A couple of years ago, I complained here about FINRA’s Office of Disciplinary Affairs, or ODA.  I am here to report that…nothing has changed.

Let me explain.  I am defending a FINRA Enforcement case that is scheduled to go to hearing in a few months.  As is often the case, before the complaint was filed, FINRA offered my client the opportunity to settle through an AWC.  Predictably, what FINRA wanted for a sanction was…a permanent bar.  Period.  No discussion, no room for compromise.  I don’t blame the lawyers for this intransigence, however.  In that setting, they are just the mouthpiece for ODA, that faceless, nameless, secretive entity that is empowered to authorize the issuance of complaints and to accept (or reject) settlements.  So here, it was ODA that decreed that only a bar would be sufficiently remedial to address the alleged rule violations at issue, and the Enforcement lawyers were stuck conveying that message to me, regardless of whether they agreed with it or not.  (And I can tell you, at least based on my own experience, that Enforcement lawyers often do not agree with ODA’s assessment, and would be more than happy to settle cases for sanctions more benign than ODA insists upon, but are not permitted to do so.)

Anyway, to the point of this post:  as happens in every Enforcement action, soon after the complaint is filed, the parties are reminded of their ability to mediate the dispute.  Mediation does not impact the timeline of the Enforcement action; that is, the various deadlines that appear in the typical Case Management Order, including the actual hearing dates, are not adjusted at all if the parties agree to mediate, so you have to find the time to squeeze it in.  On occasion, it’s worth it, as the mediation is successful, and the case settles before it lurches to a hearing.  Here, despite its repeated insistence that the only sanction it could support was a permanent bar, Enforcement agreed to mediation.

I took that to be a positive sign.  I mean, why would Enforcement mediate if it was still unwilling to compromise from the bar, right?  There would be no point, and it would be a waste of everyone’s time and money.

So we did the mediation.  It is done telephonically, with a Hearing Officer, but a different one than the one who was appointed to hear the case serving as the mediator.  She was more than competent and very experienced, and very willing to help, and things started out promising enough.

What happens in a mediation is confidential, which is why this post is short on details, so I can only give you a broad outline of what transpired.  But, what happened was this: very quickly into the mediation, it became clear that Enforcement was still insistent that the only possible remedy it would even consider was a bar.  As was the case from the outset of this exam, no room for discussion, no room for compromise.  In other words, Enforcement was at the same place it was before it filed the complaint in the first place.  With the mediator’s blessing and understanding, the mediation ended almost as soon as it began.

Which raises the question, why did Enforcement agree to mediate?  Why put my client through the time, trouble and expense of preparing for and attending the mediation only to hear the very same inflexible message that had been delivered already?  Frankly, I don’t know the answer here.  As defense counsel, I will not agree to mediate unless my client commits to a willingness to compromise, which usually means a willingness to write a check for some amount.  If my client denies liability and refuses to pay a dime, I will decline to participate in mediation (even though, admittedly, there can be a real strategic benefit of participating in a failed mediation, namely, getting a “sneak peek” of the arguments and important facts the other side will be focusing on at the final hearing, and perhaps an opportunity to gauge how the principal opposing party will perform as a testifying witness).[1]

Regardless of the reason for FINRA’s rigidity here, it left a bad taste in my mouth, and my client’s, as well.  Look, the entire Enforcement process feels stacked against the respondent from the very beginning and throughout the case.  FINRA statistics reveal that Enforcement wins the vast majority of the cases it brings.  Respondents’ procedural motions are rarely granted.  Sanctions seem overly harsh and punitive.  Parties who lose are rarely successful on appeal; indeed, the NAC is famous for increasing sanctions.  And anyone that is counting on the SEC to fix on appeal what FINRA failed to get right is more than a bit overly optimistic.

