Start Preamble
December 10, 2020.
I. Introduction
On April 3, 2020, Financial Industry Regulatory Authority, Inc. (“FINRA”) filed with the Securities and Exchange Commission (“Commission”), pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (“Exchange Act”) []
and Rule 19b-4 thereunder,[]
a proposed rule change to amend FINRA's rules to help further address the issue of associated persons with a significant history of misconduct and the broker-dealers that employ them.
The proposed rule change was published for comment in the Federal Start Printed Page 81541Register on April 14, 2020.[]
On May 27, 2020, FINRA consented to an extension of the time period in which the Commission must approve the proposed rule change, disapprove the proposed rule change, or institute proceedings to determine whether to approve or disapprove the proposed rule change to July 13, 2020.[]
On July 2, 2020, FINRA responded to the comment letters received in response to the Notice and filed an amendment to the proposed rule change (“Amendment No. 1”).[]
On July 13, 2020, the Commission filed an Order Instituting Proceedings to determine whether to approve or disapprove the proposed rule change, as modified by Amendment No. 1.[]
On October 5, 2020, FINRA consented to an extension of the time period in which the Commission must approve the proposed rule change, disapprove the proposed rule change, or institute proceedings to determine whether to approve or disapprove the proposed rule change to December 10, 2020.[]
On October 7, FINRA responded to the comment letter received in response to the Order Instituting Proceedings.[]
This order approves the proposed rule change, as modified by Amendment No. 1.
II. Description of the Proposed Rule Change
Background
FINRA's proposed rule change would: (1) Amend the FINRA Rule 9200 Series (Disciplinary Proceedings) and the 9300 Series (Review of Disciplinary Proceedings by National Adjudicatory Council and FINRA Board; Application for SEC Review) to allow a hearing officer to impose conditions or restrictions on the activities of a respondent member broker-dealer or respondent associated person (each a “Respondent” or collectively “Respondents”), and require the member broker-dealer employing a respondent associated person to adopt heightened supervisory procedures for such associated persons, when a disciplinary matter is appealed to the National Adjudicatory Council (“NAC”) or called for NAC review; (2) amend the FINRA Rule 9520 Series (Eligibility Proceedings) to require member broker-dealers to adopt heightened supervisory procedures for statutorily disqualified associated persons during the period a statutory disqualification eligibility request is under review by FINRA; (3) amend FINRA Rule 8312 (FINRA BrokerCheck Disclosure) to require disclosure through FINRA BrokerCheck of the status of a member broker-dealer as a “taping firm” under FINRA Rule 3170 (Tape Recording of Registered Persons by Certain Firms); and (4) amend the FINRA Rule 1000 Series (Member Application and Associated Person Registration) to require a member broker-dealer to submit a written request to FINRA's Department of Member Regulation (“Member Regulation”), through the Membership Application Group (“MAP Group”), seeking a materiality consultation []
and approval of a continuing membership application, if required, when a natural person seeking to become an owner, control person, principal, or registered person of the member broker-dealer has, in the prior five years, one or more “final criminal matters” or two or more “specified risk events.” []
Proposed Rule Change to the FINRA Rule 9200 Series (Disciplinary Proceedings) and 9300 Series (Review of Disciplinary Proceeding by National Adjudicatory Council and FINRA Board; Application for SEC Review)
FINRA proposed amendments to the Rule 9200 Series and Rule 9300 Series to address investor protection concerns during the pendency of an appeal from, or a NAC review of, a hearing panel or hearing officer disciplinary decision, by authorizing hearing officers to impose conditions or restrictions on disciplined Respondents and requiring broker-dealers to adopt heightened supervision plans concerning their associated persons who are disciplined respondents.[]
The proposed rule change would also establish a process for an expedited review by the Review Subcommittee of the NAC of any conditions or restrictions imposed.[]
Currently, when a hearing panel or hearing officer decision is on appeal or review before the NAC, any sanctions imposed by the decision, including bars and expulsions, are automatically stayed and not enforced against the Respondent during the pendency of the appeal or review proceeding.[]
Thereafter, the filing of an application for Commission review stays the effectiveness of any sanction, other than a bar or an expulsion, imposed in a decision constituting a final FINRA disciplinary action.[]
