Finra is determined – more than ever, it says – to crack down on high-risk brokers. But advisors are urging that any proactive move must include a clear definition of what exactly makes a broker fall under a high-risk designation.
“We’ve always been focused on high-risk individuals but when there are 633,000 registered persons [in Finra], I think historically we didn’t do as effective a job as we should have with the data and information we have,” Susan Axelrod, executive vice president of Finra’s Office of Regulatory Operations, said last month at the self-regulator’s annual conference in Washington, D.C.
In its 2017 regulatory and examination priorities letter, Finra identified attention to high-risk and recidivist – or repeat offender – brokers as its #1 priority.
“Many elements of our regulatory programs today are focused on preventing bad actors – whether they be firms or individuals – from entering the securities industry, identifying those that emerge, and, where necessary, pursuing discipline for misconduct and restitution for investors to the fullest extent of our authority,” Finra CEO Robert Cook said in a speech at Georgetown University on Monday.
Finra’s Office of Fraud Detection and Market Intelligence is its “central repository” for gathering and evaluating information about broker misconduct, Cook said. It operates a whistleblower office; triages information from various sources including tips from Finra field examiners, regulatory filings, media reports and investor complaints; expedites the review of high-risk tips and fraud-related matters by senior staff; and coordinates closely with federal and state law enforcement, he added.
Last year, OFDMI referred 785 matters – including potential insider trading and fraud – to the SEC and other law enforcement agencies.
Since 2014, OFDMI has been escalating cases in which a broker is believed to be engaging in misconduct or is an imminent threat to investors. In such cases, investigators and enforcement lawyers conduct expedited investigations and disciplinary actions regarding the broker, which has led to Finra barring nearly 300 individuals from the industry, Cook said.
OFDMI “takes in every single filing made by every single firm, and there’s a process there where we look at the intelligence coming into the organization whether through the filing, the whistleblower tip line, the customer complaint forum, and we will tag individuals in that intake process that we think are designated higher risk,” Axelrod said.
The data and analytics used by OFDMI have helped it identify high-risk brokers by an average of around 100 days per person, with the shortest period taking only eight days, Axelrod said.
“That’s pretty quick,” she said. “What we’ve done is a more effective job of weeding out a lot of the factors that go into the model. For example, the research will show that a more recent action or regulatory event will be more predictive in terms of someone’s propensity to commit a future violation than an event that goes back 20 years.”
OFDMI has also stepped up in identifying groups of high-risk brokers “who are working together, leaving together, joining other firms,” she said.
“Over the past five years, 40% of the firms we’ve identified at the highest risk level are out of business.”
Firms that hire high-risk brokers are placed under greater scrutiny, says Axelrod, who expects this to intensify: “Our specialized examinations team will create a specialized team this year with additional resources to supplement reviews of high-risk brokers – that means specialized exams on site and for those who left the business more recently. We will monitor their activities to make sure we’re notified the minute they come back in.”
An investigation by Reuters identified 48 Finra-member firms where at least 30% of the brokers have a Finra flag on their records, including regulatory sanctions, civil judgments, personal bankruptcies and broker terminations after allegations of misconduct.
In addition to the “examinations, surveillance, high-risk designation and the focus on firms that are employing clusters of high-risk brokers,” Finra is “focusing on what we can do from a rule perspective,” Axelrod said.
Finra’s board of governors has formed a special working group, led by former SEC chair Elisse Walter, to focus on the oversight of high-risk brokers.
Last month, Finra’s board approved a proposed rule amendment to require broker-dealer firms to adopt heightened supervisory procedures for individuals while a disciplinary case is pending appeal; to reinforce and clarify the firms’ existing supervisory obligations concerning brokers they employ who have disciplinary histories; to expand sanction guidelines to let adjudicators consider more severe sanctions when an individual’s disciplinary history includes additional types of past misconduct; and to allow hearing panels, in appropriate circumstances, to restrict the activities of firms and individuals while a disciplinary matter is on appeal.
Broker-dealers in attendance at Finra’s conference were supportive of the self-regulator’s efforts to crack down on high-risk brokers. But they want clarity on the definition of a high-risk broker and a viable set of criteria for determining what makes a broker fall under a high-risk designation.
Cook said Finra intends to publish additional guidance in the coming months on the broker-dealer firms’ supervisory obligations related to brokers that may pose higher risk.
“Without a doubt, our industry needs to focus on making sure that we recover from some of the black eyes that we get from the high-risk brokers,” said Amy Webber, president and CEO of Cambridge Investment Research, a broker-dealer and financial solutions firm. However, “I don’t want to see our industry throw the baby out with the bathwater. There’s not a lot of segmentation in that environment. One disclosure is not the same as another.”
Theoretically speaking, Mark Cresap, president of broker-dealer Cresap Inc., said he would put brokers under heightened supervision if “they do something wrong and may be statutorily disqualified for some administrative reason, but are good people,” but he would fire brokers who do harm to clients.
Cresap, who is part of the Finra high-risk brokers working group, says he and other brokers he’s spoken to don’t want the definition of high-risk to be too broad. “You’re really talking about the tip of the spear,” he says, adding that the numbers of high risk brokers would be in the hundreds – “we're not talking about thousands of people.”
Bari Havlik, senior vice president and chief compliance officer at Charles Schwab, said while her firm is “relatively conservative,” it would look at each broker’s case based on facts and circumstances. For example, “we would differentiate whether there was a product failure, and whether the rep got a number of complaints because of that product, versus someone who has various complaints alleging very bad behavior.”
Finra’s Axelrod said the self-regulator would take a “quantitative” approach when evaluating high-risk brokers.
“Ten customer complaints related to a product sale differs from different complaints spanning different customers and different products and different types of allegations,” she said.
“We have got to be laser-focused on this small group of people who pose a higher risk to their investors than their peers, and to make sure that’s where our regulatory resources are dedicated. We need to be aggressive in that approach, but we need to get it right and focus on the right people.”
Axelrod noted that the broker-dealer industry is already among the toughest in terms of individual-level disclosures, so what Finra is trying to achieve is very targeted.
“I think the fact that BrokerCheck exists, that investors simply can type in someone’s name and get the information, that really is important for transparency. If you look at doctors, lawyers, pilots – some of them we trust with our lives – there’s no level of disclosure on an individual level.”