So, as you undoubtedly recall, in its typical reactive approach to regulation, FINRA has expressed concern – after having concerns expressed to it by others (none of whom are actually from the securities industry, of course) – about (1) the high number of registered reps working in the industry with spotty disciplinary records, and (2) the number of arbitration awards against BDs that go unpaid. Well, FINRA is now preparing to address these pressing issues.
At its most recent Board meeting, FINRA agreed to publish a Regulatory Notice soliciting comments on proposed rules designed to address both of these “problems.” On the “rogue rep” issue, FINRA will be soliciting comments on proposed amendments to FINRA’s Membership Application Program (“MAP”) rules that would require a member firm to seek a materiality consultation, or MatCon as we like to call it, in two different circumstances. The first is when “a broker with certain specified risk events seeks to become an owner, control person or principal of the member,” and the second is when “the member seeks to add a broker with certain specified risk events to the firm.” This raises a few of issues.
First, what, exactly, are “certain specified risk events?” Are these determined qualitatively, by the nature of the individual’s disciplinary disclosures? Or, are they determined quantitatively, by the number of disclosures? Or, perhaps, some combination of the two? I guess we need to wait for the Reg Notices themselves to learn. Clearly, this is where the rubber will meet the road on these proposals. If the threshold is set too low, then too many prospective owners will be swept into this process, rendering the filter useless. But, if it is set too high, then those darned “high-risk” brokers will running things at BDs all over the place.
Second, I seriously question how much protection such amendments would actually provide. I can assure you that today, under the existing MAP rules, if someone with a disciplinary history files an application under Rule 1017 to become the owner, or even an owner, of a BD, that application would first be fly-specked to death, and then, eventually, denied. The existing MAP process is tough. MAP examiners, while lovely individuals and generally easy to work with, are pleased as punch to hold against an applicant the smallest of infractions, or perceived infractions. Indeed, a prospective new owner need not even have a formal disciplinary history to raise MAP’s eyebrows. I know of applicants that were merely the subject of pending exams – exams that had not yet even made it to the findings stage – who were told that mere “examiner concerns” were enough to cause MAP to look negatively on a 1017. I suppose that if the MatCon was required no matter how small of an ownership interest the applicant was seeking to acquire, it might add something to the existing process, but that would be an incremental change, at best.
Third, existing rules also allow FINRA today to prevent an individual RR from moving from one firm to another. Anytime a rep changes BDs, the old BD files a Form U-5 and the new firm files a Form U-4. FINRA must approve the U-4, of course. Given that, in theory, FINRA already possesses the power to serve as gatekeeper, by not approving Forms U-4 for reps with troublesome records. But, FINRA generally does not do that.
Which is the principal reason why FINRA’s professed concern about high-risk brokers is so odd to me. As I have blogged about before, there is simply no way for any of this to be a surprise to FINRA. It controls every aspect of the process that exists to become and remain a member firm, or an individual to become and remain associated with a member firm, i.e., the membership/registration piece, the examination piece, and the enforcement piece. Thus, to the extent that there are reps still working out there with lots of disciplinary events on their records, i.e., the reps about FINRA is so worked up, it is 100% because (1) FINRA approved their registrations, and (2) when it disciplined them – after all, their disciplinary histories derive from enforcement actions that FINRA brought – it determined that whatever they did wrong was not bad enough to require them to be tossed out of the industry.
Thus, whatever problem supposedly exists now regarding high-risk brokers, it has arguably been caused by FINRA itself. And now, it proposes to ride in to the rescue from its self-created problem, after the media had the bad taste to shed some light on this situation. It would be funny if it wasn’t true.
Regarding the unpaid arbitration awards, FINRA is also proposing to use its MAP rules to address the perceived problem. What FINRA has suggested is an amendment that will allow it “to presumptively deny a new membership application if the applicant or its associated persons are subject to pending arbitration claims.” In addition, in the context of a CMA, or change in ownership of an existing member, the proposed amendments would require a MatCon when “the member is seeking to effect a business expansion or asset transfer and the member or an associated person has a substantial level of pending arbitration claims, an unpaid arbitration award or an unpaid settlement related to an arbitration.”
It is really interesting that somehow FINRA’s concern about unpaid arbitration awards has morphed here into concern about “pending arbitration claims.” Aren’t the two very different? When there’s an unpaid award, it necessarily means that the firm has already lost the arbitration, and has been ordered to pay some money to the claimant because the hearing panel concluded the firm did something wrong. But, in a pending arbitration, one in which the award has not yet been rendered, the respondent firm is presumed to be innocent until proven otherwise, as the claimant has the burden of proof. It seems a bit incongruous, and certainly unfair, for FINRA to be permitted to hold mere allegations, not findings, against a prospective owner. (But, as I said above, MAP already does this today, rightly or wrongly.)
Also, as I have mentioned before, in its existing arsenal of procedural weapons, under Rule 9554, FINRA already has the right to seek summary expulsion of a firm if it fails to pay an arbitration award in a timely manner or to follow through on a settlement agreement. If it is FINRA’s goal to weed out from its ranks those firms that don’t pay arbitration awards, it has the power to accomplish that now. Moreover, if the goal is also to prevent Firm A from simply not paying an arbitration award and going down the street and opening Firm B, or just joining Firm B, this proposal would not prevent that. The proposal, at least as described by FINRA in the brief summary, is really tied to awards against individuals, either the individual owners of a firm or its associated persons. When individuals have unpaid arbitration awards, FINRA can stop them from either owning a BD or from joining one. On the other hand, when the awards are not against individuals, but, rather, against the firm for which they used to work, the individuals are free to move. And neither the existing rule nor the proposal would stop that.
One final observation. It is remarkable how quickly FINRA seems to act when it receives a complaint from Congress, or, worse, from the media, about how it does business; yet, when its own members complain about something, it falls on deaf ears. This certainly suggests that FINRA has its priorities backwards.
 Under the existing rules, neither a MatCon nor a full-blown 1017 is required unless the transaction would result in someone becoming at least a 25% owner of the firm. So, if a “bad actor” wanted to acquire, say, only 10% of a BD, that can be accomplished simply through the filing of an amendment to Form BD, without the need to obtain FINRA approval.