It’s always exciting to watch something that you just know will be deemed by later generations to be an historic event.  I mean, I distinctly remember watching Neil Armstrong on TV taking his first steps on the moon, or the tragic Challenger disaster, or OJ demonstrating how the glove just didn’t fit, and thinking: this is history happening, right now.

Well, FINRA’s roll-out of Rule 4111 may not belong on this list, I admit.  But, it is kind of interesting to watch things happen for the first time, and to see just how much of this FINRA is simply making up as they go along.  A lot, it seems.

I outlined in my previous blog post about Rule 4111 the multi-stage process spelled out in the rule.  We are now at the stage where FINRA has finished its math, assigning points to all the pertinent firm and RR disclosures, tallying them up, and seeing whether the sum is high enough to trigger further scrutiny.  Sadly, I have some clients who have found themselves in this predicament, and I am confident they are not alone.

So, what do you do if you get a letter from FINRA informing you of this unfortunate fact?

Step 1 is easy: check FINRA’s math.  Remember: what FINRA is computing here is a fraction.  The numerator represents the number of bad disclosures, and the denominator is the total number of registered reps.  While I don’t expect any issues with the denominator, it is possible that FINRA has indeed miscomputed the numerator, so if you can get that number down, you may succeed in getting the total down below the trigger.  To do this, check the disclosures that FINRA has identified to confirm that they are accurate, and that they rightfully belong in the tally that constitutes the numerator.  As the rule itself acknowledges, FINRA is not supposed to include as separate disclosures events that “are duplicative,” or which “involve[e] the same customer and the same matter,” or which “are not sales practice related.”  If you can get enough disclosures off the list based on these criteria, it might reduce your fraction to the point that the 4111 game is over for you.

Step 2 is easy, too, at least in theory: figure out if you are able to fire enough RRs with disclosures to bring your total down below the trigger.  If you are able to do this, and can get it done within 30 business days of receiving the 4111 letter, then you are also done.  Not everyone can do this, of course.  Some RRs may have old disclosures, and today, contrary to their histories, they are trusted, valuable, contributing team players who you simply don’t want to terminate.  Sometimes the disclosures come from individuals in firm management, who simply can’t be fired without severely impacting the firm’s ability to continue as a viable entity.  This is particularly true with small firms, where firm principals and officers get named as respondents way more frequently than they do at large firms.

Note that the ability to fire people to drop your total below the trigger point is not something you can keep in your pocket to use another time.  It is a one-time card to play, and is only playable the first time you receive the 4111 letter from FINRA.  If you don’t use it this year, you cannot use it next year.

It is also worth noting that you can’t achieve the same result by hiring a bunch of clean RRs, even though, mathematically speaking, it would do the trick (since increasing the denominator of the fraction can achieve the same thing as decreasing the numerator).  The only way to reduce your total is to terminate enough people with disclosures to get your fraction smaller than the threshold for your size firm.

This is where we are right now.  Firms that have received 4111 letters are busy analyzing the disclosures to see if there’s an easy way out of this mess.  I expect that BDs that have the ability to fire RRs with a lot of disclosures will strongly consider terminating them.  And perhaps this is one of the principal things that FINRA really wanted to see happen when it passed this rule.  It wants to see RRs with disclosures out of the industry, with no clear path back in (for two reasons, first, because anyone terminated under this provision cannot associate with the firm in any capacity, not just a registered capacity, for a whole year, and, second, because going forward, undoubtedly, “clean” BDs are going to be paying a great deal of attention to their 4111 threshold, and not risk exceeding it by hiring RRs with a truckload of disclosures).

But, what’s next?  What happens if you can’t reduce the fraction, or reduce it enough to fall below the trigger point?  You need to request that FINRA conduct a “Consultation,” a chance for you, basically, to somehow convince FINRA that despite the fact your number is high relative to your peer firms, you should be taken off the naughty list.  According to the rule, however, a Consultation is not something that happens automatically, or even something you can request.[1]  Certainly it’s not something that you will necessarily get even if you ask for one.  According to the rule, the Department of Member Regulation “shall conduct the Consultation to allow the member to demonstrate why it does not meet the Preliminary Criteria for Identification and should not be designated as a Restricted Firm” “[i]f the Department determines that the member meets the Preliminary Criteria for Identification and should proceed to a Consultation.”

I have to concede that I have no idea what criteria FINRA may employ to determine whether a firm “should proceed to a Consultation;” it’s not even addressed in the 4111 FAQs.  With that said, I find it difficult to believe that if a firm requests a Consultation that FINRA would deny such a request.  But, read strictly, that is certainly a possibility.  Regardless, given that the alternative – actually being branded a Restricted Firm – is so nasty, I cannot imagine a scenario in which I would not request, even demand, a Consultation.

As to what happens at the Consultation itself, at this point (since, to my knowledge, no Consultations have happened yet), all I know is what the rule itself spells out.  The good news is that if you are successful in getting a Consultation, FINRA has to listen you, given that the rule explicitly states that “[i]n conducting its evaluation of whether a member should be designated as a Restricted Firm and subject to a Restricted Deposit Requirement, the Department shall consider” the materials you provide.  Now, that doesn’t mean that FINRA will put any real stock in what you say, but at least they can’t tell you that they’re uninterested.  Still, and typically, however, there’s a caveat, maybe several.

First, the rule requires FINRA to “consider” “relevant information or documents” you supply. That means, of course, that FINRA may deem what you supply to be irrelevant, and discount it, perhaps entirely.

Second, the rule gives FINRA the right to “prescribe” the “manner and form” of the information it will consider.  So, that means that FINRA could, at least theoretically, decline to consider something you submit if it doesn’t like your chosen format.

Third, while the rule does use the phrase “shall consider” in describing what information FINRA reviews at the Consultation, it also states that such information must be “deem[ed] necessary or appropriate” by FINRA “to evaluate the matter.”  Thus, there looms the possibility that FINRA will deem your information to be unnecessary and/or inappropriate.

How this will all actually play out remains to be seen.  But, as they say, “history teaches.”  Anyone entering the Consultation process who simply presumes that FINRA will act reasonably and allow you to do whatever you want hasn’t been paying attention.  Given the gravity of being branded a Restricted Firm, it behooves you to dot every “i” and cross every “t,” make as professional and convincing a presentation as the facts allow, and be the best advocate you can be.  To half-ass the Consultation would be to invite the very outcome you’re hoping to avoid.


[1] Oddly, according to the rule, if you get the same letter next year, after next year’s annual computation by FINRA, then you can get a Consultation simply by requesting one.  But, as I said, the rule does not include similar language for the first time you are on the list.

About a month ago, the SEC announced a settlement in a modest little case that has, nevertheless, managed to garner a lot of attention.  This is a result of the fact that one of the respondents was the CCO, i.e., the Chief Compliance Officer, of the co-respondent RIA.  Determining the particular circumstances under which CCOs can be found individually liable is an extremely important analysis, but has been described as challenging, at a minimum.  Especially since, as some have argued,[1] the scope of those circumstances, as evidenced by enforcement actions brought by regulators, is slowly broadening.  Maybe I am in the minority here, but I am unsure, really, what the fuss is about.

Let’s start with some basic propositions that everyone – regulators and industry alike – agree with.  As FINRA[2] recently put it bluntly in Reg Notice 22-10, “[t]he CCO’s role, in and of itself, is advisory, not supervisory.”  As a result, to bring a case against a CCO for any sort of supervisory failure requires that the CCO actually have supervisory responsibility, which does not happen automatically simply by virtue of bearing the CCO title.  That responsibility has to be bestowed upon the CCO, either directly and explicitly, by firm management, or impliedly, as evidenced by ad hoc behavior.  Absent such supervisory responsibility, a CCO cannot be held responsible for even the worst supervisory failure.

Along that same line, as SEC Commissioner Hester Peirce recently stated, “the compliance obligation belongs to the firm, not to the CCO.”  Thus, in most instances, even egregious supervisory cases are brought against the firm only, not the president – who “bears ultimate responsibility for compliance with all applicable requirements unless and until he [or she] reasonably delegates particular functions to another person in that firm, and neither knows nor has reason to know that such person’s performance is deficient” – and not the CCO.  See, for instance, this SEC settlement from last week against Aegis Capital, which imposed a $2.3 million civil penalty, among other things, against the firm only stemming from a number of particular failures “to develop reasonable systems to implement [the firm’s] policies and procedures.”  While some human being was undoubtedly responsible for this, whether Aegis’s president or his designee(s), it remains that the SEC was content only to name the firm.  In my experience, and despite the SEC settlement that I mentioned in the first sentence of this post, this is the norm (particularly for big firms).

These are not particularly controversial pronouncements.  Seems to me that, as a default position, the regulators are hardly looking for ever more opportunities to name CCOs as respondents.  To the contrary, as long as CCOs abide by existing guidance, guidance which I think is pretty clear, and remain on the advisory – not supervisory – side of the line, then they are more or less safe.

So, what is this guidance?  I would say it starts with this nugget from a footnote buried in Notice to Members 01-51:  “NASD Regulation will continue to determine whether a chief compliance officer is acting in a supervisory capacity based on the actual responsibilities and functions that the chief compliance officer performs for the firm.”  Emphasis on the word “actual.”

Next, go to Reg Notice 22-10.  It conveniently outlines the different ways that a CCO may acquire “actual” supervisory responsibilities:

  • The WSPs “assign to the CCO the responsibility to establish, maintain and update written supervisory procedures, both generally as well as in specific areas (e.g., electronic communications)”
  • The WSPs “assign to the CCO responsibility for enforcing the member’s written supervisory procedures or other specific oversight duties usually reserved for line supervisors”
  • “apart from the written procedures, a member firm, through its president or some other senior business manager . . . expressly or impliedly designate[s] the CCO as having specific supervisory responsibilities on an ad hoc basis”
  • “the CCO may be asked to take on specific supervisory responsibilities as exigencies demand.”

