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.
Given the immense interest in the blog, #finraFridays is expanding to now include a free, live, online discussion group chat about everything FINRA. This month we will be discussing this month’s topic as well as answering your questions about FINRA’s investigations and disciplinary process. If you have an issue you want discussed, please note the question when registering for the event. Our session is on Friday, August 20, 2020 at 12:00 pm (Eastern time). Space is limited and by registration only by sending an email to gary@finrafridays.com.
This Week:
Where have all the FINRA Members (and disciplinary actions) gone?
I have been following FINRA’s disciplinary process for more than 30 years, from the inside as a Senior Counsel in FINRA’s Enforcement Department, as a FINRA Hearing Officer, and now from the outside looking in as a defense counsel. I recently had the opportunity to review key statistical data compiled by FINRA regarding its membership and its disciplinary program. As discussed below, I was struck by what can only be described as the significant shrinking of FINRA’s footprint in securities regulation.
FINRA Membership
Let’s start with membership. Generally speaking, broker-dealers who engage in securities transactions for customers are obligated to register with the SEC and be a member of FINRA.[i] And yet in the last eighteen years, between 2002 – 2019, the number of broker-dealers registered with FINRA has fallen by more than a third – from 5,392 firms in 2002 to just 3,517 in 2019.[ii]
Between 2013 and 2019, of the 629 member decline, 612 were small firms, representing more than 97 percent of the decline.[iii] Small firm is defined as having 150 or fewer registered representatives. [iv] During that same period, the number of branch offices declined nationwide by more than 6,600 branches.[v]
Where have all the FINRA members gone? Some FINRA critics claim it is almost by design to shrink the number of small firms because the cost of regulating small firms exceeds the fines that FINRA can collect from small firms.[vi] Some firms complain about the burden of FINRA regulation compared to that of serving only as an investment-advisor.
In fact, while FINRA broker-dealer only and dually registered broker-dealer/investment advisor firm memberships declined by more than 1,375 members between 2008 and 2019, the number of investment-advisor only firms (over whom FINRA lacks jurisdiction) grew by more than 6,380 in the same period and now stands at more than 30,500 investment advisory firms.[vii]
The number of registered representatives working at FINRA members also declined by more than 34,500 brokers or more than 5 percent since 2004. The result of the sharp decline in small firms has been a shift to larger firms.[viii] Between 2013 and 2019, the average number of representatives per firm has grown each year from 153 to 179.[ix]
FINRA Disciplinary Actions
FINRA’s Enforcement Department has grown significantly as it merged with FINRA’s Market Regulation staff a few years back. Although FINRA Enforcement’s budget for 2018 and 2019 remained steady at approximately $117 million,[x] representing 11-12% of FINRA’s budget, its budget got a huge increase – by $20 million – for 2020 with a budget of 137.2 million.[xi]
With increased staffing, a re-organization to become more effective nationwide, and a budget, what do FINRA’s statistics tell us about FINRA’s efforts at investigating and disciplining its members over the last five years (2015-2019)?
While the number of investor customer complaints made directly to FINRA has declined slightly over the last 5 years, from 3,250 in 2015 to 2,954 in 2019,[xii] the number of disciplinary actions filed during the same period fell 43.5 percent from 1,512 to just 854.[xiii] Most of the other statistics reflecting FINRA’s disciplinary activity during that period also show a precipitous decline in actions and results.
Although most disciplinary actions result in a settlement, FINRA prides itself on its disciplinary process highlighted by its Office of Hearing Officers (“OHO”) that presides over disciplinary hearings and issues panel decisions. In 2015, OHO issued 38 disciplinary decisions.[xiv] Nearly every year since then, the number of disciplinary decisions issued by OHO has fallen. In 2019, the last full year for which FINRA has figures, OHO issued just 16 disciplinary decisions, of which 14, or 87 percent were appealed.[xv]
So far in 2020, OHO has posted just 7 decisions on its website.[xvi] OHO remains fully staffed, so it is not a backup by OHO in issuing decisions that is accounting for the lower numbers.
For each of the last 4 years, the fines have also has fallen – from $93.8 million in 2015 and $173.8 million in 2016 to just $39.5 million in 2019.[xvii] Despite FINRA’s recent claim that it is emphasizing restitution to customers rather than the collection of fines, its restitution in 2019 was the same as its restitution in 2016 – at $27.9 million, equaling the lowest amount of restitution paid in the last 5 years.[xviii]
Beyond fines and restitution, FINRA’s other forms of sanctions have also dropped off precipitously in the last 5 years. The number of firms expelled by FINRA fell from 31 in 2015 to just 9 in 2019.[xix] Of those 9, all except two were expelled either for failure to provide information or keep information current pursuant to FINRA Rule 9552, or for failing to pay fines and/or costs pursuant to FINRA Rule 8320.
