Outside Experts Recommend Fundamental Changes to FINRA’s Enforcement Program

The Financial Industry Regulatory Authority (FINRA) recently published its long-awaited outside expert report titled "Recommendations Based on a Review of the Policies, Procedures, Processes, and Practices of FINRA’s Enforcement Program," setting forth 24 significant and wide-ranging recommendations designed to improve FINRA’s Enforcement Program. Drafted by Professor Paul Eckert of William & Mary Law School and former SEC Commissioner Troy Paredes, the Report was commissioned as part of the broader FINRA Forward initiative.[1]

Several of the Report’s[2] recommendations tie directly to enhancements FINRA has already made to the Enforcement Program. Nevertheless, as FINRA’s CEO Robert Cook stated in a message accompanying the Report, “FINRA is committed to drawing on these recommendations to strengthen our enforcement program, make necessary changes, and ensure it is operating in a fair, transparent, and effective manner.”[3]

In doing so, Cook noted that FINRA will consider the recommendations “both individually and holistically” and be guided by certain overarching themes, including FINRA’s broader role and responsibilities as a self-regulatory organization and that the principles which shape enforcement should be articulated clearly to the industry.[4]

Many of the Report’s recommendations would, if implemented, fundamentally change the Department of Enforcement’s governance, processes, procedures, and practices.[5] Below we identify and describe the recommendations we believe would have the most substantive impact on FINRA enforcement matters and provide our views on what adoption would mean and what member firms can do in the interim.

ENHANCED CEO INVOLVEMENT IN ENFORCEMENT MATTERS

The Report observes that FINRA’s CEO does not typically participate in discussions about enforcement matters prior to resolution due to the risk that a matter could result in a contested and appealed proceeding. After careful consideration of that approach, the Report recommends that the CEO be more actively engaged in certain matters before resolution.

For example, the Report suggests that the CEO should advise on whether formal action is warranted in a given case, offer guidance concerning acceptable legal theories and interpretations of rules and regulations, and provide input and perspective on the appropriateness of settlement terms.

The Report’s recommendation that the CEO become more granularly involved in enforcement matters follows last year’s reorganization of FINRA’s core regulatory functions into the newly reconstituted Regulatory Operations group, which includes Enforcement, Member Supervision and Market Oversight. The Report’s recommendation would provide member firms with an additional layer of senior management to whom to escalate critical enforcement issues or concerns.

Member firms should carefully consider potential new paths of escalation that may be open to them under the current reporting structure and the comments made in the Report concerning the appropriateness of the CEO’s role in enforcement matters, even if the recommendation is not formally adopted.

ADOPTION OF LIMITATIONS PERIODS

In contrast to the SEC and other regulatory agencies whose enforcement actions are subject to statutes of limitations, no limitations period applies to FINRA enforcement cases. Rather, FINRA can bring cases as long as any delays in doing so do not render the defense of any proceedings “inherently unfair.”[6] FINRA’s ability to conduct yearslong investigations into aged conduct with little or no time constraints has been a longstanding concern in the industry.

Recognizing this issue, the Report recommends that FINRA establish specific limitations periods for its enforcement matters. As a starting point, the Report proposes that FINRA observe the limitations periods of corresponding federal statutes for charges related to those statutes or related to FINRA rules incorporating those regulations. In instances where there is no nexus to the federal securities laws, subject to certain exceptions, the Report recommends a general time limit of five years, with potentially longer periods for matters involving intentional fraud or manipulation with attendant customer harm.

If and when FINRA moves forward with a rule proposal, the industry should actively participate in the comment process to encourage the adoption of a fair and even-handed limitations period. In the short term, member firms may consider raising the Report’s comments on limitations periods in aged matters to press for their timely resolution.

CHALLENGES AND CHANGES TO THE RULE 8210 PROCESS

The Report proposes several far-reaching changes regarding FINRA’s document and information request process under Rule 8210. The most radical of these modifications would provide member firms with a forum for challenging the appropriateness of the scope or burden imposed by a Rule 8210 request that employs a neutral decisionmaker and a process similar to those that have long been available in criminal, civil, and administrative contexts. Such a protocol would be subject to appropriate safeguards and exceptions.

If adopted, this change could be helpful for member firms who receive sweeping document, data, and information requests by arming them with the ability to seek relief from a non-interested party in an effort to pare back such demands.

