Broker- Dealer Law Corner

Broker- Dealer Law Corner

A Glaring Example Of FINRA Dragging Its Feet, Culminating In A Pointless Default Decision

Posted in Disciplinary Process, Enforcement, Examination, FINRA

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

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

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

Anyway, four of the firm’s registered representatives and two of its registered principals, including the firm’s president and its CCO, settled with FINRA. But not the firm, which answered the complaint and requested a hearing. After some delays – requested jointly by FINRA and the firm – that hearing got scheduled for December 2018. And here is where it got weird. In early October 2018, two months prior to the hearing, the firm filed Form BDW, to withdraw from FINRA membership. Consistent with that, later that month, the firm (through its president, since its attorney had been granted permission to withdraw) announced that the firm was not going to participate any further in the proceeding (for the simple reason that it was out of business). Days before the hearing was scheduled to start, the SEC terminated the firm’s registration. At the end of December 2018, FINRA also terminated the firm’s registration.

Despite all this, that is, despite the fact that FINRA had already gotten its settlements from the individuals who had been associated with the firm, and despite the fact that the firm’s registration had already been terminated, FINRA proceeded to issue a farcical “default” decision. Why farcical? Because it is based solely on the allegations in the complaint, as supported by an unopposed Declaration of a FINRA examiner effectively swearing that those allegations are well founded and supported by real evidence. Kind of difficult for FINRA to lose one of these.

In the Decision, even though it acknowledged that the firm was dead, FINRA proceeded nevertheless to impose significant monetary sanctions, including a $400,000 fine plus restitution to customer. These sanctions, of course, cannot be collected, inasmuch as a federal court determined years ago that FINRA has no legal ability to sue to collect its monetary sanctions. So, these numbers are meaningless, except, perhaps, to FINRA, since they help pad the total when FINRA tallies up at the end of the year just how many dollars in fines it imposed. Which, if that’s the motivation, is wrong. Indeed, you may recall not too long ago that FINRA was taken to task by the General Administration Office for including in its annual statistics fines imposed in cases in which the respondent was permanently barred (i.e., fines that had precisely zero chance of ever being paid), which the GAO felt was a bit misleading. (This resulted in a change of FINRA policy, and the elimination of the fine in bar cases.)

So, what do we have here? A case that took FINRA five years to file, resulting in a pointless default decision against a defunct firm that imposed meaningless monetary sanctions. All accomplished by spending money supplied by its member firms. Let me be clear about something: the fact that FINRA managed to tag the five individuals here is not a bad thing. If they violated the rules, they deserve the consequences. And if the violations were serious, as they appear to have been, those consequences are appropriately harsh. Those individuals who were not barred now have a disciplinary record that will follow them throughout their careers, which is how the system is designed. But, that is not true for the firm. It was already dead when FINRA shot it. What was the point?

The problems with this case boil down to two things. First, it is simply unfair for any respondent to be required to defend a case brought five years after the exam. FINRA needs to do something to accelerate the pace at which it conducts, and concludes, its exams, especially given the lack of any statutes of limitations. Second, FINRA should stop wasting its time – and members’ money – on activities that achieve nothing. Stated another way, FINRA should start to actually care about efficiency. Drop stupid cases early. Stop sending five people to OTRs. Indeed, better yet, eliminate some of the bureaucracy that chokes swift progress. I have said this before, but it bears repeating: when I joined NASD in 1993, there were fewer than ten corporate vice presidents; today, I believe the number has swelled to well over 100. Yet, somehow, NASD managed to regulate thousands more member firms than FINRA handles today. The bloat at FINRA’s middle-manager level – the people who have to sign off on exam dispositions, settlements, sanction recommendations, etc. – is daunting.

Implicit Recommendations To Hold: FINRA’s Suitability Rule Goes Toe-To-Toe With SEC’s Regulation BI

Posted in FINRA, Suitability

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

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

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

Anyway, apart from that particular situation, no one really pays much attention to recommendations to hold, since it’s pretty hard to establish that a recommendation was sufficiently explicit to be actionable.

Under Regulation BI, however, things will be different. The reason is that Regulation BI states that, under certain circumstances, even implicit recommendations to hold must be suitable. This will undoubtedly open the door both to increased regulatory actions and customer arbitrations.

What are the circumstances? According to the SEC,

when a broker-dealer agrees with a retail customer to monitor that customer’s account . . . such agreed-upon monitoring involves an implicit recommendation to hold (i.e., recommendation not to buy, sell, or exchange assets pursuant to that securities account review) at the time the agreed-upon monitoring occurs, which is a recommendation “of any securities transaction or investment strategy involving securities” covered by Regulation Best Interest.

What’s troubling about this to me is that the SEC has also concluded that “[a]n agreement to provide account monitoring services to a retail customer is not required to be in writing.” Thus, “a broker-dealer’s oral undertaking that the broker-dealer will monitor the retail customer’s account on a periodic basis would create an agreement to monitor the account on the terms specified orally.”

That, my friends, is quite the slippery slope, opening the door to potentially ugly arguments about who said what to whom about account monitoring. In an entirely unhelpful passage addressing this issue, the SEC says, “[w]hether an agreement with the retail customer has been established in the absence of a written agreement or express oral undertaking will depend on an objective inquiry of the particular facts and circumstances, including reasonable retail customer expectations arising from the broker-dealer’s course of conduct.”

Ugh. The dreaded “facts and circumstances” regulatory cop out. That means it’s going to be the wild west. No legal precedent, no guidance from the regulators, just lawyers posturing about what they think the SEC meant.

