Broker- Dealer Law Corner

Broker- Dealer Law Corner

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

Posted in Arbitration, FINRA, PIABA

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

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

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

2014:   38%

2015:   42%

2016:   41%

2017:   43%

2018:   40%

2019:   44%

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

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

2014:   42%

2015:   45%

2016:   42%

2017:   45%

2018:   42%

2019:   44%

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

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

All Public Panel          2 Public/1 Industry Panel

2014:               44%                             38%

2015:               47%                             45%

2016:               43%                             36%

2017:               48%                             37%

2018:               42%                             47%

2019:               55%                             29%

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

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

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


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

Posted in Disciplinary Process, Enforcement, FINRA, Sanctions

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

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

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

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

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

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

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

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

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

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

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

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

Why Is FINRA So Interested In Your Non-Securities Business?

Posted in Crypto, digital assets, FINRA

Rightly or wrongly, I don’t know much about cryptocurrencies or digital coins. But that’s ok. What is worrisome, on the other hand, is that I am increasingly concerned that FINRA doesn’t either. And while my own ignorance will have exactly zero impact on your day, that is most certainly not the case with FINRA.

I came to this conclusion after reading Reg Notice 19-24, released last week. On its face, the Notice seems fairly benign. What it does is extend by one year FINRA’s “request” that “each member keep its Regulatory Coordinator informed of new activities or plans regarding digital assets, including cryptocurrencies and other virtual coins and tokens.” You may recall that last year, in Reg Notice 18-23, FINRA issued its initial request for this sort of information through the end of July 2019. Now, FINRA is “encouraging” its member firms to keep this up for another year, through July 2020.

I don’t have any real problem with this “request,” apart from my usual cynicism when FINRA uses this particular word. Remember: FINRA characterizes its use of Rule 8210 as “requests” for documents and information, as if the recipient has a choice whether or not to respond, when, in fact, the failure to respond to the “request” can result in a permanent bar from the industry. No, my problem is that as FINRA attempts to gets its head around digital assets, as a result of the fact that it doesn’t necessarily understand the regulatory issues that such products will ultimately generate, it is asking for information beyond that which it is entitled to receive.

What do I mean? FINRA asks in the Reg Notice that firms supply all information regarding their activities relating to digital assets regardless “whether or not they meet the definition of ‘security’ for the purposes of the federal securities laws and FINRA rules.” This is a recurring problem my clients have when dealing with FINRA, i.e., having it stick its nose, or attempt to stick its nose, into things over which it has no regulatory authority. I am dealing with a case right now that presents a perfect case-in-point. My client, a broker, sits on the board of a company (not in the securities industry) that – years ago, well before any FINRA exam was commenced or even contemplated – passed a resolution that states that for privacy reasons, no corporate documents can be produced to any entity apart from a governmental agency or in response to a legally issued subpoena. Nevertheless, FINRA – which is not part of the government and has no subpoena authority – continues to “ask” my client (through 8210 letters) to produce corporate documents. Ultimately, there may be a showdown with FINRA over whether my client “controls” the requested documents because he is also the majority shareholder, which permits him – at least theoretically – to dictate the composition of the board, and create one that includes people willing to give FINRA the documents…which have nothing to do with any BD.

But I digress. What I was saying is that FINRA continues to push the boundaries of its jurisdiction, and not necessarily for any particularly good reason apart from the fact that it thinks it can. Here, FINRA wants to know everything that its member firms are doing with digital assets, regardless of whether or not such assets are securities. But, if they’re not securities, they’re not FINRA’s problem. That’s not, however, as FINRA sees it. FINRA likes to take existing rules and stretch them to their limits as a means of justifying its interest in non-securities business. In footnote 4 of the Reg Notice, FINRA makes this explicit when it writes that “[f]irms that engage in activities related to digital assets, whether or not they are securities, are reminded to consider all applicable FINRA rules and federal and state laws, rules and regulations.”

What the heck does this mean? I could be wrong, but seems to me that FINRA is making clear its view that it has the right to examine even non-securities business under the guise of some existing rule or regulation. And you need not even have to guess which ones. The footnotes make reference to Rule 3270, the outside business activity rule; Rule 3280, private securities transactions; trade reporting obligations; and both NMAs and CMAs. The point is, FINRA apparently feels that its existing arsenal of rules provide it sufficient coverage to require BDs to make disclosures about their non-securities business. But, that is not necessarily true, no matter how much FINRA may want it to be so.

And going back to my initial point, it is unclear, and troubling, that FINRA wants all this information even though at present it has no idea what, if anything, it means, or how it might possibly advance its interest in regulating the securities market. It was not too long ago that FINRA tried mightily to become the regulator of choice for investment advisors, but failed, rather publicly. Among the criticisms that were leveled at FINRA at the time was the thought that expanding the scope of its regulatory authority to include IAs was a mistake in light of the fact that FINRA was already challenged enough to do a decent job of that which it is mandated to do, i.e., regulate BDs. My point is simple: FINRA should stick to its knitting. Rather than worry about how/if it is going to deal with non-securities products such as certain digital assets, it would be better off spending its time and money and efforts becoming better at what it is required to do.

Make No Mistake, PIABA Cares About One Thing: Getting Paid

Posted in Arbitration, FINRA, PIABA

If you read this blog even semi-regularly, you know that I have taken a few shots at PIABA. I think they’re well earned, but some people – particularly PIABA lawyers, not surprisingly – have suggested that I’m overdoing it. Well, if you ever had any doubt that the motivation behind pretty much everything that PIABA does is simply doing whatever it can to ensure that its attorneys get paid, just take a look at PIABA’s comment to FINRA’s recent proposal to address rogue broker-dealers.

