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FINRA Gets a Green Light to Crack Down on High-Risk Firms, Brokers

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What You Need to Know

  • The SEC approved a FINRA rule change that would place new obligations on member firms with a long record of misconduct.
  • FINRA would also crack down on those BDs that employ brokers with such histories.
  • FINRA found such firms often had a retail business engaging in cold-calling vulnerable investors to make recommendations of securities.

The Securities and Exchange Commission approved a proposed rule change by the Financial Industry Regulatory Authority that was created to crack down on broker-dealers with a long record of misconduct and those firms employing a large number of registered representatives with long disciplinary histories.

In its order on Friday, the SEC pointed out that, in November, FINRA filed a rule amendment proposal with the SEC that was designed to “help further address the issue of associated persons with a significant history of misconduct and the broker-dealers that employ them.”

FINRA’s proposed rule change would adopt a new Rule 4111 to “address the risks that can be posed to investors by broker-dealers and their associated persons” with long histories of misconduct, the SEC said.

The proposal would impose new obligations on BDs with “significantly higher levels of risk-related disclosures (including, notably, sales-practice related disclosure events) than other similarly sized peers based on numeric, threshold-based criteria,” according to the SEC.

“FINRA is trying to deprive rogue brokers of their safe havens at a small number of broker-dealers who are happy to let them continue to ring the cash register,” according to recruiter Mark Elzweig, president of Mark Elzweig Company.

“These advisors are typically serial offenders with long rap sheets,” he told ThinkAdvisor on Monday. “FINRA wants to make hiring these miscreants a less profitable business model. The overwhelming majority of conscientious, client-centered advisors will welcome their exit from the business.”

Restricted Firms

“Specifically, FINRA is proposing to adopt FINRA Rule 4111 (Restricted Firm Obligations) to require member firms that are identified as ‘Restricted Firms’ to deposit cash or qualified securities in a segregated account, adhere to specified conditions or restrictions, or comply with a combination of such obligations,” the SEC noted in its order.

FINRA is also proposing the adoption of FINRA Rule 9561 (Procedures for Regulating Activities) and amending FINRA Rule 9559 (Hearing Procedures for Expedited Proceedings Under the Rule 9550 Series) to create a new expedited proceeding to implement proposed Rule 4111, the SEC pointed out.

“The proposed rule change would establish a process to give a Restricted Firm an opportunity to challenge the designation and the resulting obligations of that designation, as well as give the firm a one-time opportunity to avoid the imposition of obligations by voluntarily reducing its workforce,” according to the SEC.

The change was “designed to protect investors and the public interest by strengthening tools available to FINRA to address the risks posed by member firms with a significant history of misconduct, including firms with a high concentration of individuals with a significant history of misconduct,” the SEC order said.

FINRA stated that such firms expose investors to real risk, the SEC noted. For example, FINRA stated it identified certain firms having a “concentration of associated persons with a history of misconduct,” and some of those firms consistently hire such individuals anyway and then fail to reasonably supervise their activities, the SEC order said.

FINRA found that those firms generally had a retail business engaging in cold calling investors, often vulnerable ones, to make recommendations of securities, the SEC noted.

For several years, FINRA had been pressured to crack down on firms that hired too many brokers who violated the self-regulator’s rules and harmed investors. In April 2018, FINRA issued guidance on heightened supervision.

Also on Friday, SEC Commissioners Caroline A. Crenshaw and Allison Herren Lee gave a thumbs up to FINRA for agreeing to share information about high-risk BDs with state regulators.

“We appreciate FINRA’s attention to these high risk firms because they raise important investor protection concerns,” the commissioners said in a joint statement posted on the SEC website.

They were also “pleased that FINRA’s Board recently approved a plan for a separate filing to disclose the identities of high risk firms to the public, which it expects to file promptly,” they said. “A firm’s high-risk status is important information and will help investors make informed choices about the firms they select. We intend to monitor this important investor protection issue and will evaluate whether additional steps may be needed to address recidivist firms and brokers.”

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