By Daniel Guernsey
On July 18, 2017, the FINRA Board of Governors authorized FINRA to publish a Regulatory Notice soliciting comment on proposed amendments to FINRA’s Membership Application Program rules relating to member’s hiring brokers with a history of misconduct and members’ unpaid arbitration awards.
The first issue the board discussed was related to broker conduct. When a member seeks to add a broker to its firm, FINRA Rule IM-1011-1 states that the member must submit a Rule 1017 application. When determining whether a broker’s Rule 1017 application gets approved, FINRA may take into account whether “[a] . . . [broker] is the subject of a pending, adjudicated, or settled regulatory action or investigation by the Commission. . . .”
However, Rule IM-1011-1 has safe harbor provisions. For example, if a member has 1–10 brokers, it may acquire up to 10 brokers per year without having to file a Rule 1017 application for each broker. These safe harbor provisions could allow brokers who have committed securities violations to join firms and not have to file a Rule 1017 application.
FINRA’s recent board meeting proposed that even if a member is otherwise not required to file a Rule 1017 application with FINRA when acquiring a new broker, “if the member seeks to add a broker with certain specified risk events to the firm,” the member will have to file a Rule 1017 application. These risk events include prior securities violations. This proposal would remove the loophole created by the safe harbor provisions in Rule IM-1011-1.
Secondly, the board discussed members who have unpaid arbitration awards. Similar to safe harbors for adding brokers, Rule IM-1011-1 provides a safe harbor for firms looking to expand. For example, if a member has 1–5 offices, it may acquire 3 more offices per year without filing a Rule 1017 application. Therefore, if a member has an unpaid arbitration award, it may still expand without filing with FINRA if it is within the safe harbor provisions.
In its recent meeting, the FINRA Board of Governors proposed that if a member is seeking “a business expansion or asset transfer and the member. . . has a substantial level of pending arbitration claims, an unpaid arbitration award or an unpaid settlement related to an arbitration[,] . . . the safe harbor in IM-1011-1 for business expansions would not be available.” This proposal would not allow members to get away with expanding without scrutiny if they have any of the issues mentioned.
These proposals can help solve what FINRA’s executive vice president of regulatory operations, Susan Axelrod, calls “cockroaching.” “Cockroaching” refers to a practice where brokers who have committed securities violations move to risky, usually smaller sized, firms. These smaller firms then close and the risky brokers jump to the next firm. If these small firms are adding brokers within the safe harbor provisions of Rule IM-1011-1, they will not have to file a Rule 1017 application for the added broker, which could allow these risky brokers to slip through the cracks. This new proposal would remove the safe harbor of Rule IM-1011-1 for brokers that have committed securities violations and thus hopefully reduce the “cockroaching.”