Thus, only when there exist circumstances that demonstrate that a firm has expressly or impliedly designated its CCO as having supervisory responsibility will FINRA bring an enforcement action against a CCO for supervisory deficiencies.  The SEC has acted similarly.  Indeed, the Hamilton settlement that prompted this post was predicated on the finding by the SEC that the CCO “was responsible for administering [the RIA’s] compliance program and, as provided in [the RIA’s] compliance manual, for implementing the firm’s compliance policies and procedures.”  (While the SEC used the term “compliance policies and procedures” rather than “supervisory procedures,” that is a function of the fact that Rule 275.206(4)-7 does not use the word “supervisory,” and simply requires RIAs to “[a]dopt and implement written policies and procedures reasonably designed to prevent violation . . . of the Act and the rules that the Commission has adopted under the Act.”)

Again, I don’t see this as being a particularly complicated analysis.  If I was a CCO, and I was looking to avoid becoming a respondent, I would do everything possible to firmly and clearly remain in my “advisory” lane, even if that meant pushing back at efforts from firm management to saddle me with supervisory responsibilities on a short-term basis, or with respect to some discrete area of the firm’s business.

I get that this may be difficult at a small firm, where principals wear many hats, and CCOs may find themselves called on to jump into the supervisory fray.  In that case, the CCO is fair game to be named individually for his or her supervisory lapses.  But, that’s a choice the CCO gets to make: either stay there and accept the supervisory obligations that the job entails, or find another firm that won’t make such demands.  Jobs for CCOs abound.

I also get the disincentive that this provides to CCOs to help their firms with their compliance efforts.  As former SEC Commissioner Daniel Gallagher observed in 2015 (regarding Investment Advisors, not BDs), actions naming CCOs individually “are undoubtedly sending a troubling message that CCOs should not take ownership of their firm’s compliance policies and procedures, lest they be held accountable for conduct that . . . is the responsibility of the adviser itself.”  Again, agreed, dealing with this issue can put a CCO into an awkward position of balancing what’s best for him or her vs. what’s best for his or firm.  But that’s not the issue at hand, which remains: what are the circumstances that permit CCOs to be named.  In short, I think they are clearer than many commentators suggest.

It is worth mentioning that this inquiry – determining whether a CCO had “actual” supervisory responsibilities – is still just step one.  Reg Notice 22-10 makes clear that even if the answer to the threshold inquiry is “yes,” that does not necessarily mean an enforcement action will ensue, as there remain more questions to be answered.

The first is whether the CCO has met the “reasonableness standard.”  This means that “[e]ven when a CCO has been designated as having supervisory responsibilities, FINRA will bring an action under Rule 3110 against the CCO only if the CCO has failed to discharge those responsibilities in a reasonable manner—as it would with any individual who has supervisory responsibility.”  Yes, determining what is and is not reasonable can be a difficult analysis (given that what is “reasonable depends upon the facts and circumstances of a particular situation”), and a difficult argument to win with FINRA, but, importantly, it is no different for CCOs than it is for any supervisor.

The second is whether the case against the CCO should be brought even when his/her conduct is unreasonable.  Again, per Reg Notice 22-10, “not every violation of a FINRA rule results in a formal disciplinary action, so even when FINRA finds that a CCO failed to reasonably perform a designated supervisory responsibility, FINRA will consider whether charging the CCO under Rule 3110 in a formal disciplinary action is the appropriate regulatory response to address the violation.”  And, again, this is true of anyone facing regulatory action for a supervisory failure, not just CCOs.

Helpfully, Reg Notice 22-10 details the factors weighing both in favor of and against charging a CCO (or anyone, really).  I will list them here, for the sake of completeness, but, more importantly, to demonstrate that there is, in fact, a whole bunch of pretty specific guidance in this area, contrary to the arguments made in some of the frantic articles and blog posts I have read on the subject of CCO liability.

Factors that suggest a CCO should be charged:

  • the CCO was aware of multiple red flags or actual misconduct and failed to take steps to address them;
  • the CCO failed to establish, maintain, or enforce a firm’s written procedures as they related to the firm’s line of business;
  • the CCO’s supervisory failure resulted in violative conduct (e.g., a CCO who was designated with responsibility for conducting due diligence failed to do so reasonably on a private offering, resulting in the firm lacking a reasonable basis to recommend the offering to its customers); and
  • whether that violative conduct caused or created a high likelihood of customer harm.

Factors that suggest the CCO should not be charged:

  • the CCO was given insufficient support in terms of staffing, budget, training, or otherwise to reasonably fulfill his or her designated supervisory responsibilities;
  • the CCO was unduly burdened in light of competing functions and responsibilities;
  • the CCO’s supervisory responsibilities, once designated, were poorly defined, or shared by others in a confusing or overlapping way;
  • the firm joined with a new company, adopted a new business line, or made new hires, such that it would be appropriate to allow the CCO a reasonable time to update the firm’s systems and procedures; and
  • the CCO attempted in good faith to reasonably discharge his or her designated supervisory responsibilities by, among other things, escalating to firm leadership when any of (1)–(4) were occurring.

In addition to these factors, the Reg Notice states that FINRA will also consider in determining whether to charge the CCO if there is “another individual at the firm, such as an executive manager or a business line supervisor, who had more direct responsibility for the supervisory task at issue, or who was more directly involved in the supervisory deficiency.”[3]

It should be evident even to casual readers that I do not agree with many of the charging decisions that FINRA makes.  I have lamented many times in these posts the fact that, in my experience, contrary to guidance I have just quoted at length, FINRA basically demonstrates zero flexibility when it comes to meeting the reasonableness standard that governs supervision: that is, any conduct that is not exactly what FINRA expects is deemed unreasonable, which is silly, since the use of such an imprecise standard of conduct essentially invites multiple solutions.  But with that said, there is ample guidance available to help CCOs safely navigate their way through the jungle of rules, regulations and policies and avoid personal liability.

[1] According to “multiple industry-wide surveys focusing on ‘CCO Liability’ and ‘CCO Empowerment’” conducted by the NSCP “with its 2000+ membership of CCOs and other compliance professionals,” “72% of compliance professionals are concerned that regulators have expanded the role of compliance officers and the scope of their responsibilities in imposing personal liability.”  The results of those surveys are discussed here.

[2]  I am well aware that FINRA’s guidance regarding broker-dealers may vary, at least in its specifics, from the SEC’s guidance regarding advisors.  But at the conceptual level, both regulators have said the same basic things about the circumstances under which they will deign to charge a CCO.

[3] FINRA also states that it considers whether “based on the facts and circumstances of a particular case, it is more appropriate to bring informal, as opposed to formal, action against the CCO for failure to supervise.”  But, again, this statement is hardly unique to CCOs.  Theoretically, FINRA undertakes this consideration every time it makes charging decisions.

Last week I posted a blog about the dangers of not heeding findings made during a regulatory exam, at least findings of clear, undisputable compliance issues that cannot be meaningfully defended. Today I am writing to highlight a corollary rule: if one customer points out the existence of a real problem, again, a clear problem with significant financial ramifications, any remedy that is implemented to address that problem needs to be applied to all similarly situated customers, regardless of the fact that such customers may not have been aware of the problem and did not complain.

This time, it was Equitable Financial Life Insurance Company that paid the price for breaking this rule – and a pretty hefty price it was: a $50 million civil penalty.

It came in this settlement with the SEC.  The facts are pretty straightforward.  In short, “[s]ince at least 2016, Equitable provided quarterly account statements to approximately 1.4 million investors that included materially misleading statements and omissions concerning significant fees paid in connection with” particular variable annuity investments that were sold principally to educators.  Specifically, while Equitable did disclose fees in several sections of its variable annuity account statements, they created “the false impression that all fees investors paid during the period were being detailed in the account statements.”  In fact, however, “Equitable’s account statements . . . excluded the most significant fees that investors paid from the fees listed on the account statements.  Instead, the account statements listed as fees only certain types of administrative, transaction and plan operating fees – most often amounting to zero or a very small number – which were in fact only a slight fraction of the overall fees paid by the investor.”

As well, “[t]he account statements contained no clarifying language or reference to the prospectus to explain to investors what these different categories of fees represented or to put the investor on notice of the fact that they instead had paid significant Separate Account Expenses and Portfolio Operating Expenses that could amount to thousands of dollars each year.  Though affirmatively presenting an apparently all-inclusive picture of fees and expenses to investors, Equitable’s quarterly account statements actually detailed less than three percent of the revenue that Equitable received from the EQUI-VEST variable annuities.”

This was important because, as the SEC found, investors “reviewed their Equitable account statements in order to assess the impact that fees were having on their investment and to make decisions concerning their ongoing investments, including whether to make additional investments in” their variable annuities.  Compounding this problem, in some of the quarterly account statements, Equitable affirmatively encouraged investors to increase their investments in the variable annuity, knowing that a consideration of the fees paid was an important component of the investors’ analyses.

Anyways…turns out that Equitable was aware of the problem with its account statements for years.  The SEC found that back in May 2017, Equitable learned that “its account statements may have confused investors on fees paid” from one of its customers, a big customer, mind you, namely, “an advisory committee to the school district with which Equitable did the most business in terms of both assets invested and number of investors.  Apparently, that school district, which “was determining whether to renew contracts” with its vendors, including Equitable, told Equitable “that the account statements were unclear on the amount of fees investors paid.”  Two years after that, in May 2019, the same advisory committee “specifically asked if Equitable could list annuity fees on the front page of its account statements going forward,” and Equitable agreed.

That’s the good news.  The bad news, however, is that with respect to all other investors in the same annuity, “including hundreds of thousands of K-12 teachers and administrators employed by hundreds of other school districts located across the nation, Equitable made no changes to the . . . account statements that those investors received and instead continued providing them with account statements that reported fees and expenses in the same manner that Equitable had been employing since at least 2016.”

