Does FINRA Disclose Enough on High-Risk Firms?

By Brandon Greenberg

As of January 2017, FINRA had expelled about 130 firms due to misconduct including securities fraud, churning, unsuitable recommendations, records falsification, and misuse of funds. In most cases, however, the executives and brokers at these banned firms remain free to continue working at other firms. Shouldn’t investors know which brokerage firms employ the most fraudsters?

In June 2017, Reuters published a data-driven article alleging that investors are being prevented from learning which brokerage firms have an unusually high concentration of brokers flagged for violations, customer complaints, and many other “red flag” events that FINRA requires to be publicly disclosed. Reuters looked at bulk data culled by Columbia University Law’s Datalab researchers, who wrote code extracting it from FINRA’s BrokerCheck—a tool that permits users to search the backgrounds of individual financial advisors. Because this data only covered the years between 2000 and 2015, after identifying 48 firms where at least 30% of brokers had at least one red flag (out of the 12 most serious of the 23 total incidents FINRA requires to be disclosed), Reuters staff manually updated the data by using BrokerCheck to include broker disclosures at these firms through early 2017.

The twelve red flags that Reuters focused on included customer disputes involving allegations of broker sales practice violations that either (1) resulted in an arbitration award or civil judgment, or (2) were settled at some cost to the firm and/or, whether or not wrongdoing was admitted. Other flags included regulatory violations, unsatisfied judgments or liens, post-allegation employee terminations, bankruptcy and other financial problems, and both civil and criminal adjudications. While investors are free to research individual brokers on BrokerCheck, FINRA does not provide bulk data about firms with high concentrations of flagged brokers to the public.

FINRA officials argue that it is not illegal to hire possibly problematic brokers, and that many of these disclosures do not automatically equate to broker misconduct, such as when firms pay clients to settle complaints without admitting wrongdoing. The self-regulatory organization rests its “unwillingness to name names” on concerns of “fairness and due process,” as CEO Robert Cook recently said. When pressed for details about this issue during a Reuters interview, FINRA’s executive VP of regulatory operations Susan Axelrod “declined to comment on any specific firm identified by Reuters…and would not directly address why the regulator will not publicly name the firms it identified as high-risk.” “Let’s just say those are not new names to us,” Axelrod said. She also explained that FINRA already has an experienced unit of examiners and managers dedicated to monitoring high-risk firms, although she would not elaborate on the resources or functions of this unit.

The fact remains that the 48 problem firms identified by Reuters employ 4,600 brokers who manage billions of dollars in investor capital. Publicly, FINRA prides itself on providing “unparalleled transparency” to investors. And yet, it remains an industry-financed organization operating outside of public financing and records laws. In fact, Brian Kovack, president of Kovack Securities, Inc.—one of the high-risk firms Reuters identified—actually serves on FINRA’s 24-member Board of Governors, which some might argue is a conflict of interest on this issue. About one in three (34%) out of the 388 brokers at Kovack’s firm have been flagged. Regrettably, however, zero percent of its customers are able to learn this troubling fact from FINRA’s BrokerCheck tool.