For many years, FINRA has attempted in several settings to substitute objective criteria for subjective ones, to try and make things easier for itself, and to make things more consistent from district to district and from firm to firm.  For instance, FINRA used to – and may still today – identify firms whose exam cycles should be accelerated by assigning numerical values to a variety of characteristics (theoretically risk associated), and then adding them up.  If your firm’s total exceeded whatever cutoff FINRA established, well, you were lucky enough to be examined more frequently.  And then there was that infamous episode about 20 years ago, when FINRA decided to evaluate the performance of its District Offices by creating objective, numerical goals against which actual performance could be measured.  The problem was, the objective goals were themselves sometime stupid (and even controversial, such as the one that required at least 10% of exams to result in formal disciplinary actions).

Well, FINRA is still at this game, and continues its goal of identifying specific circumstances that it could use as some objective basis to cull out those individuals and firms on which to focus its regulatory attention.  Last week, a number of rule amendments became effective (others don’t become effective until May, June and September, respectively) that fulfill that desire, and they are laid out in Reg Notice 21-09.

I started talking about this in a blog post two years ago, when FINRA first broached the subject.  At the time, I expressed my concern about utilizing a quantitative standard as a means of identifying firms that ought to garner more attention.  Sadly, at least in my view, FINRA shares no such concerns.  To the contrary, citing a 2015 study published by FINRA’s Office of the Chief Economist[1] – comically, a study that admonishes on page one that “[t]he views expressed in this paper are those of the authors and do not necessarily reflect the views of FINRA” – FINRA strongly believes in “once bad/always bad” when it comes to brokers.  Given this somewhat simplistic view of the world, FINRA has now made a number of rule changes that actually implement this philosophy.

The changes impact several rules.  Let’s review them.

First, and perhaps most impactful – and NOT in a good way – on FINRA member firms, let’s see how it affects hiring decisions.  Under current rules, if a BD wants to hire someone as a registered rep, there’s really nothing to stop the firm from simply doing so, and without asking permission.  Yes, it’s true that in some very limited situations, the hiring of even a single rep might trigger a CMA if the addition of that registered rep would constitute a material, quantitative change in the firm’s business based on the number reps the firm already had as of the date of the hiring, but everyone understands that.  Here, I am not talking about that; rather, I am talking about the typical hire, one that would be permitted by a firm’s Membership Agreement without a CMA, or because the firm had the right to take advantage of the “safe harbor” in IM-1011 (also obviating the need for a CMA).  Under FINRA’s new rule, things are very, very different.  Under certain specific circumstances, a BD may NOT simply hire a registered rep – even though the rep is otherwise qualified and not statutorily disqualified – if that rep has in the prior five years, either (1) “one or more final criminal matters” or (2) “two or more specified risk events.”[2]  If he or she does, then before the BD can hire the rep, it must first file a MatCon – a Materiality Consultation – with FINRA.  If FINRA concludes the hiring would be material, then a full-blown CMA is necessary (the filing fee for which costs, at a minimum, $5,000, something FINRA pointed out would in and of itself constitute a disincentive for firms to hire reps who meet FINRA’s new criteria).  In other words, FINRA is unilaterally determining that registered reps who have these particular disclosures – disclosures which do NOT prohibit these reps from registering at any BD – cannot be hired unless FINRA says so.

As you can see, based solely on criteria that it simply plucked out of thin air, and its own unchallenge-able determination of what constitutes “materiality,” FINRA is going to be acting as gatekeeper, theoretically to prevent or dissuade firms from hiring people that FINRA’s own predictive analysis machine suggests will be likely (or more likely than others) to commit sales practice violations in the future,[3] in deference to its own awful logic that “a member firm’s hiring of a broker with a significant history of misconduct – and other associations with such persons – would reflect a material change in business operations.” Ah, FINRA is in the crystal ball business!  What ever happened to “past performance is no guarantee of future results,” a disclaimer that both the SEC and FINRA look for?  I guess it doesn’t apply to people.  (I would ask, too, what ever happened to due process, but I fear I know the answer to that one already.)

I could go on and on about this one rule change, which I think is a game-changer in terms of the power that FINRA just gave itself, but let me hit the others.

For anyone unlucky enough to have been involved in a FINRA Enforcement case, you likely know that if you lose the hearing and appeal to the NAC, then the sanctions – whatever they are, no matter how severe, even including a permanent bar – are stayed pending the disposition of the appeal.[4]  You can keep working, keep earning (perhaps to pay your attorney, which is not a crime by any means), until the NAC finally decides your fate.  That has now changed.  The new rule MANDATES that in this scenario, the BD MUST impose a heightened supervision plan on the rep.  This marks the very first time in history that FINRA has identified a circumstance that requires an HSP.  Prior to this, indeed, even as recently as Reg Notice 18-15, such a determination resided with each BD, based on guidance that FINRA offered regarding circumstances that it believes suggest that an HSP be considered.

And that’s not all.  In addition to the mandatory heightened supervision plan, FINRA has the right to ask the Hearing Officer – the very person who just found the rep to be liable in the first place – for the “imposition of conditions or restrictions on the activities” of that rep that are “reasonably necessary for the purpose of preventing customer harm.”  Not really sure how these “conditions or restrictions” differ from a heightened supervision plan, or under what circumstances FINRA will seek to impose restrictions.  The only hint, sort of, lies in a footnote in the Reg Notice:  “The conditions and restrictions are not intended to be as restrictive as the underlying sanctions imposed in the disciplinary decision and would likely not be economically equivalent to imposing the sanctions during the appeal.”

I didn’t say it was a helpful hint.  If you can figure out what this means, please, by all means, let me know.

For what it’s worth, at least these can be challenged.  If FINRA files a motion to impose these restrictions, the motion can be opposed, and the Hearing Officer’s decision can be promptly appealed to the NAC.  (Yes, that’s right, the same NAC that is going to hearing the appeal itself.  Again, no conflict of interest here!)  It is going to be exciting to see how FINRA wields this new power.  Will it seek restrictions in every case?  Only those in which bars are imposed?  Time will tell.

Having decided that it was comfortable announcing a mandatory heightened supervision plan for respondents who appeal to the NAC, FINRA just kept going.  The new rules, therefore, also require that BDs impose an HSP on registered reps on whose behalf an MC-400 is filed.  While HSPs are universally proposed in support of an MC-400 – because they are the key tool to providing FINRA with the comfort of knowing that if a disqualified person is permitted to associate with a BD he or she will not repeat the misconduct that got them disqualified in the first place – they have not, to date, been necessary prior to the approval of the MC-400.  (Again, in Reg Notice 18-15, an HSP in this scenario was merely suggested, not mandated.)  Now, the HSP must be implemented even while the MC-400 is under consideration.

Two years ago, I closed my blog post by urging members to speak up in response to FINRA’s rule proposal.  In reviewing the SEC’s Order approving the rule changes, it seems that maybe four comments were received…and two of them were in favor of the changes.

[1] Read this thing if you choose, but let me save you the time.  The authors essentially concluded that the worst 20% of brokers, based on their disciplinary disclosures, are responsible for the statistical majority of subsequent disciplinary events.  In other words, it is predictable, using math, that a bad broker will continue to be bad.