But, these are known facts, facts that I can bake into my advice to clients who have to decide whether to settle or fight.  What I cannot necessarily account for, however, is what appears to be a lack of good faith by ODA when it comes to settlement, which impacts both Enforcement and me.  ODA was created way back when to serve as a check on Enforcement’s powers, once the Code of Procedure was changed to give Enforcement, rather than the District Business Conduct Committees, the power to file complaints and accept settlements.  But, no equivalent check exists relative to ODA.  It acts with impunity, and answers to no one.  That needs to change.

[1] To combat my adversary from employing that strategy against me, I am increasingly hesitant to participate in a joint opening session at the mediation, one in which both sides appear before the arbitrator and lay out their respective cases.  Instead, when possible, I waive the opening joint session, so the opposing party only learns what I permit the mediator to share from our private caucus, which is very little if it becomes evident that the chance of settlement is remote.


Heidi continues to stay on top of developments relating to Reg BI. – Alan

Just in case you’ve not yet seen them, both the SEC and FINRA, over the last week or so, have released a series of documents that touch, partly or entirely, on Reg BI (which everyone knows they must comply with by the end of June 2020).  First, we have the 2020 Priorities Letters which, in addition to the evergreen priorities we see year-to-year (e.g., AML, suitability, fraud and sales practice violations), both regulators have announced their intention to examine firms’ compliance with Regulation Best Interest.  FINRA, in its letter, has provided a list of factors it “may” take into account when reviewing Reg BI compliance.  While such a list sounds helpful, the factors FINRA identifies in the letter do not shed any light on what kind of policies and procedures will be “acceptable” to achieve compliance with the new rule (i.e., how to comply).   Instead, the factors merely repeat the requirements imposed by the Regulation and ask whether compliance has been achieved:

  • Does your firm have procedures and training in place to assess recommendations using a best interest standard?
  • Do your firm and your associated persons apply a best interest standard to recommendations of types of accounts?
  • If your firm and your associated persons agree to provide account monitoring, do you apply the best interest standard to both explicit and implicit hold recommendations?
  • Do your firm and your associated persons consider the express new elements of care, skill and costs when making recommendations to retail customers?
  • Do your firm and your associated persons consider reasonably available alternatives to the recommendation?
  • Do your firm and your registered representatives guard against excessive trading, irrespective of whether the broker-dealer or associated person “controls” the account?
  • Does your firm have policies and procedures to provide the disclosures required by Reg BI?
  • Does your firm have policies and procedures to identify and address conflicts of interest?
  • Does your firm have policies and procedures in place regarding the filing, updating and delivery of Form CRS?

The SEC’s priority letter did little more than mention its intention to look at Reg BI Compliance.  However, shortly thereafter, it put out a much more helpful document: FAQs on Regulation Best Interest.  Unlike FINRA’s list of questions, the SEC’s “frequently asked” list comes with answers and examples.  Granted, many of these questions are also addressed in the release (and therefore the answers are not, technically, new information), but it’s useful simply to know that these are the questions that the Commission is “frequently” receiving from firms as they work on their new procedures.  Also worth noting: if the SEC takes the time to answer a question through public guidance, it’s wise to be familiar with it.  While you cannot use guidance to bind the SEC (see the disclaimer at the beginning) they can certainly use it against you (by showing the answer was publicly available and you were negligent – or worse – in not knowing it).

If you read thought these materials and are still hungry for more information, you can listen to a (brief) discussion about what a Reg BI exam will look like in the latest episode of FINRA’s podcast (Reg BI comes up in the second half of the episode).  Bringing this post full circle, FINRA notes in the podcast that Firms should continue to reach out and ask questions of FINRA between now and the June compliance deadline.  Not only might your question be met with an answer, but because FINRA is also “learning,” it collects the questions received and shares them with the SEC…who answers them by publishing FAQs on Regulation Best Interest.


