FINRA Plans to Crack Down on High-Risk Brokers, Are You at Risk?


In conversation with Chip Jones, FINRA’s Senior Vice President of Member Relations and Education, Mike Rufino, Executive Vice President and Head of FINRA Member Regulation—Sales Practice expanded on Robert Cook’s 2018 Priorities Letter, which was released during the first days of the year.

Rufino explained how FINRA plans to examine brokers to determine whether they should be included in the High-Risk Registered Representatives Program, and made some key recommendations to firms for identifying high-risk brokers within their ranks.

In his 2018 Regulatory and Examination Priorities Letter, FINRA CEO Robert Cook signaled “identifying high-risk firms and individual brokers and mitigating the potential risks that they can pose to investors,” as a “top priority” for the self-regulatory organization in the New Year.

In one of its central paragraphs the document stated:

“FINRA will focus on firms’ hiring and supervisory practices for high-risk brokers, including, for example, firms’ remote supervision arrangements; supervision of point-of-sale activities, including individual broker accountability when using joint rep codes; and branch inspection programs. FINRA reminds firms of their existing obligation to adopt and implement tailored heightened supervisory procedures under FINRA Rule 3110 (Supervision) for high-risk individuals.”

What Are Some of FINRA’s Priorities for 2018?

Cook mentioned a few specific focus areas for FINRA’s efforts to protect investors:

  • Risks for senior investors.
  • Recommendation of speculative products to unsophisticated, inexperienced investors
  • Registered representatives with control of customer finances through instruments like a power-of-attorney.
  • Rollovers of “qualified plans into non-qualified accounts” for senior customers
  • Registered representatives who raise funds from non-firm investors to conduct private transactions
  • Disclosures of brokers’ association with product issuers
  • Review of registered representatives outside business activities
  • Registered representatives who borrow from customers or pay customers from external accounts

FINRA’s Three-Pronged Approach for Identifying High-Risk Brokers

While Cook gave an overview of what FINRA plans to focus on this year, Rufino’s words were much more on-point. Among other revealing details, he offered insights into how FINRA plans to go about determining if a broker might pose a risk to investors.

The organization’s Executive VP referred to FINRA’s risk-based methodology for identifying problem brokers as a “three-pronged approach,” consisting of three distinct elements:

  1. A quantitative analysis using numeric risk scores based on specific criteria
  2. A qualitative assessment, focusing largely on disclosures
  3. A probe into brokers who are appealing a bar

Referring to the “third prong,” Rufino commented,

“If [an] individual [broker] has been barred, and pending their appeal. They can still continue to work within the industry. In our mind, they can pose a risk to investors. We make sure these individuals are monitored and examined.”

How Does FINRA Determine Whether a Broker Is High-Risk?

Initially, FINRA examiners use advanced analytics to assess risk. The result of this type of analysis is a numeric score. Then comes a qualitative assessment, “because as good as the numbers may be, there’s no substitute for having individuals look at those criteria and make an affirmative determination,” Rufino explains.

Then, FINRA’s examination team zeroes in on “the sheer number of disclosures.” Examiners look for patterns that may indicate risk. After looking at that number, FINRA will do another qualitative assessment, by reading those disclosures.

Rufino explained what examiners may be looking for, “Are [those disclosures] aged? Did they happen recently? Did they happen years ago? Things [that are] more current, naturally get a higher rating.” Finally, the regulatory authority looks at whether the brokers under scrutiny are appealing a bar and evaluate the process at hand.

FINRA’s Predictive Model

Rufino explained in detail FINRA’s predictive model, which is based on a number of specific criteria that help the watchdog establish which brokers may pose a risk to investors, firms, and the securities industry as a whole.

What Are the Criteria Utilized By FINRA to Classify Brokers as “High-risk”

  • Association with firms with a history of disciplinary action
  • Duration of association with problematic firms
  • Migration from one “bad” firm to another
  • Licensing exam history, number of examinations failed or expired
  • Investor harm disclosures
  • Complaints and arbitration
  • Prior reviews by FINRA

How Can Firms Determine a Broker Might Be High-Risk, According to FINRA?

Rufino emphasized that firms must do their do diligence to avoid hiring high-risk brokers. “They can go to BrokerCheck, see what type of firms [the brokers] worked at before,” he recommended. The criteria he mentioned are:

  • Reputation of previous firms
  • Broker’s clientele
  • Broker’s customers; are they senior investors, institutional customers?
  • Products marketed by the broker
  • Broker’s lifestyle check
  • Frequency of exception reports
  • Peer-to-peer analysis, comparing broker to peers’ performance

FINRA’s VP elaborated on the advantages of firms in terms of the scope of information they possess, which can help them quickly identify high-risk brokers.

“We don’t have that information,” he said, “so, we’re looking at information that we get within FINRA. But if I were sitting in a firm seat, what a powerful tool you can have for trying to identify… your most high-risk registered representatives,” Rufino added.

Can a Broker Get off FINRA’s High-Risk Registered Representatives List?

When asked this crucial question, Rufino responded categorically, “Absolutely. It’s not, ‘I’m on once, and I’m on forever.’ What we’ll do is we make an assessment each year… As I said, we will run the criteria, we do that qualitative assessment, and make a determination… whether or not to keep an individual on the list. We do examinations and monitorings.”

Although the criteria enumerated by Rufino seem to leave much to the discretion of FINRA examiners, especially when it comes to qualitative risk analyses, it appears that there is hope for brokers who may have ended up on FINRA’s risk prevention program without really deserving it.

Do Firms Know If Registered Representatives Are on FINRA’s High-risk List?

According to the SRO’s Head of Member Regulation-Sales Practice, FINRA has been trying to let firms know which individuals are under scrutiny “from a risk perspective.” He also clarified that FINRA expects firms to look more closely at brokers who are under the watchdog’s magnifying glass.

There is about to be “much more scrutiny than we’ve ever done in the past,” Rufino said.

“Most firms and registered representatives are doing right by their customers, this is a smaller subset of individuals that we feel require heightened scrutiny, and there is a partnership between us and the membership… When I speak to firms, we are aligned… They don’t want these individuals in the industry because they’re hurting themselves. They’re hurting… the reputation of the industry and hurting their business. We can either severely discipline these individuals or these individuals [can] decide not to be in the industry, I think it’s a win-win all around,” he concluded.

Are you or your firm targeted by FINRA for enforcement or other action? At Herskovits PLLC our lawyers focus exclusively on securities law and can tell you what to expect and how to best defuse or defend the situation. We have a national practice.  212.897.5410 or CONNECT ONLINE

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