Broker- Dealer Law Corner

Broker- Dealer Law Corner

Beyond Lucia: The Supreme Court’s Decision Is Just the Beginning

Posted in Administrative Proceedings, appeal, Defenses, SEC

Here is an important post by my partner, Ken Berg, regarding SEC administrative proceedings, and what we can expect following the Supreme Court’s recent decision in Lucia. – Alan

By now everyone knows the US Supreme Court declared the SEC’s administrative proceedings unconstitutional because the ALJs were improperly hired by the SEC staff instead of being appointed by the Commissioners. All respondents who raised this constitutional issue before the SEC, who have not settled, and whose cases are not yet final, are entitled to a new evidentiary hearing before a different ALJ.  But, here are a couple of questions the Supreme Court did not address in Lucia v. SEC and that decision may be just the beginning of the SEC’s troubles.

First. What about respondents who did not raise the issue before the SEC?  If they did not settle and their cases are not final, are they entitled to a new hearing before a different ALJ?  Looks good.  This issue is currently pending before the Tenth Circuit in a case argued by Ulmer and awaiting decision, Malouf v. SEC.  Ulmer argued even though Malouf’s former attorney did not raise the Appointment Clause issue before the SEC, the Court of Appeals can reverse because there were “reasonable grounds” for not doing so.  At oral argument, at least two of the three judges were openly skeptical of the SEC’s position that the Court of Appeals could not reverse.  Judge Hartz said to the lawyer representing the SEC, “Help me get comfortable with your position.”  The Judge was troubled because even if the constitutional issue had been raised before the SEC, the agency “almost certainly would have ignored it.”  Judge Bacharach challenged the SEC’s attorney, saying “I can’t think of a new argument that could be more futile to make than that everything [the SEC has] before [it] is invalid ….”  This bodes well for respondents getting a new hearing before a different ALJ even if they did not assert the Appointments Clause defense at the SEC.

Second. Did the SEC fix the constitutional problems when it appointed the sitting ALJs in November 2017?  Probably not.  In addition to being appointed incorrectly, there are other constitutional problems with the way SEC ALJs can be removed.  The Supreme Court did not address this issue.  (See Judge Breyer’s separate opinion.)  The Appointments Clause not only requires ALJs to be appointed by the President or the Commissioners, it also requires that the President be able to remove ALJs.  However, ALJs can only be removed “for cause” (meaning they are not doing their job) and ALJs are entitled to a hearing at the Merit Systems Protection Board before they can be removed.  These multiple levels of protection from removal violate the Appointments Clause.  Unlike the defect in appointing ALJs, the fix for the removal problem may not be within the SEC’s power and may require an act of Congress amending the Administrative Procedure Act.  Until that happens, all administrative proceedings at the SEC go forward at the risk of having to be redone.  Accordingly, all respondents should assert an appointments clause defense as early in the proceedings as possible even after Lucia.

Third. Does the five-year statute of limitations applicable to SEC enforcement proceedings bar retrying a case before a different ALJ?  Worth arguing.  SEC proceedings are commenced by the Commissioners issuing an Order Instituting Proceedings (“OIP”).  The OIP must be issued within five years of the allegedly unlawful conduct and it determines whether the case will proceed administratively or in district court.  The Appointments Clause “invalidates actions taken pursuant to defective title.” Ryder v. US, 515 US 177, 185 (1995).  An OIP issued before November 2017, when there were no constitutionally appointed ALJs, is void and did not commence an action.  Retrying a respondent before a different ALJ requires issuance of a new OIP.  But if the new OIP is issued more than five years after the allegedly unlawful conduct, then the proceedings are barred by the statute of limitations.  Accordingly, an unintended consequence of the Supreme Court’s decision in Lucia is that he and others similarly situated may be completely off-the-hook.


PIABA Lawyers Convince Congress Of The Importance Of Them Collecting Their Attorneys’ Fees

Posted in Arbitration, FINRA, PIABA

I have written before of the ferocious effort by PIABA lawyers to fight for their ability to collect attorneys’ fees on contingency matters – FINRA arbitrations – that they manage to win but which never get satisfied because the respondent broker-dealer has the temerity to go out of business rather than paying the award. PIABA members are clever enough not to make themselves the focus of the campaign, however; rather, they highlight the claimants, whom they characterize as being victimized twice, once by the bad broker and then a second time when the award is not satisfied.  As I have said before, I am not sure why people who choose to sue broker-dealers should be put into a special category of plaintiffs who are assured of collecting if they prevail, whereas anyone else in America runs the risk that judgments they obtain may go unsatisfied.

Well, apparently, at least two US Senators have been convinced by PIABA that this is a scourge that must be addressed. Forget immigration.  Forget tariffs.  Forget Russia.  It was reported this week that Elizabeth Warren (D-Mass) has been joined by John Kennedy (R-La) in a rare bipartisan agreement to co-sponsor a bill that would make PIABA’s dream come true, a law requiring FINRA to create a fund that could be tapped when respondents fail to pay adverse arbitration awards.

I won’t bother to comment on why Congress is dealing with this, given the host of other issues that it ought to be addressing. So, let’s look at the real problem.  According to the proposed bill, the fund would be created using money that FINRA collects in fines from respondents in Enforcement actions.  PIABA says that’s a winning formula, since the money will be coming not from taxpayers but from “bad guys” who violate FINRA rules.

But that’s just half the story. The money that FINRA metes out in fines is not just sitting around Robert Cook’s office in an envelope used to pay for the cakes and ice cream for his office’s monthly birthday celebration.  It is millions of dollars.  Last year, it was $73 million; in 2016, it was $176 million.  Granted, not all of that is collected, but that which is received is used by FINRA to accomplish very real and (hopefully) very important things.  According to FINRA’s Fines Policy, fine monies are used for “capital expenditures and specified regulatory projects that promote compliance and improve markets.”

