In the past week, I ran across two discrete instances in which FINRA acts as a secret gatekeeper of sorts, exercising its own subjective judgment, without anyone knowing what, exactly, it is doing or why, employing unarticulated standards, and without providing any avenue for redress.  And I find that really frightening.

The first involves CRD, which, although it is nothing more than a database of information, is a weird place.  Over the years, it seems I have spent a crazy amount of time describing to people exactly what CRD is, where the information in CRD comes from, what information properly belongs in CRD, what information is in CRD but not in BrokerCheck, etc.  With that said, clearly the most common issue I encounter when it comes to people calling me about CRD is that they feel they have required disclosures – typically a bogus customer complaint – that are inaccurate and wonder what, if anything, they can do about it. Remember: RRs are required to disclose customer complaints irrespective of their lack of merit.  This situation only got worse with the advent of BrokerCheck, since the whole world can now view pretty much all of one’s negative U-4 disclosures, making inaccurate disclosures that much more impactful.

There is more than one answer to the question what to do when faced with a customer complaint that is flat out false, as it depends on whether the RR is still in the industry.  If so, it’s easy, as the RR can, at a minimum, add a comment to the DRP (i.e., the disclosure reporting page) about the disclosure simply by having their BD amend their Form U-4.  Typically, the comment goes something like, “I didn’t do what the customer claims I did and I intend to fight these scurrilous allegations vigorously.”  Most BDs are happy to add that language, for what it’s worth.  Interestingly, however, there are no rules, or even guidelines, regarding what can be included in a comment.  As far as I can tell, an RR can say whatever he or she wants, and unless the BD has some problem with the comment, it is dutifully reported in CRD, and BrokerCheck, as well.

If the rep is no longer registered, however, the procedure is different and, frankly, odd.  The RR still gets to submit a comment, but, because he is not registered, he has no ability to file, and therefore amend, a Form U-4 (because only BDs can make such filings).  As a result, the comment has to be submitted directly to FINRA, which will then make sure that it makes its way to CRD and to BrokerCheck, so the world can see that the RR denies the allegations, etc., etc.  But, that’s not the weird part.  What is weird is that FINRA will not simply say whatever the RR wants.  Rather, FINRA will review the proposed comment and decide whether or not it will be published, or perhaps just needs to be edited or redacted.

What?  FINRA will “review” the comment, and then make a subjective determination whether or not it will be shown to the public?  I am not making this up.  The following language appears on FINRA’s website on a page called “Guidelines for Broker Comments on BrokerCheck”: “FINRA will review the comment and reserves the right to reject or redact a comment that it deems to be inappropriate or does not adhere to the following criteria.”  Before I address “inappropriate,” let me talk about the “criteria.”  There are five criteria listed, and all but the last are not particularly controversial.  They require that:

  • “The individual submitting the comment is not currently registered.” That is easy enough to establish.
  • The proposed comment must “pertain to the BrokerCheck report of the individual submitting the request.” Again, easy peasy.
  • The comment must address “information disclosed through BrokerCheck.” No problem with that.
  • The comment must be “written in the first person narrative point of view to minimize any potential confusion on the part of the reader.” I like to write in the first person, so I can’t really complain about this criterion (although it is a bit amusing that FINRA cares about something like the perspective from which a comment is offer).
  • “The comment does not contain confidential or identifying information about customers or others; offensive or potentially defamatory language; or information that raises significant identity theft, personal safety or privacy concerns.” Ok, not so fast.

What gives FINRA the right to decide whether a comment is “offensive or potentially defamatory?”  And who, exactly, at FINRA is conducting the review and making these determinations?  And what criteria are being employed to determine whether a comment is offensive?  I am confident that there are things that would not offend me, but which other, more thin-skinned folks, would be bothered by.  Take a very specific example: would FINRA deem it to be offensive if an RR called a complaining customer a “liar” (which, frankly, many complaining customers are)?  I just can’t believe that FINRA can wield editorial power like this over an RR’s own words.

