In the financial landscape, where trust and integrity are of paramount importance, regulatory entities like the Financial Industry Regulatory Authority (FINRA) are granted oversight for the purported purposes of maintaining industry integrity and investor protection. FINRA, established as an independent organization by Congress, formulates and enforces rules that govern registered brokers and broker-dealer firms. While these regulations aim to ensure fair treatment for investors, they are all too often employed and weaponized against brokers. Having an understanding of FINRA’s regulations is crucial to staying out of its crosshairs.
While brokers diligently strive to adhere to FINRA’s rules, there are times where they inadvertently violate them. Brokers can also face unjust accusations and unfounded claims. In these cases, brokers can find themselves facing unwarranted or false allegations that tarnish their records and professional reputations.
At AdvisorLaw, we understand the critical importance of compliance with FINRA rules, and we are here to assist brokers who find themselves in violation of these statutes. In this blog post, we’ll delve into some of the most commonly violated FINRA rules and shed light on why they matter.
Private Securities Transactions
FINRA’s rule regarding private securities transactions, or PSTs, is straightforward but critical. Before a broker engages in a PST, they must provide their firm with a written description of the transaction and their role in it. If the broker is receiving compensation, the broker is required to report it. The firm bears the responsibility of supervising the transaction, as though it were executed on its behalf. FINRA’s stated purpose for this requirement is to make sure that brokers do not attempt to bypass this rule for personal gain or to evade supervisory oversight.
Inadvertent breaches of this rule are not uncommon, and such breaches often result in regulatory investigations and meritless disclosures. For example, in a recent case in Seattle, Washington, dated September 9, 2022, a broker with nearly 25 years of industry experience aimed to expunge a customer dispute from his record through FINRA arbitration. This broker had been terminated by his firm for failing to disclose promissory notes issued by his wife’s start-up company, which led to a Form U5 termination disclosure and an internal review disclosure, along with regulatory action. With the assistance of AdvisorLaw, the broker successfully achieved expungement of the disclosures — a perfect demonstration of the importance of having a robust defense when faced with such allegations.
When a broker recommends a securities transaction to a customer, the recommendation must align with that customer’s investment portfolio, needs, and financial situation. If a broker suggests a transaction that is not in line with the customer’s investor profile, or one that primarily benefits the broker rather than the customer, it constitutes a violation of the suitability rule. FINRA states that this rule exists to ensure that brokers prioritize their clients’ best interests, and it is one of the most violated rules in the industry.
The suitability rule often puts brokers under regulatory scrutiny, as customers can easily lodge allegations that trigger investigations and, potentially, unwarranted disclosures. A recent case from August 25, 2023 exemplifies this challenge. In this instance, a broker in Los Angeles who had been in the financial industry for nearly 25 years faced the task of expunging two customer disputes stemming from the 2008 financial crisis from her otherwise-clean public BrokerCheck record. Seeking to clear her records, the broker engaged Harris Freedman, J.D. of HLBS Law to navigate the FINRA Dispute Resolution process. The case revolved around the broker’s interactions with a client who had wanted to open a 403(b) account in 2006. Despite a subsequent financial downturn and ensuing disputes, the Arbitrator ultimately concluded that the broker had acted professionally, ethically, and in the client’s best interest. The Arbitrator recommended expungement — clearing the broker’s record of the disputes.
The supervision rule is exactly what it sounds like — it mandates that registered firms establish a robust system for supervising brokers and other firm representatives. The system’s primary goal is to make sure that brokers adhere to applicable securities laws and regulations. Additionally, each firm must designate a representative responsible for overseeing its supervision system. FINRA claims that effective supervisory systems can help detect and prevent broker misconduct, thereby safeguarding investors’ interests.
Inadvertent and even alleged violations of the this supervision rule frequently occur, even when brokers have impeccable records. Consider our case representing a Chicago-based broker with over 35 years of experience. He had a spotless record, aside from one settled dispute in 2014, and he sought to expunge the disclosure through FINRA Dispute Resolution with the help of AdvisorLaw. The dispute stemmed from events that transpired in 2011, when an investor became a client of another broker within the same firm. The broker had no involvement with the investor, didn’t make recommendations, and held the positions of firm President and Chief Operating Officer, which didn’t entail supervising other representatives. The dispute, which resulted from actions by another broker, led to our broker having a settled dispute disclosure on his record, which caused unwarranted harm to his reputation. After a successful expungement hearing, it was determined that the claim was factually impossible, as our broker had had no contact with the customer, hadn’t been responsible for supervising the broker’s sales practices, and was wrongly included in the complaint. This example illustrates how brokers can inadvertently find themselves dealing with unwarranted disclosures, and highlights the need for a rigorous defense to protect your records.
Outside Business Activities
Outside business activities (OBAs) represent a critical aspect of financial advisory regulation, wherein employees of registered firms are strictly prohibited from engaging in outside work or receiving compensation from another entity without prior written notice to their employing firm. FINRA’s stated aim with this rule is to ensure transparency and enable firms to assess potential conflicts of interest that might arise from such activities.
Frequently, brokers properly seek guidance from their firms about whether their involvement with an external entity constitutes an OBA — only to later face termination for alleged nondisclosure. This inconsistency and ambiguity in defining OBAs and the proper method of disclosure is a recurring issue. FINRA Rule 3270 governs OBAs and broadly defines them as any compensated work outside of the broker’s role with the firm, with passive investments and activities subject to Rule 3280 exempted. When a broker notifies his firm of an OBA, the firm is obligated to evaluate whether it interferes with the broker’s responsibilities or may be perceived as part of the firm’s business. While the rule necessitates notification, it doesn’t mandate any specific actions beyond that, and the approval or denial of each OBA lies with the firm. This ongoing challenge underscores the importance of clear and consistent guidelines regarding OBAs in the financial advisory industry.
