For many years, FINRA has attempted in several settings to substitute objective criteria for subjective ones, to try and make things easier for itself, and to make things more consistent from district to district and from firm to firm. For instance, FINRA used to – and may still today – identify firms whose exam cycles should be accelerated by assigning numerical values to a variety of characteristics (theoretically risk associated), and then adding them up. If your firm’s total exceeded whatever cutoff FINRA established, well, you were lucky enough to be examined more frequently. And then there was that infamous episode about 20 years ago, when FINRA decided to evaluate the performance of its District Offices by creating objective, numerical goals against which actual performance could be measured. The problem was, the objective goals were themselves sometime stupid (and even controversial, such as the one that required at least 10% of exams to result in formal disciplinary actions).
Well, FINRA is still at this game, and continues its goal of identifying specific circumstances that it could use as some objective basis to cull out those individuals and firms on which to focus its regulatory attention. Last week, a number of rule amendments became effective (others don’t become effective until May, June and September, respectively) that fulfill that desire, and they are laid out in Reg Notice 21-09.
I started talking about this in a blog post two years ago, when FINRA first broached the subject. At the time, I expressed my concern about utilizing a quantitative standard as a means of identifying firms that ought to garner more attention. Sadly, at least in my view, FINRA shares no such concerns. To the contrary, citing a 2015 study published by FINRA’s Office of the Chief Economist – comically, a study that admonishes on page one that “[t]he views expressed in this paper are those of the authors and do not necessarily reflect the views of FINRA” – FINRA strongly believes in “once bad/always bad” when it comes to brokers. Given this somewhat simplistic view of the world, FINRA has now made a number of rule changes that actually implement this philosophy.
The changes impact several rules. Let’s review them.
First, and perhaps most impactful – and NOT in a good way – on FINRA member firms, let’s see how it affects hiring decisions. Under current rules, if a BD wants to hire someone as a registered rep, there’s really nothing to stop the firm from simply doing so, and without asking permission. Yes, it’s true that in some very limited situations, the hiring of even a single rep might trigger a CMA if the addition of that registered rep would constitute a material, quantitative change in the firm’s business based on the number reps the firm already had as of the date of the hiring, but everyone understands that. Here, I am not talking about that; rather, I am talking about the typical hire, one that would be permitted by a firm’s Membership Agreement without a CMA, or because the firm had the right to take advantage of the “safe harbor” in IM-1011 (also obviating the need for a CMA). Under FINRA’s new rule, things are very, very different. Under certain specific circumstances, a BD may NOT simply hire a registered rep – even though the rep is otherwise qualified and not statutorily disqualified – if that rep has in the prior five years, either (1) “one or more final criminal matters” or (2) “two or more specified risk events.” If he or she does, then before the BD can hire the rep, it must first file a MatCon – a Materiality Consultation – with FINRA. If FINRA concludes the hiring would be material, then a full-blown CMA is necessary (the filing fee for which costs, at a minimum, $5,000, something FINRA pointed out would in and of itself constitute a disincentive for firms to hire reps who meet FINRA’s new criteria). In other words, FINRA is unilaterally determining that registered reps who have these particular disclosures – disclosures which do NOT prohibit these reps from registering at any BD – cannot be hired unless FINRA says so.
As you can see, based solely on criteria that it simply plucked out of thin air, and its own unchallenge-able determination of what constitutes “materiality,” FINRA is going to be acting as gatekeeper, theoretically to prevent or dissuade firms from hiring people that FINRA’s own predictive analysis machine suggests will be likely (or more likely than others) to commit sales practice violations in the future, in deference to its own awful logic that “a member firm’s hiring of a broker with a significant history of misconduct – and other associations with such persons – would reflect a material change in business operations.” Ah, FINRA is in the crystal ball business! What ever happened to “past performance is no guarantee of future results,” a disclaimer that both the SEC and FINRA look for? I guess it doesn’t apply to people. (I would ask, too, what ever happened to due process, but I fear I know the answer to that one already.)
I could go on and on about this one rule change, which I think is a game-changer in terms of the power that FINRA just gave itself, but let me hit the others.