[2] What are these things?  They included as new definitions in Rule 1011.  “Final criminal matters” means a criminal matter that resulted in a conviction of, or plea of guilty or nolo contendere (‘no contest’) by, a person that is disclosed, or is or was required to be disclosed, on the applicable Uniform Registration Forms.”

A “specified risk event” is:

(1) a final investment-related, consumer-initiated customer arbitration award or civil judgment against the person for a dollar amount at or above $15,000 in which the person was a named party;

(2) a final investment-related, consumer-initiated customer arbitration settlement or civil litigation settlement for a dollar amount at or above $15,000 in which the person was a named party;

(3) a final investment-related civil action – i.e., NOT consumer initiated – where:

(A) the total monetary sanctions (including civil and administrative penalties or fines, disgorgement, monetary penalties other than fines, or restitution) were ordered for a dollar amount at or above $15,000; or

(B) the sanction against the person was a bar, expulsion, revocation, or suspension; and

(4) a final regulatory action where

(A) the total monetary sanctions (including civil and administrative penalties or fines, disgorgement, monetary penalties other than fines, or restitution) were ordered for a dollar amount at or above $15,000; or

(B) the sanction against the person was a bar (permanently or temporarily), expulsion, rescission, revocation, or suspension from associating with a member.

[3] I should point out that the rule doesn’t just apply to everyday reps who a BD may want to hire, but, as well, to principals, control persons, and new owners, both direct and indirect.

[4] Just for giggles, it is worth asking what is the point of appealing to the NAC.  In its Order approving the FINRA rule changes, the SEC observed from 2013-2019, the NAC issued decisions in 131 disciplinary matters. It affirmed the hearing panel or hearing officer findings 121 times (92%), modified the findings six times (5%), and reversed or dismissed the findings a whopping four times (3%).

FINRA is often accused (mostly rightfully, and certainly by me) of being a horse-is-already-out-of-the-barn sort of regulator, jumping on an issue only after the problem has already arisen and made it to the front page of the Wall Street Journal.  But, that’s not always the case.  Indeed, there are occasions when FINRA is out ahead of the curve, providing warnings of problems that may seem remote at the time, but which later manifest themselves.

Such is the case with FINRA’s approach to BCPs, or Business Continuity Plans.  Following the horrific events of September 11, 2001, FINRA (well, NASD, at the time) created Rule 3510, now FINRA Rule 4370, to address the disruption created in the business of many broker-dealers located in Manhattan (and others, elsewhere, who did business with those downtown Manhattan firms).  According to that rule, every BD must create and maintain a written BCP that is reasonably designed to enable the firm to meet its obligations to customers, among others, during an emergency or significant business disruption.  Among the several things that must – by rule – be included in a BCP is an effort to address “[a]lternate communications between customers and the member.”  In other words, how can customers reach the firm when circumstances render ordinary means of communications unavailable.

While the rule seems to have contemplated disasters, both natural and man-made, as the cause of such disruptions (e.g., all the cell phones stop working), ultimately the particular cause doesn’t matter.  If, for whatever reason, a problem manifests itself that results in the phones/emails/faxes/instant messages being rendered useless, a BD needs to have a Plan B in place, to minimize the repercussions to investors.  FINRA has offered pretty good guidance on this rule over the years, including a Report from 2019 on examination findings relating to BCPs, some FAQs, and even a Small Firm BCP Template.

One of the specific observations in that 2019 Report is this:

Insufficient Capacity – Some larger firms did not have sufficient capacity to handle substantially increased call volumes and online activity during a business disruption, which affected customers’ ability to access their accounts.

That is, the phones and internet are still working, but so many people are calling and emailing that they get busy signals, or their calls/emails are not returned promptly.

Let’s fast-forward to 2020 and Robinhood.  Anyone who’s followed the markets even casually is aware of the multiple instances on which Robinhood’s customers were denied access to their accounts, or couldn’t reach Robinhood even to lodge complaints about their lack of access.  That has resulted in both angry customers – read that as “arbitrations” – and angry regulators.

This is not me speculating about that last part.  Just listen to this FINRA podcast, called “Exam and Risk Monitoring Program: Responding to COVID-19 and Looking Ahead.”  It consisted of a conversation among three FINRA Senior Vice Presidents, including Bill St. Louis, SVP of the retail and capital markets firm groups (who is a certifiably nice guy).  Bill was asked about the Report on FINRA’s Examination and Risk Monitoring Program, published earlier this year:  “So, beyond Reg BI, does the report have any other priorities worth mentioning for Retail or the other firm grouping you work with, Capital Markets?”  Here is his answer:

[T]here are a number of different priority areas in there that are relevant to Retail and Capital Markets firms.  I’ll just touch on two very briefly.

One, I just want to remind everyone that there’s an intersection between cyber events and AML. So, account intrusions, takeovers, data breaches likely will be SAR reportable. So, I just wanted to remind firms of that. And that’s something that we pay quite a bit of attention to.

On tech governance, there are a number of firms that have platform outages in 2020, some of which related to market volatility. And the headline on outages, and like a lot of things on tech governance, is testing, testing, testing, capacity testing, vendor management, ongoing maintenance and testing of changes, new patches, scripts, new software, new hardware. Testing to see whether or not the linkages between systems are going to operate as expected when there are patches or changes to one part of the system.

And then the other thing about outages is we’re very focused on customer service during outages. Can firms handle the incoming calls from customers? Are there ways for customers to access and make transactions through other entry points if, for example, an app is down?

There’s actually a lot there, and I will break it down some, but let’s focus on the bit I highlighted.  This is precisely the circumstance that FINRA previously cautioned its members to be aware of, and to prepare for.  Look, I get that it’s more than a bit ironic for FINRA, of all people, to accuse others of not providing adequate customer service.  But, at least in this one instance you cannot reasonably argue that FINRA was late to the party.  It accurately anticipated a situation like those that Robinhood experienced, and gave fair warning.  (I guess I ought not to pick on Robinhood, but it did garner the most headlines, and it has been reported that it may be fined as much as $26 million for, among other things, not providing its customers with access to their accounts.)  That, ladies and gentlemen, is what FINRA is supposed to do, and when it manages actually to do it, it deserves the credit.

As for the other things Bill said, I think the most notable is his admonition that account intrusions and the like “likely will be SAR reportable.”  That’s a big deal, as I see it, and here’s why:  FINRA has made it clear that, historically, it is less interested in whether or not a SAR is actually filed than in whether or not a BD has a robust AML supervisory system, one that spots red flags, responds to them promptly, and takes appropriate action.  That action may or may not be the filing of a SAR, depending on the firm’s analysis of the circumstances.  But, as long as the firm DID spot the red flag, and DID respond, it is ok if the firm concludes that no SAR need be filed, as long as the decision not to file it was reasoned and supported by the facts.

