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.” 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.
 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.