Welcome to #finraFridays!
This Blog breaks down the mysteries of FINRA’s investigative and disciplinary process so that those of you who are facing scrutiny by the regulator are better prepared to defend yourself. In each posting, we explore a small piece of the process and explain how it impacts FINRA and you.
This Week:
Special Considerations for Small Firms when Negotiating Settlements with FINRA
In the 25 years that I worked in FINRA’s Enforcement Department, I conducted investigations and brought disciplinary actions against the largest firms in the industry and the smallest – single and two-person operations. Years ago, FINRA recognized that it needed to take firm size, particularly small firms, and their limited finances into account in assessing sanctions, due to the disparate impact it can have on a small firm versus a large firm.
While a fine of $50,000 to a large firm may have no significant impact on the firm’s business, that same fine could easily put that single-person firm with a $5,000 net capital requirement out of business. The number of FINRA’s registered broker-dealers has declined every year since at least 2002.[i] When a small firm is sanctioned with a large fine, the intended purpose in a disciplinary matter is not to close a firm but to provide a meaningful and appropriate sanction.
However, those large fines have at times had unintended consequences of causing small, not-well-funded firms to close. If FINRA believed that closing the firm was essential to its regulatory obligations, it would have expelled the firm and not rely on the secondary effects of a financial sanction.
In September 2006, NASD (now FINRA) issued a Notice to Members 06-55 (NTM 05-66), entitled “NASD Revises Sanction Guidelines to Further Address Consideration of a Firm’s Size.” The new guidance under the Sanction Guidelines directed adjudicators to consider “a firm’s size and available resources for violations that are not egregious and do not involve fraud.” According to the new guidance:
adjudicators should consider a firm’s size and available resources when imposing monetary sanctions. In particular, …in determining sanctions for violations that are not egregious and do not involve fraud, adjudicators should consider a firm’s revenues, as well as other factors indicative of firm size. (NTM 05-66, page 1)
This revision therefore allowed for fines that are below the recommended minimums in the Sanction Guidelines. Expanding on FINRA’s General Principle No. 1 of its Sanction Guidelines, the revised procedures now allows for consideration of:
the amount of the firm’s revenues; the financial resources of the firm; the nature of the firm’s business; the number of individuals associated with the firm; the level of sales and trading activity at the firm; other entities that the firm controls, is controlled by, or is under common control with; the firm’s contractual relationships; and prior disciplinary actions against the firm (see General Principle No. 2 regarding recidivists).
FINRA applies this guidance to its Enforcement Department in negotiating settlements even though NTM 05-66) says that the new guidance is for “adjudicators” which include Hearing Officers, Hearing Panelists and those at the National Adjudicatory Council involved in appeals of hearing decisions. As a matter of course, in any settlement situation, FINRA staff is obligated to consider the size of the firm, in accordance with NTM 05-66, in arriving at its initial settlement proposal with a respondent firm.
If you work at or represent a small firm and are facing potential sanctions from FINRA, it is imperative upon receiving an initial offer of settlement from FINRA to inquire whether it has taken its obligations under NTM 055-66 into consideration. It is also critical to negotiate the language of the settlement document (Letter of Acceptance, Waiver and Consent – “AWC”) to ensure that it does not alleged egregious conduct or fraud so that you can apply the small firm consideration in negotiating the sanctions.
In determining whether the firm size and financial condition are a valid basis for reducing a fine or altering another suspension, Enforcement uses a matrix in examining the firm. Even though FINRA is supposed to take the firm size into consideration, at times it fails to make such an initial calculation. It is then incumbent upon you to make sure it gets considered. The difference could mean life or death to a firm.
Once you ask for consideration as a small firm, be prepared to be bombarded with detailed requests about your firm’s financial condition. The firm’s revenues and expenses will likely come under strict scrutiny. You need to be prepared to have your financials scrutinized by Enforcement, rather than a branch examiner. If the firm really is a very small firm with limited resources, it is likely worth the effort to have FINRA go through the exercise.
Beyond reducing a fine, NTM 05-66 allows FINRA to consider other things that may also unequally and unintentionally affect a small firm. For example, you may have a situation where both principals, the CEO and FINOP of a firm are fined and ordered suspended for a period of time, say a month. In that case, a sanction could be fashioned so that the two principals would serve their suspensions consecutively with a small break in between so that the firm could continue to operate with a principal in the office at all times. Another possible alteration is to stagger the payment schedule for fines so as not to force a sanctioned firm to realize or pay the entire fine at once.
We have seen cases that have applied the small firm consideration in resolving disciplinary cases.
