FINRA’s Rule 4111 & New “Restricted” Label On BrokerCheck

The Financial Industry Regulatory Authority (FINRA) announced that effective June 1st, 2023, firms with a history of misconduct will be labeled with a “restricted” designation on BrokerCheck. This marker will appear on both a firm’s BrokerCheck summary and in detailed BrokerCheck reports.

It’s important to note that the pages of individual brokers at those firms will not be affected. However, the impact of this ruling is significant for both firms and individual financial advisors alike. The most obvious implication is that brokerages with a history of issues, misconduct, and high-risk activities can now be easily identified by firms and potential clients. Consequently, potential customers and investors may be deterred by the “restricted” designation and choose to conduct business elsewhere. This negative marketing, coupled with the financial penalties imposed by FINRA, creates a strong incentive for firms to make substantial changes to their personnel to avoid detrimental consequences.

Financial advisors with past disclosures will also feel pressure from their firms, as management may decide that terminating advisors with a history of misconduct is the simplest way to comply with Rule 4111. As a result, advisors who have recently been terminated and are seeking to join a new firm may face challenges due to the potential liability issues associated with Rule 4111.

This rule change is part of FINRA’s ongoing efforts to tighten restrictions on firms with a history of misconduct. Since January of last year, such firms have been subject to a “restricted deposit requirement (RDR),” meaning that they are required to maintain a deposit of cash or securities in a segregated account. The amount is tailored based on the size, operations, and financial conditions of the firm itself. Put bluntly — it’s a hefty deposit. But FINRA capped the deposit amount at that which would merely not cause the firm to be insolvent within the year. Then last summer, FINRA introduced a compliance tool to help firms determine whether they may be categorized as restricted. The addition of the restricted label on BrokerCheck profiles is another step in this direction.

AdvisorLaw’s Response

While the rule change has garnered support for its potential to improve industry conduct, many worry about its impact on individual brokers. In a recent Financial Advisor IQ interview, AdvisorLaw President and Founder, Dochtor Kennedy, MBA, J.D., raises concerns about how the new designation may unfairly impact individual brokers. While adding a label on BrokerCheck indicating that a firm is on the restricted list is a positive improvement, he suggests that the implementation should avoid unfairly blemishing the record of brokers who played no part in the firm earning the restricted designation in the first place. Instead, he proposes a solution where FINRA would include indicators on the BrokerCheck profiles of brokers who caused a broker-dealer to be on the restricted list due to their disclosures, or those who are simply affiliated with a restricted firm. However, no additional changes or updates have been announced, and this suggestion will likely fall on deaf ears.

Advisors Facing The Consequences: The Firm’s Free Pass

When a firm is identified as “restricted,” it will be compelled to take corrective action. At this crucial juncture, the broker-dealer faces a binary option that will shape its future. The first option entails accepting the maximum RDR, while the second option involves conducting a mass layoff of advisors with disclosures, with the hope of falling below the numeric thresholds set by FINRA. The ultimate goal for the firm is to avoid surpassing these thresholds, as failure to do so would necessitate the implementation of the RDR.

One of the most concerning aspects for advisors under the new rule is that firms now have a seemingly unrestricted ability to terminate them, thanks to FINRA. AdvisorLaw has observed that firms have made significant efforts to exploit Form U5 termination reporting in the majority of cases. When advisors are terminated, the firm publicly discloses the information on BrokerCheck. In many instances, the firm goes even further by contacting the advisor’s clients and portraying the advisor as having engaged in serious misconduct — aiming to retain the investor clients, while cutting ties with the advisor.

With the implementation of Rule 4111, advisors will face significant challenges in claiming wrongful termination. This is because FINRA essentially compels the firm to terminate them, removing any semblance of agency or discretion. What may have otherwise been perceived as a calculated attempt to harm the advisor is now portrayed as a thoughtful, pragmatic, and necessary decision that had to be made in the best interest of the broader community.

AdvisorLaw has observed an increase in Form U5 termination disclosures since FINRA first tabulated the Rule 4111 metrics in June of 2022. If you have multiple disclosures on your record, it’s crucial to take immediate steps to mitigate your exposure, in order to avoid finding yourself in the crosshairs. Removing such disclosures from public records, including the Central Registration Depository (CRD), BrokerCheck, the Investment Adviser Public Disclosure (IAPD), and the Investment Adviser Registration Depository (IARD), can be a complex process. The success of removal efforts may depend on the specific circumstances of each case.

Impacted Reputations And Recruitment Challenges For Restricted Firms

The reputations of restricted firms will undoubtedly suffer, and they will encounter significant hurdles in their recruitment efforts. Even advisors with clean records who are registered with such broker-dealers will likely face negative consequences due to their association with the restricted firm and its diminished resources.

Furthermore, it’s worth noting that firms typically bring on advisors with disclosures precisely because these individuals are high producers. However, given the limited options available to firms, they must either terminate these advisors or allocate funds to a restricted account. As a result, broker-dealers could experience adverse effects, such as substantial assets being redirected away from the firm due to the departure of terminated advisors.

Have you been affected?

If you find yourself in this situation, reach out to AdvisorLaw today. With 55 employees and nearly 20 attorneys, AdvisorLaw can represent these cases concurrently, while being able to provide unique, enterprise-level benefits and guarantees that are simply not available elsewhere. Our team of attorneys has a proven track record of successfully removing thousands of meritless or defamatory disclosures from public records, including the CRD, BrokerCheck, and the IAPD/IARD. By eliminating underlying disclosures from advisors’ records, AdvisorLaw can help protect both the advisor and the firm from the potentially damaging consequences of FINRA’s Rule 4111 “scarlet-letter” designation.

While the intention behind this change is to protect investors, it could have unintended consequences for broker-dealers and individual advisors. The presence of a restricted designation on a firm’s BrokerCheck profile may result in revenue loss, increased regulatory scrutiny, and potential monetary penalties. To mitigate these consequences, it is crucial for firms to take proactive measures and address any disclosures of misconduct in their advisors’ records. AdvisorLaw can provide valuable assistance with navigating this challenging situation and work with firms on a comprehensive level to remove any offending disclosures from advisors’ records.

Firms must take proactive steps to address any misconduct disclosures on their advisors’ records to minimize the potential negative consequences associated with the restricted label.

Contact us today for a complimentary consultation.