Proposed Rule 9285(a) would provide that the hearing officer who participated in an underlying disciplinary proceeding may impose conditions or restrictions on the activities of the Respondent during the appeal of any adverse finding. Specifically, if the hearing officer found that a Respondent violated a statute or rule provision, which is subsequently appealed to the NAC or called for NAC review, the hearing officer may impose conditions or restrictions reasonably necessary for the purpose of preventing customer harm.[]
The scope of these conditions or Start Printed Page 81542restrictions would depend on what the hearing officer determines to be reasonably necessary for the purpose of preventing customer harm. Further, the conditions and restrictions would target the misconduct demonstrated in the disciplinary proceeding and be tailored to the specific risks posed by the Respondents during the appeal period.[]
Accordingly, the conditions and restrictions are not intended to be as restrictive as the underlying sanctions and would likely not be economically equivalent to imposing the sanctions during the appeal.[]
In addition, Respondents would be able to seek expedited reviews of orders imposing conditions or restrictions.[]
Currently, any sanctions imposed by the hearing panel or hearing officer decision, including bars and expulsions, are automatically stayed and not enforced against the Respondent during the pendency of the NAC appeal or review proceeding.[]
Under the proposed rule change, the conditions or restrictions imposed by a hearing officer would remain in place until FINRA's final decision takes effect and all appeals are exhausted.[]
In addition, proposed FINRA Rule 9285(e) would require a member broker-dealer to adopt a written plan of heightened supervision for an associated person who is found to have violated a statute or rule provision. The plan of heightened supervision would be required to comply with FINRA Rule 3110, be reasonably designed and tailored to include specific supervisory policies and procedures that address the violations found by the hearing panel or hearing officer, and be reasonably designed to prevent or detect a reoccurrence of these violations.[]
Proposed Rule Change to the FINRA Rule 9520 Series (Eligibility Proceedings)
A broker-dealer is not currently required to place a statutorily disqualified individual on heightened supervision while FINRA reviews the member broker-dealer's application to continue associating with the individual (although FINRA generally will not approve an application without an acceptable plan of supervision).[]
Under the proposed rule change, FINRA would amend FINRA Rule 9522 to require a member broker-dealer that files an application to continue associating with a statutorily disqualified associated person under FINRA Rule 9522(a)(3) or 9522(b)(1)(B) to include an interim plan of heightened supervision that would be in effect throughout the entirety of the application review process.[]
The proposed rule changes would delineate the circumstances under which a statutorily disqualified individual may remain associated with a FINRA member while FINRA is reviewing the application.[]
Proposed Rule Change to FINRA Rule 8312 (FINRA BrokerCheck Disclosure)
FINRA proposed an amendment to FINRA Rule 8312 governing the information FINRA releases to the public through its BrokerCheck system. Currently, FINRA Rule 8312(b) requires that FINRA release information about, among other things, whether a particular member broker-dealer is subject to the provisions of FINRA Rule 3170 (“Taping Rule”), but only in response to telephonic inquiries via the BrokerCheck toll-free telephone listing.[]
The Taping Rule is designed to ensure that a member broker-dealer with a significant number of registered persons that previously were employed by “disciplined firms” []
has specified supervisory procedures in place to prevent fraudulent and improper sales practices or customer harm, including, among other things, procedures for recording all telephone conversations between the taping firm's registered persons and both existing and potential customers.[]
Proposed Rule 8312(b) would not eliminate the toll-free telephone listing but rather would also require FINRA to release through BrokerCheck information as to whether a particular member broker-dealer is subject to the Taping Rule.[]
The proposed rule change would remove the requirement in FINRA Rule 8312(b) that FINRA inform the public that a member broker-dealer is subject to the Taping Rule only in response to telephonic inquiry via the BrokerCheck toll-free telephone listing.[]
FINRA believes that broadening the disclosure through BrokerCheck of the status of a member broker-dealer as a taping firm would help inform more investors of the heightened procedures required of the firm, which may incentivize investors to research more carefully the background of a registered representative associated with the taping firm.[]
Proposed Rule Change to FINRA Rule 1000 Series (Member Application and Associated Person Registration)
The FINRA Rule 1000 Series governs, among other things, FINRA's membership proceedings. Currently, a member broker-dealer is permitted (subject to exceptions) to expand its business under the safe harbor set forth in FINRA interpretive material IM-1011-1 without the filing and prior approval of a CMA.[]
