FINRA Announces New Focus on Cockroaches – Recidivist Offenders in the Securities Industry

By Alexander Cook

Cockroaching is an aptly crass name for a behavior in which some of the most devious brokerage firms and brokers have engaged.  The name is given to a pattern of conduct in which less-than-ethical brokers move between less-than-ethical brokerage firms at a rapid pace, allowing them to more effectively avoid detection while repeatedly perpetrating the same type of crimes.

In a January 2, 2014 regulatory letter to members, FINRA announced the expansion of the High Risk Broker program and the creation of a six-member enforcement team devoted to prosecuting such cases.  In its release, FINRA announced that “A small number of brokers have a pattern of complaints or disclosures for sales practice abuses and could harm investors as well as the reputation of the securities industry and financial markets.”  An October 2013 Wall Street Journal exposé demonstrated that from 2005 until the end of 2012, FINRA had expelled 173 brokerage firms for wrongdoings which ranged from the firm’s refusal to pay regulatory fines to fraud committed by individual brokers.  Of the brokers employed by those firms, more than 5,000 were still licensed to sell securities in 2013.  Most startlingly, about 12% of those brokers had been employed by at least two of the expelled firms.  In one case described by the Wall Street Journal, a single broker moved between expelled firms at least ten times in little more than a decade.  The report also found that many cockroaching brokers continued to trade securities even after being involved in several arbitrations or declaring bankruptcy multiple times.  This cockroaching has now been red flagged by FINRA subsequent to the January 2014 announcement, resulting in a heightened examination process in which FINRA “will review the firm’s due diligence conducted in the hiring process, review for the adequacy of supervision of higher risk brokers, […] and […] place particular focus on these brokers’ clients’ accounts in conducting reviews of sales practices.”

Beyond simply fearing that a few brokerage firms may condone unethical behavior, FINRA also proclaimed anxiety that the small percentage of cockroach brokers in the securities industry may pollute the culture of formerly ethical firms by bringing their illegal practices with them.  For instance, the WSJ found that brokers who had left at least two previously expelled firms averaged more than eight times as many arbitration claims against them compared to the rest of the industry.  Moreover,  an October 2013 PIABA study which found that roughly $50 million of arbitration awards are left outstanding every year, as offending firms often shutter their business and allow transgressing brokers to drift to more innocuous firms.  The outcome for investors is lost capital with little to no recourse against the offenders.  FINRA’s renewed attempt to track, investigate, and halt cockroaching brokers before they have the chance to do more damage is certainly admirable and commendable.  Of the dozens of issues and problems FINRA regularly deals with, eliminating recidivist brokers and firms should be one of the most solvable.  There is no justification for allowing unethical brokers to remain brokers simply because they are able to outsmart the regulatory system; finally the regulatory system may be outsmarting them.