Other recommended changes to the Rule 8210 process include (1) requiring Enforcement staff at an appropriate level of seniority to approve information requests; (2) refraining from issuing requests that serve as contention interrogatories or seek admissions; and (3) holding pre-issuance consultations between member firms and FINRA regarding anticipated document, data, and information requests. Whether these recommendations are formally adopted, member firms should continue to meaningfully engage with Enforcement staff on a request’s scope, burden, and timeline.

LIMITING ENFORCEMENT STAFF INVOLVEMENT TO INVESTIGATIONS

Recently, Enforcement staff have been directing requests for information and documents, leading calls and meetings, and taking on-the-record testimony (OTR) prior to any referral to Enforcement. Such direct and active participation of Enforcement staff in matters outside Enforcement has engendered significant concern in the industry.

The Report observes that engagement and activity by Enforcement staff at a pre-referral stage of a matter may lead to the retention of outside counsel by a member firm and can transform the typically collaborative dynamic of an examination into one that is perceived as an adversarial exercise.

To address these issues, the Report suggests that a bright line be drawn between Enforcement and pre-referral FINRA regulatory activities. Specifically, the Report recommends Enforcement staff avoid active participation in discussions and communications with member firms in matters that have not been referred to Enforcement (e.g., examinations and other types of reviews) except in exigent situations.

In a corollary recommendation, the Report states that generally OTRs should be reserved for investigations that have been referred to Enforcement or in some other way warrant the formality of sworn testimony.

The pointed statements in the Report regarding the participation of Enforcement in pre-referral matters could lead FINRA to implement procedures to circumscribe such activity. In the interim, member firms may consider using the comments in the Report to push back on Enforcement’s active participation in any current or future matter that has not been referred, where appropriate.

REVISED STANDARD FOR CREDIT FOR MEANINGFUL MEMBER FIRM COOPERATION

FINRA Regulatory Notices 08-70 and 19-23 advise that member firms may receive credit for “extraordinary cooperation” from FINRA for (1) self-reporting violations above and beyond compliance with Rule 4530(b), (2) taking steps to correct deficient procedures and systems, (3) providing remediation to customers, and/or (4) providing substantial assistance in connection with FINRA’s inquiry.[7] Recently, senior FINRA Enforcement staff have shared a plan to issue updated guidance regarding credit for cooperation.[8]

In accord with Enforcement staff’s statements, the Report recommends that FINRA implement a new approach to providing credit for meaningful member firm cooperation. Specifically, the Report suggests that a member firm’s cooperation need not necessarily rise to the level of “extraordinary,” and that credit should not be precluded because a member firm was required to self-report the matter under Rule 4530(b) or because the remedial steps implemented by a member firm were viewed by the staff as routine or required to be undertaken.

The Report also recommends that Letters of Acceptance, Waiver, and Consent reflect more thorough explanations of the cooperation credit that was awarded. New guidance consistent with these recommendations, particularly redefining the operative standard from “extraordinary cooperation” to “cooperation,” would be heartily welcomed by the industry.

Regardless of FINRA’s next steps in this important area, member firms that wish to receive cooperation credit should develop and execute on a plan to do so from the beginning stages of a matter. That plan could include steps such as:

• Reaching out to FINRA in advance of or concurrent with the submission of any self-report filing to alert the staff and begin a dialogue about the matter;
• Establishing a proactive communication plan with FINRA to touch base regularly, even if there are no substantive updates to share;
• Notifying the staff of the firm’s goal of providing cooperation;
• Holding meetings with the staff to review the contours of the issue(s), including the cause, scope, impact, and the status of any remediation, and to share a timeline of how the firm intends to proceed;
• Voluntarily providing key documents, narratives, and data that will aid the staff in its investigation;
• When providing data, conveying what the data means, how the data should be used, and how the staff can analyze it;
• In matters that involve or may potentially involve customer harm, addressing it with the staff early and sharing any plans for remediation and/or restitution with FINRA as soon as practicable; and
• Documenting the firm’s efforts at providing cooperation.

LIMITATIONS ON THE USE OF ‘TAG ALONG’ RULE 2010 CHARGES

FINRA consistently charges member firms with a violation of Rule 2010 (Standards of Commercial Honor and Principles of Trade) based solely on a violation of another FINRA rule. The imposition of such so-called “tag along” charges has long frustrated the industry and been the subject of vigorous debate with FINRA for many years.

The Report recommends that FINRA limit this practice because such charges may suggest that the matter involved more problematic conduct than warranted and because the practice risks debasing stand-alone Rule 2010 charges in contexts where they may be appropriate (e.g., in cases of particularly abusive or intentional misconduct).