Not really sure it’s necessary for me to add very much here.  As was the case last week with Barclays, which learned from FINRA during an exam that it had a problem, here, Equitable learned about its own problem, albeit from a customer.  In both cases, the problem was serious and indefensible, and fixable.  Yet, in neither situation did the firm do anything to address the problem immediately and on a company-wide basis.  Not surprisingly, for both firms, their respective failures to have acted sooner and more systematically ended up being cited by the regulator as an aggravating circumstance justifying the imposition of hefty sanctions.

Firm management should be attentive to input from all sources, both internal and external, when it comes to spotting issues.  Not every potential problem is serious, of course, not every potential problem will impact thousands of customers, and not every potential problem will, in fact, turn out to be a real problem after all.  But ignoring potential problems and simply hoping that the regulator will not be clever enough to figure out for itself that there is something going on is a poor strategy to adopt.  Not saying it doesn’t work; to the contrary, to this day, with all their fancy algorithms and computer programs designed to ferret out firms’ most vulnerable risk exposures, regulators still whiff all the time when it comes to finding even big issues.  Thus, many broker-dealers still successfully employ the cross-your-fingers-and-hope-no-one-notices approach to compliance failures.  But that is not something I advise, principally because it is not something I can defend when it doesn’t work.

So, on balance, unless you are prepared to be embarrassed, not to mention prepared to break out your checkbook, the better course of action is to actually fix problems – real problems, anyway – whenever and however they are brought to your attention.



There is no question in my mind that the quality of FINRA examiners is a bit uneven.  Some are smart and insightful and helpful; others are, well, not.  Most of the time, they do know what they’re talking about.  That means the opportunity to make legitimate arguments against exam findings can, at least sometimes, be limited.  Often, firms find themselves in the position of acknowledging the issue, outlining the steps already taken (or that will be taken) to address the problem, and pointing out whatever mitigating circumstances may exist.  What a firm cannot do, however, is what Barclays apparently did, as described in this recent AWC, which was to simply ignore concerns raised by FINRA examiners.  Bad idea.

Apparently, Barclays – which seems to have a sketchy disciplinary history when it comes to systemic supervisory lapses, as evidenced by, among things, this 2013 AWC with a $3.75 million fine for “systemic failures to preserve electronic records and certain emails and instant messages in the manner required for a period of at least 10 years,” or this 2015 AWC with a $3.75 million fine for having “supervisory systems [that] were not sufficient to prevent unsuitable switching or to meet certain of the firm’s obligations regarding the sale of mutual funds to retail brokerage customers,” which, remarkably, are just two of 41 AWCs dating back to 2007 – had yet another issue, this time relating to its trade confirmations.  According to the AWC, starting in 2008 and continuing “through the present, Barclays sent its customers approximately 270 million confirmations that inaccurately disclosed the firm’s execution capacity, the customer’s price, the market center of execution, or whether the trade was executed at an average price.”

Let’s put aside the opportunity to criticize FINRA staff for the fact that it appears, somehow, to have taken them 15 years to address this particular misconduct, even though from the sheer number of AWCs that the firm entered into with FINRA over essentially that same time period it necessarily means that Barclays was on the receiving end of considerable regulatory scrutiny.  Instead, let’s focus on Barclays, and on what it knew about its supervisory issues and when, and how it came to know about them.

The AWC recites that “[b]eginning in at least November 2008, Barclays also had no supervisory system to review whether its confirmations complied with applicable SEC and FINRA requirements.”  Well, that’s bad, but it gets worse – and this is the point of this post:  “By mid-2017, because of two FINRA examinations, Barclays knew about several of the systemic confirmation accuracy issues described above and that it had no written supervisory procedures related to confirmations. The firm failed, however, to implement a reasonable supervisory system.”

There you go.  You can take this lesson to the bank:  it is NEVER good to learn for the first time about a supervisory issue, particularly a longstanding, systemic supervisory issue, from the examiner who is conducting a routine exam.  Doesn’t matter how many exams preceded this one, or how many FINRA examiners had, during those exams, looked at your confirms and said nothing.  You get no credit for that, partial or otherwise.  That will always be your problem, not the examiners’, and whining about the fact that you were operating under the misapprehension that you were doing things correctly is a waste of energy.

Lesson two is equally ironclad:  when an examiner points out a longstanding, systemic supervisory issue, address it, like, NOW.  Barclays did not do that.  Instead, according to the findings in the AWC, it waited “almost a full year later” before it did something.  And, even then, its remedial efforts fell woefully short, as it “established a system and procedures to monitor only whether confirmations were delivered but not whether they were accurate.”

So, Lesson three:  if you are going to do address a serious exam finding, not only do it NOW, but do it RIGHT.

Finally, it is also worth noting that even after all this, Barclays still failed to get it.  The AWC states that “[i]n May 2019, FINRA, following another examination, notified Barclays that its written supervisory procedures failed to include a review of the accuracy of its confirmations.  Nonetheless, it took until April 2020 for the firm to establish a supervisory system and written supervisory procedures to review the accuracy of its confirmations.”  And even then, FINRA points out that this “system, which remains in place at Barclays today, . . . does not reasonably assess its compliance with confirmation requirements.”  In other words, even after FINRA informed Barclays of its problems for a SECOND time, the firm still failed to act NOW and still failed to do it RIGHT.

And that’s why Barclays agreed to pay another hefty fine, this time, $2.8 million.  I am happy for Barclays that it can afford to keep writing these big checks to FINRA, and that it continues to manage to avoid having its principals named in any of these Enforcement actions.  But not every firm has the financial luxury that Barclays does to submit AWC after AWC after AWC.  (Only two so far this year, which may seem like a lot, given that we’re only half way done with 2022, but, to keep it in perspective, it’s way off the pace the firm established in 2015, when it submitted a total of 11 AWCs.)

Most firms cannot afford to do this.  Certainly small firms can’t.  What small firms generally do is grit their teeth, muster up a smile for the examiner who delivers the findings, thank them for having done such a thorough exam, promise to address the problems, and then scramble to do just that.  At least most of the time.  Sometimes, the examiners are wrong, and sometimes there’s no choice but to draw your line in the sand and dare FINRA to put its money where its mouth is and file an Enforcement complaint.  But, when FINRA has got the goods on you, that’s the time to act, and act quickly and decisively.  Dilly-dallying or half-assing it will not, as Barclays learned, pay off in the long run.



Among the criticisms I have leveled against FINRA are (1) that it is increasingly acting like a claimant’s arbitration attorney, by taking every possible opportunity to blame member firms for losses incurred by investors when other palpable reasons for those losses exist, and (2) that it loves, well after the fact, to jump in on things that have managed to garner the attention of others, perhaps just to show that it has not been asleep at the wheel.  This week, FINRA issued yet another AWC involving the sales of GPB that serves to highlight both of my observations.

By now, everyone knows about GPB, so I won’t go into any background.  But, if you do know about GPB, then you are aware that in the eyes of the federal government, specifically, the SEC and the DOJ, the “bad guy” in the GPB scenario is GPB itself, i.e., the issuer of the securities in question.  In the SEC’s complaint, it took pains to clearly and specifically allege that the “downstream broker-dealers,” i.e., the BDs that sold GPB to their customers, were effectively themselves the victims of false and misleading due diligence and marketing materials supplied by GPB, which served to stymie the BDs’ efforts to conduct reasonable due diligence and cover up issues at GPB.  Similarly, the DOJ’s Indictment paints the same picture, that the BDs that sold GPB were supplied misleading “written correspondence and marketing materials, including in due diligence questionnaires,” which gave a false impression of GPB’s true financial situation.

Of course, that has not stopped investors from filing hundreds of arbitrations involving GPB against the 60+ BDs that sold the product, in which the BDs – not GPB – are alleged to be the bad guys (for failing to conduct adequate due diligence on the front end, and/or for failing to make suitable recommendations on the back end).  These complaints largely, if not entirely, ignore the positions publicly espoused by the SEC and DOJ, and lay all blame at the feet of the BDs, rather than the issuer.

Well, in this world, that’s more than enough reason for FINRA to step in and pile on.  I am not saying that this pertains to every BD that sold GPB (or Red Oak or GWG or any other alternative investments that the claimants bar is feasting on) has been subjected to a lengthy series of 8210 requests, but I can tell you from personal experience that, at a minimum, many have.  And so far, for six firms, by my count, FINRA has exacted settlements in GPB cases in the form of AWCs, including the most recent one from earlier this week with United Planners.

Not surprisingly, all the AWCs are drafted from the same template,[1] and include the same description of the operative violation: that for some very narrow time period – usually about a month or so – the BD failed to inform a handful of investors that GPB had not timely filed its audited financials with the SEC, or the reasons that GPB had propounded for that delay.  According to FINRA, this information was “material information that should have been disclosed,” and the failure to have disclosed it amounted to “negligence,” in violation of Rule 2010.

Let’s talk about that.  What does “material” mean?  According to the U.S. Supreme Court, it means “a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available.”  I want you to take careful notice of the several loosey-goosey words baked into the definition.  “Substantial.”  “Reasonable.”  “Significantly.”  By virtue of using such fluffy, deliberately imprecise words, which permit reasonable minds to differ on their application to any particular fact pattern, the Court has explicitly recognized that there is no “bright-line” distinction between a material fact and one that is not.  It’s a facts-and-circumstances analysis. Sometimes an omitted fact can be pretty clearly material, but, in most cases, it is a hotly contested issue.

With that said, I get that FINRA is entitled to its opinion on whether something is material or not.  The problem is that here, as in many other situations, FINRA is unwilling to consider even the possibility that there are any alternative viewpoints that can be accepted.  It’s FINRA’s way or the highway.  That sounds to me like a bright-line test, not one that is highly fact-specific and depends entirely on the context of the offering.