For example, under the existing parameters of this safe harbor, a broker-dealer could hire an associated person even if he or she has a significant history of misconduct.[]
The proposed rule change would limit the application of the safe harbor by imposing additional obligations on a member broker-dealer when a natural person who has, in the prior five years, either one or more “final criminal matters” or two or more “specified risk events” seeks to become Start Printed Page 81543an owner, control person, principal, or registered person of the broker-dealer.[]
Specifically, when a natural person seeking to become an owner, control person, principal, or registered person of a member broker-dealer has, in the prior five years, one or more “final criminal matters” or two or more “specified risk events,” proposed Rule 1017(a)(7) would require a member broker-dealer to either: (1) File a CMA; or (2) submit a written request seeking a materiality consultation for the contemplated activity with FINRA's MAP Group.[]
If the broker-dealer seeks a materiality consultation, the MAP Group would consider, among other things, whether the “final criminal matters” or “specified risk events” are customer-related; whether they represent discrete actions or are based on the same underlying conduct; the anticipated activities of the person; the disciplinary history, experience and background of the proposed supervisors, if applicable; and the disciplinary history, supervisory practices, standards, systems and internal controls of the member broker-dealer and whether they are reasonably designed to achieve compliance with applicable securities laws and regulations and FINRA rules.[]
Where FINRA determines that a contemplated organizational change is material, FINRA would instruct the broker-dealer to file a CMA if it intends to proceed with such change.
Additionally, the proposed rule change would adopt a corresponding change to IM-1011-1 (Business Expansions and Persons with Specified Risk Events) to specify that the safe-harbor for business expansions in IM-1011-1 would not be available to any broker-dealer seeking to add a natural person who: (i) Has, in the prior five years, one or more “final criminal matters” or two or more “specified risk events” and (ii) seeks to become an owner, control person, principal, or registered person of the member.[]
In those circumstances, proposed IM-1011-3 would provide that if the broker-dealer is not otherwise required to file a CMA, it must comply with the requirements of proposed FINRA Rule 1017(a)(7).[]
Proposed Rule 1017(a)(7) would establish that the safe-harbor for business expansions in IM-1011-1 would not be available to a member broker-dealer when a materiality consultation is required.[]
The proposed rule change would also make non-substantive changes to the MAP rules by renumbering paragraphs and updating cross-references to reflect the other proposed rule changes.
III. Discussion and Commission Findings
After careful review of the proposed rule change, as modified by Amendment No. 1, the comment letters, and FINRA's responses to the comments, the Commission finds that the proposed rule change, as modified by Amendment No. 1, is consistent with the requirements of the Exchange Act and the rules and regulations thereunder that are applicable to a national securities association.[]
Specifically, the Commission finds that the proposed rule change, as modified by Amendment No. 1, is consistent with Section 15A(b)(6) of the Exchange Act,[]
which requires, among other things, that FINRA rules be designed to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade, and, in general, to protect investors and the public interest.
Rule 9200 Series (Disciplinary Proceedings) and 9300 Series (Review of Disciplinary Proceeding by National Adjudicatory Council and FINRA Board; Application for SEC Review)
The proposed rule change to authorize hearing officers to impose conditions or restrictions on disciplined Respondents reasonably necessary for the purpose of preventing customer harm, and to require broker-dealers to adopt heightened supervision plans concerning individual respondents, will help protect investors from associated persons found to have violated a statute or rule provision, by potentially preventing them from engaging in additional misconduct during the appeal process. These proposed rule changes are designed to help prevent fraudulent and manipulative acts and practices and address concerns related to misconduct that may occur during the pendency of an appeal from, or a NAC review of, a hearing panel or hearing officer disciplinary decision.[]
The Commission believes the ability to impose conditions or restrictions along with the proposed requirement to adopt a plan of heightened supervision will lead to greater oversight of disciplined Respondents' activities during the appeal period, thereby reducing the Start Printed Page 81544potential risk of customer harm that may occur during this period.