For anyone unlucky enough to have been involved in a FINRA Enforcement case, you likely know that if you lose the hearing and appeal to the NAC, then the sanctions – whatever they are, no matter how severe, even including a permanent bar – are stayed pending the disposition of the appeal. You can keep working, keep earning (perhaps to pay your attorney, which is not a crime by any means), until the NAC finally decides your fate. That has now changed. The new rule MANDATES that in this scenario, the BD MUST impose a heightened supervision plan on the rep. This marks the very first time in history that FINRA has identified a circumstance that requires an HSP. Prior to this, indeed, even as recently as Reg Notice 18-15, such a determination resided with each BD, based on guidance that FINRA offered regarding circumstances that it believes suggest that an HSP be considered.
And that’s not all. In addition to the mandatory heightened supervision plan, FINRA has the right to ask the Hearing Officer – the very person who just found the rep to be liable in the first place – for the “imposition of conditions or restrictions on the activities” of that rep that are “reasonably necessary for the purpose of preventing customer harm.” Not really sure how these “conditions or restrictions” differ from a heightened supervision plan, or under what circumstances FINRA will seek to impose restrictions. The only hint, sort of, lies in a footnote in the Reg Notice: “The conditions and restrictions are not intended to be as restrictive as the underlying sanctions imposed in the disciplinary decision and would likely not be economically equivalent to imposing the sanctions during the appeal.”
I didn’t say it was a helpful hint. If you can figure out what this means, please, by all means, let me know.
For what it’s worth, at least these can be challenged. If FINRA files a motion to impose these restrictions, the motion can be opposed, and the Hearing Officer’s decision can be promptly appealed to the NAC. (Yes, that’s right, the same NAC that is going to hearing the appeal itself. Again, no conflict of interest here!) It is going to be exciting to see how FINRA wields this new power. Will it seek restrictions in every case? Only those in which bars are imposed? Time will tell.
Having decided that it was comfortable announcing a mandatory heightened supervision plan for respondents who appeal to the NAC, FINRA just kept going. The new rules, therefore, also require that BDs impose an HSP on registered reps on whose behalf an MC-400 is filed. While HSPs are universally proposed in support of an MC-400 – because they are the key tool to providing FINRA with the comfort of knowing that if a disqualified person is permitted to associate with a BD he or she will not repeat the misconduct that got them disqualified in the first place – they have not, to date, been necessary prior to the approval of the MC-400. (Again, in Reg Notice 18-15, an HSP in this scenario was merely suggested, not mandated.) Now, the HSP must be implemented even while the MC-400 is under consideration.
Two years ago, I closed my blog post by urging members to speak up in response to FINRA’s rule proposal. In reviewing the SEC’s Order approving the rule changes, it seems that maybe four comments were received…and two of them were in favor of the changes.
 Read this thing if you choose, but let me save you the time. The authors essentially concluded that the worst 20% of brokers, based on their disciplinary disclosures, are responsible for the statistical majority of subsequent disciplinary events. In other words, it is predictable, using math, that a bad broker will continue to be bad.
 What are these things? They included as new definitions in Rule 1011. “Final criminal matters” means a criminal matter that resulted in a conviction of, or plea of guilty or nolo contendere (‘no contest’) by, a person that is disclosed, or is or was required to be disclosed, on the applicable Uniform Registration Forms.”
A “specified risk event” is:
(1) a final investment-related, consumer-initiated customer arbitration award or civil judgment against the person for a dollar amount at or above $15,000 in which the person was a named party;
(2) a final investment-related, consumer-initiated customer arbitration settlement or civil litigation settlement for a dollar amount at or above $15,000 in which the person was a named party;
(3) a final investment-related civil action – i.e., NOT consumer initiated – where:
(A) the total monetary sanctions (including civil and administrative penalties or fines, disgorgement, monetary penalties other than fines, or restitution) were ordered for a dollar amount at or above $15,000; or
(B) the sanction against the person was a bar, expulsion, revocation, or suspension; and
(4) a final regulatory action where
(B) the sanction against the person was a bar (permanently or temporarily), expulsion, rescission, revocation, or suspension from associating with a member.
 I should point out that the rule doesn’t just apply to everyday reps who a BD may want to hire, but, as well, to principals, control persons, and new owners, both direct and indirect.
 Just for giggles, it is worth asking what is the point of appealing to the NAC. In its Order approving the FINRA rule changes, the SEC observed from 2013-2019, the NAC issued decisions in 131 disciplinary matters. It affirmed the hearing panel or hearing officer findings 121 times (92%), modified the findings six times (5%), and reversed or dismissed the findings a whopping four times (3%).