So, back to the point of this post.  You start with a situation like GPB, where the U.S. government has taken pains to make it clear that it views the selling broker-dealers as victims, yet where claimants are, nevertheless, going to town with arbitrations.  You couple that with a dubious, difficult-to-prove legal proposition regarding materiality, i.e., a standard that is not easily divined, and which can trigger legitimate, vigorous debate on both sides of the issue.  And you have to wonder: why has FINRA bothered to bring these cases?  Do these cases really represent the best use of FINRA’s resources?  Does these cases really do anything to address investor protection and market integrity?

As I said at the outset, it seems to me that FINRA’s goal isn’t particularly noble or lofty.  FINRA just wants to do something about GPB, maybe just to demonstrate its continuing relevance.  I would hope that it has better things to do than to take this opportunity to pile on its member firms who are already grappling with the consequences of having been swindled – allegedly – by GPB.

[1] All the AWCs are not exactly the same, to be completely candid.  In one, for instance, involving Dempsey Lord, in addition to the “template” findings regarding the failure to disclose material information, FINRA also found that the firm made a few unsuitable recommendations.

Well, Memorial Day is just past us, so we all know what that means: it’s time for FINRA to conduct its first annual assessment of its member firms to determine whether they should be branded a “Restricted” firm under new Rule 4111, with all the benefits and privileges appurtenant thereto.  Given that it’s pretty clear that FINRA’s goal in identifying Restricted firms is to make it so expensive and onerous for them to remain in business that they choose, instead, simply to close down, it behooves every member to understand completely the pretty complex processes baked into the rule.  I am going to try to make it understandable, in six easy steps.

But, understand this: there are plenty of places in the application of the rule where FINRA gets to wield unfettered discretion, so while certain aspects of the rule deal with objective criteria,[1] other parts are simply left to FINRA staff to do whatever they want – but governed by whatever due process is supposedly supplied by an expedited appeal process.

First things first, Step One: we start with the Evaluation Date, which was yesterday.  This is “the date . . . as of which the Department calculates the Preliminary Identification Metrics to determine if the member meets the Preliminary Criteria for Identification.”  Starting with that date, FINRA looks back five years, which constitutes the Evaluation Period, to determine if the firm and, more importantly, persons associated with the firm display any of the six broad categories of misbehavior identified in the Rule:

  1. Registered Person Adjudicated Event
  2. Registered Person Pending Event
  3. Registered Person Termination and Internal Review Event
  4. Member Firm Adjudicated Event
  5. Member Firm Pending Event
  6. Expelled Firm Association

Within each of these categories are more specific events, which will be tallied up by FINRA.  You need to know what they are.

Registered Person Adjudicated Event.  These events are comprised of some actual arbitration or litigation in which an RR was named (or not named, but where the RR was, nevertheless, the “subject” of the case) and the RR actually lost or settled the case.  There are five possible ways for such an event to arise:

  1. Under 4111(i)(4)(A)(i): “a final investment-related, consumer-initiated customer arbitration award or civil judgment against the registered person in which the registered person was a named party or was a ‘subject of’ the customer arbitration award or civil judgment.”
  2. Under 4111(i)(4)(A)(ii): “a final investment-related, consumer-initiated customer arbitration settlement, civil litigation settlement or a settlement prior to a customer arbitration or civil litigation for a dollar amount at or above $15,000”
  3. Under 4111(i)(4)(A)(iii): “a final investment-related civil judicial matter that resulted in a finding, sanction or order”
  4. Under 4111(i)(4)(A)(iv): “a final regulatory action that resulted in a finding, sanction or order, and was brought by the SEC or Commodity Futures Trading Commission (CFTC), other federal regulatory agency, a state regulatory agency, a foreign financial regulatory authority, or a self-regulatory organization”
  5. Under 4111(i)(4)(A)(v): “a criminal matter in which the registered person was convicted of or pled guilty or nolo contendere (no contest) in a domestic, foreign, or military court to any felony or any reportable misdemeanor”

Registered Person Pending Event.  These are basically the same as the Adjudicated Events, except they’re not adjudicated and final, rather, they’re just pending.[2] There are four such events:

  1. Under 4111(i)(4)(B)(i): “a pending investment-related civil judicial matter
  2. Under 4111(i)(4)(B)(ii): “a pending investigation by a regulatory authority
  3. Under 4111(i)(4)(B)(iii): “a pending regulatory action that was brought by the SEC or CFTC, other federal regulatory agency, a state regulatory agency, a foreign financial regulatory authority, or a self- regulatory organization”
  4. 4111(i)(4)(B)(iv): “a pending criminal charge associated with any felony or any reportable misdemeanor”

Registered Person Termination and Internal Review Event.  There are only two of these, and they relate to the circumstances under which an RR left a prior BD:

  1. Under 4111(i)(4)(C)(i): “a termination in which the registered person voluntarily resigned, was discharged or was permitted to resign from a previous member after allegations
  2. Under 4111(i)(4)(C)(ii): “a pending or closed internal review by a previous member”

Member Firm Adjudicated Event.  These events are the equivalent of the Registered Person Adjudicated Events, except the firm, rather than the RR, managed to lose the arbitration or litigation.  Note, however, that unlike RRs, FINRA does not include settlements in this metric.  Not sure why.  There are four such events:

  1. Under 4111(i)(4)(D)(i): “a final investment-related, consumer-initiated customer arbitration award in which the member was a named party”
  2. Under 4111(i)(4)(D)(ii): “a final investment-related civil judicial matter that resulted in a finding, sanction or order”
  3. Under 4111(i)(4)(D)(iii): “a final regulatory action that resulted in a finding, sanction or order, and was brought by the SEC or CFTC, other federal regulatory agency, a state regulatory agency, a foreign financial regulatory authority, or a self-regulatory organization”
  4. 4111(i)(4)(D)(iv): “a criminal matter in which the member was convicted of or pled guilty or nolo contendere (no contest) in a domestic, foreign, or military court to any felony or any reportable misdemeanor”

Member Firm Pending Event.  Again, as the term suggests, these are the BD equivalent of the Register Person Pending Events.  There are three of them:

  1. Under 4111(i)(4)(E)(i): “a pending investment-related civil judicial matter
  2. Under 4111(i)(4)(E)(ii): “a pending regulatory action that was brought by the SEC or CFTC, other federal regulatory agency, a state regulatory agency, a foreign financial regulatory authority, or a self-regulatory organization”
  3. Under 4111(i)(4)(E)(iii): “a pending criminal charge associated with any felony or any reportable misdemeanor”

Expelled Firm Association.  This one is kind of the oddball in the bunch, as it has nothing whatsoever to do with any disclosures by the RR or the firm.  In other words, even RRs with perfectly clean Forms U-4 can trigger this metric (which, again, raises at least the whiff of unfairness).  Under 4111(i)(4)(F), it is driven strictly by two criteria:  (1) Has the firm registered for at least one day during the five-year Evaluation Period someone who (2) was registered for at least “one year with a previously expelled firm and whose registration with the previously expelled firm terminated during the Evaluation Period.”

Got all that?  Remember this is just Step One.  So, FINRA will look at each of these six categories and add up each firm’s score.  It’s like golf: you want the lowest possible score.  If your score does not exceed the thresholds that FINRA has conjured up for your size firm (because it has broken its membership down into seven size groups,[3] ranging from the smallest – 1 – 4 RRs – to the largest – 500+), you win!  But, sadly, if your score exceeds the threshold, you advance to Step Two, the Initial Department Evaluation, which is a scary step.

Why is this evaluation scary?  Because it represents one of the black holes in the Rule, i.e., where behind the scenes and employing criteria that are not articulated anywhere, FINRA staff decide whether they can disregard their own math and deem a BD worthy of getting kicked out of the 4111 machine notwithstanding the fact that its preliminary score exceeded FINRA’s threshold.  As FINRA put it in a webinar it presented recently, in Step Two, the Staff “will review the events and the risk profile of the firm to determine if the firm should not be subject to further review under the rule.”  According to the Rule itself, the purpose of Step Two is for the Staff to determine whether

the member does not warrant further review under this Rule because the Department has information to conclude that the computation of the member’s Preliminary Identification Metrics included disclosure events (and other conditions) that should not have been included because they are not consistent with the purpose of the Preliminary Criteria for Identification and are not reflective of a firm posing a high degree of risk.  The Department shall also consider whether the member has addressed the concerns signaled by the disclosure events or conditions or altered its business operations such that the Preliminary Criteria for Identification calculation no longer reflects the member’s current risk profile.

I am not really sure what any of that means.  And given that this is the first time that FINRA is embarking on this endeavor, it would seem that they’re making it up as they go.  I mean, just consider the phrase “high degree of risk.”  What is that?  How does it differ, whether quantitatively or qualitatively, from a normal “degree of risk,” which, apparently, is not serious enough for a firm to remain in the 4111 process.

Step Three is for any firm unfortunate to have metrics that exceed the established numerical threshold in Step One and which was deemed too much of a risk in the secret Department Evaluation in Step Two.  For such firms, Step Three is the chance to terminate enough RRs whose disclosures and employment history constitute Events in the Step One computation to bring the firm’s overall total down to the point that the thresholds are no longer met.  Kind of like the process that firms can utilize if they trigger the Taping Rule.  Firms that avail themselves of this reduction in force can only use it once, must do it quickly – within 30 days – and cannot rehire anyone terminated for a year.  But, the upside is that a firm that does this will have successfully extricated itself from the 4111 machine.

To participate in Step Four means that the firm either could not or would choose to reduce its staff in Step Three, and so keeps moving down the conveyor belt.  If you find yourself here, you are in awfully dangerous territory.  And that’s because under the Rule, you are presumed to be a Restricted Firm, and it is your burden to overcome that presumption.