In its 2018 Budget Summary, FINRA identified some of those projects that it paid for with collected fines, including “a successful multi-year effort to migrate FINRA’s technology environment from a data center structure to a cloudbased architecture, reducing expenses and increasing surveillance speeds,” moving its “continuing education program online in order to provide representatives with more flexibility to satisfy their requirements,” and the launching of “TRACE for Treasuries initiative to provide increased understanding and enhanced surveillance of the Treasury market through the reporting of secondary-market transactions in Treasury securities.”  In addition, fine monies were also earmarked “to transform the technological infrastructure of the registration systems for member firms and individuals, providing a significant upgrade to a core tool that is used by FINRA, the SEC, state regulators, the industry and – through BrokerCheck – the investing public.  The enhancements will transform the legacy registration systems to modern systems using open-source architecture and cloud-based infrastructure to deliver increased usefulness and efficiency.”

If fine monies are diverted from those intended uses and, instead, used to pay unsatisfied arbitration awards, then FINRA is going to have to come up with the money for its “capital expenditures” and “regulatory projects” from another source. And what source will that be?  According to the 2018 Budget Summary, “[i]f fine monies are not collected in amounts sufficient to fully fund these projects, the Board authorized the use of reserves.”  Well, how does FINRA replenish its reserves?  Unfortunately, there is no significant source other than the member firms.

Members represent the principal source of nearly all the revenues that FINRA generates. The 2018 Budget Summary includes statistics that reveal that fully 88% of FINRA’s “operating revenues” come from the members in the form of “Regulatory Fees” – defined to “primarily include the Gross Income Assessment, Personnel Assessment and Trading Activity Fee,” all of which come from member firms – and “User Fees” – defined to “primarily include Registration Fees, Transparency Services Fees, Dispute Resolution Fees, Qualification Fees, Continuing Education Fees, Corporate Financing Fees and Advertising Fees,” again, all derived from members.  Ultimately, if FINRA runs out of money to accomplish its goals, then necessarily it will be the members who pay through increased fees.  But, I guess that’s not PIABA’s problem.

And, to close, let’s play a little “what if” game, to demonstrate that this proposed Congressionally mandated FINRA fund may dry up rather quickly. Say you are a PIABA member, and say you are aware of a BD that’s been hit with so many arbitrations that it’s teetering on the verge of bankruptcy, and is unable even to pay to defend itself.  In the real world, an ethical attorney may have to dissuade a client from bringing such a case against that BD, notwithstanding the merits of the claim, and even though the BD might not even mount a defense, out of realization that any award obtained could not be satisfied.  But, what if you knew that unpaid arbitration awards are simply resolved by dipping into FINRA’s shiny new fund?  Why, then you would undoubtedly file your arbitration and ask for the most money imaginable.  Even if the BD defaulted, you could rest easy that FINRA would step in to satisfy the award.  Easy peasy money.  And there would be an onslaught of new cases being filed to get some of it before it’s all gone.

This proposal, apparently in danger of actually becoming a law, needs to be tossed out.

The Demise Of FINRA’s District Committees…And Self Regulation, Too?

Posted in District Committees, FINRA

Many people, myself included, are of the view that FINRA today remains a self-regulatory organization in name only. For years now, FINRA has taken a series of actions decried by its member firms – new rules, new interpretations of old rules, zealous enforcement of rules, the imposition of punitive sanctions – who correctly complain that FINRA has lost sight of the fact that it is, at its roots, a membership organization run by and for its constituents, i.e., broker-dealers.  Instead, FINRA principally acts as an enforcer, aggressively pursuing even the most modest of rule violations (despite what its senior management has said to the contrary in recent public pronouncements).

Even with that said, there has remained one last bastion of self-regulation: the District Committees. FINRA is comprised of 12 Districts, and each District has its own District Committee, elected by the membership.  Unlike the NAC, i.e., the National Adjudicatory Council, and the Board of Governors – the two levels of governance directly above the District Committees – all members of the District Committees are people currently registered with broker-dealers.  The NAC and the Board, by comparison, are comprised of a majority of non-industry members.  This was done at the SEC’s specific direction, to dilute the ability of the member firms to dictate FINRA’s ideological direction, I suppose to try to ensure that the inmates don’t somehow take over the asylum.  I mean, how can actual members of the securities industry possibly know what’s best for the industry, right?  Better bring in some CEOs and college professors.

But not at the District Committee level. There, all you see are branch office managers, chief compliance officers, firm presidents, and the like.  Everyone is registered, and everyone has skin in the game.  These are people who, almost universally, know what’s going on, how difficult it can be to run a clean shop, and how hard, at times, it can be to deal with FINRA.

The District Committee used to be a pretty powerful group of people. As I presume all readers of this blog understand, the role of District Committees changed in the late 1990s, as part of the SEC’s 21(a) Report on NASD, and not necessarily for the better.  As a result of the concerns that the SEC noted in that Report, the power of District Committees to authorize the issuance of Enforcement complaints and to review and approve settlement offers was removed and given, instead, to Enforcement itself  (subject to oversight by the Office of Disciplinary Affairs).  The only roles left to members of the District Committees following that power shift were to (1) sit on the occasional Enforcement hearing panel, and (2) attend quarterly meetings, where members of FINRA’s senior management flew in to describe all the new, cool initiatives that they’d conjured up in Rockville, DC and New York.

While those meetings were designed to be a give-and-take between the membership and management, it was clear from the outset that the collective voice of the District Committee members was faint, at best. Indeed, their job was never to approve of new proposed initiatives, since, in fact, senior management didn’t need their imprimatur to pass new rules, so their views on the subject were, ultimately, meaningless.  Simply put, the District Committee members were there to provide a degree of window dressing, to make it appear that FINRA management actually cared what the members thought.

This charade has, sadly, become obvious. What was once considered to be a position of note, a feather in the cap of anyone fortunate enough to be selected to sit on a District Committee, in short, an honor, has become something decidedly less worthy of celebration.  It has gotten to the point where instead of contested elections between multiple qualified candidates vying to win a seat on a District Committee, now, there aren’t enough people with sufficient interest in the job to bother with the process.  How do I know this?  FINRA itself told me.

