FINRA Raises Stakes in 2022 for Firms Tolerating Bad Brokerage Disciplinary Histories

Investment Management Update

Date: January 05, 2022

In the 2000 movie Boiler Room, actor Ben Affleck’s brokerage firm manager character chastises his broker trainees for failing to get customers to buy at all costs. He asks them, “Does anyone here have a Series 7?” An ambitious newbie responds that he has his brokerage license and is promptly fired. Affleck responds, “We don’t hire brokers here, we train new ones.”

In October 2020, FINRA took aim at these firm cultures, crafting a new rule focused on brokers and representatives with disciplinary histories. Effective January 2022, FINRA implements a risk score for all firms which will impose significant heightened restrictions.

FINRA Regulatory Notice 21-34 announced Rule 4111 which will ascribe a numerical score to all broker-dealer firms “with a significant history of misconduct,” identifying them with the scarlet letter of “Restricted Firms.” These firms shall be required to “… deposit [additional] cash or qualified securities in a segregated, restricted account; adhere to specified conditions or restrictions; or comply with a combination of such obligations.”

This is not a new concept. The rule was originally proposed by FINRA in 2019, which FINRA announced as an effort to provide investors greater transparency into brokerage activity of firms that investors may select, and to encourage broker-dealers to consider representatives more carefully in their hiring and retention practices.

The rule offers guidance to broker-dealers of this calculation in a matrix form as follows:

Firm Size 
Category

Number
o

Registered 
Persons
In-Scope
in Firm 
Size
Category

Preliminary Identification Metrics Thresholds1

Thresholds for Registered Person Event Metrics:

Thresholds for Member Firm Event Metrics:

Threshold
for 
Expelled
Firm 
Association Metric:

Registered Person
Adjudicated Event 
Metric

(1)

Registered Person
Pending
Event
Metric

(2)

Registered Person
Termination and Internal Review Event Metric

(3)

Member
Firm
Adjudicated Event
Metric

(4)

Member
Firm
Pending
Event
Metric

(5)

Expelled
Firm
Association
Metric

(6)

1

1-4

0.50

0.20

0.10

0.75

0.25

0.30

2

5-9

0.30

0.20

0.10

0.30

0.10

0.25

3

10-19

0.20

0.10

0.10

0.30

0.05

0.20

4

20-50

0.20

0.10

0.10

0.20

0.02

0.15

5

51-150

0.20

0.05

0.10

0.15

0.01

0.03

6

151-499

0.15

0.05

0.10

0.10

0.01

0.01

7

500+

0.10

0.05

0.10

0.05

0.01

0.01

Firms for which FINRA provides notice of exceeding minimum risk score thresholds as determined by the six matrix categories will have a few initial options:

  1. Take advantage of a one-time voluntary staff reduction of representatives whose disciplinary histories cause the risk score to exceed permissible levels;
  2. Seek a consultative meeting with FINRA to explain why the firm should not be identified as a Restricted Firm or suggest changes it may implement to comply;
  3. Concede that it qualifies as a Restricted Firm, but seek rebuttal that it should not be subject to the maximum Restricted Deposit Requirements, and argue for a lower deposit requirement; or
  4. Following a Restricted Firm determination notice, request a hearing.


Significantly, a request for hearing will NOT stay implementation of the determination but will allow appellants to establish a Restricted Deposit Account and deposit no less than 25% of the FINRA-assumed maximum amount until hearing determinations are made.

Firms that fail to comply will be subject to a suspension of all or part of their business.

Broker-dealers, and the advisors who hire them, are well advised to understand the impact of this new rule on their operations, hiring and retention practices, and the profitability of their business lines. Firms should proactively assess their books and records procedures and disciplinary monitoring processes, as well as the disclosure requirements imposed by the rule.

FOR MORE INFORMATION

For more information, please contact:

Andrew J. Davalla
614.469.3353
Andrew.Davalla@ThompsonHine.com

Marc B. Minor
614.469.3232
Marc.Minor@ThompsonHine.com

[1] Source: FINRA.org/Rules-guidance 

This advisory bulletin may be reproduced, in whole or in part, with the prior permission of Thompson Hine LLP and acknowledgment of its source and copyright. This publication is intended to inform clients about legal matters of current interest. It is not intended as legal advice. Readers should not act upon the information contained in it without professional counsel.

This document may be considered attorney advertising in some jurisdictions.

© 2022 THOMPSON HINE LLP. ALL RIGHTS RESERVED.