And that power only gets scarier when you consider the other standard, which is even loosier-goosier, i.e., that the comment not be “inappropriate.”  Again, exactly what does that mean?  Would a comment be inappropriate because the RR denies the complaint?  Because he points a finger at, say, his former BD?  Or at FINRA itself?  We also face the same problem regarding who at FINRA is the one deciding whether a proposed comment is appropriate or not.  Is it Robert Cook?  Seems doubtful.  Maybe it’s just some data entry clerk at CRD?  And what happens if you disagree with FINRA’s determination to “reject or redact” a comment?  There does not appear to be an appeal process.  How can that be fair?

As I stated at the outset, this is not the only hidden situation in which FINRA acts like Big Brother, deciding the merits of things behind the scenes, away from public scrutiny.  Just the other day, someone reminded me about mid-hearing disciplinary referrals made by arbitration hearing panels.  Under FINRA’s Code of Arbitration Procedure, if a hearing panel hears evidence of “any matter or conduct . . . during a hearing, which the arbitrator has reason to believe poses a serious threat, whether ongoing or imminent, that is likely to harm investors unless immediate action is taken,” it may make an immediate disciplinary referral. But, that’s not the end of the process.  Rather, FINRA Dispute Resolution first has to “evaluate” the referral before it is actually passed on to Member Reg or Enforcement.  Presumably then, even though a hearing panel has decided that something it heard it so egregious, so potentially harmful to investors that it makes an immediate disciplinary referral, FINRA can summarily – and subjectively – decide that the panel is wrong, and the referral dies there on someone’s desk, away from the light of day.

I don’t know about you, but these secret administrative processes that FINRA has created in which it wields such complete control over decision-making without also providing some window into what’s happening and who is making the decisions, not to mention some avenue of appeal, scare me.  FINRA is supposed to do the right thing, and usually does.  But not every time.  There should always be some sort of check on FINRA, to ensure that its decisions are made out in the open and subject to review by the SEC.  The two circumstances I have described here do not fit within that construct.  Who knows what else we don’t know?

Last year, for the first time, FINRA produced a statistical report designed to provide some perspective on the firms that comprise its membership. I blogged about it, and concluded at the time that the report basically demonstrated the following:

  • FINRA is still mostly composed of small firms
  • But the number of those firms, and the influence they wield on FINRA’s direction, continues to diminish
  • If the trend continues, the landscape for broker-dealers will no longer look as it does today, as “mom-and-pop” shops will go the way of the paper tickertape and the handwritten order ticket

This week, FINRA issued its 2019 version of that Snapshot and – spoiler alert – it appears that those same alarming trends continue.

First, perhaps the least surprising data point in the entire report is that the number of FINRA member firms continues to shrink.  As of 2018, FINRA is down to 3,607 firms, representing an overall loss of 119 firms.  Since 2014 – the earliest year for which data is included in the Report – FINRA has lost over 11% of its membership.  Going back to 2003, which the earliest year for which I can find any statistics, the number of FINRA member firms has dropped by over 31%.  Consistent with this, there was also a continuation in the drop in the number of RRs, albeit a modest one.

Second, FINRA membership still consists overwhelmingly of small firms.  When you consider the three different size categories that FINRA employs – small (which FINRA defines as 1 – 150 RRs), mid-size (151 – 499 RRs) and large firms (over 500 RRs) – the data show that 3,242 of the total of 3,607 firms are small.  In other words, over 90% of FINRA member firms are small.[1]

Third, and perhaps the most alarming, it is readily evident that the reduction in the overall number of firms was driven almost entirely by the loss of small firms.  Of the 119 firms that were lost in 2018, 112 of them – over 94% – were small.  And of those 112 firms, 104 of them were BDs with 10 or fewer RRs.  You can see why the concern I voiced last year about the demise of “mom-and-pop” shops was legitimate, and why it is even more true today.  Of course, the data in the report also show why FINRA doesn’t really care about this phenomenon: of the approximately 630,000 RRs who work for FINRA member firms, only 10% work for small firms.  Yes, you read that right: while fully 90% of FINRA members are small, only 10% of all the RRs work at those firms.

