Almost three years ago, in Reg Notice 18-08, FINRA wisely (but, nevertheless, still a bit late to the party) proposed to revise its own prior guidance regarding the troublesome intersection between outside business activities and investment advisor business, guidance that FINRA itself acknowledged had “caused significant confusion and practical challenges.”  Specifically, in crusty old Notices to Members 94-44 and 96-33, issued over two decades ago, FINRA saddled the industry with nearly inscrutable attempts to delineate the scope of a BD’s supervisory obligations over the investment advisory activities conducted by its dually registered RRs away from their BD.  Although it took FINRA about 25 years to finally attempt to clean up the muddy playing field it had created, finally, it seemed, clarity was on the way.  Astutely noting one of those rare instances in which FINRA actually seemed to be acting in its members’ best interests, I blogged about that proposal and dutifully congratulated FINRA for “provid[ing] meaningful relief to firms who are now nearly crippled by the sheer amount of their compliance obligations.”

Boy, did I speak too soon.

Three years after it was issued, the proposal has never been approved.  Indeed, who knows where it is today.  In a July 2020 release, the SEC observed that FINRA’s review of the proposed rule change was still pending, but, since then, I have seen nothing.  Making matters much, much worse, FINRA continues to enforce 94-44 and 96-33, despite FINRA’s explicit acknowledgement of the terrible job those notices have done in establishing a clear standard of conduct.  Just ask Cetera.  Right before the new year, FINRA issued an AWC from Cetera with a $1 million fine for doing something that, had FINRA followed through on the proposal in Reg Notice 18-08, would have been ok.

Before I get on my soap box, let me break down the AWC.

First you need to understand the underlying dynamic.  Cetera – like hundreds of other firms – has RRs who are simultaneously registered with an outside RIA, where the RRs serve as IARRs.  These folks are referred to as “dually registered representatives” or DRRs.  Because what the DRRs do at the RIA constitutes a securities business, from the perspective of the BD, it is a private securities transaction, thereby triggering Rule 3280.  The issue this tees up is what role, if any, Cetera has to supervise the IA work that its dually registered RR/IARRs are conducting at the RIA (where, of course, they are already subject to the RIA’s supervision).

The NASD tried in 94-44 and 96-33 to account for that fact, i.e., that DRRs are already being supervised by their RIAs, by attempting to delineate a more narrow scope of the DRRs’ RIA activities that the BDs also have to supervise.  The problem is, this was very difficult to articulate.  So difficult that the securities industry has struggled with this problem for the past 25 years.

Consider this:

  • As the AWC notes, according to Rule 3280, when a BD approves a PST, the BD must “supervise the person’s participation in those transactions as if the transactions were executed on behalf of the firm.”
  • Consistent with that, 94-44 states that “these requirements apply ‘to all investment advisory activities conducted by [DRRs] that result in the purchase or sale of securities by the associated person’s advisory clients”
  • But, curiously, 94-44 also states that Rule 3280 is focused “primarily upon the RR/RIA’s participation in the execution of the transaction – meaning participation that goes beyond a mere recommendation. Article III, Section 40 [the precursor to Rule 3280], therefore, applies to any transaction in which the dually registered person participated in the execution of the trade.”
  • 96-33 similarly states: “Most notably, Notice to Members 94-44, clarifies” – sorry, I have to pause here to insert the laughter that the use of “clarifies” will undoubtedly trigger – “the analysis that members must follow to determine whether the activity of an RR/IA falls within the parameters of Section 40. Fundamental to this analysis is whether the RR/IA participates in the execution of a securities transaction such that his or her actions go beyond a mere recommendation, thereby triggering the recordkeeping and supervision requirements of Section 40.”

So…we’ve got this hard-and-fast standard in the rule – “all” PSTs must be supervised by the BD.  But, we’ve also got this squishy interpretation that says it is NOT all PSTs, only those where the DRR “participates in the execution.”  THIS is the gray area that NASD created, which it never remedied, but teasingly proposed to fix in Reg Notice 18-08, in which poor Cetera found itself.

What, exactly, did Cetera do?  According to the AWC, “[f]rom January 2011 through December 2018, [Cetera] failed to establish, maintain and enforce a supervisory system and written supervisory procedures reasonably designed to supervise certain private securities transactions conducted by their dually-registered representatives (DRRs) at unaffiliated or ‘outside’ registered investments advisors (RIAs).”  Why did Cetera get picked on FINRA?  That’s easy: the AWC provides that Cetera underwent three SEC exams between 2013 and 2017 in which findings were made about this issue, but the firm failed to take adequate remedial measures.  FINRA had no choice, it seems, but to reluctantly step in and enforce its own fuzzy standard, just to be able to look the SEC in the eye.  In other words, Cetera paid the price for FINRA waiting 25 years to try to fix a problem that it created…and then quietly pretending that it hadn’t.  And speaking of price…how the heck did this possibly become a $1 million problem?  For a firm that has NO relevant disciplinary history?  Seems to me like FINRA trying to show the SEC something.

Ok, back to my soap box.

So, why has FINRA failed to act on the 18-08 proposal?  Let’s say I have my theory.  To start, let’s take notice of the fact that the rule proposal garnered 51 comments.  That may not be the indoor record, but it’s a lot.  I have gone through them, so you can spare yourself that exercise.  Nearly without exception (for some reason, Raymond James didn’t seem to like the rule), the industry was strongly in favor of it.  Just as a for instance, Fortune Financial Services wrote that NTM 94-44 and 96-33 were “both confusing and difficult to implement without providing any meaningful investor protection.”  Foreside noted that implementation of the proposal “will dramatically save costs and reduce a firm’s administrative and regulatory burden.”  I could go on, but you get the point.

The rule proposal – from the perspective of FINRA’s members – was a fantastic idea.  And for good reason: it saves BDs from having to try and supervise activities which they have limited, if any, access to or ability to control,[1] yet without adding any regulatory risk – given that the activities of the IARRs away from the BDs are already subject to the supervision of the particular RIA with which they are associated, under the watchful regulatory eyes of either the states or the SEC (depending on the size of the RIA).  I mean, who needs FINRA to butt into the existing supervisory scheme of an RIA that seems to be working ok on its own?

Well, guess who didn’t like the rule proposal?  Yes, that’s right, PIABA condemned it, dramatically claiming that FINRA was “contemplating the evisceration of crucial protections that have been in place for decades to safeguard investors against investment schemes!”  Ironically, and in apparent total disregard for the mess that 94-44 and 96-33 actually created, PIABA insisted that adoption of the proposed new rule “would create mass confusion for brokerage firms and registered representatives.”  That’s funny stuff.

So, there you go.  On one side, you have the industry almost entirely lined up in support of the proposed rule. On the other side, you have PIABA arguing that the rule would be bad.  Given that dynamic, who do you think FINRA is going to listen to?  You don’t have to guess, of course.  FINRA’s three-year-and-counting failure to follow through on its eminently reasonable rule proposal tells you all you need to know.  And, as I stated earlier, it’s not just FINRA’s failure to follow through on the rule proposal that is so aggravating, it’s the fact that FINRA has the temerity to nick Cetera for $1 million for failing to meet the needless and fuzzy standards that FINRA attempted to articulate in 94-44 and 96-33.



[1] As an example of this, the AWC points out that for years, Cetera did not receive “transaction data for its DRRs’ outside securities . . . and, thus, did not have the information necessary to reasonably supervise its outside RIA transactions. And even after [Cetera] began receiving transaction data, it did not receive the customer-specific account information to satisfy its supervisory obligations including, but not limited to, a suitability review.”