I have written a few times about FINRA’s ceaseless interest in bringing cases against registered reps who fail to update their Form U-4 in a timely manner to disclose the fact that a tax lien has been filed against them.  Or several tax liens.  The problem with these cases is not so much the sanctions that FINRA imposes, as they tend to be fairly modest, e.g., a fine of $5,000 or less plus a suspension, maybe of 30 or 60 days in length.  No, the problem is that FINRA often likes to characterize these failures as “willful,” which results in the registered rep being statutorily disqualified from continuing to work in the securities industry, necessitating the filing of a MC-400 application to seek FINRA’s approval to remain a registered rep notwithstanding the modest nature of the rule violation.

Well, this week, FINRA accepted a very interesting AWC from J.P. Morgan Chase, which included a $1.1 million fine, as a result of the fact that JPMC failed to update the Forms U-5 of 89 former registered representatives, over a six-year period, to disclose the fact that these RRs were the subject of an internal review concerning allegations that they had misappropriated or transmitted “proprietary Firm information,” took customer information in connection with the transfer to another broker-dealer, or violated some “investment-related banking industry standard of conduct.”[1]  A repeat violation for the firm, too. Continue Reading It Is Not Possible To Predict When FINRA Will Charge Something As Willful. Or Is It?

Once again – twice again, actually – FINRA has used Rule 8210 as a cudgel, beating the poor unfortunate recipients of the “request” for documents and information into submission, or worse.  This has got to stop.

The first case is a repeat of one I blogged about earlier this year, and it involves the use of 8210 to demand that a computer be produced to FINRA so it can make a complete copy of the hard-drive.  Here’s what happened.  At 8:45 am on Wednesday, I received by email an 8210 letter, telling me that my client had to provide “immediate access to FINRA staff to inspect and copy” “[h]ard drive(s), Google drive(s), and USB thumb drive(s).”  The letter also included this threat/promise; note that the use of bold and underlining appears in the original, just to ensure these words are not skipped:

If your client fails to provide immediate access to FINRA staff of the requested information, they may be subject to the institution of an expedited or formal disciplinary proceeding leading to sanctions, including a bar from the securities industry.

At 9:00 – 15 minutes later – the examiners showed up at my client’s office and demanded that they be provided the computers so the hard drives could be copied, in their entirety.  Now remember from my previous blog post that I have been down this very road before with FINRA.  The last time this happened, in the face of essentially the same 8210 letter, my other client elected to produce the computer rather than face an Enforcement action.  Despite that, sadly, the matter still eventually ended up as an Enforcement case.  At the hearing in that case, I objected to the 8210 request as being unlawful, as it exceeded the scope of the rule (which does not permit computers to be seized and imaged).  The Hearing Officer asked me if an objection had been lodged at the time the initial 8210 request was served, and I had to say no.  Well, then, ruled the Hearing Officer, you waived your right to object here by not objecting sooner. Continue Reading Two (More) Scary Tales Of FINRA’s Abuse Of Rule 8210

I read an article this week in Investment News with the following headline: “Brokerage Customers Winning More FINRA Arbitration Cases.” As a guy who defends customer cases, I was naturally intriguied by this. According to the article, “brokerage customers who do file claims against their registered representative or firm are faring better in the process this year. So far in 2019, 176 cases have been decided, and 44%, or 78 cases, resulted in the customer being awarded damages. That’s an uptick compared to recent history.” Wow, I thought, this could be a troubling trend.

But, then I looked at the statistics that FINRA Dispute Resolution publishes, and quickly realized that this headline, and this story, oversells the point in a big way.

The story correctly reports that customers have been awarded money in 44% of cases that went to hearing this year, and that this reflects an upwards trend. But, really, it’s hardly a significant increase. The percent of cases that result in something being awarded to customers look like this since 2014: Continue Reading All-Public Arbitration Panels Are Paying Out Money At An Unprecedented Rate…Just As PIABA Intended

What is it with big firms and fingerprints? You may recall back in October 2017, J.P. Morgan entered into an AWC with FINRA in which it agreed to pay a $1.25 million fine for the following, as described in FINRA’s press release about the case:

FINRA found that for more than eight years, J.P. Morgan did not fingerprint approximately 2,000 of its non-registered associated persons in a timely manner, preventing the firm from determining whether those persons might be disqualified from working at the firm. In addition, the firm fingerprinted other non-registered associated persons but limited its screening to criminal convictions specified in federal banking laws and an internally created list. In total, the firm did not appropriately screen 8,600 individuals for all felony convictions or for disciplinary actions by financial regulators. FINRA also found that four individuals who were subject to a statutory disqualification because of a criminal conviction were allowed to associate, or remain associated, with the firm during the relevant time period. One of the four individuals was associated with the firm for 10 years; and another for eight years.

