U.S. SRO proposes crackdown on repeat offenders

By James Langton | November 17, 2020 | Last updated on November 17, 2020
2 min read
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In an effort to crack down on the brokerage industry’s repeat offenders, the Financial Industry Regulatory Authority Inc. (FINRA) is proposing rule changes that would impose new conditions on firms with long histories of misconduct.

The U.S self-regulatory organization has filed proposals with the U.S. Securities and Exchange Commission that would require firms with poor enforcement records to maintain a restricted account that could only be used with FINRA’s approval, along with other operational restrictions.

The new rule would use numeric thresholds based on firms’ and individual brokers’ disciplinary issues to identify firms that present a high risk to the investing public. A restricted deposit requirement would then be imposed on those firms.

“FINRA believes that the direct financial impact of a restricted deposit is most likely to change such member firms’ behaviour — and therefore protect investors,” the regulator said, adding that it would also ensure that some funds are set aside to pay future investor compensation awards.

FINRA said that the proposal stems from an ongoing effort to address the risks posed by firms and individual reps with an extensive history of misconduct.

In its rule filing, the SRO noted that recent academic research has found that “some firms persistently employ brokers who engage in misconduct” and that there’s evidence that disciplinary history “can be predictive” of future misbehaviour.

Targeting firms that are likely to reoffend represents a “first line of defence” to prevent investor harm, FINRA said, noting that these firms “expose investors to real risk.”

While FINRA’s compliance examination efforts can help identify weaknesses and recommend measures to address those issues, FINRA can’t mandate that firms take remedial action without bringing enforcement proceedings.

FINRA said that repeat offenders can take advantage of these limitations to continue exploiting investors until FINRA finally takes enforcement action.

“These proceedings can take significant time to develop, prosecute and conclude, during which time the individual or firm is able to continue misconduct, with significant risks of additional harm to customers and investors,” FINRA said, adding that repeat offenders often litigate these cases, rather than settling them, which drags out the process.

Additionally, the traditional enforcement process can leave investors exposed. “When all appeals are exhausted, the firm may have withdrawn its FINRA membership and shifted its business to another member or other type of financial firm, limiting FINRA’s jurisdiction and avoiding the sanction, including making restitution to customers,” the regulator noted.

An upfront restricted deposit requirement aims to address some of the weaknesses in the existing compliance-enforcement continuum when it comes to dealing with serial offenders.

The proposal would also establish an expedited review process for firms facing restricted account requirements under the new rule.

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James Langton

James is a senior reporter for Advisor.ca and its sister publication, Investment Executive. He has been reporting on regulation, securities law, industry news and more since 1994.