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Emily Gordy quoted in Law360: FINRA To Raise Heat On Firms In Broker Disclosure Push

January 20, 2015

FINRA To Raise Heat On Firms In Broker Disclosure Push

Share us on: By Ed Beeson

Law360, New York (January 15, 2015, 6:45 PM ET) — A dark chapter in a stockbroker’s life could end up haunting his firm now that the Financial Industry Regulatory Authority has announced plans to probe compliance with rules on reporting things like convictions and liens that are disclosed in a public database about the industry’s roughly 640,000 registered representatives.

The self-regulatory organization’s rules require registered representatives and their firms to update when they’ve been hit with a significant financial or legal adversity. The disclosures, in turn, often become a part of an individual’s public profile through FINRA’s BrokerCheck website. But in a recent letter to the industry, FINRA officials said they have found a number of instances in which firms aren’t disclosing events that need reporting, or not doing so in a timely manner.

To this end, the regulator said it is revamping its process for reviewing broker registration filings and will be checking, on a periodic basis, the public records of everyone who has an active FINRA registration. By the regulator’s data, that amounts to about 640,000 background checks.

Meanwhile, the regulator has stepped up enforcement against failures to file timely and accurate Forms U4, which are used to disclose regulatory actions, liens and judgments among other things, and Forms U5, which are used to detail terminations, voluntary or not. More than 10 percent of FINRA enforcement actions last year, or at least 138 of 1,210 cases, were taken over these violations, compared to just under 7 percent of cases in 2013, according to a review of the regulator’s stats.

In most cases, these actions have been against individuals who fail to disclose items. But in 2015, there will be greater pressure on firms to make sure the whole truth has been disclosed about their representatives, experts say.

“The settlements you’ll see this year, the price tag is going up because this really is an important thing for firms to get right,” Brad Bennett, FINRA’s head of enforcement, said in an interview.

Many firms have relied on their representatives to let them know when their Forms U4 need updating, but Bennett indicated this may not be enough, as it should be a red flag for firms if they, for example, find themselves garnishing wages for a tax lien.

“They need to put to the appropriate resources on it and they need to follow up the red flags,” Bennett said.

The regulator already has taken action against one firm that allegedly missed some obvious signs. On Tuesday, FINRA fined Merrill Lynch Pierce Fenner & Smith Inc. $175,000 to settle claims that it failed to update a U5 filing for a former financial adviser after receiving customer complaints alleging that he stole money from them.

The representative, who FINRA said consented in 2013 to an industry bar over his alleged theft of about $2.2 million between two firms, left Merrill Lynch in October 2011 to join a rival firm. But three days before he departed, Merrill Lynch received a customer complaint accusing him of tapping into the customer’s accounts and misappropriating money.

Seven month later, Merrill Lynch received a second customer complaint alleging a similar theft. But it wasn’t until October 2012 that Merrill updated the former employee’s records to reflect the complaints. FINRA rules require such updates be made within 30 days.

“When we became aware in 2012 that two client complaints had not been reported in a timely manner, we took appropriate disciplinary action, including termination,” a Merrill Lynch spokesman said, adding that the firm reported the issue to FINRA and compensated the affected clients. The firm did not admit or deny wrongdoing in settling the claim.

The interests of FINRA is to make sure that all of the relevant details about salespeople and other representatives who deal with client assets are reflected in their records, as these are of keen interest to employers, potential and current clients and regulators. A large tax lien, for example, could raise questions about a representative’s ability to manage finances or indicate they could be under pressure that could tempt them to loot someone’s account, attorneys said.

“The end result is a higher degree of confidence that things are being reported in a timely fashion to BrokerCheck,” Bennett said of FINRA’s efforts. “We are doing everything on our end to make sure [BrokerCheck] remains the gold standard.”

It’s not only FINRA that will be tasked with running background checks on representatives. Firms will be required to as well, at least in certain circumstances. On Dec. 30, the regulator won U.S. Securities and Exchange Commission approval of amendments to its Rule 3110 that will require broker-dealers to search nationwide databases on all new registered representatives they hire to check the accuracy of their disclosures.

“They’re shifting gears and they’re saying it’s also a firm issue,” said Linda Riefberg, a former FINRA enforcement chief counsel who is now at Cozen O’Connor. “Now they’re saying we need to make sure firms have procedures in place to do more than just ask the question.”

The rules take effect this summer, and FINRA examiners will be out in force looking to see how firms meet this standard, the regulator said last week.

“In 2015, FINRA examiners will review whether required disclosures are complete, accurate and made within the required time periods; determine whether firms have controls, processes and procedures in place to ensure timely filings; and determine whether public records reviews are occurring,” officials at the regulator wrote in a letter about its exam priorities.

“Finally,” they added, “FINRA expects firms to investigate representatives that fail to report appropriately.”

This is not the first time FINRA has shined a bright light on lax regulatory disclosures. In 2004, FINRA’s predecessor, the National Association of Securities Dealers, fined 29 firms a total $9.2 million for some 8,000 late disclosure filings following a sweep examination, said Emily Gordy, a former senior vice president of enforcement at FINRA.

That same year, the regulator singled out Morgan Stanley for late reporting violations, fining it $2.2 million and temporarily suspending it from registering new brokers, noted Gordy, who is now an attorney at Shulman Rogers Gandal Pordy & Ecker PA.

“While these actions were taken 10 years ago,” Gordy said, “I think they are relevant both to highlight the importance of the reporting issue and may indicate what we might expect from the regulators.”

–Editing by Katherine Rautenberg and Mark Lebetkin.