Just a couple of days ago, FINRA filed a rule proposal with the SEC designed essentially to do away with the District Committees and replace them with Regional Committees.  Included in that proposal is this telling sentence: “FINRA has noted the membership’s general lack of interest in District Committee service.”  On what does it base that observation?  According to FINRA,

[t]he number of District Committee seat vacancies is the primary indicator of the membership’s declining interest in District Committee service. For the past six years, there has been an average of 29 vacant District Committee seats per year.  Of this 29-seat average, 13 (approximately 45%) have been contested seats (two or more candidates), eight (approximately 28%) have been seats with only one candidate, and eight (approximately 28%) have been seats without any candidates, thus requiring FINRA to find an eligible person to appoint to the seat.

The idea that over half the open District Committee seats attract either only one candidate or, worse, no candidates at all, speaks volumes about the superficial role that the District Committee plays in today’s FINRA, not to mention the fact that the membership correctly understands this sad truth.

To address this, FINRA has proposed several changes. First, it will eliminate the District Committees and replace them with Regional Committees.  Perhaps that’s not a big deal, inasmuch as the District Committees have already been meeting on a regional basis for years and years.  Second, it will alter the current composition of the District Committees, which is derived by a specific formula.  Now, each District Committee reflects “a configuration of three small, one mid-size and three large firm representatives.”  According to FINRA, this “three-one-three composition is intended to align District Committee representation more closely with the industry representation on the FINRA Board.”  But, FINRA maintains that this “configuration does not necessarily reflect the industry composition within the regions as each region differs regarding firm number, size and business lines.”  As a result, it wants to throw away the formula, which would make all seats on the District Committee at-large seats.  In addition, the requirement that only small firms could vote for the small firm seat, only mid-size firms could vote for the mid-size seat, etc., would be eliminated, and any member firm could vote for any vacant seat.  There are some other small tweaks, but these are the big changes.[1]


I have no idea if these changes will actually work to increase interest in District Committee membership. I hope that they do, because it is sad and disturbing that FINRA has watered down the role of the District Committees to the point that firms apparently no longer care about getting their best and brightest people to sit on them, as firms once did.  But I understand why they don’t.  I understand why people don’t want to waste their time simply being props in FINRA’s stage-managed productions where senior management pretends to be interested in what the District Committees have to say and then does what it wants anyway.

If the securities industry is ever going to get serious about fixing things, about taking back control of how FINRA acts towards its members, it must embrace that fact that changes need to start locally – at the District Committee level (or Regional Committee level, if this rule proposal is passed). Qualified individuals who feel strongly about what’s wrong with FINRA should actively participate in the FINRA committee system and make sure that their voices are heard.  If not, if the industry continues to abdicate its responsibility to ensure that self regulation survives, then it loses its right to complain about things, and, ultimately, member firms will get what they deserve.

[1] There is a very interesting throw-away line in the rule proposal regarding the role of District Committee members to comprise Enforcement hearing panels.  It states that “FINRA also is exploring options to enlarge the pool of panelists.”  I wonder what that could possibly mean?  It is incredible to consider that FINRA can’t attract enough people interested enough in the Enforcement process to volunteer to sit on hearing panels.

FINRA’s Attempt To Change Well-Established Federal Law On Churning

Posted in Churning, Enforcement, FINRA

When Michael called me to tell me about the subject of this post, I frankly thought he was making it up.  The notion that FINRA was seriously suggesting deleting one of the historically recognized essential elements of a churning claim — principally because otherwise it was too difficult for FINRA to prove churning — seemed ridiculous.  Then I read the Reg Notice.  Cleverly, FINRA tries to make it seem like the amendment isn’t necessary, arguing — incorrectly, in my view — that “[b]ecause FINRA must show that the broker recommended the transactions in order to prove a Rule 2111 violation, culpability for excessive trading will still rest with the appropriate party even absent the control element.”  But, that is wrong, unless, as FINRA seems to be suggesting, you want to split hairs and call one thing “churning” and the other “excessive trading.”  Please, even if you have never before commented on a rule proposal, now is the time to speak up.  FINRA cannot be permitted to get away with something like this, that is, simply ignoring legal precedent, because that precedent makes FINRA’s Enforcement efforts harder. 

Also, I just wanted to put in a plug for Ulmer & Berne’s Financial Services Seminar in Chicago on May 23.  If interested in attending, click here to reserve your spot. – Alan


FINRA has been busy lately issuing Reg Notices on proposed changes to its Rules. Several of the proposed changes seek to give FINRA more discretion and authority over its members and associated persons. I get that. Who wouldn’t like more control and power? But FINRA’s Reg Notice 18-13, issued on 4-20-18 of all days, makes me wonder what FINRA was smoking on this one. In that Notice, FINRA seeks to change decades-old federal securities law on churning in order for it to more easily prove that a customer’s account has been churned. That is bold.

Under well-established federal law, an investor must prove the following three elements to prevail on a churning claim: (1) the trading in the account was excessive in light of her investment objectives; (2) the FA exercised control over her account; and (3) the FA acted with scienter – intent to defraud or reckless disregard for the investor’s rights. One of the most frequently cited cases on the elements of churning is Rolf v. Blyth, Eastman, Dillon & Company, Inc., a decision issued by the Southern District of New York in the 1970s. Churning constitutes a violation of federal securities laws, specifically, Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5 thereunder.

Consistent with federal securities laws on churning, FINRA Rule 2111.05(c) currently provides that a quantitative suitability violation (i.e., churning) occurs when FINRA can establish the same three elements, namely, excessive activity, control, and scienter:  “Quantitative suitability requires a member or associated person who has actual or de facto control over a customer account to have a reasonable basis for believing that a series of recommended transactions, even if suitable when viewed in isolation, are not excessive and unsuitable for the customer when taken together in light of the customer’s investment profile, as delineated in Rule 2111(a).”

In Reg Notice 18-13, FINRA even acknowledged that Rule 2111.05(c) “codified the line of cases on excessive trading (sometimes referred to as ‘churning’).” The proposed change to Rule 2111, however, seeks to break from that line of cases by eliminating one of the elements of a churning claim: control. In other words, FINRA seeks to change well-established federal securities law by changing the definition of what does and does not constitute churning.