Bill’s comment here, however, seems to suggest that contrary to FINRA’s prior guidance, they now seem willing – and maybe even looking forward to – second-guessing even a reasoned decision not to file a SAR.  And that’s troubling.  Filing a SAR is serious business, with potentially serious consequences.  If FINRA is going to start holding against even firms with excellent AML supervisory systems the fact that they elected, after careful deliberation, not to file a SAR, then all that will accomplish is to cause firms simply to file SARs, period, regardless whether they’re truly mandated.  If you know that no one gets in trouble for filing a SAR, or even too many SARs, then why not err on the side of over-disclosure, just to avoid becoming the subject of a FINRA exam?

Indeed, this phenomenon – called “defensive” filing, when a firm files a SAR simply to avoid being questioned why it didn’t – has been observed by many, and may account for the crazy number of SARs being filed.  I came across an article that stated that in the first 11 months of 2020, 2.5 million SARs were filed with FinCEN.  I am no expert on how FinCEN triages the SARs it receives, but I would venture go guess that there’s no way for it to be nearly as effective as it might be at its job if SARs were only filed when circumstances truly mandate such, not just as a matter of being cautious.  I fear that if Bill meant what he said, things will only get worse.

So, you see?  I still got to take a shot at FINRA, even in the same post that I complimented them on their prescience when it comes to BCPs.  All is right with the world.


I have always operated with the understanding that, per FINRA rules, one cannot supervise him- or herself.  Hardly an outrageous proposition.  Today, however, that fundamental, bedrock understanding was so shaken, it has left me wondering whether anything is what it seems (especially when coupled with Loyola’s win this weekend over Illinois, which, really, can only have occurred in some bizarro alternative universe).

It all stems from an AWC submitted by The Logan Group Securities, a modest little matter resolving a modest rule violation.  But, there is more here than a quick read reveals.

According to the AWC, Logan Group is a sole proprietorship, and Mr. Logan, the firm’s owner, is its sole registered person.

Let’s stop right there.  Doesn’t that HAVE to mean that Mr. Logan – by necessity – supervises himself?  Metaphysically speaking, I just don’t see a way around that.  I mean, he can only be supervised by another registered person.  And, if there is no such person, who does that leave to supervise Mr. Logan?  [Insert “brain exploding” sound effect here.]

Ok, moving forward.  So Mr. Logan does everything at his firm, it seems.  He’s the salesman.  He’s the CEO.  He’s the CCO.  He’s the supervisor.  Heck, he probably brews the coffee and hangs the office decorations around Christmas time.  He is responsible for the WSPs, that is, creating and maintaining them, and then following them.  Given that, unlike an RR at an ordinary firm, when confronted with an apparent sales practice issue, he cannot defend himself by arguing that he lacks culpability because he did everything the WSPs required (suggesting to FINRA that the problem isn’t with the RR, but, rather, the BD, for having inadequate procedures), since to do so would simply mean he was pointing the finger at himself.

So, according the AWC, Mr. Logan sold a bunch of variable annuities.  FINRA seems to have had some concerns with the share classes that Mr. Logan recommended to his customers for a period of about one year, from October 2017 to September 2018.  Sometimes he used B shares, typically with a seven-year surrender period, other times he used L shares, with a shorter surrender period of three to four years but with higher annual fees.  Oddly, even though the AWC includes a finding that there was a violation of Rule 2330, which is the suitability rule for variable annuities, FINRA never flat out finds that the recommendations were unsuitable.

Instead, what FINRA concludes is that the supervisory procedures that Mr. Logan created to deal with the “recommendation and sale of different variable annuity share classes, specifically L shares sales,” were inadequate.

Let’s stop again.  So the issue isn’t that Mr. Logan made unsuitable recommendations to his annuity customers.  Rather, it is that the supervisory procedures he created to supervise his own sales of annuities were not reasonable because they didn’t work well enough to pick up any potential issues created by his choice of share class.

Wait, what?  The procedures that Mr. Logan created were not robust enough to allow him, as supervisor, to detect that the recommendations he himself made, as registered rep, were potentially problematic?  You can see how this AWC and its Möbius strip of an analysis has left me confounded.

There were some additional supervisory violations – the firm failed to fulfill a promise it made to FINRA to document its review of variable annuity options with customers; it failed to update its WSPs to reflect a new form it was using to highlight the features of the annuities it was selling; and it failed to collect the investment objective and risk tolerance information for three L-share contract customers – but none was particularly outrageous.  The whole case basically boiled down to the fact that Mr. Logan didn’t do a good enough job of supervising (and documenting that supervision of) Mr. Logan’s own sales of annuities.

Which, I suppose, brings me to this question:  why, for heaven’s sake, did FINRA charge this as a supervisory claim against a one-man firm, rather than charging that one man with the underlying violations themselves?  If FINRA didn’t like the share class that Mr. Logan utilized, why not simply charge him with making unsuitable recommendations?  I have devoted blog after blog to complaining about the fact that FINRA is quick to name individuals at small firms as respondents in supervisory cases, while it is loath to do the same with big firms.  Yet, here is the smallest possible firm, and rather than doing what it always does, FINRA, instead, elects not to name an individual, but, rather, only the firm.

As long as I do this, I will never understand what makes FINRA tick.

As everyone knows, back in the 1980s, broker-dealers fought hard for the ability to include in a customer agreement a clause mandating that all disputes be dealt with in the arbitration forum, rather than in court.  It was not an easy fight, as to require a customer to arbitrate means that certain rights that would otherwise be available in court – expanded discovery, additional motion practice, an actual judge presiding over the process rather than a volunteer whose skill set may or may not be appropriate or relevant, the right to appeal – are sacrificed in an effort to provide a system that is faster (Ha!) and cheaper (Ha Ha!).  But, the fight was won, and ever since, arbitration clauses are routine.

But not everyone is a fan.  Indeed, you may recall that buried in Dodd-Frank is a provision that gave the SEC the right to simply declare the end of mandatory arbitrations.  Armed with that power, the SEC basically did, um, nothing.  It conducted a study, or something.  But it’s been over ten years, and if anyone was breathlessly awaiting some action by the SEC on this hot, hot topic, they have long since expired from lack of oxygen.

I am wondering now, however, if that’s how things will remain.  Earlier this month, President Biden’s – first time I am typing those two words together! – nominee to head the SEC, Gary Gensler, was questioned by the U.S. Senate Banking Committee.  Including, notably, Elizabeth Warren, no fan of FINRA or of mandatory arbitration.  Check out this exchange she had with Mr. Gensler:

Senator Warren: Okay. And then finally, let me ask about the tilted roulette tables on Wall Street. If someone has been cheated by a broker dealer, hypothetically, for example, if Robinhood cheated individual investors, hypothetically, should that company be able to use forced arbitration clauses to avoid getting sued and held accountable?

Mr. Gensler: I think, Senator, that while arbitration has its place, I think it’s also important that investors, or in that case, customers have an avenue to redress their claims in the courts.

Senator Warren: Good. You know. As you know, the SEC has the power to require disclosures that will be helpful to the investing public-like climate risk disclosures and private equity practices. And Section 921 of the Dodd-Frank Act gives the SEC the authority to prohibit the use of forced arbitration by broker-dealers when it is “in the public interest and for the protection of investors.” In other words, the SEC has the tools to make the markets function better. So, if you are confirmed, Mr. Gensler, will you commit to picking up those tools and using them to make the markets more honest and more transparent?