The day after Christmas, FINRA issued a press release announcing that five big firms – Citigroup, J.P. Morgan Chase, LPL, Morgan Stanley and Merrill Lynch – had each entered into a settlement, collectively agreeing to pay a $1.4 million fine.  Their offense?  They each violated FINRA’s supervisory rules because for a number of years, dating all the way back to 2014, none of them had adequate written supervisory procedures regarding UTMA and UGMA accounts.  Specifically, the firms failed to have procedures in place that would ensure that the appointed custodians of such accounts – which, of course, exist for the benefit of minor children – lost their ability to continue directing trading in these accounts once the beneficiaries reached the age of majority.

My issue here is a very narrow one.  I don’t care so much about the actual rule violation; indeed, the fact pattern seems pretty cut-and-dried, and apart from the fact that FINRA is going after misconduct that is six years old – which makes it unfair to any respondent who might be inclined actually to fight the charges, rather than settle – the cases make sense.  I also am not particularly unhappy about the size of the fine, as these firms can certainly afford it.

No, my concern, or perhaps better phrased, my question, stems from what appears to be a very benign section of the five AWCs that these firms each submitted, the section called “Relevant Disciplinary History.”  The reason that section is included in every AWC – indeed, in every FINRA settlement and every adjudicated decision that FINRA reaches – lies within the FINRA Sanction Guidelines, which recite that because “[d]isciplinary sanctions should be more severe for recidivists, . . . [a]djudicators should always consider a respondent’s relevant disciplinary history in determining sanctions and should ordinarily impose progressively escalating sanctions on recidivists.”

So, what, exactly, does “relevant disciplinary history” mean?  The phrase is not defined in the Sanction Guidelines.  But, I can tell you that in each of the five AWCs that is the subject of the press release, the “Relevant Disciplinary History” section states that the respondent firm “does not have any relevant disciplinary history with the Securities and Exchange Commission, any state securities regulators, FINRA, or any other self-regulatory organization.”  I found that statement rather surprising; given how long these firms have been around and the sheer number of prior disciplinary cases that have been brought against them, it struck me as odd that none had ever been written up before for a supervisory violation.  Turns out I was right.

According to BrokerCheck, Citigroup has 1,180 total disclosures, 537 of which are characterized as “regulatory events.”  BrokerCheck defines a “regulatory event” to be “a final, formal proceeding initiated by a regulatory authority (e.g., a state securities agency, self-regulatory organization, federal regulator such as the U.S. Securities and Exchange Commission, foreign financial regulatory body) for a violation of investment-related rules or regulations.”  Of those 537 regulatory events, easily over a 100 appear to have involved a violation of a supervisory rule.[1]

J.P. Morgan has 478 total disclosures, of which 334 are regulatory events.  Of those 334 regulatory events, maybe close to 100 involved a supervisory violation.

LPL has 253 total disclosures, of which 175 are regulatory events, perhaps 20 or more of which involved a supervisory violation.

Morgan Stanley – at least in its current incarnation – has 140 total disclosures, of which 50 are regulatory events, and about 20% of those included the violation of a supervisory rule.

Finally, Merrill Lynch has 1,442 total disclosures, of which 565 are regulatory events.  Of those, it seems that over 100 involved a supervisory violation.

Clearly – and here, finally, is the point of this post – inasmuch as none of the AWCs which these five firms agreed to submit includes a recitation of any “relevant disciplinary history,” despite the statistics I have just cited, FINRA somehow does not deem them to be recidivists when it comes to supervisory violations.

Let me be clear: I am not saying that this is right or wrong.  This is FINRA’s game and its members have to play by FINRA’s rules.  So, if FINRA does not deem any of these BDs to have any relevant disciplinary history, I suppose that’s ok with me.  I’m not sure the investing public would be as understanding if this was explained to them, but, as I have made clear over the years, my clients are BDs, not investors.

But…with that said, I do insist on fair treatment of all respondents.  While I cannot cite you any statistics, I can tell you anecdotally, coming from someone who’s negotiated dozens of settlements with FINRA, that its Enforcement attorneys do not take the same approach with small firms, at least not the small firms I have represented.  When it comes to small firms, it seems that FINRA will deem any prior supervisory violation, no matter how factually disparate, to be relevant disciplinary history for the purposes of determining the sanctions.  Did the prior case include a violation of Rule 3010 (or 3110)?  If the answer is yes, regardless of the specific facts of the case, then FINRA ratchets up the fine.