Remarkably, one of the reasons that FINRA cites for the proposed change is “its experience with the rule.” This negative experience for FINRA is presumably based on a series of unsuccessful attempts to pursue churning charges in settlements and hearings (e.g., 2009 Medeck NAC Decision). In other words, the proposed change is borne out of FINRA’s attempts to fit a square peg in a round hole by pursuing churning charges where it cannot satisfy the control element of the claim.

In the Notice, FINRA goes on to say that the control element “places[s] a heavy and unnecessary burden on customers [and FINRA] by, in effect, asking them to admit that they lack sophistication or the ability to evaluate a broker’s recommendation.” (Apparently, those at FINRA responsible for the proposed Rule have never seen a customer testify at an arbitration hearing as if he just had a frontal lobotomy.) The real “control” problem here lies with FINRA, and its lack of control over customers. FINRA does not possess jurisdiction over customers. Therefore, FINRA cannot force customers to testify or even cooperate, hindering its ability to prove that a customer lacks the ability to evaluate an FA’s recommendation, or, in many instances, to rebut a letter signed by the customer acknowledging that he possess that ability.

There are several other issues with FINRA’s position. First, the control element is not an unnecessary burden. It is a burden imposed by federal securities laws and the federal courts that have interpreted those laws. If a customer has an issue with how his account is being invested, then he should say or do something about it, and not sit idly by; investing is not a heads I win (trading strategy is profitable), tails you lose (firms reimburse trading losses) endeavor. An experienced, sophisticated, or even moderately intelligent person should not be able to prevail on a churning claim if he could and should have put an end to activity that he doesn’t like; the failure to do so reflects that the investor had no issues with how his account was being handled.

Second, the burden to establish churning is heavy because the consequences for violating federal securities laws are stiff. The FINRA Sanction Guidelines on churning recommend that adjudicators “[s]trongly consider barring an individual for reckless or intentional misconduct (e.g., churning).” This, of course, makes sense. An FA should be sanctioned severely for taking advantage of a customer who lacks the sophistication or ability to evaluate his recommendations. There is no mention in the Notice of reducing the specific guideline for churning if the term is redefined, which leads me to believe that no such commensurate change will be forthcoming.

Third, the proposed change to the definition of churning presents interesting charging and legal questions. Willful violations of certain federal securities laws, including Rule 10b-5, result in an FA being subject to statutory disqualification, which is quite consequential. If the Rule change passes, it will be interesting to see if FINRA charges churning claims as violations of Rule 10b-5 under its new definition or under the actual legal definition. If it is the former, then the FA should not be subject to statutory disqualification based on existing federal case law interpreting Rule 10b-5. Notably, there is no mention of Rule 10b-5 in the Notice.

Fourth, the proposed Rule change would be a real gift to PIABA and attorneys who represent investors in FINRA arbitrations. Despite existing federal case law, these attorneys will undoubtedly argue that their clients need not prove one of the most challenging elements of a churning in order to get a payday.

Instead of closing with a clever quip, I’ll let you know that the comment period for this abomination is June 19, 2018. Here is the email address to which to send your comments:




FINRA Knows Best – At Least According To FINRA – When It Comes To Hiring Decisions

Posted in FINRA, Hiring practices, Rule 1017

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.

FINRA’s Revolving Door: Much Ado About Nothing

Posted in Board of Governors, FINRA

As loyal readers are undoubtedly already aware, I used to work for NASD, and Michael more recently came to Ulmer from FINRA.  That hardly means we win every FINRA Enforcement case we are engaged to defend.  To suggest that because we came through the “revolving door,” FINRA does whatever we suggest is, frankly, absurd.  I only wish it was true!  – Alan 


This week, FINRA named the CEO of Janney Montgomery Scott to its Board of Governors. Last week, FINRA hired the CCO of Charles Schwab to head its Member Regulation department. A few weeks ago, the former head of Member Regulation joined Merrill Lynch as its Chief Supervisory Officer. And the ill-informed, politically-motivated, and unsubstantiated cries of the supposed perils of the revolving door have followed.

In an article about the new Board member, one critic of the revolving door, who hails from investor advocacy group Public Citizen, was quoted as saying: “The revolving door means the cops on the beat and the perps can be confused in the blur.” This statement is ridiculous. First, there is no confusion over who works for who. Those who work in the securities industry know when they receive a call or letter from FINRA, and those who work for FINRA know who works in the industry, with or without the aid of CRD records.

Second, to refer to FINRA as “cops” and the industry as “perps” is ignorant, offensive, and wrong. While there may be a few bad apples in the securities industry – as there are in any bunch, industry, or profession – the overwhelming majority of FAs try to do right by their customers. It is hard to succeed in the securities industry or any other service business for that matter without referrals from satisfied customers. I’ll also add that I was surprised to see someone from a group that touts itself as a champion of democracy and citizen’s interests ascribing malicious intent to an entire group of people.

Third, FINRA is a self-regulatory organization authorized by federal law, and registered with the SEC. The Securities Exchange Act of 1934, as amended by the Maloney Act, requires that FINRA’s rules “assure a fair representation of its members in the selection of its directors and administration of its affairs.”[1] FINRA’s Board consists of 24 persons – ten seats for industry members, thirteen seats for public members, and one seat for its CEO. Therefore, it should come as no surprise that the CEO of a FINRA member was appointed to FINRA’s Board. In fact, he took the seat previously occupied by the former head of another firm.

The President of the Public Investors Arbitration Bar Association (PIABA) was recently quoted in an article saying: “If you want true stringent regulations, a compelling argument can be made that these people shouldn’t come from the securities industry.” Setting aside the issue of whether stringent regulations and enforcement, as opposed to principles-based standards and reasonable enforcement, do not make sense in many cases, a more compelling case can be made that those running, and working at, FINRA should come from the industry.