Mr. Gensler: Senator, if confirmed, I look forward to looking at all of the authorities. Not just this one. But all of the authorities to help protect investors, promote the capital formation and the efficient markets that we talked about. And this is an important authority that was vested in the agency and looking at the economic analysis, working with fellow commissioners. I think we should look at all the authorities.

Senator Warren: I appreciate that. You know. Congress has given the tools to the SEC. We just need the SEC to pick up these tools and use them. The SEC has been asleep on the job for long enough. It’s time for the Commission to get off its behind and protect investors and consumers and I expect to see progress on all of these areas under your leadership.

My heavens, do you think Senator Warren tipped her hand regarding what she wants to see happen?  “Tilted roulette wheel.”  Jeez.

Clearly, she thinks that the current system of “forced arbitration” – even her use of “forced” vs. “mandatory” conjures up rather nasty images – does not hold BDs accountable, does not make the markets more honest, does not provide transparency, and, most important, does not protect investors and consumers.  But none of that was surprising.  She has maintained these views for a long time, and her frequent expression of her distaste for mandatory arbitration may be the principal reason that FINRA has displayed its long history of kowtowing to PIABA when it complains about the supposed unfairness of FINRA’s arbitral forum.

What IS surprising is Gensler’s answer, which I highlighted, in which he acknowledged that it’s important for investors to have the ability to go to court.  THAT is nothing we have heard coming out of the mouth of any Chairperson of the SEC since Dodd-Frank.  And while Mr. Gensler is hardly obligated if he is confirmed actually to do anything that he told the Banking Committee, you still have to take his comments seriously.

It will be very interesting to see what shakes out here.  Senator Warren is a powerful force in the Senate, more so now, under the Biden administration (which she, as well as other Democratic candidates, helped happen by gracefully bowing out of the race two days after the Super Tuesday results came in) than she had been.  Does President Biden owe it to her to look into this pet issue of hers?  Gensler’s answer certainly suggests that she will be taken seriously, at a minimum.

But, let me be clear about something: as I have undoubtedly said before, I am perfectly ok if I am required to defend my BD clients in court, rather than in a FINRA arbitration.  Indeed, that’s how I started my career, almost 40 years ago now, helping Chuck Murphy, my inimitable mentor, the partner for whom I principally worked, defend BDs in customer cases filed in federal court in the Northern District of Georgia.  (My first notable accomplishment as a baby attorney was winning a partial motion for directed verdict on a claim that my client had sold an unregistered security.  We lost the rest of the case, but, hey, I won my piece, despite not really knowing what I was doing.)  I am ready, willing and able to return to the court setting, if the SEC says that must happen.

I wonder, however, if the claimants’ bar can say the same thing.  Some of the Statements of Claim I receive likely could not survive a motion to dismiss for failure to state a claim.  (Of course, I can’t file that motion in arbitration, as the Code of  Arbitration Procedure doesn’t allow it.)  Some could not survive a motion to dismiss based on the statute of limitations (an argument that makes arbitration panels really uncomfortable, for some reason).  Some could not survive a motion on the pleadings.  Some could not survive a motion for summary judgment.  Some might even subject the lawyer who signed it to sanctions under Rule 11, given how far removed some of these things are from the truth.  I acknowledge that court will cost my clients more, and will take longer.  But, if it means that justice is really served, that the playing field is truly level, and I can go into battle armed with the various procedural devices that don’t exist in arbitration, then I would be all in.

My friend and former colleague, Brian Rubin, publishes annually his analysis of FINRA Enforcement cases, spotting trends in terms of the number and types of matters it brings, the sanctions meted out, etc.  It is an excellent tool, and eagerly anticipated by lots of us who practice in this industry.  One of the hard parts of his analysis is his effort to figure out how respondents who elected to take their case to hearing, as opposed to settling, fared.  That is, did they end up getting harsher or more lenient sanctions as a result of rejecting FINRA’s offer and going to hearing.  (It’s a labor intensive analysis, inasmuch as FINRA’s (rejected) settlement offer is not public information, so Brian has to call lawyers and cajole them to share that information on an anonymous basis.)

Something that Brian’s study typically reveals is a fact well known to lawyers who defend Enforcement cases, but which is surprising to everyone else: respondents often – certainly not all the time, or even most of the time – actually do better – in terms of sanctions[1] – by going to hearing.  The so-called “hearing discount.”  Which is a bit counter-intuitive since in most settings, settlements result in more benign sanctions (because by settling, the respondent is saving the other side from having to prepare the complaint and then prepare for and attend the hearing, all of which takes a lot of time and effort).

With that introduction behind me, let me get to the point: last week, Brian himself got a result in a case that demonstrated, once again, the phenomenon of the hearing discount – in this case, the ultimate discount: a finding of no liability and, therefore, no sanctions whatsoever.  Granted, it was not a short or easy road to get to that result, as the case took a long time – seven years – and a tortured route, as follows:

If you wanted, you could stop reading here and feel good about having learned a lesson from poor Mr. Tysk’s travails, namely, if you have the gumption and the money to fight, fight, fight, you just may, someday, prevail.  Or you can simply relish the notion of FINRA taking it on the chin from the SEC, hardly an everyday occurrence.  But, if you take the time to read through these decisions, particularly the last one, there are a few more points very worthy of discussion.

Before I do that, I have to give (or try to give, anyway) a brief synopsis of this procedurally complicated case.

  • At Mr. Tysk’s recommendation, his biggest customer made a $2 million annuity investment.
  • That customer later lodged a complaint against him with his BD, Ameriprise, alleging that the recommendation was unsuitable
  • Ameriprise embarked on an internal review to assess the merits of the customer’s complaint.
  • Based on a review of Mr. Tysk’s paper files, Ameriprise concluded the complaint was meritless.
  • In addition to his paper files, Mr. Tysk also maintained an electronic file – ACT! – that he used “to document client interactions, including a chronological record of client meetings, notes, and to-dos.”
  • After Ameriprise’s review, Mr. Tysk concluded that his electronic notes relating to the complaining customer “were not as complete as he would have liked them to be. As his biggest client, Tysk was in contact with him much more frequently than his other clients and did not make notes of each interaction at the time the interaction occurred.  Consequently, Tysk’s ACT! notes for his biggest client were much sparser than for nearly all of his other clients.”
  • So, relying on his memory and his papers, Mr. Tysk added approximately 70 supplements to his notes for this customer, most of which were new entries.
  • The added notes were accurate.
  • The supplements accurately reflect the fact that they were added at a later date, and Mr. Tysk never represented that the notes were made contemporaneously with the events they described.
  • Neither Ameriprise nor Mr. Tysk relied on the notes to establish the suitability of his annuity recommendation.
  • A few months later, the customer filed an arbitration against Mr. Tysk and Ameriprise alleging that the annuity was unsuitable
  • During discovery, a hard copy of Mr. Tysk’s ACT! notes was produced to claimant, which reflected that they had been supplemented at a later date.
  • The ACT! notes played no pertinent role at the arbitration hearing.
  • The Panel issued an Award in favor of Mr. Tysk’s client on the issue .
  • More important, the Panel faulted Mr. Tysk for altering his ACT! notes, and made a disciplinary referral.
  • FINRA then brought an Enforcement action against Mr. Tysk, alleging two things:
    • First, that Mr. Tysk violated FINRA Rule 2010 and NASD Rule 2110 by “alter[ing] his customer contact notes after receiving” the complaint letter “to bolster his defense of the customer’s claim . . . in violation of his firm’s policies”
    • Second, that Mr. Tysk violated IM-12000 of the FINRA Code of Arbitration and FINRA Rule 2010 by not notifying his client or Ameriprise of the edits to his ACT! notes when he “responded to discovery requests for his notes and when he responded to subsequent requests for edits to his notes.”

