The Securities and Exchange Commission (SEC) recently approved a Financial Industry Regulatory Authority (FINRA) rule designed to rein in brokerages with a history of misconduct or that employ a high number of registered representatives with disciplinary records.
Specifically, the rule imposes additional capital obligations on high-risk firms by requiring them to deposit cash or qualified securities in an account controlled by FINRA. The money, which cannot be withdrawn without FINRA’s consent, could be used to fund arbitration awards or for other purposes.
Proposed Rule 4111 would establish numeric thresholds based on firm-level and individual-level disclosure events to identify member firms with a significantly higher level of risk-related disclosures as compared to similarly-sized peers.
Following a multi-step process of evaluating a member firm, FINRA’s Department of Member Regulation (“Department”) would be permitted to impose on member firms it determines pose a high risk to the investing public a “Restricted Deposit Requirement,” conditions or restrictions on the member firm’s operations that are necessary or appropriate to protect investors and the public interest, or both.
FINRA would conduct the process annually for each member firm, determining whether it should be designated (or re-designated) as a Restricted Firm and whether it should be subject to any obligations. Each member firm that is preliminarily identified based on its firm-level and individual-level disclosure events would have several ways to affect outcomes during subsequent steps in the evaluative process, including a one-time opportunity to terminate registered representatives with relevant disclosure events so as to no longer trigger the numeric thresholds.
The member firm would also be able to explain to the Department why it should not be subject to a Restricted Deposit Requirement or propose alternatives that would still accomplish FINRA’s goal of protecting investors and could request a hearing before a FINRA Hearing Officer in an expedited proceeding to challenge a Department determination.
The Department would begin a member firm’s Rule 4111 review process by calculating specified “Preliminary Identification Metrics” for that firm across six categories of events or conditions. These six categories include risk events, covering adjudicated and pending actions against firms and their registered representatives, along with metrics addressing registered representatives’ termination and internal review history, and their association with former member firms that were previously expelled by FINRA.
To read the complete order rule, click here.