Fourth, FINRA’s statistics again reveal clearly that it is hardly the regulator of choice in the securities industry.  This is evident from the data that show that while the number of BDs continues to plummet, the population of investment advisors – who are not, of course, regulated by FINRA – is going in the opposite direction.  Every year since 2009, the number of investment advisor firms NOT registered with FINRA has increased, up a total of 22.5% over that ten-year period.  By comparison, over that same time period, the number of FINRA members – whether BD-only or IA/BD dually registered – has dropped by 23.5%.  Stated another way, in 2009, there were about 20,000 more IA-only firms than BDs; ten years later, however, as people in the securities industry migrate away from the BD world to avoid having to deal with FINRA, there are now 26,639 more IA-only firms, an increase of 33%.

As I said before, except for the last observation about the continuing migration away from BD world to IA world, I highly doubt that FINRA cares about the fact that its population of member firms continues to drop every year, or that small firms are quickly going the way of Blockbuster video rental stores.  I mean, who would complain about having fewer firms to worry about at the same time that your number of employees, your compensation, and the amount of money you spend continue to go up?  Less to do with more people to do it, sounds like a fantastic combination.  At some point, I suppose it is possible that FINRA will have to justify its continued existence.  Based on her history, Senator Elizabeth Warren does not appear to be a big fan.  I do not doubt that certain people in FINRA management are keeping a very close eye on who turns out to be the nominee from the Democrats.

[1] Given that the overwhelming number of FINRA members are small, isn’t it odd that according to FINRA’s By-Laws, small firms get allocated the exact same number of seats on the National Adjudicatory Council as large firms?

Selflessly, Blaine Doyle recently attended a presentation here in Chicago by the SEC and CFTC, so you didn’t have to do it yourself.  Here is his recount of the highlights. – Alan

Anyone who has sat through a talk by financial regulators is undoubtedly familiar with the refrain from the individuals that they do not speak for the Commission and that the opinions offered are their own.  Even with that disclosure (and they ALWAYS make that disclosure), regulators are still notoriously tight lipped when it comes to just about anything, but especially if it relates to Enforcement.  However, when two high ranking officials from the CFTC and SEC decided to present, as the star attractions, at the Chicago Bar Association, they had no choice but to spill the beans.  While nobody would accuse them of having given up state secrets, they did offer some insights into where their respective Commissions are and, more importantly, where they are going.  With that in mind, here is what they had to say (with special emphasis on the securities side):

While the government shutdown of early 2019 is ancient history to most of us, the speakers from both the CFTC and SEC emphasized the disruption that the break caused to their respective organizations and personnel.  Moreover, on the issue of government funding, they both noted that their organizations are understaffed from past hiring freezes and are trying to backfill positions that have been open for some time.  The speaker from the CFTC mentioned that in some respects his organization had been in “triage” mode due to personnel shortages and that he was hoping that the additional hires will help ease the work load.  So why does this matter to the reader?  If you work in the industry, it would be reasonable to expect that as both organizations hire additional staff, scrutiny on registrants and, possibly, the number of enforcement actions will increase in the coming years. Continue Reading “The Opinions Offered Today Are Mine Alone And Do Not Represent The Commission” — A Summary Of Recent Remarks From SEC And CFTC Officials

I was catching up on my reading and came across a column in Investment News by Mark Schoeff  that described the results of a recent FINRA arbitration, results which I found a bit alarming.  I caution you: reading too much into any arbitration award can be dangerous and/or foolhardy since they don’t always follow – or, occasionally, even slightly resemble – the rule of law.  Indeed, screwy arbitration awards abound, and sometimes all you can say is dang, glad it wasn’t me.  That’s why, in the eyes of the law, anyway, arbitration awards, even those that are well reasoned and sensible, do not constitute binding legal precedent.

Nevertheless, this award serves as a nice cautionary tale for firms that are willing to open accounts for advisory customers but not serve as the actual advisor, which is an altogether common practice in the securities industry.  Remember: investment advisors can recommend securities transactions, but they cannot actually effect any trades.  To make a securities trade that was recommended by an IA, the customer must have a securities account at some broker-dealer.  Some advisors are dually registered, and work for a BD, and that’s where the account is generally opened.  Many other advisors, however, are not associated with a BD, so their advisory clients need a brokerage account somewhere.  Often, that somewhere is a discount BD that charges low commissions, like TD Ameritrade, the respondent in this particular arbitration. Continue Reading TD Ameritrade Latest Victim Of Head-Scratching Arbitration Award

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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