I have already written about that proposal, which is flawed in a number of fundamental ways, in my view. As expected, it elicited a bunch of comments. PIABA submitted its own comment, naturally, and, in a development that surprised exactly no one, it stated that its principal concern with the proposed rules is that they “will not cure the long-standing unpaid arbitration award issue.” Well, there you go. Leave it to PIABA to take a proposal designed by FINRA to address misconduct by rogue brokers and rogue firms – or as FINRA expressly phrased it, “to address the risks that can be posed to investors and the broader market by individual brokers and member firms that have a history of misconduct” – and focus instead on another issue, i.e., the one component of that proposal that impacts PIABA members’ pocketbooks. That is, rather than acknowledging that the proposal’s primary goal is to eliminate (or at least deter) misconduct, PIABA has chosen instead to complain that perhaps the most ridiculous aspect of the rule proposal – the creation of a fund, sourced by the BD itself, with money that would not constitute an allowable asset in the firm’s net capital computation, and which cannot be used for any purpose other than the satisfaction of a customer claim – somehow doesn’t go far enough to ensure that arbitration claimants – and their lawyers, of course – get paid.

PIABA selfishly misses the point of the proposed rule. The requirement that a BD would have to put money aside solely for the benefit of claimants who choose to file arbitrations is so absolutely crazy, so ridiculous, so financially devastating, that FINRA clearly hopes and expects that to avoid it, any reasonable BD would fire enough “bad” brokers to fall below whatever numerical threshold FINRA establishes to qualify for the sanction. In other words, FINRA probably doesn’t actually expect any firm to have to create these pools of money devoted exclusively to arbitration claimants; rather, it knows that this requirement will serve as a deterrent so grotesque that no firm would ever allow it happen.

I suppose that is the real problem for PIABA. That these pools of money may never, in fact, materialize, as firms do whatever they can to avoid the need to fund them. And there, right there, is your window into PIABA’s soul: it does not care at all that the rule proposal may conceivably achieve what FINRA intends, i.e., a reduction in the number of RRs at any given firm with significant disciplinary histories. PIABA doesn’t care about that . . . unless that result is accompanied by a requirement that the pools of money be established. Cleaning up the securities industry is, quite plainly, not PIABA’s goal. That would be ok, but, ultimately, it is not nearly as critical to PIABA as ensuring that arbitration awards get paid.

PIABA’s priorities are clear. Anyone who actually believes that PIABA is interested in eliminating bad reps or bad firms is delusional. Indeed, imagine a perfect world where no RR ever does anything wrong. There would be no one to sue! No arbitrations to file! But, alas, no legal fees to be earned. That is not the world that PIABA dreams about. It wants bad reps. It wants bad firms. So they can be named in arbitrations.

A Glaring Example Of FINRA Dragging Its Feet, Culminating In A Pointless Default Decision

Posted in Disciplinary Process, Enforcement, Examination, FINRA

FINRA loves to tout its supposed intent to bring meaningful cases, cases that matter to the investing public, rather than enforcing “foot faults,” as it has been accused of doing over the years. My own experience with FINRA suggests that while it talks a big game, in reality, we all still live in foot-fault city.

I stumbled across this decision recently, and it serves as a good example of two problems that FINRA has. First, FINRA is, at times, maybe most times, hardly the model of efficiency when it comes to promptly bringing cases against perceived bad guys. Second, it reflects how FINRA is still willing to spend its finite resources, in terms of time, manpower, and money, on an utterly fruitless pursuit, resources that anyone would agree – including the FINRA lawyers who brought the case and the Hearing Officer who had to consider the evidence – would have been better spent on something else.

The case started out normally, with FINRA filing an Enforcement action against the broker-dealer in 2017, alleging a number of nasty sounding historical sales practice violations. According to the decision, however, and for reasons that went unexplained, the complaint was filed five years after the exam of the matter was started, and fully four years after the matter was referred to Enforcement. From the defense perspective, that is a long time. A long time for documents to be preserved, for witnesses’ memories to remain intact. Remember: FINRA is not restricted by statutes of limitations (like the SEC, or like civil litigants), but it is still supposed to be procedurally fair to respondents, and one aspect of that fairness is not waiting too long to file a complaint.

Anyway, four of the firm’s registered representatives and two of its registered principals, including the firm’s president and its CCO, settled with FINRA. But not the firm, which answered the complaint and requested a hearing. After some delays – requested jointly by FINRA and the firm – that hearing got scheduled for December 2018. And here is where it got weird. In early October 2018, two months prior to the hearing, the firm filed Form BDW, to withdraw from FINRA membership. Consistent with that, later that month, the firm (through its president, since its attorney had been granted permission to withdraw) announced that the firm was not going to participate any further in the proceeding (for the simple reason that it was out of business). Days before the hearing was scheduled to start, the SEC terminated the firm’s registration. At the end of December 2018, FINRA also terminated the firm’s registration.

Despite all this, that is, despite the fact that FINRA had already gotten its settlements from the individuals who had been associated with the firm, and despite the fact that the firm’s registration had already been terminated, FINRA proceeded to issue a farcical “default” decision. Why farcical? Because it is based solely on the allegations in the complaint, as supported by an unopposed Declaration of a FINRA examiner effectively swearing that those allegations are well founded and supported by real evidence. Kind of difficult for FINRA to lose one of these.