So, is there anything to do about it, to avoid this problem? It seems that there is. After announcing this problematic standard, the SEC offered this advice:

In cases where a broker-dealer does not intend to create an implied agreement to monitor the retail customer’s account through course of conduct or otherwise, and to avoid ambiguity over whether an implied agreement has been formed, broker-dealers should take steps to ensure that all communications with the retail customer are consistent with its disclosures required under the Disclosure Obligation, which in this case would require the broker-dealer to clearly disclose that the broker-dealer does not monitor the retail customer’s account.

I am not entirely clear what this means. But, on its face, it appears to say that if a BD wants to avoid having any of customer being able to establish that the firm orally agreed to monitor his or her accounts – thus subjecting the firm to an argument that it made unsuitable albeit implicit recommendations to hold – the BD must clearly and consistently deny, in writing, that it monitors accounts. As you can divine for yourself, this is hardly a foolproof defense, since no matter what is disclosed in writing, it doesn’t mean the customer can’t claim he was orally told something different by his broker. But, hey, if the SEC says this is what you need to do, then, by all means, load up your customer agreement with disclaimers about account monitoring.

What’s the good news? Clearly, according to the SEC, there is no duty to monitor a customer’s account in the absence of an agreement to do so. That may seem like an obvious, uncontroversial proposition to some of you. I can assure you, however, that when defending a customer arbitration, it is extremely common for the claimant to argue that my client had some duty – after making the initial recommendation to buy the security at issue – to monitor the account on an ongoing basis, and, based on market conditions, to make some other recommendation (typically to sell and buy something else). Most hearing panels understand this duty doesn’t actually exist, but there are a couple of old reported cases out there from random jurisdictions that employ language sloppy enough to support a duty-to-monitor argument, and claimants’ counsel can be counted on to trot out these same decisions, case after case. In light of the SEC’s new pronouncement, however, that argument goes out the window.

One final point. The SEC isn’t stupid, and understands that its view that an implicit recommendation to hold must be suitable is contrary to FINRA’s suitability rule, which applies only to explicit hold recommendations. In an effort to assuage any concern that it is dissing FINRA, the SEC said that it

recognizes that its position with respect to Regulation Best Interest differs from that provided in FINRA guidance regarding whether implicit hold recommendations are subject to the suitability rule. This interpretation applies in the context of the protections of Regulation Best Interest, and does not change the scope of the application of the FINRA suitability rule. Further, while for purposes of Regulation Best Interest implicit hold recommendations are generally recommendations of “any securities transaction or investment strategy regarding securities” where a broker-dealer agrees to provide account monitoring services, we are not otherwise addressing the treatment of implicit hold recommendations in other contexts. In other words, except where a broker-dealer agrees to provide account monitoring services as described, consistent with existing FINRA guidance, Regulation Best Interest will only apply to explicit hold recommendations.

Ok, so both views are valid? I can’t wait to see how this let’s-figure-out-if-there-was-an-agreement-to-monitor thing plays out.

A Fish Out Of Water? A Futures Clearing Firm In A FINRA Arbitration

Posted in Arbitration, Commodities, FINRA

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

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

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

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

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

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

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

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

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

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

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

FINRA Touts The Fact That Its Examinations Need Not Be “Fair”

Posted in Disciplinary Process, Enforcement, Examination, FINRA

While I feel I have enjoyed as much success defending respondents in FINRA Enforcement matters as anyone, I am still careful to caution clients who are unwilling to consider any settlement that going toe-to-toe with FINRA at a hearing is always a difficult proposition, even though they are presumed innocent and FINRA bears the burden of proof. No matter the facts, no matter the allegations, magically, decisions by the Hearing Officer, and by the panel itself, seem to go FINRA’s way. It is, simply, very hard to convince anyone that FINRA is even capable of being wrong. About anything.

Take this example, found in a NAC decision released last week. The case involved an alleged failure by a BD to conduct on-site branch audits. FINRA’s interest got initially piqued when it conducted a routine exam of a particular branch office that was supposed to be subject to monthly on-site visits, as a consequence of the fact that the RR in that office was subject to a Heightened Supervision Plan that included such a requirement. During the course of that exam, the RR initially told the examiner that those exams hadn’t happened, but then he changed his story and told FINRA that, in fact, they had happened.

Given that interesting development, FINRA elected to expand the exam, to see if other branch audits had taken place. I have no problem with that decision; indeed, that’s how audits are supposed to work. But, here is where it gets truly scary. Rather than test a random sample of the firm’s branch offices, FINRA deliberately restricted its review only to former RRs of the firm, i.e., guys who no longer worked there. Many of whom, admittedly, carried a grudge against the firm. From that limited, intentionally skewed sample, FINRA got a few people to claim that the annual visits hadn’t happened, and, based, on that, brought an Enforcement action.

If I stopped here, I think you would agree that this is already bad enough. Everyone understands that FINRA exams don’t look at everything a BD does; that would be impossible. Rather, the exams focus on some sample of the firm’s business, and, if that sample yields funky results, then the sample is expanded. The thing is, the initial sample is supposed to statistically significant. I am not a statistician, but I understand enough to know that if you deliberately skew the sample in one direction, the results are immediately and obviously subject to question. That is exactly what happened here, when FINRA chose only to talk to former RRs of the firm. For that reason alone, the exam results should have been deemed by Enforcement to be flawed, and the referral by Member Reg to Enforcement should have been denied. Instead, Enforcement gladly shrugged off the problem and blithely proceeded with the case.

