Yesterday, FINRA sent a seemingly innocuous memo to member firms giving a brief outline of the subjects that its Board will take up at its meeting this week in sunny Boca Raton, Florida. (Wait, the Board isn’t meeting in Washington, as it normally does, but, rather, in south Florida? Oh, right, it’s February. Much better chance of securing full attendance.) Buried in the brief message from President and CEO Robert Cook was this sentence: “The Regulatory Policy Committee will review several rulemaking proposals, including proposed rule changes relating to high-risk firms.” High-risk firms? I have no recollection of ever seeing FINRA utilize that phrase. Sure, FINRA talks all the time about “high-risk brokers.” There was an entire Regulatory Notice devoted to that very subject last year. And while in that Notice FINRA made a reference to “high-risk brokers and the firms that employ them,” it never once used the phrase “high-risk firms.”

I think that Mr. Cook has, perhaps, inadvertently tipped his hand. To me, his memo means that FINRA is not so subtly shifting its focus from what it deems to be bad brokers to bad firms. Why? Bottom line is that there really is only so much that FINRA can do about bad brokers. It is really expensive and time-consuming for FINRA to bring disciplinary actions against individual brokers, one at a time, and even though FINRA routinely bars a few hundred RRs each year (492 in 2017, according to the most recent FINRA Annual Report), that is a drop in the bucket. As the data show, there are tons and tons of folks currently registered and working in the industry with lots of dings on their U-4s, and FINRA has taken a beating in the media for allowing this to happen.

So, putting aside the fact that it sure seems (to me, at least) that FINRA is itself responsible for all these “high-risk” brokers still working (because FINRA failed to impose sanctions that would preclude them from remaining registered), how can FINRA somehow repair its image as a sloppy gatekeeper? Simply, by addressing firms, not individuals. If FINRA can manage to put a firm out of business for a sales practice related reason, it becomes a “Taping Rule” firm, a stigma that follows all of the people who used to work for that firm. Under Rule 3170, if enough of the reps from the expelled firm are hired at another BD, the new BD must tape record all the conversations between its reps and their customers and prospective customers. And believe me, no firm wants to have to do that. Which means that it can become difficult for reps of an expelled firm to find a home somewhere else. Which means that FINRA can effectively get a lot more people out of the industry in one fell swoop than having to prosecute a bunch of individual Enforcement actions.

I will wait to see what comes of the Board meeting before I reach any final judgment. But, I fear that FINRA has stepped on to a very slippery slope, one that ends with it conjuring up a mechanism for segregating firms into broad and dangerous categories like high-risk and low-risk. I mean, what reasonable investor would want to do business with a firm that the regulator brands as being high-risk? FINRA had best tread very carefully as it saunters into this uncharted new territory.

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Alan Wolper

Alan focuses his practice exclusively on defending regulatory investigations and enforcement actions brought by the Financial Industry Regulatory Authority (FINRA), the United States Securities & Exchange Commission (SEC), and state securities commissioners against brokers, broker-dealers, and investment auditors. He was previously Director of the National Association of Securities Dealers (NASD) Atlanta District Office, where he oversaw nearly 600 member firms and thousands of branch offices. Alan also served as a member of the NASD’s Department of Enforcement, where he had the primary responsibility for prosecuting hundreds of formal disciplinary actions.