In TradeSpot Markets Inc. , (Discip. No. 2013037033101 Sept. 1, 2016), in an Order Accepting an Offer of Settlement, the firm and its owner/President consented to findings of penny stock violations and deficient written supervisory procedures. In discussing the sanctions imposed, the Order noted that “FINRA imposed a lower fine against the Firm in this case after it considered, among other things, the Firm’s revenues and financial resources. See Notice to Members 06-55.”
In Tradespot, FINRA imposed a censure, a fine of $10,000 and undertakings by the firm to resolve the matter. The firm’s undertakings included a prohibition from effecting any solicited or recommended purchase transactions in penny stocks for one year. The other undertaking was to “retain a consultant not unacceptable to FINRA to conduct a review of Tradespot’s written supervisory procedures relating to compliance with the penny stock rules.” Of note is that because of the expense involved in obtaining an independent consultant to conduct the review, FINRA allowed Tradespot to use a consultant that apparently already had a relationship with the firm in order to conduct the review.
While NTM 06-55 relates to sanctions against a member firm, FINRA in this case also considered the individual broker’s inability to pay in assessing the sanction against him. The Order specifically notes that “Respondent …has submitted a sworn financial statement and demonstrated an inability to pay. In light of the financial status of Respondent …, no monetary sanctions will be imposed.” It also suspended the broker for 50 days in any principal capacity for 50 days and consecutively in all capacities for just 10 days.
In another case of Titus Rockefeller, LLC, and Richard Stoyeck, (AWC 2015045794201, March 14, 2016), the AWC pointed out that the firm had just eight registered representatives. In Titus, FINRA found that Stoyeck used a personal email address to conduct firm business and also that the respondents failed to establish maintain and enforce adequate supervisory procedures and a system to ensure that business-related emails to and from the personal email addresses were subject to retention and supervision, and failed to preserve all business-related email communications.
The AWC specifically references that “FINRA imposed a lower fine in this case after it considered, among other things, the Firm’s revenues and financial resources. See Notice to Members 06-55.”
In negotiating a settlement with FINRA for a small firm, it is critical to consider the effect that a firm’s size can have on the negotiations. As discussed above, first be sure to negotiate the violations and language of the settlement document to ensure that the firm is not being charged with egregious conduct or fraud, so that it can qualify for consideration under NTM 06-55.
Make sure that FINRA has taken the firm size into account before making its initial settlement offer so that you do not find yourself having to counteroffer before FINRA has accounted for firm size. This part of the negotiation can be effective in resolving a disciplinary matter in a way that allows it to settle a matter without destroying the firm.
Gary Carleton represents individuals and firms facing FINRA investigations and disciplinary matters. He also serves as co-counsel with attorneys who have clients facing a FINRA investigation or disciplinary matter for the first time. Contact Gary Carleton at 202.744.6297 or gary@carletonlaw.net to set up a time to talk.
In Case You Missed It – You can find prior blogs on the FINRA investigative and disciplinary process at www.carletonlaw.net and go to the Blog tab.
The prior topics include:
* Receiving that First Request for Information (an 8210 Request)
- An Early Opportunity to Discover FINRA’s Evidence and Present Your Case
* Understanding the Significance of FINRA’s Limited Jurisdiction; and
* How Old is Too Old for a FINRA Disciplinary Action
About Carleton Law PLLC
Getting a call from FINRA or SEC Enforcement telling you that your work as a securities broker is under investigation could be the worst day of your life. You have worked hard for years building your business. Now, with one wrongful allegation you can see it all swept away. But with expert counsel, it does not have to end that way.
For more than 30 years, Gary Carleton was the one conducting those investigations at FINRA and SEC and now his firm, Carleton Law PLLC, brings that savvy experience to bear to advocate for brokers and FINRA firms who find themselves in that dreaded position. Carleton Law focuses on the individual needs of each client to guide them through the maze of the investigative and disciplinary process.
Carleton Law PLLC | 1015 15th Street NW, Washington, DC 20005 | info@carletonlaw.net
The information provided in this article does not, and is not intended to, constitute legal advice; instead, all information is for general informational purposes only. Readers of this article should contact their attorney to obtain advice with respect to any particular legal matter. No reader should act or refrain from acting on the basis of information contained herein without first seeking legal advice from counsel in the relevant jurisdiction. Only your individual attorney can provide assurances that the information contained herein – and your interpretation of it – is applicable or appropriate to your particular situation. Use of, and access to, this article does not create an attorney-client relationship between the reader or user and the article author or law firm.
Attorney Advertising – Gary Carleton, Principal of Carleton Law, is admitted to practice law in the State of New York and the District of Columbia. This article may be considered attorney advertising.
[i] Registered firms as of 2002 was 5,392. Registered firms as of 2019 was 3,517.