Two commenters supported the proposed rule change.[]
Two other commenters, however, expressed concern that these proposed rule changes to the Rule 9200 Series and 9300 Series do not adequately ensure due process and one specifically recommended FINRA take additional steps to “ensure due process, both in appearance and actual.” []
In response, FINRA detailed the procedural protections proposed Rule 9285 would establish. Specifically, prior to imposing any conditions or restrictions the proposed rule change would: (i) Require Enforcement to file a motion with a hearing officer, seeking the imposition of conditions or restrictions that are reasonably necessary for the purpose of preventing customer harm, specifying the conditions and restrictions that are sought to be imposed, and explaining why they are necessary; (ii) provide the Respondent an opportunity to file a written opposition or other response to the motion; (iii) require the hearing officer to issue a written order ruling upon the motion no later than 20 days after any opposition or response is filed; and (iv) afford a Respondent the right to seek expedited review []
before the NAC's Review Subcommittee of an order that imposes conditions or restrictions, and an automatic stay when a Respondent requests such an expedited review.[]
As stated above, currently any sanctions imposed by the hearing panel or hearing officer decision, including bars and expulsions, are automatically stayed and not enforced against the respondent during the pendency of the NAC appeal or review proceeding.[]
One of the commenters urging FINRA to ensure due process stated that the proposed rule change should not “be stripped away” by changing the existing stay and giving a hearing officer authority to impose conditions and restrictions on the Respondent during the process of appealing a hearing officer's decision. Accordingly, the commenter expressed concern that the imposition of such conditions or restrictions could ruin a broker-dealer's business before the expedited review process has concluded, especially a smaller broker-dealer with fewer alternatives to withstand extended impediments to one of its business lines.[]
Another commenter,[]
however, expressed support for the proposed rule change and advocated for FINRA to go further by eliminating the existing stay of decisions by the hearing officer or hearing panel in disciplinary matters pursuant to Rule 9268 []
or Rule 9269,[]
in which the adjudicator finds that a Respondent violated a statute or rule provision, during an appeal to the NAC by repealing FINRA Rule 9311.[]
FINRA considered both suggestions and decided not to amend the proposed rule change. Specifically, FINRA believes that enforcing the hearing panel's disciplinary sanctions against the Respondents during the pendency of the appeal or review proceedings could be too restrictive in disciplinary matters with significant sanctions and where the risk of harm may be specific to particular activities.[]
On the other hand, FINRA stated that the proposed rule change would authorize a hearing officer to impose conditions and restrictions that are tailored specifically to the risk posed by the Respondent during the pendency of the appeals, and reasonably necessary for the purpose of preventing customer harm that may occur during the pendency of the appeal. Accordingly, FINRA determined that the proposed rule change would strike a reasonable balance between protecting investors and preventing undue burden on individuals and firms while their appeals are pending.[]
A system designed to protect investors and the public interest will generally produce both costs and benefits. In this instance, FINRA's proposed rule change should reduce the probability of investor losses resulting from the violation of statutes or rules. At the same time, a decision to impose conditions or restrictions may disrupt the business opportunities of certain broker-dealers and individuals. In order to assess the potential risk posed by brokers during the appeal period, FINRA examined cases that were appealed to the NAC during the period of 2013-2016 and determined whether the brokers associated with an appeal to the NAC had a new disclosure event—for this analysis, a “final criminal matter” or a “specified risk event,” as defined above—at any time from the filing of the appeal through the year-end after the year in which the appeal reached a decision. Based on this analysis, FINRA estimated that 21 of the 75 brokers who appealed to the NAC during the 2013-2016 period were associated with a total of 28 disclosure events that occurred during the interstitial period after the filing of their appeal to the NAC.[]
Start Printed Page 81545
After considering these benefits and costs, the Commission believes that the proposed procedural protections provide a reasonable process to Respondents who may disagree with the particular set of conditions or restrictions imposed by a hearing officer to challenge those conditions or restrictions before they go into effect by, among other things, establishing an expedited process for the review of a hearing officer's order by the Review Subcommittee of the NAC. During a hearing officer's review, he or she may consider the specific facts and circumstances when weighing the additional risk(s) posed by the Respondent while the matter is on appeal against the costs of possible restrictions and sanctions. The Commission believes this potential disruption of the business opportunities of certain broker-dealers and individuals has been appropriately balanced against the investor protections the proposed rule change would establish, as well as the need to prevent potential customer harm from Respondents who have been found in violation of FINRA rules by a hearing officer or hearing panel.[]
