AdvisorHub (June 20, 2024) - By Miriam Rozen

Nine months after FINRA began a process to publicly label firms as ‘restricted’ if they or their brokers had a significant history of misconduct, no firms have received that scarlet letter, according to a review of the regulator’s BrokerCheck database.

FINRA’s Rule 4111, which created the framework for identifying a firm as restricted, was a cornerstone of FINRA’s long-running effort to rein in broker-dealers that pose high risks to investors. Firms in 2022 began adjusting hiring practices, and fired brokers with marks on their records, to avoid meeting a threshold to qualify for the restricted designation. A rule amendment to publish the restricted mark on BrokerCheck took effect in June 2023.

“While Rule 4111 was obviously well intended, its implementation leaves a lot to be desired,” said Hugh Berkson, a plaintiff lawyer in Ohio and former president of the Public Investors Advocate Bar Association. “We’re curious what efforts FINRA has made to actually implement the rule.”

A spokesperson for FINRA, which has been criticized by lawmakers on both sides of the political aisle in recent months, declined to say if any firms had been identified as restricted or labeled on BrokerCheck. “The process for evaluating a firm” for the restricted tag started in June 2023 time and “is ongoing,” the spokesperson said.

The review of BrokerCheck records for FINRA’s nearly 3,400 active member firms and 12,500 inactive broker-dealers was performed by SLCG Economic Consulting, an expert witness firm that frequently provides expert witness testimony for investors in securities litigation.

Lawyers representing both investors and firms said they do not know of any firms that have been deemed restricted. “Bad firms continue, like fungus, to thrive in the darkness provided by FINRA’s foot dragging on implementing this rule,” said Joe Peiffer, current PIABA president and a lawyer with Peiffer Wolf Carr Kane Conway & Wise in New Orleans.

Some of the lawyers who represent firms in enforcement cases said their clients have avoided the tag. Firms received letters in the late summer and fall of 2022 from FINRA offering them a “one-time” opportunity to terminate within 30 days brokers with red-pock-marked BrokerCheck records in order to reduce their risks of being designated as restricted.

“I do not have or know of any [broker-dealer] clients who have had to deal with the restricted label,” said Gregg Breibart, a partner at Kaufman Dolowich in Fort Lauderdale. “Most of my clients have done everything in their power to avoid even getting close to the line under that rule.”

Under Rule 4111, FINRA said it would conduct an annual analysis of each of its member firms to determine which, based on their and their brokers’ disciplinary records, should be required to have the segregated accounts to cover unpaid arbitration awards and comply with the other restrictions.

Following its second annual evaluation last year, FINRA has another scheduled for June 1 this year to determine which firms qualify as restricted, according to its website.

FINRA has not disclosed a threshold for qualifying as restricted but said in its 2019 rule proposal that it identified 20 small firms that had 30 or more disclosure events over the prior five years, ten mid-size firms with 45 such disclosures in the same period, and five large firms with 750 or more disclosure events.

Rule 4111 was supposed to follow the same preemptive regulatory approach as FINRA’s Rule 3170, which is commonly referred as the taping rule, and requires firms that employ a large number of brokers from expelled firms to record all phone conversations with customers. Rule 3710 followed a Wall Street Journal report that over 5,000 brokers from expelled firms continued to operate, and often had higher rates of customer complaints.

SLCG’s data analysis found only two broker-dealers identified by FINRA on BrokerCheck as taping firms. Bournehill Investment Services in Uniondale, New York, and Joseph Stone Capital in Garden City, New York, both have affixed to the top of their BrokerCheck record pages: “This firm is subject to FINRA Rule 3170 (Taping Rule).”

As with the restricted tag, FINRA does not provide a list of “taping” firms, the spokesperson said. Investors instead must search by the firm’s name on BrokerCheck when evaluating a prospective broker’s employer.