But, it gets worse. At the hearing, perhaps in anticipation of cross-exam, the FINRA Enforcement lawyer questioned the examiner about the decision to restrict the follow-up exam only to cherry-picked former RRs. In a display of hypocrisy that rivals that of any politician, the examiner swore under oath that she consciously didn’t reach out to current RRs because she “didn’t want to disrupt [the firm’s] business.”[1] I’m sorry, but are you kidding me? This sworn testimony comes from an examiner who works for a regulator that, among other things, happily conducts surprise exams, arriving unannounced with a team of people who upon arrival don’t exactly sit quietly in a conference room, studiously careful not to disturb anyone. A regulator that routinely sends lengthy and serial 8210 requests that take hours, or even days, to respond to, time that would otherwise be spent on “business.” A regulator that is comfortable “requesting” that individuals travel at their own expense great distances to supply sworn testimony at OTRs, taking days out of their workweek. I thought it was laughable when Secretary of Commerce Wilbur Ross testified that the desire to add the citizenship question to the upcoming 2020 census was out of concern for the enforcement of the Voting Rights Act, but, compared to that, this testimony from the FINRA examiner may be the funniest thing I ever heard.

And, it gets worse.

On appeal to the NAC from the hearing panel’s decision, the respondents appropriately complained about the patent unfairness in the exam, citing Section 15A(b)(8) of the Exchange Act, which requires that FINRA provide a “fair procedure.” Well, it seems that the fairness requirement “does not extend to investigations.” According to the SEC authority cited in the NAC decision, only the adjudicatory proceeding has to be fair, apparently, but not the exam that leads to the proceeding, which commences with the filing of the complaint. So, anything that happens up to that point, since it is not part of the proceeding, need not be fair. With that in mind, the NAC just ignored the problem with the biased exam sample that FINRA selected, and, focusing exclusively on the proceeding, concluded there was no unfairness.

It is, frankly, difficult to believe that FINRA is content to operate under such a silly standard of conduct. I have repeatedly complained that FINRA rarely holds itself to the same standards as those to which its member firms are held, and that if it had to do so, it would routinely come up well short. This is just one more example of that, granted, a pretty gruesome example. So what is the solution to an exam that is being conducted in an unfair manner? Complain to the Ombudsman? Complain to Robert Cook himself? Sadly, I don’t have a good answer. But, I can tell you that you cannot count on the hearing panel to care, or the NAC, or even the SEC, since they seem only to care about fairness once you’ve been named as a respondent. Political action, as slow and uncertain as that is, may represent the only solution to this problem. Get involved, then, with FINRA, and express your views. Loudly, if necessary. Otherwise, the next time it might be you.

[1] The examiner testified that there was a second reason, as well, that she felt the firm’s owner had influenced the RR to change his story regarding whether the monthly heightened supervisory audits had taken place, and she wanted to avoid a recurrence of that. Naturally, the hearing panel bought that story, too.

Do Customers Actually Use BrokerCheck? This FINRA Complaint Suggests They Don’t

Posted in BrokerCheck, Enforcement, FINRA

I heartily endorse this post from my colleague, Chris, who’s been quiet of late.  It says a lot about FINRA, in terms of how it deigns to spend your assessment money, how fairness in the Enforcement process can be completely illusory, and how it is consistently unable to convince much of the investing public that it is serving any real function. – Alan  

FINRA’s mission is “investor protection.” In furtherance of that goal, FINRA has devoted significant resources to its BrokerCheck database, which allows investors to look up their broker, or potential broker, and check his or her background for any red flags that might give the investor reason to shy away from that broker. Basically, FINRA wants you to know which brokers might be “bad seeds” so that you, as an investor theoretically concerned with safeguarding your money, will avoid giving it to anyone with a less than perfectly clean past. And by perfectly clean, I mean perfectly – not only does FINRA want investors to know about past customer claims and regulatory actions brought against the broker, but also past terminations, tax liens, and bankruptcies. In theory, if an investor sees any of these things on his broker’s BrokerCheck report, the investor will run the opposite direction with his or her money. But does that really happen?

A recent Complaint suggests the answer is “no.” FINRA’s Complaint alleges that two brokers, Kim Kopacka and Beth Debouvre, allowed Ms. Kopacka’s husband to conduct securities business and sell securities through a member firm, despite the fact that FINRA barred him from the industry in 1998. In essence, the Complaint alleges that after Mr. Kopacka was barred from the industry, his wife became registered and set up an office where Mr. Kopacka continued meeting with clients and selling them securities. Allegedly, his wife had no involvement with the clients and simply listed her name on paperwork as the registered representative of record handling those clients and those transactions. The Complaint alleges that from 2002 to 2016, Mr. Kopacka sold over $40 million in private placement securities to over 280 different customers – all while being barred from the industry.

If the conduct alleged in the Complaint is true (and that’s a big “if”), it raises several interesting questions. The first question that comes to mind is, why did it take FINRA 15 years to figure this out? The office where Mr. Kopacka was allegedly operating consisted of only himself, his wife (who was almost never present, allegedly), and a supervisor. Didn’t any FINRA audits of the office take place in 15 years? Didn’t anyone notice that a registered rep who was barred from the industry has a spouse who only took interest in becoming registered after her husband was barred, and that she suddenly started selling millions of dollars of unregistered securities, despite the fact that she had zero experience in the industry? And, how can FINRA bring a case against these reps for conduct that started (and arguably should have been detected) over 15 years ago? What about statutes of limitations? If you are interested in that issue, check out our prior blog post here.  The short answer is, traditional statutes of limitations do not apply to FINRA Enforcement actions. So, yes, you might be forced to defend something that you did in the prior millennium.

The other interesting question is, how did over 280 customers allegedly think it was a good idea to take investment recommendations from someone who was barred from the industry? There are only two answers: either they didn’t know that Mr. Kopacka was barred, or they didn’t care. Now, BrokerCheck has been available online since 1998, and it was significantly updated in 2007 to include many additional disclosures about brokers. If you search BrokerCheck for a person who has been barred, it is hard to miss the warnings that FINRA provides: on the search result page, the broker’s name will be inside a red box, and the word “BARRED” will appear in bright red directly under his or her name. If you click on the details for that person, FINRA will explicitly tell you that “FINRA has barred this individual from acting as a broker or otherwise associating with a broker-dealer firm.” It’s pretty hard to miss.