Ok, now compare that description to this one, from a press release that FINRA issued just two days ago to announce an AWC that Citigroup entered into, and in which it, too, agreed to pay a $1.25 million fine: Continue Reading Big Firms Paying Big Fines: A Discussion Of Two FINRA Settlements

Rightly or wrongly, I don’t know much about cryptocurrencies or digital coins. But that’s ok. What is worrisome, on the other hand, is that I am increasingly concerned that FINRA doesn’t either. And while my own ignorance will have exactly zero impact on your day, that is most certainly not the case with FINRA.

I came to this conclusion after reading Reg Notice 19-24, released last week. On its face, the Notice seems fairly benign. What it does is extend by one year FINRA’s “request” that “each member keep its Regulatory Coordinator informed of new activities or plans regarding digital assets, including cryptocurrencies and other virtual coins and tokens.” You may recall that last year, in Reg Notice 18-23, FINRA issued its initial request for this sort of information through the end of July 2019. Now, FINRA is “encouraging” its member firms to keep this up for another year, through July 2020.

I don’t have any real problem with this “request,” apart from my usual cynicism when FINRA uses this particular word. Remember: FINRA characterizes its use of Rule 8210 as “requests” for documents and information, as if the recipient has a choice whether or not to respond, when, in fact, the failure to respond to the “request” can result in a permanent bar from the industry. No, my problem is that as FINRA attempts to gets its head around digital assets, as a result of the fact that it doesn’t necessarily understand the regulatory issues that such products will ultimately generate, it is asking for information beyond that which it is entitled to receive. Continue Reading Why Is FINRA So Interested In Your Non-Securities Business?

If you read this blog even semi-regularly, you know that I have taken a few shots at PIABA. I think they’re well earned, but some people – particularly PIABA lawyers, not surprisingly – have suggested that I’m overdoing it. Well, if you ever had any doubt that the motivation behind pretty much everything that PIABA does is simply doing whatever it can to ensure that its attorneys get paid, just take a look at PIABA’s comment to FINRA’s recent proposal to address rogue broker-dealers.

I have already written about that proposal, which is flawed in a number of fundamental ways, in my view. As expected, it elicited a bunch of comments. PIABA submitted its own comment, naturally, and, in a development that surprised exactly no one, it stated that its principal concern with the proposed rules is that they “will not cure the long-standing unpaid arbitration award issue.” Well, there you go. Leave it to PIABA to take a proposal designed by FINRA to address misconduct by rogue brokers and rogue firms – or as FINRA expressly phrased it, “to address the risks that can be posed to investors and the broader market by individual brokers and member firms that have a history of misconduct” – and focus instead on another issue, i.e., the one component of that proposal that impacts PIABA members’ pocketbooks. That is, rather than acknowledging that the proposal’s primary goal is to eliminate (or at least deter) misconduct, PIABA has chosen instead to complain that perhaps the most ridiculous aspect of the rule proposal – the creation of a fund, sourced by the BD itself, with money that would not constitute an allowable asset in the firm’s net capital computation, and which cannot be used for any purpose other than the satisfaction of a customer claim – somehow doesn’t go far enough to ensure that arbitration claimants – and their lawyers, of course – get paid. Continue Reading Make No Mistake, PIABA Cares About One Thing: Getting Paid

FINRA loves to tout its supposed intent to bring meaningful cases, cases that matter to the investing public, rather than enforcing “foot faults,” as it has been accused of doing over the years. My own experience with FINRA suggests that while it talks a big game, in reality, we all still live in foot-fault city.

I stumbled across this decision recently, and it serves as a good example of two problems that FINRA has. First, FINRA is, at times, maybe most times, hardly the model of efficiency when it comes to promptly bringing cases against perceived bad guys. Second, it reflects how FINRA is still willing to spend its finite resources, in terms of time, manpower, and money, on an utterly fruitless pursuit, resources that anyone would agree – including the FINRA lawyers who brought the case and the Hearing Officer who had to consider the evidence – would have been better spent on something else.

