By Ginny Voos + Stephen Murphy
Embedded in our culture is a sense of “Innocent until proven guilty.” Apparently, once guilt is determined, it can stick with you like a Scarlet Letter. Under new Rule 4111, FINRA adds to its Sonny Liston-like approach by corralling risky Registered Reps into fewer Broker-Dealers willing to offer them employment (a left jab) and assessing a capital burden on those firms (followed by a right jab).
Rule 4111 will have FINRA evaluate its members as of June 1st (“Evaluation Date”) to determine which broker-dealers will be categorized as “Restricted Firms.” The evaluation process will begin a month later, beginning July 1, and involves comparing a number of firm-level and individual-level disclosure events to identify firms that have significantly higher levels of risk-related disclosures as compared to similarly-sized peers. FINRA provides a mapping resource on its website to assist members in understanding what types of events are considered in the evaluation.
Firms labeled as Restricted will be required to deposit cash or qualified securities in a restricted account, which will be reserved to pay pending or unpaid arbitration awards and other claims. Similar to a Standing 8 Count, there is an appeal process, and firms may also seek to correct their status through a one-time staff reduction to rid themselves of brokers with a history of disclosure events. FINRA will be making the restricted designation publicly available through BrokerCheck.
Further to their effort to weed out bad actors, in 2021 FINRA adopted enhancements to Member Application and Associated Person Registration rules effectively requiring a firm to request approval from FINRA when it seeks to hire a broker with one or more specified criminal or risk events in the previous five years. This year the SRO will revisit proposed changes to the process for broker expungements, which were previously withdrawn in May 2021. The proposed changes seek to ensure that expungements are only granted in very limited circumstances where the CRD information is clearly inaccurate.
FINRA first began discouraging firms from retaining or hiring recidivist brokers with the introduction of the “High-Risk Broker Initiative” in 2013. Since that time, FINRA has repeatedly warned its membership through annual priorities letters and focused examinations of hiring practices that it expects firms to take responsibility for hiring potentially risky brokers by supervising their activities in a manner to prevent future infractions. Rule 4111 is a more deliberate approach to an old problem that targets the broker-dealer’s capital account.
Sonny Liston knocked out the defending champion, Floyd Patterson, in the first round, not with a jab but a left hook. Rule 4111 should be an effective arrow in the FINRA quiver but just as boxing titles pass from one person to another in time, a new challenge to the reputation of the industry will arise and FINRA may have to find another style. Perhaps floating like a butterfly and stinging like a bee might be next.