I don’t know how many times I’ve written about FINRA’s efforts over the years to address “rogue brokers,” or what it refers to nowadays more politically correctly as “high-risk brokers.” It doesn’t really matter what blog post you read, or when I wrote it, as they all tell essentially the same story:  FINRA is just aghast – AGHAST! – to learn that there are actually registered reps out there with disclosures on their Form U-4 regarding customer complaints.  And so, to protect the unsuspecting investing public from having their hard-earned dollars swindled by these miscreants, from time-to-time, FINRA makes a big show of addressing the issue.

Such is the case now. Indeed, in the 2018 Exam Priorities letter, FINRA stated that “[b]uilding on our work in 2017, a top priority for FINRA will continue to be identifying high-risk firms and individual brokers and mitigating the potential risks that they can pose to investors.”  To that end, FINRA just released Reg Notice 18-16, which contains a number of proposals designed to crack down on these high-risk brokers.  I have no issue with some of the ideas, to be honest.  For instance, under current FINRA rules, if a broker loses an Enforcement case and appeals that decision to the NAC, i.e., the National Adjudicatory Council, all sanctions imposed by the hearing panel are stayed pending the disposition of the appeal.  This includes the ultimate sanction of a permanent bar from the industry.  What this means is that a truly bad guy,[1] someone bad enough to justify the imposition of a bar, can continue to work in the industry during the entire time the appeal is pending, which can take a year or more, during which time he can, at least theoretically, continue to wreak havoc on customers.

Under the proposed rule amendment, two things could happen to change that. First, when a hearing panel in an Enforcement action determines that FINRA has established liability and metes out sanctions, it will also have the ability to “impose such conditions or restrictions on the activities of a respondent as the Hearing Panel or Hearing Officer considers reasonably necessary for the purpose of preventing customer harm,” pending the disposition of the appeal.  In other words, FINRA can prevent someone who’s been barred from continuing to work while his appeal to the NAC is pending.  Second, in addition to that, the rule would require that the BD that employs the respondent who lost before the Hearing Panel to subject him or her to heightened supervision pending the disposition of the appeal.

Perhaps the most interesting feature of the proposed rule is that the first of these new powers, i.e., the hearing panel’s ability to impose “conditions or restrictions” on a respondent, is expressly tempered by the right of the affected party to obtain an extremely prompt – within 30 days of the date of filing – review of that decision. Granted, the entity that would entertain that review is the NAC, the very entity that will decide the appeal itself, and that is hardly an ideal situation, but, unlike a lot of what FINRA does, at least this provides a small semblance of fairness and due process.  A step in the right direction, let’s call it.

But, that is clearly not the case with regard to the part of the proposed rule that causes me great difficulty, and that is the amendment that provides FINRA the unilateral ability to decide, basically, who is permitted to associate with a firm.

Under existing Membership Rules, many broker-dealers are allowed to add registered representatives without having to file for permission to do so. This is a result of one of two things:  either their Membership Agreement includes a stated maximum number of reps they are permitted to hire (and even with the addition of the new reps the firm would remain below that maximum number), or the firms are subject to the safe harbor provisions found within IM-1011-1 (which allow firms without a provision in their Membership Agreement regarding the permissible maximum number of reps to add annually a modest number of reps without that addition being deemed material, thus eliminating the need to file an application under Rule 1017).  Under the proposed amendment, however, even if a firm seeks to add even a single rep – an addition that under current rules would not trigger the need for a 1017 application, or permission from FINRA – the firm would be required to request and obtain permission from FINRA to do so if that single rep, in the prior five-year, has “one or more final criminal matters or two or more specified risk events.”

The proposed rule is a little more nuanced than that, if you want to dig into the details. What a firm would have to do is obtain a “materiality consultation,” or MatCon, as we like to call it, from FINRA. Essentially, that is a determination that FINRA makes whether some anticipated change in the member firm’s business would be deemed “material,” and, therefore, requiring a full-blown 1017 application.  If the MatCon results in the conclusion that the change is not material, no 1017 is required; but, if the MatCon states that the change is material, then the 1017 must be filed, and approved, before the change can be effected.

Clearly, this proposal would give much broader powers to FINRA than it presently has to dictate to BDs who they can hire and how many. Given the high priority that FINRA has given to its high-risk broker project, it is easy to imagine that FINRA will conclude on a knee-jerk basis that any attempt to add a rep with “two or more specified risk events” will be material, requiring a 1017.  And understand this: a 1017 application is not cheap to prepare, or easy, and the outcome is never a sure thing.  The MAP group of FINRA guards the gates to FINRA membership like angry Dobermans, carefully and thoroughly sifting through the applications, looking for any reason that would support a denial.  I am not saying that they go out of their way to deny applications; I am just saying that when presented with the opportunity to do so, they’re not shy about taking advantage of it.

All this fuss is still about the same thing: there are lots of reps in the industry who are fantastic, who provide a wonderful service to their clients, but who have to deal with the fact that they live in a day and age in which it is ridiculously easy for a customer to lodge a complaint and exact a nuisance settlement from the BD, resulting in a permanent mark on the reps’ U-4. Granted, there are also reps with marks on their U4s who are bad apples, true recidivists who don’t care about rules or fiduciary duty or suitability or whatever.  But, the problem is that FINRA cannot distinguish between these two groups, so its solution is to treat them all the same, which is, in essence, to presume everyone is a bad apple.  Moreover, and worse, BDs, it seems, can no longer be trusted to figure it out for themselves as part of the exacting due diligence process that FINRA rules dictate that they undertake when they seek to hire new reps; now, apparently, FINRA has determined that only it is capable of deciding who should be hired and who should not.  Such arrogance.  The notion that FINRA is any way, shape or form still a “self-regulatory” organization has simply become a fantasy.  It is, in fact, the judge, jury and executioner, dictating to member firms what used to be permissible business judgments.


[1] I say “truly” here because, sadly, FINRA often bars people that simply don’t deserve that sanction.  Despite whatever Robert Cook and Susan Schroeder have been quoted as saying regarding the supposedly kinder, gentler FINRA when it comes to Enforcement actions and the imposition of sanctions, in reality, that’s, well, just not reality.  In reality, FINRA is still just a big bully, pushing around small firms and the reps associated with those firms.