Banking, finance, and taxes

FINRA Brings Additional Rules to Protect Investors Against Troubled Brokers

Jon C. Ogg

Published: May 2, 2019 2:38 pm

Last Updated: March 13, 2020 5:02 pm

Brokerage firms with a history of misconduct or that employ a high number of brokers and advisors with red flags may about to face even more regulatory scrutiny. FINRA has requested a comment period through July 1, 2019 regarding proposed additional investor protection guidelines for such firms.

The proposed rule would impose tailored obligations on designated member firms that cross specified numeric disclosure-event thresholds, including possible financial requirements. These thresholds are based on the number of events at similarly sized peers.

While the number of FINRA member firms that could be subject to these obligations may be small in number, its aim is to further promote investor protection and market integrity. It is also implied to give FINRA another tool to “incentivize member firms to comply with regulatory requirements and to pay arbitration awards.”

Under the so-called new Rule 4111, “Restricted Firms” would be required to make deposits (of cash or qualified securities) that could not be withdrawn without FINRA’s prior written consent. It would also force the firms to adhere to other conditions or restrictions on the member’s operations, or they could be subject to some combination of those obligations.

Despite the number of firms being relatively small, FINRA has said that the problem firms generally do not carry out their supervisory obligations around compliance with the applicable securities laws and regulations nor with FINRA’s rules; FINRA further noted that those firms often act in ways that harm their customers and erode trust in the brokerage industry.

The background of the FINRA report said:

FINRA has identified certain firms that have a concentration of individuals with a history of misconduct, and some of these firms consistently hire such individuals and fail to reasonably supervise their activities. These firms generally have a retail business with vulnerable customers and engage in cold calling to make recommendations of securities. FINRA has also identified groups of individual brokers who move from one firm of concern to another firm of concern. In addition, certain firms, along with their representatives, have substantial numbers of disclosures on their records.

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FINRA also outlined the number of firms by size. As of year-end 2018, there were the following number of instances:

• 20 small firms (150 registered persons or less) with 30 or more disclosure events over the prior five years;
• 10 mid-size firms (151 to 499 registered persons) with 45 or more disclosure events over the prior five years;
• and 5 large firms (500 or more registered persons) with 750 or more disclosure events over the prior five years.

In advisory and brokerage services, their is a policy of Know Your Client. This proposed rule would be just one more instance where the public would a better chance to Know Your Broker, but for many investors it might come only after something has gone wrong.