Again, the industry would embrace changes to FINRA’s practice of tag along Rule 2010 charges.

INCREASED AND MORE MEANINGFUL MEMBER FIRM ENGAGEMENT AT THE TIME OF REFERRAL

FINRA has recently begun to provide member firms with more opportunities to be heard earlier in the enforcement process. For example, following a referral to Enforcement, the staff now offers to meet with the member firm to provide information on the enforcement process, describe the initial areas of focus, and allow the member firm to ask questions and provide any observations or concerns it has relating to the matter.[9]

The Report recommends Enforcement go further, including through informing member firms at the time of referral not only about the nature of FINRA’s concerns but also the potential violations that triggered the referral. Of particular note, the Report suggests that as part of that conversation, the staff would explain its investigative approach and the assumptions used by FINRA to assess the conduct under review, and provide reasonable detail regarding the quantitative methodology and supporting data analysis the staff used to conclude that a potential violation occurred.

Through this process, the Report suggests that member firms would have a meaningful opportunity to engage with the staff about the underlying basis for the referral in a more formal setting.

Providing member firms with the kind of detailed information and data envisioned by the Report at an early stage of a matter would be a major sea change in the enforcement process. It is unclear if the type of information contemplated by the Report would be available at the outset of every enforcement matter given that there may still be significant investigative steps to be taken. That said, if adopted, such enhancements could help avoid the expenditure of significant resources by both member firms and FINRA in cases in which a meaningful discussion might result in FINRA narrowing the scope of its investigation or even determining to no longer pursue the matter.

Even in the absence of FINRA’s adoption of the recommendations, member firms should request that the staff provide the types of evidence described in the Report and engage in meaningful debate about the facts and legal conclusions drawn by FINRA at the earliest possible stage of any investigation.

EARLIER OPPORTUNITIES FOR RESOLUTION AND REMEDIATION

The Report includes several recommendations related to faster resolutions to matters and additional ways for member firms to remediate issues. For example, the Report calls for FINRA to provide additional opportunities for expedited resolution following a referral to Enforcement for technical matters that do not involve investor harm and that have already been remediated by the member firm or were the result of an honest mistake and good faith effort to comply with relevant rules and regulations.

As another example, the Report suggests that Enforcement engage with member firms throughout an investigation about its positions regarding the activities, practices, policies, and procedures needed for a firm to comply with its regulatory obligations. The Report explains that such a practice would allow member firms to avoid continuing violations and to more quickly remediate any compliance issues identified by the Staff.

Finally, the Report notes that FINRA’s Rapid Remediation program flags potential reporting and surveillance discrepancies for member firms and allows them to promptly correct and mitigate those issues before an enforcement investigation may be required. The Report recommends FINRA (1) further consider whether additional programs to quickly resolve matters outside of Enforcement should be developed; and (2) track and publish its efforts to enhance compliance through the Rapid Remediation program and other similar initiatives.

If adopted, these recommendations could save substantial resources for both FINRA and member firms and result in improved compliance. In the interim, in cases that do not involve customer harm, or instances where mistakes or errors occurred, member firms should consider pressing the staff for an early and fair resolution.

PUBLICATION OF AN ENFORCEMENT MANUAL AND GREATER ACCESS TO DISCIPLINARY MATERIALS

The Report recommends that, like the SEC, FINRA publish its Enforcement Manual (a step FINRA has already indicated it plans to take[10]) to provide member firms with greater visibility into the enforcement process generally, as well as to promote accountability related to the consistency and practices of Enforcement staff.

For many years, member firms and their counsel have been at a disadvantage in identifying relevant precedent due to significant limitations in the publicly available FINRA Disciplinary Actions Online database, which does not, for example, permit Boolean searches or filtering. Consistent with its theme of enhanced transparency, the Report suggests that FINRA make the information in the database more accessible and searchable, perhaps through a third-party vendor.

Taken together, these recommendations would greatly enhance transparency around FINRA’s Enforcement Program to the benefit of member firms and counsel.

CONCLUSION

FINRA’s external review and Report concerning the efficacy of its Enforcement Program demonstrate a meaningful effort to modify certain policies and procedures that have long been a concern for the industry. Implementation of many of Report’s recommendations would fundamentally alter FINRA’s Enforcement processes while conserving resources at both FINRA and member firms. Even before any of the recommendations are adopted and effective, the Report can be used by member firms to support their efforts in current or future matters.