And I expressly invite any other practitioners who may read this to weigh in, to tell me whether their experience has been the same as mine.  I will dutifully report what I learn.

[1] Given the sheer number of reported regulatory events for these firms – which comprise hundreds of pages – I did not go through the BrokerCheck reports page by page; rather, I did a search for “3010” and “3110,” i.e., the numbers of the supervisory rules.

From time to time, I have lamented that FINRA does not hold itself to the same lofty standards to which it holds its members.  I realize I am painting with a broad brush, as there are lots of folks at FINRA who do a great job, who are easy and reasonable to deal with, and who don’t play games.  But, that is not the case across the board.  And every once in a while, FINRA does something that is so staggeringly unfair that it almost leaves you speechless.  My end of the year present to you is this post, about a case that serves as well as any to highlight the occasional madness of dealing with securities regulators.

Devin Wicker, who was the “the majority owner, chief executive officer, chief financial officer and chief compliance officer of former FINRA member firm Bonwick Capital Partners, LLC,” was named in a FINRA Enforcement complaint back in 2018, accusing him of “misusing and converting $50,000 of an investment banking customer’s funds.”

The matter went to hearing, and in March 2019, FINRA issued its final Decision.  Mr. Wicker was found to have violated the FINRA rules, and, as a result, the hearing panel permanently barred him from associating with a FINRA member firm, and, to boot, required that he pay $50,000 in restitution.

If you look up Mr. Wicker on BrokerCheck, however, it reveals that the Enforcement action is still “pending.”  Indeed, there is no mention of the final Decision.  Well, that’s unusual, right?  Normally, when FINRA issues its decisions, it immediately files a Form U-6, which serves to capture the results of the decision and add them to the respondent’s CRD for the world at large to see.  So, if the Decision came down in March, why hasn’t Mr. Wicker’s CRD been updated?

It seems that FINRA made an error in its handling of the hearing.  Just one, but it was enough to cause FINRA to vacate the Decision, and give Mr. Wicker a do-over, with an entirely new hearing panel.

And what was this error?  Well, as you know, a FINRA Enforcement case is presided over by a Hearing Officer from FINRA’s Office of Hearing Officers.  The Hearing Officer is a FINRA employee, but, as FINRA extolls in its own website, “Hearing Officers are attorneys employed by FINRA and assigned to the Office of Hearing Officers. The only function of that Office is to serve as an adjudicator; it is entirely independent of the Department of Enforcement.”  At least it’s supposed to be independent. Turns out that in Mr. Wicker’s case, there was a little glitch when it came to that supposed independence.

Turns out, as reported by the Wall Street Journal, that, in fact, the Hearing Officer assigned to preside over Mr. Wicker’s case, Jennifer Crawford, was actually interviewing with FINRA at the time of the case to take a job in the Department of Enforcement.  Yes, Ms. Crawford was trying to get a job with the very group that was prosecuting the action against Mr. Wicker.

You don’t need to be a rocket scientist to figure out the ridiculously obvious conflict of interest that Ms. Crawford had.  And there simply is no reasonable way to conclude that it didn’t occur to her that she had a conflict.  She is a lawyer, and, given that, operates pursuant to standard group of ethical rules that govern her conduct, including rules about conflicts, both actual and potential.  Yet, she not only chose not to recuse herself from the case, it appears that she didn’t bother even to disclose to anyone that she had this conflict.

You would never confuse a FINRA Hearing Officer with a federal judge, but they both are supposed to be impartial, so a comparison is still apt.  The Code of Conduct for United States Judges recites that judges should avoid not just impropriety but the mere “appearance of impropriety.”  I think it’s clear that line got crossed here.