In the Decision, even though it acknowledged that the firm was dead, FINRA proceeded nevertheless to impose significant monetary sanctions, including a $400,000 fine plus restitution to customer. These sanctions, of course, cannot be collected, inasmuch as a federal court determined years ago that FINRA has no legal ability to sue to collect its monetary sanctions. So, these numbers are meaningless, except, perhaps, to FINRA, since they help pad the total when FINRA tallies up at the end of the year just how many dollars in fines it imposed. Which, if that’s the motivation, is wrong. Indeed, you may recall not too long ago that FINRA was taken to task by the General Administration Office for including in its annual statistics fines imposed in cases in which the respondent was permanently barred (i.e., fines that had precisely zero chance of ever being paid), which the GAO felt was a bit misleading. (This resulted in a change of FINRA policy, and the elimination of the fine in bar cases.)

So, what do we have here? A case that took FINRA five years to file, resulting in a pointless default decision against a defunct firm that imposed meaningless monetary sanctions. All accomplished by spending money supplied by its member firms. Let me be clear about something: the fact that FINRA managed to tag the five individuals here is not a bad thing. If they violated the rules, they deserve the consequences. And if the violations were serious, as they appear to have been, those consequences are appropriately harsh. Those individuals who were not barred now have a disciplinary record that will follow them throughout their careers, which is how the system is designed. But, that is not true for the firm. It was already dead when FINRA shot it. What was the point?

The problems with this case boil down to two things. First, it is simply unfair for any respondent to be required to defend a case brought five years after the exam. FINRA needs to do something to accelerate the pace at which it conducts, and concludes, its exams, especially given the lack of any statutes of limitations. Second, FINRA should stop wasting its time – and members’ money – on activities that achieve nothing. Stated another way, FINRA should start to actually care about efficiency. Drop stupid cases early. Stop sending five people to OTRs. Indeed, better yet, eliminate some of the bureaucracy that chokes swift progress. I have said this before, but it bears repeating: when I joined NASD in 1993, there were fewer than ten corporate vice presidents; today, I believe the number has swelled to well over 100. Yet, somehow, NASD managed to regulate thousands more member firms than FINRA handles today. The bloat at FINRA’s middle-manager level – the people who have to sign off on exam dispositions, settlements, sanction recommendations, etc. – is daunting.

Implicit Recommendations To Hold: FINRA’s Suitability Rule Goes Toe-To-Toe With SEC’s Regulation BI

Posted in FINRA, Suitability

Nearly ten years ago, FINRA decided to update its old suitability rule, NASD Rule 2310. It had been around a long time, and while it seemed to work fine, FINRA decided to incorporate into the new amended rule – FINRA Rule 2111 – some new concepts. One such concept concerned recommendations to hold. Under the old rule, only recommendations to purchase, sell or exchange a security had to be suitable. Under the new rule, FINRA added to that list recommendations to hold, provided, of course, that such recommendations are “explicit.”

And that’s been the law of the land since July 2012. There was a great deal of consternation, at first, as firms tried to figure out what, exactly, constituted an explicit recommendation to hold, and, more troubling, the best way to capture such recommendations from a books-and-records perspective. (Since no order ticket is generated by a hold recommendation, firms had to come up with some method of memorializing them, and that was a bit tricky.) But, really, it hasn’t turned out to be that big of a deal. To be honest, I don’t think I’ve ever seen a FINRA disciplinary action that involved an allegation that a broker made an unsuitable recommendation to hold.

The only place where recommendations to hold have managed to become the focus of any attention are in customer arbitrations, particularly cases where the recommendation to buy the investment at issue was made a long time ago. Pursuant to the “eligibility rule,” FINRA Rule 12206, for a claim even to be eligible for arbitration, the Statement of Claim must be filed within six years of the date of the event or occurrence which gives rise to the claim. Thus, if the purchase was made more than six years before the Statement of Claim was filed, the case is subject to dismissal. To avoid such dismissals, clever lawyers representing investors bake into their Statements of Claim vague allegations that at some time – typically no date is specifically identified – within the six-year period preceding the filing of the Statement of Claim, the BD and/or the broker made an unsuitable recommendation to hold the investment at issue. These claims serve one purpose: to avoid dismissal for being untimely. At the hearings, if the cases get that far, claimants devote almost no effort to pursue their hold claims.

Anyway, apart from that particular situation, no one really pays much attention to recommendations to hold, since it’s pretty hard to establish that a recommendation was sufficiently explicit to be actionable.

Under Regulation BI, however, things will be different. The reason is that Regulation BI states that, under certain circumstances, even implicit recommendations to hold must be suitable. This will undoubtedly open the door both to increased regulatory actions and customer arbitrations.

What are the circumstances? According to the SEC,

when a broker-dealer agrees with a retail customer to monitor that customer’s account . . . such agreed-upon monitoring involves an implicit recommendation to hold (i.e., recommendation not to buy, sell, or exchange assets pursuant to that securities account review) at the time the agreed-upon monitoring occurs, which is a recommendation “of any securities transaction or investment strategy involving securities” covered by Regulation Best Interest.

What’s troubling about this to me is that the SEC has also concluded that “[a]n agreement to provide account monitoring services to a retail customer is not required to be in writing.” Thus, “a broker-dealer’s oral undertaking that the broker-dealer will monitor the retail customer’s account on a periodic basis would create an agreement to monitor the account on the terms specified orally.”

That, my friends, is quite the slippery slope, opening the door to potentially ugly arguments about who said what to whom about account monitoring. In an entirely unhelpful passage addressing this issue, the SEC says, “[w]hether an agreement with the retail customer has been established in the absence of a written agreement or express oral undertaking will depend on an objective inquiry of the particular facts and circumstances, including reasonable retail customer expectations arising from the broker-dealer’s course of conduct.”