Rule 9520 (Eligibility Proceedings)
The proposed rule change to require broker-dealers to include a plan of heightened supervision with an application to continue associating with a statutorily disqualified individual that would be in effect throughout the entirety of the application review process also would address an investor protection concern by lowering the risk of customer harm during the pendency of an application. One commenter opposed this proposed rule change, arguing that establishing plans of heightened supervision are costly and burdensome and would discourage broker-dealers from hiring associated persons who have been disciplined.[]
However, FINRA is not creating an additional burden with respect to the requirement to create a plan of heightened supervision; it is only requiring a member broker-dealer implement such plan at an earlier point in time than under the existing rules. Currently, as part of the application process, a member broker-dealer will propose a written plan of heightened supervision to become effective upon approval of the application, and generally, the continued association of a statutorily disqualified person approved through a FINRA eligibility proceeding is conditioned on the individual being subject to a heightened supervision plan.[]
This proposed rule change would help limit the potential for customer harm at an earlier point in time and thereby help protect customers. In order to assess the potential risk posed by a statutorily disqualified person during the pendency of his or her application, FINRA examined whether individuals who filed an application between 2013-2016 had a disclosure event at any time from the filing of the application through two years after filing. Based on this analysis, FINRA estimated that 26 (or 51 percent) of the 51 individuals associated with an applications during the 2013-2016 period had a total of 41 disclosure events during the interstitial period after the filing of their application.[]
As stated above, although the Commission recognizes the potential burden imposed by requiring the supervision plan to become effective at an earlier stage of this process, it believes that the benefits of added oversight of disqualified individuals subject to the pending application process justifies the earlier timeframe. Accordingly, while the proposed rule change may negatively impact the ability of certain individuals to retain or find employment, it is a reasonable approach for seeking to achieve greater oversight by sponsoring broker-dealers of the activities of statutorily disqualified individuals during the pendency of an application. The Commission believes that applying heightened supervision specifically tailored in response to the misconduct giving rise to the statutory disqualification at an earlier stage in the process will facilitate a broker-dealer's supervision of statutorily disqualified individuals and better protect its customers from future harm.
Rule 8312 (FINRA BrokerCheck Disclosure)
The proposed rule change adding disclosure in BrokerCheck of member broker-dealers that are subject to the Taping Rule would help inform more investors when certain broker-dealers are subject to certain heightened procedures.[]
One commenter stressed that this disclosure may not be sufficient to ensure investors understand what it means to be designated a “taping firm” and suggested that FINRA amend the proposed rule change to require the BrokerCheck profiles of individual registered representatives to denote when they are associated with taping firms. FINRA did not accept this comment because it would be a substantive amendment to what is otherwise a proposed technical change.[]
FINRA also expressed concern that the commenter's suggestion to include a disclosure on the BrokerCheck profile of individuals would capture registered representatives of a taping firm with clean disciplinary histories.[]
The commenter also recommended that any disclosure of a firm as a taping firm on BrokerCheck should include “clear and complete information, comprehensible to investors, explaining what it means to be such a firm.” []
FINRA agreed with the view expressed that the BrokerCheck disclosure should include a clear explanation of what it means to be subject to the Taping Rule to help investors understand why the taping firm is subject to heightened procedures.[]
FINRA did not make a corresponding amendment to the rule but the Commission understands that FINRA has committed to including a Start Printed Page 81546clear explanation on BrokerCheck about what being subject to the Taping Rule means.[]
The Commission believes that this proposed rule change would improve the ease of obtaining this information for investors through a preexisting database with which the public is already familiar. Furthermore, the Commission believes that the proposed rule change would incentivize investors to research more carefully the background of a registered representative associated with a broker-dealer that is designated as a taping firm, including those registered representatives associated with the firm who are not subject to heightened supervision.
