So I spent last week – the whole week – doing an arbitration with JAMS.  It involved some of the typical elements of a FINRA claim, e.g., allegations of the sale of an unregistered security, of an “investment” gone bad, of misrepresentations and omissions in connection with the “sale” of that “investment,” but for reasons not pertinent here, the case did not have to be heard in the FINRA arbitral forum.  Anyway – and I acknowledge that I am painting with an awfully broad brush here – it was a remarkably different, and by different of course I mean better – experience than most any FINRA arbitration.  Let me count the ways.

First, and most important, was the quality of the arbitrator.  My case was heard by a retired Federal District Court judge.  Someone who had sat on the bench for over 27 years.  He has seen and heard it all during that time.  So, even handicapped by having to conduct the hearing through the sometimes glitchy auspices of Zoom, I was always confident that he understood the issues, was listening to hear what he knew would ultimately be relevant to his eventual decision, and could easily filter out the BS (whether from witnesses or counsel).  I would not be able to say the same, unfortunately, about some FINRA hearing panels I have appeared before.  What clearly seemed to matter to the judge were the facts and the law, period.  Well, and, maybe, an effort to be “fair” to both sides.

He was unimpressed by anything that served to waste his time as factfinder.  Both sides were given ample, but hardly unfettered, latitude to put on their cases.  If a line of questioning seemed to be of dubious relevance, he didn’t wait for an objection; rather, he would ask counsel, proactively, what was the point.  If a lawyer had already made his point, he would tell us, with a gentle admonition to move on.  He did not need witnesses or lawyers simply to read (sometimes dramatically) from exhibits when the documents were in the record and he could read them himself.  Closing arguments?  Bah, waste of time.

He was not hesitant to make rulings, or to enforce them after the fact.  I find that too often, FINRA chairpersons can be decision-averse, hesitating before ruling, perhaps hoping that the parties will simply figure it out for themselves and move on.  As a former judge, he was quick to decide any issue that arose, whether substantive or evidentiary.  Indeed, regarding the latter, when’s the last time you had an in-depth discussion with a FINRA arbitrator about the interplay between Rules 404 and 608 of the Federal Rules of Evidence?  I am going to venture to guess that the answer is “never.”  And while the rules of evidence don’t “strictly apply” in JAMS any more than they do in FINRA, that doesn’t mean such rules should be ignored, either, so it was really helpful to have an arbitrator who knew the lingo.

It was also heartening as counsel for the respondent not to have be concerned about the typical arguments that claimants make about arbitration being an equitable forum, so the arbitration panel should feel free simply “to do what’s right” and, well, law shmaw.  This former judge seemed singularly unimpressed by repeated efforts by claimant to evoke sympathy for his claimed plight, or to paint — using a very colorful verbal palette — my clients as greedy bad guys who took advantage of claimant’s feigned naivete.  I mean, he sat there and listened closely to all the testimony, but what he was listening for were facts, not emotional diatribes.

Second was the nature of the discovery we were permitted to conduct.  Specifically, the ability to take select depositions.  Having done arbitrations for the past four decades, I am, by now, pretty good at conducting “blind” cross-examinations, i.e., cross-exams of witnesses who I have not previously deposed.  (Indeed, that’s my standard retort to “litigators” who occasionally insist that doing an arbitration is somehow not as difficult as conducting a court trial: hey, man, when’s the last time you cross-examined an expert witness without having first deposed him/her, or at least had the chance to pore over a written report?  Well, I do that every day.)  With that said, if you offered me the chance to depose a claimant, or a claimant’s expert witness, in advance of the hearing, I cannot imagine the case where I would decline such an opportunity (even at the price of having to produce my own client for opposing counsel to depose).

Here, we got to depose not only the claimant, but his expert, as well as a couple of people who we knew would be called as witnesses.  It made the cross-exams at the hearing quicker, cleaner, and damning, frankly, every time the previously deposed witness attempted to pivot from prior sworn testimony. (Just as it’s supposed to be in court.)  With no surprise answers to deal with, it really was a fairer hearing for all involved, including the judge, than one where impeachment can be difficult in the absence of some document that contradicts the testimony.