The securities industry is a complex one. To successfully work at a firm, represent a firm in many legal matters, or regulate a firm, you need to have more than just a basic understanding of how stocks and bonds work. You cannot properly regulate that which you do not understand. That is precisely why FINRA hires executives and managers with securities industry experience. FINRA is not alone in this regard. Most companies prefer to hire executives and managers with relevant experience, and to keep their executives and employees with that experience from working at competitors, through non-competition and non-solicitation agreements. I can’t really imagine a company hiring only people who have no relevant experience, but I suppose the conversation would go something like this: “I know that we are a healthcare company, and that you have twenty years of experience and proven success in the healthcare industry, but we really are looking for someone who knows nothing about the healthcare industry to run the company.” That’s absurd. People with relevant experience bring their knowledge and experience to the table, and companies pay for, and benefit from, that knowledge and experience. Indeed, it makes perfect sense that FINRA would hire the CCO of a reputable firm to run its examinations program. She presumably is familiar with securities rules and regulations, and the policies, procedures, and systems that firms implement to comply with those rules and regulations.

Another problem with the arguments made by critics of the so-called revolving door is the reality of living and working in this country. Once you gain experience in an industry or field, you are free to use that experience to leverage a better paying or otherwise more desirable job. Simply because you worked as a securities regulator does not mean that you are confined to working in the securities industry only as a regulator for the rest of your life. And conversely, because you worked at or for a firm does not mean that you cannot work for a securities regulator. FINRA presumably has internal rules that govern conflicts of interests, such as prohibitions on working on a matter involving a friend, family member, former employer, or former client. FINRA Rule 9141 prohibits its former officers from appearing on behalf of a client in a FINRA disciplinary proceeding for a year after leaving the company.

My final problem with the critics is that they assume the worst in people. In other words, they assume that people who have worked at or for a firm, or who may do so at a later date, can’t function appropriately as regulators because of some hidden agenda or inherent bias. Critics cite no empirical or statistical data to support their proposition. There are, however, many lawyers and compliance consultants who have track records of success working both at FINRA and on behalf of firms.

The revolving door is much ado about nothing.

[1] 15 U.S.C. § 78-o-3(b)(4).

Reverse-Churning: BDs Are Damned If They Do, And Damned If They Don’t

Posted in Compliance, Fiduciary Rule, FINRA, Reverse churning

A couple of years ago, I blogged about the concept of “reverse churning,” i.e., putting a customer who trades only infrequently into a fee-based account, thus costing the customer a lot more than it would have cost that customer to be in a commission-based account.  The reason this became a topic was, at the time, the advent of the Fiduciary Rule, and its focus on conflicts of interest, given how a commission-based account has an inherent conflict.

Well, the Fiduciary Rule has stalled on its way to implementation, as you are likely aware, and when and if it ever gets back on track remains to be seen. Putting aside the question of whether that is a good or a bad thing, it remains that the Fiduciary Rule, even in its nascent form, is still having a real impact on the way that broker-dealers operate, and the risks they are running for, in essence, trying to do the right thing.  But, this isn’t a new phenomenon.  Broker-dealers have found themselves in this pickle for over 25 years.

Travel back with me to the year 1995. At the request of then-Chairman of the SEC Arthur Levitt, the Committee on Compensation Practices was assembled, chaired by Daniel Tully, the CEO of Merrill Lynch, and assisted by such luminaries as Warren Buffet.  The Committee issued the infamous Tully Report, designed to identify industry “best practices.”  Among the best practices identified by the Committee was the use of fee-based accounts, which were thought to “eliminate the incentive of a commission broker to make trade recommendations designed principally to enrich himself through commissions”:

PAYMENT FOR CLIENT ASSETS IN AN ACCOUNT, REGARDLESS OF TRANSACTION ACTIVITY. In many cases the best advice an RR can give a client at a point in time is to “do nothing,” or to keep assets in the safety of a money market account.  The RR’s reward for this advice is zero compensation.  Some firms’ practice of basing a portion of RR compensation on CLIENT ASSETS IN AN ACCOUNT is seen as one way to reduce the temptation for income-seeking RR’s to create inappropriate trading activity in an account.  Fee-based accounts may also be particularly appropriate for investors who prefer a consistent and explicit monthly or annual charge for services received, and whose level of trading activity is moderate.

Not surprisingly, many BDs, eager to please their regulators and to demonstrate their willingness to appear compliant, proceeded to adopt this as a best practice, and started encouraging clients to move to fee-based accounts.

Bad decision, as it turns out. Not long after the Tully Report was issued and extolled as the blueprint for modern compensation structures, NASD started to backtrack.  In November 2003, NASD issued Notice to Member 03-68, questioning whether what the Tully Report characterized as a best practice was, in fact, a good idea after all:

The . . . “Tully Report” . . . labeled fee-based programs a “best practice” because they more closely align the interests of the broker/dealer and customer and reduce the likelihood of abusive sales practices such as churning, high-pressure sales tactics, and recommending unsuitable transactions. . . . On the other hand, the Tully Report acknowledged that fee-based programs may not fit the needs of certain investors.  In this regard, commenters to the Tully Committee noted that accounts with low trading activity may be better off with a commission-based program. . . .

Based on that, NASD warned that “[i]t generally is inconsistent with just and equitable principles of trade – and therefore a violation of Rule 2110 – to place a customer in an account with a fee structure that reasonably can be expected to result in a greater cost than an alternative account offered by the member that provides the same services and benefits to the customer.”

Given these seemingly contradictory directions – it is a “best practice” to use fee-based accounts, but, if you do, you may be violating Rule 2110 – it is easy to see how BDs found themselves in a real predicament. I mean, even if they followed NASD’s advice, and “before opening a fee-based account for a customer” they took steps to ensure they had “reasonable grounds to believe that such an account is appropriate for that particular customer,” they still ran the real risk of being second-guessed by NASD. In fact, NASD, and later, FINRA, brought Enforcement actions for reverse-churning.