Rule 1000 Series (Member Application and Associated Person Registration)
The proposed rule change, requiring a member broker-dealer to seek a materiality consultation when a natural person seeking to become an owner, control person, principal, or registered person has a significant history of misconduct, would give FINRA an opportunity to assess whether the proposed association is material and warrants closer regulatory scrutiny. Similarly, in situations where a proposed association of a natural person with a significant history of misconduct would require the broker-dealer to submit a CMA, FINRA would be able to: (i) Assess whether the broker-dealer would continue to meet all of the membership standards in FINRA Rule 1014 if the proposed association were approved, and (ii) prevent the proposed association if the broker-dealer does not demonstrate that it can continue to meet those standards. This proposed rule change will further promote investor protection by applying additional safeguards and disclosure obligations for a broker-dealer's continuing membership with FINRA and for changes to a current member broker-dealer's ownership, control, or business operations. The heightened scrutiny by FINRA of registered representatives, registered principals, owners, and control persons who meet the proposed definitions and criteria would be beneficial in promoting investor protection by disincentivizing broker-dealers from engaging in higher-risk activity that could lead to additional regulatory restrictions.[]
For example, one commenter stated that this proposed rule would create obstacles for broker-dealers seeking to hire and onboard associated persons with a significant history of misconduct,[]
which may incentivize broker-dealers to reexamine their hiring practices and certain associated persons to change their behavior to avoid future misconduct.[]
Two commenters raised several concerns about, and suggested revisions to, the proposed rule changes to the Rule 1000 Series (Member Application and Associated Person Registration).[]
One of these commenters questioned whether adding one person should constitute a material change in business operations. Specifically, the commenter disagreed that adding a new owner or control person is sufficient to make a material impact in business operations unless that person is involved in sales. Accordingly, the commenter recommended revising proposed IM-1011-3 to exclude from the IM-1011-1 safe harbor only broker-dealers increasing their business operations by adding associated persons involved in sales.[]
FINRA declined to amend the proposed rule change as suggested because adding a natural person as an owner, control person, principal, or registered person who has, in the prior five years, one or more final criminal matters or two or more specified risk events could constitute a material change in business operations given the greater risk of harm to customers than the risk stemming from other associated persons. FINRA reiterated that IM-1011-3 is designed to prevent broker-dealers from relying on the IM-1011-1 safe harbor to avoid a materiality consultation—and any CMA that is subsequently required—when it seeks to add such persons.[]
The Commission agrees with FINRA's assessment of what could constitute a material change in business operations. Specifically, the Commission believes that natural persons with a certain history of misconduct holding authority to control a firm's business operations may increase the risk of investor harm. Accordingly, limiting the interpretation of materiality to persons involved in sales as suggested by the commenter could weaken the effectiveness of the proposed rule change to protect investors and incentivize improved behavior. The Commission also notes that the materiality consultation process required by proposed Rule 1017(a)(7) would be similar to FINRA's existing materiality consultation process and would provide the member broker-dealer an opportunity to be heard on whether the contemplated change is material. Specifically, under proposed Rule 1017(a)(7), a member broker-dealer would submit a written request seeking a materiality consultation and addressing the issues that are central to the materiality consultation; as part of the materiality consultation, Member Regulation must consider the written request and other information or documents provided by the member, including whether the proposed association would materially impact the broker-dealer's business operations. If Member Regulation determines that a CMA is required, the CMA would be governed by the existing process set forth in FINRA Rule 1017 and the Rule 1010 Series, including its appeal rights. The Commission agrees with FINRA's assessment that these procedures would be similar to FINRA's existing materiality consultation process and would provide the member broker-dealer an opportunity to be heard on whether the contemplated change is material.[]
