High-risk brokers – FINRA is watching you!

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May 10, 2017
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Are we deregulated yet? Nope. Not yet! And certainly not by the Financial Industry Regulatory Authority, which last week and this week issued a sizeable fine and announced the following two initiatives:

  • The first takes the next step in FINRA’s ongoing program to protect investors by strengthening controls of high-risk brokers; and
  • The second opens a review of Outside Business Activities (OBAs) and private securities transactions.

But even before making these announcements, FINRA was already on the prowl, expelling Red Rivers Securities, LLC of Plano, TX, sanctioning and barring its Chief Executive Officer Brian Keith Hardwick, and ordering both entities to pay nearly $25 million, plus interest, in restitution to customers.

Marketing and WSPs by omission

FINRA based the sanctions on findings that the firm and Hardwick made material misrepresentations and omissions related to joint venture offerings that were organized as general oil and gas drilling partnerships. At issue, according to FINRA’s findings was that that the firm and Hardwick omitted mentioning the authorizations for expenditures (AFEs) in any offerings—those expected costs required to complete the proposed projects—even though Hardwick had prepared or relied on the AFEs for those offerings in pricing them. Moving forward, the firm and Hardwick also misrepresented to investors the amount of income investors in prior wells had received, wildly inflating prior income distributions, and failing to disclose conflicts of interest to investors in offerings.

So it’s not just that Red Rivers and Hardwick were touting a risky investment (a “wildcat” oil well) that caught FINRA’s attention, but that both entities flagrantly misrepresented the facts, failing to disclose, for example, that a purportedly “independent geologist report” in the offering documents had actually been written by Hardwick himself, willful violations of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5, as well as FINRA Rule 2020.

Red Rivers’ written supervisory procedures (WSPs) were also sorely lacking. FINRA determined that both “the firm and Hardwick failed to maintain and enforce a supervisory system and WSPs to address conflicts of interests created by their participation in the offerings. Red Rivers’ supervisory system was weak and flawed, according to the regulators, and there was little oversight exercised over the sales force. “Red flags” were ignored or addressed halfheartedly.

Putting bad actors on notice

Red Rivers was just one of 23 firms FINRA fined, sanctioned, or expelled this month and Hardwick was one of 41 individuals receiving similar punishments. And it’s only the middle of May! And that’s only those miscreants published in FINRA’s monthly alert.

In light of continued rule-flaunting, it appears that this month FINRA is raising its regulatory bar. Caveat emptor. Just this week, the Authority’s Board of Governors approved the next step in its ongoing initiative to strengthen controls on brokers with a history of significant past misconduct and to ensure greater accountability for firms that choose to employ high-risk brokers. (Is that you?)

The Authority is issuing a Regulatory Notice seeking comment on key proposals ranging from strengthening protections for investors to requiring additional disclosures on BrokerCheck and heightened supervision of brokers appealing disciplinary matters.

According to Robert Cook, FINRA President and Chief Executive Officer, “These actions will build on FINRA’s extensive existing programs to address high-risk brokers and…protect investors and promote public confidence in securities firms and markets.”

The current proposals would expand sanction guidelines to permit adjudicators to consider more severe sanctions when an individual’s disciplinary history includes additional types of past misconduct. Moreover, hearing panels would be permitted, in appropriate circumstances, to restrict the activities of firms and individuals while a disciplinary matter is on appeal.

BrokerCheck disclosures

For firm’s who do employ “high-risk brokers,” FINRA is issuing a Regulatory Notice requiring reinforcement and clarification of existing supervisory obligations that would mandate the adoption of heightened supervisory procedures for brokers while FINRA is reviewing a statutory disqualification request, or the broker is appealing a hearing panel decision. FINRA’s statutory disqualification application fee for individuals would increase, and a new fee would be rolled out to account for the additional time required of FINRA staff to thoroughly screen those applications or “pay for flay?”

BrokerCheck disclosures will be required of firms that record all telephone conversations with customers and employ a specified percentage of reps who previously worked for disciplined firms. Additionally, FINRA is considering revising the guidelines established to review requests for waivers from the Authority’s exam requirements to more broadly consider an individual’s past misconduct, including arbitration awards and settlements.

Targeting OBAS and…

FINRA also is requesting comment on its rules governing outside business activities and private securities transactions as part of a new retrospective rule review. The review aligns with the ongoing FINRA360 initiative, a comprehensive review of the Authority’s operations and programs. In the crosshairs are rules governing broker-dealer employees’ business and securities activities carried out away from their firm – activities that are outside the regular course or scope of their employment with the firm.

“Regularly reviewing significant rules to ensure they remain effective at protecting investors in an efficient manner is a key priority that aligns with our FINRA360 initiative,” says FINRA’s Cook. “Successful self-regulation requires continuous renewal and improvement.”

Regulation is not going away

Really. It is not. No matter how hard you wish it. Nor is $25 million chump change. Which begs the question that with all the affordable regulatory compliance tools currently on the market, why didn’t Red Rivers or Hardwick (or others similarly compromised) do the right thing? Fines and suspensions are expensive. Compliance is cheap!

 

Procrastination is not a compliance strategy

Waiting for the rules to change…waiting for the regulatory shoe to drop — that is not a compliance strategy. Ask yourself: Why risk even the smallest fines when compliance is so much cheaper! Especially when companies like Patrina are offering comprehensive compliance solutions and compliant data capture, file storage, and records archiving specifically designed for the financial services community.

It’s so inexpensive to do the right thing. So, why don’t you? Be ready. Be compliant. Let’s talk (212-233-1155). Don’t be pennywise and pound foolish. Be safe, secure, and compliant instead.

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