A state regulator has threatened to bring an enforcement action against you for unsuitability relative to the sale of an annuity and barely exceeding the expected churn ratio in an elderly client's brokerage account. Your sister's younger brother is a top-notch commercial litigator with the biggest law firm in town (“Hot Shot”). He comes to your rescue and goes toe-to-toe with your state regulator. To your disbelief, all you must do to extract yourself from the ugliness is sign a Consent Order requiring you to disgorge commissions and pay a modest fine. Unbeknownst to you (and Hot Shot), you become statutorily disqualified from practicing in the industry for 10 years as the instant the Commissioner accepts and signs the Order.
The following are just a few critical excerpts from FINRA's website regarding industry disqualification and eligibility requirements and proceedings:
“Eligibility Requirements - Article III, Section 3 of FINRA's By-Laws provides that no member shall be continued in membership if it becomes subject to disqualification; and that no person shall be associated with a member, continue to be associated with a member, or transfer association to another member if such person is or becomes subject to disqualification. FINRA's authority to deny the registration and/or membership of disqualified persons or members is set forth in Section 15A(g)(2) of the Securities Exchange Act of 1934. Disqualification Defined - FINRA amended its By-Laws on July 30, 2007 to incorporate the definition of "disqualification" as set forth in Section 3(a)(39) of the Exchange Act.”
Section 604 of the Sarbanes-Oxley Act expanded the definition of statutory disqualification in Section 3(a)(9) of the Securities Exchange Act of 1934 by both creating and incorporating Exchange Act Section 15(b)(4)(H) so as to include persons subject to a Final Order of a state securities commission if the Order is based upon the violation of a statute or regulation that prohibits fraudulent, manipulative, and deceptive conduct. Because the list of disqualifying events prior to this expansion fell within the ambit of the obvious—such as convictions, bars, expulsions, and revocations—many members of the industry as well as the legal community remain dangerously unaware of the implications of the final state order. So, for example, while you may have neither “denied or admitted” a state enforcement section's allegations, and unsuitability is likely more a matter of negligence than deception, the Consent Order implicitly admitting you were engaged in churning could very well qualify the Final Consent Order as one based upon deceptive conduct.
No one is going to try to revoke anything from you after the Consent Order is issued. You just automatically revoked it yourself by operation of Federal Law. Once your member firm files the appropriate U-4 disclosure regarding the Consent Order, or the state enters it in to the CRD system, FINRA RAD will fax a letter to your Chief Compliance Officer politely informing your firm that it can file an MC-400 Application or “immediately terminate its association with [you].” Your firm will then have to decide if you are worth it, and you might have to hire an attorney other than Hot Shot.
One final word of caution--and I have seen this too many times--the disqualifying Final Order provision is not limited to Orders issued by your home state or even by a state in which you are registered. So don't blow off a Show-Cause Order from Alaska just because you don't have any clients there. When you default and Alaska issues a Final Order against you for something you didn't even do—you will be in the very unsavory position of having to “unring” that bell or persuade your firm to “sponsor” you through FINRA's Membership Continuation process.
“Article III, Section 3(d) of FINRA's By-Laws permits a disqualified person or member to request permission to enter or remain in the securities industry. Procedural Rules 9520-27 set forth procedures for a member to sponsor the proposed association of a person subject to disqualification or for a member to obtain approval to remain a member notwithstanding the existence of a disqualification. These actions are referred to as "Eligibility Proceedings."
Generally speaking, a person who is subject to disqualification may not associate with a FINRA member in any capacity unless and until approved in an Eligibility Proceeding. If a person is currently associated with a FINRA member at the time the disqualifying event occurs, however, the person may be permitted to continue to work in certain circumstances, provided the employer member promptly files a written application seeking permission to continue the employment in an Eligibility Proceeding. A member subject to disqualification also may be allowed to remain a member, in certain circumstances, pending the outcome of an Eligibility Proceeding, provided the member promptly files an application requesting approval of its continued membership.
Once it becomes aware of a statutory disqualifying event (related to the member or a disqualified person), the member is obligated to report the event to FINRA. In the case of a disqualified person, the Firm must either file a Form U5 if it wishes to terminate the individual's association or file a Form MC-400 application if a member wishes to sponsor the association of a disqualified person. The member should file any MC-400 application when it amends the Form U4 and it must amend the Form U4 within 10 days of learning of a statutory disqualifying event (see Art. 5, Sec. 2(c) of the FINRA By-Laws). The MC-400 application requests information about the terms and conditions of the proposed employment, with special emphasis on the proposed supervision to be accorded the disqualified person.”
FINRA SD12003 is just one of the many cautionary tales I could tell. The broker in that case purchased three (3) collateralized debt obligations his firm promoted through an auction rate securities market that his firm sponsored for a municipal client in Massachusetts in 2006. The broker entered into a Consent Order with the Massachusetts Securities Division in 2008 in which he agreed to pay a modest fine and be suspended for six (6) months. Mr. Broker returned to work with a new firm in August of 2008 after Massachusetts allowed him to re-register with the state. Everything went just swimmingly until presumably a year later, his firm received “the letter” from FINRA. According to FINRA Registration and Disclosure, Mr. Broker was out of the game when the state Consent Order was entered by the Director of the Massachusetts Securities Division.
Mr. Broker's new firm filed the MC-400 application in January of 2010. FINRA's Member Regulation staff opposed the application. A hearing was held before the National Adjudicatory Council1 18 months later, in September 2011. The National Adjudicatory Council (“NAC”) issued its opinion in favor of Mr. Broker the next year. Get the picture? So--consult with an attorney trained in state and FINRA disciplinary matters before you sign a state consent order.2 Do not rely solely upon your brother-in-law or even your firm's compliance department. Same goes for you compliance officers!
1 These are fairly uncommon and very serious. I represented an applicant in one and we prevailed.
2 David Cosgrove is the former Commissioner of Securities and has represented brokers in MC-400 proceedings since 2007. He represents brokers and broker-Dealers throughout the United States.