I know what you’re going to say: arbitration is designed to be quicker and cheaper than going to court, and adding depositions to the list of permissible discovery tools would run counter to both of those goals.  Well, I suppose I would have to agree with you.  But, I would still vote in favor.  The ultimate goal, after all, is to have everyone who participates in the process agree that they have been treated fairly, and got an equal chance to develop and then present their case.  Allowing the parties some deposition discovery – not unlimited, but some key witnesses – would, in my assessment, greatly increase the likelihood of achieving that end.  Too many times after an arbitration I am forced to look my client in the eye and vainly attempt to argue that what we both just endured was not, in fact, a free-for-all or, worse, a total s***show.  Allowing depositions could at least help avoid these difficult conversations.

Finally, it’s worth noting that JAMS tries really, really hard to provide a smooth experience for all parties.  They are accommodating and attentive.  (And when you do JAMS hearings in person, they have all kinds of snacks!  Including fresh baked cookies, yum.)  I am not necessarily saying this in any relative sense, that is, I am not necessarily saying that JAMS is more accommodating and more attentive than FINRA; I will let you reach your own conclusions about that.  Many FINRA Case Administrators are super at their jobs, and take very seriously their obligation to ensure that the cases run their course without a hitch.  But, with that said, I can’t tell you how many hearings I have participated in that didn’t start on time because the tape recorder failed to show up, and we were dealing with a Case Administrator who was hundreds of miles away, trying to figure out over the phone what hotel employee had supposedly signed for the FedEx package.

JAMS is pricey, no doubt about it.  That alone will be enough to dissuade a lot of people from considering it.  And there are no free rides: you will not get your final Decision unless/until all fees have been paid.  But, you simply have to agree that some of the fundamental things about FINRA arbitrations that are the most troubling – the qualifications of the arbitrators, the ability to prepare the case properly for hearing, and then a fast-paced, smoothly run hearing – are most assuredly not issues in JAMS.  Of course, let me remind you that a few blog posts ago, I told you that I’d be perfectly content if we just ditched arbitrations altogether in customer cases, since I know that many claimants’ counsel simply could not survive in that environment.  Maybe JAMS represents a decent compromise.

I have been in a JAMS arbitration the last week or so, so thanks to Chris — Mr. Expungement — for his thoughts about PIABA’s study. –  Alan

In a move that surprised nobody, PIABA[1] recently released an updated study on expungement awards from 2019/2020, and, in the most predictable fashion, they continue to complain that the expungement process is rigged and that brokers who seek expungement continue to “game” the system.  We’ve blogged about this before, and about the numerous changes FINRA has made to the expungement process recently, and the slew of additional rule changes that are still pending but are expected to be approved by the SEC any day now.  Even though FINRA has taken substantial steps to make expungement harder for brokers to obtain, and easier for customers to oppose, PIABA is still not satisfied.  Dare I say it – you can’t help but feel a little badly for FINRA here, as it seems none of their expungement rule changes can satisfy the PIABA attorneys.  Let’s dive into the study’s findings and PIABA’s erroneous conclusions.

First, the study found that 90% of expungements from August 2019 to October 2020 were granted.  According to the study, that number is basically the same as it was in 2015, before FINRA started making significant rule changes to the expungement process.[2]  PIABA concludes that this means arbitrators are rubber-stamping the expungement requests, arbitrator training is not working, and the recent rule changes are not working to stop useful disclosures from being removed from CRD.

I suggest that there’s a different explanation for why the number of expungements granted has not changed: there was nothing broken with the expungement process in the first place.  For as long as I can remember, FINRA arbitrators have always been warned that expungement is supposed to be an “extraordinary remedy.”  But the standard for granting expungement under FINRA Rule 2080 is that the arbitrators must find that the customer’s allegations were false or clearly erroneous.  The arbitrators are simply seeing the facts laid before them and calling it how they see it.  They either believe the evidence demonstrates that allegations are false, or not.  Unlike a true research study which proffers multiple possible explanations to explain data, PIABA’s “study” doesn’t even contemplate the notion that so many expungement requests are granted is because the claims were frivolous in the first place.  Speaking from personal experience, I take multiple expungement cases to hearing every year and end up winning (knock on wood), but I receive just as many inquiries about expungement that I never file because I will advise the client if their likelihood of success is low.  It is not a secret that attorneys only take cases to trial that they feel strongly about.  If it’s a bad case, it will likely never get to a hearing, and may never get filed in the first place.  That is why the expungement success rate is so high – not because the system is broken.

