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FINRA Proposes More Segregated Capital for Firms that Hire Bad Brokers

FINRA has proposed a new rule that would require broker-dealers with a large number of disciplinary events to set aside segregated funds to pay future penalties or arbitration awards. Proposed Rule 4111 (Restricted Firm Obligations) would score each firm against its peers based on registered person and member firm adjudicated events and expulsions. Based on FINRA’s grid, the firm would be required to deposit funds in a segregated account until the firm takes action to remedy the situation, thereby allowing a reduction in the amount deposited. FINRA seeks to address the small number of firms that attract brokers with significant disciplinary records but have not appropriately responded to FINRA’s previous efforts to require heightened supervision or enhance sanctions.

On the positive side, requiring what amounts to a net capital penalty should get the attention of senior leaders at these problem firms. On the other hand, FINRA needs to be careful that such a firm doesn’t make a cold calculation to hire a bad broker if the broker’s production offsets the additional financial obligation.

Broker-Dealer Failed to Discipline Commission-Sharing Traders

 The SEC fined a broker-dealer $1.25 Million for failing to take sufficient disciplinary action against brokers that shared commissions in violation of firm policy.  The SEC asserts that the one broker, who ultimately became a supervisor, assigned accounts to junior traders in exchange for off-the-book kickbacks paid by personal checks.  The transactions violated the firm’s policies and procedures and books and records requirements.  Upon discovering the arrangement 13 years after it began as a result of a FINRA investigation, the firm responded by issuing a memo condemning the activity and offering the participants the opportunity to resign.  The SEC faults the firm for failing to discipline the wrongdoers.

OUR TAKE: Having policies and procedures, but taking no significant action against those who violate them, eviscerates their purpose.  This compliance voodoo – the mere appearance of a compliance program – will draw the ire of the regulators.