The case started out normally, with FINRA filing an Enforcement action against the broker-dealer in 2017, alleging a number of nasty sounding historical sales practice violations. According to the decision, however, and for reasons that went unexplained, the complaint was filed five years after the exam of the matter was started, and fully four years after the matter was referred to Enforcement. From the defense perspective, that is a long time. A long time for documents to be preserved, for witnesses’ memories to remain intact. Remember: FINRA is not restricted by statutes of limitations (like the SEC, or like civil litigants), but it is still supposed to be procedurally fair to respondents, and one aspect of that fairness is not waiting too long to file a complaint. Continue Reading A Glaring Example Of FINRA Dragging Its Feet, Culminating In A Pointless Default Decision

Nearly ten years ago, FINRA decided to update its old suitability rule, NASD Rule 2310. It had been around a long time, and while it seemed to work fine, FINRA decided to incorporate into the new amended rule – FINRA Rule 2111 – some new concepts. One such concept concerned recommendations to hold. Under the old rule, only recommendations to purchase, sell or exchange a security had to be suitable. Under the new rule, FINRA added to that list recommendations to hold, provided, of course, that such recommendations are “explicit.”

And that’s been the law of the land since July 2012. There was a great deal of consternation, at first, as firms tried to figure out what, exactly, constituted an explicit recommendation to hold, and, more troubling, the best way to capture such recommendations from a books-and-records perspective. (Since no order ticket is generated by a hold recommendation, firms had to come up with some method of memorializing them, and that was a bit tricky.) But, really, it hasn’t turned out to be that big of a deal. To be honest, I don’t think I’ve ever seen a FINRA disciplinary action that involved an allegation that a broker made an unsuitable recommendation to hold.

The only place where recommendations to hold have managed to become the focus of any attention are in customer arbitrations, particularly cases where the recommendation to buy the investment at issue was made a long time ago. Pursuant to the “eligibility rule,” FINRA Rule 12206, for a claim even to be eligible for arbitration, the Statement of Claim must be filed within six years of the date of the event or occurrence which gives rise to the claim. Thus, if the purchase was made more than six years before the Statement of Claim was filed, the case is subject to dismissal. To avoid such dismissals, clever lawyers representing investors bake into their Statements of Claim vague allegations that at some time – typically no date is specifically identified – within the six-year period preceding the filing of the Statement of Claim, the BD and/or the broker made an unsuitable recommendation to hold the investment at issue. These claims serve one purpose: to avoid dismissal for being untimely. At the hearings, if the cases get that far, claimants devote almost no effort to pursue their hold claims. Continue Reading Implicit Recommendations To Hold: FINRA’s Suitability Rule Goes Toe-To-Toe With SEC’s Regulation BI

I am fortunate to have Ken Berg, a commodities regulatory guru, just down the hall from me, so I’ve never had to learn that stuff too well.  But, here, as you will see, there can be considerable overlap between the securities and the commodities regulatory regimes.  The decision that Ken writes about arose in the context of a commodities purchase, but it may have a significant impact on securities arbitrations.  It makes good reading, therefore, even for BDs that don’t trade commodities. – Alan

I have previously written about issues uniquely affecting individuals who are dually registered as securities representatives (Series 7) and commodities associated persons (Series 3). In an Opinion and Order issued June 4, 2019, Judge Joan Lefkow, a federal district court judge in the Northern District of Illinois, ruled on an issue uniquely affecting firms that are dually registered as securities broker-dealers and commodities futures commission merchants. An issue that arises not infrequently is whether a customer who trades only commodities can force the clearing firm to arbitrate at FINRA instead of at the NFA. Judge Lefkow said, “no.”

The facts are typical. The firm has a “division” registered with the SEC as a broker-dealer and is a member of FINRA. The firm also has a “division” registered with the CFTC and is a member of NFA. A group of about 300 customers opened commodities accounts traded under a written power of attorney by an independent commodity trading adviser (“CTA”)[1] who made all trading decisions. Pursuant to the customer agreement, trading was limited to commodities futures contracts and options, and the FCM’s responsibility was limited to clearing the trades on commodity exchanges. Customers signed an arbitration agreement in a form prescribed by CFTC Regulation 166.5 that requires the FCM to provide a customer with a choice of three arbitral forums. If the customer fails to select one of these forums within 45 days, the FCM can choose.