So FINRA vacated the Decision.  But it hasn’t dropped the case against Mr. Wicker; rather, he is going to have to go through the entire thing again, spending more time, more money, more effort, because FINRA failed to provide him with the impartial forum to which he is entitled.  No factfinder, no forum, is perfect, and I don’t expect perfection from any jury, or arbitration panel, or judge.  But, I do expect fairness, and that is not too much to ask of FINRA, or anyone.

I have no idea whether Mr. Wicker did what FINRA accuses him of doing, but he was certainly entitled to have his case heard by an impartial panel, one willing to give him the benefit of the presumption of innocence, and one which would hold the Department of Enforcement to its burden to prove the case by a preponderance of the evidence.  Even FINRA concluded that the optics of Mr. Wicker’s case were so bad it had no choice but to throw out the decision.  But, this case does more than make you question the propriety of a single result; it makes you wonder what else goes on that you will never know about.  If you can’t trust the very process by which FINRA adjudicates its cases, then the entire system is subject to crumbling down.

My partner, Heidi VonderHeide, has busied herself these last few months learning everything she can about Reg BI.  Happily, here is her post on the subject, and it doesn’t predict gloom and doom in the new year as that regulation is implemented.  – Alan

Just before the Holidays, I attended FINRA’s one-day Reg BI seminar in Washington D.C., where member firms and regulators (but primarily the SEC) discussed the new rule and what they hoped it meant for the industry.

As you would expect, a lot of the time was devoted to an overview discussion about the rule – most of which you’re already familiar with heard either because you’ve read the 700+ page release that accompanied the Reg or because you’ve been scouring the internet looking for any guidance on how to go about putting it into practice.

There was relatively little guidance on the how, but the most interesting discussions, in my opinion, came from the panelists from member firms.  Not that they had all the answers – to the contrary – a lot of the discussion focused on the questions or problems that they’ve encountered in attempting to implement the Reg and its procedural requirements.  Their struggle highlights the complexity behind even the simplest requirements.

Take, for example, the requirement that Form CRS be delivered to firm clients.  This new requirement is incredibly straightforward compared to others, yet, in practice it has proved incredibly problematic, even for the biggest member firms.  What mechanism does the firm use to send the CRS? Mail or email? What about the customers’ communication preferences? A lot of firms are relying on their clearing firm to send the document, but some clearing firms cannot guarantee that the Form CRS will meet the regulation’s “prominence” requirement.  And, once the Form is sent, how will the firm create and maintain adequate records of that transmittal?  How will the firm ensure timing is right for this (and other) disclosure transmittals (which must be provided to the customer at the time of the recommendation or before)?

These are the questions that firms are struggling with – and the clock is ticking.

On the plus side, the SEC and FINRA have provided repetitive reassurances (at the conference and elsewhere) that the initial Reg BI examinations – both before and after the June 30, 2020 compliance deadline – will not be looking for “foot faults” and, instead, that the focus will be on working with firms to identify deficiencies and achieve compliance.

So, what should firms be doing as the deadline approaches?  The simple answer is: taking this very seriously and being prepared to show FINRA how seriously you are taking it.

The more complex answer is:

