A Stockbroker's Introduction to FINRA Examinations and Investigations
Brokers and financial advisors oftentimes do not understand what their responsibilities and obligations are and what may result from a Financial Industry Regulatory Authority (FINRA) examination or investigation. Many brokers do not even know the role that FINRA plays within the industry. This may be due to the fact that FINRA, a self-regulatory organization, is not a government entity and cannot sentence financial professionals to jail time for violation of industry rules and regulations. Nevertheless, all broker-dealers doing business with members of the public must register with FINRA. As registered members, broker-dealers, and the brokers working for them, have agreed to abide by industry rules and regulations, which include FINRA rules.
In order to check for compliance with industry rules and regulations, FINRA conducts routine examinations or investigations of broker-dealers, which consist of inspections occurring once every one, two, or three years depending on the firm’s business model, its size, and its perceived risks. FINRA may also conduct an examination if it has reason to believe that a rule violation has occurred – an examination may be initiated based on a Form U-4 or U-5 disclosure, a customer complaint, an arbitration claim, information received from another regulator or law enforcement agency, or information received in the form of tip from a competing broker-dealer. The purpose of the examinations is to make sure that a firm is operating with sufficient capital, is properly supervising it employees and business operations, and has proper internal systems and controls in place. The examinations generally focus on unethical sales practice behavior such as conversion of funds, forgery, theft, selling away, undisclosed outside business activities, unauthorized trading, unsuitable recommendations, and misrepresentations or omissions.
Consulting an attorney is highly recommended when facing a FINRA examination because all brokerage firm "Members" and stockbroker "Associate Members" of FINRA have agreed to be subject to its jurisdiction, rules, procedures, disciplinary proceedings and sanctions which could have serious consequences. These disciplinary proceedings are like trials in a courtroom but under FINRA’s lopsided rules and procedures to the stockbroker’s disadvantage. You need to be on guard - FINRA can make referrals to the U.S. Securities & Exchange Commission (“SEC”) for injunctions, fines and/or to federal and state prosecutors for criminal prosecution.THE EXAMINATION PROCESS
Upon initiating an examination, FINRA examiners will usually send a written request for information to the broker-dealer as well as to the broker, which seeks basic information about a complaint or other disclosure. A request letter to the broker will often ask for a written response to the allegation, and a request letter to the firm will usually seek a written narrative of the complaint or other disclosure and the firm’s findings. A request letter to a firm may also include a request for relevant documents such as communications with customers and account records. Once FINRA has obtained such information, it will determine whether the issue is one over which FINRA has jurisdiction. FINRA will also determine whether there is a potential rule violation or if any other threshold has been met, which would allow it to continue to review the matter at issue.
Examiners obtain the vast majority of information needed to conduct an investigation through written correspondence. Letters requesting information and documents and responses to specific questions sent to firms, brokers, and involved personnel are not uncommon. In many cases, FINRA will require the broker to respond to a specific question with a signed, written statement. Brokers tend to receive two to four or more of such letters. In addition, examiners may conduct telephone interviews with brokers, managers, compliance employees, and customers to obtain relevant information. Although these interviews are considered informal, brokers should proceed with caution because anything they say may be used against them.
The majority of examinations that lead to a disciplinary action include an on-the-record interview (OTR), which requires the broker or other associated persons of a firm to meet with the regulators. OTRs are similar to depositions taken in civil proceedings as the witness is sworn to tell the truth, a court reporter is present to record the interview, and transcript of the interview is prepared. Seeing as brokers are permitted to have a lawyer appear at the OTRs with them, brokers are encouraged to obtain legal counsel to assist in preparing for an OTR, for the OTR proceeding itself, and for any future enforcement action.
