and underlined language in that quote at the outset of this blog post.  It’s always presented as an “or else” situation: produce the documents or else you will get barred.  Somehow, this has to change.  There has to be a mechanism by which 8210 requests can be challenged without having to risk being barred.  Unless/until that happens, FINRA will simply continue to bully its way through exams.


[1] There is another sordid component to this story that bears telling.  In the 8210 request, FINRA attempted to provide some comfort that despite the fact it was seizing the entire contents of the hard drive no matter what files it contains, it wouldn’t necessarily look at everything,  To that end, FINRA said that we had two weeks within which to identify for FINRA those files that are subject to a privilege, and which, therefore, FINRA should not inspect.  I told FINRA, however,  that I intended also to identify personal and confidential files to be clawed back, files that had nothing to do with the exam.  The examiner on-site told me that was fine, indeed, that FINRA had no interest in looking at such files.

Disturbingly, however, when I confirmed this with him in a subsequent email, he quickly backed away from what he had told me, and insisted instead that all I could prevent FINRA from reviewing were privileged documents, but not personal and confidential documents that were completely unrelated to the exam.  He even provided a cite to a prior FINRA decision, in which the NAC made the following frightening pronouncement: “FINRA is not precluded from requesting confidential and private information, and the Commission has rejected assertions of privacy and confidentiality as justifiable reasons for failing to provide FINRA with that information.”  He went on to admonish me that “a member’s obligation to respond to a FINRA Rule 8210 request is unequivocal and such member cannot impose conditions under which they will provide information.”

Putting aside the sad fact that the examiner pulled a 180 and acted as if he had never agreed that FINRA would refrain from looking at my client’s personal and confidential information, I find it rather remarkable – and disturbing and scary – that FINRA is so blatant about its supposed right to inspect this stuff.  Rule 8210 is very clear: FINRA can only review documents and information that relate to its exam.  It is difficult, therefore, to see how FINRA claims a right to review, say, one’s wedding photos, or personal emails, or orders previously placed at Amazon, i.e., the kinds of things that may reside on the hard drive of a computer.

All-Public Arbitration Panels Are Paying Out Money At An Unprecedented Rate…Just As PIABA Intended

Posted in Arbitration, FINRA, PIABA

I read an article this week in Investment News with the following headline: “Brokerage Customers Winning More FINRA Arbitration Cases.” As a guy who defends customer cases, I was naturally intriguied by this. According to the article, “brokerage customers who do file claims against their registered representative or firm are faring better in the process this year. So far in 2019, 176 cases have been decided, and 44%, or 78 cases, resulted in the customer being awarded damages. That’s an uptick compared to recent history.” Wow, I thought, this could be a troubling trend.

But, then I looked at the statistics that FINRA Dispute Resolution publishes, and quickly realized that this headline, and this story, oversells the point in a big way.

The story correctly reports that customers have been awarded money in 44% of cases that went to hearing this year, and that this reflects an upwards trend. But, really, it’s hardly a significant increase. The percent of cases that result in something being awarded to customers look like this since 2014:

2014:   38%

2015:   42%

2016:   41%

2017:   43%

2018:   40%

2019:   44%

As you can see, there’s not much difference from year-to-year. And, when you consider that the average over this entire time period works out to 41.333%, it is clear that there is nothing momentous about the 44% figure we see year-to-date in 2019.

This conclusion becomes even more evident if we look at the data only from “regular” hearings – i.e., excluding the 35 “paper-only” cases and the four “special” hearings – rather than the overall data. When you do that, we see that the upward trend is even smaller; indeed, it is barely there at all:

2014:   42%

2015:   45%

2016:   42%

2017:   45%

2018:   42%

2019:   44%

Compared to the average over these six years – 43.333% — the 44% figure from 2019 simply does not serve as the basis to conclude what the headline in Investment News touts.