  • Know thyself: the first questions firms are likely to receive will be asking what the firm has been doing to prepare for implementation.  The easiest and most obvious first step is to review your structure, relationships, business lines, existing procedures, existing documents and existing representatives.  This will be time consuming but will provide a solid starting point for identifying where changes need to be made.
  • Focus on language: What do you already disclose and how?  Are existing disclosures compliant with the Reg?  What new disclosures are needed and where do they go (i.e., how many disclosure documents are needed)?  What about titles and marketing materials?  Do they meet the new requirements around the word “advisor” and properly disclose service/account limitations?  What about account agreements and policy documents?  Do they promise any services or “monitoring” that could be problematic under the new rule?
  • Focus on training: Nothing shows seriousness more than comprehensive training.  This is not only for your registered persons, but for the individuals that supervise them.  Everyone needs to understand the Reg’s new requirements.  While the compliance and disclosure functions will largely be handled on the firm level, brokers are responsible for implementing them and, of course, ensuring that the recommendations made satisfy the care obligation.
  • Talk to your vendors now: One common theme at the conference was the shattered belief that clearing forms or other third-party vendors will be able to assist with transmission of these documents.  Don’t assume that is going to be an option. Some of the big firms at the conference told us they were using (and creating) their own technology to handle delivery and delivery record keeping.
  • Learn from others: Once the June 30, 2020 deadline comes, other firms’ Forms CRS will be available publically.  That will be the first real opportunity to see what others are doing and learn from it.  Of course, changing your Form CRS will trigger re-distribution requirements, so you may want to review as many industry examples as possible, decide on revisions, and then decide if and when to implement them.
  • Learn from those who have gone before you: It’s my prediction that FINRA will abide by its new mantra that it does not intent to institute “gotcha exams.”  Firms that try, but fail, to meet the still-unarticulated standard which FINRA will be imposing will not find themselves facing formal action….initially.

Here, we can learn a lot from the recent ADV/disclosure actions against IAs.  I expect FINRA’s enforcement trends to follow that same path.  This means that there will be relatively few formal actions for firms in the first few years – other than firms that do nothing to comply, and their refusal to act will be taken very seriously.

The first real wave of actions will be firms that pay only lip service to the rule and fail to make meaningful disclosure or procedural changes.

The next wave will come 3-5 years after implementation.  This is the arc of the enforcement-pendulum that firms fear most.  Years after the rule is in place, an industry standard will emerge and FINRA will file enforcement actions against the divergents.  The charges will perhaps be retroactive, imposing a 2025 standard on the decisions you are making right now.  It is then where this grace period will end and the enforcement sweeps will resume (think of the ADV and share-class sweeps we have seen in recent years on the IA side).

  • Don’t stop at strict compliance. The main objective on everyone’s mind is complying with the technical requirements of the rule. Given the amount of work and expense that will go into compliance, however, you should also be thinking about areas where you may want to go beyond the Reg’s threshold requirements. For example, Reg BI does not require documentation of the best interest recommendation made to a particular customer.  But that doesn’t mean you shouldn’t push your representatives to memorialize these interactions.  It may be an open question as to whether you will ever see an enforcement action arise out of your Reg BI procedures, but a customer complaint with that allegation is almost inevitable.

Of course, these are only a few of the questions firms will be asking themselves as they prepare for the June 2020 compliance deadline. If you have any questions, you can reach out to us at any time.  We’ve prepared some handy overview materials which we are happy to send to you.


Between the usual holiday season madness and a recent trial, I have been a little tied up lately.  Happily, Chris Seps has stepped up with this excellent piece on Reg BI. – Alan


My young boys will sometimes chase me around the house, catch me, and yell “gotcha” as they drag me off to their pretend jail.  No matter how much I plead that I’ve done nothing wrong, I always end up in jail, despite having no knowledge of any rules that I’ve broken – because they just make it up as they go along.  Unfortunately, it is starting to sound like complying with Reg BI might be a bit like that.

If you’ve paid attention to this blog (or many other commentators out there), you probably know that there is growing concern in the industry that there is simply not enough guidance for broker-dealers to allow them to feel comfortable that they will be in compliance with Regulation Best Interest (“Reg BI”) when it takes full effect in June 2020.  We previously voiced concerns that there are mixed messages coming from the upper ranks at FINRA regarding whether Reg BI will operate in tandem with or in replacement of FINRA’s traditional suitability standards (as set forth in Rule 2111 and various Notices to Members, as compiled into a lengthy set of FAQs).  And yet, FINRA has said it is ready to begin testing firm’s readiness for Reg BI.