As soon as the examiners believe that they have gathered all the relevant information, documents, and other evidence, a report of the examination is prepared and submitted to a supervisor. The supervisor’s role is to review the report and the evidence and make a recommendation to close the file without action, to pursue some type of informal disciplinary action, or to pursue a formal disciplinary action – matters may also be resolved through a combination of the foregoing choices.FINRA JURISDICTION AND IMPORTANT RULES
Brokers should know that FINRA does not have jurisdiction over individuals not affiliated with the securities industry. Therefore, since FINRA cannot ask for or force cooperation from non-affiliated individuals, many examinations are never fully completed if such cooperation is necessary to establish evidence of a violation. This does not mean that brokers should encourage customers to avoid or not cooperate with the authorities because this is a violation of FINRA rules itself, which can lead to sanctions,
Brokers should also know that they themselves are not obligated to respond to FINRA requests for information, but this decision may come with a significant price, such as a permanent ban from the industry. Still, FINRA makes use of Rule 8210, which serves as subpoena for FINRA examinations. Rule 8210 requires broker-dealers, registered representatives, and any other individuals subject to FINRA’s jurisdiction to cooperate in an examination and provide written, electronic, and oral information when requested. If a broker chooses not to respond, he or she may be barred from association from any FINRA member firm in any capacity in addition to other sanctions. This consequence may seem contrary to one’s 5th Amendment right against self-incrimination. However, since FINRA is not a government agency, the 5th Amendment does not apply. Nonetheless, in certain situations it may be optimal for a broker not to cooperate with FINRA if facing criminal charges since statements and information can be subpoenaed by other law enforcement agencies or voluntarily turned over by FINRA to such agencies. When faced with a decision to cooperate with FINRA or not, one should always seek advice from an attorney experienced in these matters.
In addition, FINRA’s Bylaws provide for jurisdiction for purposes of Rule 8210 over formerly registered brokers and associated persons for two years following termination of registration. This period can start all over if a broker amends his or her Form U5 to disclose actionable conduct during the two-year period following termination of registration. Therefore, it is possible for FINRA to maintain jurisdiction over a formerly registered broker for almost four years. If a formerly registered broker or associated person out of the industry for almost two years is facing an examination or disciplinary action, he or she should also seek advice from an experienced attorney about the described jurisdiction issue.INFORMAL ACTIONS BY FINRA
An informal disciplinary action by FINRA or a “Cautionary Action” commences when a broker is sent a letter explaining that FINRA has completed its examination and specifies certain industry rules believed to have been violated by the broker. In some cases, the letter will request that the broker reply acknowledging receipt of the letter and affirm that no additional violations will occur in the future. The issue is normally closed when a Cautionary Action letter has been sent and replied to unless FINRA staff is pursuing a formal action as well. In more serious situations, the staff may require the broker to attend a meeting at a FINRA office where an oral explanation of the findings is given to the broker and concerns about compliance with industry rules are relayed. At the end of the meeting, the broker may be requested to acknowledge the concerns addressed in the letter and spell out any steps that the broker may take to ensure that the violations will not happen again. Brokers should note that FINRA consistently follows up with its informal actions. So if a broker engages in unlawful conduct in the future, one can expect the informal disciplinary action to be referred to at a disciplinary hearing, which would show that the broker was warned about the alleged misconduct.FORMAL ACTIONS BY FINRA
FINRA may choose to initiate a formal disciplinary action once an examination is completed. If so, the examination is turned over to a lawyer working for FINRA, and the lawyer will review the file to make sure that the examiners have all the necessary evidence and information to proceed with the action. If the file is determined to be complete, the lawyer will contact the broker with a letter or phone call or both.
The lawyer’s initial contact with the broker is to notify him or her about FINRA’s intention to take a disciplinary action against the broker for a violation of FINRA rules or other industry rules, regulations, and laws. A description of the rules or laws alleged to have been violated is provided, and the broker is given the opportunity to submit to FINRA additional information not provided and an argument as to why FINRA should not proceed with its action. This process is known as the “Wells Submission” process.