There is, however, something newsworthy in the FINRA statistics, although you won’t find the PIABA lawyers quoted in the Investment News article talking about it publicly. It is this: the impact of allowing claimants to insist that their cases be heard by “all-public” panels has become palpable and undeniable. The following chart compares the percent of cases that result in the customer being awarded something when the panel was comprised of three public arbitrators versus a panel comprised of two public members and an industry member:

All Public Panel          2 Public/1 Industry Panel

2014:               44%                             38%

2015:               47%                             45%

2016:               43%                             36%

2017:               48%                             37%

2018:               42%                             47%

2019:               55%                             29%

These data make it clear that that all-public panels have always given away money more frequently than “standard” panels, but just look at the 2019 data! The difference now between the two types of panels has become absurd. Indeed, based on these statistics, a customer this year has nearly a 100% better chance of receiving an award using an all-public panel than a “standard” panel. No wonder PIABA fought so hard to get FINRA to make this change back in 2011…and how sad that FINRA caved so easily.

When FINRA proposed the rule that permits a customer to insist on an all-public panel, it stated in the SEC filing that it “believes that providing customers with choice on the issue of including a non-public arbitrator on the panel deciding their case will enhance customers’ perception of the fairness of our rules and of the FINRA securities arbitration process.” This is crap. For PIABA and the customers its members represent, fairness is only dictated by the outcome of a case, not the process by which the case is administered. For them, all-public panels are more fair because they award money more freely than “standard” panels. That is a flawed, but utterly predictable, analysis. And, as I said, certainly one you won’t hear from PIABA.

As for FINRA, which, as is standard for that entity, is more concerned with “perceptions” rather than reality, it could care less how this rule change has impacted the broker-dealers that comprise its membership.


Big Firms Paying Big Fines: A Discussion Of Two FINRA Settlements

Posted in Disciplinary Process, Enforcement, FINRA, Sanctions

What is it with big firms and fingerprints? You may recall back in October 2017, J.P. Morgan entered into an AWC with FINRA in which it agreed to pay a $1.25 million fine for the following, as described in FINRA’s press release about the case:

FINRA found that for more than eight years, J.P. Morgan did not fingerprint approximately 2,000 of its non-registered associated persons in a timely manner, preventing the firm from determining whether those persons might be disqualified from working at the firm. In addition, the firm fingerprinted other non-registered associated persons but limited its screening to criminal convictions specified in federal banking laws and an internally created list. In total, the firm did not appropriately screen 8,600 individuals for all felony convictions or for disciplinary actions by financial regulators. FINRA also found that four individuals who were subject to a statutory disqualification because of a criminal conviction were allowed to associate, or remain associated, with the firm during the relevant time period. One of the four individuals was associated with the firm for 10 years; and another for eight years.

Ok, now compare that description to this one, from a press release that FINRA issued just two days ago to announce an AWC that Citigroup entered into, and in which it, too, agreed to pay a $1.25 million fine:

FINRA found that from January 2010 through May 2017, CGMI failed to conduct timely or adequate background checks on approximately 10,400 of its non-registered associated persons. Also, the firm did not fingerprint at least 520 of the 10,400 non-registered associated persons until after they began their association with CGMI, thus preventing the firm from determining whether any individuals were subject to statutory disqualification from associating with a FINRA member firm. In addition, the firm was unable to determine whether it timely fingerprinted at least an additional 520 non-registered persons. While CGMI fingerprinted other non-registered associated persons, it failed to screen them as required by federal securities laws, instead limiting its screening to what was required by federal banking laws. FINRA found that because of these failures, three individuals who were subject to statutory disqualification because of criminal convictions were allowed to associate, or remain associated, with the firm during the relevant period. This arose from its failure to maintain a reasonable supervisory system and procedures to identify and properly screen all individuals who became associated with the firm in a non-registered capacity.

There is an uncanny similarity between these two cases, no? I mean, down to the amount of the fines imposed. There are few things that I’m trying to figure out about these two settlements. First, is this a problem unique to really, really big firms? I think the answer is that is has to be. No small, or even medium firm, deals with this many “non-registered associated persons,” about 10,000 each. It seems to me that it was the sheer size of the task, of doing the background check on this many people, that caused this problem. I am hardly conceding, however, that this is a legitimate excuse. FINRA remains a one-size-fits-all regulator when it comes to most of its rules. Including rules about checking the backgrounds of all associated persons. And FINRA has hardly been silent on this subject, having issued several public announcements in recent years. See, for instance, this press release and this Information Notice, both from 2018. Thus, it is incumbent on all BDs to take all necessary steps to meet their regulatory requirements, no matter how arduous the volume of work may render that task.