Ugh. The dreaded “facts and circumstances” regulatory cop out. That means it’s going to be the wild west. No legal precedent, no guidance from the regulators, just lawyers posturing about what they think the SEC meant.

So, is there anything to do about it, to avoid this problem? It seems that there is. After announcing this problematic standard, the SEC offered this advice:

In cases where a broker-dealer does not intend to create an implied agreement to monitor the retail customer’s account through course of conduct or otherwise, and to avoid ambiguity over whether an implied agreement has been formed, broker-dealers should take steps to ensure that all communications with the retail customer are consistent with its disclosures required under the Disclosure Obligation, which in this case would require the broker-dealer to clearly disclose that the broker-dealer does not monitor the retail customer’s account.

I am not entirely clear what this means. But, on its face, it appears to say that if a BD wants to avoid having any of customer being able to establish that the firm orally agreed to monitor his or her accounts – thus subjecting the firm to an argument that it made unsuitable albeit implicit recommendations to hold – the BD must clearly and consistently deny, in writing, that it monitors accounts. As you can divine for yourself, this is hardly a foolproof defense, since no matter what is disclosed in writing, it doesn’t mean the customer can’t claim he was orally told something different by his broker. But, hey, if the SEC says this is what you need to do, then, by all means, load up your customer agreement with disclaimers about account monitoring.

What’s the good news? Clearly, according to the SEC, there is no duty to monitor a customer’s account in the absence of an agreement to do so. That may seem like an obvious, uncontroversial proposition to some of you. I can assure you, however, that when defending a customer arbitration, it is extremely common for the claimant to argue that my client had some duty – after making the initial recommendation to buy the security at issue – to monitor the account on an ongoing basis, and, based on market conditions, to make some other recommendation (typically to sell and buy something else). Most hearing panels understand this duty doesn’t actually exist, but there are a couple of old reported cases out there from random jurisdictions that employ language sloppy enough to support a duty-to-monitor argument, and claimants’ counsel can be counted on to trot out these same decisions, case after case. In light of the SEC’s new pronouncement, however, that argument goes out the window.

One final point. The SEC isn’t stupid, and understands that its view that an implicit recommendation to hold must be suitable is contrary to FINRA’s suitability rule, which applies only to explicit hold recommendations. In an effort to assuage any concern that it is dissing FINRA, the SEC said that it

recognizes that its position with respect to Regulation Best Interest differs from that provided in FINRA guidance regarding whether implicit hold recommendations are subject to the suitability rule. This interpretation applies in the context of the protections of Regulation Best Interest, and does not change the scope of the application of the FINRA suitability rule. Further, while for purposes of Regulation Best Interest implicit hold recommendations are generally recommendations of “any securities transaction or investment strategy regarding securities” where a broker-dealer agrees to provide account monitoring services, we are not otherwise addressing the treatment of implicit hold recommendations in other contexts. In other words, except where a broker-dealer agrees to provide account monitoring services as described, consistent with existing FINRA guidance, Regulation Best Interest will only apply to explicit hold recommendations.

Ok, so both views are valid? I can’t wait to see how this let’s-figure-out-if-there-was-an-agreement-to-monitor thing plays out.

A Fish Out Of Water? A Futures Clearing Firm In A FINRA Arbitration

Posted in Arbitration, Commodities, FINRA

I am fortunate to have Ken Berg, a commodities regulatory guru, just down the hall from me, so I’ve never had to learn that stuff too well.  But, here, as you will see, there can be considerable overlap between the securities and the commodities regulatory regimes.  The decision that Ken writes about arose in the context of a commodities purchase, but it may have a significant impact on securities arbitrations.  It makes good reading, therefore, even for BDs that don’t trade commodities. – Alan

I have previously written about issues uniquely affecting individuals who are dually registered as securities representatives (Series 7) and commodities associated persons (Series 3). In an Opinion and Order issued June 4, 2019, Judge Joan Lefkow, a federal district court judge in the Northern District of Illinois, ruled on an issue uniquely affecting firms that are dually registered as securities broker-dealers and commodities futures commission merchants. An issue that arises not infrequently is whether a customer who trades only commodities can force the clearing firm to arbitrate at FINRA instead of at the NFA. Judge Lefkow said, “no.”

The facts are typical. The firm has a “division” registered with the SEC as a broker-dealer and is a member of FINRA. The firm also has a “division” registered with the CFTC and is a member of NFA. A group of about 300 customers opened commodities accounts traded under a written power of attorney by an independent commodity trading adviser (“CTA”)[1] who made all trading decisions. Pursuant to the customer agreement, trading was limited to commodities futures contracts and options, and the FCM’s responsibility was limited to clearing the trades on commodity exchanges. Customers signed an arbitration agreement in a form prescribed by CFTC Regulation 166.5 that requires the FCM to provide a customer with a choice of three arbitral forums. If the customer fails to select one of these forums within 45 days, the FCM can choose.

The CTA trading these accounts specialized in selling naked natural gas options. In November 2018, natural gas prices spiked about 30%, placing the customers’ accounts on margin calls. The FCM liquidated the customer accounts as required by exchange rules, resulting not only in a loss of all funds deposited by the customers but also sizeable unsecured debits.

The customers filed arbitrations at FINRA alleging the firm violated the Commodity Exchange Act. The FCM notified the customers that they could choose to arbitrate at NFA, the Chicago Mercantile Exchange, or the AAA. The customers ignored the FCM’s notice and persisted in prosecuting their FINRA arbitrations. After 45 days passed, the FCM filed debit collection arbitrations against the customers at the NFA and an action in federal court seeking (i) an injunction to halt the FINRA arbitrations; (ii) a declaration that FINRA lacked jurisdiction; and (iii) an order compelling the customers to proceed with arbitration at the NFA under § 4 of the Federal Arbitration Act.