The CTA trading these accounts specialized in selling naked natural gas options. In November 2018, natural gas prices spiked about 30%, placing the customers’ accounts on margin calls. The FCM liquidated the customer accounts as required by exchange rules, resulting not only in a loss of all funds deposited by the customers but also sizeable unsecured debits.

The customers filed arbitrations at FINRA alleging the firm violated the Commodity Exchange Act. The FCM notified the customers that they could choose to arbitrate at NFA, the Chicago Mercantile Exchange, or the AAA. The customers ignored the FCM’s notice and persisted in prosecuting their FINRA arbitrations. After 45 days passed, the FCM filed debit collection arbitrations against the customers at the NFA and an action in federal court seeking (i) an injunction to halt the FINRA arbitrations; (ii) a declaration that FINRA lacked jurisdiction; and (iii) an order compelling the customers to proceed with arbitration at the NFA under § 4 of the Federal Arbitration Act.

Three rulings by the district court are significant: 1. Even absent diversity, the court held it had subject matter jurisdiction because there was a federal question. 2. Even though the firm was a “member” of FINRA, it did not agree to arbitrate these disputes at FINRA because these were not “customers” under FINRA Rule 12200.  3. Even though firms have been sanctioned for seeking anti-arbitration injunctions, the court denied the customers’ request for sanctions.

The Federal Arbitration Act does not create subject matter jurisdiction in federal court, so absent diversity or a federal question, a federal court cannot hear a dispute just because it involves arbitration of interstate transactions. For example, a motion under § 12 of the FAA to vacate a FINRA securities arbitration award or an NFA commodities arbitration award cannot be brought in federal court if the parties are not diverse. Here, however, Judge Lefkow held that if the underlying controversy could have been brought in federal court but for the arbitration agreement because the claims allege violations of the securities or commodities laws, under § 4 of the FAA a court may “look through” the arbitration agreement and find federal subject matter jurisdiction.

FINRA Rule 12200 requires a member to arbitrate disputes with its “customers” that “arise in connection with the business activities of the member ….” Even though Rule 12200 does not define “customer,” Judge Lefkow held that “customer” means a person who engaged in “FINRA-regulated activities” with the member. Here, the customer agreement permitted the purchase and sale of commodities products regulated by the CFTC only. The court concluded that the firm did not agree to arbitrate these claims at FINRA and noted that its interpretation of FINRA Rule 12200 “harmonizes” the separate regulatory schemes for commodities and securities carefully established by Congress. (Query, whether a dually registered firm with a customer who was hedging his securities portfolio with S&P futures would be able to avoid arbitration at FINRA even if the claim involved only a botched execution of a futures order?) The court’s holding has broader implications for arbitrability of disputes at FINRA in the context of “outside business activity” claims against broker-dealers and claims involving independent contractors who market both securities for the broker-dealer and fixed income insurance products that are not securities.

Finally, in the not-so-distant past it was common for a broker-dealer or FCM to charge into court to enjoin a customer-initiated arbitration that was filed beyond the statute of limitations or beyond the FINRA (6 years) and NFA (2 years) eligibility rules. Now, sanctions on firms seeking anti-arbitration injunctions have chilled such litigation, however. Courts have imposed sanctions because “it is impossible to suffer irreparable harm from arbitrating a claim.” Here, Judge Lefkow declined to impose sanctions on the FCM because “it does not seek an injunction to resist a court order or agreement to arbitrate; it seeks an injunction to effectuate one [i.e., the NFA arbitration].” She noted that injunctions enjoining arbitrations are expressly contemplated by § 16 of the FAA, so it cannot be that all suits to enjoin arbitrations are sanctionable.

In sum, Judge Lefkow found that FINRA lacked jurisdiction, compelled the customers to proceed with arbitration at the NFA, and denied the customers’ request for sanctions. On June 12, 2019, the customers filed a notice of appeal. INTL FCStone Financial, Inc. v. Jacobson, Case No. 19 C 1438, 2019 WL 2356989 (N.D. Ill. Jun. 4, 2019).

[1] A CTA is the commodity industry’s analogue to a registered investment adviser in the securities industry.

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.”[1] 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.

[1] 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.