Blayne Yudis – The Financial Industry Regulatory Authority (“FINRA”), the securities industry’s self-regulatory organization, is, yet again, growing particularly agitated with the securities industry. A major source of these regulators’ frustrations stem from an industry-wide practice: a broker is fired from a large firm and subsequently picked up by a smaller, local firm. On its face, this practice seems harmless, but scorned brokers are typically fired due to serious offenses. In Boca Raton, a local firm employed a broker who had previously pled guilty to a $132 million-market manipulation scheme, causing serious harm to investors in the process. Even the local firm itself has over 30 disclosures on its BrokerCheck report since its registration was approved in 2000.
Despite the need to curb this practice to protect investors, FINRA has previously avoided any attempt to regulate brokerage firms’ hiring practices. FINRA spokeswoman Nancy Condon previously stated that “[w]hile FINRA monitors and tracks problem brokers and will examine high-risk firms more frequently, FINRA cannot forbid a firm from hiring someone.”
It seems, however, that FINRA may be changing course. FINRA issued a regulatory guidance in April 2018 explaining the potential liability firms can incur for hiring risky brokers. Yet the organization did not provide specifics about what constitutes a “risky broker hire” or how many brokers must be hired before a firm incurs liability. At FINRA’s Board of Governors meeting in January 2019, the Board approved moving forward with proposed rules related to firms that have a disproportionately high number of regulatory disclosure events by the firm and/or its registered representatives.
Yet FINRA also understands the importance of industry input in the conversation. In April 2019, FINRA issued a news release inviting industry professionals to a “National Compliance Outreach Program” designed to provide an open forum for regulators and industry professionals to discuss “effective compliance structure[s] for the protection of investors.” Brokerage firms would be wise to attend this event as an opportunity to have a say in the conversation, and as a means of best educating themselves on improving oversight in employment practices.
FINRA has (hopefully) decided to move on this issue because it understands the vital role firms play in protecting investors from harm. In its April 2018 regulatory guidance, FINRA states that “[m]ember firms often serve as the first line of defense against customer harm through establishing and maintaining effective supervisory systems, particularly with regard to associated persons who may pose higher risks of causing customer harm.” As such, FINRA would be wise to impose heightened liability on firms that assume the risk of hiring rogue brokers in order to caution firms against doing so. Heightened liability will incentivize firms to sufficiently invest in their supervisory and employment processes, thereby solidifying “the first line of defense” against customer harm.
Ultimately, the success of regulations depends on buy-in from the targeted industry, which makes an open forum—like the National Compliance Outreach Program—especially critical. Without industry support, FINRA cannot better protect investors from rogue brokers that can float across the industry as permitted under existing law. Perhaps current FINRA action suggests the existing law may change.
As a next step in the rule-making process, FINRA will soon publish a Regulatory Notice seeking comment on the January 2019 proposed rules.