You already know how the story eventually played out.  But, how did the SEC come to the conclusion that FINRA erred – twice – in finding Mr. Tysk liable?

It started with an analysis of FINRA Rule 2010.  You know this one, it’s the general rule that FINRA cites when there’s no specific rule governing the conduct at issue, and requires that members and associated persons “observe high standards of commercial honor and just and equitable principles of trade.”  The SEC correctly noted that “[a]ssociated persons violate these rules (where the alleged violation is not premised on the violation of another FINRA rule) if they act unethically or in bad faith.”  The SEC defined “unethical conduct” as that which is “not in conformity with moral norms or standards of professional conduct,” and “bad faith” as “dishonesty of belief or purpose.”

Applying those definitions, the SEC concluded that FINRA failed to prove its case.  While FINRA had found that Mr. Tysk acted unethically by “deliberately creat[ing] misleading evidence,” i.e., that he created “the false impression that he wrote contemporaneous notes of his conversations” with his biggest client when in fact those notes were written many months later,” the SEC disagreed, finding that “the record does not show that Tysk attempted to create a false impression as to the date he created the [supplements to the] notes, either affirmatively or by implication.”   Moreover, the SEC observed that FINRA hadn’t even bothered to attempt to prove that Mr. Tysk added his supplements in some effort to “bolster his defense.”

Which brings us to the SEC’s next point, the one with, perhaps, the biggest ramifications for respondents everywhere.  Remember, FINRA alleged that Mr. Tysk violated 2010 because his actions violated Ameriprise’s policies by supplementing his ACT! notes during the firm’s pending exam.[2]  Specific to that allegation, the SEC stated that it did not need to decide whether or not Mr. Tysk violated Ameriprise policies “because even if he did so FINRA failed to establish he thereby violated FINRA Rule 2010 and NASD Rule 2110.  A violation of a firm policy does not necessarily mean that a registered representative has also violated these rules.”

This is HUGE.  There are maybe, what, a million Enforcement cases that FINRA has brought where the allegation was simply that the respondent violated some firm policy, and, therefore, Rule 2010?  Based on the SEC’s reasoning here, it is evident that going forward, FINRA is actually going to have to do some work in such cases.  It is actually going to have to prove that the respondent somehow acted unethically or in bad faith, not merely that a firm policy was violated. And this, I venture to say, will not always be possible for FINRA to pull off.

Back to the SEC decision.  In reversing FINRA’s ruling on the second charge, the SEC made two important observations.  First, Mr. Tysk was asked in discovery in the arbitration to produce the pre-supplemented versions of his ACT! notes, but he could not do so, despite the fact that the fancy-schmancy forensic computer expert FINRA engaged was somehow able to do that.  The SEC was unimpressed by that showing:  “Tysk’s discovery obligations – under both FINRA Rule 12506(b) and IM-12000 – extended only to documents in his possession or control.  He was under no obligation to create new documents.”  This is as true in arbitrations as it is in FINRA exams: Rule 8210 allows FINRA to request the production of documents, but it does not give FINRA the power to compel you to create one.  So bear that in mind the next time you receive a request asking you to create a spreadsheet.

Second, the SEC wrote that “FINRA’s decision suggests that if Tysk could not produce documents showing edits to his ACT! notes he was nevertheless required to provide additional explanation of those edits during discovery.  But FINRA has not shown that Tysk was required by the arbitration rules or by Rule 2010 to include an explanation of the ACT! notes that he produced, particularly here where the document disclosed on its face that it had been edited in May 2008, and Tysk took no other action to state or imply that the notes were created contemporaneously.”  As the case that the SEC cites for this proposition provides, it is not bad faith not to “spontaneously volunteer information” that was not requested.  I suggest you bear this mind not only when responding to discovery in arbitration, but also when responding to questions from FINRA during exams.

A final thing worth noting is what FINRA did NOT charge Mr. Tysk with: a violation of the books-and-records rule.  There are likely a couple of reasons for this.  First, broker notes are not included in the long list of documents in SEC Rules 17a-3 and -4 that a BD has to make and preserve.  These are optional, and what you do with them is largely up to you.  Second, Mr. Tysk did not make the mistake of altering documents after they were requested by FINRA during an exam.  Do that and FINRA will write you up no matter what the document at issue happens to be.  All you have to do is look, for instance, at this AWC, which FINRA issued three days before the SEC’s Tysk decision.[3]

I apologize for the length of this post, but there was a lot to work with, and a lot of lessons to glean.  Not everyone has the luxury of being able to pay counsel to wage a seven-year fight with FINRA, I get that.  But, at least this one time, it was worth it for Mr. Tysk.


[1] The reason I highlight this point is because taking a case to hearing vs. settling can be a hugely expensive decision in terms of attorneys’fees.  Thus, even if a respondent does end up with lesser sanctions after going to hearing, it could cost hundreds of thousands of dollars in legal expenses.  That is why it is usually a difficult decision to reject a settlement offer, even in a case with good facts, because, as I tell my clients, all you are buying, ultimately, is the right to read the Panel’s decision, not the right to dictate how it reads.

[2] Oddly, although Ameriprise issued a lukewarm reprimand to Mr. Tysk, according to the SEC decision, the firm determined that Mr. Tysk’s “addition to his ACT! notes did not violate any section of [Ameriprise]’s policies and procedures” or any “specific provision of the Code of Conduct.”  Moreover, Ameriprise did not find that Mr. Tysk had “engaged in any wrongdoing.”  Just one more example of FINRA knowing more than its members.

[3] I hate to dredge up old memories, but FINRA knows this lesson very well, after being sanctioned by the SEC back in 2011 for supplying the SEC with altered or misleading documents three times in an eight-year period.  Here is that Order, in case you wanted to relive this one.