Second, the study found that customers only participate in expungement hearings 15% of the time, which has not changed much from 2019 when they only participated 13% of the time.  PIABA continues its false narrative that “the current expungement process … does not have safeguards to ensure that customers can participate in a meaningful way.”  That is just not true.  Since at least as far back as 2017 when FINRA issued its Notice to Arbitrators and Parties on Expanded Expungement Guidance, FINRA has expressly told arbitrators that “it is important to allow customers and their counsel to participate in the expungement hearing in settled cases if they wish to.”  The Guidance also contains a laundry list of ways customers are permitted to participate in expungement hearings, including by testifying, introducing documents and evidence, cross examining the broker and other witnesses, presenting opening and closing arguments, and presenting an opposition in writing.  And FINRA’s proposed rules – that will likely be approved by the SEC this week – provide for even more safeguards to give customers notice of the expungement hearings and opportunities to participate both in the pre-hearing conferences and the hearings themselves.  So, to say that there are no safeguards that allow customers to meaningfully participate is total nonsense. The real issue is that customers do not want to participate in the expungement hearings because there is no incentive for them to do so after their cases settle.

The study concludes that customers’ lack of participation in expungement cases is what causes so many expungement requests to be granted.  According to the study, “the data strongly indicates that arbitrators are granting expungement requests 90% of the time because they are being provided with one-sided presentations about the merits of the customer complaints….”   However, the study’s own data completely undercuts that conclusion. The study found that arbitrators are more likely to deny expungement requests when a customer opposes the request – not that much more likely.

According to the study, arbitrators denied expungement requests only 9% of the time when the customer did not participate, but they denied 36% of expungement requests when customers did participate.[3]  In other words, even when customers oppose an expungement request, the arbitrators still decide their allegations are false almost 7 out of 10 times.  The customer participation changes the arbitrators’ minds in only 2.7 out of 10 expungement cases.  That tells you two things: 1) customer participation in expungement cases is highly overrated and inconsequential, likely because arbitrators are smart enough to weigh facts and credibility without hearing the customer’s predictable testimony that he/she was wronged, and 2) the quality of customer claims are not very good.

And therein lies the real issue.  Any investor can file any complaint at any time, regardless of the merit, and it will live in CRD forever unless expunged.  One recent article about the study cited a Stanford Law Professor who acknowledged that FINRA should “impose a higher level of scrutiny” on what’s put on BrokerCheck in the first place. Bingo.

Finally, the study found that the number of “straight-in” expungements filings have “skyrocketed” in recent years. As the study explains, “a straight-in expungement case is an arbitration initiated by a broker against their current or former brokerage firm solely for the purpose of seeking expungement. The customer who made the complaint is not a party.”  This differs from the other scenario where a broker involved in a customer arbitration asks for expungement to be granted in the course of that customer arbitration.  The study found that in 2015 only 59 straight-in expungements were filed, but that number has increased year after year (2016 – 135; 2017 – 339; 2018 – 545; 2019/2020 – 700).  PIABA calls this a “tactic” and suggests that brokers utilize it to limit customers’ ability to participate in the expungement hearing since they will be treated simply as a “fact witness” rather than a party.  (p.21)  This is simply not true.  Even in expungement cases where the customer is not a named party, FINRA requires the broker to provide notice to the customer, and the customer is permitted to participate in many more ways than a fact witness, as described above (opening statement, closing argument, testimony, present exhibits, cross-examine other witnesses).

Furthermore, the study’s authors blatantly disregard the fact that in cases that settle, FINRA is actually in favor of requiring brokers to file a separate “straight-in” arbitration that deals only with the issue of expungement, rather than keeping the arbitration panel from the underlying arbitration in place and having them hear the expungement request.  In FINRA’s Sept. 30, 2020 filing with the SEC regarding their proposed rules (which the SEC may approve any day now), FINRA states:

The proposed rule change would provide that if, during a customer arbitration, a named associated person requests expungement or a party files an on-behalf-of request and the customer arbitration closes other than by award or by award without a hearing, the panel from the customer arbitration would not be permitted to decide the expungement request.  Instead, the associated person would be required to seek expungement by filing a request to expunge the same customer dispute information as a straight-in request under proposed Rule 13805. … FINRA believes this is the right approach because the panel selected by the parties in the customer arbitration has not heard the full merits of the case and, therefore, may not bring to bear any special insights in determining whether to recommend expungement.

