Jon Henschen Jon Henschen

As an advisor, you relentlessly perform risk assessments for your clients’ portfolios. Yet, one aspect of risk assessment you may ignore is the downside of being an advisor with a clean compliance record who is tied to a broker dealer with problematic compliance and financials.

Compliance issues at the broker-dealer level are an area of concern rarely explored by advisors, but they should be. Is your broker-dealer home to a high number of advisors with numerous compliance or credit disclosures?

As the Financial Industry Regulatory Authority drills down on anything and everything, a broker-dealer in poor standing with FINRA can make life more difficult for all its advisors — even if you may have a spotless record. It’s an issue of guilt by association.

To explore this issue, we went to securities attorney Jim Eccleston of Eccleston Law.

We asked, “If you are an advisor with a clean compliance record, but you are at a broker-dealer that has a high percentage of advisors with multiple marks on their compliance records, what impact directly and indirectly does that have on an advisor with clean compliance?”

Jim shared the following perspectives:

First, a firm in poor standing with FINRA will need to endure additional regulatory sweeps and audits. Depending upon the subject matter, these may or may not involve the clean advisor.

Second, in defending those regulatory audits, the firm will expend additional time and financial resources, which ultimately will be passed on to all advisors.

Third, if the firm needs to sacrifice a few lambs to please the regulators, morale will be affected and possible management turnover will affect the stability and predictability of the firm’s operations.

How to Check Your BDs’ Record

One way to get a feel for your broker dealer’s advisor quality is to view its advisors’ compliance record on FINRA’s BrokerCheck. Here’s how to do it:

  1. Go to:
  2. Click on the “Individual” tab (so it is highlighted blue)
  3. Click on “Firm Name or CDR #” and type in your broker dealer’s name then hit enter (Type in State under “City/State/ZIP” box to view advisors in specific state)
  4. The name of the advisors at your broker dealer will come up and you can then click on the names of the advisors that have “Yes” under disclosures
  5. You can scan page by page just to view number of “Yes” advisors or you can look at them individually to see the compliance details of each advisor

What constitutes a problematic advisor differs quite a bit.

For FINRA, most anyone with anything on his or her record is viewed as problematic. However, there also are advisors with multiple serious disclosures showing a pattern of client abuse, and yet some broker-dealers seem to have no issue with such registered reps— if these advisors have high enough production numbers.

As a recruiting firm, these are the criteria we use as a guideline to discern what constitutes problematic:

  1. Any disclosures that show serious negligence or financial abuse toward clients such as churning, borrowing money from a client, forging a client signature or selling away with products not approved by broker dealer such as a viatical contract
  1. Multiple marks where fines were paid, reflecting a pattern of guilt but not including disclosures over market loss
  1. Multiple disclosures regarding credit issues over the last five years (credit issues caused by divorce or medical hardship not as serious)
  1. Disclosures showing multiple terminations from prior broker dealers, or “permitted to resign” situations

One Measure: The Industry Average

 FINRA requires broker-dealers to keep track of the compliance and history of their advisors through a Registered Representative Composition Report.

The intent of these reports is to make the broker-dealer aware if they are above the industry average in any of the 10 categories that broker-dealers are required to track.

Here are the categories:

  1. Representatives new to the industry
  2. Transferred from another firm
  3. Registered with three or more firms in the last two years
  4. Terminated
  5. One or more disclosures
  6. Customer complaint disclosures
  7. Criminal disclosures
  8. Financial disclosures
  9. Previously with a severely disciplined firm
  10. Arbitration/civil litigation disclosures

When FINRA audits broker-dealers, they will examine the Registered Composition Report to see if the firm is above the industry average in any of the 10 categories.

It’s rather common for broker-dealers to come under heightened scrutiny by FINRA when they are above the industry average, especially if they rank poorly on multiple categories.

More Frequent Audits

One way that FINRA ramps up the pressure on broker-dealers is by auditing them more frequently or restricting their growth until they bring their numbers more in line with industry averages.

A broker-dealer in good standing with FINRA will be audited once every two years, whereas a more problematic broker dealer will be audited once a year.

As an example, a California firm we know that closed two years ago had a high ratio of problematic advisors in multiple categories. The president of the firm commented to us that FINRA spent almost 10 months at the firm, looking at every nook and cranny while tying up management in the process.

Service was severely hindered during this time, advisors had great difficulty reaching management during the audit, and any profits were absorbed by the extensive time imposed on staff and management as well as fines they incurred.

Evaluating Different Firms

When doing a compliance review of a broker dealer using FINRA broker check, small- and mid-size broker-dealers are the easiest to analyze. These also are the most important firms to check as they have less of a capital cushion or deep pocket access and thus are more vulnerable.

If you view the advisors in a large broker-dealer’s home state, you tend to find a higher concentration of advisors with multiple marks that are oftentimes required to be under heightened supervision. This is because it’s easier and less expensive for a broker-dealer to perform heightened supervision on representatives within their home state than it is on those outside their borders.

Problematic advisors at the larger-broker dealers tend to be revealed by a high frequency of press articles noting large fines being paid due to non-complaint advisors. (Perform a Google search on the broker-dealer’s name).

FINRA BrokerCheck also will reveal representatives that have been barred from the industry. If you see numerous advisors at your broker-dealer that have been barred, this is a major red flag that your BD is likely rogue in the eyes of FINRA.

Three Assessments to Make

Examining the compliance history of advisors at a broker-dealer is one of three risk assessment activities that you should perform as proper due diligence.

The other two assessments involve looking at the broker dealer’s compliance history and at its financials. Reviewing this information will give you a clear picture as to whether you, as a clean compliance advisor, need to be concerned that you may be susceptible to additional legal risk, broker-dealer expenses (such as higher E&O insurance rates) and additional administrative policies/procedures above what FINRA normally requires.

If your broker-dealer has poor financials, you run the risk of it closing its doors due to a net capital violation, leaving you with frozen client accounts and a two- to three-month unexpected disruption as you scramble to perform due diligence on an alternative broker-dealer.

If you have a clean compliance record, don’t settle for a problematic broker-dealer just to avoid the inconvenience of a broker-dealer change. Switch up to a broker-dealer that has the same high-quality standards you do.