Three rulings by the district court are significant: 1. Even absent diversity, the court held it had subject matter jurisdiction because there was a federal question. 2. Even though the firm was a “member” of FINRA, it did not agree to arbitrate these disputes at FINRA because these were not “customers” under FINRA Rule 12200.  3. Even though firms have been sanctioned for seeking anti-arbitration injunctions, the court denied the customers’ request for sanctions.

The Federal Arbitration Act does not create subject matter jurisdiction in federal court, so absent diversity or a federal question, a federal court cannot hear a dispute just because it involves arbitration of interstate transactions. For example, a motion under § 12 of the FAA to vacate a FINRA securities arbitration award or an NFA commodities arbitration award cannot be brought in federal court if the parties are not diverse. Here, however, Judge Lefkow held that if the underlying controversy could have been brought in federal court but for the arbitration agreement because the claims allege violations of the securities or commodities laws, under § 4 of the FAA a court may “look through” the arbitration agreement and find federal subject matter jurisdiction.

FINRA Rule 12200 requires a member to arbitrate disputes with its “customers” that “arise in connection with the business activities of the member ….” Even though Rule 12200 does not define “customer,” Judge Lefkow held that “customer” means a person who engaged in “FINRA-regulated activities” with the member. Here, the customer agreement permitted the purchase and sale of commodities products regulated by the CFTC only. The court concluded that the firm did not agree to arbitrate these claims at FINRA and noted that its interpretation of FINRA Rule 12200 “harmonizes” the separate regulatory schemes for commodities and securities carefully established by Congress. (Query, whether a dually registered firm with a customer who was hedging his securities portfolio with S&P futures would be able to avoid arbitration at FINRA even if the claim involved only a botched execution of a futures order?) The court’s holding has broader implications for arbitrability of disputes at FINRA in the context of “outside business activity” claims against broker-dealers and claims involving independent contractors who market both securities for the broker-dealer and fixed income insurance products that are not securities.

Finally, in the not-so-distant past it was common for a broker-dealer or FCM to charge into court to enjoin a customer-initiated arbitration that was filed beyond the statute of limitations or beyond the FINRA (6 years) and NFA (2 years) eligibility rules. Now, sanctions on firms seeking anti-arbitration injunctions have chilled such litigation, however. Courts have imposed sanctions because “it is impossible to suffer irreparable harm from arbitrating a claim.” Here, Judge Lefkow declined to impose sanctions on the FCM because “it does not seek an injunction to resist a court order or agreement to arbitrate; it seeks an injunction to effectuate one [i.e., the NFA arbitration].” She noted that injunctions enjoining arbitrations are expressly contemplated by § 16 of the FAA, so it cannot be that all suits to enjoin arbitrations are sanctionable.

In sum, Judge Lefkow found that FINRA lacked jurisdiction, compelled the customers to proceed with arbitration at the NFA, and denied the customers’ request for sanctions. On June 12, 2019, the customers filed a notice of appeal. INTL FCStone Financial, Inc. v. Jacobson, Case No. 19 C 1438, 2019 WL 2356989 (N.D. Ill. Jun. 4, 2019).

[1] A CTA is the commodity industry’s analogue to a registered investment adviser in the securities industry.

FINRA Touts The Fact That Its Examinations Need Not Be “Fair”

Posted in Disciplinary Process, Enforcement, Examination, FINRA

While I feel I have enjoyed as much success defending respondents in FINRA Enforcement matters as anyone, I am still careful to caution clients who are unwilling to consider any settlement that going toe-to-toe with FINRA at a hearing is always a difficult proposition, even though they are presumed innocent and FINRA bears the burden of proof. No matter the facts, no matter the allegations, magically, decisions by the Hearing Officer, and by the panel itself, seem to go FINRA’s way. It is, simply, very hard to convince anyone that FINRA is even capable of being wrong. About anything.

Take this example, found in a NAC decision released last week. The case involved an alleged failure by a BD to conduct on-site branch audits. FINRA’s interest got initially piqued when it conducted a routine exam of a particular branch office that was supposed to be subject to monthly on-site visits, as a consequence of the fact that the RR in that office was subject to a Heightened Supervision Plan that included such a requirement. During the course of that exam, the RR initially told the examiner that those exams hadn’t happened, but then he changed his story and told FINRA that, in fact, they had happened.

Given that interesting development, FINRA elected to expand the exam, to see if other branch audits had taken place. I have no problem with that decision; indeed, that’s how audits are supposed to work. But, here is where it gets truly scary. Rather than test a random sample of the firm’s branch offices, FINRA deliberately restricted its review only to former RRs of the firm, i.e., guys who no longer worked there. Many of whom, admittedly, carried a grudge against the firm. From that limited, intentionally skewed sample, FINRA got a few people to claim that the annual visits hadn’t happened, and, based, on that, brought an Enforcement action.

If I stopped here, I think you would agree that this is already bad enough. Everyone understands that FINRA exams don’t look at everything a BD does; that would be impossible. Rather, the exams focus on some sample of the firm’s business, and, if that sample yields funky results, then the sample is expanded. The thing is, the initial sample is supposed to statistically significant. I am not a statistician, but I understand enough to know that if you deliberately skew the sample in one direction, the results are immediately and obviously subject to question. That is exactly what happened here, when FINRA chose only to talk to former RRs of the firm. For that reason alone, the exam results should have been deemed by Enforcement to be flawed, and the referral by Member Reg to Enforcement should have been denied. Instead, Enforcement gladly shrugged off the problem and blithely proceeded with the case.