Thanks to Heidi for today’s post. – Alan

Today, the SEC put out its 2021 Exam Priorities, available here.   It is about 40 pages long and covers a lot of topics.  While I encourage everyone to read through the document, here are the primary focus items for 2021:

Overarching Themes / Focal Points:

  • Regulation Best Interest and Form CRS: Primary focus of 2021 exams based on its prominence in the letter and all the recent guidance we’ve seen.  Make sure to review the recent (December 2020) statement the SEC put out on what, specifically, it will be looking at during these exams.  That statement is located here.
  • Compliance Culture. Importance of a top-down approach to compliance, starting with Firm CCOs who are knowledgeable and empowered to make necessary changes.
  • Fees and compensation. Whether its looking at the reasonableness of a fee, whether the fee creates a conflict of interest, whether a fee is properly disclosed, or how the fee is calculated (for advisory fees), there are now a tremendous number of issues (and potential charges) that flow from fees.  If you understand how you are compensated, ensure fees are imposed properly, properly identify where that compensation creates a potential conflict, and properly disclose that conflict, you will have covered most of the areas on this year’s priority list.  Remember this is any compensation – not only compensation paid by clients.

Specific Points of Interest during Exams:

  • Best Interest Recommendations. The SEC will be looking at whether and how firms make best interest recommendations.  This will be more than just reviewing policies and paperwork – they will be conducting enhanced transaction testing to test those procedures.
  • RIA Fiduciary duties. This one is evergreen.  The SEC will be looking at whether RIA advice is in client’s best interest and whether there has been a full disclosure of conflicts of interest.  Continued focus on fees, costs, and undisclosed compensation that could result in a conflict of interest between a firm and its clients (note: its unimportant whether the conflict ever manifested or had any impact – the potential is enough to require disclosure).
    • Sustainable Investing/Socially Motivated Trading. The SEC devotes a separate section to investment strategies focused on “socially responsible” investment strategies. It’s really a subpoint of the fiduciary obligation.  If you offer investment strategies with these focuses, you need to make sure your disclosures, recommendations, and supervision of the same are accurate.
  • Form CRS and related disclosures. Broker dealers now have a similar obligation to disclose fees and potential conflicts.  BDs should be thinking hard about compensation or benefits they receive that has the potential to lead to conflicted advice.  Here, we can learn lessons from the disclosure cases brought previously against IAs.
  • Specific retail investors: Recommendations made to seniors, teachers, military personnel and “individuals saving for retirement” get special focus.  The last one on this list is a doozy.
  • Account type recs. Especially if it’s a rollover.
  • Complex products. They will be looking for best-interest grounds for the sale and, if the product is only for accredited investors, making sure customers are properly accredited under the new definition of the term.
  • Mutual Funds and ETFs. The SEC is looking for proper risk disclosures (especially with more risky options) and examining recommendations in funds that provide “incentives” to firms and their professionals.
  • Fixed Income. The Pandemic has stressed many municipal entities.  So, SEC is looking for proper risk disclosures re: muni issuer as well as whether the trades themselves show proper mark-ups/down, pricing, and achieve best execution.
  • Microcaps.  Another evergreen item. You know what they are looking for here.
  • Safeguarding customer info. Protection from hacks, email phishing, ransomware, etc. and protecting for your customer’ info whether held by you or a vendor. Especially now, as much of the country is working remotely. The SEC will be looking at how information security is handled in the new work-from-home setting.
  • Business Continuity. This has long been a focus, getting a lot of attention when Hurricane Sandy hit New York.  The pandemic only reinforced the importance of being able to respond to unexpected natural events.
  • Financial technology. Robo advisors, new software, mobile apps, digital assets.
  • AML.  Again, you’ve seen this one before.  Long-standing focus.
  • Fund examinations. The SEC will review funds’ compliance programs and governance, focusing on disclosures (including website language).
  • How RIAs treat private funds.  With a focus on funds that have experienced issues (liquidity, withdrawal freezes) or which have a high concentration of structured investments.  And, as always, surrounding disclosures

Thanks to Blaine for not only attending this panel session, but for summarizing it for us! – Alan 

Recently, the Roaring Kitty (aka Keith Gill) and his brethren made headlines with their trading (most notably in GameStop) and the impact it had on certain hedge funds and banks.  The interest on this saga seems to be universal with folks wanting to know whether or not these trader/customers were doing anything wrong and if there were any possible ramifications.  Thus, it seemed particularly timely when the Chicago Bar Association announced that it would be hosting a panel made up of SEC and FINRA personnel to discuss the topic of market manipulation (which was one of the theoretical transgressions of the traders that has been bandied about).  Before you get too excited, however, the regulators prefaced their comments by indicating they would not be discussing any current trading activity or active investigations, which would almost certainly cover GameStop, etc.  Still, as always, it is nice to learn what regulators are thinking before you end up sitting across the table from them trying to explain away your own actions.  With that in mind, here are the highlights of the discussion.

The regulators generally described manipulation as an action taken to interfere with the market in its natural state, which frequently means an act that artificially changes the price of a security or product.  Sounds amorphous, right?  Luckily, one of the regulators from the SEC outlined some of the things he looks for:

1) The trading makes no sense – e.g. orders on both sides of the market or other circumstances where even the traders themselves have no bona fide explanation for the purchases and sales.

2) Notice of illegality or rules violations – this does not necessarily mean that the SEC or FINRA are knocking on your door, it could be the BD telling the trader to stop a certain type of trade, shutting down accounts because of the trading activity or, simply, questioning the trading.  In other words, if the trader’s broker-dealer has been sniffing around, regulators are probably going to assume the trader was on notice that something might be afoot and will not look kindly upon an ignorance plea.  In theory, this should help weed out any type of mistaken or innocent acts.

3)  Hiding actions – this one seems obvious and includes opening up accounts in the names of friends, family and other entities to disperse trades and other furtive activity that indicate the trader knew or at least had reason to believe his or her actions might be wrong.

So how do these bad acts manifest themselves in the everyday market? The regulators mentioned a host of illicit activities including but not limited to spoofing, wash trades, banging the close and a healthy discussion of “pump and dumps.” A pump and dump classically occurs when a person or group of persons obtains control over a company that has a low value (sometimes known as a penny stock company).  That person might hide their control by putting their shares in the name of family members and or other entities (which would hit on Regulator’s #3, above).  After that they promote the company, either doing it themselves or by paying others to do so in chat rooms or other mediums, using false information about the future prospects of the company.  After innocent investors purchase the stock, and drive its price up, the owner dumps his or her shares and the innocent investors are left holding the bag.

These types of schemes were of particular concern last year when different companies marketed potential “miracle” cures for COVID that unsuspecting investors might have tried to jump on to make a quick dollar.  These schemes are often found in companies doing business in whatever is the fad of the day (COVID, Marijuana, etc.).  As the moderator pointed out, this fact pattern is basically the plot to the industry favorite film Boiler Room, which is worth a watch for industry wonks.

As mentioned above, the regulators promised to avoid current events (read GameStop) in favor of resolved matters. Still, it creeped into the conversation, at least tangentially.  The moderator, while not mentioning Game Stop, asked why the public should care if investors are doing something (whether manipulation or not) that ends up harming a Wall Street bank.  Notably, the question is not if there is some type of violation, but, instead, why people should care.  The answer was that it does not only impact those banks or hedge funds but interferes with market liquidity and, potentially, the average investor (especially older ones) if one of the securities at issue happens to be in average Joe’s 401K or his personal trading account.  Theoretically, that makes perfect sense, but if the average investor saw his stock in GameStop temporarily rise and then fall back down, he might not have suffered too much harm.  The real damages was done to those shorting stocks, but it is, of course, not clear how many 401Ks or elderly investors are shorting companies on a regular basis.  It will be interesting to see where the regulators, ultimately, shake out on the issue.