So, in Mr. Kopacka’s case (if FINRA’s allegations are true, and again, that’s a big “if”), the fact that Mr. Kopacka was barred was available to 280 customers and yet they allegedly decided to hand Mr. Kopacka over $40 million anyways. It’s probably safe to assume that 280 customers would not knowingly invest with someone who was barred from the industry, just like 280 people probably would not go to a doctor or any attorney if they knew his or her license had been taken away. So those 280 customers either didn’t know that BrokerCheck existed, or they chose not to use it. Both of those scenarios pose a problem for FINRA and its goals of protecting investors, particularly the casual investor.

FINRA often considers increasing the amount of information available on BrokerCheck. FINRA also makes it difficult for brokers to expunge information from their CRD records that appears in BrokerCheck (and FINRA is considering additional rules that will make expungement even more difficult). But, if customers are not actually using BrokerCheck to research their brokers, like the 280 investors in this case apparently didn’t do, then it doesn’t matter how many disclosures are made on the system.


FINRA Proposes To Dispense With Due Process, All Because It’s Failed To Do Its Job Of Policing The Markets

Posted in Disciplinary Process, FINRA, High-Risk firms

Reading Reg Notice 19-17 makes me think of the legal arguments that I’ve recently read regarding whether a president can be found guilty of obstructing justice if the actions in question were taken out in the open, for everyone to see. Here, FINRA’s proposed power grab is simply outrageous, but, you got to give them credit, it is certainly being done right out there for everyone to see. It doesn’t make it right, however, no more so than tweets designed to intimidate witnesses or steer DOJ investigations.

This is a long, sometimes boring Reg Notice. I wonder if, perhaps, FINRA didn’t deliberately publish a 43-page bear of a document, burdened with charts and 53 footnotes, with the specific intent of dissuading people from reading the whole thing, and figuring out what it’s all about. Lucky you, though, as I read it for you. And, frankly, if you harbor any degree of affinity for concepts like due process or presumption of innocence, you would undoubtedly be appalled by the time you finish it.

The notice addresses FINRA’s recently contrived concerns about “high-risk” firms. According to FINRA, there are certain firms that “have a history of misconduct” with “persistent compliance issues.” According to FINRA, academic studies statistically prove that these firms – which are called “Restricted Firms” here – are more likely than other firms to have disciplinary issues going forward. While FINRA claims that such firms have been “a top focus of FINRA regulatory programs,” it nevertheless complains that its “existing examination and enforcement programs” are inadequate to address the threat that these firms present. So, FINRA is offering a solution.

Before I get to that, let me first revisit what continues to remain a sore point for me. FINRA’s public stance is to express its dismay, even outrage, that these firms with relatively extensive regulatory histories still manage to exist, notwithstanding everything that FINRA has thrown at them from its already considerable arsenal of regulatory weapons. What FINRA has steadfastly refused to concede, however, is that the fact these supposedly terrible firms, firms that FINRA insists manifest a statistically proven likelihood of continuing misbehavior, have not yet been expelled from the industry is either (1) FINRA’s fault, or (2) because expulsion wasn’t necessary. How, after all, does a BD get a regulatory history? When it is named as a respondent in a disciplinary action. Who brings those actions? FINRA. Who decides what charges to file? FINRA. Who decides what sanctions to impose? FINRA. If FINRA has not been able to bring a disciplinary action against a “high-risk” firm that included charges or resulted in findings sufficient to result in the BD getting kicked out of the industry, it can only mean one of two things: either FINRA didn’t do its job, or, equally possible, the firm simply didn’t deserve to be expelled. With the current proposal, however, FINRA urges readers to conclude that these firms continue to operate, like cockroaches after the nuclear apocalypse, not because FINRA hasn’t been tough enough, and not because the evidence wasn’t there to justify an expulsion, but, rather, because FINRA’s existing regulatory tools are somehow inadequate. I just don’t buy that.

Ok, let’s get to the proposal. As I have previously complained about, the starting point for this proposal is FINRA’s need to define what a “high-risk” or “Restricted” firm is. No such definition exists, of course, so FINRA has to conjure one up. To do this, FINRA suggests a multi-step process, I suppose designed to give some impression of fairness, but which, ultimately, boils down to this: a firm is “high-risk” simply because FINRA says it is.

What FINRA proposes to do is create a quantitative standard for each firm, comprised of six bad facts about the firm and the firm’s registered persons. You give the firm a point for each bad fact – “adjudicated”and “pending events” for both the firm and its reps, plus terminations and internal reviews of reps – add them up and divide by the number of reps at the firm, yielding the “average number of events per registered broker.” Then, you take the number of reps at the firm who came from a “previously expelled firm,” divide that by the total number of reps, resulting in a percentage concentration.

Armed with these data, FINRA will then numerically compare the firm to its peers, based on size. (FINRA proposes seven size categories, “to ensure that each member firm is compared only to its similarly sized peers.”) While there are some nuances to that comparison, essentially, if the firm sticks out from the pack in a bad way, based solely on this quantitative analysis, it is deemed, at least preliminarily, to fall within the new rule.