But what does it mean to be a Restricted Firm?  That’s where the teeth in the Rule are, because it means that FINRA has the right to require the BD to make a Restricted Deposit, i.e., a cash deposit, and to impose a whole bunch of restrictions and conditions.  The Restricted Deposit is explicitly NOT deemed to be an allowable asset for a firm’s net capital computation, so it has to be in addition to any other cash that a firm has lying about that is used to satisfy its net capital requirement.  How much money are we talking about?  It’s anyone’s guess, as this is yet another part of the Rule that FINRA handles behind the scene, in private, away from scrutiny.  I can tell you that the Rule defines the Restricted Deposit as a sum of money

determined by the Department taking into consideration the nature of the firm’s operations and activities, revenues, commissions, assets, liabilities, expenses, net capital, the number of offices and registered persons, the nature of the disclosure events counted in the numeric thresholds, insurance coverage for customer arbitration awards or settlements, concerns raised during FINRA exams, and the amount of any of the firm’s or its Associated Persons’ Covered Pending Arbitration Claims, unpaid arbitration awards or unpaid settlements related to arbitrations.

The Rule goes on to provide that the Restricted Deposit is designed to “be consistent with the objectives of this Rule, but would not significantly undermine the continued financial stability and operational capability of the firm as an ongoing enterprise over the next 12 months.”  Again, not sure what this means.  Taking these words at face value, it seems that FINRA can make a firm deposit so much money that it “undermines” the firm’s “continued financial stability,” but not enough money to “significantly undermine” such financial stability.  What’s the difference?  Well, that’s a secret.

Making matters worse for firms that find themselves at this Step is that the Rule presumes that FINRA will impose the Maximum Restricted Deposit, which I guess is the most money possible before it would “significantly undermine” a firm’s financial stability.

Firms at Step Four bear the burden of rebutting this presumption.  The mechanism for doing so comes in the form of a Consultation. According to the Rule, there are basically two ways to go about attempting to rebut the presumption.  The first is simply demonstrating that FINRA’s computation is mathematically wrong.  Or, as the Rule puts it, “demonstrating that the Department’s calculation that the member meets the Preliminary Criteria for Identification included events in the Disclosure Event and Expelled Firm Association Categories that should not have been included because for example, they are duplicative, involving the same customer and the same matter, or are not sales practice related.”

The other approach is less precise, as it doesn’t involve the math, but, rather, FINRA’s opinion about the firm.  When you read this list of things that the Rule says you can supply to FINRA to try to rebut the presumption, you will see just how loosy-goosy this is:

  • information provided by the member during any meetings as part of the Consultation;
  • a plan, if any, submitted by the member, in the manner and form prescribed by the Department, proposing in detail the specific conditions or restrictions that the member seeks to have the Department consider;
  • such other information or documents as the Department may reasonably request in its discretion from the member related to the evaluation; and
  • any other information the Department deems necessary or appropriate to evaluate the matter.

Anyway, in theory, the Consultation could result in FINRA concluding that, gee, they were all wrong, and offer their apologies for even suggesting that a firm should be deemed to be Restricted.  Just how successful BDs will actually be remains to be seen, of course.

If a firm reaches Step Five, it means it was not successful in changing anyone’s mind, because Step Five is the issuance of a Notice by FINRA that the firm has, in fact, been determined to be a Restricted Firm.  As well, the Notice will recite the amount of the Restricted Deposit.  That Deposit must then be made within 15 days, absent a showing of good cause to delay it.

In addition, the Notice can include the requirement that the firm “implement and maintain specified conditions or restrictions.”  Like what?  According to the Supplementary Material to the Rule, these include, but are not limited to:

  • limitations on business expansions, mergers, consolidations or changes in control;
  • filing all advertising with FINRA’s Department of Advertising Regulation;
  • imposing requirements on establishing and supervising offices;
  • requiring a compliance audit by a qualified, independent third party;
  • limiting business lines or product types offered;
  • limiting the opening of new customer accounts;
  • limiting approvals of registered persons entering into borrowing or lending arrangements with their customers;
  • requiring the member to impose specific conditions or limitations on, or to prohibit, registered persons’ outside business activities of which the member has received notice pursuant to Rule 3270; and
  • requiring the member to prohibit or, as part of its supervision of approved private securities transactions for compensation under Rule 3280 or otherwise, impose specific conditions on associated persons’ participation in private securities transactions of which the member has received notice pursuant to Rule 3280.

As you can see, these restrictions can be severe; indeed, they might have a much greater impact on a firm’s operations than the Restricted Deposit Requirement.  And note that a failure to abide by any of these restrictions or conditions allows FINRA to suspend or cancel a firm’s membership on seven-day notice under new Rule 9561 (subject to a firm’s ability to stay that by requesting a hearing).

The final step is Step Six, an expedited review – by FINRA’s Office of Hearing Officers – of the determination that a firm is Restricted.  BDs have seven days from the Notice to request the hearing, and that request “must set forth with specificity the basis for eliminating any Rule 4111 Requirements.”  If such a request is made, the good news is that the firm need not make the entire Restricted Deposit; rather, it is only required to deposit “the lesser of 25 percent of its Restricted Deposit Requirement or 25 percent of its average excess net capital during the prior calendar year.”  Quite the bargain!  But, any restrictions or conditions imposed remain in place pending the outcome of the review.

As I stated at the outset, it seems to me that FINRA deliberately drafted this rule so that it is so harsh no member firm in its right mind would ever dare to take the process to the end.  Rather, I believe the hope and expectation of the drafters is that firms that would become Restricted Firms will either take advantage of the opportunity to fire a whole bunch of RRs, to avoid becoming Restricted, or simply reconsider their business model.  I am not saying that this is right, or fair.  I believe the computation that underlies the Rule accords way too much weight to pending matters – for reasons I’ve outlined above – and on settled arbitrations – which are typically settled not necessarily because the claims have merit, but because it’s faster, cheaper and easier than fighting them.

The Rule reminds me of the frustration I felt over 20 years ago, when I was the Director of NASD’s Atlanta District Office.  People often complained to me at the time about the fact that this firm or that firm was somehow still in business, notwithstanding its spotty reputation.  My response was always the same: bring me the evidence to support a case to expel the firm, and I will back that effort with all the power my position provided me.  But, absent such evidence, then stop your whining.  Here, with Rule 4111, FINRA wants to skip the hard part of actually developing cases supported by real evidence, and then bringing and winning those cases.  FINRA wants, instead, to achieve back-door expulsions simply making it too expensive for firms to choose to remain members.  That doesn’t strike me as the right, or fair, way of cleaning up the industry.

[1] I mean, objective in the sense that there are numerical thresholds actually contained in the rule that supposedly represent the cut-off between being an ok firm and a firm that might need to be Restricted.  It bears noting, however, that FINRA simply invented these thresholds.  So, in a sense, even these objective criteria embody a great deal of subjectivity.

[2] I will refrain from commenting about the seeming unfairness of holding pending events against firms, given that “pending events” mean the allegations are unproven, that the RR is presumed to be innocent, and the plaintiff/claimant/prosecutor bears the burden of proof.  You already know how I feel about that.

[3] According to the FAQs it published, FINRA stated that “there are numeric thresholds for seven different firm sizes to ensure that each member firm is compared only to its similarly sized peers.”  In other words, FINRA is looking, theoretically, only for outliers.

Shortly, I hope to get around to drafting a blog post about FINRA’s latest demonstration of abasement to PIABA and claimants’ counsel everywhere, namely new Rule 4111. But, that rule is such a monstrosity that it will take a little time to parse, and a lot of work to get the post shorter than ten pages.  Plus, my eyes roll so much every time I read the rule that I get dizzy and can’t type very well, which makes it hard to see the keyboard. For now, just enjoy the clever title of the piece-to-come: The 411 On Rule 4111.

With that said, there IS ample time today to discuss one of the central tenets of FINRA’s shiny new rule: do everything possible to ensure that any customer who files an arbitration – and, of course, the lawyer representing that customer on a contingency basis – gets paid. And note that I have chosen my words here quite carefully. I deliberately did not say “any customer who files an arbitration and then takes the case to a hearing and wins.” Nor did I say “any customer who files an arbitration and then enters into a settlement agreement that calls for installment payments over a period of time.” No, I said any customer who simply files an arbitration. Period. Regardless of the merits. For the simple fact is that FINRA – not Dispute Resolution, which, to its credit, doesn’t care who wins or loses, as long as the process is fair, but, rather, Member Supervision – will not rest until it is able to show the SEC, and, likely, Congress, all the things it is doing to address arbitration awards that do not get paid because the firm just goes out of business.

Let’s just take a minute here to discuss something important, yet widely overlooked: the size of the universe of cases at issue. From the amount of attention that FINRA devotes to the subject (which is only slightly less than PIABA), one would think that unpaid arbitration awards are rampant, affecting huge numbers of complaining customers. Not surprisingly, the actual number is really quite modest, by anyone’s definition. This is evident from FINRA’s own statistics, published here. According to the most recent data, from calendar year 2020, there were 2,145 arbitration cases closed in total that year. Of that total, 193 were closed as a result of an award following an evidentiary hearing. (As everyone knows, the overwhelming majority of arbitrations are closed due to settlement.) Of those 193, only 62 resulted in damages being awarded to the claimant. And, of those 62, only 23 had damages that were not paid. Of course, that is not particularly surprising when you consider that of those 23 cases, 17 of them were not even contested by the respondent(s). And what is the principal reason a firm would not contest an arbitration? Because it is inactive, and has no money to pay for a defense, let alone pay the award.[1]

So, when you get to the bottom of things, you can see that there were a whopping six cases in 2020 where a respondent actually appeared and defended itself in an arbitration, lost, and then failed to pay the award. Not exactly the mountain of cases that FINRA, or PIABA, make it out to be.