To add more fuel to the fire, in the past week, several SEC commissioners have expressed their own concerns that there is not enough guidance to firms on how to comply with Reg BI.  On December 6, SEC Commissioners Allison Herren Lee and Robert Jackson were asked if the agency was going to provide any clarity around “best interest” and what it means to “mitigate conflicts” – two aspects of the rule that do not seem to have any hard and fast requirements.[1]  While Lee stated that she was “hopeful” the agency would provide clarity, Jackson responded with an unequivocal “no,” according to ThinkAdvisor.  Then, when asked whether FAQs would be enough to help guide the industry, Lee reportedly seemed doubtful: “I guess that remains to be seen.  They need clarity.”

If two of the five SEC commissioners are concerned that Reg BI is not clear enough for firms to know how to comply, how exactly are firms supposed to prepare?  With so little initial guidance, we have been telling clients that we will have to see how early enforcement actions shake out to get any real sense of the boundaries of Reg BI.  Unfortunately, that provides little comfort to broker-dealers who are trying to comply with the rule.  In essence, as my colleague Heidi VonderHeide echoed in her recent webinar on Reg BI (which you can find here), the worst thing firms can do is nothing; all you can do is take your best shot, put your head down, and hope for the best.

Commissioners Lee and Jackson seem to agree.  Lee stated that she and her staff are “staying riveted on what they’re [SEC staff is] doing in these early interpretations and these early potential enforcement attempts.”  Jackson echoed that “there are going to be enforcement decisions that will have to be made.”  Jackson said “The bottom line is: How good a job Reg BI is going to be in protecting ordinary people is going to be decided by on-the-ground regulatory decisions in the future. And who’s making those decisions is going to be very important.”

In other words, since Lee and Jackson have little hope for further guidance, and have little hope that FAQs will be sufficient, industry members will just need to wait and watch the department of enforcement bring cases to test the boundaries of the rule and see who they can make examples of to set precedent for the future.  It sounds like two of the commissioners are fully expecting “regulation by enforcement,” or more pejoratively, a game of “gotcha,” right?

Not so fast.  Four days after Lee and Jackson made their comments, SEC Commission Chairman Jay Clayton expressly stated under questioning by the Senate Banking Committee that his agency “should not be in the business of gotcha” enforcement.[2]  At the time, Chairman Clayton was being questioned about the fact that the SEC’s recent mutual fund share class initiative (where the SEC asked advisor firms and broker-dealers to self-report their failure to disclose that they place customers in fund shares paying 12b-1 fees when less expensive fund shares are available) was unfair to the industry because the agency didn’t have a rule on the books that spells out that firms must disclose that they “will” accept 12b-1 fees rather than that they “may” accept them.  In response, Chairman Clayton said: “We should not be in the business of gotcha, but we do need to be in the business of making sure that we enforce our rules.  And if the Commission feels some way about it, we the Commission should articulate it. We shouldn’t be relying on staff guidance.  If there is to be a change in the law or regulation, that should come from the Commission.”

So, while Chairman Clayton hopes that only the Commission will be in charge of “chang[ing] the law or regulation,” it seems inevitable – and accepted by Commissioners Lee and Jackson – that Reg BI will be shaped by “on-the-ground regulatory decisions in the future.”  Those decisions which ultimately will be made by examiners and enforcement personal with, according to Lee and Jackson, little hope of having any further clarity on the nuances of the rule.  In other words, be prepared to hear SEC staff exclaiming “gotcha.”  But unlike when my kids say it, it won’t be fun.

[1] As reported by ThinkAdvisor, at https://www.thinkadvisor.com/2019/12/06/industry-needs-clarity-on-reg-bi-sec-commissioners/

[2] As reported by Financial Advisor Magazine, located here https://www.fa-mag.com/news/battle-between-sec-and-industry-over–regulation-by-enforcement–breaks-into-open-at-senate-hearing-53183.html

This post is about Reg BI, but if you really want to learn about it, as opposed simply to listening to me gripe, I urge you to register for the webcast that my partners Heidi VonderHeide and Rob Betman will present on Wednesday, December 11, 2019, at 2:00 PM EST.  It is just one of four financial services webcasts that Ulmer & Berne is hosting in December.  As previously noted, they are free, and not only that, depending on where you live, they can provide CLE hours, too.  I invite you to register to attend any or all of them by clicking this link. – Alan

I keep reading – I saw another article just today that was quoting Robert Cook, the head of FINRA – that while Reg BI doesn’t go into effect until June 30, 2020, FINRA will nevertheless start testing firms’ “readiness” for Reg BI much sooner.  I find that ironic, since it is not at all clear to me at this moment that FINRA understands the regulation well enough to be able to administer those tests adequately.

