FINRA Adopts Restricted Firm Rules

“The direct financial impact of a restricted deposit is likely to change such member firms’ behavior — and therefore protect investors,” FINRA said.

Rule 4111 sets up a multi-step, annual process through which FINRA will determine whether a member firm raises investor protection concerns substantial enough to require that it be designated (or re-designated) as a “Restricted Firm” and subject to additional obligations, including a “Restricted Deposit Requirement,” FINRA explained.

“The multi-step process includes numerous features designed to narrowly focus the new obligations on the firms most of concern. Each year’s process will begin with a calculation of which firms meet numeric thresholds based on firm-level and individual-level disclosure events to identify member firms with a significantly higher level of risk-related disclosures as compared to similarly sized peers,” according to FINRA.

Firms also get “a one-time opportunity to avoid the imposition of obligations by voluntarily reducing its workforce; an opportunity to explain to the Department of Member Supervision why the firm should not be designated as a Restricted Firm or be subject to a Restricted Deposit Requirement or to propose alternatives that would still accomplish FINRA’s goal of protecting investors; and the opportunity to request a hearing before a FINRA Hearing Officer in an expedited proceeding to challenge” the restricted firm label.

Jon Henschen, president of Henschen & Associates, a firm that helps advisors find broker-dealer relationships, said in a previous interview that FINRA’s new rules are “a positive for the public and a negative for the broker-dealers that are categorized as a ‘restricted firm.’”

The rules could “potentially drive out of business most firms that fall into this category,” Henschen said. “Not only will working capital have to go in a non-productive direction, but their reputation will be harmed and [recruiting] will be much more difficult.”