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Watchdog to Rogue Firms: Too Many Bad Brokers on Staff Could Cost You $6 Million Deposit

By Rita Raagas De Ramos May 3, 2019

Gone may be the days when a broker-dealer firm can rack up a long list of misconduct records by registered representatives without direct financial consequences to the firm. A bevvy of bad brokers working at your firm could require millions of dollars as a deposit with Finra.

The self-regulator published Thursday a proposed new rule – Rule 4111 (Restricted Firm Obligations) – that would impose additional obligations on firms with a significant history of misconduct.

The new rule is aimed at protecting investors from misconduct. Finra says only a “small” number of its member firms have a high concentration of records of registered representatives’ misconduct, but they present heightened risk to their clients and “may undermine confidence in the securities markets as a whole.”

The new rules would impose “tailored obligations” – including possible financial requirements – on broker-dealer firms that cross specified numeric misconduct record thresholds, which would be computed on an annual basis.

The obligations could include requiring a member to maintain a specific deposit amount with cash or qualified securities in a segregated account at a bank or clearing firm. Withdrawals could be made only with Finra approval.

In examples given by Finra involving hypothetical scenarios, the deposit could be as high as $5.75 million. The examples are for illustration purposes only and the actual deposit would be determined on a case-by-case basis.

The deposit is aimed at preserving the firm’s funds for the payment of arbitration awards that may be rendered against them. Thus, any unpaid arbitration awards could impact the size of the required deposit from the firm.

What exactly would Finra consider to be significant? The math is spelled out in the proposed rules.

To determine if a broker-dealer firm has hit the significant misconduct history threshold, Finra is proposing numeric thresholds based on six categories of events or conditions based on information disclosed through the Uniform Registration Forms. The six categories are:

  • Registered Person Adjudicated Events
  • Registered Person Pending Events
  • Registered Person Termination and Internal Review Events
  • Member Firm Adjudicated Events
  • Member Firm Pending Events
  • Registered Persons Associated with Previously Expelled Firms (also referred to as the Expelled Firm Association category).

Finra says it crafted the numeric misconduct record thresholds after a thorough calculation that took into consideration the number of misconduct records in similarly-sized firms.

For example, it may take only four misconduct records to get a firm with only one to four registered representatives in trouble, while it could take 100 misconduct records for a firm with 51 to 150 registered representatives to be held liable under the proposed rule, depending on the misconduct.

Different numeric values are assigned for each of the categories of misconducts and depending on the firm size. The proposed metrics are on page 17 of this attachment to the Finra regulatory notice.

Without naming firms, Finra says it has identified certain firms with a concentration of individuals with a history of misconduct. Some of those firms “consistently hire such individuals and fail to reasonably supervise their activities.” Finra says those firms generally have a retail business, engage in cold calling and have vulnerable customers.

Finra says it has identified individual brokers who “move from one firm of concern to another firm of concern.”

As of the end of 2018, 20 small firms (with no more than 150 registered persons) had 30 or more disclosure events over the prior five years, according to Finra’s records.

Ten mid-sized firms (with between 151 and 499 registered persons) had 45 or more disclosure events over the same period. Five large firms (with 500 or more registered persons) had 750 or more disclosure events over the same period.

In situations with a high concentration of misconduct records, Finra says it closely examines firms and broker conduct for potential enforcement actions to bar or suspend the firms and individuals involved.

Finra says individuals and firms with a history of misconduct are a challenge for its existing examination and enforcement programs.

Exams can identify existing or imminent compliance failures and prescribe remedies to be taken. But examiners are not empowered to require a firm to change or limit its business operations in a particular manner. While these constraints protect firms from potentially arbitrary or overly onerous exam findings, an individual or firm with a history of misconduct can take advantage of these limits to simply continue ongoing activities that harm or pose risk of harm to investors until they result in an enforcement action, according to Finra.

When Finra determines that a firm has a significant history of misconduct records, based on its metrics, it would evaluate if the firm requires further review.

If a firm requires further review, Finra would give the firm a one-time opportunity to reduce staffing levels within 30 days of being informed that it has met the threshold level for misconduct records. The firm would be prohibited from rehiring any of the individuals it fires for this purpose for one year. Lower staff levels would make the firm fall under a different firm-size category under Finra’s metrics.

Finra

During the review period, Finra would impose a maximum Restricted Deposit Requirement on the firm based on its size, operations and financial conditions. Finra says it will ensure the amount won’t significantly undermine the continued financial stability and operational capability of the firm over the next 12 months.

Also during the review, Finra would consult with the firm about the circumstances that merited the review.

If Finra determines that the firm should be classified as a Restricted Firm – meaning it has not successfully rebutted the reasons which led Finra to place it under review – then the firm would be required to “promptly” establish a Restricted Deposit Account, deposit and maintain in that account the maximum Restricted Deposit Requirement, and implement and maintain specified conditions or restrictions on its operations and activities as well as of its associated persons.

Finra is seeking comments on the proposed rule until July 1.