Yet, as I said, FINRA sure acts like this is a massive problem. And it makes no effort to keep secret its efforts to address it. In Reg Notice 21-34, which attempts to describe how Rule 4111 works and why FINRA created it, FINRA flat out admits that a primary motivation for the rule is unpaid arbitration awards: “An added benefit of Rule 4111” – and let’s stop right there to insert sarcastic laughter, as that certainly suggests that there are any benefits to the rule – “will be important ancillary effects in addressing unpaid arbitration awards.” If that was all there was to it, it would be bad enough. I mean, as FINRA’s statistics amply demonstrate, the supposed issue concerning unpaid arbitration awards doesn’t amount to much. Six cases, big whoop.

But, sadly, that is NOT all there is to it. FINRA’s fixation goes beyond simply “addressing unpaid arbitration awards.” No, FINRA not only wants the customers in those six cases to get paid, it wants any customer who files an arbitration to get paid. As I said above, regardless of the merits, regardless of the facts, regardless of, well, anything besides the mere fact that the Statement of Claim was filed.

Here’s what I’m talking about. Consider that one factor in FINRA’s convoluted process of deciding under Rule 4111 whether a BD should be characterized as a “Restricted Firm,” i.e., one that may have to pay a big, fat deposit just for the privilege of remaining a member, is not just unpaid arbitration awards – which should result in a firm’s being summarily suspended anyway – but, as well, “Covered Pending Arbitration Claims.”

Under Rule 4111, a “Covered Pending Arbitration Claim” is an “investment-related, consumer initiated claim filed against the member or its associated persons in any arbitration forum that is unresolved; and whose claim amount (individually or, if there is more than one claim, in the aggregate) exceeds the member’s excess net capital.” The emphasis on “unresolved” is mine, to highlight the fact that FINRA is so focused on the six unpaid arbitration awards following contested hearings in 2020 that it is willing to make broker-dealers make huge deposits to address unadjudicated claims, i.e., claims that are pending and unresolved, which are altogether different than claims that have resulted in an award. That is really staggering, as it demonstrates that FINRA has completely lost sight of some basic, but important things.

Principally, FINRA appears to have forgotten (or maybe it just doesn’t care) that in arbitration, as in court, it is the claimant who bears the burden of proof. Respondents in arbitrations, like defendants in court, are presumed to be innocent. It is up to the claimant to prove otherwise. And, frankly (and statistically), claimants aren’t very good at that. As noted above, FINRA Dispute Resolution’s 2020 statistics reveal that claimants only win 32% of the time they go to hearing. Over two-thirds of the time they go to hearing, their claims are dismissed and they recover nothing. And that’s not because respondents’ counsel are such geniuses; it’s because a lot of these claims are silly and baseless. Indeed, on occasion, a hearing panel is willing to call out a claimant (and/or claimant’s counsel) for bringing a meritless claim by awarding attorneys’ fees to the prevailing respondent.[2] FINRA, however, disregards all of this. As far as FINRA appears to be concerned, if a claimant simply files an arbitration Statement of Claim, it is presumptively valid, not the other way around, as the law and due process demand. And that is not just troubling, it’s frightening.

The same phenomenon manifests itself in connection with CMAs. Reg Notice 20-15 is all about changes FINRA made to its Membership Application Program, or MAP, rules in 2020. As with the promulgation of Rule 4111, FINRA represented that these edits were designed to reflect FINRA’s “effort to help further address the issue of customer recovery of unpaid arbitration awards.” But, just like Rule 4111, FINRA did not stop at unpaid arbitration awards. Just like Rule 4111, FINRA also baked into MAP’s consideration of a CMA a review of – you guessed it – “Covered Pending Arbitration Claims.” Indeed, it appears that Rule 4111 borrowed the definition for that awkward term from Rule 1011(c)(2), which reads the same as Rule 4111: “[a]n investment-related, consumer initiated claim filed against the transferring member or its Associated Persons in any arbitration forum that is unresolved.”

So, what this means is this, according to Reg Notice 20-15: “FINRA is concerned about prospective applicants for new membership hiring principals and registered persons with pending arbitration claims without having to demonstrate how those claims will be paid if they go to award or result in a settlement.” In other words, if you want to hire someone with a pending arbitration, you are required to show FINRA that you have the money to pay that claim IF it goes to hearing and claimant beats the odds and wins, or IF the case settles. Irrespective of its merits, irrespective of the facts, irrespective of the fact that it is the claimant’s burden of proof, irrespective of FINRA’s own statistics that show most arbitrations are without merit. And how much money will you need to show FINRA you’ve got? Well, that’s anyone’s guess, as it is entirely up to FINRA, which doesn’t publish a formula. Basically, it boils down to the more money, the better, and unless you can show you have enough money to pay 100% of the amount demanded in the Statement of Claim – despite the fact such figures are often grossly inflated – FINRA may very well conclude it’s not enough.

In sum, then, in its zeal to appease PIABA, and maybe Congress, by showing all the clever steps it is taking to address unpaid arbitration awards, FINRA has gone waaaay further than it needed to go by legislating language into at least two rules that it has the right to hold against member firms the mere existence of pending arbitrations. Ironically, even though the SEC approved the rules, this is well beyond anything the SEC itself does itself. Just consider the net capital rule, perhaps the granddaddy of customer protection rules. Remember that the net capital rule is an SEC rule, not a FINRA rule. In an interpretation that’s been around for over 30 years, the SEC has stated that a broker-dealer need not book even a contingent liability in its net capital computation to account for a pending lawsuit – and this reasoning has been extended to cover arbitrations – if it obtains an “opinion of outside counsel regarding the potential effect of such a suit on the firm’s financial condition.” In other words, from a net capital perspective, unlike FINRA, the SEC cares a lot about the merits, or lack of merits, of an arbitration. If a claim is so void of a factual or legal basis that a lawyer is willing to offer an opinion on that subject, the SEC says the amount of that claim need not be accounted for in the net capital computation. And if it’s not necessary to include it in the net capital computation, then, logically, there are no customer protection issues implicated.

As explained above (at length, sorry), FINRA has taken the opposite tack. In FINRA’s world, even utterly baseless claims have to be accounted for; for FINRA, all that matters is that they’re pending. That is not how this system is supposed to work.

[1] To its further credit, FINRA Dispute Resolution understands the problems a claimant faces when arbitrating against an inactive firm, but correctly notes that such claimants are fully advised by Dispute Resolution of the situation, and are given the chance to do something else, like go to court. When they don’t, and continue to pursue the arbitration and end up with a worthless award, well, that’s pretty much on them. As FINRA puts it, “FINRA also informs the customer that awards against such firms or associated persons have a much higher incidence of non-payment and that FINRA has limited disciplinary authority over inactive firms or associated persons that fail to pay arbitration awards. Thus, the customer knows before pursuing the claim in arbitration that collection of an award may be more difficult. . . . Accordingly, claims against inactive firms and brokers proceed in arbitration only at the customer’s option.

[2] You want proof? Look at this award we obtained a month or two ago on behalf of a BD client. While Claimant ultimately dismissed his case voluntarily (presumably for the lack of supporting evidence), that only came after we pressured him to do so. In recognition of that, the arbitrator granted my client’s motion for its attorneys’ fees “as sanctions for . . . [claimant] continuing to pursue the claim after it was apparent there were no reasonable grounds for doing so.”

Not too long ago, I wrote a piece complaining about (among other things) the fact that the potential arbitrators that FINRA rolled out to the parties in a particular arbitration I was handling skewed juuuuuuust a bit towards the older end of the age spectrum; indeed, the average age of the ten potential chairpersons was 75.3 (and seven of the ten were, in fact, 75 or older).  I have nothing against these guys, or any old person.  My point was simply that when it comes to diversity, FINRA arbitration panels are conspicuously old, white, and male.

Anyway…as I was catching up on recent FINRA publications, I ran across Reg Notice 22-09, “FINRA Requests Comment on a Proposed Rule to Accelerate Arbitration Proceedings for Seriously Ill or Elderly Parties.”  As the title suggests, FINRA is considering conjuring up some new procedural rules to increase the likelihood that an elderly or infirm claimant can “participate meaningfully in a FINRA arbitration” by shortening a bunch of the deadlines, theoretically resulting in a final evidentiary hearing that happens sooner than under the current rules.

Putting aside the questions whether this is a good or bad idea, I simply cannot help but relish the irony in the juxtaposition of my recent blog post and some of things that FINRA says in this Reg Notice about old people.

According to FINRA’s proposal, any claimant who is 75 or older can take advantage of the expedited procedures.  While FINRA takes great pains not simply to declare that anyone who’s 75 is necessarily at death’s doorstep, it is quite clear that FINRA does have grave concerns about these septuagenarians.  Citing published mortality tables, FINRA posits that “[p]arties who are 75 or older are significantly more likely to become unable to participate in a hearing after a claim is filed than those who are 65 or older, as demonstrated by published rates of adverse health conditions and mortality.”  In other words, once you hit 75, given your “relatively higher average mortality rates,” you have a statistically greater chance of not living long enough, or not staying cogent enough, from the day you file your Statement of Claim through the hearing to be able to participate in it.  Morbid stuff, to be sure.

So, you can see where I’m going with this.  If FINRA is so concerned about the ability of claimants who are 75 and older to participate in the hearing, I can’t help but wonder why FINRA apparently has zero qualms about populating its arbitration panels with candidates with the exact same demographics.  I mean, it simply has to cut both ways, right?  If hitting 75 means, statistically speaking, that you’ve entered some strange and dangerous territory that renders into question your ability to keep your wits about you, not to mention simply surviving the rigors of being cross-examined by smart ass lawyers like me, then logic dictates that the same concerns apply to arbitrators, no?  Seems to me that FINRA cannot have it both ways.  It should, therefore, take a hard look at its roster of arbitrators to figure out who is still up to the task of handling an arbitration hearing.