But, it gets worse. At the hearing, perhaps in anticipation of cross-exam, the FINRA Enforcement lawyer questioned the examiner about the decision to restrict the follow-up exam only to cherry-picked former RRs. In a display of hypocrisy that rivals that of any politician, the examiner swore under oath that she consciously didn’t reach out to current RRs because she “didn’t want to disrupt [the firm’s] business.”[1] I’m sorry, but are you kidding me? This sworn testimony comes from an examiner who works for a regulator that, among other things, happily conducts surprise exams, arriving unannounced with a team of people who upon arrival don’t exactly sit quietly in a conference room, studiously careful not to disturb anyone. A regulator that routinely sends lengthy and serial 8210 requests that take hours, or even days, to respond to, time that would otherwise be spent on “business.” A regulator that is comfortable “requesting” that individuals travel at their own expense great distances to supply sworn testimony at OTRs, taking days out of their workweek. I thought it was laughable when Secretary of Commerce Wilbur Ross testified that the desire to add the citizenship question to the upcoming 2020 census was out of concern for the enforcement of the Voting Rights Act, but, compared to that, this testimony from the FINRA examiner may be the funniest thing I ever heard.

And, it gets worse.

On appeal to the NAC from the hearing panel’s decision, the respondents appropriately complained about the patent unfairness in the exam, citing Section 15A(b)(8) of the Exchange Act, which requires that FINRA provide a “fair procedure.” Well, it seems that the fairness requirement “does not extend to investigations.” According to the SEC authority cited in the NAC decision, only the adjudicatory proceeding has to be fair, apparently, but not the exam that leads to the proceeding, which commences with the filing of the complaint. So, anything that happens up to that point, since it is not part of the proceeding, need not be fair. With that in mind, the NAC just ignored the problem with the biased exam sample that FINRA selected, and, focusing exclusively on the proceeding, concluded there was no unfairness.

It is, frankly, difficult to believe that FINRA is content to operate under such a silly standard of conduct. I have repeatedly complained that FINRA rarely holds itself to the same standards as those to which its member firms are held, and that if it had to do so, it would routinely come up well short. This is just one more example of that, granted, a pretty gruesome example. So what is the solution to an exam that is being conducted in an unfair manner? Complain to the Ombudsman? Complain to Robert Cook himself? Sadly, I don’t have a good answer. But, I can tell you that you cannot count on the hearing panel to care, or the NAC, or even the SEC, since they seem only to care about fairness once you’ve been named as a respondent. Political action, as slow and uncertain as that is, may represent the only solution to this problem. Get involved, then, with FINRA, and express your views. Loudly, if necessary. Otherwise, the next time it might be you.

[1] The examiner testified that there was a second reason, as well, that she felt the firm’s owner had influenced the RR to change his story regarding whether the monthly heightened supervisory audits had taken place, and she wanted to avoid a recurrence of that. Naturally, the hearing panel bought that story, too.

Do Customers Actually Use BrokerCheck? This FINRA Complaint Suggests They Don’t

Posted in BrokerCheck, Enforcement, FINRA

I heartily endorse this post from my colleague, Chris, who’s been quiet of late.  It says a lot about FINRA, in terms of how it deigns to spend your assessment money, how fairness in the Enforcement process can be completely illusory, and how it is consistently unable to convince much of the investing public that it is serving any real function. – Alan  

FINRA’s mission is “investor protection.” In furtherance of that goal, FINRA has devoted significant resources to its BrokerCheck database, which allows investors to look up their broker, or potential broker, and check his or her background for any red flags that might give the investor reason to shy away from that broker. Basically, FINRA wants you to know which brokers might be “bad seeds” so that you, as an investor theoretically concerned with safeguarding your money, will avoid giving it to anyone with a less than perfectly clean past. And by perfectly clean, I mean perfectly – not only does FINRA want investors to know about past customer claims and regulatory actions brought against the broker, but also past terminations, tax liens, and bankruptcies. In theory, if an investor sees any of these things on his broker’s BrokerCheck report, the investor will run the opposite direction with his or her money. But does that really happen?

A recent Complaint suggests the answer is “no.” FINRA’s Complaint alleges that two brokers, Kim Kopacka and Beth Debouvre, allowed Ms. Kopacka’s husband to conduct securities business and sell securities through a member firm, despite the fact that FINRA barred him from the industry in 1998. In essence, the Complaint alleges that after Mr. Kopacka was barred from the industry, his wife became registered and set up an office where Mr. Kopacka continued meeting with clients and selling them securities. Allegedly, his wife had no involvement with the clients and simply listed her name on paperwork as the registered representative of record handling those clients and those transactions. The Complaint alleges that from 2002 to 2016, Mr. Kopacka sold over $40 million in private placement securities to over 280 different customers – all while being barred from the industry.

If the conduct alleged in the Complaint is true (and that’s a big “if”), it raises several interesting questions. The first question that comes to mind is, why did it take FINRA 15 years to figure this out? The office where Mr. Kopacka was allegedly operating consisted of only himself, his wife (who was almost never present, allegedly), and a supervisor. Didn’t any FINRA audits of the office take place in 15 years? Didn’t anyone notice that a registered rep who was barred from the industry has a spouse who only took interest in becoming registered after her husband was barred, and that she suddenly started selling millions of dollars of unregistered securities, despite the fact that she had zero experience in the industry? And, how can FINRA bring a case against these reps for conduct that started (and arguably should have been detected) over 15 years ago? What about statutes of limitations? If you are interested in that issue, check out our prior blog post here.  The short answer is, traditional statutes of limitations do not apply to FINRA Enforcement actions. So, yes, you might be forced to defend something that you did in the prior millennium.