A Wells Submission notification is important because FINRA is advising the broker that it intends to initiate a proceeding involving a disciplinary action against the broker, and the broker will have an obligation to amend his or her Form U-4 to reflect that the broker is under an investigation. If the broker does not disclose the investigation on the Form U-4, additional charges can be brought against the broker. The broker will have a few weeks to respond by submitting a Wells Submission to FINRA or to speak with the FINRA lawyer about settling the case before a complaint is filed against the broker. A Wells Submission is simply a written argument by the broker about why FINRA’s action is inappropriate, not necessary, or both. Wells Submissions may also contain additional information and evidence not obtained during the examination that may exculpate the broker from the alleged misconduct or violation. A FINRA lawyer and a supervisor will review the Wells Submission, and if they choose to move forward with a disciplinary complaint, the Submission will also be reviewed by staff in Office of Disciplinary Affairs (ODA), which will approve the issuance of the complaint.
Prior to submitting a Wells Submission, all the facts and circumstances of the particular case must be taken into consideration because most Wells Submissions are not successful at convincing the regulators to not pursue a disciplinary action. Brokers should also keep in mind that Wells Submissions are not confidential and might be used against the broker by the regulator or by civil claimants if the Submission is subpoenaed in a concurrent or subsequent action.
Upon receiving a Wells Submission response, the regulators will determine whether or not to initiate a formal disciplinary action or close the examination and proceed with an informal action. If they choose to proceed with a formal action, the broker has the option to settle the case or establish a defense and fight the case. If the broker chooses to defend the case, he or she will answer the complaint and request a hearing before a hearing panel. The panel’s role is to hear the evidence, determine whether a violation occurred, and determine the appropriate sanctions. If the hearing panel’s decision is adverse to the broker’s interests, the broker may have the option to appeal the decision. If the broker chooses to not participate in the process, the process will continue and a default decision can be issued against the broker, which may come with sanctions.LETTER OF ACCEPTANCE, WAIVER, AND CONSENT
In many cases, FINRA “Members” and “Associate Members” will settle a FINRA action before a formal disciplinary complaint has been issued. These types of settlements are done through a Letter of Acceptance, Waiver, and Consent (AWC) in which a broker neither admits nor denies the allegations. However, a broker must agree to the findings of facts and violations and to sanctions. An AWC resolves the matter once finalized, and FINRA cannot return with another action alleging violations based on the same conduct described in the AWC. Most brokers who settle through an AWC do so to avoid the hearing process either because they cannot retain an attorney and defend themselves or because they are no longer working in the securities industry and do not plan on returning.
A broker should fully comprehend the charges being settled, the evidence presented by the regulator, and the consequences of entering into a settlement before agreeing to settle an action through an AWC. For instance, a regulator may seek to settle charges against a broker for findings including fraud or other intentional violations. These findings, which are published and final, can have a major and permanent impact on the broker’s reputation, so it is important to know what the alleged conduct is and how the broker has been charged. In addition, understanding the evidence possessed by the regulator tends to show the strengths and weaknesses of the regulator’s case. A regulator may seek to settle a case that it believes it may not win if the case went on to a hearing. Therefore, brokers and their attorneys must evaluate the unique facts and circumstances of their case as well as what the regulators must prove before agreeing to settle. Moreover, a broker should be aware of the consequences of entering into a settlement. While some brokers are not dismayed by not being able to work in the securities industry again, they should understand that a disciplinary action might have an impact on the ability to work in other fields – especially those that require licensure. Given the possibility of other repercussions beyond settlement, brokers ought to consider hiring an experienced attorney to advise them through this process.
If the broker and FINRA agree on a settlement, FINRA’s lawyer will draft the AWC for the broker to sign and return. The AWC must be approved by the prosecuting department and reviewed and approved by the ODA. Once the ODA approves the settlement, the case is resolved in accordance with the terms of the AWC. If the ODA does not approve the settlement, the FINRA lawyer will typically relay the required changes by the ODA to the broker, who can either agree to the new terms or refuse and litigate the matter.THE DISCIPLINARY HEARING
If a settlement has not been reached following the Wells Submission letter, then FINRA will seek to file a formal disciplinary complaint against the broker. However, the FINRA lawyer must first get approval from the ODA to file the complaint – similar to the process of obtaining AWC approval. The prosecuting department will also review the matter and determine if there is sufficient evidence to support a rule violation.
