Broker-Dealer Violations: FINRA and SEC Investigations.

FINRA stands for the Financial Industry Regulatory Authority. Unlike the Securities and Exchange Commission (SEC), FINRA is a self-regulatory organization overseen by the SEC, not a federal government agency. FINRA’s jurisdiction is, at present, principally limited to member firms and their “associated persons.” The SEC is a federal agency that enforces the U.S. government’s federal securities laws. Its enforcement authority extends to broker-dealers, investment advisers, registered representatives, broker-dealers’ personnel, and anyone else falling under the SEC’s broad statutory jurisdiction. A broker-dealer is a firm; and, generally speaking, its individual sales personnel are its “registered representatives.” A broker-dealer may face civil enforcement action by the SEC and subject to disciplinary proceedings by FINRA, often simultaneously and based on the same underlying conduct. The DOJ, state securities regulators, state attorneys general, and other entities may also intervene with parallel investigations and proceedings. At the state level, the securities regulator and/or the state attorney general may also intervene. At the federal level, the DOJ (either through its own prosecutors or via a U.S. Attorney’s Office) may pursue civil and/or criminal charges. FINRA has neither the authority to prosecute broker-dealers or individuals for criminal offenses, nor the authority to impose imprisonment. FINRA enforcement proceedings are distinct from customer arbitration proceedings. In customer arbitrations, customers seek private relief for various claims; FINRA enforcement proceedings involve the regulator seeking disciplinary sanctions (which may include sanctions imposed in favor of the aggrieved customer, but the issue is regulatory enforcement, not a customer seeking relief).

What Happens During SEC and FINRA Investigations?

The SEC’s enforcement process typically includes an internal investigation conducted by the SEC’s Division of Enforcement. In SEC enforcement matters, SEC staff will often designate an investigation as a “Matter Under Inquiry” (or “MUI”). At this stage, the investigation is purely preliminary, and not all SEC investigations receive this designation. Additionally, not all MUIs result in formal investigations.

The next stage in the SEC’s enforcement process is generally the issuance of a “Formal Investigation Order.” This order authorizes designated SEC staff to issue subpoenas. Prior to issuing a Formal Investigation Order, the SEC cannot authorize subpoenas; however, subpoena power is not a prerequisite for an investigation.

Another common misconception is that a Wells Notice constitutes formal authorization to investigate. While a Wells Notice appears toward the end of the SEC’s enforcement process, it is neither a subpoena, nor is it an authorization to issue subpoenas. Instead, a Wells Notice is an advisory letter that informs a brokerage firm or individual that the SEC staff has reached a preliminary determination that enforcement is warranted, and intend to recommend charges to the Commission.

Upon receiving a Wells Notice, a brokerage firm or individual typically has the opportunity to submit a “Wells Submission.” This is a written argument to a designated SEC attorney explaining why the SEC should not take enforcement action in the specific case.

Within the SEC’s enforcement system, the staff has the authority to make a recommendation to pursue enforcement action, but not the authority to authorize the action itself. This requires approval from the Commission.

III. FINRA Enforcement Proceedings

While similar in structure to the SEC’s enforcement proceedings, FINRA investigations have their own unique procedure.

The typical FINRA investigative process is as follows:

• When FINRA becomes aware of (or decides to investigate) a potential broker-dealer or individual rule violation, it will issue an investigative demand under FINRA Rule 8210.
• Under FINRA Rule 8210, member firms and associated persons are required to comply with requests for information, documents, and testimony.
• FINRA may issue requests under Rule 8210 both before and after conducting a formal investigation, and in the same case, it may pursue both routes.
• In most cases, FINRA issues requests under Rule 8210 prior to conducting a formal investigation. While FINRA’s Rule 8210 demands are not subpoenas, the rules also state that failure to comply with a request under Rule 8210 can independently support disciplinary proceedings.
• A violation of Rule 8210 can be sufficient grounds for a suspension or a bar, regardless of whether the underlying issue (i.e. the issue prompting the request under Rule 8210 in the first place) was serious enough to warrant enforcement.
• Similar to the SEC, FINRA generally gives the subject of its investigation a Wells-like opportunity to argue against disciplinary action before recommending formal discipline. However, FINRA’s process includes multilayered managerial review of enforcement recommendations, while the SEC’s process requires Commission authorization of the enforcement action.

Which Broker-Dealer Rules Create the Most Serious Exposure?