Why do I say this?  It’s simply a matter of paying attention to what FINRA has published so far about Reg BI, and hearing more questions than answers, more confusion than clarity.

Consider the FINRA Unscripted podcast with FINRA’s Chief Legal Officer Bob Colby. It’s only 23 minutes long, so if you haven’t listened to it yet, you ought to do so.  But, if you don’t want to make that commitment, I listened to it for you.  And, frankly, the guidance it provides is as about as general as it could be.  Which means it is not particularly helpful.

The biggest problem, in my view, is when he tries to articulate the difference between the current standard that governs the conduct of FINRA member firms and their associated persons – the suitability rule – and the new standard – operating in a customer’s best interest.  What neither FINRA nor the SEC has managed yet to state clearly is how those two standards compare to one another.  At the 4:55 mark in the podcast, Mr. Colby states that Reg BI is meant to be “a heightened standard.”  Great, but what does that mean?  How, exactly, is it “heightened?”  Sadly, he never explains himself.

Then, at 7:25 in the podcast, Mr. Colby says that Reg BI “largely replaces” the suitability rule, at least for retail customers.  But, again, he doesn’t explain how it manages to do that.

Making things even more confusing, and frustrating, is that I then read this article, which was published six days after the podcast was broadcast.  In the article, which relates comments that Mr. Colby made regarding Reg BI at the NSCP’s annual meeting, it states that Mr. Colby told the audience that FINRA is “not going to get rid” of the suitability rule, and that FINRA’s suitability rule and Reg BI “are not going to be in conflict. They’re very close to begin with.”

Assuming that Mr. Colby was accurately quoted in the article, then I do not understand how, on the one hand, he can tell us in the podcast that Reg BI “largely replaces” the suitability rule, but then, on the other hand, also tell us the opposite.  Making matters even murkier, Mr. Colby apparently went on to tell the NSCP members that a recommendation for a retail customer will be “covered by Reg BI and it will be covered by our suitability rule.”  So, both rules apply?

Ok, so what I know from Mr. Colby is this: Reg BI may replace the suitability rule.  But it may not.  Also, both rules will apply to retail customers.

Can you sense now why I am concerned that FINRA is hardly in a position, at least not yet, to gauge how ready member firms are for compliance with Reg BI?  I mean, if FINRA’s Chief Legal Officer doesn’t know enough to be able to cogently explain the interplay between Reg BI and the suitability rule, how the heck are FINRA examiners supposed to figure this out?

More importantly, how are member firms supposed to figure it out?

The one thing that we should all take some comfort in is what Mr. Colby said at 16:25 of the podcast, that come July 1, 2020, when Reg BI is effective and FINRA starts to examine firms for their compliance with the new standard, the examiners will not be looking for “foot faults.”  The problem is, I have heard FINRA senior management use that same phrase before, and like Charlie Brown when he runs up to kick that football that Lucy has teed up for him, I believed what was said to me, only to be disappointed – again – when some examiner apparently failed to get the message and gave one of my clients a hard time about some ticky tack issue.  So, like any good trial lawyer, I view the world through the prism of evidence.  As a result of that, I have dutifully saved a copy of Mr. Colby’s podcast, in the event that someday I need some tangible evidence to remind some FINRA examiner of FINRA’s professed disinterest in foot faults when it comes to Reg BI compliance.

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

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

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

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

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

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

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

FINRA recognizes this problem, but blithely shrugs it off:

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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