So, while PIABA may not like it, there are going to be many more “straight-in” expungement requests filed.  And many more expungement requests granted.  And mark my words – when that happens, PIABA will publish another “study” claiming that the system is still broken.

[1] PIABA is a group of plaintiffs’ attorneys who market themselves as protecting investors, while at the same time lining their own pockets.

[2] The number dropped to 81% in 2015, 2016, and 2017.

[3] This is actually the data from the 2019 study. The updated study strangely does not give the exact percentages, but just states that the arbitrators are 4.3 times more likely to deny the request when a customer opposes it – which is about the same figure they cited in the 2019 study.

I am writing this while flying home from my first business trip in over 15 months.  I have to tell you, it is more than a bit of a strange feeling to be out and among people again.  While my face is sore from wearing this N95 mask nearly non-stop for three days, my hands are dry and rough from all the washing, and I basically hid in my hotel room if I didn’t have to be somewhere, I think this still marked the start of something that I recognize as sort-of normal. Cheers to that!


FINRA, of course, has lots, and lots, of rules.  Heck, it has rules about making rules.  The things that RRs can and cannot do per those rules are strictly proscribed, mostly in great detail.  Things that ordinary people can do without a second thought are frequently off-limits for RRs.  Yet, notwithstanding the sizable breadth of the gamut of restrictions that FINRA has erected, sometimes, remarkably, BDs feel that FINRA hasn’t gone far enough, and so create their own rules that go above and beyond anything that FINRA ever contemplated.  In other words, BDs are free to create policies that are more restrictive than FINRA rules.  Like this common scenario:  FINRA Rule 3240 prohibits RRs from borrowing money from or lending money to their brokerage customers, subject to certain exceptions, like if the deal involves a family member.  Many BDs, however, prefer simply to disallow any loans, period, since that’s much easier to police.

The issues that this situation tees up are these:  Does FINRA care if an RR violates a firm policy through conduct that does not violate any specific FINRA rule?  And, if it does, should it?

The answer to the first question seems to be “it depends on the policy.”  Take an obvious example, like, I don’t know, dress code.  FINRA undoubtedly would not and does not care if an RR wore flip-flops to the office, contrary to firm policy.  But, if the policy touches the relationship with customers, then FINRA does seem to care.  I am just not sure why, or if it is appropriate.

I started thinking about this a few months ago, when I blogged about the SEC’s decision in Tysk.  Among the rulings the SEC made there in its review of the FINRA decision was a finding that FINRA failed to carry its burden of proof that Mr. Tysk violated Rule 2010 strictly by virtue of the fact that he had violated his firm’s policy regarding note-taking.  According to the SEC, “[a] violation of a firm policy does not necessarily mean that a registered representative has also violated” any FINRA rules.  Rather, FINRA must independently establish that the underlying conduct somehow violated FINRA Rule 2010 because it was unethical.  I characterized that ruling as “huge,” and I stick by that.

So, with that background in mind, I was really intrigued when I read this recent AWC regarding a guy named Gary Wells.  According to the AWC and BrokerCheck, Mr. Wells entered the securities industry in 1983 – the same year I started practicing law! – and stayed for 37 years.  The AWC says he had no relevant disciplinary history; indeed, it appears to me that the only disclosures he has are all related to the same events that led both to the AWC and his dismissal from his last job (which I will get to in a second).  Not a single customer complaint in almost four decades.  That’s pretty dang good (even though FINRA accords no “credit” for it, because FINRA says you don’t get credit simply for doing what you’re supposed to do).