OBAs have been a recent hot topic in the financial advisory industry, sparking numerous cases in which brokers have been accused of unwittingly running afoul of this rule. One compelling example revolves around a Washington, D.C.-based investment advisor representative who engaged AdvisorLaw’s services to pursue expungement through FINRA Dispute Resolution. In this case, the advisor had a five-year-old termination disclosure stemming from alleged noncompliance with the firm’s OBA policies. He had operated an ATM machine business alongside his role at the firm, making arrangements with local businesses and placing ATMs in his church to aid parishioners. Although he neglected to report the income from that separate venture to the firm, it had no bearing on the firm’s operations or customer complaints. Nonetheless, the advisor found himself abruptly terminated in 2017 — sparking a Form U5 amendment reporting OBA policy noncompliance. Fortunately, the FINRA Arbitrator recognized that this had been a mistake and that it was not a threat to the public. He recommended expunging the termination disclosure and Form U5 amendments, allowing the advisor to restore his flawless public record. The case illuminated the heightened scrutiny surrounding OBAs and the potential for expungement relief in such cases.
Standards Of Commercial Honor & Principles Of Trade
One of the fundamental principles of which FINRA boasts enforcement is the requirement for registered firms to uphold high standards of commercial honor and abide by just and equitable principles of trade. Firms are explicitly prohibited from making false, misleading, or exaggerated claims in any sales literature intended for public consumption. In essence, this rule mandates that firms adhere to both legal and ethical guidelines in their business practices.
The enforcement of high standards of commercial honor and equitable principles of trade, as mandated by FINRA, has become a prominent and challenging issue in recent times. One specific area of concern revolves around electronic signature (e-signature) violations. In response to the growing use of e-signatures, FINRA has heightened its focus on detecting instances of alleged signature forgery or falsification, raising the stakes for brokers. Alleged violations related to e-signatures have surfaced in various forms, including unauthorized signing, manipulation of e-signature processes, and inconsistencies in compliance guidelines. A notable case involving LPL Financial highlighted the complexities surrounding e-signature compliance that are leading to broker terminations and regulatory scrutiny. AdvisorLaw, led by Doc Kennedy, J.D., MBA, has been at the forefront of defending brokers affected by these violations and offering legal support to navigate the intricate regulatory landscape.
Use Of Manipulative, Deceptive, Or Other Fraudulent Devices
This rule prohibits members from employing manipulative, deceptive, or fraudulent devices in any transaction, purchase, or sale of a security. Yet inadvertent and alleged violations of this rule can occur, especially in the context of off-channel communication devices.
The advent of messaging apps has transformed communication, though it has also presented a significant compliance challenge for brokerage and advisory firms. Recent regulatory scrutiny has particularly focused on the personal and off-channel communication policies of registered investment advisors and broker-dealers. Failure to monitor and preserve employee messages on platforms like text messages and WhatsApp has led to substantial fines against major financial institutions, exceeding billions of dollars. To avoid similar penalties, brokers and firms must ensure that their policies are clear — specifically addressing the use of personal devices for business communication, including off-channel communications. Additionally, aligning policies with surveillance capabilities, continuous training, self-reporting noncompliance, and adopting the right technology and compliance processes are crucial to maintaining compliance and safeguarding reputations in the digital age of communication.
Misuse Of Customer’s Funds Or Securities
FINRA rules also prohibit borrowing a customer’s funds or securities without proper authorization. This rule is in place to protect against forgery, deception, or illegal manipulation that could harm investors’ assets and trust.
A recent case from July 27, 2022 serves as a great example. In this instance, a seasoned New York broker with nearly four decades of experience had a single customer dispute on his public BrokerCheck record that had been settled for $350,000. Seeking to clear the disclosure from his record, he engaged AdvisorLaw to navigate the FINRA Dispute Resolution process. The case revolved around allegations related to allegedly-unauthorized withdrawals from a customer’s trust, leading to a substantial settlement and a disclosure on the broker’s record. During the arbitration hearing, upon careful examination of the evidence and arguments, the Arbitrator concluded that the broker bore no responsibility for the unethical and potentially illegal activities involving the customer’s account. The Arbitrator recommended expungement, thereby clearing the broker’s public records, thanks to AdvisorLaw’s assistance.
The Stakes Are High: Responding To Regulatory Investigations
All regulatory enforcement investigations begin with a simple inquiry, but they can quickly escalate to disclosures, suspensions, fines, and a possible bar from the industry altogether. Given the high stakes involved, responding promptly, consistently, and with a high degree of precision is crucial. Having legal counsel to represent you at every stage of this process is not just advisable — it’s essential.
Your Trusted Partner In Regulatory Investigations
At AdvisorLaw, we understand the critical nature of the regulatory investigations initiated by regulatory bodies, and we are here to support brokers and investment advisors who find themselves facing such inquiries. Every word spoken and written during an investigation can be used as evidence — making precision and prompt action vital.
If you’ve received a notice from FINRA, the SEC, or the CFP® Board regarding an enforcement action, do not delay — call us immediately, at (303) 952-4025, or fill out our contact form below for a priority consultation with one of our experienced attorneys — at no charge to you.
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