The Financial Industry Regulatory Authority on Thursday proposed a plan to place restrictions on brokerage firms that hire brokers with a history of misconduct, including requiring the firm to have a fund to cover unpaid arbitration awards.
In Regulatory Notice 19-17, FINRA is seeking comment until July 1 on its plan to adopt Rule 4111, which would impose obligations on broker-dealers that have significantly higher levels of risk-related disclosures than similarly sized peers.
FINRA states that it would “preliminarily identify these members by using numeric, threshold-based criteria and several additional steps that would guard against misidentification.”
The obligations could include requiring a broker-dealer “to maintain a specific deposit amount, with cash or qualified securities, in a segregated account at a bank or clearing firm, from which the member could make withdrawals only with FINRA’s approval. This proposal also aims to preserve firm funds for payment of arbitration awards against them.”
The proposal, FINRA states, “would achieve this both through how a member’s ‘covered pending arbitration claims’ and unpaid arbitration awards could impact the size of its restricted deposit requirement, and a presumption that a member would continue to maintain a restricted deposit if it has any ‘covered pending arbitration claims’ or unpaid arbitration awards.”
A restricted deposit, FINRA states in the notice, is the most effective tool to change the behavior of the firms that present a high degree of risk to the investing public. “FINRA believes that a restricted deposit is most likely to change such members’ behavior — and therefore protect investors — through its direct financial impact.”
FINRA plans numeric thresholds based on six categories of events or conditions, nearly all of which are based on information disclosed through the Uniform Registration Forms.
1. Registered Person Adjudicated Events;
2. Registered Person Pending Events;
3. Registered Person Termination and Internal Review Events;
4. Member Firm Adjudicated Events;
5. Member Firm Pending Events;
6. Registered Persons Associated with Previously Expelled Firms (also referred to as the Expelled Firm Association category).
FINRA states in the notice that it has identified “certain firms that have a concentration of individuals with a history of misconduct, and some of these firms consistently hire such individuals and fail to reasonably supervise their activities.”
These firms, FINRA continued, “generally have a retail business with vulnerable customers and engage in cold calling to make recommendations of securities.”
FINRA states that it has also identified groups of individual brokers who move “from one firm of concern to another firm of concern,” adding that “certain firms, along with their reps, have substantial numbers of disclosures on their records.”
As of year-end 2018, FINRA states, there were 20 small firms (firms with no more than 150 registered persons) with 30 or more disclosure events over the prior five years; 10 midsize firms (firms with between 151 and 499 registered persons) with 45 or more disclosure events over the prior five years; and five large firms (firms with 500 or more registered persons) with 750 or more disclosure events over the prior five years.
“In such situations, FINRA closely examines the firms’ and brokers’ conduct, and where appropriate, FINRA will bring enforcement actions to bar or suspend the firms and individuals involved,” FINRA states.
FINRA also wants to impose, at a later date, a “terms and conditions” rule similar to Investment Industry Regulatory Organization of Canada (IIROC) Consolidated Rule 9208, “which permits IIROC, in an effort to strategically target the most problematic firms, to exercise discretion to identify firms and develop appropriate terms and conditions on their operations.”
The reg notice states that while FINRA is still considering such a rule, it is not proposing it at this time.
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