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.
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