FINRA recently published a “Discussion Paper” on expungement of customer dispute information in which it outlines its plans going forward on revising the expungement process.  Expungement_Discussion_Paper.pdf ( (Let me just start by applauding FINRA for trying hard to get this right.  The current patchwork of expungement rules and guidance could use some improvements, and there are no easy answers – although I’ll provide some ideas at the end of this post.)

The upshot of the Discussion Paper is that FINRA is contemplating dual paths: (1) in the short term, revising and resubmitting some of its proposed rule changes that it withdrew from the SEC’s consideration back in May 2021, and (2) in the long term, creating an administrative process where FINRA or state regulators make expungement decisions, which would replace the current system of seeking expungement in arbitration.  Let’s discuss.

As some of you may recall, FINRA published many proposed changes to the expungement process in Reg Notice 17-42, all the way back in 2017.  After several rounds of comments, FINRA submitted those changes to the SEC, only to withdraw them in May 2021.  That withdrawal occurred after PIABA (a trade group that works to protect investors) released a study and commentary where it argued expungement is granted too frequently and the proposed rule changes wouldn’t do enough to fix the system.  The SEC also apparently had some concerns about at least one part of the proposed changes – the Special Roster Proposal.  The Special Roster Proposal is exactly what it sounds like – a proposal to appoint arbitrators in expungement cases from a “special roster” of arbitrators who have been specifically trained by FINRA to handle expungement hearings.

The SEC’s concerns about the Special Roster Proposal haven’t been publicly discussed – yet.  We will know soon enough because the Discussion Paper states that FINRA intends to continue pursuing approval of the Special Roster Proposal in some modified format that addresses the SEC’s concerns.

Let me just do a little speculating here as to what I think one concern might be: the Special Roster Proposal may result in appointing arbitrators who do not appear neutral.  Traditionally, arbitrators are neutral triers of fact, just like judges and juries.  The idea that arbitrators are supposed to be neutral is so fundamental to the arbitration process that one of the few bases for vacating an arbitration award is if an arbitrator demonstrated “evident partiality.” 9 U.S.C. § 10.  The Special Roster Proposal included enhanced expungement training for the arbitrators on the roster regarding how to handle an expungement case and the actions they should take to ensure the customer’s side of the story is told, even if the customer does not participate.

This stems from FINRA attempting to correct the problem that most customers do not show up to participate in expungement hearings, so arbitrators might hear only one side of the story.  The Special Roster Proposal would specifically authorize these specially trained expungement arbitrators to request documentary, testimonial, and other evidence they deem relevant to the deciding the claim.  It almost deputizes the arbitrators to act as representatives of the customers.

When you combine these three aspects of the Special Roster Proposal (enhanced training from FINRA plus appointment by FINRA plus authorization to investigate evidence that might rebut the expungement request), you can start to see how an argument could be made that these arbitrators might be less than neutral.  That could set up a decent argument to vacate any expungement request that gets denied.

I believe this concern that the Special Roster Proposal might destroy arbitrators’ appearance of impartiality is precisely the reason that FINRA is now suggesting it may attempt to create a new “administrative process” where FINRA and or state regulators decide expungement requests, rather than arbitrators.  The Discussion Paper acknowledges that redesigning the expungement process altogether will take substantial time, but it is now something it is seriously considering as a way to fix “problems” with the current process.  The main “problem,” of course, is that FINRA believes too many expungements are being filed and are being granted by arbitrators who are not seeing both sides of the story because customers chose not to participate in expungement hearings.

But will designing some kind of administrative proceeding where FINRA or the state regulators decide what to expunge really going to solve that problem?  It may make it more difficult for registered reps to obtain expungement, but it won’t do anything to encourage customers to participate in the hearings.  It also seems a little circular to have FINRA / state regulators deciding what must be disclosed in the first place, and then having those same institutions deciding what may be expunged.  One winner in this situation might be broker-dealers who are often named in expungement arbitrations – and assessed large processing fees – even though they are not being accused of doing anything wrong and may choose not even to participate in the hearing.  I’m sure they would be happy to be removed from the expungement process altogether since they are required to report customer complaints regardless of their accuracy or merit.

To be clear, the Discussion Paper states that this is just the beginning of the discussion on these issues, and FINRA invites a dialogue on many questions it raises in the Discussion Paper.  Here are some of my own ideas about revising the expungement process that may be more impactful than simply creating a special “administrative proceeding” or using specialized arbitrators to hear expungement cases.

  • Reduce the number of items being disclosed. This is not as controversial as it sounds. Just hear me out.  Footnote 1 of the Discussion Paper acknowledges that FINRA makes public more information about its registered reps than is available for insurance agents, bankers, doctors, lawyers, and accountants.  If regulators are concerned about the number of expungements taking place, we need to examine WHY they are happening.  This is a situation where we know the egg definitely came before the chicken.  What do I mean? The Discussion Paper acknowledges that changes in 2009 to a registered reps’ U4/U5 reporting requirements led to an increase in number of customer disputes being reported – and in a number of expungements being sought.  The Discussion Paper also acknowledges that broker-dealers must report customer complaints even if they believe the allegations are “untrue, inaccurate or malicious.”  That’s sort of the problem.  If the goal of the CRD/BrokerCheck system is to maintain a record of “accurate” and “meaningful” information, as the Discussion Paper suggests, it seems contrary to that goal to require every little complaint to be disclosed, regardless of merit, and then sort it out later.  Even if a completely erroneous complaint is expunged, it is still likely to remain on the broker’s BrokerCheck for the 9 to 12 months it takes to go through the expungement hearing and confirm it in court.  That means the current system is perpetuating the publication of erroneous or inaccurate information until it can be expunged. That seems contrary to the goal of true and accurate reporting.

Instead of shooting first and asking questions later, maybe it should be the other way around.  What if the rules simply worked like this:

  • If an FC/BD loses an arbitration, it is reported.
  • If an FC/BD wins an arbitration, it is not reported. They’ve already had a trier of fact decide the claim was meritless, so why require an additional expungement hearing? This change may have the benefit of encouraging FCs/BDs to go to a hearing more often.
  • If a customer withdraws a complaint without receiving compensation, it is not reported.
  • If a customer complains (but does not file an arbitration or lawsuit), and the BD denies the complaint, it is not reported.
  • If an FC/BD settles a complaint, it is NOT reported unless it is (a) over a certain dollar amount, AND (b) a regulator takes some action with regard to the complaint. This one is obviously where the bulk of complaints fall.  Currently, settled complaints must be reported if they are over a certain dollar amount.  But just because a complaint is settled does not mean it had merit.  Cases often settle because it is simply cheaper than funding litigation.  Settlement by itself shouldn’t warrant a disclosure.  Instead, maybe a settled complaint should only be reported if a regulator takes some formal action.  FCs/BDs often receive exam inquiries from FINRA or other regulators after they get wind of a customer complaint.  The regulators then gather info and decide if they want to take action.  This is already occurring.  Regulators are already assessing these customer complaints.  If they decide to take further action by filing a Complaint or seeking a settlement with the FC/BD, then it should be reported.  But if a regulator looks at a customer complaint that has settled and decides not to take any action, perhaps that suggests the complaint had no merit and should not be reported.  The benefit of this method, from FINRA’s view, is that FINRA would ultimately be the one holding the keys to the castle – which seems to be what it wants.  Instead of having FINRA decide what disclosures should be removed in an expungement administrative hearing, why not have FINRA decide which complaints should be disclosed in the first place, based on their examination findings?  After all, if FINRA examiners decide the complaint doesn’t warrant any formal action, is it really something the public needs to know about?
  • Give customers a financial incentive to participate in expungements. It seems that the biggest issue FINRA is trying to tackle with current expungement arbitrations is that the complaining customers do not participate, so the arbitrators only hear one side of the story.  But customers have no incentive to participate.  Occasionally, those who are truly disgruntled write an angry letter or show up to testify against the expungement.  But that is rare. If customers had an incentive for participating, they might be more apt to do so. The best incentive is cold hard cash. Again, hear me out.  I’m not talking about paying someone to give favorable testimony (although if that seems offensive to you, you should know it happens every day with expert witnesses).  I am talking about telling customers who have already filed an arbitration and already paid a filing fee, “I know your case settled, but the broker is seeking expungement, so if you would tell your side of the story at the expungement hearing, we will give you back $____ of your filing fee.”  In small cases, the filing fees are pretty low – as low as $50. But most claims of any decent size have a filing fee of $1,000 or more.  Part of it could be set aside for this purpose. Or, FINRA could just tack on a refundable expungement fee when the customer files the arbitration.  Let’s say it’s an additional $1,000 fee.  If the customer settles, maybe give the broker six months to seek expungement.  If the broker doesn’t seek expungement, the customer gets the expungement fee back.  If the broker does seek expungement, the customer only gets the fee back if he/she submits a written statement or testifies at the expungement hearing.  This could be implemented in the current arbitration expungement process or in a new administrative proceeding process that FINRA designs.  This doesn’t work so well when the disclosure is simply a complaint that does not result in filing an arbitration or lawsuit.  But should that really be disclosable anyway?



Thanks to Chris for not only making the personal sacrifice of traveling from frigid Chicago to sunny Florida to attend the SIFMA Compliance and Legal conference last week, but for providing these helpful comments about the sessions he attended. – Alan


I attended the four-day SIFMA Compliance and Legal seminar last week, and there were a bunch of interesting soundbites from regulators that folks might find interesting.  The challenge at these conferences is always separating the chaff from the wheat.  There’s still plenty of responses that begin by stating, “Without going into the details on that,” and “That will be addressed more by the next panel.”  And, as is tradition, they saved some of the best panels for the last day.  By that time, some common themes were emerging across many of the panels.  Here’s a recap of some of the highlights.