While hundreds of rules apply in various circumstances, these rules typically present the greatest exposure to SEC and FINRA investigations:

• Regulation Best Interest (17 C.F.R. § 240.15l-1): A comprehensive rule that governs broker-dealers’ recommendations to retail customers. The rule establishes a general obligation to act in the retail customer’s best interest, satisfied through “disclosure,” “care,” “conflict of interest,” and “compliance” obligations. Broker-dealers are held to a general best interest standard of conduct that is assessed by a totality of factors.
• FINRA Rule 3110: Requires broker-dealers to establish and maintain supervisory systems (which must be reasonably designed to achieve compliance with the federal securities laws, SEC rules, and FINRA rules). The rule also requires member firms to establish and enforce written procedures consistent with FINRA’s rules and SEC rules.
• Exchange Act Rule 17a-4 (17 C.F.R. § 240.17a-4): The Exchange Act’s primary broker-dealer record preservation rule. The rule requires preservation of specified books, records, communications, and other documents for prescribed periods.
• Exchange Act Rule 15c3-5 (17 C.F.R. § 240.15c3-5): This rule is particularly relevant for high-frequency and algorithmic traders. The rule requires broker-dealers that provide market access to their customers to establish and maintain supervisory controls.
• Exchange Act Rule 15c3-1 (17 C.F.R. § 240.15c3-1): Establishes certain minimum requirements for financial soundness, including minimum net capital requirements. Violations of Rule 15c3-1 are serious and can trigger additional scrutiny under other rules as well.
• Exchange Act Rule 15c3-3 (17 C.F.R. § 240.15c3-3): This rule, often colloquially known as the “Customer Protection Rule,” is subject to heightened SEC enforcement scrutiny. The rule has implications for how broker-dealers protect customer securities and cash.
• Exchange Act Rule 17a-8 (17 C.F.R. § 240.17a-8): This rule incorporates provisions of the Bank Secrecy Act (the BSA) and imposes obligations such asAnti-Money Laundering (AML) compliance.
• SEC Rule 17a-11 (17 C.F.R. § 240.17a-11): This rule sets out the notification provisions for brokers and dealers. It requires a firm to give same-day notice to the SEC and to its designated examining authority when its net capital falls below the required minimum, or when it fails to make and keep current the books and records required by Rule 17a-3, and to transmit a report within 48 hours describing the steps taken to correct the deficiency.
• SEC Rule 15c3-2 was deleted by the SEC's 2013 amendments to the broker-dealer financial responsibility rules, effective October 21, 2013. Its requirement that broker-dealers notify customers holding free credit balances that those funds are payable on demand was moved into the Customer Protection Rule at 17 C.F.R. § 240.15c3-3(j)(1).
• The underperformance of investments in the portfolio of a broker-dealer’s customer typically does not constitute evidence of a violation of any rules. As a matter of law, this is a matter of defense strategy. Spodek Law Group, led by managing partner Todd Spodek, defends clients in federal criminal and white collar matters.

Which Form U4 and U5 Deadlines Apply?

We can explain to you the application of the Form U4 and Form U5 rules to any particular situation. But generally speaking, the key provisions and deadlines are as follows:

Form U4 Amendment Deadline

If a broker-dealer or individual must amend their Form U4 (such as due to the reportable events noted above), this must typically be done within 30 days of the triggering event. However, events that trigger a statutory disqualification generally require a Form U4 amendment within 10 days.

A violation of FINRA Rule 8210, a request to suspend or bar an individual from the brokerage industry, or a criminal charge do not necessarily cause a statutory disqualification or a reportable event. However, they can, and they can also lead to a regulatory investigation.

Statutory Disqualification

A statutory disqualification is a serious matter. It can preclude an associated person from continuing employment or associating with any broker-dealer or investment adviser in the securities industry.

Broker-dealers and other entities that require FINRA eligibility approval must generally obtain FINRA's approval through an eligibility proceeding under the FINRA Rule 9520 Series, initiated by filing an MC-400 application, before employing or otherwise associating with any statutorily disqualified individual.

Form U5 Amendment Deadline

A Form U5 must generally be filed within 30 days after the termination of employment. Amendments to the Form U5 must generally be filed within 30 days after discovery of any inaccurate or incomplete information.

BrokerCheck

As mentioned above, FINRA collects information from Form U4 filings and Form U5 filings, and it populates this information into a publicly accessible database called BrokerCheck. BrokerCheck displays information regarding an individual’s employment history, business affiliations, and any specified disclosure and disciplinary events.

Form U4 Agreement to Comply

Applicants for registration on Form U4 agree to comply with the rules of the applicable self-regulatory organization. As you can imagine, this has implications for non-compliance as well.

How Should Firms and Representatives Coordinate an Early Response?

A timely and appropriate response to a regulatory inquiry is critical. But, in cases involving a FINRA or SEC investigation, responding proactively by voluntarily disclosing the issues can be risky as well. While self-reporting does not guarantee a declination, reduced charges, or lower sanctions, there are multiple factors that regulators will consider when resolving matters. These factors include the scope of an entity’s cooperation, its efforts to remediate, paying restitution to harmed customers, and what controls it put in place to prevent similar violations going forward.

