Bad brokerages all too willing to look past an advisor's checkered past have a new hoop to jump through before potentially bringing them on board.
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The potentially uncomfortable sit-down could force a brokerage to apply for FINRA’s blessing to hire those brokers — with no guarantee the regulator would say yes.
The rules from FINRA, a self-regulating watchdog overseen by the Securities and Exchange Commission, affect firms that want to hire a broker who within the past five years has acquired at least one criminal record or racked up two so-called “specified risk events.”
That red-letter jargon refers to criminal events, arbitration awards, civil judgments, arbitration settlements, civil litigation settlements, civil judicial actions and regulatory actions, and to cases involving sums starting at $15,000. FINRA’s new rule doesn’t cover customer complaints, ongoing arbitrations or unresolved court cases.
Mark Quinn, the director of regulatory affairs at Cetera Financial Group, the second-largest independent broker-dealer, said that “I suspect that across the industry, there are a lot of advisors who have those criteria.”
‘Thousands’ of bad brokers
Just how many rogue actors in an industry of 624,000 brokers?
“I’d say there are still thousands of them out there,” said Jon Henschen, a recruiter of independent broker-dealers and industry consultant based in Marine on St. Croix, Minnesota.
The new rules come after FINRA opened a major campaign against dishonest brokers last month using an algorithmic sieve aimed at weeding out “
FINRA’s analysis of historical data showed that only small and mid-sized brokerages — the kind most likely to employ those with bad records — would potentially get a scarlet letter. Wall Street’s mainstays, like Bank of America’s Merrill Lynch, LPL Financial and Raymond James, wouldn’t trip the sieve’s thresholds.
The Sept. 1 rule is a kind of backstop to the “high risk” screen program, which all brokerages now undergo each year.
“It’s going to make it more difficult to hire problematic brokers,” Henschen said. “It’s a squeeze play to put these people out of the industry.”
A stronger FINRA?
Since launching its “High Risk Broker Initiative” nearly a decade ago, FINRA, which oversees 3,400 brokerages, has struggled to rein in rogue salespeople with staying power in the industry. But as a private, non-governmental, industry-funded organization with no power to impose criminal sanctions, it is sometimes criticized as opaque and weak in protecting investors, its primary mission as mandated by Congress.
Critics say FINRA’s time-consuming procedures to examine and discipline offenders leave bad brokers free to continue to cheat clients while their cases unfold, or to quit and slide over to other firms. FINRA’s examiners can’t force a rogue firm to change its business practices or staff.
‘Safe harbor’ rule no longer a port in a storm
The watchdog has long had complicated “safe harbor” rules, in which a brokerage that expands or changes its business model generally isn’t deemed to be making a “material,” or substantial, alteration, and thus doesn’t have to ask for FINRA’s approval.
But under the Sept. 1 rule, brokerages with “specified risk events” — like criminal judgments or arbitration awards — would be deemed to be making a “material change in operations” when seeking to hire egregious brokers. Such firms would be forced to sit down for a “materiality consultation” with a FINRA examiner and explain the potential hire’s tarnished record.
If the examiner has no objection, the brokerage may hire the broker and continue business as usual. But if the examiner is not thrilled, the brokerage has to submit a new
“FINRA has been concerned about instances where a member firm on-boards brokers with a significant history of misconduct and does so within the safe-harbor parameters, thus avoiding prior consultation or review by FINRA,” the watchdog
Brokerages and brokers are supposed to disclose criminal and civil matters, regardless of their monetary size, on forms filed to FINRA and the SEC. With the SEC’s approval last month of the “high risk firms” screen, FINRA is upping its game in trying to weed out firms that cold-call elderly customers or have a string of disciplinary and legal judgments against them. Through a complex formula, brokerages will be ranked according to how many violations they’ve piled up, with any outlier subject to being labeled a “restricted firm” and forced to set aside money to pay back swindled investors. FINRA is considering making their names public on its BrokerCheck database.
We’re listening
In May, the watchdog strengthened its so-called “taping rule,” in which brokerages with a certain number of salespeople from previously disciplined firms who engage in telemarketing have to record and preserve their phone conversations with customers for three years. Under the bolstering, firms have to disclose on BrokerCheck if they’re subject to the rule.
In its recent rules, FINRA has cited academic research showing that brokers who did bad things in the past are likely to do them again.
“There’s two types of firms,” said Max Schatzow, a securities lawyer at Stark & Stark in Lawrenceville, New Jersey. ”Those that cater to brokers and representatives with a checkered past, and then those that are just a small business.”
But the Sept. 1 rule has something new — a forward-looking element aimed at preventing future misconduct by halting problematic hires before they happen.
“FINRA is obviously getting more aggressive in policing the actions of recidivist brokers and the firms that hire them,” a