But, it wouldn’t be fair to label a firm bad based solely on numbers, right? So, the next step in the process is that FINRA then conducts an “initial internal evaluation.” The stated purpose of this evaluation is “to determine whether [FINRA] is aware of information that would show that the member – despite having met the Preliminary Criteria for Identification – does not pose a high degree of risk.” In other words…based on FINRA’s subjective consideration of the data – data that FINRA compiled pursuant to its own criteria – FINRA could step in and tell, um FINRA, that the firm ought not to have been branded as high risk. I have got to tell you, based on my historical dealings with FINRA, I am not putting a whole lot of faith in the reasonableness of any decision that FINRA might be called upon to make at this step of the process, i.e., to second-guess its own preliminary decision.

Ok, so let’s assume that FINRA doesn’t talk itself out of characterizing a firm as high-risk. The next step is that FINRA will give the firm a chance to terminate as many of its reps as necessary to reduce the bad points it accumulated in step one, the points that resulted in the firm being identified in the first place. It’s a lot like the deal already in place under the existing “Taping Rule,” when a BD hires enough reps who came from expelled firms to be forced to tape record all of its reps’ phone conversations. It’s a one-time deal, and the firm would also have to agree not to rehire any reps it fires for a year.

As gruesome as this sounds so far, the next step is even worse, and, by FINRA’s own admission, the most punitive. If a firm is still deemed high-risk at this point, FINRA will then turn its attention to calculating a number meant to represent the most money and securities that it could possibly require the firm to deposit in an account, assets which the firm cannot touch without FINRA’s approval, indeed, even if the firm goes out of business.[1] In short, FINRA proposes to make these firms deposit a whole bunch of money in an account with one essential purpose: to satisfy customer arbitrations. (Did PIABA write this rule??)

FINRA knows this will sting, and, frankly, it couldn’t care less. Indeed, it wants it to sting. FINRA admits that its “intent is that the maximum Restricted Deposit Requirement should be significant enough to change the member’s behavior but not so burdensome that it would force the member out of business solely by virtue of the imposed deposit requirement.” How nice. How magnanimous of FINRA! How industrious and clever! To be able to determine the “maximum” – its word, not mine – amount that it can require a firm to pony up as ransom, in effect, without having to declare bankruptcy. I eagerly look forward to the comments this is going to generate. And I hope that some focus on the use of the word “solely,” which leaves FINRA all kinds of running room to trample the rights of its member firms.

In its next passing effort to demonstrate a modicum of fairness, FINRA proposes to include in the process as the next step a “consultation,” that is, an opportunity for an affected firm to rebut two presumptions, that it should branded a restricted firm, and that it should be subject to the maximum deposit. Once again, the result of this lies completely within FINRA’s sole and subjective determination.

Finally, if all other steps to get FINRA to change its mind have failed, the firm may request an expedited hearing before a FINRA Hearing Officer – the same group of folks who administer Enforcement actions – to challenge FINRA’s conclusions.

I realize that this all sounds pretty crazy. But, consider this: it is actually better than an alternative that FINRA admits it’s still mulling over, and that is what it calls a “terms and conditions” approach. FINRA indicates that it could easily be convinced that this approach, which is presently employed by IIROC, the Investment Industry Regulatory Organization of Canada, and clearly something that FINRA is jealous of, would work best to address firms that “typically have substantial and unaddressed compliance failures over multiple examination cycles that put investors or market integrity at risk.” Under the “terms and conditions” regime, the regulator simply gets to decide that a firm is a problem, and unilaterally impose terms and conditions on the firm if it wants to continue to operate.[2] According to IIROC (at least as FINRA describes it), it utilizes this approach when “there are outstanding compliance issues that clearly require regulatory action, but that may be best addressed through an enforcement hearing.” On reflection, I think FINRA goes to the trouble of describing “terms and conditions” as a scare tactic, to make the ridiculous “Restricted Firm” approach sound reasonable by comparison.

In conclusion, I have read this horror show of a Notice several times, and I am still left asking, exactly what situation cannot be addressed adequately through the Enforcement program? The Enforcement scheme is hardly perfect, but at least there some deference is – by rule – paid to due process. A respondent is deemed innocent until proven guilty, and FINRA bears the burden of proof. The respondent may continue to operate despite the charges being outstanding. No deposit, of any size, has to be made as a condition of continued operations. The bottom line is that FINRA never adequately explains why its existing procedures can’t do the trick. And the reason for that is that it can’t.

FINRA’s real problem is that it simply doesn’t like having to jump through the procedural hoops that presently exist, hoops that provide safeguards to respondents. FINRA doesn’t like to have to prove its allegations. Just consider this whining, found early on in the Reg Notice: “Parties with serious compliance issues often will litigate enforcement actions brought by FINRA, which potentially involves a hearing and multiple rounds of appeals, thereby effectively forestalling the imposition of disciplinary sanctions for an extended period.” Gee, wouldn’t it be easier if we can forego the complaint, the hearing, the evidence, and jump right to sanctions? THAT, my friends, is what FINRA is proposing here.



[1] Because any cash in such an account could not be readily accessed, the proposed rule requires that such deposits be deducted when determining net capital!

[2] The terms and conditions can be appealed, but, notably, they are NOT stayed during the pendency of the appeal.

FINRA’s Proposal On High-Risk Firms Is A Must-Read, But Hardly A Must-Enjoy

Posted in FINRA, High-Risk firms

I apologize for all the posts this week, but I am traveling and am in a different time zone, so I am awake at hours when, ordinarily, I would be asleep, giving me time to muse.  Anyway, given that, I will not test your willingness to indulge my random thoughts a third time in one week.  But…you ought to be aware of what FINRA did yesterday, when it published Reg Notice 19-17.  As I have been following closely, FINRA has made it its mission in life to go after firms that it self-describes as bad — although FINRA uses the less pejorative term “restricted.”  To do this, FINRA first has to invent the standard — a quantitative standard, mind you — that it will use to identify these firms.  Then, it has to invest a mechanism for dealing with these firms.  The problems that I was able to spot in one quick read are really, troubling.

