FINRA’s Stated Paradigm Shift On Enforcement Actions

From Ulmer’s Broker-Dealer Law Corner Blog
By Michael A. Gross

I have spoken about FINRA possibly putting an end to the policy of pursuing cases where formal disciplinary action serves little to no regulatory purpose. That welcome paradigm shift may be upon us.

This year, FINRA, in essence, pronounced that its “broken windows” strategy of pursuing Enforcement cases over the smallest and most technical violations is, well, broken. In a speech at SIFMA’s Anti-Money Laundering & Financial Crimes Conference, Susan Schroeder, the head of FINRA’s Department of Enforcement, proclaimed that:

Enforcement action, while a powerful tool in FINRA’s toolbox, is not the right tool in all cases. In fact, we must be thoughtful and intentional in order to use our finite Enforcement resources in the matters where they are most needed. To determine if an enforcement action is the right tool to use in a given circumstance, we ask ourselves: Is there demonstrated financial harm resulting from the misconduct? Has there been a significant impact to market integrity? Did the misconduct create significant risk?

Instead of walking away from these remarks, FINRA adopted them, publishing the speech on its website. This is a refreshing and welcome change from the usual disclaimer that FINRA personnel provide at public speaking engagements (i.e., my words are my own, and do not necessarily reflect the views of FINRA (or something to that effect)). Last week at the SIFMA C&L Annual Seminar, Ms. Schroeder reiterated her remarks. She again declared that Enforcement action should be reserved for misconduct that creates “significant risk,” such as misconduct that results in harm to investors or market integrity.

There are a number of unintentional violations of the countless federal securities laws and FINRA rules that do not create “significant risk,” including untimely disclosure of reportable events on Form U4, non-disclosure of irrelevant outside business activities, certain inadvertent trade reporting violations, many net capital violations, and multiple types of inadvertent recordkeeping violations. FINRA has not published, and is unlikely to publish, a list of the specific types of violations that no longer warrant formal action, so it will be interesting to see which types of violations are affected by the stated policy shift over the course of the next year.

While this new stated policy is certainly welcome news, the key will be in its implementation. How will FINRA advise its staff of the new policy? How will FINRA train its staff on the policy? What, if any, guidelines has FINRA established on specific types of violations so that its staff knows whether or not formal action is warranted? How will FINRA supervise its staff – many of whom have been working under the “broken widows” approach for years – to ensure that the new policy is universally and uniformly implemented? These types of questions should sound familiar. They are the same types of questions to which FINRA demands answers of its members on their WSPs, and that FINRA now will need to answer for itself if it plans to reasonably implement its new policy.

As the saying goes, it can be challenging to teach old dogs new tricks, but FINRA will need to do just that in order to effectively implement its stated policy change. A small, technical, and/or unintentional violation that invariably resulted in a lengthy investigation, followed by formal action, over the past decade may no longer warrant the same degree of costly inquiry and the same disposition. To quote from FINRA Rule 3110, let’s hope that FINRA “shall establish and maintain a system to supervise the activities of [its staff] that is reasonably designed to achieve compliance with [the new policy].” Even if FINRA does not implement the new policy to the fullest extent in your case, you can at least thank Ms. Schroeder for providing fodder for responses to Examination Reports, Wells letters, and closing arguments.