FINRA Turns Up the Heat on Enforcement

The Financial Industry Regulatory Authority is turning up the heat on broker-dealers that break the rules.

According to recent analysis by law firm Sutherland Asbill & Brennan, the number of fines and disciplinary actions brought by FINRA so far this year is on track to outpace 2011 figures. The report shows that, during the first half of 2012, FINRA levied a total of $39 million in fines, and $12.7 million of disgorgement and restitution to investors.

At the current rate, the estimated year-end total for fines and disgorgement is projected to reach $103 million, surpassing $91 million in penalties FINRA levied against firms and individuals last year, according to FINRA's year-end financial report.

The figures indicate that the securities industry self-regulatory body is taking a more aggressive stance and could be looking to demonstrate a strong enforcement environment in an attempt to stave off more regulation from government agencies. “Expect more cases, more instances of enforcement actions, and larger fines,” says Paul DeSimone, head of the compliance and regulatory services group for LIMRA, an association of insurance and financial services companies.

The projected rise in FINRA fines and disciplinary actions would mark the third straight year of increased total penalties and set a new level of enforcement actions for the regulator. FINRA hit broker-dealers with just $42 million in fines and $6 million in restitution in 2010.

According to DeSimone, many of the recent fines are a direct result of investigations that were launched at the peak of the market meltdown in 2008 and 2009 that are just now concluding. Compliance officers can expect FINRA penalties to only “get heftier,” DeSimone says.

Sutherland's analysis supports that assertion. According to the findings, FINRA has been more aggressive in bringing so-called “supersized” fines of at least $1 million. During the first half of 2012, FINRA rendered seven supersized fines totaling $24 million, compared to the 10 supersized fines in all of 2011, totaling $35 million. 

Brian Rubin, a partner with Sutherland and a co-author of the analysis, says that FINRA has been pushing for seven-figure fines in more of its cases. “I wouldn't be surprised if the trend of supersized fines continues,” he says.

FINRA further indicated in its annual report that it has strengthened its ability to identify high-risk firms through broader data collection and more comprehensive analysis. That may be another reason why FINRA is obtaining higher fines, says Stephen Marsh, CEO of e-mail archiving and compliance vendor Smarsh and a board member of the National Association of Broker Dealers.

Prior to approaching a firm, FINRA is now conducting more comprehensive research and taking a much more targeted approach, explains Marsh. “They're more likely to find problems if they're looking at high-risk areas rather than a blanket checklist that could apply to any firm,” he says.

The regulator isn't just assessing more penalties, it's bringing a larger number of cases too. “If cases are brought at this same rate for the rest of the year, the number of cases is projected to surpass 2011's total disciplinary actions by nearly 9 percent,” according to Sutherland's analysis. In 2011, FINRA reported 1,310 disciplinary actions, compared to 1,158 in 2010.

Self-regulators “always need to look like they're doing more,” says Doug Cohen, Counsel in the Investment Management Group of law firm Lowenstein Sandler. If not, you'll always have the critics who say you're taking a step back or you're not doing enough, “and the best way to look like they're doing more is to bring more fines, or more cases, or both,” he says.

To support the increased enforcement effort, FINRA is pursuing more resources. In April, FINRA proposed a whopping 25 percent increase in the trading activity fees that it charges its brokerages, a proposal that has encountered widespread opposition from industry members. FINRA says the increase is necessary to police the securities markets and ensure fair markets. The regulator, which oversees 4,380 brokerage firms and 630,000 registered securities representatives, reported a loss of $84 million in net income in 2011.

Areas of Focus

According to Sutherland's analysis FINRA's top five enforcement issues during the first half of 2012, in terms of fines imposed, have included:

Research analyst communications:  $11.9 million, 8 cases;

Suitability:  $6.6 million, 64 cases;

Unit Investment Trusts:  $3.9 million, 4 cases;

Markups and/or markdowns:  $3.7 million, 14 cases; and

Municipal securities:  $3.7 million, 24 cases.

“They're always looking for the low-hanging fruit,” says Cohen, “and they're looking for cases where there might be some real wrongdoing and where they can make a real impact.”

“If you can address and anticipate problems and fix them now, that's so much better than FINRA telling you about them after an exam, or even worse, an enforcement action.”

—Doug Cohen,

Counsel, Investment Management Group,

Lowenstein Sandler

For a while, FINRA's area of focus seemed to be auction rate securities. So far in 2012, however, there's only been one such case. “I think we've seen that run its course,” says Rubin.

Fines imposed by FINRA for research analyst communications include a single $11 million fine imposed against Goldman Sachs for failing to supervise equity research analyst communications with traders and clients.

Another potential area of enforcement may be conflicts of interest. Last month FINRA said it would attempt to meet with compliance staff to discuss each firm's approach to conflict identification and mitigation—some called it a conflict-of-interest “sweep.”

FINRA says the initiative is a way “to better understand industry practices and determine whether firms are taking reasonable steps to properly identify and manage conflicts that could affect their clients or the marketplace.”

Cohen cautions that the move may signal further potential enforcement actions. For FINRA to conduct a sweep and invite firms to come and speak with them seems “a bit unusual,” he says. “To me, it looks like a disguised exam.”

Cohen says firms should heed it as a warning that, if they don't have sufficient policies, the agency will be “hitting firms left and right for conflicts of interest.”

Another potential driver behind FINRA's increased enforcement actions is an attempt by the regulator to position itself to become the self-regulatory organization for investment advisers. In a 2011 report to Congress on providing better oversight of the investment advisory industry, the Securities and Exchange Commission recommended expanding FINRA to oversee the industry as a possible option.

FINRA STATS

Below are statistics regarding the number of member firms, branch offices, and registered representatives under FINRA from 2007 through 2008:

FINRA

2007

2008

2009

2010

2011

July 2012

Member Firms

5,005

4,895

4,720

4,578

4,456

4,384

Branch Offices

171,287

171,659

166,893

162,847

160,483

162,845

Registered Reps

672,688

664,975

633,280

630,692

629,518

629,644

FINRA.

According to Cohen, the sweep letter could be part of that effort. It provides “perfect ground for FINRA to say, ‘look how competent we are in dealing with investment advisers. We should be the ones to take over from the SEC doing exams.'”

Cohen advises broker-dealers to go back and review any potential conflicts of interest. “If anything is less than adequate, go make changes now,” he says.

Another way to keep on top of issues that may be on FINRA's radar screen:  “Pay attention to the letters that are sent in the early part of the year,” says DeSimone.  He says FINRA sends a letter each year to chief compliance officers of member firms that essentially highlights the areas that FINRA will be looking at during the course of the year.

In this year's letter, FINRA said it intended to focus on sales practices concerns and business conduct, and it stressed the importance of heightened supervision on complex products. “So how those products get presented and sold, and how thoroughly they get sold, is really important to FINRA when examining broker-dealers and distributors this year,” says DeSimone.

Rubin also suggests that broker-dealers follow enforcement actions against competitors to gauge what other areas may be commanding the attention of FINRA. In addition, he recommends carefully reviewing speeches given by FINRA officials, which may also speak to current trends in enforcement.

“If you can address and anticipate problems and fix them now,” says Cohen, “that's so much better than FINRA telling you about them after an exam, or even worse, an enforcement action.”