Regulation Best Interest.  Every time a question on this topic was addressed to a FINRA staff member, it was met with the same tepid response: “that’s the SEC’s rule, and we are going to let them run with it.  If people have questions about it, we can help you engage in a dialogue with the SEC to get some clarity.  But it’s their rule.”  Every. Single. Time.  If there isn’t an internal memo floating around that talks about how to answer Reg BI questions, I would be shocked.  You can’t help but sympathize with FINRA a little.  Suitability was one of FINRA’s bread and butter concepts for decades.  They were the go-to source for suitability questions – including numerous rule revisions, Reg Notices, and FAQs.  Now that Reg BI has all but taken over, it makes sense that FINRA wants to give the SEC its space to call the shots on interpreting Reg BI.  The problem, however, is that FINRA still needs to enforce the rule, don’t they? One of the more entertaining – and candid, in a good way – FINRA staff members who spoke at a breakout session actually said, “we are not leading the charge on this with enforcement cases.” I was so shocked I wrote it down verbatim.  FINRA is certainly taking a look at Reg BI and Form CRS issues in their exams. They also have created guidance like the Reg BI checklist.  So, while FINRA might not be leading the charge, they are certainly following close behind.  SEC Commissioner Pierce, on the other hand, fully acknowledged that Reg BI will be shaped by how the SEC chooses to enforce it.

Bringing brokers back to the industry.  A few folks from FINRA mentioned they were pleased that Reg Notice 21-41 extended the time period – from two years to five years – for inactive advisors to rejoin the industry without having to retake exams.  FINRA President/CEO Robert Cook mentioned that he hoped this would help bring people back to the industry who may have left due to “life events.”  Mr. Cook really seemed excited about the change, at one point reminding the audience that advisors who are already out of the industry can still take advantage of the change, but they just need to “opt in.”  It is no secret that FINRA’s members have been declining for years.  We’ve blogged about it.  In fact, one of the other panels at the seminar also acknowledged that many advisors have been leaving the broker-dealer side of business that is under FINRA’s jurisdiction and moving to the registered investment advisor side regulated by the states and the SEC.  Perhaps FINRA has decided that it would benefit investors if they have more advisors to choose from.

CCO Liability.  This topic arose a few times because of the recent Reg Notice 22-10 that assures CCOs that “FINRA will not bring an action against a CCO under Rule 3110 for failure to supervise except when the firm conferred upon the CCO supervisory responsibilities and the CCO then failed to discharge those responsibilities in a reasonable manner.”  FINRA CEO Robert Cook acknowledged compliance personnel have a tough role, but hoped that the new Reg Notice would “give them comfort” because there is lots of room within the rules to operate safely.  Jessica Hopper, Executive Vice President and Head of Enforcement at FINRA, directly addressed the compliance personnel in the room by saying “we heard you,” and she reassured them that “it is not open season on CCOs.”  According to Ms. Hopper, most CCO liability cases are ones where the CCO is “dual-hatted” as CCO and either CEO, branch manager, or has been assigned some specific supervisory responsibility.  She also reminded folks that the standards at issue in these types of cases are ones of “reasonableness,” not perfection.  She did, however, point out that BDs should not try to use Reg Notice 22-10 as a shield to hide behind by calling something “compliance” rather than “supervision.”  Fair enough.

Crypto.  A lot was said about crypto at the conference, too much to go into detail here (to quote many of the SIFMA speakers).  Some of the more interesting comments came from SEC Commissioner Hester Peirce (who, it should be mentioned, is a republican appointee operating under a democratically appointed Chair).  She suggested the SEC hasn’t gone about this the right way by pursuing enforcement actions before they fully understand the technology.  She is in favor of slowing down and thinking about how calling something a security might impact it later down the line.  She even suggested allowing small scale experimentation with various rules and regulations might help “figure it out” now before crypto gets even bigger.  In fact, slowing down was a theme of her entire session.  For instance, she reiterated her disagreement with the SEC’s new policy that reduces the comment period for new rule proposals from 60 days to 30.  In her view, she would rather have a more robust and careful dialogue regarding a rule proposal, rather than acting too quickly.  Other speakers indicated that many broker-dealers are currently hesitant to sell crypto because they fear they will be accused of a Section V violation for selling unregistered securities.  So what do they do? Set up an affiliate entity to sell crypto instead. Hmmmm.

SEC sanctions / admissions.  The head of the SEC’s Division of Enforcement, Gurbir Grewal, provided some useful insight into the calculation of sanctions and the use of admissions with settling defendants.  Mr. Grewal indicated that most settlements will still use language that the defendant neither admits nor denies the allegations.  But, he warned that when the SEC does seek admissions in a settlement, they are signaling that they are willing to litigate that case to the end.  He basically said, “when we put admissions on the table, we won’t take them off.”  Melanie Lubin, the President of NASAA, added that admissions are beneficial to help customers recover their losses in civil litigation.  That’s an important point to keep in mind – an admission in a settlement with a regulator may start a feeding frenzy among plaintiffs’ lawyers who use the admission to find investors and convince them they have personally been harmed.  Both Mr. Grewal and Ms. Lubin shared another tip with regards to sanctions: when a defendant brings them a list of “comparable” cases that settled in order to try to negotiate a similar sanction, that often backfires.  Why? Because when a defendant shows them a list of other cases with lesser sanctions, that can indicate to the regulators that those lesser punishments are not having the desired deterrent effect, so they may need to ratchet up the sanctions to send a message.  Yikes!

Use of Personal Communication Devices.  Several panels briefly touched on the topic of advisors using personal communication devices (i.e., cell phones, text messages) to communicate with clients.  The message on this issue was pretty clear: the same old rules apply regarding communications with the public, supervision, and books/records (2210, 3110, 4511).  But BDs must apply those rules to current behaviors and technology.  (Specific guidance exists on these issues as well: Reg Notice 17-18, 11-39).  Folks from FINRA and the SEC explained that most firms have policies regarding the use of personal devices to communicate with customers, but the problem is they fail to adequately implement those policies.  And the policies may need to be updated for current real world behavior.  The current sentiment is that having a policy stating you prohibit use of personal devises (and since you have banned personal devices, you don’t need to supervise them) is inadequate in 2022.  Everyone is going to use a personal device from time to time, either intentionally or inadvertently, so you had better figure out how to address it.

Complex Products.  This was a hot topic because of the recent publication of Reg Notice 22-08 which “reminds” members of their obligations regarding complex products and options.  Folks from FINRA described options as the “mother” of all complex products.  And yet, FINRA staff also reported that option trading in 2021 was up 30% from 2020, and was up 100% from 2019.  If that’s true, did the investing public suddenly get a lot smarter? Maybe.  Or are we going to see a run of options-related customer arbitrations / enforcement actions filed in the coming years?  Also maybe.  Chris Kelly, Senior Vice President and Deputy Head of Enforcement, said there are two problems.  First, brokers often don’t understand the complex options spread transactions they are recommending, so they have no reasonable basis for recommending them.  Second, “options approval bots” for self-directed accounts cause problems where investors who might not qualify for options trading at first then decide to go back, reapply, and check different boxes that will get them approved.  That should raise red flags that BDs investigate – and sometimes don’t.  There was some suggestion that even though these are self-directed accounts, there needs to be stricter protocols in place to potentially protect the customers from themselves. For instance, risk disclosures for options accounts may need to be amplified, even for self-directed accounts where an investors might not fully appreciate what they are getting themselves into.  But, it is interesting to note that one of the other panel members got Chris Kelly to agree that “most” customers are knowledgeable and know what they are doing (generally speaking, not when it comes to options).  I wish I had that on video!

Acquiring Customers Through Social Media.  The topic of using “finfluencers” to gain customers was raised a few times, but disappointingly, not much was said about it.  The message was a familiar one: same old rules, new application.  FINRA staff said that tons of new client accounts were opened during the Covid pandemic, largely as a result of influencers on social media networks hyping certain platforms and firms.  Chris Kelly admitted this issue appears in the exam stages right now, but there are no enforcement cases yet.  Some important questions they are exploring are ones that you would expect: What’s the relationship between the BD and the influencer? Is the BD paying the influencer? Is the BD supervising the influencer? What about reviewing the communications? You can see how classic compensation and communications rules might come into play here. Stay tuned.

Senior Investors.   This issue is highly topical given the recent Reg Notices 22-05 and 22-09. FINRA staff discussed that the goal of Reg Notice 22-05 was to provide BDs additional time to freeze (and protect) monies of elderly clients suspected of being defrauded – and to encourage more freezes.  They have not see firms placing many holds on accounts, which they suspect is out of fear that they would face litigation.  FINRA hoped that Reg Notice 22-05 would give BDs further comfort that they have a “safe harbor” if they freeze senior investors’ accounts in certain situations.  This helps protect investors, but also BDs.  If a BD is threatened with litigation for freezing an account, it can point to the Reg Notice and related rules to argue they were acting within their rights – and hopefully avoid liability (while at the same time stopping the investor’s assets from getting taken by a scam-artist or manipulative family member).  In order to detect potential fraud against senior investors, one broker-dealer on the panel described how they use various algorithms with 75 data points to analyze changes in client behavior that might indicate they are being manipulated by an external fraudster or family member.  They compare the customer’s withdrawals for the past three months compared to the past three years, looking at items such as new recipients getting cash from the account, amounts being withdrawn in round numbers, etc.  They also look at the number of client contacts and the length of those contacts to determine of someone may be working behind the scenes to manipulate the senior investor and steal the investor’s assets.

The Upshot.  Overall, it was good to hear from some high profile regulators about what to expect in the coming year.  FINRA had a good showing and a presence on many panels, which people appreciated.  And even though there are always some competing views expressed at seminars like this, EVERYONE was in agreement that it was good to be able to share these views in-person once again.