After the complaint is filed with FINRA’s Office of Hearing Officers, a notice that the complaint has been filed as well as a copy of the complaint is mailed to the broker’s CRD address and any other address on file. The notice contains a due date for the broker to file a written answer, information on the hearing location, discovery details, and other important information. The broker will usually respond by admitting or denying the allegations and requesting a hearing. If an answer is filed and a hearing is requested, the hearing officer assigned to the case will hold a pre-hearing conference with the parties and schedule the case, which includes setting deadlines for discovery, filing of pre-hearing briefs and motions, witness and exhibit lists, and scheduling the hearing itself. The hearing officer is an employee of FINRA and serves as the chairperson of the hearing panel that will resolve the case. The other two panelists typically come from a regional committee comprised of industry professionals chosen by member firms.
The subject of the disciplinary action or the respondent is entitled to discovery in the case and is permitted to inspect and copy documents in the investigative file. However, a respondent is not entitled to all of FINRA’s documents pertaining to the case, and this is enumerated in FINRA’s rules. Brokers should note that enforcement officials do not have the power to obtain discovery from the respondent though FINRA may issue investigative letters under Rule 8210 requesting information of facts relating to certain affirmative defenses or facts a respondent may make reference to in his or her answer.
The final hearing is not as formal as a courtroom trial, though it may operate in a similar fashion. The hearing commences with opening statements by both the FINRA lawyer and the respondent’s lawyer. Afterward, FINRA will call witnesses to testify about the facts supporting its allegations in the complaint and introduce and explain the exhibits used against the respondent. The respondent is then given the opportunity to conduct cross-examinations of the witnesses called by FINRA. After FINRA has finished presenting its case, the respondent’s attorney is given the opportunity to call witnesses to testify, introduce and explain exhibits, and testify herself. Similarly, the FINRA attorney is then given the opportunity to conduct cross-examinations of any witnesses called by the respondent, which includes the respondent if he or she testified. The hearing panel may also ask questions of the witnesses and broker at any time during the hearing.
Following the close of all the evidence, each attorney will give their closing arguments and ask the panel to rule in favor of their respective clients – to find that FINRA proved or failed to prove the allegations against the broker and impose or deny sanctions. Hearing panels oftentimes make their decisions quickly, but it may not be immediately revealed to the parties. A written decision by the hearing officer, which outlines the respondent’s answer, admitted evidence and testimony, and the legal rationale for the panel’s ruling, is typically issued several months after the hearing is concluded. Upon issuance of the hearing panel’s decision, the matter is closed and the sanction imposed by the panel will go into effect unless an appeal is made or a final review is called for by the National Adjudicatory Council. The outcome of the case is reported on the broker’s U-4 and is available to the public.POST-COMPLAINT SETTLEMENTS
Many cases are also settled after a complaint is filed but before the hearing has commenced. These post-complaint settlements are resolved in a similar fashion to the pre-complaint settlements or AWCs. However, post-complaint settlements require brokers to submit an “offer of settlement.” In the offer of settlement, the broker “neither admits nor denies” FINRA’s allegations. The broker simply agrees to the entry of an order by the prosecuting FINRA department that states that the broker committed the violations described in the complaint and waives the right to a hearing. The negotiations with the prosecuting department must be approved in the same fashion as an AWC in order to close the disciplinary action.APPEALS
Appeals in FINRA disciplinary actions function differently from appeals in civil court actions. In a civil court action, if neither party decides to appeal the decision, the case is resolved and closed. In a FINRA disciplinary action, the National Adjudicatory Council (NAC) has discretion to review the case and force the parties through an appeal. The NAC’s purpose is to review case findings, evaluate the proposed sanctions, and affirm or reverse the hearing panel’s decision. Broker and prosecuting FINRA staff members can also appeal a hearing panel’s decision. These appeals are heard by the NAC, which can affirm, reverse, or modify the decision.