Today, 23 years after the Tully Report and 15 years after NTM 03-68, nothing has changed. BDs are still being second-guessed for doing what they have been told is the right thing to do.  What made me reach this conclusion was the report I read last week of a class action lawsuit just filed against Edward Jones by four customers for an illegal “reverse churning scheme.”  What makes this doubly troubling is that it seems clear the regulators themselves are potentially responsible for this lawsuit.  Remember, both FINRA and the SEC identified reverse churning in their respective 2018 Exam Priorities letters published at the beginning of this year.  The SEC said it was focusing on “advisers that changed the manner in which fees are charged from a commission on executed trades to a percentage of client assets under management.”  FINRA used very similar language, identifying “situations in which registered representatives recommend a switch from a brokerage account to a [fee-based] investment adviser account where that switch clearly disadvantages the customer.”

Claimants’ counsel are attentive to statements like this, perhaps as they should be. If they come to the understanding that regulators are purportedly concerned about fee-based accounts, then by golly, that can only mean litigation on that subject will shortly ensue.  Poor Edward Jones has just learned this unfortunate fact, the hard way.  But, how can this be fair?  How can doing what the regulators identified as a best practice simultaneously not be something that is in the customers’ best interest?  Talk about being between a rock and a hard place.

The only way out of this trap is some serious documentation and disclosure. Go back to NTM 03-68, read what it says in terms of the steps that must be taken before recommending a fee-based account.  Step one is figure out what a customer’s account is going to look like:

[M]embers should make reasonable efforts to obtain information about the customer’s financial status, investment objectives, trading history, size of portfolio, nature of securities held, and account diversification. With that and any other relevant information in hand, members should then consider whether the type of account is appropriate in light of the services provided, the projected cost to the customer, alternative fee structures that are available, and the customer’s fee structure preferences.[1]

Once the decision is made as to the proper type of account, then step two is disclosure: “[M]embers should disclose to the customer all material components of the fee-based program, including the fee schedule, services provided, and the fact that the program may cost more than paying for the services separately.”  This is very important because it shifts the burden to the customer to complain that the compensation arrangement was improper.  03-68 expressly identifies this safe harbor:  “Absent inducement by the member, no liability under Rule 2110 (unless derivative of another rule violation) will attach to a member where it is disclosed to a customer that a potentially lower cost account is available, but the member can demonstrate that the customer nevertheless opted for a fee-based account for reasons other than pricing.”

Finally, step three is monitoring. Once a decision is made to put a customer in a particular type of account, that is not the end of the story, as that decision must be revisited to ensure it continues to make sense.  In 03-68, NASD suggested that members conduct an annual review “of fee-based accounts to determine whether they remain appropriate.”  If you don’t do these annual look-backs, you clearly run the risk that you will be asked by someone, perhaps a regulator, perhaps an arbitration panel, perhaps a judge, to justify a decision that may have been made years before but which no longer matches a customer’s needs.


[1] These concepts remain valid today.  There is a Q&A currently on the FINRA website relating to fee-based accounts, and its content is largely drawn straight from NTM 03-68.

FINRA’s Stated Paradigm Shift On Enforcement Actions

Posted in Disciplinary Process, Enforcement, FINRA

I have spoken about FINRA possibly putting an end to the policy of pursuing cases where formal disciplinary action serves little to no regulatory purpose. That welcome paradigm shift may be upon us.

This year, FINRA, in essence, pronounced that its “broken windows” strategy of pursuing Enforcement cases over the smallest and most technical violations is, well, broken. In a speech at SIFMA’s Anti-Money Laundering & Financial Crimes Conference, Susan Schroeder, the head of FINRA’s Department of Enforcement, proclaimed that:

Enforcement action, while a powerful tool in FINRA’s toolbox, is not the right tool in all cases. In fact, we must be thoughtful and intentional in order to use our finite Enforcement resources in the matters where they are most needed. To determine if an enforcement action is the right tool to use in a given circumstance, we ask ourselves: Is there demonstrated financial harm resulting from the misconduct? Has there been a significant impact to market integrity? Did the misconduct create significant risk?

Instead of walking away from these remarks, FINRA adopted them, publishing the speech on its website. This is a refreshing and welcome change from the usual disclaimer that FINRA personnel provide at public speaking engagements (i.e., my words are my own, and do not necessarily reflect the views of FINRA (or something to that effect)). Last week at the SIFMA C&L Annual Seminar, Ms. Schroeder reiterated her remarks. She again declared that Enforcement action should be reserved for misconduct that creates “significant risk,” such as misconduct that results in harm to investors or market integrity.

There are a number of unintentional violations of the countless federal securities laws and FINRA rules that do not create “significant risk,” including untimely disclosure of reportable events on Form U4, non-disclosure of irrelevant outside business activities, certain inadvertent trade reporting violations, many net capital violations, and multiple types of inadvertent recordkeeping violations. FINRA has not published, and is unlikely to publish, a list of the specific types of violations that no longer warrant formal action, so it will be interesting to see which types of violations are affected by the stated policy shift over the course of the next year.

While this new stated policy is certainly welcome news, the key will be in its implementation. How will FINRA advise its staff of the new policy? How will FINRA train its staff on the policy? What, if any, guidelines has FINRA established on specific types of violations so that its staff knows whether or not formal action is warranted? How will FINRA supervise its staff – many of whom have been working under the “broken widows” approach for years – to ensure that the new policy is universally and uniformly implemented? These types of questions should sound familiar. They are the same types of questions to which FINRA demands answers of its members on their WSPs, and that FINRA now will need to answer for itself if it plans to reasonably implement its new policy.

As the saying goes, it can be challenging to teach old dogs new tricks, but FINRA will need to do just that in order to effectively implement its stated policy change. A small, technical, and/or unintentional violation that invariably resulted in a lengthy investigation, followed by formal action, over the past decade may no longer warrant the same degree of costly inquiry and the same disposition. To quote from FINRA Rule 3110, let’s hope that FINRA “shall establish and maintain a system to supervise the activities of [its staff] that is reasonably designed to achieve compliance with [the new policy].” Even if FINRA does not implement the new policy to the fullest extent in your case, you can at least thank Ms. Schroeder for providing fodder for responses to Examination Reports, Wells letters, and closing arguments.

