From Ulmer’s Broker-Dealer Law Corner Blog
By Alan M. Wolper
I told you two weeks ago in my blog post that this would happen. I told you that when Robert Cook announced the topics to be taken up at the February/March FINRA Board meeting in Boca Raton, he slipped and used the new phrase “high-risk firms.” Well, in yesterday’s announcement about what actually took place at that meeting, all mystery has been removed about FINRA’s intent. Indeed, it is now undisputable that FINRA is expanding its historic interest in rogue reps now to include rogue firms. Or, as Susan Wolburgh Jenah, a member of the Regulatory Policy Committee, put it in her video recap of the meeting (she shows up right after Robert Cook’s introduction), firms with a “disproportionately higher number of risk events and disciplinary events on their record.”
FINRA has apparently been planning this for some time, which is apparent from the fact that it is already at the point of proposing some new rule. According to yesterday’s announcement, “The Board approved moving forward with proposing new rules related to firms that have a disproportionately high number of regulatory disclosure events by the firm and/or its registered representatives.” The big development is the first part of that sentence, the focus on “firms.” As I have discussed previously, FINRA has always professed to have an interest in registered reps – yes, the rogue reps – who are working in the industry notwithstanding their checkered pasts. And, FINRA has been interested in firms that hire such reps. (See my discussion of the Taping Rule in my previous post.) But, now FINRA is, apparently, independently interested in what I am calling rogue firms, i.e., BDs that are in business notwithstanding have a disciplinary history that FINRA feels is somehow an issue.
There are all sorts of problems with this, or, frankly, any attempt to establish some quantitative standard. And note that I am saying it will be a quantitative standard based on FINRA’s use of the phrase “disproportionately higher number of risk events,” which can only be reasonably interpreted one way: that FINRA intends to characterize firms as “high risk” based on some numerical comparison of their disclosure events with other firms. So, what are the problems?
First, what is going to be the dividing line between an ok number of disclosures and too many? I, for one, would have absolutely no idea where to draw that line. I totally get that FINRA thinks it knows more than anyone, but even FINRA could do no more than spitball this concept.
For instance, what do you do about big firms, especially big firms that have been around for a long time? They have tons of disclosures. In a blog post I wrote in November, I pointed out that LPL’s BrokerCheck report reflects 123 final “Regulatory Events” encompassing an astounding 255 pages. Yikes. But, really, that’s nothing. Look at Merrill Lynch. Its BrokerCheck report shows that it has managed to garner 1,434 disclosures, 559 of which are “Regulatory Events,” five “Civil Events” and 870 arbitrations. UBS? Well, it’s only been around since 1978 (according to BrokerCheck), so it only has 265 “Regulatory Events.” I could go on, but you get the point: a lot of firms will have scary-sounding numbers. Does that mean they should, by definition, be deemed to be high-risk?
Second, and more basic, is whether a quantitative approach makes any sense at all. The idea that simply looking at the number of “risk events” – whatever Ms. Wolburgh Jenah meant by that – or “disciplinary events” as an indicator of a firm’s supposed propensity for future regulatory issues strikes me as overly simplistic and, therefore, pointless. Look, FINRA has previously considered imposing some sort of objective criteria before to distinguish between good and bad reps, but those efforts never got very far, and for good reason.
Remember back in 2003, when NASD floated a rule that would require firms to impose heightened supervision on certain reps based on an objective, numerical standard? Specifically, NASD proposed that BDs be required “to adopt heightened supervision plans for registered brokers who, within the last five years, have had three or more customer complaints and arbitrations, three or more regulatory actions or investigations, or two or more terminations or internal firm reviews involving wrongdoing.” Well, that got nowhere – and rightly so – and that was because NASD management realized (or was forced to realize) that while the imposition of such a standard was facially attractive (for its ease of definition), ultimately there was no logical correlation between the sheer number of customer complaints, or arbitrations, or regulatory actions, and a rep’s likelihood of committing a sales practice violation. Well, here we are, 16 years later, and FINRA is now back at it.
We are just in the first step of this process. FINRA is going to draft a new rule (or rules – note the use of plural in the announcement yesterday) on this topic, and send it out for comment. If you care about this sort of thing, don’t sit on the sidelines and wait for others to speak up. Exercise your rights as a member firm to tell FINRA what you think.