The other interesting question is, how did over 280 customers allegedly think it was a good idea to take investment recommendations from someone who was barred from the industry? There are only two answers: either they didn’t know that Mr. Kopacka was barred, or they didn’t care. Now, BrokerCheck has been available online since 1998, and it was significantly updated in 2007 to include many additional disclosures about brokers. If you search BrokerCheck for a person who has been barred, it is hard to miss the warnings that FINRA provides: on the search result page, the broker’s name will be inside a red box, and the word “BARRED” will appear in bright red directly under his or her name. If you click on the details for that person, FINRA will explicitly tell you that “FINRA has barred this individual from acting as a broker or otherwise associating with a broker-dealer firm.” It’s pretty hard to miss.

So, in Mr. Kopacka’s case (if FINRA’s allegations are true, and again, that’s a big “if”), the fact that Mr. Kopacka was barred was available to 280 customers and yet they allegedly decided to hand Mr. Kopacka over $40 million anyways. It’s probably safe to assume that 280 customers would not knowingly invest with someone who was barred from the industry, just like 280 people probably would not go to a doctor or any attorney if they knew his or her license had been taken away. So those 280 customers either didn’t know that BrokerCheck existed, or they chose not to use it. Both of those scenarios pose a problem for FINRA and its goals of protecting investors, particularly the casual investor.

FINRA often considers increasing the amount of information available on BrokerCheck. FINRA also makes it difficult for brokers to expunge information from their CRD records that appears in BrokerCheck (and FINRA is considering additional rules that will make expungement even more difficult). But, if customers are not actually using BrokerCheck to research their brokers, like the 280 investors in this case apparently didn’t do, then it doesn’t matter how many disclosures are made on the system.


FINRA Proposes To Dispense With Due Process, All Because It’s Failed To Do Its Job Of Policing The Markets

Posted in Disciplinary Process, FINRA, High-Risk firms

Reading Reg Notice 19-17 makes me think of the legal arguments that I’ve recently read regarding whether a president can be found guilty of obstructing justice if the actions in question were taken out in the open, for everyone to see. Here, FINRA’s proposed power grab is simply outrageous, but, you got to give them credit, it is certainly being done right out there for everyone to see. It doesn’t make it right, however, no more so than tweets designed to intimidate witnesses or steer DOJ investigations.

This is a long, sometimes boring Reg Notice. I wonder if, perhaps, FINRA didn’t deliberately publish a 43-page bear of a document, burdened with charts and 53 footnotes, with the specific intent of dissuading people from reading the whole thing, and figuring out what it’s all about. Lucky you, though, as I read it for you. And, frankly, if you harbor any degree of affinity for concepts like due process or presumption of innocence, you would undoubtedly be appalled by the time you finish it.

The notice addresses FINRA’s recently contrived concerns about “high-risk” firms. According to FINRA, there are certain firms that “have a history of misconduct” with “persistent compliance issues.” According to FINRA, academic studies statistically prove that these firms – which are called “Restricted Firms” here – are more likely than other firms to have disciplinary issues going forward. While FINRA claims that such firms have been “a top focus of FINRA regulatory programs,” it nevertheless complains that its “existing examination and enforcement programs” are inadequate to address the threat that these firms present. So, FINRA is offering a solution.

Before I get to that, let me first revisit what continues to remain a sore point for me. FINRA’s public stance is to express its dismay, even outrage, that these firms with relatively extensive regulatory histories still manage to exist, notwithstanding everything that FINRA has thrown at them from its already considerable arsenal of regulatory weapons. What FINRA has steadfastly refused to concede, however, is that the fact these supposedly terrible firms, firms that FINRA insists manifest a statistically proven likelihood of continuing misbehavior, have not yet been expelled from the industry is either (1) FINRA’s fault, or (2) because expulsion wasn’t necessary. How, after all, does a BD get a regulatory history? When it is named as a respondent in a disciplinary action. Who brings those actions? FINRA. Who decides what charges to file? FINRA. Who decides what sanctions to impose? FINRA. If FINRA has not been able to bring a disciplinary action against a “high-risk” firm that included charges or resulted in findings sufficient to result in the BD getting kicked out of the industry, it can only mean one of two things: either FINRA didn’t do its job, or, equally possible, the firm simply didn’t deserve to be expelled. With the current proposal, however, FINRA urges readers to conclude that these firms continue to operate, like cockroaches after the nuclear apocalypse, not because FINRA hasn’t been tough enough, and not because the evidence wasn’t there to justify an expulsion, but, rather, because FINRA’s existing regulatory tools are somehow inadequate. I just don’t buy that.

Ok, let’s get to the proposal. As I have previously complained about, the starting point for this proposal is FINRA’s need to define what a “high-risk” or “Restricted” firm is. No such definition exists, of course, so FINRA has to conjure one up. To do this, FINRA suggests a multi-step process, I suppose designed to give some impression of fairness, but which, ultimately, boils down to this: a firm is “high-risk” simply because FINRA says it is.

What FINRA proposes to do is create a quantitative standard for each firm, comprised of six bad facts about the firm and the firm’s registered persons. You give the firm a point for each bad fact – “adjudicated”and “pending events” for both the firm and its reps, plus terminations and internal reviews of reps – add them up and divide by the number of reps at the firm, yielding the “average number of events per registered broker.” Then, you take the number of reps at the firm who came from a “previously expelled firm,” divide that by the total number of reps, resulting in a percentage concentration.