But one quick read won’t do it.  I am going to have to dig in on this.  I urge you to do the same.  I will post something next week, but, in the meantime, read this Reg Notice.  See whether you think FINRA deserves the right to dispense with due process, whether it should have the right to forgo the need to bring Enforcement actions and actually prove a case against an entity presumed to be innocent, whether it can essentially impose another net capital requirement on those firms it decrees to be bad; indeed, see if you even agree that there is a problem that needs to be addressed, or, if there is a problem, whether FINRA itself has caused it through its own inability to regulate this industry.

I have read, and I certainly agree, that trust must be earned, not expected.  I, for one, am not convinced that FINRA deserves the trust it is asking for in this proposal.  But, let me read it over the weekend, and get back to you next week with the ugly details.


Voya Settlement Shows That Self-Reporting To FINRA Can Pay Off

Posted in Disciplinary Process, Enforcement, FINRA, Sanctions

I have written before about the troubling lack of clarity regarding the tangible benefit of self-reporting rule violations to FINRA. While FINRA purports to provide some potential advantage for doing so, it is so awfully loosy-goosy that it remains a relatively uncommon occurrence. That’s why when a case comes down that provides some clear indication (1) that there is, in fact, a benefit of self-reporting, and (2) what that self-reporting must look like to actually get some real credit for it, it is worth talking about.

Last week, Voya Financial Advisors entered into an AWC with FINRA to settle some supervisory charges relating to its sales of mutual funds. According to the facts outlined in the AWC, for over seven years, Voya failed to reasonably supervise the share class of mutual funds that it was selling to certain retirement plan and charitable organization customers. As a result of that failure, these customers either bought Class A shares and paid a front-end sales charge despite the fact a waiver of that charge was available, or were inappropriately sold Class B or C shares with a back-end sales charge and higher ongoing fees and expenses. Either way, it cost these customers more to buy these mutual funds than it should have, and had Voya had a better supervisory system, it wouldn’t have taken seven years for the firm to figure this out.

But, that’s not the story of this case. The story is that even though it took a long time for Voya’s lightbulb to go on, it still managed to illuminate before FINRA examiners could find the problem themselves, and the firm took significant steps right away to address the problem. Here’s how it played out.

In November 2015, the firm apparently determined it had an issue, and began an investigation of its sales of mutual funds to retirement plans and charities. About six months later, Voya formally self-reported to FINRA its problem. FINRA requested that Voya conduct a five-year look-back, to quantify the scope of the problem. For whatever reason, Voya decided that wasn’t good enough, and so volunteered to expand the look-back by an additional two years. Voya ultimately calculated that as a result of the over-charges, it owed its customers about $126,000, inclusive of interest. Of that sum, it is notable that nearly half was related to sales that had been made in the two-year time period that Voya voluntarily added to FINRA’s mandated look-back period.

In light of all the circumstances, particularly what FINRA characterized as Voya’s “extraordinary cooperation,” no fine was imposed in the AWC.

So, how do you, or your clients, achieve this same result? Simple, just follow Voya’s blueprint, as outlined in the AWC:

  1. Initiate your own internal investigation “prior to detection or intervention by a regulator”;
  2. promptly self-report to FINRA;
  3. voluntarily expand the look-back period that FINRA requests;
  4. establish a plan of remediation for customers who were impacted by your supervisory failure;
  5. promptly take action and remedial steps to correct the violative conduct; and
  6. take corrective measures, prior to detection or intervention by a regulator, to revise your procedures to avoid recurrence of the misconduct

I get that step (3) may not be applicable in all cases, and, even when it is applicable, there is no guarantee that you’ll “get lucky” like Voya and have that additional time period result in materially higher restitution to your customers, but, really, step (3) is just a bonus. It is the other five steps that will serve to augment your chances of avoiding a fine.

Bottom line, this is a good thing, and a positive development for FINRA. I mean, this makes two cases in two weeks – see my earlier blog on the Buckman settlement – in which FINRA has acted downright reasonably in terms of meting out sanctions, at least in settled cases. Let’s hope it’s just the start of a new trend.


The Folly Of ADV Disclosures: What The Robare Decision Teaches About Trying To Do It Right

Posted in Form ADV, RIA, SEC

Most of the time, the cases I write about were some other lawyer’s. In some respects, it’s easier to offer comments when it isn’t my case. I can, hopefully, be more objective, less pissed off (when the result is one I disagree with, of course), and content merely to mine the case for interesting lessons applicable to all my readers. This post, however, is entirely personal. It concerns a case that my colleague and partner, Heidi VonderHeide, and I have been working on for years for two guys – Mark Robare and Jack Jones, who own and run The Robare Group, an RIA in Texas. These are two people that anyone would be proud to represent, and who epitomize the kind of advisors that you would be comfortable recommending to your own mother to handle her nest egg. You probably think I’m biased – and perhaps I am – but even the judge who oversaw the trial stated, in his opinion, that he found Mark and Jack to be “honest and committed to meeting their disclosure requirements” and that it was “difficult to imagine them trying to defraud anyone, let alone their investment clients.”

Finally, Mark and Jack are nearing the end of what turned into a long, difficult road to clear their name. Yesterday, the D.C. Circuit Court of Appeals handed down its decision in what’s become known in legal/IA circles as the “Robare case.”

I have to concede at the outset that while the sanctions the SEC imposed against Mark and Jack were vacated, which is worth celebrating, we didn’t come away with a clean victory, as the court upheld one of the two violations that the SEC found, and remanded the case back to the SEC to determine what the appropriate sanctions – if any – ought to be now, in light of the court’s ruling.

