Could BDs be disqualified even after self-reporting?

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Q: I’ve heard that broker-dealers that participated in the SEC’s Share Class Selection Disclosure Initiative are going to be statutorily disqualified. Is that true and what does that mean exactly?

A: The SEC has, in recent years, filed numerous actions in which BDs (or dually registered broker-dealer investment advisors) failed to make what the SEC considers to be adequate disclosures relating to the selection of mutual fund share classes that paid 12b-1 fees when a lower-cost share class for the same fund was available to the clients.

Apparently the SEC is unwilling to remove the word “willful” from the settlements.

In February of last year, the SEC began what it called the Share Class Selection Disclosure Initiative whereby it encouraged firms to self-report and accept lesser sanctions rather than face an enforcement action and the full brunt of potential charges. Because the settlements that those firms entered into with the SEC stated that the firms had “willfully” violated the securities laws, FINRA has now indicated that those firms could be statutorily disqualified. Put bluntly, they could be shut down and put out of business.

Apparently the SEC is unwilling to remove the word “willful” from the settlements. It’s that word which causes the settlements to fall under the statutory disqualification rule. A firm that’s statutorily disqualified will receive a notice from FINRA to that effect (an SD Notification Letter). It must then file a Form MC-400A and request an eligibility proceeding at which it would make its case for why it should be allowed to remain a FINRA member. The cost to request the eligibility proceeding is $5,000.

Alternatively, the firm can request an extension to file the Form MC-400A. The request for the extension must be filed within 10 days of receipt of the SD Notification Letter. If the extension is granted, the BD can then use that time to satisfy the sanctions listed in the settlement agreement. If it fully satisfies the sanctions before the end of the extension, it should be fine. Although FINRA doesn’t say so in its FAQ page, my assumption is that the BD must file some sort of follow-up notice to FINRA before the extension has expired letting it know that all the sanctions have been complied with. If the BD either fails to request the extension or doesn’t satisfy the sanctions during the extension period, then it must proceed to file the Form MC-400A and request the eligibility proceeding.

Note also that a member firm must report to FINRA whenever it is involved in any financial dealings with any person that it knows or should have known is statutorily disqualified. However, a firm will not need to report financial dealings with a statutorily disqualified firm if the firm has filed the MC-400A or requested the extension. FINRA generally allows statutorily disqualified firms to continue as members if they’ve filed the MC-400A or have been granted the extension.

The direct link to the FAQ page on its site is: .

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