Broker- Dealer Law Corner

Broker- Dealer Law Corner

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

Posted in Disciplinary Process, Enforcement, FINRA, Willfullness

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

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

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

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

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

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

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





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

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

Posted in Examination, FINRA, Rule 8210

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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


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

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

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

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

Posted in Arbitration, FINRA, PIABA

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

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

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

2014:   38%

2015:   42%

2016:   41%

2017:   43%

2018:   40%

2019:   44%

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

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

2014:   42%

2015:   45%

2016:   42%

2017:   45%

2018:   42%

2019:   44%

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

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

All Public Panel          2 Public/1 Industry Panel

2014:               44%                             38%

2015:               47%                             45%

2016:               43%                             36%

2017:               48%                             37%

2018:               42%                             47%

2019:               55%                             29%

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

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

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


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

Posted in Disciplinary Process, Enforcement, FINRA, Sanctions

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

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

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

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

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

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

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

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

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

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

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

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

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.