The other commenter, critical of the proposed changes to the Rule 1000 Series, believes that the proposed rule changes are overbroad and that inclusion of settled matters as a Start Printed Page 81547criterion is “indefensible.” []
FINRA considered this comment but did not exclude settled matters from the list of determining factors. Instead, FINRA chose not to include certain settled matters in the proposed rule changes to the Rule 1000 Series in order to exclude individuals who are less likely to subsequently pose risk of harm to customers.[]
Specifically, in order to focus its analysis on outcomes that are more likely associated with material customer harm, FINRA studied complaints that led to an award against a broker or settled above a de minimis threshold ($15,000), which is the current CRD settlement threshold for reporting customer complaints on Uniform Registration Forms. FINRA found that a proposal based on events disclosed on the Uniform Registration Forms, which are generally available to firms and FINRA, was important to avoid confusion and provide transparency about the events that will trigger the need for a materiality consultation.[]
The Commission agrees that the proposed rule changes to the Rule 1000 Series are tailored sufficiently to achieving the goal of protecting investors from the risks associated with associated persons who have a significant history of misconduct. Specifically, the Commission agrees that excluding some settled matters from these thresholds is appropriate. For instance, recently settled matters are likely more indicative of an associated person's future misconduct than matters occurring over five years ago (absent any intervening disciplinary or other regulatory events); and individuals with a history of misconduct who have little or no control over a broker-dealer's activities may pose less threat to the broker-dealer's customers than individuals who can exercise some discretion when performing their jobs. Accordingly, settlements beyond the five-year lookback period and settlements by persons other than those seeking to be an owner, control person, principal, or registered person may have less relevance in achieving the goal of protecting investors from the risks associated with associated persons who have a significant history of misconduct.[]
This commenter also argued that FINRA's proposed definition of a “specified risk event”—a key triggering factor for the proposed enhanced membership application proceedings—is overbroad and would lead to unnecessary costs, burdens and disruptions for broker-dealer members.[]
As proposed, the definition would include any “final investment-related, consumer initiated arbitration” that results in an award or a settlement “at or above $15,000.” The commenter believes the use of arbitration awards and settlements with customers at such a “low” dollar threshold is over-inclusive and would not appropriately describe a “risk event” that should require a CMA or the proposed mandatory materiality consultation.[]
FINRA disagrees with the commenter's assessment that the proposed definition of “specified risk event” attempts to replace the analysis conducted in a CMA with a bright-line rule that any customer arbitration at or above the $15,000 threshold is defined as creating a risk to investors.[]
Under proposed Rule 1017(a)(7), only arbitration awards or settlements meeting the specific parameters detailed in Rule 1017(a)(7) and IM-1011-3 would be considered for determining when a materiality consultation would be required.[]
Moreover, a single award or settlement would not necessarily require a materiality consultation. In fact, even if a person meets the Rule 1017(a)(7) standard, it would not necessarily mean a CMA is required or, if it is, that the broker-dealer could not satisfy FINRA's membership standards.[]
FINRA also stated that the dollar thresholds as proposed are appropriate given that settlements at that level are more likely to be associated with material customer harm []
and they are the same thresholds as those used for determining appropriate disclosure events in FINRA's Uniform Registration Forms.[]
FINRA has noted that using different thresholds may result in less transparency to the public, registered persons, and broker-dealers.[]
The Commission believes FINRA made a reasonable argument for including settlements of at least $15,000 in its study []
and that its proposed definition of “specified risk event” furthers the goal of protecting investors from high risk associated persons. In addition, the Commission believes that the proposed criteria and definitions of “final criminal matter” and “specified risk event” would provide transparency regarding how the proposed rules would be applied, as the underlying events are based on disclosure events required to be reported on the Uniform Registration Forms. Accordingly, broker-dealers would be able to identify the specific set of disclosure events that would count towards the proposed criteria and, using available data, determine independently whether a proposed association with an individual would require a materiality consultation.