V. What Potential Issues Need to be Identified by Firm Counsel?

In SEC and FINRA cases, firm counsel should not just advise the firm, it must also think about the need to represent the firm’s employees. The potential issues in this regard can (and often do) present conflicts between the interests of the firm and the interests of the investigated representative.

Additionally, statements and representations made by firm counsel to one regulator may also become relevant in other parallel proceedings.

If a brokerage firm retains counsel to represent it in a regulatory matter, then, unless there is a separate engagement, this counsel represents the organization, not necessarily the individual employees interviewed by counsel on the organization’s behalf.

Finally, the issuance of a subpoena or a request for information also triggers a duty to preserve and prevents the destruction of records and other potentially relevant evidence when it becomes reasonably foreseeable that a regulator may seek to introduce the destroyed evidence at a hearing or enforcement action.

VI. Can Voluntary Disclosures Trigger Waiver?

Generally speaking, voluntary disclosures to regulators do not waive the attorney-client privilege. However, disclosures of privileged material to a regulator can be relevant against third parties. And, this is not the only situation where privilege can be at risk.

VII. What is “Extraordinary Cooperation” under FINRA Rule 8210?

Under FINRA’s rules, extraordinary cooperation generally involves proactive and voluntary steps beyond what an entity or individual is already required to do under FINRA rules. As a general matter, while compliance with Rule 8210 is expected, substantial voluntary efforts beyond compliance can lead to a “clear benefit in a specific case, or even in multiple cases,” and this can be a great benefit for associated persons.

VIII. Are You Prepared to Face the SEC or FINRA?

Our firm provides comprehensive representation for broker-dealers facing FINRA or SEC enforcement proceedings. We focus our efforts on providing strategic solutions to resolve our clients’ investigations before they lead to fines, charges, or other adverse outcomes. The firm also provides litigation and appeal representation in federal court. and our attorneys are available for meetings to discuss your case, in person or on a video conference.

What Penalties and Appeal Deadlines Can Follow Charges?

While not all SEC investigations result in enforcement action, a broad range of penalties and adverse outcomes can arise in both SEC and FINRA cases. However, this is not an absolute rule. In some cases, the SEC staff can close a matter without recommending enforcement action against a broker-dealer or associated person.

FINRA has the authority to impose various sanctions on broker-dealers and associated persons. This is consistent with the fact that the SEC can impose a wide range of sanctions as well. Some sanctions are exclusively available to one of these regulators, while others apply to both.

IX. What are the Deadlines to Answer a FINRA Complaint, Appeal a Hearing Panel Decision, and Seek SEC Review of a FINRA Action?

FINRA’s Rules govern the timeline for these matters. Specifically, FINRA Rule 9215 generally provides 25 days for a party to respond to a disciplinary complaint. However, these timelines are subject to various conditions, and it is important to contact a securities defense attorney to discuss your case.

FINRA Rule 9311 generally gives 25 days to file a written notice of appeal in the SEC’s Office of Administrative Law Judge.

Exchange Act Section 19(d)(2) generally gives 30 days to seek SEC review of a FINRA action after issuance of the Commission’s decision. These timelines are subject to modification under some circumstances.

X. What is the Deadline to Petition for Appellate Review of an SEC Order?

Exchange Act Section 25(a) allows associated persons to petition for appellate review in any court of competent jurisdiction. While statutory language refers to “any court of competent jurisdiction,” this general authority includes appeals by associated persons to the appropriate court of appeals. Exchange Act Section 25(a) generally gives 60 days to seek appellate review of an SEC order, though the timeline can change depending on the specific circumstances.

XI. Can FINRA Settle Complaints Before a Hearing?

FINRA provides the option to accept a complaint with or without admitting a violation and paying the relevant fine. The “Letter of Acceptance, Waiver, and Consent” (AWC) agreement is voluntary. However, the signer agrees that FINRA’s complaint is complete, waives the right to respond to FINRA’s complaint, waives the right to have the matter heard by a hearing panel, and waives the right to seek review from the SEC or an appellate court.

The AWC is a voluntary act but can have far-reaching implications, as a broker-dealer or associated person essentially gives up its right to defend against any allegations. Individuals are especially likely to be barred if they file an AWC agreement and accept a lifetime ban.

SEC and FINRA enforcement matters are often time-sensitive, and associated persons and firms should be prepared to react quickly when necessary.

Contact a Federal Criminal Defense Attorney

Nothing here is legal advice, and the details of your case matter. Todd Spodek and Spodek Law Group take federal criminal and white collar cases nationwide, from offices in New York, Brooklyn, Queens and Los Angeles. You can reach the firm at 212-300-5196.