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New Bad Broker Rule Reflects Finra’s “Greater Risk, Greater Capital Requirement” Policy

By Rita Raagas De Ramos May 16, 2019

A newly proposed rule from Finra that’s intended to deal with member firms who hire bad actors with significantly more misconduct records than their peers is built on the concept of equating a firm’s risk level to its capital requirement, insists Finra president and CEO Robert Cook.

“The greater the risk” posed by the firm, the greater the need to “put aside more capital,” Cook said Wednesday when explaining the thinking behind the proposed rule at Finra’s annual conference in Washington D.C.

As reported, Finra published earlier this month a proposed new rule – Rule 4111 (Restricted Firm Obligations) – that would impose additional obligations on firms with a significant history of misconduct.

Finra says only a “small” number of its member firms have a high concentration of records of registered representatives’ misconduct, but they present heightened risk to their clients and “may undermine confidence in the securities markets as a whole.”

Cook said “less than 2%” of Finra’s member firms fall under that high-risk category.

The new rules would impose “tailored obligations” – including possible financial requirements – on broker-dealer firms that cross specified numeric misconduct record thresholds, which would be computed on an annual basis.

The obligations could include requiring a member to maintain a specific deposit amount with cash or qualified securities in a segregated account at a bank or clearing firm. Withdrawals could be made only with Finra approval.

The deposit is aimed at preserving the firm’s funds for the payment of arbitration awards that may be rendered against them. Thus, any unpaid arbitration awards could impact the size of the required deposit from the firm.

Cook said Finra’s goal when crafting this proposed rule was to come up with an “objective criteria” for measuring these high-risk member firms.

To determine if a broker-dealer firm has hit the significant misconduct history threshold, Finra is proposing numeric thresholds based on six categories of events or conditions based on information disclosed through the Uniform Registration Forms. The six categories are:

  • Registered Person Adjudicated Events
  • Registered Person Pending Events
  • Registered Person Termination and Internal Review Events
  • Member Firm Adjudicated Events
  • Member Firm Pending Events
  • Registered Persons Associated with Previously Expelled Firms (also referred to as the Expelled Firm Association category).

When Finra did back-testing over the past two-to-four years, the SRO found there were member firms with up to nine times the misconduct records of their peers.

Cook said that “on first blush,” it looks like Finra got this set of high-risk member firm criteria right.