One commenter also challenged FINRA's statistical justification for the proposed rule change.[]
In particular, the commenter questioned whether the studies upon which FINRA relied adequately demonstrate that past disciplinary and other regulatory events associated with a member broker-dealer or individual can be predictive of similar future events, such as repeated disciplinary actions, arbitrations, and Start Printed Page 81548complaints.[]
The commenter suggested, among other things, that FINRA's reports used data (i.e., violative events) to measure the likelihood of recidivist behavior that would not be the subject of a disciplinary action under the proposed rule change. Accordingly, the commenter did not believe FINRA's statistical evidence justified the proposed rule change, including the additional costs and loss of rights that would result from approving the proposed rule change.[]
In response, FINRA reiterated its concern about the potential risks posed by broker-dealers that persistently employ associated persons who engage in misconduct, as well as its findings that past disciplinary and other regulatory events, such as repeated disciplinary actions, arbitrations and complaints associated with a member broker-dealer or individual can be predictive of similar future events.[]
Moreover, FINRA believes the estimated number of disclosure events associated with persons who appeal disciplinary decisions reflects a specific potential risk to investors.[]
FINRA asserted that the proposed rule change would adopt processes directly tailored to target this specific misconduct and minimize further investor harm.[]
The Commission believes that the commenter's challenge to FINRA's statistical justification for the proposed rule change obfuscates the point of the FINRA Study. In its study, FINRA uses a model that predicts investor harm based on information publicly released in BrokerCheck and non-public Central Registration Depository data and found that 20% of the 181,133 brokers in their sample with the highest ex ante predicted probability of investor harm are associated with more than 55% of the investor harm events and more than 55% of total dollar harm. Accordingly, FINRA concluded that the risk of future harm is predictable.[]
The Commission believes that the methodology used in the FINRA Study had a sound statistical basis. The Commission understands the commenter's point that the FINRA Study measured the likelihood of recidivist behavior using data (i.e., violative acts) that would not be captured under the proposed rule change; however, the Commission believes FINRA shows its result is not sensitive to a particular threshold value. In addition, while the Commission understands the commenter's point that FINRA continues the analysis through the year-end after the year in which the appeal reached a decision, the FINRA Study states that the complaint system tracks the date the complaint was filed but not the date of the actual occurrence of investor harm. The study makes a conservative assumption that the harm occurred the year before the filing so that when running a regression to predict an occurrence of harm, FINRA would not be predicting an event with data that was only available concurrently with or subsequent to the event.[]
Accordingly, the Commission believes that the methodology FINRA used to conduct its study had a sound statistical basis and that FINRA had a sound basis upon which to base the proposed rule change.
In sum, for the above reasons, the Commission believes that the proposed rule change would strengthen the tools available to FINRA in responding to associated persons who have a significant history of misconduct. In addition, the Commission believes that the proposed rule change has sufficiently tailored the proposed processes to target the specific misconduct it seeks to address, which would minimize the potential costs to broker-dealers. Moreover, the proposed rules would establish processes by which an associated person or broker-dealer would have adequate opportunities to challenge the imposed conditions and restrictions and seek further review.
Accordingly, the Commission finds the proposed rule change would result in greater investor protections by helping address the concerns raised by associated persons with a significant history of misconduct and the broker-dealers that employ them while narrowly tailoring the review process to mitigate the potential burdens on those individuals and broker-dealers.
IV. Conclusion
It Is Therefore Ordered pursuant to Section 19(b)(2) of the Exchange Act []
that the proposed rule change (SR-FINRA-2020-011), as modified by Amendment No. 1, be, and hereby is, approved.
Start Signature
Jill M. Peterson,
Assistant Secretary.
End Signature
End Preamble
[FR Doc. 2020-27626 Filed 12-15-20; 8:45 am]
BILLING CODE 8011-01-P