Again, while not mentioning GameStop, there was talk about how broker-dealers can protect themselves if, by chance, their customers are engaged in some type of market manipulation.  According to the FINRA representative, foreign nationals going through broker-dealers (especially those who offer direct to market access) have been an ongoing problem.  While FINRA, at least, would not be able to touch those unregistered foreign individuals (true of unregistered domestic individuals, as well),[1] the broker-dealer could find itself with a failure to supervise case pending against it.  The lesson is that broker-dealers need to be vigilant in ensuring (or at least taking reasonable steps to try to ensure) that its customers are not manipulating the market and to make sure they are keeping accurate tabs on who exactly is opening accounts with the firm.  In other words, and as always, vigilance is the key to avoiding entanglements with regulators whether pertaining to manipulation or any other issues that broker-dealer personnel face.


[1] The Roaring Kitty, of course, presents a different circumstance since he is currently registered.

I get the fact that anyone silly enough to work for a broker-dealer knowingly chooses to live in a fishbowl.  Thanks to BrokerCheck, you can very easily learn more about a registered representative than you can about, say, a doctor, a teacher, a lawyer, you name it, all through a couple of mouse clicks.  But, this is no secret, as I said.  It is the price one pays to work in the securities industry, and I suppose that if one feels strongly enough about not having to disclose a baseless, frivolous complaint from a customer, or an unpaid tax lien, or a personal criminal history, then, arguably, one should find a different profession, where such things do not have to be shared with the public at large.

My problem is not, therefore, with BrokerCheck per se (although I remain convinced that FINRA’s ongoing and vigorous – but largely vain – efforts every year to increase the public’s awareness of BrokerCheck just go to show that no one actually cares very much about it).  Rather, my problem is the use that claimant’s counsel make of the information available in BrokerCheck, particularly reported arbitrations, disciplinary actions taken by regulators, and even customer complaints that remain pending, or were even dismissed.  In short, they take that information – which, in theory, is designed to enable investors to check out prospective brokers, to decide whether to trust them with their investments – and turn it into advertisements, soliciting customers to engage them to file arbitrations in an effort to recover alleged losses.

Just in case you don’t know what I’m referring to, let me walk you through how it works.  And believe me, there are probably hundreds, or even thousands, of examples.

The lawyers start by taking advantage of the search algorithms buried beneath the surface of Google, acquiring and utilizing website domains designed to pop up in response to searches for lawyers who handle customer cases.  Sort of like (which, remarkably, seems to be available).  When you click on that link, you are directed to the law firm’s actual website.  There are likely dozens of these domain names.  Some are specific to particular products, so if a customer invested in a certain investment that has not performed to expectations, the thought is that they will be directed to these websites.

Once you get to the actual website of the law firm, there, you will be presented with page after page of things that read like press releases, with headlines announcing that the law firm is “investigating” – that is the verb most often used, for some reason, even though, in fact, there is no such investigation – some person or some firm that was obligated to disclose in his or her Form U-4 (or Form BD, in the case of a BD) a complaint, an arbitration settlement or award, or a regulatory matter.  The body of these “press releases” then simply parrot the language found in BrokerCheck, leading to the big finish, which is a blunt, no-nonsense solicitation: If You, Too, Have Done Business With This Guy (or This Firm), Hire US So We Can Go After Him And Accuse Him Of The Same Thing.

These are, of course, advertisements, and the lawyers who publish them are typically very careful not to say anything that is false (since to do could be defamatory).  Thus, for instance, if they run one of the press-release-sounding ads to take advantage of the disclosure of the filing of a regulatory complaint – which, of course, contains nothing but unproven allegations – they will be sure to bury the word “alleged” in there, somewhere, so they cannot be accused of actually stating that someone committed securities fraud.

Because these ads do no more than repeat (albeit in fancy, formal sounding language) information that is otherwise available to the public via BrokerCheck, there is basically nothing that you can do to stop it.  Assuming that the lawyer has not said anything actually false, requests or demands to take these “press releases” down from the website are met with laughter, or worse.  (What could be worse?  I have had claimants’ lawyers retaliate against clients who insisted that I at least try to get their names removed from these websites by actually increasing their efforts to solicit business against such clients.)

It is very frustrating, and sad, for me to have, basically, the same conversation, over and over again, with different clients.  Yes, it sucks that when you Google your name, the first three pages of results are simply lawyers hoping to sue you.  Yes, it is frustrating that there is nothing to do about that.  Yes, it would be nice if FINRA cared even in the slightest about this issue.  Sorry.  Sorry.  Sorry.

What made me think about this issue today is what happened recently regarding GPB.  GPB is an investment that hasn’t done too well.  In the least shocking development ever, that has resulted in a TON of arbitrations against BDs and registered reps, all alleging that they failed to figure out that GPB was operating some sort of fraud.  Every claimant’s counsel in the world probably has some “investigation” regarding the sale of GPB on their website.  Yet, these arbitrations came in the absence of any actions being taken by regulators, in the absence of any findings that GPB was, in fact, a fraud.  Well, that has changed.  Two weeks ago, the SEC, along with seven states, filed civil actions against GPB, and the DOJ filed a criminal case against three individuals associated with GPB, alleging – ALLEGING, not actually FINDING – that GPB was operating a “Ponzi-like scheme.”

And you know what this will mean: the websites of every claimant’s counsel will be updated immediately to disclose this development, and encourage investors to hire them…not to sue GPB, but, rather, to sue the poor BDs and RRs who sold them GPB.  I have looked, and, not surprisingly, the updates have already been made by most.

But what is very interesting is that the claimant’s lawyers point to the SEC, state and DOJ complaints as evidence of wrongdoing that investors should take into consideration, but they do not bother to state that according to the allegations in these complaints, the BDs who sold GPB were ALSO VICTIMS OF GPB’S ALLEGED FRAUD!  That is, the U.S. Government has taken the position in the formal pleadings that it has filed that GPB defrauded not just the investors, but the BDs, as well, by providing them with due diligence materials that contained false information.  The complaints do not state, or even suggest, that the BDs should have been able to figure out that the information GPB supplied was false.

Yet…the claimant’s lawyers ignore this allegation completely, talk simply about the fraud, the fraud, THE FRAUD.

So, to conclude my little rant, here is my wish list – and I call them wishes because I am well aware that none of these things will ever happen:

  • FINRA does something to prevent lawyers from using information in BrokerCheck simply to advertise for new clients
  • State Bar Associations do something to prevent lawyers from using the same information in advertisements to solicit new clients
  • FINRA tweaks BrokerCheck so that mere complaints, i.e., complaints that have not resulted in anything being done, are not disclosed
  • Complaints that are dismissed, or withdrawn, should be automatically expunged from an RR’s CRD record
  • In the same sense that communications by BDs with the public must be “fair and balanced,” ads placed by lawyers should tell the whole story. So, for instance, ads referencing the GPB complaints should have to explicitly disclose that there is nothing in those complaints that could serve as evidence of wrongdoing by a BD.

