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FINRA Plan Would Unleash 'Rogue Brokers,' Lawyers Say

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The Financial Industry Regulatory Authority’s proposed rule to free broker-dealers of liability over investment advisors’ outside business activities “is undoubtedly one of the worst rule changes ever contemplated by FINRA” and will inhibit brokerage firms’ ability “to prevent ‘selling away’ and other related schemes and scams,” Andrew Stoltmann, president of the Public Investors Arbitration Bar Association, said Thursday.

Stoltmann, an attorney with Stoltmann Law Offices in Chicago, said in releasing a new PIABA report, FINRA’s Attempt To Gut Investor Protections: Proposed Reforms To FINRA Supervision Rules, that the broker-dealer self-regulator’s plan as set forth in Regulatory Notice 18-08 would result in a “ ‘regulatory black hole’ that will leave investors significantly more at risk of abuses by eliminating supervision of the outside activities of ‘rogue brokers.’”

FINRA has proposed eliminating almost all supervision requirements for registered reps’ outside business activities, including recordkeeping, said PIABA, a group of lawyers who represent investors in disputes with the securities industry.

The change would be a win for hybrid BDs but would be a “good-news, bad-news story” on the whole, Jon Henschen of BD recruiting firm Henchen & Associates told ThinkAdvisor in January. While BDs would be freed of the need to track, and the liability for, RIA business, they would lose out on fee revenue associated with that business.

FINRA proposes to exempt member firms from supervising:

  • Investment related activities at third‐party investment advisor firms;
  • Investment related activities at member affiliates including IAs, banks and insurance companies;
  • Non‐investment related work and outside business activities; and
  • Personal investments.

These private securities transactions (often referred to as “selling away”), PIABA explained, “and other forms of outside business activities manifest themselves in a variety of schemes and fraudulent activity every year, including but not limited to, fraudulent private placements, Ponzi schemes, and investment frauds perpetrated through third-party IAs established by the registered representative.”

A FINRA spokesperson told ThinkAdvisor in an email on Thursday that FINRA continues “to listen to stakeholders and is reviewing all comments on this issue.”

The proposed rule was released for comment in early February and the comment period expired on April 27.

“Rather than fixing the rogue broker problem, FINRA has chosen to focus on how to let its member brokerage firms wash their hands of any responsibility for these unscrupulous actors,” argued Stoltmann.

The PIABA report states that “a common modus operandi in these schemes is for a registered representative to establish a solo or small IA firm and perpetrate the fraud through outside business activities in an effort to avoid member supervision.”

FINRA proposed changes to Rule 3290, the report states, “will narrow and reduce member firms’ supervisory obligations and result in unacceptable adverse consequences,” including:

  • Weakening long-standing supervisory obligations;
  • Creating supervisory deficiencies;
  • Encouraging de facto violations of federal securities laws;
  • Generating inconsistencies with other FINRA rules and regulatory guidance;
  • Producing perverse incentives for registered representatives and members; and
  • Leaving investors with inadequate protection.

“Essentially, FINRA member firms would potentially be insulated from any liability related to the outside business activities of its registered representatives,” the report states.

According to the Investment Advisor magazine’s annual Broker-Dealer Presidents Poll, published in May, 18% of BD presidents said that reviews of “selling away” and outside business activities were the FINRA activities that most concerned them.

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