The American Securities Association believes Finra isn’t going far enough in its efforts to deal with member firms who regularly hire bad actors with significant misconduct records.
The ASA says the self-regulator should impose stricter penalties — including a lifetime ban on the bad actors and a capital charge on the erring member firms — to weed out the worst actors that tarnish the industry. The ASA is a lobby group for middle-market financial services firms, including broker-dealers and advisory firms.
In May, Finra proposed a new rule — Rule 4111 (Restricted Firm Obligations) — that would impose additional obligations on firms with a significant history of misconduct.
The solutions and penalties outlined in the proposal “do not go far enough to remove the most egregious actors from our industry, and they could ultimately harm the Main Street investors and retirement savers it seeks to protect,” ASA CEO Christopher Iacovella says in a comment letter the group submitted to Finra on Tuesday night and seen ahead of time by FA-IQ.
Finra says only a “small” number of its member firms have a high concentration of registered representatives with records of misconduct, but they present heightened risk to their clients and “may undermine confidence in the securities markets as a whole.”
The proposed new rule imposes “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 of cash or qualified securities in a segregated account at a bank or clearing firm. Withdrawals could be made only with Finra approval.
The ASA believes the appropriate action from Finra would be to revoke the licenses of recidivist brokers — brokers with and multiple misconduct marks on their records — and expel firms that regularly hire them.
“Recidivist brokers should not be allowed to move from one firm to another with impunity,” Iacovella says. “And firms that have a demonstrated track record of hiring them and failing to properly oversee them have no place in our industry.”
Iacovella says the proposal is not strong enough because it creates “a byzantine process” that would only “marginally increase” the financial obligations of bad actor firms and allow the member firms that hire them to operate as usual.
“This outcome is unacceptable and contrary to Finra’s mission. Finra is not an insurer responsible for pricing certain risks in the market. It is an SRO that has an obligation to penalize and, if necessary, revoke the licenses of bad actors whether they are held by firms or by brokers,” Iacovella says.
If the problem is the authority or tools available to Finra to quash bad actors, then the SRO should work with the SEC and Congress to solve the problem, according to the ASA.
ASA also suggests Finra apply a capital charge instead of its proposed collection of funds.
“We are concerned about the precedent a rulemaking which requires firms to place funds into an account controlled by regulator will set and how such a precedent could be misused in the future,” Iacovella says.
Cetera Says Finra Shouldn’t Publicly Name Erring Member Firms
In a comment letter submitted in July, Cetera Financial Group critiqued the proposed rule’s manner of identifying restricted firms, procedural safeguards and public identification of restricted firms.
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).
Cetera believes pending events shouldn’t be included in the criteria for determining the significant misconduct threshold, while employment-related events should be considered with “great caution.”
“In determining whether to use any element of data in the evaluation process, two criteria should be applied — the degree to which the data is reliable and the degree to which it is predictive of future conduct,” Cetera says.
To ensure that the proposed rule strikes a balance between investor protection and procedural fairness, Cetera has two suggestions. One, all contested hearings should be conducted by a hearing panel made up of both an industry member and a hearing officer. Two, an expedited hearing should be conducted when a restricted firm disagrees with the initial determination of Finra.
Under the proposed rule, 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.
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.
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.
In addition, Cetera believes Finra shouldn’t publicly identify restricted firms.
“If decisions regarding restrictions on member firms’ activities become known to the public, they may create a perception of financial weakness or propensity for the firm to commit bad acts, and lead to a ‘run on the bank’ scenario in which many customers of the firm decide to close their accounts,” Cetera says.