Nevertheless, despite the finding, I can’t help but feel that Mark and Jack won. And I challenge anyone who takes the time to read the decision (and its genesis, especially the ALJ’s Initial Decision, which dismissed ALL of the SEC’s charges) to reach a contrary conclusion. The fact is, while the court partially agreed with the SEC (which had been forced to argue on appeal against the findings of its own ALJ, who had decided to dismiss all charges), the specific findings that were made by all three factfinders amply demonstrate that all my clients are “guilty” of is trying their absolute best to “meet their disclosure requirements.” The fact that THAT failure can nevertheless constitute the basis for a finding that they violated the Investment Advisors Act is, simply, silly.

And, if you work in compliance, what happened to Mark and Jack should keep you up at night.

The pertinent facts of the case aren’t too difficult to understand. Mark and Jack create model portfolios for their advisory clients comprised of no-transaction-fee mutual funds. They pick their funds from a wide variety of fund families available to them on Fidelity’s platform, based strictly on whether the funds are good performers. At one point in time, the BD with which they were – and still are – associated informed them that Fidelity offered a program that would pay them a small fee if they happened to select “eligible,” non-Fidelity NTF funds for their customers. Considering it, their sole question for Fidelity was, if they elected to participate in the program, would they be forced to select funds they otherwise would avoid, or avoid funds they would otherwise choose. They were told, no, they could continue to choose their mutual funds based on their existing, objective criteria. If one of the funds they chose happened to be “eligible” they would receive a fraction of the fund fee paid to Fidelity.

Based on that representation, they entered into a written, tri-party agreement among themselves, Fidelity and their BD. Fidelity never told them which mutual funds were “eligible” for the fee sharing, but Mark and Jack didn’t care, since they weren’t making their investment decisions based on whether the particular mutual funds they chose for their model portfolios resulted in them getting the fee. Whatever fee payments were generated were paid quarterly by Fidelity through their BD as a commission. The BD took its normal, small percentage (in accordance with the existing commission agreement between them) and the remainder was paid to The Robare Group.

Mark and Jack may be experts at making investment decisions for their advisory clients, but they are admittedly not experts at understanding what language should be used in crafting Form ADV conflict disclosures. That is hardly a knock on Mark and Jack. As our witnesses – both fact and expert – testified at the trial, the SEC’s standard for proper disclosure of conflicts of interest was a “moving target.” The scant guidance offered by the SEC was broad and general, and not of much help. Accordingly, every single time Mark and Jack filed their Form ADV, they first obtained qualified assistance. Over the years, they engaged three different compliance consultants for help with their ADV, and they never submitted a Form ADV without the help of a consultant. In addition, they paid their BD a fee in exchange for supervisory/compliance review, including review of the Form ADV disclosures.

Having surrounded themselves with experts and advisors, they firmly believed that any conflict of interest, whether actual or potential, that was created by the deal with Fidelity was adequately disclosed to the world on their Form ADV. They testified – and it was not rebutted any witness the SEC called – that anytime anyone told them to make a change to their ADV, they said, “no problem,” and promptly made the amendment.  In fact, in the middle of the time period at issue here, The Robare Group was audited by the SEC and that audit included a review of the Form ADV. In the end, the SEC examiners expressed no problems whatsoever with the Firm’s disclosures.

Despite all that, many years later, the SEC concluded that Mark and Jack’s ADV failed to disclose the conflict the Fidelity program created. The SEC offered them the chance to settle, and even though it was a “neither admit nor deny” deal, it still included a finding that they had violated an anti-fraud provision of the Advisors Act. While that would have been the easy – and certainly cheaper – way out, Mark and Jack couldn’t do it. They did not believe they committed fraud, and would not sign a settlement agreement that made such a finding. So, off we went to trial with the SEC’s Division of Enforcement.

You have undoubtedly read all the literature out there taking issue with the SEC’s increased use of administrative proceedings in recent years, rather than litigating in court. For years, the SEC ferociously defended its right and ability to bring cases before its own ALJs. The Supreme Court, of course, recently reached the opposite conclusion, finding that the SEC’s ALJs had been unconstitutionally appointed. That aside, however, from a statistical point of view, you can’t argue with the SEC’s choice of forum: rightly or wrongly, the SEC won almost every case it filed before an ALJ.

But not this case. Mark and Jack beat the odds and won their case. ALJ Grimes, after hearing the evidence, dismissed all charges against Mark and Jack. In my favorite line from his Initial Decision, worth quoting again, he said this: “[I]n listening to Mr. Robare and Mr. Jones testify and observing their demeanor under cross-examination, it is difficult to imagine them trying to defraud anyone, let alone their investment clients.”

The Division of Enforcement appealed the dismissal to the Commission. It’s worth pausing briefly here to remember that the Commission is the very entity that authorized the filing of the case in the first place. Then, on appeal, it sits as the appellate body where, because it’s a de novo review, it is empowered to agree with, disagree with, or modify the factual or legal findings of the ALJ however it likes.

Not surprisingly, when presented with this rare instance where an ALJ bucked the statistics and dismissed the case, finding it devoid of the required evidence, the Commission reversed, although not entirely. The Commission agreed with the ALJ that there was simply no evidence of intentional conduct. It found instead that my clients acted negligently, and that they “willfully” violated Section 207 in submitting the Forms ADV. The SEC is empowered to assess first, second, or third tier monetary sanctions where someone willfully violates the Act. Here, the Commission imposed second tier sanctions (i.e., aggravated sanctions), notwithstanding the ALJ’s findings. Notably, though, the imposition of sanctions was a split decision, with one Commissioner determining no sanctions were warranted.