Do FINRA’s Proposed MAP Rules Put PIABA’s Concern Over Money Ahead Of Fairness To Members?

Posted in Arbitration, FINRA, MAP, PIABA

I have often used this forum to complain about FINRA’s lack of backbone when it comes to dealing with PIABA, the group of lawyers who represent customers of broker-dealers, principally in arbitrations. Over the years, FINRA has amended its rules time and again in response to loud claims by PIABA that the arbitration process is biased in favor of the industry and against customers, each time making it more difficult for member firms to defend themselves.  All-public arbitration panels, with no one from the securities industry there to provide real-world insight into the allegations of misconduct?  Thank you, PIABA.  No ability to file motions to dismiss clearly meritless claims?  Thank you, PIABA.

As I’ve written about before, PIABA’s newest kick is to try and do something about the fact that when it prevails, sometimes the respondent is financially unable to satisfy the award, so the complaining customer – and, more important to PIABA, the customer’s lawyer – don’t collect any money. That has always struck me as a fact of life: doesn’t matter what the litigation is about, there is always a possibility that the defendant can’t pay.  That’s why before a lawyer agrees to take on a client on a contingency basis (as PIABA lawyers do), they have to pose two questions:  (1) Does the evidence suggest I will prevail?  (2) If so, will I be able to collect from the defendant?  This is as true in traffic accident cases as it is in commercial cases as it is in customer arbitrations.  And, unless the answer to both is “yes,” the case will, generally, not go forward.

Yet, PIABA lawyers argue that their cases deserve special treatment, that something needs to be done to prevent the situation where they win the case but are unable to collect.  Seems a bit presumptuous, doesn’t it?

Well, not to FINRA. Once again, FINRA is on the verge of capitulating to pressure from PIABA.  In Reg Notice 18-06, FINRA is seeking comments on proposed amendments to its membership rules.  Make no mistake about the point of these amendments.  It is not to provide greater investor protection, or greater market integrity, which remain as FINRA’s two supposed overarching goals.  Rather, as the title of the Reg Notice explicitly states, it is to “Incentivize Payment of Arbitration Awards.”  Not just any arbitration awards, no, just awards against broker-dealers.  FINRA doesn’t much care if a broker-dealer is unable to collect an award it receives against a customer with, say, an unpaid debit balance.

What do the new rules provide?

First, for applicants who are seeking FINRA’s permission to create a new broker-dealer, FINRA is proposing that it be allowed to “presumptively deny” the application if the applicant or any of the persons associated with applicant is the subject of a pending arbitration claim. Not an adjudicated claim, a pending claim, meaning a claim that has not yet gone to hearing and in which there have been no findings of liability.  I guess FINRA has no respect anymore for the quaint old concept of “presumption of innocence.”  Remember, in a FINRA arbitration, just as in court, the respondent/defendant is presumed innocent and the claimant/plaintiff has the burden of proof.  Pish posh.  So 1700s.  Instead, let’s just presume that anyone named in an arbitration is guilty, right?  So much easier.  So, rather than presuming the respondent is innocent, let’s shift the troublesome burden of proof from the claimant, and, instead, make the respondent overcome the opposite presumption, i.e., that the respondent is guilty.

Oh, it’s not all bad. FINRA helpfully identifies the facts a new member applicant might include in its application “where there are concerns about the payment of those [customer arbitration] claims should they go to award or result in settlement.”  In these cases, FINRA proposes to permit applicants to rebut the presumption of denial by proving that they could, in fact, pay the award “through an escrow agreement, insurance coverage, a clearing deposit, a guarantee, a reserve fund, or the retention of proceeds from an asset transfer, or such other forms that the Department may determine to be acceptable.”  In other words, FINRA may let you become a member if you first prove you have a stash of money laying around specifically earmarked for one thing: to satisfy an arbitration claim that hasn’t even been proven and may never be proven.

And, more infuriating, what is missing from this list of facts that would allow an applicant to rebut the presumption that its application should be denied? How about a showing by the applicant that the customer claim is ridiculously and patently without merit (as, sadly, many are)?  Shouldn’t that be enough to satisfy the MAP staff?  Apparently not.  Apparently, FINRA could actually care less about the actual merits of a customer arbitration, as its sole concern is on whether the applicant can pay the award.  In a fair world, FINRA would at least pay some lip service to an evaluation of the merits of a pending arbitration, but, as this Reg Notice reveals, FINRA doesn’t even do that.

A couple of other observations about this rule proposal that give some insight into FINRA’s thought process.

First, it is interesting how FINRA is trying to make individual liability a problem for the firm. Follow me here.  FINRA says that it is concerned “about new members onboarding principals and registered representatives with pending arbitration claims.”  Ok, let’s play that string out.  If those individuals take their arbitrations to hearing and lose, it is the individuals who have to pay the award, not the firm that they’ve registered with.  Yet, FINRA states that the proposed rule amendment “[c]reating a presumption of denial in connection with” such pending arbitration claims “would shift the burden to the new member to demonstrate how its claims would be paid should they go to award.”  How do the claims against the individuals magically become claims against the broker-dealer, for which the broker-dealer is financially responsible?  Even PIABA hasn’t conjured up that requirement.  Yet.

Second, it is almost funny how, despite the tellingly specific name it gave to the Reg Notice, FINRA attempts to make it seem like it’s not all just about getting customers and their lawyers paid. As FINRA sees it, creating a presumption of denial wouldn’t just provide greater assurances of an applicant’s specific ability to pay an adverse arbitration award, it would also “shine a spotlight on the individuals with the pending arbitration claims and the firm’s supervision of such individuals.”  Specifically, FINRA wants to be able to assess “the nature of the anticipated activities of the principals and registered representatives with the arbitration claims; the impact on the firm’s supervisory and compliance structure, personnel and finances; and any other impact on investor protection raised by adding the principals and registered representatives.”  If this was really an issue for FINRA, why did it take a complaint from PIABA to bubble it to the surface?  I can assure you, PIABA isn’t interested in better supervision or tighter controls over new member applicants; it just cares about the escrow accounts, insurance coverage, guarantees, etc., i.e., the pots of money into which it can potentially dip.  Anyway, isn’t it FINRA’s job to be shining this spotlight on potential problem areas in the industry?

