Financial Industry Regulatory Authority (FINRA) has stepped up investigations and disciplinary actions against broker-dealers (BDs) and individual registered representatives, according to a new study from Washington DC-based law firm Sutherland Asbill & Brennan LLP.

Deborah Heilizer and Brian  Rubin, Sutherland partners, and an associate, Andrew McCormick, found that the number of actions brought by FINRA jumped in 2010 to 1,310, the highest number since 1,412 were brought in 2005, according to the “Sutherland FINRA Sanction Study.”

Overall, however, they found that the dollar amount of fines was significantly less in 2010, at $45 million, than 2005's $184 million in fines and even the $50 million in fines in 2009. Fines are off, said Rubin (left), in an email message to AdvisorOne, because “several years ago, there were large cases (such as the market timing cases) that resulted in very large fines,” 

Reputation Risk

Firms that don’t heed FINRA’s more aggressive stance on enforcement and prevent the types of behaviors that bring on these investigations risk sullying their reputation and lowering their net profits because of the negative publicity and financial hit these actions can cause.

“We are seeing more aggressive enforcement from FINRA," Rubin said in the release accompanying the report. "Substantively," he said, "FINRA is focusing on an increasingly broad range of issues.”  His practice includes representing firms and individuals under investigation or prosecution by FINRA, states, or the Securities and Exchange Commission (SEC). “Procedurally, this aggressiveness has been illustrated by the types of information requested and the deadlines being imposed."

“FINRA may have brought more cases because of pressure on them, following Madoff, Stanford and the market crash," Rubin said in the email message. “It's hard to say why the fines are down, other than that there have been fewer ‘supersized’ fines.”

These cases are unrelated to investor arbitration suits and awards. “These are disciplinary proceedings where FINRA finds wrongdoing (as opposed to investors/customers who are making claims in [arbitration]),” Rubin noted.

The Top Five Types of FINRA Actions, according to the Sutherland study:  

  1. Advertising–At $4.75 million, advertising cost BDs the most in fines of any type of violation. 
  2. Credit Default Swap (CDS)–Six CDS cases brought in $4.5 million in fines, and were mostly about “alleged improper communications about customers’ proposed brokerage rate reductions in the wholesale CDS market.” The study noted, “It is unclear whether this high 2010 ranking for CDS cases signals a change in FINRA’s enforcement program or whether these cases represent the completion of FINRA’s work in this area.”
  3. Electronic Communication—Resulted in about $4 million in fines to FINRA, in 34 cases. “This includes more than $2.1 million in fines for failing to adequately maintain and preserve company e-mails in 23 cases.” 
  4. Suitability—FINRA levied a total of $3.75 million in fines for 53 suitability cases in 2010. These included “sale of collateralized mortgage obligations (five cases, $760,000 in total fines), closed-end funds (three cases, $1 million in total fines), and reverse convertible notes (two cases, $710,000 in total fines).” 
  5. Short Selling—On the top enforcement list for the first time in 2010, short –selling cases resulted in fines of about $3.5 million, in around 50 actions.  Most, (34) were for “accurate reporting of short sales,” however, the study noted, “nearly $1 million in fines from 14 actions were imposed for allegedly accepting a short sale without borrowing the security or entering into an agreement to borrow the security.”

Enforcement Trends Revealed

Sutherland’s study identified several trends in FINRA enforcement. Fines in mutual fund dropped to 20% of the dollar amount levied in 2009. FINRA fined firms just $2.4 million in 2010 versus $12 million for mutual fund cases on 2009.

FINRA  is more interested in advertising issues, meaning, the study says, that “FINRA will continue placing greater emphasis on regulating advertising materials distributed to investors as well as materials distributed to and used by internal sales forces.”

There were fewer “supersized” fines in 2010, defined by Sutherland as more than $1 million. There were 10 such fines in 2009, versus six in 2010.

Fines for electronic communications violations seem to be waning. While they comprised $30.6 million in 2005, they


were about $4 million for 2010, leading Sutherland to conclude that “more firms are installing systems to effectively manage and supervise electronic communications.”

Keep an eye open, the study advises, for potential new cases involving social media, although there haven’t been any yet.  

An ‘Ounce of Prevention’?

While the dollar amount of the fines is lower than in many years, if FINRA is enhancing its enforcement actions, what should firms do to prevent the behaviors that trigger these Finra cases? “Firms should be aware of the ‘hot’ issues by carefully reviewing regulatory alerts, enforcement actions and speeches given by the regulators,” Rubin said in his email. “Firms should respond when they see small problems to prevent them from becoming bigger.”