Second, did they get off easy? This one is debatable. Face it, in an absolute sense, a $1.25 million fine is nothing to sneeze at. Of course, for firms of this size, even a fine that large is likely to be fairly modest relative to overall revenue. But let’s remember, too, that FINRA fines are not meant to be punitive; rather, they are designed to be remedial. Thus, FINRA fines are not computed as a percentage of a respondent’s revenues (as might an award of punitive damages in a civil action or arbitration), so they are not intended to “sting” like punitive damages are.

The other issue that makes me question the sanctions is the fact that it appears both firms, as a result of failing to conduct the necessary background checks, managed to associate with a handful of individuals who were statutorily disqualified due to their criminal backgrounds. You may say, so what, it’s just a few SD’d people, so who cares? The problem is that the rule has no exceptions: when a BD associates with someone who is SD’d, it then renders the firm SD’d, too (thus triggering the need for the filing of an MC-400A application). Even if that association wasn’t done knowingly, the firm is still SD’d. The AWCs here don’t say how much of the fines were allocated to this issue, but if it wasn’t a lot, there is, arguably, a problem with the sanctions.

For me, on balance, I’d say it’s hard to argue that they got off easy, despite how long the problems continued (over eight years for J.P. Morgan, over seven for Citigroup), despite the huge number of people whose records were not properly reviewed, and despite the SD issue. The fines aren’t just big, they’re huge.

My third question is, where is the credit for self-reporting? I know that it’s supposed to be in the the J.P. Morgan AWC because it contains explicit language to that effect: “In determining the appropriate monetary sanction, FINRA staff considered the Firm’s cooperation in self-reporting and undertaking to remedy its violations.” To that language, FINRA dropped a footnote referencing Reg Notice 08-70, which, until just a week or so ago, was the latest word from FINRA on credit for self-reporting. (Now, of course, we have Reg Notice 19-23, which “restate[s] and supplement[s] prior guidance” from 08-70.) The point is, while we cannot quantify how much of a discount J.P. Morgan got for cooperating, we absolutely know that it got something.

According to Citigroup’s AWC, it also “self-reported this matter to FINRA and commenced a remedial review and screening process of non-registered associated persons across Citi.” But, there is no mention of any consideration accorded bythe FINRA staff for such cooperation, and no mention of 08-70. Thus, I am left to guess whether Citigroup actually got any credit for doing this.

The good news is that 19-23 will elimate this guesswork. How? By providing that, going forward, when a respondent receives “credit for extraordinary cooperation, FINRA will include in the Letter of Acceptance, Waiver and Consent (AWC) memorializing the settlement a new section titled, ‘Credit for Extraordinary Cooperation.’ FINRA will describe the factors that resulted in credit being given, as well as the type of credit.” As an aside: If you have not yet studied 19-23, or read one of the many articles it has generated, you ought to do so. It will enable you to join the fun by trying to calculate for yourself what may constitute the difference between “extraordinary cooperation,” which not could result in a lowered fine but could actually “result[] in FINRA electing to proceed without formal action, and mere “required cooperation,” which will get you squat.

Big firms paying big fines always tend to draw attention to their cases. Indeed, it is hardly a shock that in both matters FINRA elected to issue a press release. I suppose I am still wrestling with why FINRA does so. Part of me says, well, heck, the fines were $1.25 million, and since that doesn’t happen every day, it makes sense to publicize the settlements for that fact alone. But, part of me wonders if this isn’t simply a transparent effort by FINRA to address the persistent whispers that it is in the pocket of the big firms by saying, see how we tagged these two wirehouses for such huge fines (but which are still immaterial to the bottom line)? All you complainers who say that FINRA only goes after small firms, see how even-handed our justice is? Until FINRA nominates me to sit on its Board, I guess I’ll never know for sure.