The comment period for this proposed rule expires on April 9. Tell FINRA what you think about its plan.  Unless you speak up, you lose the right to complain about it later.

What Not To Wear (Or Do) At Your FINRA OTR

Posted in Disciplinary Process, Enforcement, FINRA, OTR

I apologize for not posting anything recently, but, sadly, I was embroiled in a two-week arbitration that occupied most of my recent attention.  I am home, however, and back in the saddle.  In the meantime, here’s a post from Blaine Doyle, author of the classiest post ever in this blog, something about ancient Greece.  I think.  Or maybe it was King Arthur.  Something memorable.  Anyway, here is Blaine passing along comments from some FINRA lawyers about how nice they’ve become and how they won’t be filing Enforcement actions willy nilly.  Another piece of classic fiction, perhaps?  –  Alan

I recently sat in on a panel of senior attorneys from FINRA Enforcement and while they did not actually discuss wardrobe selection, they did give some insight into the OTR process and Enforcement cases in general.  Here is a taste of what they had to say.

With limited staff and resources, the attorneys emphasized that the number of Enforcement cases being brought is actually down over the last few years.  Part of that is a function of a strong economy, but they also bluntly said that certain issues that in the past would have prompted an Enforcement action are now being let go by FINRA.  An example would be a firm that is dually registered as an RIA and broker-dealer.  If the issue is with the supervision of the I/A accounts and not the brokerage accounts, FINRA is less likely to bring a case now than it was just a few years back.  This is partly based on jurisdictional issues (FINRA does not have it on IAs; either the SEC does or the state) and partly based on allocation of resources.   Another example where FINRA is, today, less likely to institute an action would be failure to review broker emails where the action was corrected and no customers were harmed.

So what kind of actions will lead to an Enforcement case?   Basically, the opposite of what it is (supposedly) willing to let go, i.e., cases that feature 1) customer harm 2) ongoing violations and 3) recidivism.   Odds are if you have any of these issues, you are getting an Enforcement action from FINRA filed against you.  In an interesting note, one of the attorneys who used to be a partner at a big firm opined that there is too much review prior to the initiation of an Enforcement action.  In other words, the person/firm is brought up for votes before all kinds of committees and groups and the process can be a bit of a bureaucratic nightmare even in instances where it is readily apparent that violations were committed.

This is all putting the cart before the horse however, as an OTR will occur prior to the initiation of an Enforcement case.  Before filing an Enforcement case, FINRA will try to conduct complete discovery, so it can gather facts.  Part of this is requesting documents through 8210 requests and part of this is interviewing people “On The Record” during an OTR.  The FINRA staff didn’t say anything earth shattering about OTRs and lots of some of their comments, like “tell the truth,” seemed obvious enough that a third grader would know it.  But these comments had a little bit more nuance once they explained what they meant.  In this instance, what they meant was that you are not doing anyone any favors if you keep a defense hidden or don’t disclose it during your OTR.  They said this actually happens quite frequently and that in certain instances, they have decided to bring an Enforcement action only to have a cogent explanation/defense brought to their attention subsequent to the filing of the Enforcement action.  It was pretty clear that this really annoys FINRA, and since agitating FINRA is usually bad for business, it is best to put your cards on the table early on and to try to avoid the Enforcement action altogether.

This leads to another point, which I swear they actually said, namely, that a person facing an OTR needs to hire a lawyer.  A firm might have a great CCO and great staff but those individuals might not know what the FINRA attorneys are looking for or how to ease their concerns.  They emphasized that communication is greatly improved when there are attorneys involved as they tend to look at things with a more clinical view.  Some lawyers, including our own Alan Wolper and Michael Gross, used to be NASD/FINRA attorneys and they have even further insight as they used to sit on the other side of the table and speak fluent regulator.  The bottom line is that nobody likes to pay for lawyers but the FINRA attorneys made clear that the expense can help resolve issues early on and probably save money in the long term.

On the flip side, FINRA does not like when people plead the 5th Amendment in an attempt to avoid testimony.  As you are likely aware, because it is not part of the government, FINRA does not recognize the 5th Amendment; thus, attempts to hide behind it will likely lead to a permanent bar (for violating Rule 8210).  That said, if a person has a legitimate fear that their testimony could lead to criminal sanctions, they encouraged the interviewee’s attorney to reach out to the Staff beforehand so that they can evaluate the pleadings on a case by case basis.  In other words, don’t just show up and plead the 5th or try to hide behind it if you don’t have a legitimate criminal issue, unless you plan on getting barred.

Once a case concludes (whether it be through dismissal, settlement or administrative action), they mentioned that there will be a much larger focus on getting restitution for aggrieved investors instead of collecting fines for FINRA.  There has also been a greater emphasis on putting details of violations into consent decrees/AWCs, so that people who care to look can actually figure out what went on and why FINRA fined the firm in the first place.  Perhaps more importantly to industry folk, it appears that FINRA is actually going to let people know when and if an investigation is closed.  For many years FINRA staff had no obligation to let an individual know if an investigation was formally closed without an Enforcement case being brought.  At times, staff would let an attorney know, informally, that they probably would not be hearing from them on the issue again, but, in other instances, it was prolonged and deafening silence.  This albatross was tough on the business of the brokerage houses, not to mention the collective blood pressures of those running the firms.  According to the FINRA attorneys, the new policy is to let firms and individuals know if their investigation has concluded, especially in those instances where the CRD/ Form U-4 of the target was marked as a result of the investigation (like occurs after a Wells Notice).  This is a welcome change and should help clear the names of innocent firms/brokers.

That about sums it up, but since we did promise you fashion advice for an OTR, here goes: dress down but in a respectful manner. For instance, if you have a $5,000 suit and a $200 suit, go with the cheaper one.  Regulators don’t love flashy investment professionals but do like people that show respect for the investigatory process.