I truly feel badly for those among my clients who find themselves the victims of these advertising campaigns.  This is not why BrokerCheck was created, not at all.  Yet, FINRA sits back and lets this happen.  So, I guess you guys get a two-fer here: a reason to dislike both FINRA and lawyers.


I just read this article – admittedly authored by lawyers, Ethan Brecher and Ana Montoya, whose website provides that one of their three principal areas of practice is representing investors “who have been defrauded by their securities brokers”[1] – that advocates for a new FINRA rule designed “to limit wasteful post-arbitration appeals by brokerage firms.”  And I just had to respond.  Because I am soooo tired of claimant’s counsel complaining about the supposed advantages held by broker-dealers in arbitrations that result in the so-called “unlevel playing field.”

According to Mr. Brecher and Ms. Montoya,

Brokerage firms, with vast financial resources and the home court advantage at FINRA, have little to complain about when they lose an arbitration.  Generally, arbitrators reach fair and equitable results and give all parties a full opportunity to be heard.  Many brokerage firms, however, pursue sour grapes appeals when they lose against less financially resourced employees and customers, resulting in a man-bites-dog situation.

Based on their observations, they advocate for a new rule “that broker-dealers be required to pay liquidated damages equal to double the damages awarded in arbitration to the prevailing employee or customer if the firm loses an appeal from an adverse arbitration award.”

Where should I start?

How about the brokerage firms’ “vast financial resources.”  I wonder who they had in mind when they wrote that?  Granted, there are, of course, lots of big broker-dealers with lots of money.  But, they are hardly the only firms that get named as respondents in customer (or industry) arbitrations.  Indeed, most cases are filed against small firms, whose financial resources are anything but “vast.”  And many of those firms rely on insurance coverage to pay the cost of defense, coverage that has finite limits (not to mention deductibles – sometimes very high deductibles – that alone can bankrupt a firm).  Moreover, this ignores the fact that customers don’t always just sue their BD; often, they name their advisor, too.  And rare is the registered rep who has “vast financial resources.”  (Even when an RR is not named, if he works for an independent contractor model firm, the likelihood is that he has signed an indemnification agreement, obligating him to reimburse the BD for its “losses,” which include the firm’s self-insured retention.  That can be considerable, to say the least.  I have one client now whose deductible is $150,000.  PER CASE!)

Ok, moving on to BDs’ supposed “home court advantage at FINRA.”  Frankly, I have no idea what they are referring to, although this phrase has been used forever (but, sadly, successfully, by claimants’ counsel, who have managed over the years to gaslight FINRA into believing it).  Anyone who deals with FINRA customer arbitrations knows well that as a result of changes that have been implemented over the years – at the behest of PIABA and claimant’s counsel – FINRA has bent over backwards to avoid any argument that somehow its forum favors firms over customers.  Just consider, most notably, the drastic limitations imposed on pre-hearing, dispositive Motions to Dismiss, and the elimination – at the claimant’s option! – of the Industry member of the hearing panel.  To suggest that there is a home court advantage for respondents is to ignore this reality.

Mr. Brecher attempts to support his argument by citing FINRA Dispute Resolution statistics that show that in cases that actually go to hearing, the hearing panel only occasionally awards the claimant money.[2]  Which must mean that there is a problem with the system itself, right, that it is skewed in favor of respondents?  Well, no.  As I have stated time and time again, it is no surprise that respondents win the vast majority of cases that go to hearing, and that’s for the simple reason that we settle cases that we reasonably think we have some chance of losing.  According to FINRA statistics, in 2020, only 13% of all cases that were closed came after a hearing (or a decision on the papers).  Respondents’ counsel are clever enough not to risk taking a case with bad (or arguably bad) facts to hearing.  Thus, it makes perfect sense that claimants don’t usually receive money at a hearing.  This does not mean the playing field is not level.

There are other problems with the proposal.  To begin, the law already provides a remedy if a lawyer files a frivolous appeal.  According to Rule 38 of the Federal Rules of Appellate Procedure, “[i]f a court of appeals determines that an appeal is frivolous, it may, after a separately filed motion or notice from the court and reasonable opportunity to respond, award just damages and single or double costs to the appellee.”  That is already a big enough club for any ethical lawyer to deal with.  Besides, note that Mr. Brecher’s proposal doesn’t make any distinction between a “frivolous” appeal and an appeal that is merely unsuccessful.  According to his article, any time an appeal fails, the respondent would owe the claimant not just “costs,” as per the Federal Rule, but double the “damages,” with no consideration of whether the appeal was frivolous.  Such a powerful, preemptive procedural maneuver exists nowhere else, to my knowledge.

Also, it is sort of predictable that Mr. Brecher’s proposal is strictly a one-way street.  That is, there is no reciprocal treatment suggested for when a claimant who loses at hearing files an appeal and loses there, too.  Apparently, that either never happens, or, when it does, it is somehow ok, and respondents should just suck it up.  I can tell you from personal experience that it does, in fact, happen.  Claimants who receive a 0 from an arbitration panel sometimes decide to file a motion to vacate, and my clients are stuck defending them, no matter how spurious the arguments they contain.  At a minimum, putting aside all the other issues I have with Mr. Brecher’s proposal, shouldn’t it cut both ways?  Maybe have a rule that says if a losing claimant files a motion to vacate that is denied, then the claimant must pay the respondent’s legal fees, at least the fees incurred in connection with the defense of the appeal (but maybe, too, the fees incurred defending the hearing)?  Fair is fair, after all.

Look, I don’t know Mr. Brecher and have never litigated with him, and I have no issue with him personally.  All I am saying is that it gets old hearing complaints about how FINRA arbitration is supposedly unfair to claimants[3] when, in my experience, it is respondents who can make the much better argument.  Most of the time – the vast majority of the time – FINRA arbitrations do work.  Or, to the extent there is some unfairness, it impacts both sides equally.  But, in short, there is absolutely no evidence that I have ever seen, statistical or anecdotal, that would lead me to conclude that the playing field tilts in respondents’ favor.


[1] With that said, I looked at every arbitration award in a case that Mr. Brecher has handled – at least those that appear on FINRA’s website – and in not one did he represent an investor.  Rather, every case was on behalf of someone who worked for a BD and was either going after his/her firm for damages, or was the subject of a claim by the BD for damages.  The point is: Mr. Brecher likely knows a lot about industry cases, but, perhaps, not as much about customer cases.

[2] Mr. Brecher says 40% of the time a customer gets an awrrd, but the statistics I looked at – the ones to which the hyperlink here will send you – show that in 2020, claimants only got some money in 34% of cases that went to hearing.

[3] This is what I said on this issue back in 2017, which I think sums it up pretty well: “PIABA doesn’t care about the law; it cares about the ability of its members to make panelists feel badly for claimants.  That’s why most arbitrations end up being fights about ‘fairness,’ not about the application of actual statutes or regulations; in PIABA’s world, it is always unfair that a customer incurs a loss, no matter that investments inherently have risks, no matter how robust the risk disclosures may be, no matter the documents that claimant may have signed.”