So what happened?  Well, Mr. Wells did not violate any specific FINRA rule.[1]  Rather, like Mr. Tysk, he violated one of his firm’s policies.  In his case, Mr. Wells had the temerity to provide such good service to one of his customers that the customer decided to leave something to Mr. Wells in her will.  The AWC recites that this “long-term customer” – FINRA’s words, not mine – followed Mr. Wells to Wells Fargo Advisors in 2008 from a prior firm.  At some point prior to 2012, the customer named Mr. Wells as a beneficiary and fiduciary in her will. In 2012, as is so often the case in situations like this, not the customer but, rather, someone from the customer’s family, her brother, specifically – perhaps someone who himself stood to inherit from the customer? – filed a complaint with WFA that his sister had named Wells in a fiduciary capacity and as a beneficiary.[2]  The basis for the complaint was not indicated.  Importantly, however, there is zero indication that Mr. Wells had exerted any undue influence over his elderly customer.  Indeed, if he had done that, you could bet the farm that FINRA would’ve included that in the AWC (and that the customer’s brother would’ve mentioned it).

So, what we have is a “long-term” customer who decided, on her own, to leave a legacy to Mr. Wells, but, in so doing, managed to piss off her brother.  Perhaps the story would have just ended there, but WFA had a policy – a policy that went beyond any FINRA rule – that “prohibited acceptance of a bequest or a fiduciary appointment from a nonfamily member in the customer’s will.”  In light of that policy, FA instructed Mr. Wells to have himself removed from the fiduciary and beneficiary designations and, if his long-term customer refused, he should decline the appointments.

On December 4, 2014, following the death of the customer at age 92, Mr. Wells received a bequest in the form of a wire transfer from the customer’s estate to his WFA brokerage account. WFA reversed the transfer and told Mr. Wells the firm would not permit him to receive the funds because they represented a bequest from a non-family member.  After WFA informed him that he could not accept such funds, Mr. Wells then proceeded to accept three separate bequests from the customer’s estate, in accordance with her will.  Finally, after receiving the money, Mr. Wells “concealed the fact that he was the beneficiary and had received bequests from the customer’s estate by making false statements on [a] . . . compliance questionnaire.”

That’s the entire case.  No violation of any specific FINRA rule, but, because Mr. Wells violated a firm policy that FINRA says in the AWC was “designed to protect customers,” FINRA deemed this to be a violation of Rule 2010, the catchall rule prohibiting unethical conduct.

I am not sure why FINRA bothered with this one.  In Reg Notice 20-38, in which FINRA announced its new Rule 3241, it explicitly gave BDs the right to approve bequests from customers, particularly “long-term” customers and those customers whose bequests were not accompanied by “any red flags of improper conduct by the registered person,” such as when “the customer has a mental or physical impairment that renders the customer unable to protect his or her own interests,” or “any indicia of improper activity or conduct with respect to the customer or the customer’s account (e.g., excessive trading),” or “any indicia of customer vulnerability or undue influence of the registered person over the customer.”   Exactly NONE of those issues existed here.  To the contrary, there is no evidence of any red flags at all.  So, even though Rule 3241 was nothing more than a fantasy that FINRA harbored at the time of Mr. Wells’ conduct, and even though under that rule the facts suggest that Mr. Wells would have been permitted to inherit from his long-term customer had he asked, for the simple fact that WFA had an absolute prohibition on inheriting from customers, FINRA brought this case.

I simply do not see why, in circumstances like this, FINRA takes it upon itself to enforce BD policies.  You can make a decent argument that WFA’s policy does exist to protect customers; but that does not mean that FINRA should otherwise ignore the pertinent facts, which, as FINRA laid them out in the AWC, fail to tee up any customer protection/sales practice issues.  As it has done hundreds of times before, all FINRA did in the Wells case was prove that he violated a firm policy, not that he acted unethically.  The Tysk case states that this is not enough for FINRA to carry its burden of proof on a 2010 violation, and I agree.  FINRA needs to do more, and if it can’t, then cases like this either should no longer be brought, or hearing panels should start dismissing them.


[1] While FINRA currently has a rule – Rule 3241 – that prohibits an RR from inheriting from a non-immediate-family customer absent approval by the BD, at the time of the conduct in question, that rule was still years away from being effective.

[2] As I mentioned earlier, there are NO customer complaints reflected in Mr. Wells’ BrokerCheck report, so I don’t really know what to make of this supposed complaint from the brother.  Was it not reported because it’s not from a customer?  Was it not reported because it does not relate to sales practices?  I don’t know, but it is a bit puzzling that the AWC not only calls this a “complaint,” given that there is no record that WFA bothered to report it on Mr. Wells’ U-4, but that this “complaint” was enough to trigger an exam, and an eventual Enforcement case.

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