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...

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