The appellate process can go on for several months or a year, and brokers registered with their firms are allowed to work during this period because sanctions imposed by the hearing panel do not go into effect while the NAC is reviewing or hearing the appeal. No additional evidence or testimony is presented except for written briefs submitted by the parties. Parties are given the opportunity to make their oral arguments before a subcommittee of the NAC, which will recommend a decision to the NAC. A final decision is ultimately announced by the NAC. If a broker believes that the NAC’s decision is unsupported, he or she can make a final appeal to the SEC. However, the sanctions imposed by FINRA are not delayed and will go into effect unless the SEC gives special instructions. On the other hand, FINRA would not be entitled to an appeal beyond the NAC if it were to lose its appeal.COLLATERAL ISSUES
Brokers ought to be aware of the collateral issues that may arise following a FINRA disciplinary action. These issues may very well include consequences that impact future job prospects, create civil liability, and frustrate state licensing registration. For example, if a broker has violated an industry rule that is also considered a criminal violation, any information obtained by FINRA in its prosecution can be used by criminal prosecutors against the broker. Another example involves the possible use of information and admissions obtained in a FINRA disciplinary action by customers who have suffered investment losses and have filed arbitration claims against the broker and his or her broker-dealer. A FINRA disciplinary action can also impact future employment if an employing broker-dealer’s policy is to not employ brokers with a disclosure on their record. This means that a while pending resolution of the regulatory examination, the broker may have to seek other employment opportunities. Even if the broker manages to stay with his or her current firm, it may be difficult to retain and attract new customers after his or her record has been blemished with a disclosure. Furthermore, brokers may incur licensing complications during and after a FINRA action. In many cases, brokers with regulatory disclosures face longer wait periods after an application for licensure is submitted. Brokers are encouraged to retain an attorney to assist them in determining whether any collateral issues may transpire and assess what the best route is for obtaining a long-term beneficial outcome.THE SECURITIES AND EXCHANGE COMMISSION’S ROLE
The SEC is a federal government agency that also investigates brokers who have allegedly violated federal securities laws and SEC rules and regulations. It works closely with agencies such as the Department of Justice and can bring civil charges against brokers as well. When the SEC discovers criminal misconduct by a broker, it may refer the matter to the Federal Bureau of Investigation and the Offices of the United States Attorneys.
SEC lawyers and examiners are authorized to issue subpoenas to obtain documents and testimony once the SEC is granted a formal order of investigation. If a broker chooses to not respond, there may be significant penalties. However, unlike FINRA examinations, the broker has the right to assert his or her 5th Amendment right against self-incrimination. Brokers should note that asserting this right may create inferences that may be used in civil cases connected to the investigation.STATE INVESTIGATIONS
The states are part of the North American Securities Administrator’s Association (NASAA), which promotes unity in the regulatory oversight of securities activities. Some examples of the NASAA’s role include proposing uniform rules and laws and assisting with interstate securities laws issues. However, each state has its own unique system for investigating securities activity and enforcing local laws, rules, and regulations. An appointed commissioner in each state oversees the regulation of securities business as well as all issues related to licensing, and the level of regulatory activity generally depends on the size of the staff, budget, and main concerns of the commissioner.
Licensure and registration requirements vary from state to state. Therefore, Form U-4 disclosures made in one state may not affect registration in another state, and more stringent states may take longer to approve an applicant’s license if an investigation initiated by the state is pending. In criminal prosecutions, the state’s staff may also work closely with or refer criminal matters to other appropriate law enforcement agencies. Brokers should note that they can withdraw their application for licensure before it is formally denied by a state. This is important because a formal denial by one state may initiate a review of a broker’s record by another state, which may hinder a broker’s application in other states.
Please read this brief Introduction on FINRA Examinations and Investigations and call The Law Offices of Robert Wayne Pearce, P.A., located in Boca Raton, Florida if you still have questions that need to be answered. For over 35 years, Attorney Pearce has tried, arbitrated, and mediated hundreds of disputes involving complex securities, commodities and investment law issues. The lawyers at our law firm are devoted to protecting stockbrokers’ rights before FINRA throughout the United States! Please visit our website, www.secatty.com, call (800) 732-2889, or email Mr. Pearce at email@example.com for answers to any of your questions about this article and/or any related matter.