We then appealed to the DC Circuit, our first foray into “neutral territory.” Well, as noted above, the court didn’t entirely buy our arguments. In the most perplexing finding I can imagine, the court concluded that although Mark and Jack subjectively believed that their Form ADV was complete and accurate, based on their decision to let experts handle that difficult task, they were still “negligent.” Negligent, it seems, because even though they realized they didn’t know enough about the standards governing the disclosures in Form ADV to be able to draft them themselves, according to the court, they somehow should nevertheless have known that the disclosures drafted by their paid experts were “plainly inadequate.”

So, Mark and Jack hired experts to draft their ADV disclosures because they were NOT expert at that. Yet, they were supposed to have realized that the language their experts drafted, language that was reviewed and approved by their BD, language that was reviewed by SEC examiners, and language that the ALJ found to be just fine, wasn’t just inadequate but “plainly inadequate.” That, my friends, is a standard that exists only in the minds of jurists, but not in the real world. There is no one who could successfully thread that needle.

And that is why you can see how I am able with a very straight face to say that Mark and Jack won. Everyone agrees that they had no scienter. Heck, they didn’t even act willfully (which is why the Section 207 claim was dismissed, something for another blog post, another day). They tried their level best to meet a standard of disclosure that, apparently, even industry experts could not successfully figure out. If that makes them guilty of committing fraud, then there is a real problem with the very law they supposedly violated. That mere negligence, indeed, negligence accompanied by a good faith intent to do the right thing, can still be deemed fraudulent, is utterly nonsensical and absurd.

We are not going to ask the Supreme Court to consider this case, but I wonder…..




FINRA AWC Includes Waiver Of A Fine: Is This A Sign Of Good Things To Come?

Posted in Disciplinary Process, Enforcement, FINRA, Sanctions

Way back in 2006, NASD issued Notice to Members 06-55, which tweaked the Sanction Guidelines to allow not just the size of the firm to be taken into consideration when determining the appropriate sanctions to be meted out, but, more importantly, how well, or how poorly, the firm is doing on its income statement. Specifically, the NTM resulted in a change to the Guidelines that explicitly permitted the consideration of “the amount of the firm’s revenues” and its “financial resources.” In addition, for “violations that are neither egregious nor involve fraud of the firm,” NASD gave the greenlight to adjudicators not just to “impos[e] a sanction that is proportionately scaled to the firm’s size,” but to “reduce the level of the sanction below the minimum level otherwise recommended in the Guidelines.”

That was over a decade ago. In my experience, unfortunately, it never amounted to much in real terms. FINRA Enforcement lawyers have never paid much attention to pleas for reduced fines based on a respondent firm’s financial condition. Rather, the typical response is that the sanctions sought in a given case must be viewed relative to other cases involving similar misconduct, which means that the sanctions can’t deviate much from whatever norm already exists for that misconduct as established by prior settled or litigated cases.

Well, this week, FINRA released an AWC in which it allowed the BD respondent to avoid paying any fine whatsoever, citing NTM 06-55. This was so crazy, so out of character for FINRA, that it had to take the relatively unusual step of issuing a Press Release for an otherwise unremarkable case, I guess in anticipation of all the head-scratching that the fine waiver would undoubtedly trigger.

The case itself, as I suggested, is pretty vanilla. It concerned the failure by the firm and one of its owner/principals to exercise reasonable supervision over a couple of registered reps who reported to him. The two reps both were guilty of making unsuitable recommendations, specifically, quantitatively unsuitable recommendations. (FYI, FINRA barred both of them. Shocking.) Turns out that both of the reps were trading some of their customer accounts excessively, and one of the reps also made recommendations that resulted in accounts that were over-concentrated in certain positions. The AWC includes findings that the firm’s WSPs were deficient, and also that the firm and the supervising principal failed to detect the trading issues, or, when detected, to take any appropriate responsive action.

As a sanction, the firm was required to pay restitution to the affected customers of just over $200,000, but – here’s the punchline – there was no fine. (The individual respondent was suspended as a principal for three months, fined $20,000, and required to take some continuing education.) In a footnote, the AWC recites that no fine was imposed on the firm due to its “revenues and financial resources, as well as its agreement to pay full restitution.”

Wow! As I said, it is super common to ask FINRA to consider waiving a fine, but rare that such a request gains any traction. So rare that Susan Schroeder, the head of FINRA’s Enforcement Department, felt it necessary to offer a public comment on the case. Bear in mind that FINRA doesn’t issue that many press releases in the course of a year regarding its Enforcement actions, and, when it does, it typically reserves its comments for really big cases, involving lots of firms and big dollar sanctions. This AWC is small potatoes, sanctions-wise, yet it merited a press release. That fact alone requires that we pay close attention to this case.

So, what did Susan say about the fine waiver? Here is her quote:

In this matter, FINRA has prioritized ensuring that affected customers receive full restitution, the firm fixes its supervisory flaws, and the responsible supervisor is held accountable and receives additional training. Due to the firm’s financial condition, FINRA did not impose a fine in addition to these other sanctions – the firm’s limited resources are better spent on remedial measures designed to prevent similar misconduct in the future.

This is, um, reasonable. Not sure what else to call it. FINRA holds itself out to the world as an entity interested in “investor protection,” but too often, it seems way more interested in using its member firms as punching bags. As a guy who exclusively represents respondents in FINRA Enforcement actions, it is really, really welcome news that, perhaps at last, FINRA is paying attention to its corporate mandate.

The notion that FINRA may actually take me seriously the next time I have a small BD client with limited financial resources that doesn’t deserve to be pushed to the financial brink as the result of an Enforcement action leaves me hopeful for the future. As long, that is, as FINRA is consistent with its approach, and doesn’t treat this AWC as an aberration, a one-off case that is never to be replicated. As with many things FINRA does, I suppose only time will tell if this represents a true change in its historic approach, or whether it’s more lip service.