FINRA Rule 3110 is the new supervision rule, of course, replacing old NASD Rule 3010. Most of it became effective on December 1, 2014, but, certain parts will only become effective on July 1, 2015. One of the latter sections is 3110(e), which addresses a firm’s obligation to investigate anyone being considered for registration, and anyone actually hired. It is important that BDs understand these obligations. Interestingly, the requirements outlined in Rule 3110(e) aren’t exactly new, as you will see. It’s just that FINRA has now incorporated the requirements in the rule itself.
Under existing FINRA rules, specifically, NASD Rule 3010(e) (which is still in effect until 3110(e) takes effect), before hiring anyone, and before filing a Form U-4, a broker-dealer is required to “ascertain by investigation the good character, business repute, qualifications, and experience of” the potential applicant. FINRA has specifically articulated only two things that a firm must do to meet that requirement. First, under 3010(e) itself, for any applicant who was previously registered in the securities industry, the firm must review the applicant’s most recent Form U-5. No big deal there, everyone does that, and they should be expected to.
|Second, according the boilerplate language buried in Form U-4, when the firm’s registered principal signs the form on behalf of a new applicant, he is attesting that the BD “has communicated with all of the applicant’s previous employers for the past three years and has documentation on file with the names of the persons contacted and the date of contact.” The attestation then continues: “In addition, I have taken appropriate steps to verify the accuracy and completeness of the information contained in and with this application.”|
The supposed protection provided by the requirement to “communicate with” prior employers has always struck me as a bit illusory, for a couple of reasons. First, in my experience, many firms are not even aware of this language in the form, and don’t actually contact former employers. Second, and more important, today, and for at least several years, most former employers will provide very little, if any, information about a former employee beyond that included on Form U-5, for fear of encountering claims of defamation or violation of privacy laws.)
Regardless, new FINRA Rule 3110(e) keeps the requirements of Rule 3010, but goes well beyond. While it parrots the language from NASD Rule 3010(e) that firms must still “ascertain by investigation the good character, qualifications and experience of an applicant” before registering the applicant, it now requires that within 30 days after Form U-4 is filed, that firms “verify the accuracy and completeness of the information contained in an applicant’s” Form U-4. Attentive readers will undoubtedly note that this is precisely the same language that currently appears in Form U-4. The issue for FINRA, the one that drove it to create Rule 3110(e), is that very few firms actually did the verification.
Next, and more important, Rule 3110(e) goes on to require – “at a minimum” – that firms must “search . . . reasonably available public records” to achieve that verification. Thus, in essence, with its Rule 3110(e), FINRA has tried to take the mystery out of the phrase “appropriate steps to verify” in Form U-4 by defining that to mean a public record search.
This development is troubling for several reasons. First, it is evident that FINRA will now require two separate investigations, one pre-filing of Form U-4 and one post-filing. It is difficult to understand why FINRA has taken this approach. I mean, why not roll the two requirements up together into a single, pre-hire policy? And what, really, is the difference between the two anyway?
Second, who knows what “reasonably available” means, or what, more importantly, it will be interpreted by FINRA to mean? Who will determine how far back in time a search must go? Question 12 on Form U-4, for instance, requires an applicant to list his previous employers for ten years, and Question 11 asks for prior residential addresses for five years. How is a firm supposed to “verify” the accuracy and completeness of such information? Will it be enough to hire a competent third-party vendor? Or will FINRA scrutinize the vendor’s search protocols?
Third, it flips on its head the ability of a firm to rely on representations made to it by an applicant. When someone signs a U-4 to apply for registration, he already “swear[s] or affirm[s] that . . . [his] answers (including attachments) are true and complete to the best of [his] knowledge.” The applicant’s signature also acknowledges that he “understand[s] that [he is] subject to administrative, civil or criminal penalties if [he] give[s] false or misleading answers.” If the information is not complete and accurate, the applicant has opened himself up to disciplinary action. (And, as discussed in another entry in this Blog, if the failure to disclose is deemed to be willful, he also renders himself statutorily disqualified.)
There are many instances in the course of a typical day or year in which a BD has to rely on its registered persons to make complete and accurate representations, and historically that has been deemed to satisfy the requirement that supervisory systems only be “reasonable.” Yet, here, reliance by a BD on an applicant’s representations on Form U-4 is somehow not reasonable, despite the significant pressure on the applicant to ensure that those representations are correct. And this is a troubling direction for FINRA to be going. Will BDs soon have to verify the accuracy and completeness of the information that customers provide about their financial circumstances?