Armed with these data, FINRA will then numerically compare the firm to its peers, based on size. (FINRA proposes seven size categories, “to ensure that each member firm is compared only to its similarly sized peers.”) While there are some nuances to that comparison, essentially, if the firm sticks out from the pack in a bad way, based solely on this quantitative analysis, it is deemed, at least preliminarily, to fall within the new rule.

But, it wouldn’t be fair to label a firm bad based solely on numbers, right? So, the next step in the process is that FINRA then conducts an “initial internal evaluation.” The stated purpose of this evaluation is “to determine whether [FINRA] is aware of information that would show that the member – despite having met the Preliminary Criteria for Identification – does not pose a high degree of risk.” In other words…based on FINRA’s subjective consideration of the data – data that FINRA compiled pursuant to its own criteria – FINRA could step in and tell, um FINRA, that the firm ought not to have been branded as high risk. I have got to tell you, based on my historical dealings with FINRA, I am not putting a whole lot of faith in the reasonableness of any decision that FINRA might be called upon to make at this step of the process, i.e., to second-guess its own preliminary decision.

Ok, so let’s assume that FINRA doesn’t talk itself out of characterizing a firm as high-risk. The next step is that FINRA will give the firm a chance to terminate as many of its reps as necessary to reduce the bad points it accumulated in step one, the points that resulted in the firm being identified in the first place. It’s a lot like the deal already in place under the existing “Taping Rule,” when a BD hires enough reps who came from expelled firms to be forced to tape record all of its reps’ phone conversations. It’s a one-time deal, and the firm would also have to agree not to rehire any reps it fires for a year.

As gruesome as this sounds so far, the next step is even worse, and, by FINRA’s own admission, the most punitive. If a firm is still deemed high-risk at this point, FINRA will then turn its attention to calculating a number meant to represent the most money and securities that it could possibly require the firm to deposit in an account, assets which the firm cannot touch without FINRA’s approval, indeed, even if the firm goes out of business.[1] In short, FINRA proposes to make these firms deposit a whole bunch of money in an account with one essential purpose: to satisfy customer arbitrations. (Did PIABA write this rule??)

FINRA knows this will sting, and, frankly, it couldn’t care less. Indeed, it wants it to sting. FINRA admits that its “intent is that the maximum Restricted Deposit Requirement should be significant enough to change the member’s behavior but not so burdensome that it would force the member out of business solely by virtue of the imposed deposit requirement.” How nice. How magnanimous of FINRA! How industrious and clever! To be able to determine the “maximum” – its word, not mine – amount that it can require a firm to pony up as ransom, in effect, without having to declare bankruptcy. I eagerly look forward to the comments this is going to generate. And I hope that some focus on the use of the word “solely,” which leaves FINRA all kinds of running room to trample the rights of its member firms.

In its next passing effort to demonstrate a modicum of fairness, FINRA proposes to include in the process as the next step a “consultation,” that is, an opportunity for an affected firm to rebut two presumptions, that it should branded a restricted firm, and that it should be subject to the maximum deposit. Once again, the result of this lies completely within FINRA’s sole and subjective determination.

Finally, if all other steps to get FINRA to change its mind have failed, the firm may request an expedited hearing before a FINRA Hearing Officer – the same group of folks who administer Enforcement actions – to challenge FINRA’s conclusions.

I realize that this all sounds pretty crazy. But, consider this: it is actually better than an alternative that FINRA admits it’s still mulling over, and that is what it calls a “terms and conditions” approach. FINRA indicates that it could easily be convinced that this approach, which is presently employed by IIROC, the Investment Industry Regulatory Organization of Canada, and clearly something that FINRA is jealous of, would work best to address firms that “typically have substantial and unaddressed compliance failures over multiple examination cycles that put investors or market integrity at risk.” Under the “terms and conditions” regime, the regulator simply gets to decide that a firm is a problem, and unilaterally impose terms and conditions on the firm if it wants to continue to operate.[2] According to IIROC (at least as FINRA describes it), it utilizes this approach when “there are outstanding compliance issues that clearly require regulatory action, but that may be best addressed through an enforcement hearing.” On reflection, I think FINRA goes to the trouble of describing “terms and conditions” as a scare tactic, to make the ridiculous “Restricted Firm” approach sound reasonable by comparison.

In conclusion, I have read this horror show of a Notice several times, and I am still left asking, exactly what situation cannot be addressed adequately through the Enforcement program? The Enforcement scheme is hardly perfect, but at least there some deference is – by rule – paid to due process. A respondent is deemed innocent until proven guilty, and FINRA bears the burden of proof. The respondent may continue to operate despite the charges being outstanding. No deposit, of any size, has to be made as a condition of continued operations. The bottom line is that FINRA never adequately explains why its existing procedures can’t do the trick. And the reason for that is that it can’t.

FINRA’s real problem is that it simply doesn’t like having to jump through the procedural hoops that presently exist, hoops that provide safeguards to respondents. FINRA doesn’t like to have to prove its allegations. Just consider this whining, found early on in the Reg Notice: “Parties with serious compliance issues often will litigate enforcement actions brought by FINRA, which potentially involves a hearing and multiple rounds of appeals, thereby effectively forestalling the imposition of disciplinary sanctions for an extended period.” Gee, wouldn’t it be easier if we can forego the complaint, the hearing, the evidence, and jump right to sanctions? THAT, my friends, is what FINRA is proposing here.



[1] Because any cash in such an account could not be readily accessed, the proposed rule requires that such deposits be deducted when determining net capital!

[2] The terms and conditions can be appealed, but, notably, they are NOT stayed during the pendency of the appeal.