FINRA’s Opportunity to Regulate Bad Apples

By Blayne Justus Yudis

Picture this: You just found out your broker was fired from a larger firm only two months ago for numerous violations of company policies and regulatory rules. Now he services your needs at the local firm down the street. A Boca Raton firm exemplifies this industry-wide practice, and it is a cause for concern. The Boca Raton firm hired a broker after a larger firm discharged him for violating various firm policies while under heightened supervision—which occurred only two months prior to his hire at the Boca Raton firm. The broker’s conduct was not unique. His BrokerCheck report cites 15 more incidents over the course of his career, including customer disputes, regulatory issuances, and a criminal charge.

Unfortunately, the Boca Raton firm has a history of employing bad apples: one former broker at the firm pled guilty to securities fraud as part of a $131 million market-manipulation scheme and, in 2010, the SEC temporarily barred one of the firm’s owner because he failed to reasonably supervise a trader at the firm. Even the firm itself has over 30 disclosures on it’s BrokerCheck since its registration was approved in 2000.

FINRA spokeswoman Nancy Condon 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.” However, change may be impending.

At FINRA’s Board of Governors meeting earlier this year, 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. This decision follows pressure on FINRA to more closely regulate the hiring practices of brokerage firms. Although FINRA has made past efforts, regulatory guidance issued in April 2018 did not provide specifics about what constitutes a risky broker hire and how many risky brokers must be hired before a firm incurs liability.

FINRA understands the vital role firms play in protecting consumers 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 incentive firms to sufficiently invest in their supervisory and employment processes. In doing so, investors will ultimately be better protected from rogue investors that can move across the industry as permitted under existing law. The opportunity for FINRA to more closely target bad apples is here.

As a next step in the rule making process, FINRA will soon publish a Regulatory Notice seeking comment on the proposed rules.