Of all the compliance red flags outlined by the Financial Industry Regulatory Authority, hiring high-risk brokers is, perhaps, the one that should concern firms the most. FINRA is spending more time, effort and resources on this issue than ever before.
“There could not be a more important place for us to spend our time and resources,” said Susan Axelrod, executive vice president of regulatory operations at FINRA, speaking at the 2017 National Compliance Outreach Program for Broker-Dealers on Thursday. “One of the threshold questions that I think we don’t reinforce enough is: Know who you’re hiring. Do your diligence up front; make sure you understand who you’re taking on; make sure you understand who the customers are, what they’re selling, what they’ve had issues in the past and what you feel about that.”
FINRA recently announced new proposals that would strengthen controls on high-risk brokers by adding extra disclosures to BrokerCheck, increasing sanctions for chronic offenders and possibly restricting the activities of brokers while a disciplinary matter is on appeal. In 2014, FINRA created an algorithm—now in its fourth iteration—that ranks all registered reps in the industry based on their risk "score."
Based on that program, FINRA has barred 154 individuals from the industry. In addition, 42 percent of the firms considered by FINRA to be high risk have gone out of business over the past five years, in many cases because of regulatory action, Axelrod said.
FINRA will also look more closely at firms hiring people with compliance disclosures, or firms that have "clusters" of reps that seem to move together, the products they’re selling, and even where they may have learned to "use a script" when selling an investment product, including "rebuttals for every answer."
The regulator’s algorithm for identifying troublesome brokers is not simply a qualitative screen or recorded infractions or complaints, she said. For instance, it may be that a broker has five different disclosures on the record, but all from a single event.
And there may be circumstances under which it would be reasonable to hire somebody with marks on their books, said Georgia Bullitt, partner at Willkie Farr & Gallagher, speaking on the same panel.
“It’s important that you document your legitimate reasons for wanting to hire the person,” Bullitt said. “Those reasons are going to be dependent on understanding the reasons for the problems the individual has had in the past and also coupling that with a description of your own compliance structure and your own client base.”