In only 2 cases, did an adjudicator sanction a firm with an expulsion based on underlying violative conduct.[xx]
FINRA has expelled just 4 firms in the first 6 months of 2020. None of these expulsions were ordered based on a hearing panel’s decision following a disciplinary hearing.[xxi]
The number of registered representatives barred fell from 496 in 2015 to just 348 in 2019, and the number of individuals suspended dropped from 736 in 2015 to only 415 in 2019.[xxii]
In a June 2020 blog, Jessica Hopper, head of FINRA’s Enforcement Department explained the vetting process in bringing formal actions. Noting that only a small percent of examinations become formal enforcement matters, she added,
There are a variety of reasons why this is so. Most fundamentally, in many cases, a referral to Enforcement to pursue disciplinary action is not the appropriate regulatory result. Generally, we reserve enforcement actions for instances involving financial harm, an impact to market integrity, or significant risk to investors, member firms, or the market.[xxiii]
And what is the quality of the lower number of disciplinary actions being filed? In a July 2020 blog, Hopper acknowledged that more than a third of all disciplinary cases that resulted in individual bars from the securities industry over the last two years were based on violations of its Rule 8210 – failing to provide or timely provide requested information to FINRA as part of an investigation or proceeding, often never getting to the substantive conduct violation.[xxiv]
Hopper claims:
after FINRA bars a broker for violating Rule 8210 …that doesn’t mean FINRA’s job is done. FINRA will continue its investigation to:(a) make sure that others were not complicit in the misconduct; (b) seek, whenever possible, to make harmed customers whole;and (c) refer matters outside of FINRA’s jurisdiction to the appropriate federal and state regulators, and to law enforcement.[xxv]
While we do not have statistics of how many cases are filed regarding the same potential violative conduct once the broker is barred, it is clear that the opportunity to make a harmed customer whole from a barred individual is essentially impossible. FINRA cannot compel a barred broker to pay a fine or make any type of restitution.
Conclusion
These key statistics demonstrate that FINRA’s regulatory footprint over the securities industry has receded in the past several years, at least in terms of small firm membership, number of registered representatives and disciplinary actions taken. The shifting from securities professionals who are starting to register only as investment advisors instead of broker-dealers or dually-registered has been significant in the last five years and will likely continue.
Gary Carleton focuses his practice representing individuals and firms facing FINRA investigations and disciplinary proceedings. He also serves as co-counsel with attorneys who have clients facing a FINRA investigation or disciplinary proceedings for the first time. Contact Gary Carleton at 202.744.6297 or gary@carletonlaw.net to set up a consultation.
Next Time -We do a detailed analysis of a FINRA disciplinary hearing that went off the rails and how FINRA dealt with it. There is lots to discuss.
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:
* Special Considerations for Small Firms when Negotiating Settlements with FINRA https://carletonlaw.net/special-considerations-for-small-firms-when-negotiating-settlements-with-finra/
* Receiving that First Request for Information (a Rule 8210 Request) https://carletonlaw.net/receiving-that-first-request-for-information-a-rule-8210-request/
* Pre-Wells Notices – An Early Opportunity to Discover FINRA’s Evidence and Present Your Case https://carletonlaw.net/pre-wells-notices-an-early-opportunity-to-discover-finras-evidence-and-present-your-case/
* Understanding the Significance of FINRA’s Limited Jurisdiction; https://carletonlaw.net/315-2/ and
* How Old is Too Old for a FINRA Disciplinary Action https://carletonlaw.net/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] Register a Broker-Dealer Firm: To conduct securities transactions and business with the investing public in the United States, both firms and individuals must be registered with FINRA. Firms must apply and meet certain membership standards to become a FINRA-registered broker-dealer.
[ii] 2002 NASD Annual Financial Report, page 8: Broker/dealers regulated by NASD 5,392; FINRA Industry Snapshot 2020, page 13: All FINRA-Registered broker-dealer firms -3,517
[iii] FINRA Industry Snapshot 2018, page 12; DINRA Industry Snapshot 2020, page 12.
[iv] Id.
[v] FINRA Industry Snapshot 2018, page 14; DINRA Industry Snapshot 2020, page 14.
[v] FINRA Industry Snapshot 2018, page 14; DINRA Industry Snapshot 2020, page 14.
[vi] Julie Kamps note to FINRA on Proposed Rule 4111, July 1, 2019.
[vii] FINRA Industry Snapshot 2018, page 13; DINRA Industry Snapshot 2020, page 13.
[viii] FINRA Industry Snapshot 2018, page 7; DINRA Industry Snapshot 2020, page 7.
[ix] FINRA Industry Snapshot 2018, page 4; DINRA Industry Snapshot 2020, page 4.
[x] FINRA 2019 Annual Budget Summary, page 6.
[xi] FINRA 2020 Annual Budget Summary, page 6.
[xii] https://www.finra.org/media-center/statistics Regulatory Actions and Corporate Financing Review 2015 – 2019.
[xiii] https://www.finra.org/media-center/statistics Regulatory Actions and Corporate Financing Review 2015 – 2019.
[xiv]https://www.finra.org/rules-guidance/adjudication-decisions
[xv] https://www.finra.org/rules-guidance/adjudication-decisions
[xvi] https://www.finra.org/rules-guidance/adjudication-decisions
[xvii] https://www.finra.org/media-center/statistics Regulatory Actions and Corporate Financing Review 2015 – 2019.
[xviii] https://www.finra.org/media-center/statistics Regulatory Actions and Corporate Financing Review 2015 – 2019.
[xix] Although FINRA’s 2019 Key Statistics lists just six firms expelled, a review of FINRA’s monthly disclosures of disciplinary actions reveals the number of firms expelled in 2019 was actually nine.
[xx] FINRA’s monthly disclosures of disciplinary actions.
[xxi] FINRA’s monthly disclosures of disciplinary actions.
[xxii] https://www.finra.org/media-center/statistics Regulatory Actions and Corporate Financing Review 2015 – 2019.
[xxiii] https://www.finra.org/media-center/blog/working-on-the-front-lines-of-investor-protection-how-an-enforcement-action-becomes-an-enforcement-action
[xxiv] https://www.finra.org/media-center/blog/working-front-lines-investor-protection-importance-finra-rule-8210
[xxv] https://www.finra.org/media-center/blog/working-front-lines-investor-protection-importance-finra-rule-8210