FINRA has released two Regulatory Notices (18-15 and 18-16), each addressing the supervision of brokers with a history of past misconduct. Notice 18-15 provides firms with additional guidance on implementing effective heightened supervision procedures of these brokers, while Notice 18-16 announces proposed Rule amendments relating to such brokers. You can view these Regulatory Notices here: Notice 18-15 and Notice 18-16.
Four of the last five Regulatory and Examination Priorities Letters that FINRA has released have included a discussion about the supervision of high-risk and/or recidivist brokers. Therefore, it should come as no surprise that FINRA has taken the next step of issuing its latest guidance and proposed Rule changes.
FINRA’s Guidance – Notice 18-15
Notice 18-15 focuses on particular instances where heightened supervision of a broker with a history of industry or regulatory-related incidents might be appropriate. Although the Notice identifies “certain circumstances under which firms are encouraged to consider implementing heightened supervisory procedures for an associated person, ”FINRA’s recommendations “are not intended to be an exhaustive list of circumstances firms should consider when determining whether to implement [such] procedures.” FINRA also cautions that implementing these recommendations “in and of themselves would not necessarily satisfy [a firm’s] obligations under Rule 3110(a) to establish and maintain a supervisory system….”.
With respect to identifying brokers to place on heightened supervision, FINRA offers the following, non-exhaustive list of factors to consider:
- Customer-related regulatory actions
- The firm’s pre-registration investigation
- Firm-imposed discipline
- Final, pending and settled arbitrations
- Terminations for cause
- Criminal matters
- Internal investigations
- Disciplinary actions
- Past, open or settled customer complaints
- Other items disclosed on the person’s uniform registration forms
FINRA also notes that “[w]hile final adverse adjudicated matters such as disciplinary actions, criminal matters and arbitrations clearly indicate a disciplinary problem, a pattern of unadjudicated matters, such as unadjudicated customer complaints, also may be indicative of a history that should be carefully reviewed.”
The Notice also highlights two circumstances that FINRA believes raise “significant investor protection concerns” that firms should evaluate in deciding to place a broker on heightened supervision. These circumstances are: 1) when a statutorily disqualified person is undergoing a FINRA eligibility proceeding seeking permission to remain associated with the member firm; and 2) when a broker is appealing a disciplinary case where the Hearing Panel found a rule violation. Heightened supervision under these circumstances is most likely warranted because first, the broker is already statutorily disqualified and thus, FINRA will almost always condition his or her continued association with the firm on “being subject to a robust heighted supervision plan”; and second, a Hearing Panel has already found that the broker violated a rule. In both circumstances, FINRA recommends continuing the heightened supervision during the pendency of the eligibility review or appeal.
In addition, the Notice points to several factors that firms should consider including in their heightened supervision plans. Although the list is “neither exhaustive nor…a safe harbor….FINRA believes effective heightened supervision plans should include, at a minimum:”
- Designating a principal with the appropriate training and experience to implement and enforce the plan;
- Requiring appropriate additional training for the associated person subject to the plan to address the nature of incidents resulting in the plan;
- Requiring the written acknowledgment of the heightened supervisory plan by the associated person subject to the plan and the designated supervisory principal; and
- Periodically reviewing the heightened supervision plan to assess its effectiveness.
FINRA also notes that it has found additional items in effective heightened supervision plans, including, among others, more frequent contact with the broker, more frequent review of the broker’s communications with customers and more frequent monitoring or inspection of the broker’s office(s).
Importantly, FINRA cautions that “[t]he failure to assess the adequacy of its supervisory procedures in light of an associated person’s history of industry or regulatory-related incidents would be closely evaluated in determining whether the firm itself should be subject to disciplinary action for a failure to supervise should that person be the subject of a future industry or regulatory related incident.”
FINRA’s Proposed Rule Amendments- Notice 18-16
In addition to the guidance FINRA has provided in Notice 18-15, it has also announced (in Notice 18-16) proposed amendments to several Rules “that would impose additional restrictions on member firms that employ brokers with a history of significant past misconduct.” The first set of Rules FINRA has proposed amending are the Rule 9200 Series and 9300 Series. The 9200 Series relates to disciplinary proceedings, while the 9300 Series relates to the review of disciplinary proceedings by the National Adjudicatory Council (“NAC”) and FINRA Board. The proposed amendments to these Rules would allow Hearing Panels to include conditions or restrictions on firms’ or brokers’ activities while disciplinary matters are being appealed. These proposed amendments would also allow Hearing Panels to require firms to adopt heightened supervisory procedures for brokers while any appeal is pending. FINRA Enforcement would need to request that the Hearing Panel include such conditions, restrictions or heightened supervision and, unlike other sanctions imposed by a Hearing Panel, the conditions, restrictions or heightened supervision would not be stayed during the appeal. These amendments would also require firms to place a broker on heightened supervision if any party appeals a Hearing panel decision or if the NAC calls the case for review.
The next series of Rules FINRA has proposed amending is the 9520 Series, which relate to Eligibility Proceedings. FINRA proposes amending these rules to require automatic heightened supervision of any broker with respect to whom a Statutory Disqualification (SD) Application has been filed. The heightened supervision would need to remain in place while the SD eligibility request is being reviewed by FINRA. Additionally, the firm would be required to submit a copy of the written heightened supervision plan with its SD Application.
FINRA also proposes amending Rule 8312 (FINRA BrokerCheck Disclosure). The proposed amendment would permit FINRA to disclose on BrokerCheck that a firm is a “taping firm” under Rule 3170, i.e. a firm designated as such by FINRA because it hired a “specified percentage of registered persons from disciplined firms.” Such firms are required to “establish, maintain, and enforce special written procedures for supervising the telemarketing activities of all its registered persons.” As the name suggests, “taping firms” are, among other things, required to tape all telephone conversations between brokers and existing or potential clients.
The last series of Rules FINRA proposes amending is the NASD Rule 1010 Series, which relate to new member applications and membership changes. The proposed amendments would require firms “to first submit a written letter to FINRA’s Department of Member Regulation…seeking a materiality consultation when a natural person that has, in the prior five years, one or more final criminal actions or two or more specified risk events seeks to become an owner, control person, principal or registered person of an existing member firm.” The Notice goes on to describe “specified risk events,” but generally they are “final, adjudicated disclosure events disclosed on a person’s or firm’s Uniform Registration Forms.”
The comment period on each of these proposed rule amendments will run through June 29, 2018.
FINRA’s guidance and proposed Rule amendments, as reflected in these Regulatory Notices, highlight the fact that FINRA is focused and will continue to be focused on high-risk brokers, specifically the supervision of such brokers. As FINRA makes clear, “[t]hese brokers, while relatively small in number, may present heightened risk of harm to investors, and any misconduct by them also may undermine confidence in the securities markets as a whole.”