The effects and consequences of disclosures on advisors’ records have been growing larger and more severe over the past several years. With the implementation of the requirement to provide a readily-apparent reference and hyperlink to BrokerCheck in 2016, the broker’s public records became more visible to current and potential clients. Information that was once primarily reserved to be viewed by industry insiders became instantly accessible not just to clients — but also to the general public. The impact on advisors’ professional and personal reputations is unquestionable.
Now, FINRA takes aim at advisors who have disclosures from another vantage point – through its member firms and their hiring decisions.
As of September first of this year, any member firm that’s interested in hiring a registered person whose record reflects that they have had either: (1) one or more “final criminal matters;” or (2) two or more “specified risk events” in the past five years will be subject to the new Rule 1017(a)(7). In those cases, per FINRA Regulatory Notice 21-09, the member firm will either have to file a Continuing Membership Application (CMA), seek a Materiality Consultation (MC), or both when a person with such past history is pursuing a position as a registered person, principal, owner, or control person with the member firm.
Whenever a firm seeks to expand or implement new ways of doing business, or when a firm seeks to modify or remove restrictions that were previously imposed in a membership agreement, FINRA requires the firm to file a CMA. Examples of such instances include (1) firms making material changes to business operations; (2) firms making asset transfers; and (3) firms undergoing a change in control or ownership, mergers, or acquisitions. FINRA purports that the process of filing a CMA protects investors by “ensuring that a firm’s supervisory and compliance systems, policies, and procedures keep pace with such change.”
When a firm seeks to expand business by adding a new line to its existing business or substantially increasing the scope and size of its existing business, for example, the broker-dealer may not be required to complete a CMA. If the proposed change does not represent a material change to business operations, as defined in Rule 1011(m), if the change can be effected within the thresholds and conditions specified in the safe harbor provision under FINRA IM-1011-1, or if the change requires the firm to seek an MC, the firm may submit a voluntary MC.
Under the new Rule, before hiring a person with a final criminal matter or two specified risk events in the past five years, the member firm has the option to seek the MC at no cost. When it does, FINRA will then indicate whether: (1) the firm may proceed with hiring the individual without taking any further action; or (2) whether hiring the person would constitute a “material change in business operations,” which would then require the firm to file a CMA.
Per FINRA a “final criminal matter” is one that is disclosed or was required to be disclosed on the applicable Uniform Registration Forms and one which resulted in a conviction or a plea of guilty or no contest. This includes questions: 14A(1)(a), 14A(2)(a), 14B(1)(a), and 14B(2)(a) on the Form U4; 7C(1) and 7C(3) on the Form U5; DRP 4B on the Form U5; and 11A(1) or 11B(1) on Form BD.
A specified risk event includes: (1) investment-related civil litigation settlements or arbitration awards, judgments, and settlements of $15,000 or more, against the person, as a named party; (2) investment-related final civil judicial actions in which the total sanctions were ordered for an amount of $15,000 or more, or the person was barred, expelled, revoked or suspended; and (3) final regulator actions with total monetary sanctions of $15,000 or more or where the person was temporarily or permanently barred, expelled, rescinded, revoked, or suspended from associating with a member firm.
Regulators’ efforts to influence member firms’ employment decisions are nothing new. Broker-dealers are already prohibited from employing certain individuals with criminal events in their past by the following:
- Article III, Section 4 of FINRA’s bylaws (defining “disqualification events”);
- Rule 506 of Regulation D under the Securities Act of 1933 (adopted by the SEC and operating as the “Bad Actor Disqualification Rule”);
- 15 U.S. Code § 80a-9 (ineligibility of certain affiliated persona and underwriters); and
- Section 19 of the Federal Deposit Act (12 U.S.C. 1829) (equivalent rule pertaining to banks and federal savings associations).
While conducting safety and soundness reviews, bank regulators can critique the fitness, effectiveness, and competency of certain high-ranking officers and board members. Their criticisms ultimately have an adverse effect on those individuals’ employment, as the individuals can be relieved from their positions and effectively blacklisted from the industry by the regulators. In the UK, financial services firms are required to obtain regulatory permission before hiring individuals for certain senior positions within the firms. The Financial Conduct Authority and, in some cases, the Prudential Regulatory Authority must pre-approve nearly all senior-level hires in the country.
This new rule will impede the hiring and onboarding process of those advisors with qualifying final criminal matters or specified risk events on their records. However, FINRA did choose to narrow the Rule’s scope, and thereby its impact, by limiting the qualifying events to only those that were somewhat substantiated, rather than including all disclosures that get reported to the CRD, regardless of merit, etc.
It has become undeniably clear that FINRA is continuously becoming increasingly cognizant of financial advisors with multiple negative disclosures on their records, and it will likely continue to take measures to limit those individuals’ employability as it sees fit and where it can, including placing increasing pressure on the hiring firms. It is not out of the question to suspect that US regulators may continue revising their rules to increase their purview and ability to dictate broker-dealers’ hiring decisions, consistent with the role of the regulators’ counterparts in the UK.
Learn more about AdvisorLaw’s Enforcement Defense and FINRA Disclosure Expungement services.